[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 2015 Edition]
[From the U.S. Government Publishing Office]
[[Page i]]
Title 26
Internal Revenue
________________________
Part 1 (Sec. Sec. 1.140 to 1.169)
Revised as of April 1, 2015
Containing a codification of documents of general
applicability and future effect
As of April 1, 2015
Published by the Office of the Federal Register
National Archives and Records Administration as a
Special Edition of the Federal Register
[[Page ii]]
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[[Page iii]]
As of April 1, 2015
Title 26, Part 1 (Sec. Sec. 1.61 to 1.169)
Revised as of April 1, 2014
Is Replaced by
Title 26, Part 1 (Sec. Sec. 1.61 to 1.139)
and
Title 26, Part 1 (Sec. Sec. 1.140 to 1.169)
[[Page v]]
Table of Contents
Page
Explanation................................................. vii
Title 26:
Chapter I--Internal Revenue Service, Department of
the Treasury (Continued) 3
Finding Aids:
Table of CFR Titles and Chapters........................ 617
Alphabetical List of Agencies Appearing in the CFR...... 637
Table of OMB Control Numbers............................ 647
List of CFR Sections Affected........................... 665
[[Page vi]]
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 26 CFR 1.141-0
refers to title 26, part
1, section 141-0.
----------------------------
[[Page vii]]
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
The contents of the Federal Register are required to be judicially
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie
evidence of the text of the original documents (44 U.S.C. 1510).
HOW TO USE THE CODE OF FEDERAL REGULATIONS
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To determine whether a Code volume has been amended since its
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EFFECTIVE AND EXPIRATION DATES
Each volume of the Code contains amendments published in the Federal
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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 viii]]
Many agencies have begun publishing numerous OMB control numbers as
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PAST PROVISIONS OF THE CODE
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``[RESERVED]'' TERMINOLOGY
The term ``[Reserved]'' is used as a place holder within the Code of
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(a) The incorporation will substantially reduce the volume of
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(b) The matter incorporated is in fact available to the extent
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(c) The incorporating document is drafted and submitted for
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CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
separate volume, revised annually as of January 1, entitled CFR Index
and Finding Aids. This volume contains the Parallel Table of Authorities
and Rules. A list of CFR titles, chapters, subchapters, and parts and an
alphabetical list of agencies publishing in the CFR are also included in
this volume.
[[Page ix]]
An index to the text of ``Title 3--The President'' is carried within
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INQUIRIES
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The e-CFR is a regularly updated, unofficial editorial compilation
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of the Federal Register and the Government Publishing Office. It is
available at www.ecfr.gov.
Amy P. Bunk,
Acting Director,
Office of the Federal Register.
April 1, 2015.
[[Page xi]]
THIS TITLE
Title 26--Internal Revenue is composed of twenty-two volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
2015. The first fifteen volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Sec. Sec. 1.0-1.60;
Sec. Sec. 1.61-1.139; Sec. Sec. 1.140-1.169; Sec. Sec. 1.170-1.300;
Sec. Sec. 1.301-1.400; Sec. Sec. 1.401-1.409; Sec. Sec. 1.410-1.440;
Sec. Sec. 1.441-1.500; Sec. Sec. 1.501-1.640; Sec. Sec. 1.641-1.850;
Sec. Sec. 1.851-1.907; Sec. Sec. 1.908-1.1000; Sec. Sec. 1.1001-
1.1400; Sec. Sec. 1.1401-1.1550; and Sec. 1.1551 to end of part 1. The
sixteenth 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, Cheryl E. Sirofchuck was Chief Editor. The Code of
Federal Regulations publication program is under the direction of John
Hyrum Martinez, assisted by Stephen J. Frattini.
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains part 1, Sec. Sec. 1.140 to 1.169)
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Part
chapter i--Internal Revenue Service, Department of the
Treasury (Continued)...................................... 1
[[Page 3]]
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
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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, Mar. 31, 1980.
SUBCHAPTER A--INCOME TAX (CONTINUED)
Part Page
1 Income taxes (Continued).................... 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 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 (CONTINUED)
PART 1_INCOME TAXES (CONTINUED)--Table of Contents
1.141-0 Table of contents.
Tax Exemption Requirements for State and Local Bonds
1.141-1 Definitions and rules of general application.
1.141-2 Private activity bond tests.
1.141-3 Definition of private business use.
1.141-4 Private security or payment test.
1.141-5 Private loan financing test.
1.141-6 Allocation and accounting rules.
1.141-7 Special rules for output facilities.
1.141-8 $15 million limitation for output facilities.
1.141-9 Unrelated or disproportionate use test.
1.141-10 Coordination with volume cap. [Reserved]
1.141-11 Acquisition of nongovernmental output property. [Reserved]
1.141-12 Remedial actions.
1.141-13 Refunding issues.
1.141-14 Anti-abuse rules.
1.141-15 Effective dates.
1.141-16 Effective dates for qualified private activity bond provisions.
1.142-0 Table of contents.
1.142-1 Exempt facility bonds.
1.142-2 Remedial actions.
1.142-3 Refunding issues. [Reserved]
1.142-4 Use of proceeds to provide a facility.
1.142(a)(5)-1 Exempt facility bonds: Sewage facilities.
1.142(a)(6)-1 Exempt facility bonds: solid waste disposal facilities.
1.142(f)(4)-1 Manner of making election to terminate tax-exempt bond
financing.
1.143(g)-1 Requirements related to arbitrage.
1.144-0 Table of contents.
1.144-1 Qualified small issue bonds, qualified student loan bonds, and
qualified redevelopment bonds.
1.144-2 Remedial actions.
1.144-3 Standard deduction for individuals choosing income averaging.
[Reserved]
1.145-0 Table of contents.
1.145-1 Qualified 501(c)(3) bonds.
1.145-2 Application of private activity bond regulations.
1.147-0 Table of contents.
1.147-1 Other requirements applicable to certain private activity bonds.
1.147-2 Remedial actions.
1.147(b)-1 Bond maturity limitation--treatment of working capital.
1.148-0 Scope and table of contents.
1.148-1 Definitions and elections.
1.148-2 General arbitrage yield restriction rules.
1.148-3 General arbitrage rebate rules.
1.148-4 Yield on an issue of bonds.
1.148-5 Yield and valuation of investments.
1.148-6 General allocation and accounting rules.
1.148-7 Spending exceptions to the rebate requirement.
1.148-8 Small issuer exception to rebate requirement.
1.148-9 Arbitrage rules for refunding issues.
1.148-10 Anti-abuse rules and authority of Commissioner.
1.148-11 Effective/applicability dates.
1.149(b)-1 Federally guaranteed bonds.
1.149(d)-1 Limitations on advance refundings.
1.149(e)-1 Information reporting requirements for tax-exempt bonds.
1.149(g)-1 Hedge bonds.
1.150-1 Definitions.
1.150-2 Proceeds of bonds used for reimbursement.
1.150-4 Change in use of facilities financed with tax-exempt private
activity bonds.
1.150-5 Filing notices and elections.
Regulations Applicable to Certain Bonds Sold Prior to July 8, 1997
1.148-1A Definitions and elections.
1.148-2A General arbitrage yield restriction rules.
1.148-3A General arbitrage rebate rules.
1.148-4A Yield on an issue of bonds.
1.148-5A Yield and valuation of investments.
1.148-6A General allocation and accounting rules.
1.148-9A Arbitrage rules for refunding issues.
1.148-10A Anti-abuse rules and authority of Commissioner.
1.148-11A Effective dates.
1.149(d)-1A Limitations on advance refundings.
1.150-1A Definitions.
Deductions for Personal Exemptions
1.151-1 Deductions for personal exemptions.
1.151-2 Additional exemptions for dependents.
1.151-3 Definitions.
1.151-4 Amount of deduction for each exemption under section 151.
1.152-1 General definition of a dependent.
1.152-2 Rules relating to general definition of dependent.
1.152-3 Multiple support agreements.
1.152-4 Special rule for a child of divorced or separated parents or
parents who live apart.
1.153-1 Determination of marital status.
[[Page 6]]
1.154 Statutory provisions; cross references.
Itemized Deductions for Individuals and Corporations
1.161-1 Allowance of deductions.
1.162-1 Business expenses.
1.162-2 Traveling expenses.
1.162-3 Materials and supplies.
1.162-4 Repairs.
1.162-5 Expenses for education.
1.162-7 Compensation for personal services.
1.162-8 Treatment of excessive compensation.
1.162-9 Bonuses to employees.
1.162-10 Certain employee benefits.
1.162-10T Questions and answers relating to the deduction of employee
benefits under the Tax Reform Act of 1984; certain limits on
amounts deductible (temporary).
1.162-11 Rentals.
1.162-12 Expenses of farmers.
1.162-13 Depositors' guaranty fund.
1.162-14 Expenditures for advertising or promotion of good will.
1.162-15 Contributions, dues, etc.
1.162-16 Cross reference.
1.162-17 Reporting and substantiation of certain business expenses of
employees.
1.162-18 Illegal bribes and kickbacks.
1.162-19 Capital contributions to Federal National Mortgage Association.
1.162-20 Expenditures attributable to lobbying, political campaigns,
attempts to influence legislation, etc., and certain
advertising.
1.162-21 Fines and penalties.
1.162-22 Treble damage payments under the antitrust laws.
1.162-24 Travel expenses of state legislators.
1.162-25 Deductions with respect to noncash fringe benefits.
1.162-25T Deductions with respect to noncash fringe benefits
(temporary).
1.162-27 Certain employee remuneration in excess of $1,000,000.
1.162-28 Allocation of costs to lobbying activities.
1.162-29 Influencing legislation.
1.162-31 The $500,000 deduction limitation for remuneration provided by
certain health insurance providers.
1.162-32 Expenses paid or incurred for lodging when not traveling away
from home.
1.162(k)-1 Disallowance of deduction for reacquisition payments.
1.162(l)-1T Deduction for health insurance costs of self-employed
individuals (temporary).
1.163-1 Interest deduction in general.
1.163-2 Installment purchases where interest charge is not separately
stated.
1.163-3 Deduction for discount on bond issued on or before May 27, 1969.
1.163-4 Deduction for original issue discount on certain obligations
issued after May 27, 1969. 1
1.163-5 Denial of interest deduction on certain obligations issued after
December 31, 1982, unless issued in registered form.
1.163-5T Denial of interest deduction on certain obligations issued
after December 31, 1982, unless issued in registered form
(temporary).
1.163-6T Reduction of deduction where section 25 credit taken
(temporary).
1.163-7 Deduction for OID on certain debt instruments.
1.163-8T Allocation of interest expense among expenditures (temporary).
1.163-9T Personal interest (temporary).
1.163-10T Qualified residence interest (temporary).
1.163-11 Allocation of certain prepaid qualified mortgage insurance
premiums.
1.163-12 Deduction of original issue discount on instrument held by
related foreign person.
1.163-13 Treatment of bond issuance premium.
1.163(d)-1 Time and manner for making elections under the Omnibus Budget
Reconciliation Act of 1993 and the Jobs and Growth Tax Relief
Reconciliation Act of 2003.
1.164-1 Deduction for taxes.
1.164-2 Deduction denied in case of certain taxes.
1.164-3 Definitions and special rules.
1.164-4 Taxes for local benefits.
1.164-5 Certain retail sales taxes and gasoline taxes.
1.164-6 Apportionment of taxes on real property between seller and
purchaser.
1.164-7 Taxes of shareholder paid by corporation.
1.164-8 Payments for municipal services in atomic energy communities.
1.165-1 Losses.
1.165-2 Obsolescence of nondepreciable property.
1.165-3 Demolition of buildings.
1.165-4 Decline in value of stock.
1.165-5 Worthless securities.
1.165-6 Farming losses.
1.165-7 Casualty losses.
1.165-8 Theft losses.
1.165-9 Sale of residential property.
1.165-10 Wagering losses.
1.165-11 Election in respect of losses attributable to a disaster.
1.165-12 Denial of deduction for losses on registration-required
obligations not in registered form.
1.165-13T Questions and answers relating to the treatment of losses on
certain straddle transactions entered into before the
effective date of the Economic Recovery Tax Act of 1981, under
section 108 of the Tax Reform Act of 1984 (temporary).
1.166-1 Bad debts.
1.166-2 Evidence of worthlessness.
1.166-3 Partial or total worthlessness.
1.166-4 Reserve for bad debts.
[[Page 7]]
1.166-5 Nonbusiness debts.
1.166-6 Sale of mortgaged or pledged property.
1.166-7 Worthless bonds issued by an individual.
1.166-8 Losses of guarantors, endorsers, and indemnitors incurred on
agreements made before January 1, 1976.
1.166-9 Losses of guarantors, endorsers, and indemnitors incurred, on
agreements made after December 31, 1975, in taxable years
beginning after such date.
1.166-10 Reserve for guaranteed debt obligations.
1.167(a)-1 Depreciation in general.
1.167(a)-2 Tangible property.
1.167(a)-3 Intangibles.
1.167(a)-4 Leased property.
1.167(a)-5 Apportionment of basis.
1.167(a)-5T Application of section 1060 to section 167 (temporary).
1.167(a)-6 Depreciation in special cases.
1.167(a)-7 Accounting for depreciable property.
1.167(a)-8 Retirements.
1.167(a)-9 Obsolescence.
1.167(a)-10 When depreciation deduction is allowable.
1.167(a)-11 Depreciation based on class lives and asset depreciation
ranges for property placed in service after December 31, 1970.
1.167(a)-12 Depreciation based on class lives for property first placed
in service before January 1, 1971.
1.167(a)-13T Certain elections for intangible property (temporary).
1.167(a)-14 Treatment of certain intangible property excluded from
section 197.
1.167(b)-0 Methods of computing depreciation.
1.167(b)-1 Straight line method.
1.167(b)-2 Declining balance method.
1.167(b)-3 Sum of the years-digits method.
1.167(b)-4 Other methods.
1.167(c)-1 Limitations on methods of computing depreciation under
section 167(b) (2), (3), and (4).
1.167(d)-1 Agreement as to useful life and rates of depreciation.
1.167(e)-1 Change in method.
1.167(f)-1 Reduction of salvage value taken into account for certain
personal property.
1.167(g)-1 Basis for depreciation.
1.167(h)-1 Life tenants and beneficiaries of trusts and estates.
1.167(i)-1 Depreciation of improvements in the case of mines, etc.
1.167(l)-1 Limitations on reasonable allowance in case of property of
certain public utilities.
1.167(l)-2 Public utility property; election as to post-1969 property
representing growth in capacity.
1.167(l)-3 Multiple regulation, asset acquisitions, reorganizations,
etc.
1.167(l)-4 Public utility property; election to use asset depreciation
range system.
1.167(m)-1 Class lives.
1.168-5 Special rules.
1.168(a)-1 Modified accelerated cost recovery system.
1.168(b)-1 Definitions.
1.168(d)-0 Table of contents for the applicable convention rules.
1.168(d)-1 Applicable conventions--half-year and mid-quarter
conventions.
1.168(f)(8)-1T Safe-harbor lease information returns concerning
qualified mass commuting vehicles (temporary).
1.168(h)-1 Like-kind exchanges involving tax-exempt use property.
1.168(i)-0 Table of contents for the general asset account rules.
1.168(i)-1 General asset accounts.
1.168(i)-2 Lease term.
1.168(i)-3 Treatment of excess deferred income tax reserve upon
disposition of deregulated public utility property.
1.168(i)-4 Changes in use.
1.168(i)-5 Table of contents.
1.168(i)-6 Like-kind exchanges and involuntary conversions.
1.168(i)-7 Accounting for MACRS property.
1.168(i)-8 Dispositions of MACRS property.
1.168(j)-1T Questions and answers concerning tax-exempt entity leasing
rules (temporary).
1.168(k)-0 Table of contents.
1.168(k)-1 Additional first year depreciation deduction.
1.168A-1 Amortization of emergency facilities; general rule.
1.168A-2 Election of amortization.
1.168A-3 Election to discontinue amortization.
1.168A-4 Definitions.
1.168A-5 Adjusted basis of emergency facility.
1.168A-6 Depreciation of portion of emergency facility not subject to
amortization.
1.168A-7 Payment by United States of unamortized cost of facility.
1.169-1 Amortization of pollution control facilities.
1.169-2 Definitions.
1.169-3 Amortizable basis.
1.169-4 Time and manner of making elections
Authority: 26 U.S.C. 7805, unless otherwise noted.
Section 1.148-0 through 1.148-11 also issued under 26 U.S.C. 148(i).
Section 1.148-6 also issued under 26 U.S.C. 148 (f), (g), and (i).
Section 1.149(b)-1 also issued under 26 U.S.C. 149(b)(3)(B) (v).
Section 1.149(d)-1 also issued under 26 U.S.C. 149(d)(7).
Section 1.149(e)-1 also issued under 26 U.S.C. 149(e).
[[Page 8]]
Section 1.149(g)-1 also issued under 26 U.S.C. 149(g)(5).
Section 1.150-4 also issued under 26 U.S.C. 150 (c)(5).
Section 1.152-4 also issued under 26 U.S.C. 152(e).
Section 1.162-24 also issued under 26 U.S.C. 162(h).
Section 1.162(k)-1 is also issued under section 26 U.S.C. 162(k).
Section 1.163-8T also issued under 26 U.S.C. 469(k)(4).
Section 1.163-9T also issued under 26 U.S.C. 163(h)(3)(D).
Section 1.163-11T is also issued under 26 U.S.C. 163(h).
Section 1.165-12 also issued under 26 U.S.C. 165(j)(3).
Section 1.166-10 also issued under 26 U.S.C. 166(f).
Section 1.168(d)-1 also issued under 26 U.S.C. 168(d)(3).
Section 1.168(f)(8)-1T also added under sec. 112(c), Black Lung
Benefits Revenue Act of 1981 (Pub. L. 97-119).
Section 1.168(h)-1 also issued under 26 U.S.C. 168.
Section 1.168(i)-1 also issued under 26 U.S.C. 168(i)(4).
Section 1.168(i)-1T also issued under 26 U.S.C. 168(i)(4).
Section 1.168(i)-2 also issued under 26 U.S.C. 168.
Section 1.168(i)-4 also issued under 26 U.S.C. 168(i)(5).
Section 1.168(j)-1T also added under 26 U.S.C. 168(j)(10).
Source: T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21,
1960, unless otherwise noted.
Sec. 1.141-0 Table of contents.
This section lists the captioned paragraphs contained in Sec. Sec.
1.141-1 through 1.141-16.
Sec. 1.141-1 Definitions and rules of general application.
(a) In general.
(b) Certain general definitions.
(c) Elections.
(d) Related parties.
Sec. 1.141-2 Private activity bond tests.
(a) Overview.
(b) Scope.
(c) General definition of private activity bond.
(d) Reasonable expectations and deliberate actions.
(1) In general.
(2) Reasonable expectations test.
(3) Deliberate action defined.
(4) Special rule for dispositions of personal property in the
ordinary course of an established governmental program.
(5) Special rule for general obligation bond programs that finance a
large number of separate purposes.
(e) When a deliberate action occurs.
(f) Certain remedial actions.
(g) Examples.
Sec. 1.141-3 Definition of private business use.
(a) General rule.
(1) In general.
(2) Indirect use.
(3) Aggregation of private business use.
(b) Types of private business use arrangements.
(1) In general.
(2) Ownership.
(3) Leases.
(4) Management contracts.
(5) Output contracts.
(6) Research agreements.
(7) Other actual or beneficial use.
(c) Exception for general public use.
(1) In general.
(2) Use on the same basis.
(3) Long-term arrangements not treated as general public use.
(4) Relation to other use.
(d) Other exceptions.
(1) Agents.
(2) Use incidental to financing arrangements.
(3) Exceptions for arrangements other than arrangements resulting in
ownership of financed property by a nongovernmental person.
(4) Temporary use by developers.
(5) Incidental use.
(6) Qualified improvements.
(e) Special rule for tax assessment bonds.
(f) Examples.
(g) Measurement of private business use.
(1) In general.
(2) Measurement period.
(3) Determining average percentage of private business use.
(4) Determining the average amount of private business use for a 1-
year period.
(5) Common areas.
(6) Allocation of neutral costs.
(7) Commencement of measurement of private business use.
(8) Examples.
Sec. 1.141-4 Private security or payment test.
(a) General rule.
(1) Private security or payment.
(2) Aggregation of private payments and security.
(3) Underlying arrangement.
(b) Measurement of private payments and security.
(1) Scope.
(2) Present value measurement.
[[Page 9]]
(c) Private payments.
(1) In general.
(2) Payments taken into account.
(3) Allocation of payments.
(d) Private security.
(1) In general.
(2) Security taken into account.
(3) Pledge of unexpended proceeds.
(4) Secured by any interest in property or payments.
(5) Payments in respect of property.
(6) Allocation of security among issues.
(e) Generally applicable taxes.
(1) General rule.
(2) Definition of generally applicable taxes.
(3) Special charges.
(4) Manner of determination and collection.
(5) Payments in lieu of taxes.
(f) Certain waste remediation bonds.
(1) Scope.
(2) Persons that are not private users.
(3) Persons that are private users.
(g) Examples.
Sec. 1.141-5 Private loan financing test.
(a) In general.
(b) Measurement of test.
(c) Definition of private loan.
(1) In general.
(2) Application only to purpose investments.
(3) Grants.
(4) Hazardous waste remediation bonds.
(d) Tax assessment loan exception.
(1) General rule.
(2) Tax assessment loan defined.
(3) Mandatory tax or other assessment.
(4) Specific essential governmental function.
(5) Equal basis requirement.
(6) Coordination with private business tests.
(e) Examples.
Sec. 1.141-6 Allocation and accounting rules.
(a) Allocation of proceeds to expenditures.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds. [Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
Sec. 1.141-7 Special rules for output facilities.
(a) Overview.
(b) Definitions.
(1) Available output.
(2) Measurement period.
(3) Sale at wholesale.
(4) Take contract and take or pay contract.
(5) Requirements contract.
(6) Nonqualified amount.
(c) Output contracts.
(1) General rule.
(2) Take contract or take or pay contract.
(3) Requirements contract.
(4) Output contract properly characterized as a lease.
(d) Measurement of private business use.
(e) Measurement of private security or payment.
(f) Exceptions for certain contracts.
(1) Small purchases of output.
(2) Swapping and pooling arrangements.
(3) Short-term output contracts.
(4) Certain conduit parties disregarded.
(g) Special rules for electric output facilities used to provide
open access.
(1) Operation of transmission facilities by nongovernmental persons.
(2) Certain use by nongovernmental persons under output contracts.
(3) Ancillary services.
(4) Exceptions to deliberate action rules.
(5) Additional transactions as permitted by the Commissioner.
(h) Allocations of output facilities and systems.
(1) Facts and circumstances analysis.
(2) Illustrations.
(3) Transmission and distribution contracts.
(4) Allocation of payments.
(i) Examples.
Sec. 1.141-8 $15 million limitation for output facilities.
(a) In general.
(1) General rule.
(2) Reduction in $15 million output limitation for outstanding
issues.
(3) Benefits and burdens test applicable.
(b) Definition of project.
(1) General rule.
(2) Separate ownership.
(3) Generating property.
(4) Transmission and distribution.
(5) Subsequent improvements.
(6) Replacement property.
(c) Examples.
Sec. 1.141-9 Unrelated or disproportionate use test.
(a) General rules.
(1) Description of test.
(2) Application of unrelated or disproportionate use test.
(b) Unrelated use.
(1) In general.
(2) Use for the same purpose as government use.
(c) Disproportionate use.
(1) Definition of disproportionate use.
(2) Aggregation of related uses.
(3) Allocation rule.
(d) Maximum use taken into account.
(e) Examples.
[[Page 10]]
Sec. 1.141-10 Coordination with volume cap. [Reserved]
Sec. 1.141-11 Acquisition of nongovernmental output property.
[Reserved]
Sec. 1.141-12 Remedial actions.
(a) Conditions to taking remedial action.
(1) Reasonable expectations test met.
(2) Maturity not unreasonably long.
(3) Fair market value consideration.
(4) Disposition proceeds treated as gross proceeds for arbitrage
purposes.
(5) Proceeds expended on a governmental purpose.
(b) Effect of a remedial action.
(1) In general.
(2) Effect on bonds that have been advance refunded.
(c) Disposition proceeds.
(1) Definition.
(2) Allocating disposition proceeds to an issue.
(3) Allocating disposition proceeds to different sources of funding.
(d) Redemption or defeasance of nonqualified bonds.
(1) In general.
(2) Special rule for dispositions for cash.
(3) Notice of defeasance.
(4) Special limitation.
(5) Defeasance escrow defined.
(e) Alternative use of disposition proceeds.
(1) In general.
(2) Special rule for use by 501(c)(3) organizations.
(f) Alternative use of facility.
(g) Rules for deemed reissuance.
(h) Authority of Commissioner to provide for additional remedial
actions.
(i) Effect of remedial action on continuing compliance.
(j) Nonqualified bonds.
(1) Amount of nonqualified bonds.
(2) Allocation of nonqualified bonds.
(k) Examples.
Sec. 1.141-13 Refunding issues.
(a) In general.
(b) Application of private business use test and private loan
financing test.
(1) Allocation of proceeds.
(2) Determination of amount of private business use.
(c) Application of private security or payment test.
(1) Separate issue treatment.
(2) Combined issue treatment.
(3) Special rule for arrangements not entered into in contemplation
of the refunding issue.
(d) Multipurpose issue allocations.
(1) In general.
(2) Exceptions.
(e) Application of reasonable expectations test to certain refunding
bonds.
(f) Special rule for refundings of certain general obligation bonds.
(g) Examples.
Sec. 1.141-14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of transactions.
(b) Examples.
Sec. 1.141-15 Effective dates.
(a) Scope.
(b) Effective dates.
(1) In general.
(2) Certain short-term arrangements.
(3) Certain prepayments.
(c) Refunding bonds.
(d) Permissive application of regulations.
(e) Permissive retroactive application of certain sections.
(f) Effective dates for certain regulations relating to output
facilities.
(1) General rule.
(2) Transition rule for requirements contracts.
(g) Refunding bonds for output facilities.
(h) Permissive retroactive application.
(i) Permissive application of certain regulations relating to output
facilities.
(j) Effective dates for certain regulations relating to refundings.
(k) Effective/applicability dates for certain regulations relating
to generally applicable taxes and payments in lieu of tax.
Sec. 1.141-16 Effective dates for qualified private activity bond
provisions.
(a) Scope.
(b) Effective dates.
(c) Permissive application.
(d) Certain remedial actions.
(1) General rule.
(2) Special rule for allocations of nonqualified bonds.
[T.D. 8712, 62 FR 2283, Jan. 16, 1997, as amended by T.D. 8757, 63 FR
3259, Jan. 22, 1998; T.D. 8941, 66 FR 4664, Jan. 18, 2001; T.D. 9016, 67
FR 59759, Sept. 23, 2002; T.D. 9085, 68 FR 45775, Aug. 4, 2003; T.D.
9150, 69 FR 50066, Aug. 13, 2004; T.D. 9234, 70 FR 75031, Dec. 19, 2005;
T.D. 9429, 73 FR 63374, Oct. 24, 2008]
Tax Exemption Requirements for State and Local Bonds
Sec. 1.141-1 Definitions and rules of general application.
(a) In general. For purposes of Sec. Sec. 1.141-0 through 1.141-16,
the following definitions and rules apply: the definitions in this
section, the definitions in Sec. 1.150-1, the definition of placed in
service under Sec. 1.150-2(c), the definition of grant under Sec.
1.148-6(d)(4)(iii), the definition of reasonably required reserve or
[[Page 11]]
replacement fund in Sec. 1.148-2(f), and the following definitions
under Sec. 1.148-1: bond year, commingled fund, fixed yield issue,
higher yielding investments, investment, investment proceeds, issue
price, issuer, nonpurpose investment, purpose investment, qualified
guarantee, qualified hedge, reasonable expectations or reasonableness,
rebate amount, replacement proceeds, sale proceeds, variable yield
issue, and yield.
(b) Certain general definitions.
Common areas means portions of a facility that are equally available
to all users of a facility on the same basis for uses that are
incidental to the primary use of the facility. For example, hallways and
elevators generally are treated as common areas if they are used by the
different lessees of a facility in connection with the primary use of
that facility.
Consistently applied means applied uniformly to account for proceeds
and other amounts.
Deliberate action is defined in Sec. 1.141-2(d)(3).
Discrete portion means a portion of a facility that consists of any
separate and discrete portion of a facility to which use is limited,
other than common areas. A floor of a building and a portion of a
building separated by walls, partitions, or other physical barriers are
examples of a discrete portion.
Disposition is defined in Sec. 1.141-12(c)(1).
Disposition proceeds is defined in Sec. 1.141-12(c)(1).
Essential governmental function is defined in Sec. 1.141-
5(d)(4)(ii).
Financed means constructed, reconstructed, or acquired with proceeds
of an issue.
Governmental bond has the same meaning as in Sec. 1.150-1(b),
except that, for purposes of Sec. 1.141-13, governmental bond is
defined in Sec. 1.141-13(b)(2)(iv).
Governmental person means a state or local governmental unit as
defined in Sec. 1.103-1 or any instrumentality thereof. It does not
include the United States or any agency or instrumentality thereof.
Hazardous waste remediation bonds is defined in Sec. 1.141-4(f)(1).
Measurement period is defined in Sec. 1.141-3(g)(2).
Nongovernmental person means a person other than a governmental
person.
Output facility means electric and gas generation, transmission,
distribution, and related facilities, and water collection, storage, and
distribution facilities.
Private business tests means the private business use test and the
private security or payment test of section 141(b).
Proceeds means the sale proceeds of an issue (other than those sale
proceeds used to retire bonds of the issue that are not deposited in a
reasonably required reserve or replacement fund). Proceeds also include
any investment proceeds from investments that accrue during the project
period (net of rebate amounts attributable to the project period).
Disposition proceeds of an issue are treated as proceeds to the extent
provided in Sec. 1.141-12. The Commissioner may treat any replaced
amounts as proceeds.
Project period means the period beginning on the issue date and
ending on the date that the project is placed in service. In the case of
a multipurpose issue, the issuer may elect to treat the project period
for the entire issue as ending on either the expiration of the temporary
period described in Sec. 1.148-2(e)(2) or the end of the fifth bond
year after the issue date.
Public utility property means public utility property as defined in
section 168(i)(10).
Qualified bond means a qualified bond as defined in section 141(e).
Renewal option means a provision under which either party has a
legally enforceable right to renew the contract. Thus, for example, a
provision under which a contract is automatically renewed for 1-year
periods absent cancellation by either party is not a renewal option
(even if it is expected to be renewed).
Replaced amounts means replacement proceeds other than amounts that
are treated as replacement proceeds solely because they are sinking
funds or pledged funds.
Weighted average maturity is determined under section 147(b).
[[Page 12]]
Weighted average reasonably expected economic life is determined
under section 147(b). The reasonably expected economic life of property
may be determined by reference to the class life of the property under
section 168.
(c) Elections. Elections must be made in writing on or before the
issue date and retained as part of the bond documents, and, once made,
may not be revoked without the permission of the Commissioner.
(d) Related parties. Except as otherwise provided, all related
parties are treated as one person and any reference to ``person''
includes any related party.
[T.D. 8712, 62 FR 2284, Jan. 16, 1997, as amended by T.D. 9234, 70 FR
75032, Dec. 19, 2005]
Sec. 1.141-2 Private activity bond tests.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. The purpose of the private activity bond tests of section 141 is
to limit the volume of tax-exempt bonds that finance the activities of
nongovernmental persons, without regard to whether a financing actually
transfers benefits of tax-exempt financing to a nongovernmental person.
The private activity bond tests serve to identify arrangements that have
the potential to transfer the benefits of tax-exempt financing, as well
as arrangements that actually transfer these benefits. The regulations
under section 141 may not be applied in a manner that is inconsistent
with these purposes.
(b) Scope. Sections 1.141-0 through 1.141-16 apply generally for
purposes of the private activity bond limitations under section 141.
(c) General definition of private activity bond. Under section 141,
bonds are private activity bonds if they meet either the private
business use test and private security or payment test of section 141(b)
or the private loan financing test of section 141(c). The private
business use and private security or payment tests are described in
Sec. Sec. 1.141-3 and 1.141-4. The private loan financing test is
described in Sec. 1.141-5.
(d) Reasonable expectations and deliberate actions--(1) In general.
An issue is an issue of private activity bonds if the issuer reasonably
expects, as of the issue date, that the issue will meet either the
private business tests or the private loan financing test. An issue is
also an issue of private activity bonds if the issuer takes a deliberate
action, subsequent to the issue date, that causes the conditions of
either the private business tests or the private loan financing test to
be met.
(2) Reasonable expectations test--(i) In general. In general, the
reasonable expectations test must take into account reasonable
expectations about events and actions over the entire stated term of an
issue.
(ii) Special rule for issues with mandatory redemption provisions.
An action that is reasonably expected, as of the issue date, to occur
after the issue date and to cause either the private business tests or
the private loan financing test to be met may be disregarded for
purposes of those tests if--
(A) The issuer reasonably expects, as of the issue date, that the
financed property will be used for a governmental purpose for a
substantial period before the action;
(B) The issuer is required to redeem all nonqualifying bonds
(regardless of the amount of disposition proceeds actually received)
within 6 months of the date of the action;
(C) The issuer does not enter into any arrangement with a
nongovernmental person, as of the issue date, with respect to that
specific action; and
(D) The mandatory redemption of bonds meets all of the conditions
for remedial action under Sec. 1.141-12(a).
(3) Deliberate action defined--(i) In general. Except as otherwise
provided in this paragraph (d)(3), a deliberate action is any action
taken by the issuer that is within its control. An intent to violate the
requirements of section 141 is not necessary for an action to be
deliberate.
(ii) Safe harbor exceptions. An action is not treated as a
deliberate action if--
(A) It would be treated as an involuntary or compulsory conversion
under section 1033; or
(B) It is taken in response to a regulatory directive made by the
federal government. See Sec. 1.141-7(g)(4).
(4) Special rule for dispositions of personal property in the
ordinary course of
[[Page 13]]
an established governmental program--(i) In general. Dispositions of
personal property in the ordinary course of an established governmental
program are not treated as deliberate actions if--
(A) The weighted average maturity of the bonds financing that
personal property is not greater than 120 percent of the reasonably
expected actual use of that property for governmental purposes;
(B) The issuer reasonably expects on the issue date that the fair
market value of that property on the date of disposition will be not
greater than 25 percent of its cost; and
(C) The property is no longer suitable for its governmental purposes
on the date of disposition.
(ii) Reasonable expectations test. The reasonable expectation that a
disposition described in paragraph (d)(4)(i) of this section may occur
in the ordinary course while the bonds are outstanding will not cause
the issue to meet the private activity bond tests if the issuer is
required to deposit amounts received from the disposition in a
commingled fund with substantial tax or other governmental revenues and
the issuer reasonably expects to spend the amounts on governmental
programs within 6 months from the date of commingling.
(iii) Separate issue treatment. An issuer may treat the bonds
properly allocable to the personal property eligible for this exception
as a separate issue under Sec. 1.150-1(c)(3).
(5) Special rule for general obligation bond programs that finance a
large number of separate purposes. The determination of whether bonds of
an issue are private activity bonds may be based solely on the issuer's
reasonable expectations as of the issue date if all of the requirements
of paragraphs (d)(5)(i) through (vii) of this section are met.
(i) The issue is an issue of general obligation bonds of a general
purpose governmental unit that finances at least 25 separate purposes
(as defined in Sec. 1.150-1(c)(3)) and does not predominantly finance
fewer than 4 separate purposes.
(ii) The issuer has adopted a fund method of accounting for its
general governmental purposes that makes tracing the bond proceeds to
specific expenditures unreasonably burdensome.
(iii) The issuer reasonably expects on the issue date to allocate
all of the net proceeds of the issue to capital expenditures within 6
months of the issue date and adopts reasonable procedures to verify that
net proceeds are in fact so expended. A program to randomly spot check
that 10 percent of the net proceeds were so expended generally is a
reasonable verification procedure for this purpose.
(iv) The issuer reasonably expects on the issue date to expend all
of the net proceeds of the issue before expending proceeds of a
subsequent issue of similar general obligation bonds.
(v) The issuer reasonably expects on the issue date that it will not
make any loans to nongovernmental persons with the proceeds of the
issue.
(vi) The issuer reasonably expects on the issue date that the
capital expenditures that it could make during the 6-month period
beginning on the issue date with the net proceeds of the issue that
would not meet the private business tests are not less than 125 percent
of the capital expenditures to be financed with the net proceeds of the
issue.
(vii) The issuer reasonably expects on the issue date that the
weighted average maturity of the issue is not greater than 120 percent
of the weighted average reasonably expected economic life of the capital
expenditures financed with the issue. To determine reasonably expected
economic life for this purpose an issuer may use reasonable estimates
based on the type of expenditures made from a fund.
(e) When a deliberate action occurs. A deliberate action occurs on
the date the issuer enters into a binding contract with a
nongovernmental person for use of the financed property that is not
subject to any material contingencies.
(f) Certain remedial actions. See Sec. 1.141-12 for certain
remedial actions that prevent a deliberate action with respect to
property financed by an issue from causing that issue to meet the
private business use test or the private loan financing test.
[[Page 14]]
(g) Examples. The following examples illustrate the application of
this section:
Example 1 Involuntary action. City B issues bonds to finance the
purchase of land. On the issue date, B reasonably expects that it will
be the sole user of the land for the entire term of the bonds.
Subsequently, the federal government acquires the land in a condemnation
action. B sets aside the condemnation proceeds to pay debt service on
the bonds but does not redeem them on their first call date. The bonds
are not private activity bonds because B has not taken a deliberate
action after the issue date. See, however, Sec. 1.141-14(b), Example 2.
Example 2 Reasonable expectations test--involuntary action. The
facts are the same as in Example 1, except that, on the issue date, B
reasonably expects that the federal government will acquire the land in
a condemnation action during the term of the bonds. On the issue date,
the present value of the amount that B reasonably expects to receive
from the federal government is greater than 10 percent of the present
value of the debt service on the bonds. The terms of the bonds do not
require that the bonds be redeemed within 6 months of the acquisition by
the federal government. The bonds are private activity bonds because the
issuer expects as of the issue date that the private business tests will
be met.
Example 3 Reasonable expectations test--mandatory redemption. City C
issues bonds to rehabilitate an existing hospital that it currently
owns. On the issue date of the bonds, C reasonably expects that the
hospital will be used for a governmental purpose for a substantial
period. On the issue date, C also plans to construct a new hospital, but
the placed in service date of that new hospital is uncertain. C
reasonably expects that, when the new hospital is placed in service, it
will sell or lease the rehabilitated hospital to a private hospital
corporation. The bond documents require that the bonds must be redeemed
within 6 months of the sale or lease of the rehabilitated hospital
(regardless of the amount actually received from the sale). The bonds
meet the reasonable expectations requirement of the private activity
bond tests if the mandatory redemption of bonds meets all of the
conditions for a remedial action under Sec. 1.141-12(a).
Example 4 Dispositions in the ordinary course of an established
governmental program. City D issues bonds with a weighted average
maturity of 6 years for the acquisition of police cars. D reasonably
expects on the issue date that the police cars will be used solely by
its police department, except that, in the ordinary course of its police
operations, D sells its police cars to a taxicab corporation after 5
years of use because they are no longer suitable for police use.
Further, D reasonably expects that the value of the police cars when
they are no longer suitable for police use will be no more than 25
percent of cost. D subsequently sells 20 percent of the police cars
after only 3 years of actual use. At that time, D deposits the proceeds
from the sale of the police cars in a commingled fund with substantial
tax revenues and reasonably expects to spend the proceeds on
governmental programs within 6 months of the date of deposit. D does not
trace the actual use of these commingled amounts. The sale of the police
cars does not cause the private activity bond tests to be met because
the requirements of paragraph (d)(4) of this section are met.
[T.D. 8712, 62 FR 2284, Jan. 16, 1997, as amended by T.D. 8757, 63 FR
3260, Jan. 22, 1998; T.D. 9016, 67 FR 59759, Sept. 23, 2002]
Sec. 1.141-3 Definition of private business use.
(a) General rule--(1) In general. The private business use test
relates to the use of the proceeds of an issue. The 10 percent private
business use test of section 141(b)(1) is met if more than 10 percent of
the proceeds of an issue is used in a trade or business of a
nongovernmental person. For this purpose, the use of financed property
is treated as the direct use of proceeds. Any activity carried on by a
person other than a natural person is treated as a trade or business.
Unless the context or a provision clearly requires otherwise, this
section also applies to the private business use test under sections
141(b)(3) (unrelated or disproportionate use), 141(b)(4) ($15 million
limitation for certain output facilities), and 141(b)(5) (the
coordination with the volume cap where the nonqualified amount exceeds
$15 million).
(2) Indirect use. In determining whether an issue meets the private
business use test, it is necessary to look to both the indirect and
direct uses of proceeds. For example, a facility is treated as being
used for a private business use if it is leased to a nongovernmental
person and subleased to a governmental person or if it is leased to a
governmental person and then subleased to a nongovernmental person,
provided that in each case the nongovernmental person's use is in a
trade or business. Similarly, the issuer's use of the proceeds to engage
in a series of financing transactions for
[[Page 15]]
property to be used by nongovernmental persons in their trades or
businesses may cause the private business use test to be met. In
addition, proceeds are treated as used in the trade or business of a
nongovernmental person if a nongovernmental person, as a result of a
single transaction or a series of related transactions, uses property
acquired with the proceeds of an issue.
(3) Aggregation of private business use. The use of proceeds by all
nongovernmental persons is aggregated to determine whether the private
business use test is met.
(b) Types of private business use arrangements--(1) In general. Both
actual and beneficial use by a nongovernmental person may be treated as
private business use. In most cases, the private business use test is
met only if a nongovernmental person has special legal entitlements to
use the financed property under an arrangement with the issuer. In
general, a nongovernmental person is treated as a private business user
of proceeds and financed property as a result of ownership; actual or
beneficial use of property pursuant to a lease, or a management or
incentive payment contract; or certain other arrangements such as a take
or pay or other output-type contract.
(2) Ownership. Except as provided in paragraph (d)(1) or (d)(2) of
this section, ownership by a nongovernmental person of financed property
is private business use of that property. For this purpose, ownership
refers to ownership for federal income tax purposes.
(3) Leases. Except as provided in paragraph (d) of this section, the
lease of financed property to a nongovernmental person is private
business use of that property. For this purpose, any arrangement that is
properly characterized as a lease for federal income tax purposes is
treated as a lease. In determining whether a management contract is
properly characterized as a lease, it is necessary to consider all of
the facts and circumstances, including the following factors--
(i) The degree of control over the property that is exercised by a
nongovernmental person; and
(ii) Whether a nongovernmental person bears risk of loss of the
financed property.
(4) Management contracts--(i) Facts and circumstances test. Except
as provided in paragraph (d) of this section, a management contract
(within the meaning of paragraph (b)(4)(ii) of this section) with
respect to financed property may result in private business use of that
property, based on all of the facts and circumstances. A management
contract with respect to financed property generally results in private
business use of that property if the contract provides for compensation
for services rendered with compensation based, in whole or in part, on a
share of net profits from the operation of the facility.
(ii) Management contract defined. For purposes of this section, a
management contract is a management, service, or incentive payment
contract between a governmental person and a service provider under
which the service provider provides services involving all, a portion
of, or any function of, a facility. For example, a contract for the
provision of management services for an entire hospital, a contract for
management services for a specific department of a hospital, and an
incentive payment contract for physician services to patients of a
hospital are each treated as a management contract.
(iii) Arrangements generally not treated as management contracts.
The arrangements described in paragraphs (b)(4)(iii)(A) through (D) of
this section generally are not treated as management contracts that give
rise to private business use.
(A) Contracts for services that are solely incidental to the primary
governmental function or functions of a financed facility (for example,
contracts for janitorial, office equipment repair, hospital billing, or
similar services).
(B) The mere granting of admitting privileges by a hospital to a
doctor, even if those privileges are conditioned on the provision of de
minimis services, if those privileges are available to all qualified
physicians in the area, consistent with the size and nature of its
facilities.
[[Page 16]]
(C) A contract to provide for the operation of a facility or system
of facilities that consists predominantly of public utility property, if
the only compensation is the reimbursement of actual and direct expenses
of the service provider and reasonable administrative overhead expenses
of the service provider.
(D) A contract to provide for services, if the only compensation is
the reimbursement of the service provider for actual and direct expenses
paid by the service provider to unrelated parties.
(iv) Management contracts that are properly treated as other types
of private business use. A management contract with respect to financed
property results in private business use of that property if the service
provider is treated as the lessee or owner of financed property for
federal income tax purposes, unless an exception under paragraph (d) of
this section applies to the arrangement.
(5) Output contracts. See Sec. 1.141-7 for special rules for
contracts for the purchase of output of output facilities.
(6) Research agreements--(i) Facts and circumstances test. Except as
provided in paragraph (d) of this section, an agreement by a
nongovernmental person to sponsor research performed by a governmental
person may result in private business use of the property used for the
research, based on all of the facts and circumstances.
(ii) Research agreements that are properly treated as other types of
private business use. A research agreement with respect to financed
property results in private business use of that property if the sponsor
is treated as the lessee or owner of financed property for federal
income tax purposes, unless an exception under paragraph (d) of this
section applies to the arrangement.
(7) Other actual or beneficial use--(i) In general. Any other
arrangement that conveys special legal entitlements for beneficial use
of bond proceeds or of financed property that are comparable to special
legal entitlements described in paragraphs (b)(2), (3), (4), (5), or (6)
of this section results in private business use. For example, an
arrangement that conveys priority rights to the use or capacity of a
facility generally results in private business use.
(ii) Special rule for facilities not used by the general public. In
the case of financed property that is not available for use by the
general public (within the meaning of paragraph (c) of this section),
private business use may be established solely on the basis of a special
economic benefit to one or more nongovernmental persons, even if those
nongovernmental persons have no special legal entitlements to use of the
property. In determining whether special economic benefit gives rise to
private business use it is necessary to consider all of the facts and
circumstances, including one or more of the following factors--
(A) Whether the financed property is functionally related or
physically proximate to property used in the trade or business of a
nongovernmental person;
(B) Whether only a small number of nongovernmental persons receive
the special economic benefit; and
(C) Whether the cost of the financed property is treated as
depreciable by any nongovernmental person.
(c) Exception for general public use--(1) In general. Use as a
member of the general public (general public use) is not private
business use. Use of financed property by nongovernmental persons in
their trades or businesses is treated as general public use only if the
property is intended to be available and in fact is reasonably available
for use on the same basis by natural persons not engaged in a trade or
business.
(2) Use on the same basis. In general, use under an arrangement that
conveys priority rights or other preferential benefits is not use on the
same basis as the general public. Arrangements providing for use that is
available to the general public at no charge or on the basis of rates
that are generally applicable and uniformly applied do not convey
priority rights or other preferential benefits. For this purpose, rates
may be treated as generally applicable and uniformly applied even if--
(i) Different rates apply to different classes of users, such as
volume purchasers, if the differences in rates are customary and
reasonable; or
[[Page 17]]
(ii) A specially negotiated rate arrangement is entered into, but
only if the user is prohibited by federal law from paying the generally
applicable rates, and the rates established are as comparable as
reasonably possible to the generally applicable rates.
(3) Long-term arrangements not treated as general public use. An
arrangement is not treated as general public use if the term of the use
under the arrangement, including all renewal options, is greater than
200 days. For this purpose, a right of first refusal to renew use under
the arrangement is not treated as a renewal option if--
(i) The compensation for the use under the arrangement is
redetermined at generally applicable, fair market value rates that are
in effect at the time of renewal; and
(ii) The use of the financed property under the same or similar
arrangements is predominantly by natural persons who are not engaged in
a trade or business.
(4) Relation to other use. Use of financed property by the general
public does not prevent the proceeds from being used for a private
business use because of other use under this section.
(d) Other exceptions--(1) Agents. Use of proceeds by nongovernmental
persons solely in their capacity as agents of a governmental person is
not private business use. For example, use by a nongovernmental person
that issues obligations on behalf of a governmental person is not
private business use to the extent the nongovernmental person's use of
proceeds is in its capacity as an agent of the governmental person.
(2) Use incidental to financing arrangements. Use by a
nongovernmental person that is solely incidental to a financing
arrangement is not private business use. A use is solely incidental to a
financing arrangement only if the nongovernmental person has no
substantial rights to use bond proceeds or financed property other than
as an agent of the bondholders. For example, a nongovernmental person
that acts solely as an owner of title in a sale and leaseback financing
transaction with a city generally is not a private business user of the
property leased to the city, provided that the nongovernmental person
has assigned all of its rights to use the leased facility to the trustee
for the bondholders upon default by the city. Similarly, bond trustees,
servicers, and guarantors are generally not treated as private business
users.
(3) Exceptions for arrangements other than arrangements resulting in
ownership of financed property by a nongovernmental person--(i)
Arrangements not available for use on the same basis by natural persons
not engaged in a trade or business. Use by a nongovernmental person
pursuant to an arrangement, other than an arrangement resulting in
ownership of financed property by a nongovernmental person, is not
private business use if--
(A) The term of the use under the arrangement, including all renewal
options, is not longer than 100 days;
(B) The arrangement would be treated as general public use, except
that it is not available for use on the same basis by natural persons
not engaged in a trade or business because generally applicable and
uniformly applied rates are not reasonably available to natural persons
not engaged in a trade or business; and
(C) The property is not financed for a principal purpose of
providing that property for use by that nongovernmental person.
(ii) Negotiated arm's-length arrangements. Use by a nongovernmental
person pursuant to an arrangement, other than an arrangement resulting
in ownership of financed property by a nongovernmental person, is not
private business use if--
(A) The term of the use under the arrangement, including all renewal
options, is not longer than 50 days;
(B) The arrangement is a negotiated arm's-length arrangement, and
compensation under the arrangement is at fair market value; and
(C) The property is not financed for a principal purpose of
providing that property for use by that nongovernmental person.
(4) Temporary use by developers. Use during an initial development
period by a developer of an improvement that carries out an essential
governmental function is not private business use if the issuer and the
developer reasonably expect on the issue date to proceed
[[Page 18]]
with all reasonable speed to develop the improvement and property
benefited by that improvement and to transfer the improvement to a
governmental person, and if the improvement is in fact transferred to a
governmental person promptly after the property benefited by the
improvement is developed.
(5) Incidental use--(i) General rule. Incidental uses of a financed
facility are disregarded, to the extent that those uses do not exceed
2.5 percent of the proceeds of the issue used to finance the facility. A
use of a facility by a nongovernmental person is incidental if--
(A) Except for vending machines, pay telephones, kiosks, and similar
uses, the use does not involve the transfer to the nongovernmental
person of possession and control of space that is separated from other
areas of the facility by walls, partitions, or other physical barriers,
such as a night gate affixed to a structural component of a building (a
nonpossessory use);
(B) The nonpossessory use is not functionally related to any other
use of the facility by the same person (other than a different
nonpossessory use); and
(C) All nonpossessory uses of the facility do not, in the aggregate,
involve the use of more than 2.5 percent of the facility.
(ii) Illustrations. Incidental uses may include pay telephones,
vending machines, advertising displays, and use for television cameras,
but incidental uses may not include output purchases.
(6) Qualified improvements. Proceeds that provide a governmentally
owned improvement to a governmentally owned building (including its
structural components and land functionally related and subordinate to
the building) are not used for a private business use if--
(i) The building was placed in service more than 1 year before the
construction or acquisition of the improvement is begun;
(ii) The improvement is not an enlargement of the building or an
improvement of interior space occupied exclusively for any private
business use;
(iii) No portion of the improved building or any payments in respect
of the improved building are taken into account under section
141(b)(2)(A) (the private security test); and
(iv) No more than 15 percent of the improved building is used for a
private business use.
(e) Special rule for tax assessment bonds. In the case of a tax
assessment bond that satisfies the requirements of Sec. 1.141-5(d), the
loan (or deemed loan) of the proceeds to the borrower paying the
assessment is disregarded in determining whether the private business
use test is met. However, the use of the loan proceeds is not
disregarded in determining whether the private business use test is met.
(f) Examples. The following examples illustrate the application of
paragraphs (a) through (e) of this section. In each example, assume that
the arrangements described are the only arrangements with
nongovernmental persons for use of the financed property.
Example 1. Nongovernmental ownership. State A issues 20-year bonds
to purchase land and equip and construct a factory. A then enters into
an arrangement with Corporation X to sell the factory to X on an
installment basis while the bonds are outstanding. The issue meets the
private business use test because a nongovernmental person owns the
financed facility. See also Sec. 1.141-2 (relating to the private
activity bond tests), and Sec. 1.141-5 (relating to the private loan
financing test).
Example 2 Lease to a nongovernmental person. (i) The facts are the
same as in Example 1, except that A enters into an arrangement with X to
lease the factory to X for 3 years rather than to sell it to X. The
lease payments will be made annually and will be based on the tax-exempt
interest rate on the bonds. The issue meets the private business use
test because a nongovernmental person leases the financed facility. See
also Sec. 1.141-14 (relating to anti-abuse rules).
(ii) The facts are the same as in Example 2(i), except that the
annual payments made by X will equal fair rental value of the facility
and exceed the amount necessary to pay debt service on the bonds for the
3 years of the lease. The issue meets the private business use test
because a nongovernmental person leases the financed facility and the
test does not require that the benefits of tax-exempt financing be
passed through to the nongovernmental person.
Example 3. Management contract in substance a lease. City L issues
30-year bonds to finance the construction of a city hospital. L enters
[[Page 19]]
into a 15-year contract with M, a nongovernmental person that operates a
health maintenance organization relating to the treatment of M's members
at L's hospital. The contract provides for reasonable fixed compensation
to M for services rendered with no compensation based, in whole or in
part, on a share of net profits from the operation of the hospital.
However, the contract also provides that 30 percent of the capacity of
the hospital will be exclusively available to M's members and M will
bear the risk of loss of that portion of the capacity of the hospital so
that, under all of the facts and circumstances, the contract is properly
characterized as a lease for federal income tax purposes. The issue
meets the private business use test because a nongovernmental person
leases the financed facility.
Example 4. Ownership of title in substance a leasehold interest.
Nonprofit Corporation R issues bonds on behalf of City P to finance the
construction of a hospital. R will own legal title to the hospital. In
addition, R will operate the hospital, but R is not treated as an agent
of P in its capacity as operator of the hospital. P has certain rights
to the hospital that establish that it is properly treated as the owner
of the property for federal income tax purposes. P does not have rights,
however, to directly control operation of the hospital while R owns
legal title to it and operates it. The issue meets the private business
use test because the arrangement provides a nongovernmental person an
interest in the financed facility that is comparable to a leasehold
interest. See paragraphs (a)(2) and (b)(7)(i) of this section.
Example 5. Rights to control use of property treated as private
business use--parking lot. Corporation C and City D enter into a plan to
finance the construction of a parking lot adjacent to C's factory.
Pursuant to the plan, C conveys the site for the parking lot to D for a
nominal amount, subject to a covenant running with the land that the
property be used only for a parking lot. In addition, D agrees that C
will have the right to approve rates charged by D for use of the parking
lot. D issues bonds to finance construction of the parking lot on the
site. The parking lot will be available for use by the general public on
the basis of rates that are generally applicable and uniformly applied.
The issue meets the private business use test because a nongovernmental
person has special legal entitlements for beneficial use of the financed
facility that are comparable to an ownership interest. See paragraph
(b)(7)(i) of this section.
Example 6. Other actual or beneficial use--hydroelectric
enhancements. J, a political subdivision, owns and operates a
hydroelectric generation plant and related facilities. Pursuant to a
take or pay contract, J sells 15 percent of the output of the plant to
Corporation K, an investor-owned utility. K is treated as a private
business user of the plant. Under the license issued to J for operation
of the plant, J is required by federal regulations to construct and
operate various facilities for the preservation of fish and for public
recreation. J issues its obligations to finance the fish preservation
and public recreation facilities. K has no special legal entitlements
for beneficial use of the financed facilities. The fish preservation
facilities are functionally related to the operation of the plant. The
recreation facilities are available to natural persons on a short-term
basis according to generally applicable and uniformly applied rates.
Under paragraph (c) of this section, the recreation facilities are
treated as used by the general public. Under paragraph (b)(7) of this
section, K's use is not treated as private business use of the
recreation facilities because K has no special legal entitlements for
beneficial use of the recreation facilities. The fish preservation
facilities are not of a type reasonably available for use on the same
basis by natural persons not engaged in a trade or business. Under all
of the facts and circumstances (including the functional relationship of
the fish preservation facilities to property used in K's trade or
business) under paragraph (b)(7)(ii) of this section, K derives a
special economic benefit from the fish preservation facilities.
Therefore, K's private business use may be established solely on the
basis of that special economic benefit, and K's use of the fish
preservation facilities is treated as private business use.
Example 7. Other actual or beneficial use--pollution control
facilities. City B issues obligations to finance construction of a
specialized pollution control facility on land that it owns adjacent to
a factory owned by Corporation N. B will own and operate the pollution
control facility, and N will have no special legal entitlements to use
the facility. B, however, reasonably expects that N will be the only
user of the facility. The facility will not be reasonably available for
use on the same basis by natural persons not engaged in a trade or
business. Under paragraph (b)(7)(ii) of this section, because under all
of the facts and circumstances the facility is functionally related and
is physically proximate to property used in N's trade or business, N
derives a special economic benefit from the facility. Therefore, N's
private business use may be established solely on the basis of that
special economic benefit, and N's use is treated as private business use
of the facility. See paragraph (b)(7)(ii) of this section.
Example 8. General public use--airport runway. (i) City I issues
bonds and uses all of the proceeds to finance construction of a runway
at a new city-owned airport. The runway will be available for take-off
and landing by any operator of an aircraft desiring to use the airport,
including general
[[Page 20]]
aviation operators who are natural persons not engaged in a trade or
business. It is reasonably expected that most of the actual use of the
runway will be by private air carriers (both charter airlines and
commercial airlines) in connection with their use of the airport
terminals leased by those carriers. These leases for the use of terminal
space provide no priority rights or other preferential benefits to the
air carriers for use of the runway. Moreover, under the leases the lease
payments are determined without taking into account the revenues
generated by runway landing fees (that is, the lease payments are not
determined on a ``residual'' basis). Although the lessee air carriers
receive a special economic benefit from the use of the runway, this
economic benefit is not sufficient to cause the air carriers to be
private business users, because the runway is available for general
public use. The issue does not meet the private business use test. See
paragraphs (b)(7)(ii) and (c) of this section.
(ii) The facts are the same as in Example 8(i), except that the
runway will be available for use only by private air carriers. The use
by these private air carriers is not for general public use, because the
runway is not reasonably available for use on the same basis by natural
persons not engaged in a trade or business. Depending on all of the
facts and circumstances, including whether there are only a small number
of lessee private air carriers, the issue may meet the private business
use test solely because the private air carriers receive a special
economic benefit from the runway. See paragraph (b)(7)(ii) of this
section.
(iii) The facts are the same as in Example 8(i), except that the
lease payments under the leases with the private air carriers are
determined on a residual basis by taking into account the net revenues
generated by runway landing fees. These leases cause the private
business use test to be met with respect to the runway because they are
arrangements that convey special legal entitlements to the financed
facility to nongovernmental persons. See paragraph (b)(7)(i) of this
section.
Example 9. General public use--airport parking garage. City S issues
bonds and uses all of the proceeds to finance construction of a city-
owned parking garage at the city-owned airport. S reasonably expects
that more than 10 percent of the actual use of the parking garage will
be by employees of private air carriers (both charter airlines and
commercial airlines) in connection with their use of the airport
terminals leased by those carriers. The air carriers' use of the parking
garage, however, will be on the same basis as passengers and other
members of the general public using the airport. The leases for the use
of the terminal space provide no priority rights to the air carriers for
use of the parking garage, and the lease payments are determined without
taking into account the revenues generated by the parking garage.
Although the lessee air carriers receive a special economic benefit from
the use of the parking garage, this economic benefit is not sufficient
to cause the air carriers to be private business users, because the
parking garage is available for general public use. The issue does not
meet the private business use test. See paragraphs (b)(7)(ii) and (c) of
this section.
Example 10. Long-term arrangements not treated as general public
use--insurance fund. Authority T deposits all of the proceeds of its
bonds in its insurance fund and invests all of those proceeds in tax-
exempt bonds. The insurance fund provides insurance to a large number of
businesses and natural persons not engaged in a trade or business. Each
participant receives insurance for a term of 1 year. The use by the
participants, other than participants that are natural persons not
engaged in a trade or business, is treated as private business use of
the proceeds of the bonds because the participants have special legal
entitlements to the use of bond proceeds, even though the contractual
rights are not necessarily properly characterized as ownership,
leasehold, or similar interests listed in paragraph (b) of this section.
Use of the bond proceeds is not treated as general public use because
the term of the insurance is greater than 200 days. See paragraphs
(b)(7)(i) and (c)(3) of this section.
Example 11. General public use--port road. Highway Authority W uses
all of the proceeds of its bonds to construct a 25-mile road to connect
an industrial port owned by Corporation Y with existing roads owned and
operated by W. Other than the port, the nearest residential or
commercial development to the new road is 12 miles away. There is no
reasonable expectation that development will occur in the area
surrounding the new road. W and Y enter into no arrangement (either by
contract or ordinance) that conveys special legal entitlements to Y for
the use of the road. Use of the road will be available without
restriction to all users, including natural persons who are not engaged
in a trade or business. The issue does not meet the private business use
test because the road is treated as used only by the general public.
Example 12. General public use of governmentally owned hotel. State
Q issues bonds to purchase land and construct a hotel for use by the
general public (that is, tourists, visitors, and business travelers).
The bond documents provide that Q will own and operate the project for
the term of the bonds. Q will not enter into a lease or license with any
user for use of rooms for a period longer than 200 days (although users
may actually use rooms for consecutive periods in excess of 200 days).
Use of the hotel by hotel guests who
[[Page 21]]
are travelling in connection with trades or businesses of
nongovernmental persons is not a private business use of the hotel by
these persons because the hotel is intended to be available and in fact
is reasonably available for use on the same basis by natural persons not
engaged in a trade or business. See paragraph (c)(1) of this section.
Example 13. General public use with rights of first refusal.
Authority V uses all of the proceeds of its bonds to construct a parking
garage. At least 90 percent of the spaces in the garage will be
available to the general public on a monthly first-come, first-served
basis. V reasonably expects that the spaces will be predominantly leased
to natural persons not engaged in a trade or business who have priority
rights to renew their spaces at then current fair market value rates.
More than 10 percent of the spaces will be leased to nongovernmental
persons acting in a trade or business. These leases are not treated as
arrangements with a term of use greater than 200 days. The rights to
renew are not treated as renewal options because the compensation for
the spaces is redetermined at generally applicable, fair market value
rates that will be in effect at the time of renewal and the use of the
spaces under similar arrangements is predominantly by natural persons
who are not engaged in a trade or business. The issue does not meet the
private business use test because at least 90 percent of the use of the
parking garage is general public use. See paragraph (c)(3) of this
section.
Example 14. General public use with a specially negotiated rate
agreement with agency of United States. G, a sewage collection and
treatment district, operates facilities that were financed with its
bonds. F, an agency of the United States, has a base located within G.
Approximately 20 percent of G's facilities are used to treat sewage
produced by F under a specially negotiated rate agreement. Under the
specially negotiated rate agreement, G uses its best efforts to charge F
as closely as possible the same amount for its use of G's services as
its other customers pay for the same amount of services, although those
other customers pay for services based on standard district charges and
tax levies. F is prohibited by federal law from paying for the services
based on those standard district charges and tax levies. The use of G's
facilities by F is on the same basis as the general public. See
paragraph (c)(2)(ii) of this section.
Example 15. Arrangements not available for use by natural persons
not engaged in a trade or business--federal use of prisons. Authority E
uses all of the proceeds of its bonds to construct a prison. E contracts
with federal agency F to house federal prisoners on a space-available,
first-come, first-served basis, pursuant to which F will be charged
approximately the same amount for each prisoner as other persons that
enter into similar transfer agreements. It is reasonably expected that
other persons will enter into similar agreements. The term of the use
under the contract is not longer than 100 days, and F has no right to
renew, although E reasonably expects to renew the contract indefinitely.
The prison is not financed for a principal purpose of providing the
prison for use by F. It is reasonably expected that during the term of
the bonds, more than 10 percent of the prisoners at the prison will be
federal prisoners. F's use of the facility is not general public use
because this type of use (leasing space for prisoners) is not available
for use on the same basis by natural persons not engaged in a trade or
business. The issue does not meet the private business use test,
however, because the leases satisfy the exception of paragraph (d)(3)(i)
of this section.
Example 16. Negotiated arm's-length arrangements--auditorium
reserved in advance. (i) City Z issues obligations to finance the
construction of a municipal auditorium that it will own and operate. The
use of the auditorium will be open to anyone who wishes to use it for a
short period of time on a rate-scale basis. Z reasonably expects that
the auditorium will be used by schools, church groups, sororities, and
numerous commercial organizations. Corporation H, a nongovernmental
person, enters into an arm's-length arrangement with Z to use the
auditorium for 1 week for each year for a 10-year period (a total of 70
days), pursuant to which H will be charged a specific price reflecting
fair market value. On the date the contract is entered into, Z has not
established generally applicable rates for future years. Even though the
auditorium is not financed for a principal purpose of providing use of
the auditorium to H, H is not treated as using the auditorium as a
member of the general public because its use is not on the same basis as
the general public. Because the term of H's use of the auditorium is
longer than 50 days, the arrangement does not meet the exception under
paragraph (d)(3)(ii) of this section.
(ii) The facts are the same as in Example 16(i), except that H will
enter into an arm's-length arrangement with Z to use the auditorium for
1 week for each year for a 4-year period (a total of 28 days), pursuant
to which H will be charged a specific price reflecting fair market
value. H is not treated as a private business user of the auditorium
because its contract satisfies the exception of paragraph (d)(3)(ii) of
this section for negotiated arm's-length arrangements.
(g) Measurement of private business use--(1) In general. In general,
the private business use of proceeds is allocated to property under
Sec. 1.141-6. The amount of private business use of that
[[Page 22]]
property is determined according to the average percentage of private
business use of that property during the measurement period.
(2) Measurement period--(i) General rule. Except as provided in this
paragraph (g)(2), the measurement period of property financed by an
issue begins on the later of the issue date of that issue or the date
the property is placed in service and ends on the earlier of the last
date of the reasonably expected economic life of the property or the
latest maturity date of any bond of the issue financing the property
(determined without regard to any optional redemption dates). In
general, the period of reasonably expected economic life of the property
for this purpose is based on reasonable expectations as of the issue
date.
(ii) Special rule for refundings of short-term obligations. For an
issue of short-term obligations that the issuer reasonably expects to
refund with a long-term financing (such as bond anticipation notes), the
measurement period is based on the latest maturity date of any bond of
the last refunding issue with respect to the financed property
(determined without regard to any optional redemption dates).
(iii) Special rule for reasonably expected mandatory redemptions. If
an issuer reasonably expects on the issue date that an action will occur
during the term of the bonds to cause either the private business tests
or the private loan financing test to be met and is required to redeem
bonds to meet the reasonable expectations test of Sec. 1.141-2(d)(2),
the measurement period ends on the reasonably expected redemption date.
(iv) Special rule for ownership by a nongovernmental person. The
amount of private business use resulting from ownership by a
nongovernmental person is the greatest percentage of private business
use in any 1-year period.
(v) Anti-abuse rule. If an issuer establishes the term of an issue
for a period that is longer than is reasonably necessary for the
governmental purposes of the issue for a principal purpose of increasing
the permitted amount of private business use, the Commissioner may
determine the amount of private business use according to the greatest
percentage of private business use in any 1-year period.
(3) Determining average percentage of private business use. The
average percentage of private business use is the average of the
percentages of private business use during the 1-year periods within the
measurement period. Appropriate adjustments must be made for beginning
and ending periods of less than 1 year.
(4) Determining the average amount of private business use for a 1-
year period--(i) In general. The percentage of private business use of
property for any 1-year period is the average private business use
during that year. This average is determined by comparing the amount of
private business use during the year to the total amount of private
business use and use that is not private business use (government use)
during that year. Paragraphs (g)(4) (ii) through (v) of this section
apply to determine the average amount of private business use for a 1-
year period.
(ii) Uses at different times. For a facility in which actual
government use and private business use occur at different times (for
example, different days), the average amount of private business use
generally is based on the amount of time that the facility is used for
private business use as a percentage of the total time for all actual
use. In determining the total amount of actual use, periods during which
the facility is not in use are disregarded.
(iii) Simultaneous use. In general, for a facility in which
government use and private business use occur simultaneously, the entire
facility is treated as having private business use. For example, a
governmentally owned facility that is leased or managed by a
nongovernmental person in a manner that results in private business use
is treated as entirely used for a private business use. If, however,
there is also private business use and actual government use on the same
basis, the average amount of private business use may be determined on a
reasonable basis that properly reflects the proportionate benefit to be
derived by the various users of the facility (for example, reasonably
expected fair market value of use). For example, the average
[[Page 23]]
amount of private business use of a garage with unassigned spaces that
is used for government use and private business use is generally based
on the number of spaces used for private business use as a percentage of
the total number of spaces.
(iv) Discrete portion. For purposes of this paragraph (g),
measurement of the use of proceeds allocated to a discrete portion of a
facility is determined by treating that discrete portion as a separate
facility.
(v) Relationship to fair market value. For purposes of paragraphs
(g)(4) (ii) through (iv) of this section, if private business use is
reasonably expected as of the issue date to have a significantly greater
fair market value than government use, the average amount of private
business use must be determined according to the relative reasonably
expected fair market values of use rather than another measure, such as
average time of use. This determination of relative fair market value
may be made as of the date the property is acquired or placed in service
if making this determination as of the issue date is not reasonably
possible (for example, if the financed property is not identified on the
issue date). In general, the relative reasonably expected fair market
value for a period must be determined by taking into account the amount
of reasonably expected payments for private business use for the period
in a manner that properly reflects the proportionate benefit to be
derived from the private business use.
(5) Common areas. The amount of private business use of common areas
within a facility is based on a reasonable method that properly reflects
the proportionate benefit to be derived by the users of the facility.
For example, in general, a method that is based on the average amount of
private business use of the remainder of the entire facility reflects
proportionate benefit.
(6) Allocation of neutral costs. Proceeds that are used to pay costs
of issuance, invested in a reserve or replacement fund, or paid as fees
for a qualified guarantee or a qualified hedge must be allocated ratably
among the other purposes for which the proceeds are used.
(7) Commencement of measurement of private business use. Generally,
private business use commences on the first date on which there is a
right to actual use by the nongovernmental person. However, if an issuer
enters into an arrangement for private business use a substantial period
before the right to actual private business use commences and the
arrangement transfers ownership or is an arrangement for other long-term
use (such as a lease for a significant portion of the remaining economic
life of financed property), private business use commences on the date
the arrangement is entered into, even if the right to actual use
commences after the measurement period. For this purpose, 10 percent of
the measurement period is generally treated as a substantial period.
(8) Examples. The following examples illustrate the application of
this paragraph (g):
Example 1. Research facility. University U, a state owned and
operated university, owns and operates a research facility. U proposes
to finance general improvements to the facility with the proceeds of an
issue of bonds. U enters into sponsored research agreements with
nongovernmental persons that result in private business use because the
sponsors will own title to any patents resulting from the research. The
governmental research conducted by U and the research U conducts for the
sponsors take place simultaneously in all laboratories within the
research facility. All laboratory equipment is available continuously
for use by workers who perform both types of research. Because it is not
possible to predict which research projects will be successful, it is
not reasonably practicable to estimate the relative revenues expected to
result from the governmental and nongovernmental research. U contributed
90 percent of the cost of the facility and the nongovernmental persons
contributed 10 percent of the cost. Under this section, the
nongovernmental persons are using the facility for a private business
use on the same basis as the government use of the facility. The
portions of the costs contributed by the various users of the facility
provide a reasonable basis that properly reflects the proportionate
benefit to be derived by the users of the facility. The nongovernmental
persons are treated as using 10 percent of the proceeds of the issue.
Example 2. Stadium. (i) City L issues bonds and uses all of the
proceeds to construct a stadium. L enters into a long-term contract with
a professional sports team T under which T will use the stadium 20 times
during each year. These uses will occur on nights and weekends. L
reasonably expects that the
[[Page 24]]
stadium will be used more than 180 other times each year, none of which
will give rise to private business use. This expectation is based on a
feasibility study and historical use of the old stadium that is being
replaced by the new stadium. There is no significant difference in the
value of T's uses when compared to the other uses of the stadium, taking
into account the payments that T is reasonably expected to make for its
use. Assuming no other private business use, the issue does not meet the
private business use test because not more than 10 percent of the use of
the facility is for a private business use.
(ii) The facts are the same as in Example 2(i), except that L
reasonably expects that the stadium will be used not more than 60 other
times each year, none of which will give rise to private business use.
The issue meets the private business use test because 25 percent of the
proceeds are used for a private business use.
Example 3. Airport terminal areas treated as common areas. City N
issues bonds to finance the construction of an airport terminal. Eighty
percent of the leasable space of the terminal will be leased to private
air carriers. The remaining 20 percent of the leasable space will be
used for the term of the bonds by N for its administrative purposes. The
common areas of the terminal, including waiting areas, lobbies, and
hallways are treated as 80 percent used by the air carriers for purposes
of the private business use test.
[T.D. 8712, 62 FR 2286, Jan. 16, 1997, as amended by T.D. 8967, 66 FR
58062, Nov. 20, 2001]
Sec. 1.141-4 Private security or payment test.
(a) General rule--(1) Private security or payment. The private
security or payment test relates to the nature of the security for, and
the source of, the payment of debt service on an issue. The private
payment portion of the test takes into account the payment of the debt
service on the issue that is directly or indirectly to be derived from
payments (whether or not to the issuer or any related party) in respect
of property, or borrowed money, used or to be used for a private
business use. The private security portion of the test takes into
account the payment of the debt service on the issue that is directly or
indirectly secured by any interest in property used or to be used for a
private business use or payments in respect of property used or to be
used for a private business use. For additional rules for output
facilities, see Sec. 1.141-7.
(2) Aggregation of private payments and security. For purposes of
the private security or payment test, payments taken into account as
private payments and payments or property taken into account as private
security are aggregated. However, the same payments are not taken into
account as both private security and private payments.
(3) Underlying arrangement. The security for, and payment of debt
service on, an issue is determined from both the terms of the bond
documents and on the basis of any underlying arrangement. An underlying
arrangement may result from separate agreements between the parties or
may be determined on the basis of all of the facts and circumstances
surrounding the issuance of the bonds. For example, if the payment of
debt service on an issue is secured by both a pledge of the full faith
and credit of a state or local governmental unit and any interest in
property used or to be used in a private business use, the issue meets
the private security or payment test.
(b) Measurement of private payments and security--(1) Scope. This
paragraph (b) contains rules that apply to both private security and
private payments.
(2) Present value measurement--(i) Use of present value. In
determining whether an issue meets the private security or payment test,
the present value of the payments or property taken into account is
compared to the present value of the debt service to be paid over the
term of the issue.
(ii) Debt service--(A) Debt service paid from proceeds. Debt service
does not include any amount paid or to be paid from sale proceeds or
investment proceeds. For example, debt service does not include payments
of capitalized interest funded with proceeds.
(B) Adjustments to debt service. Debt service is adjusted to take
into account payments and receipts that adjust the yield on an issue for
purposes of section 148(f). For example, debt service includes fees paid
for qualified guarantees under Sec. 1.148-4(f) and is adjusted to take
into account payments and receipts on qualified hedges under Sec.
1.148-4(h).
(iii) Computation of present value--(A) In general. Present values
are determined by using the yield on the issue
[[Page 25]]
as the discount rate and by discounting all amounts to the issue date.
See, however, Sec. 1.141-13 for special rules for refunding bonds.
(B) Fixed yield issues. For a fixed yield issue, yield is determined
on the issue date and is not adjusted to take into account subsequent
events.
(C) Variable yield issues. The yield on a variable yield issue is
determined over the term of the issue. To determine the reasonably
expected yield as of any date, the issuer may assume that the future
interest rate on a variable yield bond will be the then-current interest
rate on the bonds determined under the formula prescribed in the bond
documents. A deliberate action requires a recomputation of the yield on
the variable yield issue to determine the present value of payments
under that arrangement. In that case, the issuer must use the yield
determined as of the date of the deliberate action for purposes of
determining the present value of payments under the arrangement causing
the deliberate action. See paragraph (g) of this section, Example 3.
(iv) Application to private security. For purposes of determining
the present value of debt service that is secured by property, the
property is valued at fair market value as of the first date on which
the property secures bonds of the issue.
(c) Private payments--(1) In general. This paragraph (c) contains
rules that apply to private payments.
(2) Payments taken into account--(i) Payments for use--(A) In
general. Both direct and indirect payments made by any nongovernmental
person that is treated as using proceeds of the issue are taken into
account as private payments to the extent allocable to the proceeds used
by that person. Payments are taken into account as private payments only
to the extent that they are made for the period of time that proceeds
are used for a private business use. Payments for a use of proceeds
include payments (whether or not to the issuer) in respect of property
financed (directly or indirectly) with those proceeds, even if not made
by a private business user. Payments are not made in respect of financed
property if those payments are directly allocable to other property
being directly used by the person making the payment and those payments
represent fair market value compensation for that other use. See
paragraph (g) of this section, Example 4 and Example 5. See also
paragraph (c)(3) of this section for rules relating to allocation of
payments to the source or sources of funding of property.
(B) Payments not to exceed use. Payments with respect to proceeds
that are used for a private business use are not taken into account to
the extent that the present value of those payments exceeds the present
value of debt service on those proceeds. Payments need not be directly
derived from a private business user, however, to be taken into account.
Thus, if 7 percent of the proceeds of an issue is used by a person over
the measurement period, payments with respect to the property financed
with those proceeds are taken into account as private payments only to
the extent that the present value of those payments does not exceed the
present value of 7 percent of the debt service on the issue.
(C) Payments for operating expenses. Payments by a person for a use
of proceeds do not include the portion of any payment that is properly
allocable to the payment of ordinary and necessary expenses (as defined
under section 162) directly attributable to the operation and
maintenance of the financed property used by that person. For this
purpose, general overhead and administrative expenses are not directly
attributable to those operations and maintenance. For example, if an
issuer receives $5,000 rent during the year for use of space in a
financed facility and during the year pays $500 for ordinary and
necessary expenses properly allocable to the operation and maintenance
of that space and $400 for general overhead and general administrative
expenses properly allocable to that space, $500 of the $5,000 received
would not be considered a payment for the use of the proceeds allocable
to that space (regardless of the manner in which that $500 is actually
used).
(ii) Refinanced debt service. Payments of debt service on an issue
to be made from proceeds of a refunding issue are
[[Page 26]]
taken into account as private payments in the same proportion that the
present value of the payments taken into account as private payments for
the refunding issue bears to the present value of the debt service to be
paid on the refunding issue. For example, if all the debt service on a
note is paid with proceeds of a refunding issue, the note meets the
private security or payment test if (and to the same extent that) the
refunding issue meets the private security or payment test. This
paragraph (c)(2)(ii) does not apply to payments that arise from
deliberate actions that occur more than 3 years after the retirement of
the prior issue that are not reasonably expected on the issue date of
the refunding issue. For purposes of this paragraph (c)(2)(ii), whether
an issue is a refunding issue is determined without regard to Sec.
1.150-1(d)(2)(i) (relating to certain payments of interest).
(3) Allocation of payments--(i) In general. Private payments for the
use of property are allocated to the source or different sources of
funding of property. The allocation to the source or different sources
of funding is based on all of the facts and circumstances, including
whether an allocation is consistent with the purposes of section 141. In
general, a private payment for the use of property is allocated to a
source of funding based upon the nexus between the payment and both the
financed property and the source of funding. For this purpose, different
sources of funding may include different tax-exempt issues, taxable
issues, and amounts that are not derived from a borrowing, such as
revenues of an issuer (equity).
(ii) Payments for use of discrete property. Payments for the use of
a discrete facility (or a discrete portion of a facility) are allocated
to the source or different sources of funding of that discrete property.
(iii) Allocations among two or more sources of funding. In general,
except as provided in paragraphs (c)(3)(iv) and (v) of this section, if
a payment is made for the use of property financed with two or more
sources of funding (for example, equity and a tax-exempt issue), that
payment must be allocated to those sources of funding in a manner that
reasonably corresponds to the relative amounts of those sources of
funding that are expended on that property. If an issuer has not
retained records of amounts expended on the property (for example,
records of costs of a building that was built 30 years before the
allocation), an issuer may use reasonable estimates of those
expenditures. For this purpose, costs of issuance and other similar
neutral costs are allocated ratably among expenditures in the same
manner as in Sec. 1.141-3(g)(6). A payment for the use of property may
be allocated to two or more issues that finance property according to
the relative amounts of debt service (both paid and accrued) on the
issues during the annual period for which the payment is made, if that
allocation reasonably reflects the economic substance of the
arrangement. In general, allocations of payments according to relative
debt service reasonably reflect the economic substance of the
arrangement if the maturity of the bonds reasonably corresponds to the
reasonably expected economic life of the property and debt service
payments on the bonds are approximately level from year to year.
(iv) Payments made under an arrangement entered into in connection
with issuance of bonds. A private payment for the use of property made
under an arrangement that is entered into in connection with the
issuance of the issue that finances that property generally is allocated
to that issue. Whether an arrangement is entered into in connection with
the issuance of an issue is determined on the basis of all of the facts
and circumstances. An arrangement is ordinarily treated as entered into
in connection with the issuance of an issue if--
(A) The issuer enters into the arrangement during the 3-year period
beginning 18 months before the issue date; and
(B) The amount of payments reflects all or a portion of debt service
on the issue.
(v) Allocations to equity. A private payment for the use of property
may be allocated to equity before payments are allocated to an issue
only if--
(A) Not later than 60 days after the date of the expenditure of
those
[[Page 27]]
amounts, the issuer adopts an official intent (in a manner comparable to
Sec. 1.150-2(e)) indicating that the issuer reasonably expects to be
repaid for the expenditure from a specific arrangement; and
(B) The private payment is made not later than 18 months after the
later of the date the expenditure is made or the date the project is
placed in service.
(d) Private security--(1) In general. This paragraph (d) contains
rules that relate to private security.
(2) Security taken into account. The property that is the security
for, or the source of, the payment of debt service on an issue need not
be property financed with proceeds. For example, unimproved land or
investment securities used, directly or indirectly, in a private
business use that secures an issue provides private security. Private
security (other than financed property and private payments) for an
issue is taken into account under section 141(b), however, only to the
extent it is provided, directly or indirectly, by a user of proceeds of
the issue.
(3) Pledge of unexpended proceeds. Proceeds qualifying for an
initial temporary period under Sec. 1.148-2(e)(2) or (3) or deposited
in a reasonably required reserve or replacement fund (as defined in
Sec. 1.148-2(f)(2)(i)) are not taken into account under this paragraph
(d) before the date on which those amounts are either expended or loaned
by the issuer to an unrelated party.
(4) Secured by any interest in property or payments. Property used
or to be used for a private business use and payments in respect of that
property are treated as private security if any interest in that
property or payments secures the payment of debt service on the bonds.
For this purpose, the phrase any interest in is to be interpreted
broadly and includes, for example, any right, claim, title, or legal
share in property or payments.
(5) Payments in respect of property. The payments taken into account
as private security are payments in respect of property used or to be
used for a private business use. Except as otherwise provided in this
paragraph (d)(5) and paragraph (d)(6) of this section, the rules in
paragraphs (c)(2)(i)(A) and (B) and (c)(2)(ii) of this section apply to
determine the amount of payments treated as payments in respect of
property used or to be used for a private business use. Thus, payments
made by members of the general public for use of a facility used for a
private business use (for example, a facility that is the subject of a
management contract that results in private business use) are taken into
account as private security to the extent that they are made for the
period of time that property is used by a private business user.
(6) Allocation of security among issues. In general, property or
payments from the disposition of that property that are taken into
account as private security are allocated to each issue secured by the
property or payments on a reasonable basis that takes into account
bondholders' rights to the payments or property upon default.
(e) Generally applicable taxes--(1) General rule. For purposes of
the private security or payment test, generally applicable taxes are not
taken into account (that is, are not payments from a nongovernmental
person and are not payments in respect of property used for a private
business use).
(2) Definition of generally applicable taxes. A generally applicable
tax is an enforced contribution exacted pursuant to legislative
authority in the exercise of the taxing power that is imposed and
collected for the purpose of raising revenue to be used for governmental
or public purposes. A generally applicable tax must have a uniform tax
rate that is applied to all persons of the same classification in the
appropriate jurisdiction and a generally applicable manner of
determination and collection.
(3) Special charges. A special charge (as defined in this paragraph
(e)(3)) is not a generally applicable tax. For this purpose, a special
charge means a payment for a special privilege granted or regulatory
function (for example, a license fee), a service rendered (for example,
a sanitation services fee), a use of property (for example, rent), or a
payment in the nature of a special assessment to finance capital
improvements that is imposed on a limited class of persons based on
benefits received from the capital improvements financed with the
assessment. Thus, a
[[Page 28]]
special assessment to finance infrastructure improvements in a new
industrial park (such as sidewalks, streets, streetlights, and utility
infrastructure improvements) that is imposed on a limited class of
persons composed of property owners within the industrial park who
benefit from those improvements is a special charge. By contrast, an
otherwise qualified generally applicable tax (such as a generally
applicable ad valorem tax on all real property within a governmental
taxing jurisdiction) or an eligible PILOT under paragraph (e)(5) of this
section that is based on such a generally applicable tax is not treated
as a special charge merely because the taxes or PILOTs received are used
for governmental or public purposes in a manner which benefits
particular property owners.
(4) Manner of determination and collection--(i) In general. A tax
does not have a generally applicable manner of determination and
collection to the extent that one or more taxpayers make any
impermissible agreements relating to payment of those taxes. An
impermissible agreement relating to the payment of a tax is taken into
account whether or not it is reasonably expected to result in any
payments that would not otherwise have been made. For example, if an
issuer uses proceeds to make a grant to a taxpayer to improve property,
agreements that impose reasonable conditions on the use of the grant do
not cause a tax on that property to fail to be a generally applicable
tax. If an agreement by a taxpayer causes the tax imposed on that
taxpayer not to be treated as a generally applicable tax, the entire tax
paid by that taxpayer is treated as a special charge, unless the
agreement is limited to a specific portion of the tax.
(ii) Impermissible agreements. The following are examples of
agreements that cause a tax to fail to have a generally applicable
manner of determination and collection: an agreement to be personally
liable on a tax that does not generally impose personal liability, to
provide additional credit support such as a third party guarantee, or to
pay unanticipated shortfalls; an agreement regarding the minimum market
value of property subject to property tax; and an agreement not to
challenge or seek deferral of the tax.
(iii) Permissible agreements. The following are examples of
agreements that do not cause a tax to fail to have a generally
applicable manner of determination and collection: an agreement to use a
grant for specified purposes (whether or not that agreement is secured);
a representation regarding the expected value of the property following
the improvement; an agreement to insure the property and, if damaged, to
restore the property; a right of a grantor to rescind the grant if
property taxes are not paid; and an agreement to reduce or limit the
amount of taxes collected to further a bona fide governmental purpose.
For example, an agreement to abate taxes to encourage a property owner
to rehabilitate property in a distressed area is a permissible
agreement.
(5) Payments in lieu of taxes. A tax equivalency payment or other
payment in lieu of a tax (``PILOT'') is treated as a generally
applicable tax if it meets the requirements of paragraphs (e)(5)(i)
through (iv) of this section--
(i) Maximum amount limited by underlying generally applicable tax.
The PILOT is not greater than the amount imposed by a statute for a
generally applicable tax in each year.
(ii) Commensurate with a generally applicable tax. The PILOT is
commensurate with the amount imposed by a statute for a generally
applicable tax in each year under the commensurate standard set forth in
this paragraph (e)(5)(ii). For this purpose, except as otherwise
provided in this paragraph (e)(5)(ii), a PILOT is commensurate with a
generally applicable tax only if it is equal to a fixed percentage of
the generally applicable tax that would otherwise apply in each year or
it reflects a fixed adjustment to the generally applicable tax that
would otherwise apply in each year. A PILOT based on a property tax does
not fail to be commensurate with the property tax as a result of changes
in the level of the percentage of or adjustment to that property tax for
a reasonable phase-in period ending when the subject property is placed
in service (as defined in Sec. 1.150-2(c)). A PILOT based on a property
tax must take into account the
[[Page 29]]
current assessed value of the property for property tax purposes for
each year in which the PILOT is paid and that assessed value must be
determined in the same manner and with the same frequency as property
subject to the property tax. A PILOT is not commensurate with a
generally applicable tax, however, if the PILOT is set at a fixed dollar
amount (for example, fixed debt service on a bond issue) that cannot
vary with changes in the level of the generally applicable tax on which
it is based.
(iii) Use of PILOTs for governmental or public purposes. The PILOT
is to be used for governmental or public purposes for which the
generally applicable tax on which it is based may be used.
(iv) No special charges. The PILOT is not a special charge under
paragraph (e)(3) of this section.
(f) Certain waste remediation bonds--(1) Scope. This paragraph (f)
applies to bonds issued to finance hazardous waste clean-up activities
on privately owned land (hazardous waste remediation bonds).
(2) Persons that are not private users. Payments from
nongovernmental persons who are not (other than coincidentally) either
users of the site being remediated or persons potentially responsible
for disposing of hazardous waste on that site are not taken into account
as private security. This paragraph (f)(2) applies to payments that
secure (directly or indirectly) the payment of principal of, or interest
on, the bonds under the terms of the bonds. This paragraph (f)(2)
applies only if the payments are made pursuant to either a generally
applicable state or local taxing statute or a state or local statute
that regulates or restrains activities on an industry-wide basis of
persons who are engaged in generating or handling hazardous waste, or in
refining, producing, or transporting petroleum, provided that those
payments do not represent, in substance, payment for the use of
proceeds. For this purpose, a state or local statute that imposes
payments that have substantially the same character as those described
in Chapter 38 of the Code are treated as generally applicable taxes.
(3) Persons that are private users. If payments from nongovernmental
persons who are either users of the site being remediated or persons
potentially responsible for disposing of hazardous waste on that site do
not secure (directly or indirectly) the payment of principal of, or
interest on, the bonds under the terms of the bonds, the payments are
not taken into account as private payments. This paragraph (f)(3)
applies only if at the time the bonds are issued the payments from those
nongovernmental persons are not material to the security for the bonds.
For this purpose, payments are not material to the security for the
bonds if--
(i) The payments are not required for the payment of debt service on
the bonds;
(ii) The amount and timing of the payments are not structured or
designed to reflect the payment of debt service on the bonds;
(iii) The receipt or the amount of the payment is uncertain (for
example, as of the issue date, no final judgment has been entered into
against the nongovernmental person);
(iv) The payments from those nongovernmental persons, when and if
received, are used either to redeem bonds of the issuer or to pay for
costs of any hazardous waste remediation project; and
(v) In the case when a judgment (but not a final judgment) has been
entered by the issue date against a nongovernmental person, there are,
as of the issue date, costs of hazardous waste remediation other than
those financed with the bonds that may be financed with the payments.
(g) Examples. The following examples illustrate the application of
this section:
Example 1. Aggregation of payments. State B issues bonds with
proceeds of $10 million. B uses $9.7 million of the proceeds to
construct a 10-story office building. B uses the remaining $300,000 of
proceeds to make a loan to Corporation Y. In addition, Corporation X
leases 1 floor of the building for the term of the bonds. Under all of
the facts and circumstances, it is reasonable to allocate 10 percent of
the proceeds to that 1 floor. As a percentage of the present value of
the debt service on the bonds, the present value of Y's loan repayments
is 3 percent and the present value of X's lease payments is 8 percent.
The
[[Page 30]]
bonds meet the private security or payment test because the private
payments taken into account are more than 10 percent of the present
value of the debt service on the bonds.
Example 2. Indirect private payments. J, a political subdivision of
a state, will issue several series of bonds from time to time and will
use the proceeds to rehabilitate urban areas. Under all of the facts and
circumstances, the private business use test will be met with respect to
each issue that will be used for the rehabilitation and construction of
buildings that will be leased or sold to nongovernmental persons for use
in their trades or businesses. Nongovernmental persons will make
payments for these sales and leases. There is no limitation either on
the number of issues or the aggregate amount of bonds that may be
outstanding. No group of bondholders has any legal claim prior to any
other bondholders or creditors with respect to specific revenues of J,
and there is no arrangement whereby revenues from a particular project
are paid into a trust or constructive trust, or sinking fund, or are
otherwise segregated or restricted for the benefit of any group of
bondholders. There is, however, an unconditional obligation by J to pay
the principal of, and the interest on, each issue. Although not directly
pledged under the terms of the bond documents, the leases and sales are
underlying arrangements. The payments relating to these leases and sales
are taken into account as private payments to determine whether each
issue of bonds meets the private security or payment test.
Example 3. Computation of payment in variable yield issues. (i) City
M issues general obligation bonds with proceeds of $10 million to
finance a 5-story office building. The bonds bear interest at a variable
rate that is recomputed monthly according to an index that reflects
current market yields. The yield that the interest index would produce
on the issue date is 6 percent. M leases 1 floor of the office building
to Corporation T, a nongovernmental person, for the term of the bonds.
Under all of the facts and circumstances, T is treated as using more
than 10 percent of the proceeds. Using the 6 percent yield as the
discount rate, M reasonably expects on the issue date that the present
value of lease payments to be made by T will be 8 percent of the present
value of the total debt service on the bonds. After the issue date of
the bonds, interest rates decline significantly, so that the yield on
the bonds over their entire term is 4 percent. Using this actual 4
percent yield as the discount rate, the present value of lease payments
made by T is 12 percent of the present value of the actual total debt
service on the bonds. The bonds are not private activity bonds because M
reasonably expected on the issue date that the bonds would not meet the
private security or payment test and because M did not take any
subsequent deliberate action to meet the private security or payment
test.
(ii) The facts are the same as Example 3(i), except that 5 years
after the issue date M leases a second floor to Corporation S, a
nongovernmental person, under a long-term lease. Because M has taken a
deliberate action, the present value of the lease payments must be
computed. On the date this lease is entered into, M reasonably expects
that the yield on the bonds over their entire term will be 5.5 percent,
based on actual interest rates to date and the then-current rate on the
variable yield bonds. M uses this 5.5 percent yield as the discount
rate. Using this 5.5 percent yield as the discount rate, as a percentage
of the present value of the debt service on the bonds, the present value
of the lease payments made by S is 3 percent. The bonds are private
activity bonds because the present value of the aggregate private
payments is greater than 10 percent of the present value of debt
service.
Example 4. Payments not in respect of financed property. In order to
further public safety, City Y issues tax assessment bonds the proceeds
of which are used to move existing electric utility lines underground.
Although the utility lines are owned by a nongovernmental utility
company, that company is under no obligation to move the lines. The debt
service on the bonds will be paid using assessments levied by City Y on
the customers of the utility. Although the utility lines are privately
owned and the utility customers make payments to the utility company for
the use of those lines, the assessments are payments in respect of the
cost of relocating the utility line. Thus, the assessment payments are
not made in respect of property used for a private business use. Any
direct or indirect payments to Y by the utility company for the
undergrounding are, however, taken into account as private payments.
Example 5. Payments from users of proceeds that are not private
business users taken into account. City P issues general obligation
bonds to finance the renovation of a hospital that it owns. The hospital
is operated for P by D, a nongovernmental person, under a management
contract that results in private business use under Sec. 1.141-3. P
will use the revenues from the hospital (after the required payments to
D and the payment of operation and maintenance expenses) to pay the debt
service on the bonds. The bonds meet the private security or payment
test because the revenues from the hospital are payments in respect of
property used for a private business use.
Example 6. Limitation of amount of payments to amount of private
business use not determined annually. City Q issues bonds with a term of
15 years and uses the proceeds to
[[Page 31]]
construct an office building. The debt service on the bonds is level
throughout the 15-year term. Q enters into a 5-year lease with
Corporation R under which R is treated as a user of 11 percent of the
proceeds. R will make lease payments equal to 20 percent of the annual
debt service on the bonds for each year of the lease. The present value
of R's lease payments is equal to 12 percent of the present value of the
debt service over the entire 15-year term of the bonds. If, however, the
lease payments taken into account as private payments were limited to 11
percent of debt service paid in each year of the lease, the present
value of these payments would be only 8 percent of the debt service on
the bonds over the entire term of the bonds. The bonds meet the private
security or payment test, because R's lease payments are taken into
account as private payments in an amount not to exceed 11 percent of the
debt service of the bonds.
Example 7. Allocation of payments to funds not derived from a
borrowing. City Z purchases property for $1,250,000 using $1,000,000 of
proceeds of its tax increment bonds and $250,000 of other revenues that
are in its redevelopment fund. Within 60 days of the date of purchase, Z
declared its intent to sell the property pursuant to a redevelopment
plan and to use that amount to reimburse its redevelopment fund. The
bonds are secured only by the incremental property taxes attributable to
the increase in value of the property from the planned redevelopment of
the property. Within 18 months after the issue date, Z sells the
financed property to Developer M for $250,000, which Z uses to reimburse
the redevelopment fund. The property that M uses is financed both with
the proceeds of the bonds and Z's redevelopment fund. The payments by M
are properly allocable to the costs of property financed with the
amounts in Z's redevelopment fund. See paragraphs (c)(3) (i) and (v) of
this section.
Example 8. Allocation of payments to different sources of funding--
improvements. In 1997, City L issues bonds with proceeds of $8 million
to finance the acquisition of a building. In 2002, L spends $2 million
of its general revenues to improve the heating system and roof of the
building. At that time, L enters into a 10-year lease with Corporation M
for the building providing for annual payments of $1 million to L. The
lease payments are at fair market value, and the lease payments do not
otherwise have a significant nexus to either the issue or to the
expenditure of general revenues. Eighty percent of each lease payment is
allocated to the issue and is taken into account under the private
payment test because each lease payment is properly allocated to the
sources of funding in a manner that reasonably corresponds to the
relative amounts of the sources of funding that are expended on the
building.
Example 9. Security not provided by users of proceeds not taken into
account. County W issues certificates of participation in a lease of a
building that W owns and covenants to appropriate annual payments for
the lease. A portion of each payment is specified as interest. More than
10 percent of the building is used for private business use. None of the
proceeds of the obligations are used with respect to the building. W
uses the proceeds of the obligations to make a grant to Corporation Y
for the construction of a factory that Y will own. Y makes no payments
to W, directly or indirectly, for its use of proceeds, and Y has no
relationship to the users of the leased building. If W defaults under
the lease, the trustee for the holders of the certificates of
participation has a limited right of repossession under which the
trustee may not foreclose but may lease the property to a new tenant at
fair market value. The obligations are secured by an interest in
property used for a private business use. However, because the property
is not provided by a private business user and is not financed property,
the obligations do not meet the private security or payment test.
Example 10. Allocation of payments among issues. University L, a
political subdivision, issued three separate series of revenue bonds
during 1989, 1991, and 1993 under the same bond resolution. L used the
proceeds to construct facilities exclusively for its own use. Bonds
issued under the resolution are equally and ratably secured and payable
solely from the income derived by L from rates, fees, and charges
imposed by L for the use of the facilities. The bonds issued in 1989,
1991, and 1993 are not private activity bonds. In 1997, L issues another
series of bonds under the resolution to finance additional facilities. L
leases 20 percent of the new facilities for the term of the 1997 bonds
to nongovernmental persons who will use the facilities in their trades
or businesses. The present value of the lease payments from the
nongovernmental users will equal 15 percent of the present value of the
debt service on the 1997 bonds. L will commingle all of the revenues
from all its bond-financed facilities in its revenue fund. The present
value of the portion of the lease payments from nongovernmental lessees
of the new facilities allocable to the 1997 bonds under paragraph (d) of
this section is less than 10 percent of the present value of the debt
service on the 1997 bonds because the bond documents provide that the
bonds are equally and ratably secured. Accordingly, the 1997 bonds do
not meet the private security test. The 1997 bonds meet the private
payment test, however, because the private lease payments for the new
facility are properly allocated to those bonds (that is, because none of
the proceeds of the prior issues were used for the new facilities). See
paragraph (c) of this section.
[[Page 32]]
Example 11. Generally applicable tax. (i) Authority N issues bonds
to finance the construction of a stadium. Under a long-term lease,
Corporation X, a professional sports team, will use more than 10 percent
of the stadium. X will not, however, make any payments for this private
business use. The security for the bonds will be a ticket tax imposed on
each person purchasing a ticket for an event at the stadium. The portion
of the ticket tax attributable to tickets purchased by persons attending
X's events will, on a present value basis, exceed 10 percent of the
present value of the debt service on N's bonds. The bonds meet the
private security or payment test. The ticket tax is not a generally
applicable tax and, to the extent that the tax receipts relate to X's
events, the taxes are payments in respect of property used for a private
business use.
(ii) The facts are the same as Example 11(i), except that the ticket
tax is imposed by N on tickets purchased for events at a number of large
entertainment facilities within the N's jurisdiction (for example, other
stadiums, arenas, and concert halls), some of which were not financed
with tax-exempt bonds. The ticket tax is a generally applicable tax and
therefore the revenues from this tax are not payments in respect of
property used for a private business use. The receipt of the ticket tax
does not cause the bonds to meet the private security or payment test.
[T.D. 8712, 62 FR 2291, Jan. 16, 1997, as amended by T.D. 9429, 73 FR
63374, Oct. 24, 2008]
Sec. 1.141-5 Private loan financing test.
(a) In general. Bonds of an issue are private activity bonds if more
than the lesser of 5 percent or $5 million of the proceeds of the issue
is to be used (directly or indirectly) to make or finance loans to
persons other than governmental persons. Section 1.141-2(d) applies in
determining whether the private loan financing test is met. In
determining whether the proceeds of an issue are used to make or finance
loans, indirect, as well as direct, use of the proceeds is taken into
account.
(b) Measurement of test. In determining whether the private loan
financing test is met, the amount actually loaned to a nongovernmental
person is not discounted to reflect the present value of the loan
repayments.
(c) Definition of private loan--(1) In general. Any transaction that
is generally characterized as a loan for federal income tax purposes is
a loan for purposes of this section. In addition, a loan may arise from
the direct lending of bond proceeds or may arise from transactions in
which indirect benefits that are the economic equivalent of a loan are
conveyed. Thus, the determination of whether a loan is made depends on
the substance of a transaction rather than its form. For example, a
lease or other contractual arrangement (for example, a management
contract or an output contract) may in substance constitute a loan if
the arrangement transfers tax ownership of the facility to a
nongovernmental person. Similarly, an output contract or a management
contract with respect to a financed facility generally is not treated as
a loan of proceeds unless the agreement in substance shifts significant
burdens and benefits of ownership to the nongovernmental purchaser or
manager of the facility.
(2) Application only to purpose investments--(i) In general. A loan
may be either a purpose investment or a nonpurpose investment. A loan
that is a nonpurpose investment does not cause the private loan
financing test to be met. For example, proceeds invested in loans, such
as obligations of the United States, during a temporary period, as part
of a reasonably required reserve or replacement fund, as part of a
refunding escrow, or as part of a minor portion (as each of those terms
are defined in Sec. 1.148-1 or Sec. 1.148-2) are generally not treated
as loans under the private loan financing test.
(ii) Certain prepayments treated as loans. Except as otherwise
provided, a prepayment for property or services, including a prepayment
for property or services that is made after the date that the contract
to buy the property or services is entered into, is treated as a loan
for purposes of the private loan financing test if a principal purpose
for prepaying is to provide a benefit of tax-exempt financing to the
seller. A prepayment is not treated as a loan for purposes of the
private loan financing test if--
(A) Prepayments on substantially the same terms are made by a
substantial percentage of persons who are similarly situated to the
issuer but who are not beneficiaries of tax-exempt financing;
(B) The prepayment is made within 90 days of the reasonably expected
date of delivery to the issuer of all of the
[[Page 33]]
property or services for which the prepayment is made; or
(C) The prepayment meets the requirements of Sec. 1.148-
1(e)(2)(iii)(A) or (B) (relating to certain prepayments to acquire a
supply of natural gas or electricity).
(iii) Customary prepayments. The determination of whether a
prepayment satisfies paragraph (c)(2)(ii)(A) of this section is
generally made based on all the facts and circumstances. In addition, a
prepayment is deemed to satisfy paragraph (c)(2)(ii)(A) of this section
if--
(A) The prepayment is made for--
(1) Maintenance, repair, or an extended warranty with respect to
personal property (for example, automobiles or electronic equipment); or
(2) Updates or maintenance or support services with respect to
computer software; and
(B) The same maintenance, repair, extended warranty, updates or
maintenance or support services, as applicable, are regularly provided
to nongovernmental persons on the same terms.
(iv) Additional prepayments as permitted by the Commissioner. The
Commissioner may, by published guidance, set forth additional
circumstances in which a prepayment is not treated as a loan for
purposes of the private loan financing test.
(3) Grants--(i) In general. A grant of proceeds is not a loan.
Whether a transaction may be treated as a grant or a loan depends on all
of the facts and circumstances.
(ii) Tax increment financing--(A) In general. Generally, a grant
using proceeds of an issue that is secured by generally applicable taxes
attributable to the improvements to be made with the grant is not
treated as a loan, unless the grantee makes any impermissible agreements
relating to the payment that results in the taxes imposed on that
taxpayer not to be treated as generally applicable taxes under Sec.
1.141-4(e).
(B) Amount of loan. If a grant is treated as a loan under this
paragraph (c)(3), the entire grant is treated as a loan unless the
impermissible agreement is limited to a specific portion of the tax. For
this purpose, an arrangement with each unrelated grantee is treated as a
separate grant.
(4) Hazardous waste remediation bonds. In the case of an issue of
hazardous waste remediation bonds, payments from nongovernmental persons
that are either users of the site being remediated or persons
potentially responsible for disposing of hazardous waste on that site do
not establish that the transaction is a loan for purposes of this
section. This paragraph (c)(4) applies only if those payments do not
secure the payment of principal of, or interest on, the bonds (directly
or indirectly), under the terms of the bonds and those payments are not
taken into account under the private payment test pursuant to Sec.
1.141-4(f)(3).
(d) Tax assessment loan exception--(1) General rule. For purposes of
this section, a tax assessment loan that satisfies the requirements of
this paragraph (d) is not a loan for purposes of the private loan
financing test.
(2) Tax assessment loan defined. A tax assessment loan is a loan
that arises when a governmental person permits or requires property
owners to finance any governmental tax or assessment of general
application for an essential governmental function that satisfies each
of the requirements of paragraphs (d) (3) through (5) of this section.
(3) Mandatory tax or other assessment. The tax or assessment must be
an enforced contribution that is imposed and collected for the purpose
of raising revenue to be used for a specific purpose (that is, to defray
the capital cost of an improvement). Taxes and assessments do not
include fees for services. The tax or assessment must be imposed
pursuant to a state law of general application that can be applied
equally to natural persons not acting in a trade or business and persons
acting in a trade or business. For this purpose, taxes and assessments
that are imposed subject to protest procedures are treated as enforced
contributions.
(4) Specific essential governmental function--(i) In general. A
mandatory tax or assessment that gives rise to a tax assessment loan
must be imposed for one or more specific, essential governmental
functions.
(ii) Essential governmental functions. For purposes of paragraph (d)
of this
[[Page 34]]
section, improvements to utilities and systems that are owned by a
governmental person and that are available for use by the general public
(such as sidewalks, streets and street-lights; electric, telephone, and
cable television systems; sewage treatment and disposal systems; and
municipal water facilities) serve essential governmental functions. For
other types of facilities, the extent to which the service provided by
the facility is customarily performed (and financed with governmental
bonds) by governments with general taxing powers is a primary factor in
determining whether the facility serves an essential governmental
function. For example, parks that are owned by a governmental person and
that are available for use by the general public serve an essential
governmental function. Except as otherwise provided in this paragraph
(d)(4)(ii), commercial or industrial facilities and improvements to
property owned by a nongovernmental person do not serve an essential
governmental
function. Permitting installment payments of property taxes or other
taxes is not an essential governmental function.
(5) Equal basis requirement--(i) In general. Owners of both business
and nonbusiness property benefiting from the financed improvements must
be eligible, or required, to make deferred payments of the tax or
assessment giving rise to a tax assessment loan on an equal basis (the
equal basis requirement). A tax or assessment does not satisfy the equal
basis requirement if the terms for payment of the tax or assessment are
not the same for all taxed or assessed persons. For example, the equal
basis requirement is not met if certain property owners are permitted to
pay the tax or assessment over a period of years while others must pay
the entire tax or assessment immediately or if only certain property
owners are required to prepay the tax or assessment when the property is
sold.
(ii) General rule for guarantees. A guarantee of debt service on
bonds, or of taxes or assessments, by a person that is treated as a
borrower of bond proceeds violates the equal basis requirement if it is
reasonable to expect on the date the guarantee is entered into that
payments will be made under the guarantee.
(6) Coordination with private business tests. See Sec. Sec. 1.141-3
and 1.141-4 for rules for determining whether tax assessment loans cause
the bonds financing those loans to be private activity bonds under the
private business use and the private security or payment tests.
(e) Examples. The following examples illustrate the application of
this section:
Example 1. Turnkey contract not treated as a loan. State agency Z
and federal agency H will each contribute to rehabilitate a project
owned by Z. H can only provide its funds through a contribution to Z to
be used to acquire the rehabilitated project on a turnkey basis from an
approved developer. Under H's turnkey program, the developer must own
the project while it is rehabilitated. Z issues its notes to provide
funds for construction. A portion of the notes will be retired using the
H contribution, and the balance of the notes will be retired through the
issuance by Z of long-term bonds. Z lends the proceeds of its notes to
Developer B as construction financing and transfers title to B for a
nominal amount. The conveyance is made on condition that B rehabilitate
the property and reconvey it upon completion, with Z retaining the right
to force reconveyance if these conditions are not satisfied. B must name
Z as an additional insured on all insurance. Upon completion, B must
transfer title to the project back to Z at a set price, which price
reflects B's costs and profit, not fair market value. Further, this
price is adjusted downward to reflect any cost-underruns. For purposes
of section 141(c), this transaction does not involve a private loan.
Example 2. Essential government function requirement not met. City D
creates a special taxing district consisting of property owned by
nongovernmental persons that requires environmental clean-up. D imposes
a special tax on each parcel within the district in an amount that is
related to the expected environmental clean-up costs of that parcel. The
payment of the tax over a 20-year period is treated as a loan by the
property owners for purposes of the private loan financing test. The
special district issues bonds, acting on behalf of D, that are payable
from the special tax levied within the district, and uses the proceeds
to pay for the costs of environmental clean-up on the property within
the district. The bonds meet the private loan financing test because
more than 5 percent of the proceeds of the issue are loaned to
nongovernmental persons. The issue does not meet the tax assessment loan
exception because the improvements to property owned by a
nongovernmental person are not an essential governmental function under
section
[[Page 35]]
141(c)(2). The issue also meets the private business tests of section
141(b).
[T.D. 8712, 62 FR 2296, Jan. 16, 1997, as amended by T.D. 9085, 68 FR
45775, Aug. 4, 2003]
Sec. 1.141-6 Allocation and accounting rules.
(a) Allocation of proceeds to expenditures. For purposes of
Sec. Sec. 1.141-1 through 1.141-15, the provisions of Sec. 1.148-6(d)
apply for purposes of allocating proceeds to expenditures. Thus,
allocations generally may be made using any reasonable, consistently
applied accounting method, and allocations under section 141 and section
148 must be consistent with each other.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds. [Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
[T.D. 8712, 62 FR 2297, Jan. 16, 1997]
Sec. 1.141-7 Special rules for output facilities.
(a) Overview. This section provides special rules to determine
whether arrangements for the purchase of output from an output facility
cause an issue of bonds to meet the private business tests. For this
purpose, unless otherwise stated, water facilities are treated as output
facilities. Sections 1.141-3 and 1.141-4 generally apply to determine
whether other types of arrangements for use of an output facility cause
an issue to meet the private business tests.
(b) Definitions. For purposes of this section and Sec. 1.141-8, the
following definitions and rules apply:
(1) Available output. The available output of a facility financed by
an issue is determined by multiplying the number of units produced or to
be produced by the facility in one year by the number of years in the
measurement period of that facility for that issue.
(i) Generating facilities. The number of units produced or to be
produced by a generating facility in one year is determined by reference
to its nameplate capacity or the equivalent (or where there is no
nameplate capacity or the equivalent, its maximum capacity), which is
not reduced for reserves, maintenance or other unutilized capacity.
(ii) Transmission and other output facilities--(A) In general. For
transmission, distribution, cogeneration, and other output facilities,
available output must be measured in a reasonable manner to reflect
capacity.
(B) Electric transmission facilities. Measurement of the available
output of all or a portion of electric transmission facilities may be
determined in a manner consistent with the reporting rules and
requirements for transmission networks promulgated by the Federal Energy
Regulatory Commission (FERC). For example, for a transmission network,
the use of aggregate load and load share ratios in a manner consistent
with the requirements of the FERC may be reasonable. In addition,
depending on the facts and circumstances, measurement of the available
output of transmission facilities using thermal capacity or transfer
capacity may be reasonable.
(iii) Special rule for facilities with significant unutilized
capacity. If an issuer reasonably expects on the issue date that persons
that are treated as private business users will purchase more than 30
percent of the actual output of the facility financed with the issue,
the Commissioner may determine the number of units produced or to be
produced by the facility in one year on a reasonable basis other than by
reference to nameplate or other capacity, such as the average expected
annual output of the facility. For example, the Commissioner may
determine the available output of a financed peaking electric generating
unit by reference to the reasonably expected annual output of that unit
if the issuer reasonably expects, on the issue date of bonds that
finance the unit, that an investor-owned utility will purchase more than
30 percent of the actual output of the facility during the measurement
period under a take or pay contract, even if the amount of output
purchased is less than 10 percent of the available output determined by
reference to nameplate
[[Page 36]]
capacity. The reasonably expected annual output of the generating
facility must be consistent with the capacity reported for prudent
reliability purposes.
(iv) Special rule for facilities with a limited source of supply. If
a limited source of supply constrains the output of an output facility,
the number of units produced or to be produced by the facility must be
determined by reasonably taking into account those constraints. For this
purpose, a limited source of supply shall include a physical limitation
(for example, flow of water), but not an economic limitation (for
example, cost of coal or gas). For example, the available output of a
hydroelectric unit must be determined by reference to the reasonably
expected annual flow of water through the unit.
(2) Measurement period. The measurement period of an output facility
financed by an issue is determined under Sec. 1.141-3(g).
(3) Sale at wholesale. A sale at wholesale means a sale of output to
any person for resale.
(4) Take contract and take or pay contract. A take contract is an
output contract under which a purchaser agrees to pay for the output
under the contract if the output facility is capable of providing the
output. A take or pay contract is an output contract under which a
purchaser agrees to pay for the output under the contract, whether or
not the output facility is capable of providing the output.
(5) Requirements contract. A requirements contract is an output
contract, other than a take contract or a take or pay contract, under
which a nongovernmental person agrees to purchase all or part of its
output requirements.
(6) Nonqualified amount. The nonqualified amount with respect to an
issue is determined under section 141(b)(8).
(c) Output contracts--(1) General rule. The purchase pursuant to a
contract by a nongovernmental person of available output of an output
facility (output contract) financed with proceeds of an issue is taken
into account under the private business tests if the purchase has the
effect of transferring the benefits of owning the facility and the
burdens of paying the debt service on bonds used (directly or
indirectly) to finance the facility (the benefits and burdens test). See
paragraph (c)(4) of this section for the treatment of an output contract
that is properly characterized as a lease for Federal income tax
purposes. See paragraphs (d) and (e) of this section for rules regarding
measuring the use of, and payments of debt service for, an output
facility for determining whether the private business tests are met. See
also Sec. 1.141-8 for rules for when an issue that finances an output
facility (other than a water facility) meets the private business tests
because the nonqualified amount of the issue exceeds $15 million.
(2) Take contract or take or pay contract. The benefits and burdens
test is met if a nongovernmental person agrees pursuant to a take
contract or a take or pay contract to purchase available output of a
facility.
(3) Requirements contract--(i) In general. A requirements contract
may satisfy the benefits and burdens test under paragraph (c)(3)(ii) or
(iii) of this section. See Sec. 1.141-15(f)(2) for special effective
dates for the application of this paragraph (c)(3) to issues financing
facilities subject to requirements contracts.
(ii) Requirements contract similar to take contract or take or pay
contract. A requirements contract generally meets the benefits and
burdens test to the extent that it contains contractual terms that
obligate the purchaser to make payments that are not contingent on the
output requirements of the purchaser or that obligate the purchaser to
have output requirements. For example, a requirements contract with an
industrial purchaser meets the benefits and burdens test if the
purchaser enters into additional contractual obligations with the issuer
or another governmental unit not to cease operations. A requirements
contract does not meet the benefits and burdens test, however, by reason
of a provision that requires the purchaser to pay reasonable and
customary damages (including liquidated damages) in the event of a
default, or a provision that permits the purchaser to pay a specified
amount to terminate the contract while the purchaser has requirements,
in each case
[[Page 37]]
if the amount of the payment is reasonably related to the purchaser's
obligation to buy requirements that is discharged by the payment.
(iii) Wholesale requirements contract--(A) In general. A
requirements contract that is a sale at wholesale (a wholesale
requirements contract) may satisfy the benefits and burdens test,
depending on all the facts and circumstances.
(B) Significant factors. Significant factors that tend to establish
that a wholesale requirements contract meets the benefits and burdens
test include, but are not limited to--
(1) The term of the contract is substantial relative to the term of
the issue or issues that finance the facility; and
(2) The amount of output to be purchased under the contract
represents a substantial portion of the available output of the
facility.
(C) Safe harbors. A wholesale requirements contract does not meet
the benefits and burdens test if--
(1) The term of the contract, including all renewal options, does
not exceed the lesser of 5 years or 30 percent of the term of the issue;
or
(2) The amount of output to be purchased under the contract (and any
other requirements contract with the same purchaser or a related party
with respect to the facility) does not exceed 5 percent of the available
output of the facility.
(iv) Retail requirements contract. Except as otherwise provided in
this paragraph (c)(3), a requirements contract that is not a sale at
wholesale does not meet the benefits and burdens test.
(4) Output contract properly characterized as a lease.
Notwithstanding any other provision of this section, an output contract
that is properly characterized as a lease for Federal income tax
purposes shall be tested under the rules contained in Sec. Sec. 1.141-3
and 1.141-4 to determine whether it is taken into account under the
private business tests.
(d) Measurement of private business use. If an output contract
results in private business use under this section, the amount of
private business use generally is the amount of output purchased under
the contract.
(e) Measurement of private security or payment. The measurement of
payments made or to be made by nongovernmental persons under output
contracts as a percent of the debt service of an issue is determined
under the rules provided in Sec. 1.141-4.
(f) Exceptions for certain contracts--(1) Small purchases of output.
An output contract for the use of a facility is not taken into account
under the private business tests if the average annual payments to be
made under the contract do not exceed 1 percent of the average annual
debt service on all outstanding tax-exempt bonds issued to finance the
facility, determined as of the effective date of the contract.
(2) Swapping and pooling arrangements. An agreement that provides
for swapping or pooling of output by one or more governmental persons
and one or more nongovernmental persons does not result in private
business use of the output facility owned by the governmental person to
the extent that--
(i) The swapped output is reasonably expected to be approximately
equal in value (determined over periods of three years or less); and
(ii) The purpose of the agreement is to enable each of the parties
to satisfy different peak load demands, to accommodate temporary
outages, to diversify supply, or to enhance reliability in accordance
with prudent reliability standards.
(3) Short-term output contracts. An output contract with a
nongovernmental person is not taken into account under the private
business tests if--
(i) The term of the contract, including all renewal options, is not
longer than 3 years;
(ii) The contract either is a negotiated, arm's-length arrangement
that provides for compensation at fair market value, or is based on
generally applicable and uniformly applied rates; and
(iii) The output facility is not financed for a principal purpose of
providing that facility for use by that nongovernmental person.
(4) Certain conduit parties disregarded. A nongovernmental person
acting solely as a conduit for the exchange of output among
governmentally owned and
[[Page 38]]
operated utilities is disregarded in determining whether the private
business tests are met with respect to financed facilities owned by a
governmental person.
(g) Special rules for electric output facilities used to provide
open access--(1) Operation of transmission facilities by nongovernmental
persons--(i) In general. The operation of an electric transmission
facility by a nongovernmental person may result in private business use
of the facility under Sec. 1.141-3 and this section based on all the
facts and circumstances. For example, a transmission facility is
generally used for a private business use if a nongovernmental person
enters into a contract to operate the facility and receives compensation
based, in whole or in part, on a share of net profits from the operation
of the facility.
(ii) Certain use by independent transmission operators. A contract
for the operation of an electric transmission facility by an independent
entity, such as a regional transmission organization or an independent
system operator (independent transmission operator), does not constitute
private business use of the facility if--
(A) The facility is owned by a governmental person;
(B) The operation of the facility by the independent transmission
operator is approved by the FERC under one or more provisions of the
Federal Power Act (16 U.S.C. 791a through 825r) (or by a state authority
under comparable provisions of state law);
(C) No portion of the compensation of the independent transmission
operator is based on a share of net profits from the operation of the
facility; and
(D) The independent transmission operator does not bear risk of loss
of the facility.
(2) Certain use by nongovernmental persons under output contracts--
(i) Transmission facilities. The use of an electric transmission
facility by a nongovernmental person pursuant to an output contract does
not constitute private business use of the facility if--
(A) The facility is owned by a governmental person;
(B) The facility is operated by an independent transmission operator
in a manner that satisfies paragraph (g)(1)(ii) of this section; and
(C) The facility is not financed for a principal purpose of
providing that facility for use by that nongovernmental person.
(ii) Distribution facilities. The use of an electric distribution
facility by a nongovernmental person pursuant to an output contract does
not constitute private business use of the facility if--
(A) The facility is owned by a governmental person;
(B) The facility is available for use on a nondiscriminatory, open
access basis by buyers and sellers of electricity in accordance with
rates that are generally applicable and uniformly applied within the
meaning of Sec. 1.141-3(c)(2); and
(C) The facility is not financed for a principal purpose of
providing that facility for use by that nongovernmental person (other
than a retail end-user).
(3) Ancillary services. The use of an electric output facility to
provide ancillary services required to be offered as part of an open
access transmission tariff under rules promulgated by the FERC under the
Federal Power Act (16 U.S.C. 791a through 825r) (or by a state
regulatory authority under comparable provisions of state law) does not
result in private business use.
(4) Exceptions to deliberate action rules--(i) Mandated wheeling.
Entering into a contract for the use of electric transmission or
distribution facilities is not treated as a deliberate action under
Sec. 1.141-2(d) if--
(A) The contract is entered into in response to (or in anticipation
of) an order by the United States under sections 211 and 212 of the
Federal Power Act (16 U.S.C. 824j and 824k) (or a state regulatory
authority under comparable provisions of state law); and
(B) The terms of the contract are bona fide and arm's-length, and
the consideration paid is consistent with the provisions of section
212(a) of the Federal Power Act.
(ii) Actions taken to implement non-discriminatory, open access. An
action is not treated as a deliberate action under Sec. 1.141-2(d) if
it is taken to implement the offering of non-discriminatory, open access
tariffs for the use of electric transmission or distribution
[[Page 39]]
facilities in a manner consistent with rules promulgated by the FERC
under sections 205 and 206 of the Federal Power Act (16 U.S.C. 824d and
824e) (or comparable provisions of state law). This paragraph (g)(4)(ii)
does not apply, however, to the sale, exchange, or other disposition
(within the meaning of section 1001(a)) of transmission or distribution
facilities to a nongovernmental person.
(iii) Application of reasonable expectations test to certain current
refunding bonds. An action taken or to be taken with respect to electric
transmission or distribution facilities refinanced by an issue is not
taken into account under the reasonable expectations test of Sec.
1.141-2(d) if--
(A) The action is described in paragraph (g)(4)(i) or (ii) of this
section;
(B) The bonds of the issue are current refunding bonds that refund
bonds originally issued before February 23, 1998; and
(C) The weighted average maturity of the refunding bonds is not
greater than the remaining weighted average maturity of the prior bonds.
(5) Additional transactions as permitted by the Commissioner. The
Commissioner may, by published guidance, set forth additional
circumstances in which the use of electric output facilities in a
restructured electric industry does not constitute private business use.
(h) Allocations of output facilities and systems--(1) Facts and
circumstances analysis. Whether output sold under an output contract is
allocated to a particular facility (for example, a generating unit), to
the entire system of the seller of that output (net of any uses of that
system output allocated to a particular facility), or to a portion of a
facility is based on all the facts and circumstances. Significant
factors to be considered in determining the allocation of an output
contract to financed property are the following:
(i) The extent to which it is physically possible to deliver output
to or from a particular facility or system.
(ii) The terms of a contract relating to the delivery of output
(such as delivery limitations and options or obligations to deliver
power from additional sources).
(iii) Whether a contract is entered into as part of a common plan of
financing for a facility.
(iv) The method of pricing output under the contract, such as the
use of market rates rather than rates designed to pay debt service of
tax-exempt bonds used to finance a particular facility.
(2) Illustrations. The following illustrate the factors set forth in
paragraph (h)(1) of this section:
(i) Physical possibility. Output from a generating unit that is fed
directly into a low voltage distribution system of the owner of that
unit and that cannot physically leave that distribution system generally
must be allocated to those receiving electricity through that
distribution system. Output may be allocated without regard to physical
limitations, however, if exchange or similar agreements provide output
to a purchaser where, but for the exchange agreements, it would not be
possible for the seller to provide output to that purchaser.
(ii) Contract terms relating to performance. A contract to provide a
specified amount of electricity from a system, but only when at least
that amount of electricity is being generated by a particular unit, is
allocated to that unit. For example, a contract to buy 20 MW of system
power with a right to take up to 40 percent of the actual output of a
specific 50 MW facility whenever total system output is insufficient to
meet all of the seller's obligations generally is allocated to the
specific facility rather than to the system.
(iii) Common plan of financing. A contract entered into as part of a
common plan of financing for a facility generally is allocated to the
facility if debt service for the issue of bonds is reasonably expected
to be paid, directly or indirectly, from payments under the contract.
(iv) Pricing method. Pricing based on the capital and generating
costs of a particular turbine tends to indicate that output under the
contract is properly allocated to that turbine.
(3) Transmission and distribution contracts. Whether use under an
output contract for transmission or distribution is allocated to a
particular facility or to a transmission or distribution
[[Page 40]]
network is based on all the facts and circumstances, in a manner similar
to paragraphs (h)(1) and (2) of this section. In general, the method
used to determine payments under a contract is a more significant
contract term for this purpose than nominal contract path. In general,
if reasonable and consistently applied, the determination of use of
transmission or distribution facilities under an output contract may be
based on a method used by third parties, such as reliability councils.
(4) Allocation of payments. Payments for output provided by an
output facility financed with two or more sources of funding are
generally allocated under the rules in Sec. 1.141-4(c).
(i) Examples. The following examples illustrate the application of
this section:
Example 1 Joint ownership. Z, an investor-owned electric utility,
and City H agree to construct an electric generating facility of a size
sufficient to take advantage of the economies of scale. H will issue $50
million of its 24-year bonds, and Z will use $100 million of its funds
for construction of a facility they will jointly own as tenants in
common. Each of the participants will share in the ownership, output,
and operating expenses of the facility in proportion to its contribution
to the cost of the facility, that is, one-third by H and two-thirds by
Z. H's bonds will be secured by H's ownership interest in the facility
and by revenues to be derived from its share of the annual output of the
facility. H will need only 50 percent of its share of the annual output
of the facility during the first 20 years of operations. It agrees to
sell 10 percent of its share of the annual output to Z for a period of
20 years pursuant to a contract under which Z agrees to take that power
if available. The facility will begin operation, and Z will begin to
receive power, 4 years after the H bonds are issued. The measurement
period for the property financed by the issue is 20 years. H also will
sell the remaining 40 percent of its share of the annual output to
numerous other private utilities under contracts of three years or less
that satisfy the exception under paragraph (f)(3) of this section. No
other contracts will be executed obligating any person to purchase any
specified amount of the power for any specified period of time. No
person (other than Z) will make payments that will result in a transfer
of the burdens of paying debt service on bonds used directly or
indirectly to provide H's share of the facilities. The bonds are not
private activity bonds, because H's one-third interest in the facility
is not treated as used by the other owners of the facility. Although 10
percent of H's share of the annual output of the facility will be used
in the trade or business of Z, a nongovernmental person, under this
section, that portion constitutes not more than 10 percent of the
available output of H's ownership interest in the facility.
Example 2 Wholesale requirements contract. (i) City J issues 20-year
bonds to acquire an electric generating facility having a reasonably
expected economic life substantially greater than 20 years and a
nameplate capacity of 100 MW. The available output of the facility under
paragraph (b)(1) of this section is approximately 17,520,000 MWh (100 MW
x 24 hours x 365 days x 20 years). On the issue date, J enters into a
contract with T, an investor-owned utility, to provide T with all of its
power requirements for a period of 10 years, commencing on the issue
date. J reasonably expects that T will actually purchase an average of
30 MW over the 10-year period. The contract is taken into account under
the private business tests pursuant to paragraph (c)(3) of this section
because the term of the contract is substantial relative to the term of
the issue and the amount of output to be purchased is a substantial
portion of the available output.
(ii) Under paragraph (d) of this section, the amount of reasonably
expected private business use under this contract is approximately 15
percent (30 MW x 24 hours x 365 days x 10 years, or 2,628,000 MWh) of
the available output. Accordingly, the issue meets the private business
use test. J reasonably expects that the amount to be paid for an average
of 30 MW of power (less the operation and maintenance costs directly
attributable to generating that 30 MW of power), will be more than 10
percent of debt service on the issue on a present-value basis.
Accordingly, the issue meets the private security or payment test
because J reasonably expects that payment of more than 10 percent of the
debt service will be indirectly derived from payments by T. The bonds
are private activity bonds under paragraph (c) of this section. Further,
if 15 percent of the sale proceeds of the issue is greater than $15
million and the issue meets the private security or payment test with
respect to the $15 million output limitation, the bonds are also private
activity bonds under section 141(b)(4). See Sec. 1.141-8.
Example 3 Retail contracts. (i) State Agency M, a political
subdivision, issues bonds in 2003 to finance the construction of a
generating facility that will be used to furnish electricity to M's
retail customers. In 2007, M enters into a 10-year contract with
industrial corporation I. Under the contract, M agrees to supply I with
all of its power requirements during the contract term, and I agrees to
pay for that power at a negotiated price as it is delivered. The
contract does not require I to pay for any power except to the
[[Page 41]]
extent I has requirements. In addition, the contract requires I to pay
reasonable and customary liquidated damages in the event of a default by
I, and permits I to terminate the contract while it has requirements by
paying M a specified amount that is a reasonable and customary amount
for terminating the contract. Any damages or termination payment by I
will be reasonably related to I's obligation to buy requirements that is
discharged by the payment. Under paragraph (c)(3) of this section, the
contract does not meet the benefits and burdens test. Thus, it is not
taken into account under the private business tests.
(ii) The facts are the same as in paragraph (i) of this Example 3,
except that the contract requires I to make guaranteed minimum payments,
regardless of I's requirements, in an amount such that the contract does
not meet the exception for small purchases in paragraph (f)(1) of this
section. Under paragraph (c)(3)(ii) of this section, the contract meets
the benefits and burdens test because it obligates I to make payments
that are not contingent on its output requirements. Thus, it is taken
into account under the private business tests.
Example 4 Allocation of existing contracts to new facilities. Power
Authority K, a political subdivision created by the legislature in State
X to own and operate certain power generating facilities, sells all of
the power from its existing facilities to four private utility systems
under contracts executed in 1999, under which the four systems are
required to take or pay for specified portions of the total power output
until the year 2029. Existing facilities supply all of the present needs
of the four utility systems, but their future power requirements are
expected to increase substantially beyond the capacity of K's current
generating system. K issues 20-year bonds in 2004 to construct a large
generating facility. As part of the financing plan for the bonds, a
fifth private utility system contracts with K to take or pay for 15
percent of the available output of the new facility. The balance of the
output of the new facility will be available for sale as required, but
initially it is not anticipated that there will be any need for that
power. The revenues from the contract with the fifth private utility
system will be sufficient to pay less than 10 percent of the debt
service on the bonds (determined on a present value basis). The balance,
which will exceed 10 percent of the debt service on the bonds, will be
paid from revenues derived from the contracts with the four systems
initially from sale of power produced by the old facilities. The output
contracts with all the private utilities are allocated to K's entire
generating system. See paragraphs (h)(1) and (2) of this section. Thus,
the bonds meet the private business use test because more than 10
percent of the proceeds will be used in the trade or business of a
nongovernmental person. In addition, the bonds meet the private security
or payment test because payment of more than 10 percent of the debt
service, pursuant to underlying arrangements, will be derived from
payments in respect of property used for a private business use.
Example 5 Allocation to displaced resource. Municipal utility MU, a
political subdivision, purchases all of the electricity required to meet
the needs of its customers (1,000 MW) from B, an investor-owned utility
that operates its own electric generating facilities, under a 50-year
take or pay contract. MU does not anticipate that it will require
additional electric resources, and any new resources would produce
electricity at a higher cost to MU than its cost under its contract with
B. Nevertheless, B encourages MU to construct a new generating plant
sufficient to meet MU's requirements. MU issues obligations to construct
facilities that will produce 1,000 MW of electricity. MU, B, and I,
another investor-owned utility, enter into an agreement under which MU
assigns to I its rights under MU's take or pay contract with B. Under
this arrangement, I will pay MU, and MU will continue to pay B, for the
1,000 MW. I's payments to MU will at least equal the amounts required to
pay debt service on MU's bonds. In addition, under paragraph (h)(1)(iii)
of this section, the contract among MU, B, and I is entered into as part
of a common plan of financing of the MU facilities. Under all the facts
and circumstances, MU's assignment to I of its rights under the original
take or pay contract is allocable to MU's new facilities under paragraph
(h) of this section. Because I is a nongovernmental person, MU's bonds
are private activity bonds.
Example 6 Operation of transmission facilities by regional
transmission organization. (i) Public Power Agency D is a political
subdivision that owns and operates electric generation, transmission and
distribution facilities. In 2003, D transfers operating control of its
transmission system to a regional transmission organization (RTO), a
nongovernmental person, pursuant to an operating agreement that is
approved by the FERC under sections 205 and 206 of the Federal Power
Act. D retains ownership of its facilities. No portion of the RTO's
compensation is based on a share of net profits from the operation of
D's facilities, and the RTO does not bear any risk of loss of those
facilities. Under paragraph (g)(1)(ii) of this section, the RTO's use of
D's facilities does not constitute a private business use.
(ii) Company A is located in D's service territory. In 2004, Power
Supplier E, a nongovernmental person, enters into a 10-year contract
with A to supply A's electricity requirements. The electricity supplied
by E to A will be transmitted over D's transmission and distribution
facilities. D's distribution
[[Page 42]]
facilities are available for use on a nondiscriminatory, open access
basis by buyers and sellers of electricity in accordance with rates that
are generally applicable and uniformly applied within the meaning of
Sec. 1.141-3(c)(2). D's facilities are not financed for a principal
purpose of providing the facilities for use by E. Under paragraph (g)(2)
of this section, the contract between A and E does not result in private
business use of D's facilities.
Example 7 Certain actions not treated as deliberate actions. The
facts are the same as in Example 6 of this paragraph (i), except that
the RTO's compensation is based on a share of net profits from operating
D's facilities. In addition, D had issued bonds in 1994 to finance
improvements to its transmission system. At the time D transfers
operating control of its transmission system to the RTO, D chooses to
apply the private activity bond regulations of Sec. Sec. 1.141-1
through 1.141-15 to the 1994 bonds. The operation of D's facilities by
the RTO results in private business use under Sec. 1.141-3 and
paragraph (g)(1)(i) of this section. Under the special exception in
paragraph (g)(4)(ii) of this section, however, the transfer of control
is not treated as a deliberate action. Accordingly, the transfer of
control does not cause the 1994 bonds to meet the private activity bond
tests.
Example 8 Current refunding. The facts are the same as in Example 7
of this paragraph (i), and in addition D issues bonds in 2004 to
currently refund the 1994 bonds. The weighted average maturity of the
2004 bonds is not greater than the remaining weighted average maturity
of the 1994 bonds. D chooses to apply the private activity bond
regulations of Sec. Sec. 1.141-1 through 1.141-15 to the refunding
bonds. In general, reasonable expectations must be separately tested on
the date that refunding bonds are issued under Sec. 1.141-2(d). Under
the special exception in paragraph (g)(4)(iii) of this section, however,
the transfer of the financed facilities to the RTO need not be taken
into account in applying the reasonable expectations test to the
refunding bonds.
[T.D. 9016, 67 FR 59759, Sept. 23, 2002; 67 FR 70845, Nov. 27, 2002]
Sec. 1.141-8 $15 million limitation for output facilities.
(a) In general--(1) General rule. Section 141(b)(4) provides a
special private activity bond limitation (the $15 million output
limitation) for issues 5 percent or more of the proceeds of which are to
be used to finance output facilities (other than a facility for the
furnishing of water). Under this rule, an issue consists of private
activity bonds under the private business tests of section 141(b)(1) and
(2) if the nonqualified amount with respect to output facilities
financed by the proceeds of the issue exceeds $15 million. The $15
million output limitation applies in addition to the private business
tests of section 141(b)(1) and (2). Under section 141(b)(4) and
paragraph (a)(2) of this section, the $15 million output limitation is
reduced in certain cases. Specifically, an issue meets the test in
section 141(b)(4) if both of the following tests are met:
(i) More than $15 million of the proceeds of the issue to be used
with respect to an output facility are to be used for a private business
use. Investment proceeds are disregarded for this purpose if they are
not allocated disproportionately to the private business use portion of
the issue.
(ii) The payment of the principal of, or the interest on, more than
$15 million of the sale proceeds of the portion of the issue used with
respect to an output facility is (under the terms of the issue or any
underlying arrangement) directly or indirectly--
(A) Secured by any interest in an output facility used or to be used
for a private business use (or payments in respect of such an output
facility); or
(B) To be derived from payments (whether or not to the issuer) in
respect of an output facility used or to be used for a private business
use.
(2) Reduction in $15 million output limitation for outstanding
issues--(i) General rule. In determining whether an issue 5 percent or
more of the proceeds of which are to be used with respect to an output
facility consists of private activity bonds under the $15 million output
limitation, the $15 million limitation on private business use and
private security or payments is applied by taking into account the
aggregate nonqualified amounts of any outstanding bonds of other issues
5 percent or more of the proceeds of which are or will be used with
respect to that output facility or any other output facility that is
part of the same project.
(ii) Bonds taken into account. For purposes of this paragraph
(a)(2), in applying the $15 million output limitation to an issue (the
later issue), a tax-exempt bond of another issue (the earlier issue) is
taken into account if--
[[Page 43]]
(A) That bond is outstanding on the issue date of the later issue;
(B) That bond will not be redeemed within 90 days of the issue date
of the later issue in connection with the refunding of that bond by the
later issue; and
(C) 5 percent or more of the sale proceeds of the earlier issue
financed an output facility that is part of the same project as the
output facility that is financed by 5 percent or more of the sale
proceeds of the later issue.
(3) Benefits and burdens test applicable--(i) In general. In
applying the $15 million output limitation, the benefits and burdens
test of Sec. 1.141-7 applies, except that ``$15 million'' is applied in
place of ``10 percent'', or ``5 percent'' as appropriate.
(ii) Earlier issues for the project. If bonds of an earlier issue
are outstanding and must be taken into account under paragraph (a)(2) of
this section, the nonqualified amount for that earlier issue is
multiplied by a fraction, the numerator of which is the adjusted issue
price of the earlier issue as of the issue date of the later issue, and
the denominator of which is the issue price of the earlier issue. Pre-
issuance accrued interest as defined in Sec. 1.148-1(b) is disregarded
for this purpose.
(b) Definition of project--(1) General rule. For purposes of
paragraph (a)(2) of this section, project has the meaning provided in
this paragraph. Facilities that are functionally related and subordinate
to a project are treated as part of that same project. Facilities having
different purposes or serving different customer bases are not
ordinarily part of the same project. For example, the following are
generally not part of the same project--
(i) Generation, transmission and distribution facilities;
(ii) Separate facilities designed to serve wholesale customers and
retail customers; and
(iii) A peaking unit and a baseload unit (regardless of the location
of the units).
(2) Separate ownership. Except as otherwise provided in this
paragraph (b)(2), facilities that are not owned by the same person are
not part of the same project. If different governmental persons act in
concert to finance a project, however (for example as participants in a
joint powers authority), their interests are aggregated with respect to
that project to determine whether the $15 million output limitation is
met. In the case of undivided ownership interests in a single output
facility, property that is not owned by different persons is treated as
separate projects only if the separate interests are financed--
(i) With bonds of different issuers; and
(ii) Without a principal purpose of avoiding the limitation in this
section.
(3) Generating property--(i) Property on same site. In the case of
generation and related facilities, project means property located at the
same site.
(ii) Special rule for generating units. Separate generating units
are not part of the same project if one unit is reasonably expected, on
the issue date of each issue that finances the units, to be placed in
service more than 3 years before the other. Common facilities or
property that will be functionally related to more than one generating
unit must be allocated on a reasonable basis. If a generating unit
already is constructed or is under construction (the first unit) and
bonds are to be issued to finance an additional generating unit (the
second unit), all costs for any common facilities paid or incurred
before the earlier of the issue date of bonds to finance the second unit
or the commencement of construction of the second unit are allocated to
the first unit. At the time that bonds are issued to finance the second
unit (or, if earlier, upon commencement of construction of that unit),
any remaining costs of the common facilities may be allocated between
the first and second units so that in the aggregate the allocation is
reasonable.
(4) Transmission and distribution. In the case of transmission or
distribution facilities, project means functionally related or
contiguous property. Separate transmission or distribution facilities
are not part of the same project if one facility is reasonably expected,
on the issue date of each issue that finances the facilities, to be
placed in service more than 2 years before the other.
[[Page 44]]
(5) Subsequent improvements--(i) In general. An improvement to
generation, transmission or distribution facilities that is not part of
the original design of those facilities (the original project) is not
part of the same project as the original project if the construction,
reconstruction, or acquisition of that improvement commences more than 3
years after the original project was placed in service and the bonds
issued to finance that improvement are issued more than 3 years after
the original project was placed in service.
(ii) Special rule for transmission and distribution facilities. An
improvement to transmission or distribution facilities that is not part
of the original design of that property is not part of the same project
as the original project if the issuer did not reasonably expect the need
to make that improvement when it commenced construction of the original
project and the construction, reconstruction, or acquisition of that
improvement is mandated by the federal government or a state regulatory
authority to accommodate requests for wheeling.
(6) Replacement property. For purposes of this section, property
that replaces existing property of an output facility is treated as part
of the same project as the replaced property unless--
(i) The need to replace the property was not reasonably expected on
the issue date or the need to replace the property occurred more than 3
years before the issuer reasonably expected (determined on the issue
date of the bonds financing the property) that it would need to replace
the property; and
(ii) The bonds that finance (and refinance) the output facility have
a weighted average maturity that is not greater than 120 percent of the
reasonably expected economic life of the facility.
(c) Example. The application of the provisions of this section is
illustrated by the following example:
Example. (i) Power Authority K, a political subdivision, intends to
issue a single issue of tax-exempt bonds at par with a stated principal
amount and sale proceeds of $500 million to finance the acquisition of
an electric generating facility. No portion of the facility will be used
for a private business use, except that L, an investor-owned utility,
will purchase 10 percent of the output of the facility under a take
contract and will pay 10 percent of the debt service on the bonds. The
nonqualified amount with respect to the bonds is $50 million.
(ii) The maximum amount of tax-exempt bonds that may be issued for
the acquisition of an interest in the facility in paragraph (i) of this
Example is $465 million (that is, $450 million for the 90 percent of the
facility that is governmentally owned and used plus a nonqualified
amount of $15 million).
[T.D. 9016, 67 FR 59763, Sept. 23, 2002]
Sec. 1.141-9 Unrelated or disproportionate use test.
(a) General rules--(1) Description of test. Under section 141(b)(3)
(the unrelated or disproportionate use test), an issue meets the private
business tests if the amount of private business use and private
security or payments attributable to unrelated or disproportionate
private business use exceeds 5 percent of the proceeds of the issue. For
this purpose, the private business use test is applied by taking into
account only use that is not related to any government use of proceeds
of the issue (unrelated use) and use that is related but
disproportionate to any government use of those proceeds
(disproportionate use).
(2) Application of unrelated or disproportionate use test--(i) Order
of application. The unrelated or disproportionate use test is applied by
first determining whether a private business use is related to a
government use. Next, private business use that relates to a government
use is examined to determine whether it is disproportionate to that
government use.
(ii) Aggregation of unrelated and disproportionate use. All the
unrelated use and disproportionate use financed with the proceeds of an
issue are aggregated to determine compliance with the unrelated or
disproportionate use test. The amount of permissible unrelated and
disproportionate private business use is not reduced by the amount of
private business use financed with the proceeds of an issue that is
neither unrelated use nor disproportionate use.
(iii) Deliberate actions. A deliberate action that occurs after the
issue date does not result in unrelated or disproportionate use if the
issue meets the conditions of Sec. 1.141-12(a).
[[Page 45]]
(b) Unrelated use--(1) In general. Whether a private business use is
related to a government use financed with the proceeds of an issue is
determined on a case-by-case basis, emphasizing the operational
relationship between the government use and the private business use. In
general, a facility that is used for a related private business use must
be located within, or adjacent to, the governmentally used facility.
(2) Use for the same purpose as government use. Use of a facility by
a nongovernmental person for the same purpose as use by a governmental
person is not treated as unrelated use if the government use is not
insignificant. Similarly, a use of a facility in the same manner both
for private business use that is related use and private business use
that is unrelated use does not result in unrelated use if the related
use is not insignificant. For example, a privately owned pharmacy in a
governmentally owned hospital does not ordinarily result in unrelated
use solely because the pharmacy also serves individuals not using the
hospital. In addition, use of parking spaces in a garage by a
nongovernmental person is not treated as unrelated use if more than an
insignificant portion of the parking spaces are used for a government
use (or a private business use that is related to a government use),
even though the use by the nongovernmental person is not directly
related to that other use.
(c) Disproportionate use--(1) Definition of disproportionate use. A
private business use is disproportionate to a related government use
only to the extent that the amount of proceeds used for that private
business use exceeds the amount of proceeds used for the related
government use. For example, a private use of $100 of proceeds that is
related to a government use of $70 of proceeds results in $30 of
disproportionate use.
(2) Aggregation of related uses. If two or more private business
uses of the proceeds of an issue relate to a single government use of
those proceeds, those private business uses are aggregated to apply the
disproportionate use test.
(3) Allocation rule. If a private business use relates to more than
a single use of the proceeds of the issue (for example, two or more
government uses of the proceeds of the issue or a government use and a
private use), the amount of any disproportionate use may be determined
by--
(i) Reasonably allocating the proceeds used for the private business
use among the related uses;
(ii) Aggregating government uses that are directly related to each
other; or
(iii) Allocating the private business use to the government use to
which it is primarily related.
(d) Maximum use taken into account. The determination of the amount
of unrelated use or disproportionate use of a facility is based on the
maximum amount of reasonably expected government use of a facility
during the measurement period. Thus, no unrelated use or
disproportionate use arises solely because a facility initially has
excess capacity that is to be used by a nongovernmental person if the
facility will be completely used by the issuer during the term of the
issue for more than an insignificant period.
(e) Examples. The following examples illustrate the application of
this section:
Example 1. School and remote cafeteria. County X issues bonds with
proceeds of $20 million and uses $18.1 million of the proceeds for
construction of a new school building and $1.9 million of the proceeds
for construction of a privately operated cafeteria in its administrative
office building, which is located at a remote site. The bonds are
secured, in part, by the cafeteria. The $1.9 million of proceeds is
unrelated to the government use (that is, school construction) financed
with the bonds and exceeds 5 percent of $20 million. Thus, the issue
meets the private business tests.
Example 2. Public safety building and courthouse. City Y issues
bonds with proceeds of $50 million for construction of a new public
safety building ($32 million) and for improvements to an existing
courthouse ($15 million). Y uses $3 million of the bond proceeds for
renovations to an existing privately operated cafeteria located in the
courthouse. The bonds are secured, in part, by the cafeteria. Y's use of
the $3 million for the privately operated cafeteria does not meet the
unrelated or disproportionate use test because these expenditures are
neither unrelated use nor disproportionate use.
[[Page 46]]
Example 3. Unrelated garage. City Y issues bonds with proceeds of
$50 million for construction of a new public safety building ($30.5
million) and for improvements to an existing courthouse ($15 million). Y
uses $3 million of the bond proceeds for renovations to an existing
privately operated cafeteria located in the courthouse. The bonds are
secured, in part, by the cafeteria. Y also uses $1.5 million of the
proceeds to construct a privately operated parking garage adjacent to a
private office building. The private business use of the parking garage
is unrelated to any government use of proceeds of the issue. Since the
proceeds used for unrelated uses and disproportionate uses do not exceed
5 percent of the proceeds, the unrelated or disproportionate use test is
not met.
Example 4. Disproportionate use of garage. County Z issues bonds
with proceeds of $20 million for construction of a hospital with no
private business use ($17 million); renovation of an office building
with no private business use ($1 million); and construction of a garage
that is entirely used for a private business use ($2 million). The use
of the garage is related to the use of the office building but not to
the use of the hospital. The private business use of the garage results
in $1 million of disproportionate use because the proceeds used for the
garage ($2 million) exceed the proceeds used for the related government
use ($1 million). The bonds are not private activity bonds, however,
because the disproportionate use does not exceed 5 percent of the
proceeds of the issue.
Example 5. Bonds for multiple projects. (i) County W issues bonds
with proceeds of $80 million for the following purposes: (1) $72 million
to construct a County-owned and operated waste incinerator; (2) $1
million for a County-owned and operated facility for the temporary
storage of hazardous waste prior to final disposal; (3) $1 million to
construct a privately owned recycling facility located at a remote site;
and (4) $6 million to build a garage adjacent to the County-owned
incinerator that will be leased to Company T to store and repair trucks
that it owns and uses to haul County W refuse. Company T uses 75 percent
of its trucks to haul materials to the incinerator and the remaining 25
percent of its trucks to haul materials to the temporary storage
facility.
(ii) The $1 million of proceeds used for the recycling facility is
used for an unrelated use. The garage is related use. In addition, 75
percent of the use of the $6 million of proceeds used for the garage is
allocable to the government use of proceeds at the incinerator. The
remaining 25 percent of the proceeds used for the garage ($1.5 million)
relates to the government use of proceeds at the temporary storage
facility. Thus, this portion of the proceeds used for the garage exceeds
the proceeds used for the temporary storage facility by $0.5 million and
this excess is disproportionate use (but not unrelated use). Thus, the
aggregate amount of unrelated use and disproportionate use financed with
the proceeds of the issue is $1.5 million. Alternatively, under
paragraph (c)(3)(iii) of this section, the entire garage may be treated
as related to the government use of the incinerator and, under that
allocation, the garage is not disproportionate use. In either event,
section 141(b)(3) limits the aggregate unrelated use and
disproportionate use to $4 million. Therefore, the bonds are not private
activity bonds under this section.
[T.D. 8712, 62 FR 2297, Jan. 16, 1997]
Sec. 1.141-10 Coordination with volume cap. [Reserved]
Sec. 1.141-11 Acquisition of nongovernmental output property. [Reserved]
Sec. 1.141-12 Remedial actions.
(a) Conditions to taking remedial action. An action that causes an
issue to meet the private business tests or the private loan financing
test is not treated as a deliberate action if the issuer takes a
remedial action described in paragraph (d), (e), or (f) of this section
with respect to the nonqualified bonds and if all of the requirements in
paragraphs (a) (1) through (5) of this section are met.
(1) Reasonable expectations test met. The issuer reasonably expected
on the issue date that the issue would meet neither the private business
tests nor the private loan financing test for the entire term of the
bonds. For this purpose, if the issuer reasonably expected on the issue
date to take a deliberate action prior to the final maturity date of the
issue that would cause either the private business tests or the private
loan financing test to be met, the term of the bonds for this purpose
may be determined by taking into account a redemption provision if the
provisions of Sec. 1.141-2(d)(2)(ii) (A) through (C) are met.
(2) Maturity not unreasonably long. The term of the issue must not
be longer than is reasonably necessary for the governmental purposes of
the issue (within the meaning of Sec. 1.148-1(c)(4)). Thus, this
requirement is met if the weighted average maturity of the bonds of the
issue is not greater than 120 percent of the average reasonably expected
economic life of the property
[[Page 47]]
financed with the proceeds of the issue as of the issue date.
(3) Fair market value consideration. Except as provided in paragraph
(f) of this section, the terms of any arrangement that results in
satisfaction of either the private business tests or the private loan
financing test are bona fide and arm's-length, and the new user pays
fair market value for the use of the financed property. Thus, for
example, fair market value may be determined in a manner that takes into
account restrictions on the use of the financed property that serve a
bona fide governmental purpose.
(4) Disposition proceeds treated as gross proceeds for arbitrage
purposes. The issuer must treat any disposition proceeds as gross
proceeds for purposes of section 148. For purposes of eligibility for
temporary periods under section 148(c) and exemptions from the
requirement of section 148(f) the issuer may treat the date of receipt
of the disposition proceeds as the issue date of the bonds and disregard
the receipt of disposition proceeds for exemptions based on expenditure
of proceeds under Sec. 1.148-7 that were met before the receipt of the
disposition proceeds.
(5) Proceeds expended on a governmental purpose. Except for a
remedial action under paragraph (d) of this section, the proceeds of the
issue that are affected by the deliberate action must have been expended
on a governmental purpose before the date of the deliberate action.
(b) Effect of a remedial action--(1) In general. The effect of a
remedial action is to cure use of proceeds that causes the private
business use test or the private loan financing test to be met. A
remedial action does not affect application of the private security or
payment test.
(2) Effect on bonds that have been advance refunded. If proceeds of
an issue were used to advance refund another bond, a remedial action
taken with respect to the refunding bond proportionately reduces the
amount of proceeds of the advance refunded bond that is taken into
account under the private business use test or the private loan
financing test.
(c) Disposition proceeds--(1) Definition. Disposition proceeds are
any amounts (including property, such as an agreement to provide
services) derived from the sale, exchange, or other disposition
(disposition) of property (other than investments) financed with the
proceeds of an issue.
(2) Allocating disposition proceeds to an issue. In general, if the
requirements of paragraph (a) of this section are met, after the date of
the disposition, the proceeds of the issue allocable to the transferred
property are treated as financing the disposition proceeds rather than
the transferred property. If a disposition is made pursuant to an
installment sale, the proceeds of the issue continue to be allocated to
the transferred property. If an issue does not meet the requirements for
remedial action in paragraph (a) of this section or the issuer does not
take an appropriate remedial action, the proceeds of the issue are
allocable to either the transferred property or the disposition
proceeds, whichever allocation produces the greater amount of private
business use and private security or payments.
(3) Allocating disposition proceeds to different sources of funding.
If property has been financed by different sources of funding, for
purposes of this section, the disposition proceeds from that property
are first allocated to the outstanding bonds that financed that property
in proportion to the principal amounts of those outstanding bonds. In no
event may disposition proceeds be allocated to bonds that are no longer
outstanding or to a source of funding not derived from a borrowing (such
as revenues of the issuer) if the disposition proceeds are not greater
than the total principal amounts of the outstanding bonds that are
allocable to that property. For purposes of this paragraph (c)(3),
principal amount has the same meaning as in Sec. 1.148-9(b)(2) and
outstanding bonds do not include advance refunded bonds.
(d) Redemption or defeasance of nonqualified bonds--(1) In general.
The requirements of this paragraph (d) are met if all of the
nonqualified bonds of the issue are redeemed. Proceeds of tax-exempt
bonds must not be used for this purpose, unless the tax-exempt bonds are
qualified bonds, taking into account the purchaser's use of the
facility. If the bonds are not redeemed
[[Page 48]]
within 90 days of the date of the deliberate action, a defeasance escrow
must be established for those bonds within 90 days of the deliberate
action.
(2) Special rule for dispositions for cash. If the consideration for
the disposition of financed property is exclusively cash, the
requirements of this paragraph (d) are met if the disposition proceeds
are used to redeem a pro rata portion of the nonqualified bonds at the
earliest call date after the deliberate action. If the bonds are not
redeemed within 90 days of the date of the deliberate action, the
disposition proceeds must be used to establish a defeasance escrow for
those bonds within 90 days of the deliberate action.
(3) Notice of defeasance. The issuer must provide written notice to
the Commissioner of the establishment of the defeasance escrow within 90
days of the date the defeasance escrow is established.
(4) Special limitation. The establishment of a defeasance escrow
does not satisfy the requirements of this paragraph (d) if the period
between the issue date and the first call date of the bonds is more than
10\1/2\ years.
(5) Defeasance escrow defined. A defeasance escrow is an irrevocable
escrow established to redeem bonds on their earliest call date in an
amount that, together with investment earnings, is sufficient to pay all
the principal of, and interest and call premium on, bonds from the date
the escrow is established to the earliest call date. The escrow may not
be invested in higher yielding investments or in any investment under
which the obligor is a user of the proceeds of the bonds.
(e) Alternative use of disposition proceeds--(1) In general. The
requirements of this paragraph (e) are met if--
(i) The deliberate action is a disposition for which the
consideration is exclusively cash;
(ii) The issuer reasonably expects to expend the disposition
proceeds within two years of the date of the deliberate action;
(iii) The disposition proceeds are treated as proceeds for purposes
of section 141 and are used in a manner that does not cause the issue to
meet either the private business tests or the private loan financing
test, and the issuer does not take any action subsequent to the date of
the deliberate action to cause either of these tests to be met; and
(iv) If the issuer does not use all of the disposition proceeds for
an alternative use described in paragraph (e)(1)(iii) of this section,
the issuer uses those remaining disposition proceeds for a remedial
action that meets paragraph (d) of this section.
(2) Special rule for use by 501(c)(3) organizations. If the
disposition proceeds are to be used by a 501(c)(3) organization, the
nonqualified bonds must in addition be treated as reissued for purposes
of sections 141, 145, 147, 149, and 150 and, under this treatment,
satisfy all of the applicable requirements for qualified 501(c)(3)
bonds. Thus, beginning on the date of the deliberate action,
nonqualified bonds that satisfy these requirements must be treated as
qualified 501(c)(3) bonds for all purposes, including sections 145(b)
and 150(b).
(f) Alternative use of facility. The requirements of this paragraph
(f) are met if--
(1) The facility with respect to which the deliberate action occurs
is used in an alternative manner (for example, used for a qualifying
purpose by a nongovernmental person or used by a 501(c)(3) organization
rather than a governmental person);
(2) The nonqualified bonds are treated as reissued, as of the date
of the deliberate action, for purposes of sections 55 through 59 and
141, 142, 144, 145, 146, 147, 149 and 150, and under this treatment, the
nonqualified bonds satisfy all the applicable requirements for qualified
bonds throughout the remaining term of the nonqualified bonds;
(3) The deliberate action does not involve a disposition to a
purchaser that finances the acquisition with proceeds of another issue
of tax-exempt bonds; and
(4) Any disposition proceeds other than those arising from an
agreement to provide services (including disposition proceeds from an
installment sale) resulting from the deliberate action are used to pay
the debt service on the bonds on the next available payment date or,
within 90 days of receipt, are
[[Page 49]]
deposited into an escrow that is restricted to the yield on the bonds to
pay the debt service on the bonds on the next available payment date.
(g) Rules for deemed reissuance. For purposes of determining whether
bonds that are treated as reissued under paragraphs (e) and (f) of this
section are qualified bonds--
(1) The provisions of the Code and regulations thereunder in effect
as of the date of the deliberate action apply; and
(2) For purposes of paragraph (f) of this section, section 147(d)
(relating to the acquisition of existing property) does not apply.
(h) Authority of Commissioner to provide for additional remedial
actions. The Commissioner may, by publication in the Federal Register or
the Internal Revenue Bulletin, provide additional remedial actions,
including making a remedial payment to the United States, under which a
subsequent action will not be treated as a deliberate action for
purposes of Sec. 1.141-2.
(i) Effect of remedial action on continuing compliance. Solely for
purposes of determining whether deliberate actions that are taken after
a remedial action cause an issue to meet the private business tests or
the private loan financing test--
(1) If a remedial action is taken under paragraph (d), (e), or (f)
of this section, the private business use or private loans resulting
from the deliberate action are not taken into account for purposes of
determining whether the bonds are private activity bonds; and
(2) After a remedial action is taken, the amount of disposition
proceeds is treated as equal to the proceeds of the issue that had been
allocable to the transferred property immediately prior to the
disposition. See paragraph (k) of this section, Example 5.
(j) Nonqualified bonds--(1) Amount of nonqualified bonds. The
percentage of outstanding bonds that are nonqualified bonds equals the
highest percentage of private business use in any 1-year period
commencing with the deliberate action.
(2) Allocation of nonqualified bonds. Allocations to nonqualified
bonds must be made on a pro rata basis, except that, for purposes of
paragraph (d) of this section (relating to redemption or defeasance), an
issuer may treat bonds with longer maturities (determined on a bond-by-
bond basis) as the nonqualified bonds.
(k) Examples. The following examples illustrate the application of
this section:
Example 1 Disposition proceeds less than outstanding bonds used to
retire bonds. On June 1, 1997, City C issues 30-year bonds with an issue
price of $10 million to finance the construction of a hospital building.
The bonds have a weighted average maturity that does not exceed 120
percent of the reasonably expected economic life of the building. On the
issue date, C reasonably expects that it will be the only user of the
building for the entire term of the bonds. Six years after the issue
date, C sells the building to Corporation P for $5 million. The sale
price is the fair market value of the building, as verified by an
independent appraiser. C uses all of the $5 million disposition proceeds
to immediately retire a pro rata portion of the bonds. The sale does not
cause the bonds to be private activity bonds because C has taken a
remedial action described in paragraph (d) of this section so that P is
not treated as a private business user of bond proceeds.
Example 2. Lease to nongovernmental person. The facts are the same
as in Example 1, except that instead of selling the building, C, 6 years
after the issue date, leases the building to P for 7 years and uses
other funds to redeem all of the $10 million outstanding bonds within 90
days of the deliberate act. The bonds are not treated as private
activity bonds because C has taken the remedial action described in
paragraph (d) of this section.
Example 3. Sale for less than fair market value. The facts are the
same as in Example 1, except that the fair market value of the building
at the time of the sale to P is $6 million. Because the transfer was for
less than fair market value, the bonds are ineligible for the remedial
actions under this section. The bonds are private activity bonds because
P is treated as a user of all of the proceeds and P makes a payment ($6
million) for this use that is greater than 10 percent of the debt
service on the bonds, on a present value basis.
Example 4. Fair market value determined taking into account
governmental restrictions. The facts are the same as in Example 1,
except that the building was used by C only for hospital purposes and C
determines to sell the building subject to a restriction that it be used
only for hospital purposes. After conducting a public bidding procedure
as required by state law, the best price that C is able to obtain for
the building subject to this
[[Page 50]]
restriction is $4.5 million from P. C uses all of the $4.5 million
disposition proceeds to immediately retire a pro rata portion of the
bonds. The sale does not cause the bonds to be private activity bonds
because C has taken a remedial action described in paragraph (d) of this
section so that P is not treated as a private business user of bond
proceeds.
Example 5. Alternative use of disposition proceeds. The facts are
the same as in Example 1, except that C reasonably expects on the date
of the deliberate action to use the $5 million disposition proceeds for
another governmental purpose (construction of governmentally owned
roads) within two years of receipt, rather than using the $5 million to
redeem outstanding bonds. C treats these disposition proceeds as gross
proceeds for purposes of section 148. The bonds are not private activity
bonds because C has taken a remedial action described in paragraph (e)
of this section. After the date of the deliberate action, the proceeds
of all of the outstanding bonds are treated as used for the construction
of the roads, even though only $5 million of disposition proceeds was
actually used for the roads.
Example 6. Alternative use of financed property. The facts are the
same as in Example 1, except that C determines to lease the hospital
building to Q, an organization described in section 501(c)(3), for a
term of 10 years rather than to sell the building to P. In order to
induce Q to provide hospital services, C agrees to lease payments that
are less than fair market value. Before entering into the lease, an
applicable elected representative of C approves the lease after a
noticed public hearing. As of the date of the deliberate action, the
issue meets all the requirements for qualified 501(c)(3) bonds, treating
the bonds as reissued on that date. For example, the issue meets the two
percent restriction on use of proceeds of finance issuance costs of
section 147(g) because the issue pays no costs of issuance from
disposition proceeds in connection with the deemed reissuance. C and Q
treat the bonds as qualified 501(c)(3) bonds for all purposes commencing
with the date of the deliberate action. The bonds are treated as
qualified 501(c)(3) bonds commencing with the date of the deliberate
action.
Example 7. Deliberate action before proceeds are expended on a
governmental purpose. County J issues bonds with proceeds of $10 million
that can be used only to finance a correctional facility. On the issue
date of the bonds, J reasonably expects that it will be the sole user of
the bonds for the useful life of the facility. The bonds have a weighted
average maturity that does not exceed 120 percent of the reasonably
expected economic life of the facility. After the issue date of the
bonds, but before the facility is placed in service, J enters into a
contract with the federal government pursuant to which the federal
government will make a fair market value, lump sum payment equal to 25
percent of the cost of the facility. In exchange for this payment, J
provides the federal government with priority rights to use of 25
percent of the facility. J uses the payment received from the federal
government to defease the nonqualified bonds. The agreement does not
cause the bonds to be private activity bonds because J has taken a
remedial action described in paragraph (d) of this section. See
paragraph (a)(5) of this section.
Example 8. Compliance after remedial action. In 1997, City G issues
bonds with proceeds of $10 million to finance a courthouse. The bonds
have a weighted average maturity that does not exceed 120 percent of the
reasonably expected economic life of the courthouse. G uses $1 million
of the proceeds for a private business use and more than 10 percent of
the debt service on the issue is secured by private security or
payments. G later sells one-half of the courthouse property to a
nongovernmental person for cash. G immediately redeems 60 percent of the
outstanding bonds. This percentage of outstanding bonds is based on the
highest private business use of the courthouse in any 1-year period
commencing with the deliberate action. For purposes of subsequently
applying section 141 to the issue, G may continue to use all of the
proceeds of the outstanding bonds in the same manner (that is, for both
the courthouse and the existing private business use) without causing
the issue to meet the private business use test. The issue, however,
continues to meet the private security or payment test. The result would
be the same if D, instead of redeeming the bonds, established a
defeasance escrow for those bonds, provided that the requirement of
paragraph (d)(4) of this section was met.
[T.D. 8712, 62 FR 2298, Jan. 16, 1997]
Sec. 1.141-13 Refunding issues.
(a) In general. Except as provided in this section, a refunding
issue and a prior issue are tested separately under section 141. Thus,
the determination of whether a refunding issue consists of private
activity bonds generally does not depend on whether the prior issue
consists of private activity bonds.
(b) Application of private business use test and private loan
financing test--(1) Allocation of proceeds. In applying the private
business use test and the private loan financing test to a refunding
issue, the proceeds of the refunding issue are allocated to the same
expenditures and purpose investments as the proceeds of the prior issue.
[[Page 51]]
(2) Determination of amount of private business use--(i) In general.
Except as provided in paragraph (b)(2)(ii) of this section, the amount
of private business use of a refunding issue is determined under Sec.
1.141-3(g), based on the measurement period for that issue (for example,
without regard to any private business use that occurred prior to the
issue date of the refunding issue).
(ii) Refundings of governmental bonds. In applying the private
business use test to a refunding issue that refunds a prior issue of
governmental bonds, the amount of private business use of the refunding
issue is the amount of private business use--
(A) During the combined measurement period; or
(B) At the option of the issuer, during the period described in
paragraph (b)(2)(i) of this section, but only if, without regard to the
reasonable expectations test of Sec. 1.141-2(d), the prior issue does
not satisfy the private business use test, based on a measurement period
that begins on the first day of the combined measurement period and ends
on the issue date of the refunding issue.
(iii) Combined measurement period--(A) In general. Except as
provided in paragraph (b)(2)(iii)(B) of this section, the combined
measurement period is the period that begins on the first day of the
measurement period (as defined in Sec. 1.141-3(g)) for the prior issue
(or, in the case of a series of refundings of governmental bonds, the
first issue of governmental bonds in the series) and ends on the last
day of the measurement period for the refunding issue.
(B) Transition rule for refundings of bonds originally issued before
May 16, 1997. If the prior issue (or, in the case of a series of
refundings of governmental bonds, the first issue of governmental bonds
in the series) was issued before May 16, 1997, then the issuer, at its
option, may treat the combined measurement period as beginning on the
date (the transition date) that is the earlier of December 19, 2005 or
the first date on which the prior issue (or an earlier issue in the case
of a series of refundings of governmental bonds) became subject to the
1997 regulations (as defined in Sec. 1.141-15(b)). If the issuer treats
the combined measurement period as beginning on the transition date in
accordance with this paragraph (b)(2)(iii)(B), then paragraph (c)(2) of
this section shall be applied by treating the transition date as the
issue date of the earliest issue, by treating the bonds as reissued on
the transition date at an issue price equal to the value of the bonds
(as determined under Sec. 1.148-4(e)) on that date, and by disregarding
any private security or private payments before the transition date.
(iv) Governmental bond. For purposes of this section, the term
governmental bond means any bond that, when issued, purported to be a
governmental bond, as defined in Sec. 1.150-1(b), or a qualified
501(c)(3) bond, as defined in section 145(a).
(v) Special rule for refundings of qualified 501(c)(3) bonds with
governmental bonds. For purposes of applying this paragraph (b)(2) to a
refunding issue that refunds a qualified 501(c)(3) bond, any use of the
property refinanced by the refunding issue before the issue date of the
refunding issue by a 501(c)(3) organization with respect to its
activities that do not constitute an unrelated trade or business under
section 513(a) is treated as government use.
(c) Application of private security or payment test--(1) Separate
issue treatment. If the amount of private business use of a refunding
issue is determined based on the measurement period for that issue in
accordance with paragraph (b)(2)(i) or (b)(2)(ii)(B) of this section,
then the amount of private security and private payments allocable to
the refunding issue is determined under Sec. 1.141-4 by treating the
refunding issue as a separate issue.
(2) Combined issue treatment. If the amount of private business use
of a refunding issue is determined based on the combined measurement
period for that issue in accordance with paragraph (b)(2)(ii)(A) of this
section, then the amount of private security and private payments
allocable to the refunding issue is determined under Sec. 1.141-4 by
treating the refunding issue and all earlier issues taken into account
in determining the combined measurement period as a combined issue. For
this
[[Page 52]]
purpose, the present value of the private security and private payments
is compared to the present value of the debt service on the combined
issue (other than debt service paid with proceeds of any refunding
bond). Present values are computed as of the issue date of the earliest
issue taken into account in determining the combined measurement period
(the earliest issue). Except as provided in paragraph (c)(3) of this
section, present values are determined by using the yield on the
combined issue as the discount rate. The yield on the combined issue is
determined by taking into account payments on the refunding issue and
all earlier issues taken into account in determining the combined
measurement period (other than payments made with proceeds of any
refunding bond), and based on the issue price of the earliest issue. In
the case of a refunding of only a portion of the original principal
amount of a prior issue, the refunded portion of the prior issue is
treated as a separate issue and any private security or private payments
with respect to the prior issue are allocated ratably between the
combined issue and the unrefunded portion of the prior issue in a
consistent manner based on relative debt service. See paragraph
(b)(2)(iii)(B) of this section for special rules relating to certain
refundings of governmental bonds originally issued before May 16, 1997.
(3) Special rule for arrangements not entered into in contemplation
of the refunding issue. In applying the private security or payment test
to a refunding issue that refunds a prior issue of governmental bonds,
the issuer may use the yield on the prior issue to determine the present
value of private security and private payments under arrangements that
were not entered into in contemplation of the refunding issue. For this
purpose, any arrangement that was entered into more than 1 year before
the issue date of the refunding issue is treated as not entered into in
contemplation of the refunding issue.
(d) Multipurpose issue allocations--(1) In general. For purposes of
section 141, unless the context clearly requires otherwise, Sec. 1.148-
9(h) applies to allocations of multipurpose issues (as defined in Sec.
1.148-1(b)), including allocations involving the refunding purposes of
the issue. An allocation under this paragraph (d) may be made at any
time, but once made may not be changed. An allocation is not reasonable
under this paragraph (d) if it achieves more favorable results under
section 141 than could be achieved with actual separate issues. The
issue to be allocated and each of the separate issues under the
allocation must consist of one or more tax-exempt bonds. Allocations
made under this paragraph (d) and Sec. 1.148-9(h) must be consistent
for purposes of section 141 and section 148.
(2) Exceptions. This paragraph (d) does not apply for purposes of
sections 141(c)(1) and 141(d)(1).
(e) Application of reasonable expectations test to certain refunding
bonds. An action that would otherwise cause a refunding issue to satisfy
the private business tests or the private loan financing test is not
taken into account under the reasonable expectations test of Sec.
1.141-2(d) if--
(1) The action is not a deliberate action within the meaning of
Sec. 1.141-2(d)(3); and
(2) The weighted average maturity of the refunding bonds is not
greater than the weighted average reasonably expected economic life of
the property financed by the prior bonds.
(f) Special rule for refundings of certain general obligation bonds.
Notwithstanding any other provision of this section, a refunding issue
does not consist of private activity bonds if--
(1) The prior issue meets the requirements of Sec. 1.141-2(d)(5)
(relating to certain general obligation bond programs that finance a
large number of separate purposes); or
(2) The refunded portion of the prior issue is part of a series of
refundings of all or a portion of an issue that meets the requirements
of Sec. 1.141-2(d)(5).
(g) Examples. The following examples illustrate the application of
this section:
Example 1. Measuring private business use. In 2002, Authority A
issues tax-exempt bonds that mature in 2032 to acquire an office
building. The measurement period for the 2002 bonds under Sec. 1.141-
3(g) is 30 years. At the time A acquires the building, it enters into a
10-year lease with a nongovernmental person under which the
nongovernmental
[[Page 53]]
person will use 5 percent of the building in its trade or business
during each year of the lease term. In 2007, A issues bonds to refund
the 2002 bonds. The 2007 bonds mature on the same date as the 2002 bonds
and have a measurement period of 25 years under Sec. 1.141-3(g). Under
paragraph (b)(2)(ii)(A) of this section, the amount of private business
use of the proceeds of the 2007 bonds is 1.67 percent, which equals the
amount of private business use during the combined measurement period (5
percent of \1/3\ of the 30-year combined measurement period). In
addition, the 2002 bonds do not satisfy the private business use test,
based on a measurement period beginning on the first day of the
measurement period for the 2002 bonds and ending on the issue date of
the 2007 bonds, because only 5 percent of the proceeds of the 2002 bonds
are used for a private business use during that period. Thus, under
paragraph (b)(2)(ii)(B) of this section, A may treat the amount of
private business use of the 2007 bonds as 1 percent (5 percent of \1/5\
of the 25-year measurement period for the 2007 bonds). The 2007 bonds do
not satisfy the private business use test.
Example 2. Combined issue yield computation. (i) On January 1, 2000,
County B issues 20-year bonds to finance the acquisition of a municipal
auditorium. The 2000 bonds have a yield of 7.7500 percent, compounded
annually, and an issue price and par amount of $100 million. The debt
service payments on the 2000 bonds are as follows:
------------------------------------------------------------------------
Date Debt service
------------------------------------------------------------------------
1/1/01............................................... $9,996,470
1/1/02............................................... 9,996,470
1/1/03............................................... 9,996,470
1/1/04............................................... 9,996,470
1/1/05............................................... 9,996,470
1/1/06............................................... 9,996,470
1/1/07............................................... 9,996,470
1/1/08............................................... 9,996,470
1/1/09............................................... 9,996,470
1/1/10............................................... 9,996,470
1/1/11............................................... 9,996,470
1/1/12............................................... 9,996,470
1/1/13............................................... 9,996,470
1/1/14............................................... 9,996,470
1/1/15............................................... 9,996,470
1/1/16............................................... 9,996,470
1/1/17............................................... 9,996,470
1/1/18............................................... 9,996,470
1/1/19............................................... 9,996,470
1/1/20............................................... 9,996,470
------------------
199,929,400
------------------------------------------------------------------------
(ii) On January 1, 2005, B issues 15-year bonds to refund all of the
outstanding 2000 bonds maturing after January 1, 2005 (in the aggregate
principal amount of $86,500,000). The 2005 bonds have a yield of 6.0000
percent, compounded annually, and an issue price and par amount of
$89,500,000. The debt service payments on the 2005 bonds are as follows:
------------------------------------------------------------------------
Date Debt service
------------------------------------------------------------------------
1/1/06............................................... $9,215,167
1/1/07............................................... 9,215,167
1/1/08............................................... 9,215,167
1/1/09............................................... 9,215,167
1/1/10............................................... 9,215,167
1/1/11............................................... 9,215,167
1/1/12............................................... 9,215,167
1/1/13............................................... 9,215,167
1/1/14............................................... 9,215,167
1/1/15............................................... 9,215,167
1/1/16............................................... 9,215,167
1/1/17............................................... 9,215,167
1/1/18............................................... 9,215,167
1/1/19............................................... 9,215,167
1/1/20............................................... 9,215,167
------------------
138,227,511
------------------------------------------------------------------------
(iii) In accordance with Sec. 1.141-15(h), B chooses to apply Sec.
1.141-13 (together with the other provisions set forth in Sec. 1.141-
15(h)), to the 2005 bonds. For purposes of determining the amount of
private security and private payments with respect to the 2005 bonds,
the 2005 bonds and the refunded portion of the 2000 bonds are treated as
a combined issue under paragraph (c)(2) of this section. The yield on
the combined issue is determined in accordance with Sec. Sec. 1.148-4,
1.141-4(b)(2)(iii) and 1.141-13(c)(2). Under this methodology, the yield
on the combined issue is 7.1062 percent per year compounded annually,
illustrated as follows:
----------------------------------------------------------------------------------------------------------------
Previous debt
service on
Date refunded Refunding debt Total debt Present value on
portion of service service 1/1/00
prior issue
----------------------------------------------------------------------------------------------------------------
1/1/00.................................... .............. .............. ................. ($86,500,000.00)
1/1/01.................................... 6,689,793 .............. 6,689,793 6,245,945.33
1/1/02.................................... 6,689,793 .............. 6,689,793 5,831,545.62
1/1/03.................................... 6,689,793 .............. 6,689,793 5,444,640.09
1/1/04.................................... 6,689,793 .............. 6,689,793 5,083,404.58
1/1/05.................................... 6,689,793 .............. 6,689,793 4,746,135.95
1/1/06.................................... .............. 9,215,167 9,215,167 6,104,023.84
1/1/07.................................... .............. 9,215,167 9,215,167 5,699,040.20
1/1/08.................................... .............. 9,215,167 9,215,167 5,320,926.00
1/1/09.................................... .............. 9,215,167 9,215,167 4,967,898.55
1/1/10.................................... .............. 9,215,167 9,215,167 4,638,293.40
1/1/11.................................... .............. 9,215,167 9,215,167 4,330,556.57
[[Page 54]]
1/1/12.................................... .............. 9,215,167 9,215,167 4,043,237.15
1/1/13.................................... .............. 9,215,167 9,215,167 3,774,980.51
1/1/14.................................... .............. 9,215,167 9,215,167 3,524,521.90
1/1/15.................................... .............. 9,215,167 9,215,167 3,290,680.46
1/1/16.................................... .............. 9,215,167 9,215,167 3,072,353.70
1/1/17.................................... .............. 9,215,167 9,215,167 2,868,512.26
1/1/18.................................... .............. 9,215,167 9,215,167 2,678,195.09
1/1/19.................................... .............. 9,215,167 9,215,167 2,500,504.89
1/1/20.................................... .............. 9,215,167 9,215,167 2,334,603.90
---------------------------------------------------------------------
33,448,965 138,227,511 171,676,4760.00 0.00
----------------------------------------------------------------------------------------------------------------
Example 3. Determination of private payments allocable to combined
issue. The facts are the same as in Example 2. In addition, on January
1, 2001, B enters into a contract with a nongovernmental person for the
use of the auditorium. The contract results in a private payment in the
amount of $500,000 on each January 1 beginning on January 1, 2001, and
ending on January 1, 2020. Under paragraph (c)(2) of this section, the
amount of the private payments allocable to the combined issue is
determined by treating the refunded portion of the 2000 bonds
($86,500,000 principal amount) as a separate issue, and by allocating
the total private payments ratably between the combined issue and the
unrefunded portion of the 2000 bonds ($13,500,000 principal amount)
based on relative debt service, as follows:
----------------------------------------------------------------------------------------------------------------
Percentage Amount of
Debt of private private
Private service on Debt service on payments payments
Date payments unrefunded combined issue allocable allocable
portion of to combined to combined
prior issue issue issue
----------------------------------------------------------------------------------------------------------------
1/1/01................................... $500,000 $3,306,677 $6,689,793 66.92 $334,608
1/1/02................................... 500,000 3,306,677 6,689,793 66.92 334,608
1/1/03................................... 500,000 3,306,677 6,689,793 66.92 334,608
1/1/04................................... 500,000 3,306,677 6,689,793 66.92 334,608
1/1/05................................... 500,000 3,306,677 6,689,793 66.92 334,608
1/1/06................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/07................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/08................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/09................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/10................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/11................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/12................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/13................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/14................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/15................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/16................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/17................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/18................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/19................................... 500,000 ........... 9,215,167 100.00 500,000
1/1/20................................... 500,000 ........... 9,215,167 100.00 500,000
----------------------------------------------------------------------
$10,000,000 $16,533,385 $171,676,476 ........... $9,173,039
----------------------------------------------------------------------------------------------------------------
Example 4. Refunding taxable bonds and qualified bonds. (i) In 1999,
City C issues taxable bonds to finance the construction of a facility
for the furnishing of water. The bonds are secured by revenues from the
facility. The facility is managed pursuant to a management contract with
a nongovernmental person that gives rise to private business use. In
2007, C terminates the management contract and takes over the operation
of the facility. In 2009, C issues bonds to refund the 1999 bonds. On
the issue date of the 2009 bonds, C reasonably expects that the facility
will not be used for a private business use during the term of the 2009
bonds. In addition, during the term of the 2009 bonds, the facility is
not used for a private business use. Under paragraph (b)(2)(i) of this
section, the 2009 bonds do not satisfy the private business use test
because the amount of private business use is based on the measurement
period for those bonds and therefore does not take
[[Page 55]]
into account any private business use that occurred pursuant to the
management contract.
(ii) The facts are the same as in paragraph (i) of this Example 4,
except that the 1999 bonds are issued as exempt facility bonds under
section 142(a)(4). The 2009 bonds do not satisfy the private business
use test.
Example 5. Multipurpose issue. In 2001, State D issues bonds to
finance the construction of two office buildings, Building 1 and
Building 2. D expends an equal amount of the proceeds on each building.
D enters into arrangements that result in 8 percent of Building 1 and 12
percent of Building 2 being used for a private business use during the
measurement period under Sec. 1.141-3(g). These arrangements result in
a total of 10 percent of the proceeds of the 2001 bonds being used for a
private business use. In 2006, D purports to allocate, under paragraph
(d) of this section, an equal amount of the outstanding 2001 bonds to
Building 1 and Building 2. D also enters into another private business
use arrangement with respect to Building 1 that results in an additional
2 percent (and a total of 10 percent) of Building 1 being used for a
private business use during the measurement period. An allocation is not
reasonable under paragraph (d) of this section if it achieves more
favorable results under section 141 than could be achieved with actual
separate issues. D's allocation is unreasonable because, if permitted,
it would result in more than 10 percent of the proceeds of the 2001
bonds being used for a private business use.
Example 6. Non-deliberate action. In 1998, City E issues bonds to
finance the purchase of land and construction of a building (the prior
bonds). On the issue date of the prior bonds, E reasonably expects that
it will be the sole user of the financed property for the entire term of
the bonds. In 2003, the federal government acquires the financed
property in a condemnation action. In 2006, E issues bonds to refund the
prior bonds (the refunding bonds). The weighted average maturity of the
refunding bonds is not greater than the reasonably expected economic
life of the financed property. In general, under Sec. 1.141-2(d) and
this section, reasonable expectations must be separately tested on the
issue date of a refunding issue. Under paragraph (e) of this section,
however, the condemnation action is not taken into account in applying
the reasonable expectations test to the refunding bonds because the
condemnation action is not a deliberate action within the meaning of
Sec. 1.141-2(d)(3) and the weighted average maturity of the refunding
bonds is not greater than the weighted average reasonably expected
economic life of the property financed by the prior bonds. Thus, the
condemnation action does not cause the refunding bonds to be private
activity bonds.
Example 7. Non-transitioned refunding of bonds subject to 1954 Code.
In 1985, County F issues bonds to finance a court house. The 1985 bonds
are subject to the provisions of the Internal Revenue Code of 1954. In
2006, F issues bonds to refund all of the outstanding 1985 bonds. The
weighted average maturity of the 2006 bonds is longer than the remaining
weighted average maturity of the 1985 bonds. In addition, the 2006 bonds
do not satisfy any transitional rule for refundings in the Tax Reform
Act of 1986, 100 Stat. 2085 (1986). Section 141 and this section apply
to determine whether the 2006 bonds are private activity bonds including
whether, for purposes of Sec. 1.141-13(b)(2)(ii)(B), the 1985 bonds
satisfy the private business use test based on a measurement period that
begins on the first day of the combined measurement period for the 2006
bonds and ends on the issue date of the 2006 bonds.
[T.D. 9234, 70 FR 75032, Dec. 19, 2006]
Sec. 1.141-14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of transactions.
If an issuer enters into a transaction or series of transactions with
respect to one or more issues with a principal purpose of transferring
to nongovernmental persons (other than as members of the general public)
significant benefits of tax-exempt financing in a manner that is
inconsistent with the purposes of section 141, the Commissioner may take
any action to reflect the substance of the transaction or series of
transactions, including--
(1) Treating separate issues as a single issue for purposes of the
private activity bond tests;
(2) Reallocating proceeds to expenditures, property, use, or bonds;
(3) Reallocating payments to use or proceeds;
(4) Measuring private business use on a basis that reasonably
reflects the economic benefit in a manner different than as provided in
Sec. 1.141-3(g); and
(5) Measuring private payments or security on a basis that
reasonably reflects the economic substance in a manner different than as
provided in Sec. 1.141-4.
(b) Examples. The following examples illustrate the application of
this section:
Example 1. Reallocating proceeds to indirect use. City C issues
bonds with proceeds of $20 million for the stated purpose of financing
improvements to roads that it owns. As a part of the same plan of
financing, however, C also agrees to make a loan of $7 million to
Corporation M from its general revenues
[[Page 56]]
that it otherwise would have used for the road improvements. The
interest rate of the loan corresponds to the interest rate on a portion
of the issue. A principal purpose of the financing arrangement is to
transfer to M significant benefits of the tax-exempt financing. Although
C actually allocates all of the proceeds of the bonds to the road
improvements, the Commissioner may reallocate a portion of the proceeds
of the bonds to the loan to M because a principal purpose of the
financing arrangement is to transfer to M significant benefits of tax-
exempt financing in a manner that is inconsistent with the purposes of
section 141. The bonds are private activity bonds because the issue
meets the private loan financing test. The bonds also meet the private
business tests. See also Sec. Sec. 1.141-3(a)(2), 1.141-4(a)(1), and
1.141-5(a), under which indirect use of proceeds and payments are taken
into account.
Example 2. Taking into account use of amounts derived from proceeds
that would be otherwise disregarded. County B issues bonds with proceeds
of $10 million to finance the purchase of land. On the issue date, B
reasonably expects that it will be the sole user of the land.
Subsequently, the federal government acquires the land for $3 million in
a condemnation action. B uses this amount to make a loan to Corporation
M. In addition, the interest rate on the loan reflects the tax-exempt
interest rate on the bonds and thus is substantially less than a current
market rate. A principal purpose of the arrangement is to transfer to M
significant benefits of the tax-exempt financing. Although the
condemnation action is not a deliberate action, the Commissioner may
treat the condemnation proceeds as proceeds of the issue because a
principal purpose of the arrangement is to transfer to M significant
benefits of tax-exempt financing in a manner inconsistent with the
purposes of section 141. The bonds are private activity bonds.
Example 3. Measuring private business use on an alternative basis.
City F issues bonds with a 30-year term to finance the acquisition of an
industrial building having a remaining reasonably expected useful
economic life of more than 30 years. On the issue date, F leases the
building to Corporation G for 3 years. F reasonably expects that it will
be the sole user of the building for the remaining term of the bonds.
Because of the local market conditions, it is reasonably expected that
the fair rental value of the industrial building will be significantly
greater during the early years of the term of the bonds than in the
later years. The annual rental payments are significantly less than fair
market value, reflecting the interest rate on the bonds. The present
value of these rental payments (net of operation and maintenance
expenses) as of the issue date, however, is approximately 25 percent of
the present value of debt service on the issue. Under Sec. 1.141-3, the
issue does not meet the private business tests, because only 10 percent
of the proceeds are used in a trade or business by a nongovernmental
person. A principal purpose of the issue is to transfer to G significant
benefits of tax-exempt financing in a manner inconsistent with the
purposes of section 141. The method of measuring private business use
over the reasonably expected useful economic life of financed property
is for the administrative convenience of issuers of state and local
bonds. In cases where this method is used in a manner inconsistent with
the purposes of section 141, the Commissioner may measure private
business use on another basis that reasonably reflects economic benefit,
such as in this case on an annual basis. If the Commissioner measures
private business use on an annual basis, the bonds are private activity
bonds because the private payment test is met and more than 10 percent
of the proceeds are used in a trade or business by a nongovernmental
person.
Example 4. Treating separate issues as a single issue. City D enters
into a development agreement with Corporation T to induce T to locate
its headquarters within D's city limits. Pursuant to the development
agreement, in 1997 D will issue $20 million of its general obligation
bonds (the 1997 bonds) to purchase land that it will grant to T. The
development agreement also provides that, in 1998, D will issue $20
million of its tax increment bonds (the 1998 bonds), secured solely by
the increase in property taxes in a special taxing district.
Substantially all of the property within the special taxing district is
owned by T or D. T will separately enter into an agreement to guarantee
the payment of tax increment to D in an amount sufficient to retire the
1998 bonds. The proceeds of the 1998 bonds will be used to finance
improvements owned and operated by D that will not give rise to private
business use. Treated separately, the 1997 issue meets the private
business use test, but not the private security or payment test; the
1998 issue meets the private security or payment test, but not the
private business use test. A principal purpose of the financing plan,
including the two issues, is to transfer significant benefits of tax-
exempt financing to T for its headquarters. Thus, the 1997 issue and the
1998 issue may be treated by the Commissioner as a single issue for
purposes of applying the private activity bond tests. Accordingly, the
bonds of both the 1997 issue and the 1998 issue may be treated as
private activity bonds.
Example 5. Reallocating proceeds. City E acquires an electric
generating facility with a useful economic life of more than 40 years
and enters into a 30-year take or pay contract to sell 30 percent of the
available output to investor-owned utility M. E plans to use the
remaining 70 percent of available output for its own governmental
purposes. To finance the entire cost of the facility, E
[[Page 57]]
issues $30 million of its series A taxable bonds at taxable interest
rates and $70 million series B bonds, which purport to be tax-exempt
bonds, at tax-exempt interest rates. E allocates all of M's private
business use to the proceeds of the series A bonds and all of its own
government use to the proceeds of the series B bonds. The series A bonds
have a weighted average maturity of 15 years, while the series B bonds
have a weighted average maturity of 26 years. M's payments under the
take or pay contract are expressly determined by reference to 30 percent
of M's total costs (that is, the sum of the debt service required to be
paid on both the series A and the series B bonds and all other operating
costs). The allocation of all of M's private business use to the series
A bonds does not reflect economic substance because the series of
transactions transfers to M significant benefits of the tax-exempt
interest rates paid on the series B bonds. A principal purpose of the
financing arrangement is to transfer to M significant benefits of the
tax-exempt financing. Accordingly, the Commissioner may allocate M's
private business use on a pro rata basis to both the series B bonds as
well as the series A bonds, in which case the series B bonds are private
activity bonds.
Example 6. Allocations respected. The facts are the same as in
Example 5, except that the debt service component of M's payments under
the take or pay contract is based exclusively on the amounts necessary
to pay the debt service on the taxable series A bonds. E's allocation of
all of M's private business use to the series A bonds is respected
because the series of transactions does not actually transfer benefits
of tax-exempt interest rates to M. Accordingly, the series B bonds are
not private activity bonds. The result would be the same if M's payments
under the take or pay contract were based exclusively on fair market
value pricing, rather than the tax-exempt interest rates on E's bonds.
The result also would be the same if the series A bonds and the series B
bonds had substantially equivalent weighted average maturities and E and
M had entered into a customary contract providing for payments based on
a ratable share of total debt service. E would not be treated by the
Commissioner in any of these cases as entering into the contract with a
principal purpose of transferring the benefits of tax-exempt financing
to M in a manner inconsistent with the purposes of section 141.
[T.D. 8712, 62 FR 2301, Jan. 16, 1997]
Sec. 1.141-15 Effective dates.
(a) Scope. The effective dates of this section apply for purposes of
Sec. Sec. 1.141-1 through 1.141-6(a), 1.141-7 through 1.141-14, 1.145-1
through 1.145-2, 1.150-1(a)(3) and the definition of bond documents
contained in Sec. 1.150-1(b).
(b) Effective dates--(1) In general. Except as otherwise provided in
this section, Sec. Sec. 1.141-0 through 1.141-6(a), 1.141-9 through
1.141-12, 1.141-14, 1.145-1 through 1.145-2(c), and the definition of
bond documents contained in Sec. 1.150-1(b) (the 1997 regulations)
apply to bonds issued on or after May 16, 1997, that are subject to
section 1301 of the Tax Reform Act of 1986 (100 Stat. 2602).
(2) Certain short-term arrangements. The provisions of Sec. 1.141-3
that refer to arrangements for 200 days, 100 days, or 50 days apply to
any bond sold on or after November 20, 2001 and may be applied to any
bond outstanding on November 20, 2001 to which Sec. 1.141-3 applies.
(3) Certain prepayments. Except as provided in paragraph (c) of this
section, paragraphs (c)(2)(ii), (c)(2)(iii) and (c)(2)(iv) of Sec.
1.141-5 apply to bonds sold on or after October 3, 2003. Issuers may
apply paragraphs (c)(2)(ii), (c)(2)(iii) and (c)(2)(iv) of Sec. 1.141-
5, in whole but not in part, to bonds sold before October 3, 2003 that
are subject to Sec. 1.141-5.
(c) Refunding bonds. Except as otherwise provided in this section,
the 1997 regulations (defined in paragraph (b)(1) of this section) do
not apply to any bonds issued on or after May 16, 1997, to refund a bond
to which those regulations do not apply unless--
(1) The refunding bonds are subject to section 1301 of the Tax
Reform Act of 1986 (100 Stat. 2602); and
(2)(i) The weighted average maturity of the refunding bonds is
longer than--
(A) The weighted average maturity of the refunded bonds; or
(B) In the case of a short-term obligation that the issuer
reasonably expects to refund with a long-term financing (such as a bond
anticipation note), 120 percent of the weighted average reasonably
expected economic life of the facilities financed; or
(ii) A principal purpose for the issuance of the refunding bonds is
to make one or more new conduit loans.
(d) Permissive application of regulations. Except as provided in
paragraph (e) of this section, the 1997 regulations (defined in
paragraph (b)(1) of this section) may be applied in whole, but not
[[Page 58]]
in part, to actions taken before February 23, 1998, with respect to--
(1) Bonds that are outstanding on May 16, 1997, and subject to
section 141; or
(2) Refunding bonds issued on or after May 16, 1997, that are
subject to 141.
(e) Permissive application of certain sections. The following
sections may each be applied to any bonds--
(1) Section 1.141-3(b)(4);
(2) Section 1.141-3(b)(6); and
(3) Section 1.141-12.
(f) Effective dates for certain regulations relating to output
facilities--(1) General rule. Except as otherwise provided in this
section, Sec. Sec. 1.141-7 and 1.141-8 apply to bonds sold on or after
November 22, 2002, that are subject to section 1301 of the Tax Reform
Act of 1986 (100 Stat. 2602).
(2) Transition rule for requirements contracts. For bonds otherwise
subject to Sec. Sec. 1.141-7 and 1.141-8, Sec. 1.141-7(c)(3) applies
to output contracts entered into on or after September 19, 2002. An
output contract is treated as entered into on or after that date if it
is amended on or after that date, but only if the amendment results in a
change in the parties to the contract or increases the amount of
requirements covered by the contract by reason of an extension of the
contract term or a change in the method for determining such
requirements. For purposes of this paragraph (f)(2)--
(i) The extension of the term of a contract causes the contract to
be treated as entered into on the first day of the additional term;
(ii) The exercise by a party of a legally enforceable right that was
provided under a contract before September 19, 2002, on terms that were
fixed and determinable before such date, is not treated as an amendment
of the contract. For example, the exercise by a purchaser after
September 19, 2002 of a renewal option that was provided under a
contract before that date, on terms identical to the original contract,
is not treated as an amendment of the contract; and
(iii) An amendment that increases the amount of requirements covered
by the contract by reason of a change in the method for determining such
requirements is treated as a separate contract that is entered into as
of the effective date of the amendment, but only with respect to the
increased output to be provided under the contract.
(g) Refunding bonds for output facilities. Except as otherwise
provided in paragraph (h) or (i) of this section, Sec. Sec. 1.141-7 and
1.141-8 do not apply to any bonds sold on or after November 22, 2002, to
refund a bond to which Sec. Sec. 1.141-7 and 1.141-8 do not apply
unless--
(1) The refunding bonds are subject to section 1301 of the Tax
Reform Act of 1986 (100 Stat. 2602); and
(2)(i) The weighted average maturity of the refunding bonds is
longer than--
(A) The weighted average maturity of the refunded bonds; or
(B) In the case of a short-term obligation that the issuer
reasonably expects to refund with a long-term financing (such as a bond
anticipation note), 120 percent of the weighted average reasonably
expected economic life of the facilities financed; or
(ii) A principal purpose for the issuance of the refunding bonds is
to make one or more new conduit loans.
(h) Permissive retroactive application. Except as provided in
paragraphs (d), (e) or (i) of this section, Sec. Sec. 1.141-1 through
1.141-6(a), 1.141-7 through 1.141-14, 1.145-1 through 1.145-2, 1.149(d)-
1(g), 1.150-1(a)(3), the definition of bond documents contained in Sec.
1.150-1(b) and Sec. 1.150-1(c)(3)(ii) may be applied by issuers in
whole, but not in part, to--
(1) Outstanding bonds that are sold before February 17, 2006, and
subject to section 141; or
(2) Refunding bonds that are sold on or after February 17, 2006, and
subject to section 141.
(i) Permissive application of certain regulations relating to output
facilities. Issuers may apply Sec. Sec. 1.141-7(f)(3) and 1.141-7(g) to
any bonds.
(j) Effective dates for certain regulations relating to refundings.
Except as otherwise provided in this section, Sec. Sec. 1.141-13,
1.145-2(d), 1.149(d)-1(g), 1.150-1(a)(3) and 1.150-1(c)(3)(ii) apply to
bonds that are sold on or after February 17, 2006, and that are subject
to the 1997 regulations (defined in paragraph (b)(1) of this section).
(k) Effective/applicability dates for certain regulations relating
to generally applicable taxes and payments in lieu of
[[Page 59]]
tax--(1) In general. Except as otherwise provided in paragraphs (k)(2)
and (k)(3) of this section, revised Sec. Sec. 1.141-4(e)(2), 1.141-
4(e)(3) and 1.141-4(e)(5) apply to bonds sold on or after October 24,
2008 that are otherwise subject to the 1997 Regulations (defined in
paragraph (b)(1) of this section).
(2) Transitional rule for certain refundings. Paragraph (k)(1) does
not apply to bonds that are issued to refund bonds if--
(i) Either--
(A) The refunded bonds (or the original bonds in a series of
refundings) were sold before October 24, 2008, or
(B) The refunded bonds (or the original bonds in a series of
refundings) satisfied the transitional rule for projects substantially
in progress under paragraph (k)(3) of this section; and
(ii) The weighted average maturity of the refunding bonds does not
exceed the remaining weighted average maturity of the refunded bonds.
(3) Transitional rule for certain projects substantially in
progress. Paragraph (k)(1) of this section does not apply to bonds
issued for projects for which all of the following requirements are met:
(i) A governmental person (as defined in Sec. 1.141-1) took
official action evidencing its preliminary approval of the project
before October 19, 2006, and the plan of finance for the project in
place at that time contemplated financing the project with tax-exempt
bonds to be paid or secured by PILOTs.
(ii) Before October 19, 2006, significant expenditures were paid or
incurred with respect to the project or a contract was entered into to
pay or incur significant expenditures with respect to the project.
(iii) The bonds for the project (excluding refunding bonds) are
issued on or before December 31, 2009.
[T.D. 8757, 63 FR 3265, Jan. 22, 1998, as amended by T.D. 8941, 66 FR
4670, Jan. 18, 2001; T.D. 8967, 66 FR 58062, Nov. 20, 2001; T.D. 9016,
67 FR 59765, Sept. 23, 2002; T.D. 9085, 68 FR 45775, Aug. 4, 2003; T.D.
9234, 70 FR 75035, Dec. 19, 2005; 71 FR 1971, Jan. 12, 2006; T.D. 9429,
73 FR 63375, Oct. 24, 2008]
Sec. 1.141-16 Effective dates for qualified private activity bond
provisions.
(a) Scope. The effective dates of this section apply for purposes of
Sec. Sec. 1.142-0 through 1.142-2, 1.144-0 through 1.144-2, 1.147-0
through 1.147-2, and 1.150-4.
(b) Effective dates. Except as otherwise provided in this section,
the regulations designated in paragraph (a) of this section apply to
bonds issued on or after May 16, 1997 (the effective date).
(c) Permissive application. The regulations designated in paragraph
(a) of this section may be applied by issuers in whole, but not in part,
to bonds outstanding on the effective date. For this purpose, issuers
may apply Sec. 1.142-2 without regard to paragraph (c)(3) thereof to
failures to properly use proceeds that occur on or after April 21, 2003.
(d) Certain remedial actions--(1) General rule. The provisions of
Sec. 1.142-2(e) apply to failures to properly use proceeds that occur
on or after August 13, 2004 and may be applied by issuers to failures to
properly use proceeds that occur on or after May 14, 2004, provided that
the bonds are subject to Sec. 1.142-2.
(2) Special rule for allocations of nonqualified bonds. For purposes
of Sec. 1.142-2(e)(2), in addition to the allocation methods permitted
in Sec. 1.142-2(e)(2), an issuer may treat bonds with the longest
maturities (determined on a bond-by-bond basis) as the nonqualified
bonds, but only with respect to failures to properly use proceeds that
occur on or after May 14, 2004, with respect to bonds sold before August
13, 2004.
[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR
50066, Aug. 13, 2004]
Sec. 1.142-0 Table of contents.
This section lists the captioned paragraphs contained in Sec. Sec.
1.142-1 through 1.142-3.
Sec. 1.142-1 Exempt facility bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.142-2 Remedial actions.
(a) General rule.
(b) Reasonable expectations requirement.
(c) Redemption or defeasance.
(1) In general.
(2) Notice of defeasance.
(3) Special limitation.
(4) Special rule for dispositions of personal property.
(5) Definitions.
[[Page 60]]
(d) When a failure to properly use proceeds occurs.
(1) Proceeds not spent.
(2) Proceeds spent.
(e) Nonqualified bonds.
(1) Amount of nonqualified bonds.
(2) Allocation of nonqualified bonds.
Sec. 1.142-3 Refunding issues. [Reserved]
[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR
50066, Aug. 13, 2004]
Sec. 1.142-1 Exempt facility bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(A), an exempt facility bond issued under
section 142 may be a qualified bond.
Under section 142(a), an exempt facility bond is any bond issued as
a part of an issue using 95 percent or more of the proceeds for certain
exempt facilities.
(b) Scope. Sections 1.142-0 through 1.142-3 apply for purposes of
the rules for exempt facility bonds under section 142, except that, with
respect to net proceeds that have been spent, Sec. 1.142-2 does not
apply to bonds issued under section 142(d) (relating to bonds issued to
provide qualified residential rental projects) and section 142(f) (2)
and (4) (relating to bonds issued to provide local furnishing of
electric energy or gas).
(c) Effective dates. For effective dates of Sec. Sec. 1.142-0
through 1.142-2, see Sec. 1.141-16.
[T.D. 8712, 62 FR 2302, Jan. 16, 1997]
Sec. 1.142-2 Remedial actions.
(a) General rule. If less than 95 percent of the net proceeds of an
exempt facility bond are actually used to provide an exempt facility,
and for no other purpose, the issue will be treated as meeting the use
of proceeds requirement of section 142(a) if the issue meets the
condition of paragraph (b) of this section and the issuer takes the
remedial action described in paragraph (c) of this section.
(b) Reasonable expectations requirement. The issuer must have
reasonably expected on the issue date that 95 percent of the net
proceeds of the issue would be used to provide an exempt facility and
for no other purpose for the entire term of the bonds (disregarding any
redemption provisions). To meet this condition the amount of the issue
must have been based on reasonable estimates about the cost of the
facility.
(c) Redemption or defeasance--(1) In general. The requirements of
this paragraph (c) are met if all of the nonqualified bonds of the issue
are redeemed on the earliest call date after the date on which the
failure to properly use the proceeds occurs under paragraph (d) of this
section. Proceeds of tax-exempt bonds (other than those described in
paragraph (d)(1) of this section) must not be used for this purpose. If
the bonds are not redeemed within 90 days of the date on which the
failure to properly use proceeds occurs, a defeasance escrow must be
established for those bonds within 90 days of that date.
(2) Notice of defeasance. The issuer must provide written notice to
the Commissioner of the establishment of the defeasance escrow within 90
days of the date the escrow is established.
(3) Special limitation. The establishment of a defeasance escrow
does not satisfy the requirements of this paragraph (c) if the period
between the issue date and the first call date is more than 10\1/2\
years.
(4) Special rule for dispositions of personal property. For
dispositions of personal property exclusively for cash, the requirements
of this paragraph (c) are met if the issuer expends the disposition
proceeds within 6 months of the date of the disposition to acquire
replacement property for the same qualifying purpose of the issue under
section 142.
(5) Definitions. For purposes of paragraph (c)(4) of this section,
disposition proceeds means disposition proceeds as defined in Sec.
1.141-12(c).
(d) When a failure to properly use proceeds occurs--(1) Proceeds not
spent. For net proceeds that are not spent, a failure to properly use
proceeds occurs on the earlier of the date on which the issuer
reasonably determines that the financed facility will not be completed
or the date on which the financed facility is placed in service.
(2) Proceeds spent. For net proceeds that are spent, a failure to
properly use proceeds occurs on the date on which
[[Page 61]]
an action is taken that causes the bonds not to be used for the
qualifying purpose for which the bonds were issued.
(e) Nonqualified bonds--(1) Amount of nonqualified bonds. For
purposes of this section, the nonqualified bonds are a portion of the
outstanding bonds in an amount that, if the remaining bonds were issued
on the date on which the failure to properly use the proceeds occurs, at
least 95 percent of the net proceeds of the remaining bonds would be
used to provide an exempt facility. If no proceeds have been spent to
provide an exempt facility, all of the outstanding bonds are
nonqualified bonds.
(2) Allocation of nonqualified bonds. Allocations of nonqualified
bonds must be made on a pro rata basis, except that an issuer may treat
any bonds of an issue as the nonqualified bonds so long as--
(i) The remaining weighted average maturity of the issue, determined
as of the date on which the nonqualified bonds are redeemed or defeased
(determination date), and excluding from the determination the
nonqualified bonds redeemed or defeased by the issuer to meet the
requirements of paragraph (c) of this section, is not greater than
(ii) The remaining weighted average maturity of the issue,
determined as of the determination date, but without regard to the
redemption or defeasance of any bonds (including the nonqualified bonds)
occurring on the determination date.
[T.D. 8712, 62 FR 2302, Jan. 16, 1997, as amended by T.D. 9150, 69 FR
50067, Aug. 13, 2004]
Sec. 1.142-3 Refunding Issues. [Reserved]
Sec. 1.142-4 Use of proceeds to provide a facility.
(a) In general. [Reserved]
(b) Reimbursement allocations. If an expenditure for a facility is
paid before the issue date of the bonds to provide that facility, the
facility is described in section 142(a) only if the expenditure meets
the requirements of Sec. 1.150-2 (relating to reimbursement
allocations). For purposes of this paragraph (b), if the proceeds of an
issue are used to pay principal of or interest on an obligation other
than a State or local bond (for example, temporary construction
financing of the conduit borrower), that issue is not a refunding issue,
and, thus, Sec. 1.150-2(g) does not apply.
(c) Limitation on use of facilities by substantial users--(1) In
general. If the original use of a facility begins before the issue date
of the bonds to provide the facility, the facility is not described in
section 142(a) if any person that was a substantial user of the facility
at any time during the 5-year period before the issue date or any
related person to that user receives (directly or indirectly) 5 percent
or more of the proceeds of the issue for the user's interest in the
facility and is a substantial user of the facility at any time during
the 5-year period after the issue date, unless--
(i) An official intent for the facility is adopted under Sec.
1.150-2 within 60 days after the date on which acquisition,
construction, or reconstruction of that facility commenced; and
(ii) For an acquisition, no person that is a substantial user or
related person after the acquisition date was also a substantial user
more than 60 days before the date on which the official intent was
adopted.
(2) Definitions. For purposes of paragraph (c)(1) of this section,
substantial user has the meaning used in section 147(a)(1), related
person has the meaning used in section 144(a)(3), and a user that is a
governmental unit within the meaning of Sec. 1.103-1 is disregarded.
(d) Effective date--(1) In general. This section applies to bonds
sold on or after July 8, 1997. See Sec. 1.103-8(a)(5) for rules
applicable to bonds sold before that date.
(2) Elective retroactive application. An issuer may apply this
section to any bond sold before July 8, 1997.
[T.D. 8718, 62 FR 25506, May 9, 1997]
Sec. 1.142(a)(5)-1 Exempt facility bonds: Sewage facilities.
(a) In general. Under section 103(a), a private activity bond is a
tax-exempt bond only if it is a qualified bond. A qualified bond
includes an exempt facility bond, defined as any bond issued as part of
an issue 95 percent or more of the net proceeds of which are used to
provide a facility specified in section 142. One type of facility
specified in section 142(a) is a sewage facility. This
[[Page 62]]
section defines the term sewage facility for purposes of section 142(a).
(b) Definitions--(1) Sewage facility defined. A sewage facility is
property--
(i) Except as provided in paragraphs (b)(2) and (d) of this section,
used for the secondary treatment of wastewater; however, for property
treating wastewater reasonably expected to have an average daily raw
wasteload concentration of biochemical oxygen demand (BOD) that exceeds
350 milligrams per liter as oxygen (measured at the time the influent
enters the facility) (the BOD limit), this paragraph (b)(1)(i) applies
only to the extent the treatment is for wastewater having an average
daily raw wasteload concentration of BOD that does not exceed the BOD
limit;
(ii) Used for the preliminary and/or primary treatment of wastewater
but only to the extent used in connection with secondary treatment
(without regard to the BOD limit described in paragraph (b)(1)(i) of
this section);
(iii) Used for the advanced or tertiary treatment of wastewater but
only to the extent used in connection with and after secondary
treatment;
(iv) Used for the collection, storage, use, processing, or final
disposal of--
(A) Wastewater, which property is necessary for such preliminary,
primary, secondary, advanced, or tertiary treatment; or
(B) Sewage sludge removed during such preliminary, primary,
secondary, advanced, or tertiary treatment (without regard to the BOD
limit described in paragraph (b)(1)(i) of this section);
(v) Used for the treatment, collection, storage, use, processing, or
final disposal of septage (without regard to the BOD limit described in
paragraph (b)(1)(i) of this section); and
(vi) Functionally related and subordinate to property described in
this paragraph (b)(1), such as sewage disinfection property.
(2) Special rules and exceptions--(i) Exception to BOD limit. A
facility treating wastewater with an average daily raw wasteload
concentration of BOD exceeding the BOD limit will not fail to qualify as
a sewage facility described in paragraph (b)(1) of this section to the
extent that the failure to satisfy the BOD limit results from the
implementation of a federal, state, or local water conservation program
(for example, a program designed to promote water use efficiency that
results in BOD concentrations beyond the BOD limit).
(ii) Anti-abuse rule for BOD limit. A facility does not satisfy the
BOD limit if there is any intentional manipulation of the BOD level to
circumvent the BOD limit (for example, increasing the volume of water in
the wastewater before the influent enters the facility with the
intention of reducing the BOD level).
(iii) Authority of Commissioner. In appropriate cases upon
application to the Commissioner, the Commissioner may determine that
facilities employing technologically advanced or innovative treatment
processes qualify as sewage facilities if it is demonstrated that these
facilities perform functions that are consistent with the definition of
sewage facilities described in paragraph (b)(1) of this section.
(3) Other applicable definitions--(i) Advanced or tertiary treatment
means the treatment of wastewater after secondary treatment. Advanced or
tertiary treatment ranges from biological treatment extensions to
physical-chemical separation techniques such as denitrification, ammonia
stripping, carbon adsorption, and chemical precipitation.
(ii) Nonconventional pollutants are any pollutants that are not
listed in 40 CFR 401.15, 401.16, or appendix A to part 423.
(iii) Preliminary treatment means treatment that removes large
extraneous matter from incoming wastewater and renders the incoming
wastewater more amenable to subsequent treatment and handling.
(iv) Pretreatment means a process that preconditions wastewater to
neutralize or remove toxic, priority, or nonconventional pollutants that
could adversely affect sewers or inhibit a preliminary, primary,
secondary, advanced, or tertiary treatment operation.
(v) Primary treatment means treatment that removes material that
floats or will settle, usually by screens or settling tanks.
[[Page 63]]
(vi) Priority pollutants are those pollutants listed in appendix A
to 40 CFR part 423.
(vii) Secondary treatment means the stage in sewage treatment in
which a bacterial process (or an equivalent process) consumes the
organic parts of wastes, usually by trickling filters or an activated
sludge process.
(viii) Sewage sludge is defined in 40 CFR 122.2 and includes
septage.
(ix) Toxic pollutants are those pollutants listed in 40 CFR 401.15.
(c) Other property not included in the definition of a sewage
facility. Property other than property described in paragraph (b)(1) of
this section is not a sewage facility. Thus, for example, property is
not a sewage facility, or functionally related and subordinate property,
if the property is used for pretreatment of wastewater (whether or not
this treatment is necessary to perform preliminary, primary, secondary,
advanced, or tertiary treatment), or the related collection, storage,
use, processing, or final disposal of the wastewater. In addition,
property used to treat, process, or use wastewater subsequent to the
time the wastewater can be discharged into navigable waters, as defined
in 33 U.S.C. 1362, is not a sewage facility.
(d) Allocation of costs. In the case of property that has both a use
described in paragraph (b)(1) of this section (a sewage treatment
function) and a use other than sewage treatment, only the portion of the
cost of the property allocable to the sewage treatment function is taken
into account as an expenditure to provide sewage facilities. The portion
of the cost of property allocable to the sewage treatment function is
determined by allocating the cost of that property between the
property's sewage treatment function and any other uses by any method
which, based on all the facts and circumstances, reasonably reflects a
separation of costs for each use of the property.
(e) Effective date--(1) In general. This section applies to issues
of bonds issued after February 21, 1995.
(2) Refundings. In the case of a refunding bond issued to refund a
bond to which this section does not apply, the issuer need not apply
this section to that refunding bond. This paragraph (e)(2) applies only
if the weighted average maturity of the refunding bonds, as described in
section 147(b), is not greater than the remaining weighted average
maturity of the refunded bonds.
[T.D. 8576, 59 FR 66163, Dec. 23, 1994, as amended by T.D. 9546, Aug.
19, 2011]
Sec. 1.142(a)(6)-1 Exempt facility bonds: solid waste disposal
facilities.
(a) In general. This section defines the term solid waste disposal
facility for purposes of section 142(a)(6).
(b) Solid waste disposal facility. The term solid waste disposal
facility means a facility to the extent that the facility--
(1) Processes solid waste (as defined in paragraph (c) of this
section) in a qualified solid waste disposal process (as defined in
paragraph (d) of this section);
(2) Performs a preliminary function (as defined in paragraph (f) of
this section); or
(3) Is functionally related and subordinate (within the meaning of
Sec. 1.103-8(a)(3)) to a facility described in paragraph (b)(1) or
(b)(2) of this section.
(c) Solid waste--(1) In general. Except to the extent excluded under
paragraph (c)(2) of this section, for purposes of section 142(a)(6), the
term solid waste means garbage, refuse, and other solid material derived
from any agricultural, commercial, consumer, governmental, or industrial
operation or activity if the material meets the requirements of both
paragraph (c)(1)(i) and paragraph (c)(1)(ii) of this section. For
purposes of this section, material is solid if it is solid at ambient
temperature and pressure.
(i) Used material or residual material. Material meets the
requirements of this paragraph (c)(1)(i) if it is either used material
(as defined in paragraph (c)(1)(i)(A)) of this section or residual
material (as defined in paragraph (c)(1)(i)(B) of this section).
(A) Used material. The term used material means any material that is
a product of any agricultural, commercial, consumer, governmental, or
industrial operation or activity, or a component of any such product or
activity, and that has been used previously. Used material also includes
animal waste
[[Page 64]]
produced by animals from a biological process.
(B) Residual material. The term residual material means material
that meets the requirements of this paragraph (c)(1)(i)(B). The material
must be a residual byproduct or excess raw material that results from or
remains after the completion of any agricultural, commercial, consumer,
governmental, or industrial production process or activity or from the
provision of any service. In the case of multiple processes constituting
an integrated manufacturing or industrial process, the material must
result from or remain after the completion of such integrated process.
As of the issue date of the bonds used to finance the solid waste
disposal facility, the material must be reasonably expected to have a
fair market value that is lower than the value of all of the products
made in that production process or lower than the value of the service
that produces such residual material.
(ii) Reasonably expected introduction into a qualified solid waste
disposal process. Material meets the requirements of this paragraph
(c)(1)(ii) if it is reasonably expected by the person who generates,
purchases, or otherwise acquires it to be introduced within a reasonable
time after such generation, purchase or acquisition into a qualified
solid waste disposal process described in paragraph (d) of this section.
(2) Exclusions from solid waste. The following materials do not
constitute solid waste:
(i) Virgin material. Except to the extent that virgin material
constitutes an input to a final disposal process or residual material,
solid waste excludes any virgin material. The term virgin material means
material that has not been processed into an agricultural, commercial,
consumer, governmental, or industrial product, or a component of any
such product. Further, for this purpose, material continues to be virgin
material after it has been grown, harvested, mined, or otherwise
extracted from its naturally occurring location and cleaned, divided
into component elements, modified, or enhanced, as long as further
processing is required before it becomes an agricultural, commercial,
consumer, or industrial product, or a component of any such product.
(ii) Solids within liquids and liquid waste. Solid waste excludes
any solid or dissolved material in domestic sewage or other significant
pollutant in water resources, such as silt, dissolved or suspended
solids in industrial waste water effluents, dissolved materials in
irrigation return flows or other common water pollutants, and liquid or
gaseous waste.
(iii) Precious metals. Except to the extent that a precious metal
constitutes an input to a final disposal process and/or an unrecoverable
trace of the particular precious metal, solid waste excludes gold,
silver, ruthenium, rhodium, palladium, osmium, iridium, platinum,
gallium, rhenium, and any other precious metal material as may be
identified by the Internal Revenue Service in future public
administrative guidance.
(iv) Hazardous material. Solid waste excludes any hazardous material
that must be disposed of at a facility that is subject to final permit
requirements under subtitle C of title II of the Solid Waste Disposal
Act as in effect on the date of the enactment of the Tax Reform Act of
1986 (which is October 22, 1986). See section 142(h)(1) of the Internal
Revenue Code for the definition of qualified hazardous waste facilities.
(v) Radioactive material. Solid waste excludes any radioactive
material subject to regulation under the Nuclear Regulatory Act (10 CFR
1.1 et seq.), as in effect on the issue date of the bonds.
(d) Qualified solid waste disposal process. The term qualified solid
waste disposal process means the processing of solid waste in a final
disposal process (as defined in paragraph (d)(1) of this section), an
energy conversion process (as defined in paragraph (d)(2) of this
section), or a recycling process (as defined in paragraph (d)(3) of this
section). Absent an express restriction to the contrary in this section,
a qualified solid waste disposal process may employ any biological,
engineering, industrial, or technological method.
(1) Final disposal process. The term final disposal process means
the placement of solid waste in a landfill (including, for this purpose,
the spreading
[[Page 65]]
of solid waste over land in an environmentally compliant and safe manner
with no intent to remove such solid waste), the incineration of solid
waste without capturing any useful energy, or the containment of solid
waste with a reasonable expectation as of the date of issue of the bonds
that the containment will continue indefinitely and that the solid waste
has no current or future beneficial use.
(2) Energy conversion process. The term energy conversion process
means a thermal, chemical, or other process that is applied to solid
waste to create and capture synthesis gas, heat, hot water, steam, or
other useful energy. The energy conversion process begins at the point
of the first application of such process. The energy conversion process
ends at the point at which the useful energy is first created, captured,
or incorporated into the form of synthesis gas, heat, hot water, or
other useful energy and before any transfer or distribution of such
synthesis gas, heat, hot water or other useful energy, regardless of
whether such synthesis gas, heat, hot water, or other useful energy
constitutes a first useful product within the meaning of paragraph (e)
of this section.
(3) Recycling process--(i) In general. The term recycling process
means reconstituting, transforming, or otherwise processing solid waste
into a useful product. The recycling process begins at the point of the
first application of a process to reconstitute or transform the solid
waste into a useful product, such as decontamination, melting, re-
pulping, shredding, or other processing of the solid waste to accomplish
this purpose. The recycling process ends at the point of completion of
production of the first useful product from the solid waste.
(ii) Refurbishment, repair, or similar activities. The term
recycling process does not include refurbishment, repair, or similar
activities. The term refurbishment means the breakdown and reassembly of
a product if such activity is done on a product-by-product basis and if
the finished product contains more than 30 percent of its original
materials or components.
(e) First useful product. The term first useful product means the
first product produced from the processing of solid waste in a solid
waste disposal process that is useful for consumption in agricultural,
consumer, commercial, governmental, or industrial operation or activity
and that could be sold for such use, whether or not actually sold. A
useful product includes both a product useful to an individual consumer
as an ultimate end-use consumer product and a product useful to an
industrial user as a material or input for processing in some stage of a
manufacturing or production process to produce a different end-use
consumer product. The determination of whether a useful product has been
produced may take into account operational constraints that affect the
point in production when a useful product reasonably can be extracted or
isolated and sold independently. For this purpose, the costs of
extracting, isolating, storing, and transporting the product to a market
may only be taken into account as operational constraints if the product
is not to be used as part of an integrated manufacturing or industrial
process in the same location as that in which the product is produced.
(f) Preliminary function. A preliminary function is a function to
collect, separate, sort, store, treat, process, disassemble, or handle
solid waste that is preliminary to and directly related to a qualified
solid waste disposal process.
(g) Mixed-use facilities--(1) In general. If a facility is used for
both a qualified solid waste disposal function (including a qualified
solid waste disposal process or a preliminary function) and a
nonqualified function (a mixed-use facility), then the costs of the
facility allocable to the qualified solid waste disposal function are
determined using any reasonable method, based on all the facts and
circumstances. See Sec. 1.103-8(a)(1) for allocation rules on amounts
properly allocable to an exempt facility. Facilities qualify as
functionally related and subordinate to a qualified solid waste disposal
function only to the extent that they are functionally related and
subordinate to the portion of the mixed-use facility that is used for
one or more qualified solid waste disposal functions (including a
qualified solid waste disposal process or a preliminary function).
[[Page 66]]
(2) Mixed inputs--(i) In general. Except as otherwise provided in
paragraph (g)(2)(ii) of this section, for each facility (or a portion of
a mixed-use facility) performing a qualified solid waste disposal
process or a preliminary function, the percentage of the costs of the
property used for such process that are allocable to a qualified solid
waste disposal process or a preliminary function cannot exceed the
average annual percentage of solid waste processed in that qualified
solid waste disposal process or that preliminary function while the
issue is outstanding. The annual percentage of solid waste processed in
that qualified solid waste disposal process or preliminary function for
any year is the percentage, by weight or volume, of the total materials
processed in that qualified solid waste disposal process or preliminary
function that constitute solid waste for that year.
(ii) Special rule for mixed-input processes if at least 65 percent
of the materials processed are solid waste--(A) In general. Except as
otherwise provided in paragraph (g)(2)(ii)(B) of this section, for each
facility (or a portion of a mixed-use facility) performing a qualified
solid waste disposal process or preliminary function, if the annual
percentage of solid waste processed in that qualified solid waste
disposal process or preliminary function for each year that the issue is
outstanding (beginning with the date such facility is placed in service
within the meaning of Sec. 1.150-2(c)) equals at least 65 percent of
the materials processed in that qualified solid waste disposal process
or preliminary function, then all of the costs of the property used for
such process are treated as allocable to a qualified solid waste
disposal process. The annual percentage of solid waste processed in such
qualified solid waste disposal process or preliminary function for any
year is the percentage, by weight or volume, of the total materials
processed in that qualified solid waste disposal process or preliminary
function that constitute solid waste for that year.
(B) Special rule for extraordinary events. In the case of an
extraordinary event that is beyond the control of the operator of a
solid waste disposal facility (such as a natural disaster, strike, major
utility disruption, or governmental intervention) and that causes a
solid waste disposal facility to be unable to meet the 65 percent test
under paragraph (g)(2)(ii)(A) of this section for a particular year, the
percentage of solid waste processed for that year equals--
(1) The sum of the amount of solid waste processed in the solid
waste disposal facility for the year affected by the extraordinary event
and the amount of solid waste processed in the solid waste disposal
facility during the following two years in excess of the amount required
to meet the general 65 percent threshold for the facility during each of
such two years; divided by
(2) The total materials processed in the solid waste disposal
facility during the year affected by the extraordinary event. If the
resulting measure of solid waste processed for the year affected by the
extraordinary event equals at least 65 percent, then the facility is
treated as meeting the requirements of the 65 percent test under
paragraph (g)(2)(ii)(A) of this section for such year.
(iii) Facilities functionally related and subordinate to mixed-input
facilities. Except to the extent that facilities are functionally
related and subordinate to a mixed-input facility that meets the 65
percent test under paragraph (g)(2)(ii) of this section, facilities
qualify as functionally related and subordinate to a mixed-input
facility only to the extent that they are functionally related and
subordinate to the qualified portion of the mixed-input facility that is
used for one or more qualified solid waste disposal functions (including
a qualified solid waste disposal process or a preliminary function).
(h) Examples. The following examples illustrate the application of
this section:
Example 1. Nonqualified Unused Material--Cloth. Company A takes wool
and weaves it into cloth and then sells the cloth to a manufacturer to
manufacture clothing. The cloth is material that has not been used
previously as a product of or otherwise used in an agricultural,
commercial, consumer, governmental, or industrial operation or activity,
or as a component of any such product or activity. Accordingly, the
cloth is not solid waste.
[[Page 67]]
Example 2. Residual Material--Waste Coal. Company B mines coal. Some
of the ore mined is a low quality byproduct of coal mining commonly
known as waste coal, which cannot be converted to energy under a normal
energy-production process because the BTU content is too low. Waste coal
has the lowest fair market value of any product produced in Company B's
coal mining process. Waste coal is solid waste because it is residual
material within the meaning of paragraph (c)(1)(i)(B) of this section
and Company B reasonably expects to introduce the waste coal into a
solid waste disposal process.
Example 3. Virgin Material--Logs. Company C cuts down trees and
sells the logs to another company, which further processes the logs into
lumber. In order to facilitate shipping, Company C cuts the trees into
uniform logs. The trees are not solid waste because they are virgin
material within the meaning of paragraph (c)(2)(i) of this section that
are not being introduced into a final disposal process within the
meaning of paragraph (d)(1) of this section. The division of such trees
into uniform logs does not change the status of the trees as virgin
material.
Example 4. Qualified Solid Waste Disposal Process--Landfill. Company
D plans to construct a landfill. The landfill will not be subject to the
final permit requirements under subtitle C of title II of the Solid
Waste Disposal Act (as in effect on the date of enactment of the Tax
Reform Act of 1986). As of the issue date, Company D expects that the
landfill will be filled entirely with material that will qualify as
solid waste within the meaning of paragraph (c) of this section. Placing
solid waste into a landfill is a qualified solid waste disposal process.
The landfill is a qualified solid waste disposal facility.
Example 5. Qualified Solid Waste Disposal Process--Recycling Tires.
Company E owns a facility that converts used tires into roadbed
material. The used tires are used material within the meaning of
paragraph (c)(1)(i)(A) of this section that qualifies as solid waste.
Between the introduction of the old tires into the roadbed manufacturing
process and the completion of the roadbed material, the facility does
not create any interim useful products. The process for the
manufacturing of the roadbed material from the old tires is a qualified
solid waste disposal process as a recycling process and the facility
that converts the tires into roadbed material is a qualified solid waste
disposal facility. This conclusion would be the same if the recycling
process took place at more than one plant.
Example 6. Qualified Solid Waste Disposal Process--Energy Conversion
Process. Company F receives solid waste from a municipal garbage
collector. Company F burns that solid waste in an incinerator to remove
exhaust gas and to produce heat. Company F further processes the heat in
a heat exchanger to produce steam. Company F further processes the steam
to generate electricity. The energy conversion process ends with the
production of steam. The facilities used to burn the solid waste and to
capture the steam as useful energy are qualified solid waste disposal
facilities because they process solid waste in an energy conversion
process. The generating facilities used to process the steam further to
generate electricity are not engaged in the energy conversion process
and are not qualified solid waste disposal facilities.
Example 7. Nonqualified Refurbishment. Company G purchases used cars
and restores them. This restoration process includes disassembly,
cleaning, and repairing of the cars. Parts that cannot be repaired are
replaced. The restored cars contain at least 30 percent of the original
parts. While the cars are used material, the refurbishing process is not
a qualified solid waste disposal process. Accordingly, Company G's
facility is not a qualified solid waste disposal facility.
Example 8. Qualified Solid Waste Disposal Facility--First Useful
Product Rule--Paper Recycling. (i) Company H employs an integrated
process to re-pulp discarded magazines, clean the pulp, and produce
retail paper towel products. Operational constraints on Company H's
process do not allow for reasonable extraction, isolation, and sale of
the cleaned paper pulp independently without degradation of the pulp.
Company H further processes the paper pulp into large industrial-sized
rolls of paper which are approximately 12 feet in diameter. At this
point in the process, Company H could either sell such industrial-sized
rolls of paper to another company for further processing to produce
retail paper products or it could produce those retail products itself.
In general, paper pulp is a useful product that is bought and sold on
the market as a material for input into manufacturing or production
processes. The discarded magazines are used material within the meaning
of paragraph (c)(1)(i)(A) of this section. Company H's facility is
engaged in a recycling process within the meaning of paragraph (d)(3) of
this section to the extent that it repulps and cleans the discarded
magazines generally and further to the extent that it produces
industrial-sized rolls of paper under the particular circumstances here.
Specifically, taking into account the operational constraints on Company
H's facility that limit its ability reasonably to extract, isolate, and
sell the paper pulp independently, the first useful products within the
meaning of paragraph (e) of this section from Company H's recycling
process are the industrial-sized rolls of paper. The portion of Company
H's facility that processes the discarded magazines and produces
industrial-sized rolls of paper is a qualified solid waste disposal
facility, and the portion of Company
[[Page 68]]
H's facility that further processes the industrial-sized rolls of paper
into retail paper towels is not a qualified solid waste facility.
(ii) The facts are the same as in paragraph (i) of this Example 8,
except that Company H is able reasonably to extract the cleaned paper
pulp from the process without degradation of the pulp and to sell the
cleaned paper pulp at its dock for a price that exceeds its costs of
extracting the pulp from the process. Therefore, the paper pulp is the
first useful product within the meaning of paragraph (e) of this
section. As a result, the portion of Company H's facility that processes
the discarded magazines is a qualified solid waste disposal facility,
and the portion of Company H's facility that produces industrial-sized
rolls of paper is not a qualified solid waste disposal facility. If,
however, the only reasonable way Company H could sell the pulp was to
transport the pulp to a distant market, then the costs of storing and
transporting the pulp to the market may be taken into account in
determining whether the pulp is the first useful product.
Example 9. Preliminary Function--Energy Conversion Process. (i)
Company I owns a paper mill. At the mill, logs from nearby timber
operations are processed through a machine that removes bark. The
stripped logs are used to manufacture paper. The stripped bark has the
lowest fair market value of any product produced from the paper mill.
The stripped bark falls onto a conveyor belt that transports the bark to
a storage bin that is used to store the bark briefly until Company I
feeds the bark into a boiler. The conveyor belt and storage bin are used
only for these purposes. The boiler is used only to create steam by
burning the bark, and the steam is used to generate electricity. The
stripped bark is solid waste because it is residual material within the
meaning of paragraph (c)(1)(i)(B) of this section and Company I expects
to introduce the bark into an energy conversion process within a
reasonable period of time. The creation of steam from the stripped bark
is an energy conversion process that starts with the incineration of the
stripped bark. The energy conversion process is a qualified solid waste
disposal process. The conveyor belt performs a collection activity that
is preliminary and that is directly related to the solid waste disposal
function. The storage bin performs a storage function that is
preliminary and that is directly related to the solid waste disposal
function. Thus, the conveyor belt and storage bin are solid waste
disposal facilities. The bark removal process is not a preliminary
function because it is not directly related to the energy conversion
process and it does not become so related merely because it results in
material that is solid waste.
(ii) The facts are the same as in paragraph (i) of this Example 9,
except that the stripped bark represents only 55 percent by weight and
volume of the materials that are transported by the conveyor belt. The
remaining 45 percent of the materials transported by the conveyor belt
are not solid waste and these other materials are sorted from the
conveyor belt by a sorting machine immediately before the stripped bark
arrives at the storage bin. Fifty-five percent of the costs of the
conveyor belt and the sorting machine are allocable to solid waste
disposal functions.
Example 10. Preliminary Function--Final Disposal Process. Company J
owns a waste transfer station and uses it to collect, sort, and process
solid waste. Company J uses its trucks to haul the solid waste to the
nearest landfill. At least 65 percent by weight and volume of the
material brought to the transfer station is solid waste. The waste
transfer station and the trucks perform functions that are preliminary
and directly related to the solid waste disposal function of the
landfill. Thus, the waste transfer station and the trucks qualify as
solid waste disposal facilities.
Example 11. Mixed-Input Facility. Company K owns an incinerator
financed by an issue and uses the incinerator exclusively to burn coal
and other solid material to create steam. Each year while the issue is
outstanding, 40 percent by volume and 45 percent by weight of the solid
material that Company K processes in the conversion process is coal. The
remainder of the solid material is either used material or residual
material within the meaning of paragraph (c)(1)(i) of this section.
Sixty percent of the costs of the property used to perform the energy
conversion process are allocable to a solid waste disposal function.
(i) Effective/Applicability Dates--(1) In general. Except as
otherwise provided in this paragraph (i), this section applies to bonds
to which section 142 applies that are sold on or after October 18, 2011.
(2) Elective retroactive application. Issuers may apply this
section, in whole, but not in part, to outstanding bonds to which
section 142 applies and which were sold before October 18, 2011.
(3) Certain refunding bonds. An issuer need not apply this section
to bonds that are issued in a current refunding to refund bonds to which
this section does not apply if the weighted average maturity of the
refunding bonds is no longer than the remaining weighted average
maturity of the refunded bonds.
[T.D. 9546, 76 FR 51881, Aug. 19, 2011; 76 FR 55255, Sept. 7, 2011]
[[Page 69]]
Sec. 1.142(f)(4)-1 Manner of making election to terminate tax-exempt
bond financing.
(a) Overview. Section 142(f)(4) permits a person engaged in the
local furnishing of electric energy or gas (a local furnisher) that uses
facilities financed with exempt facility bonds under section 142(a)(8)
and that expands its service area in a manner inconsistent with the
requirements of sections 142(a)(8) and (f) to make an election to ensure
that those bonds will continue to be treated as exempt facility bonds.
The election must meet the requirements of paragraphs (b) and (c) of
this section.
(b) Time for making election--(1) In general. An election under
section 142(f)(4)(B) must be filed with the Internal Revenue Service on
or before 90 days after the date of the service area expansion that
causes bonds to cease to meet the requirements of sections 142(a)(8) and
(f).
(2) Date of service area expansion. For the purposes of this
section, the date of the service area expansion is the first date on
which the local furnisher is authorized to collect revenue for the
provision of service in the expanded area.
(c) Manner of making election. An election under section
142(f)(4)(B) must be captioned ``ELECTION TO TERMINATE TAX-EXEMPT BOND
FINANCING'', must be signed under penalties of perjury by a person who
has authority to sign on behalf of the local furnisher, and must contain
the following information--
(1) The name of the local furnisher;
(2) The tax identification number of the local furnisher;
(3) The complete address of the local furnisher;
(4) The date of the service area expansion;
(5) Identification of each bond issue subject to the election,
including the complete name of each issue, the tax identification number
of each issuer, the report number of the information return filed under
section 149(e) for each issue, the issue date of each issue, the CUSIP
number (if any) of the bond with the latest maturity of each issue, the
issue price of each issue, the adjusted issue price of each issue as of
the date of the election, the earliest date on which the bonds of each
issue may be redeemed, and the principal amount of bonds of each issue
to be redeemed on the earliest redemption date;
(6) A statement that the local furnisher making the election agrees
to the conditions stated in section 142(f)(4)(B); and
(7) A statement that each issuer of the bonds subject to the
election has received written notice of the election.
(d) Effect on section 150(b). Except as provided in paragraph (e) of
this section, if a local furnisher files an election within the period
specified in paragraph (b) of this section, section 150(b) does not
apply to bonds identified in the election during and after that period.
(e) Effect of failure to meet agreements. If a local furnisher fails
to meet any of the conditions stated in an election pursuant to
paragraph (c)(6) of this section, the election is invalid.
(f) Corresponding provisions of the Internal Revenue Code of 1954.
Section 103(b)(4)(E) of the Internal Revenue Code of 1954 set forth
corresponding requirements for the exclusion from gross income of the
interest on bonds issued for facilities for the local furnishing of
electric energy or gas. For the purposes of this section any reference
to sections 142(a)(8) and (f) of the Internal Revenue Code of 1986
includes a reference to the corresponding portion of section
103(b)(4)(E) of the Internal Revenue Code of 1954.
(g) Effective dates. This section applies to elections made on or
after January 19, 2001.
[T.D. 8941, 66 FR 4671, Jan. 18, 2001]
Sec. 1.143(g)-1 Requirements related to arbitrage.
(a) In general. Under section 143, for an issue to be an issue of
qualified mortgage bonds or qualified veterans' mortgage bonds
(together, mortgage revenue bonds), the requirements of section 143(g)
must be satisfied. An issue satisfies the requirements of section 143(g)
only if such issue meets the requirements of paragraph (b) of this
section and, in the case of an issue 95 percent or more of the net
proceeds of which are to be used to provide residences for veterans,
such issue also
[[Page 70]]
meets the requirements of paragraph (c) of this section. The
requirements of section 143(g) and this section are applicable in
addition to the requirements of section 148 and Sec. Sec. 1.148-0
through 1.148-11.
(b) Effective rate of mortgage interest not to exceed bond yield by
more than 1.125 percentage points--(1) Maximum yield. An issue shall be
treated as meeting the requirements of this paragraph (b) only if the
excess of the effective rate of interest on the mortgages financed by
the issue, over the yield on the issue, is not greater over the term of
the issue than 1.125 percentage points.
(2) Effective rate of interest. (i) In determining the effective
rate of interest on any mortgage for purposes of this paragraph (b),
there shall be taken into account all fees, charges, and other amounts
borne by the mortgagor that are attributable to the mortgage or to the
bond issue. Such amounts include points, commitment fees, origination
fees, servicing fees, and prepayment penalties paid by the mortgagor.
(ii) Items that shall be treated as borne by the mortgagor and shall
be taken into account in calculating the effective rate of interest also
include--
(A) All points, commitment fees, origination fees, or similar
charges borne by the seller of the property; and
(B) The excess of any amounts received from any person other than
the mortgagor by any person in connection with the acquisition of the
mortgagor's interest in the property over the usual and reasonable
acquisition costs of a person acquiring like property when owner-
financing is not provided through the use of mortgage revenue bonds.
(iii) The following items shall not be treated as borne by the
mortgagor and shall not be taken into account in calculating the
effective rate of interest--
(A) Any expected rebate of arbitrage profit under paragraph (c) of
this section; and
(B) Any application fee, survey fee, credit report fee, insurance
charge or similar settlement or financing cost to the extent such amount
does not exceed amounts charged in the area in cases when owner-
financing is not provided through the use of mortgage revenue bonds. For
example, amounts paid for Federal Housing Administration, Veterans'
Administration, or similar private mortgage insurance on an individual's
mortgage, or amounts paid for pool mortgage insurance on a pool of
mortgages, are not taken into account so long as such amounts do not
exceed the amounts charged in the area with respect to a similar
mortgage, or pool of mortgages, that is not financed with mortgage
revenue bonds. For this purpose, amounts paid for pool mortgage
insurance include amounts paid to an entity (for example, the Government
National Mortgage Association, the Federal National Mortgage Association
(FNMA), the Federal Home Loan Mortgage Corporation, or other mortgage
insurer) to directly guarantee the pool of mortgages financed with the
bonds, or to guarantee a pass-through security backed by the pool of
mortgages financed with the bonds.
(C) The following example illustrates the provisions of this
paragraph (b)(2)(iii):
Example. Housing Authority X issues bonds intended to be qualified
mortgage bonds under section 143(a). At the time the bonds are issued, X
enters into an agreement with a group of mortgage lending institutions
(lenders) under which the lenders agree to originate and service
mortgages that meet certain specified requirements. After originating a
specified amount of mortgages, each lender issues a ``pass-though
security'' (each, a PTS) backed by the mortgages and sells the PTS to X.
Under the terms of the PTS, the lender pays X an amount equal to the
regular monthly payments on the mortgages (less certain fees), whether
or not received by the lender (plus any prepayments and liquidation
proceeds in the event of a foreclosure or other disposition of any
mortgages). FNMA guarantees the timely payment of principal and interest
on each PTS. From the payments received from each mortgagor, the lender
pays a fee to FNMA for its guarantee of the PTS. The amounts paid to
FNMA do not exceed the amounts charged in the area with respect to a
similar pool of mortgages that is not financed with mortgage revenue
bonds. Under this paragraph (b)(2)(iii), the fees for the guarantee
provided by FNMA are an insurance charge because the guarantee is pool
mortgage insurance. Because the amounts charged for the guarantee do not
exceed the amounts charged in the area with respect to a similar pool of
mortgages that is not financed with mortgage revenue bonds, the amounts
charged for the guarantee are not taken into
[[Page 71]]
account in computing the effective rate of interest on the mortgages
financed with X's bonds.
(3) Additional rules. To the extent not inconsistent with the Tax
Reform Act of 1986, Public Law 99-514 (the 1986 Act), or subsequent law,
Sec. 6a.103A-2(i)(2) (other than paragraphs (i)(2)(i) and (i)(2)(ii)(A)
through (C)) of this chapter applies to provide additional rules
relating to compliance with the requirement that the effective rate of
mortgage interest not exceed the bond yield by more than 1.125
percentage points.
(c) Arbitrage and investment gains to be used to reduce costs of
owner-financing. As provided in section 143(g)(3), certain earnings on
nonpurpose investments must either be paid or credited to mortgagors, or
paid to the United States, in certain circumstances. To the extent not
inconsistent with the 1986 Act or subsequent law, Sec. 6a.103A-2(i)(4)
of this chapter applies to provide guidance relating to compliance with
this requirement.
(d) Effective dates--(1) In general. Except as otherwise provided in
this section, Sec. 1.143(g)-1 applies to bonds sold on or after May 23,
2005, that are subject to section 143.
(2) Permissive retroactive application in whole. Except as provided
in paragraph (d)(4) of this section, issuers may apply Sec. 1.143(g)-1,
in whole, but not in part, to bonds sold before May 23, 2005, that are
subject to section 143.
(3) Bonds subject to the Internal Revenue Code of 1954. Except as
provided in paragraph (d)(4) of this section and subject to the
applicable effective dates for the corresponding statutory provisions,
an issuer may apply Sec. 1.143(g)-1, in whole, but not in part, to
bonds that are subject to section 103A(i) of the Internal Revenue Code
of 1954.
(4) Special rule for pre-July 1, 1993 bonds. To the extent that an
issuer applies this section to bonds issued before July 1, 1993, Sec.
6a.103A-2(i)(3) of this chapter also applies to the bonds.
[T.D. 9204, 70 FR 29449, May 23, 2005]
Sec. 1.144-0 Table of contents.
This section lists the captioned paragraphs contained in Sec. Sec.
1.144-1 and 1.144-2.
Sec. 1.144-1 Qualified small issue bonds, qualified student loan bonds,
and qualified redevelopment bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.144-2 Remedial actions.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997]
Sec. 1.144-1 Qualified small issue bonds, qualified student loan bonds,
and qualified redevelopment bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(D), a qualified small issue bond issued
under section 144(a) may be a qualified bond. Under section 144(a), any
qualified small issue bond is any bond issued as a part of an issue 95
percent or more of the proceeds of which are to be used to provide
certain manufacturing facilities or certain depreciable farm property
and which meets other requirements. Under section 141(e)(1)(F) a
qualified redevelopment bond issued under section 144(c) is a qualified
bond. Under section 144(c), a qualified redevelopment bond is any bond
issued as a part of an issue 95 percent or more of the net proceeds of
which are to be used for one or more redevelopment purposes and which
meets certain other requirements.
(b) Scope. Sections 1.144-0 through 1.144-2 apply for purposes of
the rules for small issue bonds under section 144(a) and qualified
redevelopment bonds under section 144(c), except that Sec. 1.144-2 does
not apply to the requirements for qualified small issue bonds under
section 144(a)(4) (relating to the limitation on capital expenditures)
or under section 144(a)(10) (relating to the aggregate limit of tax-
exempt bonds per taxpayer).
(c) Effective dates. For effective dates of Sec. Sec. 1.144-0
through 1.144-2, see Sec. 1.141-16.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997]
Sec. 1.144-2 Remedial actions.
The remedial action rules of Sec. 1.142-2 apply to qualified small
issue bonds issued under section 144(a) and to qualified redevelopment
bonds issued under section 144(c), for this purpose
[[Page 72]]
treating those bonds as exempt facility bonds and the qualifying
purposes for those bonds as exempt facilities.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997]
Sec. 1.145-0 Table of contents.
This section lists the captioned paragraphs contained in Sec. Sec.
1.145-1 and 1.145-2.
Sec. 1.145-1 Qualified 501(c)(3) bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.145-2 Application of private activity bond regulations.
(a) In general.
(b) Modification of private business tests.
(c) Exceptions.
(1) Certain provisions relating to governmental programs.
(2) Costs of issuance.
(d) Issuance costs financed by prior issue.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997, as amended by T.D. 9234, 70 FR
75035, Dec. 19, 2005]
Sec. 1.145-1 Qualified 501(c)(3) bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(G), a qualified 501(c)(3) bond issued
under section 145 is a qualified bond. Under section 145, a qualified
501(c)(3) bond is any bond issued as a part of an issue that satisfies
the requirements of sections 145(a) through (d).
(b) Scope. Sections 1.145-0 through 1.145-2 apply for purposes of
section 145(a).
(c) Effective dates. For effective dates of Sec. Sec. 1.145-0
through 1.145-2, see Sec. 1.141-15.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997]
Sec. 1.145-2 Application of private activity bond regulations.
(a) In general. Except as provided in this section, Sec. Sec.
1.141-0 through 1.141-15 apply to section 145(a). For example, under
this section, Sec. 1.141-1, and Sec. 1.141-2, an issue ceases to be an
issue of qualified 501(c)(3) bonds if the issuer or a conduit borrower
501(c)(3) organization takes a deliberate action, subsequent to the
issue date, that causes the issue to fail to comply with the
requirements of sections 141(e) and 145 (such as an action that results
in revocation of exempt status of the 501(c)(3) organization).
(b) Modification of private business tests. In applying Sec. Sec.
1.141-0 through 1.141-15 to section 145(a)--
(1) References to governmental persons include 501(c)(3)
organizations with respect to their activities that do not constitute
unrelated trades or businesses under section 513(a);
(2) References to ``10 percent'' and ``proceeds'' in the context of
the private business use test and the private security or payment test
mean ``5 percent'' and ``net proceeds''; and
(3) References to the private business use test in Sec. Sec. 1.141-
2 and 1.141-12 include the ownership test of section 145(a)(1).
(c) Exceptions--(1) Certain provisions relating to governmental
programs. The following provisions do not apply to section 145: Sec.
1.141-2(d)(4) (relating to the special rule for dispositions of personal
property in the ordinary course of an established governmental program)
and Sec. 1.141-2(d)(5) (relating to the special rule for general
obligation bond programs that finance a large number of separate
purposes).
(2) Costs of issuance. Section 1.141-3(g)(6) does not apply to
section 145(a)(2) to the extent that it provides that costs of issuance
are allocated ratably among the other purposes for which the proceeds
are used. For purposes of section 145(a)(2), costs of issuance are
treated as private business use.
(d) Issuance costs financed by prior issue. Solely for purposes of
applying the private business use test to a refunding issue under Sec.
1.141-13, the use of proceeds of the prior issue (or any earlier issue
in a series of refundings) to pay issuance costs of the prior issue (or
the earlier issue) is treated as a government use.
[T.D. 8712, 62 FR 2303, Jan. 16, 1997, as amended by T.D. 9234, 70 FR
75035, Dec. 19, 2005]
Sec. 1.147-0 Table of contents.
This section lists the captioned paragraphs contained in Sec. Sec.
1.147-1 and 1.147-2.
[[Page 73]]
Sec. 1.147-1 Other requirements applicable to certain private activity
bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.147-2 Remedial actions.
[T.D. 8712, 62 FR 2304, Jan. 16, 1997]
Sec. 1.147-1 Other requirements applicable to certain private activity
bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 147, certain requirements must be met for a private
activity bond to qualify as a qualified bond.
(b) Scope. Sections 1.147-0 through 1.147-2 apply for purposes of
the rules in section 147 for qualified private activity bonds that
permit use of proceeds to acquire land for environmental purposes
(section 147(c)(3)), permit use of proceeds for certain rehabilitations
(section 147(d) (2) and (3)), prohibit use of proceeds to finance
skyboxes, airplanes, gambling establishments and similar facilities
(section 147(e)), and require public approval (section 147(f)), but not
for the rules limiting use of proceeds to acquire land or existing
property under sections 147(c) (1) and (2), and (d)(1).
(c) Effective dates. For effective dates of Sec. Sec. 1.147-0
through 1.147-2, see Sec. 1.141-16.
[T.D. 8712, 62 FR 2304, Jan. 16, 1997]
Sec. 1.147-2 Remedial actions.
The remedial action rules of Sec. 1.142-2 apply to the rules in
section 147 for qualified private activity bonds that permit use of
proceeds to acquire land for environmental purposes (section 147(c)(3)),
permit use of proceeds for certain rehabilitations (section 147(d) (2)
and (3)), prohibit use of proceeds to finance skyboxes, airplanes,
gambling establishments and similar facilities (section 147(e)), and
require public approval (section 147(f)), for this purpose treating
those private activity bonds subject to the rules under section 147 as
exempt facility bonds and the qualifying purposes for those bonds as
exempt facilities.
[T.D. 8712, 62 FR 2304, Jan. 16, 1997]
Sec. 1.147(b)-1 Bond maturity limitation-treatment of working capital.
Section 147(b) does not apply to proceeds of a private activity bond
issue used to finance working capital expenditures.
[T.D. 8476, 58 FR 33515, June 18, 1993]
Sec. 1.148-0 Scope and table of contents.
(a) Overview. Under section 103(a), interest on certain obligations
issued by States and local governments is excludable from the gross
income of the owners. Section 148 was enacted to minimize the arbitrage
benefits from investing gross proceeds of tax-exempt bonds in higher
yielding investments and to remove the arbitrage incentives to issue
more bonds, to issue bonds earlier, or to leave bonds outstanding longer
than is otherwise reasonably necessary to accomplish the governmental
purposes for which the bonds were issued. To accomplish these purposes,
section 148 restricts the direct and indirect investment of bond
proceeds in higher yielding investments and requires that certain
earnings on higher yielding investments be rebated to the United States.
Violation of these provisions causes the bonds in the issue to become
arbitrage bonds, the interest on which is not excludable from the gross
income of the owners under section 103(a). The regulations in Sec. Sec.
1.148-1 through 1.148-11 apply in a manner consistent with these
purposes.
(b) Scope. Sections 1.148-1 through 1.148-11 apply generally for
purposes of the arbitrage restrictions on State and local bonds under
section 148.
(c) Table of contents. This paragraph (c) lists the table of
contents for Sec. Sec. 1.148-1, 1.148-2, 1.148-3, 1.148-4, 1.148-5,
1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10 and 1.148-11.
Sec. 1.148-1 Definitions and elections.
(a) In general.
(b) Certain definitions.
(c) Definition of replacement proceeds.
(1) In general.
(2) Sinking fund.
(3) Pledged fund.
(4) Other replacement proceeds.
[[Page 74]]
(d) Elections.
(e) Investment-type property.
(1) In general.
(2) Prepayments.
(3) Certain hedges.
Sec. 1.148-2 General arbitrage yield restriction rules.
(a) In general.
(b) Reasonable expectations.
(1) In general.
(2) Certification of expectations.
(c) Intentional acts.
(d) Materially higher yielding investments.
(1) In general.
(2) Definitions of materially higher yield.
(3) Mortgage loans.
(e) Temporary periods.
(1) In general.
(2) General 3-year temporary period for capital projects and
qualified mortgage loans.
(3) Temporary period for restricted working capital expenditures.
(4) Temporary period for pooled financings.
(5) Temporary period for replacement proceeds.
(6) Temporary period for investment proceeds.
(7) Other amounts.
(f) Reserve or replacement funds.
(1) General 10 percent limitation on funding with sale proceeds.
(2) Exception from yield restriction for reasonably required reserve
or replacement funds.
(3) Certain parity reserve funds.
(g) Minor portion.
(h) Certain waivers permitted.
Sec. 1.148-3 General arbitrage rebate rules.
(a) In general.
(b) Definition of rebate amount.
(c) Computation of future value of a payment or receipt.
(d) Payments and receipts.
(1) Definition of payments.
(2) Definition of receipts.
(3) Special rules for commingled funds.
(e) Computation dates.
(1) In general.
(2) Final computation date.
(f) Amount of required rebate installment payment.
(1) Amount of interim rebate payments.
(2) Amount of final rebate payment.
(3) Future value of rebate payments.
(g) Time and manner of payment.
(h) Penalty in lieu of loss of tax exemption.
(1) In general.
(2) Interest on underpayments.
(3) Waivers of the penalty.
(4) Application to alternative penalty under Sec. 1.148-7.
(i) Recovery of overpayment of rebate.
(1) In general.
(2) Limitations on recovery.
(3) Time and manner for requesting refund.
(j) Examples.
(k) Bona fide debt service fund exception.
Sec. 1.148-4 Yield on an issue of bonds.
(a) In general.
(b) Computing yield on a fixed yield issue.
(1) In general.
(2) Yield on certain fixed yield bonds subject to mandatory or
contingent early redemption.
(3) Yield on certain fixed yield bonds subject to optional early
redemption.
(4) Yield recomputed upon transfer of certain rights associated with
the bond.
(5) Special aggregation rule treating certain bonds as a single
fixed yield bond.
(6) Examples.
(c) Computing yield on a variable yield issue.
(1) In general.
(2) Payments on bonds included in yield for a computation period.
(3) Example.
(d) Conversion from variable yield issue to fixed yield issue.
(e) Value of bonds.
(1) Plain par bonds.
(2) Other bonds.
(f) Qualified guarantees.
(1) In general.
(2) Interest savings.
(3) Guarantee in substance.
(4) Reasonable charge.
(5) Guarantee of purpose investments.
(6) Allocation of qualified guarantee payments.
(7) Refund or reduction of guarantee payments.
(g) Yield on certain mortgage revenue and student loan bonds.
(h) Qualified hedging transactions.
(1) In general.
(2) Qualified hedge defined.
(3) Accounting for qualified hedges.
(4) Certain variable yield bonds treated as fixed yield bonds.
(5) Contracts entered into before issue date of hedged bond.
(6) Authority of the Commissioner.
Sec. 1.148-5 Yield and valuation of investments.
(a) In general.
(b) Yield on an investment.
(1) In general.
(2) Yield on a separate class of investments.
(3) Investments to be held beyond issue's maturity or beyond
temporary period.
(4) Consistent redemption assumptions on purpose investments.
(5) Student loan special allowance payments included in yield.
(c) Yield reduction payments to the United States.
[[Page 75]]
(1) In general.
(2) Manner of payment.
(3) Applicability of special yield reduction rule.
(d) Value of investments.
(1) In general.
(2) Mandatory valuation of yield restricted investments at present
value.
(3) Mandatory valuation of certain investments at fair market value.
(4) Special transition rule for transferred proceeds.
(5) Definition of present value of an investment.
(6) Definition of fair market value.
(e) Administrative costs of investments.
(1) In general.
(2) Qualified administrative costs on nonpurpose investments.
(3) Qualified administrative costs on purpose investments.
Sec. 1.148-6 General allocation and accounting rules.
(a) In general.
(1) Reasonable accounting methods required.
(2) Bona fide deviations from accounting method.
(b) Allocation of gross proceeds to an issue.
(1) One-issue rule and general ordering rules.
(2) Universal cap on value of nonpurpose investments allocated to an
issue.
(c) Fair market value limit on allocations to nonpurpose
investments.
(d) Allocation of gross proceeds to expenditures.
(1) Expenditures in general.
(2) Treatment of gross proceeds invested in purpose investments.
(3) Expenditures for working capital purposes.
(4) Expenditures for grants.
(5) Expenditures for reimbursement purposes.
(6) Expenditures of certain commingled investment proceeds of
governmental issues.
(7) Payments to related parties.
(e) Special rules for commingled funds.
(1) In general.
(2) Investments held by a commingled fund.
(3) Certain expenditures involving a commingled fund.
(4) Fiscal periods.
(5) Unrealized gains and losses on investments of a commingled fund.
(6) Allocations of commingled funds serving as common reserve funds
or sinking funds.
Sec. 1.148-7 Spending exceptions to the rebate requirement.
(a) Scope of section.
(1) In general.
(2) Relationship of spending exceptions.
(3) Spending exceptions not mandatory.
(b) Rules applicable for all spending exceptions.
(1) Special transferred proceeds rules.
(2) Application of multipurpose issue rules.
(3) Expenditures for governmental purposes of the issue.
(4) De minimis rule.
(5) Special definition of reasonably required reserve or replacement
fund.
(6) Pooled financing issue.
(c) 6-month exception.
(1) General rule.
(2) Additional period for certain bonds.
(3) Amounts not included in gross proceeds.
(4) Series of refundings.
(d) 18-month exception.
(1) General rule.
(2) Extension for reasonable retainage.
(3) Gross proceeds.
(4) Application to multipurpose issues.
(e) 2-year exception.
(1) General rule.
(2) Extension for reasonable retainage.
(3) Definitions.
(f) Construction issue.
(1) Definition.
(2) Use of actual facts.
(3) Ownership requirement.
(g) Construction expenditures.
(1) Definition.
(2) Certain acquisitions under turnkey contracts treated as
construction expenditures.
(3) Constructed personal property.
(4) Specially developed computer software.
(5) Examples.
(h) Reasonable retainage definition.
(i) Available construction proceeds.
(1) Definition in general.
(2) Earnings on a reasonably required reserve or replacement fund.
(3) Reasonable expectations test for future earnings.
(4) Issuance costs.
(5) One and one-half percent penalty in lieu of arbitrage rebate.
(6) Payments on purpose investments and repayments of grants.
(7) Examples.
(j) Election to treat portion of issue used for construction as
separate issue.
(1) In general.
(2) Example.
(k) One and one-half percent penalty in lieu of arbitrage rebate.
(1) In general.
(2) Application to reasonable retainage.
(3) Coordination with rebate requirement.
(l) Termination of 1\1/2\ percent penalty.
(1) Termination after initial temporary period.
(2) Termination before end of initial temporary period.
(3) Application to reasonable retainage.
(4) Example.
(m) Payment of penalties.
[[Page 76]]
Sec. 1.148-8 Small issuer exception to rebate requirement.
(a) Scope.
(b) General taxing powers.
(c) Size limitation.
(1) In general.
(2) Aggregation rules.
(3) Certain refunding bonds not taken into account.
(d) Pooled financings.
(1) Treatment of pool issuer.
(2) Treatment of conduit borrowers.
(e) Refunding issues.
(1) In general.
(2) Multipurpose issues.
Sec. 1.148-9 Arbitrage rules for refunding issues.
(a) Scope of application.
(b) Transferred proceeds allocation rule.
(1) In general.
(2) Special definition of principal amount.
(3) Relation of transferred proceeds rule to universal cap rule.
(4) Limitation on multi-generational transfers.
(c) Special allocation rules for refunding issues.
(1) Allocations of investments.
(2) Allocations of mixed escrows to expenditures for principal,
interest, and redemption prices on a prior issue.
(d) Temporary periods in refundings.
(1) In general.
(2) Types of temporary periods in refundings.
(e) Reasonably required reserve or replacement funds in refundings.
(f) Minor portions in refundings.
(g) Certain waivers permitted.
(h) Multipurpose issue allocations.
(1) Application of multipurpose issue allocation rules.
(2) Rules on allocations of multipurpose issues.
(3) Separate purposes of a multipurpose issue.
(4) Allocations of bonds of a multipurpose issue.
(5) Limitation on multi-generation allocations.
(i) Operating rules for separation of prior issues into refunded and
unrefunded portions.
(1) In general.
(2) Allocations of proceeds and investments in a partial refunding.
(3) References to prior issue.
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
(a) Abusive arbitrage device.
(1) In general.
(2) Abusive arbitrage device defined.
(3) Exploitation of tax-exempt interest rates.
(4) Overburdening the tax-exempt market.
(b) Consequences of overburdening the tax-exempt bond market.
(1) In general.
(2) Application.
(c) Anti-abuse rules on excess gross proceeds of advance refunding
issues.
(1) In general.
(2) Definition of excess gross proceeds.
(3) Special treatment of transferred proceeds.
(4) Special rule for crossover refundings.
(5) Special rule for gross refundings.
(d) Examples.
(e) Authority of the Commissioner to clearly reflect the economic
substance of a transaction.
(f) Authority of the Commissioner to require an earlier date for
payment of rebate.
(g) Authority of the Commissioner to waive regulatory limitations.
Sec. 1.148-11 Effective/applicability dates.
(a) In general.
(b) Elective retroactive application in whole.
(1) In general.
(2) No elective retroactive application for 18-month spending
exception.
(3) No elective retroactive application for hedges of fixed rate
issues.
(4) No elective retroactive application for safe harbor for
establishing fair market value for guaranteed investment contracts and
investments purchased for a yield restricted defeasance escrow.
(c) Elective retroactive application of certain provisions.
(1) Retroactive application of overpayment recovery provisions.
(2) Certain allocations of multipurpose issues.
(3) Special limitation.
(d) Transition rule excepting certain state guarantee funds from the
definition of replacement proceeds.
(1) Certain perpetual trust funds.
(2) Permanent University Fund.
(e) Transition rule regarding special allowance payments.
(f) Transition rule regarding applicability of yield reduction rule.
(g) Provisions applicable to certain bonds sold before effective
date.
(h) Safe harbor for establishing fair market value for guaranteed
investment contracts and investments purchased for a yield restricted
defeasance escrow.
(i) Special rule for certain broker's commissions and similar fees.
(j) Certain prepayments.
(k) [Reserved]
(l) Additional arbitrage guidance updates.
(1) - (3) [Reserved]
[[Page 77]]
(4) Application.
[T.D. 8476, 58 FR 33515, June 18, 1993, as amended by T.D. 8538, 59 FR
24041, May 10, 1994; T.D. 8718, 62 FR 25506, May 9, 1997; T.D. 9085, 68
FR 45775, Aug. 4, 2003; T.D. 9097, 68 FR 69022, Dec. 11, 2003; T.D.
9701, 79 FR 67351, Nov. 13, 2014]
Sec. 1.148-1 Definitions and elections.
(a) In general. The definitions in this section and the definitions
under section 150 apply for purposes of section 148 and Sec. Sec.
1.148-1 through 1.148-11.
(b) Certain definitions. The following definitions apply:
Accounting method means both the overall method used to account for
gross proceeds of an issue (e.g., the cash method or a modified accrual
method) and the method used to account for or allocate any particular
item within that overall accounting method (e.g., accounting for
investments, expenditures, allocations to and from different sources,
and particular items of the foregoing).
Annuity contract means annuity contract as defined in section 72.
Available amount means available amount as defined in Sec. 1.148-
6(d)(3)(iii).
Bona fide debt service fund means a fund, which may include proceeds
of an issue, that--
(1) Is used primarily to achieve a proper matching of revenues with
principal and interest payments within each bond year; and
(2) Is depleted at least once each bond year, except for a
reasonable carryover amount not to exceed the greater of:
(i) the earnings on the fund for the immediately preceding bond
year; or
(ii) one-twelfth of the principal and interest payments on the issue
for the immediately preceding bond year.
Bond year means, in reference to an issue, each 1-year period that
ends on the day selected by the issuer. The first and last bond years
may be short periods. If no day is selected by the issuer before the
earlier of the final maturity date of the issue or the date that is 5
years after the issue date, bond years end on each anniversary of the
issue date and on the final maturity date.
Capital project or capital projects means all capital expenditures,
plus related working capital expenditures to which the de minimis rule
under Sec. 1.148-6(d)(3)(ii)(A) applies, that carry out the
governmental purposes of an issue. For example, a capital project may
include capital expenditures for one or more buildings, plus related
start-up operating costs.
Commingled fund means any fund or account containing both gross
proceeds of an issue and amounts in excess of $25,000 that are not gross
proceeds of that issue if the amounts in the fund or account are
invested and accounted for collectively, without regard to the source of
funds deposited in the fund or account. An open-end regulated investment
company under section 851, however, is not a commingled fund.
Computation date means each date on which the rebate amount for an
issue is computed under Sec. 1.148-3(e).
Computation period means the period between computation dates. The
first computation period begins on the issue date and ends on the first
computation date. Each succeeding computation period begins on the date
immediately following the computation date and ends on the next
computation date.
Consistently applied means applied uniformly within a fiscal period
and between fiscal periods to account for gross proceeds of an issue and
any amounts that are in a commingled fund.
De minimis amount means--
(1) In reference to original issue discount (as defined in section
1273(a)(1)) or premium on an obligation--
(i) An amount that does not exceed 2 percent multiplied by the
stated redemption price at maturity; plus
(ii) Any original issue premium that is attributable exclusively to
reasonable underwriters' compensation; and
(2) In reference to market discount (as defined in section
1278(a)(2)(A)) or premium on an obligation, an amount that does not
exceed 2 percent multiplied by the stated redemption price at maturity.
Economic accrual method (also known as the constant interest method
or actuarial method) means the method of computing yield that is based
on the compounding of interest at the end of each compounding period.
Fair market value means fair market value as defined in Sec. 1.148-
5(d)(6).
[[Page 78]]
Fixed rate investment means any investment whose yield is fixed and
determinable on the issue date.
Fixed yield bond means any bond whose yield is fixed and
determinable on the issue date using the assumptions and rules provided
in Sec. 1.148-4(b).
Fixed yield issue means any issue if each bond that is part of the
issue is a fixed yield bond.
Gross proceeds means any proceeds and replacement proceeds of an
issue.
Guaranteed investment contract includes any nonpurpose investment
that has specifically negotiated withdrawal or reinvestment provisions
and a specifically negotiated interest rate, and also includes any
agreement to supply investments on two or more future dates (e.g., a
forward supply contract).
Higher yielding investments means higher yielding investments as
defined in section 148(b)(1).
Investment means any investment property as defined in sections
148(b)(2) and 148(b)(3), and any other tax-exempt bond.
Investment proceeds means any amounts actually or constructively
received from investing proceeds of an issue.
Investment-type property is defined in paragraph (e) of this
section.
Issue price means, except as otherwise provided, issue price as
defined in sections 1273 and 1274. Generally, the issue price of bonds
that are publicly offered is the first price at which a substantial
amount of the bonds is sold to the public. Ten percent is a substantial
amount. The public does not include bond houses, brokers, or similar
persons or organizations acting in the capacity of underwriters or
wholesalers. The issue price does not change if part of the issue is
later sold at a different price. The issue price of bonds that are not
substantially identical is determined separately. The issue price of
bonds for which a bona fide public offering is made is determined as of
the sale date based on reasonable expectations regarding the initial
public offering price. If a bond is issued for property, the applicable
Federal tax-exempt rate is used in lieu of the Federal rate in
determining the issue price under section 1274. The issue price of bonds
may not exceed their fair market value as of the sale date.
Issuer generally means the entity that actually issues the issue,
and, unless the context or a provision clearly requires otherwise, each
conduit borrower of the issue. For example, rules imposed on issuers to
account for gross proceeds of an issue apply to a conduit borrower to
account for any gross proceeds received under a purpose investment.
Provisions regarding elections, filings, liability for the rebate
amount, and certifications of reasonable expectations apply only to the
actual issuer.
Multipurpose issue means an issue the proceeds of which are used for
two or more separate purposes determined in accordance with Sec. 1.148-
9(h).
Net sale proceeds means sale proceeds, less the portion of those
sale proceeds invested in a reasonably required reserve or replacement
fund under section 148(d) and as part of a minor portion under section
148(e).
Nonpurpose investment means any investment property, as defined in
section 148(b), that is not a purpose investment.
Payment means a payment as defined in Sec. 1.148-3(d) for purposes
of computing the rebate amount, and a payment as defined in Sec. 1.148-
5(b) for purposes of computing the yield on an investment.
Plain par bond means a qualified tender bond or a bond--
(1) Issued with not more than a de minimis amount of original issue
discount or premium;
(2) Issued for a price that does not include accrued interest other
than pre-issuance accrued interest;
(3) That bears interest from the issue date at a single, stated,
fixed rate or that is a variable rate debt instrument under section
1275, in each case with interest unconditionally payable at least
annually; and
(4) That has a lowest stated redemption price that is not less than
its outstanding stated principal amount.
Plain par investment means an investment that is an obligation--
(1) Issued with not more than a de minimis amount of original issue
discount or premium, or, if acquired on a
[[Page 79]]
date other than the issue date, acquired with not more than a de minimis
amount of market discount or premium;
(2) Issued for a price that does not include accrued interest other
than pre-issuance accrued interest;
(3) That bears interest from the issue date at a single, stated,
fixed rate or that is a variable rate debt instrument under section
1275, in each case with interest unconditionally payable at least
annually; and
(4) That has a lowest stated redemption price that is not less than
its outstanding stated principal amount.
Pre-issuance accrued interest means amounts representing interest
that accrued on an obligation for a period not greater than one year
before its issue date but only if those amounts are paid within one year
after the issue date.
Proceeds means any sale proceeds, investment proceeds, and
transferred proceeds of an issue. Proceeds do not include, however,
amounts actually or constructively received with respect to a purpose
investment that are properly allocable to the immaterially higher yield
under Sec. 1.148-2(d) or section 143(g) or to qualified administrative
costs recoverable under Sec. 1.148-5(e).
Program investment means a purpose investment that is part of a
governmental program in which--
(1) The program involves the origination or acquisition of purpose
investments;
(2) At least 95 percent (90 percent for qualified student loans
under section 144(b)(1)(A)) of the cost of the purpose investments
acquired under the program represents one or more loans to a substantial
number of persons representing the general public, States or political
subdivisions, 501(c)(3) organizations, persons who provide housing and
related facilities, or any combination of the foregoing;
(3) At least 95 percent of the receipts from the purpose investments
are used to pay principal, interest, or redemption prices on issues that
financed the program, to pay or reimburse administrative costs of those
issues or of the program, to pay or reimburse anticipated future losses
directly related to the program, to finance additional purpose
investments for the same general purposes of the program, or to redeem
and retire governmental obligations at the next earliest possible date
of redemption;
(4) The program documents prohibit any obligor on a purpose
investment financed by the program or any related party to that obligor
from purchasing bonds of an issue that finance the program in an amount
related to the amount of the purpose investment acquired from that
obligor; and
(5) The issuer has not waived the right to treat the investment as a
program investment.
Purpose investment means an investment that is acquired to carry out
the governmental purpose of an issue.
Qualified administrative costs means qualified administrative costs
as defined in Sec. 1.148-5(e).
Qualified guarantee means a qualified guarantee as defined in Sec.
1.148-4(f).
Qualified hedge means a qualified hedge as defined in Sec. 1.148-
4(h)(2).
Reasonable expectations or reasonableness. An issuer's expectations
or actions are reasonable only if a prudent person in the same
circumstances as the issuer would have those same expectations or take
those same actions, based on all the objective facts and circumstances.
Factors relevant to a determination of reasonableness include the
issuer's history of conduct concerning stated expectations made in
connection with the issuance of obligations, the level of inquiry by the
issuer into factual matters, and the existence of covenants, enforceable
by bondholders, that require implementation of specific expectations.
For a conduit financing issue, factors relevant to a determination of
reasonableness include the reasonable expectations of the conduit
borrower, but only if, under the circumstances, it is reasonable and
prudent for the issuer to rely on those expectations.
Rebate amount means 100 percent of the amount owed to the United
States under section 148(f)(2), as further described in Sec. 1.148-3.
Receipt means a receipt as defined in Sec. 1.148-3(d) for purposes
of computing the rebate amount, and a receipt as defined in Sec. 1.148-
5(b) for purposes of computing yield on an investment.
[[Page 80]]
Refunding escrow means one or more funds established as part of a
single transaction or a series of related transactions, containing
proceeds of a refunding issue and any other amounts to provide for
payment of principal or interest on one or more prior issues. For this
purpose, funds are generally not so established solely because of--
(1) The deposit of proceeds of an issue and replacement proceeds of
the prior issue in an escrow more than 6 months apart, or
(2) The deposit of proceeds of completely separate issues in an
escrow.
Replacement proceeds is defined in paragraph (c) of this section.
Restricted working capital expenditures means working capital
expenditures that are subject to the proceeds-spent-last rule in Sec.
1.148-6(d)(3)(i) and are ineligible for any exception to that rule.
Sale proceeds means any amounts actually or constructively received
from the sale of the issue, including amounts used to pay underwriters'
discount or compensation and accrued interest other than pre-issuance
accrued interest. Sale proceeds also include, but are not limited to,
amounts derived from the sale of a right that is associated with a bond,
and that is described in Sec. 1.148-4(b)(4). See also Sec. 1.148-
4(h)(5) treating amounts received upon the termination of certain hedges
as sale proceeds.
Stated redemption price means the redemption price of an obligation
under the terms of that obligation, including any call premium.
Transferred proceeds means transferred proceeds as defined in Sec.
1.148-9 (or the applicable corresponding provision of prior law).
Unconditionally payable means payable under terms in which--
(1) Late payment or nonpayment results in a significant penalty to
the borrower or reasonable remedies to the lender, and
(2) It is reasonably certain on the issue date that the payment will
actually be made.
Value means value determined under Sec. 1.148-4(e) for a bond, and
value determined under Sec. 1.148-5(d) for an investment.
Variable yield bond means any bond that is not a fixed yield bond.
Variable yield issue means any issue that is not a fixed yield
issue.
Yield means yield computed under Sec. 1.148-4 for an issue, and
yield computed under Sec. 1.148-5 for an investment.
Yield restricted means required to be invested at a yield that is
not materially higher than the yield on the issue under section 148(a)
and Sec. 1.148-2.
(c) Definition of replacement proceeds--(1) In general. Amounts are
replacement proceeds of an issue if the amounts have a sufficiently
direct nexus to the issue or to the governmental purpose of the issue to
conclude that the amounts would have been used for that governmental
purpose if the proceeds of the issue were not used or to be used for
that governmental purpose. For this purpose, governmental purposes
include the expected use of amounts for the payment of debt service on a
particular date. The mere availability or preliminary earmarking of
amounts for a governmental purpose, however, does not in itself
establish a sufficient nexus to cause those amounts to be replacement
proceeds. Replacement proceeds include, but are not limited to, sinking
funds, pledged funds, and other replacement proceeds described in
paragraph (c)(4) of this section, to the extent that those funds or
amounts are held by or derived from a substantial beneficiary of the
issue. A substantial beneficiary of an issue includes the issuer and any
related party to the issuer, and, if the issuer is not a state, the
state in which the issuer is located. A person is not a substantial
beneficiary of an issue solely because it is a guarantor under a
qualified guarantee.
(2) Sinking fund. Sinking fund includes a debt service fund,
redemption fund, reserve fund, replacement fund, or any similar fund, to
the extent reasonably expected to be used directly or indirectly to pay
principal or interest on the issue.
(3) Pledged fund--(i) In general. A pledged fund is any amount that
is directly or indirectly pledged to pay principal or interest on the
issue. A pledge need not be cast in any particular form but, in
substance, must provide reasonable assurance that the amount will be
available to pay principal or interest on the issue, even if
[[Page 81]]
the issuer encounters financial difficulties. A pledge to a guarantor of
an issue is an indirect pledge to secure payment of principal or
interest on the issue. A pledge of more than 50 percent of the
outstanding stock of a corporation that is a conduit borrower of the
issue is not treated as a pledge for this purpose, unless the
corporation is formed or availed of to avoid the creation of replacement
proceeds.
(ii) Negative pledges. An amount is treated as pledged to pay
principal or interest on an issue if it is held under an agreement to
maintain the amount at a particular level for the direct or indirect
benefit of the bondholders or a guarantor of the bonds. An amount is not
treated as pledged under this paragraph (c)(3)(ii), however, if--
(A) The issuer or a substantial beneficiary may grant rights in the
amount that are superior to the rights of the bondholders or the
guarantor; or
(B) The amount does not exceed reasonable needs for which it is
maintained, the required level is tested no more frequently than every 6
months, and the amount may be spent without any substantial restriction
other than a requirement to replenish the amount by the next testing
date.
(4) Other replacement proceeds--(i) Bonds outstanding longer than
necessary--(A) In general. Replacement proceeds arise to the extent that
the issuer reasonably expects as of the issue date that--
(1) The term of an issue will be longer than is reasonably necessary
for the governmental purposes of the issue, and
(2) There will be available amounts during the period that the issue
remains outstanding longer than necessary. Whether an issue is
outstanding longer than necessary is determined under Sec. 1.148-10.
Replacement proceeds are created under this paragraph (c)(4)(i)(A) at
the beginning of each fiscal year during which an issue remains
outstanding longer than necessary in an amount equal to available
amounts of the issuer as of that date.
(B) Safe harbor against creation of replacement proceeds. As a safe
harbor, replacement proceeds do not arise under paragraph (c)(4)(i)(A)
of this section--
(1) For the portion of an issue that is to be used to finance
restricted working capital expenditures, if that portion is not
outstanding longer than 2 years;
(2) For the portion of an issue (including a refunding issue) that
is to be used to finance or refinance capital projects, if that portion
has a weighted average maturity that does not exceed 120 percent of the
average reasonably expected economic life of the financed capital
projects, determined in the same manner as under section 147(b); or
(3) For the portion of an issue that is a refunding issue, if that
portion has a weighted average maturity that does not exceed the
remaining weighted average maturity of the prior issue, and the issue of
which the prior issue is a part satisfies paragraph (c)(4)(i)(B) (1) or
(2) of this section.
(ii) Bonds financing a working capital reserve--(A) In general.
Except as otherwise provided in paragraph (c)(4)(ii)(B) of this section,
replacement proceeds arise to the extent a working capital reserve is,
directly or indirectly, financed with the proceeds of the issue
(regardless of the expenditure of proceeds of the issue). Thus, for
example, if an issuer that does not maintain a working capital reserve
borrows to fund a working capital reserve, the issuer will have
replacement proceeds. To determine the amount of a working capital
reserve maintained, an issuer may use the average amount maintained as a
working capital reserve during annual periods of at least 1 year, the
last of which ends within 1 year before the issue date. For example, the
amount of a working capital reserve may be computed using the average of
the beginning or ending monthly balances of the amount maintained as a
reserve (net of unexpended gross proceeds) during the 1 year period
preceding the issue date.
(B) Exception to creation of replacement proceeds. Replacement
proceeds do not arise under paragraph (c)(4)(ii)(A) of this section with
respect to an issue--
(1) All of the net proceeds of which are spent within 6 months of
the issue date under section 148(f)(4)(B)(iii)(I); or
(2) That is not subject to the rebate requirement under the
exception provided by section 148(f)(4)(D).
[[Page 82]]
(d) Elections. Except as otherwise provided, any required elections
must be made in writing, and, once made, may not be revoked without the
permission of the Commissioner.
(e) Investment-type property--(1) In general. Investment-type
property includes any property, other than property described in section
148(b)(2)(A), (B), (C) or (E), that is held principally as a passive
vehicle for the production of income. For this purpose, production of
income includes any benefit based on the time value of money.
(2) Prepayments--(i) In general--(A) Generally. Except as otherwise
provided in this paragraph (e)(2), a prepayment for property or
services, including a prepayment for property or services that is made
after the date that the contract to buy the property or services is
entered into, also gives rise to investment-type property if a principal
purpose for prepaying is to receive an investment return from the time
the prepayment is made until the time payment otherwise would be made. A
prepayment does not give rise to investment-type property if--
(1) Prepayments on substantially the same terms are made by a
substantial percentage of persons who are similarly situated to the
issuer but who are not beneficiaries of tax-exempt financing;
(2) The prepayment is made within 90 days of the reasonably expected
date of delivery to the issuer of all of the property or services for
which the prepayment is made; or
(3) The prepayment meets the requirements of paragraph
(e)(2)(iii)(A) or (B) of this section.
(B) Example. The following example illustrates an application of
this paragraph (e)(2)(i):
Example. Prepayment after contract is executed. In 1998, City A
enters into a ten-year contract with Company Y. Under the contract,
Company Y is to provide services to City A over the term of the contract
and in return City A will pay Company Y for its services as they are
provided. In 2004, City A issues bonds to finance a lump sum payment to
Company Y in satisfaction of City A's obligation to pay for Company Y's
services to be provided over the remaining term of the contract. The use
of bond proceeds to make the lump sum payment constitutes a prepayment
for services under paragraph (e)(2)(i) of this section, even though the
payment is made after the date that the contract is executed.
(ii) Customary prepayments. The determination of whether a
prepayment satisfies paragraph (e)(2)(i)(A)(1) of this section is
generally made based on all the facts and circumstances. In addition, a
prepayment is deemed to satisfy paragraph (e)(2)(i)(A)(1) of this
section if--
(A) The prepayment is made for--
(1) Maintenance, repair, or an extended warranty with respect to
personal property (for example, automobiles or electronic equipment); or
(2) Updates or maintenance or support services with respect to
computer software; and
(B) The same maintenance, repair, extended warranty, updates or
maintenance or support services, as applicable, are regularly provided
to nongovernmental persons on the same terms.
(iii) Certain prepayments to acquire a supply of natural gas or
electricity--(A) Natural gas prepayments. A prepayment meets the
requirements of this paragraph (e)(2)(iii)(A) if--
(1) It is made by or for one or more utilities that are owned by a
governmental person, as defined in Sec. 1.141-1(b) (each of which is
referred to in this paragraph (e)(2)(iii)(A) as the issuing municipal
utility), to purchase a supply of natural gas; and
(2) At least 90 percent of the prepaid natural gas financed by the
issue is used for a qualifying use. Natural gas is used for a qualifying
use if it is to be--
(i) Furnished to retail gas customers of the issuing municipal
utility who are located in the natural gas service area of the issuing
municipal utility, provided, however, that gas used to produce
electricity for sale shall not be included under this paragraph
(e)(2)(iii)(A)(2)(i);
(ii) Used by the issuing municipal utility to produce electricity
that will be furnished to retail electric customers of the issuing
municipal utility who are located in the electricity service area of the
issuing municipal utility;
(iii) Used by the issuing municipal utility to produce electricity
that will
[[Page 83]]
be sold to a utility that is owned by a governmental person and
furnished to retail electric customers of the purchaser who are located
in the electricity service area of the purchaser;
(iv) Sold to a utility that is owned by a governmental person if the
requirements of paragraph (e)(2)(iii)(A)(2)(i), (ii) or (iii) of this
section are satisfied by the purchaser (treating the purchaser as the
issuing municipal utility); or
(v) Used to fuel the pipeline transportation of the prepaid gas
supply acquired in accordance with this paragraph (e)(2)(iii)(A).
(B) Electricity prepayments. A prepayment meets the requirements of
this paragraph (e)(2)(iii)(B) if--
(1) It is made by or for one or more utilities that are owned by a
governmental person (each of which is referred to in this paragraph
(e)(2)(iii)(B) as the issuing municipal utility) to purchase a supply of
electricity; and
(2) At least 90 percent of the prepaid electricity financed by the
issue is used for a qualifying use. Electricity is used for a qualifying
use if it is to be--
(i) Furnished to retail electric customers of the issuing municipal
utility who are located in the electricity service area of the issuing
municipal utility; or
(ii) Sold to a utility that is owned by a governmental person and
furnished to retail electric customers of the purchaser who are located
in the electricity service area of the purchaser.
(C) Service area. For purposes of this paragraph (e)(2)(iii), the
service area of a utility owned by a governmental person consists of--
(1) Any area throughout which the utility provided, at all times
during the 5-year period ending on the issue date--
(i) In the case of a natural gas utility, natural gas transmission
or distribution service; and
(ii) In the case of an electric utility, electricity distribution
service; and
(2) Any area recognized as the service area of the utility under
state or Federal law.
(D) Retail customer. For purposes of this paragraph (e)(2)(iii), a
retail customer is a customer that purchases natural gas or electricity,
as applicable, other than for resale.
(E) Commodity swaps. A prepayment does not fail to meet the
requirements of this paragraph (e)(2)(iii) by reason of any commodity
swap contract that may be entered into between the issuer and an
unrelated party (other than the gas or electricity supplier), or between
the gas or electricity supplier and an unrelated party (other than the
issuer), so long as each swap contract is an independent contract. A
swap contract is an independent contract if the obligation of each party
to perform under the swap contract is not dependent on performance by
any person (other than the other party to the swap contract) under
another contract (for example, a gas or electricity supply contract or
another swap contract); provided, however, that a commodity swap
contract will not fail to be an independent contract solely because the
swap contract may terminate in the event of a failure of a gas or
electricity supplier to deliver gas or electricity for which the swap
contract is a hedge.
(F) Remedial action. Issuers may apply principles similar to the
rules of Sec. 1.141-12, including Sec. 1.141-12(d) (relating to
redemption or defeasance of nonqualified bonds) and Sec. 1.141-12(e)
(relating to alternative use of disposition proceeds), to cure a
violation of paragraph (e)(2)(iii)(A)(2) or (e)(2)(iii)(B)(2) of this
section. For this purpose, the amount of nonqualified bonds is
determined in the same manner as for output contracts taken into account
under the private business tests, including the principles of Sec.
1.141-7(d), treating nonqualified sales of gas or electricity under this
paragraph (e)(2)(iii) as satisfying the benefits and burdens test under
Sec. 1.141-7(c)(1).
(iv) Additional prepayments as permitted by the Commissioner. The
Commissioner may, by published guidance, set forth additional
circumstances in which a prepayment does not give rise to investment-
type property.
[T.D. 8476, 58 FR 33517, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24041, May 10, 1994; T.D. 8718, 62 FR 25507,
May 9, 1997; T.D. 9085, 68 FR 45775, Aug. 4, 2003]
[[Page 84]]
Sec. 1.148-2 General arbitrage yield restriction rules.
(a) In general. Under section 148(a), the direct or indirect
investment of the gross proceeds of an issue in higher yielding
investments causes the bonds of the issue to be arbitrage bonds. The
investment of proceeds in higher yielding investments, however, during a
temporary period described in paragraph (e) of this section, as part of
a reasonably required reserve or replacement fund described in paragraph
(f) of this section, or as part of a minor portion described in
paragraph (g) of this section does not cause the bonds of the issue to
be arbitrage bonds. Bonds are not arbitrage bonds under this section as
a result of an inadvertent, insubstantial error.
(b) Reasonable expectations--(1) In general. Except as provided in
paragraph (c) of this section, the determination of whether an issue
consists of arbitrage bonds under section 148(a) is based on the
issuer's reasonable expectations as of the issue date regarding the
amount and use of the gross proceeds of the issue.
(2) Certification of expectations--(i) In general. An officer of the
issuer responsible for issuing the bonds must, in good faith, certify
the issuer's expectations as of the issue date. The certification must
state the facts and estimates that form the basis for the issuer's
expectations. The certification is evidence of the issuer's
expectations, but does not establish any conclusions of law or any
presumptions regarding either the issuer's actual expectations or their
reasonableness.
(ii) Exceptions to certification requirement. An issuer is not
required to make a certification for an issue under paragraph (b)(2)(i)
of this section if--
(A) The issuer reasonably expects as of the issue date that there
will be no unspent gross proceeds after the issue date, other than gross
proceeds in a bona fide debt service fund (e.g., equipment lease
financings in which the issuer purchases equipment in exchange for an
installment payment note); or
(B) The issue price of the issue does not exceed $1,000,000.
(c) Intentional acts. The taking of any deliberate, intentional
action by the issuer or person acting on its behalf after the issue date
in order to earn arbitrage causes the bonds of the issue to be arbitrage
bonds if that action, had it been expected on the issue date, would have
caused the bonds to be arbitrage bonds. An intent to violate the
requirements of section 148 is not necessary for an action to be
intentional.
(d) Materially higher yielding investments--(1) In general. The
yield on investments is materially higher than the yield on the issue to
which the investments are allocated if the yield on the investments over
the term of the issue exceeds the yield on the issue by an amount in
excess of the applicable definition of materially higher set forth in
paragraph (d)(2) of this section. If yield restricted investments in the
same class are subject to different definitions of materially higher,
the applicable definition of materially higher that produces the lowest
permitted yield applies to all the investments in the class. The yield
on the issue is determined under Sec. 1.148-4. The yield on investments
is determined under Sec. 1.148-5.
(2) Definitions of materially higher yield--(i) General rule for
purpose and nonpurpose investments. For investments that are not
otherwise described in this paragraph (d)(2), materially higher means
one-eighth of 1 percentage point.
(ii) Refunding escrows and replacement proceeds. For investments in
a refunding escrow or for investments allocable to replacement proceeds,
materially higher means one-thousandth of 1 percentage point.
(iii) Program investments. For program investments that are not
described in paragraph (d)(2)(iv) of this section, materially higher
means 1 and one-half percentage points.
(iv) Student loans. For qualified student loans that are program
investments, materially higher means 2 percentage points.
(v) Tax-exempt investments. For investments that are tax-exempt
bonds and are not investment property under section 148(b)(3), no yield
limitation applies.
(3) Mortgage loans. Qualified mortgage loans that satisfy the
requirements of section 143(g) are treated as
[[Page 85]]
meeting the requirements of this paragraph (d).
(e) Temporary periods--(1) In general. During the temporary periods
set forth in this paragraph (e), the proceeds and replacement proceeds
of an issue may be invested in higher yielding investments without
causing bonds in the issue to be arbitrage bonds. This paragraph (e)
does not apply to refunding issues (see Sec. 1.148-9).
(2) General 3-year temporary period for capital projects and
qualified mortgage loans--(i) In general. The net sale proceeds and
investment proceeds of an issue reasonably expected to be allocated to
expenditures for capital projects qualify for a temporary period of 3
years beginning on the issue date (the 3-year temporary period). The 3-
year temporary period also applies to the proceeds of qualified mortgage
bonds and qualified veterans' mortgage bonds by substituting qualified
mortgage loans in each place that capital projects appears in this
paragraph (e)(2). The 3-year temporary period applies only if the issuer
reasonably expects to satisfy the expenditure test, the time test, and
the due diligence test. These rules apply separately to each conduit
loan financed by an issue (other than qualified mortgage loans), with
the expenditure and time tests measured from the issue date of the
issue.
(A) Expenditure test. The expenditure test is met if at least 85
percent of the net sale proceeds of the issue are allocated to
expenditures on the capital projects by the end of the 3-year temporary
period.
(B) Time test. The time test is met if the issuer incurs within 6
months of the issue date a substantial binding obligation to a third
party to expend at least 5 percent of the net sale proceeds of the issue
on the capital projects. An obligation is not binding if it is subject
to contingencies within the issuer's or a related party's control.
(C) Due diligence test. The due diligence test is met if completion
of the capital projects and the allocation of the net sale proceeds of
the issue to expenditures proceed with due diligence.
(ii) 5-year temporary period. In the case of proceeds expected to be
allocated to a capital project involving a substantial amount of
construction expenditures (as defined in Sec. 1.148-7), a 5-year
temporary period applies in lieu of the 3-year temporary period if the
issuer satisfies the requirements of paragraph (e)(2)(i) of this section
applied by substituting ``5 years'' in each place that ``3 years''
appears, and both the issuer and a licensed architect or engineer
certify that the longer period is necessary to complete the capital
project.
(3) Temporary period for restricted working capital expenditures--
(i) General rule. The proceeds of an issue that are reasonably expected
to be allocated to restricted working capital expenditures within 13
months after the issue date qualify for a temporary period of 13 months
beginning on the issue date. Paragraph (e)(2) of this section contains
additional temporary period rules for certain working capital
expenditures that are treated as part of a capital project.
(ii) Longer temporary period for certain tax anticipation issues. If
an issuer reasonably expects to use tax revenues arising from tax levies
for a single fiscal year to redeem or retire an issue, and the issue
matures by the earlier of 2 years after the issue date or 60 days after
the last date for payment of those taxes without interest or penalty,
the temporary period under paragraph (e)(3)(i) of this section is
extended until the maturity date of the issue.
(4) Temporary period for pooled financings--(i) In general. Proceeds
of a pooled financing issue reasonably expected to be used to finance
purpose investments qualify for a temporary period of 6 months while
held by the issuer before being loaned to a conduit borrower. Any
otherwise available temporary period for proceeds held by a conduit
borrower, however, is reduced by the period of time during which those
proceeds were held by the issuer before being loaned. For example, if
the proceeds of a pooled financing issue loaned to a conduit borrower
would qualify for a 3-year temporary period, and the proceeds are held
by the issuer for 5 months before being loaned to the conduit borrower,
the proceeds qualify for only an additional 31-month temporary period
after being loaned to the conduit borrower. Except as provided in
paragraph (e)(4)(iv) of this section,
[[Page 86]]
this paragraph (e)(4) does not apply to any qualified mortgage bond or
qualified veterans' mortgage bond under section 143.
(ii) Loan repayments--(A) Amount held by the issuer. The temporary
period under this paragraph (e)(4) for proceeds from the sale or
repayment of any loan that are reasonably expected to be used to make or
finance new loans is 3 months.
(B) Amounts re-loaned to conduit borrowers. Any temporary period for
proceeds held by a conduit borrower under a new loan from amounts
described in paragraph (e)(4)(ii)(A) of this section is determined by
treating the date the new loan is made as the issue date and by reducing
the temporary period by the period the amounts were held by the issuer
following the last repayment.
(iii) Construction issues. If all or a portion of a pooled financing
issue qualifies as a construction issue under Sec. 1.148-7(b)(6),
paragraph (e)(4)(i) of this section is applied by substituting ``2
years'' for ``6 months.''
(iv) Amounts re-loaned for qualified mortgage loans. The temporary
period under this paragraph (e)(4) for proceeds from the sale,
prepayment, or repayment of any qualified mortgage loan that are
reasonably expected to be used to make or finance new qualified mortgage
loans is 3 years.
(5) Temporary period for replacement proceeds--(i) In general.
Except as otherwise provided, replacement proceeds qualify for a
temporary period of 30 days beginning on the date that the amounts are
first treated as replacement proceeds.
(ii) Temporary period for bona fide debt service funds. Amounts in a
bona fide debt service fund for an issue qualify for a temporary period
of 13 months. If only a portion of a fund qualifies as a bona fide debt
service fund, only that portion qualifies for this temporary period.
(6) Temporary period for investment proceeds. Except as otherwise
provided in this paragraph (e), investment proceeds qualify for a
temporary period of 1 year beginning on the date of receipt.
(7) Other amounts. Gross proceeds not otherwise eligible for a
temporary period described in this paragraph (e) qualify for a temporary
period of 30 days beginning on the date of receipt.
(f) Reserve or replacement funds--(1) General 10 percent limitation
on funding with sale proceeds. An issue consists of arbitrage bonds if
sale proceeds of the issue in excess of 10 percent of the stated
principal amount of the issue are used to finance any reserve or
replacement fund, without regard to whether those sale proceeds are
invested in higher yielding investments. If an issue has more than a de
minimis amount of original issue discount or premium, the issue price
(net of pre-issuance accrued interest) is used to measure the 10-percent
limitation in lieu of stated principal amount. This rule does not limit
the use of amounts other than sale proceeds of an issue to fund a
reserve or replacement fund.
(2) Exception from yield restriction for reasonably required reserve
or replacement funds--(i) In general. The investment of amounts that are
part of a reasonably required reserve or replacement fund in higher
yielding investments will not cause an issue to consist of arbitrage
bonds. A reasonably required reserve or replacement fund may consist of
all or a portion of one or more funds, however labelled, derived from
one or more sources. Amounts in a reserve or replacement fund in excess
of the amount that is reasonably required are not part of a reasonably
required reserve or replacement fund.
(ii) Size limitation. The amount of gross proceeds of an issue that
qualifies as a reasonably required reserve or replacement fund may not
exceed an amount equal to the least of 10 percent of the stated
principal amount of the issue, the maximum annual principal and interest
requirements on the issue, or 125 percent of the average annual
principal and interest requirements on the issue. If an issue has more
than a de minimis amount of original issue discount or premium, the
issue price of the issue (net of pre-issuance accrued interest) is used
to measure the 10 percent limitation in lieu of its stated principal
amount. For a reserve or replacement fund that secures more than one
issue (e.g. a parity reserve fund), the size limitation may be measured
on an aggregate basis.
[[Page 87]]
(iii) Valuation of investments. Investments in a reasonably required
reserve or replacement fund may be valued in any reasonable,
consistently applied manner that is permitted under Sec. 1.148-5.
(iv) 150 percent debt service limitation on investment in nonpurpose
investments for certain private activity bonds. Section 148(d)(3)
contains additional limits on the amount of gross proceeds of an issue
of private activity bonds, other than qualified 501(c)(3) bonds, that
may be invested in higher yielding nonpurpose investments without
causing the bonds to be arbitrage bonds. For purposes of these rules,
initial temporary period means the temporary periods under paragraphs
(e)(2), (e)(3), and (e)(4) of this section and under Sec. 1.148-
9(d)(2)(i), (ii), and (iii).
(3) Certain parity reserve funds. The limitation contained in
paragraph (f)(1) of this section does not apply to an issue if the
master legal document authorizing the issuance of the bonds (e.g., a
master indenture) was adopted before August 16, 1986, and that
document--
(i) Requires a reserve or replacement fund in excess of 10 percent
of the sale proceeds, but not more than maximum annual principal and
interest requirements;
(ii) Is not amended after August 31, 1986 (other than to permit the
issuance of additional bonds as contemplated in the master legal
document); and
(iii) Provides that bonds having a parity of security may not be
issued by or on behalf of the issuer for the purposes provided under the
document without satisfying the reserve fund requirements of the
indenture.
(g) Minor portion. Under section 148(e), a bond of an issue is not
an arbitrage bond solely because of the investment in higher yielding
investments of gross proceeds of the issue in an amount not exceeding
the lesser of--
(1) 5 percent of the sale proceeds of the issue; or
(2) $100,000.
(h) Certain waivers permitted. On or before the issue date, an
issuer may elect to waive the right to invest in higher yielding
investments during any temporary period under paragraph (e) of this
section or as part of a reasonably required reserve or replacement fund
under paragraph (f) of this section. At any time, an issuer may waive
the right to invest in higher yielding investments as part of a minor
portion under paragraph (g) of this section.
[T.D. 8476, 58 FR 33520, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8718, 62 FR 25507,
May 9, 1997]
Sec. 1.148-3 General arbitrage rebate rules.
(a) In general. Section 148(f) requires that certain earnings on
nonpurpose investments allocable to the gross proceeds of an issue be
paid to the United States to prevent the bonds in the issue from being
arbitrage bonds. The arbitrage that must be rebated is based on the
difference between the amount actually earned on nonpurpose investments
and the amount that would have been earned if those investments had a
yield equal to the yield on the issue.
(b) Definition of rebate amount. As of any date, the rebate amount
for an issue is the excess of the future value, as of that date, of all
receipts on nonpurpose investments over the future value, as of that
date, of all payments on nonpurpose investments.
(c) Computation of future value of a payment or receipt. The future
value of a payment or receipt at the end of any period is determined
using the economic accrual method and equals the value of that payment
or receipt when it is paid or received (or treated as paid or received),
plus interest assumed to be earned and compounded over the period at a
rate equal to the yield on the issue, using the same compounding
interval and financial conventions used to compute that yield.
(d) Payments and receipts--(1) Definition of payments. For purposes
of this section, payments are--
(i) Amounts actually or constructively paid to acquire a nonpurpose
investment (or treated as paid to a commingled fund);
(ii) For a nonpurpose investment that is first allocated to an issue
on a date after it is actually acquired (e.g., an investment that
becomes allocable to transferred proceeds or to replacement proceeds) or
that becomes subject to the rebate requirement on a date
[[Page 88]]
after it is actually acquired (e.g., an investment allocated to a
reasonably required reserve or replacement fund for a construction issue
at the end of the 2-year spending period), the value of that investment
on that date;
(iii) For a nonpurpose investment that was allocated to an issue at
the end of the preceding computation period, the value of that
investment at the beginning of the computation period;
(iv) On the last day of each bond year during which there are
amounts allocated to gross proceeds of an issue that are subject to the
rebate requirement, and on the final maturity date, a computation credit
of $1,000; and
(v) Yield reduction payments on nonpurpose investments made pursuant
to Sec. 1.148-5(c).
(2) Definition of receipts. For purposes of this section, receipts
are--
(i) Amounts actually or constructively received from a nonpurpose
investment (including amounts treated as received from a commingled
fund), such as earnings and return of principal;
(ii) For a nonpurpose investment that ceases to be allocated to an
issue before its disposition or redemption date (e.g., an investment
that becomes allocable to transferred proceeds of another issue or that
ceases to be allocable to the issue pursuant to the universal cap under
Sec. 1.148-6) or that ceases to be subject to the rebate requirement on
a date earlier than its disposition or redemption date (e.g., an
investment allocated to a fund initially subject to the rebate
requirement but that subsequently qualifies as a bona fide debt service
fund), the value of that nonpurpose investment on that date; and
(iii) For a nonpurpose investment that is held at the end of a
computation period, the value of that investment at the end of that
period.
(3) Special rules for commingled funds. Section 1.148-6(e) provides
special rules to limit certain of the required determinations of
payments and receipts for investments of a commingled fund.
(e) Computation dates--(1) In general. For a fixed yield issue, an
issuer may treat any date as a computation date. For a variable yield
issue, an issuer:
(i) May treat the last day of any bond year ending on or before the
latest date on which the first rebate amount is required to be paid
under paragraph (f) of this section (the first required payment date) as
a computation date but may not change that treatment after the first
payment date; and
(ii) After the first required payment date, must consistently treat
either the end of each bond year or the end of each fifth bond year as
computation dates and may not change these computation dates after the
first required payment date.
(2) Final computation date. The date that an issue is discharged is
the final computation date. For an issue retired within 3 years of the
issue date, however, the final computation date need not occur before
the end of 8 months after the issue date or during the period in which
the issuer reasonably expects that any of the spending exceptions under
Sec. 1.148-7 will apply to the issue.
(f) Amount of required rebate installment payment--(1) Amount of
interim rebate payments. The first rebate installment payment must be
made for a computation date that is not later than 5 years after the
issue date. Subsequent rebate installment payments must be made for a
computation date that is not later than 5 years after the previous
computation date for which an installment payment was made. A rebate
installment payment must be in an amount that, when added to the future
value, as of the computation date, of previous rebate payments made for
the issue, equals at least 90 percent of the rebate amount as of that
date.
(2) Amount of final rebate payment. For the final computation date,
a final rebate payment must be paid in an amount that, when added to the
future value of previous rebate payments made for the issue, equals 100
percent of the rebate amount as of that date.
(3) Future value of rebate payments. The future value of a rebate
payment is determined under paragraph (c) of this section. This value is
computed by taking into account recoveries of overpayments.
(g) Time and manner of payment. Each rebate payment must be paid no
later than 60 days after the computation
[[Page 89]]
date to which the payment relates. Any rebate payment paid within this
60-day period may be treated as paid on the computation date to which it
relates. A rebate payment is paid when it is filed with the Internal
Revenue Service at the place or places designated by the Commissioner. A
payment must be accompanied by the form provided by the Commissioner for
this purpose.
(h) Penalty in lieu of loss of tax exemption--(1) In general. The
failure to pay the correct rebate amount when required will cause the
bonds of the issue to be arbitrage bonds, unless the Commissioner
determines that the failure was not caused by willful neglect and the
issuer promptly pays a penalty to the United States. If no bond of the
issue is a private activity bond (other than a qualified 501(c)(3)
bond), the penalty equals 50 percent of the rebate amount not paid when
required to be paid, plus interest on that amount. Otherwise, the
penalty equals 100 percent of the rebate amount not paid when required
to be paid, plus interest on that amount.
(2) Interest on underpayments. Interest accrues at the underpayment
rate under section 6621, beginning on the date the correct rebate amount
is due and ending on the date 10 days before it is paid.
(3) Waivers of the penalty. The penalty is automatically waived if
the rebate amount that the issuer failed to pay plus interest is paid
within 180 days after discovery of the failure, unless, the Commissioner
determines that the failure was due to willful neglect, or the issue is
under examination by the Commissioner at any time during the period
beginning on the date the failure first occurred and ending on the date
90 days after the receipt of the rebate amount. Generally, extensions of
this 180-day period and waivers of the penalty in other cases will be
granted by the Commissioner only in unusual circumstances. For purposes
of this paragraph (h)(3), willful neglect does not include a failure
that is attributable solely to the permissible retroactive selection of
a short first bond year if the rebate amount that the issuer failed to
pay is paid within 60 days of the selection of that bond year.
(4) Application to alternative penalty under Sec. 1.148-7.
Paragraphs (h) (1), (2), and (3) of this section apply to failures to
pay penalty payments under Sec. 1.148-7 (alternative penalty amounts)
by substituting alternative penalty amounts for rebate amount and the
last day of each spending period for computation date.
(i) Recovery of overpayment of rebate--(1) In general. An issuer may
recover an overpayment for an issue of tax-exempt bonds by establishing
to the satisfaction of the Commissioner that the overpayment occurred.
An overpayment is the excess of the amount paid to the United States for
an issue under section 148 over the sum of the rebate amount for the
issue as of the most recent computation date and all amounts that are
otherwise required to be paid under section 148 as of the date the
recovery is requested.
(2) Limitations on recovery. (i) An overpayment may be recovered
only to the extent that a recovery on the date that it is first
requested would not result in an additional rebate amount if that date
were treated as a computation date.
(ii) Except for overpayments of penalty in lieu of rebate under
section 148(f)(4)(C)(vii) and Sec. 1.148-7(k), an overpayment of less
than $5,000 may not be recovered before the final computation date.
(3) Time and manner for requesting refund. (i) An issuer must
request a refund of an overpayment (claim) no later than the date that
is two years after the final computation date for the issue to which the
overpayment relates (the filing deadline). The claim must be made using
the form provided by the Commissioner for this purpose.
(ii) The Commissioner may request additional information to support
a claim. The issuer must file the additional information by the date
specified in the Commissioner's request, which date may be extended by
the Commissioner if unusual circumstances warrant. An issuer will be
given at least 21 calendar days to respond to a request for additional
information.
(iii) A claim described in either paragraph (i)(3)(iii)(A) or (B) of
this section that has been denied by the Commissioner may be appealed to
the Office of
[[Page 90]]
Appeals under this paragraph (i)(3)(iii). Upon a determination in favor
of the issuer, the Office of Appeals must return the undeveloped case to
the Commissioner for further consideration of the substance of the
claim.
(A) A claim is described in this paragraph (i)(3)(iii)(A) if the
Commissioner asserts that the claim was filed after the filing deadline.
(B) A claim is described in this paragraph (i)(3)(iii)(B) if the
Commissioner asserts that additional information to support the claim
was not submitted within the time specified in the request for
information or in any extension of such specified time period.
(j) Examples. The provisions of this section may be illustrated by
the following examples.
Example 1. Calculation and payment of rebate for a fixed yield
issue. (i) Facts. On January 1, 1994, City A issues a fixed yield issue
and invests all the sale proceeds of the issue ($49 million). There are
no other gross proceeds. The issue has a yield of 7.0000 percent per
year compounded semiannually (computed on a 30 day month/360 day year
basis). City A receives amounts from the investment and immediately
expends them for the governmental purpose of the issue as follows:
------------------------------------------------------------------------
Date Amount
------------------------------------------------------------------------
2/1/94.................................................. $3,000,000
5/1/94.................................................. 5,000,000
1/1/95.................................................. 5,000,000
9/1/95.................................................. 20,000,000
3/1/96.................................................. 22,000,000
------------------------------------------------------------------------
(ii) First computation date. (A) City A chooses January 1, 1999, as
its first computation date. This date is the latest date that may be
used to compute the first required rebate installment payment. The
rebate amount as of this date is computed by determining the future
value of the receipts and the payments for the investment. The
compounding interval is each 6-month (or shorter) period and the 30 day
month/360 day year basis is used because these conventions were used to
compute yield on the issue. The future value of these amounts, plus the
computation credit, as of January 1, 1999, is:
------------------------------------------------------------------------
Receipts FV (7.0000
Date (payments) percent)
------------------------------------------------------------------------
1/1/94................................ ($49,000,000) ($69,119,339)
2/1/94................................ 3,000,000 4,207,602
5/1/94................................ 5,000,000 6,893,079
1/1/95................................ 5,000,000 6,584,045
1/1/95................................ (1,000) (1,317)
9/1/95................................ 20,000,000 25,155,464
1/1/96................................ (1,000) 1,229)
3/1/96................................ 22,000,000 26,735,275
1/1/97................................ (1,000) (1,148)
---------------------------------
Rebate amount (1/01/99)............... ............... 452,432
------------------------------------------------------------------------
(B) City A pays 90 percent of the rebate amount ($407,189) to the
United States within 60 days of January 1, 1999.
(iii) Second computation date. (A) On the next required computation
date, January 1, 2004, the future value of the payments and receipts is:
------------------------------------------------------------------------
Receipts FV (7.0000
Date (payments) percent)
------------------------------------------------------------------------
1/1/99........................................ $452,432 $638,200
-------------------------
Rebate amount (1/01/04)....................... ........... 638,200
------------------------------------------------------------------------
(B) As of this computation date, the future value of the payment
treated as made on January 1, 1999, is $574,380, which equals at least
90 percent of the rebate amount as of this computation date ($638,200 x
0.9), and thus no additional rebate payment is due as of this date.
(iv) Final computation date. (A) On January 1, 2009, City A redeems
all the bonds, and thus this date is the final computation date. The
future value of the receipts and payments as of this date is:
------------------------------------------------------------------------
Receipts FV (7.0000
Date (payments) percent)
------------------------------------------------------------------------
1/1/04...................................... $638,200 $900,244
1/1/09...................................... (1,000) (1,000)
---------------------------
Rebate amount (1/01/09)..................... ............ 899,244
------------------------------------------------------------------------
(B) As of this computation date, the future value of the payment
made on January 1, 1999, is $810,220 and thus an additional rebate
payment of $89,024 is due. This payment reflects the future value of the
10 percent unpaid portion, and thus would not be owed had the issuer
paid the full rebate amount as of any prior computation date.
Example 2. Calculation and payment of rebate for a variable yield
issue. (i) Facts. On July 1, 1994, City B issues a variable yield issue
and invests all of the sale proceeds of the issue ($30 million). There
are no other gross proceeds. As of July 1, 1999, there are nonpurpose
investments allocated to the issue. Prior to July 1, 1999, City B
receives amounts from nonpurpose investments and immediately expends
them for the governmental purpose of the issue as follows:
------------------------------------------------------------------------
Date Amount
------------------------------------------------------------------------
8/1/1994.................................................. $5,000,000
7/1/1995.................................................. 8,000,000
12/1/1995................................................. 17,000,000
7/1/1999.................................................. 650,000
------------------------------------------------------------------------
[[Page 91]]
(ii) First computation date. (A) City B treats the last day of the
fifth bond year (July 1, 1999) as a computation date. The yield on the
variable yield issue during the first computation period (the period
beginning on the issue date and ending on the first computation date) is
6.0000 percent per year compounded semiannually. The value of the
nonpurpose investments allocated to the issue as of July 1, 1999, is $3
million. The rebate amount as of July 1, 1999, is computed by
determining the future value of the receipts and the payments for the
nonpurpose investments. The compounding interval is each 6-month (or
shorter) period and the 30 day month/360 day year basis is used because
these conventions were used to compute yield on the issue. The future
value of these amounts and of the computation date credits as of July 1,
1999, is:
------------------------------------------------------------------------
Receipts FV (6.0000
Date (payments) percent)
------------------------------------------------------------------------
7/1/1994............................. ($30,000,000) ($40,317,491)
8/1/1994............................. 5,000,000 6,686,560
7/1/1995............................. (1,000) (1,267)
7/1/1995............................. 8,000,000 10,134,161
12/1/1995............................ 17,000,000 21,011,112
7/1/1996............................. (1,000) (1,194)
7/1/1997............................. (1,000) (1,126)
7/1/1998............................. (1,000) (1,061)
7/1/1999............................. 3,000,000 3,000,000
7/1/1999............................. 650,000 650,000
7/1/1999............................. (1,000) (1,000)
----------------------------------
Rebate amount (7/01/1999)............ .............. 1,158,694
------------------------------------------------------------------------
(B) City B pays 90 percent of the rebate amount ($1,042,824.60) to
the United States within 60 days of July 1, 1999.
(iii) Next computation date. (A) On July 1, 2004, City B redeems all
of the bonds. Thus, the next computation date is July 1, 2004. On July
30, 1999, City B chose to compute rebate for periods following the first
computation period by treating the end of each fifth bond year as a
computation date. The yield during the second computation period is
5.0000 percent per year compounded semiannually. The computation of the
rebate amount as of this date reflects the value of the nonpurpose
investments allocated to the issue at the end of the prior computation
period. On July 1, 2004, City B sells those nonpurpose investments for
$3,925,000 and expends that amount for the governmental purpose of the
issue.
(B) As of July 1, 2004, the future value of the rebate amount
computed as of July 1, 1999, and of all other payments and receipts is:
------------------------------------------------------------------------
Receipts FV (5.0000
Date (payments) percent)
------------------------------------------------------------------------
7/1/1999..................................... $1,158,694 $1,483,226
7/1/1999..................................... (3,000,000) (3,840,254)
7/1/2000..................................... (1,000) (1,218)
7/1/2001..................................... (1,000) (1,160)
7/1/2002..................................... (1,000) (1,104)
7/1/2003..................................... (1,000) (1,051)
7/1/2004..................................... (2,000) (2,000)
7/1/2004..................................... 3,925,000 3,925,000
--------------------------
........... 1,561,439
------------------------------------------------------------------------
(C) As of this computation date, the future value of the payment
made on July 1, 1999, is $1,334,904 and thus an additional rebate
payment of $226,535 is due.
(D) If the yield during the second computation period were, instead,
7.0000 percent, the rebate amount computed as of July 1, 1999, would be
$1,320,891. The future value of the payment made on July 1, 1999, would
be $1,471,007, and, therefore, City B would have overpaid the rebate
amount by $150,116.
(k) Bona fide debt service fund exception. Under section
148(f)(4)(A), the rebate requirement does not apply to amounts in
certain bona fide debt service funds. An issue with an average annual
debt service that is not in excess of $2,500,000 may be treated as
satisfying the $100,000 limitation in section 148(f)(4)(A)(ii).
[T.D. 8476, 58 FR 33522, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8476, 59 FR 24350,
May 11, 1994; T.D. 8718, 62 FR 25507, May 9, 1997; T.D. 9701, 79 FR
67351, Nov. 13, 2014]
Sec. 1.148-4 Yield on an issue of bonds.
(a) In general. The yield on an issue of bonds is used to apply
investment yield restrictions under section 148(a) and to compute rebate
liability under section 148(f). Yield is computed under the economic
accrual method using any consistently applied compounding interval of
not more than one year. A short first compounding interval and a short
last compounding interval may be used. Yield is expressed as an annual
percentage rate that is calculated to at least four decimal places
(e.g., 5.2525 percent). Other reasonable, standard financial
conventions, such as the 30 days per month/360 days per year convention,
may be used in computing yield but must be consistently applied. The
yield on an issue that would be a purpose investment (absent section
148(b)(3)(A)) is equal to the yield on the conduit financing issue that
financed that purpose investment. The Commissioner may permit issuers of
qualified
[[Page 92]]
mortgage bonds or qualified student loan bonds to use a single yield for
two or more issues.
(b) Computing yield on a fixed yield issue--(1) In general--(i)
Yield on an issue. The yield on a fixed yield issue is the discount rate
that, when used in computing the present value as of the issue date of
all unconditionally payable payments of principal, interest, and fees
for qualified guarantees on the issue and amounts reasonably expected to
be paid as fees for qualified guarantees on the issue, produces an
amount equal to the present value, using the same discount rate, of the
aggregate issue price of bonds of the issue as of the issue date.
Further, payments include certain amounts properly allocable to a
qualified hedge. Yield on a fixed yield issue is computed as of the
issue date and is not affected by subsequent unexpected events, except
to the extent provided in paragraphs (b)(4) and (h)(3) of this section.
(ii) Yield on a bond. Yield on a fixed yield bond is computed in the
same manner as yield on a fixed yield issue.
(2) Yield on certain fixed yield bonds subject to mandatory or
contingent early redemption--(i) In general. The yield on a fixed yield
issue that includes a bond subject to mandatory early redemption or
expected contingent redemption is computed by treating that bond as
redeemed on its reasonably expected early redemption date for an amount
equal to its value on that date. Reasonable expectations are determined
on the issue date. A bond is subject to mandatory early redemption if it
is unconditionally payable in full before its final maturity date. A
bond is subject to a contingent redemption if it must be, or is
reasonably expected to be, redeemed prior to final maturity upon the
occurrence of a contingency. A contingent redemption is taken into
account only if the contingency is reasonably expected to occur, in
which case the date of occurrence of the contingency must be reasonably
estimated. For example, if bonds are reasonably expected to be redeemed
early using excess revenues from general or special property taxes or
benefit assessments or similar amounts, the reasonably expected
redemption schedule is used to determine yield. For purposes of this
paragraph (b)(2)(i), excess proceeds calls for issues for which the
requirements of Sec. 1.148-2(e) (2) or (3) are satisfied, calamity
calls, and refundings do not cause a bond to be subject to early
redemption. The value of a bond is determined under paragraph (e) of
this section.
(ii) Substantially identical bonds subject to mandatory early
redemption. If substantially identical bonds of an issue are subject to
specified mandatory redemptions prior to final maturity (e.g., a
mandatory sinking fund redemption requirement), yield on that issue is
computed by treating those bonds as redeemed in accordance with the
redemption schedule for an amount equal to their value. Generally, bonds
are substantially identical if the stated interest rate, maturity, and
payment dates are the same. In computing the yield on an issue
containing bonds described in this paragraph (b)(2)(ii), each of those
bonds must be treated as redeemed at its present value, unless the
stated redemption price at maturity of the bond does not exceed the
issue price of the bond by more than one-fourth of one percent
multiplied by the product of the stated redemption price at maturity and
the number of years to the weighted average maturity date of the
substantially identical bonds, in which case each of those bonds must be
treated as redeemed at its outstanding stated principal amount, plus
accrued, unpaid interest. Weighted average maturity is determined by
taking into account the mandatory redemption schedule.
(3) Yield on certain fixed yield bonds subject to optional early
redemption--(i) In general. If a fixed yield bond is subject to optional
early redemption and is described in paragraph (b)(3)(ii) of this
section, the yield on the issue containing the bond is computed by
treating the bond as redeemed at its stated redemption price on the
optional redemption date that would produce the lowest yield on the
issue.
(ii) Fixed yield bonds subject to special yield calculation rule. A
fixed yield bond is described in this paragraph (b)(3)(ii) only if it--
(A) Is subject to optional redemption within five years of the issue
date, but only if the yield on the issue computed
[[Page 93]]
by assuming all bonds in the issue subject to redemption within 5 years
of the issue date are redeemed at maturity is more than one-eighth of
one percentage point higher than the yield on that issue computed by
assuming all bonds subject to optional redemption within 5 years of the
issue date are redeemed at the earliest date for their redemption;
(B) Is issued at an issue price that exceeds the stated redemption
price at maturity by more than one-fourth of one percent multiplied by
the product of the stated redemption price at maturity and the number of
complete years to the first optional redemption date for the bond; or
(C) Bears interest at increasing interest rates (i.e., a stepped
coupon bond).
(4) Yield recomputed upon transfer of certain rights associated with
the bond. For purposes of Sec. 1.148-3, as of the date of any transfer,
waiver, modification, or similar transaction (collectively, a transfer)
of any right that is part of the terms of a bond or is otherwise
associated with a bond (e.g., a redemption right), in a transaction that
is separate and apart from the original sale of the bond, the issue is
treated as if it were retired and a new issue issued on the date of the
transfer (reissued). The redemption price of the retired issue and the
issue price of the new issue equal the aggregate values of all the bonds
of the issue on the date of the transfer. In computing yield on the new
issue, any amounts received by the issuer as consideration for the
transfer are taken into account.
(5) Special aggregation rule treating certain bonds as a single
fixed yield bond. Two variable yield bonds of an issue are treated in
the aggregate as a single fixed yield bond if--
(i) Aggregate treatment would result in the single bond being a
fixed yield bond; and
(ii) The terms of the bonds do not contain any features that could
distort the aggregate fixed yield from what the yield would be if a
single fixed yield bond were issued. For example, if an issue contains a
bond bearing interest at a floating rate and a related bond bearing
interest at a rate equal to a fixed rate minus that floating rate, those
two bonds are treated as a single fixed yield bond only if neither bond
may be redeemed unless the other bond is also redeemed at the same time.
(6) Examples. The provisions of this paragraph (b) may be
illustrated by the following examples.
Example 1. No early call--(i) Facts. On January 1, 1994, City A
issues an issue consisting of four identical fixed yield bonds. The
stated final maturity date of each bond is January 1, 2004, and no bond
is subject to redemption before this date. Interest is payable on
January 1 of each year at a rate of 6.0000 percent per year on the
outstanding principal amount. The total stated principal amount of the
bonds is $20 million. The issue price of the bonds $20,060,000.
(ii) Computation. The yield on the issue is computed by treating the
bonds as retired at the stated maturity under the general rule of Sec.
1.148-4(b)(1). The bonds are treated as redeemed for their stated
redemption prices. The yield on the issue is 5.8731 percent per year
compounded semiannually, computed as follows:
------------------------------------------------------------------------
PV (5.8731
Date Payments percent)
------------------------------------------------------------------------
1/1/1995..................................... $1,200,000 $1,132,510
1/1/1996..................................... 1,200,000 1,068,816
1/1/1997..................................... 1,200,000 1,008,704
1/1/1998..................................... 1,200,000 951,973
1/1/1999..................................... 1,200,000 898,433
1/1/2000..................................... 1,200,000 847,903
1/1/2001..................................... 1,200,000 800,216
1/1/2002..................................... 1,200,000 755,210
1/1/2003..................................... 1,200,000 712,736
1/1/2004..................................... 21,200,000 11,883,498
-------------
20,060,000
------------------------------------------------------------------------
Example 2. Mandatory calls. (i) Facts. The facts are the same as in
Example 1. In this case, however, the bonds are subject to mandatory
sinking fund redemption on January 1 of each year, beginning January 1,
2001. On each sinking fund redemption date, one of the bonds is chosen
by lottery and is required to be redeemed at par plus accrued interest.
(ii) Computation. Because the bonds are subject to specified
redemptions, yield on the issue is computed by treating the bonds as
redeemed in accordance with the redemption schedule under Sec. 1.148-
4(b)(2)(ii). Because the bonds are not sold at a discount, the bonds are
treated as retired at their stated redemption prices. The yield on the
issue is 5.8678 percent per year compounded semiannually, computed as
follows:
------------------------------------------------------------------------
PV (5.8678
Date Payments percent)
------------------------------------------------------------------------
1/1/1995..................................... $1,200,000 $1,132,569
1/1/1996..................................... 1,200,000 1,068,926
1/1/1997..................................... 1,200,000 1,008,860
1/1/1998..................................... 1,200,000 952,169
[[Page 94]]
1/1/1999..................................... 1,200,000 898,664
1/1/2000..................................... 1,200,000 848,166
1/1/2001..................................... 6,200,000 4,135,942
1/1/2002..................................... 5,900,000 3,714,650
1/1/2003..................................... 5,600,000 3,327,647
1/1/2004..................................... 5,300,000 2,972,407
-------------
........... $20,060,000
------------------------------------------------------------------------
Example 3. Optional early call. (i) Facts. On January 1, 1994, City
C issues an issue consisting of three bonds. Each bond has a stated
principal amount of $10 million dollars and is issued for par. Bond X
bears interest at 5 percent per year and matures on January 1, 1999.
BondY bears interest at 6 percent per year and matures on January 1,
2002. Bond Z bears interest at 7 percent per year and matures on January
1, 2004. Bonds Y and Z are callable by the issuer at par plus accrued
interest after December 31, 1998.
(ii) Computation. (A) The yield on the issue computed as if each
bond is outstanding to its maturity is 6.0834 percent per year
compounded semiannually, computed as follows:
------------------------------------------------------------------------
PV (6.0834
Date Payments percent)
------------------------------------------------------------------------
1/1/1995..................................... $1,800,000 $1,695,299
1/1/1996..................................... 1,800,000 1,596,689
1/1/1997..................................... 1,800,000 1,503,814
1/1/1998..................................... 1,800,000 1,416,342
1/1/1999..................................... 11,800,000 8,744,830
1/1/2000..................................... 1,300,000 907,374
1/1/2001..................................... 1,300,000 854,595
1/1/2002..................................... 11,300,000 6,996,316
1/1/2003..................................... 700,000 408,190
1/1/2004..................................... 10,700,000 5,876,551
-------------
30,000,000
------------------------------------------------------------------------
(B) The yield on the issue computed as if all bonds are called at
the earliest date for redemption is 5.9126 percent per year compounded
semiannually, computed as follows:
------------------------------------------------------------------------
PV (5.9126
Date Payments percent)
------------------------------------------------------------------------
1/1/1995..................................... $1,800,000 $1,698,113
1/1/1996..................................... 1,800,000 1,601,994
1/1/1997..................................... 1,800,000 1,511,315
1/1/1998..................................... 1,800,000 1,425,769
1/1/1999..................................... 31,800,000 23,762,809
-------------
30,000,000
------------------------------------------------------------------------
(C) Because the yield on the issue computed by assuming all bonds in
the issue subject to redemption within 5 years of the issue date are
redeemed at maturity is more than one-eighth of one percentage point
higher than the yield on the issue computed by assuming all bonds
subject to optional redemption within 5 years of the issue date are
redeemed at the earliest date for their redemption, each bond is treated
as redeemed on the date that would produce the lowest yield for the
issue. The lowest yield on the issue would result from a redemption of
all the bonds on January 1, 1999. Thus, the yield on the issue is 5.9126
percent per year compounded semiannually.
(c) Computing yield on a variable yield issue--(1) In general. The
yield on a variable yield issue is computed separately for each
computation period. The yield for each computation period is the
discount rate that, when used in computing the present value as of the
first day of the computation period of all the payments of principal and
interest and fees for qualified guarantees that are attributable to the
computation period, produces an amount equal to the present value, using
the same discount rate, of the aggregate issue price (or deemed issue
price, as determined in paragraph (c)(2)(iv) of this section) of the
bonds of the issue as of the first day of the computation period. The
yield on a variable yield bond is computed in the same manner as the
yield on a variable yield issue. Except as provided in paragraph (c)(2)
of this section, yield on any fixed yield bond in a variable yield issue
is computed in the same manner as the yield on a fixed yield issue as
provided in paragraph (b) of this section.
(2) Payments on bonds included in yield for a computation period--
(i) Payments in general. The payments on a bond that are attributable to
a computation period include any amounts actually paid during the period
for principal on the bond. Payments also include any amounts paid during
the current period both for interest accruing on the bond during the
current period and for interest accruing during the prior period that
was included in the deemed issue price of the bond as accrued unpaid
interest at the start of the current period under this paragraph (c)(2).
Further, payments include any amounts properly allocable to fees for a
qualified guarantee of the bond for the period and to any amounts
properly allocable to a qualified hedge for the period.
(ii) Payments at actual redemption. If a bond is actually redeemed
during a computation period, an amount equal to the greater of its value
on the redemption date or the actual redemption price is a payment on
the actual redemption date.
[[Page 95]]
(iii) Payments for bonds outstanding at end of computation period.
If a bond is outstanding at the end of a computation period, a payment
equal to the bond's value is taken into account on the last day of that
period.
(iv) Issue price for bonds outstanding at beginning of next
computation period. A bond outstanding at the end of a computation
period is treated as if it were immediately reissued on the next day for
a deemed issue price equal to the value from the day before as
determined under paragraph (c)(2)(iii) of this section.
(3) Example. The provisions of this paragraph (c) may be illustrated
by the following example.
Example. On January 1, 1994, City A issues an issue of identical
plain par bonds in an aggregate principal amount of $1,000,000. The
bonds pay interest at a variable rate on each June 1 throughout the term
of the issue. The entire principal amount of the bonds plus accrued,
unpaid interest is payable on the final maturity date of January 1,
2000. No bond year is selected. On June 1, 1994, 1995, 1996, 1997, and
1998, interest in the amounts of $30,000, $55,000, $57,000, $56,000, and
$45,000 is paid on the bonds. From June 1, 1998, to January 1, 1999,
$30,000 of interest accrues on the bonds. From January 1, 1999, to June
1, 1999, another $35,000 of interest accrues. On June 1, 1999, the
issuer actually pays $65,000 of interest. On January 1, 2000, $1,000,000
of principal and $38,000 of accrued interest are paid. The payments for
the computation period starting on the issue date and ending on January
1, 1999, include all annual interest payments paid from the issue date
to June 1, 1998. Because the issue is outstanding on January 1, 1999, it
is treated as redeemed on that date for amount equal to its value
($1,000,000 plus accrued, unpaid interest of $30,000 under paragraph
(e)(1) of this section). Thus, $1,030,000 is treated as paid on January
1, 1999. The issue is then treated as reissued on January 1, 1999, for
$1,030,000. The payments for the next computation period starting on
January 1, 1999, and ending on January 1, 2000, include the interest
actually paid on the bonds during that period ($65,000 on June 1, 1999,
plus $38,000 paid on January 1, 2000). Because the issue was actually
redeemed on January 1, 2000, an amount equal to its stated redemption
price is also treated as paid on January 1, 2000.
(d) Conversion from variable yield issue to fixed yield issue. For
purposes of determining yield under this section, as of the first day on
which a variable yield issue would qualify as a fixed yield issue if it
were newly issued on that date (a conversion date), that issue is
treated as if it were reissued as a fixed yield issue on the conversion
date. The redemption price of the variable yield issue and the issue
price of the fixed yield issue equal the aggregate values of all the
bonds on the conversion date. Thus, for example, for plain par bonds
(e.g., tender bonds), the deemed issue price would be the outstanding
principal amount, plus accrued unpaid interest. If the conversion date
occurs on a date other than a computation date, the issuer may continue
to treat the issue as a variable yield issue until the next computation
date, at which time it must be treated as converted to a fixed yield
issue.
(e) Value of bonds--(1) Plain par bonds. Except as otherwise
provided, the value of a plain par bond is its outstanding stated
principal amount, plus accrued unpaid interest. The value of a plain par
bond that is actually redeemed or treated as redeemed is its stated
redemption price on the redemption date, plus accrued, unpaid interest.
(2) Other bonds. The value of a bond other than a plain par bond on
a date is its present value on that date. The present value of a bond is
computed under the economic accrual method taking into account all the
unconditionally payable payments of principal, interest, and fees for a
qualified guarantee to be paid on or after that date and using the yield
on the bond as the discount rate, except that for purposes of Sec.
1.148-6(b)(2) (relating to the universal cap), these values may be
determined by consistently using the yield on the issue of which the
bonds are a part. To determine yield on fixed yield bonds, see paragraph
(b)(1) of this section. The rules contained in paragraphs (b)(2) and
(b)(3) of this section apply for this purpose. In the case of bonds
described in paragraph (b)(2)(ii) of this section, the present value of
those bonds on any date is computed using the yield to the final
maturity date of those bonds as the discount rate. In determining the
present value of a variable yield bond under this paragraph (e)(2), the
initial interest rate on the bond established by the interest index or
other interest rate setting mechanism is used to determine the interest
payments on that bond.
[[Page 96]]
(f) Qualified guarantees--(1) In general. Fees properly allocable to
payments for a qualified guarantee for an issue (as determined under
paragraph (f)(6) of this section) are treated as additional interest on
that issue under section 148. A guarantee is a qualified guarantee if it
satisfies each of the requirements of paragraphs (f)(2) through (f)(4)
of this section.
(2) Interest savings. As of the date the guarantee is obtained, the
issuer must reasonably expect that the present value of the fees for the
guarantee will be less than the present value of the expected interest
savings on the issue as a result of the guarantee. For this purpose,
present value is computed using the yield on the issue, determined with
regard to guarantee payments, as the discount rate.
(3) Guarantee in substance. The arrangement must create a guarantee
in substance. The arrangement must impose a secondary liability that
unconditionally shifts substantially all of the credit risk for all or
part of the payments, such as payments for principal and interest,
redemption prices, or tender prices, on the guaranteed bonds. Reasonable
procedural or administrative requirements of the guarantee do not cause
the guarantee to be conditional. In the case of a guarantee against
failure to remarket a qualified tender bond, commercially reasonable
limitations based on credit risk, such as limitations on payment in the
event of default by the primary obligor or the bankruptcy of a long-term
credit guarantor, do not cause the guarantee to be conditional. The
guarantee may be in any form. The guarantor may not be a co-obligor.
Thus, the guarantor must not expect to make any payments other than
under a direct-pay letter of credit or similar arrangement for which the
guarantor will be reimbursed immediately. The guarantor and any related
parties together must not use more than 10 percent of the proceeds of
the portion of the issue allocable to the guaranteed bonds.
(4) Reasonable charge--(i) In general. Fees for a guarantee must not
exceed a reasonable, arm's-length charge for the transfer of credit
risk. In complying with this requirement, the issuer may not rely on the
representations of the guarantor.
(ii) Fees for services other than transfer of credit risk must be
separately stated. A fee for a guarantee must not include any payment
for any direct or indirect services other than the transfer of credit
risk, unless the compensation for those other services is separately
stated, reasonable, and excluded from the guarantee fee. Fees for the
transfer of credit risk include fees for the guarantor's overhead and
other costs relating to the transfer of credit risk. For example, a fee
includes payment for services other than transfer of credit risk if--
(A) It includes payment for the cost of underwriting or remarketing
bonds or for the cost of insurance for casualty to bond-financed
property;
(B) It is refundable upon redemption of the guaranteed bond before
the final maturity date and the amount of the refund would exceed the
portion of the fee that had not been earned; or
(C) The requirements of Sec. 1.148-2(e)(2) (relating to temporary
periods for capital projects) are not satisfied, and the guarantor is
not reasonably assured that the bonds will be repaid if the project to
be financed is not completed.
(5) Guarantee of purpose investments. Except for guarantees of
qualified mortgage loans and qualified student loans, a guarantee of
payments on a purpose investment is a qualified guarantee of the issue
if all payments on the purpose investment reasonably coincide with
payments on the related bonds and the payments on the purpose investment
are unconditionally payable no more than 6 months before the
corresponding interest payment and 12 months before the corresponding
principal payments on the bonds. This paragraph (f)(5) only applies if,
in addition to satisfying the other requirements of this paragraph (f),
the guarantee is, in substance, a guarantee of the bonds allocable to
that purpose investment and to no other bonds except for bonds that are
equally and ratably secured by purpose investments of the same conduit
borrower.
(6) Allocation of qualified guarantee payments--(i) In general.
Payments for a qualified guarantee must be allocated to bonds and to
computation periods in
[[Page 97]]
a manner that properly reflects the proportionate credit risk for which
the guarantor is compensated. Proportionate credit risk for bonds that
are not substantially identical may be determined using any reasonable,
consistently applied method. For example, this risk may be based on the
ratio of the total principal and interest paid and to be paid on a
guaranteed bond to the total principal and interest paid and to be paid
on all bonds of the guaranteed issue. An allocation method generally is
not reasonable, for example, if a substantial portion of the fee is
allocated to the construction portion of the issue and a correspondingly
insubstantial portion is allocated to the later years covered by the
guarantee. Reasonable letter of credit set up fees may be allocated
ratably during the initial term of the letter of credit. Upon an early
redemption of a variable yield bond, fees otherwise allocable to the
period after the redemption are allocated to remaining outstanding bonds
of the issue or, if none remain outstanding, to the period before the
redemption.
(ii) Safe harbor for allocation of qualified guarantee fees for
variable yield issues. An allocation of non-level payments for a
qualified guarantee for variable yield bonds is treated as meeting the
requirements of paragraph (f)(6)(i) of this section if, for each bond
year for which the guarantee is in effect, an equal amount (or for any
short bond year, a proportionate amount of the equal amount) is treated
as paid as of the beginning of that bond year. The present value of the
annual amounts must equal the fee for the guarantee allocated to that
bond, with present value computed as of the first day the guarantee is
in effect by using as the discount rate the yield on the variable yield
bonds covered by the guarantee, determined without regard to any fee
allocated under this paragraph (f)(6)(ii).
(7) Refund or reduction of guarantee payments. If as a result of an
investment of proceeds of a refunding issue in a refunding escrow, there
will be a reduction in, or refund of, payments for a guarantee
(savings), the savings must be treated as a reduction in the payments on
the refunding issue.
(g) Yield on certain mortgage revenue and student loan bonds. For
purposes of section 148 and this section, section 143(g)(2)(C)(ii)
applies to the computation of yield on an issue of qualified mortgage
bonds or qualified veterans' mortgage bonds. For purposes of applying
section 148 and section 143(g) with respect to purpose investments
allocable to a variable yield issue of qualified mortgage bonds,
qualified veterans' mortgage bonds, or qualified student loan bonds that
is reasonably expected as of the issue date to convert to a fixed yield
issue, the yield may be computed over the term of the issue, and, if the
yield is so computed, paragraph (d) of this section does not apply to
the issue. As of any date, the yield over the term of the issue is based
on--
(1) With respect to any bond of the issue that has not converted to
a fixed and determinable yield on or before that date, the actual
amounts paid or received to that date and the amounts that are
reasonably expected (as of that date) to be paid or received with
respect to that bond over the remaining term of the issue (taking into
account prepayment assumptions under section 143(g)(2)(B)(iv), if
applicable); and
(2) With respect to any bond of the issue that has converted to a
fixed and determinable yield on or before that date, the actual amounts
paid or received before that bond converted, if any, and the amount that
was reasonably expected (on the date that bond converted) to be paid or
received with respect to that bond over the remaining term of the issue
(taking into account prepayment assumptions under section
143(g)(2)(B)(iv), if applicable).
(h) Qualified hedging transactions--(1) In general. Payments made or
received by an issuer under a qualified hedge (as defined in paragraph
(h)(2) of this section) relating to bonds of an issue are taken into
account (as provided in paragraph (h)(3) of this section) to determine
the yield on the issue. Except as provided in paragraphs (h)(4) and
(h)(5)(ii)(E) of this section, the bonds to which a qualified hedge
relates are treated as variable yield bonds from the issue date of the
bonds. This paragraph (h) applies solely for purposes of sections
143(g), 148, and 149(d).
[[Page 98]]
(2) Qualified hedge defined. Except as provided in paragraph (h)(5)
of this section, the term qualified hedge means a contract that
satisfies each of the following requirements:
(i) Hedge--(A) In general. The contract is entered into primarily to
modify the issuer's risk of interest rate changes with respect to a bond
(a hedge). For example, the contract may be an interest rate swap, an
interest rate cap, a futures contract, a forward contract, or an option.
(B) Special rule for fixed rate issues. If the contract modifies the
issuer's risk of interest rate changes with respect to a bond that is
part of an issue that, absent the contract, would be a fixed rate issue,
the contract must be entered into--
(1) No later than 15 days after the issue date (or the deemed issue
date under paragraph (d) of this section) of the issue; or
(2) No later than the expiration of a qualified hedge with respect
to bonds of that issue that satisfies paragraph (h)(2)(i)(B)(1) of this
section; or
(3) No later than the expiration of a qualified hedge with respect
to bonds of that issue that satisfies either paragraph (h)(2)(i)(B)(2)
of this section or this paragraph (h)(2)(i)(B)(3).
(C) Contracts with certain acquisition payments. If a hedge provider
makes a single payment to the issuer (e.g., a payment for an off-market
swap) in connection with the acquisition of a contract, the issuer may
treat a portion of that contract as a hedge provided--
(1) The hedge provider's payment to the issuer and the issuer's
payments under the contract in excess of those that it would make if the
contract bore rates equal to the on-market rates for the contract
(determined as of the date the parties enter into the contract) are
separately identified in a certification of the hedge provider; and
(2) The payments described in paragraph (h)(2)(i)(C)(1) of this
section are not treated as payments on the hedge.
(ii) No significant investment element--(A) In general. The contract
does not contain a significant investment element. Except as provided in
paragraph (h)(2)(ii)(B) of this section, a contract contains a
significant investment element if a significant portion of any payment
by one party relates to a conditional or unconditional obligation by the
other party to make a payment on a different date. Examples of contracts
that contain a significant investment element are a debt instrument held
by the issuer; an interest rate swap requiring any payments other than
periodic payments, within the meaning of Sec. 1.446-3 (periodic
payments) (e.g., a payment for an off-market swap or prepayment of part
or all of one leg of a swap); and an interest rate cap requiring the
issuer's premium for the cap to be paid in a single, up-front payment.
(B) Special level payment rule for interest rate caps. An interest
rate cap does not contain a significant investment element if--
(1) All payments to the issuer by the hedge provider are periodic
payments;
(2) The issuer makes payments for the cap at the same time as
periodic payments by the hedge provider must be made if the specified
index (within the meaning of Sec. 1.446-3) of the cap is above the
strike price of the cap; and
(3) Each payment by the issuer bears the same ratio to the notional
principal amount (within the meaning of Sec. 1.446-3) that is used to
compute the hedge provider's payment, if any, on that date.
(iii) Parties. The contract is entered into between the issuer or
the political subdivision on behalf of which the issuer issues the bonds
(collectively referred to in this paragraph (h) as the issuer) and a
provider that is not a related party (the hedge provider).
(iv) Hedged bonds. The contract covers, in whole or in part, all of
one or more groups of substantially identical bonds in the issue (i.e.,
all of the bonds having the same interest rate, maturity, and terms).
Thus, for example, a qualified hedge may include a hedge of all or a pro
rata portion of each interest payment on the variable rate bonds in an
issue for the first 5 years following their issuance. For purposes of
this paragraph (h), unless the context clearly requires otherwise,
hedged bonds means the specific bonds or portions thereof covered by a
hedge.
(v) Interest based contract. The contract is primarily interest
based. A
[[Page 99]]
contract is not primarily interest based unless--
(A) The hedged bond, without regard to the contract, is either a
fixed rate bond, a variable rate debt instrument within the meaning of
Sec. 1.1275-5 provided the rate is not based on an objective rate other
than a qualified inverse floating rate or a qualified inflation rate, a
tax-exempt obligation described in Sec. 1.1275-4(d)(2), or an
inflation-indexed debt instrument within the meaning of Sec. 1.1275-7;
and
(B) As a result of treating all payments on (and receipts from) the
contract as additional payments on (and receipts from) the hedged bond,
the resulting bond would be substantially similar to either a fixed rate
bond, a variable rate debt instrument within the meaning of Sec.
1.1275-5 provided the rate is not based on an objective rate other than
a qualified inverse floating rate or a qualified inflation rate, a tax-
exempt obligation described in Sec. 1.1275-4(d)(2), or an inflation-
indexed debt instrument within the meaning of Sec. 1.1275-7. For this
purpose, differences that would not prevent the resulting bond from
being substantially similar to another type of bond include a difference
between the index used to compute payments on the hedged bond and the
index used to compute payments on the hedge where one index is
substantially the same, but not identical to, the other; the difference
resulting from the payment of a fixed premium for a cap (e.g., payments
for a cap that are made in other than level installments); and the
difference resulting from the allocation of a termination payment where
the termination was not expected as of the date the contract was entered
into.
(vi) Payments closely correspond. The payments received by the
issuer from the hedge provider under the contract correspond closely in
time to either the specific payments being hedged on the hedged bonds or
specific payments required to be made pursuant to the bond documents,
regardless of the hedge, to a sinking fund, debt service fund, or
similar fund maintained for the issue of which the hedged bond is a
part.
(vii) Source of payments. Payments to the hedge provider are
reasonably expected to be made from the same source of funds that,
absent the hedge, would be reasonably expected to be used to pay
principal and interest on the hedged bonds.
(viii) Identification. The contract must be identified by the actual
issuer on its books and records maintained for the hedged bonds not
later than 3 days after the date on which the issuer and the hedge
provider enter into the contract. The identification must specify the
hedge provider, the terms of the contract, and the hedged bonds. The
identification must contain sufficient detail to establish that the
requirements of this paragraph (h)(2) and, if applicable, paragraph
(h)(4) of this section are satisfied. In addition, the existence of the
hedge must be noted on the first form relating to the issue of which the
hedged bonds are a part that is filed with the Internal Revenue Service
on or after the date on which the contract is identified pursuant to
this paragraph (h)(2)(viii).
(3) Accounting for qualified hedges--(i) In general. Except as
otherwise provided in paragraph (h)(4) of this section, payments made or
received by the issuer under a qualified hedge are treated as payments
made or received, as appropriate, on the hedged bonds that are taken
into account in determining the yield on those bonds. These payments are
reasonably allocated to the hedged bonds in the period to which the
payments relate, as determined under paragraph (h)(3)(iii) of this
section. Payments made or received by the issuer include payments deemed
made or received when a contract is terminated or deemed terminated
under this paragraph (h)(3). Payments reasonably allocable to the
modification of risk of interest rate changes and to the hedge
provider's overhead under this paragraph (h) are included as payments
made or received under a qualified hedge.
(ii) Exclusions from hedge. If any payment for services or other
items under the contract is not expressly treated by paragraph (h)(3)(i)
of this section as a payment under the qualified hedge, the payment is
not a payment with respect to a qualified hedge.
(iii) Timing and allocation of payments. Except as provided in
paragraphs
[[Page 100]]
(h)(3)(iv) and (h)(5) of this section, payments made or received by the
issuer under a qualified hedge are taken into account in the same period
in which those amounts would be treated as income or deductions under
Sec. 1.446-4 (without regard to Sec. 1.446-4(a)(2)(iv)) and are
adjusted as necessary to reflect the end of a computation period and the
start of a new computation period.
(iv) Termination payments--(A) Termination defined. A termination of
a qualified hedge includes any sale or other disposition of the hedge by
the issuer or the acquisition by the issuer of an offsetting hedge. A
deemed termination occurs when the hedged bonds are redeemed or when a
hedge ceases to be a qualified hedge of the hedged bonds. In the case of
an assignment by a hedge provider of its remaining rights and
obligations under the hedge to a third party or a modification of the
hedging contract, the assignment or modification is treated as a
termination with respect to the issuer only if it results in a deemed
exchange of the hedge and a realization event under section 1001 to the
issuer.
(B) General rule. A payment made or received by an issuer to
terminate a qualified hedge, including loss or gain realized or deemed
realized, is treated as a payment made or received on the hedged bonds,
as appropriate. The payment is reasonably allocated to the remaining
periods originally covered by the terminated hedge in a manner that
reflects the economic substance of the hedge.
(C) Special rule for terminations when bonds are redeemed. Except as
otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph
(h)(3)(iv)(D) of this section, when a qualified hedge is deemed
terminated because the hedged bonds are redeemed, the fair market value
of the qualified hedge on the redemption date is treated as a
termination payment made or received on that date. When hedged bonds are
redeemed, any payment received by the issuer on termination of a hedge,
including a termination payment or a deemed termination payment,
reduces, but not below zero, the interest payments made by the issuer on
the hedged bonds in the computation period ending on the termination
date. The remainder of the payment, if any, is reasonably allocated over
the bond years in the immediately preceding computation period or
periods to the extent necessary to eliminate the excess.
(D) Special rules for refundings. To the extent that the hedged
bonds are redeemed using the proceeds of a refunding issue, the
termination payment is accounted for under paragraph (h)(3)(iv)(B) of
this section by treating it as a payment on the refunding issue, rather
than the hedged bonds. In addition, to the extent that the refunding
issue is redeemed during the period to which the termination payment has
been allocated to that issue, paragraph (h)(3)(iv)(C) of this section
applies to the termination payment by treating it as a payment on the
redeemed refunding issue.
(E) Safe harbor for allocation of certain termination payments. A
payment to terminate a qualified hedge does not result in that hedge
failing to satisfy the applicable provisions of paragraph (h)(3)(iv)(B)
of this section if the payment is allocated in accordance with this
paragraph (h)(3)(iv)(E). For an issue that is a variable yield issue
after termination of a qualified hedge, an amount must be allocated to
each date on which the hedge provider's payment, if any, would have been
made had the hedge not been terminated. The amounts allocated to each
date must bear the same ratio to the notional principal amount (within
the meaning of Sec. 1.446-3) that would have been used to compute the
hedge provider's payment, if any, on that date, and the sum of the
present values of those amounts must equal the present value of the
termination payment. Present value is computed as of the day the
qualified hedge is terminated, using the yield on the hedged bonds,
determined without regard to the termination payment. The yield used for
this purpose is computed for the period beginning on the first date the
qualified hedge is in effect and ending on the date the qualified hedge
is terminated. On the other hand, for an issue that is a fixed yield
issue after termination of a qualified hedge, the termination payment is
taken into account as a single payment on the date it is paid.
[[Page 101]]
(4) Certain variable yield bonds treated as fixed yield bonds--(i)
In general. Except as otherwise provided in this paragraph (h)(4), if
the issuer of variable yield bonds enters into a qualified hedge, the
hedged bonds are treated as fixed yield bonds paying a fixed interest
rate if:
(A) Maturity. The term of the hedge is equal to the entire period
during which the hedged bonds bear interest at variable interest rates,
and the issuer does not reasonably expect that the hedge will be
terminated before the end of that period.
(B) Payments closely correspond. Payments to be received under the
hedge correspond closely in time to the hedged portion of payments on
the hedged bonds. Hedge payments received within 15 days of the related
payments on the hedged bonds generally so correspond.
(C) Aggregate payments fixed. Taking into account all payments made
and received under the hedge and all payments on the hedged bonds (i.e.,
after netting all payments), the issuer's aggregate payments are fixed
and determinable as of a date not later than 15 days after the issue
date of the hedged bonds. Payments on bonds are treated as fixed for
purposes of this paragraph (h)(4)(i)(C) if payments on the bonds are
based, in whole or in part, on one interest rate, payments on the hedge
are based, in whole or in part, on a second interest rate that is
substantially the same as, but not identical to, the first interest rate
and payments on the bonds would be fixed if the two rates were
identical. Rates are treated as substantially the same if they are
reasonably expected to be substantially the same throughout the term of
the hedge. For example, an objective 30-day tax-exempt variable rate
index or other objective index may be substantially the same as an
issuer's individual 30-day interest rate.
(ii) Accounting. Except as otherwise provided in this paragraph
(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's
payments on the hedged bonds and all payments made and received on a
hedge described in paragraph (h)(4)(i) of this section are taken into
account. If payments on the bonds and payments on the hedge are based,
in whole or in part, on variable interest rates that are substantially
the same within the meaning of paragraph (h)(4)(i)(C) of this section
(but not identical), yield on the issue is determined by treating the
variable interest rates as identical. For example, if variable rate
bonds bearing interest at a weekly rate equal to the rate necessary to
remarket the bonds at par are hedged with an interest rate swap under
which the issuer receives payments based on a short-term floating rate
index that is substantially the same as, but not identical to, the
weekly rate on the bonds, the interest payments on the bonds are treated
as equal to the payments received by the issuer under the swap for
purposes of computing the yield on the bonds.
(iii) Effect of termination--(A) In general. Except as otherwise
provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this
section, the issue of which the hedged bonds are a part is treated as if
it were reissued as of the termination date of the qualified hedge
covered by paragraph (h)(4)(i) of this section in determining yield on
the hedged bonds for purposes of Sec. 1.148-3. The redemption price of
the retired issue and the issue price of the new issue equal the
aggregate values of all the bonds of the issue on the termination date.
In computing the yield on the new issue for this purpose, any
termination payment is accounted for under paragraph (h)(3)(iv) of this
section, applied by treating the termination payment as made or received
on the new issue under this paragraph (h)(4)(iii).
(B) Effect of early termination. Except as otherwise provided in
this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of
this section do not apply in determining the yield on the hedged bonds
for purposes of Sec. 1.148-3 if the hedge is terminated or deemed
terminated within 5 years after the issue date of the issue of which the
hedged bonds are a part. Thus, the hedged bonds are treated as variable
yield bonds for purposes of Sec. 1.148-3 from the issue date.
(C) Certain terminations disregarded. This paragraph (h)(4)(iii)
does not apply to a termination if, based on the facts and circumstances
(e.g., taking into account both the termination and
[[Page 102]]
any qualified hedge that immediately replaces the terminated hedge),
there is no change in the yield.
(5) Contracts entered into before issue date of hedged bond--(i) In
general. A contract does not fail to be a hedge under paragraph
(h)(2)(i) of this section solely because it is entered into before the
issue date of the hedged bond. However, that contract must be one to
which either paragraph (h)(5)(ii) or (h)(5)(iii) of this section
applies.
(ii) Contracts expected to be closed substantially contemporaneously
with the issue date of hedged bond--(A) Application. This paragraph
(h)(5)(ii) applies to a contract if, on the date the contract is
identified, the issuer reasonably expects to terminate or otherwise
close (terminate) the contract substantially contemporaneously with the
issue date of the hedged bond.
(B) Contract terminated. If a contract to which this paragraph
(h)(5)(ii) applies is terminated substantially contemporaneously with
the issue date of the hedged bond, the amount paid or received, or
deemed to be paid or received, by the issuer in connection with the
issuance of the hedged bond to terminate the contract is treated as an
adjustment to the issue price of the hedged bond and as an adjustment to
the sale proceeds of the hedged bond for purposes of section 148.
Amounts paid or received, or deemed to be paid or received, before the
issue date of the hedged bond are treated as paid or received on the
issue date in an amount equal to the future value of the payment or
receipt on that date. For this purpose, future value is computed using
yield on the hedged bond without taking into account amounts paid or
received (or deemed paid or received) on the contract.
(C) Contract not terminated. If a contract to which this paragraph
(h)(5)(ii) applies is not terminated substantially contemporaneously
with the issue date of the hedged bond, the contract is deemed
terminated for its fair market value as of the issue date of the hedged
bond. Once a contract has been deemed terminated pursuant to this
paragraph (h)(5)(ii)(C), payments on and receipts from the contract are
no longer taken into account under this paragraph (h) for purposes of
determining yield on the hedged bond.
(D) Relation to other requirements of a qualified hedge. Payments
made in connection with the issuance of a bond to terminate a contract
to which this paragraph (h)(5)(ii) applies do not prevent the contract
from satisfying the requirements of paragraph (h)(2)(vi) of this
section.
(E) Fixed yield treatment. A bond that is hedged with a contract to
which this paragraph (h)(5)(ii) applies does not fail to be a fixed
yield bond if, taking into account payments on the contract and the
payments to be made on the bond, the bond satisfies the definition of
fixed yield bond. See also paragraph (h)(4) of this section.
(iii) Contracts expected not to be closed substantially
contemporaneously with the issue date of hedged bond--(A) Application.
This paragraph (h)(5)(iii) applies to a contract if, on the date the
contract is identified, the issuer does not reasonably expect to
terminate the contract substantially contemporaneously with the issue
date of the hedge bond.
(B) Contract terminated. If a contract to which this paragraph
(h)(5)(iii) applies is terminated in connection with the issuance of the
hedged bond, the amount paid or received, or deemed to be paid or
received, by the issuer to terminate the contract is treated as an
adjustment to the issue price of the hedged bond and as an adjustment to
the sale proceeds of the hedged bond for purposes of section 148.
(C) Contract not terminated. If a contract to which this paragraph
(h)(5)(iii) applies is not terminated substantially contemporaneously
with the issue date of the hedged bond, no payments with respect to the
hedge made by the issuer before the issue date of the hedged bond are
taken into account under this section.
(iv) Identification. The identification required under paragraph
(h)(2)(viii) of this section must specify the reasonably expected
governmental purpose, issue price, maturity, and issue date of the
hedged bond, the manner in which interest is reasonably expected to be
computed, and whether paragraph
[[Page 103]]
(h)(5)(ii) or (h)(5)(iii) of this section applies to the contract. If an
issuer identifies a contract under this paragraph (h)(5)(iv) that would
be a qualified hedge with respect to the anticipated bond, but does not
issue the anticipated bond on the identified issue date, the contract is
taken into account as a qualified hedge of any bond of the issuer that
is issued for the identified governmental purpose within a reasonable
interval around the identified issue date of the anticipated bond.
(6) Authority of the Commissioner. The Commissioner, by publication
of a revenue ruling or revenue procedure (see Sec. 601.601(d)(2) of
this chapter), may specify contracts that, although they do not meet the
requirements of paragraph (h)(2) of this section, are qualified hedges
or, although they do not meet the requirements of paragraph (h)(4) of
this section, cause the hedged bonds to be treated as fixed yield bonds.
[T.D. 8476, 58 FR 33524, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24042, May 10, 1994; T.D. 8718, 62 FR 25507,
May 9, 1997; T.D. 8838, 64 FR 48547, Sept. 7, 1999]
Sec. 1.148-5 Yield and valuation of investments.
(a) In general. This section provides rules for computing the yield
and value of investments allocated to an issue for various purposes
under section 148.
(b) Yield on an investment--(1) In general. Except as otherwise
provided, the yield on an investment allocated to an issue is computed
under the economic accrual method, using the same compounding interval
and financial conventions used to compute the yield on the issue. The
yield on an investment allocated to an issue is the discount rate that,
when used in computing the present value as of the date the investment
is first allocated to the issue of all unconditionally payable receipts
from the investment, produces an amount equal to the present value of
all unconditionally payable payments for the investment. For this
purpose, payments means amounts to be actually or constructively paid to
acquire the investment, and receipts means amounts to be actually or
constructively received from the investment, such as earnings and return
of principal. The yield on a variable rate investment is determined in a
manner comparable to the determination of the yield on a variable rate
issue. For an issue of qualified mortgage bonds, qualified veterans'
mortgage bonds, or qualified student loan bonds on which interest is
paid semiannually, all regular monthly loan payments to be received
during a semiannual debt service period may be treated as received at
the end of that period. In addition, for any conduit financing issue,
payments made by the conduit borrower are not treated as paid until the
conduit borrower ceases to receive the benefit of earnings on those
amounts.
(2) Yield on a separate class of investments--(i) In general. For
purposes of the yield restriction rules of section 148(a) and Sec.
1.148-2, yield is computed separately for each class of investments. For
this purpose, in determining the yield on a separate class of
investments, the yield on each individual investment within the class is
blended with the yield on other individual investments within the class,
whether or not held concurrently, by treating those investments as a
single investment. The yields on investments that are not within the
same class are not blended.
(ii) Separate classes of investments. Each of the following is a
separate class of investments--
(A) Each category of yield restricted purpose investment and program
investment that is subject to a different definition of materially
higher under Sec. 1.148-2(d)(2);
(B) Yield-restricted nonpurpose investments; and
(C) All other nonpurpose investments;
(iii) Permissive application of single investment rules to certain
yield restricted investments for all purposes of section 148. For all
purposes of section 148, if an issuer reasonably expects as of the issue
date to establish and maintain a sinking fund solely to reduce the yield
on the investments in a refunding escrow, then the issuer may treat all
of the yield restricted nonpurpose investments in the refunding escrow
and that sinking fund as a single investment having a single yield,
determined under
[[Page 104]]
this paragraph (b)(2). Thus, an issuer may not treat the nonpurpose
investments in a reasonably required reserve fund and a refunding escrow
as a single investment having a single yield under this paragraph
(b)(2)(iii).
(iv) Mandatory application of single investment rules for refunding
escrows for all purposes of section 148. For all purposes of section
148, in computing the yield on yield restricted investments allocable to
proceeds (i.e., sale proceeds, investment proceeds, and transferred
proceeds) of a refunding issue that are held in one or more refunding
escrows, the individual investments are treated as a single investment
having a single yield, whether or not held concurrently. For example,
this single investment includes both the individual investments
allocable to sale and investment proceeds of a refunding issue that are
held in one refunding escrow for a prior issue and the investments
allocable to transferred proceeds of that refunding issue that are held
in another refunding escrow.
(3) Investments to be held beyond issue's maturity or beyond
temporary period. In computing the yield on investments allocable to an
issue that are to be held beyond the reasonably expected redemption date
of the issue, those investments are treated as sold for an amount equal
to their value on that date. In computing the yield on investments that
are held beyond an applicable temporary period under Sec. 1.148-2, for
purposes of Sec. 1.148-2 those investments may be treated as purchased
for an amount equal to their fair market value as of the end of the
temporary period.
(4) Consistent redemption assumptions on purpose investments. The
yield on purpose investments allocable to an issue is computed using the
same redemption assumptions used to compute the yield on the issue.
Yield on purpose investments allocable to an issue of qualified mortgage
bonds and qualified veterans' mortgage bonds must be determined in a
manner that is consistent with, and using the assumptions required by,
section 143(g)(2)(B).
(5) Student loan special allowance payments included in yield.
Except as provided in Sec. 1.148-11(e), the yield on qualified student
loans is computed by including as receipts any special allowance
payments made by the Secretary of Education pursuant to section 438 of
the Higher Education Act of 1965.
(c) Yield reduction payments to the United States--(1) In general.
In determining the yield on an investment to which this paragraph (c)
applies, any amount paid to the United States in accordance with this
paragraph (c), including a rebate amount, is treated as a payment for
that investment that reduces the yield on that investment.
(2) Manner of payment--(i) In general. Except as otherwise provided
in paragraph (c)(2)(ii) of this section, an amount is paid under this
paragraph (c) if it is paid to the United States at the same time and in
the same manner as rebate amounts are required to be paid or at such
other time or in such manner as the Commissioner may prescribe. For
example, yield reduction payments must be made on or before the date of
required rebate installment payments as described in Sec. Sec. 1.148-
3(f), (g), and (h). The provisions of Sec. 1.148-3(i) apply to payments
made under this paragraph (c).
(ii) Special rule for purpose investments. For purpose investments
allocable to an issue--
(A) No amounts are required to be paid to satisfy this paragraph (c)
until the earlier of the end of the tenth bond year after the issue date
of the issue or 60 days after the date on which the issue is no longer
outstanding; and
(B) For payments made prior to the date on which the issue is
retired, the issuer need not pay more than 75 percent of the amount
otherwise required to be paid as of the date to which the payment
relates.
(3) Applicability of special yield reduction rule--(i) Covered
investments. This paragraph (c) applies to--
(A) Nonpurpose investments allocable to proceeds of an issue that
qualified for one of the temporary periods available for capital
projects, restricted working capital expenditures, pooled financings, or
investment proceeds under Sec. 1.148-2(e)(2), (e)(3), (e)(4), or
(e)(6), respectively;
(B) Investments allocable to a variable yield issue during any
computation period in which at least 5 percent of the value of the issue
is represented
[[Page 105]]
by variable yield bonds, unless the issue is an issue of hedge bonds (as
defined in section 149(g)(3)(A));
(C) Nonpurpose investments allocable to transferred proceeds of--
(1) A current refunding issue to the extent necessary to reduce the
yield on those investments to satisfy yield restrictions under section
148(a); or
(2) An advance refunding issue to the extent that investment of the
refunding escrows allocable to the proceeds, other than transferred
proceeds, of the refunding issue in zero-yielding nonpurpose investments
is insufficient to satisfy yield restrictions under section 148(a);
(D) Purpose investments allocable to qualified student loans under a
program described in section 144(b)(1)(A);
(E) Nonpurpose investments allocable to gross proceeds of an issue
in a reasonably required reserve or replacement fund or in a fund that,
except for its failure to satisfy the size limitation in Sec. 1.148-
2(f)(2)(ii), would qualify as a reasonably required reserve or
replacement fund, but only to the extent that--
(1) The value of the nonpurpose investments in the fund is not
greater than 15 percent of the stated principal amount of the issue, as
computed under Sec. 1.148-2(f)(2)(ii), or
(2) The amounts in the fund (other than investment earnings) are not
reasonably expected to be used to pay debt service on the issue other
than in connection with reductions in the amount required to be in that
fund (e.g. a reserve fund for a revolving fund loan program);
(F) Nonpurpose investments allocated to replacement proceeds of a
refunded issue as a result of the application of the universal cap to
amounts in a refunding escrow (see Sec. 1.148-11(c)(1)(ii)); and
(G) Investments described in Sec. 1.148-11(f).
(ii) Exception to yield reduction payments rule for advance
refunding issues. Paragraph (c)(1) of this section does not apply to
investments allocable to gross proceeds of an advance refunding issue,
other than--
(A) Transferred proceeds to which paragraph (c)(3)(i)(C) of this
section applies;
(B) Replacement proceeds to which paragraph (c)(3)(i)(F) of this
section applies; and
(C) Transferred proceeds to which paragraph (c)(3)(i)(E) of this
section applies, but only to the extent necessary to satisfy yield
restriction under section 148(a) on those proceeds treating all
investments allocable to those proceeds as a separate class.
(d) Value of investments--(1) In general. Except as otherwise
provided, the value of an investment (including a payment or receipt on
the investment) on a date must be determined using one of the following
valuation methods consistently for all purposes of section 148 to that
investment on that date:
(i) Plain par investment--outstanding principal amount. A plain par
investment may be valued at its outstanding stated principal amount,
plus any accrued unpaid interest on that date.
(ii) Fixed rate investment--present value. A fixed rate investment
may be valued at its present value on that date.
(iii) Any investment--fair market value. An investment may be valued
at its fair market value on that date.
(2) Mandatory valuation of yield restricted investments at present
value. Any yield restricted investment must be valued at present value.
For example, a purpose investment or an investment allocable to gross
proceeds in a refunding escrow after the expiration of the initial
temporary period must be valued at present value. See, however,
paragraph (b)(3) of this section.
(3) Mandatory valuation of certain investments at fair market
value--(i) In general. Except as provided in paragraphs (d)(2),
(d)(3)(ii), and (d)(4) of this section, an investment must be valued at
fair market value on the date that it is first allocated to an issue or
first ceases to be allocated to an issue as a consequence of a deemed
acquisition or deemed disposition. For example, if an issuer deposits
existing investments into a sinking fund for an issue, those investments
must be valued at fair market value as of the date first deposited into
the fund.
(ii) Exception to fair market value requirement for transferred
proceeds allocations, universal cap allocations, and commingled funds.
Paragraph (d)(3)(i) of
[[Page 106]]
this section does not apply if the investment is allocated from one
issue to another issue as a result of the transferred proceeds
allocation rule under Sec. 1.148-9(b) or the universal cap rule under
Sec. 1.148-6(b)(2), provided that both issues consist exclusively of
tax-exempt bonds. In addition, paragraph (d)(3)(i) of this section does
not apply to investments in a commingled fund (other than a bona fide
debt service fund) unless it is an investment being initially deposited
in or withdrawn from a commingled fund described in Sec. 1.148-
6(e)(5)(iii).
(4) Special transition rule for transferred proceeds. The value of a
nonpurpose investment that is allocated to transferred proceeds of a
refunding issue on a transfer date may not exceed the value of that
investment on the transfer date used for purposes of applying the
arbitrage restrictions to the refunded issue.
(5) Definition of present value of an investment. Except as
otherwise provided, present value of an investment is computed under the
economic accrual method, using the same compounding interval and
financial conventions used to compute the yield on the issue. The
present value of an investment on a date is equal to the present value
of all unconditionally payable receipts to be received from and payments
to be paid for the investment after that date, using the yield on the
investment as the discount rate.
(6) Definition of fair market value--(i) In general. The fair market
value of an investment is the price at which a willing buyer would
purchase the investment from a willing seller in a bona fide, arm's-
length transaction. Fair market value generally is determined on the
date on which a contract to purchase or sell the nonpurpose investment
becomes binding (i.e., the trade date rather than the settlement date).
Except as otherwise provided in this paragraph (d)(6), an investment
that is not of a type traded on an established securities market, within
the meaning of section 1273, is rebuttably presumed to be acquired or
disposed of for a price that is not equal to its fair market value. The
fair market value of a United States Treasury obligation that is
purchased directly from the United States Treasury is its purchase
price.
(ii) Safe harbor for establishing fair market value for certificates
of deposit. This paragraph (d)(6)(ii) applies to a certificate of
deposit that has a fixed interest rate, a fixed payment schedule, and a
substantial penalty for early withdrawal. The purchase price of such a
certificate of deposit is treated as its fair market value on the
purchase date if the yield on the certificate of deposit is not less
than--
(A) The yield on reasonably comparable direct obligations of the
United States; and
(B) The highest yield that is published or posted by the provider to
be currently available from the provider on reasonably comparable
certificates of deposit offered to the public.
(iii) Safe harbor for establishing fair market value for guaranteed
investment contracts and investments purchased for a yield restricted
defeasance escrow. The purchase price of a guaranteed investment
contract and the purchase price of an investment purchased for a yield
restricted defeasance escrow will be treated as the fair market value of
the investment on the purchase date if all of the following requirements
are satisfied:
(A) The issuer makes a bona fide solicitation for the purchase of
the investment. A bona fide solicitation is a solicitation that
satisfies all of the following requirements:
(1) The bid specifications are in writing and are timely forwarded
to potential providers.
(2) The bid specifications include all material terms of the bid. A
term is material if it may directly or indirectly affect the yield or
the cost of the investment.
(3) The bid specifications include a statement notifying potential
providers that submission of a bid is a representation that the
potential provider did not consult with any other potential provider
about its bid, that the bid was determined without regard to any other
formal or informal agreement that the potential provider has with the
issuer or any other person (whether or not in connection with the bond
issue), and that the bid is not being submitted solely as a courtesy to
the
[[Page 107]]
issuer or any other person for purposes of satisfying the requirements
of paragraph (d)(6)(iii)(B)(1) or (2) of this section.
(4) The terms of the bid specifications are commercially reasonable.
A term is commercially reasonable if there is a legitimate business
purpose for the term other than to increase the purchase price or reduce
the yield of the investment. For example, for solicitations of
investments for a yield restricted defeasance escrow, the hold firm
period must be no longer than the issuer reasonably requires.
(5) For purchases of guaranteed investment contracts only, the terms
of the solicitation take into account the issuer's reasonably expected
deposit and drawdown schedule for the amounts to be invested.
(6) All potential providers have an equal opportunity to bid. For
example, no potential provider is given the opportunity to review other
bids (i.e., a last look) before providing a bid.
(7) At least three reasonably competitive providers are solicited
for bids. A reasonably competitive provider is a provider that has an
established industry reputation as a competitive provider of the type of
investments being purchased.
(B) The bids received by the issuer meet all of the following
requirements:
(1) The issuer receives at least three bids from providers that the
issuer solicited under a bona fide solicitation meeting the requirements
of paragraph (d)(6)(iii)(A) of this section and that do not have a
material financial interest in the issue. A lead underwriter in a
negotiated underwriting transaction is deemed to have a material
financial interest in the issue until 15 days after the issue date of
the issue. In addition, any entity acting as a financial advisor with
respect to the purchase of the investment at the time the bid
specifications are forwarded to potential providers has a material
financial interest in the issue. A provider that is a related party to a
provider that has a material financial interest in the issue is deemed
to have a material financial interest in the issue.
(2) At least one of the three bids described in paragraph
(d)(6)(iii)(B)(1) of this section is from a reasonably competitive
provider, within the meaning of paragraph (d)(6)(iii)(A)(7) of this
section.
(3) If the issuer uses an agent to conduct the bidding process, the
agent did not bid to provide the investment.
(C) The winning bid meets the following requirements:
(1) Guaranteed investment contracts. If the investment is a
guaranteed investment contract, the winning bid is the highest yielding
bona fide bid (determined net of any broker's fees).
(2) Other investments. If the investment is not a guaranteed
investment contract, the following requirements are met:
(i) The winning bid is the lowest cost bona fide bid (including any
broker's fees). The lowest cost bid is either the lowest cost bid for
the portfolio or, if the issuer compares the bids on an investment-by-
investment basis, the aggregate cost of a portfolio comprised of the
lowest cost bid for each investment. Any payment received by the issuer
from a provider at the time a guaranteed investment contract is
purchased (e.g., an escrow float contract) for a yield restricted
defeasance escrow under a bidding procedure meeting the requirements of
this paragraph (d)(6)(iii) is taken into account in determining the
lowest cost bid.
(ii) The lowest cost bona fide bid (including any broker's fees) is
not greater than the cost of the most efficient portfolio comprised
exclusively of State and Local Government Series Securities from the
United States Department of the Treasury, Bureau of Public Debt. The
cost of the most efficient portfolio of State and Local Government
Series Securities is to be determined at the time that bids are required
to be submitted pursuant to the terms of the bid specifications.
(iii) If State and Local Government Series Securities from the
United States Department of the Treasury, Bureau of Public Debt are not
available for purchase on the day that bids are required to be submitted
pursuant to terms of the bid specifications because sales of those
securities have been suspended, the cost comparison of paragraph
(d)(6)(iii) (C)(2)(ii) of this section is not required.
[[Page 108]]
(D) The provider of the investments or the obligor on the guaranteed
investment contract certifies the administrative costs that it pays (or
expects to pay, if any) to third parties in connection with supplying
the investment.
(E) The issuer retains the following records with the bond documents
until three years after the last outstanding bond is redeemed:
(1) For purchases of guaranteed investment contracts, a copy of the
contract, and for purchases of investments other than guaranteed
investment contracts, the purchase agreement or confirmation.
(2) The receipt or other record of the amount actually paid by the
issuer for the investments, including a record of any administrative
costs paid by the issuer, and the certification under paragraph
(d)(6)(iii)(D) of this section.
(3) For each bid that is submitted, the name of the person and
entity submitting the bid, the time and date of the bid, and the bid
results.
(4) The bid solicitation form and, if the terms of the purchase
agreement or the guaranteed investment contract deviated from the bid
solicitation form or a submitted bid is modified, a brief statement
explaining the deviation and stating the purpose for the deviation. For
example, if the issuer purchases a portfolio of investments for a yield
restricted defeasance escrow and, in order to satisfy the yield
restriction requirements of section 148, an investment in the winning
bid is replaced with an investment with a lower yield, the issuer must
retain a record of the substitution and how the price of the substitute
investment was determined. If the issuer replaces an investment in the
winning bid portfolio with another investment, the purchase price of the
new investment is not covered by the safe harbor unless the investment
is bid under a bidding procedure meeting the requirements of this
paragraph (d)(6)(iii).
(5) For purchases of investments other than guaranteed investment
contracts, the cost of the most efficient portfolio of State and Local
Government Series Securities, determined at the time that the bids were
required to be submitted pursuant to the terms of the bid
specifications.
(e) Administrative costs of investments--(1) In general. Except as
otherwise provided in this paragraph (e), an allocation of gross
proceeds of an issue to a payment or a receipt on an investment is not
adjusted to take into account any costs or expenses paid, directly or
indirectly, to purchase, carry, sell, or retire the investment
(administrative costs). Thus, these administrative costs generally do
not increase the payments for, or reduce the receipts from, investments.
(2) Qualified administrative costs on nonpurpose investments--(i) In
general. In determining payments and receipts on nonpurpose investments,
qualified administrative costs are taken into account. Thus, qualified
administrative costs increase the payments for, or decrease the receipts
from, the investments. Qualified administrative costs are reasonable,
direct administrative costs, other than carrying costs, such as
separately stated brokerage or selling commissions, but not legal and
accounting fees, recordkeeping, custody, and similar costs. General
overhead costs and similar indirect costs of the issuer such as employee
salaries and office expenses and costs associated with computing the
rebate amount under section 148(f) are not qualified administrative
costs. In general, administrative costs are not reasonable unless they
are comparable to administrative costs that would be charged for the
same investment or a reasonably comparable investment if acquired with a
source of funds other than gross proceeds of tax-exempt bonds.
(ii) Special rule for administrative costs of nonpurpose investments
in certain regulated investment companies and commingled funds.
Qualified administrative costs include all reasonable administrative
costs, without regard to the limitation on indirect costs under
paragraph (e)(2)(i) of this section, incurred by:
(A) Regulated investment companies. A publicly offered regulated
investment company (as defined in section 67(c)(2)(B)); and
(B) External commingled funds. A widely held commingled fund in
which no investor in the fund owns more than 10 percent of the
beneficial interest in the fund. For purposes of this paragraph
[[Page 109]]
(e)(2)(ii)(B), a fund is treated as widely held only if, during the
immediately preceding fixed, semiannual period chosen by the fund (e.g.,
semiannual periods ending June 30 and December 31), the fund had a daily
average of more than 15 investors that were not related parties, and the
daily average amount each investor had invested in the fund was not less
than the lesser of $500,000 and 1 percent of the daily average of the
total amount invested in the fund. For purposes of this paragraph
(e)(2)(ii)(B), an investor will be treated as owning not more than 10
percent of the beneficial interest in the fund if, on the date of each
deposit by the investor into the fund, the total amount the investor and
any related parties have on deposit in the fund is not more than 10
percent of the total amount that all investors have on deposit in the
fund. For purposes of the preceding sentence, the total amount that all
investors have on deposit in the fund is equal to the sum of all
deposits made by the investor and any related parties on the date of
those deposits and the closing balance in the fund on the day before
those deposits. If any investor in the fund owns more than 10 percent of
the beneficial interest in the fund, the fund does not qualify under
this paragraph (e)(2)(ii)(B) until that investor makes sufficient
withdrawals from the fund to reduce its beneficial interest in the fund
to 10 percent or less.
(iii) Special rule for guaranteed investment contracts and
investments purchased for a yield restricted defeasance escrow--(A) In
general. An amount paid for a broker's commission or similar fee with
respect to a guaranteed investment contract or investments purchased for
a yield restricted defeasance escrow is a qualified administrative cost
if the fee is reasonable within the meaning of paragraph (e)(2)(i) of
this section.
(B) Safe harbor--(1) In general. A broker's commission or similar
fee with respect to the acquisition of a guaranteed investment contract
or investments purchased for a yield restricted defeasance escrow is
reasonable within the meaning of paragraph (e)(2)(i) of this section to
the extent that--
(i) The amount of the fee that the issuer treats as a qualified
administrative cost does not exceed the lesser of:
(A) $30,000 and
(B) 0.2% of the computational base or, if more, $3,000; and
(ii) For any issue, the issuer does not treat as qualified
administrative costs more than $85,000 in brokers' commissions or
similar fees with respect to all guaranteed investment contracts and
investments for yield restricted defeasance escrows purchased with gross
proceeds of the issue.
(2) Computational base. For purposes of paragraph (e)(2)(iii)(B)(1)
of this section, computational base shall mean--
(i) For a guaranteed investment contract, the amount of gross
proceeds the issuer reasonably expects, as of the date the contract is
acquired, to be deposited in the guaranteed investment contract over the
term of the contract, and
(ii) For investments (other than guaranteed investment contracts) to
be deposited in a yield restricted defeasance escrow, the amount of
gross proceeds initially invested in those investments.
(3) Cost-of-living adjustment. In the case of a calendar year after
2004, each of the dollar amounts in paragraph (e)(2)(iii)(B)(1) of this
section shall be increased by an amount equal to--
(i) Such dollar amount; multiplied by
(ii) The cost-of-living adjustment determined under section 1(f)(3)
for such calendar year by using the language ``calendar year 2003''
instead of ``calendar year 1992'' in section 1(f)(3)(B).
(4) Rounding. If any increase determined under paragraph
(e)(2)(iii)(B)(3) of this section is not a multiple of $1,000, such
increase shall be rounded to the nearest multiple thereof.
(5) Applicable year for cost-of-living adjustment. The cost-of-
living adjustments under paragraph (e)(2)(iii)(B)(3) of this section
shall apply to the safe harbor amounts under paragraph (e)(2)(iii)(B)(1)
of this section based on the year the guaranteed investment contract or
the investments for the yield restricted defeasance escrow, as
applicable, are acquired.
(6) Cost-of-living adjustment to determine remaining amount of per-
issue safe harbor--(i) In general. This paragraph (e)(2)(iii)(B)(6)
applies to determine the
[[Page 110]]
portion of the safe harbor amount under paragraph (e)(2)(iii)(B)(1)(ii)
of this section, as modified by paragraph (e)(2)(iii)(B)(3) of this
section (the per-issue safe harbor), that is available (the remaining
amount) for any year (the determination year) if the per-issue safe
harbor was partially used in one or more prior years.
(ii) Remaining amount of per-issue safe harbor. The remaining amount
of the per-issue safe harbor for any determination year is equal to the
per-issue safe harbor for that year, reduced by the portion of the per-
issue safe harbor used in one or more prior years.
(iii) Portion of per-issue safe harbor used in prior years. The
portion of the per-issue safe harbor used in any prior year (the prior
year) is equal to the total amount of broker's commissions or similar
fees paid in connection with guaranteed investment contracts or
investments for a yield restricted defeasance escrow acquired in the
prior year that the issuer treated as qualified administrative costs for
the issue, multiplied by a fraction the numerator of which is the per-
issue safe harbor for the determination year and the denominator of
which is the per-issue safe harbor for the prior year. See paragraph
(e)(2)(iii)(C) Example 2 of this section.
(C) Examples. The following examples illustrate the application of
the safe harbor in paragraph (e)(2)(iii)(B) of this section:
Example 1. Multipurpose issue. In 2003, the issuer of a multipurpose
issue uses brokers to acquire the following investments with gross
proceeds of the issue: a guaranteed investment contract for amounts to
be deposited in a construction fund (construction GIC), Treasury
securities to be deposited in a yield restricted defeasance escrow
(Treasury investments) and a guaranteed investment contract that will be
used to earn a return on what otherwise would be idle cash balances from
maturing investments in the yield restricted defeasance escrow (the
float GIC). The issuer deposits $22,000,000 into the construction GIC
and reasonably expects that no further deposits will be made over its
term. The issuer uses $8,040,000 of the proceeds to purchase the
Treasury investments. The issuer reasonably expects that it will make
aggregate deposits of $600,000 to the float GIC over its term. The
brokers' fees are $30,000 for the construction GIC, $16,080 for the
Treasury investments and $3,000 for the float GIC. The issuer has not
previously treated any brokers' commissions or similar fees as qualified
administrative costs. The issuer may claim all $49,080 in brokers' fees
for these investments as qualified administrative costs because the fees
do not exceed the safe harbors in paragraph (e)(2)(iii)(B) of this
section. Specifically, each of the brokers' fees equals the lesser of
$30,000 and 0.2% of the computational base (or, if more, $3,000) (i.e.,
lesser of $30,000 and 0.2% x $22,000,000 for the construction GIC;
lesser of $30,000 and 0.2% x $8,040,000 for the Treasury investments;
and lesser of $30,000 and $3,000 for the float GIC). In addition, the
total amount of brokers' fees claimed by the issuer as qualified
administrative costs ($49,080) does not exceed the per-issue safe harbor
of $85,000.
Example 2. Cost-of-living adjustment. In 2003, an issuer issues
bonds and uses gross proceeds of the issue to acquire two guaranteed
investment contracts. The issuer pays a total of $50,000 in brokers'
fees for the two guaranteed investment contracts and treats these fees
as qualified administrative costs. In a year subsequent to 2003 (Year
Y), the issuer uses gross proceeds of the issue to acquire two
additional guaranteed investment contracts, paying a total of $20,000 in
broker's fees for the two guaranteed investment contracts, and treats
those fees as qualified administrative costs. For Year Y, applying the
cost-of-living adjustment under paragraph (e)(2)(iii)(B)(3) of this
section, the safe harbor dollar limits under paragraph (e)(2)(iii)(B)(1)
of this section are $3,000, $32,000 and $90,000. The remaining amount of
the per-issue safe harbor for Year Y is $37,059 ($90,000-[$50,000 x
$90,000/$85,000]). The broker's fees in Year Y do not exceed the per-
issue safe harbor under paragraph (e)(2)(iii)(B)(1)(ii) (as modified by
paragraph (e)(2)(iii)(B)(3)) of this section because the broker's fees
do not exceed the remaining amount of the per-issue safe harbor
determined under paragraph (e)(2)(iii)(B)(6) of this section for Year Y.
In a year subsequent to Year Y (Year Z), the issuer uses gross proceeds
of the issue to acquire an additional guaranteed investment contract,
pays a broker's fee of $15,000 for the guaranteed investment contract,
and treats the broker's fee as a qualified administrative cost. For Year
Z, applying the cost-of-living adjustment under paragraph
(e)(2)(iii)(B)(3) of this section, the safe harbor dollar limits under
paragraph (e)(2)(iii)(B)(1) of this section are $3,000, $33,000 and
$93,000. The remaining amount of the per-issue safe harbor for Year Z is
$17,627 ($93,000--[($50,000 x $93,000/$85,000) + ($20,000 x $93,000/
$90,000)]). The broker's fee incurred in Year Z does not exceed the per-
issue safe harbor under paragraph (e)(2)(iii)(B)(1)(ii) (as modified by
paragraph (e)(2)(iii)(B)(3)) of this section because the broker's fee
does not exceed the remaining amount of the per-issue safe harbor
determined under paragraph
[[Page 111]]
(e)(2)(iii)(B)(6) of this section for Year Z. See paragraph
(e)(2)(iii)(B)(6) of this section.
(3) Qualified administrative costs on purpose investments--(i) In
general. In determining payments and receipts on purpose investments,
qualified administrative costs described in this paragraph (e)(3) paid
by the conduit borrower are taken into account. Thus, these costs
increase the payments for, or decrease the receipts from, the purpose
investments. This rule applies even if those payments merely reimburse
the issuer. Although the actual payments by the conduit borrower may be
made at any time, for this purpose, a pro rata portion of each payment
made by a conduit borrower is treated as a reimbursement of reasonable
administrative costs, if the present value of those payments does not
exceed the present value of the reasonable administrative costs paid by
the issuer, using the yield on the issue as the discount rate.
(ii) Definition of qualified administrative costs of purpose
investments--(A) In general. Except as otherwise provided in this
paragraph (e)(3)(ii), qualified administrative costs of a purpose
investment means--
(1) Costs or expenses paid, directly or indirectly, to purchase,
carry, sell, or retire the investment; and
(2) Costs of issuing, carrying, or repaying the issue, and any
underwriters' discount.
(B) Limitation on program investments. For a program investment,
qualified administrative costs include only those costs described in
paragraph (e)(3)(ii)(A)(2) of this section.
[T.D. 8476, 58 FR 33529, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24044, May 10, 1994; T.D. 8718, 62 FR 25511,
May 9, 1997; T.D. 8801, 63 FR 71751, Dec. 30, 1998; T.D. 9097, 68 FR
69022, Dec. 11, 2003]
Sec. 1.148-6 General allocation and accounting rules.
(a) In general--(1) Reasonable accounting methods required. An
issuer may use any reasonable, consistently applied accounting method to
account for gross proceeds, investments, and expenditures of an issue.
(2) Bona fide deviations from accounting method. An accounting
method does not fail to be reasonable and consistently applied solely
because a different accounting method is used for a bona fide
governmental purpose to consistently account for a particular item. Bona
fide governmental purposes may include special State law restrictions
imposed on specific funds or actions to avoid grant forfeitures.
(3) Absence of allocation and accounting methods. If an issuer fails
to maintain books and records sufficient to establish the accounting
method for an issue and the allocation of the proceeds of that issue,
the rules of this section are applied using the specific tracing method.
This paragraph (a)(3) applies to bonds issued on or after May 16, 1997.
(b) Allocation of gross proceeds to an issue--(1) One-issue rule and
general ordering rules. Except as otherwise provided, amounts are
allocable to only one issue at a time as gross proceeds, and if amounts
simultaneously are proceeds of one issue and replacement proceeds of
another issue, those amounts are allocable to the issue of which they
are proceeds. Amounts cease to be allocated to an issue as proceeds only
when those amounts are allocated to an expenditure for a governmental
purpose, are allocated to transferred proceeds of another issue, or
cease to be allocated to that issue at retirement of the issue or under
the universal cap of paragraph (b)(2) of this section. Amounts cease to
be allocated to an issue as replacement proceeds only when those amounts
are allocated to an expenditure for a governmental purpose, are no
longer used in a manner that causes those amounts to be replacement
proceeds of that issue, or cease to be allocated to that issue because
of the retirement of the issue or the application of the universal cap
under paragraph (b)(2) of this section. Amounts that cease to be
allocated to an issue as gross proceeds are eligible for allocation to
another issue. Under Sec. 1.148-10(a), however, the rules in this
paragraph (b)(1) do not apply in certain cases involving abusive
arbitrage devices.
(2) Universal cap on value of nonpurpose investments allocated to an
issue--(i) Application. The rules in this paragraph (b)(2) provide an
overall limitation on the amount of gross proceeds allocable to an
issue. Although the universal cap generally may be applied at any time
[[Page 112]]
in the manner described in this paragraph (b)(2), it need not be applied
on any otherwise required date of application if its application on that
date would not result in a reduction or reallocation of gross proceeds
of an issue. For this purpose, if an issuer reasonably expects as of the
issue date that the universal cap will not reduce the amount of gross
proceeds allocable to the issue during the term of the issue, the
universal cap need not be applied on any date on which an issue actually
has all of the following characteristics--
(A) No replacement proceeds are allocable to the issue, other than
replacement proceeds in a bona fide debt service fund or a reasonably
required reserve or replacement fund;
(B) The net sale proceeds of the issue--
(1) Qualified for one of the temporary periods available for capital
projects, restricted working capital expenditures, or pooled financings
under Sec. 1.148-2 (e)(2), (e)(3), or (e)(4), and those net sales
proceeds were in fact allocated to expenditures prior to the expiration
of the longest applicable temporary period; or
(2) were deposited in a refunding escrow and expended as originally
expected;
(C) The issue does not refund a prior issue that, on any transfer
date, has unspent proceeds allocable to it;
(D) None of the bonds are retired prior to the date on which those
bonds are treated as retired in computing the yield on the issue; and
(E) No proceeds of the issue are invested in qualified student loans
or qualified mortgage loans.
(ii) General rule. Except as otherwise provided below, amounts that
would otherwise be gross proceeds allocable to an issue are allocated
(and remain allocated) to the issue only to the extent that the value of
the nonpurpose investments allocable to those gross proceeds does not
exceed the value of all outstanding bonds of the issue. For this
purpose, gross proceeds allocable to cash, tax-exempt bonds that would
be nonpurpose investments (absent section 148(b)(3)(A)), qualified
student loans, and qualified mortgage loans are treated as nonpurpose
investments. The values of bonds and investments are determined under
Sec. 1.148-4(e) and Sec. 1.148-5(d), respectively. The value of all
outstanding bonds of the issue is referred to as the universal cap.
Thus, for example, the universal cap for an issue of plain par bonds is
equal to the outstanding stated principal amount of those bonds plus
accrued interest.
(iii) Determination and application of the universal cap. Except as
otherwise provided, beginning with the first bond year that commences
after the second anniversary of the issue date, the amount of the
universal cap and the value of the nonpurpose investments must be
determined as of the first day of each bond year. For refunding and
refunded issues, the cap and values must be determined as of each date
that, but for this paragraph (b)(2), proceeds of the refunded issue
would become transferred proceeds of the refunding issue, and need not
otherwise be determined in the bond year in which that date occurs. All
values are determined as of the close of business on each determination
date, after giving effect to all payments on bonds and payments for and
receipts on investments on that date.
(iv) General ordering rule for allocations of amounts in excess of
the universal cap--(A) In general. If the value of all nonpurpose
investments allocated to the gross proceeds of an issue exceeds the
universal cap for that issue on a date as of which the cap is determined
under paragraph (b)(2)(iii) of this section, nonpurpose investments
allocable to gross proceeds necessary to eliminate that excess cease to
be allocated to the issue, in the following order of priority--
(1) First, nonpurpose investments allocable to replacement proceeds;
(2) Second, nonpurpose investments allocable to transferred
proceeds; and
(3) Third, nonpurpose investments allocable to sale proceeds and
investment proceeds.
(B) Re-allocation of certain amounts. Except as provided in Sec.
1.148-9(b)(3), amounts that cease to be allocated to an issue as a
result of the application of the universal cap may only be allocated to
another issue as replacement proceeds.
[[Page 113]]
(C) Allocations of portions of investments. Portions of investments
to which this paragraph (b)(2)(iv) applies are allocated under either
the ratable method or the representative method in the same manner as
allocations of portions of investments to transferred proceeds under
Sec. 1.148-9(c).
(v) Nonpurpose investments in a bona fide debt service fund not
counted. For purposes of this paragraph (b)(2), nonpurpose investments
allocated to gross proceeds in a bona fide debt service fund for an
issue are not taken into account in determining the value of the
nonpurpose investments, and those nonpurpose investments remain
allocated to the issue.
(c) Fair market value limit on allocations to nonpurpose
investments. Upon a purchase or sale of a nonpurpose investment, gross
proceeds of an issue are not allocated to a payment for that nonpurpose
investment in an amount greater than, or to a receipt from that
nonpurpose investment in an amount less than, the fair market value of
the nonpurpose investment as of the purchase or sale date. For purposes
of this paragraph (c) only, the fair market value of a nonpurpose
investment is adjusted to take into account qualified administrative
costs allocable to the investment.
(d) Allocation of gross proceeds to expenditures--(1) Expenditures
in general--(i) General rule. Reasonable accounting methods for
allocating funds from different sources to expenditures for the same
governmental purpose include any of the following methods if
consistently applied: a specific tracing method; a gross proceeds spent
first method; a first-in, first-out method; or a ratable allocation
method.
(ii) General limitation. An allocation of gross proceeds of an issue
to an expenditure must involve a current outlay of cash for a
governmental purpose of the issue. A current outlay of cash means an
outlay reasonably expected to occur not later than 5 banking days after
the date as of which the allocation of gross proceeds to the expenditure
is made.
(iii) Timing. An issuer must account for the allocation of proceeds
to expenditures not later than 18 months after the later of the date the
expenditure is paid or the date the project, if any, that is financed by
the issue is placed in service. This allocation must be made in any
event by the date 60 days after the fifth anniversary of the issue date
or the date 60 days after the retirement of the issue, if earlier. This
paragraph (d)(1)(iii) applies to bonds issued on or after May 16, 1997.
(2) Treatment of gross proceeds invested in purpose investments--(i)
In general. Gross proceeds of an issue invested in a purpose investment
are allocated to an expenditure on the date on which the conduit
borrower under the purpose investment allocates the gross proceeds to an
expenditure in accordance with this paragraph (d).
(ii) Exception for qualified mortgage loans and qualified student
loans. If gross proceeds of an issue are allocated to a purpose
investment that is a qualified mortgage loan or a qualified student
loan, those gross proceeds are allocated to an expenditure for the
governmental purpose of the issue on the date on which the issuer
allocates gross proceeds to that purpose investment.
(iii) Continuing allocation of gross proceeds to purpose
investments. Regardless of whether gross proceeds of a conduit financing
issue invested in a purpose investment have been allocated to an
expenditure under paragraph (d)(2) (i) or (ii) of this section, with
respect to the actual issuer those gross proceeds continue to be
allocated to the purpose investment until the sale, discharge, or other
disposition of the purpose investment.
(3) Expenditures for working capital purposes--(i) In general.
Except as otherwise provided in this paragraph (d)(3) or paragraph
(d)(4) of this section, proceeds of an issue may only be allocated to
working capital expenditures as of any date to the extent that those
working capital expenditures exceed available amounts (as defined in
paragraph (d)(3)(iii) of this section) as of that date (i.e., a
``proceeds-spent-last'' method). For this purpose, proceeds include
replacement proceeds described in Sec. 1.148-1(c)(4).
(ii) Exceptions--(A) General de minimis exception. Paragraph
(d)(3)(i) of this section does not apply to expenditures to pay--
[[Page 114]]
(1) Any issuance costs of the issue or any qualified administrative
costs within the meaning of Sec. Sec. 1.148-5(e)(2) (i) or (ii), or
Sec. 1.148-5(e)(3)(ii)(A);
(2) Fees for qualified guarantees of the issue or payments for a
qualified hedge for the issue;
(3) Interest on the issue for a period commencing on the issue date
and ending on the date that is the later of three years from the issue
date or one year after the date on which the project is placed in
service;
(4) Amounts paid to the United States under Sec. Sec. 1.148-3,
1.148-5(c), or 1.148-7 for the issue;
(5) Costs, other than those described in paragraphs (d)(3)(ii)(A)
(1) through (4) of this section, that do not exceed 5 percent of the
sale proceeds of an issue and that are directly related to capital
expenditures financed by the issue (e.g., initial operating expenses for
a new capital project);
(6) Principal or interest on an issue paid from unexpected excess
sale or investment proceeds; and
(7) Principal or interest on an issue paid from investment earnings
on a reserve or replacement fund that are deposited in a bona fide debt
service fund.
(B) Exception for extraordinary items. Paragraph (d)(3)(i) of this
section does not apply to expenditures for extraordinary, nonrecurring
items that are not customarily payable from current revenues, such as
casualty losses or extraordinary legal judgments in amounts in excess of
reasonable insurance coverage. If, however, an issuer or a related party
maintains a reserve for such items (e.g., a self-insurance fund) or has
set aside other available amounts for such expenses, gross proceeds
within that reserve must be allocated to expenditures only after all
other available amounts in that reserve are expended.
(C) Exception for payment of principal and interest on prior issues.
Paragraph (d)(3)(i) of this section does not apply to expenditures for
payment of principal, interest, or redemption prices on a prior issue
and, for a crossover refunding issue, interest on that issue.
(D) No exceptions if replacement proceeds created. The exceptions
provided in this paragraph (d)(3)(ii) do not apply if the allocation
merely substitutes gross proceeds for other amounts that would have been
used to make those expenditures in a manner that gives rise to
replacement proceeds. For example, if a purported reimbursement
allocation of proceeds of a reimbursement bond does not result in an
expenditure under Sec. 1.150-2, those proceeds may not be allocated to
pay interest on an issue that, absent this allocation, would have been
paid from the issuer's current revenues.
(iii) Definition of available amount--(A) In general. For purposes
of this paragraph (d)(3), available amount means any amount that is
available to an issuer for working capital expenditure purposes of the
type financed by an issue. Except as otherwise provided, available
amount excludes proceeds of the issue but includes cash, investments,
and other amounts held in accounts or otherwise by the issuer or a
related party if those amounts may be used by the issuer for working
capital expenditures of the type being financed by an issue without
legislative or judicial action and without a legislative, judicial, or
contractual requirement that those amounts be reimbursed.
(B) Reasonable working capital reserve treated as unavailable. A
reasonable working capital reserve is treated as unavailable. Any
working capital reserve is reasonable if it does not exceed 5 percent of
the actual working capital expenditures of the issuer in the fiscal year
before the year in which the determination of available amounts is made.
For this purpose only, in determining the working capital expenditures
of an issuer for a prior fiscal year, any expenditures (whether capital
or working capital expenditures) that are paid out of current revenues
may be treated as working capital expenditures.
(C) Qualified endowment funds treated as unavailable. For a
501(c)(3) organization, a qualified endowment fund is treated as
unavailable. A fund is a qualified endowment fund if--
(1) The fund is derived from gifts or bequests, or the income
thereon, that were neither made nor reasonably expected to be used to
pay working capital expenditures;
(2) Pursuant to reasonable, established practices of the
organization,
[[Page 115]]
the governing body of the 501(c)(3) organization designates and
consistently operates the fund as a permanent endowment fund or quasi-
endowment fund restricted as to use; and
(3) There is an independent verification that the fund is reasonably
necessary as part of the organization's permanent capital.
(D) Application to statutory safe harbor for tax and revenue
anticipation bonds. For purposes of section 148(f)(4)(B)(iii)(II),
available amount has the same meaning as in paragraph (d)(3)(iii) of
this section, except that the otherwise-permitted reasonable working
capital reserve is treated as part of the available amount.
(4) Expenditures for grants--(i) In general. Gross proceeds of an
issue that are used to make a grant are allocated to an expenditure on
the date on which the grant is made.
(ii) Characterization of repayments of grants. If any amount of a
grant financed by gross proceeds of an issue is repaid to the grantor,
the repaid amount is treated as unspent proceeds of the issue as of the
repayment date unless expended within 60 days of repayment.
(iii) Definition of grant. Grant means a transfer for a governmental
purpose of money or property to a transferee that is not a related party
to or an agent of the transferor. The transfer must not impose any
obligation or condition to directly or indirectly repay any amount to
the transferor. Obligations or conditions intended solely to assure
expenditure of the transferred moneys in accordance with the
governmental purpose of the transfer do not prevent a transfer from
being a grant.
(5) Expenditures for reimbursement purposes. In allocating gross
proceeds of issues of reimbursement bonds (as defined in Sec. 1.150-2))
to certain expenditures, Sec. 1.150-2 applies. In allocating gross
proceeds to an expenditure to reimburse a previously paid working
capital expenditure, paragraph (d)(3) of this section applies. Thus, if
the expenditure is described in paragraph (d)(3)(ii) of this section or
there are no available amounts on the date a working capital expenditure
is made and there are no other available amounts on the date of the
reimbursement of that expenditure, gross proceeds are allocated to the
working capital expenditure as of the date of the reimbursement.
(6) Expenditures of certain commingled investment proceeds of
governmental issues. This paragraph (d)(6) applies to any issue of
governmental bonds, any issue of private activity bonds issued to
finance a facility that is required by section 142 to be owned by a
governmental unit, and any portion of an issue that is not treated as
consisting of private activity bonds under section 141(b)(9). Investment
proceeds of the issue (other than investment proceeds held in a
refunding escrow) are treated as allocated to expenditures for a
governmental purpose when the amounts are deposited in a commingled fund
with substantial tax or other revenues from governmental operations of
the issuer and the amounts are reasonably expected to be spent for
governmental purposes within 6 months from the date of the commingling.
In establishing these reasonable expectations, an issuer may use any
reasonable accounting assumption and is not bound by the proceeds-spent-
last assumption generally required for working capital expenditures
under paragraph (d)(3) of this section.
(7) Payments to related parties. Any payment of gross proceeds of
the issue to a related party of the payor is not an expenditure of those
gross proceeds.
(e) Special rules for commingled funds--(1) In general. An
accounting method for gross proceeds of an issue in a commingled fund,
other than a bona fide debt service fund, is reasonable only if it
satisfies the requirements of paragraphs (e)(2) through (6) of this
section in addition to the other requirements of this section.
(2) Investments held by a commingled fund--(i) Required ratable
allocations. Not less frequently than as of the close of each fiscal
period, all payments and receipts (including deemed payments and
receipts) on investments held by a commingled fund must be allocated
(but not necessarily distributed) among the different investors in the
fund. This allocation must be based on a consistently applied,
reasonable ratable allocation method.
[[Page 116]]
(ii) Safe harbors for ratable allocation methods. Reasonable ratable
allocation methods include, without limitation, methods that allocate
these items in proportion to either--
(A) The average daily balances of the amounts in the commingled fund
from different investors during a fiscal period (as described in
paragraph (e)(4) of this section); or
(B) The average of the beginning and ending balances of the amounts
in the commingled fund from different investors for a fiscal period that
does not exceed one month.
(iii) Definition of investor. For purposes of this paragraph (e),
the term investor means each different source of funds invested in a
commingled fund. For example, if a city invests gross proceeds of an
issue and tax revenues in a commingled fund, it is treated as two
different investors.
(3) Certain expenditures involving a commingled fund. If a ratable
allocation method is used under paragraph (d) of this section to
allocate expenditures from the commingled fund, the same ratable
allocation method must be used to allocate payments and receipts on
investments in the commingled fund under paragraph (e)(2) of this
section.
(4) Fiscal periods. The fiscal year of a commingled fund is the
calendar year unless the fund adopts another fiscal year. A commingled
fund may use any consistent fiscal period that does not exceed three
months (e.g., a daily, weekly, monthly, or quarterly fiscal period).
(5) Unrealized gains and losses on investments of a commingled
fund--(i) Mark-to-market requirement for internal commingled funds with
longer-term investment portfolios. Except as otherwise provided in this
paragraph (e), in the case of a commingled fund in which the issuer and
any related party own more than 25 percent of the beneficial interests
in the fund (an internal commingled fund), the fund must treat all its
investments as if sold at fair market value either on the last day of
the fiscal year or the last day of each fiscal period. The net gains or
losses from these deemed sales of investments must be allocated to all
investors of the commingled fund during the period since the last
allocation.
(ii) Exception for internal commingled funds with shorter-term
investment portfolios. If the remaining weighted average maturity of all
investments held by a commingled fund during a particular fiscal year
does not exceed 18 months, and the investments held by the commingled
fund during that fiscal year consist exclusively of obligations, the
mark-to-market requirement of paragraph (e)(5)(i) of this section does
not apply.
(iii) Exception for commingled reserve funds and sinking funds. The
mark-to-market requirement of paragraph (e)(5)(i) of this section does
not apply to a commingled fund that operates exclusively as a reserve
fund, sinking fund, or replacement fund for two or more issues of the
same issuer.
(6) Allocations of commingled funds serving as common reserve funds
or sinking funds--(i) Permitted ratable allocation methods. If a
commingled fund serves as a common reserve fund, replacement fund, or
sinking fund for two or more issues (a commingled reserve), after making
reasonable adjustments to account for proceeds allocated under paragraph
(b)(1) or (b)(2) of this section, investments held by that commingled
fund must be allocated ratably among the issues served by the commingled
fund in accordance with one of the following methods--
(A) The relative values of the bonds of those issues under Sec.
1.148-4(e);
(B) The relative amounts of the remaining maximum annual debt
service requirements on the outstanding principal amounts of those
issues; or
(C) The relative original stated principal amounts of the
outstanding issues.
(ii) Frequency of allocations. An issuer must make any allocations
required by this paragraph (e)(6) as of a date at least every 3 years
and as of each date that an issue first becomes secured by the
commingled reserve. If relative original principal amounts are used to
allocate, allocations must also be made on the retirement of any issue
secured by the commingled reserve.
[T.D. 8476, 58 FR 33532, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24045, May 10, 1994; T.D. 8712, 62 FR 2304,
Jan. 16, 1997; T.D. 8718, 62 FR 25512, May 9, 1997]
[[Page 117]]
Sec. 1.148-7 Spending exceptions to the rebate requirement.
(a) Scope of section--(1) In general. This section provides guidance
on the spending exceptions to the arbitrage rebate requirement of
section 148(f)(2). These exceptions are the 6-month exception in section
148(f)(4)(B) (the 6-month exception), the 18-month exception under
paragraph (d) of this section (the 18-month exception), and the 2-year
construction exception under section 148(f)(4)(C) (the 2-year exception)
(collectively, the spending exceptions).
(2) Relationship of spending exceptions. Each of the spending
exceptions is an independent exception to arbitrage rebate. For example,
a construction issue may qualify for the 6-month exception or the 18-
month exception even though the issuer makes one or more elections under
the 2-year exception with respect to the issue.
(3) Spending exceptions not mandatory. Use of the spending
exceptions is not mandatory. An issuer may apply the arbitrage rebate
requirement to an issue that otherwise satisfies a spending exception.
If an issuer elects to pay penalty in lieu of rebate under the 2-year
exception, however, the issuer must apply those penalty provisions.
(b) Rules applicable for all spending exceptions. The provisions of
this paragraph (b) apply for purposes of applying each of the spending
exceptions.
(1) Special transferred proceeds rules--(i) Application to prior
issues. For purposes of applying the spending exceptions to a prior
issue only, proceeds of the prior issue that become transferred proceeds
of the refunding issue continue to be treated as unspent proceeds of the
prior issue. If the prior issue satisfies one of the spending
exceptions, the proceeds of the prior issue that are excepted from
rebate under that spending exception are not subject to rebate either as
proceeds of the prior issue or as transferred proceeds of the refunding
issue.
(ii) Application to refunding issues--(A) In general. The only
spending exception applicable to refunding issues is the 6-month
exception. For purposes of applying the 6-month exception to a refunding
issue only, proceeds of the prior issue that become transferred proceeds
of the refunding issue generally are not treated as proceeds of the
refunding issue and need not be spent for the refunding issue to satisfy
that spending exception. Even if the refunding issue qualifies for that
spending exception, those transferred proceeds are subject to rebate as
proceeds of the refunding issue unless an exception to rebate applied to
those proceeds as proceeds of the prior issue.
(B) Exception. For purposes of applying the 6-month exception to
refunding issues, those transferred proceeds of the refunding issue
excluded from the gross proceeds of the prior issue under the special
definition of gross proceeds in paragraph (c)(3) of this section, and
those that transferred from a prior taxable issue, are generally treated
as gross proceeds of the refunding issue. Thus, for the refunding issue
to qualify for the 6-month exception, those proceeds must be spent
within 6 months of the issue date of the refunding issue, unless those
amounts continue to be used in a manner that does not cause those
amounts to be gross proceeds under paragraph (c)(3) of this section.
(2) Application of multipurpose issue rules. Except as otherwise
provided, if any portion of an issue is treated as a separate issue
allocable to refunding purposes under Sec. 1.148-9(h) (relating to
multipurpose issues), for purposes of this section, that portion is
treated as a separate issue.
(3) Expenditures for governmental purposes of the issue. For
purposes of this section, expenditures for the governmental purpose of
an issue include payments for interest, but not principal, on the issue,
and for principal or interest on another issue of obligations. The
preceding sentence does not apply for purposes of the 18-month and 2-
year exceptions if those payments cause the issue to be a refunding
issue.
(4) De minimis rule. Any failure to satisfy the final spending
requirement of the 18-month exception or the 2-year exception is
disregarded if the issuer exercises due diligence to complete the
project financed and the amount of the failure does not exceed the
lesser of 3 percent of the issue price of the issue or $250,000.
(5) Special definition of reasonably required reserve or replacement
fund. For
[[Page 118]]
purposes of this section only, a reasonably required reserve or
replacement fund also includes any fund to the extent described in Sec.
1.148-5(c)(3)(i)(E) or (G).
(6) Pooled financing issue--(i) In general. Except as otherwise
provided in this paragraph (b)(6), the spending exceptions apply to a
pooled financing issue as a whole, rather than to each loan separately.
(ii) Election to apply spending exceptions separately to each loan--
(A) In general. At the election (made on or before the issue date) of
the issuer of a pooled financing issue, the spending exceptions are
applied separately to each conduit loan, and the applicable spending
requirements for a loan begin on the earlier of the date the loan is
made, or the first day following the 1-year period beginning on the
issue date of the pooled financing issue. If this election is made, the
rebate requirement applies to, and none of the spending exceptions are
available for, gross proceeds of the pooled financing bonds before the
date on which the spending requirements for those proceeds begin.
(B) Application of spending exceptions. If the issuer makes the
election under this paragraph (b)(6)(ii), the rebate requirement is
satisfied for proceeds used to finance a particular conduit loan to the
extent that the loan satisfies a spending exception or the small issuer
exception under Sec. 1.148-8, regardless of whether any other conduit
loans allocable to the issue satisfy such an exception. A pooled
financing issue is an issue of arbitrage bonds, however, unless the
entire issue satisfies the requirements of section 148. An issuer may
pay rebate for some conduit loans and 1\1/2\ percent penalty for other
conduit loans from the same pooled financing issue. The 1\1/2\ percent
penalty is computed separately for each conduit loan.
(C) Elections under 2-year exception. If the issuer makes the
election under this paragraph (b)(6)(ii), the issuer may make all
elections under the 2-year exception separately for each loan. Elections
regarding a loan that otherwise must be made by the issuer on or before
the issue date instead may be made on or before the date the loan is
made (but not later than 1 year after the issue date).
(D) Example. The operation of this paragraph (b)(6) is illustrated
by the following example:
Example. Pooled financing issue. On January 1, 1994, Authority J
issues bonds. As of the issue date, J reasonably expects to use the
proceeds of the issue to make loans to City K, County L, and City M. J
does not reasonably expect to use more than 75 percent of the available
construction proceeds of the issue for construction expenditures. On or
before the issue date, J elects to apply the spending exceptions
separately for each loan, with spending requirements beginning on the
earlier of the date the loan is made or the first day following the 1-
year period beginning on the issue date. On February 1, 1994, J loans a
portion of the proceeds to K, and K reasonably expects that 45 percent
of those amounts will be used for construction expenditures. On the date
this loan is made, J elects under paragraph (j) of this section to treat
60 percent of the amount loaned to K as a separate construction issue,
and also elects the 1\1/2\ percent penalty under paragraph (k) of this
section for the separate construction issue. On March 1, 1994, J loans a
portion of the proceeds to L, and L reasonably expects that more than 75
percent of those amounts will be used for construction expenditures. On
March 1, 1995, J loans the remainder of the proceeds to M, and none of
those amounts will be used for construction expenditures. J must satisfy
the rebate requirement for all gross proceeds before those amounts are
loaned. For the loan to K, the spending periods begin on February 1,
1994, and the 1\1/2\ percent penalty must be paid for any failure to
meet a spending requirement for the portion of the loan to K that is
treated as a separate construction issue. Rebate must be paid on the
remaining portion of the loan to K, unless that portion qualifies for
the 6-month exception. For the loan to L, the spending periods begin on
March 1, 1994, and the rebate requirement must be satisfied unless the
6-month, 18-month, or the 2-year exception is satisfied with respect to
those amounts. For the loan to M, the spending periods begin on January
2, 1995, and the rebate requirement must be satisfied for those amounts
unless the 6-month or 18-month exception is satisfied.
(c) 6-month exception--(1)General rule. An issue is treated as
meeting the rebate requirement if--
(i) The gross proceeds (as modified by paragraph (c)(3) of this
section) of the issue are allocated to expenditures for the governmental
purposes of the issue within the 6-month period beginning on
[[Page 119]]
the issue date (the 6-month spending period); and
(ii) The rebate requirement is met for amounts not required to be
spent within the 6-month spending period (excluding earnings on a bona
fide debt service fund).
(2) Additional period for certain bonds. The 6-month spending period
is extended for an additional 6 months in certain circumstances
specified under section 148(f)(4)(B)(ii).
(3) Amounts not included in gross proceeds. For purposes of
paragraph (c)(1)(i) of this section only, gross proceeds has the meaning
used in Sec. 1.148-1, except it does not include amounts--
(i) In a bona fide debt service fund;
(ii) In a reasonably required reserve or replacement fund (see Sec.
1.148-7(b)(5));
(iii) That, as of the issue date, are not reasonably expected to be
gross proceeds but that become gross proceeds after the end of the 6-
month spending period;
(iv) Representing sale or investment proceeds derived from payments
under any purpose investment of the issue; and
(v) Representing repayments of grants (as defined in Sec. 1.148-
6(d)(4)) financed by the issue.
(4) Series of refundings. If a principal purpose of a series of
refunding issues is to exploit the difference between taxable and tax-
exempt interest rates by investing proceeds during the temporary periods
provided in Sec. 1.148-9(d), the 6-month spending period for all issues
in the series begins on the issue date of the first issue in the series.
(d) 18-month exception--(1) General rule. An issue is treated as
meeting the rebate requirement if all of the following requirements are
satisfied--
(i) 18-month expenditure schedule met. The gross proceeds (as
defined in paragraph (d)(3) of this section) are allocated to
expenditures for a governmental purpose of the issue in accordance with
the following schedule (the 18-month expenditure schedule) measured from
the issue date--
(A) At least 15 percent within 6 months (the first spending period);
(B) At least 60 percent within 12 months (the second spending
period); and
(C) 100 percent within 18 months (the third spending period).
(ii) Rebate requirement met for amounts not required to be spent.
The rebate requirement is met for all amounts not required to be spent
in accordance with the 18-month expenditure schedule (other than
earnings on a bona fide debt service fund).
(iii) Issue qualifies for initial temporary period. All of the gross
proceeds (as defined in paragraph (d)(3)(i) of this section) of the
issue qualify for the initial temporary period under Sec. 1.148-
2(e)(2).
(2) Extension for reasonable retainage. An issue does not fail to
satisfy the spending requirement for the third spending period as a
result of a reasonable retainage if the reasonable retainage is
allocated to expenditures within 30 months of the issue date. Reasonable
retainage has the meaning under paragraph (h) of this section, as
modified to refer to net sale proceeds on the date 18 months after the
issue date.
(3) Gross proceeds--(i) Definition of gross proceeds. For purposes
of paragraph (d)(1) of this section only, gross proceeds means gross
proceeds as defined in paragraph (c)(3) of this section, as modified to
refer to ``18 months'' in paragraph (c)(3)(iii) of this section in lieu
of ``6 months.''
(ii) Estimated earnings. For purposes of determining compliance with
the first two spending periods under paragraph (d)(1)(i) of this
section, the amount of investment proceeds included in gross proceeds of
the issue is determined based on the issuer's reasonable expectations on
the issue date.
(4) Application to multipurpose issues. This paragraph (d) does not
apply to an issue any portion of which is treated as meeting the rebate
requirement under paragraph (e) of this section (relating to the 2-year
exception).
(e) 2-year exception--(1) General rule. A construction issue is
treated as meeting the rebate requirement for available construction
proceeds if those proceeds are allocated to expenditures for
governmental purposes of the issue in accordance with the following
schedule (the 2-year expenditure schedule), measured from the issue
date--
(i) At least 10 percent within 6 months (the first spending period);
[[Page 120]]
(ii) At least 45 percent within 1 year (the second spending period);
(iii) At least 75 percent within 18 months (the third spending
period); and
(iv) 100 percent within 2 years (the fourth spending period).
(2) Extension for reasonable retainage. An issue does not fail to
satisfy the spending requirement for the fourth spending period as a
result of unspent amounts for reasonable retainage (as defined in
paragraph (h) of this section) if those amounts are allocated to
expenditures within 3 years of the issue date.
(3) Definitions. For purposes of the 2-year exception, the following
definitions apply:
(i) Real property means land and improvements to land, such as
buildings or other inherently permanent structures, including interests
in real property. For example, real property includes wiring in a
building, plumbing systems, central heating or air-conditioning systems,
pipes or ducts, elevators, escalators installed in a building, paved
parking areas, roads, wharves and docks, bridges, and sewage lines.
(ii) Tangible personal property means any tangible property other
than real property, including interests in tangible personal property.
For example, tangible personal property includes machinery that is not a
structural component of a building, subway cars, fire trucks,
automobiles, office equipment, testing equipment, and furnishings.
(iii) Substantially completed. Construction may be treated as
substantially completed when the issuer abandons construction or when at
least 90 percent of the total costs of the construction reasonably
expected, as of that date, to be financed with the available
construction proceeds have been allocated to expenditures.
(f) Construction issue--(1) Definition. Construction issue means any
issue that is not a refunding issue if--
(i) The issuer reasonably expects, as of the issue date, that at
least 75 percent of the available construction proceeds of the issue
will be allocated to construction expenditures (as defined in paragraph
(g) of this section) for property owned by a governmental unit or a
501(c)(3) organization; and
(ii) Any private activity bonds that are part of the issue are
qualified 501(c)(3) bonds or private activity bonds issued to finance
property to be owned by a governmental unit or a 501(c)(3) organization.
(2) Use of actual facts. For the provisions of paragraphs (e)
through (m) of this section that apply based on the issuer's reasonable
expectations, an issuer may elect on or before the issue date to apply
all of those provisions based on actual facts, except that this election
does not apply for purposes of determining whether an issue is a
construction issue under paragraph (f)(1) of this section if the 1\1/2\
percent penalty election is made under paragraph (k) of this section.
(3) Ownership requirement--(i) In general. A governmental unit or
501(c)(3) organization is treated as the owner of property if it would
be treated as the owner for Federal income tax purposes. For obligations
issued on behalf of a State or local governmental unit, the entity that
actually issues the bonds is treated as a governmental unit.
(ii) Safe harbor for leases and management contracts. Property
leased by a governmental unit or a 501(c)(3) organization is treated as
owned by the governmental unit or 501(c)(3) organization if the lessee
complies with the requirements of section 142(b)(1)(B). For a bond
described in section 142(a)(6), the requirements of section 142(b)(1)(B)
apply as modified by section 146(h)(2).
(g) Construction expenditures--(1) Definition. Except as otherwise
provided, construction expenditures means capital expenditures (as
defined in Sec. 1.150-1) that are allocable to the cost of real
property or constructed personal property (as defined in paragraph
(g)(3) of this section). Except as provided in paragraph (g)(2) of this
section, construction expenditures do not include expenditures for
acquisitions of interests in land or other existing real property.
(2) Certain acquisitions under turnkey contracts treated as
construction expenditures. Expenditures are not for the acquisition of
an interest in existing real property other than land if the contract
between the seller and the issuer
[[Page 121]]
requires the seller to build or install the property (e.g., a turnkey
contract), but only to the extent that the property has not been built
or installed at the time the parties enter into the contract.
(3) Constructed personal property. Constructed personal property
means tangible personal property (or, if acquired pursuant to a single
acquisition contract, properties) or specially developed computer
software if--
(i) A substantial portion of the property or properties is completed
more than 6 months after the earlier of the date construction or
rehabilitation commenced and the date the issuer entered into an
acquisition contract;
(ii) Based on the reasonable expectations of the issuer, if any, or
representations of the person constructing the property, with the
exercise of due diligence, completion of construction or rehabilitation
(and delivery to the issuer) could not have occurred within that 6-month
period; and
(iii) If the issuer itself builds or rehabilitates the property, not
more than 75 percent of the capitalizable cost is attributable to
property acquired by the issuer (e.g., components, raw materials, and
other supplies).
(4) Specially developed computer software. Specially developed
computer software means any programs or routines used to cause a
computer to perform a desired task or set of tasks, and the
documentation required to describe and maintain those programs, provided
that the software is specially developed and is functionally related and
subordinate to real property or other constructed personal property.
(5) Examples. The operation of this paragraph (g) is illustrated by
the following examples:
Example 1. Purchase of construction materials. City A issues bonds
to finance a new office building. A uses proceeds of the bonds to
purchase materials to be used in constructing the building, such as
bricks, pipes, wires, lighting, carpeting, heating equipment, and
similar materials. Expenditures by A for the construction materials are
construction expenditures because those expenditures will be
capitalizable to the cost of the building upon completion, even though
they are not initially capitalizable to the cost of existing real
property. This result would be the same if A hires a third-party to
perform the construction, unless the office building is partially
constructed at the time that A contracts to purchase the building.
Example 2. Turnkey contract. City B issues bonds to finance a new
office building. B enters into a turnkey contract with developer D under
which D agrees to provide B with a completed building on a specified
completion date on land currently owned by D. Under the agreement, D
holds title to the land and building and assumes any risk of loss until
the completion date, at which time title to the land and the building
will be transferred to B. No construction has been performed by the date
that B and D enter into the agreement. All payments by B to D for
construction of the building are construction expenditures because all
the payments are properly capitalized to the cost of the building, but
payments by B to D allocable to the acquisition of the land are not
construction expenditures.
Example 3. Right-of-way. P, a public agency, issues bonds to finance
the acquisition of a right-of-way and the construction of sewage lines
through numerous parcels of land. The right-of-way is acquired primarily
through P' s exercise of its powers of eminent domain. As of the issue
date, P reasonably expects that it will take approximately 2 years to
acquire the entire right-of-way because of the time normally required
for condemnation proceedings. No expenditures for the acquisition of the
right-of-way are construction expenditures because they are costs
incurred to acquire an interest in existing real property.
Example 4. Subway cars. City C issues bonds to finance new subway
cars. C reasonably expects that it will take more than 6 months for the
subway cars to be constructed to C's specifications. The subway cars are
constructed personal property. Alternatively, if the builder of the
subway cars informs C that it will only take 3 months to build the
subway cars to C's specifications, no payments for the subway cars are
construction expenditures.
Example 5. Fractional interest in property. U, a public agency,
issues bonds to finance an undivided fractional interest in a newly
constructed power-generating facility. U contributes its ratable share
of the cost of building the new facility to the project manager for the
facility. U's contributions are construction expenditures in the same
proportion that the total expenditures for the facility qualify as
construction expenditures.
Example 6. Park land. City D issues bonds to finance the purchase of
unimproved land and the cost of subsequent improvements to the land,
such as grading and landscaping, necessary to transform it into a park.
The costs of the improvements are properly capitalizable to the cost of
the land, and therefore, are construction expenditures, but
[[Page 122]]
expenditures for the acquisition of the land are not.
(h) Reasonable retainage definition. Reasonable retainage means an
amount, not to exceed 5 percent of available construction proceeds as of
the end of the fourth spending period, that is retained for reasonable
business purposes relating to the property financed with the proceeds of
the issue. For example, a reasonable retainage may include a retention
to ensure or promote compliance with a construction contract in
circumstances in which the retained amount is not yet payable, or in
which the issuer reasonably determines that a dispute exists regarding
completion or payment.
(i) Available construction proceeds--(1) Definition in general.
Available construction proceeds has the meaning used in section
148(f)(4)(C)(vi). For purposes of this definition, earnings include
earnings on any tax-exempt bond. Pre-issuance accrued interest and
earnings thereon may be disregarded. Amounts that are not gross proceeds
as a result of the application of the universal cap under Sec. 1.148-
6(b)(2) are not available construction proceeds.
(2) Earnings on a reasonably required reserve or replacement fund.
Earnings on any reasonably required reserve or replacement fund are
available construction proceeds only to the extent that those earnings
accrue before the earlier of the date construction is substantially
completed or the date that is 2 years after the issue date. An issuer
may elect on or before the issue date to exclude from available
construction proceeds the earnings on such a fund. If the election is
made, the rebate requirement applies to the excluded amounts from the
issue date.
(3) Reasonable expectations test for future earnings. For purposes
of determining compliance with the spending requirements as of the end
of each of the first three spending periods, available construction
proceeds include the amount of future earnings that the issuer
reasonably expected as of the issue date.
(4) Issuance costs. Available construction proceeds do not include
gross proceeds used to pay issuance costs financed by an issue, but do
include earnings on such proceeds. Thus, an expenditure of gross
proceeds of an issue for issuance costs does not count toward meeting
the spending requirements. The expenditure of earnings on gross proceeds
used to pay issuance costs does count toward meeting those requirements.
If the spending requirements are met and the proceeds used to pay
issuance costs are expended by the end of the fourth spending period,
those proceeds and the earnings thereon are treated as having satisfied
the rebate requirement.
(5) One and one-half percent penalty in lieu of arbitrage rebate.
For purposes of the spending requirements of paragraph (e) of this
section, available construction proceeds as of the end of any spending
period are reduced by the amount of penalty in lieu of arbitrage rebate
(under paragraph (k) of this section) that the issuer has paid from
available construction proceeds before the last day of the spending
period.
(6) Payments on purpose investments and repayments of grants.
Available construction proceeds do not include--
(i) Sale or investment proceeds derived from payments under any
purpose investment of the issue; or
(ii) Repayments of grants (as defined in Sec. 1.148-6(d)(4))
financed by the issue.
(7) Examples. The operation of this paragraph (i) is illustrated by
the following examples:
Example 1. Treatment of investment earnings. City F issues bonds
having an issue price of $10,000,000. F deposits all of the proceeds of
the issue into a construction fund to be used for expenditures other
than costs of issuance. F estimates on the issue date that, based on
reasonably expected expenditures and rates of investment, earnings on
the construction fund will be $800,000. As of the issue date and the end
of each of the first three spending periods, the amount of available
construction proceeds is $10,800,000. To qualify as a construction
issue, F must reasonably expect on the issue date that at least
$8,100,000 (75 percent of $10,800,000) will be used for construction
expenditures. In order to meet the 10 percent spending requirement at
the end of the first spending period, F must spend at least $1,080,000.
As of the end of the fourth spending period, F has received $1,100,000
in earnings. In order to meet the spending requirement at the end of the
fourth spending period, however, F must spend all of the $11,100,000 of
actual available construction proceeds (except for reasonable retainage
not exceeding $555,000).
[[Page 123]]
Example 2. Treatment of investment earnings without a reserve fund.
City G issues bonds having an issue price of $11,200,000. G does not
elect to exclude earnings on the reserve fund from available
construction proceeds. G uses $200,000 of proceeds to pay issuance costs
and deposits $1,000,000 of proceeds into a reasonably required reserve
fund. G deposits the remaining $10,000,000 of proceeds into a
construction fund to be used for construction expenditures. On the issue
date, G reasonably expects that, based on the reasonably expected date
of substantial completion and rates of investment, total earnings on the
construction fund will be $800,000, and total earnings on the reserve
fund to the date of substantial completion will be $150,000. G
reasonably expects that substantial completion will occur during the
fourth spending period. As of the issue date, the amount of available
construction proceeds is $10,950,000 ($10,000,000 originally deposited
into the construction fund plus $800,000 expected earnings on the
construction fund and $150,000 expected earnings on the reserve fund).
To qualify as a construction issue, G must reasonably expect on the
issue date that at least $8,212,500 will be used for construction
expenditures.
Example 3. Election to exclude earnings on a reserve fund. The facts
are the same as Example 2, except that G elects on the issue date to
exclude earnings on the reserve fund from available construction
proceeds. The amount of available construction proceeds as of the issue
date is $10,800,000.
(j) Election to treat portion of issue used for construction as
separate issue--(1) In general. For purposes of paragraph (e) of this
section, if any proceeds of an issue are to be used for construction
expenditures, the issuer may elect on or before the issue date to treat
the portion of the issue that is not a refunding issue as two, and only
two, separate issues, if--
(i) One of the separate issues is a construction issue as defined in
paragraph (f) of this section;
(ii) The issuer reasonably expects, as of the issue date, that this
construction issue will finance all of the construction expenditures to
be financed by the issue; and
(iii) The issuer makes an election to apportion the issue under this
paragraph (j)(1) in which it identifies the amount of the issue price of
the issue allocable to the construction issue.
(2) Example. The operation of this paragraph (j) is illustrated by
the following example.
Example. City D issues bonds having an issue price of $19,000,000.
On the issue date, D reasonably expects to use $10,800,000 of bond
proceeds (including investment earnings) for construction expenditures
for the project being financed. D deposits $10,000,000 in a construction
fund to be used for construction expenditures and $9,000,000 in an
acquisition fund to be used for acquisition of equipment not qualifying
as construction expenditures. D estimates on the issue date, based on
reasonably expected expenditures and rates of investment, that total
earnings on the construction fund will be $800,000 and total earnings on
the acquisition fund will be $200,000. Because the total construction
expenditures to be financed by the issue are expected to be $10,800,000,
the maximum available construction proceeds for a construction issue is
$14,400,000 ($10,800,000 divided by 0.75). To determine the maximum
amount of the issue price allocable to a construction issue, the
estimated investment earnings allocable to the construction issue are
subtracted. The entire $800,000 of earnings on the construction fund are
allocable to the construction issue. Only a portion of the $200,000 of
earnings on the acquisition fund, however, are allocable to the
construction issue. The total amount of the available construction
proceeds that is expected to be used for acquisition is $3,600,000
($14,400,000-$10,800,000). The portion of earnings on the acquisition
fund that is allocable to the construction issue is $78,261
($200,000x$3,600,000/$9,200,000). Accordingly, D may elect on or before
the issue date to treat up to $13,521,739 of the issue price as a
construction issue ($14,400,000-$800,000-$78,261). D's election must
specify the amount of the issue price treated as a construction issue.
The balance of the issue price is treated as a separate nonconstruction
issue that is subject to the rebate requirement unless it meets another
exception to arbitrage rebate. Because the financing of a construction
issue is a separate governmental purpose under Sec. 1.148-9(h), the
election causes the issue to be a multipurpose issue under that section.
(k) One and one-half percent penalty in lieu of arbitrage rebate--
(1) In general. Under section 148(f)(4)(C)(vii), an issuer of a
construction issue may elect on or before the issue date to pay a
penalty (the 1\1/2\ percent penalty) to the United States in lieu of the
obligation to pay the rebate amount on available construction proceeds
upon failure to satisfy the spending requirements of paragraph (e) of
this section. The 1\1/2\ percent penalty is calculated separately for
each spending period, including each semiannual period after the end of
the fourth spending period, and is equal
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to 1.5 percent times the underexpended proceeds as of the end of the
spending period. For each spending period, underexpended proceeds equal
the amount of available construction proceeds required to be spent by
the end of the spending period, less the amount actually allocated to
expenditures for the governmental purposes of the issue by that date.
The 1\1/2\ percent penalty must be paid to the United States no later
than 90 days after the end of the spending period to which it relates.
The 1\1/2\ percent penalty continues to apply at the end of each
spending period and each semiannual period thereafter until the earliest
of the following--
(i) The termination of the penalty under paragraph (l) of this
section;
(ii) The expenditure of all of the available construction proceeds;
or
(iii) The last stated final maturity date of bonds that are part of
the issue and any bonds that refund those bonds.
(2) Application to reasonable retainage. If an issue meets the
exception for reasonable retainage except that all retainage is not
spent within 3 years of the issue date, the issuer must pay the 1\1/2\
percent penalty to the United States for any reasonable retainage that
was not so spent as of the close of the 3-year period and each later
spending period.
(3) Coordination with rebate requirement. The rebate requirement is
treated as met with respect to available construction proceeds for a
period if the 1\1/2\ percent penalty is paid in accordance with this
section.
(l) Termination of 1\1/2\ percent penalty--(1)Termination after
initial temporary period. The issuer may terminate the 1\1/2\ percent
penalty after the initial temporary period (a section 148(f)(4)(C)(viii)
penalty termination) if--
(i) Not later than 90 days after the earlier of the end of the
initial temporary period or the date construction is substantially
completed, the issuer elects to terminate the 1\1/2\ percent penalty;
provided that solely for this purpose, the initial temporary period may
be extended by the issuer to a date ending 5 years after the issue date;
(ii) Within 90 days after the end of the initial temporary period,
the issuer pays a penalty equal to 3 percent of the unexpended available
construction proceeds determined as of the end of the initial temporary
period, multiplied by the number of years (including fractions of years
computed to 2 decimal places) in the initial temporary period;
(iii) For the period beginning as of the close of the initial
temporary period, the unexpended available construction proceeds are not
invested in higher yielding investments; and
(iv) On the earliest date on which the bonds may be called or
otherwise redeemed, with or without a call premium, the unexpended
available construction proceeds as of that date (not including any
amount earned after the date on which notice of the redemption was
required to be given) must be used to redeem the bonds. Amounts used to
pay any call premium are treated as used to redeem bonds. This
redemption requirement may be met by purchases of bonds by the issuer on
the open market at prices not exceeding fair market value. A portion of
the annual principal payment due on serial bonds of a construction issue
may be paid from the unexpended amount, but only in an amount no greater
than the amount that bears the same ratio to the annual principal due
that the total unexpended amount bears to the issue price of the
construction issue.
(2) Termination before end of initial temporary period. If the
construction to be financed by the construction issue is substantially
completed before the end of the initial temporary period, the issuer may
elect to terminate the 1\1/2\ percent penalty before the end of the
initial temporary period (a section 148(f)(4)(C)(ix) penalty
termination) if--
(i) Before the close of the initial temporary period and not later
than 90 days after the date the construction is substantially completed,
the issuer elects to terminate the 1\1/2\ percent penalty;
(ii) The election identifies the amount of available construction
proceeds that will not be spent for the governmental purposes of the
issue; and
(iii) The issuer has met all of the conditions for a section
148(f)(4)(C)(viii) penalty termination, applied as if the initial
temporary period ended as of
[[Page 125]]
the date the required election for a section 148(f)(4)(C)(ix) penalty
termination is made. That penalty termination election satisfies the
required election for a section 148(f)(4)(C)(viii) termination.
(3) Application to reasonable retainage. Solely for purposes of
determining whether the conditions for terminating the 1\1/2\ percent
penalty are met, reasonable retainage may be treated as spent for a
governmental purpose of the construction issue. Reasonable retainage
that is so treated continues to be subject to the 1\1/2\ percent
penalty.
(4) Example. The operation of this paragraph (l) is illustrated by
the following example.
Example. City I issues a construction issue having a 20-year
maturity and qualifying for a 3-year initial temporary period. The bonds
are first subject to optional redemption 10 years after the issue date
at a premium of 3 percent. I elects, on or before the issue date, to pay
the 1\1/2\ percent penalty in lieu of arbitrage rebate. At the end of
the 3-year temporary period, the project is not substantially completed,
and $1,500,000 of available construction proceeds of the issue are
unspent. At that time, I reasonably expects to need $500,000 to complete
the project. I may terminate the 1\1/2\ percent penalty in lieu of
arbitrage rebate with respect to the excess $1,500,000 by electing to
terminate within 90 days of the end of the initial temporary period;
paying a penalty to the United States of $135,000 (3 percent of
$1,500,000 multiplied by 3 years); restricting the yield on the
investment of unspent available construction proceeds for 7 years until
the first call date, although any portion of these proceeds may still be
spent on the project prior to that call date; and using the available
construction proceeds that, as of the first call date, have not been
allocated to expenditures for the governmental purposes of the issue to
redeem bonds on that call date. If I fails to make the termination
election, I is required to pay the 1\1/2\ percent penalty on unspent
available construction proceeds every 6 months until the latest maturity
date of bonds of the issue (or any bonds of another issue that refund
such bonds).
(m) Payment of penalties. Each penalty payment under this section
must be paid in the manner provided in Sec. 1.148-3(g). See Sec.
1.148-3(h) for rules on failures to pay penalties under this section.
[T.D. 8476, 58 FR 33535, June 18, 1993; 58 FR 44452, Aug. 23, 1993]
Sec. 1.148-8 Small issuer exception to rebate requirement.
(a) Scope. Under section 148(f)(4)(D), bonds issued to finance
governmental activities of certain small issuers are treated as meeting
the arbitrage rebate requirement of section 148(f)(2) (the ``small
issuer exception''). This section provides guidance on the small issuer
exception.
(b) General taxing powers. The small issuer exception generally
applies only to bonds issued by governmental units with general taxing
powers. A governmental unit has general taxing powers if it has the
power to impose taxes (or to cause another entity to impose taxes) of
general applicability which, when collected, may be used for the general
purposes of the issuer. The taxing power may be limited to a specific
type of tax, provided that the applicability of the tax is not limited
to a small number of persons. The governmental unit's exercise of its
taxing power may be subject to procedural limitations, such as voter
approval requirements, but may not be contingent on approval by another
governmental unit. See, also, section 148(f)(4)(D)(iv).
(c) Size limitation--(1) In general. An issue (other than a
refunding issue) qualifies for the small issuer exception only if the
issuer reasonably expects, as of the issue date, that the aggregate face
amount of all tax-exempt bonds (other than private activity bonds)
issued by it during that calendar year will not exceed $5,000,000; or
the aggregate face amount of all tax-exempt bonds of the issuer (other
than private activity bonds) actually issued during that calendar year
does not exceed $5,000,000. For this purpose, if an issue has more than
a de minimis amount of original issue discount or premium, aggregate
face amount means the aggregate issue price of that issue (determined
without regard to pre-issuance accrued interest).
(2) Aggregation rules. The following aggregation rules apply for
purposes of applying the $5,000,000 size limitation under paragraph
(c)(1) of this section.
(i) On-behalf-of issuers. An issuer and all entities (other than
political subdivisions) that issue bonds on behalf of that issuer are
treated as one issuer.
[[Page 126]]
(ii) Subordinate entities--(A) In general. Except as otherwise
provided in paragraph (d) of this section and section 148(f)(4)(D)(iv),
all bonds issued by a subordinate entity are also treated as issued by
each entity to which it is subordinate. An issuer is subordinate to
another governmental entity if it is directly or indirectly controlled
by the other entity within the meaning of Sec. 1.150-1(e).
(B) Exception for allocations of size limitation. If an entity
properly makes an allocation of a portion of its $5,000,000 size
limitation to a subordinate entity (including an on behalf of issuer)
under section 148(f)(4)(D)(iv), the portion of bonds issued by the
subordinate entity under the allocation is treated as issued only by the
allocating entity and not by any other entity to which the issuing
entity is subordinate. These allocations are irrevocable and must bear a
reasonable relationship to the benefits received by the allocating unit
from issues issued by the subordinate entity. The benefits to be
considered include the manner in which--
(1) Proceeds are to be distributed;
(2) The debt service is to be paid;
(3) The facility financed is to be owned;
(4) The use or output of the facility is to be shared; and
(5) Costs of operation and maintenance are to be shared.
(iii) Avoidance of size limitation. An entity formed or availed of
to avoid the purposes of the $5,000,000 size limitation and all entities
that would benefit from the avoidance are treated as one issuer.
Situations in which an entity is formed or availed of to avoid the
purposes of the $5,000,000 size limitation include those in which the
issuer--
(A) Issues bonds which, but for the $5,000,000 size limitation,
would have been issued by another entity; and
(B) Does not receive a substantial benefit from the project financed
by the bonds.
(3) Certain refunding bonds not taken into account. In applying the
$5,000,000 size limitation, there is not taken into account the portion
of an issue that is a current refunding issue to the extent that the
stated principal amount of the refunding bond does not exceed the
portion of the outstanding stated principal amount of the refunded bond
paid with proceeds of the refunding bond. For this purpose, principal
amount means, in reference to a plain par bond, its stated principal
amount plus accrued unpaid interest, and in reference to any other bond,
its present value.
(d) Pooled financings--(1) Treatment of pool issuer. To the extent
that an issuer of a pooled financing is not an ultimate borrower in the
financing and the conduit borrowers are governmental units with general
taxing powers and not subordinate to the issuer, the pooled financing is
not counted towards the $5,000,000 size limitation of the issuer for
purposes of applying the small issuer exception to its other issues. The
issuer of the pooled financing issue is, however, subject to the rebate
requirement for any unloaned gross proceeds.
(2) Treatment of conduit borrowers. A loan to a conduit borrower in
a pooled financing qualifies for the small issuer exception, regardless
of the size of either the pooled financing or of any loan to other
conduit borrowers, only if--
(i) The bonds of the pooled financing are not private activity
bonds;
(ii) None of the loans to conduit borrowers are private activity
bonds; and
(iii) The loan to the conduit borrower meets all the requirements of
the small issuer exception.
(e) Refunding issues--(1) In general. Sections 148(f)(4)(D) (v) and
(vi) provide restrictions on application of the small issuer exception
to refunding issues.
(2) Multipurpose issues. The multipurpose issue allocation rules of
Sec. 1.148-9(h) apply for purposes of determining whether refunding
bonds meet the requirements of section 148(f)(4)(D)(v).
[T.D. 8476, 58 FR 33540, June 18, 1993]
Sec. 1.148-9 Arbitrage rules for refunding issues.
(a) Scope of application. This section contains special arbitrage
rules for refunding issues. These rules apply for all purposes of
section 148 and govern allocations of proceeds, bonds, and investments
to determine transferred proceeds, temporary periods, reasonably
required reserve or replacement funds, minor portions, and separate
issue
[[Page 127]]
treatment of certain multipurpose issues.
(b) Transferred proceeds allocation rule--(1) In general. When
proceeds of the refunding issue discharge any of the outstanding
principal amount of the prior issue, proceeds of the prior issue become
transferred proceeds of the refunding issue and cease to be proceeds of
the prior issue. The amount of proceeds of the prior issue that becomes
transferred proceeds of the refunding issue is an amount equal to the
proceeds of the prior issue on the date of that discharge multiplied by
a fraction--
(i) The numerator of which is the principal amount of the prior
issue discharged with proceeds of the refunding issue on the date of
that discharge; and
(ii) The denominator of which is the total outstanding principal
amount of the prior issue on the date immediately before the date of
that discharge.
(2) Special definition of principal amount. For purposes of this
section, principal amount means, in reference to a plain par bond, its
stated principal amount, and in reference to any other bond, its present
value.
(3) Relation of transferred proceeds rule to universal cap rule--(i)
In general. Paragraphs (b)(1) and (c) of this section apply to allocate
transferred proceeds and corresponding investments to a refunding issue
on any date required by those paragraphs before the application of the
universal cap rule of Sec. 1.148-6(b)(2) to reallocate any of those
amounts. To the extent nonpurpose investments allocable to proceeds of a
refunding issue exceed the universal cap for the issue on the date that
amounts become transferred proceeds of the refunding issue, those
transferred proceeds and corresponding investments are reallocated back
to the issue from which they transferred on that same date to the extent
of the unused universal cap on that prior issue.
(ii) Example. The following example illustrates the application of
this paragraph of (b)(3):
Example. On January 1, 1995, $100,000 of nonpurpose investments
allocable to proceeds of issue A become transferred proceeds of issue B
under Sec. 1.148-9, but the unused portion of issue B' s universal cap
is $75,000 as of that date. On January 1, 1995, issue A has unused
universal cap in excess of $25,000. Thus, $25,000 of nonpurpose
investments representing the transferred proceeds are immediately
reallocated back to issue A on January 1, 1995, and are proceeds of
issue A. On the next transfer date under Sec. 1.148-9, the $25,000
receives no priority in determining transferred proceeds as of that date
but is treated the same as all other proceeds of issue A subject to
transfer.
(4) Limitation on multi-generational transfers. This paragraph
(b)(4) contains limitations on the manner in which proceeds of a first
generation issue that is refunded by a refunding issue (a second
generation issue) become transferred proceeds of a refunding issue (a
third generation issue) that refunds the second generation issue.
Proceeds of the first generation issue that become transferred proceeds
of the third generation issue are treated as having a yield equal to the
yield on the refunding escrow allocated to the second generation issue
(i.e., as determined under Sec. 1.148-5(b)(2)(iv)). The determination
of the transferred proceeds of the third generation issue does not
affect compliance with the requirements of section 148, including the
determination of the amount of arbitrage rebate with respect to or the
yield on the refunding escrow, of the second generation issue.
(c) Special allocation rules for refunding issues--(1) Allocations
of investments--(i) In general. Except as otherwise provided in this
paragraph (c), investments purchased with sale proceeds or investment
proceeds of a refunding issue must be allocated to those proceeds, and
investments not purchased with those proceeds may not be allocated to
those proceeds (i.e., a specific tracing method).
(ii) Allocations to transferred proceeds. When proceeds of a prior
issue become transferred proceeds of a refunding issue, investments (and
the related payments and receipts) of proceeds of the prior issue that
are held in a refunding escrow for another issue are allocated to the
transferred proceeds under the ratable allocation method described in
paragraph (c)(1)(iii) of this section. Investments of proceeds of the
prior issue that are not held in a refunding escrow for another issue
are allocated to the transferred proceeds by application of the
allocation methods described in paragraph (c)(1) (iii) or (iv)
[[Page 128]]
of this section, consistently applied to all investments on a transfer
date.
(iii) Ratable allocation method. Under the ratable allocation
method, a ratable portion of each nonpurpose and purpose investment of
proceeds of the prior issue is allocated to transferred proceeds of the
refunding issue.
(iv) Representative allocation method--(A) In general. Under the
representative allocation method, representative portions of the
portfolio of nonpurpose investments and the portfolio of purpose
investments of proceeds of the prior issue are allocated to transferred
proceeds of the refunding issue. Unlike the ratable allocation method,
this representative allocation method permits an allocation of
particular whole investments. Whether a portion is representative is
based on all the facts and circumstances, including, without limitation,
whether the current yields, maturities, and current unrealized gains or
losses on the particular allocated investments are reasonably comparable
to those of the unallocated investments in the aggregate. In addition,
if a portion of nonpurpose investments is otherwise representative, it
is within the issuer's discretion to allocate the portion from whichever
source of funds it deems appropriate, such as a reserve fund or a
construction fund for a prior issue.
(B) Mark-to-market safe harbor for representative allocation method.
In addition to other representative allocations, a specific allocation
of a particular nonpurpose investment to transferred proceeds (e.g., of
lower yielding investments) is treated as satisfying the representative
allocation method if that investment is valued at fair market value on
the transfer date in determining the payments and receipts on that date,
but only if the portion of the nonpurpose investments that transfers is
based on the relative fair market value of all nonpurpose investments.
(2) Allocations of mixed escrows to expenditures for principal,
interest, and redemption prices on a prior issue--(i) In general. Except
for amounts required or permitted to be accounted for under paragraph
(c)(2)(ii) of this section, proceeds of a refunding issue and other
amounts that are not proceeds of a refunding issue that are deposited in
a refunding escrow (a mixed escrow) must be accounted for under this
paragraph (c)(2)(i). Those proceeds and other amounts must be allocated
to expenditures for principal, interest, or stated redemption prices on
the prior issue so that the expenditures of those proceeds do not occur
faster than ratably with expenditures of the other amounts in the mixed
escrow. During the period that the prior issue has unspent proceeds,
however, these allocations must be ratable (with reasonable adjustments
for rounding) both between sources for expenditures (i.e., proceeds and
other amounts) and between uses (i.e., principal, interest, and stated
redemption prices on the prior issue).
(ii) Exceptions--(A) Mandatory allocation of certain non-proceeds to
earliest expenditures. If amounts other than proceeds of the refunding
issue are deposited in a mixed escrow, but before the issue date of the
refunding issue those amounts had been held in a bona fide debt service
fund or a fund to carry out the governmental purpose of the prior issue
(e.g., a construction fund), those amounts must be allocated to the
earliest maturing investments in the mixed escrow.
(B) Permissive allocation of non-proceeds to earliest expenditures.
Excluding amounts covered by paragraph (c)(2)(ii)(A) of this section and
subject to any required earlier expenditure of those amounts, any
amounts in a mixed escrow that are not proceeds of a refunding issue may
be allocated to the earliest maturing investments in the mixed escrow,
provided that those investments mature and the proceeds thereof are
expended before the date of any expenditure from the mixed escrow to pay
any principal of the prior issue.
(d) Temporary periods in refundings--(1) In general. Proceeds of a
refunding issue may be invested in higher yielding investments under
section 148(c) only during the temporary periods described in paragraph
(d)(2) of this section.
(2) Types of temporary periods in refundings. The available
temporary periods for proceeds of a refunding issue are as follows:
(i) General temporary period for refunding issues. Except as
otherwise provided
[[Page 129]]
in this paragraph (d)(2), the temporary period for proceeds (other than
transferred proceeds) of a refunding issue is the period ending 30 days
after the issue date of the refunding issue.
(ii) Temporary periods for current refunding issues--(A) In general.
Except as otherwise provided in paragraph (d)(2)(ii)(B) of this section,
the temporary period for proceeds (other than transferred proceeds) of a
current refunding issue is 90 days.
(B) Temporary period for short-term current refunding issues. The
temporary period for proceeds (other than transferred proceeds) of a
current refunding issue that has an original term to maturity of 270
days or less may not exceed 30 days. The aggregate temporary periods for
proceeds (other than transferred proceeds) of all current refunding
issues described in the preceding sentence that are part of the same
series of refundings is 90 days. An issue is part of a series of
refundings if it finances or refinances the same expenditures for a
particular governmental purpose as another issue.
(iii) Temporary periods for transferred proceeds--(A) In general.
Except as otherwise provided in paragraph (d)(2)(iii)(B) of this
section, each available temporary period for transferred proceeds of a
refunding issue begins on the date those amounts become transferred
proceeds of the refunding issue and ends on the date that, without
regard to the discharge of the prior issue, the available temporary
period for those proceeds would have ended had those proceeds remained
proceeds of the prior issue.
(B) Termination of initial temporary period for prior issue in an
advance refunding. The initial temporary period under Sec. 1.148-2(e)
(2) and (3) for the proceeds of a prior issue that is refunded by an
advance refunding issue (including transferred proceeds) terminates on
the issue date of the advance refunding issue.
(iv) Certain short-term gross proceeds. Except for proceeds of a
refunding issue held in a refunding escrow, proceeds otherwise
reasonably expected to be used to pay principal or interest on the prior
issue, replacement proceeds not held in a bona fide debt service fund,
and transferred proceeds, the temporary period for gross proceeds of a
refunding issue is the 13-month period beginning on the date of receipt.
(e) Reasonably required reserve or replacement funds in refundings.
In addition to the requirements of Sec. 1.148-2(f), beginning on the
issue date of a refunding issue, a reserve or replacement fund for a
refunding issue or a prior issue is a reasonably required reserve or
replacement fund under section 148(d) that may be invested in higher
yielding investments only if the aggregate amount invested in higher
yielding investments under this paragraph (e) for both the refunding
issue and the prior issue does not exceed the size limitations under
Sec. 1.148-2 (f)(2) and (f)(3), measured by reference to the refunding
issue only (regardless of whether proceeds of the prior issue have
become transferred proceeds of the refunding issue).
(f) Minor portions in refundings. Beginning on the issue date of the
refunding issue, gross proceeds not in excess of a minor portion of the
refunding issue qualify for investment in higher yielding investments
under section 148(e), and gross proceeds not in excess of a minor
portion of the prior issue qualify for investment in higher yielding
investments under either section 148(e) or section 149(d)(3)(A)(v),
whichever is applicable. Minor portion is defined in Sec. 1.148-2(g).
(g) Certain waivers permitted. On or before the issue date, an
issuer may waive the right to invest in higher yielding investments
during any temporary period or as part of a reasonably required reserve
or replacement fund. At any time, an issuer may waive the right to
invest in higher yielding investments as part of a minor portion.
(h) Multipurpose issue allocations--(1) Application of multipurpose
issue allocation rules. The portion of the bonds of a multipurpose issue
reasonably allocated to any separate purpose under this paragraph (h) is
treated as a separate issue for all purposes of section 148 except the
following--
(i) Arbitrage yield. Except to the extent that the proceeds of an
issue are allocable to two or more conduit loans that are tax-exempt
bonds, determining the yield on a multipurpose issue and the yield on
investments for
[[Page 130]]
purposes of the arbitrage yield restrictions of section 148 and the
arbitrage rebate requirement of section 148(f);
(ii) Rebate amount. Except as provided in paragraph (h)(1)(i) of
this section, determining the rebate amount for a multipurpose issue,
including subsidiary matters with respect to that determination, such as
the computation date credit under Sec. 1.148-3(d)(1), the due date for
payments, and the $100,000 bona fide debt service fund exception under
section 148(f)(4)(A)(ii);
(iii) Minor portion. Determining the minor portion of an issue under
section 148(e);
(iv) Reasonably required reserve or replacement fund. Determining
the portion of an issue eligible for investment in higher yielding
investments as part of a reasonably required reserve or replacement fund
under section 148(d); and
(v) Effective date. Applying the provisions of Sec. 1.148-11(b)
(relating to elective retroactive application of Sec. Sec. 1.148-1
through 1.148-10 to certain issues).
(2) Rules on allocations of multipurpose issues--(i) In general.
This paragraph (h) applies to allocations of multipurpose issues,
including allocations involving the refunding purposes of the issue.
Except as otherwise provided in this paragraph (h), proceeds,
investments, and bonds of a multipurpose issue may be allocated among
the various separate purposes of the issue using any reasonable,
consistently applied allocation method. An allocation is not reasonable
if it achieves more favorable results under section 148 or 149(d) than
could be achieved with actual separate issues. An allocation under this
paragraph (h) may be made at any time, but once made may not be changed.
(ii) Allocations involving certain common costs. A ratable
allocation of common costs (as described in paragraph (h)(3)(ii) of this
section) among the separate purposes of the multipurpose issue is
generally reasonable. If another allocation method more accurately
reflects the extent to which any separate purpose of a multipurpose
issue enjoys the economic benefit or bears the economic burden of
certain common costs, that allocation method may be used.
(3) Separate purposes of a multipurpose issue--(i) In general.
Separate purposes of a multipurpose issue include refunding a separate
prior issue, financing a separate purpose investment, financing a
construction issue (as defined in Sec. 1.148-7(f)), and any clearly
discrete governmental purpose reasonably expected to be financed by that
issue. In general, all integrated or functionally related capital
projects that qualify for the same initial temporary period under Sec.
1.148-2(e)(2) are treated as having a single governmental purpose. The
separate purposes of a refunding issue include the separate purposes of
the prior issue, if any. Separate purposes may be treated as a single
purpose if the proceeds used to finance those purposes are eligible for
the same initial temporary period under section 148(c). For example, the
use of proceeds of a multipurpose issue to finance separate qualified
mortgage loans may be treated as a single purpose.
(ii) Financing common costs. Common costs of a multipurpose issue
are not separate purposes. Common costs include issuance costs, accrued
interest, capitalized interest on the issue, a reserve or replacement
fund, qualified guarantee fees, and similar costs properly allocable to
the separate purposes of the issue.
(iii) Example. The following example illustrates the application of
this paragraph (h)(3).
Example. On January 1, 1994, Housing Authority of State A issues a
$10 million issue (the 1994 issue) at an interest rate of 10 percent to
finance qualified mortgage loans for owner-occupied residences under
section 143. During 1994, A originates $5 million in qualified mortgage
loans at an interest rate of 10 percent. In 1995, the market interest
rates for housing loans falls to 8 percent and A is unable to originate
further loans from the 1994 issue. On January 1, 1996, A issues a $5
million issue (the 1996 issue) at an interest rate of 8 percent to
refund partially the 1994 issue. Under paragraph (h) of this section, A
treats the portion of the 1994 issue used to originate $5 million in
loans as a separate issue comprised of that group of purpose
investments. A allocates those purpose investments representing those
loans to that separate unrefunded portion of the issue. In addition, A
treats the unoriginated portion of the 1994 issue as a separate issue
and allocates the nonpurpose investments representing the unoriginated
proceeds of the 1994 issue to the
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refunded portion of the issue. Thus, when proceeds of the 1996 issue are
used to pay principal on the refunded portion of the 1994 issue that is
treated as a separate issue under paragraph (h) of this section, only
the portion of the 1994 issue representing unoriginated loan funds
invested in nonpurpose investments transfer to become transferred
proceeds of the 1996 issue.
(4) Allocations of bonds of a multipurpose issue--(i) Reasonable
allocation of bonds to portions of issue. After reasonable adjustment of
the issue price of a multipurpose issue to account for common costs, the
portion of the bonds of a multipurpose issue allocated to a separate
purpose must have an issue price that bears the same ratio to the
aggregate issue price of the multipurpose issue as the portion of the
sale proceeds of the multipurpose issue used for that separate purpose
bears to the aggregate sale proceeds of the multipurpose issue. For a
refunding issue used to refund two or more prior issues, the portion of
the sales proceeds allocated to the refunding of a separate prior issue
is based on the present value of the refunded debt service on that prior
issue, using the yield on investments in the refunding escrow allocable
to the entire refunding issue as the discount rate.
(ii) Safe harbor for pro rata allocation method for bonds. The use
of the relative amount of sales proceeds used for each separate purpose
to ratably allocate each bond or a ratable number of substantially
identical whole bonds is a reasonable method for allocating bonds of a
multipurpose issue.
(iii) Safe harbor for allocations of bonds used to finance separate
purpose investments. An allocation of a portion of the bonds of a
multipurpose issue to a particular purpose investment is generally
reasonable if that purpose investment has principal and interest
payments that reasonably coincide in time and amount to principal and
interest payments on the bonds allocated to that purpose investment.
(iv) Rounding of bond allocations to next whole bond denomination
permitted. An allocation that rounds each resulting fractional bond up
or down to the next integral multiple of a permitted denomination of
bonds of that issue not in excess of $100,000 does not prevent the
allocation from satisfying this paragraph (h)(4).
(v) Restrictions on allocations of bonds to refunding purposes. For
each portion of a multipurpose issue that is used to refund a separate
prior issue, a method of allocating bonds of that issue is reasonable
under this paragraph (h) only if, in addition to the requirements of
paragraphs (h)(1) and (h)(2) of this section, the portion of the bonds
allocated to the refunding of that prior issue--
(A) Results from a pro rata allocation under paragraph (h)(4)(ii) of
this section;
(B) Reflects aggregate principal and interest payable in each bond
year that is less than, equal to, or proportionate to, the aggregate
principal and interest payable on the prior issue in each bond year;
(C) Results from an allocation of all the bonds of the entire
multipurpose issue in proportion to the remaining weighted average
economic life of the capital projects financed or refinanced by the
issue, determined in the same manner as under section 147(b); or
(D) Results from another reasonable allocation method, but only to
the extent that the application of the allocation methods provided in
this paragraph (h)(4)(v) is not permitted under state law restrictions
applicable to the bonds, reasonable terms of bonds issued before, or
subject to a master indenture that became effective prior to, July 1,
1993, or other similar restrictions or circumstances. This paragraph
(h)(4)(v)(D) shall be strictly construed and is available only if it
does not result in a greater burden on the market for tax-exempt bonds
than would occur using one of the other allocation methods provided in
this paragraph (h)(4)(v). (See also Sec. 1.148-11(c)(2).)
(vi) Exception for refundings of interim notes. Paragraph (h)(4)(v)
of this section need not be applied to refunding bonds issued to provide
permanent financing for one or more projects if the prior issue had a
term of less than 3 years and was sold in anticipation of permanent
financing, but only if the aggregate term of all prior issues sold in
anticipation of permanent financing was less than 3 years.
(5) Limitation on multi-generation allocations. This paragraph (h)
does not
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apply to allocations of a multipurpose refunded issue unless that
refunded issue is refunded directly by an issue to which this paragraph
(h) applies. For example, if a 1994 issue refunds a 1984 multipurpose
issue, which in turn refunded a 1980 multipurpose issue, this paragraph
(h) applies to allocations of the 1984 issue for purposes of allocating
the refunding purposes of the 1994 issue, but does not permit
allocations of the 1980 issue.
(i) Operating rules for separation of prior issue into refunded and
unrefunded portions--(1) In general. For purposes of paragraph (h)(3)(i)
of this section, the separate purposes of a prior issue include the
refunded and unrefunded portions of the prior issue. Thus, the refunded
and unrefunded portions are treated as separate issues under paragraph
(h)(1) of this section. Those separate issues must satisfy the
requirements of paragraphs (h) and (i) of this section. The refunded
portion of the bonds of a prior issue is based on a fraction the
numerator of which is the principal amount of the prior issue to be paid
with proceeds of the refunding issue and the denominator of which is the
outstanding principal amount of the bonds of the prior issue, each
determined as of the issue date of the refunding issue. (See also
paragraph (b)(2) of this section.)
(2) Allocations of proceeds and investments in a partial refunding.
As of the issue date of a partial refunding issue under this paragraph
(i), unspent proceeds of the prior issue are allocated ratably between
the refunded and unrefunded portions of the prior issue and the
investments allocable to those unspent proceeds are allocated in the
manner required for the allocation of investments to transferred
proceeds under paragraph (c)(1)(ii) of this section.
(3) References to prior issue. If the refunded and unrefunded
portions of a prior issue are treated as separate issues under this
paragraph (i), then, except to the extent that the context clearly
requires otherwise (e.g., references to the aggregate prior issue in the
mixed escrow rule in paragraph (c)(2) of this section), all references
in this section to a prior issue refer only to the refunded portion of
that prior issue.
[T.D. 8476, 58 FR 33541, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24045, May 10, 1994; T.D. 8718, 62 FR 25512,
May 9, 1997]
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
(a) Abusive arbitrage device--(1) In general. Bonds of an issue are
arbitrage bonds under section 148 if an abusive arbitrage device under
paragraph (a)(2) of this section is used in connection with the issue.
This paragraph (a) is to be applied and interpreted broadly to carry out
the purposes of section 148, as further described in Sec. 1.148-0.
Except as otherwise provided in paragraph (c) of this section, any
action that is expressly permitted by section 148 or Sec. Sec. 1.148-1
through 1.148-11 is not an abusive arbitrage device (e.g., investment in
higher yielding investments during a permitted temporary period under
section 148(c)).
(2) Abusive arbitrage device defined. Any action is an abusive
arbitrage device if the action has the effect of--
(i) Enabling the issuer to exploit the difference between tax-exempt
and taxable interest rates to obtain a material financial advantage; and
(ii) Overburdening the tax-exempt bond market.
(3) Exploitation of tax-exempt interest rates. An action may exploit
tax-exempt interest rates under paragraph (a)(2) of this section as a
result of an investment of any portion of the gross proceeds of an issue
over any period of time, notwithstanding that, in the aggregate, the
gross proceeds of the issue are not invested in higher yielding
investments over the term of the issue.
(4) Overburdening the tax-exempt market. An action overburdens the
tax-exempt bond market under paragraph (a)(2)(ii) of this section if it
results in issuing more bonds, issuing bonds earlier, or allowing bonds
to remain outstanding longer than is otherwise reasonably necessary to
accomplish the governmental purposes of the bonds, based on all the
facts and circumstances. Whether an action is reasonably necessary to
accomplish the governmental purposes of the bonds depends on whether the
primary purpose
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of the transaction is a bona fide governmental purpose (e.g., an issue
of refunding bonds to achieve a debt service restructuring that would be
issued independent of any arbitrage benefit). An important factor
bearing on this determination is whether the action would reasonably be
taken to accomplish the governmental purpose of the issue if the
interest on the issue were not excludable from gross income under
section 103(a) (assuming that the hypothetical taxable interest rate
would be the same as the actual tax-exempt interest rate). Factors
evidencing an overissuance include the issuance of an issue the proceeds
of which are reasonably expected to exceed by more than a minor portion
the amount necessary to accomplish the governmental purposes of the
issue, or an issue the proceeds of which are, in fact, substantially in
excess of the amount of sale proceeds allocated to expenditures for the
governmental purposes of the issue. One factor evidencing an early
issuance is the issuance of bonds that do not qualify for a temporary
period under Sec. 1.148-2(e)(2), (e)(3), or (e)(4). One factor
evidencing that bonds may remain outstanding longer than necessary is a
term that exceeds the safe harbors against the creation of replacement
proceeds under Sec. 1.148-1(c)(4)(i)(B). These factors may be
outweighed by other factors, however, such as bona fide cost underruns
or long-term financial distress.
(b) Consequences of overburdening the tax-exempt bond market--(1) In
general. An issue that overburdens the tax-exempt bond market (within
the meaning of paragraph (a)(4) of this section) is subject to the
following special limitations--
(i) Special yield restriction. Investments are subject to the
definition of materially higher yield under Sec. 1.148-2(d) that is
equal to one-thousandth of 1 percent. In addition, each investment is
treated as a separate class of investments under Sec. 1.148-
5(b)(2)(ii), the yield on which may not be blended with that of other
investments.
(ii) Certain regulatory provisions inapplicable. The provisions of
Sec. 1.148-5(c) (relating to yield reduction payments) and Sec. 1.148-
5(e) (2) and (3) (relating to recovery of qualified administrative
costs) do not apply.
(iii) Restrictive expenditure rule. Proceeds are not allocated to
expenditures unless the proceeds-spent-last rule under Sec. 1.148-
6(d)(3)(i) is satisfied, applied by treating those proceeds as proceeds
to be used for restricted working capital expenditures. For this
purpose, available amount includes a reasonable working capital reserve
as defined in Sec. 1.148-6(d)(3)(iii)(B).
(2) Application. The provisions of this paragraph (b) only apply to
the portion of an issue that, as a result of actions taken (or actions
not taken) after the issue date, overburdens the market for tax-exempt
bonds, except that for an issue that is reasonably expected as of the
issue date to overburden the market, those provisions apply to all of
the gross proceeds of the issue.
(c) Anti-abuse rules on excess gross proceeds of advance refunding
issues--(1) In general. Except as otherwise provided in this paragraph
(c), an abusive arbitrage device is used and bonds of an advance
refunding issue are arbitrage bonds if the issue has excess gross
proceeds.
(2) Definition of excess gross proceeds. Excess gross proceeds means
all gross proceeds of an advance refunding issue that exceed an amount
equal to 1 percent of sale proceeds of the issue, other than gross
proceeds allocable to--
(i) Payment of principal, interest, or call premium on the prior
issue;
(ii) Payment of pre-issuance accrued interest on the refunding
issue, and interest on the refunding issue that accrues for a period up
to the completion date of any capital project for which the prior issue
was issued, plus one year;
(iii) A reasonably required reserve or replacement fund for the
refunding issue or investment proceeds of such a fund;
(iv) Payment of costs of issuance of the refunding issue;
(v) Payment of administrative costs allocable to repaying the prior
issue, carrying and repaying the refunding issue, or investments of the
refunding issue;
(vi) Transferred proceeds that will be used or maintained for the
governmental purpose of the prior issue;
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(vii) Interest on purpose investments;
(viii) Replacement proceeds in a sinking fund for the refunding
issue;
(ix) Qualified guarantee fees for the refunding issue or the prior
issue; and
(x) Fees for a qualified hedge for the refunding issue.
(3) Special treatment of transferred proceeds. For purposes of this
paragraph (c), all unspent proceeds of the prior issue as of the issue
date of the refunding issue are treated as transferred proceeds of the
advance refunding issue.
(4) Special rule for crossover refundings. An advance refunding
issue is not an issue of arbitrage bonds under this paragraph (c) if all
excess gross proceeds of the refunding issue are used to pay interest
that accrues on the refunding issue before the prior issue is
discharged, and no gross proceeds of any refunding issue are used to pay
interest on the prior issue or to replace funds used directly or
indirectly to pay such interest (other than transferred proceeds used to
pay interest on the prior issue that accrues for a period up to the
completion date of the project for which the prior issue was issued,
plus one year, or proceeds used to pay principal that is attributable to
accrued original issue discount).
(5) Special rule for gross refundings. This paragraph (c)(5) applies
if an advance refunding issue (the series B issue) is used together with
one or more other advance refunding issues (the series A issues) in a
gross refunding of a prior issue, but only if the use of a gross
refunding method is required under bond documents that were effective
prior to November 6, 1992. These advance refunding issues are not
arbitrage bonds under this paragraph (c) if--
(i) All excess gross proceeds of the series B issue and each series
A issue are investment proceeds used to pay principal and interest on
the series B issue;
(ii) At least 99 percent of all principal and interest on the series
B issue is paid with proceeds of the series B and series A issues or
with the earnings on other amounts in the refunding escrow for the prior
issue;
(iii) The series B issue is discharged not later than the prior
issue; and
(iv) As of any date, the amount of gross proceeds of the series B
issue allocated to expenditures does not exceed the aggregate amount of
expenditures before that date for principal and interest on the series B
issue, and administrative costs of carrying and repaying the series B
issue, or of investments of the series B issue.
(d) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. Mortgage sale. In 1982, City issued its revenue issue
(the 1982 issue) and lent the proceeds to Developer to finance a low-
income housing project under former section 103(b)(4)(A) of the 1954
Code. In 1994, Developer encounters financial difficulties and
negotiates with City to refund the 1982 issue. City issues $10 million
in principal amount of its 8 percent bonds (the 1994 issue). City lends
the proceeds of the 1994 issue to Developer. To evidence Developer's
obligation to repay that loan, Developer, as obligor, issues a note to
City (the City note). Bank agrees to provide Developer with a direct-pay
letter of credit pursuant to which Bank will make all payments to the
trustee for the 1994 issue necessary to meet Developer's obligations
under the City note. Developer pays Bank a fee for the issuance of the
letter of credit and issues a note to Bank (the Bank note). The Bank
note is secured by a mortgage on the housing project and is guaranteed
by FHA. The Bank note and the 1994 issue have different prepayment
terms. The City does not reasonably expect to treat prepayments of the
Bank note as gross proceeds of the 1994 issue. At the same time or
pursuant to a series of related transactions, Bank sells the Bank note
to Investor for $9.5 million. Bank invests these monies together with
its other funds. In substance, the transaction is a loan by City to
Bank, under which Bank enters into a series of transactions that, in
effect, result in Bank retaining $9.5 million in amounts treated as
proceeds of the 1994 issue. Those amounts are invested in materially
higher yielding investments that provide funds sufficient to equal or
exceed the Bank's liability under the letter of credit. Alternatively,
the letter of credit is investment property in a sinking fund for the
1994 issue provided by Developer, a substantial beneficiary of the
financing. Because, in substance, Developer acquires the $10 million
principal amount letter of credit for a fair market value purchase price
of $9.5 million, the letter of credit is a materially higher yielding
investment. Neither result would change if Developer's obligation under
the Bank note is contingent on Bank performing its obligation under the
letter of credit. Each characterization causes the bonds to be arbitrage
bonds.
Example 2. Bonds outstanding longer than necessary for yield-
blending device. (i) Longer
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bond maturity to create sinking fund. In 1994, Authority issues an
advance refunding issue (the refunding issue) to refund a 1982 prior
issue (the prior issue). Under current market conditions, Authority will
have to invest the refunding escrow at a yield significantly below the
yield on the refunding issue. Authority issues its refunding issue with
a longer weighted average maturity than otherwise necessary primarily
for the purpose of creating a sinking fund for the refunding issue that
will be invested in a guaranteed investment contract. The weighted
average maturity of the refunding issue is less than 120 percent of the
remaining average economic life of the facilities financed with the
proceeds of the prior issue. The guaranteed investment contract has a
yield that is higher than the yield on the refunding issue. The yield on
the refunding escrow blended with the yield on the guaranteed investment
contract does not exceed the yield on the issue. The refunding issue
uses an abusive arbitrage device and the bonds of the issue are
arbitrage bonds under section 148(a).
(ii) Refunding of noncallable bonds. The facts are the same as in
paragraph (i) of this Example 2 except that instead of structuring the
refunding issue to enable it to take advantage of sinking fund
investments, Authority will also refund other long-term, non-callable
bonds in the same refunding issue. There are no savings attributable to
the refunding of the non-callable bonds (e.g., a low-to-high refunding).
The Authority invests the portion of the proceeds of the refunding issue
allocable to the refunding of the non-callable bonds in the refunding
escrow at a yield that is higher than the yield on the refunding issue,
based on the relatively long escrow period for this portion of the
refunding. The Authority invests the other portion of the proceeds of
the refunding issue in the refunding escrow at a yield lower than the
yield on the refunding issue. The blended yield on all the investments
in the refunding escrow for the prior issues does not exceed the yield
on the refunding issue. The portion of the refunding issue used to
refund the noncallable bonds, however, was not otherwise necessary and
was issued primarily to exploit the difference between taxable and tax-
exempt rates for that long portion of the refunding escrow to minimize
the effect of lower yielding investments in the other portion of the
escrow. The refunding issue uses an abusive arbitrage device and the
bonds of the issue are arbitrage bonds.
(iii) Governmental purpose. In paragraphs (i) and (ii) of this
Example 2, the existence of a governmental purpose for the described
financing structures would not change the conclusions unless Authority
clearly established that the primary purpose for the use of the
particular structure was a bona fide governmental purpose. The fact that
each financing structure had the effect of eliminating significant
amounts of negative arbitrage is strong evidence of a primary purpose
that is not a bona fide governmental purpose. Moreover, in paragraph (i)
of this Example 2, the structure of the refunding issue coupled with the
acquisition of the guaranteed investment contract to lock in the
investment yield associated with the structure is strong evidence of a
primary purpose that is not a bona fide governmental purpose.
Example 3. Window refunding. (i) Authority issues its 1994 refunding
issue to refund a portion of the principal and interest on its
outstanding 1985 issue. The 1994 refunding issue is structured using
zero-coupon bonds that pay no interest or principal for the 5-year
period following the issue date. The proceeds of the 1994 refunding
issue are deposited in a refunding escrow to be used to pay only the
interest requirements of the refunded portion of the 1985 issue.
Authority enters into a guaranteed investment contract with a financial
institution, G, under which G agrees to provide a guaranteed yield on
revenues invested by Authority during the 5-year period following the
issue date. The guaranteed investment contract has a yield that is no
higher than the yield on the refunding issue. The revenues to be
invested under this guaranteed investment contract consist of the
amounts that Authority otherwise would have used to pay principal and
interest on the 1994 refunding issue. The guaranteed investment contract
is structured to generate receipts at times and in amounts sufficient to
pay the principal and redemption requirements of the refunded portion of
the 1985 issue. A principal purpose of these transactions is to avoid
transferred proceeds. Authority will continue to invest the unspent
proceeds of the 1985 issue that are on deposit in a refunding escrow for
its 1982 issue at a yield equal to the yield on the 1985 issue and will
not otherwise treat those unspent proceeds as transferred proceeds of
the 1994 refunding issue. The 1994 refunding issue is an issue of
arbitrage bonds since those bonds involve a transaction or series of
transactions that overburdens the market by leaving bonds outstanding
longer than is necessary to obtain a material financial advantage based
on arbitrage. Specifically, Authority has structured the 1994 refunding
issue to make available for the refunding of the 1985 issue replacement
proceeds rather than proceeds so that the unspent proceeds of the 1985
issue will not become transferred proceeds of the 1994 refunding issue.
(ii) The result would be the same in each of the following
circumstances:
(A) The facts are the same as in paragraph (i) of this Example 3
except that Authority does not enter into the guaranteed investment
contract but instead, as of the issue date of the 1994 refunding issue,
reasonably expects that the released revenues will be
[[Page 136]]
available for investment until used to pay principal and interest on the
1985 issue.
(B) The facts are the same as in paragraph (i) of this Example 3
except that there are no unspent proceeds of the 1985 issue and
Authority invests the released revenues at a yield materially higher
than the yield on the 1994 issue.
(C) The facts are the same as in paragraph (i) of this Example 3
except that Authority uses the proceeds of the 1994 issue for capital
projects instead of to refund a portion of the 1985 issue.
Example 4. Sale of conduit loan. On January 1, 1994, Authority
issues a conduit financing issue (the 1994 conduit financing issue) and
uses the proceeds to purchase from City, an unrelated party, a tax-
exempt bond of City (the City note). The proceeds of the 1994 conduit
financing issue are to be used to advance refund a prior conduit
financing issue that was issued in 1988 and used to make a loan to City.
The 1994 conduit financing issue and the City note each have a yield of
8 percent on January 1, 1994. On June 30, 1996, interest rates have
decreased and Authority sells the City note to D, a person unrelated to
either City or Authority. Based on the sale price of the City note and
treating June 30, 1996 as the issue date of the City note, the City note
has a 6 percent yield. Authority deposits the proceeds of the sale of
the City note into an escrow to redeem the bonds of the 1994 conduit
financing issue on January 1, 2001. The escrow is invested in nonpurpose
investments having a yield of 8 percent. For purposes of section 149(d),
City and Authority are related parties and, therefore, the issue date of
the City note is treated as being June 30, 1996. Thus, the City note is
an advance refunding of Authority's 1994 conduit financing issue.
Interest on the City note is not exempt from Federal income tax from the
date it is sold to D under section 149(d), because, by investing the
escrow investments at a yield of 8 percent instead of a yield not
materially higher than 6 percent, the sale of the City note employs a
device to obtain a material financial advantage, based on arbitrage,
apart from the savings attributable to lower interest rates. In
addition, the City note is not a tax-exempt bond because the note is the
second advance refunding of the original bond under section 149(d)(3).
The City note also employs an abusive arbitrage device and is an
arbitrage bond under section 148.
Example 5. Re-refunding. (i) On January 1, 1984, City issues a tax-
exempt issue (the 1984 issue) to finance the cost of constructing a
prison. The 1984 issue has a 7 percent yield and a 30-year maturity. The
1984 issue is callable at any time on or after January 1, 1994. On
January 1, 1990, City issues a refunding issue (the 1990 issue) to
advance refund the 1984 issue. The 1990 issue has an 8 percent yield and
a 30-year maturity. The 1990 issue is callable at any time on or after
January 1, 2000. The proceeds of the 1990 issue are invested at an 8
percent yield in a refunding escrow for the 1984 issue (the original
1984 escrow) in a manner sufficient to pay debt service on the 1984
issue until maturity (i.e., an escrow to maturity). On January 1, 1994,
City issues a refunding issue (the 1994 issue). The 1994 issue has a 6
percent yield and a 30-year maturity. City does not invest the proceeds
of the 1994 issue in a refunding escrow for the 1990 issue in a manner
sufficient to pay a portion of the debt service until, and redeem a
portion of that issue on, January 1, 2000. Instead, City invests those
proceeds at a 6 percent yield in a new refunding escrow for a portion of
the 1984 issue (the new 1984 escrow) in a manner sufficient to pay debt
service on a portion of the 1984 issue until maturity. City also
liquidates the investments allocable to the proceeds of the 1990 issue
held in the original 1984 escrow and reinvests those proceeds in an
escrow to pay a portion of the debt service on the 1990 issue itself
until, and redeem a portion of that issue on, January 1, 2000 (the 1990
escrow). The 1994 bonds are arbitrage bonds and employ an abusive device
under section 149(d)(4). Although, in form, the proceeds of the 1994
issue are used to pay principal on the 1984 issue, this accounting for
the use of the proceeds of the 1994 issue is an unreasonable,
inconsistent accounting method under Sec. 1.148-6(a). Moreover, since
the proceeds of the 1990 issue were set aside in an escrow to be used to
retire the 1984 issue, the use of proceeds of the 1994 issue for that
same purpose involves a replacement of funds invested in higher yielding
investments under section 148(a)(2). Thus, using a reasonable,
consistent accounting method and giving effect to the substance of the
transaction, the proceeds of the 1994 issue are treated as used to
refund the 1990 issue and are allocable to the 1990 escrow. The proceeds
of the 1990 issue are treated as used to refund the 1984 issue and are
allocable to the investments in the new 1984 escrow. The proceeds of the
1990 issue allocable to the nonpurpose investments in the new 1984
escrow become transferred proceeds of the 1994 issue as principal is
paid on the 1990 issue from amounts on deposit in the 1990 escrow. As a
result, the yield on nonpurpose investments allocable to the 1994 issue
is materially higher than the yield on the 1994 issue, causing the bonds
of the 1994 issue to be arbitrage bonds. In addition, the transaction
employs a device under section 149(d)(4) to obtain a material financial
advantage based on arbitrage, other than savings attributable to lower
interest rates.
(ii) The following changes in the facts do not affect the conclusion
that the 1994 issue consists of arbitrage bonds--
(1) The 1990 issue is a taxable issue;
(2) The original 1984 escrow is used to pay the 1994 issue (rather
than the 1990 issue); or
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(3) The 1994 issue is used to retire the 1984 issue within 90 days
of January 1, 1994.
(e) Authority of the Commissioner to clearly reflect the economic
substance of a transaction. If an issuer enters into a transaction for a
principal purpose of obtaining a material financial advantage based on
the difference between tax-exempt and taxable interest rates in a manner
that is inconsistent with the purposes of section 148, the Commissioner
may exercise the Commissioner's discretion to depart from the rules of
Sec. 1.148-1 through Sec. 1.148-11 as necessary to clearly reflect the
economic substance of the transaction. For this purpose, the
Commissioner may recompute yield on an issue or on investments,
reallocate payments and receipts on investments, recompute the rebate
amount on an issue, treat a hedge as either a qualified hedge or not a
qualified hedge, or otherwise adjust any item whatsoever bearing upon
the investments and expenditures of gross proceeds of an issue. For
example, if the amount paid for a hedge is specifically based on the
amount of arbitrage earned or expected to be earned on the hedged bonds,
a principal purpose of entering into the contract is to obtain a
material financial advantage based on the difference between tax-exempt
and taxable interest rates in a manner that is inconsistent with the
purposes of section 148.
(f) Authority of the Commissioner to require an earlier date for
payment of rebate. If the Commissioner determines that an issue is
likely to fail to meet the requirements of Sec. 1.148-3 and that a
failure to serve a notice of demand for payment on the issuer will
jeopardize the assessment or collection of tax on interest paid or to be
paid on the issue, the date that the Commissioner serves notice on the
issuer is treated as a required computation date for payment of rebate
for that issue.
(g) Authority of the Commissioner to waive regulatory limitations.
Notwithstanding any specific provision in Sec. Sec. 1.148-1 through
1.148-11, the Commissioner may prescribe extensions of temporary
periods, larger reasonably required reserve or replacement funds, or
consequences of failures or remedial action under section 148 in lieu of
or in addition to other consequences of those failures, or take other
action, if the Commissioner finds that good faith or other similar
circumstances so warrant, consistent with the purposes of section 148.
[T.D. 8476, 58 FR 33544, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8476, 59 FR 24351,
May 11, 1994; T.D. 8718, 62 FR 25512, May 9, 1997]
Sec. 1.148-11 Effective/applicability dates.
(a) In general. Except as otherwise provided in this section,
Sec. Sec. 1.148-1 through 1.148-11 apply to bonds sold on or after July
8, 1997.
(b) Elective retroactive application in whole--(1) In general.
Except as otherwise provided in this section, and subject to the
applicable effective dates for the corresponding statutory provisions,
an issuer may apply the provisions of Sec. Sec. 1.148-1 through 1.148-
11 in whole, but not in part, to any issue that is outstanding on July
8, 1997, and is subject to section 148(f) or to sections 103(c)(6) or
103A(i) of the Internal Revenue Code of 1954, in lieu of otherwise
applicable regulations under those sections.
(2) No elective retroactive application for 18-month spending
exception. The provisions of Sec. 1.148-7(d) (relating to the 18-month
spending exception) may not be applied to any issue issued on or before
June 30, 1993.
(3) No elective retroactive application for hedges of fixed rate
issues. The provisions of Sec. 1.148-4(h)(2)(i)(B) (relating to hedges
of fixed rate issues) may not be applied to any bond sold on or before
July 8, 1997.
(4) No elective retroactive application for safe harbor for
establishing fair market value for guaranteed investment contracts and
investments purchased for a yield restricted defeasance escrow. The
provisions of Sec. Sec. 1.148-5(d)(6)(iii) (relating to the safe harbor
for establishing fair market value of guaranteed investment contracts
and yield restricted defeasance escrow investments) and 1.148-
5(e)(2)(iv) (relating to a special rule for yield restricted defeasance
escrow investments) may not be applied to any bond sold before December
30, 1998.
(c) Elective retroactive application of certain provisions and
special rules--(1) Retroactive application of overpayment
[[Page 138]]
recovery provisions. An issuer may apply the provisions of Sec. 1.148-
3(i) to any issue that is subject to section 148(f) or to sections
103(c)(6) or 103A(i) of the Internal Revenue Code of 1954.
(2) Certain allocations of multipurpose issues. An allocation of
bonds to a refunding purpose under Sec. 1.148-9(h) may be adjusted as
necessary to reflect allocations made between May 18, 1992, and August
15, 1993, if the allocations satisfied the corresponding prior provision
of Sec. 1.148-11(j)(4) under applicable prior regulations.
(3) Special limitation. The provisions of Sec. 1.148-9 apply to
issues issued before August 15, 1993, only if the issuer in good faith
estimates the present value savings, if any, associated with the effect
of the application of that section on refunding escrows, using any
reasonable accounting method, and applies those savings, if any, to
redeem outstanding tax-exempt bonds of the applicable issue at the
earliest possible date on which those bonds may be redeemed or otherwise
retired. These savings are not reduced to take into account any
administrative costs associated with applying these provisions
retroactively.
(d) Transition rule excepting certain state guarantee funds from the
definition of replacement proceeds--(1) Certain perpetual trust funds. A
guarantee by a fund created and controlled by a State and established
pursuant to its constitution does not cause the amounts in the fund to
be pledged funds treated as replacement proceeds if--
(i) Substantially all of the corpus of the fund consists of
nonfinancial assets, revenues derived from these assets, gifts, and
bequests;
(ii) The corpus of the guarantee fund may be invaded only to support
specifically designated essential governmental functions (designated
functions) carried on by political subdivisions with general taxing
powers;
(iii) Substantially all of the available income of the fund is
required to be applied annually to support designated functions;
(iv) The issue guaranteed consists of general obligations that are
not private activity bonds substantially all of the proceeds of which
are to be used for designated functions;
(v) The fund satisfied each of the requirements of paragraphs
(d)(1)(i) through (d)(1)(iii) of this section on August 16, 1986; and
(vi) The guarantee is not attributable to a deposit to the fund made
after May 14, 1989, unless--
(A) The deposit is attributable to the sale or other disposition of
fund assets; or
(B) Prior to the deposit, the outstanding amount of the bonds
guaranteed by the fund did not exceed 250 percent of the lower of the
cost or fair market value of the fund.
(2) Permanent University Fund. Replacement proceeds do not include
amounts allocable to investments of the fund described in section 648 of
Public Law 98-369.
(e) Transition rule regarding special allowance payments. Section
1.148-5(b)(5) applies to any bond issued after January 5, 1990, except a
bond issued exclusively to refund a bond issued before January 6, 1990,
if the amount of the refunding bond does not exceed 101 percent of the
amount of the refunded bond, and the maturity date of the refunding bond
is not later than the date that is 17 years after the date on which the
refunded bond was issued (or, in the case of a series of refundings, the
date on which the original bond was issued), but only if Sec. 1.148-
2(d)(2)(iv) is applied by substituting 1 and one-half percentage points
for 2 percentage points.
(f) Transition rule regarding applicability of yield reduction rule.
Section 1.148-5(c) applies to nonpurpose investments allocable to
replacement proceeds of an issue that are held in a reserve or
replacement fund to the extent that--
(1) Amounts must be paid into the fund under a constitutional
provision, statute, or ordinance adopted before May 3, 1978;
(2) Under that provision, amounts paid into the fund (and investment
earnings thereon) can be used only to pay debt service on the issues;
and
(3) The size of the payments made into the fund is independent of
the size of the outstanding issues or the debt service thereon.
(g) Provisions applicable to certain bonds sold before effective
date. Except
[[Page 139]]
for bonds to which paragraph (b)(1) of this section applies--
(1) Section 1.148-11A provides rules applicable to bonds sold after
June 6, 1994, and before July 8, 1997; and
(2) Sections 1.148-1 through 1.148-11 as in effect on July 1, 1993
(see 26 CFR part 1 as revised April 1, 1994), and Sec. 1.148-11A(i)
(relating to elective retroactive application of certain provisions)
provide rules applicable to certain issues issued before June 7, 1994.
(h) Safe harbor for establishing fair market value for guaranteed
investment contracts and investments purchased for a yield restricted
defeasance escrow. The provisions of Sec. 1.148-5(d)(6)(iii) are
applicable to bonds sold on or after March 1, 1999. Issuers may apply
these provisions to bonds sold on or after December 30, 1998, and before
March 1, 1999.
(i) Special rule for certain broker's commissions and similar fees.
Section 1.148-5(e)(2)(iii) applies to bonds sold on or after February 9,
2004. In the case of bonds sold before February 9, 2004, that are
subject to Sec. 1.148-5 (pre-effective date bonds), issuers may apply
Sec. 1.148-5(e)(2)(iii), in whole but not in part, with respect to
transactions entered into on or after December 11, 2003. If an issuer
applies Sec. 1.148-5(e)(2)(iii) to pre-effective date bonds, the per-
issue safe harbor in Sec. 1.148-5(e)(2)(iii)(B)(1)(ii) is applied by
taking into account all brokers' commissions or similar fees with
respect to guaranteed investment contracts and investments for yield
restricted defeasance escrows that the issuer treats as qualified
administrative costs for the issue, including all such commissions or
fees paid before February 9, 2004. For purposes of Sec. Sec. 1.148-
5(e)(2)(iii)(B)(3) and 1.148-5(e)(2)(iii)(B)(6) (relating to cost-of-
living adjustments), transactions entered into before 2003 are treated
as entered into in 2003.
(j) Certain prepayments. Section 1.148-1(e)(1) and (2) apply to
bonds sold on or after October 3, 2003. Issuers may apply Sec. 1.148-
1(e)(1) and (2), in whole but not in part, to bonds sold before October
3, 2003, that are subject to Sec. 1.148-1.
(k) [Reserved]
(l) Additional arbitrage guidance updates.
(1) [Reserved]
(2) [Reserved]
(3) [Reserved]
(4) Application. (i) Section 1.148-3(i)(3)(i) applies to claims
arising from an issue of bonds to which Sec. 1.148-3(i) applies and for
which the final computation date is after June 24, 2008. For purposes of
this paragraph (l)(4), issues for which the actual final computation
date is on or before June 24, 2008, are deemed to have a final
computation date of July 1, 2008 for purposes of applying Sec. 1.148-
3(i)(3)(i).
(ii) Section 1.148-3(i)(3)(ii) and (iii) apply to claims arising
from an issue of bonds to which Sec. 1.148-3(i) applies and for which
the final computation date is after September 16, 2013.
[T.D. 8476, 58 FR 33547, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8718, 62 FR 25512,
May 9, 1997; T.D. 8476, 64 FR 37037, July 9, 1999; T.D. 9085, 68 FR
45777, Aug. 4, 2003; T.D. 9097, 68 FR 69023, Dec. 11, 2003; T.D. 9701,
79 FR 67351, Nov. 13, 2014]
Sec. 1.149(b)-1 Federally guaranteed bonds.
(a) General rule. Under section 149(b) and this section, nothing in
section 103(a) or in any other provision of law shall be construed to
provide an exemption from Federal income tax for interest on any bond
issued as part of an issue that is federally guaranteed.
(b) Exceptions. Pursuant to section 149(b)(3)(B), section 149(b)(1)
and paragraph (a) of this section do not apply to--
(1) Investments in obligations issued pursuant to Sec. 21B(d)(3) of
the Federal Home Loan Bank Act, as amended by Sec. 511 of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989, or any
successor provision; or
(2) Any investments that are held in a refunding escrow (as defined
in Sec. 1.148-1).
(c) Effective date. This section applies to investments made after
June 30, 1993.
[T.D. 8476, 58 FR 33548, June 18, 1993]
Sec. 1.149(d)-1 Limitations on advance refundings.
(a) General rule. Under section 149(d) and this section, nothing in
section 103(a) or in any other provision of law
[[Page 140]]
shall be construed to provide an exemption from Federal income tax for
interest on any bond issued as part of an issue described in paragraphs
(2), (3), or (4) of section 149(d).
(b) Advance refunding issues that employ abusive devices--(1) In
general. An advance refunding issue employs an abusive device and is
described in section 149(d)(4) if the issue violates any of the anti-
abuse rules under Sec. 1.148-10.
(2) Failure to pay required rebate. An advance refunding issue is
described in section 149(d)(4) if the issue fails to meet the
requirements of Sec. 1.148-3. This paragraph (b)(2) applies to any
advance refunding issue issued after August 31, 1986.
(3) Mixed escrows invested in tax-exempt bonds. An advance refunding
issue is described in section 149(d)(4) if--
(i) Any of the proceeds of the issue are invested in a refunding
escrow in which a portion of the proceeds are invested in tax-exempt
bonds and a portion of the proceeds are invested in nonpurpose
investments;
(ii) The yield on the tax-exempt bonds in the refunding escrow
exceeds the yield on the issue;
(iii) The yield on all the investments (including investment
property and tax-exempt bonds) in the refunding escrow exceeds the yield
on the issue; and
(iv) The weighted average maturity of the tax-exempt bonds in the
refunding escrow is more than 25 percent greater or less than the
weighted average maturity of the nonpurpose investments in the refunding
escrow, and the weighted average maturity of nonpurpose investments in
the refunding escrow is greater than 60 days.
(4) Tax-exempt conduit loans. For purposes of applying section
149(d) to a conduit financing issue that finances any conduit loan that
is a tax-exempt bond, the actual issuer of a conduit financing issue and
the conduit borrower of that conduit financing issue are treated as
related parties. Thus, the issue date of the conduit loan does not occur
prior to the date on which the actual issuer of the conduit financing
issue sells, exchanges, or otherwise disposes of that conduit loan, and
the use of the proceeds of the disposition to pay debt service on the
conduit financing issue causes the conduit loan to be a refunding issue.
See Sec. 1.148-10(d), Example 4.
(c) Unrefunded debt service remains eligible for future advance
refunding. For purposes of section 149(d)(3)(A)(i), any principal or
interest on a prior issue that has not been paid or provided for by any
advance refunding issue is treated as not having been advance refunded.
(d) Application of arbitrage regulations--(1) Application of
multipurpose issue rules. For purposes of sections 149(d)(2) and
(3)(A)(i), (ii), and (iii), the provisions of the multipurpose issue
rule in Sec. 1.148-9(h) apply, except that the limitation in Sec.
1.148-9(h)(5) is disregarded.
(2) General mixed escrow rules. For purposes of section 149(d), the
provisions of Sec. 1.148-9(c) (relating to mixed escrows) apply, except
that those provisions do not apply for purposes of section 149(d)(2) and
(d)(3)(A) (i) and (ii) to amounts that were not gross proceeds of the
prior issue before the issue date of the refunding issue.
(3) Temporary periods and minor portions. Section 1.148-9(d) and (f)
contains rules applicable to temporary periods and minor portions for
advance refunding issues.
(4) Definitions. Section 1.148-1 applies for purposes of section
149(d).
(e) Taxable refundings--(1) In general. Except as provided in
paragraph (e)(2) of this section, for purposes of section
149(d)(3)(A)(i), an advance refunding issue the interest on which is not
excludable from gross income under section 103(a) (i.e., a taxable
advance refunding issue) is not taken into account. In addition, for
this purpose, an advance refunding of a taxable issue is not taken into
account unless the taxable issue is a conduit loan of a tax-exempt
conduit financing issue.
(2) Use to avoid section 149(d)(3)(A)(i). A taxable issue is taken
into account under section 149(d)(3)(A)(i) if it is issued to avoid the
limitations of that section. For example, in the case of a refunding of
a tax-exempt issue with a taxable advance refunding issue that is, in
turn, currently refunded with a tax-exempt issue, the taxable advance
refunding issue is taken into account under section 149(d)(3)(A)(i) if
the two
[[Page 141]]
tax-exempt issues are outstanding concurrently for more than 90 days.
(f) Redemption at first call date--(1) General rule. Under sections
149(d)(3)(A) (ii) and (iii) (the first call requirement), bonds refunded
by an advance refunding must be redeemed on their first call date if the
savings test under section 149(d)(3)(B)(i) (the savings test) is
satisfied. The savings test is satisfied if the issuer may realize
present value debt service savings (determined without regard to
administrative expenses) in connection with the issue of which the
refunding bond is a part.
(2) First call date. First call date means the earliest date on
which a bond may be redeemed (or, if issued before 1986, on the earliest
date on which that bond may be redeemed at a redemption price not in
excess of 103 percent of par). If, however, the savings test is not met
with respect to the date described in the preceding sentence (i.e.,
there are no present value savings if the refunded bonds are retired on
that date), the first call date is the first date thereafter on which
the bonds can be redeemed and on which the savings test is met.
(3) Application of savings test to multipurpose issues. Except as
otherwise provided in this paragraph (f)(3), the multipurpose issue
rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any
separate issue in a multipurpose issue increases the aggregate present
value debt service savings on the entire multipurpose issue or reduces
the present value debt service losses on that entire multipurpose issue,
that separate issue satisfies the savings test.
(g) Limitation on advance refundings of private activity bonds.
Under section 149(d)(2) and this section, interest on a bond is not
excluded from gross income if any portion of the issue of which the bond
is a part is issued to advance refund a private activity bond (other
than a qualified 501(c)(3) bond). For this purpose, the term private
activity bond--
(1) Includes a qualified bond described in section 141(e) (other
than a qualified 501(c)(3) bond), regardless of whether the refunding
issue consists of private activity bonds under Sec. 1.141-13; and
(2) Does not include a taxable bond.
(h) Effective dates--(1) In general. Except as provided in this
paragraph (h), this section applies to bonds issued after June 30, 1993,
to which Sec. Sec. 1.148-1 through 1.148-11 apply, including conduit
loans that are treated as issued after June 30, 1993, under paragraph
(b)(4) of this section. In addition, this section applies to any issue
to which the election described in Sec. 1.148-11(b)(1) is made.
(2) Special effective date for paragraph (b)(3). Paragraph (b)(3) of
this section applies to any advance refunding issue issued after May 28,
1991.
(3) Special effective date for paragraph (f)(3). Paragraph (f)(3) of
this section applies to bonds sold on or after July 8, 1997 and to any
issue to which the election described in Sec. 1.148-11(b)(1) is made.
See Sec. 1.148-11A(i) for rules relating to certain bonds sold before
July 8, 1997.
(4) Special effective date for paragraph (g). See Sec. 1.141-15 for
the applicability date of paragraph (g) of this section.
[T.D. 8476, 58 FR 33548, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8718, 62 FR 25513,
May 9, 1997; T.D. 9234, 70 FR 75035, Dec. 19, 2005]
Sec. 1.149(e)-1 Information reporting requirements for tax-exempt bonds.
(a) General rule. Interest on a bond is included in gross income
unless certain information with respect to the issue of which the bond
is a part is reported to the Internal Revenue Service in accordance with
the requirements of this section. This section applies to any bond if
the issue of which the bond is a part is issued after December 31, 1986
(including any bond issued to refund a bond issued on or before December
31, 1986).
(b) Requirements for private activity bonds--(1) In general. If the
issue of which the bond is a part is an issue of private activity bonds,
the issuer must comply with the following requirements--
(i) Not later than the 15th day of the second calendar month after
the close of the calendar quarter in which the issue is issued, the
issuer must file with the Internal Revenue Service a completed
information reporting form prescribed for this purpose;
[[Page 142]]
(ii) If any bond that is part of the issue is taken into account
under section 146 (relating to volume cap on private activity bonds),
the state certification requirement of paragraph (b)(2) of this section
must be satisfied; and
(iii) If any bond that is part of the issue is a qualified mortgage
bond or qualified veterans' mortgage bond (within the meaning of section
143 (a) or (b) or section 103A(c) (1) or (3) as in effect on the day
before enactment of the Tax Reform Act of 1986), the issuer must submit
the annual report containing information on the borrowers of the
original proceeds of the issue as required under Sec. 1.103A-2
(k)(2)(ii) and (k)(3) through (k)(6).
(2) State certification with respect to volume cap--(i) In general.
If an issue is subject to the volume cap under section 146, a state
official designated by state law (if there is no such official, then the
governor or the governor's delegate) must certify that the issue meets
the requirements of section 146, and a copy of this certification must
be attached to the information reporting form filed with respect to the
issue. In the case of any constitutional home rule city (as defined in
section 146(d)(3)(C)), the preceding sentence is applied by substituting
``city'' for ``state'' and ``chief executive officer'' for ``governor.''
(ii) Certification. The certifying official need not perform an
independent investigation in order to certify that the issue meets the
requirements of section 146. For example, if the certifying official
receives an affidavit that was executed by an officer of the issuer who
is responsible for issuing the bonds and that sets forth, in brief and
summary terms, the facts necessary to determine that the issue meets the
requirements of section 146 and if the certifying official has compared
the information in that affidavit to other readily available information
with respect to that issuer (e.g., previous affidavits and
certifications for other private activity bonds issued by that issuer),
the certifying official may rely on the affidavit.
(c) Requirements for governmental bonds--(1) Issue price of $100,000
or more. If the issue of which the bond is a part has an issue price of
$100,000 or more and is not an issue of private activity bonds, then,
not later than the 15th day of the second calendar month after the close
of the calendar quarter in which the issue is issued, the issuer must
file with the Internal Revenue Service a completed information reporting
form prescribed for this purpose.
(2) Issue price of less than $100,000--(i) In general. If the issue
of which the bond is a part has an issue price of less than $100,000 and
is not an issue of private activity bonds, the issuer must file with the
Internal Revenue Service one of the following information reporting
forms within the prescribed period--
(A) Separate return. Not later than the 15th day of the second
calendar month after the close of the calendar quarter in which the
issue is issued, a completed information reporting form prescribed for
this purpose with respect to that issue; or
(B) Consolidated return. Not later than February 15 of the calendar
year following the calendar year in which the issue is issued, a
completed information form prescribed for this purpose with respect to
all issues to which this paragraph (c)(2) applies that were issued by
the issuer during the calendar year and for which information was not
reported on a separate information return pursuant to paragraph
(c)(2)(i)(A) of this section.
(ii) Bond issues issued before January 1, 1992. Paragraph
(c)(2)(i)(A) of this section does not apply if the issue of which the
bond is a part is issued before January 1, 1992.
(iii) Extended filing date for first and second calendar quarters of
1992. If the issue of which the bond is a part is issued during the
first or second calendar quarter of 1992, the prescribed period for
filing an information reporting form with respect to that issue pursuant
to paragraph (c)(2)(i)(A) of this section is extended until November 16,
1992.
(d) Filing of forms and special rules--(1) Completed form. For
purposes of this section--
(i) Good faith effort. An information reporting form is treated as
completed if the issuer (or a person acting on behalf of the issuer) has
made a good
[[Page 143]]
faith effort to complete the form (taking into account the instructions
to the form).
(ii) Information. In general, information reporting forms filed
pursuant to this section must be completed on the basis of available
information and reasonable expectations as of the date the issue is
issued. Forms that are filed on a consolidated basis pursuant to
paragraph (c)(2)(i)(B) of this section, however, may be completed on the
basis of information readily available to the issuer at the close of the
calendar year to which the form relates, supplemented by estimates made
in good faith.
(iii) Certain information not required. An issuer need not report to
the Internal Revenue Service any information specified in the first
sentence of section 149(e)(2) that is not required to be reported to the
Internal Revenue Service pursuant to the information reporting forms
prescribed under that section and the instructions to those forms.
(2) Manner of filing--(i) Place for filing. The information
reporting form must be filed with the Internal Revenue Service at the
address specified on the form or in the instructions to the form.
(ii) Extension of time. The Commissioner may grant an extension of
time to file any form or attachment required under this section if the
Commissioner determines that the failure to file in a timely manner was
not due to willful neglect. The Commissioner may make this determination
with respect to an issue or to a class of issues.
(e) Definitions. For purposes of this section only--(1) Private
activity bond. The term ``private activity bond'' has the meaning given
that term in section 141(a) of the Internal Revenue Code, except that
the term does not include any bond described in section 1312(c) of the
Tax Reform Act of 1986 to which section 1312 or 1313 of the Tax Reform
Act of 1986 applies.
(2) Issue--(i) In general. Except as otherwise provided in this
paragraph (e)(2), bonds are treated as part of the same issue only if
the bonds are issued--
(A) By the same issuer;
(B) On the same date; and
(C) Pursuant to a single transaction or to a series of related
transactions.
(ii) Draw-down loans, commercial paper, etc. (A) Bonds issued during
the same calendar year may be treated as part of the same tissue if the
bonds are issued--
(1) Pursuant to a loan agreement under which amounts are to be
advanced periodically (``draw-down loan''); or
(2) With a term not exceeding 270 days.
(B) In addition, the bonds must be equally and ratably secured under
a single indenture or loan agreement and issued pursuant to a common
financing arrangement (e.g., pursuant to the same official statement
that is periodically updated to reflect changing factual circumstances).
In the case of bonds issued pursuant to a draw-down loan that meets the
requirements of the preceding sentence, bonds issued during different
calendar years may be treated as part of the same issue if all the
amounts to be advanced pursuant to the draw-down loan are reasonably
expected to be advanced within three years of the date of issue of the
first bond.
(iii) Leases and installment sales. Bonds other than private
activity bonds may be treated as part of the same issue if--
(A) The bonds are issued pursuant to a single agreement that is in
the form of a lease or installment sales agreement; and
(B) All of the property covered by that agreement is reasonably
expected to be delivered within three years of the date of issue of the
first bond.
(iv) Qualified 501(c)(3) bonds. If an issuer elects under section
141(b)(9) to treat a portion of an issue as a qualified 501(c)(3) bond,
that portion is treated as a separate issue.
(3) Date of issue--(i) Bond. The date of issue of a bond is
determined under Sec. 1.150-1.
(ii) Issue. The date of issue of an issue of bonds is the date of
issue of the first bond that is part of the issue. See paragraphs (e)(2)
(ii) and (iii) of this section for rules relating to draw-down loans,
commercial paper, etc., and leases and installment sales.
(iii) Bonds to which prior law applied. Notwithstanding the
provisions of this paragraph (e)(3), an issue for which an
[[Page 144]]
information report was required to be filed under section 103(l) or
section 103A(j)(3) is treated as issued prior to January 1, 1987.
(4) Issue price. The term ``issue price'' has the same meaning given
the term under Sec. 1.148-1(b).
[T.D. 8425, 57 FR 36002, Aug. 12, 1992, as amended at 59 FR 24351, May
11, 1994]
Sec. 1.149(g)-1 Hedge bonds.
(a) Certain definitions. Except as otherwise provided, the
definitions set forth in Sec. 1.148-1 apply for purposes of section
149(g) and this section. In addition, the following terms have the
following meanings:
Reasonable expectations means reasonable expectations (as defined in
Sec. 1.148-1), as modified to take into account the provisions of
section 149(f)(2)(B).
Spendable proceeds means net sale proceeds (as defined in Sec.
1.148-1).
(b) Applicability of arbitrage allocation and accounting rules.
Section 1.148-6 applies for purposes of section 149(g), except that an
expenditure that results in the creation of replacement proceeds (other
than amounts in a bona fide debt service fund or a reasonably required
reserve or replacement fund) is not an expenditure for purposes of
section 149(g).
(c) Refundings--(1) Investment in tax-exempt bonds. A bond issued to
refund a bond that is a tax-exempt bond by virtue of the rule in section
149(g)(3)(B) is not a tax-exempt bond unless the gross proceeds of that
refunding bond (other than proceeds in a refunding escrow for the
refunded bond) satisfy the requirements of section 149(g)(3)(B).
(2) Anti-abuse rule. A refunding bond is treated as a hedge bond
unless there is a significant governmental purpose for the issuance of
that bond (e.g., an advance refunding bond issued to realize debt
service savings or to relieve the issuer of significantly burdensome
document provisions, but not to otherwise hedge against future increases
in interest rates).
(d) Effective date. This section applies to bonds issued after June
30, 1993 to which Sec. Sec. 1.148-1 through 1.148-11 apply. In
addition, this section applies to any issue to which the election
described in Sec. 1.148-11(b)(1) is made.
[T.D. 8476, 58 FR 33549, June 18, 1993]
Sec. 1.150-1 Definitions.
(a) Scope and effective date--(1) In general. Except as otherwise
provided, the definitions in this section apply for all purposes of
sections 103 and 141 through 150.
(2) Effective/applicability date--(i) In general. Except as
otherwise provided in this paragraph (a)(2), this section applies to
issues issued after June 30, 1993 to which Sec. Sec. 1.148-1 through
1.148-11 apply. In addition, this section (other than paragraph (c)(3)
of this section) applies to any issue to which the election described in
Sec. 1.148-11(b)(1) is made.
(ii) Special effective date for paragraphs (c)(1), (c)(4)(iii), and
(c)(6). Paragraphs (c)(1), (c)(4)(iii), and (c)(6) of this section apply
to bonds sold on or after July 8, 1997 and to any issue to which the
election described in Sec. 1.148-11(b)(1) is made. See Sec. 1.148-
11A(i) for rules relating to certain bonds sold before July 8, 1997.
(3) Exceptions to general effective date. See Sec. 1.141-15 for the
applicability date of the definition of bond documents contained in
paragraph (b) of this section and the effective date of paragraph
(c)(3)(ii) of this section.
(4) Additional exception to the general applicability date. Section
1.150-1(b), Issuance costs, applies on and after July 6, 2011.
(b) Certain general definitions. The following definitions apply:
Bond means any obligation of a State or political subdivision
thereof under section 103(c)(1).
Bond documents means the bond indenture or resolution, transcript of
proceedings, and any related documents.
Capital expenditure means any cost of a type that is properly
chargeable to capital account (or would be so chargeable with a proper
election or with the application of the definition of placed in service
under Sec. 1.150-2(c)) under general Federal income tax principles. For
example, costs incurred to acquire, construct, or improve land,
buildings, and equipment generally are capital expenditures. Whether an
expenditure is a capital expenditure is determined
[[Page 145]]
at the time the expenditure is paid with respect to the property. Future
changes in law do not affect whether an expenditure is a capital
expenditure.
Conduit borrower means the obligor on a purpose investment (as
defined in Sec. 1.148-1). For example, if an issuer invests proceeds in
a purpose investment in the form of a loan, lease, installment sale
obligation, or similar obligation to another entity and the obligor uses
the proceeds to carry out the governmental purpose of the issue, the
obligor is a conduit borrower.
Conduit financing issue means an issue the proceeds of which are
used or are reasonably expected to be used to finance at least one
purpose investment representing at least one conduit loan to one conduit
borrower.
Conduit loan means a purpose investment (as defined in Sec. 1.148-
1).
Governmental bond means any bond of an issue of tax-exempt bonds in
which none of the bonds are private activity bonds.
Issuance costs means costs to the extent incurred in connection
with, and allocable to, the issuance of an issue within the meaning of
section 147(g). For example, issuance costs include the following costs
but only to the extent incurred in connection with, and allocable to,
the borrowing: underwriters' spread; counsel fees; financial advisory
fees; fees paid to an organization to evaluate the credit quality of an
issue; trustee fees; paying agent fees; bond registrar, certification,
and authentication fees; accounting fees; printing costs for bonds and
offering documents; public approval process costs; engineering and
feasibility study costs; guarantee fees, other than for qualified
guarantees (as defined in Sec. 1.148-4(f)); and similar costs.
Issue date means, in reference to an issue, the first date on which
the issuer receives the purchase price in exchange for delivery of the
evidence of indebtedness representing any bond included in the issue.
Issue date means, in reference to a bond, the date on which the issuer
receives the purchase price in exchange for that bond. In no event is
the issue date earlier than the first day on which interest begins to
accrue on the bond or bonds for Federal income tax purposes.
Obligation means any valid evidence of indebtedness under general
Federal income tax principles.
Pooled financing issue means an issue the proceeds of which are to
be used to finance purpose investments representing conduit loans to two
or more conduit borrowers, unless those conduit loans are to be used to
finance a single capital project.
Private activity bond means a private activity bond (as defined in
section 141).
Qualified mortgage loan means a mortgage loan with respect to an
owner-occupied residence acquired with the proceeds of an obligation
described in section 143(a)(1) or 143(b) (or applicable prior law).
Qualified student loan means a student loan acquired with the
proceeds of an obligation described in section 144(b)(1).
Related party means, in reference to a governmental unit or a
501(c)(3) organization, any member of the same controlled group, and, in
reference to any person that is not a governmental unit or 501(c)(3)
organization, a related person (as defined in section 144(a)(3)).
Taxable bond means any obligation the interest on which is not
excludable from gross income under section 103.
Tax-exempt bond means any bond the interest on which is excludable
from gross income under section 103(a). For purposes of section 148,
tax-exempt bond includes:
(1) An interest in a regulated investment company to the extent that
at least 95 percent of the income to the holder of the interest is
interest that is excludable from gross income under section 103; and
(2) A certificate of indebtedness issued by the United States
Treasury pursuant to the Demand Deposit State and Local Government
Series program described in 31 CFR part 344.
Working capital expenditure means any cost that is not a capital
expenditure. Generally, current operating expenses are working capital
expenditures.
(c) Definition of issue--(1) In general. Except as otherwise
provided in this paragraph (c), the term issue means two or more bonds
that meet all of the following requirements:
[[Page 146]]
(i) Sold at substantially the same time. The bonds are sold at
substantially the same time. Bonds are treated as sold at substantially
the same time if they are sold less than 15 days apart.
(ii) Sold pursuant to the same plan of financing. The bonds are sold
pursuant to the same plan of financing. Factors material to the plan of
financing include the purposes for the bonds and the structure of the
financing. For example, generally--
(A) Bonds to finance a single facility or related facilities are
part of the same plan of financing;
(B) Short-term bonds to finance working capital expenditures and
long-term bonds to finance capital projects are not part of the same
plan of financing; and
(C) Certificates of participation in a lease and general obligation
bonds secured by tax revenues are not part of the same plan of
financing.
(iii) Payable from same source of funds. The bonds are reasonably
expected to be paid from substantially the same source of funds,
determined without regard to guarantees from parties unrelated to the
obligor.
(2) Exception for taxable bonds. Taxable bonds and tax-exempt bonds
are not part of the same issue under this paragraph (c). The issuance of
tax-exempt bonds in a transaction (or series of related transactions)
that includes taxable bonds, however, may constitute an abusive
arbitrage device under Sec. 1.148-10(a) or a device to avoid other
limitations in sections 103 and 141 through 150 (for example, structures
involving windows or unreasonable allocations of bonds).
(3) Exception for certain bonds financing separate purposes--(i) In
general. Bonds may be treated as part of separate issues if the
requirements of this paragraph (c)(3) are satisfied. Each of these
separate issues must finance a separate purpose (e.g., refunding a
separate prior issue, financing a separate purpose investment, financing
integrated or functionally related capital projects, and financing any
clearly discrete governmental purpose). Each of these separate issues
independently must be a tax-exempt bond (e.g., a governmental bond or a
qualified mortgage bond). The aggregate proceeds, investments, and bonds
in such a transaction must be allocated between each of the separate
issues using a reasonable, consistently applied allocation method. If
any separate issue consists of refunding bonds, the allocation rules in
Sec. 1.148-9(h) must be satisfied. An allocation is not reasonable if
it achieves more favorable results under sections 103 and 141 to 150
than could be achieved with actual separate issues. All allocations
under this paragraph (c)(3) must be made in writing on or before the
issue date.
(ii) Exceptions. This paragraph (c)(3) does not apply for purposes
of sections 141, 144(a), 148, 149(d) and 149(g).
(4) Special rules for certain financings--(i) Draw-down loans. Bonds
issued pursuant to a draw-down loan are treated as part of a single
issue. The issue date of that issue is the first date on which the
aggregate draws under the loan exceed the lesser of $50,000 or 5 percent
of the issue price.
(ii) Commercial paper--(A) In general. Short-term bonds having a
maturity of 270 days or less (commercial paper) issued pursuant to the
same commercial paper program may be treated as part of a single issue,
the issue date of which is the first date the aggregate amount of
commercial paper issued under the program exceeds the lesser of $50,000
or 5 percent of the aggregate issue price of the commercial paper in the
program. A commercial paper program is a program to issue commercial
paper to finance or refinance the same governmental purpose pursuant to
a single master legal document. Commercial paper is not part of the same
commercial paper program unless issued during an 18-month period,
beginning on the deemed issue date. In addition, commercial paper issued
after the end of this 18-month period may be treated as part of the
program to the extent issued to refund commercial paper that is part of
the program, but only to the extent that--
(1) There is no increase in the principal amount outstanding; and
(2) The program does not have a term in excess of--
(i) 30 years; or
(ii) The period reasonably necessary for the governmental purposes
of the program.
[[Page 147]]
(B) Safe harbor. The requirement of paragraph (c)(4)(ii)(A)(2) of
this section is treated as satisfied if the weighted average maturity of
the issue does not exceed 120 percent of the weighted average expected
economic life of the property financed by the issue.
(iii) Certain general obligation bonds. Except as otherwise provided
in paragraph (c)(2) of this section, bonds that are secured by a pledge
of the issuer's full faith and credit (or a substantially similar
pledge) and sold and issued on the same dates pursuant to a single
offering document may be treated as part of the same issue if the issuer
so elects on or before the issue date.
(5) Anti-abuse rule. In order to prevent the avoidance of sections
103 and 141 through 150 and the general purposes thereof, the
Commissioner may treat bonds as part of the same issue or as part of
separate issues to clearly reflect the economic substance of a
transaction.
(6) Sale date. The sale date of a bond is the first day on which
there is a binding contract in writing for the sale or exchange of the
bond.
(d) Definition of refunding issue and related definitions--(1)
General definition of refunding issue. Refunding issue means an issue of
obligations the proceeds of which are used to pay principal, interest,
or redemption price on another issue (a prior issue, as more
particularly defined in paragraph (d)(5) of this section), including the
issuance costs, accrued interest, capitalized interest on the refunding
issue, a reserve or replacement fund, or similar costs, if any, properly
allocable to that refunding issue.
(2) Exceptions and special rules. For purposes of paragraph (d)(1)
of this section, the following exceptions and special rules apply--
(i) Payment of certain interest. An issue is not a refunding issue
if the only principal and interest that is paid with proceeds of the
issue (determined without regard to the multipurpose issue rules of
Sec. 1.148-9(h)) is interest on another issue that--
(A) Accrues on the other issue during a one-year period including
the issue date of the issue that finances the interest;
(B) Is a capital expenditure; or
(C) Is a working capital expenditure to which the de minimis rule of
Sec. 1.148-6(d)(3)(ii)(A) applies.
(ii) Certain issues with different obligors--(A) In general. An
issue is not a refunding issue to the extent that the obligor (as
defined in paragraph (d)(2)(ii)(B) of this section) of one issue is
neither the obligor of the other issue nor a related party with respect
to the obligor of the other issue.
(B) Definition of obligor. The obligor of an issue means the actual
issuer of the issue, except that the obligor of the portion of an issue
properly allocable to an investment in a purpose investment means the
conduit borrower under that purpose investment. The obligor of an issue
used to finance qualified mortgage loans, qualified student loans, or
similar program investments (as defined in Sec. 1.148-1) does not
include the ultimate recipient of the loan (e.g., the homeowner, the
student).
(iii) Certain special rules for purpose investments. For purposes of
this paragraph (d), the following special rules apply:
(A) Refunding of a conduit financing issue by a conduit loan
refunding issue. Except as provided in paragraph (d)(2)(iii)(B) of this
section, the use of the proceeds of an issue that is used to refund an
obligation that is a purpose investment (a conduit refunding issue) by
the actual issuer of the conduit financing issue determines whether the
conduit refunding issue is a refunding of the conduit financing issue
(in addition to a refunding of the obligation that is the purpose
investment).
(B) Recycling of certain payments under purpose investments. A
conduit refunding issue is not a refunding of a conduit financing issue
to the extent that the actual issuer of the conduit financing issue
reasonably expects as of the date of receipt of the proceeds of the
conduit refunding issue to use those amounts within 6 months (or, if
greater, during the applicable temporary period for those amounts under
section 148(c) or under applicable prior law) to acquire a new purpose
investment. Any new purpose investment is treated as made from the
proceeds of the conduit financing issue.
[[Page 148]]
(C) Application to tax-exempt loans. For purposes of this paragraph
(d), obligations that would be purpose investments (absent section
148(b)(3)(A)) are treated as purpose investments.
(iv) Substance of transaction controls. In the absence of other
applicable controlling rules under this paragraph (d), the determination
of whether an issue is a refunding issue is based on the substance of
the transaction in light of all the facts and circumstances.
(v) Certain integrated transactions in connection with asset
acquisition not treated as refunding issues. If, within six months
before or after a person assumes (including taking subject to)
obligations of an unrelated party in connection with an asset
acquisition (other than a transaction to which section 381(a) applies if
the person assuming the obligation is the acquiring corporation within
the meaning of section 381(a)), the assumed issue is refinanced, the
refinancing issue is not treated as a refunding issue.
(3) Current refunding issue. Current refunding issue means:
(i) Except as provided in paragraph (d)(3)(ii) of this section, a
refunding issue that is issued not more than 90 days before the last
expenditure of any proceeds of the refunding issue for the payment of
principal or interest on the prior issue; and
(ii) In the case of a refunding issue issued before 1986--
(A) A refunding issue that is issued not more than 180 days before
the last expenditure of any proceeds of the refunding issue for the
payment of principal or interest on the prior issue; or
(B) A refunding issue if the prior issue had a term of less than 3
years and was sold in anticipation of permanent financing, but only if
the aggregate term of all prior issues sold in anticipation of permanent
financing was less than 3 years.
(4) Advance refunding issue. Advance refunding issue means a
refunding issue that is not a current refunding issue.
(5) Prior issue. Prior issue means an issue of obligations all or a
portion of the principal, interest, or call premium on which is paid or
provided for with proceeds of a refunding issue. A prior issue may be
issued before, at the same time as, or after a refunding issue. If the
refunded and unrefunded portions of a prior issue are treated as
separate issues under Sec. 1.148-9(i), for the purposes for which that
section applies, except to the extent that the context clearly requires
otherwise, references to a prior issue refer only to the refunded
portion of that prior issue.
(e) Controlled group means a group of entities controlled directly
or indirectly by the same entity or group of entities within the meaning
of this paragraph (e).
(1) Direct control. The determination of direct control is made on
the basis of all the relevant facts and circumstances. One entity or
group of entities (the controlling entity) generally controls another
entity or group of entities (the controlled entity) for purposes of this
paragraph if the controlling entity possesses either of the following
rights or powers and the rights or powers are discretionary and non-
ministerial--
(i) The right or power both to approve and to remove without cause a
controlling portion of the governing body of the controlled entity; or
(ii) The right or power to require the use of funds or assets of the
controlled entity for any purpose of the controlling entity.
(2) Indirect control. If a controlling entity controls a controlled
entity under the test in paragraph (e)(1) of this section, then the
controlling entity also controls all entities controlled, directly or
indirectly, by the controlled entity or entities.
(3) Exception for general purpose governmental entities. An entity
is not a controlled entity under this paragraph (e) if the entity
possesses substantial taxing, eminent domain, and police powers. For
example, a city possessing substantial amounts of each of these
sovereign powers is not a controlled entity of the state.
[T.D. 8476, 58 FR 33549, June 18, 1993; 58 FR 44453, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24046, May 10, 1994; T.D. 8712, 62 FR 2304,
Jan. 16, 1997; T.D. 8718, 62 FR 25513, May 9, 1997; T.D. 9234, 70 FR
75036, Dec. 19, 2005; T.D. 9533, 76 FR 39280, July 6, 2011; T.D. 9637,
78 FR 54759, Sept. 6, 2013]
[[Page 149]]
Sec. 1.150-2 Proceeds of bonds used for reimbursement.
(a) Table of contents. This table of contents contains a listing of
the headings contained in Sec. 1.150-2.
(a) Table of contents.
(b) Scope.
(c) Definitions.
(d) General operating rules for reimbursement expenditures.
(1) Official intent.
(2) Reimbursement period.
(3) Nature of expenditure.
(e) Official intent rules.
(1) Form of official intent.
(2) Project description in official intent.
(3) Reasonableness of official intent.
(f) Exceptions to general operating rules.
(1) De minimis exception.
(2) Preliminary expenditures exception.
(g) Special rules on refundings.
(1) In general--once financed, not reimbursed.
(2) Certain proceeds of prior issue used for reimbursement treated
as unspent.
(h) Anti-abuse rules.
(1) General rule.
(2) One-year step transaction rule.
(i) Authority of the Commissioner to prescribe rules.
(j) Effective date.
(1) In general.
(2) Transitional rules.
(b) Scope. This section applies to reimbursement bonds (as defined
in paragraph (c) of this section) for all purposes of sections 103 and
141 to 150.
(c) Definitions. The following definitions apply:
Issuer means--
(1) For any private activity bond (excluding a qualified 501(c)(3)
bond, qualified student loan bond, qualified mortgage bond, or qualified
veterans' mortgage bond), the entity that actually issues the
reimbursement bond; and
(2) For any bond not described in paragraph (1) of this definition,
either the entity that actually issues the reimbursement bond or, to the
extent that the reimbursement bond proceeds are to be loaned to a
conduit borrower, that conduit borrower.
Official intent means an issuer's declaration of intent to reimburse
an original expenditure with proceeds of an obligation.
Original expenditure means an expenditure for a governmental purpose
that is originally paid from a source other than a reimbursement bond.
Placed in service means, with respect to a facility, the date on
which, based on all the facts and circumstances--
(1) The facility has reached a degree of completion which would
permit its operation at substantially its design level; and
(2) The facility is, in fact, in operation at such level.
Reimbursement allocation means an allocation in writing that
evidences an issuer's use of proceeds of a reimbursement bond to
reimburse an original expenditure. An allocation made within 30 days
after the issue date of a reimbursement bond may be treated as made on
the issue date.
Reimbursement bond means the portion of an issue allocated to
reimburse an original expenditure that was paid before the issue date.
(d) General operating rules for reimbursement expenditures. Except
as otherwise provided, a reimbursement allocation is treated as an
expenditure of proceeds of a reimbursement bond for the governmental
purpose of the original expenditure on the date of the reimbursement
allocation only if:
(1) Official intent. Not later than 60 days after payment of the
original expenditure, the issuer adopts an official intent for the
original expenditure that satisfies paragraph (e) of this section.
(2) Reimbursement period--(i) In general. The reimbursement
allocation is made not later than 18 months after the later of--
(A) The date the original expenditure is paid; or
(B) The date the project is placed in service or abandoned, but in
no event more than 3 years after the original expenditure is paid.
(ii) Special rule for small issuers. In applying paragraph (d)(2)(i)
of this section to an issue that satisfies section 148(f)(4)(D)(i) (I)
through (IV), the ``18 month'' limitation is changed to ``3 years'' and
the ``3-year'' maximum reimbursement period is disregarded.
(iii) Special rule for long-term construction projects. In applying
paragraph (d)(2)(i) to a construction project for which both the issuer
and a licensed architect or engineer certify that at least 5 years is
necessary to complete construction of the project, the maximum
[[Page 150]]
reimbursement period is changed from ``3 years'' to ``5 years.''
(3) Nature of expenditure. The original expenditure is a capital
expenditure, a cost of issuance for a bond, an expenditure described in
Sec. 1.148-6(d)(3)(ii)(B) (relating to certain extraordinary working
capital items), a grant (as defined in Sec. 1.148-6(d)(4)), a qualified
student loan, a qualified mortgage loan, or a qualified veterans'
mortgage loan.
(e) Official intent rules. An official intent satisfies this
paragraph (e) if:
(1) Form of official intent. The official intent is made in any
reasonable form, including issuer resolution, action by an appropriate
representative of the issuer (e.g., a person authorized or designated to
declare official intent on behalf of the issuer), or specific
legislative authorization for the issuance of obligations for a
particular project.
(2) Project description in official intent--(i) In general. The
official intent generally describes the project for which the original
expenditure is paid and states the maximum principal amount of
obligations expected to be issued for the project. A project includes
any property, project, or program (e.g., highway capital improvement
program, hospital equipment acquisition, or school building renovation).
(ii) Fund accounting. A project description is sufficient if it
identifies, by name and functional purpose, the fund or account from
which the original expenditure is paid (e.g., parks and recreation
fund--recreational facility capital improvement program).
(iii) Reasonable deviations in project description. Deviations
between a project described in an official intent and the actual project
financed with reimbursement bonds do not invalidate the official intent
to the extent that the actual project is reasonably related in function
to the described project. For example, hospital equipment is a
reasonable deviation from hospital building improvements. In contrast, a
city office building rehabilitation is not a reasonable deviation from
highway improvements.
(3) Reasonableness of official intent. On the date of the
declaration, the issuer must have a reasonable expectation (as defined
in Sec. 1.148-1(b)) that it will reimburse the original expenditure
with proceeds of an obligation. Official intents declared as a matter of
course or in amounts substantially in excess of the amounts expected to
be necessary for the project (e.g., blanket declarations) are not
reasonable. Similarly, a pattern of failure to reimburse actual original
expenditures covered by official intents (other than in extraordinary
circumstances) is evidence of unreasonableness. An official intent
declared pursuant to a specific legislative authorization is rebuttably
presumed to satisfy this paragraph (e)(3).
(f) Exceptions to general operating rules--(1) De minimis exception.
Paragraphs (d)(1) and (d)(2) of this section do not apply to costs of
issuance of any bond or to an amount not in excess of the lesser of
$100,000 or 5 percent of the proceeds of the issue.
(2) Preliminary expenditures exception. Paragraphs (d)(1) and (d)(2)
of this section do not apply to any preliminary expenditures, up to an
amount not in excess of 20 percent of the aggregate issue price of the
issue or issues that finance or are reasonably expected by the issuer to
finance the project for which the preliminary expenditures were
incurred. Preliminary expenditures include architectural, engineering,
surveying, soil testing, reimbursement bond issuance, and similar costs
that are incurred prior to commencement of acquisition, construction, or
rehabilitation of a project, other than land acquisition, site
preparation, and similar costs incident to commencement of construction.
(g) Special rules on refundings--(1) In general--once financed, not
reimbursed. Except as provided in paragraph (g)(2) of this section,
paragraph (d) of this section does not apply to an allocation to pay
principal or interest on an obligation or to reimburse an original
expenditure paid by another obligation. Instead, such an allocation is
analyzed under rules on refunding issues. See Sec. 1.148-9.
(2) Certain proceeds of prior issue used for reimbursement treated
as unspent. In the case of a refunding issue (or series of refunding
issues), proceeds of a prior issue purportedly used to reimburse
original expenditures are treated as unspent proceeds of the prior issue
unless the purported reimbursement was
[[Page 151]]
a valid expenditure under applicable law on reimbursement expenditures
on the issue date of the prior issue.
(h) Anti-abuse rules--(1) General rule. A reimbursement allocation
is not an expenditure of proceeds of an issue under this section if the
allocation employs an abusive arbitrage device under Sec. 1.148-10 to
avoid the arbitrage restrictions or to avoid the restrictions under
sections 142 through 147.
(2) One-year step transaction rule--(i) Creation of replacement
proceeds. A purported reimbursement allocation is invalid and thus is
not an expenditure of proceeds of an issue if, within 1 year after the
allocation, funds corresponding to the proceeds of a reimbursement bond
for which a reimbursement allocation was made are used in a manner that
results in the creation of replacement proceeds (as defined in Sec.
1.148-1) of that issue or another issue. The preceding sentence does not
apply to amounts deposited in a bona fide debt service fund (as defined
in Sec. 1.148-1).
(ii) Example. The provisions of paragraph (h)(2)(i) of this section
are illustrated by the following example.
Example. On January 1, 1994, County A issues an issue of 7 percent
tax-exempt bonds (the 1994 issue) and makes a purported reimbursement
allocation to reimburse an original expenditure for specified capital
improvements. A immediately deposits funds corresponding to the proceeds
subject to the reimbursement allocation in an escrow fund to provide for
payment of principal and interest on its outstanding 1991 issue of 9
percent tax-exempt bonds (the prior issue). The use of amounts
corresponding to the proceeds of the reimbursement bonds to create a
sinking fund for another issue within 1 year after the purported
reimbursement allocation invalidates the reimbursement allocation. The
proceeds retain their character as unspent proceeds of the 7 percent
issue upon deposit in the escrow fund. Accordingly, the proceeds are
subject to the 7 percent yield restriction of the 1994 issue instead of
the 9 percent yield restriction of the prior issue.
(i) Authority of the Commissioner to prescribe rules. The
Commissioner may by revenue ruling or revenue procedure (see Sec.
601.601(d)(2)(ii)(b) of this chapter) prescribe rules for the
expenditure of proceeds of reimbursement bonds in circumstances that do
not otherwise satisfy this section.
(j) Effective date--(1) In general. The provisions of this section
apply to all allocations of proceeds of reimbursement bonds issued after
June 30, 1993.
(2) Transitional rules--(i) Official intent. An official intent is
treated as satisfying the official intent requirement of paragraph
(d)(1) of this section if it--
(A) Satisfied the applicable provisions of Sec. 1.103-8(a)(5) as in
effect prior to July 1, 1993, (as contained in 26 CFR part 1 revised as
of April 1, 1993) and was made prior to that date, or
(B) Satisfied the applicable provisions of Sec. 1.103-18 as in
effect between January 27, 1992, and June 30, 1993, (as contained in 26
CFR part 1 revised as of April 1, 1993) and was made during that period.
(ii) Certain expenditures of private activity bonds. For any
expenditure that was originally paid prior to August 15, 1993, and that
would have qualified for expenditure by reimbursement from the proceeds
of a private activity bond under T.D. 7199, section 1.103-8(a)(5), 1972-
2 C.B. 45 (see Sec. 601.601(d)(2)(ii)(b)) of this chapter, the
requirements of that section may be applied in lieu of this section.
[T.D. 8476, 58 FR 33551, June 18, 1993; 58 FR 44453, Aug. 23, 1993]
Sec. 1.150-4 Change in use of facilities financed with tax-exempt
private activity bonds.
(a) Scope. This section applies for purposes of the rules for change
of use of facilities financed with private activity bonds under sections
150(b)(3) (relating to qualified 501(c)(3) bonds), 150(b)(4) (relating
to certain exempt facility bonds and small issue bonds), 150(b)(5)
(relating to facilities required to be owned by governmental units or
501(c)(3) organizations), and 150(c).
(b) Effect of remedial actions--(1) In general. Except as provided
in this section, the change of use provisions of sections 150(b) (3)
through (5), and 150(c) apply even if the issuer takes a remedial action
described in Sec. Sec. 1.142-2, 1.144-2, or 1.145-2.
(2) Exceptions--(i) Redemption. If nonqualified bonds are redeemed
within 90 days of a deliberate action under Sec. 1.145-2(a) or within
90 days of the date
[[Page 152]]
on which a failure to properly use proceeds occurs under Sec. 1.142-2
or Sec. 1.144-2, sections 150(b) (3) through (5) do not apply during
the period between that date and the date on which the nonqualified
bonds are redeemed.
(ii) Alternative qualifying use of facility. If a bond-financed
facility is used for an alternative qualifying use under Sec. Sec.
1.145-2 and 1.141-12(f), sections 150(b) (3) and (5) do not apply
because of the alternative use.
(iii) Alternative use of disposition proceeds. If disposition
proceeds are used for a qualifying purpose under Sec. Sec. 1.145-2 and
1.141-12(e), 1.142-2(c)(4), or 1.144-2, sections 150(b) (3) through (5)
do not apply because of the deliberate action that gave rise to the
disposition proceeds after the date on which all of the disposition
proceeds have been expended on the qualifying purpose. If all of the
disposition proceeds are so expended within 90 days of the date of the
deliberate action, however, sections 150(b) (3) through (5) do not apply
because of the deliberate action.
(c) Allocation rules--(1) In general. If a change in use of a
portion of the property financed with an issue of qualified private
activity bonds causes section 150 (b)(3), (b)(4), or (b)(5) to apply to
an issue, the bonds of the issue allocable to that portion under section
150(c)(3) are the same as the nonqualified bonds determined for purposes
of Sec. Sec. 1.142-1, 1.144-1, and 1.145-1, except that bonds allocable
to all common areas are also allocated to that portion.
(2) Special rule when remedial action is taken. If an issuer takes a
remedial action with respect to an issue of private activity bonds under
Sec. Sec. 1.142-2, 1.144-2, or 1.145-2, the bonds of the issue
allocable to a portion of property are the same as the nonqualified
bonds determined for purposes of those sections.
(d) Effective dates. For effective dates of this section, see Sec.
1.141-16.
[T.D. 8712, 62 FR 2304, Jan. 16, 1997]
Sec. 1.150-5 Filing notices and elections.
(a) In general. Notices and elections under the following sections
must be filed with the Internal Revenue Service, 1111 Constitution
Avenue, NW, Attention: T:GE:TEB:O, Washington, DC 20224 or such other
place designated by publication of a notice in the Internal Revenue
Bulletin--
(1) Section 1.141-12(d)(3);
(2) Section 1.142(f)(4)-1; and
(3) Section 1.142-2(c)(2).
(b) Effective dates. This section applies to notices and elections
filed on or after January 19, 2001.
[T.D. 8941, 66 FR 4671, Jan. 18, 2001]
Regulations Applicable to Certain Bonds Sold Prior to July 8, 1997
Editorial Note: IRS redesignated the following sections to appear
below the undesignated center heading ``Regulations Applicable to
Certain Bonds Sold Prior to July 8, 1997'' and preceding the
undesignated center heading ``Deductions for Personal Exemptions.'' See
62 FR 25507 and 25513, May 9, 1997 for the specific sections involved in
the redesignation.
Sec. 1.148-1A Definitions and elections.
(a) [Reserved]. For guidance see Sec. 1.148-1.
(b) Certain definitions.
Investment-type property. See Sec. 1.148-1(b). Investment-type
property also includes a contract that would be a hedge (within the
meaning of Sec. 1.148-4(h)) except that it contains a significant
investment element.
(c) through (c)(4)(i) [Reserved]. For guidance see Sec. 1.148-1.
(c)(4)(ii) Bonds financing a working capital reserve--(A) In
general. Except as otherwise provided in Sec. 1.148-1(c)(4)(ii)(B),
replacement proceeds arise to the extent a working capital reserve is,
directly or indirectly, financed with the proceeds of the issue
(regardless of the expenditure of proceeds of the issue). Thus, for
example, if an issuer that does not maintain a working capital reserve
borrows to fund such a reserve, the issuer will have replacement
proceeds. To determine the amount of a working capital reserve
maintained, an issuer may use the average amount maintained as a working
capital reserve during annual periods of at least one year, the last of
which ends within a year before the issue date. For example, the amount
of a working capital reserve may be computed using the average of the
beginning or ending monthly balances of the amount maintained as a
reserve (net of unexpended gross proceeds) during the
[[Page 153]]
one year period preceding the issue date.
[T.D. 8538, 59 FR 24041, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-2A General arbitrage yield restriction rules.
(a) through (b)(2)(i) [Reserved]. For guidance see Sec. 1.148-2.
(b)(2)(ii) Exceptions to certification requirement. An issuer is not
required to make a certification for an issue under Sec. 1.148-
2(b)(2)(i) if--
(A) The issuer reasonably expects as of the issue date that there
will be no unspent gross proceeds after the issue date, other than gross
proceeds in a bona fide debt service fund (e.g., equipment lease
financings in which the issuer purchases equipment in exchange for an
installment payment note); or
(B) The issue price of the issue does not exceed $1,000,000.
[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-3A General arbitrage rebate rules.
(a) through (h)(2) [Reserved]. For guidance see Sec. 1.148-3.
(h)(3) Waivers of the penalty. For purposes of Sec. 1.148-3(h)(3),
willful neglect does not include a failure that is attributable solely
to the permissible retroactive selection of a short first bond year if
the rebate amount that the issuer failed to pay is paid within 60 days
of the selection of that bond year.
[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-4A Yield on an issue of bonds.
(a) through (b)(4) [Reserved]. For guidance see Sec. 1.148-4.
(b)(5) Special aggregation rule treating certain bonds as a single
fixed yield bond. Two variable yield bonds of an issue are treated in
the aggregate as a single fixed yield bond if--
(i) Aggregate treatment would result in the single bond being a
fixed yield bond; and
(ii) The terms of the bonds do not contain any features that could
distort the aggregate fixed yield from what the yield would be if a
single fixed yield bond were issued. For example, if an issue contains a
bond bearing interest at a floating rate and a related bond bearing
interest at a rate equal to a fixed rate minus that floating rate, those
two bonds are treated as a single fixed yield bond only if neither bond
may be redeemed unless the other bond is also redeemed at the same time.
(c) through (f) [Reserved]. For guidance see Sec. 1.148-4.
(g) Yield on certain mortgage revenue and student loan bonds. For
purposes of section 148 and Sec. 1.148-4, section 143(g)(2)(C)(ii)
applies to the computation of yield on an issue of qualified mortgage
bonds or qualified veterans' mortgage bonds. For purposes of applying
sections 148 and 143(g) to a variable yield issue of qualified mortgage
bonds, qualified veterans' mortgage bonds, or qualified student loan
bonds, the yield on that issue is computed over the term of the issue,
and Sec. 1.148-4(d) does not apply to the issue. As of any date before
the final maturity date, the yield over the term of the issue is based
on the actual amounts paid or received to that date and the amounts that
are reasonably expected (as of that date) to be paid or received over
the remaining term of the issue.
(h) Qualified hedging transactions--(1) In general. Payments made or
received by an issuer under a qualified hedge (as defined in Sec.
1.148-4(h)(2)) relating to bonds of an issue are taken into account (as
provided in paragraph (h)(3) of this section) to determine the yield on
the issue. Except as provided in paragraphs (h)(4) and (h)(5)(ii)(C) of
this section, the bonds to which a qualified hedge relates are treated
as variable yield bonds. These hedging rules apply solely for purposes
of sections 143(g), 148, and 149(d).
(2) (i) through (vi) [Reserved]. For guidance see Sec. 1.148-
4(h)(2).
(2)(vii) Timing and duration. For a contract to be a qualified hedge
under Sec. 1.148-4(h)(2), payments must not begin to accrue under the
contract on a date earlier than the issue date of the hedged bonds and
must not accrue longer than the hedged interest payments on the hedged
bonds.
(viii) [Reserved]. For guidance see Sec. 1.148-4(h).
[[Page 154]]
(ix) Identification. For a contract to be a qualified hedge under
Sec. 1.148-4(h)(2), the contract must be identified by the actual
issuer on its books and records maintained for the hedged bonds not
later than three days after the date on which the parties enter into the
contract. The identification must specify the hedge provider, the terms
of the contract, and the hedged bonds. The identification must contain
sufficient detail to establish that the requirements of Sec. 1.148-
4(h)(2), and if applicable, paragraph (h)(4) of this section are
satisfied. The existence of the hedge must be noted on all forms filed
with the Internal Revenue Service for the issue on or after the date on
which the hedge is entered into.
(3) Accounting for qualified hedges--(i) In general. Except as
otherwise provided in paragraph (h)(4) of this section, payments made or
received by the issuer under a qualified hedge are treated as payments
made or received, as appropriate, on the hedged bonds that are taken
into account in determining the yield on those bonds. These payments are
reasonably allocated to the hedged bonds in the period to which the
payments relate, as determined under paragraph (h)(3)(iii) of this
section. Payments made or received by the issuer include payments deemed
made or received when a contract is terminated or deemed terminated
under this paragraph (h)(3). Payments reasonably allocable to the
reduction of risk of interest rate changes and to the hedge provider's
overhead under this paragraph (h) are included as payments made or
received under a qualified hedge.
(ii) Exclusions from hedge. Payments for services or other items
under the contract that are not expressly treated as payments under the
qualified hedge under paragraph (h)(3)(i) of this section are not
payments with respect to a qualified hedge.
(iii) Timing and allocation of payments. The period to which a
payment made by the issuer relates is determined under general Federal
income tax principles, including, without limitation, Sec. 1.446-3, and
adjusted as necessary to reflect the end of a computation period and the
start of a new computation period. Except as provided in paragraphs
(h)(3)(iv) and (h)(5)(ii) of this section, a payment received by the
issuer is taken into account in the period that the interest payment
that the payment hedges is required to be made.
(iv) Termination payments--(A) Termination defined. A termination of
a qualified hedge includes any sale or other disposition of the hedge by
the issuer, or the acquisition by the issuer of an offsetting hedge. A
deemed termination occurs when the hedged bonds are redeemed and when a
hedge ceases to be a qualified hedge of the hedged bonds. In the case of
an assignment by a hedge provider of its remaining rights and
obligations on the hedge to a third party or a modification of the
hedging contract, the assignment or modification is treated as a
termination with respect to the issuer only if it results in a deemed
exchange of the hedge and a realization event under section 1001.
(B) General rule. A payment made or received by an issuer to
terminate a qualified hedge, including loss or gain realized or deemed
realized, is treated as a payment made or received on the hedged bonds,
as appropriate. The payment is reasonably allocated to the remaining
periods originally covered by the terminated hedge in a manner that
reflects the economic substance of the hedge.
(C) Special rule for terminations when bonds are redeemed. Except as
otherwise provided in this paragraph (h)(3)(iv)(C) and in paragraph
(h)(3)(iv)(D) of this section, when a qualified hedge is deemed
terminated because the hedged bonds are redeemed, the fair market value
of the contract on the redemption date is treated as a termination
payment made or received on that date. When hedged bonds are redeemed,
any payment received by the issuer on termination of a hedge, including
a termination payment or a deemed termination payment, reduces, but not
below zero, the interest payments made by the issuer on the hedged bonds
in the computation period ending on the termination date. The remainder
of the payment, if any, is reasonably allocated over the bond years in
the immediately preceding computation period or periods to the extent
necessary to eliminate the excess.
[[Page 155]]
(D) Special rules for refundings. To the extent that the hedged
bonds are redeemed using the proceeds of a refunding issue, the
termination payment is accounted for under paragraph (h)(3)(iv)(B) of
this section by treating it as a payment on the refunding issue, rather
than the hedged bonds. In addition, to the extent that the refunding
issue, rather than the hedged bonds, has been redeemed, paragraph
(h)(3)(iv)(C) of this section applies to the termination payment by
treating it as a payment on the redeemed refunding issue.
(E) Safe harbor for certain non-level payments. A non-level payment
to terminate a hedge does not result in that hedge failing to satisfy
the applicable provisions of paragraph (h)(3)(iv)(B) of this section if
the payment is allocated to each bond year for which the hedge would
have been in effect in accordance with this paragraph (h)(3)(iv)(E). For
a variable yield issue, an equal amount (or for any short bond year, a
proportionate amount of the equal amount) must be allocated to each bond
year such that the sum of the present values of the annual amounts
equals the present value of the non-level payment. Present value is
computed as of the day the hedge is terminated, using the yield on the
hedged bonds, determined without regard to the non-level payment. The
yield used for this purpose is computed for the period beginning on the
first date the hedge is in effect and ending on the date the hedge is
terminated. On the other hand, for a fixed yield issue, the non-level
payment is taken into account as a single payment on the date it is
paid.
(4) Certain variable yield bonds treated as fixed yield bonds--(i)
In general. Except as otherwise provided in this paragraph (h)(4), if
the issuer of variable yield bonds enters into a qualified hedge, the
hedged bonds are treated as fixed yield bonds paying a fixed interest
rate if:
(A) Start date. The date on which payments begin to accrue on the
hedge is not later than 15 days after the issue date of the hedged
bonds.
(B) Maturity. The term of the hedge is equal to the entire period
during which the hedged bonds bear interest at variable interest rates.
(C) Payments closely correspond. Payments to be received under the
hedge correspond closely in time to the hedged portion of the payments
on the hedged bonds. Hedge payments received within 15 days of the
related payments on the hedged bonds generally so correspond.
(D) Aggregate payments fixed. Taking into account all payments made
and received under the hedge and all payments on the hedged bonds (i.e.,
after netting all payments), the issuer's aggregate payments are fixed
and determinable as of a date not later than 15 days after the issue
date of the hedged bonds. Payments on bonds are treated as fixed for
purposes of this paragraph (h)(4)(i)(D) if payments on the bonds are
based, in whole or in part, on one interest rate, payments on the hedge
are based, in whole or in part, on a second interest rate that is
substantially the same as, but not identical to, the first interest rate
and payments on the bonds would be fixed if the two rates were
identical. Rates are treated as substantially the same if they are
reasonably expected to be substantially the same throughout the term of
the hedge. For example, an objective 30-day tax-exempt variable rate
index or other objective index (e.g., J.J. Kenny Index, PSA Municipal
swap index, a percentage of LIBOR) may be substantially the same as an
issuer's individual 30-day interest rate.
(ii) Accounting. Except as otherwise provided in this paragraph
(h)(4)(ii), in determining yield on the hedged bonds, all the issuer's
actual interest payments on the hedged bonds and all payments made and
received on a hedge described in paragraph (h)(4)(i) of this section are
taken into account. If payments on the bonds and payments on the hedge
are based, in whole or in part, on variable interest rates that are
substantially the same within the meaning of paragraph (h)(4)(i)(D) of
this section (but not identical), yield on the issue is determined by
treating the variable interest rates as identical. For example, if
variable rate bonds bearing interest at a weekly rate equal to the rate
necessary to remarket the bonds at par are hedged with an interest rate
swap under which the issuer receives payments based on a short-
[[Page 156]]
term floating rate index that is substantially the same as, but not
identical to, the weekly rate on the bonds, the interest payments on the
bonds are treated as equal to the payments received by the issuer under
the swap for purposes of computing the yield on the bonds.
(iii) Effect of termination--(A) In general. Except as otherwise
provided in this paragraph (h)(4)(iii) and paragraph (h)(5) of this
section, the issue of which the hedged bonds are a part is treated as if
it were reissued as of the termination date of the qualified hedge
covered by paragraph (h)(4)(i) of this section in determining yield on
the hedged bonds for purposes of Sec. 1.148-3. The redemption price of
the retired issue and the issue price of the new issue equal the
aggregate values of all the bonds of the issue on the termination date.
In computing the yield on the new issue for this purpose, any
termination payment is accounted for under paragraph (h)(3)(iv) of this
section, applied by treating the termination payment as made or received
on the new issue under this paragraph (h)(4)(iii).
(B) Effect of early termination. Except as otherwise provided in
this paragraph (h)(4)(iii), the general rules of paragraph (h)(4)(i) of
this section do not apply in determining the yield on the hedged bonds
for purposes of Sec. 1.148-3 if the hedge is terminated or deemed
terminated within 5 years after the issue date of the issue of which the
hedged bonds are a part. Thus, the hedged bonds are treated as variable
yield bonds for purposes of Sec. 1.148-3 from the issue date.
(C) Certain terminations disregarded. This paragraph (h)(4)(iii)
does not apply to a termination if, based on the facts and circumstances
(e.g., taking into account both the termination and any qualified hedge
that immediately replaces the terminated hedge), there is no change in
the yield. In addition, this paragraph (h)(4)(iii) does not apply to a
termination caused by the bankruptcy or insolvency of the hedge provider
if the Commissioner determines that the termination occurred without any
action by the issuer (other than to protect its rights under the hedge).
(5) Special rules for certain hedges--(i) Certain acquisition
payments. A payment to the issuer by the hedge provider (e.g., an up-
front payment for an off-market swap) in connection with the acquisition
of a hedge that, but for that payment, would be a qualified hedge, does
not cause the hedge to fail to be a qualified hedge provided the payment
to the issuer and the issuer's payments under the hedge in excess of
those that it would make if the hedge bore rates equal to the on-market
rates for the hedge are separately identified in a certification of the
hedge provider and not taken into account in determining the yield on
the issue of which the hedged bonds are a part. The on-market rates are
determined as of the date the parties enter into the contract.
(ii) Anticipatory hedges--(A) In general. A contract does not fail
to be a hedge under Sec. 1.148-4(h)(2)(i)(A) solely because it is
entered into with respect to an anticipated issuance of tax-exempt
bonds. The identification required under Sec. 1.148-4T(h)(2)(ix) must
specify the reasonably expected governmental purpose, principal amount,
and issue date of the hedged bonds, and the manner in which interest is
reasonably expected to be computed.
(B) Special rules. Payments made in connection with the issuance of
a bond to terminate or otherwise close (terminate) an anticipatory hedge
of that bond do not prevent the hedge from satisfying the requirements
of Sec. 1.148-4(h)(2)(vi) and paragraph (h)(2)(vii) of this section.
Amounts received or deemed to be received by the issuer in connection
with the issuance of the hedged bonds to terminate an anticipatory hedge
are treated as proceeds of the hedged bonds.
(C) Fixed yield treatment. A bond that is hedged with an
anticipatory hedge is a fixed yield bond if, taking into account
payments on the hedge that are made or fixed on or before the issue date
of the bond and the payments to be made on the bond, the bond satisfies
the definition of fixed yield bond. See also paragraph (h)(4) of this
section.
(6) Authority of the Commissioner--(i) In general. A contract is not
a qualified hedge if the Commissioner determines, based on all the facts
and circumstances, that treating the contract as a qualified hedge would
provide a
[[Page 157]]
material potential for arbitrage, or a principal purpose for entering
into the contract is that arbitrage potential. For example, a contract
that requires a substantial nonperiodic payment may constitute, in whole
or part, an embedded loan, investment-type property, or other
investment.
(ii) Other qualified hedges. The Commissioner, by publication of a
revenue ruling or revenue procedure, may specify contracts that do not
otherwise meet the requirements of Sec. 1.148-4(h)(2) as qualified
hedges and contracts that do not otherwise meet the requirements of
paragraph (h)(4) of this section as causing the hedged bonds to be
treated as fixed yield bonds.
(iii) Recomputation of yield. If an issuer enters into a hedge that
is not properly identified, fails to properly associate an anticipatory
hedge with the hedged bonds, or otherwise fails to meet the requirements
of this section, the Commissioner may recompute the yield on the issue
taking the hedge into account if the failure to take the hedge into
account distorts that yield or otherwise fails to clearly reflect the
economic substance of the transaction.
[T.D. 8538, 59 FR 24042, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-5A Yield and valuation of investments.
(a) through (b)(2)(ii) [Reserved]. For guidance see Sec. 1.148-5.
(b)(2)(iii) Permissive application of single investment rules to
certain yield restricted investments for all purposes of section 148.
For all purposes of section 148, an issuer may treat all of the yield
restricted nonpurpose investments in a refunding escrow and a sinking
fund that is reasonably expected as of the issue date to be maintained
to reduce the yield on the investments in the refunding escrow as a
single investment having a single yield, determined under Sec.
1.148(b)(2).
(b) (2)(iv) through (c)(1) [Reserved]. For guidance see Sec. 1.148-
5.
(c)(2) Manner of payment--(i) In general. Except as otherwise
provided in Sec. 1.148-5(c)(2)(ii), an amount is paid under Sec.
1.148-5(c) if it is paid to the United States at the same time and in
the same manner as rebate amounts are required to be paid or at such
other time or in such manner as the Commissioner may prescribe. For
example, yield reduction payments must be made on or before the date of
required rebate installment payments as described in Sec. 1.148-3(f).
The date a payment is required to be paid is determined without regard
to Sec. 1.148-3(h). An amount that is paid untimely is not taken into
account under this paragraph (c) unless the Commissioner determines that
the failure to pay timely is not due to willful neglect. The provisions
of Sec. 1.148-3(i) apply to payments made under Sec. 1.148-5(c).
(c)(2)(ii) through (c)(3)(i) [Reserved]. For guidance see Sec.
1.148-5.
(c)(3)(ii) Exception to yield reduction payments rule for advance
refunding issues. Section 1.148-5(c)(1) does not apply to investments
allocable to gross proceeds of an advance refunding issue, other than--
(A) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(C) applies;
(B) Replacement proceeds to which Sec. 1.148-5(c)(3)(i)(F) applies;
and
(C) Transferred proceeds to which Sec. 1.148-5(c)(3)(i)(E) applies,
but only to the extent necessary to satisfy yield restriction under
section 148(a) on those proceeds treating all investments allocable to
those proceeds as a separate class.
(d)(1) through (d)(3)(i) [Reserved]. For guidance see Sec. 1.148-5.
(d)(3)(ii) Exception to fair market value requirement for
transferred proceeds allocations, universal cap allocations, and
commingled funds. Section 1.148-5(d)(3)(i) does not apply if the
investment is allocated from one issue to another issue as a result of
the transferred proceeds allocation rule under Sec. 1.148-9(b) or the
universal cap rule under Sec. 1.148-6(b)(2), provided that both issues
consist exclusively of tax-exempt bonds. In addition, Sec. 1.148-
5(d)(3)(i) does not apply to investments in a commingled fund (other
than a bona fide debt service fund) unless it is an investment being
initially deposited in or withdrawn from a commingled fund described in
Sec. 1.148-6(e)(5)(iii).
(e)(1) through (e)(2)(ii)(A) [Reserved]. For guidance see Sec.
1.148-5.
[[Page 158]]
(e)(2)(ii)(B) External commingled funds. For any semiannual period,
a commingled fund satisfies the 10 percent requirement of Sec. 1.148-
5(e)(2)(ii)(B) if--
(1) Based on average amounts on deposit, this requirement was
satisfied for the prior semiannual period; and
(2) The fund does not accept deposits that would cause it to fail to
meet this requirement.
(iii) Special rule for guaranteed investment contracts. For a
guaranteed investment contract, a broker's commission or similar fee
paid on behalf of either an issuer or the provider is treated as an
administrative cost and, except in the case of an issue that satisfies
section 148(f)(4)(D)(i), is not a qualified administrative cost to the
extent that the present value of the commission, as of the date the
contract is allocated to the issue, exceeds the present value of annual
payments equal to .05 percent of the weighted average amount reasonably
expected to be invested each year of the term of the contract. For this
purpose, present value is computed using the taxable discount rate used
by the parties to compute the commission or, if not readily
ascertainable, a reasonable taxable discount rate.
[T.D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-6A General allocation and accounting rules.
(a) through (d)(3)(iii)(B) [Reserved]. For guidance see Sec. 1.148-
6.
(d)(3)(iii)(C) Qualified endowment funds treated as unavailable. For
a 501(c)(3) organization, a qualified endowment fund is treated as
unavailable. A fund is a qualified endowment fund if--
(1) The fund is derived from gifts or bequests, or the income
thereon, that were neither made nor reasonably expected to be used to
pay working capital expenditures;
(2) Pursuant to reasonable, established practices of the
organization, the governing body of the 501(c)(3) organization
designates and consistently operates the fund as a permanent endowment
fund or quasi-endowment fund restricted as to use; and
(3) There is an independent verification (e.g., from an independent
certified public accountant) that the fund is reasonably necessary as
part of the organization's permanent capital.
[T.D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-9A Arbitrage rules for refunding issues.
(a) through (c)(2)(ii)(A) [Reserved]. For guidance see Sec. 1.148-
9.
(c)(2)(ii)(B) Permissive allocation of non-proceeds to earliest
expenditures. Excluding amounts covered by Sec. 1.148-9(c)(2)(ii)(A)
and subject to any required earlier expenditure of those amounts, any
amounts in a mixed escrow that are not proceeds of a refunding issue may
be allocated to the earliest maturing investments in the mixed escrow,
provided that those investments mature and the proceeds thereof are
expended before the date of any expenditure from the mixed escrow to pay
any principal of the prior issue.
(d) through (h)(4)(v) [Reserved]. For guidance see Sec. 1.148-9.
(h)(4)(vi) Exception for refundings of interim notes. Section 1.148-
9(h)(4)(v) need not be applied to refunding bonds issued to provide
permanent financing for one or more projects if the prior issue had a
term of less than 3 years and was sold in anticipation of permanent
financing, but only if the aggregate term of all prior issues sold in
anticipation of permanent financing was less than 3 years.
[T.D. 8538, 59 FR 24045, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-10A Anti-abuse rules and authority of Commissioner.
(a) through (b)(1) [Reserved]. For guidance see Sec. 1.148-10.
(b)(2) Application. The provisions of Sec. 1.148-10(b) only apply
to the portion of an issue that, as a result of actions taken (or
actions not taken) after the issue date, overburdens the market for tax-
exempt bonds, except that for an issue that is reasonably expected as of
the issue date to overburden the market, those provisions apply to all
of the gross proceeds of the issue.
(c) through (c)(2)(viii) [Reserved]. For guidance see Sec. 1.148-
10.
(c)(2)(ix) For purposes of Sec. 1.148-10(c)(2), excess gross
proceeds do not include gross proceeds allocable to fees
[[Page 159]]
for a qualified hedge for the refunding issue.
[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25507, May 9, 1997]
Sec. 1.148-11A Effective dates.
(a) through (c)(3) [Reserved]. For guidance see Sec. 1.148-11.
(c)(4) Retroactive application of overpayment recovery provisions.
An issuer may apply the provisions of Sec. 1.148-3(i) to any issue that
is subject to section 148(f) or to sections 103(c)(6) or 103A(i) of the
Internal Revenue Code of 1954.
(d) through (h) [Reserved]. For guidance see Sec. 1.148-11.
(i) Transition rules for certain amendments--(1) In general. Section
1.103-8(a)(5), Sec. Sec. 1.148-1, 1.148-2, 1.148-3, 1.148-4, .148-5,
1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10, 1.148-11, 1.149(d)-1, and
1.150-1 as in effect on June 7, 1994 (see 26 CFR part 1 as revised April
1, 1997), and Sec. Sec. 1.148-1A through 1.148-11A, 1.149(d)-1A, and
1.150-1A apply, in whole, but not in part--
(i) To bonds sold after June 6, 1994, and before July 8, 1997;
(ii) To bonds issued before July 1, 1993, that are outstanding on
June 7, 1994, if the first time the issuer applies Sec. Sec. 1.148-1
through 1.148-11 as in effect on June 7, 1994 (see 26 CFR part 1 as
revised April 1, 1997), to the bonds under Sec. 1.148-11 (b) or (c) is
after June 6, 1994, and before July 8, 1997;
(iii) At the option of the issuer, to bonds to which Sec. Sec.
1.148-1 through 1.148-11, as in effect on July 1, 1993 (see 26 CFR part
1 as revised April 1, 1994), apply, if the bonds are outstanding on June
7, 1994, and the issuer applies Sec. 1.103-8(a)(5), Sec. Sec. 1.148-1,
1.148-2, 1.148-3, 1.148-4, 1.148-5, 1.148-6, 1.148-7, 1.148-8, 1.148-9,
1.148-10, 1.148-11, 1.149(d)-1, and 1.150-1 as in effect on June 7, 1994
(see 26 CFR part 1 as revised April 1, 1997), and Sec. Sec. 1.148-1A
through 1.148-11A, 1.149(d)-1A, and 1.150-1A to the bonds before July 8,
1997.
(2) Special rule. For purposes of paragraph (i)(1) of this section,
any reference to a particular paragraph of Sec. Sec. 1.148-1T, 1.148-
2T, 1.148-3T, 1.148-4T, 1.148-5T, 1.148-6T, 1.148-9T, 1.148-10T, 1.148-
11T, 1.149(d)-1T, or 1.150-1T shall be applied as a reference to the
corresponding paragraph of Sec. Sec. 1.148-1A, 1.148-2A, 1.148-3A,
1.148-4A, 1.148-5A, 1.148-6A, 1.148-9A, 1.148-10A, 1.148-11A, 1.149(d)-
1A, or 1.150-1A, respectively.
(3) Identification of certain hedges. For any hedge entered into
after June 18, 1993, and on or before June 6, 1994, that would be a
qualified hedge within the meaning of Sec. 1.148-4(h)(2), as in effect
on June 7, 1994 (see 26 CFR part 1 as revised April 1, 1997), except
that the hedge does not meet the requirements of Sec. 1.148-
4A(h)(2)(ix) because the issuer failed to identify the hedge not later
than 3 days after which the issuer and the provider entered into the
contract, the requirements of Sec. 1.148-4A(h)(2)(ix) are treated as
met if the contract is identified by the actual issuer on its books and
records maintained for the hedged bonds not later than July 8, 1997.
[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated and amended by T.D.
8718, 62 FR 25507, 25513, May 9, 1997]
Sec. 1.149(d)-1A Limitations on advance refundings.
(a) through (f)(2) [Reserved]. For guidance see Sec. 1.149(d)-1.
(f)(3) Application of savings test to multipurpose issues. Except as
otherwise provided in this paragraph (f)(3), the multipurpose issue
rules in Sec. 1.148-9(h) apply for purposes of the savings test. If any
separate issue in a multipurpose issue increases the aggregate present
value debt service savings on the entire multipurpose issue or reduces
the present value debt service losses on that entire multipurpose issue,
that separate issue satisfies the savings test.
[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25513, May 9, 1997]
Sec. 1.150-1A Definitions.
(a) through (b) [Reserved]. For guidance see Sec. 1.150-1.
(c) Definition of issue--(1) In general. Except as otherwise
provided, the provisions of this paragraph (c) apply for all purposes of
sections 103 and 141 through 150. Except as otherwise provided in this
paragraph (c), two or more bonds are treated as part of the same issue
if all of the following factors are present:
(i) Sold at substantially the same time. The bonds are sold at
substantially the same time. Bonds are treated as sold at
[[Page 160]]
substantially the same time if they are sold less than 15 days apart.
For this purpose only, a variable yield bond is treated as sold on its
issue date.
(ii) Sold pursuant to the same plan of financing. The bonds are sold
pursuant to the same plan of financing. Factors material to the plan of
financing include the purposes for the bonds and the structure of the
financing. For example, generally--
(A) Bonds to finance a single facility or related facilities are
part of the same plan of financing;
(B) Short-term bonds to finance working capital expenditures and
long-term bonds to finance capital projects are not part of the same
plan of financing; and
(C) Certificates of participation in a lease and general obligation
bonds secured by tax revenues are not part of the same plan of
financing.
(iii) Payable from same source of funds. The bonds are reasonably
expected to be paid from substantially the same source of funds,
determined without regard to guarantees from parties unrelated to the
obligor.
(2) through (4)(ii) [Reserved]. For guidance see Sec. 1.150-1
(c)(3) through (c)(4)(ii).
(c)(4)(iii) Certain general obligation bonds. Bonds are part of the
same issue if secured by a pledge of the issuer's full faith and credit
(or a substantially similar pledge) and sold and issued on the same
dates pursuant to a single offering document.
(5) [Reserved]. For guidance see Sec. 1.150-1(c)(5).
(6) Sale date. The sale date of a bond is the first day on which
there is a binding contract in writing for the sale or exchange of the
bond.
[T.D. 8538, 59 FR 24046, May 10, 1994. Redesignated by T.D. 8718, 62 FR
25513, May 9, 1997]
Deductions for Personal Exemptions
Sec. 1.151-1 Deductions for personal exemptions.
(a) In general. (1) In computing taxable income, an individual is
allowed a deduction for the exemptions specified in section 151. Such
exemptions are: (i) The exemptions for an individual taxpayer and spouse
(the so-called personal exemptions); (ii) the additional exemptions for
a taxpayer attaining the age of 65 years and spouse attaining the age of
65 years (the so-called old-age exemptions); (iii) the additional
exemptions for a blind taxpayer and a blind spouse; and (iv) the
exemptions for dependents of the taxpayer.
(2) A nonresident alien individual who is a bona fide resident of
Puerto Rico during the entire taxable year and subject to tax under
section 1 or 1201(b) is allowed as deductions the exemptions specified
in section 151, even though as to the United States such individual is a
nonresident alien. See section 876 and the regulations thereunder,
relating to alien residents of Puerto Rico.
(b) Exemptions for individual taxpayer and spouse (so-called
personal exemptions). Section 151(b) allows an exemption for the
taxpayer and an additional exemption for the spouse of the taxpayer if a
joint return is not made by the taxpayer and his spouse, and if the
spouse, for the calendar year in which the taxable year of the taxpayer
begins, has no gross income and is not the dependent of another
taxpayer. Thus, a husband is not entitled to an exemption for his wife
on his separate return for the taxable year beginning in a calendar year
during which she has any gross income (though insufficient to require
her to file a return). Since, in the case of a joint return, there are
two taxpayers (although under section 6013 there is only one income for
the two taxpayers on such return, i.e., their aggregate income), two
exemptions are allowed on such return, one for each taxpayer spouse. If
in any case a joint return is made by the taxpayer and his spouse, no
other person is allowed an exemption for such spouse even though such
other person would have been entitled to claim an exemption for such
spouse as a dependent if such joint return had not been made.
(c) Exemptions for taxpayer attaining the age of 65 and spouse
attaining the age of 65 (so-called old-age exemptions). (1) Section
151(c) provides an additional exemption for the taxpayer if he has
attained the age of 65 before the close of his taxable year. An
additional exemption is also allowed to the taxpayer for his spouse if a
joint return is not made by the taxpayer and his spouse
[[Page 161]]
and if the spouse has attained the age of 65 before the close of the
taxable year of the taxpayer and, for the calendar year in which the
taxable year of the taxpayer begins, the spouse has no gross income and
is not the dependent of another taxpayer. If a husband and wife make a
joint return, an old-age exemption will be allowed as to each taxpayer
spouse who has attained the age of 65 before the close of the taxable
year for which the joint return is made. The exemptions under section
151(c) are in addition to the exemptions for the taxpayer and spouse
under section 151(b).
(2) In determining the age of an individual for the purposes of the
exemption for old age, the last day of the taxable year of the taxpayer
is the controlling date. Thus, in the event of a separate return by a
husband, no additional exemption for old age may be claimed for his
spouse unless such spouse has attained the age of 65 on or before the
close of the taxable year of the husband. In no event shall the
additional exemption for old age be allowed with respect to a spouse who
dies before attaining the age of 65 even though such spouse would have
attained the age of 65 before the close of the taxable year of the
taxpayer. For the purposes of the old-age exemption, an individual
attains the age of 65 on the first moment of the day preceding his
sixty-fifth birthday. Accordingly, an individual whose sixty-fifth
birthday falls on January 1 in a given year attains the age of 65 on the
last day of the calendar year immediately preceding.
(d) Exemptions for the blind. (1) Section 151(d) provides an
additional exemption for the taxpayer if he is blind at the close of his
taxable year. An additional exemption is also allowed to the taxpayer
for his spouse if the spouse is blind and, for the calendar year in
which the taxable year of the taxpayer begins, has no gross income and
is not the dependent of another taxpayer. The determination of whether
the spouse is blind shall be made as of the close of the taxable year of
the taxpayer, unless the spouse dies during such taxable year, in which
case such determination shall be made as of the time of such death.
(2) The exemptions for the blind are in addition to the exemptions
for the taxpayer and spouse under section 151(b) and are also in
addition to the exemptions under section 151(c) for taxpayers and
spouses attaining the age of 65 years. Thus, a single individual who has
attained the age of 65 before the close of his taxable year and who is
blind at the close of his taxable year is entitled, in addition to the
so-called personal exemption, to two further exemptions, one by reason
of his age and the other by reason of his blindness. If a husband and
wife make a joint return, an exemption for the blind will be allowed as
to each taxpayer spouse who is blind at the close of the taxable year
for which the joint return is made.
(3) A taxpayer claiming an exemption allowed by section 151(d) for a
blind taxpayer and a blind spouse shall, if the individual for whom the
exemption is claimed is not totally blind as of the last day of the
taxable year of the taxpayer (or, in the case of a spouse who dies
during such taxable year, as of the time of such death), attach to his
return a certificate from a physician skilled in the diseases of the eye
or a registered optometrist stating that as of the applicable status
determination date in the opinion of such physician or optometrist (i)
the central visual acuity of the individual for whom the exemption is
claimed did not exceed 20/200 in the better eye with correcting lenses
or (ii) such individual's visual acuity was accompanied by a limitation
in the fields of vision such that the widest diameter of the visual
field subtends an angle no greater than 20 degrees. If such individual
is totally blind as of the status determination date there shall be
attached to the return a statement by the person or persons making the
return setting forth such fact.
(4) Notwithstanding subparagraph (3) of this paragraph, this
subparagraph may be applied where the individual for whom an exemption
under section 151(d) is claimed is not totally blind, and in the
certified opinion of an examining physician skilled in the diseases
[[Page 162]]
of the eye there is no reasonable probability that the individual's
visual acuity will ever improve beyond the minimum standards described
in subparagraph (3) of this paragraph. In this event, if the examination
occurs during a taxable year for which the exemption is claimed, and the
examining physician certifies that, in his opinion, the condition is
irreversible, and a copy of this certification is filed with the return
for that taxable year, then a statement described in subparagraph (3) of
this paragraph need not be attached to such individual's return for
subsequent taxable years so long as the condition remains irreversible.
The taxpayer shall retain a copy of the certified opinion in his
records, and a statement referring to such opinion shall be attached to
future returns claiming the section 151(d) exemption.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7114, 36 FR
9018, May 18, 1971; T.D. 7230, 37 FR 28288, Dec. 22, 1972]
Sec. 1.151-2 Additional exemptions for dependents.
(a) Section 151(e) allows to a taxpayer an exemption for each
dependent (as defined in section 152) whose gross income (as defined in
section 61) for the calendar year in which the taxable year of the
taxpayer begins is less than the amount provided in section 151(e)(1)(A)
applicable to the taxable year of the taxpayer, or who is a child of the
taxpayer and who--
(1) The taxable year of the taxpayer begins, or
(2) Is a student, as defined in paragraph (b) of Sec. 1.151-3.
No exemption shall be allowed under section 151(e) for any dependent who
has made a joint return with his spouse under section 6013 for the
taxable year beginning in the calendar year in which the taxable year of
the taxpayer begins. The amount provided in section 151(e)(1)(A) is $750
in the case of a taxable year beginning after December 31, 1972; $700 in
the case of a taxable year beginning after December 31, 1971, and before
January 1, 1973; $650 in the case of a taxable year beginning after
December 31, 1970, and before January 1, 1972; $625 in the case of a
taxable year beginning after December 31, 1969, and before January 1,
1971; and $600 in the case of a taxable year beginning before January 1,
1970. For special rules in the case of a taxpayer whose taxable year is
a fiscal year ending after December 31, 1969, and beginning before
January 1, 1973, see section 21(d) and the regulations thereunder.
(b) The only exemption allowed for a dependent of the taxpayer is
that provided by section 151(e). The exemptions provided by section
151(c) (old-age exemptions) and section 151(d) (exemptions for the
blind) are allowed only for the taxpayer or his spouse. For example,
where a taxpayer provides the entire support for his father who meets
all the requirements of a dependent, he is entitled to only one
exemption for his father (section 151(e)), even though his father is
over the age of 65.
[T.D. 7114, 36 FR 9019, May 18, 1971]
Sec. 1.151-3 Definitions.
(a) Child. For purposes of sections 151(e), 152, and the regulations
thereunder, the term ``child'' means a son, stepson, daughter,
stepdaughter, adopted son, adopted daughter, or for taxable years
beginning after December 31, 1958, a child who is a member of an
individual's household if the child was placed with the individual by an
authorized placement agency for legal adoption pursuant to a formal
application filed by the individual with the agency (see paragraph
(c)(2) of Sec. 1.152-2), or, for taxable years beginning after December
31, 1969, a foster child (if such foster child satisfies the
requirements set forth in paragraph (b) of Sec. 1.152-1 with respect to
the taxpayer) of the taxpayer.
(b) Student. For purposes of section 151(e) and section 152(d), and
the regulations thereunder, the term ``student'' means an individual who
during each of 5 calendar months during the calendar year in which the
taxable year of the taxpayer begins is a full-time student at an
educational institution or is pursuing a full-time course of
institutional on-farm training under the supervision of an accredited
agent of an educational institution or of a State or political
subdivision of a State. An example of ``institutional on-farm training''
is that authorized by 38 U.S.C. 1652 (formerly section 252 of the
Veterans' Readjustment Assistance Act of
[[Page 163]]
1952), as described in section 252 of such act. A full-time student is
one who is enrolled for some part of 5 calendar months for the number of
hours or courses which is considered to be full-time attendance. The 5
calendar months need not be consecutive. School attendance exclusively
at night does not constitute full-time attendance. However, full-time
attendance at an educational institution may include some attendance at
night in connection with a full-time course of study.
(c) Educational institution. For purposes of sections 151(e) and
152, and the regulations thereunder, the term ``educational
institution'' means a school maintaining a regular faculty and
established curriculum, and having an organized body of students in
attendance. It includes primary and secondary schools, colleges,
universities, normal schools, technical schools, mechanical schools, and
similar institutions, but does not include noneducational institutions,
on-the-job training, correspondence schools, night schools, and so
forth.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7051, 35 FR
11020, July 9, 1970]
Sec. 1.151-4 Amount of deduction for each exemption under section 151.
The amount allowed as a deduction for each exemption under section
151 is (a) $750 in the case of a taxable year beginning after December
31, 1972; (b) $700 in the case of a taxable year beginning after
December 31, 1971, and before January 1, 1973; (c) $650 in the case of a
taxable year beginning after December 31, 1970, and before January 1,
1972; (d) $625 in the case of a taxable year beginning after December
31, 1969, and before January 1, 1971; and (e) $600 in the case of a
taxable year beginning before January 1, 1970. For special rules in the
case of a fiscal year ending after December 31, 1969, and beginning
before January 1, 1973, see section 21(d) and the regulations
thereunder.
[T.D. 7114, 36 FR 9019, May 18, 1971]
Sec. 1.152-1 General definition of a dependent.
(a)(1) For purposes of the income taxes imposed on individuals by
chapter 1 of the Code, the term ``dependent'' means any individual
described in paragraphs (1) through (10) of section 152(a) over half of
whose support, for the calendar year in which the taxable year of the
taxpayer begins, was received from the taxpayer.
(2)(i) For purposes of determining whether or not an individual
received, for a given calendar year, over half of his support from the
taxpayer, there shall be taken into account the amount of support
received from the taxpayer as compared to the entire amount of support
which the individual received from all sources, including support which
the individual himself supplied. The term ``support'' includes food,
shelter, clothing, medical and dental care, education, and the like.
Generally, the amount of an item of support will be the amount of
expense incurred by the one furnishing such item. If the item of support
furnished an individual is in the form of property or lodging, it will
be necessary to measure the amount of such item of support in terms of
its fair market value.
(ii) In computing the amount which is contributed for the support of
an individual, there must be included any amount which is contributed by
such individual for his own support, including income which is
ordinarily excludable from gross income, such as benefits received under
the Social Security Act (42 U.S.C. ch. 7). For example, a father
receives $800 social security benefits, $400 interest, and $1,000 from
his son during 1955, all of which sums represent his sole support during
that year. The fact that the social security benefits of $800 are not
includible in the father's gross income does not prevent such amount
from entering into the computation of the total amount contributed for
the father's support. Consequently, since the son's contribution of
$1,000 was less than one-half of the father's support ($2,200) he may
not claim his father as a dependent.
(iii)(a) For purposes of determining the amount of support furnished
for a child (or children) by a taxpayer for a given calendar year, an
arrearage payment made in a year subsequent to a calendar year for which
there is an unpaid liability shall not be treated as paid either during
that calendar year or in the year of payment, but no
[[Page 164]]
amount shall be treated as an arrearage payment to the extent that there
is an unpaid liability (determined without regard to such payment) with
respect to the support of a child for the taxable year of payment; and
(b) Similarly, payments made prior to any calendar year (whether or
not made in the form of a lump sum payment in settlement of the parent's
liability for support) shall not be treated as made during such calendar
year, but payments made during any calendar year from amounts set aside
in trust by a parent in a prior year, shall be treated as made during
the calendar year in which paid.
(b) Section 152(a)(9) applies to any individual (other than an
individual who at any time during the taxable year was the spouse,
determined without regard to section 153, of the taxpayer) who lives
with the taxpayer and is a member of the taxpayer's household during the
entire taxable year of the taxpayer. An individual is not a member of
the taxpayer's household if at any time during the taxable year of the
taxpayer the relationship between such individual and the taxpayer is in
violation of local law. It is not necessary under section 152(a)(9) that
the dependent be related to the taxpayer. For example, foster children
may qualify as dependents. It is necessary, however, that the taxpayer
both maintain and occupy the household. The taxpayer and dependent 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 the dependent is absent for less than six
months in the taxable year of the taxpayer, shall be considered
temporary absence due to special circumstances. The fact that the
dependent dies during the year shall not deprive the taxpayer of the
deduction if the dependent lived in the household for the entire part of
the year preceding his death. Likewise, the period during the taxable
year preceding the birth of an individual shall not prevent such
individual from qualifying as a dependent under section 152(a)(9).
Moreover, a child who actually becomes a member of the taxpayer's
household during the taxable year shall not be prevented from being
considered a member of such household for the entire taxable year, if
the child is required to remain in a hospital for a period following its
birth, and if such child would otherwise have been a member of the
taxpayer's household during such period.
(c) In the case of a child of the taxpayer who is under 19 or who is
a student, the taxpayer may claim the dependency exemption for such
child provided he has furnished more than one-half of the support of
such child for the calendar year in which the taxable year of the
taxpayer begins, even though the income of the child for such calendar
year may be equal to or in excess of the amount determined pursuant to
Sec. 1.151-2 applicable to such calendar year. In such a case, there
may be two exemptions claimed for the child: One on the parent's (or
stepparent's) return, and one on the child's return. In determining
whether the taxpayer does in fact furnish more than one-half of the
support of an individual who is a child, as defined in paragraph (a) of
Sec. 1.151-3, of the taxpayer and who is a student, as defined in
paragraph (b) of Sec. 1.151-3, a special rule regarding scholarships
applies. Amounts received as scholarships, as defined in paragraph (a)
of Sec. 1.117-3, for study at an educational institution shall not be
considered in determining whether the taxpayer furnishes more than one-
half the support of such individual. For example, A has a child who
receives a $1,000 scholarship to the X college for 1 year. A contributes
$500, which constitutes the balance of the child's support for that
year. A may claim the child as a dependent, as the $1,000 scholarship is
not counted in determining the support of the child. For purposes of
this paragraph, amounts received for tuition payments and allowances by
a veteran under the provisions of the Servicemen's Readjustment Act of
1944 (58 Stat. 284) or the Veterans' Readjustment Assistance Act of 1952
(38 U.S.C. ch. 38) are not amounts received as scholarships. See also
Sec. 1.117-4. For definition of the
[[Page 165]]
terms ``child'', ``student'', and ``educational institution'', as used
in this paragraph, see Sec. 1.151-3.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR
7094, July 11, 1963; T.D. 7099, 36 FR 5337, Mar. 20, 1971; T.D. 7114, 36
FR 9019, May 18, 1971]
Sec. 1.152-2 Rules relating to general definition of dependent.
(a)(1) Except as provided in subparagraph (2) of this paragraph, to
qualify as a dependent an individual must be a citizen or resident of
the United States or be a resident of the Canal Zone, the Republic of
Panama, Canada, or Mexico, or, for taxable years beginning after
December 31, 1971, a national of the United States, at some time during
the calendar year in which the taxable year of the taxpayer begins. A
resident of the Republic of the Philippines who was born to or legally
adopted by the taxpayer in the Philippine Islands before January 1,
1956, at a time when the taxpayer was a member of the Armed Forces of
the United States, may also be claimed as a dependent if such resident
otherwise qualifies as a dependent. For definition of ``Armed Forces of
the United States,'' see section 7701(a)(15).
(2)(i) For any taxable year beginning after December 31, 1957, a
taxpayer who is a citizen, or, for any taxable year beginning after
December 31, 1971, a national, of the United States is permitted under
section 152(b)(3)(B) to treat as a dependent his legally adopted child
who lives with him, as a member of his household, for the entire taxable
year and who, but for the citizenship, nationality, or residence
requirements of section 152(b)(3) and subparagraph (1) of this
paragraph, would qualify as a dependent of the taxpayer for such taxable
year.
(ii) Under section 152(b)(3)(B) and this subparagraph, it is
necessary that the taxpayer both maintain and occupy the household. The
taxpayer and his legally adopted child will be considered as occupying
the household for the entire taxable year of the taxpayer
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 the legally adopted child is absent for
less than six months in the taxable year of the taxpayer shall be
considered temporary absence due to special circumstances. The fact that
a legally adopted child dies during the year shall not deprive the
taxpayer of the deduction if the child lived in the household for the
entire part of the year preceding his death. The period during the
taxable year preceding the birth of a child shall not prevent such child
from qualifying as a dependent under this subparagraph. Moreover, a
legally adopted child who actually becomes a member of the taxpayer's
household during the taxable year shall not be prevented from being
considered a member of such household for the entire taxable year, if
the child is required to remain in a hospital for a period following its
birth and if such child would otherwise have been a member of the
taxpayer's household during such period.
(iii) For purposes of section 152(b)(3)(B) and this subparagraph,
any child whose legal adoption by the taxpayer (a citizen or national of
the United States) becomes final at any time before the end of the
taxable year of the taxpayer shall not be disqualified as a dependent of
such taxpayer by reason of his citizenship, nationality, or residence,
provided the child lived with the taxpayer and was a member of the
taxpayer's household for the entire taxable year in which the legal
adoption became final. For example, A, a citizen of the United States
who makes his income tax returns on the basis of the calendar year, is
employed in Brazil by an agency of the United States Government. In
October 1958 he takes into his household C, a resident of Brazil who is
not a citizen of the United States, for the purpose of initiating
adoption proceedings. C lives with A and is a member of his household
for the remainder of 1958 and for the entire calendar year 1959. On July
1, 1959, the adoption proceedings were completed and C became the
legally adopted child of A. If C otherwise qualifies as a dependent, he
may be claimed as a dependent by A for 1959.
[[Page 166]]
(b) A payment to a wife which is includible in her gross income
under section 71 or section 682 shall not be considered a payment by her
husband for the support of any dependent.
(c)(1) For purposes of determining the existence of any of the
relationships specified in section 152 (a) or (b)(1), a legally adopted
child of an individual shall be treated as a child of such individual by
blood.
(2) For any taxable year beginning after December 31, 1958, a child
who is a member of an individual's household also shall be treated as a
child of such individual by blood if the child was placed with the
individual by an authorized placement agency for legal adoption pursuant
to a formal application filed by the individual with the agency. For
purposes of this subparagraph an authorized placement agency is any
agency which is authorized by a State, the District of Columbia, a
possession of the United States, a foreign country, or a political
subdivision of any of the foregoing to place children for adoption. A
taxpayer who claims as a dependent a child placed with him for adoption
shall attach to his income tax return a statement setting forth the name
of the child for whom the dependency deduction is claimed, the name and
address of the authorized placement agency, and the date the formal
application was filed with the agency.
(3) The application of this paragraph may be illustrated by the
following example:
Example. On March 1, 1959, D, a resident of the United States, made
formal application to an authorized child placement agency for the
placement of E, a resident of the United States, with him for legal
adoption. On June 1, 1959, E was placed with D for legal adoption.
During the year 1959 E received over one-half of his support from D. D
may claim E as a dependent for 1959. Since E was a resident of the
United States, his qualification as a dependent is in no way based on
the provisions of section 152(b)(3)(B). Therefore, it is immaterial that
E was not a member of D's household during the entire taxable year.
(4) For purposes of determining the existence of any of the
relationships specified in section 152 (a) or (b)(1), a foster child of
an individual (if such foster child satisfies the requirements set forth
in paragraph (b) of Sec. 1.152-1 with respect to such individual)
shall, for taxable years beginning after December 31, 1969, be treated
as a child of such individual by blood. For purposes of this
subparagraph, a foster child is a child who is in the care of a person
or persons (other than the parents or adopted parents of the child) who
care for the child as their own child. Status as a foster child is not
dependent upon or affected by the circumstances under which the child
became a member of the household.
(d) In the case of a joint return it is not necessary that the
prescribed relationship exist between the person claimed as a dependent
and the spouse who furnishes the support; it is sufficient if the
prescribed relationship exists with respect to either spouse. Thus, a
husband and wife making a joint return may claim as a dependent a
daughter of the wife's brother (wife's niece) even though the husband is
the one who furnishes the chief support. The relationship of affinity
once existing will not terminate by divorce or the death of a spouse.
For example, a widower may continue to claim his deceased wife's father
(his father-in-law) as a dependent provided he meets the other
requirements of section 151.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR
7094, July 11, 1963; T.D. 7051, 35 FR 11020, July 9, 1970; T.D. 7291, 38
FR 33396, Dec. 4, 1973]
Sec. 1.152-3 Multiple support agreements.
(a) Section 152(c) provides that a taxpayer shall be treated as
having contributed over half of the support of an individual for the
calendar year (in cases where two or more taxpayers contributed to the
support of such individual) if--
(1) No one person contributed over half of the individual's support,
(2) Each member of the group which collectively contributed more
than half of the support of the individual would have been entitled to
claim the individual as a dependent but for the fact that he did not
contribute more than one-half of such support.
(3) The member of the group claiming the individual as a dependent
contributed more than 10 percent of the individual's support, and
(4) Each other person in the group who contributed more than 10
percent
[[Page 167]]
of such support furnishes to the taxpayer claiming the dependent a
written declaration that such other person will not claim the individual
as a dependent for any taxable year beginning in such calendar year.
(b) Examples. Application of the rule contained in paragraph (a) of
this section may be illustrated by the following examples:
Example 1. During the taxable year, brothers A, B, C, and D
contributed the entire support of their mother in the following
percentages: A, 30 percent; B, 20 percent; C, 29 percent; and D, 21
percent. Any one of the brothers, except for the fact that he did not
contribute more than half of her support, would have been entitled to
claim his mother as a dependent. Consequently, any one of the brothers
could claim a deduction for the exemption of the mother if he obtained a
written declaration (as provided in paragraph (a)(4) of this section)
from each of the other brothers. Even though A and D together
contributed more than one-half the support of the mother, A, if he
wished to claim his mother as a dependent, would be required to obtain
written declarations from B, C, and D, since each of those three
contributed more than 10 percent of the support and, but for the failure
to contribute more than half of the mother's support, would have been
entitled to claim his mother as a dependent.
Example 2. During the taxable year, E, an individual who resides
with his son, S, received his entire support for that year as follows:
------------------------------------------------------------------------
Percentage
Source of total
------------------------------------------------------------------------
Social Security............................................ 25
N, an unrelated neighbor................................... 11
B, a brother............................................... 14
D, a daughter.............................................. 10
S, a son................................................... 40
Total received by E.................................... 100
------------------------------------------------------------------------
B, D, and S are persons each of whom, but for the fact that none
contributed more than half of E's support, could claim E as a dependent
for the taxable year. The three together contributed 64 percent of E's
support, and, thus, each is a member of the group to be considered for
the purpose of section 152(c). B and S are the only members of such
group who can meet all the requirements of section 152(c), and either
one could claim E as a dependent for his taxable year if he obtained a
written declaration (as provided in paragraph (a)(4) of this section)
signed by the other, and furnished the other information required by the
return with respect to all the contributions to E. Inasmuch as D did not
contribute more than 10 percent of E's support, she is not entitled to
claim E as a dependent for the taxable year nor is she required to
furnish a written declaration with respect to her contributions to E. N
contributed over 10 percent of the support of E, but, since he is an
unrelated neighbor, he does not qualify as a member of the group for the
purpose of the multiple support agreement under section 152(c).
(c)(1) The member of a group of contributors who claims an
individual as a dependent for a taxable year beginning before January 1,
2002, under the multiple support agreement provisions of section 152(c)
must attach to the member's income tax return for the year of the
deduction a written declaration from each of the other persons who
contributed more than 10 percent of the support of such individual and
who, but for the failure to contribute more than half of the support of
the individual, would have been entitled to claim the individual as a
dependent.
(2) The taxpayer claiming an individual as a dependent for a taxable
year beginning after December 31, 2001, under the multiple support
agreement provisions of section 152(c) must provide with the income tax
return for the year of the deduction--
(i) A statement identifying each of the other persons who
contributed more than 10 percent of the support of the individual and
who, but for the failure to contribute more than half of the support of
the individual, would have been entitled to claim the individual as a
dependent; and
(ii) A statement indicating that the taxpayer obtained a written
declaration from each of the persons described in section 152(c)(2)
waiving the right to claim the individual as a dependent.
(3) The taxpayer claiming the individual as a dependent for a
taxable year beginning after December 31, 2001, must retain the waiver
declarations and should be prepared to furnish the waiver declarations
and any other information necessary to substantiate the claim, which may
include a statement showing the names of all contributors (whether or
not members of the group described in section 152(c)(2)) and
[[Page 168]]
the amount contributed by each to the support of the claimed dependent.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6603, 28 FR
7094, July 11, 1963; T.D. 8989, 67 FR 20031, Apr. 24, 2002; T.D. 9040,
68 FR 4920, Jan. 31, 2003]
Sec. 1.152-4 Special rule for a child of divorced or separated
parents or parents who live apart.
(a) In general. A taxpayer may claim a dependency deduction for a
child (as defined in section 152(f)(1)) only if the child is the
qualifying child of the taxpayer under section 152(c) or the qualifying
relative of the taxpayer under section 152(d). Section 152(c)(4)(B)
provides that a child who is claimed as a qualifying child by parents
who do not file a joint return together is treated as the qualifying
child of the parent with whom the child resides for a longer period of
time during the taxable year or, if the child resides with both parents
for an equal period of time, of the parent with the higher adjusted
gross income. However, a child is treated as the qualifying child or
qualifying relative of the noncustodial parent if the custodial parent
releases a claim to the exemption under section 152(e) and this section.
(b) Release of claim by custodial parent--(1) In general. Under
section 152(e)(1), notwithstanding section 152(c)(1)(B), (c)(4), or
(d)(1)(C), a child is treated as the qualifying child or qualifying
relative of the noncustodial parent (as defined in paragraph (d) of this
section) if the requirements of paragraphs (b)(2) and (b)(3) of this
section are met.
(2) Support, custody, and parental status--(i) In general. The
requirements of this paragraph (b)(2) are met if the parents of the
child provide over one-half of the child's support for the calendar
year, the child is in the custody of one or both parents for more than
one-half of the calendar year, and the parents--
(A) Are divorced or legally separated under a decree of divorce or
separate maintenance;
(B) Are separated under a written separation agreement; or
(C) Live apart at all times during the last 6 months of the calendar
year whether or not they are or were married.
(ii) Multiple support agreement. The requirements of this paragraph
(b)(2) are not met if over one-half of the support of the child is
treated as having been received from a taxpayer under section 152(d)(3).
(3) Release of claim to child. The requirements of this paragraph
(b)(3) are met for a calendar year if--
(i) The custodial parent signs a written declaration that the
custodial parent will not claim the child as a dependent for any taxable
year beginning in that calendar year and the noncustodial parent
attaches the declaration to the noncustodial parent's return for the
taxable year; or
(ii) A qualified pre-1985 instrument, as defined in section
152(e)(3)(B), applicable to the taxable year beginning in that calendar
year, provides that the noncustodial parent is entitled to the
dependency exemption for the child and the noncustodial parent provides
at least $600 for the support of the child during the calendar year.
(c) Custody. A child is in the custody of one or both parents for
more than one-half of the calendar year if one or both parents have the
right under state law to physical custody of the child for more than
one-half of the calendar year.
(d) Custodial parent--(1) In general. The custodial parent is the
parent with whom the child resides for the greater number of nights
during the calendar year, and the noncustodial parent is the parent who
is not the custodial parent. A child is treated as residing with neither
parent if the child is emancipated under state law. For purposes of this
section, a child resides with a parent for a night if the child sleeps--
(i) At the residence of that parent (whether or not the parent is
present); or
(ii) In the company of the parent, when the child does not sleep at
a parent's residence (for example, the parent and child are on vacation
together).
(2) Night straddling taxable years. A night that extends over two
taxable years is allocated to the taxable year in which the night
begins.
(3) Absences. (i) Except as provided in paragraph (d)(3)(ii) of this
section, for purposes of this paragraph (d), a child
[[Page 169]]
who does not reside (within the meaning of paragraph (d)(1) of this
section) with a parent for a night is treated as residing with the
parent with whom the child would have resided for the night but for the
absence.
(ii) A child who does not reside (within the meaning of paragraph
(d)(1) of this section) with a parent for a night is treated as not
residing with either parent for that night if it cannot be determined
with which parent the child would have resided or if the child would not
have resided with either parent for the night.
(4) Special rule for equal number of nights. If a child is in the
custody of one or both parents for more than one-half of the calendar
year and the child resides with each parent for an equal number of
nights during the calendar year, the parent with the higher adjusted
gross income for the calendar year is treated as the custodial parent.
(5) Exception for a parent who works at night. If, in a calendar
year, due to a parent's nighttime work schedule, a child resides for a
greater number of days but not nights with the parent who works at
night, that parent is treated as the custodial parent. On a school day,
the child is treated as residing at the primary residence registered
with the school.
(e) Written declaration--(1) Form of declaration--(i) In general.
The written declaration under paragraph (b)(3)(i) of this section must
be an unconditional release of the custodial parent's claim to the child
as a dependent for the year or years for which the declaration is
effective. A declaration is not unconditional if the custodial parent's
release of the right to claim the child as a dependent requires the
satisfaction of any condition, including the noncustodial parent's
meeting of an obligation such as the payment of support. A written
declaration must name the noncustodial parent to whom the exemption is
released. A written declaration must specify the year or years for which
it is effective. A written declaration that specifies all future years
is treated as specifying the first taxable year after the taxable year
of execution and all subsequent taxable years.
(ii) Form designated by IRS. A written declaration may be made on
Form 8332, Release/Revocation of Release of Claim to Exemption for Child
by Custodial Parent, or successor form designated by the IRS. A written
declaration not on the form designated by the IRS must conform to the
substance of that form and must be a document executed for the sole
purpose of serving as a written declaration under this section. A court
order or decree or a separation agreement may not serve as a written
declaration.
(2) Attachment to return. A noncustodial parent must attach a copy
of the written declaration to the parent's return for each taxable year
in which the child is claimed as a dependent.
(3) Revocation of written declaration--(i) In general. A parent may
revoke a written declaration described in paragraph (e)(1) of this
section by providing written notice of the revocation to the other
parent. The parent revoking the written declaration must make reasonable
efforts to provide actual notice to the other parent. The revocation may
be effective no earlier than the taxable year that begins in the first
calendar year after the calendar year in which the parent revoking the
written declaration provides, or makes reasonable efforts to provide,
the written notice.
(ii) Form of revocation. The revocation may be made on Form 8332,
Release/Revocation of Release of Claim to Exemption for Child by
Custodial Parent, or successor form designated by the IRS whether or not
the written declaration was made on a form designated by the IRS. A
revocation not on that form must conform to the substance of the form
and must be a document executed for the sole purpose of serving as a
revocation under this section. The revocation must specify the year or
years for which the revocation is effective. A revocation that specifies
all future years is treated as specifying the first taxable year after
the taxable year the revocation is executed and all subsequent taxable
years.
(iii) Attachment to return. The parent revoking the written
declaration must attach a copy of the revocation to the parent's return
for each taxable year for which the parent claims a child as a dependent
as a result of the revocation. The parent revoking the written
declaration must keep a copy of the
[[Page 170]]
revocation and evidence of delivery of the notice to the other parent,
or of the reasonable efforts to provide actual notice.
(4) Ineffective declaration or revocation. A written declaration or
revocation that fails to satisfy the requirements of this paragraph (e)
has no effect.
(5) Written declaration executed in a taxable year beginning on or
before July 2, 2008. A written declaration executed in a taxable year
beginning on or before July 2, 2008, that satisfies the requirements for
the form of a written declaration in effect at the time the written
declaration is executed, will be treated as meeting the requirements of
paragraph (e)(1) of this section. Paragraph (e)(3) of this section
applies without regard to whether a custodial parent executed the
written declaration in a taxable year beginning on or before July 2,
2008.
(f) Coordination with other sections. If section 152(e) and this
section apply, a child is treated as the dependent of both parents for
purposes of sections 105(b), 132(h)(2)(B), and 213(d)(5).
(g) Examples. The provisions of this section are illustrated by the
following examples that assume, unless otherwise provided, that each
taxpayer's taxable year is the calendar year, one or both of the child's
parents provide over one-half of the child's support for the calendar
year, one or both parents have the right under state law to physical
custody of the child for more than one-half of the calendar year, and
the child otherwise meets the requirements of a qualifying child under
section 152(c) or a qualifying relative under section 152(d). In
addition, in each of the examples, no qualified pre-1985 instrument or
multiple support agreement is in effect. The examples are as follows:
Example 1. (i) B and C are the divorced parents of Child. In 2009,
Child resides with B for 210 nights and with C for 155 nights. B
executes a Form 8332 for 2009 releasing B's right to claim Child as a
dependent for that year, which C attaches to C's 2009 return.
(ii) Under paragraph (d) of this section, B is the custodial parent
of Child in 2009 because B is the parent with whom Child resides for the
greater number of nights in 2009. Because the requirements of paragraphs
(b)(2) and (3) of this section are met, C may claim Child as a
dependent.
Example 2. The facts are the same as in Example 1 except that B does
not execute a Form 8332 or similar declaration for 2009. Therefore,
section 152(e) and this section do not apply. Whether Child is the
qualifying child or qualifying relative of B or C is determined under
section 152(c) or (d).
Example 3. (i) D and E are the divorced parents of Child. Under a
custody decree, Grandmother has the right under state law to physical
custody of Child from January 1 to July 31, 2009.
(ii) Because D and E do not have the right under state law to
physical custody of Child for over one-half of the 2009 calendar year,
under paragraph (c) of this section, Child is not in the custody of one
or both parents for over one-half of the calendar year. Therefore,
section 152(e) and this section do not apply, and whether Child is the
qualifying child or qualifying relative of D, E, or Grandmother is
determined under section 152(c) or (d).
Example 4. (i) The facts are the same as in Example 3, except that
Grandmother has the right to physical custody of Child from January 1 to
March 31, 2009, and, as a result, Child resides with Grandmother during
this period. D and E jointly have the right to physical custody of Child
from April 1 to December 31, 2009. During this period, Child resides
with D for 180 nights and with E for 95 nights. D executes a Form 8332
for 2009 releasing D's right to claim Child as a dependent for that
year, which E attaches to E's 2009 return.
(ii) Under paragraph (c) of this section, Child is in the custody of
D and E for over one-half of the calendar year, because D and E have the
right under state law to physical custody of Child for over one-half of
the calendar year.
(iii) Under paragraph (d)(3)(ii) of this section, the nights that
Child resides with Grandmother are not allocated to either parent. Child
resides with D for a greater number of nights than with E during the
calendar year and, under paragraph (d)(1) of this section, D is the
custodial parent.
(iv) Because the requirements of paragraphs (b)(2) and (3) of this
section are met, section 152(e) and this section apply, and E may claim
Child as a dependent.
Example 5. (i) The facts are the same as in Example 4, except that D
is away on military service from April 10 to June 15, 2009, and
September 6 to October 20, 2009. During these periods Child resides with
Grandmother in Grandmother's residence. Child would have resided with D
if D had not been away on military service. Grandmother claims Child as
a dependent on Grandmother's 2009 return.
(ii) Under paragraph (d)(3)(i) of this section, Child is treated as
residing with D for the nights that D is away on military service.
Because the requirements of paragraphs (b)(2) and (3) of this section
are met, section 152(e) and this section apply, and E, not
[[Page 171]]
Grandmother, may claim Child as a dependent.
Example 6. F and G are the divorced parents of Child. In May of
2009, Child turns age 18 and is emancipated under the law of the state
where Child resides. Therefore, in 2009 and later years, F and G do not
have the right under state law to physical custody of Child for over
one-half of the calendar year, and Child is not in the custody of F and
G for over one-half of the calendar year. Section 152(e) and this
section do not apply, and whether Child is the qualifying child or
qualifying relative of F or G is determined under section 152(c) or (d).
Example 7. (i) The facts are the same as in Example 6, except that
Child turns age 18 and is emancipated under state law on August 1, 2009,
resides with F from January 1, 2009, through May 31, 2009, and resides
with G from June 1, 2009, through December 31, 2009. F executes a Form
8332 releasing F's right to claim Child as a dependent for 2009, which G
attaches to G's 2009 return.
(ii) Under paragraph (c) of this section, Child is in the custody of
F and G for over one-half of the calendar year.
(iii) Under paragraph (d)(1) of this section, Child is treated as
not residing with either parent after Child's emancipation. Therefore,
Child resides with F for 151 nights and with G for 61 nights. Because
the requirements of paragraphs (b)(2) and (3) of this section are met,
section 152(e) and this section apply, and G may claim Child as a
dependent.
Example 8. H and J are the divorced parents of Child. Child
generally resides with H during the week and with J every other weekend.
Child resides with J in H's residence for 10 consecutive nights while H
is hospitalized. Under paragraph (d)(1)(i) of this section, Child
resides with H for the 10 nights.
Example 9. K and L, who are separated under a written separation
agreement, are the parents of Child. In August 2009, K and Child spend
10 nights together in a hotel while on vacation. Under paragraph
(d)(1)(ii) of this section, Child resides with K for the 10 nights that
K and Child are on vacation.
Example 10. M and N are the divorced parents of Child. On December
31, 2009, Child attends a party at M's residence. After midnight on
January 1, 2010, Child travels to N's residence, where Child sleeps.
Under paragraph (d)(1) of this section, Child resides with N for the
night of December 31, 2009, to January 1, 2010, because Child sleeps at
N's residence that night. However, under paragraph (d)(2) of this
section, the night of December 31, 2009, to January 1, 2010, is
allocated to taxable year 2009 for purposes of determining whether Child
resides with M or N for a greater number of nights in 2009.
Example 11. O and P, who never married, are the parents of Child. In
2009, Child spends alternate weeks residing with O and P. During a week
that Child is residing with O, O gives Child permission to spend a night
at the home of a friend. Under paragraph (d)(3)(i) of this section, the
night Child spends at the friend's home is treated as a night that Child
resides with O.
Example 12. The facts are the same as in Example 11, except that
Child also resides at summer camp for 6 weeks. Because Child resides
with each parent for alternate weeks, Child would have resided with O
for 3 weeks and with P for 3 weeks of the period that Child is at camp.
Under paragraph (d)(3)(i) of this section, Child is treated as residing
with O for 3 weeks and with P for 3 weeks.
Example 13. The facts are the same as in Example 12, except that
Child does not spend alternate weeks residing with O and P, and it
cannot be determined whether Child would have resided with O or P for
the period that Child is at camp. Under paragraph (d)(3)(ii) of this
section, Child is treated as residing with neither parent for the 6
weeks.
Example 14. (i) Q and R are the divorced parents of Child. Q works
from 11 PM to 7 AM Sunday through Thursday nights. Because of Q's
nighttime work schedule, Child resides with R Sunday through Thursday
nights and with Q Friday and Saturday nights. Therefore, in 2009, Child
resides with R for 261 nights and with Q for 104 nights. Child spends
all daytime hours when Child is not in school with Q and Q's address is
registered with Child's school as Child's primary residence. Q executes
a Form 8332 for 2009 releasing Q's right to claim Child as a dependent
for that year, which R attaches to R's 2009 return.
(ii) Under paragraph (d) of this section, Q is the custodial parent
of Child in 2009. Child resides with R for a greater number of nights
than with Q due to Q's nighttime work schedule, and Child spends a
greater number of days with Q. Therefore, paragraph (d)(5) of this
section applies rather than paragraph (d)(1) of this section. Because
the requirements of paragraphs (b)(2) and (3) of this section are met, R
may claim Child as a dependent.
Example 15. (i) In 2009, S and T, the parents of Child, execute a
written separation agreement. The agreement provides that Child will
live with S and that T will make monthly child support payments to S. In
2009, Child resides with S for 335 nights and with T for 30 nights. S
executes a letter declaring that S will not claim Child as a dependent
in 2009 and in subsequent alternate years. The letter contains all the
information requested on Form 8332, does not require the satisfaction of
any condition such as T's payment of support, and has no purpose other
than to serve as a written declaration under section 152(e) and this
section. T attaches the letter to T's return for 2009 and 2011.
(ii) In 2010, T fails to provide support for Child, and S executes a
Form 8332 revoking
[[Page 172]]
the release of S's right to claim Child as a dependent for 2011. S
delivers a copy of the Form 8332 to T, attaches a copy of the Form 8332
to S's tax return for 2011, and keeps a copy of the Form 8332 and
evidence of delivery of the written notice to T.
(iii) T may claim Child as a dependent for 2009 because S releases
the right to claim Child as a dependent under paragraph (b)(3) of this
section by executing the letter, which conforms to the requirements of
paragraph (e)(1) of this section, and T attaches the letter to T's
return in accordance with paragraph (e)(2) of this section. In 2010, S
revokes the release of the claim in accordance with paragraph (e)(3) of
this section, and the revocation takes effect in 2011, the taxable year
that begins in the first calendar year after S provides written notice
of the revocation to T. Therefore, in 2011, section 152(e) and this
section do not apply, and whether Child is the qualifying child or
qualifying relative of S or T is determined under section 152(c) or (d).
Example 16. The facts are the same as Example 15, except that the
letter expressly states that S releases the right to claim Child as a
dependent only if T is current in the payment of support for Child at
the end of the calendar year. The letter does not qualify as a written
declaration under paragraph (b)(3) of this section because S's agreement
not to claim Child as a dependent is conditioned on T's payment of
support and, under paragraph (e)(1)(i) of this section, a written
declaration must be unconditional. Therefore, section 152(e) and this
section do not apply, and whether Child is the qualifying child or
qualifying relative of S or T for 2009 as well as 2011 is determined
under section 152(c) or (d).
Example 17. (i) U and V are the divorced parents of Child. Child
resides with U for more nights than with V in 2009 through 2011. In
2009, U provides a written statement to V declaring that U will not
claim Child as a dependent, but the statement does not specify the year
or years it is effective. V attaches the statement to V's returns for
2009 through 2011.
(ii) Because the written statement does not specify a year or years,
under paragraph (e)(1) of this section, it is not a written declaration
that conforms to the substance of Form 8332. Under paragraph (e)(4) of
this section, the statement has no effect. Section 152(e) and this
section do not apply, and whether Child is the qualifying child or
qualifying relative of U or V is determined under section 152(c) or (d).
Example 18. (i) W and X are the divorced parents of Child. In 2009,
Child resides solely with W. The divorce decree requires X to pay child
support to W and requires W to execute a Form 8332 releasing W's right
to claim Child as a dependent. W fails to sign a Form 8332 for 2009, and
X attaches an unsigned Form 8332 to X's return for 2009.
(ii) The order in the divorce decree requiring W to execute a Form
8332 is ineffective to allocate the right to claim Child as a dependent
to X. Furthermore, under paragraph (e)(1) of this section, the unsigned
Form 8332 does not conform to the substance of Form 8332, and under
paragraph (e)(4) of this section, the Form 8332 has no effect.
Therefore, section 152(e) and this section do not apply, and whether
Child is the qualifying child or qualifying relative of W or X is
determined under section 152(c) or (d).
(iii) If, however, W executes a Form 8332 for 2009, and X attaches
the Form 8332 to X's return, then X may claim Child as a dependent in
2009.
Example 19. (i) Y and Z are the divorced parents of Child. In 2003,
Y and Z enter into a separation agreement, which is incorporated into a
divorce decree, under which Y, the custodial parent, releases Y's right
to claim Child as a dependent for all future years. The separation
agreement satisfies the requirements for the form of a written
declaration in effect at the time it is executed. Z attaches a copy of
the separation agreement to Z's returns for 2003 through 2009.
(ii) Under paragraph (e)(1)(ii) of this section, a separation
agreement may not serve as a written declaration. However, under
paragraph (e)(5) of this section, a written declaration executed in a
taxable year beginning on or before July 2, 2008, that satisfies the
requirements for the form of a written declaration in effect at the time
the written declaration is executed, will be treated as meeting the
requirements of paragraph (e)(1) of this section. Therefore, the
separation agreement may serve as the written declaration required by
paragraph (b)(3)(i) of this section for 2009, and Z may claim Child as a
dependent in 2009 and later years.
Example 20. (i) The facts are the same as in Example 19, except that
in 2009 Y executes a Form 8332 revoking the release of Y's right to
claim Child as a dependent for 2010. Y complies with all the
requirements of paragraph (e)(3) of this section.
(ii) Although Y executes the separation agreement releasing Y's
right to claim Child as a dependent in a taxable year beginning on or
before July 2, 2008, under paragraph (e)(5) of this section, Y's
execution of the Form 8332 in 2009 is effective to revoke the release.
Therefore, section 152(e) and this section do not apply in 2010, and
whether Child is the qualifying child or qualifying relative of Y or Z
is determined under section 152(c) or (d).
[[Page 173]]
(h) Effective/applicability date. This section applies to taxable
years beginning after July 2, 2008.
[T.D. 9408, 73 FR 37801, July 2, 2008]
Sec. 1.153-1 Determination of marital status.
For the purpose of determining the right of an individual to claim
an exemption for his spouse under section 151(b), the determination of
whether such individual is married shall be made as of the close of his
taxable year, unless his spouse dies during such year, in which case the
determination shall be made as of the time of such death. An individual
legally separated from his spouse under a decree of divorce or separate
maintenance shall not be considered as married. The provisions of this
section may be illustrated by the following examples:
Example 1. A, who files his returns on the basis of a calendar year,
married B on December 31, 1956. B, who had never previously married, had
no gross income for the calendar year 1956 nor was she the dependent of
another taxpayer for such year. A may claim an exemption for B for 1956.
Example 2. C and his wife, D, were married in 1940. They remained
married until July 1956 at which time D was granted a decree of divorce.
C, who files his income tax returns on a calendar year basis, cannot
claim an exemption for D on his 1956 return as C and D were not married
on the last day of C's taxable year. Had D died instead of being
divorced, C could have claimed an exemption for D for 1956 as their
marital status would have been determined as of the date of D's death.
Sec. 1.154 Statutory provisions; cross references.
Sec. 154. Cross references. (1) For definitions of ``husband'' and
``wife'', as used in section 152(b)(4), see section 7701(a)(17).
(2) For deductions of estates and trusts, in lieu of the exemptions
under section 151, see section 642(b).
(3) For exemptions of nonresident aliens, see section 873(b)(3).
(4) For exemptions of citizens deriving income mainly from sources
within possessions of the United States, see section 931(e).
(Sec. 154 as amended by sec. 103(c)(2), Foreign Investors Tax Act 1966
(80 Stat. 1551))
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 7332, 39 FR 44216, Dec. 23, 1974]
Itemized Deductions for Individuals and Corporations
Sec. 1.161-1 Allowance of deductions.
Section 161 provides for the allowance as deductions, in computing
taxable income under section 63(a), of the items specified in Part VI
(section 161 and following), Subchapter B, Chapter 1 of the Code,
subject to the exceptions provided in Part IX (section 261 and
following), of such Subchapter B, relating to items not deductible.
Double deductions are not permitted. Amounts deducted under one
provision of the Internal Revenue Code of 1954 cannot again be deducted
under any other provision thereof. See also section 7852(c), relating to
the taking into account, both in computing a tax under Subtitle A of the
Internal Revenue Code of 1954 and a tax under Chapter 1 or 2 of the
Internal Revenue Code of 1939, of the same item of deduction.
Sec. 1.162-1 Business expenses.
(a) In general. Business expenses deductible from gross income
include the ordinary and necessary expenditures directly connected with
or pertaining to the taxpayer's trade or business, except items which
are used as the basis for a deduction or a credit under provisions of
law other than section 162. The cost of goods purchased for resale, with
proper adjustment for opening and closing inventories, is deducted from
gross sales in computing gross income. See paragraph (a) of Sec. 1.161-
3. Among the items included in business expenses are management
expenses, commissions (but see section 263 and the regulations
thereunder), labor, supplies, incidental repairs, operating expenses of
automobiles used in the trade or business, traveling expenses while away
from home solely in the pursuit of a trade or business (see Sec. 1.162-
2), advertising and other selling expenses, together with insurance
premiums against fire, storm, theft, accident, or other similar losses
in the case of a business, and rental for the use of business property.
No such item shall be included in business expenses, however, to the
extent that it is used by the taxpayer in computing the cost of property
included in its inventory or used in determining the gain or loss basis
of
[[Page 174]]
its plant, equipment, or other property. See section 1054 and the
regulations thereunder. A deduction for an expense paid or incurred
after December 30, 1969, which would otherwise be allowable under
section 162 shall not be denied on the grounds that allowance of such
deduction would frustrate a sharply defined public policy. See section
162(c), (f), and (g) and the regulations thereunder. The full amount of
the allowable deduction for ordinary and necessary expenses in carrying
on a business is deductible, even though such expenses exceed the gross
income derived during the taxable year from such business. In the case
of any sports program to which section 114 (relating to sports programs
conducted for the American National Red Cross) applies, expenses
described in section 114(a)(2) shall be allowable as deductions under
section 162(a) only to the extent that such expenses exceed the amount
excluded from gross income under section 114(a).
(b) Cross references. (1) For charitable contributions by
individuals and corporations not deductible under section 162, see Sec.
1.162-15.
(2) For items not deductible, see sections 261-276, inclusive, and
the regulations thereunder.
(3) For research and experimental expenditures, see section 174 and
regulations thereunder.
(4) For soil and water conservation expenditures, see section 175
and regulations thereunder.
(5) For expenditures attributable to grant or loan by United States
for encouragement of exploration for, or development or mining of,
critical and strategic minerals or metals, see section 621 and
regulations thereunder.
(6) For treatment of certain rental payments with respect to public
utility property, see section 167(1) and Sec. 1.167(1)-3.
(7) For limitations on the deductibility of miscellaneous itemized
deductions, see section 67 and Sec. Sec. 1.67-1T through 1.67-4T.
(8) For the timing of deductions with respect to notional principal
contracts. see Sec. 1.446-3.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6690, 28 FR
12253, Nov. 19, 1963; T.D. 6996, 34 FR 835, Jan. 18, 1969; T.D. 7315, 39
FR 20203, June 7, 1974; T.D. 7345, 40 FR 7437, Feb. 20, 1975; T.D. 8189,
53 FR 9881, Mar. 28, 1988; T.D. 8491, 58 FR 53128, Oct. 14, 1993]
Sec. 1.162-2 Traveling expenses.
(a) Traveling expenses include travel fares, meals and lodging, and
expenses incident to travel such as expenses for sample rooms, telephone
and telegraph, public stenographers, etc. Only such traveling expenses
as are reasonable and necessary in the conduct of the taxpayer's
business and directly attributable to it may be deducted. If the trip is
undertaken for other than business purposes, the travel fares and
expenses incident to travel are personal expenses and the meals and
lodging are living expenses. If the trip is solely on business, the
reasonable and necessary traveling expenses, including travel fares,
meals and lodging, and expenses incident to travel, are business
expenses. For the allowance of traveling expenses as deductions in
determining adjusted gross income, see section 62(2)(B) and the
regulations thereunder.
(b)(1) If a taxpayer travels to a destination and while at such
destination engages in both business and personal activities, traveling
expenses to and from such destination are deductible only if the trip is
related primarily to the taxpayer's trade or business. If the trip is
primarily personal in nature, the traveling expenses to and from the
destination are not deductible even though the taxpayer engages in
business activities while at such destination. However, expenses while
at the destination which are properly allocable to the taxpayer's trade
or business are deductible even though the traveling expenses to and
from the destination are not deductible.
(2) Whether a trip is related primarily to the taxpayer's trade or
business or is primarily personal in nature depends on the facts and
circumstances in each case. The amount of time during the period of the
trip which is spent on personal activity compared to the
[[Page 175]]
amount of time spent on activities directly relating to the taxpayer's
trade or business is an important factor in determining whether the trip
is primarily personal. If, for example, a taxpayer spends one week while
at a destination on activities which are directly related to his trade
or business and subsequently spends an additional five weeks for
vacation or other personal activities, the trip will be considered
primarily personal in nature in the absence of a clear showing to the
contrary.
(c) Where a taxpayer's wife accompanies him on a business trip,
expenses attributable to her travel are not deductible unless it can be
adequately shown that the wife's presence on the trip has a bona fide
business purpose. The wife's performance of some incidental service does
not cause her expenses to qualify as deductible business expenses. The
same rules apply to any other members of the taxpayer's family who
accompany him on such a trip.
(d) Expenses paid or incurred by a taxpayer in attending a
convention or other meeting may constitute an ordinary and necessary
business expense under section 162 depending upon the facts and
circumstances of each case. No distinction will be made between self-
employed persons and employees. The fact that an employee uses vacation
or leave time or that his attendance at the convention is voluntary will
not necessarily prohibit the allowance of the deduction. The allowance
of deductions for such expenses will depend upon whether there is a
sufficient relationship between the taxpayer's trade of business and his
attendance at the convention or other meeting so that he is benefiting
or advancing the interests of his trade or business by such attendance.
If the convention is for political, social or other purposes unrelated
to the taxpayer's trade or business, the expenses are not deductible.
(e) Commuters' fares are not considered as business expenses and are
not deductible.
(f) For rules with respect to the reporting and substantiation of
traveling and other business expenses of employees for taxable years
beginning after December 31, 1957, see Sec. 1.162-17.
Sec. 1.162-3 Materials and supplies.
(a) In general--(1) Non-incidental materials and supplies. Except as
provided in paragraphs (d), (e), and (f) of this section, amounts paid
to acquire or produce materials and supplies (as defined in paragraph
(c) of this section) are deductible in the taxable year in which the
materials and supplies are first used in the taxpayer's operations or
are consumed in the taxpayer's operations.
(2) Incidental materials and supplies. Amounts paid to acquire or
produce incidental materials and supplies (as defined in paragraph (c)
of this section) that are carried on hand and for which no record of
consumption is kept or of which physical inventories at the beginning
and end of the taxable year are not taken, are deductible in the taxable
year in which these amounts are paid, provided taxable income is clearly
reflected.
(3) Use or consumption of rotable and temporary spare parts. Except
as provided in paragraphs (d), (e), and (f) of this section, for
purposes of paragraph (a)(1) of this section, rotable and temporary
spare parts (defined under paragraph (c)(2) of this section) are first
used in the taxpayer's operations or are consumed in the taxpayer's
operations in the taxable year in which the taxpayer disposes of the
parts.
(b) Coordination with other provisions of the Internal Revenue Code.
Nothing in this section changes the treatment of any amount that is
specifically provided for under any provision of the Internal Revenue
Code (Code) or regulations other than section 162(a) or section 212 and
the regulations under those sections. For example, see Sec. 1.263(a)-3,
which requires taxpayers to capitalize amounts paid to improve tangible
property and section 263A and the regulations under section 263A, which
require taxpayers to capitalize the direct and allocable indirect costs,
including the cost of materials and supplies, of property produced by
the taxpayer and property acquired for resale. See also Sec. 1.471-1,
which requires taxpayers to include in inventory certain materials and
supplies.
[[Page 176]]
(c) Definitions--(1) Materials and supplies. For purposes of this
section, materials and supplies means tangible property that is used or
consumed in the taxpayer's operations that is not inventory and that--
(i) Is a component acquired to maintain, repair, or improve a unit
of tangible property (as determined under Sec. 1.263(a)-3(e)) owned,
leased, or serviced by the taxpayer and that is not acquired as part of
any single unit of tangible property;
(ii) Consists of fuel, lubricants, water, and similar items,
reasonably expected to be consumed in 12 months or less, beginning when
used in the taxpayer's operations;
(iii) Is a unit of property as determined under Sec. 1.263(a)-3(e)
that has an economic useful life of 12 months or less, beginning when
the property is used or consumed in the taxpayer's operations;
(iv) Is a unit of property as determined under Sec. 1.263(a)-3(e)
that has an acquisition cost or production cost (as determined under
section 263A) of $200 or less (or other amount as identified in
published guidance in the Federal Register or in the Internal Revenue
Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this chapter); or
(v) Is identified in published guidance in the Federal Register or
in the Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this
chapter) as materials and supplies for which treatment is permitted
under this section.
(2) Rotable and temporary spare parts. For purposes of this section,
rotable spare parts are materials and supplies under paragraph (c)(1)(i)
of this section that are acquired for installation on a unit of
property, removable from that unit of property, generally repaired or
improved, and either reinstalled on the same or other property or stored
for later installation. Temporary spare parts are materials and supplies
under paragraph (c)(1)(i) of this section that are used temporarily
until a new or repaired part can be installed and then are removed and
stored for later installation.
(3) Standby emergency spare parts. Standby emergency spare parts are
materials and supplies under paragraph (c)(1)(i) of this section that
are--
(i) Acquired when particular machinery or equipment is acquired (or
later acquired and set aside for use in particular machinery or
equipment);
(ii) Set aside for use as replacements to avoid substantial
operational time loss caused by emergencies due to particular machinery
or equipment failure;
(iii) Located at or near the site of the installed related machinery
or equipment so as to be readily available when needed;
(iv) Directly related to the particular machinery or piece of
equipment they serve;
(v) Normally expensive;
(vi) Only available on special order and not readily available from
a vendor or manufacturer;
(vii) Not subject to normal periodic replacement;
(viii) Not interchangeable in other machines or equipment;
(ix) [Reserved]
(x) Not acquired in quantity (generally only one is on hand for each
piece of machinery or equipment); and
(xi) Not repaired and reused.
(4) Economic useful life--(i) General rule. The economic useful life
of a unit of property is not necessarily the useful life inherent in the
property but is the period over which the property may reasonably be
expected to be useful to the taxpayer or, if the taxpayer is engaged in
a trade or business or an activity for the production of income, the
period over which the property may reasonably be expected to be useful
to the taxpayer in its trade or business or for the production of
income, as applicable. The factors that must be considered in
determining this period are provided under Sec. 1.167(a)-1(b).
(ii) Taxpayers with an applicable financial statement. For taxpayers
with an applicable financial statement (as defined in paragraph
(c)(4)(iii) of this section), the economic useful life of a unit of
property, solely for the purposes of applying the provisions of this
paragraph (c), is the useful life initially used by the taxpayer for
purposes of determining depreciation in its applicable financial
statement, regardless of any salvage value of the property. If a
taxpayer does not have an applicable financial statement for the taxable
[[Page 177]]
year in which a unit of property was originally acquired or produced,
the economic useful life of the unit of property must be determined
under paragraph (c)(4)(i) of this section. Further, if a taxpayer treats
amounts paid for a unit of property as an expense in its applicable
financial statement on a basis other than the useful life of the
property or if a taxpayer does not depreciate the unit of property on
its applicable financial statement, the economic useful life of the unit
of property must be determined under paragraph (c)(4)(i) of this
section. For example, if a taxpayer has a policy of treating as an
expense on its applicable financial statement amounts paid for a unit of
property costing less than a certain dollar amount, notwithstanding that
the unit of property has a useful life of more than one year, the
economic useful life of the unit of property must be determined under
paragraph (c)(4)(i) of this section.
(iii) Definition of applicable financial statement. The taxpayer's
applicable financial statement is the taxpayer's financial statement
listed in paragraphs (c)(4)(iii)(A) through (C) of this section that has
the highest priority (including within paragraph (c)(4)(iii)(B) of this
section). The financial statements are, in descending priority--
(A) A financial statement required to be filed with the Securities
and Exchange Commission (SEC) (the 10-K or the Annual Statement to
Shareholders);
(B) A certified audited financial statement that is accompanied by
the report of an independent certified public accountant (or in the case
of a foreign entity, by the report of a similarly qualified independent
professional), that is used for--
(1) Credit purposes;
(2) Reporting to shareholders, partners, or similar persons; or
(3) Any other substantial non-tax purpose; or
(C) A financial statement (other than a tax return) required to be
provided to the federal or a state government or any federal or state
agency (other than the SEC or the Internal Revenue Service).
(5) Amount paid. For purposes of this section, in the case of a
taxpayer using an accrual method of accounting, the terms amount paid
and payment mean a liability incurred (within the meaning of Sec.
1.446-1(c)(1)(ii)). A liability may not be taken into account under this
section prior to the taxable year during which the liability is
incurred.
(6) Produce. For purposes of this section, produce means construct,
build, install, manufacture, develop, create, raise, or grow. This
definition is intended to have the same meaning as the definition used
for purposes of section 263A(g)(1) and Sec. 1.263A-2(a)(1)(i), except
that improvements are excluded from the definition in this paragraph
(c)(6) and are separately defined and addressed in Sec. 1.263(a)-3.
Amounts paid to produce materials and supplies are subject to section
263A.
(d) Election to capitalize and depreciate certain materials and
supplies--(1) In general. A taxpayer may elect to treat as a capital
expenditure and to treat as an asset subject to the allowance for
depreciation the cost of any rotable spare part, temporary spare part,
or standby emergency spare part as defined in paragraph (c)(2) or (c)(3)
of this section. Except as specified in paragraph (d)(2) of this
section, an election made under this paragraph (d) applies to amounts
paid during the taxable year to acquire or produce any rotable,
temporary, or standby emergency spare part to which paragraph (a) of
this section would apply (but for the election under this paragraph
(d)). Any property for which this election is made shall not be treated
as a material or a supply.
(2) Exceptions. A taxpayer may not elect to capitalize and
depreciate under this paragraph (d) any amount paid to acquire or
produce a rotable, temporary, or standby emergency spare part defined in
paragraph (c)(2) or (c)(3) of this section if--
(i) The rotable, temporary, or standby emergency spare part is
intended to be used as a component of a unit of property under paragraph
(c)(1)(iii), (iv), or (v) of this section;
(ii) The rotable, temporary, or standby emergency spare part is
intended to be used as a component of a property described in paragraph
(c)(1)(i) and the taxpayer cannot or has not elected to
[[Page 178]]
capitalize and depreciate that property under this paragraph (d); or
(iii) The amount is paid to acquire or produce a rotable or
temporary spare part and the taxpayer uses the optional method of
accounting for rotable and temporary spare parts under paragraph (e) to
of this section.
(3) Manner of electing. A taxpayer makes the election under this
paragraph (d) by capitalizing the amounts paid to acquire or produce a
rotable, temporary, or standby emergency spare part in the taxable year
the amounts are paid and by beginning to depreciate the costs when the
asset is placed in service by the taxpayer for purposes of determining
depreciation under the applicable provisions of the Internal Revenue
Code and the Treasury Regulations. Section 1.263(a)-2 provides for the
treatment of amounts paid to acquire or produce real or personal
tangible property. A taxpayer must make the election under this
paragraph (d) in its timely filed original Federal tax return (including
extensions) for the taxable year the asset is placed in service by the
taxpayer for purposes of determining depreciation. Sections 301.9100-1
through 301.9100-3 of this chapter provide the rules governing
extensions of the time to make regulatory elections. In the case of an S
corporation or a partnership, the election is made by the S corporation
or partnership, and not by the shareholders or partners. A taxpayer may
make an election for each rotable, temporary, or standby emergency spare
part that qualifies for the election under this paragraph (d). This
election does not apply to an asset or a portion thereof placed in
service and disposed of in the same taxable year. A taxpayer may revoke
an election made under this paragraph (d) or made under Sec. 1.162-
3T(d), as contained in 26 CFR part 1, revised as of April 1, 2013, only
by filing a request for a private letter ruling and obtaining the
Commissioner's consent to revoke the election. The Commissioner may
grant a request to revoke this election if the taxpayer acted reasonably
and in good faith and the revocation will not prejudice the interests of
the Government. See generally Sec. 301.9100-3 of this chapter. The
manner of electing and revoking the election to capitalize under this
paragraph (d) or under Sec. 1.162-3T(d), as contained in 26 CFR part 1,
revised as of April 1, 2013, may be modified through guidance of general
applicability (see Sec. Sec. 601.601(d)(2) and 601.602 of this
chapter). An election may not be made or revoked through the filing of
an application for change in accounting method or, before obtaining the
Commissioner's consent to make the late election or to revoke the
election, by filing an amended Federal tax return.
(e) Optional method of accounting for rotable and temporary spare
parts--(1) In general. This paragraph (e) provides an optional method of
accounting for rotable and temporary spare parts (the optional method
for rotable parts). A taxpayer may use the optional method for rotable
parts, instead of the general rule under paragraph (a)(3) of this
section, to account for its rotable and temporary spare parts as defined
in paragraph (c)(2) of this section. A taxpayer that uses the optional
method for rotable parts must use this method for all of its pools of
rotable and temporary spare parts used in the same trade or business and
for which it uses this method for its books and records. If a taxpayer
uses the optional method for rotable parts for pools of rotable and
temporary spare parts for which the taxpayer does not use the optional
method for its books and records, then the taxpayer must use the
optional method for all its pools in the same trade or business, whether
rotable or temporary. The optional method for rotable parts is a method
of accounting under section 446(a). Under the optional method for
rotable parts, the taxpayer must apply the rules in this paragraph (e)
to each rotable or temporary spare part (part) upon the taxpayer's
initial installation, removal, repair, maintenance or improvement,
reinstallation, and disposal of each part.
(2) Description of optional method for rotable parts--(i) Initial
installation. The taxpayer must deduct the amount paid to acquire or
produce the part in the taxable year that the part is first installed on
a unit of property for use in the taxpayer's operations.
(ii) Removal from unit of property. In each taxable year in which
the part is
[[Page 179]]
removed from a unit of property to which it was initially or
subsequently installed, the taxpayer must--
(A) Include in gross income the fair market value of the part; and
(B) Include in the basis of the part the fair market value of the
part included in income under paragraph (e)(2)(ii)(A) of this section
and the amount paid to remove the part from the unit of property.
(iii) Repair, maintenance, or improvement of part. The taxpayer may
not currently deduct and must include in the basis of the part any
amounts paid to maintain, repair, or improve the part in the taxable
year these amounts are paid.
(iv) Reinstallation of part. The taxpayer must deduct the amounts
paid to reinstall the part and those amounts included in the basis of
the part under paragraphs (e)(2)(ii)(B) and (e)(2)(iii) of this section,
to the extent that those amounts have not been previously deducted under
this paragraph (e)(2)(iv), in the taxable year that the part is
reinstalled on a unit of property.
(v) Disposal of the part. The taxpayer must deduct the amounts
included in the basis of the part under paragraphs (e)(2)(ii)(B) and
(e)(2)(iii) of this section, to the extent that those amounts have not
been previously deducted under paragraph (e)(2)(iv) of this section, in
the taxable year in which the part is disposed of by the taxpayer.
(f) Application of de minimis safe harbor. If a taxpayer elects to
apply the de minimis safe harbor under Sec. 1.263(a)-1(f) to amounts
paid for the production or acquisition of tangible property, then the
taxpayer must apply the de minimis safe harbor to amounts paid for all
materials and supplies that meet the requirements of Sec. 1.263(a)-
1(f), except for those materials and supplies that the taxpayer elects
to capitalize and depreciate under paragraph (d) of this section or for
which the taxpayer properly uses the optional method of accounting for
rotable and temporary spare parts under paragraph (e) of this section.
If the taxpayer properly applies the de minimis safe harbor under Sec.
1.263(a)-1(f) to amounts paid for materials and supplies, then these
amounts are not treated as amounts paid for materials and supplies under
this section. See Sec. 1.263(a)-1(f)(5) for the time and manner of
electing the de minimis safe harbor and Sec. 1.263(a)-1(f)(3)(iv) for
the treatment of safe harbor amounts.
(g) Sale or disposition of materials and supplies. Upon sale or
other disposition, materials and supplies as defined in this section are
not treated as a capital asset under section 1221 or as property used in
the trade or business under section 1231. Any asset for which the
taxpayer makes the election to capitalize and depreciate under paragraph
(d) of this section shall not be treated as a material or supply, and
the recognition and character of the gain or loss for such depreciable
asset are determined under other applicable provisions of the Code.
(h) Examples. The rules of this section are illustrated by the
following examples, in which it is assumed, unless otherwise stated,
that the property is not an incidental material or supply, that the
taxpayer computes its income on a calendar year basis, that the taxpayer
does not make the election to apply paragraph (d) of this section, or
use the method of accounting described in paragraph (e) of this section,
and that the taxpayer has not elected to apply the de minimis safe
harbor under Sec. 1.263(a)-1(f). The following examples illustrate only
the application of this section and, unless otherwise stated, do not
address the treatment under other provisions of the Code (for example,
section 263A).
Example 1 Non-rotable components. A owns a fleet of aircraft that it
operates in its business. In Year 1, A purchases a stock of spare parts,
which it uses to maintain and repair its aircraft. A keeps a record of
consumption of these spare parts. In Year 2, A uses the spare parts for
the repair and maintenance of one of its aircraft. Assume each aircraft
is a unit of property under Sec. 1.263(a)-3(e) and that spare parts are
not rotable or temporary spare parts under paragraph (c)(2) of this
section. Assume these repair and maintenance activities do not improve
the aircraft under Sec. 1.263(a)-3. These parts are materials and
supplies under paragraph (c)(1)(i) of this section because they are
components acquired and used to maintain and repair A's aircraft. Under
paragraph (a)(1) of this section, the amounts that A paid for the spare
parts in Year 1 are deductible in Year 2, the taxable year in which the
spare parts are first used to repair and maintain the aircraft.
[[Page 180]]
Example 2 Rotable spare parts; disposal method. B operates a fleet
of specialized vehicles that it uses in its service business. Assume
that each vehicle is a unit of property under Sec. 1.263(a)-3(e). At
the time that it acquires a new type of vehicle, B also acquires a
substantial number of rotable spare parts that it will keep on hand to
quickly replace similar parts in B's vehicles as those parts break down
or wear out. These rotable parts are removable from the vehicles and are
repaired so that they can be reinstalled on the same or similar
vehicles. In Year 1, B acquires several vehicles and a number of rotable
spare parts to be used as replacement parts in these vehicles. In Year
2, B repairs several vehicles by using these rotable spare parts to
replace worn or damaged parts. In Year 3, B removes these rotable spare
parts from its vehicles, repairs the parts, and reinstalls them on other
similar vehicles. In Year 5, B can no longer use the rotable parts it
acquired in Year 1 and disposes of them as scrap. Assume that B does not
improve any of the rotable spare parts under Sec. 1.263(a)-3. Under
paragraph (c)(1)(i) of this section, the rotable spare parts acquired in
Year 1 are materials and supplies. Under paragraph (a)(3) of this
section, rotable spare parts are generally used or consumed in the
taxable year in which the taxpayer disposes of the parts. Therefore,
under paragraph (a)(1) of this section, the amounts that B paid for the
rotable spare parts in Year 1 are deductible in Year 5, the taxable year
in which B disposes of the parts.
Example 3 Rotable spare parts; application of optional method of
accounting. C operates a fleet of specialized vehicles that it uses in
its service business. Assume that each vehicle is a unit of property
under Sec. 1.263(a)-3(e). At the time that it acquires a new type of
vehicle, C also acquires a substantial number of rotable spare parts
that it will keep on hand to replace similar parts in C's vehicles as
those parts break down or wear out. These rotable parts are removable
from the vehicles and are repaired so that they can be reinstalled on
the same or similar vehicles. C uses the optional method of accounting
for all its rotable and temporary spare parts under paragraph (e) of
this section. In Year 1, C acquires several vehicles and a number of
rotable spare parts (the ``Year 1 rotable parts'') to be used as
replacement parts in these vehicles. In Year 2, C repairs several
vehicles and uses the Year 1 rotable parts to replace worn or damaged
parts. In Year 3, C pays amounts to remove these Year 1 rotable parts
from its vehicles. In Year 4, C pays amounts to maintain, repair, or
improve the Year 1 rotable parts. In Year 5, C pays amounts to reinstall
the Year 1 rotable parts on other similar vehicles. In Year 8, C removes
the Year 1 rotable parts from these vehicles and stores these parts for
possible later use. In Year 9, C disposes of the Year 1 rotable parts.
Under paragraph (e) of this section, C must deduct the amounts paid to
acquire and install the Year 1 rotable parts in Year 2, the taxable year
in which the rotable parts are first installed by C in C's vehicles. In
Year 3, when C removes the Year 1 rotable parts from its vehicles, C
must include in its gross income the fair market value of each part.
Also, in Year 3, C must include in the basis of each Year 1 rotable part
the fair market value of the rotable part and the amount paid to remove
the rotable part from the vehicle. In Year 4, C must include in the
basis of each Year 1 rotable part the amounts paid to maintain, repair,
or improve each rotable part. In Year 5, the year that C reinstalls the
Year 1 rotable parts (as repaired or improved) in other vehicles, C must
deduct the reinstallation costs and the amounts previously included in
the basis of each part. In Year 8, the year that C removes the Year 1
rotable parts from the vehicles, C must include in income the fair
market value of each rotable part removed. In addition, in Year 8, C
must include in the basis of each part the fair market value of that
part and the amount paid to remove each rotable part from the vehicle.
In Year 9, the year that C disposes of the Year 1 rotable parts, C may
deduct the amounts remaining in the basis of each rotable part.
Example 4 Rotable part acquired as part of a single unit of
property; not material or supply. D operates a fleet of aircraft. In
Year 1, D acquires a new aircraft, which includes two new aircraft
engines. The aircraft costs $500,000 and has an economic useful life of
more than 12 months, beginning when it is placed in service. In Year 5,
after the aircraft is operated for several years in D's business, D
removes the engines from the aircraft, repairs or improves the engines,
and either reinstalls the engines on a similar aircraft or stores the
engines for later reinstallation. Assume the aircraft purchased in Year
1, including its two engines, is a unit of property under Sec.
1.263(a)-3(e). Because the engines were acquired as part of the
aircraft, a single unit of property, the engines are not materials or
supplies under paragraph (c)(1)(i) of this section nor rotable or
temporary spare parts under paragraph (c)(2) of this section.
Accordingly, D may not apply the rules of this section to the aircraft
engines upon the original acquisition of the aircraft nor after the
removal of the engines from the aircraft for use in the same or similar
aircraft. Rather, D must apply the rules under Sec. Sec. 1.263(a)-2 and
1.263(a)-3 to the aircraft, including its engines, to determine the
treatment of amounts paid to acquire, produce, or improve the unit of
property.
Example 5 Consumable property. E operates a fleet of aircraft that
carries freight for its customers. E has several storage tanks on its
premises, which hold jet fuel for its aircraft.
[[Page 181]]
Assume that once the jet fuel is placed in E's aircraft, the jet fuel is
reasonably expected to be consumed within 12 months or less. On December
31, Year 1, E purchases a two-year supply of jet fuel. In Year 2, E uses
a portion of the jet fuel purchased on December 31, Year 1, to fuel the
aircraft used in its business. The jet fuel that E purchased in Year 1
is a material or supply under paragraph (c)(1)(ii) of this section
because it is reasonably expected to be consumed within 12 months or
less from the time it is placed in E's aircraft. Under paragraph (a)(1)
of this section, E may deduct in Year 2 the amounts paid for the portion
of jet fuel used in the operation of E's aircraft in Year 2.
Example 6 Unit of property that costs $200 or less. F operates a
business that rents out a variety of small individual items to customers
(rental items). F maintains a supply of rental items on hand. In Year 1,
F purchases a large quantity of rental items to use in its rental
business. Assume that each rental item is a unit of property under Sec.
1.263(a)-3(e) and costs $200 or less. In Year 2, F begins using all the
rental items purchased in Year 1 by providing them to customers of its
rental business. F does not sell or exchange these items on established
retail markets at any time after the items are used in the rental
business. The rental items are materials and supplies under paragraph
(c)(1)(iv) of this section. Under paragraph (a)(1) of this section, the
amounts that F paid for the rental items in Year 1 are deductible in
Year 2, the taxable year in which the rental items are first used in F's
business.
Example 7 Unit of property that costs $200 or less. G provides
billing services to its customers. In Year 1, G pays amounts to purchase
50 scanners to be used by its employees. Assume each scanner is a unit
of property under Sec. 1.263(a)-3(e) and costs less than $200. In Year
1, G's employees begin using 35 of the scanners, and F stores the
remaining 15 scanners for use in a later taxable year. The scanners are
materials and supplies under paragraph (c)(1)(iv) of this section. Under
paragraph (a)(1) of this section, the amounts G paid for 35 of the
scanners are deductible in Year 1, the taxable year in which G first
uses each of those scanners. The amounts that G paid for each of the
remaining 15 scanners are deductible in the taxable year in which each
machine is first used in G's business.
Example 8 Materials and supplies that cost less than $200; de
minimis safe harbor. Assume the same facts as in Example 7 except that
G's scanners qualify for the de minimis safe harbor under Sec.
1.263(a)-1(f), and G properly elects to apply the de minimis safe harbor
under Sec. 1.263(a)-1(f) to amounts paid in Year 1. G must apply the de
minimis safe harbor under Sec. 1.263(a)-1(f) to amounts paid for the
scanners, rather than treat these amounts as costs of materials and
supplies under this section. In accordance with Sec. 1.263(a)-
1(f)(3)(iv), G may deduct the amounts paid for all 50 scanners under
Sec. 1.162-1 in the taxable year the amounts are paid.
Example 9 Unit of property that costs $200 or less; bulk purchase. H
provides consulting services to its customers. In Year 1, H pays $500 to
purchase one box of 10 toner cartridges to use as needed for H's
printers. Assume each toner cartridge is a unit of property under Sec.
1.263(a)-3(e). In Year 1, H's employees place 8 of the toner cartridges
in printers in H's office, and store the remaining 2 cartridges for use
in a later taxable year. The toner cartridges are materials and supplies
under paragraph (c)(1)(iv) of this section because even though purchased
in one box costing more than $200, the allocable cost of each unit of
property equals $50. Therefore, under paragraph (a)(1) of this section,
the $400 paid by H for 8 of the cartridges is deductible in Year 1, the
taxable year in which H first uses each of those cartridges. The amounts
paid by H for each of the remaining 2 cartridges ($50 each) are
deductible in the taxable year in which each cartridge is first used in
H's business.
Example 10 Materials and supplies used in improvements; coordination
with Sec. 1.263(a)-3. J owns various machines that are used in its
business. Assume that each machine is a unit of property under Sec.
1.263(a)-3(e). In Year 1, J purchases a supply of spare parts for its
machines. J acquired the parts to use in the repair or maintenance of
the machines under Sec. 1.162-4 or in the improvement of the machines
under Sec. 1.263(a)-3. The spare parts are not rotable or temporary
spare parts under paragraph (c)(2) of this section. In Year 2, J uses
all of these spare parts in an activity that improves a machine under
Sec. 1.263(a)-3. Under paragraph (c)(1)(i) of this section, the spare
parts purchased by J in Year 1 are materials and supplies. Under
paragraph (a)(1) of this section, the amounts paid for the spare parts
are otherwise deductible as materials and supplies in Year 2, the
taxable year in which J uses those parts. However, because these
materials and supplies are used to improve J's machine, J is required to
capitalize the amounts paid for those spare parts under Sec. 1.263(a)-
3.
Example 11 Cost of producing materials and supplies; coordination
with section 263A. K is a manufacturer that produces liquid waste as
part of its operations. K determines that its current liquid waste
disposal process is inadequate. To remedy the problem, in Year 1, K
constructs a leaching pit to provide a draining area for the liquid
waste. Assume the leaching pit is a unit of property under Sec.
1.263(a)-3(e) and has an economic useful life of 12 months or less,
starting on the date that K begins to use the leaching pit as a draining
area. At the end of this period, K's factory will be connected to the
local sewer
[[Page 182]]
system. In Year 2, K starts using the leaching pit in its operations.
The amounts paid to construct the leaching pit (including the direct and
allocable indirect costs of property produced under section 263A) are
amounts paid for a material or supply under paragraph (c)(1)(iii) of
this section. However, the amounts paid to construct the leaching pit
may be subject to capitalization under section 263A if these amounts
comprise the direct or allocable indirect costs of property produced by
K.
Example 12 Costs of acquiring materials and supplies for production
of property; coordination with section 263A. In Year 1, L purchases
jigs, dies, molds, and patterns for use in the manufacture of L's
products. Assume each jig, die, mold, and pattern is a unit of property
under Sec. 1.263(a)-3(e). The economic useful life of each jig, die,
mold, and pattern is 12 months or less, beginning when each item is used
in the manufacturing process. The jigs, dies, molds, and patterns are
not components acquired to maintain, repair, or improve any of L's
equipment under paragraph (c)(1)(i) of this section. L begins using the
jigs, dies, molds and patterns in Year 2 to manufacture its products.
These items are materials and supplies under paragraph (c)(1)(iii) of
this section. Under paragraph (a)(1) of this section, the amounts paid
for the items are otherwise deductible in Year 2, the taxable year in
which L first uses those items. However, the amounts paid for these
materials and supplies may be subject to capitalization under section
263A if these amounts comprise the direct or allocable indirect costs of
property produced by L.
Example 13 Election to capitalize and depreciate. M is in the mining
business. M acquires certain temporary spare parts, which it keeps on
hand to avoid operational time loss in the event it must make temporary
repairs to a unit of property that is subject to depreciation. These
parts are not used to improve property under Sec. 1.263(a)-3(d). These
temporary spare parts are used until a new or repaired part can be
installed and then are removed and stored for later temporary
installation. M does not use the optional method of accounting for
rotable and temporary spare parts in paragraph (e) of this section for
any of its rotable or temporary spare parts. The temporary spare parts
are materials and supplies under paragraph (c)(1)(i) of this section.
Under paragraphs (a)(1) and (a)(3) of this section, the amounts paid for
the temporary spare parts are deductible in the taxable year in which
they are disposed of by M. However, because it is unlikely that the
temporary spare parts will be disposed of in the near future, M would
prefer to treat the amounts paid for the spare parts as capital
expenditures subject to depreciation. M may elect under paragraph (d) of
this section to treat the cost of each temporary spare part as a capital
expenditure and as an asset subject to an allowance for depreciation. M
makes this election by capitalizing the amounts paid for each spare part
in the taxable year that M acquires the spare parts and by beginning to
recover the costs of each part on its timely filed Federal tax return
for the taxable year in which the part is placed in service for purposes
of determining depreciation under the applicable provisions of the
Internal Revenue Code and the Treasury Regulations. See Sec. 1.263(a)-
2(g) for the treatment of capital expenditures.
Example 14 Election to apply de minimis safe harbor. (i) N provides
consulting services to its customers. In Year 1, N pays amounts to
purchase 50 laptop computers. Each laptop computer is a unit of property
under Sec. 1.263(a)-3(e), costs $400, and has an economic useful life
of more than 12 months. Also in Year 1, N purchases 50 office chairs to
be used by its employees. Each office chair is a unit of property that
costs $100. N has an applicable financial statement (as defined in Sec.
1.263(a)-1(f)(4)) and N has a written accounting policy at the beginning
Year 1 to expense amounts paid for units of property costing $500 or
less. N treats amounts paid for property costing $500 or less as an
expense on its applicable financial statement in Year 1.
(ii) The laptop computers are not materials or supplies under
paragraph (c) of this section. Therefore, the amounts N pays for the
computers must generally be capitalized under Sec. 1.263(a)-2(d) as
amounts paid for the acquisition of tangible property. The office chairs
are materials and supplies under paragraph (c)(1)(iv) of this section.
Thus, under paragraph (a)(1) of this section, the amounts paid for the
office chairs are deductible in the taxable year in which they are first
used in N's business. However, under paragraph (f) of this section, if N
properly elects to apply the de minimis safe harbor under Sec.
1.263(a)-1(f) to amounts paid in Year 1, then N must apply the de
minimis safe harbor under Sec. 1.263(a)-1(f) to amounts paid for the
computers and the office chairs, rather than treat the office chairs as
the costs of materials and supplies under Sec. 1.162-3. Under the de
minimis safe harbor, N may not capitalize the amounts paid for the
computers under Sec. 1.263(a)-2 nor treat the office chairs as
materials and supplies under Sec. 1.162-3. Instead, in accordance with
Sec. 1.263(a)-1(f)(3)(iv), under Sec. 1.162-1, N may deduct the
amounts paid for the computers and the office chairs in the taxable year
paid.
(i) Accounting method changes. Except as otherwise provided in this
section, a change to comply with this section is a change in method of
accounting to which the provisions of sections 446 and 481 and the
accompanying regulations apply. A taxpayer seeking to change to a method
of accounting permitted in
[[Page 183]]
this section must secure the consent of the Commissioner in accordance
with Sec. 1.446-1(e) and follow the administrative procedures issued
under Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's consent
to change its accounting method.
(j) Effective/applicability date--(1) In general. This section
generally applies to amounts paid or incurred in taxable years beginning
on or after January 1, 2014. However, a taxpayer may apply paragraph (e)
of this section (the optional method of accounting for rotable and
temporary spare parts) to taxable years beginning on or after January 1,
2014. Except as provided in paragraphs (j)(2) and (j)(3) of this
section, Sec. 1.162-3 as contained in 26 CFR part 1 edition revised as
of April 1, 2011, applies to taxable years beginning before January 1,
2014.
(2) Early application of this section--(i) In general. Except for
paragraph (e) of this section, a taxpayer may choose to apply this
section to amounts paid or incurred in taxable years beginning on or
after January 1, 2012. A taxpayer may choose to apply paragraph (e) of
this section (the optional method of accounting for rotable and
temporary spare parts) to taxable years beginning on or after January 1,
2012.
(ii) Transition rule for election to capitalize materials and
supplies on 2012 and 2013 returns. If under paragraph (j)(2)(i) of this
section, a taxpayer chooses to make the election to capitalize and
depreciate certain materials and supplies under paragraph (d) of this
section for its taxable year beginning on or after January 1, 2012, and
ending on or before September 19, 2013 (applicable taxable year), and
the taxpayer did not make the election specified in paragraph (d)(3) of
this section on its timely filed original Federal tax return for the
applicable taxable year, the taxpayer must make the election specified
in paragraph (d)(3) of this section for the applicable taxable year by
filing an amended Federal tax return for the applicable taxable year on
or before 180 days from the due date including extensions of the
taxpayer's Federal tax return for the applicable taxable year,
notwithstanding that the taxpayer may not have extended the due date.
(3) Optional application of TD 9564. Except for Sec. 1.162-3T(e), a
taxpayer may choose to apply Sec. 1.162-3T as contained in TD 9564 (76
FR 81060) December 27, 2011, to amounts paid or incurred (to acquire or
produce property) in taxable years beginning on or after January 1,
2012, and before January 1, 2014. In applying Sec. 1.162-3T(d)(3), as
contained in 26 CFR part 1, revised as of April 1, 2013, a taxpayer
makes the election under Sec. 1.162-3T(d) by capitalizing the amounts
paid to acquire or produce a material or supply in the taxable year the
amounts are paid and by beginning to depreciate the costs when the asset
is placed in service by the taxpayer for purposes of determining
depreciation under the applicable provisions of the Internal Revenue
Code and the Treasury Regulations. The election under Sec. 1.162-3T(d),
as contained in 26 CFR part 1, revised as of April 1, 2013, does not
apply to an asset or a portion thereof placed in service and disposed of
in the same taxable year. A taxpayer may choose to apply Sec. 1.162-
3T(e) (the optional method of accounting for rotable and temporary spare
parts) as contained in TD 9564 (76 FR 81060) December 27, 2011, to
taxable years beginning on or after January 1, 2012, and before January
1, 2014.
[T.D. 9636, 78 FR 57701, Sept. 19, 2013, as amended at 79 FR 42190, July
21, 2014]
Sec. 1.162-4 Repairs.
(a) In general. A taxpayer may deduct amounts paid for repairs and
maintenance to tangible property if the amounts paid are not otherwise
required to be capitalized. Optionally, Sec. 1.263(a)-3(n) provides an
election to capitalize amounts paid for repair and maintenance
consistent with the taxpayer's books and records.
(b) Accounting method changes. A change to comply with this section
is a change in method of accounting to which the provisions of sections
446 and 481 and the accompanying regulations apply. A taxpayer seeking
to change to a method of accounting permitted in this section must
secure the consent of the Commissioner in accordance with Sec. 1.446-
1(e) and follow the administrative procedures issued under Sec. 1.446-
[[Page 184]]
1(e)(3)(ii) for obtaining the Commissioner's consent to change its
accounting method.
(c) Effective/applicability date--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (c)(2) and (c)(3) of this section, Sec.
1.162-4 as contained in 26 CFR part 1 edition revised as of April 1,
2011, applies to taxable years beginning before January 1, 2014.
(2) Early application of this section. A taxpayer may choose to
apply this section to taxable years beginning on or after January 1,
2012.
(3) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.162-4T as contained in TD 9564 (76 FR 81060), December 27, 2011,
to taxable years beginning on or after January 1, 2012, and before
January 1, 2014.
[T.D. 9636, 78 FR 57705, Sept. 19, 2013, as amended at 79 FR 42191, July
21, 2014]
Sec. 1.162-5 Expenses for education.
(a) General rule. Expenditures made by an individual for education
(including research undertaken as part of his educational program) which
are not expenditures of a type described in paragraph (b) (2) or (3) of
this section are deductible as ordinary and necessary business expenses
(even though the education may lead to a degree) if the education--
(1) Maintains or improves skills required by the individual in his
employment or other trade or business, or
(2) Meets the express requirements of the individual's employer, or
the requirements of applicable law or regulations, imposed as a
condition to the retention by the individual of an established
employment relationship, status, or rate of compensation.
(b) Nondeductible educational expenditures--(1) In general.
Educational expenditures described in subparagraphs (2) and (3) of this
paragraph are personal expenditures or constitute an inseparable
aggregate of personal and capital expenditures and, therefore, are not
deductible as ordinary and necessary business expenses even though the
education may maintain or improve skills required by the individual in
his employment or other trade or business or may meet the express
requirements of the individual's employer or of applicable law or
regulations.
(2) Minimum educational requirements. (i) The first category of
nondeductible educational expenses within the scope of subparagraph (1)
of this paragraph are expenditures made by an individual for education
which is required of him in order to meet the minimum educational
requirements for qualification in his employment or other trade or
business. The minimum education necessary to qualify for a position or
other trade or business must be determined from a consideration of such
factors as the requirements of the employer, the applicable law and
regulations, and the standards of the profession, trade, or business
involved. The fact that an individual is already performing service in
an employment status does not establish that he has met the minimum
educational requirements for qualification in that employment. Once an
individual has met the minimum educational requirements for
qualification in his employment or other trade or business (as in effect
when he enters the employment or trade or business), he shall be treated
as continuing to meet those requirements even though they are changed.
(ii) The minimum educational requirements for qualification of a
particular individual in a position in an educational institution is the
minimum level of education (in terms of aggregate college hours or
degree) which under the applicable laws or regulations, in effect at the
time this individual is first employed in such position, is normally
required of an individual initially being employed in such a position.
If there are no normal requirements as to the minimum level of education
required for a position in an educational institution, then an
individual in such a position shall be considered to have met the
minimum educational requirements for qualification in that position when
he becomes a member of the faculty of the educational institution. The
determination of whether an individual is a member of the faculty of an
educational institution must be made on the basis of
[[Page 185]]
the particular practices of the institution. However, an individual will
ordinarily be considered to be a member of the faculty of an institution
if (a) he has tenure or his years of service are being counted toward
obtaining tenure; (b) the institution is making contributions to a
retirement plan (other than Social Security or a similar program) in
respect of his employment; or (c) he has a vote in faculty affairs.
(iii) The application of this subparagraph may be illustrated by the
following examples:
Example 1. General facts:State X requires a bachelor's degree for
beginning secondary school teachers which must include 30 credit hours
of professional educational courses. In addition, in order to retain his
position, a secondary school teacher must complete a fifth year of
preparation within 10 years after beginning his employment. If an
employing school official certifies to the State Department of Education
that applicants having a bachelor's degree and the required courses in
professional education cannot be found, he may hire individuals as
secondary school teachers if they have completed a minimum of 90
semester hours of college work. However, to be retained in his position,
such an individual must obtain his bachelor's degree and complete the
required professional educational courses within 3 years after his
employment commences. Under these facts, a bachelor's degree, without
regard to whether it includes 30 credit hours of professional
educational courses, is considered to be the minimum educational
requirement for qualification as a secondary school teacher in State X.
This is the case notwithstanding the number of teachers who are actually
hired without such a degree. The following are examples of the
application of these facts in particular situations:
Situation 1. A, at the time he is employed as a secondary school
teacher in State X, has a bachelor's degree including 30 credit hours of
professional educational courses. After his employment, A completes a
fifth college year of education and, as a result, is issued a standard
certificate. The fifth college year of education undertaken by A is not
education required to meet the minimum educational requirements for
qualification as a secondary school teacher. Accordingly, the
expenditures for such education are deductible unless the expenditures
are for education which is part of a program of study being pursued by A
which will lead to qualifying him in a new trade or business.
Situation 2. Because of a shortage of applicants meeting the stated
requirements, B, who has a bachelor's degree, is employed as a secondary
school teacher in State X even though he has only 20 credit hours of
professional educational courses. After his employment, B takes an
additional 10 credit hours of professional educational courses. Since
these courses do not constitute education required to meet the minimum
educational requirements for qualification as a secondary school teacher
which is a bachelor's degree and will not lead to qualifying B in a new
trade or business, the expenditures for such courses are deductible.
Situation 3. Because of a shortage of applicants meeting the stated
requirements, C is employed as a secondary school teacher in State X
although he has only 90 semester hours of college work toward his
bachelor's degree. After his employment, C undertakes courses leading to
a bachelor's degree. These courses (including any courses in
professional education) constitute education required to meet the
minimum educational requirements for qualification as a secondary school
teacher. Accordingly, the expenditures for such education are not
deductible.
Situation 4. Subsequent to the employment of A, B, and C, but before
they have completed a fifth college year of education, State X changes
its requirements affecting secondary school teachers to provide that
beginning teachers must have completed 5 college years of preparation.
In the cases of A, B, and C, a fifth college year of education is not
considered to be education undertaken to meet the minimum educational
requirements for qualifications as a secondary school teacher.
Accordingly, expenditures for a fifth year of college will be deductible
unless the expenditures are for education which is part of a program
being pursued by A, B, or C which will lead to qualifying him in a new
trade or business.
Example 2. D, who holds a bachelor's degree, obtains temporary
employment as an instructor at University Y and undertakes graduate
courses as a candidate for a graduate degree. D may become a faculty
member only if he obtains a graduate degree and may continue to hold a
position as instructor only so long as he shows satisfactory progress
towards obtaining this graduate degree. The graduate courses taken by D
constitute education required to meet the minimum educational
requirements for qualification in D's trade or business and, thus, the
expenditures for such courses are not deductible.
Example 3. E, who has completed 2 years of a normal 3-year law
school course leading to a bachelor of laws degree (LL.B.), is hired by
a law firm to do legal research and perform other functions on a full-
time basis. As a condition to continued employment, E is required to
obtain an LL.B. and pass the State bar examination. E completes his law
school education by attending night law school, and he takes a bar
review course in order to prepare for the State bar examination. The law
[[Page 186]]
courses and bar review course constitute education required to meet the
minimum educational requirements for qualification in E's trade or
business and, thus, the expenditures for such courses are not
deductible.
(3) Qualification for new trade or business. (i) The second category
of nondeductible educational expenses within the scope of subparagraph
(1) of this paragraph are expenditures made by an individual for
education which is part of a program of study being pursued by him which
will lead to qualifying him in a new trade or business. In the case of
an employee, a change of duties does not constitute a new trade or
business if the new duties involve the same general type of work as is
involved in the individual's present employment. For this purpose, all
teaching and related duties shall be considered to involve the same
general type of work. The following are examples of changes in duties
which do not constitute new trades or businesses:
(a) Elementary to secondary school classroom teacher.
(b) Classroom teacher in one subject (such as mathematics) to
classroom teacher in another subject (such as science).
(c) Classroom teacher to guidance counselor.
(d) Classroom teacher to principal.
(ii) The application of this subparagraph to individuals other than
teachers may be illustrated by the following examples:
Example 1. A, a self-employed individual practicing a profession
other than law, for example, engineering, accounting, etc., attends law
school at night and after completing his law school studies receives a
bachelor of laws degree. The expenditures made by A in attending law
school are nondeductible because this course of study qualifies him for
a new trade or business.
Example 2. Assume the same facts as in example (1) except that A has
the status of an employee rather than a self-employed individual, and
that his employer requires him to obtain a bachelor of laws degree. A
intends to continue practicing his nonlegal profession as an employee of
such employer. Nevertheless, the expenditures made by A in attending law
school are not deductible since this course of study qualifies him for a
new trade or business.
Example 3. B, a general practitioner of medicine, takes a 2-week
course reviewing new developments in several specialized fields of
medicine. B's expenses for the course are deductible because the course
maintains or improves skills required by him in his trade or business
and does not qualify him for a new trade or business.
Example 4. C, while engaged in the private practice of psychiatry,
undertakes a program of study and training at an accredited
psychoanalytic institute which will lead to qualifying him to practice
psychoanalysis. C's expenditures for such study and training are
deductible because the study and training maintains or improves skills
required by him in his trade or business and does not qualify him for a
new trade or business.
(c) Deductible educational expenditures--(1) Maintaining or
improving skills. The deduction under the category of expenditures for
education which maintains or improves skills required by the individual
in his employment or other trade or business includes refresher courses
or courses dealing with current developments as well as academic or
vocational courses provided the expenditures for the courses are not
within either category of nondeductible expenditures described in
paragraph (b) (2) or (3) of this section.
(2) Meeting requirements of employer. An individual is considered to
have undertaken education in order to meet the express requirements of
his employer, or the requirements of applicable law or regulations,
imposed as a condition to the retention by the taxpayer of his
established employment relationship, status, or rate of compensation
only if such requirements are imposed for a bona fide business purpose
of the individual's employer. Only the minimum education necessary to
the retention by the individual of his established employment
relationship, status, or rate of compensation may be considered as
undertaken to meet the express requirements of the taxpayer's employer.
However, education in excess of such minimum education may qualify as
education undertaken in order to maintain or improve the skills required
by the taxpayer in his employment or other trade or business (see
subparagraph (1) of this paragraph). In no event, however, is a
deduction allowable for expenditures for education which, even though
for education required by the employer or applicable law or regulations,
are within one of
[[Page 187]]
the categories of nondeductible expenditures described in paragraph (b)
(2) and (3) of this section.
(d) Travel as a form of education. Subject to the provisions of
paragraph (b) and (e) of this section, expenditures for travel
(including travel while on sabbatical leave) as a form of education are
deductible only to the extent such expenditures are attributable to a
period of travel that is directly related to the duties of the
individual in his employment or other trade or business. For this
purpose, a period of travel shall be considered directly related to the
duties of an individual in his employment or other trade or business
only if the major portion of the activities during such period is of a
nature which directly maintains or improves skills required by the
individual in such employment or other trade or business. The approval
of a travel program by an employer or the fact that travel is accepted
by an employer in the fulfillment of its requirements for retention of
rate of compensation, status or employment, is not determinative that
the required relationship exists between the travel involved and the
duties of the individual in his particular position.
(e) Travel away from home. (1) If an individual travels away from
home primarily to obtain education the expenses of which are deductible
under this section, his expenditures for travel, meals, and lodging
while away from home are deductible. However, if as an incident of such
trip the individual engages in some personal activity such as
sightseeing, social visiting, or entertaining, or other recreation, the
portion of the expenses attributable to such personal activity
constitutes nondeductible personal or living expenses and is not
allowable as a deduction. If the individual's travel away from home is
primarily personal, the individual's expenditures for travel, meals and
lodging (other than meals and lodging during the time spent in
participating in deductible education pursuits) are not deductible.
Whether a particular trip is primarily person or primarily to obtain
education the expenses of which are deductible under this section
depends upon all the facts and circumstances of each case. An important
factor to be taken into consideration in making the determination is the
relative amount of time devoted to personal activity as compared with
the time devoted to educational pursuits. The rules set forth in this
paragraph are subject to the provisions of section 162(a)(2), relating
to deductibility of certain traveling expenses, and section 274 (c) and
(d), relating to allocation of certain foreign travel expenses and
substantiation required, respectively, and the regulations thereunder.
(2) Examples. The application of this subsection may be illustrated
by the following examples:
Example 1. A, a self-employed tax practitioner, decides to take a 1-
week course in new developments in taxation, which is offered in City X,
500 miles away from his home. His primary purpose in going to X is to
take the course, but he also takes a side trip to City Y (50 miles from
X) for 1 day, takes a sightseeing trip while in X, and entertains some
personal friends. A's transportation expenses to City X and return to
his home are deductible but his transportation expenses to City Y are
not deductible. A's expenses for meals and lodging while away from home
will be allocated between his educational pursuits and his personal
activities. Those expenses which are entirely personal, such as
sightseeing and entertaining friends, are not deductible to any extent.
Example 2. The facts are the same as in example (1) except that A's
primary purpose in going to City X is to take a vacation. This purpose
is indicated by several factors, one of which is the fact that he spends
only 1 week attending the tax course and devotes 5 weeks entirely to
personal activities. None of A's transportation expenses are deductible
and his expenses for meals and lodging while away from home are not
deductible to the extent attributable to personal activities. His
expenses for meals and lodging allocable to the week attending the tax
course are, however, deductible.
Example 3. B, a high school mathematics teacher in New York City, in
the summertime travels to a university in California in order to take a
mathematics course the expense of which is deductible under this
section. B pursues only one-fourth of a full course of study and the
remainder of her time is devoted to personal activities the expense of
which is not deductible. Absent a showing by B of a substantial
nonpersonal reason for taking the course in the university in
California, the trip is considered taken primarily for personal reasons
and the cost of traveling from New York City to California and return
would not be deductible. However, one-fourth of the cost of B's
[[Page 188]]
meals and lodging while attending the university in California may be
considered properly allocable to deductible educational pursuits and,
therefore, is deductible.
[T.D. 6918, 32 FR 6679, May 2, 1967]
Sec. 1.162-7 Compensation for personal services.
(a) There may be included among the ordinary and necessary expenses
paid or incurred in carrying on any trade or business a reasonable
allowance for salaries or other compensation for personal services
actually rendered. The test of deductibility in the case of compensation
payments is whether they are reasonable and are in fact payments purely
for services.
(b) The test set forth in paragraph (a) of this section and its
practical application may be further stated and illustrated as follows:
(1) Any amount paid in the form of compensation, but not in fact as
the purchase price of services, is not deductible. An ostensible salary
paid by a corporation may be a distribution of a dividend on stock. This
is likely to occur in the case of a corporation having few shareholders,
practically all of whom draw salaries. If in such a case the salaries
are in excess of those ordinarily paid for similar services and the
excessive payments correspond or bear a close relationship to the
stockholdings of the officers or employees, it would seem likely that
the salaries are not paid wholly for services rendered, but that the
excessive payments are a distribution of earnings upon the stock. An
ostensible salary may be in part payment for property. This may occur,
for example, where a partnership sells out to a corporation, the former
partners agreeing to continue in the service of the corporation. In such
a case it may be found that the salaries of the former partners are not
merely for services, but in part constitute payment for the transfer of
their business.
(2) The form or method of fixing compensation is not decisive as to
deductibility. While any form of contingent compensation invites
scrutiny as a possible distribution of earnings of the enterprise, it
does not follow that payments on a contingent basis are to be treated
fundamentally on any basis different from that applying to compensation
at a flat rate. Generally speaking, if contingent compensation is paid
pursuant to a free bargain between the employer and the individual made
before the services are rendered, not influenced by any consideration on
the part of the employer other than that of securing on fair and
advantageous terms the services of the individual, it should be allowed
as a deduction even though in the actual working out of the contract it
may prove to be greater than the amount which would ordinarily be paid.
(3) In any event the allowance for the compensation paid may not
exceed what is reasonable under all the circumstances. It is, in
general, just to assume that reasonable and true compensation is only
such amount as would ordinarily be paid for like services by like
enterprises under like circumstances. The circumstances to be taken into
consideration are those existing at the date when the contract for
services was made, not those existing at the date when the contract is
questioned.
(4) For disallowance of deduction in the case of certain transfers
of stock pursuant to employees stock options, see section 421 and the
regulations thereunder.
Sec. 1.162-8 Treatment of excessive compensation.
The income tax liability of the recipient in respect of an amount
ostensibly paid to him as compensation, but not allowed to be deducted
as such by the payor, will depend upon the circumstances of each case.
Thus, in the case of excessive payments by corporations, if such
payments correspond or bear a close relationship to stockholdings, and
are found to be a distribution of earnings or profits, the excessive
payments will be treated as a dividend. If such payments constitute
payment for property, they should be treated by the payor as a capital
expenditure and by the recipient as part of the purchase price. In the
absence of evidence to justify other treatment, excessive payments for
salaries or other compensation for personal services will be included in
gross income of the recipient.
[[Page 189]]
Sec. 1.162-9 Bonuses to employees.
Bonuses to employees will constitute allowable deductions from gross
income when such payments are made in good faith and as additional
compensation for the services actually rendered by the employees,
provided such payments, when added to the stipulated salaries, do not
exceed a reasonable compensation for the services rendered. It is
immaterial whether such bonuses are paid in cash or in kind or partly in
cash and partly in kind. Donations made to employees and others, which
do not have in them the element of compensation or which are in excess
of reasonable compensation for services, are not deductible from gross
income.
Sec. 1.162-10 Certain employee benefits.
(a) In general. Amounts paid or accrued by a taxpayer on account of
injuries received by employees and lump sum amounts paid or accrued as
compensation for injuries, are proper deductions as ordinary and
necessary expenses. Such deductions are limited to the amount not
compensated for by insurance or otherwise. Amounts paid or accrued
within the taxable year for dismissal wages, unemployment benefits,
guaranteed annual wages, vacations, or a sickness, accident,
hospitalization, medical expense, recreational, welfare, or similar
benefit plan, are deductible under section 162(a) if they are ordinary
and necessary expenses of the trade or business. However, except as
provided in paragraph (b) of this section, such amounts shall not be
deductible under section 162(a) if, under any circumstances, they may be
used to provide benefits under a stock bonus, pension, annuity, profit-
sharing, or other deferred compensation plan of the type referred to in
section 404(a). In such an event, the extent to which these amounts are
deductible from gross income shall be governed by the provisions of
section 404 and the regulations issued thereunder.
(b) Certain negotiated plans. (1) Subject to the limitations set
forth in subparagraphs (2) and (3) of this paragraph, contributions paid
by an employer under a plan under which such contributions are held in a
welfare trust for the purpose of paying (either from principal or income
or both) for the benefit of employees, their families, and dependents,
at least medical or hospital care, and pensions on retirement or death
of employees, are deductible when paid as business expenses under
section 162(a).
(2) For the purpose of subparagraph (1) of this paragraph, the word
``plan'' means any plan established prior to January 1, 1954, as a
result of an agreement between employee representatives and the
Government of the United States, during a period of Government
operation, under seizure powers, of a major part of the productive
facilities of the industry in which the employer claiming the deduction
is engaged. The phrase ``plan established prior to January 1, 1954, as a
result of an agreement'' is intended primarily to cover a trust
established under the terms of such an agreement. It also includes a
trust established under a plan of an employer, or group of employers,
who, by reason of producing the same commodity, are in competition with
the employers whose facilities were seized and who would therefore be
expected to establish such a trust as a reasonable measure to maintain a
sound position in the labor market producing the commodity. For example,
if a trust was established under such an agreement in the bituminous
coal industry, a similar trust established in the anthracite coal
industry within a reasonable time, but before January 1, 1954, would
qualify under subparagraph (1) of this paragraph.
(3) If any trust described in subparagraph (2) of this paragraph
becomes qualified for exemption from tax under the provisions of section
501(a), the deductibility of contributions by an employer to such trust
on or after any date of such qualification shall no longer be governed
by the provisions of section 162, even though the trust may later lose
its exemption from tax under section 501(a).
(c) Other plans providing deferred compensation. For rules relating
to the deduction of amounts paid to or under a stock bonus, pension,
annuity, or profit-sharing plan or amounts paid or accrued under any
other plan deferring
[[Page 190]]
the receipt of compensation, see section 404 and the regulations
thereunder.
Sec. 1.162-10T Questions and answers relating to the deduction of
employee benefits under the Tax Reform Act of 1984; certain limits
on amounts deductible (temporary).
Q-1: How does the amendment of section 404(b) by the Tax Reform Act
of 1984 affect the deduction of employee benefits under section 162 of
the Internal Revenue Code?
A-1: As amended by the Tax Reform Act of 1984, section 404(b)
clarifies that section 404(a) and (d) (in the case of employees and
nonemployees, respectively) shall govern the deduction of contributions
paid or compensation paid or incurred under a plan, or method or
arrangement, deferring the receipt of compensation or providing for
deferred benefits. Section 404(a) and (d) requires that such a
contribution or compensation be paid or incurred for purposes of section
162 or 212 and satisfy the requirements for deductibility under either
of these sections. However, notwithstanding the above, section 404 does
not apply to contributions paid or accrued with respect to a ``welfare
benefit fund'' (as defined in section 419(e)) after July 18, 1984, in
taxable years of employers (and payors) ending after that date.
Also, section 463 shall govern the deduction of vacation pay by a
taxpayer that has elected the application of such section. Section
404(b), as amended, generally applies to contributions paid and
compensation paid or incurred after July 18, 1984, in taxable years of
employers (and payors) ending after that date. See Q&A-3 of Sec.
1.404(b)-1T. For rules relating to the deduction of contributions
attributable to the provision of deferred benefits, see section 404 (a),
(b) and (d) and Sec. 1.404(a)-1T, Sec. 1.404(b)-1T and Sec. 1.404(d)-
1T. For rules relating to the deduction of contributions paid or accrued
with respect to a welfare benefit fund, see section 419, Sec. 1.419-1T
and Sec. 1.419A-2T. For rules relating to the deduction of vacation pay
for which an election is made under section 463, see Sec. 301.9100-16T
of this chapter and Sec. 1.463-1T.
Q-2: How does the enactment of section 419 by the Tax Reform Act of
1984 affect the deduction of employee benefits under section 162?
A-2: As enacted by the Tax Reform Act of 1984, section 419 shall
govern the deduction of contributions paid or accrued by an employer (or
a person receiving services under section 419(g)) with respect to a
``welfare benefit fund'' (within the meaning of section 419(e)) after
December 31, 1985, in taxable years of the employer (or person receiving
the services) ending after that date. Section 419(a) requires that such
a contribution be paid or accrued for purposes of section 162 or 212 and
satisfy the requirements for deductibility under either of those
sections. Generally, subject to a binding contract exception (as
described in section 511(e)(5) of the Tax Reform Act of 1984), section
419 shall also govern the deduction of the contribution of a facility
(or other contribution used to acquire or improve a facility) to a
welfare benefit fund after June 22, 1984. See Q&A-11 of Sec. 1.419-1T.
In the case of a welfare benefit fund maintained pursuant to a
collective bargaining agreement, section 419 applies to the extent
provided under the special effective date rule described in Q&A-2 of
Sec. 1.419-1T and the special rules of Sec. 1.419A-2T. For rules
relating to the deduction of contributions paid or accrued with respect
to a welfare benefit fund, see section 419 and Sec. 1.419-1T.
[T.D. 8073, 51 FR 4319, Feb. 4, 1986, as amended by T.D. 8435, 57 FR
43896, Sept. 23, 1992]
Sec. 1.162-11 Rentals.
(a) Acquisition of a leasehold. If a leasehold is acquired for
business purposes for a specified sum, the purchaser may take as a
deduction in his return an aliquot part of such sum each year, based on
the number of years the lease has to run. Taxes paid by a tenant to or
for a landlord for business property are additional rent and constitute
a deductible item to the tenant and taxable income to the landlord, the
amount of the tax being deductible by the latter. For disallowance of
deduction for income taxes paid by a lessee corporation pursuant to a
lease arrangement with the lessor corporation, see section 110 and the
regulations thereunder. See section 178 and the regulations thereunder
for rules governing the effect to
[[Page 191]]
be given renewal options in amortizing the costs incurred after July 28,
1958 of acquiring a lease. See Sec. 1.197-2 for rules governing the
amortization of costs to acquire limited interests in section 197
intangibles.
(b) Improvements by lessee on lessor's property--(1) In general. The
cost to a taxpayer of erecting buildings or making permanent
improvements on property of which the taxpayer is a lessee is a capital
expenditure. For the rules regarding improvements to leased property
when the improvements are tangible property, see Sec. 1.263(a)-3(f).
For the rules regarding depreciation or amortization deductions for
leasehold improvements, see Sec. 1.167(a)-4.
(2) Effective/applicability date--(i) In general. This paragraph (b)
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (b)(2)(ii) and (b)(2)(iii) of this section,
Sec. 1.162-11(b) as contained in 26 CFR part 1 edition revised as of
April 1, 2011, applies to taxable years beginning before January 1,
2014.
(ii) Early application of this paragraph. A taxpayer may choose to
apply this paragraph (b) to taxable years beginning on or after January
1, 2012.
(iii) Optional application of TD 9564. A taxpayer may choose to
apply Sec. 1.162-11T(b) as contained in TD 9564 (76 FR 81060) December
27, 2011, to taxable years beginning on or after January 1, 2012, and
before January 1, 2014.
[T.D. 6520, 25 FR 13692, Dec. 24, 1960, as amended by T.D. 8865, 65 FR
3825, Jan. 25, 2000; T.D. 9564, 76 FR 81084, Dec. 27, 2011; T.D. 9636,
78 FR 57706, Sept. 19, 2013 ]
Sec. 1.162-12 Expenses of farmers.
(a) Farms engaged in for profit. A farmer who operates a farm for
profit is entitled to deduct from gross income as necessary expenses all
amounts actually expended in the carrying on of the business of farming.
The cost of ordinary tools of short life or small cost, such as hand
tools, including shovels, rakes, etc., may be deducted. The purchase of
feed and other costs connected with raising livestock may be treated as
expense deductions insofar as such costs represent actual outlay, but
not including the value of farm produce grown upon the farm or the labor
of the taxpayer. For rules regarding the capitalization of expenses of
producing property in the trade or business of farming, see section 263A
and the regulations thereunder. For taxable years beginning after July
12, 1972, where a farmer is engaged in producing crops and the process
of gathering and disposal of such crops is not completed within the
taxable year in which such crops were planted, expenses deducted may,
with the consent of the Commissioner (see section 446 and the
regulations thereunder), be determined upon the crop method, and such
deductions must be taken in the taxable year in which the gross income
from the crop has been realized. For taxable years beginning on or
before July 12, 1972, where a farmer is engaged in producing crops which
take more than a year from the time of planting to the process of
gathering and disposal, expenses deducted may, with the consent of the
Commissioner (see section 446 and the regulations thereunder), be
determined upon the crop method, and such deductions must be taken in
the taxable year in which the gross income from the crop has been
realized. If a farmer does not compute income upon the crop method, the
cost of seeds and young plants which are purchased for further
development and cultivation prior to sale in later years may be deducted
as an expense for the year of purchase, provided the farmer follows a
consistent practice of deducting such costs as an expense from year to
year. The preceding sentence does not apply to the cost of seeds and
young plants connected with the planting of timber (see section 611 and
the regulations thereunder). For rules regarding the capitalization of
expenses of producing property in the trade or business of farming, see
section 263A of the Internal Revenue Code and Sec. 1.263A-4. The cost
of farm machinery, equipment, and farm buildings represents a capital
investment and is not an allowable deduction as an item of expense.
Amounts expended in the development of farms, orchards, and ranches
prior to the time when the productive state is reached may, at the
election of the taxpayer, be regarded as investments of capital. For the
treatment of soil and
[[Page 192]]
water conservation expenditures as expenses which are not chargeable to
capital account, see section 175 and the regulations thereunder. For
taxable years beginning after December 31, 1959, in the case of
expenditures paid or incurred by farmers for fertilizer, lime, etc., see
section 180 and the regulations thereunder. Amounts expended in
purchasing work, breeding, dairy, or sporting animals are regarded as
investments of capital, and shall be depreciated unless such animals are
included in an inventory in accordance with Sec. 1.61-4. The purchase
price of an automobile, even when wholly used in carrying on farming
operations, is not deductible, but is regarded as an investment of
capital. The cost of gasoline, repairs, and upkeep of an automobile if
used wholly in the business of farming is deductible as an expense; if
used partly for business purposes and partly for the pleasure or
convenience of the taxpayer or his family, such cost may be apportioned
according to the extent of the use for purposes of business and pleasure
or convenience, and only the proportion of such cost justly attributable
to business purposes is deductible as a necessary expense.
(b) Farms not engaged in for profit; taxable years beginning before
January 1, 1970--(1) In general. If a farm is operated for recreation or
pleasure and not on a commercial basis, and if the expenses incurred in
connection with the farm are in excess of the receipts therefrom, the
entire receipts from the sale of farm products may be ignored in
rendering a return of income, and the expenses incurred, being regarded
as personal expenses, will not constitute allowable deductions.
(2) Effective date. The provisions of this paragraph shall apply
with respect to taxable years beginning before January 1, 1970.
(3) Cross reference. For provisions relating to activities not
engaged in for profit, applicable to taxable years beginning after
December 31, 1969, see section 183 and the regulations thereunder.
[T.D. 7198, 37 FR 13679, July 13, 1972, as amended by T.D. 8729, 62 FR
44546, Aug. 22, 1997; T.D. 8897, 65 FR 50643, Aug. 21, 2000]
Sec. 1.162-13 Depositors' guaranty fund.
Banking corporations which pursuant to the laws of the State in
which they are doing business are required to set apart, keep, and
maintain in their banks the amount levied and assessed against them by
the State authorities as a ``Depositors' guaranty fund,'' may deduct
from their gross income the amount so set apart each year to this fund
provided that such fund, when set aside and carried to the credit of the
State banking board or duly authorized State officer, ceases to be an
asset of the bank and may be withdrawn in whole or in part upon demand
by such board or State officer to meet the needs of these officers in
reimbursing depositors in insolvent banks, and provided further that no
portion of the amount thus set aside and credited is returnable under
the laws of the State to the assets of the banking corporation. If,
however, such amount is simply set up on the books of the bank as a
reserve to meet a contingent liability and remains an asset of the bank,
it will not be deductible except as it is actually paid out as required
by law and upon demand of the proper State officers.
Sec. 1.162-14 Expenditures for advertising or promotion of good will.
A corporation which has, for the purpose of computing its excess
profits tax credit under Subchapter E, Chapter 2, or Subchapter D,
Chapter 1 of the Internal Revenue Code of 1939, elected under section
733 or section 451 (applicable to the excess profits tax imposed by
Subchapter E of Chapter 2, and Subchapter D of Chapter 1, respectively)
to charge to capital account for taxable years in its base period
expenditures for advertising or the promotion of good will which may be
regarded as capital investments, may not deduct similar expenditures for
the taxable year. See section 263(b). Such a taxpayer has the burden of
proving that expenditures for advertising or the promotion of good will
which it seeks to deduct in the taxable year may not be regarded as
capital investments under the provisions of the regulations prescribed
under section 733 or section 451 of the Internal Revenue Code of 1939.
[[Page 193]]
See 26 CFR, 1938 ed., 35.733-2 (Regulations 112) and 26 CFR (1939)
40.451-2 (Regulations 130). For the disallowance of deductions for the
cost of advertising in programs of certain conventions of political
parties, or in publications part of the proceeds of which directly or
indirectly inures (or is intended to inure) to or for the use of a
political party or political candidate, see Sec. 1.276-1.
[T.D. 6996, 34 FR 835, Jan. 18, 1969]
Sec. 1.162-15 Contributions, dues, etc.
(a) Contributions to organizations described in section 170--(1) In
general. No deduction is allowable under section 162(a) for a
contribution or gift by an individual or a corporation if any part
thereof is deductible under section 170. For example, if a taxpayer
makes a contribution of $5,000 and only $4,000 of this amount is
deductible under section 170(a) (whether because of the percentage
limitation under either section 170(b) (1) or (2), the requirement as to
time of payment, or both) no deduction is allowable under section 162(a)
for the remaining $1,000.
(2) Scope of limitations. The limitations provided in section 162(b)
and this paragraph apply only to payments which are in fact
contributions or gifts to organizations described in section 170. For
example, payments by a transit company to a local hospital (which is a
charitable organization within the meaning of section 170) in
consideration of a binding obligation on the part of the hospital to
provide hospital services and facilities for the company's employees are
not contributions or gifts within the meaning of section 170 and may be
deductible under section 162(a) if the requirements of section 162(a)
are otherwise satisfied.
(b) Other contributions. Donations to organizations other than those
described in section 170 which bear a direct relationship to the
taxpayer's business and are made with a reasonable expectation of a
financial return commensurate with the amount of the donation may
constitute allowable deductions as business expenses, provided the
donation is not made for a purpose for which a deduction is not
allowable by reason of the provisions of paragraph (b)(1)(i) or (c) of
Sec. 1.162-20. For example, a transit company may donate a sum of money
to an organization (of a class not referred to in section 170) intending
to hold a convention in the city in which it operates, with a reasonable
expectation that the holding of such convention will augment its income
through a greater number of people using its transportation facilities.
(c) Dues. Dues and other payments to an organization, such as a
labor union or a trade association, which otherwise meet the
requirements of the regulations under section 162, are deductible in
full. For limitations on the deductibility of dues and other payments,
see paragraph (b) and (c) of Sec. 1.162-20.
(d) Cross reference. For provisions dealing with expenditures for
institutional or ``good will'' advertising, see Sec. 1.162-20.
[T.D. 6819, 30 FR 5580, Apr. 20, 1965]
Sec. 1.162-16 Cross reference.
For special rules relating to expenses in connection with
subdividing real property for sale, see section 1237 and the regulations
thereunder.
Sec. 1.162-17 Reporting and substantiation of certain business
expenses of employees.
(a) Introductory. The purpose of the regulations in this section is
to provide rules for the reporting of information on income tax returns
by taxpayers who pay or incur ordinary and necessary business expenses
in connection with the performance of services as an employee and to
furnish guidance as to the type of records which will be useful in
compiling such information and in its substantiation, if required. The
rules prescribed in this section do not apply to expenses paid or
incurred for incidentals, such as office supplies for the employer or
local transportation in connection with an errand. Employees incurring
such incidental expenses are not required to provide substantiation for
such amounts. The term ``ordinary and necessary business expenses''
means only those expenses which are ordinary and necessary in the
conduct of the taxpayer's business and are directly attributable to such
business. The term does not include nondeductible personal, living or
family expenses.
[[Page 194]]
(b) Expenses for which the employee is required to account to his
employer--(1) Reimbursements equal to expenses. The employee need not
report on his tax return (either itemized or in total amount) expenses
for travel, transportation, entertainment, and similar purposes paid or
incurred by him solely for the benefit of his employer for which he is
required to account and does account to his employer and which are
charged directly or indirectly to the employer (for example, through
credit cards) or for which the employee is paid through advances,
reimbursements, or otherwise, provided the total amount of such
advances, reimbursements, and charges is equal to such expenses. In such
a case the taxpayer need only state in his return that the total of
amounts charged directly or indirectly to his employer through credit
cards or otherwise and received from the employer as advances or
reimbursements did not exceed the ordinary and necessary business
expenses paid or incurred by the employee.
(2) Reimbursements in excess of expenses. In case the total of
amounts charged directly or indirectly to the employer and received from
the employer as advances, reimbursements, or otherwise, exceeds the
ordinary and necessary business expenses paid or incurred by the
employee and the employee is required to and does account to his
employer for such expenses, the taxpayer must include such excess in
income and state on his return that he has done so.
(3) Expenses in excess of reimbursements. If the employee's ordinary
and necessary business expenses exceed the total of the amounts charged
directly or indirectly to the employer and received from the employer as
advances, reimbursements, or otherwise, and the employee is required to
and does account to his employer for such expenses, the taxpayer may
make the statement in his return required by subparagraph (1) of this
paragraph unless he wishes to claim a deduction for such excess. If,
however, he wishes to secure a deduction for such excess, he must submit
a statement showing the following information as part of his tax return:
(i) The total of any charges paid or borne by the employer and of
any other amounts received from the employer for payment of expenses
whether by means of advances, reimbursements or otherwise; and
(ii) The nature of his occupation, the number of days away from home
on business, and the total amount of ordinary and necessary business
expenses paid or incurred by him (including those charged directly or
indirectly to the employer through credit cards or otherwise) broken
down into such broad categories as transportation, meals and lodging
while away from home overnight, entertainment expenses, and other
business expenses.
(4) To ``account'' to his employer as used in this section means to
submit an expense account or other required written statement to the
employer showing the business nature and the amount of all the
employee's expenses (including those charged directly or indirectly to
the employer through credit cards or otherwise) broken down into such
broad categories as transportation, meals and lodging while away from
home overnight, entertainment expenses, and other business expenses. For
this purpose, the Commissioner in his discretion may approve reasonable
business practices under which mileage, per diem in lieu of subsistence,
and similar allowances providing for ordinary and necessary business
expenses in accordance with a fixed scale may be regarded as equivalent
to an accounting to the employer.
(c) Expenses for which the employee is not required to account to
his employer. If the employee is not required to account to his employer
for his ordinary and necessary business expenses, e.g., travel,
transportation, entertainment, and similar items, or, though required,
fails to account for such expenses, he must submit, as a part of his tax
return, a statement showing the following information:
(1) The total of all amounts received as advances or reimbursements
from his employer in connection with the ordinary and necessary business
expenses of the employee, including amounts charged directly or
indirectly to the employer through credit cards or otherwise; and
[[Page 195]]
(2) The nature of his occupation, the number of days away from home
on business, and the total amount of ordinary and necessary business
expenses paid or incurred by him (including those charged directly or
indirectly to the employer through credit cards or otherwise) broken
down into such broad categories as transportation, meals and lodging
while away from home overnight, entertainment expenses, and other
business expenses.
(d) Substantiation of items of expense. (1) Although the
Commissioner may require any taxpayer to substantiate such information
concerning expense accounts as may appear to be pertinent in determining
tax liability, taxpayers ordinarily will not be called upon to
substantiate expense account information except those in the following
categories:
(i) A taxpayer who is not required to account to his employer, or
who does not account;
(ii) A taxpayer whose expenses exceed the total of amounts charged
to his employer and amounts received through advances, reimbursements or
otherwise and who claims a deduction on his return for such excess;
(iii) A taxpayer who is related to his employer within the meaning
of section 267(b); and
(iv) Other taxpayers in cases where it is determined that the
accounting procedures used by the employer for the reporting and
substantiation of expenses by employees are not adequate.
(2) The Code contemplates that taxpayers keep such records as will
be sufficient to enable the Commissioner to correctly determine income
tax liability. Accordingly, it is to the advantage of taxpayers who may
be called upon to substantiate expense account information to maintain
as adequate and detailed records of travel, transportation,
entertainment, and similar business expenses as practical since the
burden of proof is upon the taxpayer to show that such expenses were not
only paid or incurred but also that they constitute ordinary and
necessary business expenses. One method for substantiating expenses
incurred by an employee in connection with his employment is through the
preparation of a daily diary or record of expenditures, maintained in
sufficient detail to enable him to readily identify the amount and
nature of any expenditure, and the preservation of supporting documents,
especially in connection with large or exceptional expenditures.
Nevertheless, it is recognized that by reason of the nature of certain
expenses or the circumstances under which they are incurred, it is often
difficult for an employee to maintain detailed records or to preserve
supporting documents for all his expenses. Detailed records of small
expenditures incurred in traveling or for transportation, as for
example, tips, will not be required.
(3) Where records are incomplete or documentary proof is
unavailable, it may be possible to establish the amount of the
expenditures by approximations based upon reliable secondary sources of
information and collateral evidence. For example, in connection with an
item of traveling expense a taxpayer might establish that he was in a
travel status a certain number of days but that it was impracticable for
him to establish the details of all his various items of travel expense.
In such a case rail fares or plane fares can usually be ascertained with
exactness and automobile costs approximated on the basis of mileage
covered. A reasonable approximation of meals and lodging might be based
upon receipted hotel bills or upon average daily rates for such
accommodations and meals prevailing in the particular community for
comparable accommodations. Since detailed records of incidental items
are not required, deductions for these items may be based upon a
reasonable approximation. In cases where a taxpayer is called upon to
substantiate expense account information, the burden is on the taxpayer
to establish that the amounts claimed as a deduction are reasonably
accurate and constitute ordinary and necessary business expenses paid or
incurred by him in connection with his trade or business. In connection
with the determination of factual matters of this type, due
consideration will be given to the reasonableness of the stated
expenditures for the claimed purposes in relation to the taxpayer's
circumstances (such as his income and the nature of his occupation), to
the reliability and accuracy of records in
[[Page 196]]
connection with other items more readily lending themselves to detailed
recordkeeping, and to all of the facts and circumstances in the
particular case.
(e) Applicability. (1) Except as provided in subparagraph (2) of
this paragraph, the provisions of the regulations in this section are
supplemental to existing regulations relating to information required to
be submitted with income tax returns, and shall be applicable with
respect to taxable years beginning after December 31, 1957,
notwithstanding any existing regulation to the contrary.
(2) With respect to taxable years ending after December 31, 1962,
but only in respect of periods after such date, the provisions of the
regulations in this section are superseded by the regulations under
section 274(d) to the extent inconsistent therewith. See Sec. 1.274-5.
(3) For taxable years beginning on or after January 1, 1989, the
provisions of this section are superseded by the regulations under
section 62(c) to the extent this section is inconsistent with those
regulations. See Sec. 1.62-2.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6630, 27 FR
12935, Dec. 29, 1962; T.D. 8276, 54 FR 51026, Dec. 12, 1989; T.D. 8324,
55 FR 51695, Dec. 17, 1990]
Sec. 1.162-18 Illegal bribes and kickbacks.
(a) Illegal payments to government officials or employees--(1) In
general. No deduction shall be allowed under section 162(a) for any
amount paid or incurred, directly or indirectly, to an official or
employee of any government, or of any agency or other instrumentality of
any government, if--
(i) In the case of a payment made to an official or employee of a
government other than a foreign government described in subparagraph (3)
(ii) or (iii) of this paragraph, the payment constitutes an illegal
bribe or kickback, or
(ii) In the case of a payment made to an official or employee of a
foreign government described in subparagraph (3) (ii) or (iii) of this
paragraph, the making of the payment would be unlawful under the laws of
the United States (if such laws were applicable to the payment and to
the official or employee at the time the expenses were paid or
incurred).
No deduction shall be allowed for an accrued expense if the eventual
payment thereof would fall within the prohibition of this section. The
place where the expenses are paid or incurred is immaterial. For
purposes of subdivision (ii) of this subparagraph, lawfulness, or
unlawfulness of the payment under the laws of the foreign country is
immaterial.
(2) Indirect payment. For purposes of this paragraph, an indirect
payment to an individual shall include any payment which inures to his
benefit or promotes his interests, regardless of the medium in which the
payment is made and regardless of the identity of the immediate
recipient or payor. Thus, for example, payment made to an agent,
relative, or independent contractor of an official or employee, or even
directly into the general treasury of a foreign country of which the
beneficiary is an official or employee, may be treated as an indirect
payment to the official or employee, if in fact such payment inures or
will inure to his benefit or promotes or will promote his financial or
other interests. A payment made by an agent or independent contractor of
the taxpayer which benefits the taxpayer shall be treated as an indirect
payment by the taxpayer to the official or employee.
(3) Official or employee of a government. Any individual officially
connected with--
(i) The Government of the United States, a State, a territory or
possession of the United States, the District of Columbia, or the
Commonwealth of Puerto Rico,
(ii) The government of a foreign country, or
(iii) A political subdivision of, or a corporation or other entity
serving as an agency or instrumentality of, any of the above,
in whatever capacity, whether on a permanent or temporary basis, and
whether or not serving for compensation, shall be included within the
term ``official or employee of a government'', regardless of the place
of residence or post of duty of such individual. An independent
contractor would not ordinarily be considered to
[[Page 197]]
be an official or employee. For purposes of section 162(c) and this
paragraph, the term ``foreign country'' shall include any foreign
nation, whether or not such nation has been accorded diplomatic
recognition by the United States. Individuals who purport to act on
behalf of or as the government of a foreign nation, or an agency or
instrumentality thereof, shall be treated under this section as
officials or employees of a foreign government, whether or not such
individuals in fact control such foreign nation, agency, or
instrumentality, and whether or not such individuals are accorded
diplomatic recognition. Accordingly, a group in rebellion against an
established government shall be treated as officials or employees of a
foreign government, as shall officials or employees of the government
against which the group is in rebellion.
(4) Laws of the United States. The term ``laws of the United
States'', to which reference is made in paragraph (a)(1)(ii) of this
section, shall be deemed to include only Federal statutes, including
State laws which are assimilated into Federal law by Federal statute,
and legislative and interpretative regulations thereunder. The term
shall also be limited to statutes which prohibit some act or acts, for
the violation of which there is a civil or criminal penalty.
(5) Burden of proof. In any proceeding involving the issue of
whether, for purposes of section 162(c)(1), a payment made to a
government official or employee constitutes an illegal bribe or kickback
(or would be unlawful under the laws of the United States) the burden of
proof in respect of such issue shall be upon the Commissioner to the
same extent as he bears the burden of proof in civil fraud cases under
section 7454 (i.e., he must prove the illegality of the payment by clear
and convincing evidence).
(6) Example. The application of this paragraph may be illustrated by
the following example:
Example. X Corp. is in the business of selling hospital equipment in
State Y. During 1970, X Corp. employed A who at the time was employed
full time by State Y as Superintendent of Hospitals. The purpose of A's
employment by X Corp. was to procure for it an improper advantage over
other concerns in the making of sales to hospitals in respect of which
A, as Superintendent, had authority. X Corp. paid A $5,000 during 1970.
The making of this payment was illegal under the laws of State Y. Under
section 162(c)(1), X Corp. is precluded from deducting as a trade or
business expense the $5,000 paid to A.
(b) Other illegal payments--(1) In general. No deduction shall be
allowed under section 162(a) for any payment (other than a payment
described in paragraph (a) of this section) made, directly or
indirectly, to any person, if the payment constitutes an illegal bribe,
illegal kickback, or other illegal payment under the laws of the United
States (as defined in paragraph (a)(4) of this section), or under any
State law (but only if such State law is generally enforced), which
subjects the payor to a criminal penalty or the loss (including a
suspension) of license or privilege to engage in a trade or business
(whether or not such penalty or loss is actually imposed upon the
taxpayer). For purposes of this paragraph, a kickback includes a payment
in consideration of the referral of a client, patient, or customer. This
paragraph applies only to payments made after December 30, 1969.
(2) State law. For purposes of this paragraph, State law means a
statute of a State or the District of Columbia.
(3) Generally enforced. For purposes of this paragraph, a State law
shall be considered to be generally enforced unless it is never enforced
or the only persons normally charged with violations thereof in the
State (or the District of Columbia) enacting the law are infamous or
those whose violations are extraordinarily flagrant. For example, a
criminal statute of a State shall be considered to be generally enforced
unless violations of the statute which are brought to the attention of
appropriate enforcement authorities do not result in any enforcement
action in the absence of unusual circumstances.
(4) Burden of proof. In any proceeding involving the issue of
whether, for purposes of section 162(c)(2), a payment constitutes an
illegal bribe, illegal kickback, or other illegal payment the burden of
proof in respect of such issue shall be upon the Commissioner to the
same extent as he bears the burden of
[[Page 198]]
proof in civil fraud cases under section 7454 (i.e., he must prove the
illegality of the payment by clear and convincing evidence).
(5) Example. The application of this paragraph may be illustrated by
the following example:
Example. X Corp., a calendar-year taxpayer, is engaged in the ship
repair business in State Y. During 1970, repairs on foreign ships
accounted for a substantial part of its total business. It was X Corp.'s
practice to kick back approximately 10 percent of the repair bill to the
captain and chief engineer of all foreign-owned vessels, which kickbacks
are illegal under a law of State Y (which is generally enforced) and
potentially subject X Corp. to fines. During 1970, X Corp. paid $50,000
in such kickbacks. On X Corp.'s return for 1970, a deduction under
section 162 was taken for the $50,000. The deduction of the $50,000 of
illegal kickbacks during 1970 is disallowed under section 162(c)(2),
whether or not X Corp. is prosecuted with respect to the kickbacks.
(c) Kickbacks, rebates, and bribes under medicare and medicaid. No
deduction shall be allowed under section 162(a) for any kickback,
rebate, or bribe (whether or not illegal) made on or after December 10,
1971, by any provider of services, supplier, physician, or other person
who furnishes items or services for which payment is or may be made
under the Social Security Act, as amended, or in whole or in part out of
Federal funds under a State plan approved under such Act, if such
kickback, rebate, or bribe is made in connection with the furnishing of
such items or services or the making or receipt of such payments. For
purposes of this paragraph, a kickback includes a payment in
consideration of the referral of a client, patient, or customer.
[T.D. 7345, 40 FR 7437, Feb. 20, 1975; 40 FR 8948, Mar. 4, 1975]
Sec. 1.162-19 Capital contributions to Federal National Mortgage
Association.
(a) In general. The initial holder of stock of the Federal National
Mortgage Association (FNMA) which is issued pursuant to section 303(c)
of the Federal National Mortgage Association Charter Act (12 U.S.C.,
section 1718) in a taxable year beginning after December 31, 1959, shall
treat the excess, if any, of the issuance price (the amount of capital
contributions evidenced by a share of stock) over the fair market value
of the stock as of the issue date of such stock as an ordinary and
necessary business expense paid or incurred during the year in which
occurs the date of issuance of the stock. To the extent that a sale to
FNMA of mortgage paper gives rise to the issuance of a share of FNMA
stock during a taxable year beginning after December 31, 1959, such sale
is to be treated in a manner consistent with the purpose for, and the
legislative intent underlying the enactment of, the provisions of
section 8, Act of September 14, 1960 (Pub. L. 86-779, 74 Stat. 1003).
Thus, for the purpose of determining an initial holder's gain or loss
from the sale to FNMA of mortgage paper, with respect to which a share
of FNMA stock is issued in a taxable year beginning after December 31,
1959 (irrespective of when the sale is made), the amount realized by the
initial holder from the sale of the mortgage paper is the amount of the
``FNMA purchase price''. The ``FNMA purchase price'' is the gross amount
of the consideration agreed upon between FNMA and the initial holder for
the purchase of the mortgage paper, without regard to any deduction
therefrom as, for example, a deduction representing a capital
contribution or a purchase or marketing fee. The date of issuance of the
stock is the date which appears on the stock certificates of the initial
holder as the date of issue. The initial holder is the original
purchaser who is issued stock of the Federal National Mortgage
Association pursuant to section 303(c) of the Act, and who appears on
the books of FNMA as the initial holder. In determining the period for
which the initial holder has held such stock, such period shall begin
with the date of issuance.
(b) Examples. The provisions of paragraph (a) of this section may be
illustrated by the following examples:
Example 1. A, a banking institution which reports its income on a
calendar year basis, sold mortgage paper with an outstanding principal
balance of $12,500 to FNMA on October 17, 1960. The FNMA purchase price
was $11,500. A's basis for the mortgage paper was $10,500. In accordance
with the terms of the contract, FNMA deducted $375 ($250 representing
capital contribution and $125 representing purchase and marketing fee)
from
[[Page 199]]
the amount of the purchase price. FNMA credited A's account with the
amount of the capital contribution. A stock certificate evidencing two
shares of FNMA common stock of $100 par value was mailed to A and FNMA
deducted $200 from A's account, leaving a net balance of $50 in such
account. The stock certificate, bearing an issue date of November 1,
1960, was received by A on November 7, 1960. The fair market value of a
share of FNMA stock on October 17, 1960, was $65, on November 1, 1960,
was $67, and on November 7, 1960, was $68. A may deduct $66 the
difference between the issuance price ($200) and the fair market value
($134) of the two shares of stock on the date of issuance (November 1,
1960), as a business expense for the taxable year 1960. The basis of
each share of stock issued as of November 1, 1960 will be $67. See
section 1054 and Sec. 1.1054-1. A's gain from the sale of the mortgage
paper is $875 computed as follows:
Amount realized in FNMA purchase price........................ $11,500
A's basis in mortgage paper......................... $10,500
Purchase and marketing fee.......................... 125
----------
........ 10,625
---------
Gain on sale.................................................. 875
Example 2. Assume the same facts as in Example (1), and, in
addition, that A sold to FNMA on December 15, 1960, additional mortgage
paper having an outstanding principal balance of $12,500. FNMA deducted
from the FNMA purchase price $250 representing capital contribution and
credited A's account with this amount. A then had a total credit of $300
to his account consisting of the $50 balance from the transaction
described in Example (1) and $250 from the December 15th transaction. A
stock certificate evidencing three shares of FNMA common stock of $100
par value was mailed to A and FNMA deducted $300 from A's account. The
stock certificate, bearing an issue date of January 1, 1961, was
received by A on January 9, 1961. The fair market value of a share of
FNMA stock on January 1, 1961, was $69. A may deduct $93, the difference
between the issuance price ($300) and the fair market value ($207) of
the three shares of stock on the date of issuance (January 1, 1961), as
a business expense for the taxable year 1961. The gain or loss on the
sale of mortgage paper on December 15, 1960, is reportable for the
taxable year 1960.
[T.D. 6690, 28 FR 12253, Nov. 19, 1963]
Sec. 1.162-20 Expenditures attributable to lobbying, political
campaigns, attempts to influence legislation, etc., and certain
advertising.
(a) In general--(1) Scope of section. This section contains rules
governing the deductibility or nondeductibility of expenditures for
lobbying purposes, for the promotion or defeat of legislation, for
political campaign purposes (including the support of or opposition to
any candidate for public office) or for carrying on propaganda
(including advertising) related to any of the foregoing purposes. For
rules applicable to such expenditures in respect of taxable years
beginning before January 1, 1963, and for taxable years beginning after
December 31, 1962, see paragraphs (b) and (c), respectively, of this
section. This section also deals with expenditures for institutional or
``good will'' advertising.
(2) Institutional or ``good will'' advertising. Expenditures for
institutional or ``good will'' advertising which keeps the taxpayer's
name before the public are generally deductible as ordinary and
necessary business expenses provided the expenditures are related to the
patronage the taxpayer might reasonably expect in the future. For
example, a deduction will ordinarily be allowed for the cost of
advertising which keeps the taxpayer's name before the public in
connection with encouraging contributions to such organizations as the
Red Cross, the purchase of United States Savings Bonds, or participation
in similar causes. In like fashion, expenditures for advertising which
presents views on economic, financial, social, or other subjects of a
general nature, but which does not involve any of the activities
specified in paragraph (b) or (c) of this section for which a deduction
is not allowable, are deductible if they otherwise meet the requirements
of the regulations under section 162.
(b) Taxable years beginning before January 1, 1963--(1) In general.
(i) For taxable years beginning before January 1, 1963, expenditures for
lobbying purposes, for the promotion or defeat of legislation, for
political campaign purposes (including the support of or opposition to
any candidate for public office), or for carrying on propaganda
(including advertising) related to any of the foregoing purposes are not
deductible from gross income. For example, the cost of advertising to
promote or defeat legislation or to influence the public with respect to
the desirability
[[Page 200]]
or undesirability of proposed legislation is not deductible as a
business expense, even though the legislation may directly affect the
taxpayer's business.
(ii) If a substantial part of the activities of an organization,
such as a labor union or a trade association, consists of one or more of
the activities specified in the first sentence of this subparagraph,
deduction will be allowed only for such portion of the dues or other
payments to the organization as the taxpayer can clearly establish is
attributable to activities other than those so specified. The
determination of whether such specified activities constitute a
substantial part of an organization's activities shall be based on all
the facts and circumstances. In no event shall special assessments or
similar payments (including an increase in dues) made to any
organization for any of such specified purposes be deductible. For other
provisions relating to the deductibility of dues and other payments to
an organization, such as a labor union or a trade association, see
paragraph (c) of Sec. 1.162-15.
(2) Expenditures for promotion or defeat of legislation. For
purposes of this paragraph, expenditures for the promotion or the defeat
of legislation include, but shall not be limited to, expenditures for
the purpose of attempting to--
(i) Influence members of a legislative body directly, or indirectly
by urging or encouraging the public to contact such members for the
purpose of proposing, supporting, or opposing legislation, or
(ii) Influence the public to approve or reject a measure in a
referendum, initiative, vote on a constitutional amendment, or similar
procedure.
(c) Taxable years beginning after December 31, 1962--(1) In general.
For taxable years beginning after December 31, 1962, certain types of
expenses incurred with respect to legislative matters are deductible
under section 162(a) if they otherwise meet the requirements of the
regulations under section 162. These deductible expenses are described
in subparagraph (2) of this paragraph. All other expenditures for
lobbying purposes, for the promotion or defeat of legislation (see
paragraph (b)(2) of this section), for political campaign purposes
(including the support of or opposition to any candidate for public
office), or for carrying on propaganda (including advertising) relating
to any of the foregoing purposes are not deductible from gross income
for such taxable years. For the disallowance of deductions for bad debts
and worthless securities of a political party, see Sec. 1.271-1. For
the disallowance of deductions for certain indirect political
contributions, such as the cost of certain advertising and the cost of
admission to certain dinners, programs, and inaugural events, see Sec.
1.276-1.
(2) Appearances, etc., with respect to legislation--(i) General
rule. Pursuant to the provisions of section 162(e), expenses incurred
with respect to legislative matters which may be deductible are those
ordinary and necessary expenses (including, but not limited to,
traveling expenses described in section 162(a)(2) and the cost of
preparing testimony) paid or incurred by the taxpayer during a taxable
year beginning after December 31, 1962, in carrying on any trade or
business which are in direct connection with--
(a) Appearances before, submission of statements to, or sending
communications to, the committees, or individual members of Congress or
of any legislative body of a State, a possession of the United States,
or a political subdivision of any of the foregoing with respect to
legislation or proposed legislation of direct interest to the taxpayer,
or
(b) Communication of information between the taxpayer and an
organization of which he is a member with respect to legislation or
proposed legislation of direct interest to the taxpayer and to such
organization.
For provisions relating to dues paid or incurred with respect to an
organization of which the taxpayer is a member, see subparagraph (3) of
this paragraph.
(ii) Legislation or proposed legislation of direct interest to the
taxpayer--(a) Legislation or proposed legislation. The term
``legislation or proposed legislation'' includes bills and resolutions
introduced by a member of Congress or other legislative body referred to
in subdivision (i)(a) of this subparagraph for consideration by such
body as well
[[Page 201]]
as oral or written proposals for legislative action submitted to the
legislative body or to a committee or member of such body.
(b) Direct interest--(1) In general. (i) Legislation or proposed
legislation is of direct interest to a taxpayer if the legislation or
proposed legislation is of such a nature that it will, or may reasonably
be expected to, affect the trade or business of the taxpayer. It is
immaterial whether the effect, or expected effect, on the trade or
business will be beneficial or detrimental to the trade or business or
whether it will be immediate. If legislation or proposed legislation has
such a relationship to a trade or business that the expenses of any
appearance or communication in connection with the legislation meets the
ordinary and necessary test of section 162(a), then such legislation
ordinarily meets the direct interest test of section 162(e). However, if
the nature of the legislation or proposed legislation is such that the
likelihood of its having an effect on the trade or business of the
taxpayer is remote or speculative, the legislation or proposed
legislation is not of direct interest to the taxpayer. Legislation or
proposed legislation which will not affect the trade or business of the
taxpayer is not of direct interest to the taxpayer even though such
legislation will affect the personal, living, or family activities or
expenses of the taxpayer. Legislation or proposed legislation is not of
direct interest to a taxpayer merely because it may affect business in
general; however, if the legislation or proposed legislation will, or
may reasonably be expected to, affect the taxpayer's trade or business
it will be of direct interest to the taxpayer even though it also will
affect the trade or business of other taxpayers or business in general.
To meet the direct interest test, it is not necessary that all
provisions of the legislation or proposed legislation have an effect, or
expected effect, on the taxpayer's trade or business. The test will be
met if one of the provisions of the legislation has the specified
effect. Legislation or proposed legislation will be considered to be of
direct interest to a membership organization if it is of direct interest
to the organization, as such, or if it is of direct interest to one or
more of its members.
(ii) Legislation which would increase or decrease the taxes
applicable to the trade or business, increase or decrease the operating
costs or earnings of the trade or business, or increase or decrease the
administrative burdens connected with the trade or business meets the
direct interest test. Legislation which would increase the social
security benefits or liberalize the right to such benefits meets the
direct interest test because such changes in the social security
benefits may reasonably be expected to affect the retirement benefits
which the employer will be asked to provide his employees or to increase
his taxes. Legislation which would impose a retailer's sales tax is of
direct interest to a retailer because, although the tax may be passed on
to his customers, collection of the tax will impose additional burdens
on the retailer, and because the increased cost of his products to the
consumer may reduce the demand for them. Legislation which would provide
an income tax credit or exclusion for shareholders is of direct interest
to a corporation, because those tax benefits may increase the sources of
capital available to the corporation. Legislation which would favorably
or adversely affect the business of a competitor so as to affect the
taxpayer's competitive position is of direct interest to the taxpayer.
Legislation which would improve the school system of a community is of
direct interest to a membership organization comprised of employers in
the community because the improved school system is likely to make the
community more attractive to prospective employees of such employers. On
the other hand, proposed legislation relating to Presidential succession
in the event of the death of the President has only a remote and
speculative effect on any trade or business and therefore does not meet
the direct interest test. Similarly, if a corporation is represented
before a congressional committee to oppose an appropriation bill merely
because of a desire to bring increased Government economy with the hope
that such economy will eventually cause a reduction in the Federal
income tax, the legislation does not
[[Page 202]]
meet the direct interest test because any effect it may have upon the
corporation's trade or business is highly speculative.
(2) Appearances, etc., by expert witnesses. (i) An appearance or
communication (of a type described in paragraph (c)(2)(i)(a) of this
section) by an individual in connection with legislation or proposed
legislation shall be considered to be with respect to legislation of
direct interest to such individual if the legislation is in a field in
which he specializes as an employee, if the appearance or communication
is not on behalf of his employer, and if it is customary for individuals
in his type of employment to publicly express their views in respect of
matters in their field of competence. Expenses incurred by such an
individual in connection with such an appearance of communication,
including traveling expenses properly allocable thereto, represent
ordinary and necessary business expenses and are, therefore, deductible
under section 162. For example, if a university professor who teaches in
the field of money and banking appears, on his own behalf, before a
legislative committee to testify on proposed legislation regarding the
banking system, his expenses incurred in connection with such appearance
are deductible under section 162 since university professors customarily
take an active part in the development of the law in their field of
competence and publicly communicate the results of their work.
(ii) An appearance or communication (of a type described in
paragraph (c)(2)(i)(a) of this section) by an employee or self-employed
individual in connection with legislation or proposed legislation shall
be considered to be with respect to legislation of direct interest to
such person if the legislation is in the field in which he specializes
in his business (or as an employee) and if the appearance or
communication is made pursuant to an invitation extended to him
individually for the purpose of receiving his expert testimony. Expenses
incurred by an employee or self-employed individual in connection with
such an appearance or communication, including traveling expenses
properly allocable thereto, represent ordinary and necessary business
expenses and are, therefore, deductible under section 162. For example,
if a self-employed individual is personally invited by a congressional
committee to testify on proposed legislation in the field in which he
specializes in his business, his expenses incurred in connection with
such appearance are deductible under section 162. If a self-employed
individual makes an appearance, on his own behalf, before a legislative
committee without having been extended an invitation his expenses will
be deductible to the extent otherwise provided in this paragraph.
(3) Nominations, etc. A taxpayer does not have a direct interest in
matters such as nominations, appointments, or the operation of the
legislative body.
(iii) Allowable expenses. To be deductible under section 162(a),
expenditures which meet the tests of deductibility under the provisions
of this paragraph must also qualify as ordinary and necessary business
expenses under section 162(a) and, in addition, be in direct connection
with the carrying on of the activities specified in subdivision (i)(a)
or (i)(b) of this subparagraph. For example, a taxpayer appearing before
a committee of the Congress to present testimony concerning legislation
or proposed legislation in which he has a direct interest may deduct the
ordinary and necessary expenses directly connected with his appearance,
such as traveling expenses described in section 162(a)(2), and the cost
of preparing testimony.
(3) Deductibility of dues and other payments to an organization. If
a substantial part of the activities of an organization, such as a labor
union or a trade association, consists of one or more of the activities
to which this paragraph relates (legislative matters, political
campaigns, etc.), exclusive of any activity constituting an appearance
or communication with respect to legislation or proposed legislation of
direct interest to the organization (see subparagraph (c)(2)(ii)(b)(1)),
a deduction will be allowed only for such portion of the dues or other
payments to the organization as the taxpayer can clearly establish is
attributable to activities to which this paragraph does not relate
[[Page 203]]
and to any activity constituting an appearance or communication with
respect to legislation or proposed legislation of direct interest to the
organization. The determination of whether a substantial part of an
organization's activities consists of one or more of the activities to
which this paragraph relates (exclusive of appearances or communications
with respect to legislation or proposed legislation of direct interest
to the organization) shall be based on all the facts and circumstances.
In no event shall a deduction be allowed for that portion of a special
assessment or similar payment (including an increase in dues) made to
any organization for any activity to which this paragraph relates if the
activity does not constitute an appearance or communication with respect
to legislation or proposed legislation of direct interest to the
organization. If an organization pays or incurs expenses allocable to
legislative activities which meet the tests of subdivisions (i) and (ii)
of subparagraph (2) of this paragraph (appearances or communications
with respect to legislation or proposed legislation of direct interest
to the organization), on behalf of its members, the dues paid by a
taxpayer are deductible to the extent used for such activities. Dues
paid by a taxpayer will be considered to be used for such an activity,
and thus deductible, although the legislation or proposed legislation
involved is not of direct interest to the taxpayer, if, pursuant to the
provisions of subparagraph (2)(ii)(b)(1) of this paragraph, the
legislation or proposed legislation is of direct interest to the
organization, as such, or is of direct interest to one or more members
of the organization. For other provisions relating to the deductibility
of dues and other payments to an organization, such as a labor union or
a trade association, see paragraph (c) of Sec. 1.162-15.
(4) Limitations. No deduction shall be allowed under section 162(a)
for any amount paid or incurred (whether by way of contribution, gift,
or otherwise) in connection with any attempt to influence the general
public, or segments thereof, with respect to legislative matters,
elections, or referendums. For example, no deduction shall be allowed
for any expenses incurred in connection with ``grassroot'' campaigns or
any other attempts to urge or encourage the public to contact members of
a legislative body for the purpose of proposing, supporting, or opposing
legislation.
(5) Expenses paid or incurred after December 31, 1993, in connection
with influencing legislation other than certain local legislation. The
provisions of paragraphs (c)(1) through (3) of this section are
superseded for expenses paid or incurred after December 31, 1993, in
connection with influencing legislation (other than certain local
legislation) to the extent inconsistent with section 162(e)(1)(A) (as
limited by section 162(e)(2)) and Sec. Sec. 1.162-20(d) and 1.162-29.
(d) Dues allocable to expenditures after 1993. No deduction is
allowed under section 162(a) for the portion of dues or other similar
amounts paid by the taxpayer to an organization exempt from tax (other
than an organization described in section 501(c)(3)) which the
organization notifies the taxpayer under section 6033(e)(1)(A)(ii) is
allocable to expenditures to which section 162(e)(1) applies. The first
sentence of this paragraph (d) applies to dues or other similar amounts
whether or not paid on or before December 31, 1993. Section 1.162-
20(c)(3) is superseded to the extent inconsistent with this paragraph
(d).
[T.D. 6819, 30 FR 5581, Apr. 20, 1965, as amended by T.D. 6996, 34 FR
835, Jan. 18, 1969; T.D. 8602, 60 FR 37573, July 21, 1995]
Sec. 1.162-21 Fines and penalties.
(a) In general. No deduction shall be allowed under section 162(a)
for any fine or similar penalty paid to--
(1) The government of the United States, a State, a territory or
possession of the United States, the District of Columbia, or the
Commonwealth of Puerto Rico;
(2) The government of a foreign country; or
(3) A political subdivision of, or corporation or other entity
serving as an agency or instrumentality of, any of the above.
(b) Definition. (1) For purposes of this section a fine or similar
penalty includes an amount--
(i) Paid pursuant to conviction or a plea of guilty or nolo
contendere for a
[[Page 204]]
crime (felony or misdemeanor) in a criminal proceeding;
(ii) Paid as a civil penalty imposed by Federal, State, or local
law, including additions to tax and additional amounts and assessable
penalties imposed by chapter 68 of the Internal Revenue Code of 1954;
(iii) Paid in settlement of the taxpayer's actual or potential
liability for a fine or penalty (civil or criminal); or
(iv) Forfeited as collateral posted in connection with a proceeding
which could result in imposition of such a fine or penalty.
(2) The amount of a fine or penalty does not include legal fees and
related expenses paid or incurred in the defense of a prosecution or
civil action arising from a violation of the law imposing the fine or
civil penalty, nor court costs assessed against the taxpayer, or
stenographic and printing charges. Compensatory damages (including
damages under section 4A of the Clayton Act (15 U.S.C. 15a), as amended)
paid to a government do not constitute a fine or penalty.
(c) Examples. The application of this section may be illustrated by
the following examples:
Example 1. M Corp. was indicted under section 1 of the Sherman Anti-
Trust Act (15 U.S.C. 1) for fixing and maintaining prices of certain
electrical products. M Corp. was convicted and was fined $50,000. The
United States sued M Corp. under section 4A of the Clayton Act (15
U.S.C. 15a) for $100,000, the amount of the actual damages resulting
from the price fixing of which M Corp. was convicted. Pursuant to a
final judgment entered in the civil action. M Corp. paid the United
States $100,000 in damages. Section 162(f) precludes M Corp. from
deducting the fine of $50,000 as a trade or business expense. Section
162(f) does not preclude it from deducting the $100,000 paid to the
United States as actual damages.
Example 2. N Corp. was found to have violated 33 U.S.C. 1321(b)(3)
when a vessel it operated discharged oil in harmful quantities into the
navigable waters of the United States. A civil penalty under 33 U.S.C.
1321(b)(6) of $5,000 was assessed against N Corp. with respect to the
discharge. N Corp. paid $5,000 to the Coast Guard in payment of the
civil penalty. Section 162(f) precludes N Corp. from deducting the
$5,000 penalty.
Example 3. O Corp., a manufacturer of motor vehicles, was found to
have violated 42 U.S.C. 1857f-2(a)(1) by selling a new motor vehicle
which was not covered by the required certificate of conformity.
Pursuant to 42 U.S.C. 1857f-4, O Corp. was required to pay, and did pay,
a civil penalty of $10,000. In addition, pursuant to 42 U.S.C. 1857f-
5a(c)(1), O Corp. was required to expend, and did expend, $500 in order
to remedy the nonconformity of that motor vehicle. Section 162(f)
precludes O Corp. from deducting the $10,000 penalty as a trade or
business expense, but does not preclude it from deducting the $500 which
it expended to remedy the nonconformity.
Example 4. P Corp. was the operator of a coal mine in which occurred
a violation of a mandatory safety standard prescribed by the Federal
Coal Mine Health and Safety Act of 1969 (30 U.S.C. 801 et seq.).
Pursuant to 30 U.S.C. 819(a), a civil penalty of $10,000 was assessed
against P Corp., and P Corp. paid the penalty. Section 162(f) precludes
P Corp. from deducting the $10,000 penalty.
Example 5. Q Corp., a common carrier engaged in interstate commerce
by railroad, hauled a railroad car which was not equipped with efficient
hand brakes, in violation of 45 U.S.C. 11. Q Corp. was found to be
liable for a penalty of $250 pursuant to 45 U.S.C. 13. Q Corp. paid that
penalty. Section 162(f) precludes Q Corp. from deducting the $250
penalty.
Example 6. R Corp. owned and operated on the highways of State X a
truck weighing in excess of the amount permitted under the law of State
X. R Corp. was found to have violated the law and was assessed a fine of
$85 which it paid to State X. Section 162(f) precludes R Corp. from
deducting the amount so paid.
Example 7. S Corp. was found to have violated a law of State Y which
prohibited the emission into the air of particulate matter in excess of
a limit set forth in a regulation promulgated under that law. The
Environmental Quality Hearing Board of State Y assessed a fine of $500
against S Corp. The fine was payable to State Y, and S Corp. paid it.
Section 162(f) precludes S Corp. from deducting the $500 fine.
Example 8. T Corp. was found by a magistrate of City Z to be
operating in such city an apartment building which did not conform to a
provision of the city housing code requiring operable fire escapes on
apartment buildings of that type. Upon the basis of the magistrate's
finding, T Corp. was required to pay, and did pay, a fine of $200 to
City Z. Section 162(f) precludes T Corp. from deducting the $200 fine.
[T.D. 7345, 40 FR 7437, Feb. 20, 1975; 40 FR 8948, Mar. 4, 1975, as
amended by T.D. 7366, 40 FR 29290, July 11, 1975]
[[Page 205]]
Sec. 1.162-22 Treble damage payments under the antitrust laws.
(a) In general. In the case of a taxpayer who after December 31,
1969, either is convicted in a criminal action of a violation of the
Federal antitrust laws or enters a plea of guilty or nolo contendere to
an indictment or information charging such a violation, and whose
conviction or plea does not occur in a new trial following an appeal of
a conviction on or before such date, no deduction shall be allowed under
section 162(a) for two-thirds of any amount paid or incurred after
December 31, 1969, with respect to--
(1) Any judgment for damages entered against the taxpayer under
section 4 of the Clayton Act (15 U.S.C. 15), as amended, on account of
such violation or any related violation of the Federal antitrust laws,
provided such related violation occurred prior to the date of the final
judgment of such conviction, or
(2) Settlement of any action brought under such section 4 on account
of such violation or related violation.
For the purposes of this section, where a civil judgment has been
entered or a settlement made with respect to a violation of the
antitrust laws and a criminal proceeding is based upon the same
violation, the criminal proceeding need not have been brought prior to
the civil judgment or settlement. If, in his return for any taxable
year, a taxpayer claims a deduction for an amount paid or incurred with
respect to a judgment or settlement described in the first sentence of
this paragraph and is subsequently convicted of a violation of the
antitrust laws which makes a portion of such amount unallowable, then
the taxpayer shall file an amended return for such taxable year on which
the amount of the deduction is appropriately reduced. Attorney's fees,
court costs, and other amounts paid or incurred in connection with a
controversy under such section 4 which meet the requirements of section
162 are deductible under that section. For purposes of subparagraph (2)
of this paragraph, the amount paid or incurred in settlement shall not
include amounts attributable to the plaintiff's costs of suit and
attorney's fees, to the extent that such costs or fees have actually
been paid.
(b) Conviction. For purposes of paragraph (a) of this section, a
taxpayer is convicted of a violation of the antitrust laws if a judgment
of conviction (whether or not a final judgment) with respect to such
violation has been entered against him, provided a subsequent final
judgment of acquittal has not been entered or criminal prosecution with
respect to such violation terminated without a final judgment of
conviction. During the pendency of an appeal or other action directly
contesting a judgment of conviction, the taxpayer should file a
protective claim for credit or refund to avoid being barred by the
period of limitations on credit or refund under section 6511.
(c) Related violation. For purposes of this section, a violation of
the Federal antitrust laws is related to a subsequent violation if (1)
with respect to the subsequent violation the United States obtains both
a judgment in a criminal proceeding and an injunction against the
taxpayer, and (2) the taxpayer's actions which constituted the prior
violation would have contravened such injunction if such injunction were
applicable at the time of the prior violation.
(d) Settlement following a dismissal of an action or amendment of
the complaint. For purposes of paragraph (a)(2) of this section, an
amount may be considered as paid in settlement of an action even though
the action is dismissed or otherwise disposed of prior to such
settlement or the complaint is amended to eliminate the claim with
respect to the violation or related violation.
(e) Antitrust laws. The term ``antitrust laws'' as used in section
162(g) and this section shall include the Federal acts enumerated in
paragraph (1) of section 1 of the Clayton Act (15 U.S.C. 12), as
amended.
(f) Examples. The application of this section may be illustrated by
the following examples:
Example 1. In 1970, the United States instituted a criminal
prosecution against X Co., Y Co., A, the president of X Co., and B, the
president of Y Co., under section 1 of the Sherman Anti-Trust Act, 15
U.S.C. 1. In the indictment, the defendants were charged with conspiring
to fix and maintain prices of electrical transformers from 1965 to 1970.
All
[[Page 206]]
defendants entered pleas of nolo contendere to these charges. These
pleas were accepted and judgments of conviction entered. In a companion
civil suit, the United States obtained an injunction prohibiting the
defendants from conspiring to fix and maintain prices in the electrical
transformer market. Thereafter, Z Co. sued X Co. and Y Co. for $300,000
in treble damages under section 4 of the Clayton Act. Z Co.'s complaint
alleged that the criminal conspiracy between X Co. and Y Co. forced Z
Co. to pay excessive prices for electrical transformers. X Co. and Y Co.
each paid Z Co. $85,000 in full settlement of Z Co.'s action. Of each
$85,000 paid, $10,000 was attributable to court costs and attorney's
fees actually paid by Z Co. Under section 162(g), X Co. and Y Co. are
each precluded from deducting as a trade or business expense more than
$35,000 of the $85,000 paid to Z Co. in settlement--
$10,000+[($85,000-$10,000)/3]
Example 2. Assume the same facts as in example (1) except that Z
Co.'s claim for treble damages was based on a conspiracy to fix and
maintain prices in the sale of electrical transformers during 1963.
Although the criminal prosecution of the defendants did not involve 1963
(a year barred by the applicable criminal statute of limitations when
the prosecution was instituted), Z Co.'s pleadings alleged that the
civil statute of limitations had been tolled by the defendants'
fraudulent concealment of their conspiracy. Since the United States has
obtained both a judgment in a criminal proceeding and an injunction
against the defendants in connection with their activities from 1965 to
1970, and the alleged actions of the defendants in 1963 would have
contravened such injunction if it were applicable in 1963, the alleged
violation in 1963 is related to the violation from 1965 to 1970.
Accordingly, the tax consequences to X Co. and Y Co. of the payments of
$85,000 in settlement of Z Co.'s claim against X Co. and Y Co. are the
same as in example (1).
Example 3. Assume the same facts as in example (1) except that Z
Co.'s claim for treble damages was based on a conspiracy to fix and
maintain prices with respect to electrical insulators for high-tension
power poles. Since the civil action was not based on the same violation
of the Federal antitrust laws as the criminal action, or on a related
violation (a violation which would have contravened the injunction if it
were applicable), X Co. and Y Co. are not precluded by section 162(g)
from deducting as a trade or business expense the entire $85,000 paid by
each in settlement of the civil action.
[T.D. 7217, 37 FR 23916, Nov. 10, 1972]
Sec. 1.162-24 Travel expenses of state legislators.
(a) In general. For purposes of section 162(a), in the case of any
taxpayer who is a state legislator at any time during the taxable year
and who makes an election under section 162(h) for the taxable year--
(1) The taxpayer's place of residence within the legislative
district represented by the taxpayer is the taxpayer's home for that
taxable year;
(2) The taxpayer is deemed to have expended for living expenses (in
connection with the taxpayer's trade or business as a legislator) an
amount determined by multiplying the number of legislative days of the
taxpayer during the taxable year by the greater of--
(i) The amount generally allowable with respect to those days to
employees of the state of which the taxpayer is a legislator for per
diem while away from home, to the extent the amount does not exceed 110
percent of the amount described in paragraph (a)(2)(ii) of this section;
or
(ii) The Federal per diem with respect to those days for the
taxpayer's state capital; and
(3) The taxpayer is deemed to be away from home in the pursuit of a
trade or business on each legislative day.
(b) Legislative day. For purposes of section 162(h)(1) and this
section, for any taxpayer who makes an election under section 162(h), a
legislative day is any day on which the taxpayer is a state legislator
and--
(1) The legislature is in session;
(2) The legislature is not in session for a period that is not
longer than 4 consecutive days, without extension for Saturdays,
Sundays, or holidays;
(3) The taxpayer's attendance at a meeting of a committee of the
legislature is formally recorded; or
(4) The taxpayer's attendance at any session of the legislature that
only a limited number of members are expected to attend (such as a pro
forma session), on any day not described in paragraph (b)(1) or (b)(2)
of this section, is formally recorded.
(c) Fifty mile rule. Section 162(h) and this section do not apply to
any taxpayer who is a state legislator and whose place of residence
within the
[[Page 207]]
legislative district represented by the taxpayer is 50 or fewer miles
from the capitol building of the state. For purposes of this paragraph
(c), the distance between the taxpayer's place of residence within the
legislative district represented by the taxpayer and the capitol
building of the state is the shortest of the more commonly traveled
routes between the two points.
(d) Definitions and special rules. The following definitions apply
for purposes of section 162(h) and this section.
(1) State legislator. A taxpayer becomes a state legislator on the
day the taxpayer is sworn into office and ceases to be a state
legislator on the day following the day on which the taxpayer's term in
office ends.
(2) Living expenses. Living expenses include lodging, meals, and
incidental expenses. Incidental expenses has the same meaning as in 41
CFR 300-3.1.
(3) In session--(i) In general. For purposes of this section, the
legislature of which a taxpayer is a member is in session on any day if,
at any time during that day, the members of the legislature are expected
to attend and participate as an assembled body of the legislature.
(ii) Examples. The following examples illustrate the rules of this
paragraph (d)(3):
Example 1. B is a member of the legislature of State X. On Day 1,
the State X legislature is convened and the members of the legislature
are expected to attend and participate. On Day 1, the State X
legislature is in session within the meaning of paragraph (d)(3)(i) of
this section. B does not attend the session of the State X legislature
on Day 1. However, Day 1 is a legislative day for B for purposes of
section 162(h)(2)(A) and paragraph (b)(1) of this section.
Example 2. C, D, and E are members of the legislature of State X. On
Day 2, the State X legislature is convened for a limited session in
which not all members of the legislature are expected to attend and
participate. Thus, on Day 2 the legislature is not in session within the
meaning of paragraph (d)(3)(i) of this section, and Day 2 is not a
legislative day under paragraph (b)(1) of this section. In addition, Day
2 is not a day described in paragraph (b)(2) of this section. C and D
are the only members who are called to, and do, attend the limited
session on Day 2, and their attendance at the session is formally
recorded. E is not called and does not attend. Therefore, Day 2 is a
legislative day as to C and D under section 162(h)(2)(B) and paragraph
(b)(4) of this section. Day 2 is not a legislative day as to E.
(4) Committee of the legislature. A committee of the legislature is
any group that includes one or more legislators and that is charged with
conducting business of the legislature. Committees of the legislature
include, but are not limited to, committees to which the legislature
refers bills for consideration, committees that the legislature has
authorized to conduct inquiries into matters of public concern, and
committees charged with the internal administration of the legislature.
For purposes of this section, groups that are not considered committees
of the legislature include, but are not limited to, groups that promote
particular issues, raise campaign funds, or are caucuses of members of a
political party.
(5) Federal per diem. The Federal per diem for any city and day is
the maximum amount allowable to employees of the executive branch of the
Federal government for living expenses while away from home in pursuit
of a trade or business in that city on that day. See 5 U.S.C. 5702 and
the regulations under that section.
(e) Election--(1) Time for making election. A taxpayer's election
under section 162(h) must be made for each taxable year for which the
election is to be in effect and must be made no later than the due date
(including extensions) of the taxpayer's Federal income tax return for
the taxable year.
(2) Manner of making election. A taxpayer makes an election under
section 162(h) by attaching a statement to the taxpayer's income tax
return for the taxable year for which the election is made. The
statement must include--
(i) The taxpayer's name, address, and taxpayer identification
number;
(ii) A statement that the taxpayer is making an election under
section 162(h); and
(iii) Information establishing that the taxpayer is a state
legislator entitled to make the election, for example, a statement
identifying the taxpayer's state and legislative district and
representing that the taxpayer's place of residence in the legislative
district is not 50 or fewer miles from the state capitol building.
[[Page 208]]
(3) Revocation of election. An election under section 162(h) may be
revoked only with the consent of the Commissioner. An application for
consent to revoke an election must be signed by the taxpayer and filed
with the submission processing center with which the election was filed,
and must include--
(i) The taxpayer's name, address, and taxpayer identification
number;
(ii) A statement that the taxpayer is revoking an election under
section 162(h) for a specified year; and
(iii) A statement explaining why the taxpayer seeks to revoke the
election.
(f) Effect of election on otherwise deductible expenses for travel
away from home--(1) Legislative days--(i) Living expenses. For any
legislative day for which an election under section 162(h) and this
section is in effect, the amount of an electing taxpayer's living
expenses while away from home is the greater of the amount of the living
expenses--
(A) Specified in paragraph (a)(2) of this section in connection with
the trade or business of being a legislator; or
(B) Otherwise allowable under section 162(a)(2) in the pursuit of
any trade or business of the taxpayer.
(ii) Other expenses. For any legislative day for which an election
under section 162(h) and this section is in effect, the amount of an
electing taxpayer's expenses (other than living expenses) for travel
away from home is the sum of the substantiated expenses, such as
expenses for travel fares, telephone calls, and local transportation,
that are otherwise deductible under section 162(a)(2) in the pursuit of
any trade or business of the taxpayer.
(2) Non-legislative days. For any day that is not a legislative day,
the amount of an electing taxpayer's expenses (including amounts for
living expenses) for travel away from home is the sum of the
substantiated expenses that are otherwise deductible under section
162(a)(2) in the pursuit of any trade or business of the taxpayer.
(g) Cross references. See Sec. 1.62-1T(e)(4) for rules regarding
allocation of unreimbursed expenses of state legislators and section
274(n) for limitations on the amount allowable as a deduction for
expenses for or allocable to meals.
(h) Effective/applicability date. This section applies to expenses
paid or incurred, or deemed expended under section 162(h), in taxable
years beginning after April 8, 2010.
[T.D. 9481, 75 FR 17856, Apr. 8, 2010]
Sec. 1.162-25 Deductions with respect to noncash fringe benefits.
(a) [Reserved]
(b) Employee. If an employer provides the use of a vehicle (as
defined in Sec. 1.61-21(e)(2)) to an employee as a noncash fringe
benefit and includes the entire value of the benefit in the employee's
gross income without taking into account any exclusion for a working
condition fringe allowable under section 132 and the regulations
thereunder, the employee may deduct that value multiplied by the
percentage of the total use of the vehicle that is in connection with
the employer's trade or business (business value). For taxable years
beginning before January 1, 1990, the employee may deduct the business
value from gross income in determining adjusted gross income. For
taxable years beginning on or after January 1, 1990, the employee may
deduct the business value only as a miscellaneous itemized deduction in
determining taxable income, subject to the 2-percent floor provided in
section 67. If the employer determines the value of the noncash fringe
benefit under a special accounting rule that allows the employer to
treat the value of benefits provided during the last two months of the
calendar year or any shorter period as paid during the subsequent
calendar year, then the employee must determine the deduction allowable
under this paragraph (b) without regard to any use of the benefit during
those last two months or any shorter period. The employee may not use a
cents-per-mile valuation method to determine the deduction allowable
under this paragraph (b).
[T.D. 8451, 57 FR 57669, Dec. 7, 1992; 57 FR 60568, Dec. 21, 1992]
Sec. 1.162-25T Deductions with respect to noncash fringe benefits
(temporary).
(a) Employer. If an employer includes the value of a noncash fringe
benefit in
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an employee's gross income, the employer may not deduct this amount as
compensation for services, but rather may deduct only the costs incurred
by the employer in providing the benefit to the employee. The employer
may be allowed a cost recovery deduction under section 168 or a
deduction under section 179 for an expense not chargeable to capital
account, or, if the noncash fringe benefit is property leased by the
employer, a deduction for the ordinary and necessary business expense of
leasing the property.
(b) [Reserved]
(c) Examples. The following examples illustrate the provisions of
this section.
Example 1. On January 1, 1986, X Company owns and provides the use
of an automobile with a fair market value of $20,000 to E, an employee,
for the entire calendar year. Both X and E compute taxable income on the
basis of the calendar year. Seventy percent of the use of the automobile
by E is in connection with X's trade or business. If X uses the special
rule provided in Sec. 1.61-2T for valuing the availability of the
automobile and takes into account the amount excludable as a working
condition fringe, X would include $1,680 ($5,600, the Annual Lease
Value, less 70 percent of $5,600) in E's gross income for 1986. X may
not deduct the amount included in E's income as compensation for
services. X may, however, determine a cost recovery deduction under
section 168, subject to the limitations under section 280F, for taxable
year 1986.
Example 2. The facts are the same as in example (1), except that X
includes $5,600 in E's gross income, the value of the noncash fringe
benefit without taking into account the amount excludable as a working
condition fringe. X may not deduct that amount as compensation for
services, but may determine a cost recovery deduction under section 168,
subject to the limitations under section 280F. For purposes of
determining adjusted gross income, E may deduct $3,920 ($5,600
multiplied by the percent of business use).
[T.D. 8061, 50 FR 46013, Nov. 6, 1985, as amended by T.D. 8063, 50 FR
52312, Dec. 23, 1985; T.D. 8276, 54 FR 51026, Dec. 12, 1989; T.D. 8451,
57 FR 57669, Dec. 7, 1992]
Sec. 1.162-27 Certain employee remuneration in excess of $1,000,000.
(a) Scope. This section provides rules for the application of the $1
million deduction limit under section 162(m) of the Internal Revenue
Code. Paragraph (b) of this section provides the general rule limiting
deductions under section 162(m). Paragraph (c) of this section provides
definitions of generally applicable terms. Paragraph (d) of this section
provides an exception from the deduction limit for compensation payable
on a commission basis. Paragraph (e) of this section provides an
exception for qualified performance-based compensation. Paragraphs (f)
and (g) of this section provide special rules for corporations that
become publicly held corporations and payments that are subject to
section 280G, respectively. Paragraph (h) of this section provides
transition rules, including the rules for contracts that are
grandfathered and not subject to section 162(m). Paragraph (j) of this
section contains the effective date provisions. For rules concerning the
deductibility of compensation for services that are not covered by
section 162(m) and this section, see section 162(a)(1) and Sec. 1.162-
7. This section is not determinative as to whether compensation meets
the requirements of section 162(a)(1).
(b) Limitation on deduction. Section 162(m) precludes a deduction
under chapter 1 of the Internal Revenue Code by any publicly held
corporation for compensation paid to any covered employee to the extent
that the compensation for the taxable year exceeds $1,000,000.
(c) Definitions--(1) Publicly held corporation--(i) General rule. A
publicly held corporation means any corporation issuing any class of
common equity securities required to be registered under section 12 of
the Exchange Act. A corporation is not considered publicly held if the
registration of its equity securities is voluntary. For purposes of this
section, whether a corporation is publicly held is determined based
solely on whether, as of the last day of its taxable year, the
corporation is subject to the reporting obligations of section 12 of the
Exchange Act.
(ii) Affiliated groups. A publicly held corporation includes an
affiliated group of corporations, as defined in section 1504 (determined
without regard to section 1504(b)). For purposes of this section,
however, an affiliated group of corporations does not include any
subsidiary that is itself a publicly held corporation. Such a publicly
held
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subsidiary, and its subsidiaries (if any), are separately subject to
this section. If a covered employee is paid compensation in a taxable
year by more than one member of an affiliated group, compensation paid
by each member of the affiliated group is aggregated with compensation
paid to the covered employee by all other members of the group. Any
amount disallowed as a deduction by this section must be prorated among
the payor corporations in proportion to the amount of compensation paid
to the covered employee by each such corporation in the taxable year.
(2) Covered employee--(i) General rule. A covered employee means any
individual who, on the last day of the taxable year, is--
(A) The chief executive officer of the corporation or is acting in
such capacity; or
(B) Among the four highest compensated officers (other than the
chief executive officer).
(ii) Application of rules of the Securities and Exchange Commission.
Whether an individual is the chief executive officer described in
paragraph (c)(2)(i)(A) of this section or an officer described in
paragraph (c)(2)(i)(B) of this section is determined pursuant to the
executive compensation disclosure rules under the Exchange Act.
(3) Compensation--(i) In general. For purposes of the deduction
limitation described in paragraph (b) of this section, compensation
means the aggregate amount allowable as a deduction under chapter 1 of
the Internal Revenue Code for the taxable year (determined without
regard to section 162(m)) for remuneration for services performed by a
covered employee, whether or not the services were performed during the
taxable year.
(ii) Exceptions. Compensation does not include--
(A) Remuneration covered in section 3121(a)(5)(A) through section
3121(a)(5)(D) (concerning remuneration that is not treated as wages for
purposes of the Federal Insurance Contributions Act); and
(B) Remuneration consisting of any benefit provided to or on behalf
of an employee if, at the time the benefit is provided, it is reasonable
to believe that the employee will be able to exclude it from gross
income. In addition, compensation does not include salary reduction
contributions described in section 3121(v)(1).
(4) Compensation Committee. The compensation committee means the
committee of directors (including any subcommittee of directors) of the
publicly held corporation that has the authority to establish and
administer performance goals described in paragraph (e)(2) of this
section, and to certify that performance goals are attained, as
described in paragraph (e)(5) of this section. A committee of directors
is not treated as failing to have the authority to establish performance
goals merely because the goals are ratified by the board of directors of
the publicly held corporation or, if applicable, any other committee of
the board of directors. See paragraph (e)(3) of this section for rules
concerning the composition of the compensation committee.
(5) Exchange Act. The Exchange Act means the Securities Exchange Act
of 1934.
(6) Examples. This paragraph (c) may be illustrated by the following
examples:
Example 1. Corporation X is a publicly held corporation with a July
1 to June 30 fiscal year. For Corporation X's taxable year ending on
June 30, 1995, Corporation X pays compensation of $2,000,000 to A, an
employee. However, A's compensation is not required to be reported to
shareholders under the executive compensation disclosure rules of the
Exchange Act because A is neither the chief executive officer nor one of
the four highest compensated officers employed on the last day of the
taxable year. A's compensation is not subject to the deduction
limitation of paragraph (b) of this section.
Example 2. C, a covered employee, performs services and receives
compensation from Corporations X, Y, and Z, members of an affiliated
group of corporations. Corporation X, the parent corporation, is a
publicly held corporation. The total compensation paid to C from all
affiliated group members is $3,000,000 for the taxable year, of which
Corporation X pays $1,500,000; Corporation Y pays $900,000; and
Corporation Z pays $600,000. Because the compensation paid by all
affiliated group members is aggregated for purposes of section 162(m),
$2,000,000 of the aggregate compensation paid is nondeductible.
Corporations X, Y, and Z each are treated as paying a ratable portion of
the nondeductible compensation. Thus, two
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thirds of each corporation's payment will be nondeductible. Corporation
X has a nondeductible compensation expense of $1,000,000
($1,500,000x$2,000,000/$3,000,000). Corporation Y has a nondeductible
compensation expense of $600,000 ($900,000x$2,000,000/$3,000,000).
Corporation Z has a nondeductible compensation expense of $400,000
($600,000x$2,000,000/$3,000,000).
Example 3. Corporation W, a calendar year taxpayer, has total assets
equal to or exceeding $5 million and a class of equity security held of
record by 500 or more persons on December 31, 1994. However, under the
Exchange Act, Corporation W is not required to file a registration
statement with respect to that security until April 30, 1995. Thus,
Corporation W is not a publicly held corporation on December 31, 1994,
but is a publicly held corporation on December 31, 1995.
Example 4. The facts are the same as in Example 3, except that on
December 15, 1996, Corporation W files with the Securities and Exchange
Commission to disclose that Corporation W is no longer required to be
registered under section 12 of the Exchange Act and to terminate its
registration of securities under that provision. Because Corporation W
is no longer subject to Exchange Act reporting obligations as of
December 31, 1996, Corporation W is not a publicly held corporation for
taxable year 1996, even though the registration of Corporation W's
securities does not terminate until 90 days after Corporation W files
with the Securities and Exchange Commission.
(d) Exception for compensation paid on a commission basis. The
deduction limit in paragraph (b) of this section shall not apply to any
compensation paid on a commission basis. For this purpose, compensation
is paid on a commission basis if the facts and circumstances show that
it is paid solely on account of income generated directly by the
individual performance of the individual to whom the compensation is
paid. Compensation does not fail to be attributable directly to the
individual merely because support services, such as secretarial or
research services, are utilized in generating the income. However, if
compensation is paid on account of broader performance standards, such
as income produced by a business unit of the corporation, the
compensation does not qualify for the exception provided under this
paragraph (d).
(e) Exception for qualified performance-based compensation--
(1) In general. The deduction limit in paragraph (b) of this section
does not apply to qualified performance-based compensation. Qualified
performance-based compensation is compensation that meets all of the
requirements of paragraphs (e)(2) through (e)(5) of this section.
(2) Performance goal requirement--(i) Preestablished goal. Qualified
performance-based compensation must be paid solely on account of the
attainment of one or more preestablished, objective performance goals. A
performance goal is considered preestablished if it is established in
writing by the compensation committee not later than 90 days after the
commencement of the period of service to which the performance goal
relates, provided that the outcome is substantially uncertain at the
time the compensation committee actually establishes the goal. However,
in no event will a performance goal be considered to be preestablished
if it is established after 25 percent of the period of service (as
scheduled in good faith at the time the goal is established) has
elapsed. A performance goal is objective if a third party having
knowledge of the relevant facts could determine whether the goal is met.
Performance goals can be based on one or more business criteria that
apply to the individual, a business unit, or the corporation as a whole.
Such business criteria could include, for example, stock price, market
share, sales, earnings per share, return on equity, or costs. A
performance goal need not, however, be based upon an increase or
positive result under a business criterion and could include, for
example, maintaining the status quo or limiting economic losses
(measured, in each case, by reference to a specific business criterion).
A performance goal does not include the mere continued employment of the
covered employee. Thus, a vesting provision based solely on continued
employment would not constitute a performance goal. See paragraph
(e)(2)(vi) of this section for rules on compensation that is based on an
increase in the price of stock.
(ii) Objective compensation formula. A preestablished performance
goal must state, in terms of an objective formula or standard, the
method for computing the amount of compensation payable to the employee
if the goal is attained. A
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formula or standard is objective if a third party having knowledge of
the relevant performance results could calculate the amount to be paid
to the employee. In addition, a formula or standard must specify the
individual employees or class of employees to which it applies.
(iii) Discretion. (A) The terms of an objective formula or standard
must preclude discretion to increase the amount of compensation payable
that would otherwise be due upon attainment of the goal. A performance
goal is not discretionary for purposes of this paragraph (e)(2)(iii)
merely because the compensation committee reduces or eliminates the
compensation or other economic benefit that was due upon attainment of
the goal. However, the exercise of negative discretion with respect to
one employee is not permitted to result in an increase in the amount
payable to another employee. Thus, for example, in the case of a bonus
pool, if the amount payable to each employee is stated in terms of a
percentage of the pool, the sum of these individual percentages of the
pool is not permitted to exceed 100 percent. If the terms of an
objective formula or standard fail to preclude discretion to increase
the amount of compensation merely because the amount of compensation to
be paid upon attainment of the performance goal is based, in whole or in
part, on a percentage of salary or base pay and the dollar amount of the
salary or base pay is not fixed at the time the performance goal is
established, then the objective formula or standard will not be
considered discretionary for purposes of this paragraph (e)(2)(iii) if
the maximum dollar amount to be paid is fixed at that time.
(B) If compensation is payable upon or after the attainment of a
performance goal, and a change is made to accelerate the payment of
compensation to an earlier date after the attainment of the goal, the
change will be treated as an increase in the amount of compensation,
unless the amount of compensation paid is discounted to reasonably
reflect the time value of money. If compensation is payable upon or
after the attainment of a performance goal, and a change is made to
defer the payment of compensation to a later date, any amount paid in
excess of the amount that was originally owed to the employee will not
be treated as an increase in the amount of compensation if the
additional amount is based either on a reasonable rate of interest or on
one or more predetermined actual investments (whether or not assets
associated with the amount originally owed are actually invested
therein) such that the amount payable by the employer at the later date
will be based on the actual rate of return of a specific investment
(including any decrease as well as any increase in the value of an
investment). If compensation is payable in the form of property, a
change in the timing of the transfer of that property after the
attainment of the goal will not be treated as an increase in the amount
of compensation for purposes of this paragraph (e)(2)(iii). Thus, for
example, if the terms of a stock grant provide for stock to be
transferred after the attainment of a performance goal and the transfer
of the stock also is subject to a vesting schedule, a change in the
vesting schedule that either accelerates or defers the transfer of stock
will not be treated as an increase in the amount of compensation payable
under the performance goal.
(C) Compensation attributable to a stock option, stock appreciation
right, or other stock-based compensation does not fail to satisfy the
requirements of this paragraph (e)(2) to the extent that a change in the
grant or award is made to reflect a change in corporate capitalization,
such as a stock split or dividend, or a corporate transaction, such as
any merger of a corporation into another corporation, any consolidation
of two or more corporations into another corporation, any separation of
a corporation (including a spinoff or other distribution of stock or
property by a corporation), any reorganization of a corporation (whether
or not such reorganization comes within the definition of such term in
section 368), or any partial or complete liquidation by a corporation.
(iv) Grant-by-grant determination. The determination of whether
compensation satisfies the requirements of this paragraph (e)(2)
generally shall be made on a grant-by-grant basis. Thus,
[[Page 213]]
for example, whether compensation attributable to a stock option grant
satisfies the requirements of this paragraph (e)(2) generally is
determined on the basis of the particular grant made and without regard
to the terms of any other option grant, or other grant of compensation,
to the same or another employee. As a further example, except as
provided in paragraph (e)(2)(vi), whether a grant of restricted stock or
other stock-based compensation satisfies the requirements of this
paragraph (e)(2) is determined without regard to whether dividends,
dividend equivalents, or other similar distributions with respect to
stock, on such stock-based compensation are payable prior to the
attainment of the performance goal. Dividends, dividend equivalents, or
other similar distributions with respect to stock that are treated as
separate grants under this paragraph (e)(2)(iv) are not performance-
based compensation unless they separately satisfy the requirements of
this paragraph (e)(2).
(v) Compensation contingent upon attainment of performance goal.
Compensation does not satisfy the requirements of this paragraph (e)(2)
if the facts and circumstances indicate that the employee would receive
all or part of the compensation regardless of whether the performance
goal is attained. Thus, if the payment of compensation under a grant or
award is only nominally or partially contingent on attaining a
performance goal, none of the compensation payable under the grant or
award will be considered performance-based. For example, if an employee
is entitled to a bonus under either of two arrangements, where payment
under a nonperformance-based arrangement is contingent upon the failure
to attain the performance goals under an otherwise performance-based
arrangement, then neither arrangement provides for compensation that
satisfies the requirements of this paragraph (e)(2). Compensation does
not fail to be qualified performance-based compensation merely because
the plan allows the compensation to be payable upon death, disability,
or change of ownership or control, although compensation actually paid
on account of those events prior to the attainment of the performance
goal would not satisfy the requirements of this paragraph (e)(2). As an
exception to the general rule set forth in the first sentence of
paragraph (e)(2)(iv) of this section, the facts-and-circumstances
determination referred to in the first sentence of this paragraph
(e)(2)(v) is made taking into account all plans, arrangements, and
agreements that provide for compensation to the employee.
(vi) Application of requirements to stock options and stock
appreciation rights--(A) In general. Compensation attributable to a
stock option or a stock appreciation right is deemed to satisfy the
requirements of this paragraph (e)(2) if the grant or award is made by
the compensation committee; the plan under which the option or right is
granted states the maximum number of shares with respect to which
options or rights may be granted during a specified period to any
individual employee; and, under the terms of the option or right, the
amount of compensation the employee may receive is based solely on an
increase in the value of the stock after the date of the grant or award.
A plan may satisfy the requirement to provide a maximum number of shares
with respect to which stock options and stock appreciation rights may be
granted to any individual employee during a specified period if the plan
specifies an aggregate maximum number of shares with respect to which
stock options, stock appreciation rights, restricted stock, restricted
stock units and other equity-based awards that may be granted to any
individual employee during a specified period under a plan approved by
shareholders in accordance with Sec. 1.162-27(e)(4). If the amount of
compensation the employee may receive under the grant or award is not
based solely on an increase in the value of the stock after the date of
grant or award (for example, in the case of restricted stock, or an
option that is granted with an exercise price that is less than the fair
market value of the stock as of the date of grant), none of the
compensation attributable to the grant or award is qualified
performance-based compensation under this paragraph (e)(2)(vi)(A).
Whether a stock option grant is based solely on an increase in
[[Page 214]]
the value of the stock after the date of grant is determined without
regard to any dividend equivalent that may be payable, provided that
payment of the dividend equivalent is not made contingent on the
exercise of the option. The rule that the compensation attributable to a
stock option or stock appreciation right must be based solely on an
increase in the value of the stock after the date of grant or award does
not apply if the grant or award is made on account of, or if the vesting
or exercisability of the grant or award is contingent on, the attainment
of a performance goal that satisfies the requirements of this paragraph
(e)(2).
(B) Cancellation and repricing. Compensation attributable to a stock
option or stock appreciation right does not satisfy the requirements of
this paragraph (e)(2) to the extent that the number of options granted
exceeds the maximum number of shares for which options may be granted to
the employee as specified in the plan. If an option is canceled, the
canceled option continues to be counted against the maximum number of
shares for which options may be granted to the employee under the plan.
If, after grant, the exercise price of an option is reduced, the
transaction is treated as a cancellation of the option and a grant of a
new option. In such case, both the option that is deemed to be canceled
and the option that is deemed to be granted reduce the maximum number of
shares for which options may be granted to the employee under the plan.
This paragraph (e)(2)(vi)(B) also applies in the case of a stock
appreciation right where, after the award is made, the base amount on
which stock appreciation is calculated is reduced to reflect a reduction
in the fair market value of stock.
(vii) Examples. This paragraph (e)(2) may be illustrated by the
following examples:
Example 1. No later than 90 days after the start of a fiscal year,
but while the outcome is substantially uncertain, Corporation S
establishes a bonus plan under which A, the chief executive officer,
will receive a cash bonus of $500,000, if year-end corporate sales are
increased by at least 5 percent. The compensation committee retains the
right, if the performance goal is met, to reduce the bonus payment to A
if, in its judgment, other subjective factors warrant a reduction. The
bonus will meet the requirements of this paragraph (e)(2).
Example 2. The facts are the same as in Example 1, except that the
bonus is based on a percentage of Corporation S's total sales for the
fiscal year. Because Corporation S is virtually certain to have some
sales for the fiscal year, the outcome of the performance goal is not
substantially uncertain, and therefore the bonus does not meet the
requirements of this paragraph (e)(2).
Example 3. The facts are the same as in Example 1, except that the
bonus is based on a percentage of Corporation S's total profits for the
fiscal year. Although some sales are virtually certain for virtually all
public companies, it is substantially uncertain whether a company will
have profits for a specified future period even if the company has a
history of profitability. Therefore, the bonus will meet the
requirements of this paragraph (e)(2).
Example 4. B is the general counsel of Corporation R, which is
engaged in patent litigation with Corporation S. Representatives of
Corporation S have informally indicated to Corporation R a willingness
to settle the litigation for $50,000,000. Subsequently, the compensation
committee of Corporation R agrees to pay B a bonus if B obtains a formal
settlement for at least $50,000,000. The bonus to B does not meet the
requirement of this paragraph (e)(2) because the performance goal was
not established at a time when the outcome was substantially uncertain.
Example 5. Corporation S, a public utility, adopts a bonus plan for
selected salaried employees that will pay a bonus at the end of a 3-year
period of $750,000 each if, at the end of the 3 years, the price of S
stock has increased by 10 percent. The plan also provides that the 10-
percent goal will automatically adjust upward or downward by the
percentage change in a published utilities index. Thus, for example, if
the published utilities index shows a net increase of 5 percent over a
3-year period, then the salaried employees would receive a bonus only if
Corporation S stock has increased by 15 percent. Conversely, if the
published utilities index shows a net decrease of 5 percent over a 3-
year period, then the salaried employees would receive a bonus if
Corporation S stock has increased by 5 percent. Because these automatic
adjustments in the performance goal are preestablished, the bonus meets
the requirement of this paragraph (e)(2), notwithstanding the potential
changes in the performance goal.
Example 6. The facts are the same as in Example 5, except that the
bonus plan provides that, at the end of the 3-year period, a bonus of
$750,000 will be paid to each salaried employee if either the price of
Corporation S stock has increased by 10 percent or the earnings per
share on Corporation S stock
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have increased by 5 percent. If both the earnings-per-share goal and the
stock-price goal are preestablished, the compensation committee's
discretion to choose to pay a bonus under either of the two goals does
not cause any bonus paid under the plan to fail to meet the requirement
of this paragraph (e)(2) because each goal independently meets the
requirements of this paragraph (e)(2). The choice to pay under either of
the two goals is tantamount to the discretion to choose not to pay under
one of the goals, as provided in paragraph (e)(2)(iii) of this section.
Example 7. Corporation U establishes a bonus plan under which a
specified class of employees will participate in a bonus pool if certain
preestablished performance goals are attained. The amount of the bonus
pool is determined under an objective formula. Under the terms of the
bonus plan, the compensation committee retains the discretion to
determine the fraction of the bonus pool that each employee may receive.
The bonus plan does not satisfy the requirements of this paragraph
(e)(2). Although the aggregate amount of the bonus plan is determined
under an objective formula, a third party could not determine the amount
that any individual could receive under the plan.
Example 8. The facts are the same as in Example 7, except that the
bonus plan provides that a specified share of the bonus pool is payable
to each employee, and the total of these shares does not exceed 100% of
the pool. The bonus plan satisfies the requirements of this paragraph
(e)(2). In addition, the bonus plan will satisfy the requirements of
this paragraph (e)(2) even if the compensation committee retains the
discretion to reduce the compensation payable to any individual
employee, provided that a reduction in the amount of one employee's
bonus does not result in an increase in the amount of any other
employee's bonus.
Example 9. Corporation V establishes a stock option plan for
salaried employees. The terms of the stock option plan specify that no
individual salaried employee shall receive options for more than 100,000
shares over any 3-year period. The compensation committee grants options
for 50,000 shares to each of several salaried employees. The exercise
price of each option is equal to or greater than the fair market value
of a share of V stock at the time of each grant. Compensation
attributable to the exercise of the options satisfies the requirements
of paragraph (e)(2)(vi) of this section. If, however, the terms of the
options provide that the exercise price is less than fair market value
of a share of V stock at the date of grant, no compensation attributable
to the exercise of those options satisfies the requirements of this
paragraph (e)(2) unless issuance or exercise of the options was
contingent upon the attainment of a preestablished performance goal that
satisfies this paragraph (e)(2). If, however, the terms of the plan also
provide that Corporation V could grant options to purchase no more than
900,000 shares over any 3-year period, but did not provide a limitation
on the number of shares that any individual employee could purchase,
then no compensation attributable to the exercise of those options
satisfies the requirements of paragraph (e)(2)(vi) of this section.
Example 10. The facts are the same as in Example 9, except that,
within the same 3-year grant period, the fair market value of
Corporation V stock is significantly less than the exercise price of the
options. The compensation committee reprices those options to that lower
current fair market value of Corporation V stock. The repricing of the
options for 50,000 shares held by each salaried employee is treated as
the grant of new options for an additional 50,000 shares to each
employee. Thus, each of the salaried employees is treated as having
received grants for 100,000 shares. Consequently, if any additional
options are granted to those employees during the 3-year period,
compensation attributable to the exercise of those additional options
would not satisfy the requirements of this paragraph (e)(2). The results
would be the same if the compensation committee canceled the outstanding
options and issued new options to the same employees that were
exercisable at the fair market value of Corporation V stock on the date
of reissue.
Example 11. Corporation W maintains a plan under which each
participating employee may receive incentive stock options, nonqualified
stock options, stock appreciation rights, or grants of restricted
Corporation W stock. The plan specifies that each participating employee
may receive options, stock appreciation rights, restricted stock, or any
combination of each, for no more than 20,000 shares over the life of the
plan. The plan provides that stock options may be granted with an
exercise price of less than, equal to, or greater than fair market value
on the date of grant. Options granted with an exercise price equal to,
or greater than, fair market value on the date of grant do not fail to
meet the requirements of this paragraph (e)(2) merely because the
compensation committee has the discretion to determine the types of
awards (i.e., options, rights, or restricted stock) to be granted to
each employee or the discretion to issue options or make other
compensation awards under the plan that would not meet the requirements
of this paragraph (e)(2). Whether an option granted under the plan
satisfies the requirements of this paragraph (e)(2) is determined on the
basis of the specific terms of the option and without regard to other
options or awards under the plan.
Example 12. Corporation X maintains a plan under which stock
appreciation rights may
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be awarded to key employees. The plan permits the compensation committee
to make awards under which the amount of compensation payable to the
employee is equal to the increase in the stock price plus a percentage
``gross up'' intended to offset the tax liability of the employee. In
addition, the plan permits the compensation committee to make awards
under which the amount of compensation payable to the employee is equal
to the increase in the stock price, based on the highest price, which is
defined as the highest price paid for Corporation X stock (or offered in
a tender offer or other arms-length offer) during the 90 days preceding
exercise. Compensation attributable to awards under the plan satisfies
the requirements of paragraph (e)(2)(vi) of this section, provided that
the terms of the plan specify the maximum number of shares for which
awards may be made.
Example 13. Corporation W adopts a plan under which a bonus will be
paid to the CEO only if there is a 10% increase in earnings per share
during the performance period. The plan provides that earnings per share
will be calculated without regard to any change in accounting standards
that may be required by the Financial Accounting Standards Board after
the goal is established. After the goal is established, such a change in
accounting standards occurs. Corporation W's reported earnings, for
purposes of determining earnings per share under the plan, are adjusted
pursuant to this plan provision to factor out this change in standards.
This adjustment will not be considered an exercise of impermissible
discretion because it is made pursuant to the plan provision.
Example 14. Corporation X adopts a performance-based incentive pay
plan with a four-year performance period. Bonuses under the plan are
scheduled to be paid in the first year after the end of the performance
period (year 5). However, in the second year of the performance period,
the compensation committee determines that any bonuses payable in year 5
will instead, for bona fide business reasons, be paid in year 10. The
compensation committee also determines that any compensation that would
have been payable in year 5 will be adjusted to reflect the delay in
payment. The adjustment will be based on the greater of the future rate
of return of a specified mutual fund that invests in blue chip stocks or
of a specified venture capital investment over the five-year deferral
period. Each of these investments, considered by itself, is a
predetermined actual investment because it is based on the future rate
of return of an actual investment. However, the adjustment in this case
is not based on predetermined actual investments within the meaning of
paragraph (e)(2)(iii)(B) of this section because the amount payable by
Corporation X in year 10 will be based on the greater of the two
investment returns and, thus, will not be based on the actual rate of
return on either specific investment.
Example 15. The facts are the same as in Example 14, except that the
increase will be based on Moody's Average Corporate Bond Yield over the
five-year deferral period. Because this index reflects a reasonable rate
of interest, the increase in the compensation payable that is based on
the index's rate of return is not considered an impermissible increase
in the amount of compensation payable under the formula.
Example 16. The facts are the same as in Example 14, except that the
increase will be based on the rate of return for the Standard & Poor's
500 Index. This index does not measure interest rates and thus does not
represent a reasonable rate of interest. In addition, this index does
not represent an actual investment. Therefore, any additional
compensation payable based on the rate of return of this index will
result in an impermissible increase in the amount payable under the
formula. If, in contrast, the increase were based on the rate of return
of an existing mutual fund that is invested in a manner that seeks to
approximate the Standard & Poor's 500 Index, the increase would be based
on a predetermined actual investment within the meaning of paragraph
(e)(2)(iii)(B) of this section and thus would not result in an
impermissible increase in the amount payable under the formula.
(3) Outside directors--(i) General rule. The performance goal under
which compensation is paid must be established by a compensation
committee comprised solely of two or more outside directors. A director
is an outside director if the director--
(A) Is not a current employee of the publicly held corporation;
(B) Is not a former employee of the publicly held corporation who
receives compensation for prior services (other than benefits under a
tax-qualified retirement plan) during the taxable year;
(C) Has not been an officer of the publicly held corporation; and
(D) Does not receive remuneration from the publicly held
corporation, either directly or indirectly, in any capacity other than
as a director. For this purpose, remuneration includes any payment in
exchange for goods or services.
(ii) Remuneration received. For purposes of this paragraph (e)(3),
remuneration is received, directly or indirectly, by a director in each
of the following circumstances:
(A) If remuneration is paid, directly or indirectly, to the director
personally
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or to an entity in which the director has a beneficial ownership
interest of greater than 50 percent. For this purpose, remuneration is
considered paid when actually paid (and throughout the remainder of that
taxable year of the corporation) and, if earlier, throughout the period
when a contract or agreement to pay remuneration is outstanding.
(B) If remuneration, other than de minimis remuneration, was paid by
the publicly held corporation in its preceding taxable year to an entity
in which the director has a beneficial ownership interest of at least 5
percent but not more than 50 percent. For this purpose, remuneration is
considered paid when actually paid or, if earlier, when the publicly
held corporation becomes liable to pay it.
(C) If remuneration, other than de minimis remuneration, was paid by
the publicly held corporation in its preceding taxable year to an entity
by which the director is employed or self-employed other than as a
director. For this purpose, remuneration is considered paid when
actually paid or, if earlier, when the publicly held corporation becomes
liable to pay it.
(iii) De minimis remuneration--(A) In general. For purposes of
paragraphs (e)(3)(ii)(B) and (C) of this section, remuneration that was
paid by the publicly held corporation in its preceding taxable year to
an entity is de minimis if payments to the entity did not exceed 5
percent of the gross revenue of the entity for its taxable year ending
with or within that preceding taxable year of the publicly held
corporation.
(B) Remuneration for personal services and substantial owners.
Notwithstanding paragraph (e)(3)(iii)(A) of this section, remuneration
in excess of $60,000 is not de minimis if the remuneration is paid to an
entity described in paragraph (e)(3)(ii)(B) of this section, or is paid
for personal services to an entity described in paragraph (e)(3)(ii)(C)
of this section.
(iv) Remuneration for personal services. For purposes of paragraph
(e)(3)(iii)(B) of this section, remuneration from a publicly held
corporation is for personal services if--
(A) The remuneration is paid to an entity for personal or
professional services, consisting of legal, accounting, investment
banking, and management consulting services (and other similar services
that may be specified by the Commissioner in revenue rulings, notices,
or other guidance published in the Internal Revenue Bulletin), performed
for the publicly held corporation, and the remuneration is not for
services that are incidental to the purchase of goods or to the purchase
of services that are not personal services; and
(B) The director performs significant services (whether or not as an
employee) for the corporation, division, or similar organization (within
the entity) that actually provides the services described in paragraph
(e)(3)(iv)(A) of this section to the publicly held corporation, or more
than 50 percent of the entity's gross revenues (for the entity's
preceding taxable year) are derived from that corporation, subsidiary,
or similar organization.
(v) Entity defined. For purposes of this paragraph (e)(3), entity
means an organization that is a sole proprietorship, trust, estate,
partnership, or corporation. The term also includes an affiliated group
of corporations as defined in section 1504 (determined without regard to
section 1504(b)) and a group of organizations that would be an
affiliated group but for the fact that one or more of the organizations
are not incorporated. However, the aggregation rules referred to in the
preceding sentence do not apply for purposes of determining whether a
director has a beneficial ownership interest of at least 5 percent or
greater than 50 percent.
(vi) Employees and former officers. Whether a director is an
employee or a former officer is determined on the basis of the facts at
the time that the individual is serving as a director on the
compensation committee. Thus, a director is not precluded from being an
outside director solely because the director is a former officer of a
corporation that previously was an affiliated corporation of the
publicly held corporation. For example, a director of a parent
corporation of an affiliated group is not precluded from being an
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outside director solely because that director is a former officer of an
affiliated subsidiary that was spun off or liquidated. However, an
outside director would no longer be an outside director if a corporation
in which the director was previously an officer became an affiliated
corporation of the publicly held corporation.
(vii) Officer. Solely for purposes of this paragraph (e)(3), officer
means an administrative executive who is or was in regular and continued
service. The term implies continuity of service and excludes those
employed for a special and single transaction. An individual who merely
has (or had) the title of officer but not the authority of an officer is
not considered an officer. The determination of whether an individual is
or was an officer is based on all of the facts and circumstances in the
particular case, including without limitation the source of the
individual's authority, the term for which the individual is elected or
appointed, and the nature and extent of the individual's duties.
(viii) Members of affiliated groups. For purposes of this paragraph
(e)(3), the outside directors of the publicly held member of an
affiliated group are treated as the outside directors of all members of
the affiliated group.
(ix) Examples. This paragraph (e)(3) may be illustrated by the
following examples:
Example 1. Corporations X and Y are members of an affiliated group
of corporations as defined in section 1504, until July 1, 1994, when Y
is sold to another group. Prior to the sale, A served as an officer of
Corporation Y. After July 1, 1994, A is not treated as a former officer
of Corporation X by reason of having been an officer of Y.
Example 2. Corporation Z, a calendar-year taxpayer, uses the
services of a law firm by which B is employed, but in which B has a
less-than-5-percent ownership interest. The law firm reports income on a
July 1 to June 30 basis. Corporation Z appoints B to serve on its
compensation committee for calendar year 1998 after determining that, in
calendar year 1997, it did not become liable to the law firm for
remuneration exceeding the lesser of $60,000 or five percent of the law
firm's gross revenue (calculated for the year ending June 30, 1997). On
October 1, 1998, Corporation Z becomes liable to pay remuneration of
$50,000 to the law firm on June 30, 1999. For the year ending June 30,
1998, the law firm's gross revenue was less than $1 million. Thus, in
calendar year 1999, B is not an outside director. However, B may satisfy
the requirements for an outside director in calendar year 2000, if, in
calendar year 1999, Corporation Z does not become liable to the law firm
for additional remuneration. This is because the remuneration actually
paid on June 30, 1999 was considered paid on October 1, 1998 under
paragraph (e)(3)(ii)(C) of this section.
Example 3. Corporation Z, a publicly held corporation, purchases
goods from Corporation A. D, an executive and less- than-5-percent owner
of Corporation A, sits on the board of directors of Corporation Z and on
its compensation committee. For 1997, Corporation Z obtains
representations to the effect that D is not eligible for any commission
for D's sales to Corporation Z and that, for purposes of determining D's
compensation for 1997, Corporation A's sales to Corporation Z are not
otherwise treated differently than sales to other customers of
Corporation A (including its affiliates, if any) or are irrelevant. In
addition, Corporation Z has no reason to believe that these
representations are inaccurate or that it is otherwise paying
remuneration indirectly to D personally. Thus, in 1997, no remuneration
is considered paid by Corporation Z indirectly to D personally under
paragraph (e)(3)(ii)(A) of this section.
Example 4. (i) Corporation W, a publicly held corporation, purchases
goods from Corporation T. C, an executive and less- than-5-percent owner
of Corporation T, sits on the board of directors of Corporation W and on
its compensation committee. Corporation T develops a new product and
agrees on January 1, 1998 to pay C a bonus of $500,000 if Corporation W
contracts to purchase the product. Even if Corporation W purchases the
new product, sales to Corporation W will represent less than 5 percent
of Corporation T's gross revenues. In 1999, Corporation W contracts to
purchase the new product and, in 2000, C receives the $500,000 bonus
from Corporation T. In 1998, 1999, and 2000, Corporation W does not
obtain any representations relating to indirect remuneration to C
personally (such as the representations described in Example 3).
(ii) Thus, in 1998, 1999, and 2000, remuneration is considered paid
by Corporation W indirectly to C personally under paragraph
(e)(3)(ii)(A) of this section. Accordingly, in 1998, 1999, and 2000, C
is not an outside director of Corporation W. The result would have been
the same if Corporation W had obtained appropriate representations but
nevertheless had reason to believe that it was paying remuneration
indirectly to C personally.
Example 5. Corporation R, a publicly held corporation, purchases
utility service from Corporation Q, a public utility. The chief
executive officer, and less-than-5-percent
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owner, of Corporation Q is a director of Corporation R. Corporation R
pays Corporation Q more than $60,000 per year for the utility service,
but less than 5 percent of Corporation Q's gross revenues. Because
utility services are not personal services, the fees paid are not
subject to the $60,000 de minimis rule for remuneration for personal
services within the meaning of paragraph (e)(3)(iii)(B) of this section.
Thus, the chief executive officer qualifies as an outside director of
Corporation R, unless disqualified on some other basis.
Example 6. Corporation A, a publicly held corporation, purchases
management consulting services from Division S of Conglomerate P. The
chief financial officer of Division S is a director of Corporation A.
Corporation A pays more than $60,000 per year for the management
consulting services, but less than 5 percent of Conglomerate P's gross
revenues. Because management consulting services are personal services
within the meaning of paragraph (e)(3)(iv)(A) of this section, and the
chief financial officer performs significant services for Division S,
the fees paid are subject to the $60,000 de minimis rule as remuneration
for personal services. Thus, the chief financial officer does not
qualify as an outside director of Corporation A.
Example 7. The facts are the same as in Example 6, except that the
chief executive officer, and less-than-5-percent owner, of the parent
company of Conglomerate P is a director of Corporation A and does not
perform significant services for Division S. If the gross revenues of
Division S do not constitute more than 50 percent of the gross revenues
of Conglomerate P for P's preceding taxable year, the chief executive
officer will qualify as an outside director of Corporation A, unless
disqualified on some other basis.
(4) Shareholder approval requirement--(i) General rule. The material
terms of the performance goal under which the compensation is to be paid
must be disclosed to and subsequently approved by the shareholders of
the publicly held corporation before the compensation is paid. The
requirements of this paragraph (e)(4) are not satisfied if the
compensation would be paid regardless of whether the material terms are
approved by shareholders. The material terms include the employees
eligible to receive compensation; a description of the business criteria
on which the performance goal is based; and either the maximum amount of
compensation that could be paid to any employee or the formula used to
calculate the amount of compensation to be paid to the employee if the
performance goal is attained (except that, in the case of a formula
based, in whole or in part, on a percentage of salary or base pay, the
maximum dollar amount of compensation that could be paid to the employee
must be disclosed).
(ii) Eligible employees. Disclosure of the employees eligible to
receive compensation need not be so specific as to identify the
particular individuals by name. A general description of the class of
eligible employees by title or class is sufficient, such as the chief
executive officer and vice presidents, or all salaried employees, all
executive officers, or all key employees.
(iii) Description of business criteria--(A) In general. Disclosure
of the business criteria on which the performance goal is based need not
include the specific targets that must be satisfied under the
performance goal. For example, if a bonus plan provides that a bonus
will be paid if earnings per share increase by 10 percent, the 10-
percent figure is a target that need not be disclosed to shareholders.
However, in that case, disclosure must be made that the bonus plan is
based on an earnings-per-share business criterion. In the case of a plan
under which employees may be granted stock options or stock appreciation
rights, no specific description of the business criteria is required if
the grants or awards are based on a stock price that is no less than
current fair market value.
(B) Disclosure of confidential information. The requirements of this
paragraph (e)(4) may be satisfied even though information that otherwise
would be a material term of a performance goal is not disclosed to
shareholders, provided that the compensation committee determines that
the information is confidential commercial or business information, the
disclosure of which would have an adverse effect on the publicly held
corporation. Whether disclosure would adversely affect the corporation
is determined on the basis of the facts and circumstances. If the
compensation committee makes such a determination, the disclosure to
shareholders must state the compensation committee's
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belief that the information is confidential commercial or business
information, the disclosure of which would adversely affect the company.
In addition, the ability not to disclose confidential information does
not eliminate the requirement that disclosure be made of the maximum
amount of compensation that is payable to an individual under a
performance goal. Confidential information does not include the identity
of an executive or the class of executives to which a performance goal
applies or the amount of compensation that is payable if the goal is
satisfied.
(iv) Description of compensation. Disclosure as to the compensation
payable under a performance goal must be specific enough so that
shareholders can determine the maximum amount of compensation that could
be paid to any individual employee during a specified period. If the
terms of the performance goal do not provide for a maximum dollar
amount, the disclosure must include the formula under which the
compensation would be calculated. Thus, if compensation attributable to
the exercise of stock options is equal to the difference between the
exercise price and the current value of the stock, then disclosure of
the maximum number of shares for which grants may be made to any
individual employee during a specified period and the exercise price of
those options (for example, fair market value on date of grant) would
satisfy the requirements of this paragraph (e)(4)(iv). In that case,
shareholders could calculate the maximum amount of compensation that
would be attributable to the exercise of options on the basis of their
assumptions as to the future stock price.
(v) Disclosure requirements of the Securities and Exchange
Commission. To the extent not otherwise specifically provided in this
paragraph (e)(4), whether the material terms of a performance goal are
adequately disclosed to shareholders is determined under the same
standards as apply under the Exchange Act.
(vi) Frequency of disclosure. Once the material terms of a
performance goal are disclosed to and approved by shareholders, no
additional disclosure or approval is required unless the compensation
committee changes the material terms of the performance goal. If,
however, the compensation committee has authority to change the targets
under a performance goal after shareholder approval of the goal,
material terms of the performance goal must be disclosed to and
reapproved by shareholders no later than the first shareholder meeting
that occurs in the fifth year following the year in which shareholders
previously approved the performance goal.
(vii) Shareholder vote. For purposes of this paragraph (e)(4), the
material terms of a performance goal are approved by shareholders if, in
a separate vote, a majority of the votes cast on the issue (including
abstentions to the extent abstentions are counted as voting under
applicable state law) are cast in favor of approval.
(viii) Members of affiliated group. For purposes of this paragraph
(e)(4), the shareholders of the publicly held member of the affiliated
group are treated as the shareholders of all members of the affiliated
group.
(ix) Examples. This paragraph (e)(4) may be illustrated by the
following examples:
Example 1. Corporation X adopts a plan that will pay a specified
class of its executives an annual cash bonus based on the overall
increase in corporate sales during the year. Under the terms of the
plan, the cash bonus of each executive equals $100,000 multiplied by the
number of percentage points by which sales increase in the current year
when compared to the prior year. Corporation X discloses to its
shareholders prior to the vote both the class of executives eligible to
receive awards and the annual formula of $100,000 multiplied by the
percentage increase in sales. This disclosure meets the requirements of
this paragraph (e)(4). Because the compensation committee does not have
the authority to establish a different target under the plan,
Corporation X need not redisclose to its shareholders and obtain their
reapproval of the material terms of the plan until those material terms
are changed.
Example 2. The facts are the same as in Example 1 except that
Corporation X discloses only that bonuses will be paid on the basis of
the annual increase in sales. This disclosure does not meet the
requirements of this paragraph (e)(4) because it does not include the
formula for calculating the compensation or a maximum amount of
compensation to be paid if the performance goal is satisfied.
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Example 3. Corporation Y adopts an incentive compensation plan in
1995 that will pay a specified class of its executives a bonus every 3
years based on the following 3 factors: increases in earnings per share,
reduction in costs for specified divisions, and increases in sales by
specified divisions. The bonus is payable in cash or in Corporation Y
stock, at the option of the executive. Under the terms of the plan,
prior to the beginning of each 3-year period, the compensation committee
determines the specific targets under each of the three factors (i.e.,
the amount of the increase in earnings per share, the reduction in
costs, and the amount of sales) that must be met in order for the
executives to receive a bonus. Under the terms of the plan, the
compensation committee retains the discretion to determine whether a
bonus will be paid under any one of the goals. The terms of the plan
also specify that no executive may receive a bonus in excess of
$1,500,000 for any 3-year period. To satisfy the requirements of this
paragraph (e)(4), Corporation Y obtains shareholder approval of the plan
at its 1995 annual shareholder meeting. In the proxy statement issued to
shareholders, Corporation Y need not disclose to shareholders the
specific targets that are set by the compensation committee. However,
Corporation Y must disclose that bonuses are paid on the basis of
earnings per share, reductions in costs, and increases in sales of
specified divisions. Corporation Y also must disclose the maximum amount
of compensation that any executive may receive under the plan is
$1,500,000 per 3-year period. Unless changes in the material terms of
the plan are made earlier, Corporation Y need not disclose the material
terms of the plan to the shareholders and obtain their reapproval until
the first shareholders' meeting held in 2000.
Example 4. The same facts as in Example 3, except that prior to the
beginning of the second 3-year period, the compensation committee
determines that different targets will be set under the plan for that
period with regard to all three of the performance criteria (i.e.,
earnings per share, reductions in costs, and increases in sales). In
addition, the compensation committee raises the maximum dollar amount
that can be paid under the plan for a 3-year period to $2,000,000. The
increase in the maximum dollar amount of compensation under the plan is
a changed material term. Thus, to satisfy the requirements of this
paragraph (e)(4), Corporation Y must disclose to and obtain approval by
the shareholders of the plan as amended.
Example 5. In 1998, Corporation Z establishes a plan under which a
specified group of executives will receive a cash bonus not to exceed
$750,000 each if a new product that has been in development is completed
and ready for sale to customers by January 1, 2000. Although the
completion of the new product is a material term of the performance goal
under this paragraph (e)(4), the compensation committee determines that
the disclosure to shareholders of the performance goal would adversely
affect Corporation Z because its competitors would be made aware of the
existence and timing of its new product. In this case, the requirements
of this paragraph (e)(4) are satisfied if all other material terms,
including the maximum amount of compensation, are disclosed and the
disclosure affirmatively states that the terms of the performance goal
are not being disclosed because the compensation committee has
determined that those terms include confidential information, the
disclosure of which would adversely affect Corporation Z.
(5) Compensation committee certification. The compensation committee
must certify in writing prior to payment of the compensation that the
performance goals and any other material terms were in fact satisfied.
For this purpose, approved minutes of the compensation committee meeting
in which the certification is made are treated as a written
certification. Certification by the compensation committee is not
required for compensation that is attributable solely to the increase in
the value of the stock of the publicly held corporation.
(f) Companies that become publicly held, spinoffs, and similar
transactions--(1) In general. In the case of a corporation that was not
a publicly held corporation and then becomes a publicly held
corporation, the deduction limit of paragraph (b) of this section does
not apply to any remuneration paid pursuant to a compensation plan or
agreement that existed during the period in which the corporation was
not publicly held. However, in the case of such a corporation that
becomes publicly held in connection with an initial public offering,
this relief applies only to the extent that the prospectus accompanying
the initial public offering disclosed information concerning those plans
or agreements that satisfied all applicable securities laws then in
effect. In accordance with paragraph (c)(1)(ii) of this section, a
corporation that is a member of an affiliated group that includes a
publicly held corporation is considered publicly held and, therefore,
cannot rely on this paragraph (f)(1).
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(2) Reliance period. Paragraph (f)(1) of this section may be relied
upon until the earliest of--
(i) The expiration of the plan or agreement;
(ii) The material modification of the plan or agreement, within the
meaning of paragraph (h)(1)(iii) of this section;
(iii) The issuance of all employer stock and other compensation that
has been allocated under the plan; or
(iv) The first meeting of shareholders at which directors are to be
elected that occurs after the close of the third calendar year following
the calendar year in which the initial public offering occurs or, in the
case of a privately held corporation that becomes publicly held without
an initial public offering, the first calendar year following the
calendar year in which the corporation becomes publicly held.
(3) Stock-based compensation. Paragraph (f)(1) of this section will
apply to any compensation received pursuant to the exercise of a stock
option or stock appreciation right, or the substantial vesting of
restricted property, granted under a plan or agreement described in
paragraph (f)(1) of this section if the grant occurs on or before the
earliest of the events specified in paragraph (f)(2) of this section.
This paragraph does not apply to any form of stock-based compensation
other than the forms listed in the immediately preceding sentence. Thus,
for example, compensation payable under a restricted stock unit
arrangement or a phantom stock arrangement must be paid, rather than
merely granted, on or before the occurrence of the earliest of the
events specified in paragraph (f)(2) of this section in order for
paragraph (f)(1) of this section to apply.
(4) Subsidiaries that become separate publicly held corporations--
(i) In general. If a subsidiary that is a member of the affiliated group
described in paragraph (c)(1)(ii) of this section becomes a separate
publicly held corporation (whether by spinoff or otherwise), any
remuneration paid to covered employees of the new publicly held
corporation will satisfy the exception for performance-based
compensation described in paragraph (e) of this section if the
conditions in either paragraph (f)(4)(ii) or (f)(4)(iii) of this section
are satisfied.
(ii) Prior establishment and approval. Remuneration satisfies the
requirements of this paragraph (f)(4)(ii) if the remuneration satisfies
the requirements for performance-based compensation set forth in
paragraphs (e)(2), (e)(3), and (e)(4) of this section (by application of
paragraphs (e)(3)(viii) and (e)(4)(viii) of this section) before the
corporation becomes a separate publicly held corporation, and the
certification required by paragraph (e)(5) of this section is made by
the compensation committee of the new publicly held corporation (but if
the performance goals are attained before the corporation becomes a
separate publicly held corporation, the certification may be made by the
compensation committee referred to in paragraph (e)(3)(viii) of this
section before it becomes a separate publicly held corporation). Thus,
this paragraph (f)(4)(ii) requires that the outside directors and
shareholders (within the meaning of paragraphs (e)(3)(viii) and
(e)(4)(viii) of this section) of the corporation before it becomes a
separate publicly held corporation establish and approve, respectively,
the performance-based compensation for the covered employees of the new
publicly held corporation in accordance with paragraphs (e)(3) and
(e)(4) of this section.
(iii) Transition period. Remuneration satisfies the requirements of
this paragraph (f)(4)(iii) if the remuneration satisfies all of the
requirements of paragraphs (e)(2), (e)(3), and (e)(5) of this section.
The outside directors (within the meaning of paragraph (e)(3)(viii) of
this section) of the corporation before it becomes a separate publicly
held corporation, or the outside directors of the new publicly held
corporation, may establish and administer the performance goals for the
covered employees of the new publicly held corporation for purposes of
satisfying the requirements of paragraphs (e)(2) and (e)(3) of this
section. The certification required by paragraph (e)(5) of this section
must be made by the compensation committee of the new publicly held
corporation. However, a taxpayer may rely on this paragraph (f)(4)(iii)
to satisfy the requirements of paragraph (e) of this section only for
compensation paid, or stock options, stock appreciation
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rights, or restricted property granted, prior to the first regularly
scheduled meeting of the shareholders of the new publicly held
corporation that occurs more than 12 months after the date the
corporation becomes a separate publicly held corporation. Compensation
paid, or stock options, stock appreciation rights, or restricted
property granted, on or after the date of that meeting of shareholders
must satisfy all requirements of paragraph (e) of this section,
including the shareholder approval requirement of paragraph (e)(4) of
this section, in order to satisfy the requirements for performance-based
compensation.
(5) Example. The following example illustrates the application of
paragraph (f)(4)(ii) of this section:
Example. Corporation P, which is publicly held, decides to spin off
Corporation S, a wholly owned subsidiary of Corporation P. After the
spinoff, Corporation S will be a separate publicly held corporation.
Before the spinoff, the compensation committee of Corporation P,
pursuant to paragraph (e)(3)(viii) of this section, establishes a bonus
plan for the executives of Corporation S that provides for bonuses
payable after the spinoff and that satisfies the requirements of
paragraph (e)(2) of this section. If, pursuant to paragraph (e)(4)(viii)
of this section, the shareholders of Corporation P approve the plan
prior to the spinoff, that approval will satisfy the requirements of
paragraph (e)(4) of this section with respect to compensation paid
pursuant to the bonus plan after the spinoff. However, the compensation
committee of Corporation S will be required to certify that the goals
are satisfied prior to the payment of the bonuses in order for the
bonuses to be considered performance-based compensation.
(g) Coordination with disallowed excess parachute payments. The
$1,000,000 limitation in paragraph (b) of this section is reduced (but
not below zero) by the amount (if any) that would have been included in
the compensation of the covered employee for the taxable year but for
being disallowed by reason of section 280G. For example, assume that
during a taxable year a corporation pays $1,500,000 to a covered
employee and no portion satisfies the exception in paragraph (d) of this
section for commissions or paragraph (e) of this section for qualified
performance-based compensation. Of the $1,500,000, $600,000 is an excess
parachute payment, as defined in section 280G(b)(1) and is disallowed by
reason of that section. Because the excess parachute payment reduces the
limitation of paragraph (b) of this section, the corporation can deduct
$400,000, and $500,000 of the otherwise deductible amount is
nondeductible by reason of section 162(m).
(h) Transition rules--(1) Compensation payable under a written
binding contract which was in effect on February 17, 1993--(i) General
rule. The deduction limit of paragraph (b) of this section does not
apply to any compensation payable under a written binding contract that
was in effect on February 17, 1993. The preceding sentence does not
apply unless, under applicable state law, the corporation is obligated
to pay the compensation if the employee performs services. However, the
deduction limit of paragraph (b) of this section does apply to a
contract that is renewed after February 17, 1993. A written binding
contract that is terminable or cancelable by the corporation after
February 17, 1993, without the employee's consent is treated as a new
contract as of the date that any such termination or cancellation, if
made, would be effective. Thus, for example, if the terms of a contract
provide that it will be automatically renewed as of a certain date
unless either the corporation or the employee gives notice of
termination of the contract at least 30 days before that date, the
contract is treated as a new contract as of the date that termination
would be effective if that notice were given. Similarly, for example, if
the terms of a contract provide that the contract will be terminated or
canceled as of a certain date unless either the corporation or the
employee elects to renew within 30 days of that date, the contract is
treated as renewed by the corporation as of that date. Alternatively, if
the corporation will remain legally obligated by the terms of a contract
beyond a certain date at the sole discretion of the employee, the
contract will not be treated as a new contract as of that date if the
employee exercises the discretion to keep the corporation bound to the
contract. A contract is not treated as terminable or cancelable if it
can be terminated or canceled only
[[Page 224]]
by terminating the employment relationship of the employee.
(ii) Compensation payable under a plan or arrangement. If a
compensation plan or arrangement meets the requirements of paragraph
(h)(1)(i) of this section, the compensation paid to an employee pursuant
to the plan or arrangement will not be subject to the deduction limit of
paragraph (b) of this section even though the employee was not eligible
to participate in the plan as of February 17, 1993. However, the
preceding sentence does not apply unless the employee was employed on
February 17, 1993, by the corporation that maintained the plan or
arrangement, or the employee had the right to participate in the plan or
arrangement under a written binding contract as of that date.
(iii) Material modifications. (A) Paragraph (h)(1)(i) of this
section will not apply to any written binding contract that is
materially modified. A material modification occurs when the contract is
amended to increase the amount of compensation payable to the employee.
If a binding written contract is materially modified, it is treated as a
new contract entered into as of the date of the material modification.
Thus, amounts received by an employee under the contract prior to a
material modification are not affected, but amounts received subsequent
to the material modification are not treated as paid under a binding,
written contract described in paragraph (h)(1)(i) of this section.
(B) A modification of the contract that accelerates the payment of
compensation will be treated as a material modification unless the
amount of compensation paid is discounted to reasonably reflect the time
value of money. If the contract is modified to defer the payment of
compensation, any compensation paid in excess of the amount that was
originally payable to the employee under the contract will not be
treated as a material modification if the additional amount is based on
either a reasonable rate of interest or one or more predetermined actual
investments (whether or not assets associated with the amount originally
owed are actually invested therein) such that the amount payable by the
employer at the later date will be based on the actual rate of return of
the specific investment (including any decrease as well as any increase
in the value of the investment).
(C) The adoption of a supplemental contract or agreement that
provides for increased compensation, or the payment of additional
compensation, is a material modification of a binding, written contract
where the facts and circumstances show that the additional compensation
is paid on the basis of substantially the same elements or conditions as
the compensation that is otherwise paid under the written binding
contract. However, a material modification of a written binding contract
does not include a supplemental payment that is equal to or less than a
reasonable cost-of-living increase over the payment made in the
preceding year under that written binding contract. In addition, a
supplemental payment of compensation that satisfies the requirements of
qualified performance-based compensation in paragraph (e) of this
section will not be treated as a material modification.
(iv) Examples. The following examples illustrate the exception of
this paragraph (h)(1):
Example 1. Corporation X executed a 3-year compensation arrangement
with C on February 15, 1993, that constitutes a written binding contract
under applicable state law. The terms of the arrangement provide for
automatic extension after the 3-year term for additional 1-year periods,
unless the corporation exercises its option to terminate the arrangement
within 30 days of the end of the 3-year term or, thereafter, within 30
days before each anniversary date. Termination of the compensation
arrangement does not require the termination of C's employment
relationship with Corporation X. Unless terminated, the arrangement is
treated as renewed on February 15, 1996, and the deduction limit of
paragraph (b) of this section applies to payments under the arrangement
after that date.
Example 2. Corporation Y executed a 5-year employment agreement with
B on January 1, 1992, providing for a salary of $900,000 per year.
Assume that this agreement constitutes a written binding contract under
applicable state law. In 1992 and 1993, B receives the salary of
$900,000 per year. In 1994, Corporation Y increases B's salary with a
payment of $20,000. The $20,000 supplemental payment does not constitute
a material modification of the written binding contract
[[Page 225]]
because the $20,000 payment is less than or equal to a reasonable cost-
of-living increase from 1993. However, the $20,000 supplemental payment
is subject to the limitation in paragraph (b) of this section. On
January 1, 1995, Corporation Y increases B's salary to $1,200,000. The
$280,000 supplemental payment is a material modification of the written
binding contract because the additional compensation is paid on the
basis of substantially the same elements or conditions as the
compensation that is otherwise paid under the written binding contract
and it is greater than a reasonable, annual cost-of-living increase.
Because the written binding contract is materially modified as of
January 1, 1995, all compensation paid to B in 1995 and thereafter is
subject to the deduction limitation of section 162(m).
Example 3. Assume the same facts as in Example 2, except that
instead of an increase in salary, B receives a restricted stock grant
subject to B's continued employment for the balance of the contract. The
restricted stock grant is not a material modification of the binding
written contract because any additional compensation paid to B under the
grant is not paid on the basis of substantially the same elements and
conditions as B's salary because it is based both on the stock price and
B's continued service. However, compensation attributable to the
restricted stock grant is subject to the deduction limitation of section
162(m).
(2) Special transition rule for outside directors. A director who is
a disinterested director is treated as satisfying the requirements of an
outside director under paragraph (e)(3) of this section until the first
meeting of shareholders at which directors are to be elected that occurs
on or after January 1, 1996. For purposes of this paragraph (h)(2) and
paragraph (h)(3) of this section, a director is a disinterested director
if the director is disinterested within the meaning of Rule 16b-
3(c)(2)(i), 17 CFR 240.16b-3(c)(2)(i), under the Exchange Act (including
the provisions of Rule 16b-3(d)(3), as in effect on April 30, 1991).
(3) Special transition rule for previously-approved plans--(i) In
general. Any compensation paid under a plan or agreement approved by
shareholders before December 20, 1993, is treated as satisfying the
requirements of paragraphs (e)(3) and (e)(4) of this section, provided
that the directors administering the plan or agreement are disinterested
directors and the plan was approved by shareholders in a manner
consistent with Rule 16b-3(b), 17 CFR 240.16b-3(b), under the Exchange
Act or Rule 16b-3(a), 17 CFR 240.16b-3(a) (as contained in 17 CFR part
240 revised April 1, 1990). In addition, for purposes of satisfying the
requirements of paragraph (e)(2)(vi) of this section, a plan or
agreement is treated as stating a maximum number of shares with respect
to which an option or right may be granted to any employee if the plan
or agreement that was approved by the shareholders provided for an
aggregate limit, consistent with Rule 16b-3(b), 17 CFR 250.16b-3(b), on
the shares of employer stock with respect to which awards may be made
under the plan or agreement.
(ii) Reliance period. The transition rule provided in this paragraph
(h)(3) shall continue and may be relied upon until the earliest of--
(A) The expiration or material modification of the plan or
agreement;
(B) The issuance of all employer stock and other compensation that
has been allocated under the plan; or
(C) The first meeting of shareholders at which directors are to be
elected that occurs after December 31, 1996.
(iii) Stock-based compensation. This paragraph (h)(3) will apply to
any compensation received pursuant to the exercise of a stock option or
stock appreciation right, or the substantial vesting of restricted
property, granted under a plan or agreement described in paragraph
(h)(3)(i) of this section if the grant occurs on or before the earliest
of the events specified in paragraph (h)(3)(ii) of this section.
(iv) Example. The following example illustrates the application of
this paragraph (h)(3):
Example. Corporation Z adopted a stock option plan in 1991. Pursuant
to Rule 16b-3 under the Exchange Act, the stock option plan has been
administered by disinterested directors and was approved by Corporation
Z shareholders. Under the terms of the plan, shareholder approval is not
required again until 2001. In addition, the terms of the stock option
plan include an aggregate limit on the number of shares available under
the plan. Option grants under the Corporation Z plan are made with an
exercise price equal to or greater than the fair market value of
Corporation Z stock. Compensation attributable to the exercise of
options that are granted under the plan before the earliest of the dates
specified in paragraph (h)(3)(ii) of this
[[Page 226]]
section will be treated as satisfying the requirements of paragraph (e)
of this section for qualified performance-based compensation, regardless
of when the options are exercised.
(i) [Reserved]
(j) Effective date--(1) In general. Section 162(m) and this section
apply to compensation that is otherwise deductible by the corporation in
a taxable year beginning on or after January 1, 1994.
(2) Delayed effective date for certain provisions--(i) Date on which
remuneration is considered paid. Notwithstanding paragraph (j)(1) of
this section, the rules in the second sentence of each of paragraphs
(e)(3)(ii)(A), (e)(3)(ii)(B), and (e)(3)(ii)(C) of this section for
determining the date or dates on which remuneration is considered paid
to a director are effective for taxable years beginning on or after
January 1, 1995. Prior to those taxable years, taxpayers must follow the
rules in paragraphs (e)(3)(ii)(A), (e)(3)(ii)(B), and (e)(3)(ii)(C) of
this section or another reasonable, good faith interpretation of section
162(m) with respect to the date or dates on which remuneration is
considered paid to a director.
(ii) Separate treatment of publicly held subsidiaries.
Notwithstanding paragraph (j)(1) of this section, the rule in paragraph
(c)(1)(ii) of this section that treats publicly held subsidiaries as
separately subject to section 162(m) is effective as of the first
regularly scheduled meeting of the shareholders of the publicly held
subsidiary that occurs more than 12 months after December 2, 1994. The
rule for stock-based compensation set forth in paragraph (f)(3) of this
section will apply for this purpose, except that the grant must occur
before the shareholder meeting specified in this paragraph (j)(2)(ii).
Taxpayers may choose to rely on the rule referred to in the first
sentence of this paragraph (j)(2)(ii) for the period prior to the
effective date of the rule.
(iii) Subsidiaries that become separate publicly held corporations.
Notwithstanding paragraph (j)(1) of this section, if a subsidiary of a
publicly held corporation becomes a separate publicly held corporation
as described in paragraph (f)(4)(i) of this section, then, for the
duration of the reliance period described in paragraph (f)(2) of this
section, the rules of paragraph (f)(1) of this section are treated as
applying (and the rules of paragraph (f)(4) of this section do not
apply) to remuneration paid to covered employees of that new publicly
held corporation pursuant to a plan or agreement that existed prior to
December 2, 1994, provided that the treatment of that remuneration as
performance-based is in accordance with a reasonable, good faith
interpretation of section 162(m). However, if remuneration is paid to
covered employees of that new publicly held corporation pursuant to a
plan or agreement that existed prior to December 2, 1994, but that
remuneration is not performance-based under a reasonable, good faith
interpretation of section 162(m), the rules of paragraph (f)(1) of this
section will be treated as applying only until the first regularly
scheduled meeting of shareholders that occurs more than 12 months after
December 2, 1994. The rules of paragraph (f)(4) of this section will
apply as of that first regularly scheduled meeting. The rule for stock-
based compensation set forth in paragraph (f)(3) of this section will
apply for purposes of this paragraph (j)(2)(iii), except that the grant
must occur before the shareholder meeting specified in the preceding
sentence if the remuneration is not performance-based under a
reasonable, good faith interpretation of section 162(m). Taxpayers may
choose to rely on the rules of paragraph (f)(4) of this section for the
period prior to the applicable effective date referred to in the first
or second sentence of this paragraph (j)(2)(iii).
(iv) Bonus pools. Notwithstanding paragraph (j)(1) of this section,
the rules in paragraph (e)(2)(iii)(A) that limit the sum of individual
percentages of a bonus pool to 100 percent will not apply to
remuneration paid before January 1, 2001, based on performance in any
performance period that began prior to December 20, 1995.
(v) Compensation based on a percentage of salary or base pay.
Notwithstanding paragraph (j)(1) of this section, the requirement in
paragraph (e)(4)(i) of this section that, in the case of certain
formulas based on a percentage of salary or base pay, a corporation
disclose to shareholders the maximum dollar
[[Page 227]]
amount of compensation that could be paid to the employee, will apply
only to plans approved by shareholders after April 30, 1995.
(vi) The modifications to paragraphs (e)(2)(vi)(A), (e)(2)(vii)
Example 9, and (e)(4)(iv) of this section concerning the maximum number
of shares with respect to which a stock option or stock appreciation
right that may be granted and the amount of compensation that may be
paid to any individual employee apply to compensation attributable to
stock options and stock appreciation rights that are granted on or after
June 24, 2011. The last two sentences of Sec. 1.162-27(f)(3) apply to
remuneration that is otherwise deductible resulting from a stock option,
stock appreciation right, restricted stock (or other property),
restricted stock unit, or any other form of equity-based remuneration
that is granted on or after April 1, 2015.
[T.D. 8650, 60 FR 65537, Dec. 20, 1995, as amended at 61 FR 4350, Feb.
6, 1996; T.D. 9716, 80 FR 16972, Mar. 31, 2015]
Sec. 1.162-28 Allocation of costs to lobbying activities.
(a) Introduction--(1) In general. Section 162(e)(1) denies a
deduction for certain amounts paid or incurred in connection with
activities described in section 162(e)(1) (A) and (D) (lobbying
activities). To determine the nondeductible amount, a taxpayer must
allocate costs to lobbying activities. This section describes costs that
must be allocated to lobbying activities and prescribes rules permitting
a taxpayer to use a reasonable method to allocate those costs. This
section does not apply to taxpayers subject to section 162(e)(5)(A). In
addition, this section does not apply for purposes of sections 4911 and
4945 and the regulations thereunder.
(2) Recordkeeping. For recordkeeping requirements, see section 6001
and the regulations thereunder.
(b) Reasonable method of allocating costs--(1) In general. A
taxpayer must use a reasonable method to allocate the costs described in
paragraph (c) of this section to lobbying activities. A method is not
reasonable unless it is applied consistently and is consistent with the
special rules in paragraph (g) of this section. Except as provided in
paragraph (b)(2) of this section, reasonable methods of allocating costs
to lobbying activities include (but are not limited to)--
(i) The ratio method described in paragraph (d) of this section;
(ii) The gross-up method described in paragraph (e) of this section;
and
(iii) A method that applies the principles of section 263A and the
regulations thereunder (see paragraph (f) of this section).
(2) Taxpayers not permitted to use certain methods. A taxpayer
(other than one subject to section 6033(e)) that does not pay or incur
reasonable labor costs for persons engaged in lobbying activities may
not use the gross-up method. For example, a partnership or sole
proprietorship in which the lobbying activities are performed by the
owners who do not receive a salary or guaranteed payment for services
does not pay or incur reasonable labor costs for persons engaged in
those activities and may not use the gross-up method.
(c) Costs allocable to lobbying activities--(1) In general. Costs
properly allocable to lobbying activities include labor costs and
general and administrative costs.
(2) Labor costs. For each taxable year, labor costs include costs
attributable to full-time, part-time, and contract employees. Labor
costs include all elements of compensation, such as basic compensation,
overtime pay, vacation pay, holiday pay, sick leave pay, payroll taxes,
pension costs, employee benefits, and payments to a supplemental
unemployment benefit plan.
(3) General and administrative costs. For each taxable year, general
and administrative costs include depreciation, rent, utilities,
insurance, maintenance costs, security costs, and other administrative
department costs (for example, payroll, personnel, and accounting).
(d) Ratio method--(1) In general. Under the ratio method described
in this paragraph (d), a taxpayer allocates to lobbying activities the
sum of its third-party costs (as defined in paragraph (d)(5) of this
section) allocable to lobbying activities and the costs determined by
using the following formula:
[[Page 228]]
[GRAPHIC] [TIFF OMITTED] TR21JY95.001
(2) Lobbying labor hours. Lobbying labor hours are the hours that a
taxpayer's personnel spend on lobbying activities during the taxable
year. A taxpayer may use any reasonable method to determine the number
of labor hours spent on lobbying activities and may use the de minimis
rule of paragraph (g)(1) of this section. A taxpayer may treat as zero
the lobbying labor hours of personnel engaged in secretarial, clerical,
support, and other administrative activities (as opposed to activities
involving significant judgment with respect to lobbying activities).
Thus, for example, the hours spent on lobbying activities by para-
professionals and analysts may not be treated as zero.
(3) Total labor hours. Total labor hours means the total number of
hours that a taxpayer's personnel spend on a taxpayer's trade or
business during the taxable year. A taxpayer may make reasonable
assumptions concerning total hours spent by personnel on the taxpayer's
trade or business. For example, it may be reasonable, based on all the
facts and circumstances, to assume that all full-time personnel spend
1,800 hours per year on a taxpayer's trade or business. If, under
paragraph (d)(2) of this section, a taxpayer treats as zero the lobbying
labor hours of personnel engaged in secretarial, clerical, support, and
other administrative activities, the taxpayer must also treat as zero
the total labor hours of all personnel engaged in those activities.
(4) Total costs of operations. A taxpayer's total costs of
operations means the total costs of the taxpayer's trade or business for
a taxable year, excluding third-party costs (as defined in paragraph
(d)(5) of this section).
(5) Third-party costs. Third-party costs are amounts paid or
incurred in whole or in part for lobbying activities conducted by third
parties (such as amounts paid to taxpayers subject to section
162(e)(5)(A) or dues or other similar amounts that are not deductible in
whole or in part under section 162(e)(3)) and amounts paid or incurred
for travel (including meals and lodging while away from home) and
entertainment relating in whole or in part to lobbying activities.
(6) Example. The provisions of this paragraph (d) are illustrated by
the following example.
Example. (i) In 1996, three full-time employees, A, B, and C, of
Taxpayer W engage in both lobbying activities and nonlobbying
activities. A spends 300 hours, B spends 1,700 hours, and C spends 1,000
hours on lobbying activities, for a total of 3,000 hours spent on
lobbying activities for W. W reasonably assumes that each of its three
employees spends 2,000 hours a year on W's business.
(ii) W's total costs of operations are $300,000. W has no third-
party costs.
(iii) Under the ratio method, X allocates $150,000 to its lobbying
activities for 1996, as follows:
[GRAPHIC] [TIFF OMITTED] TR21JY95.002
(e) Gross-up method--(1) In general. Under the gross-up method
described in this paragraph (e)(1), the taxpayer allocates to lobbying
activities the sum of its third-party costs (as defined in paragraph
(d)(5) of this section) allocable to lobbying activities and 175 percent
of its basic lobbying labor costs (as defined in paragraph (e)(3) of
this section) of all personnel.
(2) Alternative gross-up method. Under the alternative gross-up
method described in this paragraph (e)(2), the taxpayer allocates to
lobbying activities the sum of its third-party costs (as
[[Page 229]]
defined in paragraph (d)(5) of this section) allocable to lobbying
activities and 225 percent of its basic lobbying labor costs (as defined
in paragraph (e)(3)), excluding the costs of personnel who engage in
secretarial, clerical, support, and other administrative activities (as
opposed to activities involving significant judgment with respect to
lobbying activities).
(3) Basic lobbying labor costs. For purposes of this paragraph (e),
basic lobbying labor costs are the basic costs of lobbying labor hours
(as defined in paragraph (d)(2) of this section) determined for the
appropriate personnel. For purposes of this paragraph (e), basic costs
of lobbying labor hours are wages or other similar costs of labor,
including, for example, guaranteed payments for services. Basic costs do
not include pension, profit-sharing, employee benefits, and supplemental
unemployment benefit plan costs, or other similar costs.
(4) Example. The provisions of this paragraph (e) are illustrated by
the following example.
Example. (i) In 1996, three employees, A, B, and C, of Taxpayer X
engage in both lobbying activities and nonlobbying activities. A spends
300 hours, B spends 1,700 hours, and C spends 1,000 hours on lobbying
activities.
(ii) X has no third-party costs.
(iii) For purposes of the gross-up method, X determines that its
basic labor costs are $20 per hour for A, $30 per hour for B, and $25
per hour for C. Thus, its basic lobbying labor costs are
($20x300)+($30x1,700)+($25x1,000), or ($6,000+$51,000+$25,000), for
total basic lobbying labor costs for 1996 of $82,000.
(iv) Under the gross-up method, X allocates $143,500 to its lobbying
activities for 1996, as follows:
[GRAPHIC] [TIFF OMITTED] TR21JY95.003
(f) Section 263A cost allocation methods--(1) In general. A taxpayer
may allocate its costs to lobbying activities under the principles set
forth in section 263A and the regulations thereunder, except to the
extent inconsistent with paragraph (g) of this section. For this
purpose, lobbying activities are considered a service department or
function. Therefore, a taxpayer may allocate costs to lobbying
activities by applying the methods provided in Sec. Sec. 1.263A-1
through 1.263A-3. See Sec. 1.263A-1(e)(4), which describes service
costs generally; Sec. 1.263A-1(f), which sets forth cost allocation
methods available under section 263A; and Sec. 1.263A-1(g)(4), which
provides methods of allocating service costs.
(2) Example. The provisions of this paragraph (f) are illustrated by
the following example.
Example. (i) Three full-time employees, A, B, and C, work in the
Washington office of Taxpayer Y, a manufacturing concern. They each
engage in lobbying activities and nonlobbying activities. In 1996, A
spends 75 hours, B spends 1,750 hours, and C spends 2,000 hours on
lobbying activities. A's hours are not spent on direct contact lobbying
as defined in paragraph (g)(2) of this section. All three work 2,000
hours during 1996. The Washington office also employs one secretary, D,
who works exclusively for A, B, and C.
(ii) In addition, three departments in the corporate headquarters in
Chicago benefit the Washington office: Public affairs, human resources,
and insurance.
(iii) Y is subject to section 263A and uses the step-allocation
method to allocate its service costs. Prior to the amendments to section
162(e), the Washington office was treated as an overall management
function for purposes of section 263A. As such, its costs were fully
deductible and no further allocations were made under Y's step
allocation. Following the amendments to section 162(e), Y adopts its
263A step-allocation methodology to allocate costs to lobbying
activities. Y adds a lobbying department to its step-allocation program,
which results in an allocation of costs to the lobbying department from
both the Washington office and the Chicago office.
(iv) Y develops a labor ratio to allocate its Washington office
costs between the newly defined lobbying department and the overall
management department. To determine the hours allocable to lobbying
activities, Y uses
[[Page 230]]
the de minimis rule of paragraph (g)(1) of this section. Under this
rule, A's hours spent on lobbying activities are treated as zero because
less than 5 percent of A's time is spent on lobbying (75/2,000 = 3.75%).
In addition, because D works exclusively for personnel engaged in
lobbying activities, D's hours are not used to develop the allocation
ratio. Y assumes that D's allocation of time follows the average time of
all the personnel engaged in lobbying activities. Thus, Y's labor ratio
is determined as follows:
----------------------------------------------------------------------------------------------------------------
Departments
-----------------------------------------------
Employee Overall
Lobbying hours management Total hours
hours
----------------------------------------------------------------------------------------------------------------
A............................................................... 0 2,000 2,000
B............................................................... 1,750 250 2,000
C............................................................... 2,000 0 2,000
-----------------------------------------------
Totals.................................................... 3,750 2,250 6,000
----------------------------------------------------------------------------------------------------------------
[GRAPHIC] [TIFF OMITTED] TR21JY95.004
(v) In 1996, the Washington office has the following costs:
------------------------------------------------------------------------
Account Amount
------------------------------------------------------------------------
Professional Salaries and Benefits........................... $660,000
Clerical Salaries and Benefits............................... 50,000
Rent Expense................................................. 100,000
Depreciation on Furniture and Equip.......................... 40,000
Utilities.................................................... 15,000
Outside Payroll Service...................................... 5,000
Miscellaneous................................................ 10,000
Third-Party Lobbying (Law Firm).............................. 90,000
----------
Total Washington Costs................................. $970,000
------------------------------------------------------------------------
(vi) In addition, $233,800 of costs from the public affairs
department, $30,000 of costs from the insurance department, and $5,000
of costs from the human resources department are allocable to the
Washington office from departments in Chicago. Therefore, the Washington
office costs are allocated to the Lobbying and Overall Management
departments as follows:
Total Washington department costs from above............... $970,000
Plus Costs Allocated From Other Departments................ 268,800
Less third-party costs directly allocable to lobbying...... (90,000)
------------
Total Washington office costs........................ 1,148,800
------------------------------------------------------------------------
Overall
Lobbying management
department department
------------------------------------------------------------------------
Department Allocation Ratios.................. 62.5% 37.5%
x Washington Office Costs..................... $1,148,800 $1,148,800
= Costs Allocated to Departments.............. $718,000 $430,800
------------------------------------------------------------------------
(vii) Y's step-allocation for its Lobbying Department is determined
as follows:
------------------------------------------------------------------------
Lobbying
Y's step-allocation department
------------------------------------------------------------------------
Washington costs allocated to lobbying department........... $718,000
Plus third-party costs...................................... 90,000
-----------
Total costs of lobbying activities.................... 808,000
------------------------------------------------------------------------
(g) Special rules. The following rules apply to any reasonable
method of allocating costs to lobbying activities.
(1) De minimis rule for labor hours. Subject to the exception
provided in paragraph (g)(2) of this section, a taxpayer may treat time
spent by an individual on lobbying activities as zero if less than five
percent of the person's time is spent on lobbying activities. Reasonable
methods must be used to determine if less than five percent of a
person's time is spent on lobbying activities.
(2) Direct contact lobbying labor hours. Notwithstanding paragraph
(g)(1) of this section, a taxpayer must treat all hours spent by a
person on direct contact lobbying (as well as the hours that person
spends in connection with direct contact lobbying, including time spent
traveling that is allocable to the direct contact lobbying) as labor
hours allocable to lobbying activities. An activity is direct contact
lobbying if it is a meeting, telephone conversation, letter, or other
similar means of communication with a legislator (other than a local
legislator) or covered executive branch official (as defined in section
162(e)(6)) and otherwise qualifies as a lobbying activity. A person who
engages in research, preparation, and other background activities
related to
[[Page 231]]
direct contact lobbying but who does not make direct contact with a
legislator or covered executive branch official is not engaged in direct
contact lobbying.
(3) Taxpayer defined. For purposes of this section, a taxpayer
includes a tax-exempt organization subject to section 6033(e).
(h) Effective date. This section is effective for amounts paid or
incurred on or after July 21, 1995. Taxpayers must adopt a reasonable
interpretation of sections 162(e)(1)(A) and (D) for amounts paid or
incurred before this date.
[T.D. 8602, 60 FR 37573, July 21, 1995]
Sec. 1.162-29 Influencing legislation.
(a) Scope. This section provides rules for determining whether an
activity is influencing legislation for purposes of section
162(e)(1)(A). This section does not apply for purposes of sections 4911
and 4945 and the regulations thereunder.
(b) Definitions. For purposes of this section--
(1) Influencing legislation. Influencing legislation means--
(i) Any attempt to influence any legislation through a lobbying
communication; and
(ii) All activities, such as research, preparation, planning, and
coordination, including deciding whether to make a lobbying
communication, engaged in for a purpose of making or supporting a
lobbying communication, even if not yet made. See paragraph (c) of this
section for rules for determining the purposes for engaging in an
activity.
(2) Attempt to influence legislation. An attempt to influence any
legislation through a lobbying communication is making the lobbying
communication.
(3) Lobbying communication. A lobbying communication is any
communication (other than any communication compelled by subpoena, or
otherwise compelled by Federal or State law) with any member or employee
of a legislative body or any other government official or employee who
may participate in the formulation of the legislation that--
(i) Refers to specific legislation and reflects a view on that
legislation; or
(ii) Clarifies, amplifies, modifies, or provides support for views
reflected in a prior lobbying communication.
(4) Legislation. Legislation includes any action with respect to
Acts, bills, resolutions, or other similar items by a legislative body.
Legislation includes a proposed treaty required to be submitted by the
President to the Senate for its advice and consent from the time the
President's representative begins to negotiate its position with the
prospective parties to the proposed treaty.
(5) Specific legislation. Specific legislation includes a specific
legislative proposal that has not been introduced in a legislative body.
(6) Legislative bodies. Legislative bodies are Congress, state
legislatures, and other similar governing bodies, excluding local
councils (and similar governing bodies), and executive, judicial, or
administrative bodies. For this purpose, administrative bodies include
school boards, housing authorities, sewer and water districts, zoning
boards, and other similar Federal, State, or local special purpose
bodies, whether elective or appointive.
(7) Examples. The provisions of this paragraph (b) are illustrated
by the following examples.
Example 1. Taxpayer P's employee, A, is assigned to approach members
of Congress to gain their support for a pending bill. A drafts and P
prints a position letter on the bill. P distributes the letter to
members of Congress. Additionally, A personally contacts several members
of Congress or their staffs to seek support for P's position on the
bill. The letter and the personal contacts are lobbying communications.
Therefore, P is influencing legislation.
Example 2. Taxpayer R is invited to provide testimony at a
congressional oversight hearing concerning the implementation of The
Financial Institutions Reform, Recovery, and Enforcement Act of 1989.
Specifically, the hearing concerns a proposed regulation increasing the
threshold value of commercial and residential real estate transactions
for which an appraisal by a state licensed or certified appraiser is
required. In its testimony, R states that it is in favor of the proposed
regulation. Because R does not refer to any specific legislation or
reflect a view on any such legislation, R has not made a lobbying
communication. Therefore, R is not influencing legislation.
Example 3. State X enacts a statute that requires the licensing of
all day-care providers.
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Agency B in State X is charged with writing rules to implement the
statute. After the enactment of the statute, Taxpayer S sends a letter
to Agency B providing detailed proposed rules that S recommends Agency B
adopt to implement the statute on licensing of day-care providers.
Because the letter to Agency B neither refers to nor reflects a view on
any specific legislation, it is not a lobbying communication. Therefore,
S is not influencing legislation.
Example 4. Taxpayer T proposes to a State Park Authority that it
purchase a particular tract of land for a new park. Even if T's proposal
would necessarily require the State Park Authority eventually to seek
appropriations to acquire the land and develop the new park, T has not
made a lobbying communication because there has been no reference to,
nor any view reflected on, any specific legislation. Therefore, T's
proposal is not influencing legislation.
Example 5. (i) Taxpayer U prepares a paper that asserts that lack of
new capital is hurting State X's economy. The paper indicates that State
X residents either should invest more in local businesses or increase
their savings so that funds will be available to others interested in
making investments. U forwards a summary of the unpublished paper to
legislators in State X with a cover letter that states in part:
You must take action to improve the availability of new capital in
the state.
(ii) Because neither the summary nor the cover letter refers to any
specific legislative proposal and no other facts or circumstances
indicate that they refer to an existing legislative proposal, forwarding
the summary to legislators in State X is not a lobbying communication.
Therefore, U is not influencing legislation.
(iii) Q, a member of the legislature of State X, calls U to request
a copy of the unpublished paper from which the summary was prepared. U
forwards the paper with a cover letter that simply refers to the
enclosed materials. Because U's letter to Q and the unpublished paper do
not refer to any specific legislation or reflect a view on any such
legislation, the letter is not a lobbying communication. Therefore, U is
not influencing legislation.
Example 6. (i) Taxpayer V prepares a paper that asserts that lack of
new capital is hurting the national economy. The paper indicates that
lowering the capital gains rate would increase the availability of
capital and increase tax receipts from the capital gains tax. V forwards
the paper to its representatives in Congress with a cover letter that
says, in part:
I urge you to support a reduction in the capital gains tax rate.
(ii) V's communication is a lobbying communication because it refers
to and reflects a view on a specific legislative proposal (i.e.,
lowering the capital gains rate). Therefore, V is influencing
legislation.
Example 7. Taxpayer W, based in State A, notes in a letter to a
legislator of State A that State X has passed a bill that accomplishes a
stated purpose and then says that State A should pass such a bill. No
such bill has been introduced into the State A legislature. The
communication is a lobbying communication because it refers to and
reflects a view on a specific legislative proposal. Therefore, W is
influencing legislation.
Example 8. (i) Taxpayer Y represents citrus fruit growers. Y writes
a letter to a United States senator discussing how pesticide O has
benefited citrus fruit growers and disputing problems linked to its use.
The letter discusses a bill pending in Congress and states in part:
This bill would prohibit the use of pesticide O. If citrus growers
are unable to use this pesticide, their crop yields will be severely
reduced, leading to higher prices for consumers and lower profits, even
bankruptcy, for growers.
(ii) Y's views on the bill are reflected in this statement. Thus,
the communication is a lobbying communication, and Y is influencing
legislation.
Example 9. (i) B, the president of Taxpayer Z, an insurance company,
meets with Q, who chairs the X state legislature's committee with
jurisdiction over laws regulating insurance companies, to discuss the
possibility of legislation to address current problems with surplus-line
companies. B recommends that legislation be introduced that would create
minimum capital and surplus requirements for surplus-line companies and
create clearer guidelines concerning the risks that surplus-line
companies can insure. B's discussion with Q is a lobbying communication
because B refers to and reflects a view on a specific legislative
proposal. Therefore, Z is influencing legislation.
(ii) Q is not convinced that the market for surplus-line companies
is substantial enough to warrant such legislation and requests that B
provide information on the amount and types of risks covered by surplus-
line companies. After the meeting, B has employees of Z prepare
estimates of the percentage of property and casualty insurance risks
handled by surplus-line companies. B sends the estimates with a cover
letter that simply refers to the enclosed materials. Although B's
follow-up letter to Q does not refer to specific legislation or reflect
a view on such legislation, B's letter supports the views reflected in
the earlier communication. Therefore, the letter is a lobbying
communication and Z is influencing legislation.
(c) Purpose for engaging in an activity--(1) In general. The
purposes for engaging in an activity are determined
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based on all the facts and circumstances. Facts and circumstances
include, but are not limited to--
(i) Whether the activity and the lobbying communication are
proximate in time;
(ii) Whether the activity and the lobbying communication relate to
similar subject matter;
(iii) Whether the activity is performed at the request of, under the
direction of, or on behalf of a person making the lobbying
communication;
(iv) Whether the results of the activity are also used for a
nonlobbying purpose; and
(v) Whether, at the time the taxpayer engages in the activity, there
is specific legislation to which the activity relates.
(2) Multiple purposes. If a taxpayer engages in an activity both for
the purpose of making or supporting a lobbying communication and for
some nonlobbying purpose, the taxpayer must treat the activity as
engaged in partially for a lobbying purpose and partially for a
nonlobbying purpose. This division of the activity must result in a
reasonable allocation of costs to influencing legislation. See Sec.
1.162-28 (allocation rules for certain expenditures to which section
162(e)(1) applies). A taxpayer's treatment of these multiple-purpose
activities will, in general, not result in a reasonable allocation if it
allocates to influencing legislation--
(i) Only the incremental amount of costs that would not have been
incurred but for the lobbying purpose; or
(ii) An amount based solely on the number of purposes for engaging
in that activity without regard to the relative importance of those
purposes.
(3) Activities treated as having no purpose to influence
legislation. A taxpayer that engages in any of the following activities
is treated as having done so without a purpose of making or supporting a
lobbying communication--
(i) Before evidencing a purpose to influence any specific
legislation referred to in paragraph (c)(3)(i)(A) or (B) of this section
(or similar legislation)--
(A) Determining the existence or procedural status of specific
legislation, or the time, place, and subject of any hearing to be held
by a legislative body with respect to specific legislation; or
(B) Preparing routine, brief summaries of the provisions of specific
legislation;
(ii) Performing an activity for purposes of complying with the
requirements of any law (for example, satisfying state or federal
securities law filing requirements);
(iii) Reading any publications available to the general public or
viewing or listening to other mass media communications; and
(iv) Merely attending a widely attended speech.
(4) Examples. The provisions of this paragraph (c) are illustrated
by the following examples.
Example 1. (i) Facts. In 1997, Agency F issues proposed regulations
relating to the business of Taxpayer W. There is no specific legislation
during 1997 that is similar to the regulatory proposal. W undertakes a
study of the impact of the proposed regulations on its business. W
incorporates the results of that study in comments sent to Agency F in
1997. In 1998, legislation is introduced in Congress that is similar to
the regulatory proposal. Also in 1998, W writes a letter to Senator P
stating that it opposes the proposed legislation. W encloses with the
letter a copy of the comments it sent to Agency F.
(ii) Analysis. W's letter to Senator P refers to and reflects a view
on specific legislation and therefore is a lobbying communication.
Although W's study of the impact of the proposed regulations is
proximate in time and similar in subject matter to its lobbying
communication, W performed the study and incorporated the results in
comments sent to Agency F when no legislation with a similar subject
matter was pending (a nonlobbying use). On these facts, W engaged in the
study solely for a nonlobbying purpose.
Example 2. (i) Facts. The governor of State Q proposes a budget that
includes a proposed sales tax on electricity. Using its records of
electricity consumption, Taxpayer Y estimates the additional costs that
the budget proposal would impose upon its business. In the same year, Y
writes to members of the state legislature and explains that it opposes
the proposed sales tax. In its letter, Y includes its estimate of the
costs that the sales tax would impose on its business. Y does not
demonstrate any other use of its estimates.
(ii) Analysis. The letter is a lobbying communication (because it
refers to and reflects a view on specific legislation, the governor's
proposed budget). Y's estimate of additional costs under the proposal
supports the lobbying communication, is proximate in time and similar in
subject matter to a specific legislative proposal then in existence, and
is not used for a nonlobbying purpose. Based on
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these facts, Y estimated its additional costs under the budget proposal
solely to support the lobbying communication.
Example 3. (i) Facts. A senator in the State Q legislature announces
her intention to introduce legislation to require health insurers to
cover a particular medical procedure in all policies sold in the state.
Taxpayer Y has different policies for two groups of employees, one of
which covers the procedure and one of which does not. After the bill is
introduced, Y's legislative affairs staff asks Y's human resources staff
to estimate the additional cost to cover the procedure for both groups
of employees. Y's human resources staff prepares a study estimating Y's
increased costs and forwards it to the legislative affairs staff. Y's
legislative staff then writes to members of the state legislature and
explains that it opposes the proposed change in insurance coverage based
on the study. Y's legislative affairs staff thereafter forwards the
study, prepared for its use in opposing the statutory proposal, to its
labor relations staff for use in negotiations with employees scheduled
to begin later in the year.
(ii) Analysis. The letter to legislators is a lobbying communication
(because it refers to and reflects a view on specific legislation). The
activity of estimating Y's additional costs under the proposed
legislation relates to the same subject as the lobbying communication,
occurs close in time to the lobbying communication, is conducted at the
request of a person making a lobbying communication, and relates to
specific legislation then in existence. Although Y used the study in its
labor negotiations, mere use for that purpose does not establish that Y
estimated its additional costs under the proposed legislation in part
for a nonlobbying purpose. Thus, based on all the facts and
circumstances, Y estimated the additional costs it would incur under the
proposal solely to make or support the lobbying communication.
Example 4. (i) Facts. After several years of developmental work
under various contracts, in 1996, Taxpayer A contracts with the
Department of Defense (DOD) to produce a prototype of a new generation
military aircraft. A is aware that DOD will be able to fund the contract
only if Congress appropriates an amount for that purpose in the upcoming
appropriations process. In 1997, A conducts simulation tests of the
aircraft and revises the specifications of the aircraft's expected
performance capabilities, as required under the contract. A submits the
results of the tests and the revised specifications to DOD. In 1998,
Congress considers legislation to appropriate funds for the contract. In
that connection, A summarizes the results of the simulation tests and of
the aircraft's expected performance capabilities, and submits the
summary to interested members of Congress with a cover letter that
encourages them to support appropriations of funds for the contract.
(ii) Analysis. The letter is a lobbying communication (because it
refers to specific legislation (i.e., appropriations) and requests
passage). The described activities in 1996, 1997, and 1998 relate to the
same subject as the lobbying communication. The summary was prepared
specifically for, and close in time to, that communication. Based on
these facts, the summary was prepared solely for a lobbying purpose. In
contrast, A conducted the tests and revised the specifications to comply
with its production contract with DOD. A conducted the tests and revised
the specifications solely for a nonlobbying purpose.
Example 5. (i) Facts. C, president of Taxpayer W, travels to the
state capital to attend a two-day conference on new manufacturing
processes. C plans to spend a third day in the capital meeting with
state legislators to explain why W opposes a pending bill unrelated to
the subject of the conference. At the meetings with the legislators, C
makes lobbying communications by referring to and reflecting a view on
the pending bill.
(ii) Analysis. C's traveling expenses (transportation and meals and
lodging) are partially for the purpose of making or supporting the
lobbying communications and partially for a nonlobbying purpose. As a
result, under paragraph (c)(2) of this section, W must reasonably
allocate C's traveling expenses between these two purposes. Allocating
to influencing legislation only C's incremental transportation expenses
(i.e., the taxi fare to meet with the state legislators) does not result
in a reasonable allocation of traveling expenses.
Example 6. (i) Facts. On February 1, 1997, a bill is introduced in
Congress that would affect Company E. Employees in E's legislative
affairs department, as is customary, prepare a brief summary of the bill
and periodically confirm the procedural status of the bill through
conversations with employees and members of Congress. On March 31, 1997,
the head of E's legislative affairs department meets with E's President
to request that B, a chemist, temporarily help the legislative affairs
department analyze the bill. The President agrees, and suggests that B
also be assigned to draft a position letter in opposition to the bill.
Employees of the legislative affairs department continue to confirm
periodically the procedural status of the bill. On October 31, 1997, B's
position letter in opposition to the bill is delivered to members of
Congress.
(ii) Analysis. B's letter is a lobbying communication because it
refers to and reflects a view on specific legislation. Under paragraph
(c)(3)(i) of this section, the assignment
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of B to assist the legislative affairs department in analyzing the bill
and in drafting a position letter in opposition to the bill evidences a
purpose to influence legislation. Neither the activity of periodically
confirming the procedural status of the bill nor the activity of
preparing the routine, brief summary of the bill before March 31
constitutes influencing legislation. In contrast, periodically
confirming the procedural status of the bill on or after March 31
relates to the same subject as, and is close in time to, the lobbying
communication and is used for no nonlobbying purpose. Consequently,
after March 31, E determined the procedural status of the bill for the
purpose of supporting the lobbying communication by B.
(d) Lobbying communication made by another. If a taxpayer engages in
activities for a purpose of supporting a lobbying communication to be
made by another person (or by a group of persons), the taxpayer's
activities are treated under paragraph (b) of this section as
influencing legislation. For example, if a taxpayer or an employee of
the taxpayer (as a volunteer or otherwise) engages in an activity to
assist a trade association in preparing its lobbying communication, the
taxpayer's activities are influencing legislation even if the lobbying
communication is made by the trade association and not the taxpayer. If,
however, the taxpayer's employee, acting outside the employee's scope of
employment, volunteers to engage in those activities, then the taxpayer
is not influencing legislation.
(e) No lobbying communication. Paragraph (e) of this section applies
if a taxpayer engages in an activity for a purpose of making or
supporting a lobbying communication, but no lobbying communication that
the activity supports has yet been made.
(1) Before the filing date. Under this paragraph (e)(1), if on the
filing date of the return for any taxable year the taxpayer no longer
expects, under any reasonably foreseeable circumstances, that a lobbying
communication will be made that is supported by the activity, then the
taxpayer will be treated as if it did not engage in the activity for a
purpose of making or supporting a lobbying communication. Thus, the
taxpayer need not treat any amount allocated to that activity for that
year under Sec. 1.162-28 as an amount to which section 162(e)(1)(A)
applies. The filing date for purposes of paragraph (e) of this section
is the earlier of the time the taxpayer files its timely return for the
year or the due date of the timely return.
(2) After the filing date--(i) In general. If, at any time after the
filing date, the taxpayer no longer expects, under any reasonably
foreseeable circumstances, that a lobbying communication will be made
that is supported by the activity, then any amount previously allocated
under Sec. 1.162-28 to the activity and disallowed under section
162(e)(1)(A) is treated as an amount that is not subject to section
162(e)(1)(A) and that is paid or incurred only at the time the taxpayer
no longer expects that a lobbying communication will be made.
(ii) Special rule for certain tax-exempt organizations. For a tax-
exempt organization subject to section 6033(e), the amounts described in
paragraph (e)(2)(i) of this section are treated as reducing (but not
below zero) its expenditures to which section 162(e)(1) applies
beginning with that year and continuing for subsequent years to the
extent not treated in prior years as reducing those expenditures.
(f) Anti-avoidance rule. If a taxpayer, alone or with others,
structures its activities with a principal purpose of achieving results
that are unreasonable in light of the purposes of section 162(e)(1)(A)
and section 6033(e), the Commissioner can recast the taxpayer's
activities for federal tax purposes as appropriate to achieve tax
results that are consistent with the intent of section 162(e)(1)(A),
section 6033(e) (if applicable), and this section, and the pertinent
facts and circumstances.
(g) Taxpayer defined. For purposes of this section, a taxpayer
includes a tax-exempt organization subject to section 6033(e).
(h) Effective date. This section is effective for amounts paid or
incurred on or after July 21, 1995. Taxpayers must adopt a reasonable
interpretation of section 162(e)(1)(A) for amounts paid or incurred
before this date.
[T.D. 8602, 60 FR 37575, July 21, 1995]
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Sec. 1.162-31 The $500,000 deduction limitation for remuneration
provided by certain health insurance providers.
(a) Scope. This section sets forth rules regarding the deduction
limitation under section 162(m)(6), which provides that a covered health
insurance provider's deduction for applicable individual remuneration
(AIR) and deferred deduction remuneration (DDR) attributable to services
performed by an applicable individual in a disqualified taxable year is
limited to $500,000. Paragraph (b) of this section sets forth
definitions of the terms used in this section. Paragraph (c) of this
section explains the general limitation on deductions under section
162(m)(6). Paragraph (d) of this section sets forth the methods that
must be used to attribute AIR and DDR to services performed in one or
more taxable years of a covered health insurance provider. Paragraph (e)
of this section sets forth rules on how the deduction limit applies to
AIR and DDR that is otherwise deductible under chapter 1 of the Internal
Revenue Code (Code) but for the deduction limitation under section
162(m)(6) (referred to in this section as remuneration that is otherwise
deductible). Paragraph (f) of this section sets forth additional rules
for persons participating in certain corporate transactions. Paragraph
(g) of this section explains the interaction of section 162(m)(6) with
sections 162(m)(1) and 280G. Paragraph (h) of this section sets forth
rules for determining the amounts of remuneration that are not subject
to the deduction limitation under section 162(m)(6) due to the statutory
effective date (referred to in this section as grandfathered amounts).
Paragraph (i) of this section sets forth transition rules for DDR that
is attributable to services performed in taxable years beginning after
December 31, 2009 and before January 1, 2013. Paragraph (j) of this
section sets forth the effective and applicability dates of the rules in
this section.
(b) Definitions--(1) Health insurance issuer. For purposes of this
section, a health insurance issuer is a health insurance issuer as
defined in section 9832(b)(2).
(2) Aggregated group. For purposes of this section, an aggregated
group is a health insurance issuer and each other person that is treated
as a single employer with the health insurance issuer at any time during
the taxable year of the health insurance issuer under sections 414(b)
(controlled groups of corporations), 414(c) (partnerships,
proprietorships, etc. under common control), 414(m) (affiliated service
groups), or 414(o), except that the rules in section 1563(a)(2) and (3)
(with respect to corporations) and Sec. 1.414(c)-2(c) and (d) (with
respect to trades or businesses under common control) for brother-sister
groups and combined groups are disregarded.
(3) Parent entity--(i) In general. For purposes of this section, a
parent entity is either--
(A) The common parent of a parent-subsidiary controlled group of
corporations (within the meaning of section 414(b)) or a parent-
subsidiary group of trades or businesses under common control (within
the meaning of section 414(c)) that includes a health insurance issuer,
or
(B) the health insurance issuer in an aggregated group that is an
affiliated service group (within the meaning of section 414(m)) or a
group described in section 414(o).
(ii) Certain aggregated groups with multiple health insurance
issuers--(A) In general. If two or more health insurance issuers are
members of an aggregated group that is an affiliated service group
(within the meaning of section 414(m)) or group described in section
414(o), the parent entity is the health insurance issuer in the
aggregated group that is designated in writing by the other members of
the aggregated group to act as the parent entity.
(B) Successor parent entities. If a health insurance issuer that is
the parent entity of an aggregated group pursuant to paragraph
(b)(3)(ii)(A) of this section (a predecessor parent entity) ceases to be
a member of the aggregated group (for example, as a result of a
corporate transaction) and, after the predecessor parent entity ceases
to be a member of the aggregated group, two or more health insurance
issuers are members of the aggregated group, the
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new parent entity (the successor parent entity) is another member of the
aggregated group designated in writing by the remaining members of the
aggregated group. The successor parent entity must be a health insurance
issuer in the aggregated group that has the same taxable year as the
predecessor parent entity; provided, however, that if no health
insurance issuer in the aggregated group has the same taxable year as
the predecessor parent entity, the members of the aggregated group may
designate in writing any other health insurance issuer in the aggregated
group to be the parent entity.
(C) Failure to designate a parent entity. If the members of an
aggregated group that includes two or more health insurance issuers and
that is an affiliated service group (within the meaning of section
414(m)) or a group described in section 414(o) fail to designate in
writing a health insurance issuer to act as the parent entity of the
aggregated group, the parent entity of the aggregated group for all
taxable years is deemed to be an entity with a taxable year that is the
calendar year (without regard to whether the aggregated group includes
or has ever included an entity with a calendar year taxable year) for
all purposes under this section for which a parent entity's taxable year
is relevant.
(4) Covered health insurance provider--(i) In general. For purposes
of this section and except as otherwise provided in this paragraph
(b)(4), a covered health insurance provider is--
(A) A health insurance issuer for any of its taxable years beginning
after December 31, 2012 in which at least 25 percent of the gross
premiums it receives from providing health insurance coverage (as
defined in section 9832(b)(1)) are from providing minimum essential
coverage (as defined in section 5000A(f)),
(B) a health insurance issuer for any of its taxable years beginning
after December 31, 2009 and before January 1, 2013 in which it receives
premiums from providing health insurance coverage (as defined in section
9832(b)(1)),
(C) the parent entity of an aggregated group of which one or more
health insurance issuers described in paragraphs (b)(4)(i)(A) or (B) of
this section are members for the taxable year of the parent entity with
which, or in which, ends the taxable year of any such health insurance
issuer; however, if the parent entity of an aggregated group is a health
insurance issuer described in paragraphs (b)(4)(i)(A) or (B) of this
section, that health insurance issuer is a covered health insurance
provider for any taxable year that it is otherwise a covered health
insurance provider, without regard to whether the taxable year of any
other health insurance issuer described in paragraphs (b)(4)(i)(A) or
(B) of this section ends with or within its taxable year, and
(D) each other member of an aggregated group of which one or more
health insurance issuers described in paragraphs (b)(4)(i)(A) or (B) of
this section are members for the taxable year of the other member ending
with, or within, the parent entity's taxable year.
(ii) Parent entities with short taxable years. If for any reason a
parent entity has a taxable year that is less than 12 months (for
example, because the taxable year of a predecessor parent entity ends
when it ceases to be a member of an aggregated group), then, for
purposes of determining whether the parent entity and each other member
of the aggregated group is a covered health insurance provider with
respect to the parent entity's short taxable year (that is, for purposes
of determining whether the taxable year of a health insurance issuer
described in paragraph (b)(4)(i)(A) or (B) of this section ends with or
within the short taxable year of the parent entity and for purposes of
determining whether another member of the aggregated group has a taxable
year ending with or within the short taxable year of the parent entity),
the taxable year of the parent entity is treated as the 12-month period
ending on the last day of the short taxable year. Accordingly, a parent
entity is a covered health insurance provider for its short taxable year
if it is a health insurance issuer described in paragraph (b)(4)(i)(A)
or (B) of this section or if the taxable year of a health insurance
issuer described in paragraph (b)(4)(i)(A) or (B) of this section in an
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aggregated group with the parent entity ends with or within the 12-month
period ending on the last day of the parent entity's short taxable year.
Similarly, each other member of the parent entity's aggregated group is
a covered health insurance provider for its taxable year ending with or
within the 12-month period ending on the last day of the parent entity's
short taxable year.
(iii) Predecessor and successor parent entities. If the parent
entity of an aggregated group changes, the members of the aggregated
group may be covered health insurance providers based on their
relationship to either or both parent entities with respect to the
taxable years of the parent entities in which the change occurs.
(iv) Self-insured plans. For purposes of this section, a person is
not a covered health insurance provider solely because it maintains a
self-insured medical reimbursement plan. For this purpose, a self-
insured medical reimbursement plan is a separate written plan for the
benefit of employees (including former employees) that provides for
reimbursement of medical expenses referred to in section 105(b) and does
not provide for reimbursement under an individual or group policy of
accident or health insurance issued by a licensed insurance company or
under an arrangement in the nature of a prepaid health care plan that is
regulated under federal or state law in a manner similar to the
regulation of insurance companies, and may include a plan maintained by
an employee organization described in section 501(c)(9).
(v) De minimis exception--(A) In general. A health insurance issuer
and any member of its aggregated group that would otherwise be a covered
health insurance provider under paragraph (b)(4)(i), (ii), or (iii) of
this section for a taxable year beginning after December 31, 2012 is not
a covered health insurance provider under this section for that taxable
year if the premiums received by the health insurance issuer and any
other health insurance issuers in its aggregated group from providing
health insurance coverage (as defined in section 9832(b)(1)) that
constitutes minimum essential coverage (as defined in section 5000A(f))
are less than two percent of the gross revenues of the health insurance
issuer and all other members of its aggregated group for that taxable
year. A health insurance issuer and any member of its aggregated group
that would otherwise be a covered health insurance provider under
paragraph (b)(4)(i), (ii), or (iii) of this section for a taxable year
beginning after December 31, 2009 and before January 1, 2013 is not a
covered health insurance provider for purposes of this section for that
taxable year if the premiums received by the health insurance issuer and
any other health insurance issuers in its aggregated group from
providing health insurance coverage (as defined in section 9832(b)(1))
are less than two percent of the gross revenues of the health insurance
issuer and all other members of its aggregated group for that taxable
year. In determining whether premiums constitute less than two percent
of gross revenues, the amount of gross revenues must be determined in
accordance with generally accepted accounting principles. For the
definition of the term premiums, see paragraph (b)(5) of this section. A
person that would be a covered health insurance provider for a taxable
year in an aggregated group with a predecessor parent entity and that
would also be a covered health insurance provider for that taxable year
in an aggregated group with a successor parent entity is not a covered
health insurance provider under the de minimis exception only if the
aggregated groups of which the person is a member meet the requirements
of the de minimis exception based on both the taxable year of the
predecessor parent entity and the taxable year of the successor parent
entity.
(B) One-year de minimis exception transition period. If a health
insurance issuer or a member of an aggregated group is not a covered
health insurance provider for a taxable year solely by reason of the de
minimis exception described in paragraph (b)(4)(v)(A) of this section,
but fails to meet the requirements of the de minimis exception described
in paragraph (b)(4)(v)(A) of this section for the immediately following
taxable year, that health insurance issuer or member of an aggregated
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group will not be a covered health insurance provider for that
immediately following taxable year.
(vi) Examples. The following examples illustrate the principles of
this paragraph (b)(4). For purposes of these examples, each corporation
has a taxable year that is the calendar year, unless the example
provides otherwise.
Example 1. (i) Corporations Y and Z are members of an aggregated
group under paragraph (b)(2) of this section. Y is a health insurance
issuer that is a covered health insurance provider pursuant to paragraph
(b)(4)(i)(A) of this section and receives premiums from providing health
insurance coverage that is minimum essential coverage during its 2015
taxable year in an amount that is less than two percent of the combined
gross revenues of Y and Z for their 2015 taxable years. Z is not a
health insurance issuer.
(ii) Y and Z are not covered health insurance providers under
paragraph (b)(4) of this section for their 2015 taxable years because
they meet the requirements of the de minimis exception under paragraph
(b)(4)(v)(A) of this section.
Example 2. (i) Corporations V, W, and X are members of an aggregated
group under paragraph (b)(2) of this section. V is a health insurance
issuer that is a covered health insurance provider pursuant to paragraph
(b)(4)(i)(A) of this section, but neither W nor X is a health insurance
issuer. W is the parent entity of the aggregated group. V's taxable year
ends on December 31, W's taxable year ends on June 30, and X's taxable
year ends on September 30. For its taxable year ending December 31,
2016, V receives $3x of premiums from providing minimum essential
coverage and has no other revenue. For its taxable year ending June 30,
2017, W has $100x in gross revenue. For its taxable year ending
September 30, 2016, X has $60x in gross revenue.
(ii) But for the de minimis exception, V (the health insurance
issuer) would be a covered health insurance provider for its taxable
year ending December 31, 2016; W (the parent entity) would be a covered
health insurance provider for its taxable year ending June 30, 2017 (its
taxable year with which, or within which, ends the taxable year of the
health insurance issuer); and X (the other member of the aggregated
group) would be a covered health insurance provider for its taxable year
ending on September 30, 2016 (its taxable year ending with, or within,
the taxable year of the parent entity). However, the premiums received
by V (the health insurance issuer) from providing minimum essential
coverage during the taxable year that it would otherwise be a covered
health insurance provider under paragraph (b)(4)(i)(A) of this section
are less than two percent of the combined gross revenues of V, W, and X
for the related taxable years that they would otherwise be covered
health insurance providers under paragraph (b)(4)(i) of this section
($3x is less than $3.26x (two percent of $163x)). Therefore, the de
minimis exception of paragraph (b)(4)(v)(A) of this section applies, and
V, W, and X are not covered health insurance providers for these taxable
years.
Example 3. (i) The facts are the same as Example 2, except that V
receives $4x of premiums for providing minimum essential coverage for
its taxable year ending December 31, 2016. In addition, the members of
the VWX aggregated group were not covered health insurance providers for
their taxable years ending December 31, 2015, June 30, 2016, and
September 30, 2015, respectively (their immediately preceding taxable
years) solely by reason of the de minimis exception of paragraph
(b)(4)(v)(A) of this section.
(ii) Although the premiums received by the members of the aggregated
group from providing minimum essential coverage are more than two
percent of the gross revenues of the aggregated group for the taxable
years during which the members would otherwise be treated as covered
health insurance providers under paragraph (b)(4)(i) of this section
($4x is greater than $3.28x (two percent of $164x)), they were not
covered health insurance providers for their immediately preceding
taxable years solely because of the de minimis exception of paragraph
(b)(4)(v)(A) of this section. Therefore, V, W, and X are not covered
health insurance providers for their taxable years ending on December
31, 2016, June 30, 2017, and September 30, 2016, respectively, because
of the one-year transition period under paragraph (b)(4)(v)(B) of this
section. However, the members of the VWX aggregated group will be
covered health insurance providers for their subsequent taxable years if
they would otherwise be covered health insurance providers for those
taxable years under paragraph (b)(4) of this section.
Example 4. (i) Corporations W, X, Y, and Z are members of a
controlled group described in section 414(b)) that is an aggregated
group under paragraph (b)(2) of this section. W and X are health
insurance issuers. Y and Z are not health insurance issuers. W is the
parent entity of the aggregated group. W's and Y's taxable years end on
December 31; X's taxable year ends on March 31; and Z's taxable year
ends on June 30. As a result of a corporate transaction, W is no longer
a member of the WXYZ aggregated group as of September 30, 2016, and W's
taxable year ends on that date. Following the corporate transaction, X
becomes the parent entity of the XYZ aggregated group.
(ii) Because W's taxable year is treated as the 12-month period
ending on September 30,
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2016, W is the parent entity for X's taxable year ending March 31, 2016,
Z's taxable year ending June 30, 2016, and Y's taxable year ending
December 31, 2015. Because X's taxable year begins on April 1, 2016 and
ends on March 31, 2017, for purposes of paragraph (b)(4) of this
section, X is the parent entity for Z's taxable year ending June 30,
2016, Y's taxable year ending December 31, 2016, and W's taxable year
ending September 30, 2016.
Example 5. (i) The facts are the same as Example 4. In addition, W
receives $4x of premiums for providing minimum essential coverage and no
other revenue for its taxable year beginning January 1, 2016 and ending
September 30, 2016. X receives $2x of premiums for providing minimum
essential coverage and has no other revenue for its taxable year ending
March 31, 2016. X receives $1x of premiums for providing minimum
essential coverage and no other revenue for its taxable year ending
March 31, 2017. For its taxable year ending December 31, 2015, Y has
$100x in gross revenue. For its taxable year ending December 31, 2016, Y
has $200x in gross revenue. For its taxable year ending June 30, 2016, Z
has $120x in gross revenue (none of which constitute premiums for
providing health insurance coverage that constitutes minimum essential
coverage (as defined in section 5000A(f)). W, X, Y, and Z did not
qualify for the de minimis exception in any prior taxable years.
(ii) For its taxable year ending June 30, 2016, Z does not meet the
requirements for the de minimis exception described in paragraph
(b)(4)(v)(A). Even though Z meets the requirements for the de minimis
exception with respect to the taxable year of parent entity X ending
March 31, 2017 ($5x is less than two percent of $325x), Z does not meet
the requirements for the de minimis exception based on the premiums and
gross revenues of the taxable years of its aggregated group members
ending with or within the deemed 12-month taxable year of parent entity
W ending September 30, 2016 ($6x is more than two percent of $226x).
Therefore, Z is a covered health insurance provider for its June 30,
2016 taxable year.
(iii) For its taxable year ending December 31, 2015, Y does not meet
the requirements for the de minimis exception described in paragraph
(b)(4)(v)(A) ($6x is more than two percent of $226x). For its taxable
year ending December 31, 2016, Y meets the requirements for the de
minimis exception described in paragraph (b)(4)(v)(A) ($5x is less than
two percent of $325x). Therefore, Y is a covered health insurance
provider for its December 31, 2015 taxable year, but is not a covered
health insurance provider for its December 31, 2016 taxable year.
(iv) For its taxable year ending September 30, 2016, W does not meet
the requirements for the de minimis exception described in paragraph
(b)(4)(v)(A). Even though W meets the requirements for the de minimis
exception with respect to X's taxable year ending March 31, 2017 ($5x is
less than two percent of $325x), W does not meet the requirements for
the de minimis exception with respect its taxable year ending September
30, 2016 ($6x is more than two percent of $226x). Therefore, W is a
covered health insurance provider for its September 30, 2016 taxable
year.
(v) For its taxable year ending March 31, 2016, X does not meet the
requirements for the de minimis exception ($6x is more than two percent
of $226x). For its taxable year ending March, 31 2017, X meets the
requirements for the de minimis exception ($5x is less than two percent
of $325x). Therefore, X is a covered health insurance provider for its
March 31, 2016 taxable year, but is not a covered health insurance
provider for its March 31, 2017 taxable year.
(5) Premiums--(i) For purposes of this section, the term premiums
means premiums written (including premiums written for assumption
reinsurance, but reduced by assumption reinsurance ceded (as described
in paragraph (b)(5)(ii) of this section), excluding indemnity
reinsurance written (as described in paragraph (b)(5)(iii) of this
section) and direct service payments (as described in paragraph
(b)(5)(iv) of this section), but without reduction for ceding
commissions or medical loss ratio rebates, determined in a manner
consistent with the requirements for reporting under the Supplemental
Health Care Exhibit published by the National Association of Insurance
Commissioners or the MLR Annual Reporting Form filed with the Center for
Medicare & Medicaid Services' Center for Consumer Information and
Insurance Oversight of the U.S. Department of Health and Human Services
(or any successor or replacement exhibits or forms).
(ii) Assumption reinsurance. For purposes of this paragraph (b)(5),
the term assumption reinsurance means reinsurance for which there is a
novation and the reinsurer takes over the entire risk of loss pursuant
to a new contract.
(iii) Indemnity reinsurance. For purposes of this paragraph (b)(5),
the term indemnity reinsurance means reinsurance provided pursuant to an
agreement between a health insurance issuer and a reinsuring company
under which the reinsuring company agrees to indemnify the health
insurance issuer for all or part of the risk of loss under
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policies specified in the agreement, and the health insurance issuer
retains its liability to provide health insurance coverage (as defined
in section 9832(b)(1)) to, and its contractual relationship with, the
insured.
(iv) Direct service payments. For purposes of this paragraph (b)(5),
the term direct service payment means a capitated, prepaid, periodic, or
other payment made by a health insurance issuer or another entity that
receives premiums from providing health insurance coverage (as defined
in section 9832(b)(1)) to another organization as compensation for
providing, managing, or arranging for the provision of healthcare
services by physicians, hospitals, or other healthcare providers,
regardless of whether the organization that receives the compensation is
subject to healthcare provider, health insurance, health plan licensing,
financial solvency, or other similar regulatory requirements under state
insurance law.
(6) Disqualified taxable year. For purposes of this section, the
term disqualified taxable year means, with respect to any person, any
taxable year for which the person is a covered health insurance
provider.
(7) Applicable individual--(i) In general. For purposes of this
section, except as provided in paragraph (b)(7)(ii) of this section, the
term applicable individual means, with respect to any covered health
insurance provider for any disqualified taxable year, any individual (or
any other person described in guidance of general applicability
published in the Internal Revenue Bulletin)--
(A) who is an officer, director, or employee in that taxable year,
or
(B) who provides services for or on behalf of the covered health
insurance provider during that taxable year.
(ii) Independent contractors--Remuneration for services performed by
an independent contractor for a covered health insurance provider is
subject to the deduction limitation under section 162(m)(6). However, an
independent contractor is not an applicable individual with respect to a
covered health insurance provider for a disqualified taxable year if
each of the following requirements is satisfied:
(A) The independent contractor is actively engaged in the trade or
business of providing services to recipients, other than as an employee
or as a member of the board of directors of a corporation (or similar
position with respect to an entity that is not a corporation);
(B) The independent contractor provides significant services (as
defined in Sec. 1.409A-1(f)(2)(iii)) to two or more persons to which
the independent contractor is not related and that are not related to
one another (as defined in Sec. 1.409A-1(f)(2)(ii)); and
(C) The independent contractor is not related to the covered health
insurance provider or any member of its aggregated group, applying the
definition of related person contained in Sec. 1.409A-1(f)(2)(ii),
subject to the modification that for purposes of applying the references
to sections 267(b) and 707(b)(1), the language ``20 percent'' is not
used instead of ``50 percent'' each place ``50 percent'' appears in
sections 267(b) and 707(b)(1).
(8) Service provider. For purposes of this section, the term service
provider means, with respect to a covered health insurance provider for
any period, an individual who is an officer, director, or employee, or
who provides services for, or on behalf of, the covered health insurance
provider or any member of its aggregated group.
(9) Remuneration--(i) In general. For purposes of this section,
except as provided in paragraph (b)(9)(ii) of this section, the term
remuneration has the same meaning as the term applicable employee
remuneration, as defined in section 162(m)(4), but without regard to the
exceptions under section 162(m)(4)(B) (remuneration payable on a
commission basis), section 162(m)(4)(C) (performance-based
compensation), and section 162(m)(4)(D) (existing binding contracts),
and the regulations under those sections.
(ii) Exceptions. For purposes of this section, remuneration does not
include--
(A) A payment made to, or for the benefit of, an applicable
individual from or to a trust described in section 401(a) within the
meaning of section 3121(a)(5)(A),
[[Page 242]]
(B) A payment made under an annuity plan described in section 403(a)
within the meaning of section 3121(a)(5)(B),
(C) A payment made under a simplified employee pension plan
described in section 408(k)(1) within the meaning of section
3121(a)(5)(C),
(D) A payment made under an annuity contract described in section
403(b) within the meaning of section 3121(a)(5)(D),
(E) Salary reduction contributions described in section 3121(v)(1),
and
(F) Remuneration consisting of any benefit provided to, or on behalf
of, an employee if, at the time the benefit is provided, it is
reasonable to believe that the employee will be able to exclude the
value of the benefit from gross income.
(10) Applicable Individual Remuneration or AIR. For purposes of this
section, the term applicable individual remuneration or AIR means, with
respect to any applicable individual for any disqualified taxable year,
the aggregate amount allowable as a deduction under this chapter for
that taxable year (determined without regard to section 162(m)) for
remuneration for services performed by that applicable individual
(whether or not in that taxable year). AIR does not include any DDR with
respect to services performed during any taxable year. AIR for a
disqualified taxable year may include remuneration for services
performed in a taxable year before the taxable year in which the
deduction for the remuneration is allowable. For example, a
discretionary bonus granted and paid to an applicable individual in a
disqualified taxable year in recognition of services performed in prior
taxable years is AIR for the disqualified taxable year in which the
bonus is granted and paid. In addition, a grant of restricted stock in a
disqualified taxable year with respect to which an applicable individual
makes an election under section 83(b) is AIR for the disqualified
taxable year of the covered health insurance provider in which the grant
of the restricted stock is made. See paragraph (b)(9)(ii) of this
section for certain remuneration that is not treated as AIR for purposes
of this section.
(11) Deferred Deduction Remuneration or DDR. For purposes of this
section, the term deferred deduction remuneration or DDR means
remuneration that would be AIR for services performed in a disqualified
taxable year but for the fact that the deduction (determined without
regard to section 162(m)(6)) for the remuneration is allowable in a
subsequent taxable year. Whether remuneration is DDR is determined
without regard to when the remuneration is paid, except to the extent
that the timing of the payment affects the taxable year in which the
remuneration is otherwise deductible. For example, payments that are
otherwise deductible by a covered health insurance provider in an
initial taxable year, but are paid to an applicable individual by the
15th day of the third month of the immediately subsequent taxable year
of the covered health insurance provider (as described in Sec.
1.404(b)-1T, Q&A-2(b)(1)), are AIR for the initial taxable year (and not
DDR) because the deduction for the payments is allowable in the initial
taxable year, and not a subsequent taxable year. Except as otherwise
provided in paragraph (i) of this section (regarding transition rules
for certain DDR attributable to services performed in taxable years
beginning before January 1, 2013), DDR that is attributable to services
performed in a disqualified taxable year of a covered health insurance
provider is subject to the section 162(m)(6) deduction limitation even
if the taxable year in which the remuneration is otherwise deductible is
not a disqualified taxable year. Similarly, DDR is subject to the
section 162(m)(6) deduction limitation regardless of whether an
applicable individual is a service provider of the covered health
insurance provider in the taxable year in which the DDR is otherwise
deductible. However, remuneration that is attributable to services
performed in a taxable year that is not a disqualified taxable year is
not DDR even if the remuneration is otherwise deductible in a
disqualified taxable year. See also paragraph (b)(9)(ii) of this section
for certain remuneration that is not treated as DDR for purposes of this
section.
[[Page 243]]
(12) Substantial risk of forfeiture. For purposes of this section,
the term substantial risk of forfeiture has the same meaning as provided
in Sec. 1.409A-1(d).
(13) In-service payment. An in-service payment is any amount that is
paid with respect to an applicable individual from an account balance
plan described in Sec. 1.409A-1(c)(2)(i)(A) or (B) or a nonaccount
balance plan described in Sec. 1.409A-1(c)(2)(i)(C) in a taxable year
of a covered health insurance provider during which at any time the
applicable individual is a service provider (including amounts that
became otherwise deductible, but were not paid, in a previous taxable
year of a covered health insurance provider). Amounts that are paid in
the last year that an applicable individual is a service provider (for
example, amounts paid at separation from service) are in-service
payments if the applicable individual is a service provider at any time
during the taxable year of the covered health insurance provider in
which the payment is made.
(14) Payment year. For purposes of this section, the term payment
year means the taxable year of a covered health insurance provider for
which remuneration becomes otherwise deductible.
(15) Measurement date. For purposes of this section, the term
measurement date means the last day of the taxable year of a covered
health insurance provider.
(c) Deduction Limitation--(1) AIR. For any disqualified taxable year
beginning after December 31, 2012, no deduction is allowed under this
chapter for AIR that is attributable to services performed by an
applicable individual in that taxable year to the extent that the amount
of that remuneration exceeds $500,000.
(2) DDR. For any taxable year beginning after December 31, 2012, no
deduction is allowed under this chapter for DDR that is attributable to
services performed by an applicable individual in any disqualified
taxable year beginning after December 31, 2009, to the extent that the
amount of such remuneration exceeds $500,000 reduced (but not below
zero) by the sum of:
(i) The AIR for that applicable individual for that disqualified
taxable year; and
(ii) The portion of the DDR for those services that was subject to
the deduction limitation under section 162(m)(6)(A)(ii) and this
paragraph (c)(2) in a preceding taxable year, or would have been subject
to the deduction limitation under section 162(m)(6)(A)(ii) and this
paragraph (c)(2) in a preceding taxable year if section 162(m)(6) was
effective for taxable years beginning after December 31, 2009 and before
January 1, 2013.
(d) Services to which remuneration is attributable--(1) Attribution
to a taxable year--(i) In general. The deduction limitation under
section 162(m)(6) applies to AIR and DDR attributable to services
performed by an applicable individual in a disqualified taxable year of
a covered health insurance provider. When an amount of AIR or DDR
becomes otherwise deductible (and not before that time), that
remuneration must be attributed to services performed by an applicable
individual in a taxable year of the covered health insurance provider in
accordance with the rules of this paragraph (d). After the remuneration
has been attributed to services performed by an applicable individual in
a taxable year of a covered health insurance provider, the rules of
paragraph (e) of this section are then applied to determine whether the
deduction with respect to the remuneration is limited by section
162(m)(6).
(ii) Overview. Paragraphs (d)(1)(iii) through (v) of this section,
and paragraph (d)(2) of this section, set forth rules of general
applicability for attributing remuneration to services performed by an
applicable individual in a taxable year of a covered health insurance
provider. Paragraph (d)(3) sets forth two methods for attributing
remuneration provided under an account balance plan--the account balance
ratio method (described in paragraph (d)(3)(ii) of this section) and the
principal additions method (described in paragraph (d)(3)(iii) of this
section). Paragraph (d)(4) of this section sets forth two methods for
attributing remuneration provided under a nonaccount balance plan--the
present value ratio method (described in paragraph (d)(4)(ii) of this
section) and the
[[Page 244]]
formula benefit ratio method (described in paragraph (d)(4)(iii) of this
section). Paragraph (d)(5) of this section sets forth rules for
attributing remuneration resulting from equity-based remuneration (such
as stock options, stock appreciation rights, restricted stock, and
restricted stock units). Paragraph (d)(6) of this section sets forth
rules for attributing remuneration that is involuntary separation pay.
Paragraph (d)(7) of this section sets forth rules for attributing
remuneration that is received under a reimbursement arrangement, and
paragraph (d)(8) of this section sets forth rules for attributing
remuneration that results from a split-dollar life insurance
arrangement.
(iii) No attribution to taxable years during which no services are
performed or before a legally binding right arises--(A) In general. For
purposes of this section, remuneration is not attributable--
(1) To a taxable year of a covered health insurance provider ending
before the later of the date the applicable individual begins providing
services to the covered health insurance provider (or any member of its
aggregated group) and the date the applicable individual obtains a
legally binding right to the remuneration, or
(2) To any other taxable year of a covered health insurance provider
during which the applicable individual is not a service provider.
(B) Attribution of remuneration before the commencement of services
or a legally binding right arises. To the extent that remuneration would
otherwise be attributable in accordance with paragraphs (d)(2) through
(11) of this section to a taxable year ending before the later of the
date an applicable individual begins providing services to a covered
health insurance provider (or any member of its aggregated group) and
the date the applicable individual obtains a legally binding right to
the remuneration, the remuneration is attributed to services performed
in the taxable year in which the later of these dates occurs. For
example, if an applicable individual obtains a contractual right to
remuneration in a taxable year of a covered health insurance provider
and the remuneration would otherwise be attributable to that taxable
year pursuant to paragraph (d)(2) of this section, but the applicable
individual does not begin providing services to the covered health
insurance provider until the next taxable year, the remuneration is
attributable to the taxable year in which the applicable individual
begins providing services.
(iv) Attribution to 12-month periods. To the extent that a covered
health insurance provider is required to attribute remuneration on a
daily pro rata basis under this paragraph (d), it may treat any 12-month
period as having 365 days (and so may ignore the extra day in leap
years).
(v) Remuneration subject to nonlapse restriction or similar formula.
For purposes of this section, if stock or other property is subject to a
nonlapse restriction (as defined in Sec. 1.83-3(h)), or if the
remuneration payable to an applicable individual is determined under a
formula that, if applied to stock or other property, would be a nonlapse
restriction, the amount of the remuneration and the attribution of that
remuneration to taxable years must be determined based upon application
of the nonlapse restriction or formula. For example, if the earnings or
losses on an account under an account balance plan are determined based
upon the performance of company stock, the valuation of which is based
on a formula that if applied to the stock would be a nonlapse
restriction, then that formula must be used consistently for purposes of
determining the amount of the remuneration credited to that account
balance in taxable years and the attribution of that remuneration to
taxable years.
(2) Legally binding right. Unless attributable to services performed
in a different taxable year pursuant to paragraphs (d)(3) through (11)
of this section, remuneration is attributable to services performed in
the taxable year of a covered health insurance provider in which an
applicable individual obtains a legally binding right to the
remuneration. An applicable individual does not have a legally binding
right to remuneration if the remuneration may be reduced unilaterally or
eliminated by a covered health insurance provider or other person after
the services creating the right to the remuneration
[[Page 245]]
have been performed. However, if the facts and circumstances indicate
that the discretion to reduce or eliminate the remuneration is available
or exercisable only upon a condition, or the discretion to reduce or
eliminate the remuneration lacks substantive significance, an applicable
individual will be considered to have a legally binding right to the
remuneration. For this purpose, remuneration is not considered to be
subject to unilateral reduction or elimination merely because it may be
reduced or eliminated by operation of the objective terms of a plan,
such as the application of a nondiscretionary, objective provision
creating a substantial risk of forfeiture.
(3) Account balance plans--(i) In general. When remuneration for
services performed by an applicable individual for a covered health
insurance provider becomes otherwise deductible (for example, because
the amount was paid or made available during that taxable year) from a
plan described in Sec. 1.409A-1(c)(2)(i)(A) or (B) (an account balance
plan), that remuneration must be attributed to services performed by the
applicable individual in a taxable year of the covered health insurance
provider in accordance with an attribution method described in either
paragraph (d)(3)(ii) or (d)(3)(iii) of this section. However, except as
provided in paragraphs (d)(3)(ii)(D) and (f)(3) of this section, the
covered health insurance provider and all members of its aggregated
group must apply the same attribution method under this paragraph (d)(3)
consistently for all taxable years beginning after September 23, 2014
for all amounts that become otherwise deductible under all account
balance plans.
(ii) Account balance ratio method--(A) In general. Under this
method, remuneration for services performed by an applicable individual
for a covered health insurance provider that becomes otherwise
deductible under an account balance plan must be attributed to services
performed by the applicable individual in each taxable year of the
covered health insurance provider ending with or before the payment year
during which the applicable individual was a service provider and for
which the account balance of the applicable individual increased
(determined in accordance with paragraph (d)(3)(ii)(B) and (C) of this
section). The amount attributed to each such taxable year is equal to
the amount of remuneration that becomes otherwise deductible multiplied
by a fraction, the numerator of which is the increase in the applicable
individual's account balance under the plan for the taxable year, and
the denominator of which is the sum of all such increases for all
taxable years during which the applicable individual was a service
provider. Thus, remuneration that becomes otherwise deductible under a
plan is attributed to a taxable year of the covered health insurance
provider in proportion to the increase in the applicable individual's
account balance for that taxable year.
(B) Increase in the account balance. For purposes of this paragraph
(d)(3)(ii), an increase in an account balance under an account balance
plan occurs for a taxable year if the account balance as of the
measurement date in that taxable year is greater than the account
balance as of the measurement date in every earlier taxable year. In
that case, the amount of the increase for that taxable year is equal to
the excess of the applicable individual's account balance as of the
measurement date for that taxable year over the greatest of the
applicable individual's account balances under the plan as of the
measurement date in every earlier taxable year. If the applicable
individual's account balance as of the measurement date in a taxable
year is less than or equal to the applicable individual's account
balance as of the measurement date in any earlier taxable year, there is
no increase in the account balance for that later taxable year.
(C) Certain account balance adjustments. For purposes of determining
the account balance on a measurement date under paragraph (d)(3)(ii)(B)
of this section, the account balance is adjusted as provided in this
paragraph (d)(3)(ii)(C).
(1) In-service payments. If an in-service payment is made from the
account of an applicable individual under an account balance plan in any
taxable year of a covered health insurance provider,
[[Page 246]]
then the rules of this paragraph (d)(3)(ii)(C)(1) apply.
(i) Solely for purposes of determining the increase in the
applicable individual's account balance as of the measurement date in
the payment year (and not for purposes of attributing any amount that
becomes otherwise deductible in any later taxable year), the account
balance as of the measurement date for that taxable year is increased by
the amount of all in-service payments made from the plan during that
taxable year.
(ii) For purposes of attributing any amount that becomes otherwise
deductible under the plan in any taxable year after the payment year of
the in-service payment--
(A) the account balance as of the measurement date in each taxable
year that ends before the taxable year to which the in-service payment
is attributed pursuant to this paragraph (d)(3)(ii) is reduced by the
sum of the amount of the in-service payment that is attributed to that
taxable year and the amount of the in-service payment that is attributed
to each taxable year that ends before that taxable year, if any, and
(B) to the extent that the in-service payment includes an amount
that was deductible by the covered health insurance provider in a
previous taxable year and, therefore, was previously attributable to
services performed by the applicable individual in one or more taxable
years of the covered health insurance provider (for example, because the
amount was made available in a previous taxable year but was not paid at
that time), the account balance as of the measurement date for each
taxable year that ends before the taxable year to which the in-service
payment is attributed pursuant to this paragraph (d)(3)(ii) is reduced
by the sum of the amount of the in-service payment previously
attributable to that taxable year and the amount of the in-service
payment previously attributable to each taxable year that ends before
that taxable year, if any.
(2) Certain increases after ceasing to be a service provider. Any
addition (other than income or earnings) to an account balance plan made
in a taxable year that begins after an applicable individual ceases to
be a service provider (and that ends before the applicable individual
becomes a service provider again, if applicable) is added to the account
balance of the applicable individual as of the measurement date of the
first preceding taxable year in which the applicable individual was a
service provider.
(3) Account balance adjustments for grandfathered amounts. If a
covered health insurance provider uses the principal additions method
for determining grandfathered amounts for an applicable individual under
paragraph (h) of this section, then, for purposes of determining the
increase in the applicable individual's account balance, the account
balance as of any measurement date is reduced by the amount of any
grandfathered amounts otherwise included in the account balance.
(D) Transition rule for amounts attributed before the applicability
date of the final regulations. Amounts that become otherwise deductible
in taxable years beginning before September 23, 2014 may be attributed
to services performed in taxable years of a covered health insurance
provider under the rules set forth in the proposed regulations. If a
covered health insurance provider attributes an amount paid to an
applicable individual pursuant to a method permitted under the proposed
regulations and then chooses to use the account balance ratio method to
attribute amounts that subsequently become otherwise deductible with
respect to that applicable individual, then, for purposes of applying
the account balance ratio method to attribute any amount that becomes
otherwise deductible under the plan after the taxable year in which the
last payment was made that was attributed pursuant to the proposed
regulations, the account balance as of the measurement date for each
taxable year that ends before the taxable year in which the last payment
that was attributed pursuant to the proposed regulations is reduced by
the sum of the amount previously attributed to that taxable year under
the proposed regulations and the amount previously attributable to each
taxable year that ends prior to that taxable year under the proposed
regulations, if any.
[[Page 247]]
(iii) Principal additions method--(A) In general. Under this method,
remuneration that becomes otherwise deductible under an account balance
plan during a payment year must be attributed to services performed by
the applicable individual in the taxable year of the covered health
insurance provider during which the applicable individual was a service
provider and in which the principal addition to which the amount relates
is credited under the plan (determined in accordance with paragraph
(d)(3)(iii)(B) and (C) of this section). An amount relates to a
principal addition if the amount is a payment of the principal addition
or earnings on the principal addition, based on a separate accounting of
these amounts. The principal additions method described in this
paragraph may be used to attribute amounts that become otherwise
deductible under an account balance plan only if the covered health
insurance provider separately accounts for each principal addition to
the plan (and any earnings thereon) and traces each amount that becomes
otherwise deductible under the plan to a principal addition made in a
taxable year of the covered health insurance provider.
(B) Principal addition--(1) For purposes of this paragraph
(d)(3)(iii), the excess (if any) of the sum of the account balance of an
applicable individual in an account balance plan as of the last day of a
taxable year and any payments made during the taxable year over the
account balance as of the last day of the immediately preceding taxable
year, that is not due to earnings or losses (as described in paragraph
(d)(3)(iii)(C) of this section), is treated as a principal addition that
is credited to the plan in that taxable year if the applicable
individual was a service provider during that taxable year. If the
applicable individual was not a service provider during that taxable
year, the excess described in the preceding sentence is treated as a
principal addition that is credited to the plan in accordance with
paragraph (d)(3)(iii)(B)(2) of this section.
(2) Principal additions after termination of employment. Any
principal addition to an account balance plan made in a taxable year
that begins after an applicable individual ceases to be a service
provider (and that ends before the applicable individual becomes a
service provider again, if applicable) is treated as a principal
addition that is credited in the first preceding taxable year in which
the applicable individual was a service provider.
(C) Earnings. Whether remuneration constitutes earnings on a
principal addition is determined under the principles defining income
attributable to an amount taken into account under Sec. 31.3121(v)(2)-
1(d)(2). Therefore, for an account balance plan, earnings on an amount
deferred generally include an amount credited on behalf of an applicable
individual under the terms of the arrangement that reflects a rate of
return that does not exceed either the rate of return on a predetermined
actual investment (as defined in Sec. 31.3121(v)(2)-1(d)(2)(i)(B)), or,
if the income does not reflect the rate of return on a predetermined
actual investment, a rate of return that reflects a reasonable rate of
interest (as defined in Sec. 31.3121(v)(2)-1(d)(2)(i)(C)). For purposes
of this paragraph (d)(3)(iii), the use of a rate of return that is not
based on a predetermined actual investment or a reasonable rate of
interest generally will result in the treatment of some or all of the
remuneration as a principal addition that is attributable to services
performed by an applicable individual in a taxable year of a covered
health insurance provider in accordance with this paragraph (d)(3)(iii)
of this section.
(4) Nonaccount balance plans--(i) In general. When remuneration for
services performed by an applicable individual for a covered health
insurance provider becomes otherwise deductible under a plan described
in Sec. 1.409A-1(c)(2)(i)(C) (a nonaccount balance plan), that
remuneration must be attributed to services performed by the applicable
individual in a taxable year of the covered health insurance provider in
accordance with the attribution method described in either paragraph
(d)(4)(ii) or (d)(4)(iii) of this section. However, except as provided
in paragraphs (d)(4)(ii)(D) and (d)(4)(iii)(D) and (f)(3) of this
section, the covered health insurance provider and all members of its
aggregated group must apply the same attribution method under
[[Page 248]]
this paragraph (d)(4) consistently for all taxable years beginning after
September 23, 2014 for all amounts that become deductible under all
nonaccount balance plans.
(ii) Present value ratio attribution method--(A) In general. Under
this method, remuneration for services performed by an applicable
individual for a covered health insurance provider that becomes
otherwise deductible under a nonaccount balance plan must be attributed
to services performed by the applicable individual in each taxable year
of the covered health insurance provider ending with or before the
payment year during which the applicable individual was a service
provider for which the present value of the future payment(s) to be made
to or on behalf of the applicable individual under the plan increased
(determined in accordance with paragraph (d)(3)(ii)(B) and (C) of this
section). The amount attributed to each such taxable year is equal to
the amount of remuneration that becomes otherwise deductible under the
plan multiplied by a fraction, the numerator of which is the increase in
the present value of the future payment(s) to which the applicable
individual has a legally binding right under the plan for the taxable
year, and the denominator of which is the sum of all such increases for
all taxable years during which the applicable individual was a service
provider. Thus, remuneration that becomes otherwise deductible under a
plan is attributed to a taxable year of the covered health insurance
provider in proportion to the increase in the present value of the
future payment(s) under the plan for that taxable year.
(B) Increase in present value of future payments. For purposes of
this paragraph (d)(4)(ii), for a taxable year of a covered health
insurance provider, an increase in the present value of the future
payment(s) to which an applicable individual has a legally binding right
under a nonaccount balance plan occurs if the present value of the
future payment(s) as of the measurement date in the taxable year is
greater than the present value of the future payment(s) as of the
measurement date in every earlier taxable year. In that case, the amount
of the increase for that taxable year is equal to the excess of the
present value of the future payment(s) to which the applicable
individual has a legally binding right under the plan as of the
measurement date for that taxable year over the greatest present value
of the future payment(s) to which the applicable individual had a
legally binding right under the plan as of the measurement date in every
earlier taxable year. If the present value of the future payment(s) as
of a measurement date in a taxable year is less than or equal to the
present value of the future payment(s) as of the measurement date in any
earlier taxable year, then there is no increase in the present value of
the future payment(s) to which the applicable individual has a legally
binding right under the plan for that later taxable year. For purposes
of determining the increase (or decrease) in the present value of a
future payment(s) under a nonaccount balance plan, the rules of Sec.
31.3121(v)(2)-1(c)(2) apply (including the requirement that reasonable
actuarial assumptions and methods be used).
(C) Certain present value adjustments. For purposes of determining
the present value of the future payment(s) to which an applicable
individual has a legally binding right to receive as of a measurement
date under paragraph (d)(4)(ii)(B) of this section, the present value is
adjusted as provided in this paragraph (d)(3)(iii)(C).
(1) In-service payments. If an in-service payment is made to or on
behalf of an applicable individual under a nonaccount balance plan in
any taxable year of a covered health insurance provider, then the rules
of this paragraph (d)(3)(iii)(C)(1) apply.
(i) Solely for purposes of determining the increase in the present
value of the future payment(s) under the plan for the payment year (and
not for purposes of attributing any amount that becomes otherwise
deductible in any later taxable year), the present value of the future
payment(s) under the plan as of the measurement date in the payment year
is increased by the amount of any reduction in the present value of the
future payment(s) resulting from the in-service payment made from the
plan during that taxable year.
[[Page 249]]
(ii) For purposes of attributing any amount that becomes otherwise
deductible under the plan in any taxable year after the payment year of
the in-service payment, the present value of the future payment(s) as of
the measurement date for each taxable year that ends before the payment
year is reduced by the present value of the future payment to which the
applicable individual had a legally binding right to be paid on the date
of the in-service payment (determined as of the measurement date based
upon all of the applicable factors under the plan as of the measurement
date, such as compensation and years of service on that date).
(2) Increases in the present value of future payments after ceasing
to be a service provider. Any increase in the present value of the
future payment(s) under a plan in a taxable year that begins after an
applicable individual ceases to be a service provider (and that ends
before the applicable individual becomes a service provider again, if
applicable) that is not due merely to the passage of time or a change in
the reasonable actuarial assumptions used to determine the present value
of the future payment(s) is added to the present value of the future
payment(s) for the applicable individual as of the measurement date of
the most recent preceding taxable year in which the applicable
individual was a service provider.
(D) Transition rule for amounts attributed before the effective date
of the final regulations. Amounts that become otherwise deductible in
taxable years beginning before September 23, 2014 may be attributed
under the rules set forth in the proposed regulations. If a covered
health insurance provider attributes an amount paid to an applicable
individual pursuant to the proposed regulations and then chooses to use
the present value ratio method to attribute amounts that subsequently
become otherwise deductible with respect to that applicable individual,
then, for purposes of applying the present value ratio method to
attribute any amount that becomes otherwise deductible under the plan in
any taxable year after the taxable year in which the last payment was
made that was attributed pursuant to the proposed regulations, the
present value of the future payment(s) as of the measurement date for
each taxable year that ends before the taxable year in which the last
payment that was attributed pursuant to the proposed regulations is
reduced by the present value of each future payment to which the
applicable individual had a legally binding right to be paid that was
attributed pursuant to the proposed regulations (determined as of the
measurement date based upon all of the applicable factors under the plan
as of the measurement date, such as compensation and years of service on
that date), with no adjustment for an amount that became otherwise
deductible, but was not paid.
(iii) Formula benefit ratio method--(A) In general. Under this
method, remuneration that becomes otherwise deductible under a
nonaccount balance plan on a date (referred to for these purposes as the
date of payment) must be attributed to services performed by the
applicable individual in each taxable year of the covered health
insurance provider ending with or before the payment year during which
the applicable individual was a service provider and for which the
formula benefit of the applicable individual under the plan increased
(determined in accordance with paragraph (d)(3)(iii)(B), (C) and (D) of
this section). The amount attributed to each such taxable year is equal
to the amount of remuneration that becomes otherwise deductible under
the plan on the date of payment multiplied by a fraction, the numerator
of which is the increase in the applicable individual's formula benefit
under the plan for the taxable year and the denominator of which is the
sum of all such increases for all taxable years during which the
applicable individual was a service provider (which will generally be
the amount that becomes otherwise deductible under the plan on the date
of payment). Thus, remuneration that becomes otherwise deductible under
a plan is attributed to a taxable year of the covered health insurance
provider in proportion to the increase in the applicable individual's
formula benefit under the plan in that taxable year.
(B) Formula benefit. For purposes of this paragraph (d)(4)(iii), an
applicable
[[Page 250]]
individual's formula benefit as of any date is the benefit (or portion
thereof) to which the applicable individual has a legally binding right
under a nonaccount balance plan as of that date determined based upon
all of the applicable factors under the plan (for example, compensation
and years of service as of that date), disregarding any substantial risk
of forfeiture and assuming that the applicable individual meets any
applicable eligibility requirements for the benefit as of that date. For
this purpose, the formula benefit is expressed in the form that it has
become otherwise deductible. For example, if an applicable individual's
benefit under a plan is paid in the form of a single lump sum, then the
applicable individual's formula benefit under the plan is expressed in
the form of a single lump sum for all purposes under this paragraph
(d)(4)(iii). If the amount that becomes otherwise deductible is payable
in more than one form of payment (for example, 50 percent of the benefit
is paid in the form of a lump sum and 50 percent is paid in the form of
a life annuity), then each separate form of payment is treated as a
separate formula benefit to which this paragraph (d)(4)(iii) is applied
separately.
(C) Increase in formula benefit. For purposes of this paragraph
(d)(4)(iii), an increase in an applicable individual's formula benefit
under a nonaccount balance plan occurs for a taxable year of a covered
health insurance provider if the formula benefit as of the measurement
date in that taxable year is greater than the formula benefit as of the
measurement date in every earlier taxable year. In that case, the amount
of the increase for that taxable year is equal to excess of the formula
benefit as of the measurement date in that taxable year over the
greatest formula benefit as of any measurement date in any earlier
taxable year. If the applicable individual's formula benefit as of a
measurement date in a taxable year is less than or equal to the
applicable individual's formula benefit as of the measurement date in
any earlier taxable year, there is no increase in the formula benefit to
which the applicable individual has a legally binding right under the
plan for that later taxable year.
(D) Certain adjustments. For purposes of determining the increase in
the formula benefit as of a date of payment under paragraph
(d)(4)(iii)(C) of this section, the rules of this paragraph
(d)(3)(iii)(D) apply--
(1) Attribution to payment year. Solely for purposes of attributing
a payment under this paragraph (d)(4)(iii) (including an in-service
payment), the date of payment is substituted for the measurement date in
the payment year to determine whether an increase in the formula benefit
occurs in the payment year and the amount of any such increase.
(2) Amounts not paid. If an amount becomes otherwise deductible
under a nonaccount balance plan, but is not paid, the formula benefit
for that amount must be determined using the form in which it will be
paid, if that form is known, or any form in which it may be paid, if the
actual form of payment is unknown.
(3) Increases in the formula benefit after ceasing to be a service
provider. Any increase in the formula benefit with respect to an
applicable individual resulting from a legally binding right arising in
a taxable year that begins after the applicable individual ceases to be
a service provider (and that ends before the applicable individual
becomes a service provider again, if applicable) is added to the formula
benefit with respect to the applicable individual as of the measurement
date of the first preceding taxable year in which the applicable
individual was a service provider. However, any increase in the formula
benefit resulting from a legally binding right arising in a taxable year
that begins before the applicable individual ceases to be a service
provider is added to the formula benefit with respect to the applicable
individual as of the measurement date of the taxable year in which the
legally binding right arises, even if the increase is not reflected
until after the applicable individual ceases to be a service provider
(such as in the case of a cost of living adjustment).
(5) Equity-based remuneration--(i) Stock options and stock
appreciation rights--(A) In general. Except as provided in paragraph
(d)(5)(i)(B) of this section, remuneration resulting from
[[Page 251]]
the exercise of a stock option (including compensation income arising at
the time of a disqualifying disposition of an incentive stock option
described in section 422 or an option under an employee stock purchase
plan described in section 423) or a stock appreciation right (SAR) is
attributable to services performed by an applicable individual for a
covered health insurance provider on a daily pro rata basis over the
period beginning on the date of grant (within the meaning of Sec.
1.409A-1(b)(5)(vi)(B)) of the stock option or SAR and ending on the date
that the stock option or SAR is exercised, excluding any days on which
the applicable individual is not a service provider.
(B) Stock options or SARs subject to a substantial risk of
forfeiture. If a stock option or SAR is subject to a substantial risk of
forfeiture, a covered health insurance provider may attribute
remuneration resulting from the exercise of the stock option or SAR to
services performed by an applicable individual in a taxable year on a
daily pro rata basis over the period beginning on the date of grant
(within the meaning of Sec. 1.409A-1(b)(5)(vi)(B)) of the stock option
or SAR and ending on the first date that the stock option or SAR is no
longer subject to a substantial risk of forfeiture, but only if the
covered health insurance provider uses this attribution method
consistently for all stock options or SARs exercised in taxable years of
a covered health insurance provider beginning after September 23, 2014,
except as provided in paragraph (f)(3) of this section.
(ii) Restricted stock. Remuneration resulting from restricted stock,
for which an election under section 83(b) has not been made, that
becomes substantially vested or transferred is attributed on a daily pro
rata basis to services performed by an applicable individual for a
covered health insurance provider over the period, excluding any days on
which the applicable individual is not a service provider, beginning on
the date the applicable individual obtains a legally binding right to
the restricted stock and ending on the earliest of--
(A) The date the restricted stock becomes substantially vested, or
(B) The date the restricted stock is transferred by the applicable
individual.
(iii) Restricted stock units. Remuneration resulting from a
restricted stock unit (RSU) is attributed on a daily pro rata basis to
services performed by an applicable individual for a covered health
insurance provider over the period beginning on the date the applicable
individual obtains a legally binding right to the RSU and ending on the
date the remuneration is paid or made available, excluding any days on
which the applicable individual is not a service provider.
(iv) Partnership interests and other equity. [Reserved]
(6) Involuntary separation pay. Involuntary separation pay is
attributable to services performed by an applicable individual for a
covered health insurance provider in the taxable year in which the
involuntary separation from service occurs. Alternatively, the covered
health insurance provider may attribute involuntary separation pay to
services performed by an applicable individual on a daily pro rata basis
beginning on the date that the applicable individual obtains a legally
binding right to the involuntary separation pay and ending on the date
of the involuntary separation from service. Involuntary separation pay
to different individuals may be attributed using different methods;
however, if involuntary separation payments are made to the same
individual over multiple taxable years, all the payments must be
attributed using the same method. For purposes of this section, the term
involuntary separation pay means remuneration to which an applicable
individual has a right to payment solely as a result of the individual's
involuntary separation from service (within the meaning of Sec. 1.409A-
1(n)). To the extent that involuntary separation pay is attributed to
services performed in two or more taxable years of a covered health
insurance provider as permitted under this paragraph, any amount of
involuntary separation pay that is paid or made available must be
attributed to services performed in all of those taxable years in the
same proportion that the
[[Page 252]]
total involuntary separation pay is attributed to taxable years of the
covered health insurance provider.
(7) Reimbursements. Remuneration that is provided in the form of a
reimbursement or benefit provided in-kind (other than cash) is
attributable to services performed by an applicable individual in the
taxable year of a covered health insurance provider in which the
applicable individual makes a payment for which the applicable
individual has a right to reimbursement or receives an in-kind benefit,
except that remuneration provided in the form of a reimbursement or in-
kind benefit during a taxable year of a covered health insurance
provider in which an applicable individual is not a service provider is
attributable to services performed in the most recent preceding taxable
year of the covered health insurance provider in which the applicable
individual is a service provider.
(8) Split-dollar life insurance. Remuneration resulting from a
split-dollar life insurance arrangement (as defined in Sec. 1.61-22(b))
under which an applicable individual has a legally binding right to
economic benefits described in Sec. 1.61-22(d)(2)(ii) (policy cash
value to which the non-owner has current access within the meaning of
Sec. 1.61-22(d)(4)(ii)) or Sec. 1.61-22(d)(2)(iii) (any other economic
benefits provided to the non-owner) is attributable to services
performed in the taxable year of the covered health insurance provider
in which the legally binding right arises. Split-dollar life insurance
arrangements under which payments are treated as split-dollar loans
under Sec. 1.7872-15 generally will not give rise to DDR within the
meaning of paragraph (b)(11) of this section, although they may give
rise to AIR. However, in certain situations, this type of arrangement
may give rise to DDR for purposes of section 162(m)(6), for example, if
amounts due on a split-dollar loan are waived, cancelled, or forgiven.
(9) Examples. The following examples illustrate the principles of
paragraphs (d)(1) through (8) of this section. For purposes of these
examples, each corporation has a taxable year that is the calendar year
and is a covered health insurance provider for all relevant taxable
years, DDR is otherwise deductible in the taxable year in which it is
paid, and amounts payable under nonaccount balance plans are not
forfeitable upon the death of the applicable individual. For purposes of
these examples, the interest rates used in these examples are assumed to
be reasonable.
Example 1 (Account balance plan--account balance ratio method with
earnings and a single payment). (i) B is an applicable individual of
corporation Y for all relevant taxable years. On January 1, 2016, B
begins participating in a nonqualified deferred compensation plan of Y
that is an account balance plan. Under the terms of the plan, all
amounts are fully vested at all times, and Y will pay B's entire account
balance on January 1, 2019. B's account earns five percent interest per
year, compounded annually. Y credits $10,000 to B under the plan
annually on January 1 for three years beginning on January 1, 2016.
Thus, B's account balance is $10,500 ($10,000 + ($10,000 x 5%)) on
December 31, 2016; $21,525 ($10,500 + $10,000 + ($20,500 x 5%)) on
December 31, 2017; and $33,101 ($21,525 + $10,000 + ($31,525 x 5%)) on
December 31, 2018. On January 1, 2019, Y pays B $33,101, the entire
account balance. Y attributes payments under its account balance plans
using the account balance ratio method described in paragraph (d)(3)(i)
of this section.
(ii) The increase in B's account balance during 2016 is $10,500
($10,500 - zero); the increase in B's account balance for 2017 is
$11,025 ($21,525 - $10,500); and the increase in B's account balance for
2018 is $11,576 ($33,101 - $21,525). The sum of all the increases is
$33,101 ($10,500 + $11,025 + $11,576). Accordingly, for Y's 2016 taxable
year, the attribution fraction is .3172 ($10,500/$33,101); for Y's 2017
taxable year, the attribution fraction is .3331 ($11,025/$33,101); and
for Y's 2018 taxable year, the attribution fraction is .3497 ($11,576/
$33,101).
(iii) With respect to the $33,301 payment made on January 1, 2019,
$10,500 ($33,101 x .3172) of DDR is attributable to services performed
by B in Y's 2016 taxable year; $11,026 ($33,101 x .3331) of DDR is
attributable to services performed by B in Y's 2017 taxable year; and
$11,575 ($33,101 x .3497) of DDR is attributable to services performed
by B in Y's 2018 taxable year.
Example 2 (Account balance plan--principal additions method with
earnings and a single payment. (i) The facts are the same as in Example
1, except that Y attributes remuneration using the principal additions
method described in paragraph (d)(3)(ii) of this section.
(ii) The $10,000 principal addition made on January 1, 2016 and
$1,576 of earnings thereon
[[Page 253]]
(interest on the 2016 $10,000 principal addition at five percent for
three years compounded annually) are attributable to services performed
by B in Y's 2016 taxable year; the principal addition of $10,000 on
January 1, 2017 and $1,025 of earnings thereon (interest on the 2017
$10,000 principal addition at five percent for two years compounded
annually) are attributable to services performed by B in Y's 2017
taxable year; and the principal addition of $10,000 to B's account on
January 1, 2018 and $500 of earnings thereon (interest on the 2018
$10,000 principal addition at five percent for one year compounded
annually) are attributable to services performed by B in Y's 2018
taxable year. Accordingly, with respect to the $33,301 payment made on
January 1, 2019, $11,576 ($10,000 + $1,576) is attributable to services
performed by B in Y's 2016 taxable year; $11,025 ($10,000 + $1,025) is
attributable to services performed in Y's 2017 taxable year; and $10,500
($10,000 + $500) is attributable to services performed by B in Y's 2018
taxable year.
Example 3 (Account balance plan--account balance ratio method with
earnings and losses). (i) J is an applicable individual of corporation Z
for all relevant taxable years. On January 1, 2016, J begins
participating in a nonqualified deferred compensation plan of Z that is
an account balance plan. Under the terms of the plan, all amounts are
fully vested at all times, and Z will pay J's entire account balance on
January 1, 2019. Z credits $10,000 to J under the plan on January 1,
2016 and January 1, 2018. Earnings under the terms of the plan are based
on a predetermined actual investment (as defined in Sec. 31.3121(v)(2)-
1(e)(2)(i)(B)), which results in J's account balance increasing by five
percent in the 2016 taxable year, decreasing by five percent in the 2017
taxable year, and increasing again by five percent in the 2018 taxable
year. Therefore, on December 31, 2016, J's account balance is $10,500
($10,000 + ($10,000 x 5%)); on December 31, 2017, J's account balance is
$9,975 ($10,500 - ($10,500 x 5%)); and on December 31, 2018, J's account
balance is $20,974 ($9,975 + $10,000 + ($19,975 x 5%)). On January 1,
2019, Z pays J the entire account balance of $20,974.
(ii) The increase in J's account balance for 2016 is $10,500
($10,500 - zero); the increase in J's account balance for 2017 is zero
(because J's account balance decreased by $525 ($9,975 - $10,500)); the
increase in J's account balance for 2018 is $10,474 ($20,974 - $10,500,
which is the highest account balance in any prior taxable year). The sum
of all the increases is $20,974 ($10,500 + $10,474). Thus, for Z's 2016
taxable year the attribution fraction is .5006 ($10,500/$20,974); for
Z's 2017 taxable year the attribution fraction is zero because there was
a decrease in the account balance for the year; and for Z's 2018 taxable
year the attribution fraction is .4994 ($10,474/$20,974).
(iii) Accordingly, with respect to the $20,974 payment made on
January 1, 2019, $10,499 ($20,974 x .5006) of DDR is attributable to
services performed by J in Z's 2016 taxable year, and $10,474
($20,973.75 x .4994) of DDR is attributable to services performed by J
in Z's 2018 taxable year. No amount is attributable to services
performed by J in Z's 2017 taxable year because there was no increase in
the account balance for that taxable year.
Example 4 (Account balance plan--principal additions method with
earnings and losses). (i) The facts are the same as in Example 3, except
that Z attributes remuneration using the principal additions method
described in paragraph (d)(3)(ii) of this section.
(ii) The $10,000 principal addition made on January 1, 2016 and the
$474 of net earnings thereon ($500 of earnings for 2016, $525 of losses
for 2017, and $499 of earnings for 2018) are attributable to services
performed by J in Z's 2016 taxable year; and the $10,000 principal
addition made on January 1, 2018 and the $500 of earnings thereon are
attributable to services performed by J in Z's 2018 taxable year.
Accordingly, with respect to the $20,974 payment made on January 1,
2019, $10,474 ($10,000 + $474) of DDR is attributable to services
performed by J in Z's 2016 taxable year, and $10,500 ($10,000 + $500) of
DDR is attributable to services performed by J in Z's 2018 taxable year.
Example 5 (Account balance plan--account balance ratio method with
losses and an in-service payment). (i) N is an applicable individual of
corporation M for all relevant taxable years. On January 1, 2016, N
begins participating in a nonqualified deferred compensation plan
sponsored by M that is an account balance plan. Under the plan, all
amounts are fully vested at all times. The balances in N's account are
$110,000 on December 31, 2016; $90,000 on December 31, 2017; $250,000 on
December 31, 2018; and $240,000 on December 31, 2019. N ceases providing
services to N on December 31, 2019. In accordance with the plan terms, M
pays to N $10,000 on September 30, 2017, $150,000 on January 1, 2021,
and $100,000 on January 1, 2022. M attributes payments under its account
balance plans using the account balance ratio method described in
paragraph (d)(3)(i) of this section.
(ii) For purposes of attributing the $10,000 payment made on
September 30, 2017 to taxable years, the increase in N's account balance
for 2016 is $110,000 ($110,000 - zero). N's account balance for 2017 is
treated as $100,000 ($90,000 + $10,000 payment on September 30, 2017),
but, because the account balance of $100,000 is less than the account
balance in an earlier year, the increase in N's account balance for 2017
is zero. The sum of all the increases in N's account balance is $110,000
($110,000 + $0). Thus, the attribution fraction for 2016 is 1 ($110,000/
$110,000), and the attribution fraction for 2017 is zero ($0/$110,000).
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Accordingly, with respect to the $10,000 payment made on September 30,
2017, the entire $10,000 is attributable to services performed by N in
M's 2016 taxable year, and no amount is attributable to services
performed by N in M's 2017 taxable year.
(iii) After attributing the September 30, 2017 payment of $10,000 to
2016, N's account balance for 2016 is treated as being $100,000
($110,000 - $10,000), and the increase for 2016 is likewise treated as
$100,000; N's account balance for 2017 decreased; the increase in N's
account balance for 2018 is $150,000 ($250,000 - $100,000); and N's
account balance for 2018 decreased. The sum of all the increases is
$250,000 ($100,000 + $150,000). Thus, the attribution fraction for 2016
is .40 ($100,000/$250,000); the attribution fraction for 2017 is zero
($0/$250,000); the attribution fraction for 2018 is .60 ($150,000/
$250,000); and the attribution fraction for 2019 is zero ($0/$250,000).
(iv) Accordingly, with respect to the $150,000 payment made on
January 1, 2021, $60,000 ($150,000 x .40) is attributable to services
performed by N in M's 2016 taxable year, and $90,000 ($150,000 x .60) is
attributable to services performed by N in M's 2018 taxable year. With
respect to the $100,000 payment made on January 1, 2022, $40,000
($100,000 x .40) is attributable to services performed by N in M's 2016
taxable year, and $60,000 ($100,000 x .60) is attributable to services
performed by N in M's 2018 taxable year. No amount is attributable to
services performed by N in M's 2017 and 2019 taxable years.
Example 6 (Account balance plan--principal additions method with
multiple payments). (i) O is an applicable individual of corporation L
for all relevant taxable years. On January 1, 2016, O begins
participating in a nonqualified deferred compensation plan sponsored by
L that is an account balance plan. Under the plan, all amounts are fully
vested at all times. L credits principal additions to O's account each
year, and credits earnings based on a predetermined actual investment
within the meaning of Sec. 31.3121(v)(2)-1(d)(2)(i)(B). L makes
principal additions of $90,000 on June 30, 2016; $140,000 on June 30,
2017; and $180,000 on June 30, 2018. The predetermined actual investment
earns five percent for 2016, seven percent for 2017; eight percent for
2018; and nine percent for 2019. Thus, as of December 31, 2018, the
earnings with respect to the $90,000 principal addition made on June 30,
2016 are $16,605, for a total of $106,605; and the earnings with respect
to the $140,000 principal addition made on June 30, 2017 are $16,492,
for a total of $156,492. As of January 1, 2020, the earnings with
respect to the $180,000 principal addition made on June 30, 2018 are
$24,048, for a total of $204,048. Under the terms of the plan, the
principal addition (and earnings thereon) made on June 30, 2016 and June
30, 2017 are payable on December 31, 2018, and the principal addition
(and earnings thereon) made on June 30, 2018 is payable on January 1,
2020. On December 31, 2018, L pays O $263,097 in accordance with the
plan terms. On January 1, 2020, L pays O the remaining account balance
of $204,048 in accordance with the plan terms.
(ii) The $263,097 payment made on December 31, 2018 is attributed to
services performed by O in the 2016 and 2017 taxable years. Of the
$263,097 payment, $106,605 is attributable to services performed by O in
L's 2016 taxable year because this amount represents the $90,000
principal addition made on June 30, 2016 and earnings thereon. The
remaining $156,492 is attributable to services performed by O in L's
2017 taxable year because this amount represents the $140,000 principal
addition made on June 30, 2017 and earnings thereon. The $204,048
payment made on January 1, 2020 is attributable to services performed by
O in L's 2018 taxable year because this amount represents the $180,000
principal addition made on June 30, 2018 and earnings thereon.
Example 7 (Account balance plan--account balance ratio method with
an employer contribution after the applicable individual ceases to be a
service provider). (i) A is an applicable individual of corporation Z
for all relevant taxable years. On January 1, 2016, A begins
participating in a nonqualified deferred compensation plan of Z that is
an account balance plan. Under the terms of the plan, all amounts are
fully vested at all times. The balances in A's account (including
employer contributions and earnings) are $20,000 on December 31, 2016,
and $60,000 on December 31, 2017. On December 31, 2017, A ceases
providing services to Z. On January 1, 2019, Z makes a discretionary
contribution of $30,000 to A's account balance plan. On December 31,
2019, in accordance with the plan terms, Z pays $120,000 to A, which is
N's entire account balance. Z attributes payments under its account
balance plans using the account balance ratio method described in
paragraph (d)(3)(i) of this section.
(ii) The increase in A's account balance for 2016 is $20,000; the
increase in A's account balance for 2017 is $40,000. The discretionary
contribution made on January 1, 2019 of $30,000 is added to the account
balance for 2017. Thus, the discretionary contribution of $30,000 on
January 1, 2019, is treated as increasing A's account balance for 2017
by $30,000. The increase in A's account balance for 2016 is $20,000, and
the increase in A's account balance for 2017 is $70,000 ($40,000 +
$30,000). The sum of all the increases is $90,000 ($20,000+$70,000).
(iii) Thus, the attribution fraction for 2016 is .2222 ($20,000/
$90,000); and the attribution fraction for 2017 is .7778 ($70,000/
$90,000). Accordingly, with respect to the $120,000 payment made on
January 1, 2019, $26,664 ($120,000 x .2222) is attributable to services
performed by A in Z's 2016 taxable year, and
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$93,336 ($120,000 x .7778) is attributable to services performed by A in
Z's 2017 taxable year.
Example 8 (Account balance plan--principal additions method with a
principal addition after the applicable individual ceases to be a
service provider). (i) C is an applicable individual of corporation X
for all relevant taxable years. On January 1, 2016, C begins
participating in a nonqualified deferred compensation plan of X that is
an account balance plan. Earnings under the terms of the plan are based
on a predetermined actual investment (as defined in Sec. 31.3121(v)(2)-
1(e)(2)(i)(B)). Under the terms of the plan, all amounts are fully
vested at all times. X credits a $10,000 principal addition to C under
the plan on April 1, 2016, and a $20,000 principal addition to C on
April 1, 2017. C ceases providing services to X on December 31, 2017. On
January 1, 2019, X credits $30,000 to C's account in recognition of C's
past services. The $10,000 principal addition made on April 1, 2016
increases to $15,000 as of December 31, 2019, as a result of earnings.
The $20,000 principal addition made on April 1, 2017, increases to
$28,000 as of December 31, 2019 as a result of earnings. The January 1,
2019, contribution of $30,000 increases to $33,000 as of December 31,
2019, as a result of earnings. On December 31, 2019, in accordance with
the plan terms, X pays C's entire account balance of $76,000. X
attributes payments under its account balance plans using the principal
additions method described in paragraph (d)(3)(ii) of this section.
(ii) When the $76,000 payment is made to C on December 31, 2019, the
remuneration becomes attributable to service performed by C in prior
taxable years. The $10,000 principal addition in 2016 plus earnings
thereon of $5,000 are attributable to services performed by C in X's
2016 taxable year, and the $20,000 principal addition in 2017 (plus
earnings thereon of $8,000) are attributable to services performed by C
in X's 2017 taxable year. The principal addition of $30,000 plus
earnings thereon of $3,000 ($33,000) are also attributable to services
performed by C in X's 2017 taxable year. Thus, $16,500 of the $33,000 is
attributed to services performed by C in X's 2017 taxable year.
(iii) Accordingly, with respect to the $76,000 payment by X to C on
December 31, 2019, $15,000 ($10,000 + $5,000) is attributed to services
performed by C in X's 2016 taxable year, and $61,000 ($20,000 + $8,000 +
$33,000) is attributed to services performed by C in X's 2017 taxable
year.
Example 9 (Nonaccount balance plan--present value ratio method with
a single payment). (i) C is an applicable individual of corporation X
for all relevant taxable years. On January 1, 2015, X grants C a vested
right to a $100,000 payment on January 1, 2020. C ceases providing
services on December 31, 2019. The payment of $100,000 is made on
January 1, 2020. X determines the present value of the payment using an
interest rate of five percent for all years.
(ii) The present value of $100,000 payable on January 1, 2020,
determined using a five percent interest rate, is $82,270 as of December
31, 2015; $86,384 as of December 31, 2016; $90,703 as of December 31,
2017; $95,238 as of December 31, 2018, and $100,000 as of December 31,
2019. Accordingly, $82,270 is the amount of the increase in the present
value of the future payment of $100,000 for X's 2015 taxable year
($82,270 - $0); $4,114 ($86,384 - $82,270) is the increase in the
present value of the future payment for X's 2016 taxable year; $4,319
($90,703 - $86,384) is the increase in the present value of the future
payment for X's 2017 taxable year; $4,535 ($95,238 - $90,703) is the
increase in the present value of the future payment for X's 2018 taxable
year; and $4,762 ($100,000 - $95,238) is the increase in the present
value of the future payment for X's 2019 taxable year. The sum of all
the increases is $100,000 ($82,270 + $4,114 + $4,319 + $4,535 + $4,762).
Thus, the attribution fraction for 2015 is .8227 ($82,270/$100,000); the
attribution fraction for 2016 is .0411 ($4,114/$100,000); the
attribution fraction for 2017 is .0432 ($4,319/$100,000); the
attribution fraction for 2018 is .0454 ($4,535/$100,000); and the
attribution fraction for 2019 is .0476 ($4,762/$100,000).
(iii) The $100,000 payment made on January 1, 2020 is multiplied by
the attribution fraction for each taxable year, and the result is the
amount that is attributable to service performed by C for that taxable
year. Accordingly, $82,270 ($100,000 x .8227) is attributable to
services performed by C in X's 2015 taxable year; $4,114 ($100,000 x
.0411) is attributable to services performed by C in X's 2016 taxable
year; $4,319 ($100,000 x .0432) is attributable to services performed by
C in X's 2017 taxable year; $4,535 ($100,000 x .0454) is attributable to
services performed by C in X's 2018 taxable year; and $4,762 ($100,000 x
.0476) is attributable to services performed by C in X's 2019 taxable
year.
Example 10. (Nonaccount balance plan--present value ratio method
with an in-service payment). (i) The facts are the same as Example 9,
except that X grants C a vested right to a $40,000 payment on June 30,
2018 and a vested right to a $60,000 payment on January 1, 2020.
(ii) The present value of the future payments ($40,000 payable on
June 30, 2018 and $60,000 payable on January 1, 2020), determined using
a five percent interest rate, is $84,758 as of December 31, 2015;
$88,996 as of December 31, 2016; $93,446 as of December 31, 2017; and
$57,143 as of December 31, 2018. However, for purposes of determining
the increase in the present value of the future payments during 2018
(the year of the in-service payment), $57,143 must be increased by
$40,000, the amount of the in-service payment, resulting in a present
value of future payments as of December 31, 2018, of $97,143
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solely for purposes of attributing the $40,000 in-service payment.
Accordingly, $84,758 is the amount of the increase in the present value
of the future payments for X's 2015 taxable year, $4,238 ($88,896 -
$84,758) is the increase in the present value of the future payments for
X's 2016 taxable year, $4,450 ($93,446 - $88,996) is the increase in the
present value of the future payments for X's 2017 taxable year, and
$3,697 ($97,143 - $93,446) is the increase in the present value of the
future payments for X's 2018 taxable year. The sum of all the increases
is $97,143 ($84,758 + $4,238 + $4,450 + $3,697). Thus, the attribution
fraction for 2015 is .8725 ($84,758/$97,143); the attribution fraction
for 2016 is .0436 ($4,238/$97,143); the attribution fraction for 2017 is
.0458 ($4,450/$97,143); and the attribution fraction for 2018 is .0381
($3,697/$97,143).
(iii) Accordingly, with respect to the $40,000 payment made on June
30, 2018, $34,900 ($40,000 x .8725) is attributable to services
performed by C in X's 2015 taxable year; $1,744 ($40,000 x .0436) is
attributable to services performed by C in X's 2016 taxable year; $1,832
($40,000 x .0458) is attributable to services performed by C in X's 2017
taxable year; and $1,524 ($40,000 x .0381) is attributable to services
performed by C in X's 2018 taxable year.
(iv) For purposes of attributing the $60,000 payment made on January
1, 2020, the present value of the future payments for each taxable year
that ends prior to the taxable year in which the $40,000 in-service
payment is paid is reduced by the present value of the future payment to
which the applicable individual had a legally binding right to be paid
on the date the $40,000 in-service is paid (based on the applicable
factors and plan provisions as of the measurement date in each such
taxable year). The present value of that future payment is $35,396 as of
December 31, 2015; $37,166 as of December 31, 2016; and $39,024 as of
December 31, 2017. Therefore, for purposes of attributing the $60,000
payment on January 1, 2020, the present value of future payments as of
December 31, 2015, is $49,362 ($84,758 - $35,396); the present value of
future payments as of December 31, 2016, is $51,830 ($88,996 - $37,166);
the present value of future payments as of December 31, 2017, is $54,422
($93,446 - $39,024). The present value of future payments as of December
31, 2018, is $57,143. Accordingly, $49,362 is the increase in the
present value of the future payment of $60,000 for X's 2015 taxable
year; $2,468 ($51,830 - $49,362) is the increase in the present value of
the future payment for X's 2016 taxable year; $2,592 ($54,422 - $51,830)
is the increase in the future value of the payment for X's 2017 taxable
year; $2,721 ($57,143 - $54,422) is the increase in the future value of
the payments for X's 2018 taxable year; and $2,857 ($60,000 - $57,143)
is the increase in the future value of the payment for X's 2019 taxable
year. The sum of all the increases is $60,000 ($49,362 + $2,468 + $2,592
+ $2,721 + $2,857). Thus, the attribution fraction for 2015 is .8227
($49,362/$60,000); the attribution fraction for 2016 is .0411 ($2,468/
$60,000); the attribution fraction for 2017 is .0432 ($2,592/$60,000);
the attribution fraction for 2018 is .0454 ($2,721/$60,000); and the
attribution fraction for 2019 is .0476 ($2,857/$60,000).
(v) Accordingly, with respect to the $60,000 payment made on January
1, 2020, $49,362 ($60,000 x .8227) is attributable to services performed
by C in X's 2015 taxable year; $2,468 ($60,000 x .0411) is attributable
to services performed by C in X's 2016 taxable year; $2,592($60,000 x
.0432) is attributable to services performed by C in X's 2017 taxable
year; $2,721 ($60,000 x .0454) is attributable to services performed by
C in X's 2018 taxable year; and $2,857 ($60,000 x .0476) is attributable
to services performed by C in X's 2019 taxable year.
Example 11 (Nonaccount balance plan--formula benefit ratio method
with losses and multiple payments). (i) D is an applicable individual of
W for all relevant taxable years. D becomes a participant in a
nonaccount balance plan sponsored by R on January 1, 2018. The plan
provides W with the vested right to receive a five annual installments
each equal to $20,000 times the full years of service that D completes.
The first payment is to be made on the later of December 31, 2027, or on
the December 31 of the first year in which D is no longer a service
provider. D has a break in service in 2020 and does not accrue an
additional benefit during 2020. D ceases to be a service provider on
December 31, 2022, after having completed four years of service,
entitling D to five annual payments equal to $80,000 per year commencing
on December 31, 2027. W determines the present value of amounts to be
paid under the plan using an interest rate of five percent for 2018 and
2019, and seven percent for 2021, 2022, and 2023. W uses the formula
benefit ratio method described in paragraph (d)(4)(ii) of this section.
(ii) Under the plan formula, in 2018, E accrued the right to a
$20,000 annual payment for five years, and E accrued an additional
$20,000 in annual payments in 2019, 2021, and 2022, resulting in the
right to receive an annual payment of $80,000 commencing on December 31,
2027. Thus, the attribution fraction is .25 for 2018 ($20,000/$80,000),
.25 for 2019 ($20,000/$80,000), .25 for 2021 ($20,000/$80,000), and .25
for 2022 ($20,000/$80,000). The attribution fraction for 2020 is zero
because no additional formula benefit accrued during that year.
(iii) The attribution fraction for each disqualified taxable year is
multiplied by each payment and the result is attributed to that taxable
year. Accordingly, with respect to each $80,000 payment, $20,000
($80,000 x .25) is attributable to services performed by D in W's 2018
taxable year; $20,000 ($80,000 x .25) is
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attributable to services performed by D in W's 2019 taxable year;
$20,000 ($80,000 x .25) is attributable to services performed by D in
W's 2021 taxable year; and $20,000 ($80,000 x .25) is attributable to
services performed by D in W's 2022 taxable year. No amount is
attributable to services performed by D in W's 2020 taxable year.
Example 12 (Stock option). (i) E is an applicable individual of
corporation V for all relevant taxable years. On January 1, 2016, V
grants E an option to purchase 100 shares of V common stock at an
exercise price of $50 per share (the fair market value of V common stock
on the date of grant). The stock option is not subject to a substantial
risk of forfeiture. On December 31, 2017, E ceases to be a service
provider of V or any member of V's aggregated group. On January 1, 2019,
E resumes providing services for V and again becomes both a service
provider and an applicable individual of V. On December 31, 2020, when
the fair market value of V common stock is $196 per share, E exercises
the stock option. The remuneration resulting from the stock option
exercise is $14,600 (($196 -- $50) x 100).
(ii) The $14,600 is attributed pro rata over the 1,460 days from
January 1, 2016 to December 31, 2017 and from January 1, 2019 to
December 31, 2020 (365 days per year for the 2016, 2017, 2019, and 2020
taxable years), so that $10 ($14,600 divided by 1,460) is attributed to
each calendar day in this period, and $3,650 (365 days x $10) of
remuneration is attributed to services performed by E in each of V's
2016, 2017, 2019, and 2020 taxable years.
Example 13 (Stock option subject to a substantial risk of
forfeiture). (i) The facts are the same as Example 14, except that the
stock option is subject to a substantial risk of forfeiture that lapses
on December 31, 2017, and is not transferable until that date, and V
chooses to attribute remuneration resulting from the exercise of stock
options that are subject to a substantial risk of forfeiture over the
period beginning on the date of grant and ending on the date the
substantial risk of forfeiture lapses, as permitted under paragraph
(d)(5)(i)(B) of this section.
(ii) The $14,600 is attributed pro rata over the 730 days from
January 1, 2016 to December 31, 2017 (365 days per year for the 2016 and
2017 taxable years), so that $20 ($14,600 divided by 730) is attributed
to each calendar day in this period, and $7,300 (365 days x $20) is
attributed to services performed by E in each of V's 2016 and 2017
taxable years.
Example 14 (Restricted stock). (i) F is an applicable individual of
corporation U for all relevant taxable years. On January 1, 2017, U
grants to F 1000 shares of restricted U common stock. Under the terms of
the grant, the shares will be forfeited if F voluntarily terminates
employment before December 31, 2019 (so that the shares are subject to a
substantial risk of forfeiture through that date) and are
nontransferable until the substantial risk of forfeiture lapses. F does
not make an election under section 83(b) and continues in employment
with U through December 31, 2019, at which time F's rights in the stock
become substantially vested within the meaning of Sec. 1.83-3(b) and
the fair market value of a share of the stock is $109.50. The
remuneration resulting from the vesting of the restricted stock is
$109,500 ($109.50 x 1000).
(ii) The $109,500 of remuneration is attributed to services
performed by F over the 1,095 days between January 1, 2017 and December
31, 2019 (365 days per year for the 2017, 2018, and 2019 taxable years),
so that $100 ($109,500 divided by 1,095) is attributed to each calendar
day in this period, and remuneration of $36,500 (365 days x $100) is
attributed to services performed by F in each of U's 2017, 2018, and
2019 taxable years.
Example 15 (RSUs). (i) G is an applicable individual of corporation
T for all relevant taxable years. On January 1, 2018, T grants to G 1000
RSUs. Under the terms of the grant, T will pay G an amount on December
31, 2020 equal to the fair market value of 1000 shares of T common stock
on that date, but only if G continues to provide substantial services to
T (so that the RSU is subject to a substantial risk of forfeiture)
through December 31, 2020. G remains employed by T through December 31,
2020, at which time the fair market value of a share of the stock is
$219, and T pays G $219,000 ($219 x 1000).
(ii) The $219,000 in remuneration is attributed to services
performed by G over the 1,095 days beginning on January 1, 2018 and
ending on December 31, 2020 (365 days per year for the 2018, 2019, and
2020 taxable years), so that $200 ($219,000/1,095) is attributed to each
calendar day in this period, and $73,000 (365 days x $200) is attributed
to service performed by G in each of T's 2018, 2019, and 2020 taxable
years.
Example 16 (Involuntary separation pay). (i) H is an applicable
individual of corporation S. On January 1, 2015, H and S enter into an
employment contract providing that S will make two payments of $150,000
each to H if H has an involuntary separation from service. Under the
terms of the contract, the first payment is due on January 1 following
the involuntary separation from service, and the second payment is due
on January 1 of the following year. On December 31, 2016, H has an
involuntary separation from service. S pays H $150,000 on January 1,
2017 and $150,000 on January 1, 2018.
(ii) Pursuant to paragraph (d)(6) of this section, involuntary
separation pay may be attributed to services performed by H in the
taxable year of S in which the involuntary separation from service
occurs. Alternatively, involuntary separation pay may be attributed to
services performed by H on a daily pro rata basis beginning on the date
H
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obtains a legally binding right to the involuntary separation pay and
ending on the date of the involuntary separation from service. The
entire $300,000 amount, including both $150,000 payments, must be
attributed using the same method. Therefore, the entire $300,000 amount
(comprised of two $150,000 payments) may be attributed to services
performed by H in S's 2016 taxable year, which is the taxable year in
which the involuntary separation from service occurs. Alternatively,
each $150,000 payment may be attributed on a daily pro rata basis to the
period beginning on January 1, 2015 and ending December 31, 2016, so
that $410.96 (($150,000 x 2)/(365 x 2)) is attributed to each day of S's
2015 and 2016 taxable years. Accordingly, $150,000 is attributed to
services performed by H in each of S's 2015 and 2016 taxable years.
Example 17 (Reimbursement after termination of services). (i) I is
an applicable individual of corporation R. On January 1, 2018, I enters
into an agreement with R under which R will reimburse I's country club
dues for two years following I's separation from service. On December
31, 2020, I ceases to be a service provider of R. I pays $50,000 in
country club dues on January 1, 2021 and $50,000 on January 2, 2022.
Pursuant to the agreement, R reimburses I $50,000 for the country club
dues in 2021 and $50,000 in 2022.
(ii) $100,000 is attributed to services performed in R's 2020
taxable year, the taxable year in which I ceases to be a service
provider.
(10) Certain remuneration subject to a substantial risk of
forfeiture. If remuneration is attributable in accordance with
paragraphs (d)(2) (legally binding right), (d)(3) (account balance
plan), or (d)(4) (nonaccount balance plan) of this section to services
performed in a period that includes two or more taxable years of a
covered health insurance provider during which the remuneration is
subject to a substantial risk of forfeiture, that remuneration must be
attributed using a two-step process. First, the remuneration must be
attributed to the taxable years of the covered health insurance provider
in accordance with paragraph (d)(2), (3), or (4) of this section, as
applicable. Second, the remuneration attributed to the period during
which the remuneration is subject to a substantial risk of forfeiture
(the vesting period) must be reattributed on a daily pro rata basis over
that period beginning on the date that the applicable individual obtains
a legally binding right to the remuneration and ending on the date that
the substantial risk of forfeiture lapses. If a vesting period begins on
a day other than the first day of a covered health insurance provider's
taxable year or ends on a day other than the last day of the covered
health insurance provider's taxable year, the remuneration attributable
to that taxable year under the first step of the attribution process is
divided between the portion of the taxable year that includes the
vesting period and the portion of the taxable year that does not include
the vesting period. The amount attributed to the portion of the taxable
year that includes the vesting period is equal to the total amount of
remuneration that would be attributable to the taxable year under the
first step of the attribution process, multiplied by a fraction, the
numerator of which is the number of days during the taxable year that
the amount is subject to a substantial risk of forfeiture and the
denominator of which is the number of days in such taxable year. The
remaining amount is attributed to the portion of the taxable year that
does not include the vesting period and, therefore, is not reattributed
under the second step of the attribution process.
(11) Example. The following example illustrates the principles of
paragraph (d)(10) of this section. For purposes of this example, the
corporation has a taxable year that is the calendar year and is a
covered health insurance provider for all relevant taxable years, DDR is
otherwise deductible in the taxable year in which it is paid, and
amounts payable under nonaccount balance plans are not forfeitable upon
the death of the applicable individual.
Example (Account balance plan subject to a substantial risk of
forfeiture using the principal additions method). (i) J is an applicable
individual of corporation Q for all relevant taxable years. On January
1, 2016, J begins participating in a nonqualified deferred compensation
plan that is an account balance plan. Under the terms of the plan, Q
will pay J's account balance on January 1, 2021, but only if J continues
to provide substantial services to Q through December 31, 2018 (so that
the amount credited to J's account is subject to a substantial risk of
forfeiture through that date). Q credits $10,000 to J's account annually
for five years on January 1 of each year beginning on January 1, 2016.
The account earns interest at a fixed rate of five percent per year,
compounded annually,
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which solely for the purposes of this example, is assumed to be a
reasonable rate of interest. Q attributes increases in account balances
under the plan using the principal additions method described in
paragraph (d)(3)(ii) of this section.
(ii) Earnings on a principal addition are attributed to the same
disqualified taxable year of Q to which the principal addition is
attributed; therefore, the amount initially attributable to Q's 2016
taxable year is $12,763 (the $10,000 principal addition in 2016 at five
percent interest for five years); the amount initially attributable to
Q's 2017 taxable year is $12,155 (the $10,000 principal addition in 2017
at five percent interest for four years); the amount initially
attributable to Q's 2018 taxable year is $11,576 (the $10,000 principal
addition in 2018 at five percent interest for three years); the amount
attributable to Q's 2019 taxable year is $11,025 (the $10,000 principal
addition in 2019 at five percent interest for two years); and the amount
attributable to Q's 2020 taxable year is $10,500 (the $10,000 principal
addition in 2020 at five percent interest for one year).
(iii) Remuneration that is attributable to two or more taxable years
of Q during which it is subject to a substantial risk of forfeiture must
be reattributed on a daily pro rata basis to the period beginning on the
date that J obtains a legally binding right to the remuneration and
ending on the date that the substantial risk of forfeiture lapses.
Therefore, $36,494 ($12,763 + $12,155 + $11,576) is reattributed on a
daily pro rata basis over the period beginning on January 1, 2016, and
ending on December 31, 2018. Thus, $12,165 is attributed to services
performed by J in each of Q's 2016, 2017, and 2018 taxable years.
(e) Application of the deduction limitation--(1) Application to
aggregate amounts. The $500,000 deduction limitation is applied to the
aggregate amount of AIR and DDR attributable to services performed by an
applicable individual in a disqualified taxable year. The aggregate
amount of AIR and DDR attributable to services performed by an
applicable individual in a disqualified taxable year that exceeds the
$500,000 deduction limit is not allowed as a deduction in any taxable
year. Therefore, for example, if an applicable individual has more than
$500,000 of AIR attributable to services performed for a covered health
insurance provider in a disqualified taxable year, the amount of that
AIR that exceeds $500,000 is not deductible in any taxable year, and no
DDR attributable to services performed by the applicable individual in
that disqualified taxable year is deductible in any taxable year.
However, if an applicable individual has AIR for a disqualified taxable
year that is $500,000 or less and DDR attributable to services performed
in the same disqualified taxable year that, when combined with the AIR
for the year, exceeds $500,000, all of the AIR is deductible in that
disqualified taxable year, but the amount of DDR attributable to that
taxable year that is deductible in future taxable years is limited to an
amount equal to $500,000 less the amount of the AIR for that taxable
year.
(2) Order of application and calculation of deduction limitation--
(i) In general. The deduction limitation with respect to any applicable
individual for any disqualified taxable year is applied to AIR and DDR
attributable to services performed by that applicable individual in that
disqualified taxable year at the time that the remuneration becomes
otherwise deductible, and each time the deduction limitation is applied
to an amount that is otherwise deductible, the deduction limit is
reduced (but not below zero) by the amount against which it is applied.
Accordingly, the deduction limitation is applied first to an applicable
individual's AIR attributable to services performed in a disqualified
taxable year and is reduced (but not below zero) by the amount of the
AIR to which the deduction limit is applied. If the applicable
individual also has an amount of DDR attributable to services performed
in that disqualified taxable year that becomes otherwise deductible in a
subsequent taxable year, the deduction limit, as reduced, is applied to
that amount of DDR in the first taxable in which the DDR becomes
otherwise deductible. The deduction limit is then further reduced (but
not below zero) by the amount of the DDR to which the deduction limit is
applied. If the applicable individual has an additional amount of DDR
attributable to services performed in the original disqualified taxable
year that becomes otherwise deductible in a subsequent taxable year, the
deduction limit, as further reduced, is applied to that amount of DDR in
the taxable year in which it is otherwise deductible. This process
continues for future taxable years in
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which DDR attributable to services performed by the applicable
individual in the original disqualified taxable year is otherwise
deductible. No deduction is allowed in any taxable year for any AIR or
DDR attributable to services performed by an applicable individual in a
disqualified taxable year for the excess of those amounts over the
deduction limit (as reduced, if applicable) for that disqualified
taxable year at the time the deduction limitation is applied to the
remuneration.
(ii) Application to payments--(A) In general. Any payment of
remuneration may include amounts that are attributable to services
performed by an applicable individual in one or more taxable years of a
covered health insurance provider pursuant to paragraphs (d)(2) through
(11) of this section. In that case, a separate deduction limitation
applies to each portion of the payment that is attributed to services
performed in a different disqualified taxable year. Any portion of a
payment that is attributed to a taxable year that is a disqualified
taxable year is deductible only to the extent that it does not exceed
the deduction limit that applies with respect to the applicable
individual for that disqualified taxable year, as reduced by the amount,
if any, of AIR and DDR attributable to services performed in that
disqualified taxable year that was deductible in an earlier taxable
year.
(3) Examples. The following examples illustrate the rules of
paragraphs (e)(1) and (2) of this section. For purposes of these
examples, each corporation has a taxable year that is the calendar year
and is a covered health insurance provider for all relevant taxable
years; DDR is otherwise deductible in the taxable year in which it is
paid; and amounts payable under nonaccount balance plans are not
forfeitable upon the death of the applicable individual.
Example 1 (Lump-sum payment of DDR attributable to a single taxable
year). (i) L is an applicable individual of corporation O. During O's
2015 taxable year, O pays L $550,000 in salary, which is AIR, and grants
L a right to $50,000 of DDR payable upon L's separation from service
from O. L has a separation from service in 2020, at which time O pays L
the $50,000 of DDR attributable to services performed by L in O's 2015
taxable year.
(ii) The $500,000 deduction limitation for 2015 is applied first to
L's $550,000 of AIR for 2015. Because the $550,000 of AIR in 2015 is
greater than the deduction limit, O may deduct only $500,000 of the AIR
for 2015, and $50,000 of the $550,000 of AIR is not deductible for any
taxable year. The deduction limit for remuneration attributable to
services provided by L in O's 2015 taxable year is then reduced to zero.
Because the $50,000 in DDR attributable to services performed by L in
2015 exceeds the reduced deduction limit of zero, that $50,000 is not
deductible for any taxable year.
Example 2 (Installment payments of DDR attributable to a single
taxable year). (i) M is an applicable individual of corporation N.
During N's 2016 taxable year, N pays M $300,000 in salary, which is AIR,
and grants M a right to $220,000 of DDR payable on a fixed schedule
beginning upon M's separation from service. The $220,000 is attributable
to services provided by M in N's 2016 taxable year. M ceases providing
services on December 31, 2016. In 2020, N pays M $120,000 of DDR that is
attributable to services performed in N's 2016 taxable year. In 2021, N
pays M the remaining $100,000 of DDR attributable to services performed
by M in N's 2016 taxable year.
(ii) The $500,000 deduction limitation for 2016 is applied first to
M's $300,000 of AIR for 2016. Because the deduction limit is greater
than the AIR, N may deduct the entire $300,000 of AIR paid in 2016. The
$500,000 deduction limit is then reduced to $200,000 because the
limitation is reduced by the amount of AIR ($500,000 - $300,000). The
reduced deduction limit is then applied to M's $120,000 of DDR
attributable to services performed by M in N's 2016 taxable year that is
paid in 2020. Because the reduced deduction limit of $200,000 is greater
than the $120,000 of DDR, N may deduct the entire $120,000 of DDR paid
in 2020. The $200,000 deduction limit is reduced to $80,000 by the
$120,000 in DDR because the limit is reduced by the amount of DDR to
which the deduction limit applied ($200,000 - $120,000). The reduced
deduction limit of $80,000 is then applied to the remaining $100,000
payment of DDR attributable to services performed by M in N's 2016
taxable year. Because the $100,000 payment by N for 2021 exceeds the
reduced deduction limit of $80,000, N may deduct only $80,000 of the
payment for the 2021 taxable year, and $20,000 of the $100,000 payment
is not deductible by N for any taxable year.
Example 3 (Lump-sum payment attributable to multiple years from an
account balance plan using the account balance ratio method). (i) N is
an applicable individual of corporation M for all relevant taxable
years. On January 1, 2015, N begins participating in a nonqualified
deferred compensation plan sponsored by M that is an account balance
plan. Under the plan, all amounts are fully vested at all
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times. The balances in N's account (including earnings) are $50,000 on
December 31, 2015, $100,000 on December 31, 2016, and $200,000 on
December 31, 2017. N's AIR from M is $425,000 for 2015, $450,000 for
2016, and $500,000 for 2017. On January 1, 2018, in accordance with the
plan terms, M pays $200,000 to N, which is a payment of N's entire
account balance under the plan. M uses the account balance ratio method
to attribute amounts to services performed in taxable years.
(ii) To determine the extent to which M is entitled to a deduction
for any portion of the $200,000 payment under the plan, the payment must
first be attributed to services performed by N in M's taxable years in
accordance with the attribution rules set forth in paragraph (d) of this
section. The increase in N's account balance during 2015 is $50,000
($50,000 - zero); the increase in N's account balance for 2016 is
$50,000 ($100,000 - $50,000); and the increase in N's account balance
for 2017 is $100,000 ($200,000 - $100,000). The sum of all the increases
is $200,000 ($50,000 + $50,000 + $100,000). Accordingly, for N's 2015
taxable year, the attribution fraction is .25 ($50,000/$200,000); for
N's 2016, taxable year, the attribution fraction is .25 ($50,000/
$200,000); and for N's 2017 taxable year, the attribution fraction is
.50 ($100,000/$200,000).
(iii) With respect to the $200,000 payment made on January 1, 2018,
$50,000 ($200,000 x .25) of DDR is attributable to services performed by
N in M's 2015 taxable year; $50,000 ($200,000 x .25) of DDR is
attributable to services performed by N in M's 2016 taxable year; and
$100,000 ($200,000 x .50) of DDR is attributable to services performed
by N in M's 2017 taxable year.
(iv) The $500,000 deduction limitation for 2015 is applied first to
N's $425,000 of AIR for 2015. Because the deduction limit is greater
than the AIR, M may deduct the entire $425,000 of AIR paid in 2015. The
$500,000 deduction limit is then reduced to $75,000 by the amount of AIR
against which it is applied ($500,000 - $425,000). The reduced deduction
limit is then applied to N's $50,000 of DDR attributable to services
performed by N in M's 2015 taxable year that is paid in 2018. Because
$50,000 does not exceed the reduced deduction limit of $75,000, all
$50,000 of the DDR attributable to services performed by N in M's 2015
taxable year is deductible for 2018, the year of payment. The deduction
limit for remuneration attributable to services performed by N in 2015
is then reduced to $25,000 ($75,000 - $50,000), and this reduced limit
is applied to any future payment of DDR attributable to services
performed by N in 2015. With respect to M's 2016 taxable year, the
$500,000 deduction limit for 2016 is applied first to N's $450,000 of
AIR for 2016. Because the deduction limit is greater than the AIR, M may
deduct the entire $450,000 of AIR paid in 2016. The $500,000 deduction
limit is then reduced to $50,000 by the AIR ($500,000 - $450,000). The
reduced deduction limit is then applied to N's $50,000 of DDR
attributable to services performed by N in M's 2016 taxable year that is
paid in 2018. Because $50,000 does not exceed the reduced deduction
limit of $50,000, all $50,000 of the DDR attributed to M's 2016 taxable
year is deductible for 2018, the year of payment. The deduction limit
for remuneration attributable to services performed by N in 2016 is then
reduced to zero, and this reduced limit is applied to any future payment
of DDR attributable to services performed by N in 2016. With respect to
M's 2017 taxable year, the $500,000 deduction limit for 2017 is applied
first to N's $500,000 of AIR for 2017. Because the deduction limit is
not greater than the AIR, M may deduct the entire $500,000 of AIR paid
in 2017. The $500,000 deduction limit is then reduced to zero by the
amount of the AIR against which it is applied ($500,000 - $500,000). The
reduced deduction limit is applied to N's $100,000 of DDR attributable
to services performed by N in M's 2017 taxable year that is paid in
2018. Because $100,000 exceeds the reduced deduction limit of zero, the
$100,000 of the DDR attributed to services performed by N in M's 2017
taxable year is not deductible for the year of payment (or any other
taxable year). As a result, $100,000 of the $200,000 payment ($50,000 +
$50,000 + $0) is deductible by M for M's 2018 taxable year, and the
remaining $100,000 is not deductible by M for any taxable year.
Example 4 (Installment payments and in-service payment attributable
to multiple taxable years from an account balance plan using the account
balance ratio method). (i) O is an applicable individual of corporation
L for all relevant taxable years. On January 1, 2016, O begins
participating in a nonqualified deferred compensation plan sponsored by
L that is an account balance plan. Under the plan, all amounts are fully
vested at all times. L makes contributions to O's account each year and
credits earnings based on a predetermined actual investment within the
meaning of Sec. 31.3121(v)(2)-1(d)(2)(i)(B). The closing balances in
O's account (including contributions, earnings, and distributions made
during the year) are $100,000 on December 31, 2016, $250,000 on December
31, 2017, and $50,000 on December 31, 2018. O's AIR from L is $500,000
for 2016, $300,000 for 2017, and $450,000 for 2018. On December 31,
2018, L pays O $400,000 in accordance with the plan terms. On December
31, 2019, O's account balance is $200,000, reflecting additional credits
of $125,000 made during the year and earnings on the account. O's AIR
from L is $200,000 for 2019. O ceases providing services to L on
December 31, 2019. On January 1, 2020, L pays O $200,000 in accordance
with the plan terms. L uses the account balance ratio method to
attribute amounts to services performed in taxable years.
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(ii) To determine the extent to which L is entitled to a deduction
for any portion of either of the payments under the plan, O's payments
under the plan must first be attributed to services performed by O in
L's taxable years in accordance with the attribution rules set forth in
paragraph (d) of this section. For purposes of attributing the $400,000
payment made on December 31, 2018 to a taxable year, the increase in O's
account balance during 2016 is $100,000 ($100,000 - zero); the increase
in O's account balance for 2017 is $150,000 ($250,000 - $100,000); and
the increase in O's account balance for 2018 is $200,000 ($50,000 -
$250,000 + $400,000 (payment on December 31, 2018)). The sum of all the
increases is $450,000 ($100,000 + $150,000 + $200,000). Thus, for L's
2016 taxable year, the attribution fraction is .2222 ($100,000/
$450,000); for L's 2017 taxable year, the attribution fraction is .3333
($150,000/$450,000); and for L's 2018 taxable year, the attribution
fraction is .4444 ($200,000/$450,000). Accordingly, with respect to the
$400,000 payment made on December 31, 2019, $88,889 ($400,000 x .2222)
is attributable to services performed by O in L's 2016 taxable year;
$133,333 ($400,000 x .3333) is attributable to services performed by O
in L's 2017 taxable year; and $177,778 ($400,000 x .4444) is
attributable to services performed by O in L's 2018 taxable year.
(iii) The portion of the $400,000 payment attributed to services
performed in a disqualified taxable year under paragraph (d) of this
section that exceeds the deduction limit for that disqualified taxable
year, as reduced through the date of payment, is not deductible in any
taxable year. The $500,000 deduction limit for 2016 is applied first to
O's $500,000 of AIR for 2016. Because the deduction limit is equal to
the $500,000 of AIR, L may deduct the entire $500,000 of AIR paid in
2016. The $500,000 deduction limit is then reduced to zero by the amount
of the AIR ($500,000 - $500,000). The reduced deduction limit is applied
to O's $88,889 of DDR attributable to services performed by O in L's
2016 taxable year that is paid in 2018. Because $88,889 exceeds the
reduced deduction limit of zero, the $88,889 of DDR attributed to 2016
is not deductible for L's 2018 taxable year or any other taxable year.
With respect to L's 2017 taxable year, the $500,000 deduction limitation
for 2017 is applied first to O's $300,000 of AIR for 2017. Because the
$500,000 deduction limit is greater than the $300,000 of AIR, L may
deduct the entire $300,000 of AIR paid in 2017. The $500,000 deduction
limit is reduced to $200,000 by the amount of the AIR ($500,000 -
$300,000). The reduced deduction limit is then applied to O's $133,333
of DDR attributable to services performed by O in L's 2017 taxable year
that is paid in 2018. Because $133,333 does not exceed that reduced
deduction limit of $200,000, the $133,333 is deductible for 2018. The
deduction limit for remuneration attributable to services performed by O
in 2017 is then reduced to $66,667 ($200,000 - $133,333), and this
reduced limit is applied to any future payment of DDR attributable to
services performed by O in 2017. With respect to L's 2018 taxable year,
the $500,000 deduction limit for 2018 is applied first to O's $450,000
of AIR for 2018. Because the deduction limit is greater than the AIR, L
may deduct the entire $450,000 of AIR paid in 2017. The $500,000
deduction limit is reduced to $50,000 by the amount of the AIR ($500,000
- $450,000). The reduced deduction limit is applied to O's $177,778
attributable to services performed by O in L's 2018 taxable year that is
paid in 2018. Because the $177,778 exceeds the reduced deduction limit
of $50,000, $50,000 of DDR is deductible for L's 2018 taxable year, and
$127,778 of the $177,778 is not deductible for L's 2018 taxable year or
any other taxable year. As a result, $183,333 of the $400,000 payment
($0 + $133,333 + $50,000) is deductible by L for L's 2018 taxable year,
and the remaining $216,667 is not deductible by L for any taxable year.
(iv) For purposes of attributing amounts paid or made available from
the plan in future taxable years, the following adjustments are made to
O's account balances to reflect the in-service payment of $400,000 in
2018. O's account balance as of December 31, 2016 is reduced by the
$88,889 attributable to 2016; and for 2017 is reduced by the sum of the
$133,333 attributable to 2017 and the $88,889 attributable to 2016.
Therefore, after attributing the $400,000 payment, O's adjusted closing
account balance as of December 31, 2016, is $11,111 ($100,000 -
$88,889), and as of December 31, 2017, is $27,778 ($250,000 - $133,333 -
$88,889).
(v) For purposes of attributing the $200,000 payment made on January
1, 2020, to services performed in the taxable years of S, the increase
in O's account balance during 2016 is $11,111 ($11,111 - $0); the
increase in O's account balance for 2017 is $16,667 ($27,778 - $11,111);
the increase in O's account balance for 2018 is $22,222 ($50,000 -
$27,778), and the increase in O's account balance for 2019 is $150,000
($200,000 - $50,000). The sum of all such increases is $200,000 ($11,111
+ $16,667 + $22,222 + $150,000). Thus, for O's 2016 taxable year, the
attribution fraction is .0556 ($11,111/$200,000); for O's 2017, taxable
year, the attribution fraction is .0833 ($16,667/$200,000); for O's 2018
taxable year, the attribution fraction is .1111 ($22,222/$200,000); for
O's 2019 taxable year, the attribution fraction is .7500 ($150,000/
$200,000). Accordingly, with respect to the $200,000 payment made on
January 1, 2020, $11,111 ($200,000 x .0556) of DDR is attributable to
services performed by O in L's 2016 taxable year; $16,667 ($200,000 x
.0833) of DDR is attributable to services performed by O in L's 2017
taxable year; $22,222 ($200,000 x .1111) of DDR is attributable to
services performed by O in L's 2018 taxable year; and $150,000 ($200,000
x .7500) of DDR is attributable to
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services performed by O in L's 2019 taxable year.
(vi) The portion of the DDR attributed to a disqualified taxable
year under paragraph (d) of this section that exceeds the deduction
limit for that disqualified taxable year, as reduced, is not deductible
for any taxable year. For L's 2016 taxable year, the deduction limit is
reduced to zero by the $500,000 of AIR for that year. Because $11,111
exceeds the reduced deduction limit of zero, $11,111 of the DDR is not
deductible for L's 2020 taxable year or any other taxable year. For L's
2017 taxable year, the deduction limit is reduced to $200,000 by the
$300,000 of AIR for that year and further reduced to $66,667 by the
$133,333 of DDR previously attributed to 2017. Because $16,667 does not
exceed the $66,667 deduction limit, the $16,667 of DDR is deductible for
L's 2020 taxable year, the year of payment. The deduction limit for
remuneration attributable to services performed by O in 2017 is then
reduced to $50,000 ($66,667 - $16,667), and this reduced limit is
applied to any future payment attributable to services performed by O in
2017. For L's 2018 taxable year, the deduction limit is reduced to zero
by the $450,000 of AIR for that year and the $50,000 of DDR previously
attributed to 2018. Because $22,222 exceeds the reduced deduction limit
of zero for 2018, the $22,222 of DDR is not deductible for L's 2020
taxable year or any other taxable year. For L's 2019 taxable year, the
$500,000 deduction limit for 2019 is applied first to O's $200,000 of
AIR for 2019. Because the deduction limit is greater than the AIR, L may
deduct the entire $200,000 of AIR paid in 2019. The $500,000 deduction
limit is reduced to $300,000 by the amount of the AIR ($500,000 -
$200,000). The reduced deduction limit is applied to O's $150,000 of DDR
attributable to services performed by O in L's 2019 taxable year that is
paid in 2020. Because $150,000 does not exceed the $300,000 limit, the
$150,000 of DDR is deductible for L's 2020 taxable year, the year of
payment. The deduction limit for remuneration attributable to services
performed by O in 2019 is then reduced to $150,000 ($500,000 - $200,000
- $150,000), and this reduced limit is applied to any future payment
attributable to services performed by O in 2019. As a result, $166,667
of the $200,000 payment ($0 + $16,667 + $0 + $150,000) is deductible by
L for L's 2020 taxable year, the year of payment, and the remaining
$33,333 is not deductible by L for any taxable year.
Example 5 (Installment payments and in-service payment attributable
to multiple taxable years from an account balance plan using the
principal additions method). (i) The facts are the same as set forth in
Example 4, paragraph (i), except that L uses the principal additions
method for attributing remuneration from an account balance plan;
principal additions under the plan are $100,000 in 2016, $125,000 in
2017, $150,000 in 2018, and $125,000 in 2019; as of the December 31,
2018 initial date of payment, earnings on the 2016, 2017, and 2018
principal additions are $40,000, $30,000, and $5,000 respectively. Under
the terms of the plan, the $400,000 payment made on December 31, 2018,
is from principal additions in 2016, 2017, and 2018, and earnings
thereon, and the $200,000 payment made on January 1, 2020, is from
principal additions in 2018 and 2019, and earnings thereon.
(ii) To determine the extent to which L is entitled to a deduction
for any portion of either payment under the plan, the payments to O
under the plan must first be attributed to services performed by O in
F's taxable years in accordance with the attribution rules set forth in
paragraph (d) of this section. Under the rules in paragraph (d)(3)(ii)
of this section, the $400,000 payment on January 1, 2019, is attributed
to services performed by O in the taxable year to which the payment
relates under the terms of the plan. DDR including principal additions
and earnings thereon are attributed to services performed by O in a
taxable year of L when the $400,000 payment is made to O on December 31,
2018. Under the terms of the plan, the $400,000 payment made on December
31, 2018 is attributed to services performed by O in L's 2016 taxable
year in the amount of $140,000, and is attributed to services performed
by O in L's 2017 taxable year in the amount of $155,000, and the
remaining $105,000 ($400,000 - $140,000 - $155,000) is attributed to
services performed by O in L's 2018 taxable year.
(iii) The portion of the DDR attributable to services performed in a
disqualified taxable year under paragraph (d) of this section that
exceeds the deduction limit for that disqualified taxable year, as
reduced, is not deductible for any taxable year. The $500,000 deduction
limitation for 2016 is applied first to O's $500,000 of AIR for 2016.
Because the deduction limit is equal to the $500,000 of AIR, L may
deduct the entire $500,000 of AIR paid in 2016. The $500,000 deduction
limit is then reduced to zero by the amount of the AIR ($500,000 -
$500,000). The reduced deduction limit is applied to O's $140,000 of DDR
attributable to services performed by O in L's 2016 taxable year that is
paid in 2018. Because $140,000 exceeds the reduced deduction limit of
zero, the $140,000 is not deductible for L's 2018 taxable year (the year
of payment), or any other taxable year. For L's 2017 taxable year, the
$500,000 deduction limit for 2017 is applied first to O's $300,000 of
AIR for 2017. Because the deduction limit is greater than the AIR, L may
deduct the entire $300,000 of AIR paid in 2017. The $500,000 deduction
limit is then reduced to $200,000 by the amount of the AIR ($500,000 -
$300,000). The reduced deduction limit is applied to O's $155,000 of DDR
attributable to services performed by O in L's 2017 taxable year that is
paid in 2018. Because $155,000 does not exceed
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the reduced deduction limit of $200,000, the $155,000 payment is
deductible for 2018. For L's 2018 taxable year, the $500,000 deduction
limitation for 2018 is applied first to O's $450,000 of AIR for 2018.
Because the deduction limit is greater than the AIR, L may deduct the
entire $450,000 of AIR paid in 2018. The $500,000 deduction limit is
then reduced to $50,000 by the amount of the AIR ($500,000 - $450,000).
The reduced deduction limit is applied to O's $105,000 of DDR
attributable to services performed by O in L's 2018 taxable year that is
paid in 2018. Because $105,000 exceeds the reduced deduction limit of
$50,000, $55,000 of the $105,000 attributable to L's 2018 taxable year
is not deductible for 2018 (the year of payment), or any other taxable
year. As a result, $205,000 of the $400,000 payment ($0 + $155,000 +
$50,000) is deductible by L for L's 2018 taxable year (the year of
payment) and the remaining $195,000 is not deductible by L for any
taxable year.
(iv) Earnings through January 1, 2020 on the principal addition for
L's 2018 taxable year ($50,000) that was not paid as part of the
December 31, 2018 payment are $5,000. Earnings through January 1, 2020
on the $125,000 credited to O's account on January 1, 2019 are $20,000.
On December 31, 2018, after the $400,000 payment is applied to 2016,
2017, and 2018, the account balance for 2016 and 2017 is reduced to
zero, and the account balance for 2018 is reduced to $50,000 ($150,000 +
$5,000 (earnings) - $105,000). Under the terms of the plan, the $200,000
payment made on January 1, 2020, is attributable to services performed
by O in L's 2018 and 2019 taxable years. Therefore, the $200,000 payment
on January 1, 2020 is attributed to services performed by O in L's
taxable years as follows: $55,000 ($50,000 + $5,000) to 2018 and
$145,000 ($125,000 + $20,000) to 2019.
(v) The portion of the DDR attributed to a disqualified taxable year
under paragraph (d) of this section that exceeds the deduction limit for
that disqualified taxable year, as reduced, is not deductible for any
taxable year. For L's 2018 taxable year, the deduction limit is reduced
to zero by the $450,000 of AIR for that year and the payment of $50,000
of DDR attributable to that year. Because $55,000 exceeds the reduced
deduction limit of zero, the $55,000 is not deductible for 2020, the
year of payment (or any other taxable year). With respect to L's 2019
taxable year, the $500,000 deduction limit for 2019 is applied first to
O's $200,000 of AIR for 2019. Because the deduction limit is greater
than the AIR, L may deduct the entire $200,000 of AIR paid in 2019. The
$500,000 deduction limit is then reduced to $300,000 by the amount of
the AIR ($500,000 - $200,000). The reduced deduction limit is applied to
O's $145,000 of DDR attributable to services performed by O in L's 2019
taxable year that is paid in 2020. Because $145,000 does not exceed the
$300,000 reduced limit, the $145,000 is deductible for 2020 (the year of
payment). As a result, $145,000 of the $200,000 payment ($0 + $145,000)
is deductible for L's 2020 taxable year, and the remaining $55,000 is
not deductible by L for any taxable year.
(4) Application of deduction limitation to aggregated groups of
covered health insurance providers--(i) In general. The total combined
deduction for AIR and DDR attributable to services performed by an
applicable individual in a disqualified taxable year allowed for all
members of an aggregated group that are covered health insurance
providers for any taxable year is limited to $500,000. Therefore, if two
or more members of an aggregated group that are covered health insurance
providers may otherwise deduct AIR or DDR attributable to services
performed by an applicable individual in a disqualified taxable year,
the AIR and DDR otherwise deductible by all members of the aggregated
group is combined, and the deduction limitation is applied to the total
amount.
(ii) Proration of deduction limitation. If the total amount of AIR
or DDR attributable to services performed by an applicable individual in
a disqualified taxable year that is otherwise deductible by two or more
members of an aggregated group in any taxable year exceeds the $500,000
deduction limit (as reduced by previously deductible AIR or DDR, if
applicable), the deduction limit is prorated based on the AIR or DDR
otherwise deductible by the members of the aggregated group in the
taxable year and allocated to each member of the aggregated group. The
deduction limit allocated to each member of the aggregated group is
determined by multiplying the deduction limit for the disqualified
taxable year (as previously reduced, if applicable) by a fraction, the
numerator of which is the AIR or DDR otherwise deductible by that member
in that taxable year that is attributable to services performed by the
applicable individual in the disqualified taxable year, and the
denominator of which is the total AIR or DDR otherwise deductible by all
members of the aggregated group in that taxable year that is
attributable to services performed by the applicable individual in the
disqualified taxable year. The
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amount of AIR or DDR otherwise deductible by a member of the aggregated
group in excess of the portion of the deduction limit allocated to that
member is not deductible in any taxable year. If a covered health
insurance provider is a member of more than one aggregated group, the
deduction limit for that covered health insurance provider under section
162(m)(6) may in no event exceed $500,000 for AIR and DDR attributable
to services performed by an applicable individual in a disqualified
taxable year.
(5) Examples. The following examples illustrate the rules of
paragraph (e)(4) of this section. For purposes of these examples, each
corporation has a taxable year that is the calendar year and is a
covered health insurance provider for all relevant taxable years, and
DDR is otherwise deductible by the covered health insurance provider in
the taxable year in which it is paid.
Example 1. (i) Corporations I, J, and K are members of the same
aggregated group under paragraph (b)(3) of this section. At separate
times during 2016, C is an employee of, and performs services for, I, J,
and K. C's total AIR for 2016 is $1,500,000, which consists of $750,000
of AIR for services performed to K; $450,000 of AIR for services
provided to J; and $300,000 of AIR for services to I.
(ii) Because I, J, and K are members of the same aggregated group,
the AIR otherwise deductible by them is aggregated for purposes of
applying the deduction limitation. Further, because the aggregate AIR
otherwise deductible by I, J, and K for 2016 exceeds the deduction
limitation for C for that taxable year, the deduction limit is prorated
and allocated to the members of the aggregated group in proportion to
the AIR otherwise deductible by each member of the aggregated group for
that taxable year. Therefore, the deduction limit that applies to the
AIR otherwise deductible by K is $250,000 ($500,000 x ($750,000/
$1,500,000)); the deduction limit that applies to the AIR otherwise
deductible by J is $150,000 ($500,000 x ($450,000/$1,500,000)); and the
deduction limit that applies to AIR otherwise deductible by I is
$100,000 ($500,000 x ($300,000/$1,500,000)). For the 2016 taxable year,
K may not deduct $500,000 of the $750,000 of AIR paid to C ($750,000 -
$250,000); J may not deduct $300,000 of the $450,000 of AIR paid to C
($450,000 - $150,000); and I may not deduct $200,000 of the $300,000 of
AIR paid to C ($300,000 - $100,000).
Example 2. (i) The facts are the same as Example 1, except that C's
total AIR for 2016 is $400,000, which consists of $75,000 for services
provided to K; $150,000 for services provided to J; and $175,000 for
services provided to I. In addition, C becomes entitled to $60,000 of
DDR attributable to services provided to K in 2016, which is payable
(and paid) on April 1, 2018, and $75,000 of DDR attributable to services
provided to J in 2016, which is payable (and paid) on April 1, 2019.
(ii) Because C's total AIR of $400,000 for 2016 for services
provided to K, J, and I do not exceed the $500,000 limitation, K, J, and
I may deduct $75,000, $150,000, and $175,000, respectively, for 2016.
The deduction limit is then reduced to $100,000 by the total AIR
deductible by all members of the aggregated group ($500,000 - $400,000).
The deduction limit, as reduced, is then applied to any DDR attributable
to services provided by C in 2016 in the first subsequent taxable year
that DDR becomes deductible. The first year that DDR for 2016 becomes
deductible is 2018, due to the $60,000 payment made on April 1, 2018.
Because the $60,000 of DDR otherwise deductible by K does not exceed the
2016 $100,000 deduction limit, K may deduct the entire $60,000 for its
2018 taxable year. The $100,000 deduction limit is then reduced by the
$60,000 of DDR deductible by K for 2018, and the reduced deduction limit
of $40,000 ($100,000 - $60,000) is applied to the $75,000 of DDR that is
otherwise deductible for 2019. Because the DDR of $75,000 otherwise
deductible by J exceeds the reduced deduction limit of $40,000, J may
deduct only $40,000, and the remaining $35,000 ($75,000 - $40,000) is
not deductible by J for that taxable year or any other taxable year.
Example 3. (i) The facts are the same as Example 2, except that C's
DDR of $75,000 attributable to services performed by C in J's 2016
taxable year is payable (and paid) on July 1, 2018.
(ii) The results are the same as Example 2, except that the reduced
deduction limit of $100,000 is prorated between K and J in proportion to
the DDR otherwise deductible by them for 2018. Accordingly, $44,444 of
the remaining deduction limit is allocated to K ($100,000 x ($60,000/
$135,000)), and $55,556 of the remaining deduction limit is allocated to
J ($100,000 x ($75,000/$135,000)). Because the $60,000 of DDR otherwise
deductible by K exceeds the $44,444 deduction limit applied to that
remuneration, K may deduct only $44,444 of the $60,000 payment, and
$15,556 may not be deducted by K for the 2018 taxable year or any other
taxable year. Similarly, because the $75,000 of DDR otherwise deductible
by J exceeds the $55,556 deduction limit applied to that remuneration, J
may deduct only $55,556 of the $75,000 payment, and $19,444 may not be
deducted by J for that taxable year or any other taxable year.
(f) Corporate transactions--(1) Treatment as a covered health
insurance provider in connection with a corporate
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transaction. Except as otherwise provided in this paragraph (f), a
person that participates in a corporate transaction is a covered health
insurance provider for the taxable year in which the corporate
transaction occurs (and any other taxable year) if it would otherwise be
a covered health insurance provider under paragraph (b)(4) of this
section for that taxable year. For example, if a member of an aggregated
group that did not previously include a health insurance issuer
purchases a health insurance issuer that is a covered health insurance
provider (so that the health insurance issuer becomes a member of the
aggregated group), each member of the acquiring aggregated group will be
a covered health insurance provider for its full taxable year in which
the corporate transaction occurs and each subsequent taxable year in
which the health insurance issuer continues to be a member of the group,
if it would otherwise be a covered health insurance provider under
paragraph (b)(4), except as otherwise provided in this paragraph (f).
For purposes of this section, the term corporate transaction means a
merger, acquisition or disposition of assets or stock, reorganization,
consolidation, separation, or any other transaction resulting in a
change in the composition of an aggregated group.
(2) Transition period relief for a person becoming a covered health
insurance provider solely as a result of a corporate transaction--(i) In
general. Except as provided in paragraph (f)(2)(ii) of this section, a
person that is not a covered health insurance provider before a
corporate transaction, but would (except for application of this
paragraph (f)(2)(i)) become a covered health insurance provider solely
because it becomes a member of an aggregated group with another person
that is a health insurance issuer as a result of the corporate
transaction, is not a covered health insurance provider subject to the
deduction limitation of section 162(m)(6) for the taxable year of that
person in which the corporate transaction occurs (the transition period
relief).
(ii) Certain applicable individuals. The transition period relief
described in paragraph (f)(2)(i) of this section does not apply with
respect to the remuneration of any individual who is an applicable
individual of a person that would have been a covered health insurance
provider for the taxable year in which the corporate transaction
occurred without regard to the occurrence of the corporate transaction
(for example, the applicable individuals of a health insurance issuer
and the members of its affiliated group that were covered health
insurance issuers before the occurrence of a corporate transaction).
This exception to the transition period relief applies even with respect
to remuneration attributable to services performed by the applicable
individual for a person that is eligible for the transition period
relief described in paragraph (f)(1)(ii)(A) of this section.
Accordingly, each member of an acquiring aggregated group that would
become a covered health insurance provider solely as a result of a
corporate transaction, but is not a covered health insurance provider
under the transition period relief described in paragraph (f)(1)(ii)(A)
of this section, is subject to the deduction limitation of section
162(m)(6) for its taxable year in which the corporate transaction occurs
with respect to AIR and DDR attributable to services performed by any
individual who is an applicable individual of the acquired health
insurance issuer and any member of its aggregated group that would have
been a covered health insurance provider in the taxable year in which
the corporate transaction occurred, even if the corporate transaction
had not occurred.
(3) Transition relief from the attribution consistency
requirements--(i) In general. Paragraphs (d)(3)(i), (d)(4)(i) and
(d)(5)(i)(B) of this section require a covered health insurance provider
and all members of its aggregated group to use the same method for
attributing remuneration to services performed by applicable individuals
consistently for all taxable years (attribution consistency
requirements). As a result of a corporate transaction, however, a
covered health insurance provider that uses an attribution method for
its account balance plans, nonaccount balance plans, or stock options or
SARs may become a member of an aggregated group with
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another covered health insurance provider that uses a different
attribution method for those types of plans or arrangements. In that
case, neither member of the aggregated group will be treated as
violating the attribution consistency requirements merely because it
uses an attribution method that is different from the attribution method
used by another member of its aggregated group to attribute remuneration
that becomes otherwise deductible in the taxable year in which the
corporate transaction occurs. However, the attribution consistency
requirements apply with respect to remuneration that becomes otherwise
deductible in all subsequent taxable years. Following the date of the
corporate transaction, any member of the aggregated group may change the
attribution method that it used before the date of the corporate
transaction to attribute remuneration under its account balance plans,
nonaccount balance plans, or stock options or SARs to make its method
consistent with the method used by any other member of the aggregated
group. Notwithstanding the foregoing, the Secretary may subject this
change in attribution method to limitations, or may otherwise modify the
attribution consistency requirements, pursuant to a notice, revenue
ruling, or other guidance of general applicability published in the
Internal Revenue Bulletin.
(ii) Exception for certain applicable individuals. Notwithstanding
the transition relief described in paragraphs (f)(2)(A) of this section,
if a covered health insurance provider has attributed remuneration under
a method described in paragraphs (d)(3), (d)(4), or (d)(5) of this
section with respect to an applicable individual before a corporate
transaction, the covered health insurance provider must continue at all
times to use that attribution method for all other remuneration that
becomes otherwise deductible under the same type of plan (that is, an
account balance plan, a nonaccount balance plan, or a stock option or
SAR) to which the applicable individual has a legally binding right as
of the corporate transaction.
(4) Deduction limitation not prorated for short taxable years. If a
corporate transaction results in a short taxable year for a covered
health insurance provider, the $500,000 deduction limit for the short
taxable year is neither prorated nor reduced. For example, if a
corporate transaction results in a short taxable year of three months,
the deduction limit under section 162(m)(6) for that short taxable year
is $500,000 (and is not reduced to $125,000).
(5) Effect of a corporate transaction on the application of the de
minimis exception. If a person becomes or ceases to be a member of an
aggregated group, only the premiums and gross revenues of that person
for the portion of its taxable year during which it is a member of the
aggregated group are taken into account for purposes of determining
whether the de minimis exception applies.
(6) Examples. The following examples illustrate the principles of
this paragraph (f). For purposes of these examples, each corporation has
a taxable year that is the calendar year unless stated otherwise, and
none of the corporations qualify for the de minimis exception under
paragraph (b)(4)(v) of this section.
Example 1. (i) Corporation J merges with and into corporation H on
June 30, 2015, such that H is the surviving entity. As a result of the
merger, J's taxable year ends on June 30, 2015. For its taxable year
ending June 30, 2015, J is a health insurance issuer that is a covered
health insurance provider. For all taxable years before the taxable year
of the merger, H is not a covered health insurance provider.
(ii) Corporation J is a covered health insurance provider for its
short taxable year ending June 30, 2015. As a result of the merger, H
becomes a covered health insurance provider for its 2015 taxable year,
but Corporation H is not a covered health insurance provider for its
2015 taxable year by reason of the transition period relief in paragraph
(f)(1)(ii)(A) of this section. However, applicable individuals of J
continue to be subject to the deduction limit under section 162(m)(6)
for amounts that become otherwise deductible in the 2015 taxable year
and DDR that is attributable to services performed by applicable
individuals of J, and H is a covered health insurance provider for all
subsequent taxable years for which it is a covered health insurance
provider under paragraph (b)(4) of this section.
Example 2. (i) On January 1, 2016, corporations D, E, and F are
members of a controlled group within the meaning of section
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414(b). F is a health insurance issuer that is a covered health
insurance provider under paragraph (b)(4)(i)(A) of this section. D and E
are not health insurance issuers (but are covered health insurance
providers pursuant to paragraphs (b)(4)(i)(C) and (D) of this section).
D is the parent entity of the DEF aggregated group. F's taxable year
ends on September 30. P is an applicable individual of F for all taxable
years. On May 1, 2016, a controlled group within the meaning of section
414(b) consisting of corporations C and B purchases all of the stock of
corporation F, resulting in a controlled group within the meaning of
section 414(b) consisting of corporations C, B, and F. The amount of
premiums received by F from providing minimum essential coverage during
the portion of its taxable year when it was a member of the DEF
aggregated group constitute more than two percent of the gross revenues
of the aggregated group for the taxable year of D (the parent entity)
ending on December 31, 2016, and the taxable years of E and F ending
with or within D's taxable year (December 31, 2016 and May 1, 2016
respectively). C and B are not health insurance issuers. C is the parent
entity of the CBF aggregated group. The CBF aggregated group is also a
consolidated group within the meaning of Sec. 1.1502-1(h). Thus, F's
taxable year ends on May 1, 2016 by reason of Sec. 1.1502-
76(b)(1)(ii)(A)(1), and F becomes part of the CBF consolidated group for
the taxable year ending December 31, 2016.
(ii) D and E are covered health insurance providers for the taxable
year ending December 31, 2016, and the de minimis exception does not
apply because the amount of premiums received by F from providing
minimum essential coverage during the short taxable year that it was a
member of the DEF aggregated group are more than two percent of the
gross revenues of the aggregated group for the taxable years during
which the members would otherwise be a covered health insurance
providers under paragraph (b)(4)(i) of this section. Accordingly, D and
E are subject to the deduction limitation under section 162(m)(6) for
their taxable years ending December 31, 2016. C and B are not covered
health insurance providers for their taxable year ending December 31,
2016, by reason of the transition period relief of paragraph
(f)(1)(ii)(A) of this section.
(iii) As a result of leaving the aggregated group, F has a new
taxable year beginning on May 2, 2016 and ending on December 31, 2016. F
is a covered health insurance provider within the meaning of paragraph
(b)(4) of this section for its new taxable year ending on December 31,
2016 (even though C and B are not covered health insurance providers for
their taxable years ending December 31, 2016) unless the CBF aggregated
group qualifies for the de minimis exception for that taxable year.
(iv) P is an applicable individual whose remuneration from F is
subject to the deduction limitation under section 162(m)(6) for F's
short taxable year ending May 1, 2016 and F's taxable year ending
December 31, 2016. In addition, any remuneration provided to P by C or B
at any time for services provided by P from May 1, 2016 to December 31,
2016 is also subject to the deduction limitation under section
162(m)(6), even though C and B are not covered health insurance
providers for their taxable years ending December 31, 2016 by reason of
the transition period relief of paragraph (f)(1)(ii)(A) of this section.
Remuneration to which P had the legally binding right on or before the
date of the transaction is subject to the deduction limitation when that
remuneration becomes otherwise deductible.
Example 3. (i) The same facts as Example 2, except that E is a
health insurance issuer that is a covered health insurance provider
under paragraph (b)(4) of this section and thus receives premiums from
providing minimum essential coverage (instead of F), and F is not a
health insurance issuer.
(ii) F is a covered health insurance provider for its short taxable
year ending May 1, 2016. However, because F is not a health insurance
issuer that is a covered health insurance provider and there are no
other health insurance issuers in the BCF aggregated group, F is not a
covered health insurance provider for its short, post-acquisition
taxable year ending December 31, 2016.
(iii) With respect to P, remuneration to which P had the legally
binding right on or before the date of the transaction is subject to the
deduction limitation. However, remuneration to which P obtains the
legally binding right after the date of the corporate transaction is not
subject to the deduction limitation.
Example 4. (i) Corporations N, O, and P are members of an aggregated
group as described in paragraph (b)(2) of this section. N is a health
insurance issuer that is a covered health insurance provider pursuant to
paragraph (b)(4)(i)(A) of this section, but neither O nor P is a health
insurance issuer. P is the parent entity of the aggregated group. On
April 1, 2016, O ceases to be a member of the NOP aggregated group as
the result of a corporate transaction. O's taxable year does not end as
a result of the corporate transaction.
(ii) Because O was a member of the NOP aggregated group during a
portion of its taxable year, O is a covered health insurance provider
for its taxable year ending December 31, 2016.
Example 5. (i) Corporations V, W, and X are members of an aggregated
group as described in paragraph (b)(2) of this section. V is a health
insurance issuer that is a covered
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health insurance provider pursuant to paragraph (b)(4)(i)(A) of this
section, but neither W nor X is a health insurance issuer. W is the
parent entity of the aggregated group. V's taxable year ends on December
31; W's taxable year ends on June 30; and X's taxable year ends on
September 30. For its taxable year ending June 30, 2017, W has $100x in
gross revenue. For its taxable year ending September 30, 2016, X has
$60x in gross revenue. For its taxable year ending December 31, 2016, V
receives $4x of premiums from providing minimum essential coverage and
has no other revenue. As of September 30, 2016, V ceases to be a member
of the VWX aggregated group. V's taxable year does not end on September
30, 2016 as a result of the transaction. Of the $4x that that V receives
for providing minimum essential coverage during its taxable year ending
December 31, 2016, $3x is received during the period from January 1,
2016 through September 30, 2016. As a result of the corporate
transaction, V's taxable year ends on September 30, 2016. The de minimis
exception of paragraph (b)(4)(v)(A) of this section did not apply to the
members of the VWX aggregated group for their immediately preceding
taxable years ending December 31, 2015, June 30, 2016, and September 30,
2015, respectively.
(ii) For purposes of applying the de minimis exception to an
aggregated group for a taxable year during which a person leaves or
joins the aggregated group, only the premiums and revenues of the person
for the portion of its taxable year during which it was a member of the
aggregated group are taken into account. The premiums from providing
minimum essential coverage received by the VWX aggregated group for W's
taxable year ending June 30, 2017 are $3x. The revenues of the V, W, and
X aggregated group for W's taxable year ending June 30, 2017 are $163x.
Accordingly, the premiums received by the members of the aggregated
group from providing minimum essential coverage are less than two
percent of the gross revenues of the aggregated group ($3x is less than
$3.26x (two percent of $163x)). Therefore, V, W and X are not covered
health insurance providers for their taxable years ending December 31,
2016, June 30, 2017, and September 30, 2016, respectively.
Example 6. (i) The facts are the same as Example 5, except that F
received $4x of premiums during the period from January 1, 2016 to
September 30, 2016, and the members of the VWX aggregated group were not
covered health insurance providers for their taxable years ending
December 31, 2015, June 30, 2016, and September 30, 2015, respectively
(their immediately preceding taxable years) solely by reason of the de
minimis exception of paragraph (b)(4)(v)(A) of this section.
(ii) The premiums from providing minimum essential coverage received
by the VWX aggregated group for W's taxable year ending June 30, 2017
are $4x. The revenues of the VWX aggregated group for W's taxable year
ending June 30, 2017 are $164x. Accordingly, the premiums received by
the members of the aggregated group from providing minimum essential
coverage are greater than two percent of the gross revenues of the
aggregated group ($4x is greater than $3.28x (two percent of $164x)).
Therefore, V, W, and X do not qualify for the de minimis exception for
their taxable years ending December 31, 2016, June 30, 2017, and
September 30, 2016, respectively. However, V, W, and X are not covered
health insurance providers for these taxable years by reason of the de
minimis exception one year transition period described in paragraph
(b)(4)(v)(B) of this section.
Example 7. (i) Corporation N is a health insurance issuer that is a
covered health insurance provider. Corporation O is also a health
insurance issuer that is a covered health insurance provider. Both N and
O have taxable years ending December 31. N uses the account balance
ratio method to attribute remuneration that becomes otherwise deductible
under its account balance plans. O uses the principal additions method
to attribute amounts that become otherwise deductible under its account
balance plans. On June 30, 2016, O purchases all of the stock of N.
(ii) For the taxable year of N and O ending December 31, 2016, N may
continue to attribute amounts that become deductible under its account
balance plans using the account balance ratio method, and O can continue
to attribute amounts that become otherwise deductible under its account
balance plan using the principal additions method, even though they are
members of the same aggregated group, pursuant to the transition period
relief described in paragraph (f)(2) of this section. In all subsequent
taxable years, N and O must use the same method to attribute amounts
that become otherwise deductible under their account balance plans.
Either N or O may change the method that it uses to attribute amounts
under its account balance plans to be consistent with the attribution
method used by the other.
Example 8. (i) The facts are the same as Example 7. In addition, B
is an applicable individual of N before the corporate transaction and is
a participant in an account balance plan of N. On December 31, 2015, N
made a payment to B, and N used the account balance ratio method
described in paragraph (d)(3)(ii) of this section to attribute the
payment to services performed by B in taxable years of N.
(ii) Because N used the account balance ratio method described in
paragraph (d)(3)(ii) of this section to attribute an amount that became
otherwise deductible under the plan
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before the corporate transaction, N must continue to use the account
balance ratio method for attributing amounts to which B had a legally
binding right as of the corporate transaction, whenever those amounts
become otherwise deductible.
(g) Coordination--(1) Coordination with section 162(m)(1). If
section 162(m)(1) and section 162(m)(6) both otherwise would apply with
respect to the remuneration of an applicable individual, the deduction
limitation under section 162(m)(6) applies without regard to section
162(m)(1). For example, if an applicable individual is both a covered
employee of a publicly held corporation (see sections 162(m)(2) and (3);
Sec. 1.162-27) and an applicable individual within the meaning of
paragraph (b)(7) of this section, remuneration earned by the applicable
individual that is attributable to a disqualified taxable year of a
covered health insurance provider is subject to the $500,000 deduction
limitation under section 162(m)(6) with respect to such disqualified
taxable year, without regard to section 162(m)(1).
(2) Coordination with disallowed excess parachute payments--(i) In
general. The $500,000 deduction limitation of section 162(m)(6) is
reduced (but not below zero) by the amount (if any) that would have been
included in the AIR or DDR of the applicable individual for a taxable
year but for the deduction for the AIR or DDR being disallowed by reason
of section 280G.
(ii) Example. The following example illustrates the rule of this
paragraph (g)(2).
Example. Corporation A, a covered health insurance provider, pays
$750,000 of AIR to P, an applicable individual, during A's disqualified
taxable year ending December 31, 2016. Of the $750,000, $300,000 is an
excess parachute payment as defined in section 280G(b)(1), the deduction
for which is disallowed by reason of that section. The excess parachute
payment reduces the $500,000 deduction limit to $200,000 ($500,000 -
$300,000). Therefore, A may deduct only $200,000 of the $750,000 in AIR,
and $250,000 of the payment is not deductible by reason of section
162(m)(6).
(h) Grandfathered amounts attributable to services performed in
taxable years beginning before January 1, 2010--(1) In general. The
section 162(m)(6) deduction limitation does not apply to remuneration
attributable to services performed in taxable years of a covered health
insurance provider beginning before January 1, 2010 (grandfathered
amounts). For purposes of this paragraph (h), whether remuneration is
attributable to services performed in a taxable year beginning before
January 1, 2010, is determined by applying an attribution method
described in paragraph (h)(2) of this section.
(2) Identification of services performed in taxable years beginning
before January 1, 2010--(i) In general. DDR described in paragraphs
(d)(2) (legally binding right), (d)(3) (account balance plans), (d)(4)
(nonaccount balance plans), (d)(6) (involuntary separation pay), (d)(7)
(reimbursements), and (d)(8) (split dollar life insurance) of this
section is attributable to services performed in a taxable year
beginning before January 1, 2010 if it is attributable to services
performed before that date under the rules of these paragraphs, without
regard to whether that remuneration is subject to a substantial risk of
forfeiture on or after that date. Notwithstanding the requirement under
paragraph (d)(3)(i) of this section that a covered health insurance
provider must use the same attribution method for its account balance
plans for all taxable years, a covered health insurance provider that
uses the account balance ratio method described in paragraph (d)(3)(i)
of this section to attribute remuneration to services performed in
taxable years beginning after December 31, 2009 may use the principal
additions method described in paragraph (d)(3)(ii) of this section to
attribute remuneration under an account balance plan to services
performed in a taxable year beginning before January 1, 2010 for
purposes of determining grandfathered amounts under the plan. (See
paragraph (d)(3)(ii)(C)(3) of this section for required account balance
adjustments if a covered health insurance provider generally uses the
account balance ratio method to attribute amounts otherwise deductible
under its account balance plans but uses the principal additions method
to attribute remuneration to services performed in taxable years
beginning before January 1, 2010.)
(ii) Equity-based remuneration. For purposes of this section, all
remuneration resulting from a stock option,
[[Page 271]]
stock appreciation right, restricted stock, or restricted stock unit and
the right to any associated dividends or dividend equivalents (together,
referred to as equity-based remuneration) granted before the first day
of the taxable year of the covered health insurance provider beginning
on or after January 1, 2010, is attributable to services performed in
taxable years beginning before January 1, 2010, regardless of the date
on which the equity-based remuneration is exercised (in the case of a
stock option or SAR), the date on which the amounts due under the
equity-based remuneration are paid or includible in income, or whether
the equity-based remuneration is subject to a substantial risk of
forfeiture on or after the first day of the taxable year of the covered
health insurance provider beginning on or after January 1, 2010. For
example, appreciation in the value of restricted shares granted before
the first day of the taxable year beginning on or after January 1, 2010
is treated as remuneration that is attributable to services performed in
taxable years beginning before January 1, 2010, regardless of whether
the shares are vested at that time.
(i) Transition rules for certain DDR--(1) Transition rule for DDR
attributable to services performed in taxable years of the covered
health insurance provider beginning after December 31, 2009 and before
January 1, 2013. The deduction limitation under section 162(m)(6)
applies to DDR attributable to services performed in a disqualified
taxable year of a covered health insurance provider beginning after
December 31, 2009 and before January 1, 2013, only if that remuneration
is otherwise deductible in a disqualified taxable year of the covered
health insurance provider beginning after December 31, 2012. However, if
the deduction limitation applies to DDR attributable to services
performed by an applicable individual in a disqualified taxable year of
a covered health insurance provider beginning after December 31, 2009
and before January 1, 2013, the deduction limitation is calculated as if
it had been applied to the applicable individual's AIR and DDR
deductible in those taxable years.
(2) Examples. The following examples illustrate the principles of
this paragraph (i). For purposes of these examples, each corporation has
a taxable year that is the calendar year, and DDR is otherwise
deductible by the covered health insurance provider in the taxable year
in which it is paid.
Example 1. (i) Q is an applicable individual of corporation Z. Z's
2010, 2011, and 2012 taxable years are disqualified taxable years. Z's
2013, 2014, and 2015 taxable years are not disqualified taxable years.
However, Z's 2016 taxable year and all subsequent taxable years are
disqualified taxable years. Q receives $200,000 of AIR from Z for 2012,
and becomes entitled to $800,000 of DDR that is attributable to services
performed by Q in 2012. Z pays Q $350,000 of the DDR in 2015, and the
remaining $450,000 of the DDR in 2016. These payments are otherwise
deductible by Z in 2015 and 2016, respectively.
(ii) DDR attributable to services performed by Q in Z's 2010, 2011,
and 2012 taxable years that is otherwise deductible in Z's 2013, 2014,
or 2015 taxable years is not subject to the deduction limitation under
section 162(m)(6) by reason of the transition rule under paragraph
(i)(1) of this section. However, DDR attributable to services performed
in Z's 2010, 2011, and 2012 taxable years that is otherwise deductible
in a later taxable year that is a disqualified taxable year (in this
case, Z's 2016 and subsequent taxable years) is subject to the deduction
limitation under section 162(m)(6). Accordingly, the deduction
limitation with respect to AIR and DDR attributable to services
performed by Q in 2012 is determined by reducing the $500,000 deduction
limit by the $200,000 of AIR paid to Q by Z for 2012 ($500,000 -
$200,000). Under the transition rule of paragraph (i)(1) of this
section, no portion of the reduced deduction limit of $300,000 for the
2012 taxable year is applied against the $350,000 payment made in 2015,
and accordingly, the deduction limit is not reduced by the amount of
that payment. The reduced deduction limit is then applied to Q's
$450,000 of DDR attributable to services performed by Q in 2012 that is
paid to Q and becomes otherwise deductible in 2016. Because the reduced
deduction limit of $300,000 is less than the $450,000 otherwise
deductible by Z in 2016, Z may deduct only $300,000 of the DDR, and
$150,000 of the $450,000 payment is not deductible by Z in that taxable
year or any taxable year.
Example 2. (i) R is an applicable individual of corporation Y, which
is a covered health insurance provider for all relevant taxable years.
During 2010, Y pays R $400,000 in salary and grants R a right to
$200,000 in DDR payable on a fixed schedule in 2011, 2012, and 2013.
Pursuant to the fixed schedule, Y pays R $50,000 of DDR in 2011, $50,000
of DDR in
[[Page 272]]
2012, and the remaining $100,000 of DDR in 2013.
(ii) Because the deduction limitation for DDR under section
162(m)(6)(A)(ii) is effective for DDR that is attributable to services
performed by an applicable individual during any disqualified taxable
year beginning after December 31, 2009 that would otherwise be
deductible in a taxable year beginning after December 31, 2012, only the
DDR paid by Y in 2013 is subject to the deduction limitation. However,
the limitation is applied as if section 162(m)(6) and paragraph (c)(2)
of this section were effective for taxable years beginning after
December 31, 2009 and before January 1, 2013. Accordingly, the deduction
limitation with respect to remuneration for services performed by R in
2010 is determined by reducing the $500,000 deduction limit by the
$400,000 of AIR paid to R for 2010 ($500,000 -$400,000). The reduced
deduction limit of $100,000 is further reduced to zero by the $50,000 of
DDR attributable to services performed by R in Y's 2010 taxable year
that is deductible in each of 2011 and 2012 (($100,000 - $50,000 -
$50,000). Because the deduction limit is reduced to zero, none of the
$100,000 of DDR attributable to services performed by R in Y's 2010
taxable year and paid to R in 2013 is deductible.
(j) Effective/applicability dates. These regulations are effective
on September 23, 2014. The regulations apply to taxable years beginning
on or after September 23, 2014.
[T.D, 9694, 79 FR 56904, Sept. 23, 2014]
Sec. 1.162-32 Expenses paid or incurred for lodging when not
traveling away from home.
(a) In general. Expenses paid or incurred for lodging of an
individual who is not traveling away from home (local lodging) generally
are personal, living, or family expenses that are nondeductible by the
individual under section 262(a). Under certain circumstances, however,
local lodging expenses may be deductible under section 162(a) as
ordinary and necessary expenses paid or incurred in connection with
carrying on a taxpayer's trade or business, including a trade or
business as an employee. Whether local lodging expenses are paid or
incurred in carrying on a taxpayer's trade or business is determined
under all the facts and circumstances. One factor is whether the
taxpayer incurs an expense because of a bona fide condition or
requirement of employment imposed by the taxpayer's employer. Expenses
paid or incurred for local lodging that is lavish or extravagant under
the circumstances or that primarily provides an individual with a social
or personal benefit are not incurred in carrying on a taxpayer's trade
or business.
(b) Safe harbor for local lodging at business meetings and
conferences. An individual's local lodging expenses will be treated as
ordinary and necessary business expenses if--
(1) The lodging is necessary for the individual to participate fully
in or be available for a bona fide business meeting, conference,
training activity, or other business function;
(2) The lodging is for a period that does not exceed five calendar
days and does not recur more frequently than once per calendar quarter;
(3) If the individual is an employee, the employee's employer
requires the employee to remain at the activity or function overnight;
and
(4) The lodging is not lavish or extravagant under the circumstances
and does not provide any significant element of personal pleasure,
recreation, or benefit.
(c) Examples. The provisions of the facts and circumstances test of
paragraph (a) of this section are illustrated by the following examples.
In each example the employer and the employees meet all other
requirements (such as substantiation) for deductibility of the expense
and for exclusion from income of the value of the lodging as a working
condition fringe or of reimbursements under an accountable plan.
Example 1. (i) Employer conducts a seven-day training session for
its employees at a hotel near Employer's main office. The training is
directly connected with Employer's trade or business. Some employees
attending the training are traveling away from home and some employees
are not traveling away from home. Employer requires all employees
attending the training to remain at the hotel overnight for the bona
fide purpose of facilitating the training. Employer pays the costs of
the lodging at the hotel directly to the hotel and does not treat the
value as compensation to the employees.
(ii) Because the training is longer than five calendar days, the
safe harbor in paragraph (b) of this section does not apply. However,
the value of the lodging may be excluded from income if the facts and
circumstances test in paragraph (a) of this section is satisfied.
[[Page 273]]
(iii) The training is a bona fide condition or requirement of
employment and Employer has a noncompensatory business purpose for
paying the lodging expenses. Employer is not paying the expenses
primarily to provide a social or personal benefit to the employees, and
the lodging Employer provides is not lavish or extravagant. If the
employees who are not traveling away from home had paid for their own
lodging, the expenses would have been deductible by the employees under
section 162(a) as ordinary and necessary business expenses. Therefore,
the value of the lodging is excluded from the employees' income as a
working condition fringe under section 132(a) and (d).
(iv) Employer may deduct the lodging expenses, including lodging for
employees who are not traveling away from home, as ordinary and
necessary business expenses under section a162(a).
Example 2. (i) The facts are the same as in Example 1, except that
the employees pay the cost of their lodging at the hotel directly to the
hotel, Employer reimburses the employees for the cost of the lodging,
and Employer does not treat the reimbursement as compensation to the
employees.
(ii) Because the training is longer than five calendar days, the
safe harbor in paragraph (b) of this section does not apply. However,
the reimbursement of the expenses for the lodging may be excluded from
income if the facts and circumstances test in paragraph (a) of this
section is satisfied.
(iii) The training is a bona fide condition or requirement of
employment and Employer is reimbursing the lodging expenses for a
noncompensatory business purpose and not primarily to provide a social
or personal benefit to the employees and the lodging Employer provides
is not lavish or extravagant. The employees incur the expenses in
performing services for the employer. If Employer had not reimbursed the
employees who are not traveling away from home for the cost of the
lodging, the expenses would have been deductible by the employees under
section 162(a) as ordinary and necessary business expenses. Therefore,
the reimbursements to the employees are made under an accountable plan
and are excluded from the employees' gross income.
(iv) Employer may deduct the lodging expense reimbursements,
including reimbursements for employees who are not traveling away from
home, as ordinary and necessary business expenses under section 162(a).
Example 3. (i) Employer is a professional sports team. Employer
requires its employees (for example, players and coaches) to stay at a
local hotel the night before a home game to conduct last minute training
and ensure the physical preparedness of the players. Employer pays the
lodging expenses directly to the hotel and does not treat the value as
compensation to the employees.
(ii) Because the overnight stays occur more than once per calendar
quarter, the safe harbor in paragraph (b) of this section does not
apply. However, the value of the lodging may be excluded from income if
the facts and circumstances test in paragraph (a) of this section is
satisfied.
(iii) The overnight stays are a bona fide condition or requirement
of employment and Employer has a noncompensatory business purpose for
paying the lodging expenses. Employer is not paying the lodging expenses
primarily to provide a social or personal benefit to the employees and
the lodging Employer provides is not lavish or extravagant. If the
employees had paid for their own lodging, the expenses would have been
deductible by the employees under section 162(a) as ordinary and
necessary business expenses. Therefore, the value of the lodging is
excluded from the employees' income as a working condition fringe.
(iv) Employer may deduct the expenses for lodging the employees at
the hotel as ordinary and necessary business expenses under section
162(a).
Example 4. (i) Employer hires Employee, who currently resides 500
miles from Employer's business premises. Employer pays for temporary
lodging for Employee near Employer's business premises while Employee
searches for a residence.
(ii) Employer is paying the temporary lodging expense primarily to
provide a personal benefit to Employee by providing housing while
Employee searches for a residence. Employer incurs the expense only as
additional compensation and not for a noncompensatory business purpose.
If Employee paid the temporary lodging expense, the expense would not be
an ordinary and necessary employee business expense under section 162(a)
because the lodging primarily provides a personal benefit to Employee.
Therefore, the value of the lodging is includible in Employee's gross
income as additional compensation.
(iii) Employer may deduct the lodging expenses as ordinary and
necessary business expenses under section 162(a) and Sec. 1.162-25T.
Example 5. (i) Employee normally travels two hours each way between
her home and her office. Employee is working on a project that requires
Employee to work late hours. Employer provides Employee with lodging at
a hotel near the office.
(ii) Employer is paying the temporary lodging expense primarily to
provide a personal benefit to Employee by relieving her of the daily
commute to her residence. Employer incurs the expense only as additional
compensation and not for a noncompensatory business purpose. If Employee
paid the temporary lodging expense, the expense would not be an ordinary
and necessary business expense under section 162(a) because the lodging
primarily provides a personal benefit
[[Page 274]]
to Employee. Therefore, the value of the lodging is includible in
Employee's gross income as additional compensation.
(iii) Employer may deduct the lodging expenses as ordinary and
necessary business expenses under section 162(a) and Sec. 1.162-25T.
Example 6. (i) Employer requires an employee to be ``on duty'' each
night to respond quickly to emergencies that may occur outside of normal
working hours. Employees who work daytime hours each serve a ``duty
shift'' once each month in addition to their normal work schedule.
Emergencies that require the duty shift employee to respond occur
regularly. Employer has no sleeping facilities on its business premises
and pays for a hotel room nearby where the duty shift employee stays
until called to respond to an emergency.
(ii) Because an employee's expenses for lodging while on the duty
shift occur more frequently than once per calendar quarter, the safe
harbor in paragraph (b) of this section does not apply. However, the
value of the lodging may be excluded from income if the facts and
circumstances test in paragraph (a) of this section is satisfied.
(iii) The duty shift is a bona fide condition or requirement of
employment and Employer has a noncompensatory business purpose for
paying the lodging expenses. Employer is not providing the lodging to
duty shift employees primarily to provide a social or personal benefit
to the employees and the lodging Employer provides is not lavish or
extravagant. If the employees had paid for their lodging, the expenses
would have been deductible by the employees under section 162(a) as
ordinary and necessary business expenses. Therefore, the value of the
lodging is excluded from the employees' income as a working condition
fringe.
(iv) Employer may deduct the lodging expenses as ordinary and
necessary business expenses under section 162(a).
(d) Effective/applicability date. This section applies to expenses
paid or incurred on or after October 1, 2014. However, taxpayers may
apply these regulations to local lodging expenses that are paid or
incurred in taxable years for which the period of limitation on credit
or refund under section 6511 has not expired.
[T.D. 9696, 79 FR 59113, Oct. 1, 2014]
Sec. 1.162(k)-1 Disallowance of deduction for reacquisition payments.
(a) In general. Except as provided in paragraph (b) of this section,
no deduction otherwise allowable is allowed under Chapter 1 of the
Internal Revenue Code for any amount paid or incurred by a corporation
in connection with the reacquisition of its stock or the stock of any
related person (as defined in section 465(b)(3)(C)). Amounts paid or
incurred in connection with the reacquisition of stock include amounts
paid by a corporation to reacquire its stock from an ESOP that are used
in a manner described in section 404(k)(2)(A). See Sec. 1.404(k)-3.
(b) Exceptions. Paragraph (a) of this section does not apply to
any--
(1) Deduction allowable under section 163 (relating to interest);
(2) Deduction for amounts that are properly allocable to
indebtedness and amortized over the term of such indebtedness;
(3) Deduction for dividends paid (within the meaning of section
561); or
(4) Amount paid or incurred in connection with the redemption of any
stock in a regulated investment company that issues only stock which is
redeemable upon the demand of the shareholder.
(c) Effective date. This section applies with respect to amounts
paid or incurred on or after August 30, 2006.
[T.D. 9282, 71 FR 51473, Aug. 30, 2006]
Sec. 1.162(l)-1T Deduction for health insurance costs of self-employed
individuals (temporary).
(a) Coordination of section 162(l) deduction for taxpayers subject
to section 36B--(1) In general. A taxpayer is allowed a deduction under
section 162(l) for specified premiums, as defined in paragraph (a)(2) of
this section, not to exceed an amount equal to the lesser of--
(i) The specified premiums less the premium tax credit attributable
to the specified premiums; and
(ii) The sum of the specified premiums not paid through advance
credit payments, as described in paragraph (a)(3) of this section, and
the additional tax (if any) imposed under section 36B(f)(2)(A) and Sec.
1.36B-4(a)(1) with respect to the specified premiums after application
of the limitation on additional tax in section 36B(f)(2)(B) and Sec.
1.36B-4(a)(3).
(2) Specified premiums. For purposes of paragraph (a)(1) of this
section, specified premiums means premiums for a specified qualified
health plan or plans for which the taxpayer may otherwise
[[Page 275]]
claim a deduction under section 162(l). For purposes of this paragraph
(a)(2), a specified qualified health plan is a qualified health plan, as
defined in Sec. 1.36B-1(c), covering the taxpayer, the taxpayer's
spouse, or a dependent of the taxpayer (enrolled family member) for a
month that is a coverage month within the meaning of Sec. 1.36B-3(c)
for the enrolled family member. If a specified qualified health plan
covers individuals other than enrolled family members, the specified
premiums include only the portion of the premiums for the specified
qualified health plan that is allocable to the enrolled family members
under rules similar to Sec. 1.36B-3(h), which provides rules for
determining the amount under Sec. 1.36B-3(d)(1) when two families are
enrolled in the same qualified health plan.
(3) Specified premiums not paid through advance credit payments. For
purposes of paragraph (a)(1)(ii) of this section, specified premiums not
paid through advance credit payments equal the amount of the specified
premiums minus the advance credit payments attributable to the specified
premiums.
(b) Additional guidance. The Secretary may provide by publication in
the Federal Register or in the Internal Revenue Bulletin (see Sec.
601.601(d)(2) of this chapter) additional guidance on coordinating the
deduction allowed under section 162(l) and the credit provided under
section 36B.
(c) Effective/applicability date. This section applies for taxable
years beginning after December 31, 2013.
(d) Expiration date. This section expires on July 24, 2017.
[T.D. 9683, 79 FR 43631, July 28, 2014]
Sec. 1.163-1 Interest deduction in general.
(a) Except as otherwise provided in sections 264 to 267, inclusive,
interest paid or accrued within the taxable year on indebtedness shall
be allowed as a deduction in computing taxable income. For rules
relating to interest on certain deferred payments, see section 483 and
the regulations thereunder.
(b) Interest paid by the taxpayer on a mortgage upon real estate of
which he is the legal or equitable owner, even though the taxpayer is
not directly liable upon the bond or note secured by such mortgage, may
be deducted as interest on his indebtedness. Pursuant to the provisions
of section 163(c), any annual or periodic rental payment made by a
taxpayer on or after January 1, 1962, under a redeemable ground rent, as
defined in section 1055(c) and paragraph (b) of Sec. 1.1055-1, is
required to be treated as interest on an indebtedness secured by a
mortgage and, accordingly, may be deducted by the taxpayer as interest
on his indebtedness. Section 163(c) has no application in respect of any
annual or periodic rental payment made prior to January 1, 1962, or
pursuant to an arrangement which does not constitute a ``redeemable
ground rent'' as defined in section 1055(c) and paragraph (b) of Sec.
1.1055-1. Accordingly, annual or periodic payments of Pennsylvania
ground rents made before, on, or after January 1, 1962, are deductible
as interest if the ground rent is redeemable. An annual or periodic
rental payment under a Maryland redeemable ground rent made prior to
January 1, 1962, is deductible in accordance with the rules and
regulations applicable at the time such payment was made. Any annual or
periodic rental payment under a Maryland redeemable ground rent made by
the taxpayer on or after January 1, 1962, is, pursuant to the provisions
of section 163(c), treated as interest on an indebtedness secured by a
mortgage and, accordingly, is deductible by the taxpayer as interest on
his indebtedness. In any case where the ground rent is irredeemable, any
annual or periodic ground rent payment shall be treated as rent and
shall be deductible only to the extent that the payment constitutes a
proper business expense. Amounts paid in redemption of a ground rent
shall not be treated as interest. For treatment of redeemable ground
rents and real property held subject to liabilities under redeemable
ground rents, see section 1055 and the regulations thereunder.
(c) Interest calculated for costkeeping or other purposes on account
of capital or surplus invested in the business which does not represent
a charge arising under an interest-bearing obligation, is not an
allowable deduction from gross income. Interest paid by a corporation on
scrip dividends is an allowable deduction. So-called interest on
preferred stock,
[[Page 276]]
which is in reality a dividend thereon, cannot be deducted in computing
taxable income. (See, however, section 583.) In the case of banks and
loan or trust companies, interest paid within the year on deposits, such
as interest paid on moneys received for investment and secured by
interest-bearing certificates of indebtedness issued by such bank or
loan or trust company, may be deducted from gross income.
(d) To the extent of assistance payments made in respect of an
indebtedness of the taxpayer during the taxable year by the Department
of Housing and Urban Development under section 235 of the National
Housing Act (12 U.S.C. 1715z), as amended, no deduction shall be allowed
under section 163 and this section for interest paid or accrued with
respect to such indebtedness. However, such payments shall not affect
the amount of any deduction under any section of the Code other than
section 163. The provisions of this paragraph shall apply to taxable
years beginning after December 31, 1974.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6821, 30 FR
6216, May 4, 1965; T.D. 6873, 31 FR 941, Jan. 25, 1966; T.D. 7408, 41 FR
9547, Mar. 5, 1976]
Sec. 1.163-2 Installment purchases where interest charge is not
separately stated.
(a) In general. (1) Whenever there is a contract with a seller for
the purchase of personal property providing for payment of part or all
of the purchase price in installments and there is a separately stated
carrying charge (including a finance charge, service charge, and the
like) but the actual interest charge cannot be ascertained, a portion of
the payments made during the taxable year under the contract shall be
treated as interest and is deductible under section 163 and this
section. Section 163(b) contains a formula, described in paragraph (b)
of this section, in accordance with which the amount of interest
deductible in the taxable year must be computed. This formula is
designed to operate automatically in the case of any installment
purchase, without regard to whether payments under the contract are made
when due or are in default. For applicable limitations when an
obligation to pay is terminated, see paragraph (c) of this section.
(2) Whenever there is a contract with an educational institution for
the purchase of educational services providing for payment of part or
all of the purchase price in installments and there is a separately
stated carrying charge (including a finance charge, service charge, and
the like) but the actual interest charge cannot be ascertained, a
portion of the payments made during the taxable year under the contract
shall be treated as interest and is deductible under section 163 and
this section. See paragraphs (b) and (c) of this section for the
applicable computation and limitations rules. For purposes of section
163(b) and this section, the term ``educational services'' means any
service (including lodging) which is purchased from an educational
institution (as defined in section 151(e)(4) and paragraph (c) of Sec.
1.151-3) and which is provided for a student of such institution.
(3) Section 163(b) and this section do not apply to a contract for
the loan of money, even if the loan is to be repaid in installments and
even if the borrowed amount is used to purchase personal property or
educational services. In cases to which the preceding sentence applies,
the portion of the installment payment which constitutes interest (as
distinguished from payments of principal and charges such as payments
for credit life insurance) is deductible under section 163(a) and Sec.
1.163-1.
(b) Computation. The portion of any such payments to be treated as
interest shall be equal to 6 percent of the average unpaid balance under
the contract during the taxable year. For purposes of this computation,
the average unpaid balance under the contract is the sum of the unpaid
balance outstanding on the first day of each month beginning during the
taxable year, divided by 12.
(c) Limitations. The amount treated as interest under section 163(b)
and this section for any taxable year shall not exceed the amount of the
payments made under the contract during the taxable year nor the
aggregate carrying charges properly attributable to each contract for
such taxable year. In
[[Page 277]]
computing the amount to be treated as interest if the obligation to pay
is terminated as, for example, in the case of a repossession of the
property, the unpaid balance on the first day of the month during which
the obligation is terminated shall be zero.
(d) Illustrations. The provisions of this section may be illustrated
by the following examples:
Example 1. On January 20, 1955, A purchased a television set for
$400, including a stated carrying charge of $25. The down payment was
$50, and the balance was paid in 14 monthly installments of $25 each, on
the 20th day of each month commencing with February. Assuming that A is
a cash method, calendar year taxpayer and that no other installment
purchases were made, the amount to be treated as interest in 1955 is
$12.38, computed as follows:
Year 1955
------------------------------------------------------------------------
Unpaid
First day of balance
outstanding
------------------------------------------------------------------------
January.................................................... 0
February................................................... $350
March...................................................... 325
April...................................................... 300
May........................................................ 275
June....................................................... 250
July....................................................... 225
August..................................................... 200
September.................................................. 175
October.................................................... 150
November................................................... 125
December................................................... 100
------------
2,475
------------------------------------------------------------------------
Sum of unpaid balances $2,475/12 = $206.25; 6 percent thereof =
$12.38.
Example 2. On November 20, 1955, B purchased a furniture set for
$1,250, including a stated carrying charge of $48. The down payment was
$50 and the balance was payable in 12 monthly installments of $100 each,
on the first day of each month commencing with December 1955. Assume
that B is a cash method, calendar year taxpayer and that no other
installment purchases were made. Assume further that B made the first
payment when due, but made only one other payment on June 1, 1956. The
amount to be treated as interest in 1955 is $4, and the amount to be
treated as interest in 1956 is $33, computed as follows:
Year 1955
------------------------------------------------------------------------
Unpaid
First day of balance
outstanding
------------------------------------------------------------------------
December................................................... $1,200
------------------------------------------------------------------------
Sum of unpaid balances $1,200/12 = $100; 6 percent thereof = $6.
Carrying charges attributable to 1955 = $4.
Year 1956
------------------------------------------------------------------------
Unpaid
First day of balance
outstanding
------------------------------------------------------------------------
January.................................................... $1,100
February................................................... 1,000
March...................................................... 900
April...................................................... 800
May........................................................ 700
June....................................................... 600
July....................................................... 500
August..................................................... 400
September.................................................. 300
October.................................................... 200
November................................................... 100
------------
6,600
------------------------------------------------------------------------
Sum of unpaid balances $6,600/12 = $550; 6 percent thereof = $33.
Carrying charges attributable to 1956 = $44 ($4x11).
Example 3. Assume the same facts as in example (2), except that the
furniture was repossessed and B's obligation to pay terminated as of
July 15, 1956. The amount to be treated as interest in 1955 is $4,
computed as in example (2) above. The amount to be treated as interest
in 1956 is $25.50, computed as follows:
Year 1956
------------------------------------------------------------------------
Unpaid
First day of balance
outstanding
------------------------------------------------------------------------
January.................................................... $1,100
February................................................... 1,000
March...................................................... 900
April...................................................... 800
May........................................................ 700
June....................................................... 600
July-November.............................................. 0
------------
5,100
------------------------------------------------------------------------
Sum of unpaid balances $5,100/12 = $425. 6 percent thereof = $25.50.
Carrying charges attributable to 1956 = $44 ($4x11).
Example 4. (i) On September 15, 1968, C registered at X University
for the 1968-69 academic year. C entered into an agreement
[[Page 278]]
with the X University for the purchase during such academic year of
educational services (including lodging and tuition) for a total fee of
$1,000, including a separately stated carrying charge of $50. Under the
terms of the agreement, an initial payment of $200 was to be made by C
on September 15, 1968, and the balance was to be paid in 8 monthly
installments of $100 each, on the 15th day of each month commencing with
October 1968. C made all of the required 1968 payments. Assuming that C
is a cash method, calendar year taxpayer and that no other installment
purchases of services or property were made, the amount to be treated as
interest in 1968 is $10.50, computed as follows:
Year 1968
------------------------------------------------------------------------
Unpaid
First day of balance
outstanding
------------------------------------------------------------------------
January-September.......................................... 0
October.................................................... $800
November................................................... 700
December................................................... 600
------------
Total.................................................. 2,100
------------------------------------------------------------------------
The sum of unpaid balances ($2,100) divided by 12 is $175; 6 percent
thereof is $10.50. The carrying charges attributable to 1968 are $18.75
(i.e., the total carrying charges ($50), divided by the total number of
payments (8), multiplied by the number of payments made in 1968 (3)).
Since the amount to be treated as interest in 1968 ($10.50) does not
exceed the carrying charges attributable to 1968 ($18.75), the
limitation set forth in paragraph (c) of this section is not applicable.
(ii) The result in this example would be the same even if the X
University assigned the agreement to a bank or other financial
institution and C made his payments directly to the bank or other
financial institution.
Example 5. On September 15, 1968, D registered at Y University for
the 1968-69 academic year. The tuition for such year was $1,500. In
order to pay his tuition, D borrowed $1,500 from the M Corporation, a
lending institution, and remitted that sum to the Y University. The loan
agreement between M Corporation and D provided that D was to repay the
loan, plus a service charge, in 10 equal monthly installments, on the
first day of each month commencing with October 1968. The service charge
consisted of interest and the cost of credit life insurance on D's life.
Since section 163(b) and this section do not apply to a contract for the
loan of money, D is not entitled to compute his interest deduction with
respect to his loan from M Corporation under such sections. D may deduct
that portion of each installment payment which constitutes interest (as
distinguished from payments of principal and the charge for credit life
insurance) under section 163(a) and Sec. 1.163-1, provided that the
amount of such interest can be ascertained.
(e) Effective date. Except in the case of payments made under a
contract for educational services, the rule provided in section 163(b)
and this section applies to payments made during taxable years beginning
after December 31, 1953, and ending after August 16, 1954, regardless of
when the contract of sale was made. In the case of payments made under a
contract for educational services, the rule provided in section 163(b)
and this section applies to payments made during taxable years beginning
after December 31, 1963, regardless of when the contract for educational
services was made.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6991, 34 FR
742, Jan. 17, 1969]
Sec. 1.163-3 Deduction for discount on bond issued on or before
May 27, 1969.
(a) Discount upon issuance. (1) If bonds are issued by a corporation
at a discount, the net amount of such discount is deductible and should
be prorated or amortized over the life of the bonds. For purposes of
this section, the amortizable bond discount equals the excess of the
amount payable at maturity (or, in the case of a callable bond, at the
earlier call date) over the issue price of the bond (as defined in
paragraph (b)(2) of Sec. 1.1232-3).
(2) In the case of a bond issued by a corporation after December 31,
1954, as part of an investment unit consisting of an obligation and an
option, the issue price of the bond is determined by allocating the
amount received for the investment unit to the individual elements of
the unit in the manner set forth in subdivision (ii)(a) of Sec. 1.1232-
3(b)(2). Discount with respect to bonds issued by a corporation as part
of investment units consisting of obligations and options after December
31, 1954, and before Dec. 24, 1968--
(i) Increased by any amount treated as bond premium which has been
included in gross income with respect to such bonds prior to Dec. 24,
1968, or
(ii) Decreased by any amount which has been deducted by the issuer
as discount attributable to such bonds prior to Dec. 24, 1968, and
[[Page 279]]
(iii) Decreased by any amount which has been deducted by the issuer
prior to Dec. 24, 1968 upon the exercise or sale by investors of options
issued in investment units with such bonds,
should be amortized, starting with the first taxable year ending on or
after Dec. 24, 1968 over the remaining life of such bonds.
(b) Examples. The rules in paragraph (a) of this section are
illustrated by the following examples:
Example 1. M Corporation, on January 1, 1960, the beginning of its
taxable year issued for $95,000, 3 percent bonds, maturing 10 years from
the date of issue, with a stated redemption price at maturity of
$100,000. M Corporation should treat $5,000 ($100,000-$95,000) as the
total amount to be amortized over the life of the bonds.
Example 2. Assume the same facts as example (1), except that the
bonds are convertible into common stock of M Corporation. Since the
issue price of the bonds includes any amount attributable to the
conversion privilege, the result is the same as in example (1).
Example 3. Assume the same facts as example (1), except that the
bonds are issued as part of an investment unit consisting of an
obligation and an option. Assume further that the issue price of the
bonds as determined under the rules of allocation set forth in
subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $94,000. Accordingly, M
Corporation should treat $6,000 ($100,000-$94,000) as the total amount
to be amortized over the life of the bonds.
Example 4. Assume in example (3), that prior to Dec. 24, 1968, M
Corporation had only treated $5,000 as the bond discount to be amortized
and deducted only $4,000 of this amount. Starting with the first taxable
year ending on or after Dec. 24, 1968, M Corporation should amortize
$2,000 ($6,000 discount, less $4,000 previously deducted) over the
remaining life of the bonds.
Example 5. N Corporation, on January 1, 1956, for a consideration of
$102,000, issued 20-year bonds in the face amount of $100,000, together
with options to purchase stock of N Corporation. The issue price of the
bonds as determined under the rules of allocation set forth in
subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $99,000. Until Dec. 24,
1968, N Corporation has treated as bond premium, $2,000, representing
the excess of the consideration received for the bond-option investment
units over the maturity value of the bonds, and has accordingly prorated
and included in income $1,200 of such amount. Starting with the first
taxable year beginning on or after Dec. 24, 1968, N Corporation may
amortize as a deduction over the remaining life of the bonds the amount
of $2,200 ($1,000 discount, plus $1,200 previously included in income).
Example 6. O Corporation, on January 1, 1956, for a consideration of
$100,000, issued 20-year bonds with a $100,000 face value, together with
options to purchase stock of O Corporation, which could be exercised at
any time up to 5 years from the date of issue. The issue price of the
bonds as determined under the rules of allocation set forth in
subdivision (ii)(a) of Sec. 1.1232-3(b)(2) is $98,000. O Corporation,
upon the exercise of the options prior to Dec. 24, 1968, had deducted
from income their fair market value at the time of exercise, which is
assumed for purposes of this example to have been $3,000. Even though
the bonds are considered to have been issued at a discount under
paragraph (a)(1) of this section, O Corporation would have no deduction
over the remaining life of the bonds, inasmuch as O Corporation, in
computing the amount of such deduction, is required under paragraph
(a)(2)(iii) of this section to reduce the amount which would otherwise
be treated as bond discount, $2,000 ($100,000-$98,000), by the amount
deducted from income upon the exercise of the options, in this case,
$3,000.
(c) Deduction upon repurchase. (1) Except as provided in
subparagraphs (2) and (3) of this paragraph, if bonds are issued by a
corporation and are subsequently repurchased by the corporation at a
price in excess of the issue price plus any amount of discount deducted
prior to repurchase, or (in the case of bonds issued subsequent to Feb.
28, 1913) minus any amount of premium returned as income prior to
repurchase, the excess of the purchase price over the issue price
adjusted for amortized premium or discount is a deductible expense for
the taxable year.
(2) In the case of a convertible bond (except a bond which the
corporation, before Sept. 5, 1968, has obligated itself to repurchase at
a specified price), the deduction allowable under subparagraph (1) of
this paragraph may not exceed an amount equal to 1 year's interest at
the rate specified in the bond, except to the extent that the
corporation can demonstrate to the satisfaction of the Commissioner or
his delegate that an amount in excess of 1 year's interest does not
include any amount attributable to the conversion feature.
(3) No deduction shall be allowed under subparagraph (1) of this
paragraph to the extent a deduction is disallowed under subparagraph (2)
of this
[[Page 280]]
paragraph or to the extent a deduction is disallowed by section 249
(relating to limitation on deduction of bond premium on repurchase of
convertible obligation) and the regulations thereunder. See paragraph
(f) of Sec. 1.249-1 for effective date limitation on section 249.
(d) Definition. For purposes of this section, a debenture, note,
certificate other evidence of indebtedness, issued by a corporation and
bearing interest shall be given the same treatment as a bond.
(e) Effective date. The provisions of this section shall not apply
in respect of a bond issued after May 27, 1969, unless issued pursuant
to a written commitment which was binding on that date and at all times
thereafter.
[T.D. 6984, 33 FR 19175, Dec. 24, 1968, as amended by T.D. 7154, 36 FR
24996, Dec. 28, 1971; T.D. 7259, 38 FR 4253, Feb. 12, 1973]
Sec. 1.163-4 Deduction for original issue discount on certain
obligations issued after May 27, 1969.
(a) In general. (1) If an obligation is issued by a corporation with
original issue discount, the amount of such discount is deductible as
interest and shall be prorated or amortized over the life of the
obligation. For purposes of this section the term ``obligation'' shall
have the same meaning as in Sec. 1.1232-1 (without regard to whether
the obligation is a capital asset in the hands of the holder) and the
term ``original issue discount'' shall have the same meaning as in
section 1232(b)(1) (without regard to the one-fourth of 1 percent
limitation in the second sentence thereof). Thus, in general, the amount
of original issue discount equals the excess of the amount payable at
maturity over the issue price of the bond (as defined in paragraph
(b)(2) of Sec. 1.1232-3), regardless of whether that amount is less
than one-fourth of 1 percent of the redemption price at maturity
multiplied by the number of complete years to maturity. For the rule as
to whether there is original issue discount in the case of an obligation
issued in an exchange for property other than money, and the amount
thereof, see paragraph (b)(2)(iii) of Sec. 1.1232-3. In any case in
which original issue discount is carried over from one corporation to
another corporation under section 381(c)(9) or from an obligation
exchanged to an obligation received in any exchange under paragraph
(b)(1)(iv) of Sec. 1.1232-3, such discount shall be carried over for
purposes of this section. The amount of original issue discount carried
over in an exchange of obligations under the preceding sentence shall be
prorated or amortized over the life of the obligation issued in such
exchange. For computation of issue price and the amount of original
issue discount in the case of serial obligations, see paragraph
(b)(2)(iv) of Sec. 1.1232-3.
(2) In the case of an obligation issued by a corporation as part of
an investment unit (as defined in paragraph (b)(2)(ii)(a) of Sec.
1.1232-3) consisting of an obligation and other property, the issue
price of the obligation is determined by allocating the amount received
for the investment unit to the individual elements of the unit in the
manner set forth in paragraph (b)(2)(ii) of Sec. 1.1232-3.
(3) Recovery or retention of amounts previously deducted. In any
taxable year in which an amount of original issue discount which was
deducted as interest under this section is retained or recovered by the
taxpayer, such as, for example, by reason of a fine, penalty,
forfeiture, or other withdrawal fee, such amount shall be includible in
the gross income of such taxpayer for such taxable year.
(b) Examples. The rules in paragraph (a) of this section are
illustrated by the following examples:
Example 1. N Corporation, which uses the calendar year as its
taxable year, on January 1, 1970, issued for $99,000, 9 percent bonds
maturing 10 years from the date of issue, with a stated redemption price
at maturity of $100,000. The original issue discount on each bond (as
determined under section 1232(b)(1) without regard to the one-fourth-of-
1-percent limitation in the second sentence thereof) is $1,000, i.e.,
redemption price, $100,000, minus issue price, $99,000. N shall treat
$1,000 as the total amount to be amortized over the life of the bonds.
Example 2. Assume the same facts as example (1), except that the
bonds are convertible into common stock of N Corporation. Since the
issue price of the bonds includes any amount attributable to the
conversion privilege, the result is the same as in example (1).
Example 3. Assume the same facts as example (1), except that the
bonds are issued as
[[Page 281]]
part of an investment unit consisting of an obligation and an option.
Assume further that the issue price of the bonds as determined under the
rules of allocation set forth in paragraph (b)(2)(ii) of Sec. 1.1232-3
is $94,000. The original issue discount on the bond (as determined under
section 1232(b)(1) without regard to the one-fourth-of-1-percent
limitation in the second sentence thereof) is $6,000, i.e., redemption
price, $100,000, minus issue price, $94,000. N shall treat $6,000 as the
total amount to be amortized over the life of the bonds.
Example 4. On January 1, 1971, a commercial bank which uses the
calendar year as its taxable year, issued a certificate of deposit for
$10,000. The certificate of deposit is not redeemable until December 31,
1975, except in an emergency as defined in, and subject to the
qualifications provided by Regulations Q of the Board of Governors of
the Federal Reserve. See 12 CFR Sec. 217.4(d). The stated redemption
price at maturity is $13,382.26. The certificate is an obligation to
which section 1232(a)(3)(A) applies (see paragraph (d) of Sec. 1.1232-
1), and the original issue discount with respect to the certificate (as
determined under section 1232(b)(1) without regard to the one-fourth-of-
1-percent limitation in the second sentence thereof) is $3,382.26 (i.e.,
redemption price, $13,382.26, minus issued price, $10,000). Y shall
treat $3,382.26 as the total amount to be amortized over the life of the
certificate.
(c) Deduction upon repurchase. (1) Except as provided in
subparagraph (2) of this paragraph, if bonds are issued by a corporation
and are subsequently repurchased by the corporation at a price in excess
of the issue price plus any amount of original issue discount deducted
prior to repurchase, or minus any amount of premium returned as income
prior to repurchase, the excess of the repurchase price over the issue
price adjusted for amortized premium or deducted discount is deductible
as interest for the taxable year.
(2) The provisions of subparagraph (1) of this paragraph shall not
apply to the extent a deduction is disallowed by section 249 (relating
to limitation on deduction of bond premium or repurchase of convertible
obligation) and the regulations thereunder.
(d) Effective date. The provisions of this section shall apply in
respect of obligations issued after May 27, 1969, other than--
(1) Obligations issued pursuant to a written commitment which was
binding on May 27, 1969, and at all times thereafter, and
(2) Deposits made before January 1, 1971, in the case of
certificates of deposit, time deposits, bonus plans, and other deposit
arrangements with banks, domestic building and loan associations, and
similar financial institutions.
[36 FR 24996, Dec. 28, 1971, as amended by T.D. 7213, 37 FR 21991, Oct.
18, 1972; T.D. 7259, 38 FR 4253, Feb. 12, 1973]
Sec. 1.163-5 Denial of interest deduction on certain obligations
issued after December 31, 1982, unless issued in registered form.
(a)-(b) [Reserved]
(c) Obligations issued to foreign persons after September 21, 1984--
(1) In general. A determination of whether an obligation satisfies each
of the requirements of this paragraph shall be made on an obligation-by-
obligation basis. An obligation issued directly (or through affiliated
entities) in bearer form by, or guaranteed by, a United States
Government-owned agency or a United States Government-sponsored
enterprise, such as the Federal National Mortgage Association, the
Federal Home Loan Banks, the Federal Loan Mortgage Corporation, the Farm
Credit Administration, and the Student Loan Marketing Association, may
not satisfy this paragraph (c). An obligation issued after September 21,
1984 is described in this paragraph if--
(i) There are arrangements reasonably designed to ensure that such
obligation will be sold (or resold in connection with its original
issuance) only to a person who is not a United States person or who is a
United States person that is a financial institution (as defined in
Sec. 1.165-12(c)(1)(v)) purchasing for its own account or for the
account of a customer and that agrees to comply with the requirements of
section 165(j)(3) (A), (B), or (C) and the regulations thereunder, and
(ii) In the case of an obligation which is not in registered form--
(A) Interest on such obligation is payable only outside the United
States and its possessions, and
(B) Unless the obligation is described in subparagraph (2)(i)(C) of
this paragraph or is a temporary global security, the following
statement in English either appears on the face of
[[Page 282]]
the obligation and on any interest coupons which may be detached
therefrom or, if the obligation is evidenced by a book entry, appears in
the book or record in which the book entry is made: ``Any United States
person who holds this obligation will be subject to limitations under
the United States income tax laws, including the limitations provided in
sections 165(j) and 1287(a) of the Internal Revenue Code.'' For purposes
of this paragraph, the term ``temporary global security'' means a
security which is held for the benefit of the purchasers of the
obligations of the issuer and interests in which are exchangeable for
securities in definitive registered or bearer form prior to its stated
maturity.
(2) Rules for the application of this paragraph--(i) Arrangements
reasonably designed to ensure sale to non-United States persons. An
obligation will be considered to satisfy paragraph (c)(1)(i) of this
section if the conditions of paragraph (c)(2)(i) (A), (B), (C), or (D)
of this section are met in connection with the original issuance of the
obligation. An exchange of one obligation for another is considered an
original issuance if and only if the exchange constitutes a disposition
of property for purposes of section 1001 of the Code. However, an
exchange of one obligation for another will not be considered a new
issuance if the obligation received is identical in all respects to the
obligation surrendered in exchange therefor, except that the obligor of
the obligation received need not be the same obligor as the obligor of
the obligation surrendered. Obligations that meet the conditions of
paragraph (c)(2)(i) (A), (B), (C) or (D) of this section may be issued
in a single public offering. The preceding sentence does not apply to
certificates of deposit issued under the conditions of paragraph
(c)(2)(i)(C) of this section by a United States person or by a
controlled foreign corporation within the meaning of section 957(a) that
is engaged in the active conduct of a banking business within the
meaning of section 954(c)(3)(B) as in effect prior to the Tax Reform Act
of 1986, and the regulations thereunder. A temporary global security
need not satisfy the conditions of paragraph (c)(2)(i) (A), (B) or (C)
of this section, but must satisfy the applicable requirements of
paragraph (c)(2)(i)(D) of this section.
(A) In connection with the original issuance of an obligation, the
obligation is offered for sale or resale only outside of the United
States and its possessions, is delivered only outside the United States
and its possessions and is not registered under the Securities Act of
1933 because it is intended for distribution to persons who are not
United States persons. An obligation will not be considered to be
required to be registered under the Securities Act of 1933 if the
issuer, in reliance on the written opinion of counsel received prior to
the issuance thereof, determines in good faith that the obligation need
not be registered under the Securities Act of 1933 for the reason that
it is intended for distribution to persons who are not United States
persons. Solely for purposes of this subdivision (i)(A), the term
``United States person'' has the same meaning as it has for purposes of
determining whether an obligation is intended for distribution to
persons under the Securities Act of 1933. Except as provided in
paragraph (c)(3) of this section, this paragraph (c)(2)(i)(A) applies
only to obligations issued on or before September 7, 1990.
(B) The obligation is registered under the Securities Act of 1933,
is exempt from registration by reason of section 3 or section 4 of such
Act, or does not qualify as a security under the Securities Act of 1933;
all of the conditions set forth in paragraph (c)(2)(i)(B) (1), (2), (3),
(4), and (5) of this section are met with respect to such obligations;
and, except as provided in paragraph (c)(3) of this section, the
obligation is issued on or before September 7, 1990.
(1) In connection with the original issuance of an obligation in
bearer form, the obligation is offered for sale or resale only outside
the United States and its possessions.
(2) The issuer does not, and each underwriter and each member of the
selling group, if any, covenants that it will not, in connection with
the original issuance of the obligation, offer to sell or resell the
obligation in bearer form to any person inside the United States or to a
United States person unless such United States person is a financial
institution as defined in Sec. 1.165-
[[Page 283]]
12(c)(v) purchasing for its own account or for the account of a
customer, which financial institution, as a condition of the purchase,
agrees to provide on delivery of the obligation (or on issuance, if the
obligation is not in definitive form) the certificate required under
paragraph (c)(2)(i)(B)(4).
(3) In connection with its sale or resale during the original
issuance of the obligation in bearer form, each underwriter and each
member of the selling group, if any, or the issuer, if there is no
underwriter or selling group, sends a confirmation to the purchaser of
the bearer obligation stating that the purchaser represents that it is
not a United States person or, if it is a United States person, it is a
financial institution as defined in Sec. 1.165-12(c)(v) purchasing for
its own account or for the account of a customer and that the financial
institution will comply with the requirements of section 165(j)(3) (A),
(B), or (C) and the regulations thereunder. The confirmation must also
state that, if the purchaser is a dealer, it will send similar
confirmations to whomever purchases from it.
(4) In connection with the original issuance of the obligation in
bearer form it is delivered in definitive form (or issued, if the
obligation is not in definitive form) to the person entitled to physical
delivery thereof only outside the United States and its possessions and
only upon presentation of a certificate signed by such person to the
issuer, underwriter, or member of the selling group, which certificate
states that the obligation is not being acquired by or on behalf of a
United States person, or for offer to resell or for resale to a United
States person or any person inside the United States, or, if a
beneficial interest in the obligation is being acquired by a United
States person, that such person is a financial institution as defined in
Sec. 1.165.12(c)(1)(v) or is acquiring through a financial institution
and that the obligation is held by a financial institution that has
agreed to comply with the requirements of section 165(j)(3) (A), (B), or
(C) and the regulations thereunder and that is not purchasing for offer
to resell or for resale inside the United States. When a certificate is
provided by a clearing organization, it must be based on statements
provided to it by its member organizations. A clearing organization is
an entity which is in the business of holding obligations for member
organizations and transferring obligations among such members by credit
or debit to the account of a member without the necessity of physical
delivery of the obligation. For purposes of paragraph (c)(2)(i)(B), the
term ``delivery'' does not include the delivery of an obligation to an
underwriter or member of the selling group, if any.
(5) The issuer, underwriter, or member of the selling group does not
have actual knowledge that the certificate described in paragraph
(c)(2)(i)(B)(4) of this section is false. The issuer, underwriter, or
member of the selling group shall be deemed to have actual knowledge
that the certificate described in paragraph (c)(2)(i)(B)(4) of this
section is false if the issuer, underwriter, or member of the selling
group has a United States address for the beneficial owner (other than a
financial institution as defined in Sec. 1.165-12(c)(v) that represents
that it will comply with the requirements of section 165(j)(3) (A), (B),
or (C) and the regulations thereunder) and does not have documentary
evidence as described in Sec. 1.6049-5(c)(1) that the beneficial owner
is not a United States person.
(C) The obligation is issued only outside the United States and its
possessions by an issuer that does not significantly engage in
interstate commerce with respect to the issuance of such obligation
either directly or through its agent, an underwriter, or a member of the
selling group. In the case of an issuer that is a United States person,
such issuer may only satisfy the test set forth in this paragraph
(c)(2)(i)(C) if--
(1) It is engaged through a branch in the active conduct of a
banking business, within the meaning of section 954(c)(3)(B) as in
effect before the Tax Reform Act of 1986, and the regulations
thereunder, outside the United States;
(2) The obligation is issued outside of the United States by the
branch in connection with that trade or business;
(3) The obligation that is so issued is sold directly to the public
and is not
[[Page 284]]
issued as a part of a larger issuance made by means of a public
offering; and
(4) The issuer either maintains documentary evidence as described in
subdivision (iii) of A-5 of Sec. 35a.9999-4T that the purchaser is not
a United States person (provided that the issuer has no actual knowledge
that the documentary evidence is false) or on delivery of the obligation
the issuer receives a statement signed by the person entitled to
physical delivery thereof and stating either that the obligation is not
being acquired by or on behalf of a United States person or that, if a
beneficial interest in the obligation is being acquired by a United
States person, such person is a financial institution as defined in
Sec. 1.165-12(c)(v) or is acquiring through a financial institution and
the obligation is held by a financial institution that has agreed to
comply with the requirements of 165(j)(3) (A), (B) or (C) and the
regulations thereunder and that it is not purchasing for offer to resell
or for resale inside the United States (provided that the issuer has no
actual knowledge that the statement is false).
In addition, an issuer that is a controlled foreign corporation within
the meaning of section 957 (a) that is engaged in the active conduct of
a banking business outside the United States within the meaning of
section 954(c)(3)(B) as in effect before the Tax Reform Act of 1986, and
the regulations thereunder, can only satisfy the provisions of this
paragraph (c)(2)(i)(C), if it meets the requirements of this paragraph
(c)(2)(i)(C)(2), (3) and (4).
(D) The obligation is issued after September 7, 1990, and all of the
conditions set forth in this paragraph (c)(2)(i)(D) are met with respect
to such obligation.
(1) Offers and sales--(i) Issuer. The issuer does not offer or sell
the obligation during the restricted period to a person who is within
the United States or its possessions or to a United States person.
(ii) Distributors. (A) The distributor of the obligation does not
offer or sell the obligation during the restricted period to a person
who is within the United States or its possessions or to a United States
person.
(B) The distributor of the obligation will be deemed to satisfy the
requirements of paragraph (c)(2)(i)(D)(1)(ii)(A) of this section if the
distributor of the obligation convenants that it will not offer or sell
the obligation during the restricted period to a person who is within
the United States or its possessions or to a United States person; and
the distributor of the obligation has in effect, in connection with the
offer and sale of the obligation during the restricted period,
procedures reasonably designed to ensure that its employees or agents
who are directly engaged in selling the obligation are aware that the
obligation cannot be offered or sold during the restricted period to a
person who is within the United States or its possessions or is a United
States person.
(iii) Certain rules. For purposes of paragraph (c)(2)(i)(D)(1) (i)
and (ii) of this section:
(A) An offer or sale will be considered to be made to a person who
is within the United States or its possessions if the offeror or seller
of the obligation has an address within the United States or its
possessions for the offeree or buyer of the obligation with respect to
the offer or sale.
(B) An offer or sale of an obligation will not be treated as made to
a person within the United States or its possessions or to a United
States person if the person to whom the offer or sale is made is: An
exempt distributor, as defined in paragraph (c)(2)(i)(D)(5) of this
section; An international organization as defined in section 7701(a)(18)
and the regulations thereunder, or a foreign central bank as defined in
section 895 and the regulations thereunder; or The foreign branch of a
United States financial institution as described in paragraph
(c)(2)(i)(D)(6)(i) of this section.
Paragraph (c)(2)(i)(D)(1)(iii)(B) regarding an exempt distributor will
only apply to an offer to the United States office of an exempt
distributor, and paragraph (c)(2)(i)(D)(1)(iii)(B) regarding an
international organization or foreign central bank will only apply to an
offer to an international organization or foreign central bank, if such
offer is made directly and specifically
[[Page 285]]
to the United States office, organization or bank.
(C) A sale of an obligation will not be treated as made to a person
within the United States or its possessions or to a United States person
if the person to whom the sale is made is a person described in
paragraph (c)(2)(i)(D)(6)(ii) of this section.
(2) Delivery. In connection with the sale of the obligation during
the restricted period, neither the issuer nor any distributor delivers
the obligation in definitive form within the United States or it
possessions.
(3) Certification--(i) In general. On the earlier of the date of the
first actual payment of interest by the issuer on the obligation or the
date of delivery by the issuer of the obligation in definitive form, a
certificate is provided to the issuer of the obligation stating that on
such date:
(A) The obligation is owned by a person that is not a United States
person:
(B) The obligation is owned by a United States person described in
paragraph (c)(2)(i)(D)(6) of this section; or
(C) The obligation is owned by a financial institution for purposes
of resale during the restricted period, and such financial institution
certifies in addition that it has not acquired the obligation for
purposes of resale directly or indirectly to a United States person or
to a person within the United States or its possessions.
A certificate described in paragraph (c)(2)(i)(D)(3)(i) (A) or (B) of
this section may not be given with respect to an obligation that is
owned by a financial institution for purposes of resale during the
restricted period. For purposes of paragraph (c)(2)(i)(D) (2) and (3) of
this section, a temporary global security (as defined in Sec. 1.163-5
(c)(1)(ii)(B)) is not considered to be an obligation in definitive form.
If the issuer does not make the obligation available for delivery in
definitive form within a reasonable period of time after the end of the
restricted period, then the obligation shall be treated as not
satisfying the requirements of this paragraph (c)(2)(i)(D)(3). The
certificate must be signed (or sent, as provided in paragraph
(c)(2)(i)(D)(3)(ii) of this section) either by the owner of the
obligation or by a financial institution or clearing organization
through which the owner holds the obligation, directly or indirectly.
For purposes of this paragraph (c)(2)(i)(D)(3), the term ``financial
institution'' means a financial institution described in Sec. 1.165-
12(c)(i)(v). When a certificate is provided by a clearing organization,
the certificate must be based on statements provided to it by its member
organizations. The requirement of this paragraph (c)(1)(D)(3) shall be
deemed not to be satisfied with respect to an obligation if the issuer
knows or has reason to know that the certificate with respect to such
obligation is false. The certificate must be retained by the issuer (and
statements by member organizations must be retained by the clearing
organization, in the case of certificates based on such statements) for
a period of four calendar years following the year in which the
certificate is received.
(ii) Electronic certification. The certificate required by paragraph
(c)(2)(i)(D)(3)(i) of this section (including a statement provided to a
clearing organization by a member organization) may be provided
electronically, but only if the person receiving such electronic
certificate maintains adequate records, for the retention period
described in paragraph (c)(2)(i)(D)(3)(i) of this section, establishing
that such certificate was received in respect of the subject obligation,
and only if there is a written agreement entered into prior to the time
of certification (including the written membership rules of a clearing
organization) to which the sender and recipient are subject, providing
that the electronic certificate shall have the effect of a signed
certificate described in paragraph (c)(2)(i)(D)(3)(i) of this section.
(iii) Exception for certain obligations. This paragraph
(c)(2)(i)(D)(3) shall not apply, and no certificate shall be required,
in the case of an obligation that is sold during the restricted period
and that satisfies all of the following requirements:
(A) The interest and principal with respect to the obligation are
denominated only in the currency of a single foreign country.
(B) The interest and principal with respect to the obligation are
payable
[[Page 286]]
only within that foreign country (according to rules similar to those
set forth in Sec. 1.163-5(c)(2)(v)).
(C) The obligation is offered and sold in accordance with practices
and documentation customary in that foreign country.
(D) The distributor covenants to use reasonable efforts to sell the
obligation within that foreign country.
(E) The obligation is not listed, or the subject of an application
for listing, on an exchange located outside that foreign country.
(F) The Commissioner has designated that foreign country as a
foreign country in which certification under paragraph
(c)(2)(i)(D)(3)(i) of this section is not permissible.
(G) The issuance of the obligation is subject to guidelines or
restrictions imposed by governmental, banking or securities authorities
in that foreign country.
(H) More than 80 percent by value of the obligations included in the
offering of which the obligation is a part are offered and sold to non-
distributors by distributors maintaining an office located in that
foreign country. Foreign currency denominated obligations that are
convertible into U.S. dollar denominated obligations or that by their
terms are linked to the U.S. dollar in a way which effectively converts
the obligations to U.S. dollar denominated obligations do not satisfy
the requirements of this paragraph (c)(2)(i)(D)(3)(iii). A foreign
currency denominated obligation will not be treated as linked, by its
terms, to the U.S. dollar solely because the obligation is the subject
of a swap transaction.
(4) Distributor. For purposes of this paragraph (c)(2)(i)(D), the
term ``distributor'' means:
(i) A person that offers or sells the obligation during the
restricted period pursuant to a written contract with the issuer;
(ii) Any person that offers or sells the obligation during the
restricted period pursuant to a written contract with a person described
in paragraph (c)(2)(i)(D) (4) (i); and
(iii) Any affiliate that acquires the obligation from another member
of its affiliated group for the purpose of offering or selling the
obligation during the restricted period, but only if the transferor
member of the group is the issuer or a person described in paragraph
(c)(2)(i)(D) (4)(i) or (ii) of this section. The terms ``affiliate'' and
``affiliated group'' have the same meanings as in section 1504(a) of the
Code, but without regard to the exceptions contained in section 1504(b)
and substituting ``50 percent'' for ``80 percent'' each time it appears.
For purposes of this paragraph (c)(2)(i)(D)(4), a written contract does
not include a confirmation or other notice of the transaction.
(5) Exempt distributor. For purposes of this paragraph (c)(2)(i)(D),
the term ``exempt distributor'' means a distributor that convenants in
its contract with the issuer or with a distributor described in
paragraph (c)(2)(i)(D)(4)(i) that it is buying the obligation for the
purpose of resale in connection with the original issuance of the
obligation, and that if it retains the obligation for its own account,
it will only do so in accordance with the requirements of paragraph
(c)(2)(i)(D)(6) of this section. In the latter case, the convenant will
constitute the certificate required under paragraph (c)(2)(i)(D)(6). The
provisions of paragraph (c)(2)(i)(D)(7) governing the restricted period
for unsold allotments or subscriptions shall apply to any obligation
retained for investment by an exempt distributor.
(6) Certain United States persons. A person is described in this
paragraph (c)(2)(i)(D)(6) if the requirements of this paragraph are
satisfied and the person is:
(i) The foreign branch of a United States financial institution
purchasing for its own account or for resale, or
(ii) A United States person who acquired the obligation through the
foreign branch of a United States financial institution and who, for
purposes of the certification required in paragraph (c)(2)(i)(D)(3) of
this section, holds the obligation through such financial institution on
the date of certification.
For purposes of paragraph (c)(2)(i)(D)(6)(ii) of this section, a United
States person will be considered to acquire and hold an obligation
[[Page 287]]
through the foreign branch of a United States financial institution if
the United States person has an account with the United States office of
a financial institution, and the transaction is executed by a foreign
office of that financial institution, or by the foreign office of
another financial institution acting on behalf of that financial
institution. This paragraph (c)(2)(i)(D)(6) will apply, however, only if
the United States financial institution (or the United States office of
a foreign financial institution) holding the obligation provides a
certificate to the issuer or distributor selling the obligation within a
reasonable time stating that it agrees to comply with the requirements
of section 165(j)(3)(A), (B), or (C) and the regulations thereunder. For
purposes of this paragraph (c)(2)(i)(D)(6), the term ``financial
institution'' means a financial institution as defined in Sec. 1.165-
12(c)(1)(v). As an alternative to the certification required above, a
financial institution may provide a blanket certificate to the issuer or
distributor selling the obligation stating that the financial
institution will comply with the requirements of section 165(j)(3)(A),
(B) or (C) and the regulations thereunder. A blanket certificate must be
received by the issuer or the distributor in the year of the issuance of
the obligation or in either of the preceding two calendar years, and
must be retained by the issuer or distributor for at least four years
after the end of the last calendar year to which it relates.
(7) Restricted period. For purposes of this paragraph (c)(2)(i)(D),
the restricted period with respect to an obligation begins on the
earlier of the closing date (or the date on which the issuer receives
the loan proceeds, if there is no closing with respect to the
obligation), or the first date on which the obligation is offered to
persons other than a distributor. The restricted period with respect to
an obligation ends on the expiration of the forty day period beginning
on the closing date (or the date on which the issuer receives the loan
proceeds, if there is no closing with respect to the obligation).
Notwithstanding the preceding sentence, any offer or sale of the
obligation by the issuer or a distributor shall be deemed to be during
the restricted period if the issuer or distributor holds the obligation
as part of an unsold allotment or subscription.
(8) Clearing organization. For purposes of this paragraph
(c)(2)(i)(D), a ``clearing organization'' is an entity which is in the
business of holding obligations for member organizations and
transferring obligations among such members by credit or debit to the
account of a member without the necessity of physical delivery of the
obligation.
(ii) Special rules. An obligation shall not be considered to be
described in paragraph (c)(2)(i)(C) of this section if it is--
(A) Guaranteed by a United States shareholder of the issuer;
(B) Convertible into a debt or equity interest in a United States
shareholder of the issuer; or
(C) Substantially identical to an obligation issued by a United
States shareholder of the issuer.
For purposes of this paragraph (c)(2)(ii), the term ``United States
shareholder'' is defined as it is defined in section 951 (b) and the
regulations thereunder. For purposes of this paragraph (c)(2)(ii)(C),
obligations are substantially identical if the face amount, interest
rate, term of the issue, due dates for payments, and maturity date of
each is substantially identical to the other.
(iii) Interstate commerce. For purposes of this paragraph, the term
``interstate commerce'' means trade or commerce in obligations or any
transportation or communication relating thereto between any foreign
country and the United States or its possessions.
(A) An issuer will not be considered to engage significantly in
interstate commerce with respect to the issuance of an obligation if the
only activities with respect to which the issuer uses the means or
instrumentalities of interstate commerce are activities of a preparatory
or auxiliary character that do not involve communication between a
prospective purchaser and an issuer, its agent, an underwriter, or
member of the selling group if either is inside the United States or its
possessions. Activities of a preparatory or auxiliary character include,
but are not limited to, the following activities:
[[Page 288]]
(1) Establishment or participation in establishment of policies
concerning the issuance of obligations and the allocation of funding by
a United States shareholder with respect to obligations issued by a
foreign corporation or by a United States office with respect to
obligations issued by a foreign branch;
(2) Negotiation between the issuer and underwriters as to the terms
and pricing of an issue;
(3) Transfer of funds to an office of an issuer in the United States
or its possessions by a foreign branch or to a United States shareholder
by a foreign corporation;
(4) Consultation by an issuer with accountants and lawyers or other
financial advisors in the United States or its possessions regarding the
issuance of an obligation;
(5) Document drafting and printing; and
(6) Provision of payment or delivery instructions to members of the
selling group by an issuer's office or agent that is located in the
United States or its possessions.
(B) Activities that will not be considered to be of a preparatory or
auxiliary character include, but are not limited to, any of the
following activities:
(1) Negotiation or communication between a prospective purchaser and
an issuer, its agent, an underwriter, or a member of the selling group
concerning the sale of an obligation if either is inside the United
States or its possessions;
(2) Involvement of an issuer's office, its agent, an underwriter, or
a member of the selling group in the United States or its possessions in
the offer or sale of a particular obligation, either directly with the
prospective purchaser, or through the issuer in a foreign country;
(3) Delivery of an obligation in the United States or its
possessions; or
(4) Advertising or otherwise promoting an obligation in the United
States or its possessions.
(C) The following examples illustrate the application of this
subdivision (iii) of Sec. 1.163-5(c)(2).
Example 1. Foreign corporation A, a corporation organized in and
doing business in foreign country Z, and not a controlled foreign
corporation within the meaning of section 957(a) that is engaged in the
conduct of a banking business within the meaning of section 954(c)(3)(B)
as in effect before the Tax Reform Act of 1986, issues its debentures
outside the United States. The debentures are not guaranteed by a United
States shareholder of A, nor are they convertible into a debt or equity
interest of a United States shareholder of A, nor are they substantially
identical to an obligation issued by a United States shareholder of A. A
consults its accountants and lawyers in the United States for certain
securities and tax advice regarding the debt offering. The underwriting
and selling group in respect to A's offering is composed entirely of
foreign securities firms, some of which are foreign subsidiaries of
United States securities firms. A U.S. affiliate of the foreign
underwriter communicates payment and delivery instructions to the
selling group. All offering circulars for the offering are mailed and
delivered outside the United States and its possessions. All debentures
are delivered and paid for outside the United States and its
possessions. No office located in the United States or in a United
States possession is involved in the sale of debentures. Interest on the
debentures is payable only outside the United States and its
possessions. A is not significantly engaged in interstate commerce with
respect to the offering.
Example 2. B, a United States bank, does business in foreign country
X through a branch located in X. The branch is a staffed and operating
unit engaged in the active conduct of a banking business consisting of
one or more of the activities set forth in Sec. 1.954-2(d)(2)(ii). As
part of its ongoing business, the branch in X issues negotiable
certificates of deposit with a maturity in excess of one year to
customers upon request. The certificates of deposit are not guaranteed
by a United States shareholder of B, nor are they convertible into a
debt or equity interest of a United States shareholder of B, nor are
they substantially identical to an obligation issued by a United States
shareholder of B. Policies regarding the issuance of negotiable
certificates of deposit and funding allocations for foreign branches are
set in the United States at B's main office. Branch personnel decide
whether to issue a negotiable certificate of deposit based on the
guidelines established by the United States offices of B, but without
communicating with the United States offices of B with respect to the
issuance of a particular obligation. Negotiable certificates of deposits
are delivered and paid for outside the United States and its
possessions. Interest on the negotiable certificates of deposit is
payable only outside the United States and its possessions. B maintains
documentary evidence described in Sec. 1.163-5(c)(2)(i)(C)(4). After
the issuance of negotiable certificates of deposit by the foreign branch
of B, the foreign branch sends
[[Page 289]]
the funds to a United States branch of B for use in domestic operations.
B is not significantly engaged in interstate commerce with respect to
the issuance of such obligation.
Example 3. The facts in Example (2) apply except that the foreign
branch of B consulted, by telephone, the main office in the United
States to request approval of the issuance of the certificate of deposit
at a particular rate of interest. The main office granted permission to
issue the negotiable certificate of deposit to the customer by a telex
sent from the main office of B to the branch in X. B is significantly
engaged in interstate commerce with respect to the issuance of the
obligation as a result of involvement of B's United States office in the
issuance of the obligation.
Example 4. The facts in Example (2) apply with the additional fact
that a customer contacted the foreign branch of B through a telex
originating in the United States or its possessions. Subsequent to the
telex, the foreign branch issued the negotiable certificate of deposit
and recorded it on the books. B is significantly engaged in interstate
commerce with respect to the issuance of the obligation as a result of
its communication by telex with a customer in the United States.
(iv) Possessions. For purposes of this section, the term
``possessions'' includes Puerto Rico, the U.S. Virgin Islands, Guam,
American Samoa, Wake Island, and Northern Mariana Islands.
(v) Interest payable outside of the United States. Interest will be
considered payable only outside the United States and its possessions if
payment of such interest can be made only upon presentation of a coupon,
or upon making of any other demand for payment, outside of the United
States and its possessions to the issuer or a paying agent. The fact
that payment is made by a draft drawn on a United States bank account or
by a wire or other electronic transfer from a United States account does
not affect this result. Interest payments will be considered to be made
within the United States if the payments are made by a transfer of funds
into an account maintained by the payee in the United States or mailed
to an address in the United States, if--
(A) The interest is paid on an obligation issued by either a United
States person, a controlled foreign corporation as defined in section
957 (a), or a foreign corporation if 50 percent or more of the gross
income of the foreign corporation from all sources of the 3-year period
ending with the close of its taxable year preceding the original
issuance of the obligation (or for such part of the period that the
foreign corporation has been in existence) was effectively connected
with the conduct of a trade or business within the United States; and
(B) The interest is paid to a person other than--
(1) A person who may satisfy the requirements of section 165 (j)(3)
(A), (B), or (C) and the regulations thereunder; and
(2) A financial institution as a step in the clearance of funds and
such interest is promptly credited to an account maintained outside the
United States for such financial institution or for persons for which
the financial institution has collected such interest.
Interest is considered to be paid within the United States and its
possessions if a coupon is presented, or a demand for payment is
otherwise made, to the issuer or a paying agent (whether a United States
or foreign person) in the United States and its possessions even if the
funds paid are credited to an account maintained by the payee outside
the United States and its possessions. Interest will be considered
payable only outside the United States and its possessions
notwithstanding that such interest may become payable at the office of
the issuer or its United States paying agent under the following
conditions: the issuer has appointed paying agents located outside the
United States and its possessions with the reasonable expectation that
such paying agents will be able to pay the interest in United States
dollars, and the full amount of such payment at the offices of all such
paying agents is illegal or effectively precluded because of the
imposition of exchange controls or other similar restrictions on the
full payment or receipt of interest in United States dollars. A lawsuit
brought in the United States or its possessions for payment of the
obligation or interest thereon as a result of a default shall not be
considered to be a demand for payment. For purposes of this subdivision
(v), interest includes original issue discount as defined in section
1273(a). Therefore, an amount equal to the original issue discount as
defined in
[[Page 290]]
section 1273(a) is payable only outside the United States and its
possessions. The amount of market discount as defined in section 1278(a)
does not affect the amount of interest to be considered payable only
outside the United States and its possessions.
(vi) Rules relating to obligations issued after December 31, 1982
and on or before September 21, 1984. Whether an obligation originally
issued after December 31, 1982 and on or before September 21, 1984, or
an obligation originally issued after September 21, 1984 pursuant to the
exercise of a warrant or the conversion of a convertible obligation,
which warrant or obligation (including conversion privilege) was issued
after December 31, 1982 and on or before September 21, 1984, is
described in section 163(f)(2)(B) shall be determined under the rules
provided in Sec. 5f.163-1(c) as in effect prior to its removal.
Notwithstanding the preceding sentence, an issuer will be considered to
satisfy the requirements of section 163(f)(2)(B) with respect to an
obligation issued after December 31, 1982 and on or before September 21,
1984 or after September 21, 1984 pursuant to the exercise of a warrant
or the conversion of a convertible obligation, which warrant or
obligation (including conversion privilege) was issued after December
31, 1982 and on or before September 21, 1984, if the issuer
substantially complied with the proposed regulations provided in Sec.
1.163-5(c), which were published in the Federal Register on September 2,
1983 (48 FR 39953) and superseded by temporary regulations published in
the Federal Register on August 22, 1984 (49 FR 33228).
(3) Effective date--(i) In general. These regulations apply
generally to obligations issued after January 20, 1987. A taxpayer may
choose to apply the rules of Sec. 1.163-5(c) with respect to an
obligation issued after December 31, 1982 and on or before January 20,
1987. If this choice is made, the rules of Sec. 1.163-5(c) will apply
in lieu of Sec. 1.163-5T(c) except that the legend requirement under
Sec. 1.163-5(c)(l)(ii)(B) does not apply with respect to a bearer
obligation evidenced exclusively by a book entry and that the
certification requirement under Sec. 1.163-5T(c)(2)(B)(4) applies in
lieu of the certification under Sec. 1.163-5(c)(2)(i)(B)(4).
(ii) Special rules. If an obligation is originally issued after
September 7, 1990 pursuant to the exercise of a warrant or the
conversion of a convertible obligation, which warrant or obligation
(including conversion privilege) was issued on or before May 10, 1990,
then the issuer may choose to apply either the rules of Sec. 1.163-
5(c)(2)(i)(A) or Sec. 1.163-5(c)(2)(i)(B), or the rules of Sec. 1.163-
5(c)(2)(i)(D). The issuer of an obligation may choose to apply either
the rules of Sec. 1.163-5(c)(2)(i) (A) or (B), or the rules of Sec.
1.163-5(c)(2)(i)(D), to an obligation that is originally issued after
May 10, 1990, and on or before September 7, 1990. However, any issuer
choosing to apply the rules of Sec. 1.163-5(c)(2)(i)(A) must apply the
definition of United States person used for such purposes on December
31, 1989, and must obtain any certificates that would have been required
under applicable law on December 31, 1989.
[T.D. 8110, 51 FR 45456, Dec. 19, 1986, as amended by T.D. 8203, 53 FR
17926, May 19, 1988; T.D. 8300, 55 FR 19624, May 10, 1990; T.D. 8734, 62
FR 53416, Oct. 14, 1997]
Sec. 1.163-5T Denial of interest deduction on certain obligations
issued after December 31, 1982, unless issued in registered form
(temporary).
(a)-(c) [Reserved]
(d) Pass-through certificates. (1) A pass-through or participation
certificate evidencing an interest in a pool of mortgage loans which
under subpart E of subchapter J of the Code is treated as a trust of
which the grantor is the owner (or similar evidence of interest in a
similar pooled fund or pooled trust treated as a grantor trust) (``pass-
through certificate'') is considered to be a ``registration-required
obligation'' under section 163(f)(2)(A) and Sec. 1.163-5(c) if the
pass-through certificate is described in section 163(f)(2)(A) and Sec.
1.163-5(c) without regard to whether any obligation held by the fund or
trust to which the pass-through certificate relates is described in
section 163(f)(2)(A) and Sec. 1.163-5(c). A pass-through certificate is
considered to be described in section 163(f)(2)(B) and Sec. 1.163-5(c)
if the pass-through certificate is described in section 163(f)(2)(B)
[[Page 291]]
and Sec. 1.163-5(c) without regard to whether any obligation held by
the fund or trust to which the pass-through certificate relates is
described in section 163(f)(2)(B) and Sec. 1.163-5(c).
(2) An obligation held by a fund or trust in which ownership
interests are represented by pass-through certificates is considered to
be in registered form under section 149(a) and the regulations
thereunder or to be described in section 163(f)(2) (A) or (B), if the
obligation held by the fund or trust is in registered form under section
149(a) and the regulations thereunder or is described in section
163(f)(2) (A) or (B), respectively, without regard to whether the pass-
through certificates are so considered.
(3) For purposes of section 4701, a pass-through certificate is
considered to be issued solely by the recipient of the proceeds from the
issuance of the pass-through certificate (hereinafter the ``sponsor'').
The sponsor is therefore liable for any excise tax under section 4701
that may be imposed with reference to the principal amount of the pass-
through certificate.
(4) In order to implement the purpose of section 163, Sec. 1.163-
5(c) and this section, the Commissioner may characterize a certificate
or other evidence of interest in a fund or trust which under subpart E
of subchapter J of the Code is treated as a trust of which the grantor
is the owner and any obligation held by such fund or trust in accordance
with the substance of the arrangement they represent and may impose the
penalties provided under sections 163(f)(1) and 4701 in the appropriate
amounts and on the appropriate persons. This provision may be applied,
for example, where a corporation issues obligations purportedly in
registered form, contributes them to a grantor trust as its only assets,
and arranges for the sale to investors of bearer certificates of
interest in the trust which do not meet the requirements of section
163(f)(2)(B). If this provision is applied, the obligations held by the
fund or trust will not be considered to be issued in registered form or
to meet the requirements of section 163(f)(2)(B). The corporation will
not be allowed a deduction for the payment of interest on the
obligations held by the trust, and the excise tax under section 4701,
calculated with reference to the principal amount of the obligations
held by the trust will be imposed on the corporation may be collected
from the corporation and its agents. This paragraph (d)(4) will not be
applied so as to alter the tax consequences of transactions as to which
rulings have been issued by the Internal Revenue Service prior to
September 19, 1985.
(5) The rules set forth in this paragraph (d) apply solely for
purposes of sections 4701, 163(f)(2)(A), 163(f)(2)(B), Sec. 1.163-5(c),
and any other section that refers to this section for the definition of
the term ``registration-required obligation'' (such as the regulations
under sections 871(h) and 881(c)). The treatment of obligations
described in this paragraph (d) for purposes of section 163(f)(2) (A)
and (B) does not affect the determination of whether bearer obligations
that are issued or guaranteed by the United States Government, a United
States Government-owned agency, a United States Government sponsored
enterprise (within the meaning of Sec. 1.163-5(c)(1)) or that are
backed (as described in the Treasury Department News Release R-2835 of
September 10, 1984 and Treasury Department News Release R-2847 of
September 14, 1984) by obligations issued by the United States
Government, a United States Government-owned agency, or a United States
Government sponsored enterprise comply with the requirements of section
163(f)(2)(B) and the regulations thereunder.
(6) The provisions of paragraphs (d) (1) through (5) may be
illustrated by the following example:
Commercial Bank K forms a pool of 1000 residential mortgage loans,
each made to a different individual homeowner, by assigning them to
Commercial Bank L, an unrelated entity serving as trustee of the pool.
Commercial Bank L immediately sells in a public offering certificates of
interest in the trust of a maturity of 10 years in registered form.
Commercial Bank L transfers the cash proceeds of the offering to
Commercial Bank K. The certificates of interest in the trust are of a
type offered to the public and are not described in section
163(f)(2)(B). Pursuant to paragraph (d)(1), the certificates of interest
in the pool are registration-required obligations without regard to the
fact that the obligations held by the trust are not registration-
required obligations.
[[Page 292]]
(e) Regular interests in REMICS. (1) A regular interest in a REMIC,
as defined in sections 860D and 860G and the regulations thereunder, is
considered to be a ``registration-required obligation'' under section
163(f)(2)(A) and Sec. 1.163-5(c) if the regular interest is described
in section 163(f)(2)(A) and Sec. 1.163-5(c), without regard to whether
any obligation held by the REMIC to which the regular interest relates
is described in section 163(f)(2)(A) and Sec. 1.163-5(c). A regular
interest in a REMIC is considered to be described in section
163(f)(2)(B) and Sec. 1.163-5(c), if the regular interest is described
in section 163(f)(2)(B) and Sec. 1.163(c), without regard to whether
any obligation held by the REMIC to which the regular interest relates
is described in section 163(f)(2)(B) and Sec. 1.163-5(c).
(2) An obligation held by a REMIC is considered to be described in
section 163(f)(2) (A) or (B) if such obligation is described in section
163(f)(2) (A) or (B), respectively, without regard to whether the
regular interests in the REMIC are so considered.
(3) For purposes of section 4701, a regular interest is considered
to be issued solely by the recipient of the proceeds from the issuance
of the regular interest (hereinafter the ``sponsor''). The sponsor is
therefore liable for any excise tax under section 4701 that may be
imposed with reference to the principal amount of the regular interest.
(4) In order to implement the purpose of section 163, Sec. 1.163-
5(c), and this section, the Commissioner may characterize a regular
interest in a REMIC and any obligation held by such REMIC in accordance
with the substance of the arrangement they represent and may impose the
penalties provided under sections 163(f)(1) and 4701 in the appropriate
amounts and on the appropriate persons. This provision may be applied,
for example, where a corporation issues an obligation that is
purportedly in registered form and that will qualify as a ``qualified
mortgage'' within the meaning of section 860G(a)(3) in the hands of a
REMIC, contributes the obligation to a REMIC as its only asset, and
arranges for the sale to investors of regular interests in the REMIC in
bearer form that do not meet the requirements of section 163(f)(2)(B).
If this provision is applied, the obligation held by the REMIC will not
be considered to be issued in registered form or to meet the
requirements of section 163(f)(2)(B). The corporation will not be
allowed a deduction for the payment of interest on the obligation held
by the REMIC, and the excise tax under section 4701, calculated with
reference to the principal amount of the obligation held by the REMIC,
will be imposed on the corporation and may be collected from the
corporation and its agents.
[T.D. 8202, 53 FR 17928, May 19, 1988, as amended by T.D. 8300, 55 FR
19626, May 10, 1990]
Sec. 1.163-6T Reduction of deduction where section 25 credit taken
(temporary).
(a) In general. The amount of the deduction under section 163 for
interest paid or accrued during any taxable year on a certified
indebtedness amount with respect to a mortgage credit certificate which
has been issued under section 25 shall be reduced by the amount of the
credit allowable with respect to such interest under section 25
(determined without regard to section 26).
(b) Cross reference. See Sec. Sec. 1.25-1T through 1.25-8T with
respect to rules relating to mortgage credit certificates.
[T.D. 8023, 50 FR 19355, May 8, 1985]
Sec. 1.163-7 Deduction for OID on certain debt instruments.
(a) General rule. Except as otherwise provided in paragraph (b) of
this section, an issuer (including a transferee) determines the amount
of OID that is deductible each year under section 163(e)(1) by using the
constant yield method described in Sec. 1.1272-1(b). This
determination, however, is made without regard to section 1272(a)(7)
(relating to acquisition premium) and Sec. 1.1273-1(d) (relating to de
minimis OID). An issuer is permitted a deduction under section 163(e)(1)
only to the extent the issuer is primarily liable on the debt
instrument. For certain limitations on the deductibility of OID, see
sections 163(e) and 1275(b)(2). To determine the amount of interest
(OID) that
[[Page 293]]
is deductible each year on a debt instrument that provides for
contingent payments, see Sec. 1.1275-4.
(b) Special rules for de minimis OID--(1) Stated interest. If a debt
instrument has a de minimis amount of OID (within the meaning of Sec.
1.1273-1(d)), the issuer treats all stated interest on the debt
instrument as qualified stated interest. See Sec. Sec. 1.446-2(b) and
1.461-1 for the treatment of qualified stated interest.
(2) Deduction of de minimis OID on other than a constant yield
basis. In lieu of deducting de minimis OID under the general rule of
paragraph (a) of this section, an issuer of a debt instrument with a de
minimis amount of OID (other than a de minimis amount treated as
qualified stated interest under paragraph (b)(1) of this section) may
choose to deduct the OID at maturity, on a straight-line basis over the
term of the debt instrument, or in proportion to stated interest
payments. The issuer makes this choice by reporting the de minimis OID
in a manner consistent with the method chosen on the issuer's timely
filed Federal income tax return for the taxable year in which the debt
instrument is issued.
(c) Deduction upon repurchase. Except to the extent disallowed by
any other section of the Internal Revenue Code (e.g., section 249) or
this paragraph (c), if a debt instrument is repurchased by the issuer
for a price in excess of its adjusted issue price (as defined in Sec.
1.1275-1(b)), the excess (repurchase premium) is deductible as interest
for the taxable year in which the repurchase occurs. If the issuer
repurchases a debt instrument in a debt-for-debt exchange, the
repurchase price is the issue price of the newly issued debt instrument
(reduced by any unstated interest within the meaning of section 483).
However, if the issue price of the newly issued debt instrument is
determined under either section 1273(b)(4) or section 1274, any
repurchase premium is not deductible in the year of the repurchase, but
is amortized over the term of the newly issued debt instrument in the
same manner as if it were OID.
(d) Choice of accrual periods to determine whether a debt instrument
is an applicable high yield discount obligation (AHYDO). Section
163(e)(5) affects an issuer's OID deductions for certain high yield debt
instruments that have significant OID. For purposes of section
163(i)(2), which defines significant OID, the issuer's choice of accrual
periods to determine OID accruals is used to determine whether a debt
instrument has significant OID. See Sec. 1.1275-2(e) for rules relating
to the issuer's obligation to disclose certain information to holders.
(e) Qualified reopening--(1) In general. In a qualified reopening of
an issue of debt instruments, if a holder pays more or less than the
adjusted issue price of the original debt instruments to acquire an
additional debt instrument, the issuer treats this difference as an
adjustment to the issuer's interest expense for the original and
additional debt instruments. As provided by paragraphs (e)(2) through
(5) of this section, the adjustment is taken into account over the term
of the instrument using constant yield principles.
(2) Positive adjustment. If the difference is positive (that is, the
holder pays more than the adjusted issue price of the original debt
instrument), then, with respect to the issuer but not the holder, the
difference increases the aggregate adjusted issue prices of all of the
debt instruments in the issue, both original and additional.
(3) Negative adjustment. If the difference is negative (that is, the
holder pays less than the adjusted issue price of the original debt
instrument), then, with respect to the issuer but not the holder, the
difference reduces the aggregate adjusted issue prices of all of the
debt instruments in the issue, both original and additional.
(4) Determination of issuer's interest accruals. As of the reopening
date, the issuer must redetermine the yield of the debt instruments in
the issue for purposes of applying the constant yield method described
in Sec. 1.1272-1(b) to determine the issuer's accruals of interest
expense over the remaining term of the debt instruments in the issue.
This redetermined yield is based on the aggregate adjusted issue prices
of the debt instruments in the issue (as determined under this paragraph
(e)) and the remaining payment schedule of the debt instruments in the
issue. If the aggregate adjusted issue prices of the
[[Page 294]]
debt instruments in the issue (as determined under this paragraph (e))
are less than the aggregate stated redemption price at maturity of the
instruments (determined as of the reopening date) by a de minimis amount
(within the meaning of Sec. 1.1273-1(d)), the issuer may use the rules
in paragraph (b) of this section to determine the issuer's accruals of
interest expense.
(5) Effect of adjustments on issuer's adjusted issue price. The
adjustments made under this paragraph (e) are taken into account for
purposes of determining the issuer's adjusted issue price under Sec.
1.1275-1(b).
(6) Definitions. The terms additional debt instrument, original debt
instrument, qualified reopening, and reopening date have the same
meanings as in Sec. 1.1275-2(k).
(f) Effective dates. This section (other than paragraph (e) of this
section) applies to debt instruments issued on or after April 4, 1994.
Taxpayers, however, may rely on this section (other than paragraph (e)
of this section) for debt instruments issued after December 21, 1992,
and before April 4, 1994. Paragraph (e) of this section applies to
qualified reopenings where the reopening date is on or after March 13,
2001.
[T.D. 8517, 59 FR 4804, Feb. 2, 1994, as amended by T.D. 8674, 61 FR
30138, June 14, 1996; T.D. 8934, 66 FR 2815, Jan. 12, 2001]
Sec. 1.163-8T Allocation of interest expense among expenditures
(temporary).
(a) In general--(1) Application. This section prescribes rules for
allocating interest expense for purposes of applying sections 469 (the
``passive loss limitation'') and 163 (d) and (h) (the ``nonbusiness
interest limitations'').
(2) Cross-references. This paragraph provides an overview of the
manner in which interest expense is allocated for the purposes of
applying the passive loss limitation and nonbusiness interest
limitations and the manner in which interest expense allocated under
this section is treated. See paragraph (b) of this section for
definitions of certain terms, paragraph (c) for the rules for allocating
debt and interest expense among expenditures, paragraphs (d) and (e) for
the treatment of debt repayments and refinancings, paragraph (j) for the
rules for reallocating debt upon the occurrence of certain events,
paragraph (m) for the coordination of the rules in this section with
other limitations on the deductibility of interest expense, and
paragraph (n) of this section for effective date and transitional rules.
(3) Manner of allocation. In general, interest expense on a debt is
allocated in the same manner as the debt to which such interest expense
relates is allocated. Debt is allocated by tracing disbursements of the
debt proceeds to specific expenditures. This section prescribes rules
for tracing debt proceeds to specific expenditures.
(4) Treatment of interest expenses--(i) General rule. Except as
otherwise provided in paragraph (m) of this section (relating to
limitations on interest expense other than the passive loss and
nonbusiness interest limitations), interest expense allocated under the
rules of this section is treated in the following manner:
(A) Interest expense allocated to a trade or business expenditure
(as defined in paragraph (b)(7) of this section) is taken into account
under section 163 (h)(2)(A);
(B) Interest expense allocated to a passive activity expenditure (as
defined in paragraph (b)(4) of this section) or a former passive
activity expenditure (as defined in paragraph (b)(2) of this section) is
taken into account for purposes of section 469 in determining the income
or loss from the activity to which such expenditure relates;
(C) Interest expense allocated to an investment expenditure (as
defined in paragraph (b)(3) of this section) is treated for purposes of
section 163(d) as investment interest;
(D) Interest expense allocated to a personal expenditure (as defined
in paragraph (b)(5) of this section) is treated for purposes of section
163(h) as personal interest; and
(E) Interest expense allocated to a portfolio expenditure (as
defined in paragraph (b)(6) of this section) is treated for purposes of
section 469(e)(2)(B)(ii) as interest expense described in section
469(e)(1)(A)(i)(III).
(ii) Examples. The following examples illustrate the application of
this paragraph (a)(4):
[[Page 295]]
Example 1. Taxpayer A, an individual, incurs interest expense
allocated under the rules of this section to the following expenditures:
$6,000 Passive activity expenditure.
$4,000 Personal expenditure.
The $6,000 interest expense allocated to the passive activity
expenditure is taken into account for purposes of section 469 in
computing A's income or loss from the activity to which such interest
relates. Pursuant to section 163(h), A may not deduct the $4,000
interest expense allocated to the personal expenditure (except to the
extent such interest is qualified residence interest, within the meaning
of section 163(h)(3)).
Example 2. (i) Corporation M, a closely held C corporation (within
the meaning of section 469 (j)(1)) has $10,000 of interest expense for a
taxable year. Under the rules of this section, M's interest expense is
allocated to the following expenditures:
$2,000 Passive activity expenditure.
$3,000 Portfolio expenditure.
$5,000 Other expenditures.
(ii) Under section 163(d)(3)(D) and this paragraph (a)(4), the
$2,000 interest expense allocated to the passive activity expenditure is
taken into account in computing M's passive activity loss for the
taxable year, but, pursuant to section 469(e)(1) and this paragraph
(a)(4), the interest expense allocated to the portfolio expenditure and
the other expenditures is not taken into account for such purposes.
(iii) Since M is a closely held C corporation, its passive activity
loss is allowable under section 469(e)(2)(A) as a deduction from net
active income. Under section 469(e)(2)(B) and this paragraph (a)(4), the
$5,000 interest expense allocated to other expenditures is taken into
account in computing M's net active income, but the interest expense
allocated to the passive activity expenditure and the portfolio
expenditure is not taken into account for such purposes.
(iv) Since M is a corporation, the $3,000 interest expense allocated
to the portfolio expenditure is allowable without regard to section
163(d). If M were an individual, however, the interest expense allocated
to the portfolio expenditure would be treated as investment interest for
purposes of applying the limitation of section 163(d).
(b) Definitions. For purposes of this section--
(1) ``Former passive activity'' means an activity described in
section 469(f)(3), but only if an unused deduction or credit (within the
meaning of section 469(f)(1) (A) or (B)) is allocable to the activity
under section 469(b) for the taxable year.
(2) ``Former passive activity expenditure'' means an expenditure
that is taken into account under section 469 in computing the income or
loss from a former passive activity of the taxpayer or an expenditure
(including an expenditure properly chargeable to capital account) that
would be so taken into account if such expenditure were otherwise
deductible.
(3) ``Investment expenditure'' means an expenditure (other than a
passive activity expenditure) properly chargeable to capital account
with respect to property held for investment (within the meaning of
section 163(d)(5)(A)) or an expenditure in connection with the holding
of such property.
(4) ``Passive activity expenditure'' means an expenditure that is
taken into account under section 469 in computing income or loss from a
passive activity of the taxpayer or an expenditure (including an
expenditure properly chargeable to capital account) that would be so
taken into account if such expenditure were otherwise deductible. For
purposes of this section, the term ``passive activity expenditure'' does
not include any expenditure with respect to any low-income housing
project in any taxable year in which any benefit is allowed with respect
to such project under section 502 of the Tax Reform Act of 1986.
(5) ``Personal expenditure'' means an expenditure that is not a
trade or business expenditure, a passive activity expenditure, or an
investment expenditure.
(6) ``Portfolio expenditure'' means an investment expenditure
properly chargeable to capital account with respect to property
producing income of a type described in section 469(e)(1)(A) or an
investment expenditure for an expense clearly and directly allocable to
such income.
(7) ``Trade or business expenditure'' means an expenditure (other
than a passive activity expenditure or an investment expenditure) in
connection with the conduct of any trade or business other than the
trade or business of performing services as an employee.
(c) Allocation of debt and interest expense--(1) Allocation in
accordance with use of proceeds. Debt is allocated to expenditures in
accordance with the use
[[Page 296]]
of the debt proceeds and, except as provided in paragraph (m) of this
section, interest expense accruing on a debt during any period is
allocated to expenditures in the same manner as the debt is allocated
from time to time during such period. Except as provided in paragraph
(m) of this section, debt proceeds and related interest expense are
allocated solely by reference to the use of such proceeds, and the
allocation is not affected by the use of an interest in any property to
secure the repayment of such debt or interest. The following example
illustrates the principles of this paragraph (c)(1):
Example. Taxpayer A, an individual, pledges corporate stock held for
investment as security for a loan and uses the debt proceeds to purchase
an automobile for personal use. Interest expense accruing on the debt is
allocated to the personal expenditure to purchase the automobile even
though the debt is secured by investment property.
(2) Allocation period--(i) Allocation of debt. Debt is allocated to
an expenditure for the period beginning on the date the proceeds of the
debt are used or treated as used under the rules of this section to make
the expenditure and ending on the earlier of--
(A) The date the debt is repaid; or
(B) The date the debt is reallocated in accordance with the rules in
paragraphs (c)(4) and (j) of this section.
(ii) Allocation of interest expense--(A) In general. Except as
otherwise provided in paragraph (m) of this section, interest expense
accruing on a debt for any period is allocated in the same manner as the
debt is allocated from time to time, regardless of when the interest is
paid.
(B) Effect of compounding. Accrued interest is treated as a debt
until it is paid and any interest accruing on unpaid interest is
allocated in the same manner as the unpaid interest is allocated. For
the taxable year in which a debt is reallocated under the rules in
paragraphs (c)(4) and (j) of this section, however, compound interest
accruing on such debt (other than compound interest accruing on interest
that accrued before the beginning of the year) may be allocated between
the original expenditure and the new expenditure on a straight-line
basis (i.e., by allocating an equal amount of such interest expense to
each day during the taxable year). In addition, a taxpayer may treat a
year as consisting of 12 30-day months for purposes of allocating
interest on a straight-line basis.
(C) Accrual of interest expense. For purposes of this paragraph
(c)(2)(ii), the amount of interest expense that accrues during any
period is determined by taking into account relevant provisions of the
loan agreement and any applicable law such as sections 163(e), 483, and
1271 through 1275.
(iii) Examples. The following examples illustrate the principles of
this paragraph (c)(2):
Example 1. (i) On January 1, taxpayer B, a calendar year taxpayer,
borrows $1,000 at an interest rate of 11 percent, compounded
semiannually. B immediately uses the debt proceeds to purchase an
investment security. On July 1, B sells the investment security for
$1,000 and uses the sales proceeds to make a passive activity
expenditure. On December 31, B pays accrued interest on the $1,000 debt
for the entire year.
(ii) Under this paragraph (c)(2) and paragraph (j) of this section,
the $1,000 debt is allocated to the investment expenditure for the
period from January 1 through June 30, and to the passive activity
expenditure from July 1 through December 31. Interest expense accruing
on the $1,000 debt is allocated in accordance with the allocation of the
debt from time to time during the year even though the debt was
allocated to the passive activity expenditure on the date the interest
was paid. Thus, the $55 interest expense for the period from January 1
through June 30 is allocated to the investment expenditure. In addition,
during the period from July 1 through December 31, the interest expense
allocated to the investment expenditure is a debt, the proceeds of which
are treated as used to make an investment expenditure. Accordingly, an
additional $3 of interest expense for the period from July 1 through
December 31 ($55x.055) is allocated to the investment expenditure. The
remaining $55 of interest expense for the period from July 1 through
December 31 ($1,000x.055) is allocated to the passive activity
expenditure.
(iii) Alternatively, under the rule in paragraph (c)(2)(ii)(B) of
this section, B may allocate the interest expense on a straight-line
basis and may also treat the year as consisting of 12 30-day months for
this purpose. In that case, $56.50 of interest expense (180/360x$113)
would be allocated to the investment expenditure and the remaining
$56.50 of interest expense would be allocated to the passive activity
expenditure.
[[Page 297]]
Example 2. On January 1, 1988, taxpayer C borrows $10,000 at an
interest rate of 11 percent, compounded annually. All interest and
principal on the debt is payable in a lump sum on December 31, 1992. C
immediately uses the debt proceeds to make a passive activity
expenditure. C materially participates in the activity in 1990, 1991,
and 1992. Therefore, under paragraphs (c)(2) (i) and (j) of this
section, the debt is allocated to a passive activity expenditure from
January 1, 1988, through December 31, 1989, and to a former passive
activity expenditure from January 1, 1990, through December 31, 1992. In
accordance with the loan agreement (and consistent with Sec. 1.1272-
1(d)(1) of the proposed regulations, 51 FR 12022, April 8, 1986),
interest expense accruing during any period is determined on the basis
of annual compounding. Accordingly, the interest expense on the debt is
allocated as follows:
----------------------------------------------------------------------------------------------------------------
Year Amount Expenditure
----------------------------------------------------------------------------------------------------------------
1988.................................. $10,000 x .11 $1,100 Passive activity.
1989.................................. 11,100 x .11 1,221 Passive activity.
1990.................................. 12,321 x .11 = 1,355 ........ .........................
1,355 x 2,321/12,321 255 Passive activity.
1,355 x 10,000/12,321 1,100 Former passive activity.
----------
................................... 1,355 .........................
1991.................................. 13,676 x .11 = 1,504 ........ .........................
1,504 x 2,576/13,676 283 Passive activity.
1,504 x 11,100/13,676 1,221 Former passive activity.
----------
................................... 1,504 .........................
1992.................................. 15,180 x .11 = 1,670 ........ .........................
1,670 x 2,859/15,180 315 Passive activity.
1,670 x 12,321/15,180 1,355 Former passive activity.
----------
................................... 1,670 .........................
----------------------------------------------------------------------------------------------------------------
(3) Allocation of debt; proceeds not disbursed to borrower--(i)
Third-party financing. If a lender disburses debt proceeds to a person
other than the borrower in consideration for the sale or use of
property, for services, or for any other purpose, the debt is treated
for purposes of this section as if the borrower used an amount of the
debt proceeds equal to such disbursement to make an expenditure for such
property, services, or other purpose.
(ii) Debt assumptions not involving cash disbursements. If a
taxpayer incurs or assumes a debt in consideration for the sale or use
of property, for services, or for any other purpose, or takes property
subject to a debt, and no debt proceeds are disbursed to the taxpayer,
the debt is treated for purposes of this section as if the taxpayer used
an amount of the debt proceeds equal to the balance of the debt
outstanding at such time to make an expenditure for such property,
services, or other purpose.
(4) Allocation of debt; proceeds deposited in borrower's account--
(i) Treatment of deposit. For purposes of this section, a deposit of
debt proceeds in an account is treated as an investment expenditure, and
amounts held in an account (whether or not interest bearing) are treated
as property held for investment. Debt allocated to an account under this
paragraph (c)(4)(i) must be reallocated as required by paragraph (j) of
this section whenever debt proceeds held in the account are used for
another expenditure. This paragraph (c)(4) provides rules for
determining when debt proceeds are expended from the account. The
following example illustrates the principles of this paragraph
(c)(4)(i):
Example. Taxpayer C, a calendar year taxpayer, borrows $100,000 on
January 1 and immediately uses the proceeds to open a noninterest-
bearing checking account. No other amounts are deposited in the account
during the year, and no portion of the principal amount of the debt is
repaid during the year. On April 1, C uses $20,000 of the debt proceeds
held in the account for a passive activity expenditure. On September 1,
C uses an additional $40,000 of the debt proceeds held in the account
for a personal expenditure. Under this paragraph (c)(4)(i), from January
1 through March 31 the entire $100,000 debt is allocated to an
investment expenditure for the account. From April 1 through August 31,
$20,000 of the debt is allocated to the passive activity expenditure,
and $80,000 of the
[[Page 298]]
debt is allocated to the investment expenditure for the account. From
September 1 through December 31, $40,000 of the debt is allocated to the
personal expenditure, $20,000 is allocated to the passive activity
expenditure, and $40,000 is allocated to an investment expenditure for
the account.
(ii) Expenditures from account; general ordering rule. Except as
provided in paragraph (c)(4)(iii) (B) or (C) of this section, debt
proceeds deposited in an account are treated as expended before--
(A) Any unborrowed amounts held in the account at the time such debt
proceeds are deposited; and
(B) Any amounts (borrowed or unborrowed) that are deposited in the
account after such debt proceeds are deposited.
The following example illustrates the application of this paragraph
(c)(4)(ii):
Example. On January 10, taxpayer E opens a checking account,
depositing $500 of proceeds of Debt A and $1,000 of unborrowed funds.
The following chart summarizes the transactions which occur during the
year with respect to the account:
------------------------------------------------------------------------
Date Transaction
------------------------------------------------------------------------
Jan. 10................................... $500 proceeds of Debt A and
$1,000 unborowed funds
deposited.
Jan. 11................................... $500 proceeds of Debt B
deposited.
Feb. 17................................... $800 personal expenditure.
Feb. 26................................... $700 passive activity
expenditure.
June 21................................... $1,000 proceeds of Debt C
deposited.
Nov. 24................................... $800 investment expenditure.
Dec. 20................................... $600 personal expenditure.
------------------------------------------------------------------------
The $800 personal expenditure is treated as made from the $500 proceeds
of Debt A and $300 of the proceeds of Debt B. The $700 passive activity
expenditure is treated as made from the remaining $200 proceeds of Debt
B and $500 of unborrowed funds. The $800 investment expenditure is
treated as made entirely from the proceeds of Debt C. The $600 personal
expenditure is treated as made from the remaining $200 proceeds of Debt
C and $400 of unborrowed funds. Under paragraph (c)(4)(i) of this
section, debt is allocated to an investment expenditure for periods
during which debt proceeds are held in the account.
(iii) Expenditures from account; supplemental ordering rules--(A)
Checking or similar accounts. Except as otherwise provided in this
paragraph (c)(4)(iii), an expenditure from a checking or similar account
is treated as made at the time the check is written on the account,
provided the check is delivered or mailed to the payee within a
reasonable period after the writing of the check. For this purpose, the
taxpayer may treat checks written on the same day as written in any
order. In the absence of evidence to the contrary, a check is presumed
to be written on the date appearing on the check and to be delivered or
mailed to the payee within a reasonable period thereafter. Evidence to
the contrary may include the fact that a check does not clear within a
reasonable period after the date appearing on the check.
(B) Expenditures within 15 days after deposit of borrowed funds. The
taxpayer may treat any expenditure made from an account within 15 days
after debt proceeds are deposited in such account as made from such
proceeds to the extent thereof even if under paragraph (c)(4)(ii) of
this section the debt proceeds would be treated as used to make one or
more other expenditures. Any such expenditures and the debt proceeds
from which such expenditures are treated as made are disregarded in
applying paragraph (c)(4)(ii) of this section. The following examples
illustrate the application of this paragraph (c)(4)(iii)(B):
Example 1. Taxpayer D incurs a $1,000 debt on June 5 and immediately
deposits the proceeds in an account (``Account A''). On June 17, D
transfers $2,000 from Account A to another account (``Account B''). On
June 30, D writes a $1,500 check on Account B for a passive activity
expenditure. In addition, numerous deposits of borrowed and unborrowed
amounts and expenditures occur with respect to both accounts throughout
the month of June. Notwithstanding these other transactions, D may treat
$1,000 of the deposit to Account B on June 17 as an expenditure from the
debt proceeds deposited in Account A on June 5. In addition, D may
similarly treat $1,000 of the passive activity expenditure on June 30 as
made from debt proceeds treated as deposited in Account B on June 17.
Example 2. The facts are the same as in the example in paragraph
(c)(4)(ii) of this section, except that the proceeds of Debt B are
deposited on February 11 rather than on January 11. Since the $700
passive activity expenditure occurs within 15 days after the proceeds of
Debt B are deposited in the account, E may treat such expenditure as
being made from the proceeds of Debt B to the extent thereof. If E
treats the passive activity expenditure in this manner, the expenditures
from the account are treated as follows: The $800 personal expenditure
is treated as made from the $500 proceeds of
[[Page 299]]
Debt A and $300 of unborrowed funds. The $700 passive activity
expenditure is treated as made from the $500 proceeds of Debt B and $200
of unborrowed funds. The remaining expenditures are treated as in the
example in paragraph (c)(4)(ii) of this section.
(C) Interest on segregated account. In the case of an account
consisting solely of the proceeds of a debt and interest earned on such
account, the taxpayer may treat any expenditure from such account as
made first from amounts constituting interest (rather than debt
proceeds) to the extent of the balance of such interest in the account
at the time of the expenditure, determined by applying the rules in this
paragraph (c)(4). To the extent any expenditure is treated as made from
interest under this paragraph (c)(4)(iii)(C), the expenditure is
disregarded in applying paragraph (c)(4)(ii) of this section.
(iv) Optional method for determining date of reallocation. Solely
for the purpose of determining the date on which debt allocated to an
account under paragraph (c)(4)(i) of this section is reallocated, the
taxpayer may treat all expenditures made during any calendar month from
debt proceeds in the account as occurring on the later of the first day
of such month or the date on which such debt proceeds are deposited in
the account. This paragraph (c)(4)(iv) applies only if all expenditures
from an account during the same calendar month are similarly treated.
The following example illustrates the application of this paragraph
(c)(4)(iv):
Example. On January 10, taxpayer G opens a checking account,
depositing $500 of proceeds of Debt A and $1,000 of unborrowed funds.
The following chart summarizes the transactions which occur during the
year with respect to the account (note that these facts are the same as
the facts of the example in paragraph (c)(4)(ii) of this section):
------------------------------------------------------------------------
Date Transaction
------------------------------------------------------------------------
Jan. 10................................... $500 proceeds of Debt A and
$1,000 unborrowed funds
deposited.
Jan. 11................................... $500 proceeds of Debt B
deposited.
Feb. 17................................... $800 personal expenditure.
Feb. 26................................... $700 passive activity
expenditure.
June 21................................... $1,000 proceeds of Debt C
deposited.
Nov. 24................................... $800 investment expenditure.
Dec. 20................................... $600 personal expenditure.
------------------------------------------------------------------------
Assume that G chooses to apply the optional rule of this paragraph
(c)(4)(iv) to all expenditures. For purposes of determining the date on
which debt is allocated to the $800 personal expenditure made on
February 17, the $500 treated as made from the proceeds of Debt A and
the $300 treated as made from the proceeds of Debt B are treated as
expenditures occurring on February 1. Accordingly, Debt A is allocated
to an investment expenditure for the account from January 10 through
January 31 and to the personal expenditure from February 1 through
December 31, and $300 of Debt B is allocated to an investment
expenditure for the account from January 11 through January 31 and to
the personal expenditure from February 1 through December 31. The
remaining $200 of Debt B is allocated to an investment expenditure for
the account from January 11 through January 31 and to the passive
activity expenditure from February 1 through December 31. The $800 of
Debt C used to make the investment expenditure on November 24 is
allocated to an investment expenditure for the account from June 21
through October 31 and to an investment expenditure from November 1
through December 31. The remaining $200 of Debt C is allocated to an
investment expenditure for the account from June 21 through November 30
and to a personal expenditure from December 1 through December 31.
(v) Simultaneous deposits--(A) In general. If the proceeds of two or
more debts are deposited in an account simultaneously, such proceeds are
treated for purposes of this paragraph (c)(4) as deposited in the order
in which the debts were incurred.
(B) Order in which debts incurred. If two or more debts are incurred
simultaneously or are treated under applicable law as incurred
simultaneously, the debts are treated for purposes of this paragraph
(c)(4)(v) as incurred in any order the taxpayer selects.
(C) Borrowings on which interest accrues at different rates. If
interest does not accrue at the same fixed or variable rate on the
entire amount of a borrowing, each portion of the borrowing on which
interest accrues at a different fixed or variable rate is treated as a
separate debt for purposes of this paragraph (c)(4)(v).
(vi) Multiple accounts. The rules in this paragraph (c)(4) apply
separately to each account of a taxpayer.
(5) Allocation of debt; proceeds received in cash--(i) Expenditure
within 15 days of receiving debt proceeds. If a taxpayer receives the
proceeds of a debt in cash, the taxpayer may treat any cash expenditure
made within 15 days after receiving the cash as made from such
[[Page 300]]
debt proceeds to the extent thereof and may treat such expenditure as
made on the date the taxpayer received the cash. The following example
illustrates the rule in this paragraph (c)(5)(i):
Example. Taxpayer F incurs a $1,000 debt on August 4 and receives
the debt proceeds in cash. F deposits $1,500 cash in an account on
August 15 and on August 27 writes a check on the account for a passive
activity expenditure. In addition, F engages in numerous other cash
transactions throughout the month of August, and numerous deposits of
borrowed and unborrowed amounts and expenditures occur with respect to
the account during the same period. Notwithstanding these other
transactions, F may treat $1,000 of the deposit on August 15 as an
expenditure made from the debt proceeds on August 4. In addition, under
the rule in paragraph (c)(4)(v)(B) of this section, F may treat the
passive activity expenditure on August 27 as made from the $1,000 debt
proceeds treated as deposited in the account.
(ii) Other expenditures. Except as provided in paragraphs (c)(5) (i)
and (iii) of this section, any debt proceeds a taxpayer (other than a
corporation) receives in cash are treated as used to make personal
expenditures. For purposes of this paragraph (c)(5), debt proceeds are
received in cash if, for example, a withdrawal of cash from an account
is treated under the rules of this section as an expenditure of debt
proceeds.
(iii) Special rules for certain taxpayers. [Reserved]
(6) Special rules--(i) Qualified residence debt. [Reserved]
(ii) Debt used to pay interest. To the extent proceeds of a debt are
used to pay interest, such debt is allocated in the same manner as the
debt on which such interest accrued is allocated from time to time. The
following example illustrates the application of this paragraph
(c)(6)(ii):
Example. On January 1, taxpayer H incurs a debt of $1,000, bearing
interest at an annual rate of 10 percent, compounded annually, payable
at the end of each year (``Debt A''). H immediately opens a checking
account, in which H deposits the proceeds of Debt A. No other amounts
are deposited in the account during the year. On April 1, H writes a
check for a personal expenditure in the amount of $1,000. On December
31, H borrows $100 (``Debt B'') and immediately uses the proceeds of
Debt B to pay the accrued interest of $100 on Debt A. From January 1
through March 31, Debt A is allocated, under the rule in paragraph
(c)(4)(i) of this section, to the investment expenditure for the
account. From April 1 through December 31, Debt A is allocated to the
personal expenditure. Under the rule in paragraph (c)(2)(ii) of this
section, $25 of the interest on Debt A for the year is allocated to the
investment expenditure, and $75 of the interest on Debt A for the year
is allocated to the personal expenditure. Accordingly, for the purpose
of allocating the interest on Debt B for all periods until Debt B is
repaid, $25 of Debt B is allocated to the investment expenditure, and
$75 of Debt B is allocated to the personal expenditure.
(iii) Debt used to pay borrowing costs--(A) Borrowing costs with
respect to different debt. To the extent the proceeds of a debt (the
``ancillary debt'') are used to pay borrowing costs (other than
interest) with respect to another debt (the ``primary debt''), the
ancillary debt is allocated in the same manner as the primary debt is
allocated from time to time. To the extent the primary debt is repaid,
the ancillary debt will continue to be allocated in the same manner as
the primary debt was allocated immediately before its repayment. The
following example illustrates the rule in this paragraph (c)(6)(iii)(A):
Example. Taxpayer I incurs debts of $60,000 (``Debt A'') and $10,000
(``Debt B''). I immediately uses $30,000 of the proceeds of Debt A to
make a trade or business expenditure, $20,000 to make a passive activity
expenditure, and $10,000 to make an investment expenditure. I
immediately use $3,000 of the proceeds of Debt B to pay borrowing costs
(other than interest) with respect to Debt A (such as loan origination,
loan commitment, abstract, and recording fees) and deposits the
remaining $7,000 in an account. Under the rule in this paragraph
(c)(6)(iii)(A), the $3,000 of Debt B used to pay expenses of incurring
Debt A is allocated $1,500 to the trade or business expenditure ($3,000
x $30,000/$60,000), $1,000 to the passive activity expenditure ($3,000 x
$20,000/$60,000), and $500 ($3,000 x $10,000/$60,000) to the investment
expenditure. The manner in which the $3,000 of Debt B used to pay
expenses of incurring Debt A is allocated may change if the allocation
of Debt A changes, but such allocation will be unaffected by any
repayment of Debt A. The remaining $7,000 of Debt B is allocated to an
investment expenditure for the account until such time, if any, as this
amount is used for a different expenditure.
(B) Borrowing costs with respect to same debt. To the extent the
proceeds of
[[Page 301]]
a debt are used to pay borrowing costs (other than interest) with
respect to such debt, such debt is allocated in the same manner as the
remaining debt is allocated from time to time. The remaining debt for
this purpose is the portion of the debt that is not used to pay
borrowing costs (other than interst) with respect to such debt. Any
repayment of the debt is treated as a repayment of the debt allocated
under this paragraph (c)(6)(iii)(B) and the remaining debt is the same
proportion as such amount bear to each other. The following example
illustrates the application of this paragraph (c)(6)(iii)(B):
Example. (i) Taxpayer J borrows $85,000. The lender disburses
$80,000 of this amount to J, retaining $5,000 for borrowing costs (other
than interest) with respect to the loan. J immediately uses $40,000 of
the debt proceeds to make a personal expenditure, $20,000 to make a
passive activity expenditure, and $20,000 to make an investment
expenditure. Under the rule in this paragraph (c)(6)(iii)(B), the $5,000
used to pay borrowing costs is allocated $2,500 ($5,000 x $40,000/
$80,000) to the personal expenditure, $1,250 ($5,000 x $20,000/$80,000)
to the investment expenditure. The manner in which this $5,000 is
allocated may change if the allocation of the remaining $80,000 of debt
is changed.
(ii) Assume that J repays $50,000 of the debt. The repayment is
treated as a repayment of $2,941 ($50,000 x $5,000/$85,000) of the debt
used to pay borrowing costs and a repayment of $47,059 ($50,000 x
$80,000/$85,000) of the remaining debt. Under paragraph (d) of this
section, J is treated as repaying the $42,500 of debt allocated to the
personal expenditure ($2,500 of debt used to pay borrowing costs and
$40,000 of remaining debt). In addition, assuming that under paragraph
(d)(2) J chooses to treat the allocation to the passive activity
expenditure as having occurred before the allocation to the investment
expenditure, J is treated as repaying $7,500 of debt allocated to the
passive activity expenditure ($441 of debt used to pay borrowing costs
and $7,059 of remaining debt).
(iv) Allocation of debt before actual receipt of debt proceeds. If
interest properly accrues on a debt during any period before the debt
proceeds are actually received or used to make an expenditure, the debt
is allocated to an investment expenditure for such period.
(7) Antiabuse rules. [Reserved]
(d) Debt repayments--(1) General ordering rule. If, at the time any
portion of a debt is repaid, such debt is allocated to more than one
expenditure, the debt is treated for purposes of this section as repaid
in the following order:
(i) Amounts allocated to personal expenditures;
(ii) Amounts allocated to investment expenditures and passive
activity expenditures (other than passive activity expenditures
described in paragraph (d)(1)(iii) of this section);
(iii) Amounts allocated to passive activity expenditures in
connection with a rental real estate activity with respect to which the
taxpayer actively participates (within the meaning of section 469(i));
(iv) Amounts allocated to former passive activity expenditures; and
(v) Amounts allocated to trade or business expenditures and to
expenditures described in the last sentence of paragraph (b)(4) of this
section.
(2) Supplemental ordering rules for expenditures in same class.
Amounts allocated to two or more expenditures that are described in the
subdivision of paragraph (d)(1) of this section (e.g., amounts allocated
to different personal expenditures) are treated as repaid in the order
in which the amounts were allocated (or reallocated) to such
expenditures. For purposes of this paragraph (d)(2), the taxpayer may
treat allocations and reallocations that occur on the same day as
occurring in any order (without regard to the order in which
expenditures are treated as made under paragraph (c)(4)(iii)(A) of this
section).
(3) Continuous borrowings. In the case of borrowings pursuant to a
line of credit or similar account or arrangement that allows a taxpayer
to borrow funds periodically under a single loan agreement--
(i) All borrowings on which interest accrues at the same fixed or
variable rate are treated as a single debt; and
(ii) Borrowings or portions of borrowings on which interest accrues
at different fixed or variable rates are treated as different debts, and
such debts are treated as repaid for purposes of this paragraph (d) in
the order in which such borrowings are treated as repaid under the loan
agreement.
(4) Examples. The following examples illustrate the application of
this paragraph (d):
[[Page 302]]
Example 1. Taxpayer B borrows $100,000 (``Debt A'') on July 12,
immediately deposits the proceeds in an account, and uses the debt
proceeds to make the following expenditures on the following dates:
August 31--$40,000 passive activity expenditure 1.
October 5--$20,000 passive activity expenditure 2.
December 24--$40,000 personal expenditure.
On January 19 of the following year, B repays $90,000 of Debt A (leaving
$10,000 of Debt A outstanding). The $40,000 of Debt A allocated to the
personal expenditure, the $40,000 allocated to passive activity
expenditure 1, and $10,000 of the $20,000 allocated to passive activity
expenditure 2 are treated as repaid.
Example 2. (i) Taxpayer A obtains a line of credit. Interest on any
borrowing on the line of credit accrues at the lender's ``prime lending
rate'' on the date of the borrowing plus two percentage points. The loan
documents provide that borrowings on the line of credit are treated as
repaid in the order the borrowings were made. A borrows $30,000
(``Borrowing 1'') on the line of credit and immediately uses $20,000 of
the debt proceeds to make a personal expenditure (``personal expenditure
1'') and $10,000 to make a trade or business expenditure (``trade or
business expenditure 1''). A subsequently borrows another $20,000
(``Borrowing 2'') on the line of credit and immediately uses $15,000 of
the debt proceeds to make a personal expenditure (``personal expenditure
2'') and $5,000 to make a trade or business expenditure (``trade or
business expenditure 2''). A then repays $40,000 of the borrowings.
(ii) If the prime lending rate plus two percentage points was the
same on both the date of Borrowing 1 and the date of Borrowing 2, the
borrowings are treated for purposes of this paragraph (d) as a single
debt, and A is treated as having repaid $35,000 of debt allocated to
personal expenditure 1 and personal expenditure 2, and $5,000 of debt
allocated to trade or business expenditure 1.
(iii) If the prime lending rate plus two percentage points was
different on the date of Borrowing 1 and Borrowing 2, the borrowings
are treated as two debts, and, in accordance with the loan agreement,
the $40,000 repaid amount is treated as a repayment of Borrowing 1 and
$10,000 of Borrowing 2. Accordingly, A is treated as having repaid
$20,000 of debt allocated to personal expenditure 1, $10,000 of debt
allocated to trade or business expenditure 1, and $10,000 of debt
allocated to personal expenditure 2.
(e) Debt refinancings--(1) In general. To the extent proceeds of any
debt (the ``replacement debt'') are used to repay any portion of a debt,
the replacement debt is allocated to the expenditures to which the
repaid debt was allocated. The amount of replacement debt allocated to
any such expenditure is equal to the amount of debt allocated to such
expenditure that was repaid with proceeds of the replacement debt. To
the extent proceeds of the replacement debt are used for expenditures
other than repayment of a debt, the replacement debt is allocated to
expenditures in accordance with the rules of this section.
(2) Example. The following example illustrates the application of
this paragraph (e):
Example. Taxpayer C borrows $100,000 (``Debt A'') on July 12,
immediately deposits the debt proceeds in an account, and uses the
proceeds to make the following expenditures on the following dates (note
that the facts of this example are the same as the facts of example (1)
in paragraph (d)(4) of this section):
August 31--$40,000 passive activity expenditure 1.
October 5--$20,000 passive activity expenditure 2.
December 24--$40,000 personal expenditure 1.
On January 19 of the following year, C borrows $120,000 (``Debt B'') and
uses $90,000 of the proceeds of repay $90,000 of Debt A (leaving $10,000
of Debt A outstanding). In addition, C uses $30,000 of the proceeds of
Debt B to make a personal expenditure (``personal expenditure 2'').
Debt B is allocated $40,000 to personal expenditure 1, $40,000 to
passive activity expenditure 1, $10,000 to passive activity expenditure
2, and $30,000 to personal expenditure 2. Under paragraph (d)(1) of
this section, Debt B will be treated as repaid in the following order:
(1) amounts allocated to personal expenditure 1, (2) amounts allocated
to personal expenditure 2, (3) amounts allocated to passive activity
expenditure 1, and (4) amounts allocated to passive activity
expenditure 2.
(f) Debt allocated to distributions by passthrough entities.
[Reserved]
(g) Repayment of passthrough entity debt. [Reserved]
(h) Debt allocated to expenditures for interests in passthrough
entities. [Reserved]
(i) Allocation of debt to loans between passthrough entities and
interest holders. [Reserved]
(j) Reallocation of debt--(1) Debt allocated to capital
expenditures--(i) Time of
[[Page 303]]
reallocation. Except as provided in paragraph (j)(2) of this section,
debt allocated to an expenditure properly chargeable to capital account
with respect to an asset (the ``first expenditure'') is reallocated to
another expenditure on the earlier of--
(A) The date on which proceeds from a disposition of such asset are
used for another expenditure; or
(B) The date on which the character of the first expenditure changes
(e.g., from a passive activity expenditure to an expenditure that is not
a passive activity expenditure) by reason of a change in the use of the
asset with respect to which the first expenditure was capitalized.
(ii) Limitation on amount reallocated. The amount of debt
reallocated under paragraph (j)(1)(i)(A) of this section may not exceed
the proceeds from the disposition of the asset. The amount of debt
reallocated under paragraph (j)(1)(i)(B) of this section may not exceed
the fair market value of the asset on the date of the change in use. In
applying this paragraph (j)(1)(ii) with respect to a debt in any case in
which two or more debts are allocable to expenditures properly
chargeable to capital account with respect to the same asset, only a
ratable portion (determined with respect to any such debt by dividing
the amount of such debt by the aggregate amount of all such debts) of
the fair market value or proceeds from the disposition of such asset
shall be taken into account.
(iii) Treatment of loans made by the taxpayer. Except as provided in
paragraph (j)(1)(iv) of this section, an expenditure to make a loan is
treated as an expenditure properly chargeable to capital account with
respect to an asset, and for purposes of paragraph (j)(1)(i)(A) of this
section any repayment of the loan is treated as a disposition of the
asset. Paragraph (j)(3) of this section applies to any repayment of a
loan in installments.
(iv) Treatment of accounts. Debt allocated to an account under
paragraph (c)(4)(i) of this section is treated as allocated to an
expenditure properly chargeable to capital account with respect to an
asset, and any expenditure from the account is treated as a disposition
of the asset. See paragraph (c)(4) of this section for rules under which
debt proceeds allocated to an account are treated as used for another
expenditure.
(2) Disposition proceeds in excess of debt. If the proceeds from the
disposition of an asset exceed the amount of debt reallocated by reason
of such disposition, or two or more debts are reallocated by reason of
the disposition of an asset, the proceeds of the disposition are treated
as an account to which the rules in paragraph (c)(4) of this section
apply.
(3) Special rule for deferred payment sales. If any portion of the
proceeds of a disposition of an asset are received subsequent to the
disposition--
(i) The portion of the proceeds to be received subsequent to the
disposition is treated for periods prior to the receipt as used to make
an investment expenditure; and
(ii) Debt reallocated by reason of the disposition is allocated to
such investment expenditure to the extent such debt exceeds the proceeds
of the disposition previously received (other than proceeds used to
repay such debt).
(4) Examples. The following examples illustrate the application of
this paragraph (j):
Example 1. On January 1, 1988, taxpayer D sells an asset for
$25,000. Immediately before the sale, the amount of debt allocated to
expenditures properly chargeable to capital account with respect to the
asset was $15,000. The proceeds of the disposition are treated as an
account consisting of $15,000 of debt proceeds and $10,000 of unborrowed
funds to which paragraph (c)(4) of this section applies. Thus, if D
immediately makes a $10,000 personal expenditure from the proceeds and
within 15 days deposits the remaining proceeds in an account, D may,
pursuant to paragraph (c)(4)(iii)(B) of this section, treat the entire
$15,000 deposited in the account as proceeds of a debt.
Example 2. The facts are the same as in example (1) except that,
instead of receiving all $25,000 of the sale proceeds on January 1,
1988, D receives 5,000 on that date, $10,000 on January 1, 1989, and
$10,000 on January 1, 1990. D does not use any portion of the sale
proceeds to repay the debt. Between January 1, 1988, and December 31,
1988, D is treated under paragraph (j)(3) of this section as making an
investment expenditure of $20,000 to which $10,000 of debt is allocated.
In addition, the remaining $5,000 of debt is reallocated on January 1,
1988, in accordance with D's use of the sales proceeds received on that
[[Page 304]]
date. Between January 1, 1989, and December 31, 1989, D is treated as
making an investment expenditure of $10,000 to which no debt is
allocated. In addition, as of January 1, 1989, $10,000 of debt is
reallocated in accordance with D's use of the sales proceeds received on
that date.
Example 3. The facts are the same as in example (2), except that D
immediately uses the $5,000 sale proceeds received on January 1, 1988,
to repay $5,000 of the $15,000 debt. Between January 1, 1988, and
December 31, 1988, D is treated as making an investment expenditure of
$20,000 to which the remaining balance ($10,000) of the debt is
reallocated. The results in 1989 are as described in example (2).
(k) Modification of rules in the case of interest expense allocated
to foreign source income. [Reserved]
(l) [Reserved]
(m) Coordination with other provisions--(1) Effect of other
limitations--(i) In general. All debt is allocated among expenditures
pursuant to the rules in this section, without regard to any limitations
on the deductibility of interest expense on such debt. The applicability
of the passive loss and nonbusiness interest limitations to interest on
such debt, however, may be affected by other limitations on the
deductibility of interest expense.
(ii) Disallowance provisions. (Interest expense that is not
allowable as a deduction by reason of a disallowance provision (within
the meaning of paragraph (m)(7)(ii) of this section) is not taken into
account for any taxable year for purposes of applying the passive loss
and nonbusiness interest limitations.
(iii) Deferral provisions. Interest expense that is not allowable as
a deduction for the taxable year in which paid or accrued by reason of a
deferral provision (within the meaning of paragraph (m)(7)(iii) of this
section) is allocated in the same manner as the debt giving rise to the
interest expense is allocated for such taxable year. Such interest
expense is taken into account for purposes of applying the passive loss
and nonbusiness interest limitations for the taxable year in which such
interest expense is allowable under such deferral provision.
(iv) Capitalization provisions. Interest expense that is capitalized
pursuant to a capitalization provision (within the meaning of paragraph
(m)(7)(i) of this section) is not taken into account as interest for any
taxable year for purposes of applying the passive loss and nonbusiness
interest limitations.
(2) Effect on other limitations--(i) General rule. Except as
provided in paragraph (m)(2)(ii) of this section, any limitation on the
deductibility of an item (other than the passive loss and nonbusiness
interest limitations) applies without regard to the manner in which debt
is allocated under this section. Thus, for example, interest expense
treated under section 265(a)(2) as interest on indebtedness incurred or
continued to purchase or carry obligations the interest on which is
wholly exempt from Federal income tax is not deductible regardless of
the expenditure to which the underlying debt is allocated under this
section.
(ii) Exception. Capitalization provisions (within the meaning of
paragraph (m)(7)(i) of this section) do not apply to interest expense
allocated to any personal expenditure under the rules of this section.
(3) Qualified residence interest. Qualified residence interest
(within the meaning of section 163(h)(3)) is allowable as a deduction
without regard to the manner in which such interest expense is allocated
under the rules of this section. In addition, qualified residence
interest is not taken into account in determining the income or loss
from any activity for purposes of section 469 or in determining the
amount of investment interest for purposes of section 163(d). The
following example illustrates the rule in this paragraph (m)(3):
Example. Taxpayer E, an individual, incurs a $20,000 debt secured by
a residence and immediately uses the proceeds to purchase an automobile
exclusively for E's personal use. Under the rules in this section, the
debt and interest expense on the debt are allocated to a personal
expenditure. If, however, the interest on the debt is qualified
residence interest within the meaning of section 163(h)(3), the interest
is not treated as personal interest for purposes of section 163(h).
(4) Interest described in section 163(h)(2)(E). Interest described
in section 163(h)(2)(E) is allowable as a deduction without regard to
the rules of this section.
[[Page 305]]
(5) Interest on deemed distributee debt. [Reserved]
(6) Examples. The following examples illustrate the relationship
between the passive loss and nonbusiness interest limitations and other
limitations on the deductibility of interest expense:
Example 1. Debt is allocated pursuant to the rules in this section
to an investment expenditure for the purchase of taxable investment
securities. Pursuant to section 265(a)(2), the debt is treated as
indebtedness incurred or continued to purchase or carry obligations the
interest on which is wholly exempt from Federal income tax, and,
accordingly, interest on the debt is disallowed. If section 265(a)(2)
subsequently ceases to apply (because, for example, the taxpayer ceases
to hold any tax-exempt obligations), and the debt at such time continues
to be allocated to an investment expenditure, interest on the debt that
accrues after such time is subject to section 163(d).
Example 2. An accrual method taxpayer incurs a debt payable to a
cash method lender who is related to the taxpayer within the meaning of
section 267(b). During the period in which interest on the debt is not
deductible by reason of section 267(a)(2), the debt is allocated to a
passive activity expenditure. Thus, interest that accrues on the debt
for such period is also allocated to the passive activity expenditure.
When such interest expense becomes deductible under section 267(a)(2),
it will be allocated to the passive activity expenditure, regardless of
how the debt is allocated at such time.
Example 3. A taxpayer incurs debt that is allocated under the rules
of this section to an investment expenditure. Under section 263A(f),
however, interest expense on such debt is capitalized during the
production period (within the meaning of section 263A(f)(4)(B)) of
property used in a passive activity of the taxpayer. The capitalized
interest expense is not allocated to the investment expenditure, and
depreciation deductions attributable to the capitalized interest expense
are subject to the passive loss limitation as long as the property is
used in a passive activity. However, interest expense on the debt for
periods after the production period is allocated to the investment
expenditure as long as the debt remains allocated to the investment
expenditure.
(7) Other limitations on interest expense--(i) Capitalization
provisions. A capitalization provision is any provision that requires or
allows interest expense to be capitalized. Capitalization provisions
include sections 263(g), 263A(f), and 266.
(ii) Disallowance provisions. A disallowance provision is any
provision (other than the passive loss and nonbusiness interest
limitations) that disallows a deduction for interest expense for all
taxable years and is not a capitalization provision. Disallowance
provisions include sections 163(f)(2), 264(a)(2), 264(a)(4), 265(a)(2),
265(b)(2), 279(a), 291(e)(1)(B)(ii), 805(b)(1), and 834(c)(5).
(iii) Deferral provisions. A deferral provision is any provision
(other than the passive loss and nonbusiness interest limitations) that
disallows a deduction for interest expense for any taxable year and is
not a capitalization or disallowance provision. Deferral provisions
include sections 267(a)(2), 465, 1277, and 1282.
(n) Effective date--(1) In general. This section applies to interest
expense paid or accrued in taxable years beginning after December 31,
1986.
(2) Transitional rule for certain expenditures. For purposes of
determining whether debt is allocated to expenditures made on or before
August 3, 1987, paragraphs (c)(4)(iii)(B) and (c)(5)(i) of this section
are applied by substituting ``90 days'' for ``15 days.''
(3) Transitional rule for certain debt--(i) General rule. Except as
provided in paragraph (n)(3)(ii) of this section, any debt outstanding
on December 31, 1986, that is properly attributable to a business or
rental activity is treated for purposes of this section as debt
allocated to expenditures properly chargeable to capital account with
respect to the assets held for use or for sale to customers in such
business or rental activity. Debt is properly attributable to a business
or rental activity for purposes of this section (regardless of whether
such debt otherwise would be allocable under this section to
expenditures in connection with such activity) if the taxpayer has
properly and consistently deducted interest expense (including interest
subject to limitation under section 163(d) as in effect prior to the Tax
Reform Act of 1986) on such debt on Schedule C, E, or F of Form 1040 in
computing income or loss from such business or rental activity for
taxable years beginning before January 1, 1987. For purposes of this
paragraph (n)(3), amended returns filed after July 2, 1987 are
disregarded in determining whether a taxpayer has consistently
[[Page 306]]
deducted interest expense on Schedule C, E, or F of Form 1040 in
computing income or loss from a business or rental activity.
(ii) Exceptions--(A) Debt financed distributions by passthrough
entities. [Reserved]
(B) Election out. This paragraph (n)(3) does not apply with respect
to debt of a taxpayer who elects under paragraph (n)(3) (viii) of this
section to allocate debt outstanding on December 31, 1986, in accordance
with the provisions of this section other than this paragraph (n)(3)
(i.e., in accordance with the use of the debt proceeds).
(iii) Business or rental activity. For purposes of this paragraph
(n)(3), a business or rental activity is any trade or business or rental
activity of the taxpayer. For this purpose--
(A) A trade or business includes a business or profession the income
and deductions of which (or, in the case of a partner or S corporation
shareholder, the taxpayer's share thereof) are properly reported on
Schedule C, E, or F of Form 1040; and
(B) A rental activity includes an activity of renting property the
income and deductions of which (or, in the case of a partner or S
corporation shareholder, the taxpayer's share thereof) are properly
reported on Schedule E of Form 1040.
(iv) Example. The following example illustrates the circumstances in
which debt is properly attributable to a business or rental activity:
Example. Taxpayer H incurred a debt in 1979 and properly deducted
the interest expense on the debt on Schedule C of Form 1040 for each
year from 1979 through 1986. Under this paragraph (n) (3), the debt is
properly attributable to the business the results of which are reported
on Schedule C.
(v) Allocation requirement--(A) In general. Debt outstanding on
December 31, 1986, that is properly attributable (within the meaning of
paragraph (n)(3)(i) of this section) to a business or rental activity
must be allocated in a reasonable and consistent manner among the assets
held for use or for sale to customers in such activity on the last day
of the taxable year that includes December 31, 1986. The taxpayer shall
specify the manner in which such debt is allocated by filing a statement
in accordance with paragraph (n)(3)(vii) of this section. If the
taxpayer does not file such a statement or fails to allocate such debt
in a reasonable and consistent manner, the Commissioner shall allocate
the debt.
(B) Reasonable and consistent manner--examples of improper
allocation. For purposes of this paragraph (n)(3)(v), debt is not
treated as allocated in a reasonable and consistent manner if--
(1) The amount of debt allocated to goodwill exceeds the basis of
the goodwill; or
(2) The amount of debt allocated to an asset exceeds the fair market
value of the asset, and the amount of debt allocated to any other asset
is less than the fair market value (lesser of basis or fair market value
in the case of goodwill) of such other asset.
(vi) Coordination with other provisions. The effect of any events
occurring after the last day of the taxable year that includes December
31, 1986, shall be determined under the rules of this section, applied
by treating the debt allocated to an asset under paragraph (n)(3)(v) of
this section as if proceeds of such debt were used to make an
expenditure properly chargeable to capital account with respect to such
asset on the last day of the taxable year that includes December 31,
1986. Thus, debt that is allocated to an asset in accordance with this
paragraph (n)(3) must be reallocated in accordance with paragraph (j) of
this section upon the occurrence with respect to such asset of any event
described in such paragraph (j). Similarly, such debt is treated as
repaid in the order prescribed in paragraph (d) of this section. In
addition, a replacement debt (within the meaning of paragraph (e) of
this section) is allocated to an expenditure properly chargeable to
capital account with respect to an asset to the extent the proceeds of
such debt are used to repay the portion of a debt allocated to such
asset under this paragraph (n)(3).
(vii) Form for allocation of debt. A taxpayer shall allocate debt
for purposes of this paragraph (n)(3) by attaching to the taxpayer's
return for the first taxable year beginning after December 31, 1986, a
statement that is prominently identified as a transitional allocation
[[Page 307]]
statement under Sec. 1.163-8T(n)(3) and includes the following
information:
(A) A description of the business or rental activity to which the
debt is properly attributable;
(B) The amount of debt allocated;
(C) The assets among which the debt is allocated;
(D) The manner in which the debt is allocated;
(E) The amount of debt allocated to each asset; and
(F) Such other information as the Commissioner may require.
(viii) Form for election out. A taxpayer shall elect to allocate
debt outstanding on December 31, 1986, in accordance with the provisions
of this section other than this paragraph (n)(3) by attaching to the
taxpayer's return (or amended return) for the first taxable year
beginning after December 31, 1986, a statement to that effect,
prominently identified as as election out under Sec. 1.163-8T(n)(3).
(ix) Special rule for partnerships and S corporations. For purposes
of paragraph (n)(3)(ii)(B), (v), (vii) and (viii) of this section
(relating to the allocation of debt and election out), a partnership or
S corporation shall be treated as the taxpayer with respect to the debt
of the partnership or S corporation.
(x) Irrevocability. An allocation or election filed in accordance
with paragraph (n)(3) (vii) or (viii) of this section may not be revoked
or modified except with the consent of the Commissioner.
[T.D. 8145, 52 FR 24999, July 2, 1987, as amended by T.D. 8145, 62 FR
40270, July 28, 1997]
Sec. 1.163-9T Personal interest (temporary).
(a) In general. No deduction under any provision of Chapter 1 of the
Internal Revenue Code shall be allowed for personal interest paid or
accrued during the taxable year by a taxpayer other than a corporation.
(b) Personal interest--(1) Definition. For purposes of this section,
personal interest is any interest expense other than--
(i) Interest paid or accrued on indebtedness properly allocable
(within the meaning of Sec. 1.163-8T) to the conduct of trade or
business (other than the trade or business of performing services as an
employee),
(ii) Any investment interest (within the meaning of section
163(d)(3)),
(iii) Any interest that is taken into account under section 469 in
computing income or loss from a passive activity of the taxpayer,
(iv) Any qualified residence interest (within the meaning of section
163(h)(3) and Sec. 1.163-10T), and
(v) Any interest payable under section 6601 with respect to the
unpaid portion of the tax imposed by section 2001 for the period during
which an extension of time for payment of such tax is in effect under
section 6163, 6166, or 6166A (as in effect before its repeal by the
Economic Recovery Tax Act of 1981).
(2) Interest relating to taxes--(i) In general. Except as provided
in paragraph (b)(2)(iii) of this section, personal interest includes
interest--
(A) Paid on underpayments of individual Federal, State or local
income taxes and on indebtedness used to pay such taxes (within the
meaning of Sec. 1.163-8T), regardless of the source of the income
generating the tax liability;
(B) Paid under section 453(e)(4)(B) (interest on deferred tax
resulting from certain installment sales) and section 1291(c) (interest
on deferred tax attributable to passive foreign investment companies);
or
(C) Paid by a trust, S corporation, or other pass-through entity on
underpayments of State or local income taxes and on indebtedness used to
pay such taxes.
(ii) Example. A, an individual, owns stock of an S corporation. On
its return for 1987, the corporation underreports its taxable income.
Consequently, A underreports A's share of that income on A's tax return.
In 1989, A pays the resulting deficiency plus interest to the Internal
Revenue Service. The interest paid by A in 1989 on the tax deficiency is
personal interest, notwithstanding the fact that the additional tax
liability may have arisen out of income from a trade or business. The
result would be the same if A's business had been operated as a sole
proprietorship.
(iii) Certain other taxes. Personal interest does not include
interest--
[[Page 308]]
(A) Paid with respect to sales, excise and similar taxes that are
incurred in connection with a trade or business or an investment
activity;
(B) Paid by an S corporation with respect to an underpayment of
income tax from a year in which the S corporation was a C corporation or
with respect to an underpayment of the taxes imposed by sections 1374 or
1375, or similar provision of State law; or
(C) Paid by a transferee under section 6901 (tax liability resulting
from transferred assets), or a similar provision of State law, with
respect to a C corporation's underpayment of income tax.
(3) Cross references. See Sec. 1.163-8T for rules for determining
the allocation of interest expense to various activities. See Sec.
1.163-10T for rules concerning qualified residence interest.
(c) Effective date--(1) In general. The provisions of this section
are effective for taxable years beginning after December 31, 1986. In
the case of any taxable year beginning in calendar years 1987 through
1990, the amount of personal interest that is nondeductible under this
section is limited to the applicable percentage of such amount.
(2) Applicable percentages. The applicable percentage for taxable
years beginning in 1987 through 1990 are as follows:
1987: 35 percent
1988: 60 percent
1989: 80 percent
1990: 90 percent
[T.D. 8168, 52 FR 48409, Dec. 22, 1987; 68 FR 13226, Mar. 19, 2003]
Sec. 1.163-10T Qualified residence interest (temporary).
(a) Table of contents. This paragraph (a) lists the major paragraphs
that appear in this Sec. 1.163-10T.
(a) Table of contents.
(b) Treatment of qualified residence interest.
(c) Determination of qualified residence interest when secured debt
does not exceed the adjusted purchase price.
(1) In general.
(2) Examples.
(d) Determination of qualified residence interest when secured debt
exceeds adjusted purchase price--Simplified method.
(1) In general.
(2) Treatment of interest paid or accrued on secured debt that is
not qualified residence interest.
(3) Example.
(e) Determination of qualified residence interest when secured debt
exceeds adjusted purchase price--Exact method.
(1) In general.
(2) Determination of applicable debt limit.
(3) Example.
(4) Treatment of interest paid or accrued with respect to secured
debt that is not qualified residence interest.
(i) In general.
(ii) Example.
(iii) Special rule of debt is allocated to more than one
expenditure.
(iv) Example.
(f) Special rules.
(1) Special rules for personal property.
(i) In general.
(ii) Example.
(2) Special rule for real property.
(i) In general.
(ii) Example.
(g) Selection of method.
(h) Average balance.
(1) Average balance defined.
(2) Average balance reported by lender.
(3) Average balance computed on a daily basis.
(i) In general.
(ii) Example.
(4) Average balance computed using the interest rate.
(i) In general.
(ii) Points and prepaid interest.
(iii) Examples.
(5) Average balance computed using average of beginning and ending
balance.
(i) In general.
(ii) Example.
(6) Highest principal balance.
(7) Other methods provided by the Commissioner.
(8) Anti-abuse rule.
(i) [Reserved]
(j) Determination of interest paid or accrued during the taxable
year.
(1) In general.
(2) Special rules for cash-basis taxpayers.
(i) Points deductible in year paid under section 461(g)(2).
(ii) Points and other prepaid interest described in section
461(g)(1).
(3) Examples.
(k) Determination of adjusted purchase price and fair market value.
(1) Adjusted purchase price.
(i) In general.
(ii) Adjusted purchase price of a qualified residence acquired
incident to divorce.
(iii) Examples.
(2) Fair market value.
(i) In general.
(ii) Examples.
[[Page 309]]
(3) Allocation of adjusted purchase price and fair market value.
(l) [Reserved]
(m) Grandfathered amount.
(1) Substitution for adjusted purchase price.
(2) Determination of grandfathered amount.
(i) In general.
(ii) Special rule for lines of credit and certain other debt.
(iii) Fair market value limitation.
(iv) Examples.
(3) Refinancing of grandfathered debt.
(i) In general.
(ii) Determination of grandfathered amount.
(4) Limitation on terms of grandfathered debt.
(i) In general.
(ii) Special rule for nonamortizing debt.
(iii) Example.
(n) Qualified indebtedness (secured debt used for medical and
educational purposes).
(1) In general.
(i) Treatment of qualified indebtedness.
(ii) Determination of amount of qualified indebtedness.
(iii) Determination of amount of qualified indebtedness for mixed-
use debt.
(iv) Example.
(v) Prevention of double counting in year of refinancing.
(vi) Special rule for principal payments in excess of qualified
expenses.
(2) Debt used to pay for qualified medical or educational expenses.
(i) In general.
(ii) Special rule for refinancing.
(iii) Other special rules.
(iv) Examples.
(3) Qualified medical expenses.
(4) Qualified educational expenses.
(o) Secured debt.
(1) In general.
(2) Special rule for debt in certain States.
(3) Time at which debt is treated as secured.
(4) Partially secured debt.
(i) In general.
(ii) Example.
(5) Election to treat debt as not secured by a qualified residence.
(i) In general.
(ii) Example.
(iii) Allocation of debt secured by two qualified residences.
(p) Definition of qualified residence.
(1) In general.
(2) Principal residence.
(3) Second residence.
(i) In general.
(ii) Definition of residence.
(iii) Use as a residence.
(iv) Election of second residence.
(4) Allocations between residence and other property.
(i) In general.
(ii) Special rule for rental of residence.
(iii) Examples.
(5) Residence under construction.
(i) In general.
(ii) Example.
(6) Special rule for the time-sharing arrangements.
(q) Special rules for tenant-stockholders in cooperative housing
corporations.
(1) In general.
(2) Special rule where stock may not be used to secure debt.
(3) Treatment of interest expense of the cooperative described in
section 216(a)(2).
(4) Special rule to prevent tax avoidance.
(5) Other definitions.
(r) Effective date.
(b) Treatment of qualified residence interest. Except as provided
below, qualified residence interest is deductible under section 163(a).
Qualified residence interest is not subject to limitation or otherwise
taken into account under section 163(d) (limitation on investment
interest), section 163(h)(1) (disallowance of deduction for personal
interest), section 263A (capitalization and inclusion in inventory costs
of certain expenses) or section 469 (limitations on losses from passive
activities). Qualified residence interest is subject to the limitation
imposed by section 263(g) (certain interest in the case of straddles),
section 264(a) (2) and (4) (interest paid in connection with certain
insurance), section 265(a)(2) (interest relating to tax-exempt income),
section 266 (carrying charges), section 267(a)(2) (interest with respect
to transactions between related taxpayers) section 465 (deductions
limited to amount at risk), section 1277 (deferral of interest deduction
allocable to accrued market discount), and section 1282 (deferral of
interest deduction allocable to accrued discount).
(c) Determination of qualified residence interest when secured debt
does not exceed adjusted purchase price--(1) In general. If the sum of
the average balances for the taxable year of all secured debts on a
qualified residence does not exceed the adjusted purchase price
(determined as of the end of the taxable year) of the qualified
residence, all of the interest paid or accrued during the taxable year
with respect to the secured debts is qualified residence interest. If
the sum of the average balances for the taxable year of all secured
debts
[[Page 310]]
exceeds the adjusted purchase price of the qualified residences
(determined as of the end of the taxable year), the taxpayer must use
either the simplified method (see paragraph (d) of this section) or the
exact method (see paragraph (e) of this section) to determine the amount
of interest that is qualified residence interest.
(2) Examples.
Example 1. T purchases a qualified residence in 1987 for $65,000. T
pays $6,500 in cash and finances the remainder of the purchase with a
mortgage of $58,500. In 1988, the average balance of the mortgage is
$58,000. Because the average balance of the mortgage is less than the
adjusted purchase price of the residence ($65,000), all of the interest
paid or accrued during 1988 on the mortgage is qualified residence
interest.
Example 2. The facts are the same as in example (1), except that T
incurs a second mortgage on January 1, 1988, with an initial principal
balance of $2,000. The average balance of the second mortgage in 1988 is
$1,900. Because the sum of the average balance of the first and second
mortgages ($59,900) is less than the adjusted purchase price of the
residence ($65,000), all of the interest paid or accrued during 1988 on
both the first and second mortgages is qualified residence interest.
Example 3. P borrows $50,000 on January 1, 1988 and secures the debt
by a qualified residence. P pays the interest on the debt monthly, but
makes no principal payments in 1988. There are no other debts secured by
the residence during 1988. On December 31, 1988, the adjusted purchase
price of the residence is $40,000. The average balance of the debt in
1988 is $50,000. Because the average balance of the debt exceeds the
adjusted purchase price ($10,000), some of the interest on the debt is
not qualified residence interest. The portion of the total interest that
is qualified residence interest must be determined in accordance with
the rules of paragraph (d) or paragraph (e) of this section.
(d) Determination of qualified residence interest when secured debt
exceeds adjusted purchase price--Simplified method--(1) In general.
Under the simplified method, the amount of qualified residence interest
for the taxable year is equal to the total interest paid or accrued
during the taxable year with respect to all secured debts multiplied by
a fraction (not in excess of one), the numerator of which is the
adjusted purchase price (determined as of the end of the taxable year)
of the qualified residence and the denominator of which is the sum of
the average balances of all secured debts.
(2) Treatment of interest paid or accrued on secured debt that is
not qualified residence interest. Under the simplified method, the
excess of the total interest paid or accrued during the taxable year
with respect to all secured debts over the amount of qualified residence
interest is personal interest.
(3) Example.
Example. R's principal residence has an adjusted purchase price on
December 31, 1988, of $105,000. R has two debts secured by the
residence, with the following average balances and interest payments:
------------------------------------------------------------------------
Debt Date secured Average balance Interest
------------------------------------------------------------------------
Debt 1 June 1983 $80,000 $8,000
Debt 2 May 1987 40,000 4,800
---------------------------------
Total .................. 120,000 12,800
------------------------------------------------------------------------
The amount of qualified residence interest is determined under the
simplified method by multiplying the total interest ($12,800) by a
fraction (expressed as a decimal amount) equal to the adjusted purchase
price ($105,000) of the residence divided by the combined average
balances ($120,000). For 1988, this fraction is equal to 0.875
($105,000/$120,000). Therefore, $11,200 ($12,800 x 0.875) of the total
interest is qualified residence interest. The remaining $1,600 in
interest ($12,800 - $11,200) is personal interest, even if (under the
rules of Sec. 1.163-8T) such remaining interest would be allocated to
some other category of interest.
(e) Determination of qualified residence interest when secured debt
exceeds adjusted purchase price--Exact method--(1) In general. Under the
exact method, the amount of qualified residence interest for the taxable
year is determined on a debt-by-debt basis by computing the applicable
debt limit for each secured debt and comparing each such applicable debt
limit to the average balance of the corresponding debt. If, for the
taxable year, the average balance of a secured debt does not exceed the
applicable debt limit for that debt, all of the interest paid or accrued
during the taxable year with respect to the debt is qualified residence
interest. If the average balance of the secured debt exceeds the
applicable debt limit for that debt, the amount of qualified residence
interest with respect to the debt is determined by multiplying the
interest
[[Page 311]]
paid or accrued with respect to the debt by a fraction, the numerator of
which is the applicable debt limit for that debt and the denominator of
which is the average balance of the debt.
(2) Determination of applicable debt limit. For each secured debt,
the applicable debt limit for the taxable year is equal to
(i) The lesser of--
(A) The fair market value of the qualified residence as of the date
the debt is first secured, and
(B) The adjusted purchase price of the qualified residence as of the
end of the taxable year,
(ii) Reduced by the average balance of each debt previously secured
by the qualified residence.
For purposes of paragraph (e)(2)(ii) of this section, the average
balance of a debt shall be treated as not exceeding the applicable debt
limit of such debt. See paragraph (n)(1)(i) of this section for the rule
that increases the adjusted purchase price in paragraph (e)(2)(i)(B) of
this section by the amount of any qualified indebtedness (certain
medical and educational debt). See paragraph (f) of this section for
special rules relating to the determination of the fair market value of
the qualified residence.
(3) Example. (i) R's principal residence has an adjusted purchase
price on December 31, 1988, of $105,000. R has two debts secured by the
residence. The average balances and interest payments on each debt
during 1988 and fair market value of the residence on the date each debt
was secured are as follows:
------------------------------------------------------------------------
Fair market Average
Debt Date secured value balance Interest
------------------------------------------------------------------------
Debt 1 June 1983 $100,000 $80,000 $8,000
Debt 2 May 1987 140,000 40,000 4,800
---------------------------
Total .............. ............. 120,000 12,800
------------------------------------------------------------------------
(ii) The amount of qualified residence interest for 1988 under the
exact method is determined as follows. Because there are no debts
previously secured by the residence, the applicable debt limit for Debt
1 is $100,000 (the lesser of the adjusted purchase price as of the end
of the taxable year and the fair market value of the residence at the
time the debt was secured). Because the average balance of Debt 1
($80,000) does not exceed its applicable debt limit ($100,000), all of
the interest paid on the debt during 1988 ($8,000) is qualified
residence interest.
(iii) The applicable debt limit for Debt 2 is $25,000 ($105,000 (the
lesser of $140,000 fair market value and $105,000 adjusted purchase
price) reduced by $80,000 (the average balance of Debt 1)). Because the
average balance of Debt 2 ($40,000) exceeds its applicable debt limit,
the amount of qualified residence interest on Debt 2 is determined by
multiplying the amount of interest paid on the debt during the year
($4,800) by a fraction equal to its applicable debt limit divided by its
average balance ($25,000/$40,000 = 0.625). Accordingly, $3,000 ($4,800 x
0.625) of the interest paid in 1988 on Debt 2 is qualified residence
interest. The character of the remaining $1,800 of interest paid on Debt
2 is determined under the rules of paragraph (e)(4) of this section.
(4) Treatment of interest paid or accrued with respect to secured
debt that is not qualified residence interest--(i) In general. Under the
exact method, the excess of the interest paid or accrued during the
taxable year with respect to a secured debt over the amount of qualified
residence interest with respect to the debt is allocated under the rules
of Sec. 1.163-8T.
(ii) Example. T borrows $20,000 and the entire proceeds of the debt
are disbursed by the lender to T's broker to purchase securities held
for investment. T secures the debt with T's principal residence. In
1990, T pays $2,000 of interest on the debt. Assume that under the rules
of paragraph (e) of this section, $1,500 of the interest is qualified
residence interest. The remaining $500 in interest expense would be
allocated under the rules of Sec. 1.163-8T. Section 1.163-8T generally
allocates debt
[[Page 312]]
(and the associated interest expense) by tracing disbursements of the
debt proceeds to specific expenditures. Accordingly, the $500 interest
expense on the debt that is not qualified residence interest is
investment interest subject to section 163(d).
(iii) Special rule if debt is allocated to more than one
expenditure. If--
(A) The average balance of a secured debt exceeds the applicable
debt limit for that debt, and
(B) Under the rules of Sec. 1.163-8T, interest paid or accrued with
respect to such debt is allocated to more than one expenditure,
the interest expense that is not qualified residence interest may be
allocated among such expenditures, to the extent of such expenditures,
in any manner selected by the taxpayer.
(iv) Example. (i) C borrows $60,000 secured by a qualified
residence. C uses (within the meaning of Sec. 1.163-8T) $20,000 of the
proceeds in C's trade or business, $20,000 to purchase stock held for
investment and $20,000 for personal purposes. In 1990, C pays $6,000 in
interest on the debt and, under the rules of Sec. 1.163-8T, $2,000 in
interest is allocable to trade or business expenses, $2,000 to
investment expenses and $2,000 to personal expenses. Assume that under
paragraph (e) of this section, $2,500 of the interest is qualified
residence interest and $3,500 of the interest is not qualified residence
interest.
(ii) Under paragraph (e)(4)(iii) of this section, C may allocate up
to $2,000 of the interest that is not qualified residence interest to
any of the three categories of expenditures up to a total of $3,500 for
all three categories. Therefore, for example, C may allocate $2,000 of
such interest to C's trade or business and $1,500 of such interest to
the purchase of stock.
(f) Special rules--(1) Special rules for personal property--(i) In
general. If a qualified residence is personal property under State law
(e.g., a boat or motorized vehicle)--
(A) For purposes of paragraphs (c)(1) and (d)(1) of this section, if
the fair market value of the residence as of the date that any secured
debt (outstanding during the taxable year) is first secured by the
residence is less than the adjusted purchase price as of the end of the
taxable year, the lowest such fair market value shall be substituted for
the adjusted purchase price.
(B) For purposes of paragraphs (e)(2)(i)(A) and (f)(1)(i)(A) of this
section, the fair market value of the residence as of the date the debt
is first secured by the residence shall not exceed the fair market value
as of any date on which the taxpayer borrows any additional amount with
respect to the debt.
(ii) Example. D owns a recreational vehicle that is a qualified
residence under paragraph (p)(4) of this section. The adjusted purchase
price and fair market value of the recreational vehicle is $20,000 in
1989. In 1989, D establishes a line of credit secured by the
recreational vehicle. As of June 1, 1992, the fair market value of the
vehicle has decreased to $10,000. On that day, D borrows an additional
amount on the debt by using the line of credit. Although under
paragraphs (e)(2)(i) and (f)(1)(i)(A) of this section, fair market value
is determined at the time the debt is first secured, under paragraph
(f)(1)(i)(B) of this section, the fair market value is the lesser of
that amount or the fair market value on the most recent date that D
borrows any additional amount with respect to the line of credit.
Therefore, the fair market value with respect to the debt is $10,000.
(2) Special rule for real property--(i) In general. For purposes of
paragraph (e)(2)(i)(A) of this section, the fair market value of a
qualified residence that is real property under State law is presumed
irrebuttably to be not less than the adjusted purchase price of the
residence as of the last day of the taxable year.
(ii) Example. (i) C purchases a residence on August 11, 1987, for
$50,000, incurring a first mortgage. The residence is real property
under State law. During 1987, C makes $10,000 in home improvements.
Accordingly, the adjusted purchase price of the residence as of December
31, 1988, is $60,000. C incurs a second mortgage on May 19, 1988, as of
which time the fair market value of the residence is $55,000.
(ii) For purposes of determining the applicable debt limit for each
debt, the fair market value of the residence is
[[Page 313]]
generally determined as of the time the debt is first secured.
Accordingly, the fair market value would be $50,000 and $55,000 with
respect to the first and second mortgage, respectively. Under the
special rule of paragraph (f)(2)(i) of this section, however, the fair
market value with respect to both debts in 1988 is $60,000, the adjusted
purchase price on December 31, 1988.
(g) Selection of method. For any taxable year, a taxpayer may use
the simplified method (described in paragraph (d) of this section) or
the exact method (described in paragraph (e) of this section) by
completing the appropriate portion of Form 8598. A taxpayer with two
qualified residences may use the simplified method for one residence and
the exact method for the other residence.
(h) Average balance--(1) Average balance defined. For purposes of
this section, the term ``average balance'' means the amount determined
under this paragraph (h). A taxpayer is not required to use the same
method to determine the average balance of all secured debts during a
taxable year or of any particular secured debt from one year to the
next.
(2) Average balance reported by lender. If a lender that is subject
to section 6050H (returns relating to mortgage interest received in
trade or business from individuals) reports the average balance of a
secured debt on Form 1098, the taxpayer may use the average balance so
reported.
(3) Average balance computed on a daily basis--(i) In general. The
average balance may be determined by--
(A) Adding the outstanding balance of a debt on each day during the
taxable year that the debt is secured by a qualified residence, and
(B) Dividing the sum by the number of days during the taxable year
that the residence is a qualified residence.
(ii) Example. Taxpayer A incurs a debt of $10,000 on September 1,
1989, securing the debt with A's principal residence. The residence is
A's principal residence during the entire taxable year. A pays current
interest on the debt monthly, but makes no principal payments. The debt
is, therefore, outstanding for 122 days with a balance each day of
$10,000. The residence is a qualified residence for 365 days. The
average balance of the debt for 1989 is $3,342 (122 x $10,000/365).
(4) Average balance computed using the interest rate--(i) In
general. If all accrued interest on a secured debt is paid at least
monthly, the average balance of the secured debt may be determined by
dividing the interest paid or accrued during the taxable year while the
debt is secured by a qualified residence by the annual interest rate on
the debt. If the interest rate on a debt varies during the taxable year,
the lowest annual interest rate that applies to the debt during the
taxable year must be used for purposes of this paragraph (h)(4). If the
residence securing the debt is a qualified residence for less than the
entire taxable year, the average balance of any secured debt may be
determined by dividing the average balance determined under the
preceding sentence by the percentage of the taxable year that the debt
is secured by a qualified residence.
(ii) Points and prepaid interest. For purposes of paragraph
(h)(4)(i) of this section, the amount of interest paid during the
taxable year does not include any amount paid as points and includes
prepaid interest only in the year accrued.
(iii) Examples.
Example 1. B has a line of credit secured by a qualified residence
for the entire taxable year. The interest rate on the debt is 10 percent
throughout the taxable year. The principal balance on the debt changes
throughout the year. B pays the accrued interest on the debt monthly. B
pays $2,500 in interest on the debt during the taxable year. The average
balance of the debt ($25,000) may be computed by dividing the total
interest paid by the interest rate ($25,000 = $2,500/0.10).
Example 2. Assume the same facts as in example 1, except that the
residence is a qualified residence, and the debt is outstanding, for
only one-half of the taxable year and B pays only $1,250 in interest on
the debt during the taxable year. The average balance of the debt may be
computed by first dividing the total interest paid by the interest rate
($12,500 = $1,250/0.10). Second, because the residence is not a
qualified residence for the entire taxable year, the average balance
must be determined by dividing this amount ($12,500) by the portion of
the year that the residence is qualified (0.50). The average balance is
therefore $25,000 ($12,500/0.50).
[[Page 314]]
(5) Average balance computed using average of beginning and ending
balances--(i) In general. If--
(A) A debt requires level payments at fixed equal intervals (e.g.,
monthly, quarterly) no less often than semi-annually during the taxable
year,
(B) The taxpayer prepays no more than one month's principal on the
debt during the taxable year, and
(C) No new amounts are borrowed on the debt during the taxable year,
the average balance of the debt may be determined by adding the
principal balance as of the first day of the taxable year that the debt
is secured by the qualified residence and the principal balance as of
the last day of the taxable year that the debt is secured by the
qualified residence and dividing the sum by 2. If the debt is secured by
a qualified residence for less than the entire period during the taxable
year that the residence is a qualified residence, the average balance
may be determined by multiplying the average balance determined under
the preceding sentence by a fraction, the numerator of which is the
number of days during the taxable year that the debt is secured by the
qualified residence and the denominator of which is the number of days
during the taxable year that the residence is a qualified residence. For
purposes of this paragraph (h)(5)(i), the determination of whether
payments are level shall disregard the fact that the amount of the
payments may be adjusted from time to time to take into account changes
in the applicable interest rate.
(ii) Example. C borrows $10,000 in 1988, securing the debt with a
second mortgage on a principal residence. The terms of the loan require
C to make equal monthly payments of principal and interest so as to
amortize the entire loan balance over 20 years. The balance of the debt
is $9,652 on January 1, 1990, and is $9,450 on December 31, 1990. The
average balance of the debt during 1990 may be computed as follows:
Balance on first day of the year: $9,652
Balance on last day of the year: $9,450
[GRAPHIC] [TIFF OMITTED] TC14NO91.175
(6) Highest principal balance. The average balance of a debt may be
determined by taking the highest principal balance of the debt during
the taxable year.
(7) Other methods provided by the Commissioner. The average balance
may be determined using any other method provided by the Commissioner by
form, publication, revenue ruling, or revenue procedure. Such methods
may include methods similar to (but with restrictions different from)
those provided in paragraph (h) of this section.
(8) Anti-abuse rule. If, as a result of the determination of the
average balance of a debt using any of the methods specified in
paragraphs (h) (4), (5), or (6) of this section, there is a significant
overstatement of the amount of qualified residence interest and a
principal purpose of the pattern of payments and borrowing on the debt
is to cause the amount of such qualified residence interest to be
overstated, the district director may redetermine the average balance
using the method specified under paragraph (h)(3) of this section.
(i) [Reserved]
(j) Determination of interest paid or accrued during the taxable
year--(1) In general. For purposes of determining the amount of
qualified residence interest with respect to a secured debt, the amount
of interest paid or accrued during the taxable year includes only
interest paid or accrued while the debt is secured by a qualified
residence.
(2) Special rules for cash-basis taxpayers--(i) Points deductible in
year paid under section 461(g)(2). If points described in section
461(g)(2) (certain points paid in respect of debt incurred in connection
with the purchase or improvement of a principal residence) are paid with
respect to a debt, the amount of such points is qualified residence
interest.
(ii) Points and other prepaid interest described in section
461(g)(1). The amount of points or other prepaid interest charged to
capital account under section 461(g)(1) (prepaid interest) that is
qualified residence interest shall be determined under the rules of
paragraphs (c) through (e) of this section in the same manner as any
other interest paid with respect to the debt in the
[[Page 315]]
taxable year to which such payments are allocable under section
461(g)(1).
(3) Examples.
Example 1. T designates a vacation home as a qualified residence as
of October 1, 1987. The home is encumbered by a mortgage during the
entire taxable year. For purposes of determining the amount of qualified
residence interest for 1987, T may take into account the interest paid
or accrued on the secured debt from October 1, 1987, through December
31, 1987.
Example 2. R purchases a principal residence on June 17, 1987. As
part of the purchase price, R obtains a conventional 30-year mortgage,
secured by the residence. At closing, R pays 2\1/2\ points on the
mortgage and interest on the mortgage for the period June 17, 1987
through June 30, 1987. The points are actually paid by R and are not
merely withheld from the loan proceeds. R incurs no additional secured
debt during 1987. Assuming that the points satisfy the requirements of
section 461(g) (2), the entire amount of points and the interest paid at
closing are qualified residence interest.
Example 3. (i) On July 1, 1987, W borrows $120,000 to purchase a
residence to use as a vacation home. W secures the debt with the
residence. W pays 2 points, or $2,400. The debt has a term of 10 years
and requires monthly payments of principal and interest. W is permitted
to amortize the points at the rate of $20 per month over 120 months. W
elects to treat the residence as a second residence. W has no other debt
secured by the residence. The average balance of the debt in each
taxable year is less than the adjusted purchase price of the residence.
W sells the residence on June 30, 1990, and pays off the remaining
balance of the debt.
(ii) W is entitled to treat the following amounts of the points as
interest paid on a debt secured by a qualified residence--
1987...................................... $120 = $20x6 months;
1988...................................... $240 = $20x12 months;
1989...................................... $120 = $20x6 months.
Total..................................... $480
All of the interest paid on the debt, including the allocable
points, is qualified residence interest. Upon repaying the debt, the
remaining $1,920 ($2,400-$480) in unamortized points is treated as
interest paid in 1990 and, because the average balance of the secured
debt in 1990 is less than the adjusted purchase price, is also qualified
residence interest.
(k) Determination of adjusted purchase price and fair market value--
(1) Adjusted purchase price--(i) In general. For purposes of this
section, the adjusted purchase price of a qualified residence is equal
to the taxpayer's basis in the residence as initially determined under
section 1012 or other applicable sections of the Internal Revenue Code,
increased by the cost of any improvements to the residence that have
been added to the taxpayer's basis in the residence under section
1016(a)(1). Any other adjustments to basis, including those required
under section 1033(b) (involuntary conversions), and 1034(e) (rollover
of gain or sale of principal residence) are disregarded in determining
the taxpayer's adjusted purchase price. If, for example, a taxpayer's
second residence is rented for a portion of the year and its basis is
reduced by depreciation allowed in connection with the rental use of the
property, the amount of the taxpayer's adjusted purchase price in the
residence is not reduced. See paragraph (m) of this section for a rule
that treats the sum of the grandfathered amounts of all secured debts as
the adjusted purchase price of the residence.
(ii) Adjusted purchase price of a qualified residence acquired
incident to divorce. [Reserved]
(iii) Examples.
Example 1. X purchases a residence for $120,000. X's basis, as
determined under section 1012, is the cost of the property, or $120,000.
Accordingly, the adjusted purchase price of the residence is initially
$120,000.
Example 2. Y owns a principal residence that has a basis of $30,000.
Y sells the residence for $100,000 and purchases a new principal
residence for $120,000. Under section 1034, Y does not recognize gain on
the sale of the former residence. Under section 1034(e), Y's basis in
the new residence is reduced by the amount of gain not recognized.
Therefore, under section 1034(e), Y's basis in the new residence is
$50,000 ($120,000-$70,000). For purposes of section 163(h), however, the
adjusted purchase price of the residence is not adjusted under section
1034(e). Therefore, the adjusted purchase price of the residence is
initially $120,000.
Example 3. Z acquires a residence by gift. The donor's basis in the
residence was $30,000. Z's basis in the residence, determined under
section 1015, is $30,000. Accordingly, the adjusted purchase price of
the residence is initially $30,000.
(2) Fair market value--(i) In general. For purposes of this section,
the fair market value of a qualified residence on any date is the fair
market value of the taxpayer's interest in the residence
[[Page 316]]
on such date. In addition, the fair market value determined under this
paragraph (k)(2)(i) shall be determined by taking into account the cost
of improvements to the residence reasonably expected to be made with the
proceeds of the debt.
(ii) Example. In 1988, the adjusted purchase price of P's second
residence is $65,000 and the fair market value of the residence is
$70,000. At that time, P incurs an additional debt of $10,000, the
proceeds of which P reasonably expects to use to add two bedrooms to the
residence. Because the fair market value is determined by taking into
account the cost of improvements to the residence that are reasonably
expected to be made with the proceeds of the debt, the fair market value
of the residence with respect to the debt incurred in 1988 is $80,000
($70,000+$10,000).
(3) Allocation of adjusted purchase price and fair market value. If
a property includes both a qualified residence and other property, the
adjusted purchase price and the fair market value of such property must
be allocated between the qualified residence and the other property. See
paragraph (p)(4) of this section for rules governing such an allocation.
(l) [Reserved]
(m) Grandfathered amount--(1) Substitution for adjusted purchase
price. If, for the taxable year, the sum of the grandfathered amounts,
if any, of all secured debts exceeds the adjusted purchase price of the
qualified residence, such sum may be treated as the adjusted purchase
price of the residence under paragraphs (c), (d) and (e) of this
section.
(2) Determination of grandfathered amount--(i) In general. For any
taxable year, the grandfathered amount of any secured debt that was
incurred on or before August 16, 1986, and was secured by the residence
continuously from August 16, 1986, through the end of the taxable year,
is the average balance of the debt for the taxable year. A secured debt
that was not incurred and secured on or before August 16, 1986, has no
grandfathered amount.
(ii) Special rule for lines of credit and certain other debt. If,
with respect to a debt described in paragraph (m)(2)(i) of this section,
a taxpayer has borrowed any additional amounts after August 16, 1986,
the grandfathered amount of such debt is equal to the lesser of--
(A) The average balance of the debt for the taxable year, or
(B) The principal balance of the debt as of August 16, 1986, reduced
(but not below zero) by all principal payments after August 16, 1986,
and before the first day of the current taxable year.
For purposes of this paragraph (m)(2)(ii), a taxpayer shall not be
considered to have borrowed any additional amount with respect to a debt
merely because accrued interest is added to the principal balance of the
debt, so long as such accrued interest is paid by the taxpayer no less
often than quarterly.
(iii) Fair market value limitation. The grandfathered amount of any
debt for any taxable year may not exceed the fair market value of the
residence on August 16, 1986, reduced by the principal balance on that
day of all previously secured debt.
(iv) Examples.
Example 1. As of August 16, 1986, T has one debt secured by T's
principal residence. The debt is a conventional self-amortizing mortgage
and, on August 16, 1986, it has an outstanding principal balance of
$75,000. In 1987, the average balance of the mortgage is $73,000. The
adjusted purchase price of the residence as of the end of 1987 is
$50,000. Because the mortgage was incurred and secured on or before
August 16, 1986 and T has not borrowed any additional amounts with
respect to the mortgage, the grandfathered amount is the average
balance, $73,000. Because the grandfathered amount exceeds the adjusted
purchase price ($50,000), T may treat the grandfathered amount as the
adjusted purchase price in determining the amount of qualified residence
interest.
Example 2. (i) The facts are the same as in example (1), except that
in May 1986, T also obtains a home equity line of credit that, on August
16, 1986, has a principal balance of $40,000. In November 1986, T
borrows an additional $10,000 on the home equity line, increasing the
balance to $50,000. In December 1986, T repays $5,000 of principal on
the home equity line. The average balance of the home equity line in
1987 is $45,000.
(ii) Because T has borrowed additional amounts on the line of credit
after August 16, 1986, the grandfathered amount for that debt must be
determined under the rules of paragraph (m)(2)(ii) of this section.
Accordingly, the grandfathered amount for the line of credit is equal to
the lesser of $45,000, the average balance of the debt in 1987, and
[[Page 317]]
$35,000, the principal balance on August 16, 1986, reduced by all
principal payments between August 17, 1986, and December 31, 1986
($40,000-$5,000). The sum of the grandfathered amounts with respect to
the residence is $108,000 ($73,000+$35,000). Because the sum of the
grandfathered amounts exceeds the adjusted purchase price ($50,000), T
may treat the sum as the adjusted purchase price in determining the
qualified residence interest for 1987.
(3) Refinancing of grandfathered debt--(i) In general. A debt
incurred and secured on or before August 16, 1986, is refinanced if some
or all of the outstanding balance of such a debt (the ``original debt'')
is repaid out of the proceeds of a second debt secured by the same
qualified residence (the ``replacement debt''). In the case of a
refinancing, the replacement debt is treated as a debt incurred and
secured on or before August 16, 1986, and the grandfathered amount of
such debt is the amount (but not less than zero) determined pursuant to
paragraph (m)(3)(ii) of this section.
(ii) Determination of grandfathered amount--(A) Exact refinancing.
If--
(1) The entire proceeds of a replacement debt are used to refinance
one or more original debts, and
(2) The taxpayer has not borrowed any additional amounts after
August 16, 1986, with respect to the original debt or debts,
the grandfathered amount of the replacement debt is the average balance
of the replacement debt. For purposes of the preceding sentence, the
fact that proceeds of a replacement debt are used to pay costs of
obtaining the replacement debt (including points or other closing costs)
shall be disregarded in determining whether the entire proceeds of the
replacement debt have been used to refinance one or more original debts.
(B) Refinancing other than exact refinancings--(1) Year of
refinancing. In the taxable year in which an original debt is
refinanced, the grandfathered amount of the original and replacement
debts is equal to the lesser of--
(i) The sum of the average balances of the original debt and the
replacement debt, and
(ii) The principal balance of the original debt as of August 16,
1986, reduced by all principal payments on the original debt after
August 16, 1986, and before the first day of the current taxable year.
(2) In subsequent years. In any taxable year after the taxable year
in which an original debt is refinanced, the grandfathered amount of the
replacement debt is equal to the least of--
(i) The average balance of the replacement debt for the taxable
year,
(ii) The amount of the replacement debt used to repay the principal
balance of the original debt, reduced by all principal payments on the
replacement debt after the date of the refinancing and before the first
day of the current taxable year, or
(iii) The principal balance of the original debt on August 16, 1986,
reduced by all principal payments on the original debt after August 16,
1986, and before the date of the refinancing, and further reduced by all
principal payments on the replacement debt after the date of the
refinancing and before the first day of the current taxable year.
(C) Example. (i) Facts. On August 16, 1986, T has a single debt
secured by a principal residence with a balance of $150,000. On July 1,
1988, T refinances the debt, which still has a principal balance of
$150,000, with a new secured debt. The principal balance of the
replacement debt throughout 1988 and 1989 is $150,000. The adjusted
purchase price of the residence is $100,000 throughout 1987, 1988 and
1989. The average balance of the original debt was $150,000 in 1987 and
$75,000 in 1988. The average balance of the replacement debt is $75,000
in 1988 and $150,000 in 1989.
(ii) Grandfathered amount in 1987. The original debt was incurred
and secured on or before August 16, 1986 and T has not borrowed any
additional amounts with respect to the debt. Therefore, its
grandfathered amount in 1987 is its average balance ($150,000). This
amount is treated as the adjusted purchase price for 1987 and all of the
interest paid on the debt is qualified residence interest.
(iii) Grandfathered amount in 1988. Because the replacement debt was
used to refinance a debt incurred and secured
[[Page 318]]
on or before August 16, 1986, the replacement debt is treated as a
grandfathered debt. Because all of the proceeds of the replacement debt
were used in the refinancing and because no amounts have been borrowed
after August 16, 1986, on the original debt, the grandfathered amount
for the original debt is its average balance ($75,000) and the
grandfathered amount for the replacement debt is its average balance
($75,000). Since the sum of the grandfathered amounts ($150,000) exceeds
the adjusted purchase price of the residence, the sum of the
grandfathered amounts may be substituted for the adjusted purchase price
for 1988 and all of the interest paid on the debt is qualified residence
interest.
(iv) Grandfathered amount in 1989. The grandfathered amount for the
placement debt is its average balance ($150,000). This amount is treated
as the adjusted purchase price for 1989 and all of the interest paid on
the mortgage is qualified residence interest.
(4) Limitation on term of grandfathered debt--(i) In general. An
original debt or replacement debt shall not have any grandfathered
amount in any taxable year that begins after the date, as determined on
August 16, 1986, that the original debt was required to be repaid in
full (the ``maturity date''). If a replacement debt is used to refinance
more than one original debt, the maturity date is determined by
reference to the original debt that, as of August 16, 1986, had the
latest maturity date.
(ii) Special rule for nonamortizing debt. If an original debt was
actually incurred and secured on or before August 16, 1986, and if as of
such date the terms of such debt did not require the amortization of its
principal over its original term, the maturity date of the replacement
debt is the earlier of the maturity date of the replacement debt or the
date 30 years after the date the original debt is first refinanced.
(iii) Example. C incurs a debt on May 10, 1986, the final payment of
which is due May 1, 2006. C incurs a second debt on August 11, 1990,
with a term of 20 years and uses the proceeds of the second debt to
refinance the first debt. Because, under paragraph (m)(4)(i) of this
section, a replacement debt will not have any grandfathered amount in
any taxable year that begins after the maturity date of the original
debt (May 1, 2006), the second debt has no grandfathered amount in any
taxable year after 2006.
(n) Qualified indebtedness (secured debt used for medical and
educational purposes)--(1) In general--(i) Treatment of qualified
indebtedness. The amount of any qualified indebtedness resulting from a
secured debt may be added to the adjusted purchase price under paragraph
(e)(2)(i)(B) of this section to determine the applicable debt limit for
that secured debt and any other debt subsequently secured by the
qualified residence.
(ii) Determination of amount of qualified indebtedness. If, as of
the end of the taxable year (or the last day in the taxable year that
the debt is secured), at least 90 percent of the proceeds of a secured
debt are used (within the meaning of paragraph (n)(2) of this section)
to pay for qualified medical and educational expenses (within the
meaning of paragraphs (n)(3) and (n)(4) of this section), the amount of
qualified indebtedness resulting from that debt for the taxable year is
equal to the average balance of such debt for the taxable year.
(iii) Determination of amount of qualified indebtedness for mixed-
use debt. If, as of the end of the taxable year (or the last day in the
taxable year that the debt is secured), more than ten percent of the
proceeds of a secured debt are used to pay for expenses other than
qualified medical and educational expenses, the amount of qualified
indebtedness resulting from that debt for the taxable year shall equal
the lesser of--
(A) The average balance of the debt, or
(B) The amount of the proceeds of the debt used to pay for qualified
medical and educational expenses through the end of the taxable year,
reduced by any principal payments on the debt before the first day of
the current taxable year.
(iv) Example. (i) C incurs a $10,000 debt on April 20, 1987, which
is secured on that date by C's principal residence. C immediately uses
(within the meaning of paragraph (n)(2) of this section) $4,000 of the
proceeds of the debt to pay for a qualified medical expense. C
[[Page 319]]
makes no principal payments on the debt during 1987. During 1988 and
1989, C makes principal payments of $1,000 per year. The average balance
of the debt during 1988 is $9,500 and the average balance during 1989 is
$8,500.
(ii) Under paragraph (n)(1)(iii) of this section, C determines the
amount of qualified indebtedness for 1988 as follows:
Average balance....................................... ....... $9,500
Amount of debt used to pay for qualified medical $4,000
expenses...........................................
Less payments of principal before 1988.............. $0
---------
Net qualified expenses................................ ....... $4,000
The amount of qualified indebtedness for 1988 is, therefore, $4,000
(lesser of $9,500 average balance or $4,000 net qualified expenses).
This amount may be added to the adjusted purchase price of C's principal
residence under paragraph (e)(2)(i)(B) of this section for purposes of
computing the applicable debt limit for this debt and any other debt
subsequently secured by the principal residence.
(iii) C determines the amount of qualified indebtedness for 1989 as
follows:
Average balance....................................... ....... $8,500
Amount of debt used to pay for qualified medical $4,000
expenses...........................................
Less payments of principal before 1988.............. $1,000
---------
Net qualified expenses................................ ....... $3,000
The amount of qualified indebtedness for 1989 is, therefore, $3,000
(lesser of $8,500 average balance or $3,000 net qualified expenses).
(v) Prevention of double counting in year of refinancing--(A) In
general. A debt used to pay for qualified medical or educational
expenses is refinanced if some or all of the outstanding balance of the
debt (the ``original debt'') is repaid out of the proceeds of a second
debt (the ``replacement debt''). If, in the year of a refinancing, the
combined qualified indebtedness of the original debt and the replacement
debt exceeds the combined qualified expenses of such debts, the amount
of qualified indebtedness for each such debt shall be determined by
multiplying the amount of qualified indebtedness for each such debt by a
fraction, the numerator of which is the combined qualified expenses and
the denominator of which is the combined qualified indebtedness.
(B) Definitions. For purposes of paragraph (n)(1)(v)(A) of this
section--
(1) The term ``combined qualified indebtedness'' means the sum of
the qualified indebtedness (determined without regard to paragraph
(n)(1)(v) of this section) for the original debt and the replacement
debt.
(2) The term ``combined qualified expenses'' means the amount of the
proceeds of the original debt used to pay for qualified medical and
educational expenses through the end of the current taxable year,
reduced by any principal payments on the debt before the first day of
the current taxable year, and increased by the amount, if any, of the
proceeds of the replacement debt used to pay such expenses through the
end of the current taxable year other than as part of the refinancing.
(C) Example. (i) On August 11, 1987, C incurs a $8,000 debt secured
by a principal residence. C uses (within the meaning of paragraph
(n)(2)(i) of this section) $5,000 of the proceeds of the debt to pay for
qualified educational expenses. C makes no principal payments on the
debt. On July 1, 1988, C incurs a new debt in the amount of $8,000
secured by C's principal residence and uses all of the proceeds of the
new debt to repay the original debt. Under paragraph (n)(2)(ii) of this
section $5,000 of the new debt is treated as being used to pay for
qualified educational expenses. C makes no principal payments (other
than the refinancing) during 1987 or 1988 on either debt and pays all
accrued interest monthly. The average balance of each debt in 1988 is
$4,000.
(ii) Under paragraph (n)(1)(iii) of this section, the amount of
qualified indebtedness for 1988 with respect to the original debt is
$4,000 (the lesser of its average balance ($4,000) and the amount of the
debt used to pay for qualified medical and educational expenses
($5,000)). Similarly, the amount of qualified indebtedness for 1988 with
respect to the replacement debt is also $4,000. Both debts, however, are
subject in 1988 to the limitation in paragraph
[[Page 320]]
(n)(1)(v)(A) of this section. The combined qualified indebtedness,
determined without regard to the limitation, is $8,000 ($4,000 of
qualified indebtedness from each debt). The combined qualified expenses
are $5,000 ($5,000 from the original debt and $0 from the replacement
debt). The amount of qualified indebtedness from each debt must,
therefore, be reduced by a fraction, the numerator of which is $5,000
(the combined qualified expenses) and the denominator of which is $8,000
(the combined qualified indebtedness). After application of the
limitation, the amount of qualified indebtedness for the original debt
is $2,500 ($4,000 x x \5/8\). Similarly, the amount of qualified
indebtedness for the replacement debt is $2,500. Note that the total
qualified indebtedness for both the original and the replacement debt is
$5,000 ($2,500 + $2,500). Therefore, C is entitled to the same amount of
qualified indebtedness as C would have been entitled to if C had not
refinanced the debt.
(vi) Special rule for principal payments in excess of qualified
expenses. For purposes of paragraph (n)(1)(iii)(B), (n)(1)(v)(B)(2) and
(n)(2)(ii) of this section, a principal payment is taken into account
only to the extent that the payment, when added to all prior payments,
does not exceed the amount used on or before the date of the payment to
pay for qualified medical and educational expenses.
(2) Debt used to pay for qualified medical or educational expenses--
(i) In general. For purposes of this section, the proceeds of a debt are
used to pay for qualified medical or educational expenses to the extent
that--
(A) The taxpayer pays qualified medical or educational expenses
within 90 days before or after the date that amounts are actually
borrowed with respect to the debt, the proceeds of the debt are not
directly allocable to another expense under Sec. 1.163-8T(c)(3)
(allocation of debt; proceeds not disbursed to borrower) and the
proceeds of any other debt are not allocable to the medical or
educational expenses under Sec. 1.163-8T(c)(3), or
(B) The proceeds of the debt are otherwise allocated to such
expenditures under Sec. 1.163-8T.
(ii) Special rule for refinancings. For purposes of this section,
the proceeds of a debt are used to pay for qualified medical and
educational expenses to the extent that the proceeds of the debt are
allocated under Sec. 1.163-8T to the repayment of another debt (the
``original debt''), but only to the extent of the amount of the original
debt used to pay for qualified medical and educational expenses, reduced
by any principal payments on such debt up to the time of the
refinancing.
(iii) Other special rules. The following special rules apply for
purposes of this section.
(A) Proceeds of a debt are used to pay for qualified medical or
educational expenses as of the later of the taxable year in which such
proceeds are borrowed or the taxable year in which such expenses are
paid.
(B) The amount of debt which may be treated as being used to pay for
qualified medical or educational expenses may not exceed the amount of
such expenses.
(C) Proceeds of a debt may not be treated as being used to pay for
qualified medical or educational expenses to the extent that:
(1) The proceeds have been repaid as of the time the expense is
paid;
(2) The proceeds are actually borrowed before August 17, 1986; or
(3) The medical or educational expenses are paid before August 17,
1986.
(iv) Examples--
Example 1. A pays a $5,000 qualified educational expense from a
checking account that A maintains at Bank 1 on November 9, 1987. On
January 1, 1988, A incurs a $20,000 debt that is secured by A's
residence and places the proceeds of the debt in a savings account that
A also maintains at Bank 1. A pays another $5,000 qualified educations
expense on March 15 from a checking account that A maintains at Bank 2.
Under paragraph (n)(2) of this section, the debt proceeds are used to
pay for both educational expenses, regardless of other deposits to, or
expenditures from, the accounts, because both expenditures are made
within 90 days before or after the debt was incurred.
Example 2. B pays a $5,000 qualified educational expense from a
checking account on November 1, 1987. On November 30, 1987, B incurs a
debt secured by B's residence, and the lender disburses the debt
proceeds directly to a person who sells B a new car. Although the
educational expense is paid within 90 days of
[[Page 321]]
the date the debt is incurred, the proceeds of the debt are not used to
pay for the educational expense because the proceeds are directly
allocable to the purchase of the new car under Sec. 1.163-8T(c)(3).
Example 3. On November 1, 1987, C borrows $5,000 from C's college.
The proceeds of this debt are not disbursed to C, but rather are used to
pay tuition fees for C's attendance at the college. On November 30,
1987, C incurs a second debt and secures the debt by C's residence.
Although the $5,000 educational expense is paid within 90 days before
the second debt is incurred, the proceeds of the second debt are not
used to pay for the educational expense, because the proceeds of the
first debt are directly allocable to the educational expense under Sec.
1.163-8T(c)(3).
Example 4. On January 1, 1988, D incurs a $20,000 debt secured by a
qualified residence. D places the proceeds of the debt in a separate
account (i.e., the proceeds of the debt are the only deposit in the
account). D makes payments of $5,000 each for qualified educational
expenses on September 1, 1988, September 1, 1989, September 1, 1990, and
September 1, 1991. Because the debt proceeds are allocated to
educational expenses as of the date the expenses are paid, under the
rules of Sec. 1.163-8T(c)(4), the following amounts of the debt
proceeds are used to pay for qualified educational expenses as of the
end of each year:
1988: $5,000
1989: $10,000
1990: $15,000
1991: $20,000
Example 5. During 1987 E incurs a $10,000 debt secured by a
principal residence. E uses (within the meaning of paragraph (n)(2)(i)
of this section) all of the proceeds of the debt to pay for qualified
educational expenses. On August 20, 1988, at which time the balance of
the debt is $9,500, E incurs a new debt in the amount of $9,500 secured
by E's principal residence and uses all of the proceeds of the new debt
to repay the original debt. Under paragraph (n)(2)(ii) of this section,
all of the proceeds of the new debt are used to pay for qualified
educational expenses.
(3) Qualified medical expenses. Qualified medical expenses are
amounts that are paid for medical care (within the meaning of section
213(d)(1) (A) and (B)) for the taxpayer, the taxpayer's spouse, or a
dependent of the taxpayer (within the meaning of section 152), and that
are not compensated for by insurance or otherwise.
(4) Qualified educational expenses. Qualified educational expenses
are amounts that are paid for tuition, fees, books, supplies and
equipment required for enrollment, attendance or courses of instruction
at an educational organization described in section 170(b) (1)(A)(ii)
and for any reasonable living expenses while away from home while in
attendance at such an institution, for the taxpayer, the taxpayer's
spouse or a dependent of the taxpayer (within the meaning of section
152) and that are not reimbursed by scholarship or otherwise.
(o) Secured debt--(1) In general. For purposes of this section, the
term ``secured debt'' means a debt that is on the security of any
instrument (such as a mortgage, deed of trust, or land contract)--
(i) That makes the interest of the debtor in the qualified residence
specific security for the payment of the debt,
(ii) Under which, in the event of default, the residence could be
subjected to the satisfaction of the debt with the same priority as a
mortgage or deed of trust in the jurisdiction in which the property is
situated, and
(iii) That is recorded, where permitted, or is otherwise perfected
in accordance with applicable State law.
A debt will not be considered to be secured by a qualified residence if
it is secured solely by virtue of a lien upon the general assets of the
taxpayer or by a security interest, such as a mechanic's lien or
judgment lien, that attaches to the property without the consent of the
debtor.
(2) Special rule for debt in certain States. Debt will not fail to
be treated as secured solely because, under an applicable State or local
homestead law or other debtor protection law in effect on August 16,
1986, the security interest is ineffective or the enforceability of the
security interest is restricted.
(3) Times at which debt is treated as secured. For purposes of this
section, a debt is treated as secured as of the date on which each of
the requirements of paragraph (o)(1) of this section are satisfied,
regardless of when amounts are actually borrowed with respect to the
debt. For purposes of this paragraph (o)(3), if the instrument is
recorded within a commercially reasonable time after the security
interest is granted, the instrument will be treated as recorded on the
date that the security interest was granted.
[[Page 322]]
(4) Partially secured debt--(i) In general. If the security interest
is limited to a prescribed maximum amount or portion of the residence,
and the average balance of the debt exceeds such amount or the value of
such portion, such excess shall not be treated as secured debt for
purposes of this section.
(ii) Example. T borrows $80,000 on January 1, 1991. T secures the
debt with a principal residence. The security in the residence for the
debt, however, is limited to $20,000. T pays $8,000 in interest on the
debt in 1991 and the average balance of the debt in that year is
$80,000. Because the average balance of the debt exceeds the maximum
amount of the security interest, such excess is not treated as secured
debt. Therefore, for purposes of applying the limitation on qualified
residence interest, the average balance of the secured debt is $20,000
(the maximum amount of the security interest) and the interest paid or
accrued on the secured debt is $2,000 (the total interest paid on the
debt multiplied by the ratio of the average balance of the secured debt
($20,000) and the average balance of the total debt ($80,000)).
(5) Election to treat debt as not secured by a qualified residence--
(i) In general. For purposes of this section, a taxpayer may elect to
treat any debt that is secured by a qualified residence as not secured
by the qualified residence. An election made under this paragraph shall
be effective for the taxable year for which the election is made and for
all subsequent taxable years unless revoked with the consent of the
Commissioner.
(ii) Example. T owns a principal residence with a fair market value
of $75,000 and an adjusted purchase price of $40,000. In 1988, debt A,
the proceeds of which were used to purchase the residence, has an
average balance of $15,000. The proceeds of debt B, which is secured by
a second mortgage on the property, are allocable to T's trade or
business under Sec. 1.163-8T and has an average balance of $25,000. In
1988, T incurs debt C, which is also secured by T's principal residence
and which has an average balance in 1988 of $5,000. In the absence of an
election to treat debt B as unsecured, the applicable debt limit for
debt C in 1988 under paragraph (e) of this section would be zero dollars
($40,000-$15,000-$25,000) and none of the interest paid on debt C would
be qualified residence interest. If, however, T makes or has previously
made an election pursuant to paragraph (o)(5)(i) of this section to
treat debt B as not secured by the residence, the applicable debt limit
for debt C would be $25,000 ($40,000-$15,000), and all of the interest
paid on debt C during the taxable year would be qualified residence
interest. Since the proceeds of debt B are allocable to T's trade or
business under Sec. 1.163-8T, interest on debt B may be deductible
under other sections of the Internal Revenue Code.
(iii) Allocation of debt secured by two qualified residences.
[Reserved]
(p) Definition of qualified residence--(1) In general. The term
``qualified residence'' means the taxpayer's principal residence (as
defined in paragraph (p)(2) of this section), or the taxpayer's second
residence (as defined in paragraph (p)(3) of this section).
(2) Principal residence. The term ``principal residence'' means the
taxpayer's principal residence within the meaning of section 1034. For
purposes of this section, a taxpayer cannot have more than one principal
residence at any one time.
(3) Second residence--(i) In general. The term ``second residence''
means--
(A) A residence within the meaning of paragraph (p)(3)(ii) of this
section,
(B) That the taxpayer uses as a residence within the meaning of
paragraph (p)(3)(iii) of this section, and
(C) That the taxpayer elects to treat as a second residence pursuant
to paragraph (p)(3)(iv) of this section.
A taxpayer cannot have more than one second residence at any time.
(ii) Definition of residence. Whether property is a residence shall
be determined based on all the facts and circumstances, including the
good faith of the taxpayer. A residence generally includes a house,
condominium, mobile home, boat, or house trailer, that contains sleeping
space and toilet and cooking facilities. A residence does not include
personal property, such as furniture or a television, that, in
accordance with the applicable local law, is not a fixture.
[[Page 323]]
(iii) Use as a residence. If a residence is rented at any time
during the taxable year, it is considered to be used as a residence only
if the taxpayer uses it during the taxable year as a residence within
the meaning of section 280A(d). If a residence is not rented at any time
during the taxable year, it shall be considered to be used as a
residence. For purposes of the preceding sentence, a residence will be
deemed to be rented during any period that the taxpayer holds the
residence out for rental or resale or repairs or renovates the residence
with the intention of holding it out for rental or resale.
(iv) Election of second residence. A taxpayer may elect a different
residence (other than the taxpayer's principal residence) to be the
taxpayer's second residence for each taxable year. A taxpayer may not
elect different residences as second residences at different times of
the same taxable year except as provided below--
(A) If the taxpayer acquires a new residence during the taxable
year, the taxpayer may elect the new residence as a taxpayer's second
residence as of the date acquired;
(B) If property that was the taxpayer's principal residence during
the taxable year ceases to qualify as the taxpayer's principal
residence, the taxpayer may elect that property as the taxpayer's second
residence as of the date that the property ceases to be the taxpayer's
principal residence; or
(C) If property that was the taxpayer's second residence is sold
during the taxable year or becomes the taxpayer's principal residence,
the taxpayer may elect a new second residence as of such day.
(4) Allocations between residence and other property--(i) In
general. For purposes of this section, the adjusted purchase price and
fair market value of property must be allocated between the portion of
the property that is a qualified residence and the portion that is not a
qualified residence. Neither the average balance of the secured debt nor
the interest paid or accrued on secured debt is so allocated. Property
that is not used for residential purposes does not qualify as a
residence. For example, if a portion of the property is used as an
office in the taxpayer's trade or business, that portion of the property
does not qualify as a residence.
(ii) Special rule for rental of residence. If a taxpayer rents a
portion of his or her principal or second residence to another person (a
``tenant''), such portion may be treated as used by the taxpayer for
residential purposes if, but only if--
(A) Such rented portion is used by the tenant primarily for
residential purposes,
(B) The rented portion is not a self-contained residential unit
containing separate sleeping space and toilet and cooking facilities,
and
(C) The total number of tenants renting (directly or by sublease)
the same or different portions of the residence at any time during the
taxable year does not exceed two. For this purpose, if two persons (and
the dependents, as defined by section 152, of either of them) share the
same sleeping quarters, they shall be treated as a single tenant.
(iii) Examples.
Example 1. D, a dentist, uses a room in D's principal residence as
an office which qualifies under section 280A(c)(1)(B) as a portion of
the dwelling unit used exclusively on a regular basis as a place of
business for meeting with patients in the normal course of D's trade or
business. D's adjusted purchase price of the property is $65,000;
$10,000 of which is allocable under paragraph (o)(4)(i) of this section
to the room used as an office. For purposes of this section, D's
residence does not include the room used as an office. The adjusted
purchase price of the residence is, accordingly, $55,000. Similarly, the
fair market value of D's residence must be allocated between the office
and the remainder of the property.
Example 2. J rents out the basement of property that is otherwise
used as J's principal residence. The basement is a self-contained
residential unit, with sleeping space and toilet and cooking facilities.
The adjusted purchase price of the property is $100,000; $15,000 of
which is allocable under paragraph (o)(4)(i) of this section to the
basement. For purposes of this section, J's residence does not include
the basement and the adjusted purchase price of the residence is
$85,000. Similarly, the fair market value of the residence must be
allocated between the basement unit and the remainder of the property.
(5) Residence under construction--(i) In general. A taxpayer may
treat a residence under construction as a qualified residence for a
period of up to 24
[[Page 324]]
months, but only if the residence becomes a qualified residence, without
regard to this paragraph (p)(5)(i), as of the time that the residence is
ready for occupancy.
(ii) Example. X owns a residential lot suitable for the construction
of a vacation home. On April 20, 1987, X obtains a mortgage secured by
the lot and any property to be constructed on the lot. On August 9,
1987, X begins construction of a residence on the lot. The residence is
ready for occupancy on November 9, 1989. The residence is used as a
residence within the meaning of paragraph (p)(3)(iii) of this section
during 1989 and X elects to treat the residence as his second residence
for the period November 9, 1989, through December 31, 1989. Since the
residence under construction is a qualified residence as of the first
day that the residence is ready for occupancy (November 9, 1987), X may
treat the residence as his second residence under paragraph (p)(5)(i) of
this section for up to 24 months of the period during which the
residence is under construction, commencing on or after the date that
construction is begun (August 9, 1987). If X treats the residence under
construction as X's second residence beginning on August 9, 1987, the
residence under construction would cease to qualify as a qualified
residence under paragraph (p)(5)(i) on August 8, 1989. The residence's
status as a qualified residence for future periods would be determined
without regard to paragraph (p)(5)(i) of this section.
(6) Special rule for time-sharing arrangements. Property that is
otherwise a qualified residence will not fail to qualify as such solely
because the taxpayer's interest in or right to use the property is
restricted by an arrangement whereby two or more persons with interests
in the property agree to exercise control over the property for
different periods during the taxable year. For purposes of determining
the use of a residence under paragraph (p)(3)(iii) of this section, a
taxpayer will not be considered to have used or rented a residence
during any period that the taxpayer does not have the right to use the
property or to receive any benefits from the rental of the property.
(q) Special rules for tenant-stockholders in cooperative housing
corporations--(1) In general. For purposes of this section, a residence
includes stock in a cooperative housing corporation owned by a tenant-
stockholder if the house or apartment which the tenant-stockholder is
entitled to occupy by virtue of owning such stock is a residence within
the meaning of paragraph (p)(3)(ii) of this section.
(2) Special rule where stock may not be used to secure debt. For
purposes of this section, if stock described in paragraph (q)(1) of this
section may not be used to secure debt because of restrictions under
local or State law or because of restrictions in the cooperative
agreement (other than restrictions the principal purpose of which is to
permit the tenant-stockholder to treat unsecured debt as secured debt
under this paragraph (q)(2)), debt may be treated as secured by such
stock to the extent that the proceeds of the debt are allocated to the
purchase of the stock under the rules of Sec. 1.163-8T. For purposes of
this paragraph (q)(2), proceeds of debt incurred prior to January 1,
1987, may be treated as allocated to the purchase of such stock to the
extent that the tenant-stockholder has properly and consistently
deducted interest expense on such debt as home mortgage interest
attributable to such stock on Schedule A of Form 1040 in determining his
taxable income for taxable years beginning before January 1, 1987. For
purposes of this paragraph (q)(2), amended returns filed after December
22, 1987, are disregarded.
(3) Treatment of interest expense of the cooperative described in
section 216(a)(2). For purposes of section 163(h) and Sec. 1.163-9T
(disallowance of deduction for personal interest) and section 163(d)
(limitation on investment interest), any amount allowable as a deduction
to a tenant-stockholder under section 216(a)(2) shall be treated as
interest paid or accrued by the tenant-stockholder. If a tenant-
stockholder's stock in a cooperative housing corporation is a qualified
residence of the tenant-shareholder, any amount allowable as a deduction
to the tenant-stockholder under section 216(a)(2) is qualified residence
interest.
[[Page 325]]
(4) Special rule to prevent tax avoidance. If the amount treated as
qualified residence interest under this section exceeds the amount which
would be so treated if the tenant-stockholder were treated as directly
owning his proportionate share of the assets and liabilities of the
cooperative and one of the principal purposes of the cooperative
arrangement is to permit the tenant-stockholder to increase the amount
of qualified residence interest, the district director may determine
that such excess is not qualified residence interest.
(5) Other definitions. For purposes of this section, the terms
``tenant-stockholder,'' ``cooperative housing corporation'' and
``proportionate share'' shall have the meaning given by section 216 and
the regulations thereunder.
(r) Effective date. The provisions of this section are effective for
taxable years beginning after December 31, 1986.
[T.D. 8168, 52 FR 48410, Dec. 22, 1987]
Sec. 1.163-11 Allocation of certain prepaid qualified mortgage
insurance premiums.
(a) Allocation--(1) In general. As provided in section 163(h)(3)(E),
premiums paid or accrued for qualified mortgage insurance during the
taxable year in connection with acquisition indebtedness with respect to
a qualified residence (as defined in section 163(h)(4)(A)) of the
taxpayer shall be treated as qualified residence interest (as defined in
section 163(h)(3)(A)). If an individual taxpayer pays such a premium
that is properly allocable to a mortgage the payment of which extends to
periods beyond the close of the taxable year in which the premium is
paid, the taxpayer must allocate the premium to determine the amount
treated as qualified residence interest for each taxable year. The
premium must be allocated ratably over the shorter of--
(i) The stated term of the mortgage; or
(ii) A period of 84 months, beginning with the month in which the
insurance was obtained.
(2) Limitation. If a mortgage is satisfied before the end of its
stated term, no deduction as qualified residence interest shall be
allowed for any amount of the premium that is allocable to periods after
the mortgage is satisfied.
(b) Scope. The allocation requirement in paragraph (a) of this
section applies only to mortgage insurance provided by the Federal
Housing Administration or private mortgage insurance (as defined by
section 2 of the Homeowners Protection Act of 1998 (12 U.S.C. 4901) as
in effect on December 20, 2006). It does not apply to mortgage insurance
provided by the Department of Veterans Affairs or the Rural Housing
Service. Paragraph (a) of this section applies whether the qualified
mortgage insurance premiums are paid in cash or are financed, without
regard to source.
(c) Limitation on the treatment of mortgage insurance premiums as
interest. This section applies to prepaid qualified mortgage insurance
premiums described in paragraph (a) of this section that are paid or
accrued on or after January 1, 2011, and during periods to which section
163(h)(3)(E) is applicable. This section does not apply to any amount of
prepaid qualified mortgage insurance premiums that are allocable to any
periods to which section 163(h)(3)(E) is not applicable.
(d) Effective/applicability date. This section is applicable on and
after January 1, 2011. For regulations applicable before January 1,
2011, see Sec. 1.163-11T in effect prior to January 1, 2011 (Sec.
1.163-11T as contained in 26 CFR part 1 edition revised as of April 1,
2011).
[T.D. 9588, 77 FR 26699, May 7, 2012]
Sec. 1.163-12 Deduction of original issue discount on instrument
held by related foreign person.
(a) General rules--(1) Deferral of deduction. Except as provided in
paragraph (b) of this section, section 163(e)(3) requires a taxpayer to
use the cash method of accounting with respect to the deduction of
original issue discount owed to a related foreign person. A deduction
for an otherwise deductible portion of original issue discount with
respect to a debt instrument will not be allowable as a deduction to the
issuer until paid if, at the close of the issuer's taxable year in which
such amount would otherwise be deductible, the person holding the debt
instrument
[[Page 326]]
is a related foreign person. For purposes of this section, a related
foreign person is any person that is not a United States person within
the meaning of section 7701(a)(30), and that is related (within the
meaning of section 267(b)) to the issuer at the close of the taxable
year in which the amount incurred by the taxpayer would otherwise be
deductible. Section 267(f) defines ``controlled group'' for purposes of
section 267(b) without regard to the limitations of section 1563(b). An
amount is treated as paid for purposes of this section if the amount is
considered paid for purposes of section 1441 or section 1442 (including
an amount taken into account pursuant to section 871(a)(1)(C), section
881(a)(3), or section 884(f)). The rules of this paragraph (a) apply
even if the original issue discount is not subject to United States tax,
or is subject to a reduced rate of tax, pursuant to a provision of the
Internal Revenue Code or a treaty obligation of the United States. For
purposes of this section, original issue discount is an amount described
in section 1273, whether from sources inside or outside the United
States.
(2) Change in method of accounting. A taxpayer that uses a method of
accounting other than that required by the rules of this section must
change its method of accounting to conform its method to the rules of
this section. The taxpayer's change in method must be made pursuant to
the rules of section 446(e), the regulations thereunder, and any
applicable administrative procedures prescribed by the Commissioner.
Because the rules of this section prescribe a method of accounting,
these rules apply in the determination of a taxpayer's earnings and
profits pursuant to Sec. 1.312-6(a).
(b) Exceptions and special rules--(1) Effectively connected income.
The provisions of section 267(a)(2) and the regulations thereunder, and
not the provisions of paragraph (a) of this section, apply to an amount
of original issue discount that is income of the related foreign person
that is effectively connected with the conduct of a United States trade
or business of such related foreign person. An amount described in this
paragraph (b)(1) thus is allowable as a deduction as of the day on which
the amount is includible in the gross income of the related foreign
person as effectively connected income under sections 872(a)(2) or
882(b) (or, if later, as of the day on which the deduction would be so
allowable but for section 267(a)(2)). However, this paragraph (b)(1)
does not apply if the related foreign person is exempt from United
States income tax on the amount owed, or is subject to a reduced rate of
tax, pursuant to a treaty obligation of the United States (such as under
an article relating to the taxation of business profits).
(2) Certain obligations issued by natural persons. This section does
not apply to any debt instrument described in section 163(e)(4)
(relating to obligations issued by natural persons before March 2, 1984,
and to loans between natural persons).
(3) Amounts owed to a foreign personal holding company, controlled
foreign corporation, or passive foreign investment company--(i) Foreign
personal holding companies. If an amount to which paragraph (a) of this
section otherwise applies is owed to a related foreign person that is a
foreign personal holding company within the meaning of section 552, then
the amount is allowable as a deduction as of the day on which the amount
is includible in the income of the foreign personal holding company. The
day on which the amount is includible in income is determined with
reference to the method of accounting under which the foreign personal
holding company computes its taxable income and earnings and profits for
purposes of sections 551 through 558. See section 551(c) and the
regulations thereunder for the reporting requirements of the foreign
personal holding company provisions (sections 551 through 558).
(ii) Controlled foreign corporations. If an amount to which
paragraph (a) of this section otherwise applies is owed to a related
foreign person that is a controlled foreign corporation within the
meaning of section 957, then the amount is allowable as a deduction as
of the day on which the amount is includible in the income of the
controlled foreign corporation. The day on which the amount is
includible in income is
[[Page 327]]
determined with reference to the method of accounting under which the
controlled foreign corporation computes its taxable income and earnings
and profits for purposes of sections 951 through 964. See section 6038
and the regulations thereunder for the reporting requirements of the
controlled foreign corporation provisions (sections 951 through 964).
(iii) Passive foreign investment companies. If an amount to which
paragraph (a) of this section otherwise applies is owed to a related
foreign person that is a passive foreign investment company within the
meaning of section 1296, then the amount is allowable as a deduction as
of the day on which amount is includible in the income of the passive
foreign investment company. The day on which the amount is includible in
income is determined with reference to the method of accounting under
which the earnings and profits of the passive foreign investment company
are computed for purposes of sections 1291 through 1297. See sections
1291 through 1297 and the regulations thereunder for the reporting
requirements of the passive foreign investment company provisions. This
exception shall apply, however, only if the person that owes the amount
at issue has made and has in effect an election pursuant to section 1295
with respect to the passive foreign investment company to which the
amount at issue is owed.
(c) Application of section 267. Except as limited in paragraph
(b)(1) of this section, the provisions of section 267 and the
regulations thereunder shall apply to any amount of original issue
discount to which the provisions of this section do not apply.
(d) Effective date. The rules of this section are effective with
respect to all original issue discount on debt instruments issued after
June 9, 1984.
[T.D. 8465, 58 FR 236, Jan. 5, 1993; 58 FR 8098, Feb. 11, 1993]
Sec. 1.163-13 Treatment of bond issuance premium.
(a) General rule. If a debt instrument is issued with bond issuance
premium, this section limits the amount of the issuer's interest
deduction otherwise allowable under section 163(a). In general, the
issuer determines its interest deduction by offsetting the interest
allocable to an accrual period with the bond issuance premium allocable
to that period. Bond issuance premium is allocable to an accrual period
based on a constant yield. The use of a constant yield to amortize bond
issuance premium is intended to generally conform the treatment of debt
instruments having bond issuance premium with those having original
issue discount. Unless otherwise provided, the terms used in this
section have the same meaning as those terms in section 163(e), sections
1271 through 1275, and the corresponding regulations. Moreover, unless
otherwise provided, the provisions of this section apply in a manner
consistent with those of section 163(e), sections 1271 through 1275, and
the corresponding regulations. In addition, the anti-abuse rule in Sec.
1.1275-2(g) applies for purposes of this section. For rules dealing with
the treatment of bond premium by a holder, see Sec. Sec. 1.171-1
through 1.171-5.
(b) Exceptions. This section does not apply to--
(1) A debt instrument described in section 1272(a)(6)(C) (regular
interests in a REMIC, qualified mortgages held by a REMIC, and certain
other debt instruments, or pools of debt instruments, with payments
subject to acceleration); or
(2) A debt instrument to which Sec. 1.1275-4 applies (relating to
certain debt instruments that provide for contingent payments).
(c) Bond issuance premium. Bond issuance premium is the excess, if
any, of the issue price of a debt instrument over its stated redemption
price at maturity. For purposes of this section, the issue price of a
convertible bond (as defined in Sec. 1.171-1(e)(1)(iii)(C)) does not
include an amount equal to the value of the conversion option (as
determined under Sec. 1.171-1(e)(1)(iii)(A)).
(d) Offsetting qualified stated interest with bond issuance
premium--(1) In general. An issuer amortizes bond issuance premium by
offsetting the qualified stated interest allocable to an accrual period
with the bond issuance premium allocable to the accrual period. This
offset occurs when the issuer takes the qualified stated interest into
account
[[Page 328]]
under its regular method of accounting.
(2) Qualified stated interest allocable to an accrual period. See
Sec. 1.446-2(b) to determine the accrual period to which qualified
stated interest is allocable and to determine the accrual of qualified
stated interest within an accrual period.
(3) Bond issuance premium allocable to an accrual period. The bond
issuance premium allocable to an accrual period is determined under this
paragraph (d)(3). Within an accrual period, the bond issuance premium
allocable to the period accrues ratably.
(i) Step one: Determine the debt instrument's yield to maturity. The
yield to maturity of a debt instrument is determined under the rules of
Sec. 1.1272-1(b)(1)(i).
(ii) Step two: Determine the accrual periods. The accrual periods
are determined under the rules of Sec. 1.1272-1(b)(1)(ii).
(iii) Step three: Determine the bond issuance premium allocable to
the accrual period. The bond issuance premium allocable to an accrual
period is the excess of the qualified stated interest allocable to the
accrual period over the product of the adjusted issue price at the
beginning of the accrual period and the yield. In performing this
calculation, the yield must be stated appropriately taking into account
the length of the particular accrual period. Principles similar to those
in Sec. 1.1272-1(b)(4) apply in determining the bond issuance premium
allocable to an accrual period.
(4) Bond issuance premium in excess of qualified stated interest--
(i) Ordinary income. If the bond issuance premium allocable to an
accrual period exceeds the qualified stated interest allocable to the
accrual period, the excess is treated as ordinary income by the issuer
for the accrual period. However, the amount treated as ordinary income
is limited to the amount by which the issuer's total interest deductions
on the debt instrument in prior accrual periods exceed the total amount
treated by the issuer as ordinary income on the debt instrument in prior
accrual periods.
(ii) Carryforward. If the bond issuance premium allocable to an
accrual period exceeds the sum of the qualified stated interest
allocable to the accrual period and the amount treated as ordinary
income for the accrual period under paragraph (d)(4)(i) of this section,
the excess is carried forward to the next accrual period and is treated
as bond issuance premium allocable to that period. If a carryforward
exists on the date the debt instrument is retired, the carryforward is
treated as ordinary income on that date.
(e) Special rules--(1) Variable rate debt instruments. An issuer
determines bond issuance premium on a variable rate debt instrument by
reference to the stated redemption price at maturity of the equivalent
fixed rate debt instrument constructed for the variable rate debt
instrument. The issuer also allocates any bond issuance premium among
the accrual periods by reference to the equivalent fixed rate debt
instrument. The issuer constructs the equivalent fixed rate debt
instrument, as of the issue date, by using the principles of Sec.
1.1275-5(e).
(2) Inflation-indexed debt instruments. An issuer determines bond
issuance premium on an inflation-indexed debt instrument by assuming
that there will be no inflation or deflation over the term of the
instrument. The issuer also allocates any bond issuance premium among
the accrual periods by assuming that there will be no inflation or
deflation over the term of the instrument. The bond issuance premium
allocable to an accrual period offsets qualified stated interest
allocable to the period. Notwithstanding paragraph (d)(4) of this
section, if the bond issuance premium allocable to an accrual period
exceeds the qualified stated interest allocable to the period, the
excess is treated as a deflation adjustment under Sec. 1.1275-
7(f)(1)(ii). See Sec. 1.1275-7 for other rules relating to inflation-
indexed debt instruments.
(3) Certain debt instruments subject to contingencies--(i) In
general. Except as provided in paragraph (e)(3)(ii) of this section, the
rules of Sec. 1.1272-1(c) apply to determine a debt instrument's
payment schedule for purposes of this section. For example, an issuer
uses the payment schedule determined under Sec. 1.1272-1(c) to
determine the amount, if any, of bond issuance premium on the
[[Page 329]]
debt instrument, the yield and maturity of the debt instrument, and the
allocation of bond issuance premium to an accrual period.
(ii) Mandatory sinking fund provision. Notwithstanding paragraph
(e)(3)(i) of this section, if a debt instrument is subject to a
mandatory sinking fund provision described in Sec. 1.1272-1(c)(3), the
issuer must determine the payment schedule by assuming that a pro rata
portion of the debt instrument will be called under the sinking fund
provision.
(4) Remote and incidental contingencies. For purposes of determining
the amount of bond issuance premium and allocating bond issuance premium
among accrual periods, if a bond provides for a contingency that is
remote or incidental (within the meaning of Sec. 1.1275-2(h)), the
issuer takes the contingency into account under the rules for remote and
incidental contingencies in Sec. 1.1275-2(h).
(f) Example. The following example illustrates the rules of this
section:
Example. (i) Facts. On February 1, 1999, X issues for $110,000 a
debt instrument maturing on February 1, 2006, with a stated principal
amount of $100,000, payable at maturity. The debt instrument provides
for unconditional payments of interest of $10,000, payable on February 1
of each year. X uses the calendar year as its taxable year, X uses the
cash receipts and disbursements method of accounting, and X decides to
use annual accrual periods ending on February 1 of each year. X's
calculations assume a 30-day month and 360-day year.
(ii) Amount of bond issuance premium. The issue price of the debt
instrument is $110,000. Because the interest payments on the debt
instrument are qualified stated interest, the stated redemption price at
maturity of the debt instrument is $100,000. Therefore, the amount of
bond issuance premium is $10,000 ($110,000-$100,000).
(iii) Bond issuance premium allocable to the first accrual period.
Based on the payment schedule and the issue price of the debt
instrument, the yield of the debt instrument is 8.07 percent, compounded
annually. (Although, for purposes of simplicity, the yield as stated is
rounded to two decimal places, the computations do not reflect this
rounding convention.) The bond issuance premium allocable to the accrual
period ending on February 1, 2000, is the excess of the qualified stated
interest allocable to the period ($10,000) over the product of the
adjusted issue price at the beginning of the period ($110,000) and the
yield (8.07 percent, compounded annually). Therefore, the bond issuance
premium allocable to the accrual period is $1,118.17 ($10,000-
$8,881.83).
(iv) Premium used to offset interest. Although X makes an interest
payment of $10,000 on February 1, 2000, X only deducts interest of
$8,881.83, the qualified stated interest allocable to the period
($10,000) offset with the bond issuance premium allocable to the period
($1,118.17).
(g) Effective date. This section applies to debt instruments issued
on or after March 2, 1998.
(h) Accounting method changes--(1) Consent to change. An issuer
required to change its method of accounting for bond issuance premium to
comply with this section must secure the consent of the Commissioner in
accordance with the requirements of Sec. 1.446-1(e). Paragraph (h)(2)
of this section provides the Commissioner's automatic consent for
certain changes.
(2) Automatic consent. The Commissioner grants consent for an issuer
to change its method of accounting for bond issuance premium on debt
instruments issued on or after March 2, 1998. Because this change is
made on a cut-off basis, no items of income or deduction are omitted or
duplicated and, therefore, no adjustment under section 481 is allowed.
The consent granted by this paragraph (h)(2) applies provided--
(i) The change is made to comply with this section;
(ii) The change is made for the first taxable year for which the
issuer must account for a debt instrument under this section; and
(iii) The issuer attaches to its federal income tax return for the
taxable year containing the change a statement that it has changed its
method of accounting under this section.
[T.D. 8746, 62 FR 68176, Dec. 31, 1997, as amended by T.D. 8838, 64 FR
48547, Sept. 7, 1999]
Sec. 1.163(d)-1 Time and manner for making elections under the Omnibus
Budget Reconciliation Act of 1993 and the Jobs and Growth Tax Relief
Reconciliation Act of 2003.
(a) Description. Section 163(d)(4)(B)(iii), as added by section
13206(d) of the Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-
66, 107 Stat. 467), allows an electing taxpayer to take all or a portion
of certain
[[Page 330]]
net capital gain attributable to dispositions of property held for
investment into account as investment income. Section 163(d)(4)(B), as
amended by section 302(b) of the Jobs and Growth Tax Relief
Reconciliation Act of 2003 (Pub. L. 108-27, 117 Stat. 762), allows an
electing taxpayer to take all or a portion of qualified dividend income,
as defined in section 1(h)(11)(B), into account as investment income. As
a consequence, the net capital gain and qualified dividend income taken
into account as investment income under these elections are not eligible
to be taxed at the capital gains rates. An election may be made for net
capital gain recognized by noncorporate taxpayers during any taxable
year beginning after December 31, 1992. An election may be made for
qualified dividend income received by noncorporate taxpayers during any
taxable year beginning after December 31, 2002, but before January 1,
2009.
(b) Time and manner for making the elections. The elections for net
capital gain and qualified dividend income must be made on or before the
due date (including extensions) of the income tax return for the taxable
year in which the net capital gain is recognized or the qualified
dividend income is received. The elections are to be made on Form 4952,
``Investment Interest Expense Deduction,'' in accordance with the form
and its instructions.
(c) Revocability of elections. The elections described in this
section are revocable with the consent of the Commissioner.
(d) Effective date. The rules set forth in this section regarding
the net capital gain election apply beginning December 12, 1996. The
rules set forth in this section regarding the qualified dividend income
election apply to any taxable year beginning after December 31, 2002,
but before January 1, 2009.
[T.D. 9191, 70 FR 13100, Mar. 18, 2005]
Sec. 1.164-1 Deduction for taxes.
(a) In general. Only the following taxes shall be allowed as a
deduction under this section for the taxable year within which paid or
accrued, according to the method of accounting used in computing taxable
income:
(1) State and local, and foreign, real property taxes.
(2) State and local personal property taxes.
(3) State and local, and foreign, income, war profits, and excess
profits taxes.
(4) State and local general sales taxes.
(5) State and local taxes on the sale of gasoline, diesel fuel, and
other motor fuels.
In addition, there shall be allowed as a deduction under this section
State and local and foreign taxes not described in subparagraphs (1)
through (5) of this paragraph which are paid or accrued within the
taxable year in carrying on a trade or business or an activity described
in section 212 (relating to expenses for production of income). For
example, dealers or investors in securities and dealers or investors in
real estate may deduct State stock transfer and real estate transfer
taxes, respectively, under section 164, to the extent they are expenses
incurred in carrying on a trade or business or an activity for the
production of income. In general, taxes are deductible only by the
person upon whom they are imposed. However, see Sec. 1.164-5 in the
case of certain taxes paid by the consumer. Also, in the case of a
qualified State individual income tax (as defined in section 6362 and
the regulations thereunder) which is determined by reference to a
percentage of the Federal income tax (pursuant to section 6362 (c)), an
accrual method taxpayer shall use the cash receipts and disbursements
method to compute the amount of his deduction therefor. Thus, the
deduction under section 164 is in the amount actually paid with respect
to the qualified tax, rather than the amount accrued with respect
thereto, during the taxable year even though the taxpayer uses the
accrual method of accounting for other purposes. In addition, see
paragraph (f)(1) of Sec. 301.6361-1 of this chapter (Regulations on
Procedure and Administration) with respect to rules relating to
allocation and reallocation of amounts collected on account of the
Federal income tax and qualified taxes.
(b) Taxable years beginning before January 1, 1964. For taxable
years beginning before January 1, 1964, except as otherwise provided in
Sec. Sec. 1.164-2 through
[[Page 331]]
1.164-8, inclusive, taxes imposed by the United States, any State,
territory, possession of the United States, or a political subdivision
of any of the foregoing, or by any foreign country, are deductible from
gross income for the taxable year in which paid or accrued, according to
the method of accounting used in computing taxable income. For this
purpose, postage is not a tax and automobile license or registration
fees are ordinarily taxes.
(c) Cross references. For the definition of the term ``real property
taxes'', see paragraph (d) of Sec. 1.164-3. For the definition of the
term ``foreign taxes'', see paragraph (d) of Sec. 1.164-3. For the
definition of the term ``general sales taxes'', see paragraph (f) of
Sec. 1.164-3. For the treatment of gasoline, diesel fuel, and other
motor fuel taxes, see Sec. 1.164-5. For apportionment of taxes on real
property between seller and purchaser, see section 164(d) and Sec.
1.164-6. For the general rule for taxable year of deduction, see section
461. For provisions disallowing any deduction for the tax paid at the
source on interest from tax-free covenant bonds, see section 1451(f).
[T.D. 6780, 29 FR 18145, Dec. 22, 1964, as amended by T.D. 7577, 43 FR
59357, Dec. 20, 1978]
Sec. 1.164-2 Deduction denied in case of certain taxes.
This section and Sec. 1.275 describe certain taxes for which no
deduction is allowed. In the case of taxable years beginning before
January 1, 1964, the denial is provided for by section 164(b) (prior to
being amended by section 207 of the Revenue Act of 1964 (78 Stat. 40)).
In the case of taxable years beginning after December 31, 1963, the
denial is governed by sections 164 and 275. No deduction is allowed for
the following taxes:
(a) Federal income taxes. Federal income taxes, including the taxes
imposed by section 3101, relating to the tax on employees under the
Federal Insurance Contributions Act (chapter 21 of the Code); sections
3201 and 3211, relating to the taxes on railroad employees and railroad
employee representatives; section 3402, relating to the tax withheld at
source on wages; and by corresponding provisions of prior internal
revenue laws.
(b) Federal war profits and excess profits taxes. Federal war
profits and excess profits taxes including those imposed by title II of
the Revenue Act of 1917 (39 Stat. 1000), title III of the Revenue Act of
1918 (40 Stat. 1088), title III of the Revenue Act of 1921 (42 Stat.
271), section 216 of the National Industrial Recovery Act (48 Stat.
208), section 702 of the Revenue Act of 1934 (48 Stat. 770), Subchapter
D, Chapter 1 of the Internal Revenue Code of 1939, and Subchapter E,
Chapter 2 of the Internal Revenue Code of 1939.
(c) Estate and gift taxes. Estate, inheritance, legacy, succession,
and gift taxes.
(d) Foreign income, war profits, and excess profits taxes. Income,
war profits, and excess profits taxes imposed by the authority of any
foreign country or possession of the United States, if the taxpayer
chooses to take to any extent the benefits of section 901, relating to
the credit for taxes of foreign countries and possessions of the United
States.
(e) Real property taxes. Taxes on real property, to the extent that
section 164(d) and Sec. 1.164-6 require such taxes to be treated as
imposed on another taxpayer.
(f) Federal duties and excise taxes. Federal import or tariff
duties, business, license, privilege, excise, and stamp taxes (not
described in paragraphs (a), (b), (c), or (h) of this section, or Sec.
1.164-4) paid or accrued within the taxable year. The fact that any such
tax is not deductible as a tax under section 164 does not prevent (1)
its deduction under section 162 or section 212, provided it represents
an ordinary and necessary expense paid or incurred during the taxable
year by a corporation or an individual in the conduct of any trade or
business or, in the case of an individual for the production or
collection of income, for the management, conservation, or maintenance
of property held for the production of income, or in connection with the
determination, collection, or refund of any tax, or (2) its being taken
into account during the taxable year by a corporation or an individual
as a part of the cost of acquiring or producing property in the trade
[[Page 332]]
or business or, in the case of an individual, as a part of the cost of
property held for the production of income with respect to which it
relates.
(g) Taxes for local benefits. Except as provided in Sec. 1.164-4,
taxes assessed against local benefits of a kind tending to increase the
value of the property assessed.
(h) Excise tax on real estate investment trusts. The excise tax
imposed on certain real estate investment trusts by section 4981.
[T.D. 6780, 29 FR 18145, Dec. 22, 1964, as amended by T.D. 7767, 46 FR
11263, Feb. 6, 1981]
Sec. 1.164-3 Definitions and special rules.
For purposes of section 164 and Sec. 1.164-1 to Sec. 1.164-8,
inclusive--
(a) State or local taxes. A State or local tax includes only a tax
imposed by a State, a possession of the United States, or a political
subdivision of any of the foregoing, or by the District of Columbia.
(b) Real property taxes. The term ``real property taxes'' means
taxes imposed on interests in real property and levied for the general
public welfare, but it does not include taxes assessed against local
benefits. See Sec. 1.164-4.
(c) Personal property taxes. The term ``personal property tax''
means an ad valorem tax which is imposed on an annual basis in respect
of personal property. To qualify as a personal property tax, a tax must
meet the following three tests:
(1) The tax must be ad valorem--that is, substantially in proportion
to the value of the personal property. A tax which is based on criteria
other than value does not qualify as ad valorem. For example, a motor
vehicle tax based on weight, model year, and horsepower, or any of these
characteristics is not an ad valorem tax. However, a tax which is partly
based on value and partly based on other criteria may qualify in part.
For example, in the case of a motor vehicle tax of 1 percent of value
plus 40 cents per hundredweight, the part of the tax equal to 1 percent
of value qualifies as an ad valorem tax and the balance does not
qualify.
(2) The tax must be imposed on an annual basis, even if collected
more frequently or less frequently.
(3) The tax must be imposed in respect of personal property. A tax
may be considered to be imposed in respect of personal property even if
in form it is imposed on the exercise of a privilege. Thus, for taxable
years beginning after December 31, 1963, State and local taxes on the
registration or licensing of highway motor vehicles are not deductible
as personal property taxes unless and to the extent that the tests
prescribed in this subparagraph are met. For example, an annual ad
valorem tax qualifies as a personal property tax although it is
denominated a registration fee imposed for the privilege of registering
motor vehicles or of using them on the highways.
(d) Foreign taxes. The term ``foreign tax'' includes only a tax
imposed by the authority of a foreign country. A tax-imposed by a
political subdivision of a foreign country is considered to be imposed
by the authority of that foreign country.
(e) Sales tax. (1) The term ``sales tax'' means a tax imposed upon
persons engaged in selling tangible personal property, or upon the
consumers of such property, including persons selling gasoline or other
motor vehicle fuels at wholesale or retail, which is a stated sum per
unit of property sold or which is measured by the gross sales price or
the gross receipts from the sale. The term also includes a tax imposed
upon persons engaged in furnishing services which is measured by the
gross receipts for furnishing such services.
(2) In general, the term ``consumer'' means the ultimate user or
purchaser; it does not include a purchaser such as a retailer, who
acquires the property for resale.
(f) General sales tax. A ``general sales tax'' is a sales tax which
is imposed at one rate in respect of the sale at retail of a broad range
of classes of items. No foreign sales tax is deductible under section
164(a) and paragraph (a)(4) of Sec. 1.164-1. To qualify as a general
sales tax, a tax must meet the following two tests:
(1) The tax must be a tax in respect of sales at retail. This may
include a
[[Page 333]]
tax imposed on persons engaged in selling property at retail or
furnishing services at retail, for example, if the tax is measured by
gross sales price or by gross receipts from sales or services. Rentals
qualify as sales at retail if so treated under applicable State sales
tax laws.
(2) The tax must be general--that is, it must be imposed at one rate
in respect of the retail sales of a broad range of classes of items. A
sales tax is considered to be general although imposed on sales of
various classes of items at more than one rate provided that one rate
applies to the retail sales of a broad range of classes of items. The
term ``items'' includes both commodities and services.
(g) Special rules relating to general sales taxes. (1) A sales tax
which is general is usually imposed at one rate in respect of the retail
sales of all tangible personal property (with exceptions and additions).
However, a sales tax which is selective--that is, a tax which applies at
one rate with respect to retail sales of specified classes of items also
qualifies as general if the specified classes represent a broad range of
classes of items. A selective sales tax which does not apply at one rate
to the retail sales of a broad range of classes of items is not general.
For example, a tax which applies only to sales of alcoholic beverages,
tobacco, admissions, luxury items, and a few other items is not general.
Similarly, a tax imposed solely on services is not general. However, a
selective sales tax may be deemed to be part of the general sales tax
and hence may be deductible, even if imposed by a separate title, etc.,
of the State or local law, if imposed at the same rate as the general
rate of tax (as defined in subparagraph (4) of this paragraph) which
qualifies a tax in the taxing jurisdiction as a general sales tax. For
example, if a State has a 5 percent general sales tax and a separate
selective sales tax of 5 percent on transient accommodations, the tax on
transient accommodations is deductible.
(2) A tax is imposed at one rate only if it is imposed at that rate
on generally the same base for all items subject to tax. For example, a
sales tax imposed at a 3 percent rate on 100 percent of the sales price
of some classes of items and at a 3 percent rate on 50 percent of the
sales price of other classes of items would not be imposed at one rate
with respect to all such classes. However, a tax is considered to be
imposed at one rate although it allows dollar exemptions, if the
exemptions are designed to exclude all sales under a certain dollar
amount. For example, a tax may be imposed at one rate although it
applies to all sales of tangible personal property but applies only to
sales amounting to more than 10 cents.
(3) The fact that a sales tax exempts food, clothing, medical
supplies, and motor vehicles, or any of them, shall not be taken into
account in determining whether the tax applies to a broad range of
classes of items. The fact that a sales tax applies to food, clothing,
medical supplies, and motor vehicles, or any of them, at a rate which is
lower than the general rate of tax (as defined in subparagraph (4) of
this paragraph) is not taken into account in determining whether the tax
is imposed at one rate on the retail sales of a broad range of classes
of items. For purposes of this section, the term ``food'' means food for
human consumption off the premises where sold, and the term ``medical
supplies'' includes drugs, medicines, and medical devices.
(4) Except in the case of a lower rate of tax applicable in respect
of food, clothing, medical supplies, and motor vehicles, or any of them,
no deduction is allowed for a general sales tax in respect of any item
if the tax is imposed on such item at a rate other than the general rate
of tax. The general rate of tax is the one rate which qualifies a tax in
a taxing jurisdiction as a general sales tax because the tax is imposed
at such one rate on a broad range of classes of items. There can be only
one general rate of tax in any one taxing jurisdiction. However, a
general sales tax imposed at a lower rate or rates on food, clothing,
motor vehicles, and medical supplies, or any of them, may nonetheless be
deductible with respect to such items. For example, a sales tax which is
imposed at 1 percent with respect to food, imposed at 3 percent with
respect to a broad range of classes
[[Page 334]]
of tangible personal property, and imposed at 4 percent with respect to
transient accommodations would qualify as a general sales tax. Taxes
paid at the 1 percent and the 3 percent rates are deductible, but tax
paid at the 4 percent rate is not deductible. The fact that a sales tax
provides for the adjustment of the general rate of tax to reflect the
sales tax rate in another taxing jurisdiction shall not be taken into
account in determining whether the tax is imposed at one rate on the
retail sales of a broad range of classes of items. Moreover, a general
sales tax imposed at a lower rate with respect to an item in order to
reflect the tax rate in another jurisdiction is also deductible at such
lower rate. For example, State E imposes a general sales tax whose
general rate is 3 percent. The State E sales tax law provides that in
areas bordering on States with general sales taxes, selective sales
taxes, or special excise taxes, the rate applied in the adjoining State
will be used if such rate is under 3 percent. State F imposes a 2
percent sales tax. The 2 percent sales tax paid by residents of State E
in areas bordering on State F is deductible.
(h) Compensating use taxes. A compensating use tax in respect of any
item is treated as a general sales tax. The term ``compensating use
tax'' means, in respect of any item, a tax which is imposed on the use,
storage, or consumption of such item and which is complementary to a
general sales tax which is deductible with respect to sales of similar
items.
(i) Special rules relating to compensating use taxes. (1) In
general, a use tax on an item is complementary to a general sales tax on
similar items if the use tax is imposed on an item which was not subject
to such general sales tax but which would have been subject to such
general sales tax if the sale of the item had taken place within the
jurisdiction imposing the use tax. For example, a tax imposed by State A
on the use of a motor vehicle purchased in State B is complementary to
the general sales tax of State A on similar items, if the latter tax
applies to motor vehicles sold in State A.
(2) Since a compensating use tax is treated as a general sales tax,
it is subject to the rule of subparagraph (C) of section 164(b)(2) and
paragraph (g)(4) of this section that no deduction is allowed for a
general sales tax imposed in respect of an item at a rate other than the
general rate of tax (except in the case of lower rates on the sale of
food, clothing, medical supplies, and motor vehicles). The fact that a
compensating use tax in respect of any item provides for an adjustment
in the rate of the compensating use tax or the amount of such tax to be
paid on account of a sales tax on such item imposed by another taxing
jurisdiction is not taken into account in determining whether the
compensating use tax is imposed in respect of the item at a rate other
than the general rate of tax. For example, a compensating use tax
imposed by State C on the use of an item purchased in State D is
considered to be imposed at the general rate of tax even though the tax
imposed by State C allows a credit for any sales tax paid on such item
in State D, or the rate of such compensating use tax is adjusted to
reflect the rate of sales tax imposed by State D.
[T.D. 6780, 29 FR 18146, Dec. 22, 1964]
Sec. 1.164-4 Taxes for local benefits.
(a) So-called taxes for local benefits referred to in paragraph (g)
of Sec. 1.164-2, more properly assessments, paid for local benefits
such as street, sidewalk, and other like improvements, imposed because
of and measured by some benefit inuring directly to the property against
which the assessment is levied are not deductible as taxes. A tax is
considered assessed against local benefits when the property subject to
the tax is limited to property benefited. Special assessments are not
deductible, even though an incidental benefit may inure to the public
welfare. The real property taxes deductible are those levied for the
general public welfare by the proper taxing authorities at a like rate
against all property in the territory over which such authorities have
jurisdiction. Assessments under the statutes of California relating to
irrigation, and of Iowa relating to drainage, and under certain statutes
of Tennessee relating to levees, are limited to property benefited, and
if the assessments are so limited, the amounts paid thereunder are not
deductible as taxes.
[[Page 335]]
For treatment of assessments for local benefits as adjustments to the
basis of property, see section 1016(a)(1) and the regulations
thereunder.
(b)(1) Insofar as assessments against local benefits are made for
the purpose of maintenance or repair or for the purpose of meeting
interest charges with respect to such benefits, they are deductible. In
such cases, the burden is on the taxpayer to show the allocation of the
amounts assessed to the different purposes. If the allocation cannot be
made, none of the amount so paid is deductible.
(2) Taxes levied by a special taxing district which was in existence
on December 31, 1963, for the purpose of retiring indebtedness existing
on such date, are deductible, to the extent levied for such purpose, if
(i) the district covers the whole of at least one county, (ii) if at
least 1,000 persons are subject to the taxes levied by the district, and
(iii) if the district levies its assessments annually at a uniform rate
on the same assessed value of real property, including improvements, as
is used for purposes of the real property tax generally.
[T.D. 6780, 29 FR 18147, Dec. 22, 1964]
Sec. 1.164-5 Certain retail sales taxes and gasoline taxes.
For taxable years beginning before January 1, 1964, any amount
representing a State or local sales tax paid by a consumer of services
or tangible personal property is deductible by such consumer as a tax,
provided it is separately stated and not paid in connection with his
trade or business. For taxable years beginning after December 31, 1963,
only the amount of any separately stated State and local general sales
tax (as defined in paragraph (g) of Sec. 1.164-3) and tax on the sale
of gasoline, diesel fuel or other motor fuel paid by the consumer (other
than in connection with his trade or business) is deductible by the
consumer as tax. The fact that, under the law imposing it, the incidence
of such State or local tax does not fall on the consumer is immaterial.
The requirement that the amount of tax must be separately stated will be
deemed complied with where it clearly appears that at the time of sale
to the consumer, the tax was added to the sales price and collected or
charged as a separate item. It is not necessary, for the purpose of this
section, that the consumer be furnished with a sales slip, bill,
invoice, or other statement on which the tax is separately stated. For
example, where the law imposing the State or local tax for which the
taxpayer seeks a deduction contains a prohibition against the seller
absorbing the tax, or a provision requiring a posted notice stating that
the tax will be added to the quoted price, or a requirement that the tax
be separately shown in advertisements or separately stated on all bills
and invoices, it is presumed that the amount of the State or local tax
was separately stated at the time paid by the consumer; except that such
presumption shall have no application to a tax on the sale of gasoline,
diesel fuel or other motor fuel imposed upon a wholesaler unless such
provisions of law apply with respect to both the sale at wholesale and
the sale at retail.
[T.D. 6780, 29 FR 18147, Dec. 22, 1964]
Sec. 1.164-6 Apportionment of taxes on real property between seller
and purchaser.
(a) Scope. Except as provided otherwise in section 164(f) and Sec.
1.164-8, when real property is sold, section 164(d)(1) governs the
deduction by the seller and the purchaser of current real property
taxes. Section 164(d)(1) performs two functions: (1) It provides a
method by which a portion of the taxes for the real property tax year in
which the property is sold may be deducted by the seller and a portion
by the purchaser; and (2) it limits the deduction of the seller and the
purchaser to the portion of the taxes corresponding to the part of the
real property tax year during which each was the owner of the property.
These functions are accomplished by treating a portion of the taxes for
the real property tax year in which the property is sold as imposed on
the seller and a portion as imposed on the purchaser. To the extent that
the taxes are treated as imposed on the seller and the purchaser, each
shall be allowed a deduction, under section 164(a), in the taxable year
such tax is paid or accrued, or treated as paid or accrued under section
164(d)(2) (A) or
[[Page 336]]
(D) and this section. No deduction is allowed for taxes on real property
to the extent that they are imposed on another taxpayer, or are treated
as imposed on another taxpayer under section 164(d). For the election to
accrue real property taxes ratably see section 461(c) and the
regulations thereunder.
(b) Application of rule of apportionment. (1)(i) For purposes of the
deduction provided by section 164(a), if real property is sold during
any real property tax year, the portion of the real property tax
properly allocable to that part of the real property tax year which ends
on the day before the date of the sale shall be treated as a tax imposed
on the seller, and the portion of such tax properly allocable to that
part of such real property tax year which begins on the date of the sale
shall be treated as a tax imposed on the purchased. For definition of
``real property tax year'' see paragraph (c) of this section. This rule
shall apply whether or not the seller and the purchaser apportion such
tax. The rule of apportionment contained in section 164(d)(1) applies
even though the same real property is sold more than once during the
real property tax year. (See paragraph (d)(5) of this section for rule
requiring inclusion in gross income of excess deductions.)
(ii) Where the real property tax becomes a personal liability or a
lien before the beginning of the real property tax year to which it
relates and the real property is sold subsequent to the time the tax
becomes a personal liability or a lien but prior to the beginning of the
related real property tax year--
(a) The seller may not deduct any amount for real property taxes for
the related real property tax year, and
(b) To the extent that he holds the property for such real property
tax year, the purchaser may deduct the amount of such taxes for the
taxable year they are paid (or amounts representing such taxes are paid
to the seller, mortgagee, trustee or other person having an interest in
the property as security) or accrued by him according to his method of
accounting.
(iii) Similarly, where the real property tax becomes a personal
liability or a lien after the end of the real property tax year to which
it relates and the real property is sold prior to the time the tax
becomes a personal liability or a lien but after the end of the related
real property tax year--
(a) The purchaser may not deduct any amount for real property taxes
for the related real property tax year, and
(b) To the extent that he holds the property for such real property
tax year, the seller may deduct the amount of such taxes for the taxable
year they are paid (or amounts representing such taxes are paid to the
purchaser, mortgagee, trustee, or other person having an interest in the
property as security) or accrued by him according to his method of
accounting.
(iv) Where the real property is sold (or purchased) during the
related real property tax year the real property taxes for such year are
apportioned between the parties to such sale and may be deducted by such
parties in accordance with the provisions of paragraph (d) of this
section.
(2) Section 164(d) does not apply to delinquent real property taxes
for any real property tax year prior to the real property tax year in
which the property is sold.
(3) The provisions of this paragraph may be illustrated by the
following examples:
Example 1. The real property tax year in County R is April 1 to
March 31. A, the owner on April 1, 1954, of real property located in
County R sells the real property to B on June 30, 1954. B owns the real
property from June 30, 1954, through March 31, 1955. The real property
tax for the real property tax year April 1, 1954-March 31, 1955 is $365.
For purposes of section 164(a), $90 (90/365x$365, April 1, 1954-June 29,
1954) of the real property tax is treated as imposed on A, the seller,
and $275 (275/365x $365, June 30, 1954-March 31, 1955) of such real
property tax is treated as imposed on B, the purchaser.
Example 2. In County S the real property tax year is the calendar
year. The real property tax becomes a lien on June 1 and is payable on
July 1 of the current real property tax year, but there is no personal
liability for such tax. On April 30, 1955, C, the owner of real property
in County S on January 1, 1955, sells the real property to D. On July 1,
1955, D pays the 1955 real property tax. On August 31, 1955, D sells the
same real property to E. C, D, and E use the cash receipts and
disbursements method of accounting. Under the provisions of section
164(d)(1), 119/365 (January 1-April 29, 1955) of the real property tax
payable on July 1, 1955, for the 1955
[[Page 337]]
real property tax year is treated as imposed on C, and, under the
provisions of section 164(d)(2)(A), such portion is treated as having
been paid by him on the date of sale. Under the provisions of section
164(d)(1), 123/365 (April 30-August 30, 1955) of the real property tax
paid July 1, 1955, for the 1955 real property tax year is treated as
imposed on D and may be deducted by him. Under the provisions of section
164(d)(1), 123/365 (August 31-December 31, 1955) of the real property
tax due and paid on July 1, 1955, for the 1955 real property tax year is
treated as imposed on E and, under the provisions of section
164(d)(2)(A) such portion is treated as having been paid by him on the
date of sale.
Example 3. In State X the real property tax year is the calendar
year. The real property tax becomes a lien on November 1 of the
preceding calendar year. On November 15, 1955, F sells real property in
State X to G. G owns the real property through December 31, 1956. Under
section 164(d)(1), the real property tax (which became a lien on
November 1, 1954) for the 1955 real property tax year is apportioned
between F and G. No part of the real property tax for the 1956 real
property tax year may be deducted by F. The entire real property tax for
the 1956 real property tax year may be deducted by G when paid or
accrued, depending upon the method of accounting used by him. See
subparagraph (6) of paragraph (d) and section 461(c) and the regulations
thereunder.
(c) Real property tax year. As used in section 164(d), the term
``real property tax year'' refers to the period which, under the law
imposing the tax, is regarded as the period to which the tax imposed
relates. Where the State and one or more local governmental units each
imposes a tax on real property, the real property tax year for each tax
must be determined for purposes of applying the rule of apportionment of
section 164(d)(1) to each tax. The time when the tax rate is determined,
the time when the assessment is made, the time when the tax becomes a
lien, or the time when the tax becomes due or delinquent does not
necessarily determine the real property tax year. The real property tax
year may or may not correspond to the fiscal year of the governmental
unit imposing the tax. In each case the State or local law determines
what constitutes the real property tax year. Although the seller and the
purchaser may or may not make an allocation of real property taxes, the
meaning of ``real property tax year'' in section 164(d) and the
application of section 164(d) do not depend upon what real property
taxes were allocated nor the method of allocation used by the parties.
(d) Special rules--(1) Seller using cash receipts and disbursements
method of accounting. Under the provisions of section 164(d), if the
seller by reason of his method of accounting may not deduct any amount
for taxes unless paid, and--
(i) The purchaser (under the law imposing the real property tax) is
liable for the real property tax for the real property tax year, or
(ii) The seller (under the law imposing the real property tax) is
liable for the real property tax for the real property tax year and the
tax is not payable until after the date of sale, then the portion of the
tax treated under section 164(d)(1) as imposed upon the seller (whether
or not actually paid by him in the taxable year in which the sale
occurs) shall be considered as having been paid by him in such taxable
year. Such portion may be deducted by him for the taxable year in which
the sale occurs, or, if at a later time, for the taxable year (which
would be proper under the taxpayer's method of accounting) in which the
tax is actually paid, or an amount representing such tax is paid to the
purchaser, mortgagee, trustee, or other person having an interest in the
property as security.
(2) Purchasers using the cash receipts and disbursements method of
accounting. Under the provisions of section 164(d), if the purchaser by
reason of his method of accounting may not deduct any amount for taxes
unless paid and the seller (under the law imposing the real property
tax) is liable for the real property tax for the real property tax year,
the portion of the tax treated under section 164(d)(1) as imposed upon
the purchaser (whether or not actually paid by him in the taxable year
in which the sale occurs) shall be considered as having been paid by him
in such taxable year. Such portion may be deducted by him for the
taxable year in which the sale occurs, or, if at a later time, for the
taxable year (which would be proper under the taxpayer's method of
accounting) in which the tax is actually paid, or an amount representing
[[Page 338]]
such tax is paid to the seller, mortgagee, trustee, or other person
having an interest in the property as security.
(3) Persons considered liable for tax. Where the tax is not a
liability of any person, the person who holds the property at the time
the tax becomes a lien on the property shall be considered liable for
the tax. As to a particular sale, in determining:
(i) Whether the other party to the sale is liable for the tax or,
(ii) The person who holds the property at the time the tax becomes a
lien on the property (where the tax is not a liability of any person),
prior or subsequent sales of the property during the real property tax
year shall be disregarded.
(4) Examples. The provisions of subparagraphs (1), (2), and (3) of
this paragraph may be illustrated as follows:
Example 1. In County X the real property tax year is the calendar
year. The real property tax is a personal liability of the owner of the
real property on June 30 of the current real property tax year, but is
not payable until February 28 of the following real property tax year.
A, the owner of real property in County X on January 1, 1955, uses the
cash receipts and disbursements method of accounting. On May 30, 1955, A
sells the real property to B, who also uses the cash receipts and
disbursements method of accounting. B retains ownership of the real
property for the balance of the 1955 calendar year. Under the provisions
of section 164(d)(1), 149/365 (January 1-May 29, 1955) of the real
property tax payable on February 28, 1956, for the 1955 real property
tax year is treated as imposed on A, the seller, and under the
provisions of section 164(d)(2)(A) such portion is treated as having
been paid by him on the date of sale and may be deducted by him for his
taxable year in which the sale occurs (whether or not such portion is
actually paid by him in that year) or for his taxable year in which the
tax is actually paid or an amount representing such tax is paid. Under
the provisions of section 164(d)(1), 216/365 (May 30-December 31, 1955)
of the real property tax payable on February 28, 1956, for the 1955 real
property tax year is treated as imposed on B, the purchaser, and may be
deducted by him for his taxable year in which the tax is actually paid,
or an amount representing such tax is paid.
Example 2. In County Y, the real property tax year is the calendar
year. The real property tax becomes a lien on January 1, 1955, and is
payable on April 30, 1955. There is no personal liability for the real
property tax imposed by County Y. On April 30, 1955, C, the owner of
real property in County Y on January 1, 1955, pays the real property tax
for the 1955 real property tax year. On May 1, 1955, C sells the real
property to D. On September 1, 1955, D sells the real property to E. C,
D, and E use the cash receipts and disbursements method of accounting.
Under the provisions of section 164(d)(1), 120/365 (January 1-April 30,
1955) of the real property tax is treated as imposed upon C and may be
deducted by him for his taxable year in which the tax is actually paid.
Under section 164(d)(1), 123/365 (May 1-August 31, 1955) of the real
property tax is treated as imposed upon D and, under the provisions of
section 164(d)(2)(A), is treated as having been paid by him on May 1,
1955, and may be deducted by D for his taxable year in which the sale
from C to him occurs (whether or not such portion is actually paid by
him in that year), or for his taxable year in which an amount
representing such tax is paid. Since, according to paragraph (d)(3) of
this section, the prior sale by C to D is disregarded, under the
provisions of section 164(d)(1), 122/365 (September 1-December 31, 1955)
of the real property tax is treated as imposed on E and, under the
provisions of section 164(d)(2)(A), is treated as having been paid by
him on September 1, 1955, and may be deducted by E for his taxable year
in which the sale from D to him occurs (whether or not such portion is
actually paid by him in that year), or for his taxable year in which an
amount representing such tax is paid.
Example 3. In County X the real property tax year is the calendar
year and the real property taxes are assessed and become a lien on June
30 of the current real property tax year, but are not payable until
September 1 of that year. There is no personal liability for the real
property tax imposed by County X. A, the owner on January 1, 1955, of
real property in County X, uses the cash receipts and disbursements
method of accounting. On July 15, 1955, A sells the real property to B.
Under the provisions of section 164(d)(1), 195/365 (January 1-July 14,
1955) of the real property tax payable on September 1, 1955, for the
1955 real property tax year is treated as imposed on A, and may be
deducted by him for his taxable year in which the sale occurs (whether
or not such portion is actually paid by him in that year) or for his
taxable year in which the tax is actually paid or an amount representing
such tax is paid. Under the provisions of section 164(d)(1), 170/365
(July 15-December 31, 1955) of the real property tax is treated as
imposed on B and may be deducted by him for his taxable year in which
the sale occurs (whether or not such portion is actually paid by him in
that year), or for his taxable year in which the tax is actually paid or
an amount representing such tax is paid.
[[Page 339]]
(5) Treatment of excess deduction. If, for a taxable year prior to
the taxable year of sale of real property, a taxpayer has deducted an
amount for real property tax in excess of the portion of such real
property tax treated as imposed on him under the provisions of section
164(d), the excess of the amount deducted over the portion treated as
imposed on him shall be included in his gross income for the taxable
year of the sale, subject to the provisions of section 111, relating to
the recovery of bad debts, prior taxes, and delinquency amounts. The
provisions of this subparagraph may be illustrated as follows:
Example 1. In Borough Y the real property tax is due and payable on
November 30 for the succeeding calendar year, which is also the real
property tax year. On November 30, 1954, taxpayer A, who reports his
income on a calendar year under the cash receipts and disbursements
method of accounting, pays the real property tax on real property owned
by him in Borough Y for the 1955 real property tax year. On June 30,
1955, A sells the real property. Under the provisions of section 164(d),
only 180/365 (January 1-June 29, 1955) of the real property tax for the
1955 real property tax year is treated as imposed on A, and the excess
of the amount of real property tax for 1955 deducted by A, on his 1954
income tax return, over the 180/365 portion of such tax treated as
imposed on him under section 164(d), must be included in gross income in
A's 1955 income tax return, subject to the provisions of section 111.
Example 2. In County Z the real property tax year is the calendar
year. The real property tax becomes a personal liability of the owner of
real property on January 1 of the current real property tax year, and is
payable on July 1 of the current real property tax year. On May 1, 1955,
A, the owner of real property in County Z on January 1, 1955, sells the
real property to B. On November 1, 1955, B sells the same real property
to C. B uses the cash receipts and disbursements method of accounting
and reports his income on the basis of a fiscal year ending July 31. B,
on July 1, 1955, pays the entire real property tax for the real property
tax year ending December 31, 1955. Under the provisions of section
164(d), only 184/365 (May 1-October 31, 1955) of the real property tax
for the 1955 real property tax year is treated as imposed on B, and the
excess of the amount of real property tax for 1955 deducted by B on his
income tax return for the fiscal year ending July 31, 1955, over the
184/365 portion of such tax treated as imposed on him under section
164(d), must be included in gross income in B's income tax return for
his fiscal year ending July 31, 1956, subject to the provisions of
section 111.
(6) Persons using an accrual method of accounting. Where real
property is sold and the seller or the purchaser computes his taxable
income (for the taxable year during which the sale occurs) on an accrual
method of accounting then, if the seller or the purchaser has not made
the election provided in section 461(c) (relating to the accrual of real
property taxes), the portion of any real property tax which is treated
as imposed on him and which may not be deducted by him for any taxable
year by reason of his method of accounting shall be treated as having
accrued on the date of sale. The provisions of this subparagraph may be
illustrated as follows:
Example. In County X the real property tax becomes a lien on
property and is assessed on November 30 for the current calendar year,
which is also the real property tax year. There is no personal liability
for the real property tax imposed by County X. A owns, on January 1,
1955, real property in County X. A uses an accrual method of accounting
and has not made any election under section 461(c) to accrue ratably
real property taxes. A sells real property on June 30, 1955. By reason
of A's method of accounting, he could not deduct any part of the real
property tax for 1955 on the real property since he sold the real
property prior to November 30, 1955, the accrual date. Under section
164(d)(1), 180/365 (January 1-June 29, 1955) of the real property tax
for the 1955 real property tax year is treated as imposed on A, and
under section 164(d)(2)(D) that portion is treated as having accrued on
June 30, 1955, and may be deducted by A for his taxable year in which
such date falls. B, the purchaser from A, who uses an accrual method of
accounting, has likewise not made an election under section 461(c) to
accrue real property taxes ratably. Under section 164(d)(1), 185/365 of
the real property taxes may be accrued by B on November 30, 1955, and
deducted for his taxable year in which such date falls.
(7) Cross references. For determination of amount realized on a sale
of real property, see section 1001(b) and the regulations thereunder.
For determination of basis of real property acquired by purchase, see
section 1012 and the regulations thereunder.
(8) Effective dates. Section 164(d) applies to taxable years ending
after December 31, 1953, but only in the case of sales made after
December 31, 1953.
[[Page 340]]
However, section 164(d) does not apply to any real property tax to the
extent that such tax was allowable as a deduction under the Internal
Revenue Code of 1939 to the seller for any taxable year which ended
before January 1, 1954.
Sec. 1.164-7 Taxes of shareholder paid by corporation.
Banks and other corporations paying taxes assessed against their
shareholders on account of their ownership of the shares of stock issued
by such corporations without reimbursement from such shareholders may
deduct the amount of taxes so paid. In such cases no deduction shall be
allowed to the shareholders for such taxes. The amount so paid should
not be included in the gross income of the shareholder.
Sec. 1.164-8 Payments for municipal services in atomic energy
communities.
(a) General. For taxable years beginning after December 31, 1957,
amounts paid or accrued by any owner of real property within any
community (as defined in section 21b of the Atomic Energy Community Act
of 1955 (42 U.S.C. 2304)) to compensate the Atomic Energy Commission for
municipal-type services (or any agent or contractor authorized by the
Atomic Energy Commission to charge for such services) shall be treated
as State real property taxes paid or accrued for purposes of section
164. Such amounts shall be deductible as taxes to the extent provided in
section 164, Sec. Sec. 1.164-1 through 1.164-7, and this section. See
paragraph (b) of this section for definition of the term ``Atomic Energy
Commission''; paragraph (c) of this section for the definition of the
term ``municipal-type services''; and paragraph (d) of this section for
the definition of the term ``owner''.
(b) Atomic Energy Commission. For purposes of paragraph (a) of this
section, the term ``Atomic Energy Commission'' shall mean--
(1) The Atomic Energy Commission, and
(2) Any other agency of the United States Government to which the
duties and responsibilities of providing municipal-type services are
delegated under the authority of section 101 of the Atomic Energy
Community Act of 1955 (42 U.S.C. 2313).
(c) Municipal-type services. For purposes of paragraph (a) of this
section, the term ``municipal-type services'' includes services usually
rendered by a municipality and usually paid for by taxes. Examples of
municipal-type services are police protection, fire protection, public
recreational facilities, public libraries, public schools, public
health, public welfare, and the maintenance of roads and streets. The
term shall include sewage and refuse disposal which are maintained out
of revenues derived from a general charge for municipal-type services;
however, the term shall not include sewage and refuse disposal if a
separate charge for such services is made. Charges assessed against
local benefits of a kind tending to increase the value of the property
assessed are not charges for municipal-type services. See section
164(c)(1) and Sec. 1.164-4.
(d) Owner. For purposes of paragraph (a) of this section, the term
``owner'' includes a person who holds the real property under a
leasehold of 40 or more years from the Atomic Energy Commission (or any
agency of the United States Government to which the duties and
responsibilities of leasing real property are delegated under section
101 of the Atomic Energy Community Act of 1955), and a person who has
entered into a contract to purchase under section 61 of the Atomic
Energy Community Act of 1955 (42 U.S.C. 2361). An assignee (either
immediate or more remote) of a lessee referred to in the preceding
sentence will also qualify as an owner for purposes of paragraph (a) of
this section.
(e) Nonapplication of section 164(d). Section 164(d) and Sec.
1.164-6, relating to apportionment of taxes on real property between
seller and purchaser, do not apply to a sale by the United States or any
of its agencies of real property to which section 164(f) and this
section apply. Thus, amounts paid or accrued which qualify under
paragraph (a) of this section will continue to be deductible as taxes to
the extent provided in this section, even in the taxable year in which
the owner actually purchases the real property from
[[Page 341]]
the United States or any of its agencies. However, the provisions of
section 164(d) and Sec. 1.164-6 shall apply to a sale of real property
to which section 164(f) and this section apply, if the seller is other
than the United States or any of its agencies.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6789, 29 FR
18147, Dec. 22, 1964]
Sec. 1.165-1 Losses.
(a) Allowance of deduction. Section 165(a) provides that, in
computing taxable income under section 63, any loss actually sustained
during the taxable year and not made good by insurance or some other
form of compensation shall be allowed as a deduction subject to any
provision of the internal revenue laws which prohibits or limits the
amount of the deduction. This deduction for losses sustained shall be
taken in accordance with section 165 and the regulations thereunder. For
the disallowance of deductions for worthless securities issued by a
political party, see Sec. 1.271-1.
(b) Nature of loss allowable. To be allowable as a deduction under
section 165(a), a loss must be evidenced by closed and completed
transactions, fixed by identifiable events, and, except as otherwise
provided in section 165(h) and Sec. 1.165-11, relating to disaster
losses, actually sustained during the taxable year. Only a bona fide
loss is allowable. Substance and not mere form shall govern in
determining a deductible loss.
(c) Amount deductible. (1) The amount of loss allowable as a
deduction under section 165(a) shall not exceed the amount prescribed by
Sec. 1.1011-1 as the adjusted basis for determining the loss from the
sale or other disposition of the property involved. In the case of each
such deduction claimed, therefore, the basis of the property must be
properly adjusted as prescribed by Sec. 1.1011-1 for such items as
expenditures, receipts, or losses, properly chargeable to capital
account, and for such items as depreciation, obsolescence, amortization,
and depletion, in order to determine the amount of loss allowable as a
deduction. To determine the allowable loss in the case of property
acquired before March 1, 1913, see also paragraph (b) of Sec. 1.1053-1.
(2) The amount of loss recognized upon the sale or exchange of
property shall be determined for purposes of section 165(a) in
accordance with Sec. 1.1002-1.
(3) A loss from the sale or exchange of a capital asset shall be
allowed as a deduction under section 165(a) but only to the extent
allowed in section 1211 (relating to limitation on capital losses) and
section 1212 (relating to capital loss carrybacks and carryovers), and
in the regulations under those sections.
(4) In determining the amount of loss actually sustained for
purposes of section 165(a), proper adjustment shall be made for any
salvage value and for any insurance or other compensation received.
(d) Year of deduction. (1) A loss shall be allowed as a deduction
under section 165(a) only for the taxable year in which the loss is
sustained. For this purpose, a loss shall be treated as sustained during
the taxable year in which the loss occurs as evidenced by closed and
completed transactions and as fixed by identifiable events occurring in
such taxable year. For provisions relating to situations where a loss
attributable to a disaster will be treated as sustained in the taxable
year immediately preceding the taxable year in which the disaster
actually occurred, see section 165(h) and Sec. 1.165-11.
(2)(i) If a casualty or other event occurs which may result in a
loss and, in the year of such casualty or event, there exists a claim
for reimbursement with respect to which there is a reasonable prospect
of recovery, no portion of the loss with respect to which reimbursement
may be received is sustained, for purposes of section 165, until it can
be ascertained with reasonable certainty whether or not such
reimbursement will be received. Whether a reasonable prospect of
recovery exists with respect to a claim for reimbursement of a loss is a
question of fact to be determined upon an examination of all facts and
circumstances. Whether or not such reimbursement will be received may be
ascertained with reasonable certainty, for example, by a settlement of
the claim, by an adjudication of the claim, or by an abandonment of
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the claim. When a taxpayer claims that the taxable year in which a loss
is sustained is fixed by his abandonment of the claim for reimbursement,
he must be able to produce objective evidence of his having abandoned
the claim, such as the execution of a release.
(ii) If in the year of the casualty or other event a portion of the
loss is not covered by a claim for reimbursement with respect to which
there is a reasonable prospect of recovery, then such portion of the
loss is sustained during the taxable year in which the casualty or other
event occurs. For example, if property having an adjusted basis of
$10,000 is completely destroyed by fire in 1961, and if the taxpayer's
only claim for reimbursement consists of an insurance claim for $8,000
which is settled in 1962, the taxpayer sustains a loss of $2,000 in
1961. However, if the taxpayer's automobile is completely destroyed in
1961 as a result of the negligence of another person and there exists a
reasonable prospect of recovery on a claim for the full value of the
automobile against such person, the taxpayer does not sustain any loss
until the taxable year in which the claim is adjudicated or otherwise
settled. If the automobile had an adjusted basis of $5,000 and the
taxpayer secures a judgment of $4,000 in 1962, $1,000 is deductible for
the taxable year 1962. If in 1963 it becomes reasonably certain that
only $3,500 can ever be collected on such judgment, $500 is deductible
for the taxable year 1963.
(iii) If the taxpayer deducted a loss in accordance with the
provisions of this paragraph and in a subsequent taxable year receives
reimbursement for such loss, he does not recompute the tax for the
taxable year in which the deduction was taken but includes the amount of
such reimbursement in his gross income for the taxable year in which
received, subject to the provisions of section 111, relating to recovery
of amounts previously deducted.
(3) Any loss arising from theft shall be treated as sustained during
the taxable year in which the taxpayer discovers the loss (see Sec.
1.165-8, relating to theft losses). However, if in the year of discovery
there exists a claim for reimbursement with respect to which there is a
reasonable prospect of recovery, no portion of the loss with respect to
which reimbursement may be received is sustained, for purposes of
section 165, until the taxable year in which it can be ascertained with
reasonable certainty whether or not such reimbursement will be received.
(4) The rules of this paragraph are applicable with respect to a
casualty or other event which may result in a loss and which occurs
after January 16, 1960. If the casualty or other event occurs on or
before such date, a taxpayer may treat any loss resulting therefrom in
accordance with the rules then applicable, or, if he so desires, in
accordance with the provisions of this paragraph; but no provision of
this paragraph shall be construed to permit a deduction of the same loss
or any part thereof in more than one taxable year or to extend the
period of limitations within which a claim for credit or refund may be
filed under section 6511.
(e) Limitation on losses of individuals. In the case of an
individual, the deduction for losses granted by section 165(a) shall,
subject to the provisions of section 165(c) and paragraph (a) of this
section, be limited to:
(1) Losses incurred in a trade or business;
(2) Losses incurred in any transaction entered into for profit,
though not connected with a trade or business; and
(3) Losses of property not connected with a trade or business and
not incurred in any transaction entered into for profit, if such losses
arise from fire, storm, shipwreck, or other causalty, or from theft, and
if the loss involved has not been allowed for estate tax purposes in the
estate tax return. For additional provisions pertaining to the allowance
of casualty and theft losses, see Sec. Sec. 1.165-7 and 1.165-8,
respectively.
For special rules relating to an election by a taxpayer to deduct
disaster losses in the taxable year immediately preceding the taxable
year in which the disaster occurred, see section 165(h) and Sec. 1.165-
11.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6735, 29 FR
6493, May 19, 1964; T.D. 6996, 34 FR 835, Jan. 18, 1969; T.D. 7301, 39
FR 963, Jan. 4, 1974; T.D. 7522, 42 FR 63411, Dec. 16, 1977]
[[Page 343]]
Sec. 1.165-2 Obsolescence of nondepreciable property.
(a) Allowance of deduction. A loss incurred in a business or in a
transaction entered into for profit and arising from the sudden
termination of the usefulness in such business or transaction of any
nondepreciable property, in a case where such business or transaction is
discontinued or where such property is permanently discarded from use
therein, shall be allowed as a deduction under section 165(a) for the
taxable year in which the loss is actually sustained. For this purpose,
the taxable year in which the loss is sustained is not necessarily the
taxable year in which the overt act of abandonment, or the loss of title
to the property, occurs.
(b) Exceptions. This section does not apply to losses sustained upon
the sale or exchange of property, losses sustained upon the obsolescence
or worthlessness of depreciable property, casualty losses, or losses
reflected in inventories required to be taken under section 471. The
limitations contained in sections 1211 and 1212 upon losses from the
sale or exchange of capital assets do not apply to losses allowable
under this section.
(c) Cross references. For the allowance under section 165(a) of
losses arising from the permanent withdrawal of depreciable property
from use in the trade or business or in the production of income, see
Sec. 1.167(a)-8, Sec. 1.168(i)-1, or Sec. 1.168(i)-8, as applicable.
For provisions respecting the obsolescence of depreciable property for
which depreciation is determined under section 167 (but not under
section 168, section 1400I, section 1400L(c), section 168 prior to its
amendment by the Tax Reform Act of 1986, Public Law 99-514 (100 Stat.
2121 (1986)), or under an additional first year depreciation deduction
provision of the Internal Revenue Code (for example, section 168(k)
through (n), 1400L(b), or 1400N(d))), see Sec. 1.167(a)-9. For the
allowance of casualty losses, see Sec. 1.165-7.
(d) Effective/applicability date--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (d)(2) and (d)(3) of this section, Sec.
1.165-2 as contained in 26 CFR part 1 edition revised as of April 1,
2011, applies to taxable years beginning before January 1, 2014.
(2) Early application of Sec. 1.165-2(c). A taxpayer may choose to
apply paragraph (c) of this section to taxable years beginning on or
after January 1, 2012.
(3) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.165-2T as contained in TD 9564 (76 FR 81060) December 27, 2011,
to taxable years beginning on or after January 1, 2012, and before
January 1, 2014.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 9564, 76 FR 81084, Dec. 27, 2011; T.D. 9636, 78 FR
57706, Sept. 19, 2013; T.D. 9689, 79 FR 48667, Aug. 18, 2014]
Sec. 1.165-3 Demolition of buildings.
(a) Intent to demolish formed at time of purchase. (1) Except as
provided in subparagraph (2) of this paragraph, the following rule shall
apply when, in the course of a trade or business or in a transaction
entered into for profit, real property is purchased with the intention
of demolishing either immediately or subsequently the buildings situated
thereon: No deduction shall be allowed under section 165(a) on account
of the demolition of the old buildings even though any demolition
originally planned is subsequently deferred or abandoned. The entire
basis of the property so purchased shall, notwithstanding the provisions
of Sec. 1.167(a)-5, be allocated to the land only. Such basis shall be
increased by the net cost of demolition or decreased by the net proceeds
from demolition.
(2)(i) If the property is purchased with the intention of
demolishing the buildings and the buildings are used in a trade or
business or held for the production of income before their demolition, a
portion of the basis of the property may be allocated to such buildings
and depreciated over the period during which they are so used or held.
The fact that the taxpayer intends to demolish the buildings shall be
taken into account in making the apportionment of basis between the land
and buildings under Sec. 1.167(a)-5. In any event, the portion of the
purchase price which may be allocated to the buildings shall not exceed
the present value of the right to receive rentals from the
[[Page 344]]
buildings over the period of their intended use. The present value of
such right shall be determined at the time that the buildings are first
used in the trade or business or first held for the production of
income. If the taxpayer does not rent the buildings, but uses them in
his own trade or business or in the production of his income, the
present value of such right shall be determined by reference to the
rentals which could be realized during such period of intended use. The
fact that the taxpayer intends to rent or use the buildings for a
limited period before their demolition shall also be taken into account
in computing the useful life in accordance with paragraph (b) of Sec.
1.167(a)-1.
(ii) Any portion of the purchase price which is allocated to the
buildings in accordance with this subparagraph shall not be included in
the basis of the land computed under subparagraph (1) of this paragraph,
and any portion of the basis of the buildings which has not been
recovered through depreciation or otherwise at the time of the
demolition of the buildings is allowable as a deduction under section
165.
(iii) The application of this subparagraph may be illustrated by the
following example:
Example. In January 1958, A purchased land and a building for
$60,000 with the intention of demolishing the building. In the following
April, A concludes that he will be unable to commence the construction
of a proposed new building for a period of more than 3 years.
Accordingly, on June 1, 1958, he leased the building for a period of 3
years at an annual rental of $1,200. A intends to demolish the building
upon expiration of the lease. A may allocate a portion of the $60,000
basis of the property to the building to be depreciated over the 3-year
period. That portion is equal to the present value of the right to
receive $3,600 (3 times $1,200). Assuming that the present value of that
right determined as of June 1, 1958, is $2,850, A may allocate that
amount to the building and, if A files his return on the basis of a
taxable year ending May 31, 1959, A may take a depreciation deduction
with respect to such building of $950 for such taxable year. The basis
of the land to A as determined under subparagraph (1) of this paragraph
is reduced by $2,850. If on June 1, 1960, A ceases to rent the building
and demolishes it, the balance of the undepreciated portion allocated to
the buildings, $950, may be deducted from gross income under section
165.
(3) The basis of any building acquired in replacement of the old
buildings shall not include any part of the basis of the property
originally purchased even though such part was, at the time of purchase,
allocated to the buildings to be demolished for purposes of determining
allowable depreciation for the period before demolition.
(b) Intent to demolish formed subsequent to the time of acquisition.
(1) Except as provided in subparagraph (2) of this paragraph, the loss
incurred in a trade or business or in a transaction entered into for
profit and arising from a demolition of old buildings shall be allowed
as a deduction under section 165(a) if the demolition occurs as a result
of a plan formed subsequent to the acquisition of the buildings
demolished. The amount of the loss shall be the adjusted basis of the
buildings demolished increased by the net cost of demolition or
decreased by the net proceeds from demolition. See paragraph (c) of
Sec. 1.165-1 relating to amount deductible under section 165. The basis
of any building acquired in replacement of the old buildings shall not
include any part of the basis of the property demolished.
(2) If a lessor or lessee of real property demolishes the buildings
situated thereon pursuant to a lease or an agreement which resulted in a
lease, under which either the lessor was required or the lessee was
required or permitted to demolish such buildings, no deduction shall be
allowed to the lessor under section 165(a) on account of the demolition
of the old buildings. However, the adjusted basis of the demolished
buildings, increased by the net cost of demolition or decreased by the
net proceeds from demolition, shall be considered as a part of the cost
of the lease to be amortized over the remaining term thereof.
(c) Evidence of intention. (1) Whether real property has been
purchased with the intention of demolishing the buildings thereon or
whether the demolition of the buildings occurs as a result of a plan
formed subsequent to their acquisition is a question of fact, and the
answer depends upon an examination of all the surrounding facts and
circumstances. The answer to the question does not depend solely upon
the
[[Page 345]]
statements of the taxpayer at the time he acquired the property or
demolished the buildings, but such statements, if made, are relevant and
will be considered. Certain other relevant facts and circumstances that
exist in some cases and the inferences that might reasonably be drawn
from them are described in subparagraphs (2) and (3) of this paragraph.
The question as to the taxpayer's intention is not answered by any
inference that is drawn from any one fact or circumstance but can be
answered only by a consideration of all relevant facts and circumstances
and the reasonable inferences to be drawn therefrom.
(2) An intention at the time of acquisition to demolish may be
suggested by:
(i) A short delay between the date of acquisition and the date of
demolition;
(ii) Evidence of prohibitive remodeling costs determined at the time
of acquisition;
(iii) Existence of municipal regulations at the time of acquisition
which would prohibit the continued use of the buildings for profit
purposes;
(iv) Unsuitability of the buildings for the taxpayer's trade or
business at the time of acquisition; or
(v) Inability at the time of acquisition to realize a reasonable
income from the buildings.
(3) The fact that the demolition occurred pursuant to a plan formed
subsequent to the acquisition of the property may be suggested by:
(i) Substantial improvement of the buildings immediately after their
acquisition;
(ii) Prolonged use of the buildings for business purposes after
their acquisition;
(iii) Suitability of the buildings for investment purposes at the
time of acquisition;
(iv) Substantial change in economic or business conditions after the
date of acquisition;
(v) Loss of useful value occurring after the date of acquisition;
(vi) Substantial damage to the buildings occurring after their
acquisition;
(vii) Discovery of latent structural defects in the buildings after
their acquisition;
(viii) Decline in the taxpayer's business after the date of
acquisition;
(ix) Condemnation of the property by municipal authorities after the
date of acquisition; or
(x) Inability after acquisition to obtain building material
necessary for the improvement of the property.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 74474, 41 FR
55710, Dec. 22, 1976]
Sec. 1.165-4 Decline in value of stock.
(a) Deduction disallowed. No deduction shall be allowed under
section 165(a) solely on account of a decline in the value of stock
owned by the taxpayer when the decline is due to a fluctuation in the
market price of the stock or to other similar cause. A mere shrinkage in
the value of stock owned by the taxpayer, even though extensive, does
not give rise to a deduction under section 165(a) if the stock has any
recognizable value on the date claimed as the date of loss. No loss for
a decline in the value of stock owned by the taxpayer shall be allowed
as a deduction under section 165(a) except insofar as the loss is
recognized under Sec. 1.1002-1 upon the sale or exchange of the stock
and except as otherwise provided in Sec. 1.165-5 with respect to stock
which becomes worthless during the taxable year.
(b) Stock owned by banks. (1) In the regulation of banks and certain
other corporations, Federal and State authorities may require that stock
owned by such organizations be charged off as worthless or written down
to a nominal value. If, in any such case, this requirement is premised
upon the worthlessness of the stock, the charging off or writing down
will be considered prima facie evidence of worthlessness for purposes of
section 165(a); but, if the charging off or writing down is due to a
fluctuation in the market price of the stock or if no reasonable attempt
to determine the worthlessness of the stock has been made, then no
deduction shall be allowed under section 165(a) for the amount so
charged off or written down.
(2) This paragraph shall not be construed, however, to permit a
deduction under section 165(a) unless the stock owned by the bank or
other corporation actually becomes worthless in the
[[Page 346]]
taxable year. Such a taxpayer owning stock which becomes worthless
during the taxable year is not precluded from deducting the loss under
section 165(a) merely because, in obedience to the specific orders or
general policy of such supervisory authorities, the value of the stock
is written down to a nominal amount instead of being charged off
completely.
(c) Application to inventories. This section does not apply to a
decline in the value of corporate stock reflected in inventories
required to be taken by a dealer in securities under section 471. See
Sec. 1.471-5.
(d) Definition. As used in this section, the term ``stock'' means a
share of stock in a corporation or a right to subscribe for, or to
receive, a share of stock in a corporation.
Sec. 1.165-5 Worthless securities.
(a) Definition of security. As used in section 165(g) and this
section, the term ``security'' means:
(1) A share of stock in a corporation;
(2) A right to subscribe for, or to receive, a share of stock in a
corporation; or
(3) A bond, debenture, note, or certificate, or other evidence of
indebtedness to pay a fixed or determinable sum of money, which has been
issued with interest coupons or in registered form by a domestic or
foreign corporation or by any government or political subdivision
thereof.
(b) Ordinary loss. If any security which is not a capital asset
becomes wholly worthless during the taxable year, the loss resulting
therefrom may be deducted under section 165(a) as an ordinary loss.
(c) Capital loss. If any security which is a capital asset becomes
wholly worthless at any time during the taxable year, the loss resulting
therefrom may be deducted under section 165(a) but only as though it
were a loss from a sale or exchange, on the last day of the taxable
year, of a capital asset. See section 165(g)(1). The amount so allowed
as a deduction shall be subject to the limitations upon capital losses
described in paragraph (c)(3) of Sec. 1.165-1.
(d) Loss on worthless securities of an affiliated corporation--(1)
Deductible as an ordinary loss. If a taxpayer which is a domestic
corporation owns any security of a domestic or foreign corporation which
is affiliated with the taxpayer within the meaning of subparagraph (2)
of this paragraph and such security becomes wholly worthless during the
taxable year, the loss resulting therefrom may be deducted under section
165(a) as an ordinary loss in accordance with paragraph (b) of this
section. The fact that the security is in fact a capital asset of the
taxpayer is immaterial for this purpose, since section 165(g)(3)
provides that such security shall be treated as though it were not a
capital asset for the purposes of section 165(g)(1). A debt which
becomes wholly worthless during the taxable year shall be as an ordinary
loss in accordance with the provisions of this subparagraph, to the
extent that such debt is a security within the meaning of paragraph
(a)(3) of this section.
(2) Affiliated corporation defined. For purposes of this paragraph,
a corporation shall be treated as affiliated with the taxpayer owning
the security if--
(i)(a) In the case of a taxable year beginning on or after January
1, 1970, the taxpayer owns directly--
(1) Stock possessing at least 80 percent of the voting power of all
classes of such corporation's stock, and
(2) At least 80 percent of each class of such corporation's
nonvoting stock excluding for purposes of this subdivision (i)(a)
nonvoting stock which is limited and preferred as to dividends (see
section 1504(a)), or
(b) In the case of a taxable year beginning before January 1, 1970,
the taxpayer owns directly at least 95 percent of each class of the
stock of such corporation;
(ii) None of the stock of such corporation was acquired by the
taxpayer solely for the purpose of converting a capital loss sustained
by reason of the worthlessness of any such stock into an ordinary loss
under section 165(g)(3), and
(iii) More than 90 percent of the aggregate of the gross receipts of
such corporation for all the taxable years during which it has been in
existence has been from sources other than royalties, rents (except
rents derived from rental of properties to employees of such corporation
in the ordinary
[[Page 347]]
course of its operating business), dividends, interest (except interest
received on the deferred purchase price of operating assets sold),
annuities, and gains from sales or exchanges of stocks and securities.
For this purpose, the term ``gross receipts'' means total receipts
determined without any deduction for cost of goods sold, and gross
receipts from sales or exchanges of stocks and securities shall be taken
into account only to the extent of gains from such sales or exchanges.
(e) Bonds issued by an insolvent corporation. A bond of an insolvent
corporation secured only by a mortgage from which nothing is realized
for the bondholders on foreclosure shall be regarded as having become
worthless not later than the year of the foreclosure sale, and no
deduction in respect of the loss shall be allowed under section 165(a)
in computing a bondholder's taxable income for a subsequent year. See
also paragraph (d) of Sec. 1.165-1.
(f) Decline in market value. A taxpayer possessing a security to
which this section relates shall not be allowed any deduction under
section 165(a) on account of mere market fluctuation in the value of
such security. See also Sec. 1.165-4.
(g) Application to inventories. This section does not apply to any
loss upon the worthlessness of any security reflected in inventories
required to be taken by a dealer in securities under section 471. See
Sec. 1.471-5.
(h) Special rules for banks. For special rules applicable under this
section to worthless securities of a bank, including securities issued
by an affiliated bank, see Sec. 1.582-1.
(i) Abandonment of securities--(1) In general. For purposes of
section 165 and this section, a security that becomes wholly worthless
includes a security described in paragraph (a) of this section that is
abandoned and otherwise satisfies the requirements for a deductible loss
under section 165. If the abandoned security is a capital asset and is
not described in section 165(g)(3) and paragraph (d) of this section
(concerning worthless securities of certain affiliated corporations),
the resulting loss is treated as a loss from the sale or exchange, on
the last day of the taxable year, of a capital asset. See section
165(g)(1) and paragraph (c) of this section. To abandon a security, a
taxpayer must permanently surrender and relinquish all rights in the
security and receive no consideration in exchange for the security. For
purposes of this section, all the facts and circumstances determine
whether the transaction is properly characterized as an abandonment or
other type of transaction, such as an actual sale or exchange,
contribution to capital, dividend, or gift.
(2) Effective/applicability date. This paragraph (i) applies to any
abandonment of stock or other securities after March 12, 2008.
(j) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. (i) X Corporation, a domestic manufacturing corporation
which makes its return on the basis of the calendar year, owns 100
percent of each class of the stock of Y Corporation; and, in addition,
19 percent of the common stock (the only class of stock) of Z
Corporation, which it acquired in 1948. Y Corporation, a domestic
manufacturing corporation which makes its return on the basis of the
calendar year, owns 81 percent of the common stock of Z Corporation,
which it acquired in 1946. It is established that the stock of Z
Corporation, which has from its inception derived all of its gross
receipts from manufacturing operations, became worthless during 1971.
(ii) Since the stock of Z Corporation which is owned by X
Corporation is a capital asset and since X Corporation does not directly
own at least 80 percent of the stock of Z Corporation, any loss
sustained by X Corporation upon the worthlessness of such stock shall be
deducted under section 165(g)(1) and paragraph (c) of this section as a
loss from a sale or exchange on December 31, 1971, of a capital asset.
The loss so sustained by X Corporation shall be considered a long-term
capital loss under the provisions of section 1222(4), since the stock
was held by that corporation for more than 6 months.
(iii) Since Z Corporation is considered to be affiliated with Y
Corporation under the provisions of paragraph (d)(2) of this section,
any loss sustained by Y Corporation upon the worthlessness of the stock
of Z Corporation shall be deducted in 1971 under section 165(g)(3) and
paragraph (d)(1) of this section as an ordinary loss.
Example 2. (i) On January 1, 1971, X Corporation, a domestic
manufacturing corporation which makes its return on the basis of the
calendar year, owns 60 percent of each class of the stock of Y
Corporation, a foreign
[[Page 348]]
corporation, which it acquired in 1950. Y Corporation has, from the date
of its incorporation, derived all of its gross receipts from
manufacturing operations. It is established that the stock of Y
Corporation became worthless on June 30, 1971. On August 1, 1971, X
Corporation acquires the balance of the stock of Y Corporation for the
purpose of obtaining the benefit of section 165(g)(3) with respect to
the loss it has sustained on the worthlessness of the stock of Y
Corporation.
(ii) Since the stock of Y Corporation which is owned by X
Corporation is a capital asset and since Y Corporation is not to be
treated as affiliated with X Corporation under the provisions of
paragraph (d)(2) of this section, notwithstanding the fact that, at the
close of 1971, X Corporation owns 100 percent of each class of stock of
Y Corporation, any loss sustained by X Corporation upon the
worthlessness of such stock shall be deducted under the provisions of
section 165(g)(1) and paragraph (c) of this section as a loss from a
sale or exchange on December 31, 1971, of a capital asset.
Example 3. (i) X Corporation, a domestic manufacturing corporation
which makes its return on the basis of the calendar year, owns 80
percent of each class of the stock of Y Corporation, which from its
inception has derived all of its gross receipts from manufacturing
operations. As one of its capital assets, X Corporation owns $100,000 in
registered bonds issued by Y Corporation payable at maturity on December
31, 1974. It is established that these bonds became worthless during
1971.
(ii) Since Y Corporation is considered to be affiliated with X
Corporation under the provisions of paragraph (d)(2) of this section,
any loss sustained by X Corporation upon the worthlessness of these
bonds may be deducted in 1971 under section 165(g)(3) and paragraph
(d)(1) of this section as an ordinary loss. The loss may not be deducted
under section 166 as a bad debt. See section 166(e).
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 7224, 37 FR 25928, Dec. 6, 1972; T.D. 9386, 73 FR 13124,
Mar. 12, 2008]
Sec. 1.165-6 Farming losses.
(a) Allowance of losses. (1) Except as otherwise provided in this
section, any loss incurred in the operation of a farm as a trade or
business shall be allowed as a deduction under section 165(a) or as a
net operating loss deduction in accordance with the provisions of
section 172. See Sec. 1.172-1.
(2) If the taxpayer owns and operates a farm for profit in addition
to being engaged in another trade or business, but sustains a loss from
the operation of the farming business, then the amount of loss sustained
in the operation of the farm may be deducted from gross income, if any,
from all other sources.
(3) Loss incurred in the operation of a farm for recreation or
pleasure shall not be allowed as a deduction from gross income. See
Sec. 1.162-12.
(b) Loss from shrinkage. If, in the course of the business of
farming, farm products are held for a favorable market, no deduction
shall be allowed under section 165(a) in respect of such products merely
because of shrinkage in weight, decline in value, or deterioration in
storage.
(c) Loss of prospective crop. The total loss by frost, storm, flood,
or fire of a prospective crop being grown in the business of farming
shall not be allowed as a deduction under section 165(a).
(d) Loss of livestock--(1) Raised stock. A taxpayer engaged in the
business of raising and selling livestock, such as cattle, sheep, or
horses, may not deduct as a loss under section 165(a) the value of
animals that perish from among those which were raised on the farm.
(2) Purchased stock. The loss sustained upon the death by disease,
exposure, or injury of any livestock purchased and used in the trade or
business of farming shall be allowed as a deduction under section
165(a). See, also, paragraph (e) of this section.
(e) Loss due to compliance with orders of governmental authority.
The loss sustained upon the destruction by order of the United States, a
State, or any other governmental authority, of any livestock, or other
property, purchased and used in the trade or business of farming shall
be allowed as a deduction under section 165(a).
(f) Amount deductible--(1) Expenses of operation. The cost of any
feed, pasture, or care which is allowed under section 162 as an expense
of operating a farm for profit shall not be included as a part of the
cost of livestock for purposes of determining the amount of loss
deductible under section 165(a) and this section. For the deduction of
farming expenses, see Sec. 1.162-12.
[[Page 349]]
(2) Losses reflected in inventories. If inventories are taken into
account in determining the income from the trade or business of farming,
no deduction shall be allowed under this section for losses sustained
during the taxable year upon livestock or other products, whether
purchased for resale or produced on the farm, to the extent such losses
are reflected in the inventory on hand at the close of the taxable year.
Nothing in this section shall be construed to disallow the deduction of
any loss reflected in the inventories of the taxpayer. For provisions
relating to inventories of farmers, see section 471 and the regulations
thereunder.
(3) Other limitations. For other provisions relating to the amount
deductible under this section, see paragraph (c) of Sec. 1.165-1,
relating to the amount deductible under section 165(a); Sec. 1.165-7,
relating to casualty losses; and Sec. 1.1231-1, relating to gains and
losses from the sale or exchange of certain property used in the trade
or business.
(g) Other provisions applicable to farmers. For other provisions
relating to farmers, see Sec. 1.61-4, relating to gross income of
farmers; paragraph (b) of Sec. 1.167(a)-6, relating to depreciation in
the case of farmers; and Sec. 1.175-1, relating to soil and water
conservation expenditures.
Sec. 1.165-7 Casualty losses.
(a) In general--(1) Allowance of deduction. Except as otherwise
provided in paragraphs (b)(4) and (c) of this section, any loss arising
from fire, storm, shipwreck, or other casualty is allowable as a
deduction under section 165(a) for the taxable year in which the loss is
sustained. However, see Sec. 1.165-6, relating to farming losses, and
Sec. 1.165-11, relating to an election by a taxpayer to deduct disaster
losses in the taxable year immediately preceding the taxable year in
which the disaster occurred. The manner of determining the amount of a
casualty loss allowable as a deduction in computing taxable income under
section 63 is the same whether the loss has been incurred in a trade or
business or in any transaction entered into for profit, or whether it
has been a loss of property not connected with a trade or business and
not incurred in any transaction entered into for profit. The amount of a
casualty loss shall be determined in accordance with paragraph (b) of
this section. For other rules relating to the treatment of deductible
casualty losses, see Sec. 1.1231-1, relating to the involuntary
conversion of property.
(2) Method of valuation. (i) In determining the amount of loss
deductible under this section, the fair market value of the property
immediately before and immediately after the casualty shall generally be
ascertained by competent appraisal. This appraisal must recognize the
effects of any general market decline affecting undamaged as well as
damaged property which may occur simultaneously with the casualty, in
order that any deduction under this section shall be limited to the
actual loss resulting from damage to the property.
(ii) The cost of repairs to the property damaged is acceptable as
evidence of the loss of value if the taxpayer shows that (a) the repairs
are necessary to restore the property to its condition immediately
before the casualty, (b) the amount spent for such repairs is not
excessive, (c) the repairs do not care for more than the damage
suffered, and (d) the value of the property after the repairs does not
as a result of the repairs exceed the value of the property immediately
before the casualty.
(3) Damage to automobiles. An automobile owned by the taxpayer,
whether used for business purposes or maintained for recreation or
pleasure, may be the subject of a casualty loss, including those losses
specifically referred to in subparagraph (1) of this paragraph. In
addition, a casualty loss occurs when an automobile owned by the
taxpayer is damaged and when:
(i) The damage results from the faulty driving of the taxpayer or
other person operating the automobile but is not due to the willful act
or willful negligence of the taxpayer or of one acting in his behalf or
(ii) The damage results from the faulty driving of the operator of
the vehicle with which the automobile of the taxpayer collides.
(4) Application to inventories. This section does not apply to a
casualty loss
[[Page 350]]
reflected in the inventories of the taxpayer. For provisions relating to
inventories, see section 471 and the regulations thereunder.
(5) Property converted from personal use. In the case of property
which originally was not used in the trade or business or for income-
producing purposes and which is thereafter converted to either of such
uses, the fair market value of the property on the date of conversion,
if less than the adjusted basis of the property at such time, shall be
used, after making proper adjustments in respect of basis, as the basis
for determining the amount of loss under paragraph (b)(1) of this
section. See paragraph (b) of Sec. 1.165-9, and Sec. 1.167(g)-1.
(6) Theft losses. A loss which arises from theft is not considered a
casualty loss for purposes of this section. See Sec. 1.165-8, relating
to theft losses.
(b) Amount deductible--(1) General rule. In the case of any casualty
loss whether or not incurred in a trade or business or in any
transaction entered into for profit, the amount of loss to be taken into
account for purposes of section 165(a) shall be the lesser of either--
(i) The amount which is equal to the fair market value of the
property immediately before the casualty reduced by the fair market
value of the property immediately after the casualty; or
(ii) The amount of the adjusted basis prescribed in Sec. 1.1011-1
for determining the loss from the sale or other disposition of the
property involved.
However, if property used in a trade or business or held for the
production of income is totally destroyed by casualty, and if the fair
market value of such property immediately before the casualty is less
than the adjusted basis of such property, the amount of the adjusted
basis of such property shall be treated as the amount of the loss for
purposes of section 165(a).
(2) Aggregation of property for computing loss. (i) A loss incurred
in a trade or business or in any transaction entered into for profit
shall be determined under subparagraph (1) of this paragraph by
reference to the single, identifiable property damaged or destroyed.
Thus, for example, in determining the fair market value of the property
before and after the casualty in a case where damage by casualty has
occurred to a building and ornamental or fruit trees used in a trade or
business, the decrease in value shall be measured by taking the building
and trees into account separately, and not together as an integral part
of the realty, and separate losses shall be determined for such building
and trees.
(ii) In determining a casualty loss involving real property and
improvements thereon not used in a trade or business or in any
transaction entered into for profit, the improvements (such as buildings
and ornamental trees and shrubbery) to the property damaged or destroyed
shall be considered an integral part of the property, for purposes of
subparagraph (1) of this paragraph, and no separate basis need be
apportioned to such improvements.
(3) Examples. The application of this paragraph may be illustrated
by the following examples:
Example 1. In 1956 B purchases for $3,600 an automobile which he
uses for nonbusiness purposes. In 1959 the automobile is damaged in an
accidental collision with another automobile. The fair market value of
B's automobile is $2,000 immediately before the collision and $1,500
immediately after the collision. B receives insurance proceeds of $300
to cover the loss. The amount of the deduction allowable under section
165(a) for the taxable year 1959 is $200, computed as follows:
Value of automobile immediately before casualty............... $2,000
Less: Value of automobile immediately after casualty.......... 1,500
---------
Value of property actually destroyed.......................... 500
=========
Loss to be taken into account for purposes of section 165(a): 500
Lesser amount of property actually destroyed ($500) or
adjusted basis of property ($3,600)..........................
Less: Insurance received...................................... 300
---------
Deduction allowable........................................... 200
Example 2. In 1958 A purchases land containing an office building
for the lump sum of $90,000. The purchase price is allocated between the
land ($18,000) and the building ($72,000) for purposes of determining
basis. After the purchase A planted trees and ornamental shrubs on the
grounds surrounding the building. In 1961 the land, building, trees, and
shrubs are damaged by hurricane. At the time of the casualty the
adjusted basis of the land is $18,000 and the adjusted basis of the
building is $66,000. At that time the trees and shrubs have an adjusted
basis of $1,200. The fair market value of the land and building
immediately before the casualty is $18,000
[[Page 351]]
and $70,000, respectively, and immediately after the casualty is $18,000
and $52,000, respectively. The fair market value of the trees and shrubs
immediately before the casualty is $2,000 and immediately after the
casualty is $400. In 1961 insurance of $5,000 is received to cover the
loss to the building. A has no other gains or losses in 1961 subject to
section 1231 and Sec. 1.1231-1. The amount of the deduction allowable
under section 165(a) with respect to the building for the taxable year
1961 is $13,000, computed as follows:
Value of property immediately before casualty................. $70,000
Less: Value of property immediately after casualty............ 52,000
---------
Value of property actually destroyed.......................... 18,000
=========
Less: Insurance received...................................... 5,000
Loss to be taken into account for purposes of section 165(a): 18,000
Lesser amount of property actually destroyed ($18,000) or
adjusted basis of property ($66,000).........................
Less: Insurance received...................................... 5,000
---------
Deduction allowable........................................... 13,000
The amount of the deduction allowable under section 165(a) with respect
to the trees and shrubs for the taxable year 1961 is $1,200, computed as
follows:
Value of property immediately before casualty................. $2,000
Less: Value of property immediately after casualty............ $400
---------
Value of property actually destroyed.......................... 1,600
=========
Loss to be taken into account for purposes of section 165(a): 1,200
Lesser amount of property actually destroyed ($1,600) or
adjusted basis of property ($1,200)..........................
Example 3. Assume the same facts as in example (2) except that A
purchases land containing a house instead of an office building. The
house is used as his private residence. Since the property is used for
personal purposes, no allocation of the purchase price is necessary for
the land and house. Likewise, no individual determination of the fair
market values of the land, house, trees, and shrubs is necessary. The
amount of the deduction allowable under section 165(a) with respect to
the land, house, trees, and shrubs for the taxable year 1961 is $14,600,
computed as follows:
Value of property immediately before casualty................. $90,000
Less: Value of property immediately after casualty............ 70,400
---------
Value of property actually destroyed.......................... 19,600
=========
Loss to be taken into account for purposes of section 165(a): 19,600
Lesser amount of property actually destroyed ($19,600) or
adjusted basis of property ($91,200).........................
Less: Insurance received...................................... 5,000
---------
Deduction allowable........................................... 14,600
(4) Limitation on certain losses sustained by individuals after
December 31, 1963. (i) Pursuant to section 165(c)(3), the deduction
allowable under section 165(a) in respect of a loss sustained--
(a) After December 31, 1963, in a taxable year ending after such
date,
(b) In respect of property not used in a trade or business or for
income producing purposes, and
(c) From a single casualty
shall be limited to that portion of the loss which is in excess of $100.
The nondeductibility of the first $100 of loss applies to a loss
sustained after December 31, 1963, without regard to when the casualty
occurred. Thus, if property not used in a trade or business or for
income producing purposes is damaged or destroyed by a casualty which
occurred prior to January 1, 1964, and loss resulting therefrom is
sustained after December 31, 1963, the $100 limitation applies.
(ii) The $100 limitation applies separately in respect of each
casualty and applies to the entire loss sustained from each casualty.
Thus, if as a result of a particular casualty occurring in 1964, a
taxpayer sustains in 1964 a loss of $40 and in 1965 a loss of $250, no
deduction is allowable for the loss sustained in 1964 and the loss
sustained in 1965 must be reduced by $60 ($100-$40). The determination
of whether damage to, or destruction of, property resulted from a single
casualty or from two or more separate casualties will be made upon the
basis of the particular facts of each case. However, events which are
closely related in origin generally give rise to a single casualty. For
example, if a storm damages a taxpayer's residence and his automobile
parked in his driveway, any loss sustained results from a single
casualty. Similarly, if a hurricane causes high waves, all wind and
flood damage to a taxpayer's property caused by the hurricane and the
waves results from a single casualty.
(iii) Except as otherwise provided in this subdivision, the $100
limitation applies separately to each individual taxpayer who sustains a
loss even though the property damaged or destroyed is owned by two or
more individuals. Thus, if a house occupied by two sisters and jointly
owned by them is damaged or destroyed, the $100 limitation applies
separately to each sister in respect of any loss sustained by her.
However, for purposes of applying the
[[Page 352]]
$100 limitation, a husband and wife who file a joint return for the
first taxable year in which the loss is allowable as a deduction are
treated as one individual taxpayer. Accordingly, if property jointly
owned by a husband and wife, or property separately owned by the husband
or by the wife, is damaged or destroyed by a single casualty in 1964,
and a loss is sustained in that year by either or both the husband or
wife, only one $100 limitation applies if a joint return is filed for
1964. If, however, the husband and wife file separate returns for 1964,
the $100 limitation applies separately in respect of any loss sustained
by the husband and in respect of any loss sustained by the wife. Where
losses from a single casualty are sustained in two or more separate tax
years, the husband and wife shall, for purposes of applying the $100
limitation to such losses, be treated as one individual for all such
years if they file a joint return for the first year in which a loss is
sustained from the casualty; they shall be treated as separate
individuals for all such years if they file separate returns for the
first such year. If a joint return is filed in the first loss year but
separate returns are filed in a subsequent year, any unused portion of
the $100 limitation shall be allocated equally between the husband and
wife in the latter year.
(iv) If a loss is sustained in respect of property used partially
for business and partially for nonbusiness purposes, the $100 limitation
applies only to that portion of the loss properly attributable to the
nonbusiness use. For example, if a taxpayer sustains a $1,000 loss in
respect of an automobile which he uses 60 percent for business and 40
percent for nonbusiness, the loss is allocated 60 percent to business
use and 40 percent to nonbusiness use. The $100 limitation applies to
the portion of the loss allocable to the nonbusiness loss.
(c) Loss sustained by an estate. A casualty loss of property not
connected with a trade or business and not incurred in any transaction
entered into for profit which is sustained during the settlement of an
estate shall be allowed as a deduction under sections 165(a) and 641(b)
in computing the taxable income of the estate if the loss has not been
allowed under section 2054 in computing the taxable estate of the
decedent and if the statement has been filed in accordance with Sec.
1.642(g)-1. See section 165(c)(3).
(d) Loss treated as though attributable to a trade or business. For
the rule treating a casualty loss not connected with a trade or business
as though it were a deduction attributable to a trade or business for
purposes of computing a net operating loss, see paragraph (a)(3)(iii) of
Sec. 1.172-3.
(e) Effective date. The rules of this section are applicable to any
taxable year beginning after January 16, 1960. If, for any taxable year
beginning on or before such date, a taxpayer computed the amount of any
casualty loss in accordance with the rules then applicable, such
taxpayer is not required to change the amount of the casualty loss
allowable for any such prior taxable year. On the other hand, the
taxpayer may, if he so desires, amend his income tax return for such
year to compute the amount of a casualty loss in accordance with the
provisions of this section, but no provision in this section shall be
construed as extending the period of limitations within which a claim
for credit or refund may be filed under section 6511.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR
3652, Mar. 24, 1964; T.D. 6786, 29 FR 18501, Dec. 29, 1964; T.D. 7522,
42 FR 63411, Dec. 16, 1977]
Sec. 1.165-8 Theft losses.
(a) Allowance of deduction. (1) Except as otherwise provided in
paragraphs (b) and (c) of this section, any loss arising from theft is
allowable as a deduction under section 165(a) for the taxable year in
which the loss is sustained. See section 165(c)(3).
(2) A loss arising from theft shall be treated under section 165(a)
as sustained during the taxable year in which the taxpayer discovers the
loss. See section 165(e). Thus, a theft loss is not deductible under
section 165(a) for the taxable year in which the theft actually occurs
unless that is also the year in which the taxpayer discovers the loss.
However, if in the year of discovery there exists a claim for
reimbursement with respect to which there is a reasonable prospect of
recovery, see paragraph (d) of Sec. 1.165-1.
[[Page 353]]
(3) The same theft loss shall not be taken into account both in
computing a tax under chapter 1, relating to the income tax, or chapter
2, relating to additional income taxes, of the Internal Revenue Code of
1939 and in computing the income tax under the Internal Revenue Code of
1954. See section 7852(c), relating to items not to be twice deducted
from income.
(b) Loss sustained by an estate. A theft loss of property not
connected with a trade or business and not incurred in any transaction
entered into for profit which is discovered during the settlement of an
estate, even though the theft actually occurred during a taxable year of
the decedent, shall be allowed as a deduction under sections 165(a) and
641(b) in computing the taxable income of the estate if the loss has not
been allowed under section 2054 in computing the taxable estate of the
decedent and if the statement has been filed in accordance with Sec.
1.642(g)-1. See section 165(c)(3). For purposes of determining the year
of deduction, see paragraph (a)(2) of this section.
(c) Amount deductible. The amount deductible under this section in
respect of a theft loss shall be determined consistently with the manner
prescribed in Sec. 1.165-7 for determining the amount of casualty loss
allowable as a deduction under section 165(a). In applying the
provisions of paragraph (b) of Sec. 1.165-7 for this purpose, the fair
market value of the property immediately after the theft shall be
considered to be zero. In the case of a loss sustained after December
31, 1963, in a taxable year ending after such date, in respect of
property not used in a trade or business or for income producing
purposes, the amount deductible shall be limited to that portion of the
loss which is in excess of $100. For rules applicable in applying the
$100 limitation, see paragraph (b)(4) of Sec. 1.165-7. For other rules
relating to the treatment of deductible theft losses, see Sec. 1.1231-
1, relating to the involuntary conversion of property.
(d) Definition. For purposes of this section the term ``theft''
shall be deemed to include, but shall not necessarily be limited to,
larceny, embezzlement, and robbery.
(e) Application to inventories. This section does not apply to a
theft loss reflected in the inventories of the taxpayer. For provisions
relating to inventories, see section 471 and the regulations thereunder.
(f) Example. The application of this section may be illustrated by
the following example:
Example. In 1955 B, who makes her return on the basis of the
calendar year, purchases for personal use a diamond brooch costing
$4,000. On November 30, 1961, at which time it has a fair market value
of $3,500, the brooch is stolen; but B does not discover the loss until
January 1962. The brooch was fully insured against theft. A controversy
develops with the insurance company over its liability in respect of the
loss. However, in 1962, B has a reasonable prospect of recovery of the
fair market value of the brooch from the insurance company. The
controversy is settled in March 1963, at which time B receives $2,000 in
insurance proceeds to cover the loss from theft. No deduction for the
loss is allowable for 1961 or 1962; but the amount of the deduction
allowable under section 165(a) for the taxable year 1963 is $1,500,
computed as follows:
Value of property immediately before theft.................... $3,500
Less: Value of property immediately after the theft........... 0
---------
Balance....................................................... 3,500
=========
Loss to be taken into account for purposes of section 165(a): $3,500
($3,500 but not to exceed adjusted basis of $4,000 at time of
theft).......................................................
Less: Insurance received in 1963.............................. 2,000
---------
Deduction allowable for 1963.................................. 1,500
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6786, 29 FR
18502, Dec. 29, 1964]
Sec. 1.165-9 Sale of residential property.
(a) Losses not allowed. A loss sustained on the sale of residential
property purchased or constructed by the taxpayer for use as his
personal residence and so used by him up to the time of the sale is not
deductible under section 165(a).
(b) Property converted from personal use. (1) If property purchased
or constructed by the taxpayer for use as his personal residence is,
prior to its sale, rented or otherwise appropriated to income-producing
purposes and is used for such purposes up to the time of its sale, a
loss sustained on the sale of the property shall be allowed as a
deduction under section 165(a).
[[Page 354]]
(2) The loss allowed under this paragraph upon the sale of the
property shall be the excess of the adjusted basis prescribed in Sec.
1.1011-1 for determining loss over the amount realized from the sale.
For this purpose, the adjusted basis for determining loss shall be the
lesser of either of the following amounts, adjusted as prescribed in
Sec. 1.1011-1 for the period subsequent to the conversion of the
property to income-producing purposes:
(i) The fair market value of the property at the time of conversion,
or
(ii) The adjusted basis for loss, at the time of conversion,
determined under Sec. 1.1011-1 but without reference to the fair market
value.
(3) For rules relating to casualty losses of property converted from
personal use, see paragraph (a)(5) of Sec. 1.165-7. To determine the
basis for depreciation in the case of such property, see Sec. 1.167(g)-
1. For limitations on the loss from the sale of a capital asset, see
paragraph (c)(3) of Sec. 1.165-1.
(c) Examples. The application of paragraph (b) of this section may
be illustrated by the following examples:
Example 1. Residential property is purchased by the taxpayer in 1943
for use as his personal residence at a cost of $25,000, of which $15,000
is allocable to the building. The taxpayer uses the property as his
personal residence until January 1, 1952, at which time its fair market
value is $22,000, of which $12,000 is allocable to the building. The
taxpayer rents the property from January 1, 1952, until January 1, 1955,
at which time it is sold for $16,000. On January 1, 1952, the building
has an estimated useful life of 20 years. It is assumed that the
building has no estimated salvage value and that there are no
adjustments in respect of basis other than depreciation, which is
computed on the straight-line method. The loss to be taken into account
for purposes of section 165(a) for the taxable year 1955 is $4,200,
computed as follows:
Basis of property at time of conversion for purposes of this $22,000
section (that is, the lesser of $25,000 cost or $22,000 fair
market value)................................................
Less: Depreciation allowable from January 1, 1952, to January 1,800
1, 1955 (3 years at 5 percent based on $12,000, the value of
the building at time of conversion, as prescribed by Sec.
1.167(g)-1)..................................................
---------
Adjusted basis prescribed in Sec. 1.1011-1 for determining 20,200
loss on sale of the property.................................
Less: Amount realized on sale................................. 16,000
---------
Loss to be taken into account for purposes of section 165(a).. 4,200
In this example the value of the building at the time of conversion is
used as the basis for computing depreciation. See example (2) of this
paragraph wherein the adjusted basis of the building is required to be
used for such purpose.
Example 2. Residential property is purchased by the taxpayer in 1940
for use as his personal residence at a cost of $23,000, of which $10,000
is allocable to the building. The taxpayer uses the property as his
personal residence until January 1, 1953, at which time its fair market
value is $20,000, of which $12,000 is allocable to the building. The
taxpayer rents the property from January 1, 1953, until January 1, 1957,
at which time it is sold for $17,000. On January 1, 1953, the building
has an estimated useful life of 20 years. It is assumed that the
building has no estimated salvage value and that there are no
adjustments in respect of basis other than depreciation, which is
computed on the straight-line method. The loss to be taken into account
for purposes of section 165(a) for the taxable year 1957 is $1,000,
computed as follows:
Basis of property at time of conversion for purposes of this $20,000
section (that is, the lesser of $23,000 cost or $20,000 fair
market value)................................................
Less: Depreciation allowable from January 1, 1953, to January 2,000
1, 1957 (4 years at 5 percent based on $10,000, the cost of
the building, as prescribed by Sec. 1.167(g)-1.............
---------
Adjusted basis prescribed in Sec. 1.1011-1 for determining $18,000
loss on sale of the property.................................
Less: Amount realized on sale................................. 17,000
---------
Loss to be taken into account for purposes of section 165(a).. 1,000
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR
3652, Mar. 24, 1964]
Sec. 1.165-10 Wagering losses.
Losses sustained during the taxable year on wagering transactions
shall be allowed as a deduction but only to the extent of the gains
during the taxable year from such transactions. In the case of a husband
and wife making a joint return for the taxable year, the combined losses
of the spouses from wagering transactions shall be allowed to the extent
of the combined gains of the spouses from wagering transactions.
[[Page 355]]
Sec. 1.165-11 Election in respect of losses attributable to a disaster.
(a) In general. Section 165(h) provides that a taxpayer who has
sustained a disaster loss which is allowable as a deduction under
section 165(a) may, under certain circumstances, elect to deduct such
loss for the taxable year immediately preceding the taxable year in
which the disaster actually occurred.
(b) Loss subject to election. The election provided by section
165(h) and paragraph (a) of this section applies only to a loss:
(1) Arising from a disaster resulting in a determination referred to
in subparagraph (2) of this paragraph and occurring--
(i) After December 31, 1971, or
(ii) After December 31, 1961, and before January 1, 1972, and during
the period following the close of a particular taxable year of the
taxpayer and on or before the due date for filing the income tax return
for that taxable year (determined without regard to any extension of
time granted the taxpayer for filing such return);
(2) Occurring in an area subsequently determined by the President of
the United States to warrant assistance by the Federal Government under
the Disaster Relief Act of 1974; and
(3) Constituting a loss otherwise allowable as a deduction for the
year in which the loss occurred under section 165(a) and the provisions
of Sec. Sec. 1.165-1 through 1.165-10 which are applicable to such
losses.
(c) Amount of loss to which election applies. The amount of the loss
to which section 165(h) and this section apply shall be the amount of
the loss sustained during the period specified in paragraph (b)(1) of
this section computed in accordance with the provisions of section 165
and those provisions of Sec. Sec. 1.165-1 through 1.165-10 which are
applicable to such losses. However, for purposes of making such
computation, the period specified in paragraph (b)(1) of this section
shall be deemed to be a taxable year.
(d) Scope and effect of election. An election made pursuant to
section 165(h) and this section in respect of a loss arising from a
particular disaster shall apply to the entire loss sustained by the
taxpayer from such disaster during the period specified in paragraph
(b)(1) of this section in the area specified in paragraph (b)(2) of this
section. If such an election is made, the disaster to which the election
relates will be deemed to have occurred in the taxable year immediately
preceding the taxable year in which the disaster actually occurred, and
the loss to which the election applies will be deemed to have been
sustained in such preceding taxable year.
(e) Time and manner of making election. An election to claim a
deduction with respect to a disaster loss described in paragraph (b) of
this section for the taxable year immediately preceding the taxable year
in which the disaster actually occurred must be made by filing a return,
an amended return, or a claim for refund clearly showing that the
election provided by section 165(h) has been made. In general, the
return or claim should specify the date or dates of the disaster which
gave rise to the loss, and the city, town, county, and State in which
the property which was damaged or destroyed was located at the time of
the disaster. An election in respect of a loss arising from a particular
disaster occurring after December 31, 1971, must be made on or before
the later of (1) the due date for filing the income tax return
(determined without regard to any extension of time granted the taxpayer
for filing such return) for the taxable year in which the disaster
actually occurred, or (2) the due date of filing the income tax return
(determined with regard to any extension of time granted the taxpayer
for filing such return) for the taxable year immediately preceding the
taxable year in which the disaster actually occurred. Such election
shall be irrevocable after the later of (1) 90 days after the date on
which the election was made, or (2) March 6, 1973. No revocation of such
election shall be effective unless the amount of any credit or refund
which resulted from such election is paid to the Internal Revenue
Service within the revocation period described in the preceding
sentence. However, in the case of a revocation made before receipt by
the taxpayer of
[[Page 356]]
a refund claimed pursuant to such election, the revocation shall be
effective if the refund is repaid within 30 calendar days after such
receipt. An election in respect of a loss arising from a particular
disaster occurring after December 31, 1961, and before January 1, 1972,
must be made on or before the later of (1) the 15th day of the third
month following the month in which falls the date prescribed for the
filing of the income tax return (determined without regard to any
extension of time granted the taxpayer for filing such return) for the
taxable year immediately preceding the taxable year in which the
disaster actually occurred, or (2) the due date for filing the income
tax return (determined with regard to any extension of time granted the
taxpayer for filing such return) for the taxable year immediately
preceding the taxable year in which the disaster actually occurred. Such
election shall be irrevocable after the date by which it must be made.
[T.D. 6735, 29 FR 6493, May 19, 1964, as amended by T.D. 7224, 37 FR
25928, Dec. 6, 1972; T.D. 7522, 42 FR 63411, Dec. 16, 1977]
Sec. 1.165-12 Denial of deduction for losses on registration-required
obligations not in registered form.
(a) In general. Except as provided in paragraph (c) of this section,
nothing in section 165(a) and the regulations thereunder, or in any
other provision of law, shall be construed to provide a deduction for
any loss sustained on any registration-required obligation held after
December 31, 1982, unless the obligation is in registered form or the
issuance of the obligation was subject to tax under section 4701. The
term ``registration-required obligation'' has the meaning given to that
term in section 163(f)(2), except that clause (iv) of subparagraph (A)
thereof shall not apply. Therefore, although an obligation that is not
in registered form is described in Sec. 1.163-5(c)(1), the holder of
such an obligation shall not be allowed a deduction for any loss
sustained on such obligation unless paragraph (c) of this section
applies. The term ``holder'' means the person that would be denied a
loss deduction under section 165(j)(1) or denied capital gain treatment
under section 1287(a). For purposes of this section, the term United
States means the United States and its possessions within the meaning of
Sec. 1.163-5(c)(2)(iv).
(b) Registered form--(1) Obligations issued after September 21,
1984. With respect to any obligation originally issued after September
21, 1984, the term ``registered form'' has the meaning given that term
in section 103(j)(3) and the regulations thereunder. Therefore, an
obligation that would otherwise be in registered form is not considered
to be in registered form if it can be transferred at that time or at any
time until its maturity by any means not described in Sec. 5f.103-1(c).
An obligation that, as of a particular time, is not considered to be in
registered form because it can be transferred by any means not described
in Sec. 5f.103-1(c) is considered to be in registered form at all times
during the period beginning with a later time and ending with the
maturity of the obligation in which the obligation can be transferred
only by a means described in Sec. 5f.103-1(c).
(2) Obligations issued after December 31, 1982 and on or before
September 21, 1984. With respect to any obligation originally issued
after December 31, 1982 and on or before September 21, 1984 or an
obligation originally issued after September 21, 1984 pursuant to the
exercise of a warrant or the conversion of a convertible obligation,
which warrant or obligation (including conversion privilege) was issued
after December 31, 1982 and on or before September 21, 1984, that
obligation will be considered in registered form if it satisfied Sec.
5f.163-1 or the proposed regulations provided in Sec. 1.163-5(c) and
published in the Federal Register on September 2, 1983 (48 FR 39953).
(c) Registration-required obligations not in registered form which
are not subject to section 165(j)(1). Notwithstanding the fact that an
obligation is a registration-required obligation that is not in
registered form, the holder will not be subject to section 165(j)(1) if
the holder meets the conditions of any one of the following
subparagraphs (1), (2), (3), or (4) of this paragraph (c).
(1) Persons permitted to hold in connection with the conduct of a
trade or business. (i) The holder is an underwriter, broker, dealer,
bank, or other financial institution (defined in paragraph
[[Page 357]]
(c)(1)(iv)) that holds such obligation in connection with its trade or
business conducted outside the United States; or the holder is a broker-
dealer (registered under Federal or State law or exempted from
registration by the provisions of such law because it is a bank) that
holds such obligation for sale to customers in the ordinary course of
its trade or business.
(ii) The holder must offer to sell, sell and deliver the obligation
in bearer form only outside of the United States except that a holder
that is a registered broker-dealer as described in paragraph (c)(1)(i)
of this section may offer to sell and sell the obligation in bearer form
inside the United States to a financial institution as defined in
paragraph (c)(1)(iv) of this section for its own account or for the
account of another financial institution or of an exempt organization as
defined in section 501(c)(3).
(iii) The holder may deliver an obligation in bearer form that is
offered or sold inside the United States only if the holder delivers it
to a financial institution that is purchasing for its own account, or
for the account of another financial institution or of an exempt
organization, and the financial institution or organization that
purchases the obligation for its own account or for whose account the
obligation is purchased represents that it will comply with the
requirements of section 165(j)(3) (A), (B), or (C). Absent actual
knowledge that the representation is false, the holder may rely on a
written statement provided by the financial institution or exempt
organization, including a statement that is delivered in electronic
form. The holder may deliver a registration-required obligation in
bearer form that is offered and sold outside the United States to a
person other than a financial institution only if the holder has
evidence in its records that such person is not a U.S. citizen or
resident and does not have actual knowledge that such evidence is false.
Such evidence may include a written statement by that person, including
a statement that is delivered electronically. For purposes of this
paragraph (c), the term deliver includes a transfer of an obligation
evidenced by a book entry including a book entry notation by a clearing
organization evidencing transfer of the obligation from one member of
the organization to another member. For purposes of this paragraph (c),
the term deliver does not include a transfer of an obligation to the
issuer or its agent for cancellation or extinguishment. The record-
retention provisions in Sec. 1.1441-1(e)(4)(iii) shall apply to any
statement that a holder receives pursuant to this paragraph (c)(1)(iii).
(iv) For purposes of paragraph (c) of this section, the term
``financial institution'' means a person which itself is, or more than
50 percent of the total combined voting power of all classes of whose
stock entitled to vote is owned by a person which is--
(A) Engaged in the conduct of a banking, financing, or similar
business within the meaning of section 954(c)(3)(B) as in effect before
the Tax Reform Act of 1986, and the regulations thereunder;
(B) Engaged in business as a broker or dealer in securities;
(C) An insurance company;
(D) A person that provides pensions or other similar benefits to
retired employees;
(E) Primarily engaged in the business of rendering investment
advice;
(F) A regulated investment company or other mutual fund; or
(G) A finance corporation a substantial part of the business of
which consists of making loans (including the acquisition of obligations
under a lease which is entered into primarily as a financing
transaction), acquiring accounts receivable, notes or installment
obligations arising out of the sale of tangible personal property or the
performing of services, or servicing debt obligations.
(2) Persons permitted to hold obligations for their own investment
account. The holder is a financial institution holding the obligation
for its own investment account that satisfies the conditions set forth
in subdivisions (i), (ii), (iii), and (iv) of his paragraph (c) (2).
(i) The holder reports on its Federal income tax return for the
taxable year any interest payments received (including original issue
discount includable in gross income for such taxable year) with respect
to such obligation
[[Page 358]]
and gain or loss on the sale or other disposition of such obligation;
(ii) The holder indicates on its Federal income tax return that
income, gain or loss described in paragraph (c)(2)(i) is attributable to
registration-required obligations held in bearer form for its own
account;
(iii) The holder of a bearer obligation that resells the obligation
inside the United States resells the obligation only to another
financial institution for its own account or for the account of another
financial institution or exempt organization; and
(iv) The holder delivers such obligation in bearer form to any other
person in accordance with paragraph (c)(1) (ii) and (iii) of this
section.
(3) Persons permitted to hold through financial institutions. The
holder is any person that purchases and holds a registration-required
obligation in bearer form through a financial institution with which the
holder maintains a customer, custodial or nominee relationship and such
institution agrees to satisfy, and does in fact satisfy, the conditions
set forth in subdivisions (i), (ii), (iii), (iv) and (v) of this
paragraph (c)(3).
(i) The financial institution makes a return of information to the
Internal Revenue Service with respect to any interest payments received.
The financial institution must report original issue discount includable
in the holder's gross income for the taxable year on any obligation so
held, but only if the obligation appears in an Internal Revenue Service
publication of obligations issued at an original issue discount and only
in an amount determined in accordance with information contained in that
publication. An information return for any interest payment shall be
made on a Form 1099 for the calendar year. It shall indicate the
aggregate amount of the payment received, the name, address and taxpayer
identification number of the holder, and such other information as is
required by the form. No return of information is required under this
subdivision if the financial institution reports payments under section
6041 or 6049.
(ii) The financial institution makes a return of information on Form
1099B with respect to any disposition by the holder of such obligation.
The return shall show the name, address, and taxpayer identification
number of the holder of the obligation, Committee on Uniform Security
Information Procedures (CUSIP), gross proceeds, sale date, and such
other information as may be required by the form. No return of
information is required under this subdivision if such financial
institution reports with respect to the disposition under section 6045.
(iii) In the case of a bearer obligation offered for resale or
resold in the United States, the financial institution may resell the
obligation only to another financial institution for its own account or
for the account of an exempt organization.
(iv) The financial institution covenants with the holder that the
financial institution will deliver the obligation in bearer form in
accordance with the requirements set forth in paragraph (c)(1) (ii) and
(iii).
(v) The financial institution delivers the obligation in bearer form
in accordance with paragraph (c)(1) (ii) and (iv) as if the financial
institution delivering the obligation were the holder referred to in
such paragraph.
(4) Conversion of obligations into registered form. The holder is
not a person described in paragraph (c) (1), (2), or (3) of this
section, and within thirty days of the date when the seller or other
transferor is reasonably able to make the bearer obligation available to
the holder, the holder surrenders the obligation to a transfer agent or
the issuer for conversion of the obligation into registered form. If
such obligation is not registered within such 30 day period, the holder
shall be subject to sections 165(j) and 1287(a).
(d) Effective date. These regulations apply generally to obligations
issued after January 20, 1987. However, a taxpayer may choose to apply
the rules of Sec. 1.165-12 with respect to an obligation issued after
December 31, 1982 and on or before January 20, 1987, which obligation is
held after January 20, 1987.
[T.D. 8110, 51 FR 45459, Dec. 19, 1986, as amended by T.D. 8734, 62 FR
53416, Oct. 14, 1997]
[[Page 359]]
Sec. 1.165-13T Questions and answers relating to the treatment of
losses on certain straddle transactions entered into before the
effective date of the Economic Recovery Tax Act of 1981, under
section 108 of the Tax Reform Act of 1984 (temporary).
The following questions and answers concern the treatment of losses
on certain straddle transactions entered into before the effective date
of the Economic Recovery Tax Act of 1981, under the Tax Reform Act of
1984 (98 Stat. 494).
Q-1 What is the scope of section 108 of the Tax Reform Act of 1984
(Act)?
A-1 Section 108 of the Act provides that in the case of any
disposition of one or more positions, which were entered into before
1982 and form part of a straddle, and to which the provisions of title V
of The Economic Recovery Act of 1981 (ERTA) do not apply, any loss from
such disposition shall be allowed for the taxable year of the
disposition if such position is part of a transaction entered into for
profit. For purposes of section 108 of the Act, the term ``straddle''
has the meaning given to such term by section 1092(c) of the Internal
Revenue Code of 1954 as in effect on the day after the date of enactment
of ERTA; including a straddle all the positions of which are regulated
futures contracts (as defined in Q&A-6 of this section). Straddles in
certain listed stock options were not covered by ERTA and are not
affected by this provision.
Q-2 What transactions are considered entered into for profit?
A-2 A transaction is considered entered into for profit if the
transaction is entered into for profit within the meaning of section
165(c)(2) of the Code. In this respect, section 108 of the Act restates
existing law applicable to straddle transactions. All the circumstances
surrounding the transaction, including the magnitude and timing for
entry into, and disposition of, the positions comprising the transaction
are relevant in making the determination whether a transaction is
considered entered into for profit. Moreover, in order for section 108
of the Act to apply, the transaction must have sufficient substance to
be recognized for Federal income tax purposes. Thus, for example, since
a ``sham'' transaction would not be recognized for tax purposes, section
108 of the Act would not apply to such a transaction.
Q-3 If a loss is disallowed in a taxable year (year 1) because the
transaction was not entered into for profit, is the entire gain from the
straddle occurring in a later taxable year taxed?
A-3 No. Under section 108(c) of the Act the taxpayer is allowed to
offset the gain in the subsequent taxable year by the amount of loss
(including expenses) disallowed in year 1.
Q-4 In what manner does the for-profit test of Q&A-2 apply to
losses from straddle transactions sustained by commodities dealers and
persons regularly engaged in investing in regulated futures contracts?
A-4 In general, for a loss to be allowable with respect to
positions that form part of a straddle, the for-profit test of Q&A-2
must be satisfied. However, certain positions (see Q&A-6) held by a
commodities dealer or person regularly engaged in investing in regulated
futures contracts are rebuttably presumed to be part of a transaction
entered into for profit. Thus, the for profit test is applied to
commodities dealers and persons regularly engaged in investing in
regulated futures contracts in light of the factors relating to the
applicability and rebuttal of the profit presumption, including, for
example, the nature and extent of the taxpayer's trading activities.
Q-5 Under what circumstances is the presumption considered
rebutted?
A-5 All the facts and circumstances of each case are to be
considered in determining if the presumption is rebutted. The following
factors are significant in making this determination: (1) The level of
transaction costs; (2) the extent to which the transaction results from
trading patterns different from the taxpayer's regular patterns; and (3)
the extent of straddle transactions having tax results disproportionate
to economic consequences. Factors other than the ones described above
may be taken into account in making the determination. Moreover, a
determination is not to be made solely on the basis of the number of
factors indicating that the presumption is rebutted.
[[Page 360]]
Q-6 Does a commodities dealer or person regularly engaged in
investing in regulated futures contracts qualify for the profit
presumption for all transactions?
A-6 No. The presumption is only applicable to regulated futures
contract transactions in property that is the subject of the person's
regular trading activity. For example, a commodities dealer who
regularly trades only in agricultural futures will not qualify for the
presumption for a silver futures straddle transaction. For purposes of
this section, the term ``regulated futures contracts'' has the meaning
given to such term by section 1256(b) of the Code as in effect before
the enactment of the Tax Reform Act of 1984.
Q-7 Who qualifies as a commodities dealer or as a person regularly
engaged in investing in regulated futures contracts for purposes of the
profit presumption?
A-7 For purposes of this section, the term ``commodities dealer''
has the meaning given to such term by section 1402(i)(2)(B) of the Code.
Section 1402(i)(2)(B) defines a commodities dealer as a person who is
actively engaged in trading section 1256 contracts (which includes
regulated futures contracts as defined in Q&A-6) and is registered with
a domestic board of trade which is designated as a contract market by
the Commodity Futures Trading Commission. To determine if a person is
regularly engaged in investing in regulated futures contracts all the
facts and circumstances should be considered including, but not limited
to, the following factors: (1) Regularity of trading at all times
throughout the year; (2) the level of transaction costs; (3) substantial
volume and economic consequences of trading at all times throughout the
year; (4) percentage of time dedicated to commodity trading activities
as compared to other activities; and (5) the person's knowledge of the
regulated futures contract market.
Q-8 If a commodities dealer or a person regularly engaged in
investing in regulated futures contracts participates in a syndicate, as
defined in section 1256(e)(3)(B) of the Code, does the rebuttable
presumption of ``entered into for profit'' apply to the transactions
entered into through the syndicate?
A-8 No. A participant in a syndicate does not qualify for the
rebuttable presumption of ``entered into for profit'' with respect to
transactions entered into by or for the syndicate. A syndicate is
defined in section 1256(e)(3)(B) of the Code as any partnership or other
entity (other than a corporation which is not an S corporation) if more
than 35 percent of the losses of such entity during the taxable year are
allocable to limited partners or limited entrepreneurs (within the
meaning of section 464(e)(2)).
Q-9 Will the Service continue to make the closed and completed
transaction argument set forth in Rev. Rul. 77-185, 1977-1 C.B. 48, with
respect to transactions covered by section 108 of the Act?
A-9 No. The closed and completed transaction argument will not be
made regarding transactions subject to section 108 of the Act. In
general, losses in such transactions will be allowed for the taxable
year of disposition if the transaction is not viewed as a sham and
satisfies the ``entered into for profit'' test described in Q&A-2.
Nevertheless, for certain positions covered by section 108 of the Act,
various Code sections may apply without regard to whether such position
constitutes a straddle to disallow or limit the loss otherwise allowable
in the year of the disposition. For example, dispositions of certain
positions held by a partnership which resulted in a loss to a partner
may be limited or disallowed under section 465 of 704(d).
[T.D. 7968, 49 FR 33445, Aug. 23, 1984]
Sec. 1.166-1 Bad debts.
(a) Allowance of deduction. Section 166 provides that, in computing
taxable income under section 63, a deduction shall be allowed in respect
of bad debts owed to the taxpayer. For this purpose, bad debts shall,
subject to the provisions of section 166 and the regulations thereunder,
be taken into account either as--
(1) A deduction in respect of debts which become worthless in whole
or in part; or as
(2) A deduction for a reasonable addition to a reserve for bad
debts.
[[Page 361]]
(b) Manner of selecting method. (1) A taxpayer filing a return of
income for the first taxable year for which he is entitled to a bad debt
deduction may select either of the two methods prescribed by paragraph
(a) of this section for treating bad debts, but such selection is
subject to the approval of the district director upon examination of the
return. If the method so selected is approved, it shall be used in
returns for all subsequent taxable years unless the Commissioner grants
permission to use the other method. A statement of facts substantiating
any deduction claimed under section 166 on account of bad debts shall
accompany each return of income.
(2) Taxpayers who have properly selected one of the two methods for
treating bad debts under provisions of prior law corresponding to
section 166 shall continue to use that method for all subsequent taxable
years unless the Commissioner grants permission to use the other method.
(3)(i) For taxable years beginning after December 31, 1959,
application for permission to change the method of treating bad debts
shall be made in accordance with section 446(e) and paragraph (e)(3) of
Sec. 1.446-1.
(ii) For taxable years beginning before January 1, 1960, application
for permission to change the method of treating bad debts shall be made
at least 30 days before the close of the taxable year for which the
change is effective.
(4) Nothwithstanding paragraphs (b) (1), (2), and (3) of this
section, a dealer in property currently employing the accrual method of
accounting and currently maintaining a reserve for bad debts under
section 166(c) (which may have included guaranteed debt obligations
described in section 166(f)(1)(A)) may establish a reserve for section
166(f)(1)(A) guaranteed debt obligations for a taxable year ending after
October 21, 1965 under section 166(f) and Sec. 1.166-10 by filing on or
before April 17, 1986 an amended return indicating that such a reserve
has been established. The establishment of such a reserve will not be
considered a change in method of accounting for purposes of section
446(e). However, an election by a taxpayer to establish a reserve for
bad debts under section 166(c) shall be treated as a change in method of
accounting. See also Sec. 1.166-4, relating to reserve for bad debts,
and Sec. 1.166-10, relating to reserve for guaranteed debt obligations.
(c) Bona fide debt required. Only a bona fide debt qualifies for
purposes of section 166. A bona fide debt is a debt which arises from a
debtor-creditor relationship based upon a valid and enforceable
obligation to pay a fixed or determinable sum of money. A debt arising
out of the receivables of an accrual method taxpayer is deemed to be an
enforceable obligation for purposes of the preceding sentence to the
extent that the income such debt represents have been included in the
return of income for the year for which the deduction as a bad debt is
claimed or for a prior taxable year. For example, a debt arising out of
gambling receivables that are unenforceable under state or local law,
which an accrual method taxpayer includes in income under section 61, is
an enforceable obligation for purposes of this pargarph. A gift or
contribution to capital shall not be considered a debt for purposes of
section 166. The fact that a bad debt its not due at the time of
deduction shall not of itself prevent is allowance under section 166.
For the disallowance of deductions for bad debts owed by a political
party, see Sec. 1.271-1.
(d) Amount deductible--(1) General rule. Except in the case of a
deduction for a reasonable addition to a reserve for bad debts, the
basis for determining the amount of deduction under section 166 in
respect of a bad debt shall be the same as the adjusted basis prescribed
by Sec. 1.1011-1 for determining the loss from the sale or other
disposition of property. To determine the allowable deduction in the
case of obligations acquired before March 1, 1913, see also paragraph
(b) of Sec. 1.1053-1.
(2) Specific cases. Subject to any provision of section 166 and the
regulations thereunder which provides to the contrary, the following
amounts are deductible as bad debts:
(i) Notes or accounts receivable. (a) If, in computing taxable
income, a taxpayer values his notes or accounts receivable at their fair
market value when received, the amount deductible
[[Page 362]]
as a bad debt under section 166 in respect of such receivables shall be
limited to such fair market value even though it is less than their face
value.
(b) A purchaser of accounts receivable which become worthless during
the taxable year shall be entitled under section 166 to a deduction
which is based upon the price he paid for such receivables but not upon
their face value.
(ii) Bankruptcy claim. Only the difference between the amount
received in distribution of the assets of a bankrupt and the amount of
the claim may be deducted under section 166 as a bad debt.
(iii) Claim against decedent's estate. The excess of the amount of
the claim over the amount received by a creditor of a decedent in
distribution of the assets of the decedent's estate may be considered a
worthless debt under section 166.
(e) Prior inclusion in income required. Worthless debts arising from
unpaid wages, salaries, fees, rents, and similar items of taxable income
shall not be allowed as a deduction under section 166 unless the income
such items represent has been included in the return of income for the
year for which the deduction as a bad debt is claimed or for a prior
taxable year.
(f) Recovery of bad debts. Any amount attributable to the recovery
during the taxable year of a bad debt, or of a part of a bad debt, which
was allowed as a deduction from gross income in a prior taxable year
shall be included in gross income for the taxable year of recovery,
except to the extent that the recovery is excluded from gross income
under the provisions of Sec. 1.111-1, relating to the recovery of
certain items previously deducted or credited. This paragraph shall not
apply, however, to a bad debt which was previously charged against a
reserve by a taxpayer on the reserve method of treating bad debts.
(g) Worthless securities. (1) Section 166 and the regulations
thereunder do not apply to a debt which is evidenced by a bond,
debenture, note, or certificate, or other evidence of indebtedness,
issued by a corporation or by a government or political subdivision
thereof, with interest coupons or in registered form. See section
166(e). For provisions allowing the deduction of a loss resulting from
the worthlessness of such a debt, see Sec. 1.165-5.
(2) The provisions of subparagraph (1) of this paragraph do not
apply to any loss sustained by a bank and resulting from the
worthlessness of a security described in section 165(g)(2)(C). See
paragraph (a) of Sec. 1.582-1.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6996, 34 FR
835, Jan. 18, 1969; T.D. 7902, 48 FR 33260, July 21, 1983; T.D. 8071, 51
FR 2479, Jan. 17, 1986]
Sec. 1.166-2 Evidence of worthlessness.
(a) General rule. In determining whether a debt is worthless in
whole or in part the district director will consider all pertinent
evidence, including the value of the collateral, if any, securing the
debt and the financial condition of the debtor.
(b) Legal action not required. Where the surrounding circumstances
indicate that a debt is worthless and uncollectible and that legal
action to enforce payment would in all probability not result in the
satisfaction of execution on a judgment, a showing of these facts will
be sufficient evidence of the worthlessness of the debt for purposes of
the deduction under section 166.
(c) Bankruptcy--(1) General rule. Bankruptcy is generally an
indication of the worthlessness of at least a part of an unsecured and
unpreferred debt.
(2) Year of deduction. In bankruptcy cases a debt may become
worthless before settlement in some instances; and in others, only when
a settlement in bankruptcy has been reached. In either case, the mere
fact that bankruptcy proceedings instituted against the debtor are
terminated in a later year, thereby confirming the conclusion that the
debt is worthless, shall not authorize the shifting of the deduction
under section 166 to such later year.
(d) Banks and other regulated corporations--(1) Worthlessness
presumed in year of charge-off. If a bank or other corporation which is
subject to supervision by Federal authorities, or by State authorities
maintaining substantially equivalent standards, charges off a debt in
whole or in part, either--
[[Page 363]]
(i) In obedience to the specific orders of such authorities, or
(ii) In accordance with established policies of such authorities,
and, upon their first audit of the bank or other corporation subsequent
to the charge-off, such authorities confirm in writing that the charge-
off would have been subject to such specific orders if the audit had
been made on the date of the charge-off,
then the debt shall, to the extent charged off during the taxable year,
be conclusively presumed to have become worthless, or worthless only in
part, as the case may be, during such taxable year. But no such debt
shall be so conclusively presumed to be worthless, or worthless only in
part, as the case may be, if the amount so charged off is not claimed as
a deduction by the taxpayer at the time of filing the return for the
taxable year in which the charge-off takes place.
(2) Evidence of worthlessness in later taxable year. If such a bank
or other corporation does not claim a deduction for such a totally or
partially worthless debt in its return for the taxable year in which the
charge-off takes place, but claims the deduction for a later taxable
year, then the charge-off in the prior taxable year shall be deemed to
have been involuntary and the deduction under section 166 shall be
allowed for the taxable year for which claimed, provided that the
taxpayer produces sufficient evidence to show that--
(i) The debt became wholly worthless in the later taxable year, or
became recoverable only in part subsequent to the taxable year of the
involuntary charge-off, as the case may be; and,
(ii) To the extent that the deduction claimed in the later taxable
year for a debt partially worthless was not involuntarily charged off in
prior taxable years, it was charged off in the later taxable year.
(3) Conformity election--(i) Eligibility for election. In lieu of
applying paragraphs (d)(1) and (2) of this section, a bank (as defined
in paragraph (d)(4)(i) of this section) that is subject to supervision
by Federal authorities, or by state authorities maintaining
substantially equivalent standards, may elect under this paragraph
(d)(3) to use a method of accounting that establishes a conclusive
presumption of worthlessness for debts, provided that the bank meets the
express determination requirement of paragraph (d)(3)(iii)(D) of this
section for the taxable year of the election.
(ii) Conclusive presumption--(A) In general. If a bank satisfies the
express determination requirement of paragraph (d)(3)(iii)(D) of this
section and elects to use the method of accounting under this paragraph
(d)(3)--
(1) Debts charged off, in whole or in part, for regulatory purposes
during a taxable year are conclusively presumed to have become
worthless, or worthless only in part, as the case may be, during that
year, but only if the charge-off results from a specific order of the
bank's supervisory authority or corresponds to the bank's classification
of the debt, in whole or in part, as a loss asset, as described in
paragraph (d)(3)(ii)(C) of this section; and
(2) A bad debt deduction for a debt that is subject to regulatory
loss classification standards is allowed for a taxable year only to the
extent that the debt is conclusively presumed to have become worthless
under paragraph (d)(3)(ii)(A)(1) of this section during that year.
(B) Charge-off should have been made in earlier year. The conclusive
presumption that a debt is worthless in the year that it is charged off
for regulatory purposes applies even if the bank's supervisory authority
determines in a subsequent year that the charge-off should have been
made in an earlier year. A pattern of charge-offs in the wrong year,
however, may result in revocation of the bank's election by the
Commissioner pursuant to paragraph (d)(3)(iv)(D) of this section.
(C) Loss asset defined. A debt is classified as a loss asset by a
bank if the bank assigns the debt to a class that corresponds to a loss
asset classification under the standards set forth in the ``Uniform
Agreement on the Classification of Assets and Securities Held by Banks''
(See Attachment to Comptroller of the Currency Banking Circular No. 127,
Rev. 4-26-91, Comptroller of the Currency, Communications Department,
Washington, DC 20219) or similar guidance issued by the Office of
[[Page 364]]
the Comptroller of the Currency, the Federal Deposit Insurance
Corporation, the Board of Governors of the Federal Reserve, or the Farm
Credit Administration; or for institutions under the supervision of the
Office of Thrift Supervision, 12 CFR 563.160(b)(3).
(iii) Election--(A) In general. An election under this paragraph
(d)(3) is to be made on bank-by-bank basis and constitutes either the
adoption of or a change in method of accounting, depending on the
particular bank's facts. A change in method of accounting that results
from the making of an election under this paragraph (d)(3) has the
effects described in paragraph (d)(3)(iii)(B) of this section.
(B) Effect of change in method of accounting. A change in method of
accounting resulting from an election under this paragraph (d)(3) does
not require or permit an adjustment under section 481(a). Under this
cut-off approach--
(1) There is no change in the Sec. 1.1011-1 adjusted basis of the
bank's existing debts (as determined under the bank's former method of
accounting for bad debts) as a result of the change in method of
accounting;
(2) With respect to debts that are subject to regulatory loss
classification standards and are held by the bank at the beginning of
the year of change (to the extent that they have not been charged off
for regulatory purposes), and with respect to debts subject to
regulatory loss classification standards that are originated or acquired
subsequent to the beginning of the year of change, bad debt deductions
in the year of change and thereafter are determined under the method of
accounting for bad debts prescribed by this paragraph (d)(3);
(3) With respect to debts that are not subject to regulatory loss
classification standards or that have been totally charged off prior to
the year of change, bad debt deductions are determined under the general
rules of section 166; and
(4) If there was any partial charge-off of a debt in a prechange
year, any portion of which was not claimed as a deduction, the deduction
reflecting that partial charge-off must be taken in the first year in
which there is any further charge-off of the debt for regulatory
purposes.
(C) Procedures--(1) In general. A new bank adopts the method of
accounting under this paragraph (d)(3) for any taxable year ending on or
after December 31, 1991 (and for all subsequent taxable years) when it
adopts its overall method of accounting for bad debts, by attaching a
statement to this effect to its income tax return for that year. Any
other bank makes an election for any taxable year ending on or after
December 31, 1991 (and for all subsequent taxable years) by filing a
completed Form 3115 (Application for Change in Accounting Method) in
accordance with the rules of paragraph (d)(3)(iii)(C)(2) or (3) of this
section. The statement or Form 3115 must include the name, address, and
taxpayer identification number of the electing bank and contain a
declaration that the express determination requirement of paragraph
(d)(3)(iii)(D) of this section is satisfied for the taxable year of the
election. When a Form 3115 is used, the declaration must be made in the
space provided on the form for ``Other changes in method of
accounting.'' The words ``ELECTION UNDER Sec. 1.166-2(d)(3)'' must be
typed or legibly printed at the top of the statement or page 1 of the
Form 3115.
(2) First election. The first time a bank makes this election, the
statement or Form 3115 must be attached to the bank's timely filed
return (taking into account extensions of time to file) for the first
taxable year covered by the election. The consent of the Commissioner to
make a change in method of accounting under this paragraph (d)(3) is
granted, pursuant to section 446(e), to any bank that makes the election
in accordance with this paragraph (d)(3)(iii)(C), provided the bank has
not made a prior election under this paragraph (d)(3).
(3) Subsequent elections. The advance consent of the Commissioner is
required to make any election under this paragraph (d)(3) after a
previous election has been revoked pursuant to paragraph (d)(3)(iv) of
this section. This consent must be requested under the procedures,
terms, and conditions
[[Page 365]]
prescribed under the authority of section 446(e) and Sec. 1.446-1(e)
for requesting a change in method of accounting.
(D) Express determination requirement. In connection with its most
recent examination involving the bank's loan review process, the bank's
supervisory authority must have made an express determination (in
accordance with any applicable administrative procedure prescribed
hereunder) that the bank maintains and applies loan loss classification
standards that are consistent with the regulatory standards of that
supervisory authority. For purposes of this paragraph (d)(3)(iii)(D),
the supervisory authority of a bank is the appropriate Federal banking
agency for the bank, as that term is defined in 12 U.S.C. 1813(q), or,
in the case of an institution in the Farm Credit System, the Farm Credit
Administration.
(E) Transition period election. For taxable years ending before
completion of the first examination of the bank by its supervisory
authority (as defined in paragraph (d)(3)(iii)(D) of this section) that
is after October 1, 1992, and that involves the bank's loan review
process, the statement or Form 3115 filed by the bank must include a
declaration that the bank maintains and applies loan loss classification
standards that are consistent with the regulatory standards of that
supervisory authority. A bank that makes this declaration is deemed to
satisfy the express determination requirement of paragraph
(d)(3)(iii)(D) of this section for those years, even though an express
determination has not yet been made.
(iv) Revocation of Election--(A) In general. Revocation of an
election under this paragraph (d)(3) constitutes a change in method of
accounting that has the effects described in paragraph (d)(3)(iv)(B) of
this section. If an election under this paragraph (d)(3) has been
revoked, a bank may make a subsequent election only under the provisions
of paragraph (d)(3)(iii)(C)(3) of this section.
(B) Effect of change in method of accounting. A change in method of
accounting resulting from revocation of an election under this paragraph
(d)(3) does not require or permit an adjustment under section 481(a).
Under this cut-off approach--
(1) There is no change in the Sec. 1.1011-1 adjusted basis of the
bank's existing debts (as determined under this paragraph (d)(3) method
or any other former method of accounting used by the bank with respect
to its bad debts) as a result of the change in method of accounting; and
(2) Bad debt deductions in the year of change and thereafter with
respect to all debts held by the bank, whether in existence at the
beginning of the year of change or subsequently originated or acquired,
are determined under the new method of accounting.
(C) Automatic revocation--(1) In general--A bank's election under
this paragraph (d)(3) is revoked automatically if, in connection with
any examination involving the bank's loan review process by the bank's
supervisory authority as defined in paragraph (d)(3)(iii)(D) of this
section, the bank does not obtain the express determination required by
that paragraph.
(2) Year of revocation. If a bank makes the conformity election
under the transition rules of paragraph (d)(3)(iii)(E) of this section
and does not obtain the express determination in connection with the
first examination involving the bank's loan review process that is after
October 1, 1992, the election is revoked as of the beginning of the
taxable year of the election or, if later, the earliest taxable year for
which tax may be assessed. In other cases in which a bank does not
obtain an express determination in connection with an examination of its
loan review process, the election is revoked as of the beginning of the
taxable year that includes the date as of which the supervisory
authority conducts the examination even if the examination is completed
in the following taxable year.
(3) Consent granted. Under the Commissioner's authority in section
446(e) and Sec. 1.446-1(e), the bank is directed to and is granted
consent to change from this paragraph (3)(1) method as of the year of
revocation (year of change) prescribed by paragraph (d)(3)(iv)(C)(2) of
this section.
[[Page 366]]
(4) Requirements. A bank changing its method of accounting under the
automatic revocation rules of this paragraph (d)(3)(iv)(C) must attach a
completed Form 3115 to its income tax return for the year of revocation
prescribed by paragraph (d)(3)(iv)(C)(2) of this section. The words
``REVOCATION OF Sec. 1.166-2(d)(3) ELECTION'' must be typed or legibly
printed at the top of page 1 of the Form 3115. If the year of revocation
is a year for which the bank has already filed its income tax return,
the bank must file an amended return for that year reflecting its change
in method of accounting and must attach the completed Form 3115 to that
amended return. The bank also must file amended returns reflecting the
new method of accounting for all subsequent taxable years for which
returns have been filed and tax may be assessed.
(D) Revocation by Commissioner. An election under this paragraph
(d)(3) may be revoked by the Commissioner as of the beginning of any
taxable year for which a bank fails to follow the method of accounting
prescribed by this paragraph. In addition, the Commissioner may revoke
an election as of the beginning of any taxable year for which the
Commissioner determines that a bank has taken charge-offs and deductions
that, under all facts and circumstances existing at the time, were
substantially in excess of those warranted by the exercise of reasonable
business judgment in applying the regulatory standards of the bank's
supervisory authority as defined in paragraph (d)(3)(III)(D) of this
section.
(E) Voluntary revocation. A bank may apply for revocation of its
election made under this paragraph (d)(3) by timely filing a completed
Form 3115 for the appropriate year and obtaining the consent of the
Commissioner in accordance with section 446(e) and Sec. 1.446-1(e)
(including any applicable administrative procedures prescribed
thereunder). The words ``REVOCATION OF Sec. 1.166-2(d)(3) ELECTION''
must be typed or legibly printed at the top of page 1 of the Form 3115.
If any bank has had its election automatically revoked pursuant to
paragraph (d)(3)(iv)(C) of this section and has not changed its method
of accounting in accordance with the requirements of that paragraph, the
Commissioner will require that any voluntary change in method of
accounting under this paragraph (d)(3)(iv)(E) be implemented
retroactively pursuant to the same amended return terms and conditions
as are prescribed by paragraph (d)(3)(iv)(C) of this section.
(4) Definitions. For purposes of this paragraph (d)--
(i) Bank. The term bank has the meaning assigned to it by section
581. The term bank also includes any corporation that would be a bank
within the meaning of section 581 except for the fact that it is a
foreign corporation, but this paragraph (d) applies only with respect to
loans the interest on which is effectively connected with the conduct of
a banking business within the United States. In addition, the term bank
includes a Farm Credit System institution that is subject to supervision
by the Farm Credit Administration.
(ii) Charge-off. For banks regulated by the Office of Thrift
Supervision, the term charge-off includes the establishment of specific
allowances for loan losses in the amount of 100 percent of the portion
of the debt classified as loss.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 7254, 38 FR 2418, Jan. 26, 1973; T.D. 8396, 57 FR 6294,
Feb. 24, 1992; T.D. 8441, 57 FR 45569, Oct. 2, 1992; T.D. 8492, 58 FR
53658, Oct. 18, 1993]
Sec. 1.166-3 Partial or total worthlessness.
(a) Partial worthlessness--(1) Applicable to specific debts only. A
deduction under section 166(a)(2) on account of partially worthless
debts shall be allowed with respect to specific debts only.
(2) Charge-off required. (i) If, from all the surrounding and
attending circumstances, the district director is satisfied that a debt
is partially worthless, the amount which has become worthless shall be
allowed as a deduction under section 166(a)(2) but only to the extent
charged off during the taxable year.
(ii) If a taxpayer claims a deduction for a part of a debt for the
taxable year within which that part of the debt is
[[Page 367]]
charged off and the deduction is disallowed for that taxable year, then,
in a case where the debt becomes partially worthless after the close of
that taxable year, a deduction under section 166(a)(2) shall be allowed
for a subsequent taxable year but not in excess of the amount charged
off in the prior taxable year plus any amount charged off in the
subsequent taxable year. In such instance, the charge-off in the prior
taxable year shall, if consistently maintained as such, be sufficient to
that extent to meet the charge-off requirement of section 166(a)(2) with
respect to the subsequent taxable year.
(iii) Before a taxpayer may deduct a debt in part, he must be able
to demonstrate to the satisfaction of the district director the amount
thereof which is worthless and the part thereof which has been charged
off.
(3) Significantly modified debt--(i) Deemed charge-off. If a
significant modification of a debt instrument (within the meaning of
Sec. 1.1001-3) during a taxable year results in the recognition of gain
by a taxpayer under Sec. 1.1001-1(a), and if the requirements of
paragraph (a)(3)(ii) of this section are met, there is a deemed charge-
off of the debt during that taxable year in the amount specified in
paragraph (a)(3)(iii) of this section.
(ii) Requirements for deemed charge-off. A debt is deemed to have
been charged off only if--
(A) The taxpayer (or, in the case of a debt that constitutes
transferred basis property within the meaning of section 7701(a)(43), a
transferor taxpayer) has claimed a deduction for partial worthlessness
of the debt in any prior taxable year; and
(B) Each prior charge-off and deduction for partial worthlessness
satisfied the requirements of paragraphs (a) (1) and (2) of this
section.
(iii) Amount of deemed charge-off. The amount of the deemed charge-
off, if any, is the amount by which the tax basis of the debt exceeds
the greater of the fair market value of the debt or the amount of the
debt recorded on the taxpayer's books and records reduced as appropriate
for a specific allowance for loan losses. The amount of the deemed
charge-off, however, may not exceed the amount of recognized gain
described in paragraph (a)(3)(i) of this section.
(iv) Effective date. This paragraph (a)(3) applies to significant
modifications of debt instruments occurring on or after September 23,
1996.
(b) Total worthlessness. If a debt becomes wholly worthless during
the taxable year, the amount thereof which has not been allowed as a
deduction from gross income for any prior taxable year shall be allowed
as a deduction for the current taxable year.
[T.D. 6500, 25 FR 11402, Nov. 29, 1960, as amended by T.D. 8763, 63 FR
4396, Jan. 29, 1998]
Sec. 1.166-4 Reserve for bad debts.
(a) Allowance of deduction. A taxpayer who has established the
reserve method of treating bad debts and has maintained proper reserve
accounts for bad debts or who, in accordance with paragraph (b) of Sec.
1.166-1, adopts the reserve method of treating bad debts may deduct from
gross income a reasonable addition to a reserve for bad debts in lieu of
deducting specific bad debt items. This paragraph applies both to bad
debts owed to the taxpayer and to bad debts arising out of section
166(f)(1)(A) guaranteed debt obligations. If a reserve is maintained for
bad debts arising out of section 166(f)(1)(A) guaranteed debt
obligations, then a separate reserve must also be maintained for all
other debt obligations of the taxpayer in the same trade or business, if
any. A taxpayer may not maintain a reserve for bad debts arising out of
section 166(f)(1)(A) guaranteed debt obligations if with respect to
direct debt obligations in the same trade or business the taxpayer takes
deductions when the debts become worthless in whole or in part rather
than maintaining a reserve for such obligations. See Sec. 1.166-10 for
rules concerning section 166(f)(1)(A) guaranteed debt obligations.
(b) Reasonableness of addition to reserve--(1) Relevant factors.
What constitutes a reasonable addition to a reserve for bad debts shall
be determined in the light of the facts existing at the close of the
taxable year of the proposed addition. The reasonableness of the
addition will vary as between classes of business and with conditions of
[[Page 368]]
business prosperity. It will depend primarily upon the total amount of
debts outstanding as of the close of the taxable year, including those
arising currently as well as those arising in prior taxable years, and
the total amount of the existing reserve.
(2) Correction of errors in prior estimates. In the event that
subsequent realizations upon outstanding debts prove to be more or less
than estimated at the time of the creation of the existing reserve, the
amount of the excess or inadequacy in the existing reserve shall be
reflected in the determination of the reasonable addition necessary in
the current taxable year.
(c) Statement required. A taxpayer using the reserve method shall
file with his return a statement showing--
(1) The volume of his charge sales or other business transactions
for the taxable year and the percentage of the reserve to such amount;
(2) The total amount of notes and accounts receivable at the
beginning and close of the taxable year;
(3) The amount of the debts which have become wholly or partially
worthless and have been charged against the reserve account; and
(4) The computation of the addition to the reserve for bad debts.
(d) Special rules applicable to financial institutions. (1) For
special rules for the addition to the bad debt reserves of certain
banks, see Sec. Sec. 1.585-1 through 1.585-3.
(2) For special rules for the addition to the bad debt reserves of
small business investment companies and business development
corporations, see Sec. Sec. 1.586-1 and 1.586-2.
(3) For special rules for the addition to the bad debts reserves of
certain mutual savings banks, domestic building and loan associations,
and cooperative banks, see Sec. Sec. 1.593-1 through 1.593-11.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6728, 29 FR
5855, May 5, 1964; T.D. 7444, 41 FR 53481, Dec. 7, 1976; T.D. 8071, 51
FR 2479, Jan. 17, 1986]
Sec. 1.166-5 Nonbusiness debts.
(a) Allowance of deduction as capital loss. (1) The loss resulting
from any nonbusiness debt's becoming partially or wholly worthless
within the taxable year shall not be allowed as a deduction under either
section 166(a) or section 166(c) in determining the taxable income of a
taxpayer other than a corporation. See section 166(d)(1)(A).
(2) If, in the case of a taxpayer other than a corporation, a
nonbusiness debt becomes wholly worthless within the taxable year, the
loss resulting therefrom shall be treated as a loss from the sale or
exchange, during the taxable year, of a capital asset held for not more
than 1 year (6 months for taxable years beginning before 1977; 9 months
for taxable years beginning in 1977). Such a loss is subject to the
limitations provided in section 1211, relating to the limitation on
capital losses, and section 1212, relating to the capital loss
carryover, and in the regulations under those sections. A loss on a
nonbusiness debt shall be treated as sustained only if and when the debt
has become totally worthless, and no deduction shall be allowed for a
nonbusiness debt which is recoverable in part during the taxable year.
(b) Nonbusiness debt defined. For purposes of section 166 and this
section, a nonbusiness debt is any debt other than--
(1) A debt which is created, or acquired, in the course of a trade
or business of the taxpayer, determined without regard to the
relationship of the debt to a trade or business of the taxpayer at the
time when the debt becomes worthless; or
(2) A debt the loss from the worthlessness of which is incurred in
the taxpayer's trade or business.
The question whether a debt is a nonbusiness debt is a question of fact
in each particular case. The determination of whether the loss on a
debt's becoming worthless has been incurred in a trade or business of
the taxpayer shall, for this purpose, be made in substantially the same
manner for determining whether a loss has been incurred in a trade or
business for purposes of section 165(c)(1). For purposes of subparagraph
(2) of this paragraph, the character of the debt is to be determined by
the relation which the loss resulting from the debt's becoming worthless
bears to the trade or business of the taxpayer. If that relation is a
proximate one in the conduct of the trade or business in which the
taxpayer
[[Page 369]]
is engaged at the time the debt becomes worthless, the debt comes within
the exception provided by that subparagraph. The use to which the
borrowed funds are put by the debtor is of no consequence in making a
determination under this paragraph. For purposes of section 166 and this
section, a nonbusiness debt does not include a debt described in section
165(g)(2)(C). See Sec. 1.165-5, relating to losses on worthless
securities.
(c) Guaranty of obligations. For provisions treating a loss
sustained by a guarantor of obligations as a loss resulting from the
worthlessness of a debt, see Sec. Sec. 1.166-8 and 1.166-9.
(d) Examples. The application of this section may be illustrated by
the following examples involving a case where A, an individual who is
engaged in the grocery business and who makes his return on the basis of
the calendar year, extends credit to B in 1955 on an open account:
Example 1. In 1956 A sells the business but retains the claim
against B. The claim becomes worthless in A's hands in 1957. A's loss is
not controlled by the nonbusiness debt provisions, since the original
consideration has been advanced by A in his trade or business.
Example 2. In 1956 A sells the business to C but sells the claim
against B to the taxpayer, D. The claim becomes worthless in D's hands
in 1957. During 1956 and 1957, D is not engaged in any trade or
business. D's loss is controlled by the nonbusiness debt provisions even
though the original consideration has been advanced by A in his trade or
business, since the debt has not been created or acquired in connection
with a trade or business of D and since in 1957 D is not engaged in a
trade or business incident to the conduct of which a loss from the
worthlessness of such claim is a proximate result.
Example 3. In 1956 A dies, leaving the business, including the
accounts receivable, to his son, C, the taxpayer. The claim against B
becomes worthless in C's hands in 1957. C's loss is not controlled by
the nonbusiness debt provisions. While C does not advance any
consideration for the claim, or create or acquire it in connection with
his trade or business, the loss is sustained as a proximate incident to
the conduct of the trade or business in which he is engaged at the time
the debt becomes worthless.
Example 4. In 1956 A dies, leaving the business to his son, C, but
leaving the claim against B to his son, D, the taxpayer. The claim
against B becomes worthless in D's hands in 1957. During 1956 and 1957,
D is not engaged in any trade or business. D's loss is controlled by the
nonbusiness debt provisions even though the original consideration has
been advanced by A in his trade or business, since the debt has not been
created or acquired in connection with a trade or business of D and
since in 1957 D is not engaged in a trade or business incident to the
conduct of which a loss from the worthlessness of such claim is a
proximate result.
Example 5. In 1956 A dies; and, while his executor, C, is carrying
on the business, the claim against B becomes worthless in 1957. The loss
sustained by A's estate is not controlled by the nonbusiness debt
provisions. While C does not advance any consideration for the claim on
behalf of the estate, or create or acquire it in connection with a trade
or business in which the estate is engaged, the loss is sustained as a
proximate incident to the conduct of the trade or business in which the
estate is engaged at the time the debt becomes worthless.
Example 6. In 1956, A, in liquidating the business, attempts to
collect the claim against B but finds that it has become worthless. A's
loss is not controlled by the nonbusiness debt provisions, since the
original consideration has been advanced by A in his trade or business
and since a loss incurred in liquidating a trade or business is a
proximate incident to the conduct thereof.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657, 44 FR
68464, Nov. 29, 1979; T.D. 7728, 45 FR 72650, Nov. 3, 1980]
Sec. 1.166-6 Sale of mortgaged or pledged property.
(a) Deficiency deductible as bad debt--(1) Principal amount. If
mortgaged or pledged property is lawfully sold (whether to the creditor
or another purchaser) for less than the amount of the debt, and the
portion of the indebtedness remaining unsatisfied after the sale is
wholly or partially uncollectible, the mortgagee or pledgee may deduct
such amount under section 166(a) (to the extent that it constitutes
capital or represents an item the income from which has been returned by
him) as a bad debt for the taxable year in which it becomes wholly
worthless or is charged off as partially worthless. See Sec. 1.166-3.
(2) Accrued interest. Accrued interest may be included as part of
the deduction allowable under this paragraph, but only if it has
previously been returned as income.
(b) Realization of gain or loss--(1) Determination of amount. If, in
the case of a sale described in paragraph (a) of this
[[Page 370]]
section, the creditor buys in the mortgaged or pledged property, loss or
gain is also realized, measured by the difference between the amount of
those obligations of the debtor which are applied to the purchase or bid
price of the property (to the extent that such obligations constitute
capital or represent an item the income from which has been returned by
the creditor) and the fair market value of the property.
(2) Fair market value defined. The fair market value of the property
for this purpose shall, in the absence of clear and convincing proof to
the contrary, be presumed to be the amount for which it is bid in by the
taxpayer.
(c) Basis of property purchased. If the creditor subsequently sells
the property so acquired, the basis for determining gain or loss upon
the subsequent sale is the fair market value of the property at the date
of its acquisition by the creditor.
(d) Special rules applicable to certain banking organizations. For
special rules relating to the treatment of mortgaged or pledged property
by certain mutual savings banks, domestic building and loan
associations, and cooperative banks, see section 595 and the regulations
thereunder.
(e) Special rules applicable to certain reacquisitions of real
property. Notwithstanding this section, special rules apply for taxable
years beginning after September 2, 1964 (and for certain taxable years
beginning after December 31, 1957), to the gain or loss on certain
reacquisitions of real property, to indebtedness remaining unsatisfied
as a result of such reacquisitions, and to the basis of the reacquired
real property. See Sec. Sec. 1.1038-1 through 1.1038-3.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6814, 30 FR
4472, Apr. 7, 1965, T.D. 6916, 32 FR 5923, Apr. 13, 1967]
Sec. 1.166-7 Worthless bonds issued by an individual.
(a) Allowance of deduction. A bond or other similar obligation
issued by an individual, if it becomes worthless in whole or in part, is
subject to the bad debt provisions of section 166. The loss from the
worthlessness of any such bond or obligation is deductible in accordance
with section 166(a), unless such bond or obligation is a nonbusiness
debt as defined in section 166(d)(2). If the bond or obligation is a
nonbusiness debt, it is subject to section 166(d) and Sec. 1.166-5.
(b) Decline in market value. A taxpayer possessing debts evidenced
by bonds or other similar obligations issued by an individual shall not
be allowed any deduction under section 166 on account of mere market
fluctuation in the value of such obligations.
(c) Worthless bonds issued by corporation. For provisions allowing
the deduction under section 165(a) of the loss sustained upon the
worthlessness of any bond or similar obligation issued by a corporation
or a government, see Sec. 1.165-5.
(d) Application to inventories. This section does not apply to any
loss upon the worthlessness of any bond or similar obligation reflected
in inventories required to be taken by a dealer in securities under
section 471. See Sec. 1.471-5.
Sec. 1.166-8 Losses of guarantors, endorsers, and indemnitors incurred
on agreements made before January 1, 1976.
(a) Noncorporate obligations--(1) Deductible as bad debt. A payment
during the taxable year by a taxpayer other than a corporation in
discharge of part or all of his obligation as a guarantor, endorser, or
indemnitor of an obligation issued by a person other than a corporation
shall, for purposes of section 166 and the regulations thereunder, be
treated as a debt's becoming worthless within the taxable year, if--
(i) The proceeds of the obligation so issued have been used in the
trade or business of the borrower, and
(ii) The borrower's obligation to the person to whom the taxpayer's
payment is made is worthless at the time of payment except for the
existence of the guaranty, endorsement, or indemnity, whether or not
such obligation has in fact become worthless within the taxable year in
which payment is made.
(2) Nonbusiness debt rule not applicable. If a payment is treated as
a loss in accordance with the provisions of subparagraph (1) of this
paragraph, section 166(d), relating to the special rule for losses
sustained on the worthlessness of a nonbusiness debt, shall not apply.
[[Page 371]]
Accordingly, in each instance the loss shall be deducted under section
166(a)(1) as a wholly worthless debt even though there has been a
discharge of only a part of the taxpayer's obligation. Thus, if the
taxpayer makes a payment during the taxable year in discharge of only
part of his obligation as a guarantor, endorser, or indemnitor, he may
treat such payment under section 166(a)(1) as a debt's becoming wholly
worthless within the taxable year, provided that he can establish that
such part of the borrower's obligation to the person to whom the
taxpayer's payment is made is worthless at the time of payment and the
conditions of subparagraph (1) of this paragraph have otherwise been
satisfied.
(3) Other applicable provisions. Other provisions of the internal
revenue laws relating to bad debts, such as section 111, relating to the
recovery of bad debts, shall be deemed to apply to any payment which,
under the provisions of this paragraph, is treated as a bad debt. If the
requirements of section 166(f) are not met, any loss sustained by a
guarantor, endorser, or indemnitor upon the worthlessness of the
debtor's obligation shall be treated under the provisions of law
applicable thereto. See, for example, paragraph (b) of this section.
(b) Corporate obligations. The loss sustained during the taxable
year by a taxpayer other than a corporation in discharge of all of his
obligation as a guarantor of an obligation issued by a corporation shall
be treated, in accordance with section 166(d) and the regulations
thereunder, as a loss sustained on the worthlessness of a nonbusiness
debt if the debt created in the guarantor's favor as a result of the
payment does not come within the exceptions prescribed by section
166(d)(2) (A) or (B). See paragraph (a)(2) of Sec. 1.166-5.
(c) Examples. The application of this section may be illustrated by
the following examples:
Example 1. During 1955, A, an individual who makes his return on the
basis of the calendar year, guarantees payment of an obligation of B, an
individual, to the X Bank, the proceeds of the obligation being used in
B's business. B defaults on his obligation in 1956. A makes payment to
the X Bank during 1957 in discharge of his entire obligation as a
guarantor, the obligation of B to the X Bank being wholly worthless. For
his taxable year 1957, A is entitled to a deduction under section
166(a)(1) as a result of his payment during that year.
Example 2. During 1955, A, an individual who makes his return on the
basis of the calendar year, guarantees payment of an obligation of B, an
individual, to the X Bank, the proceeds of the obligation being used in
B's business. In 1956, B pays a part of his obligation to the X Bank but
defaults on the remaining part. In 1957, A makes payment to the X Bank,
in discharge of part of his obligation as a guarantor, of the remaining
unpaid part of B's obligation to the bank, such part of B's obligation
then being worthless. For his taxable year 1957, A is entitled to a
deduction under section 166(a) (1) as a result of his payment of the
remaining unpaid part of B's obligation.
Example 3. During 1955, A, an individual who makes his return on the
basis of the calendar year, guarantees payment of an obligation of B, an
individual, to the X Bank, the proceeds of the obligation being used for
B's personal use. B defaults on his obligation in 1956. A makes payment
to the X Bank during 1957 in discharge of his entire obligation as a
guarantor, the obligation of B to X Bank being wholly worthless. A may
not apply the benefit of section 166(f) to his loss, since the proceeds
of B's obligation have not been used in B's trade or business.
Example 4. During 1955, A, an individual who makes his return on the
basis of the calendar year, guarantees payment of an obligation of Y
Corporation to the X Bank, the proceeds of the obligation being used in
Y Corporation's business. Y Corporation defaults on its obligation in
1956. A makes payment to the X Bank during 1957 in discharge of his
entire obligation as a guarantor, the obligation of Y Corporation to the
X Bank being wholly worthless. At no time during 1955 or 1957 is A
engaged in a trade or business. For his taxable year 1957, A is entitled
to deduct a capital loss in accordance with the provisions of section
166(d) and paragraph (a) (2) of Sec. 1.166-5. He may not apply the
benefit of section 166(f) to his loss, since his payment is in discharge
of an obligation issued by a corporation.
(d) Effective date. This section applies only to losses, regardless
of the taxable year in which incurred, on agreements made before January
1, 1976.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7657, 44 FR
68464, Nov. 29, 1979]
[[Page 372]]
Sec. 1.166-9 Losses of guarantors, endorsers, and indemnitors incurred,
on agreements made after December 31, 1975, in taxable years beginning
after such date.
(a) Payment treated as worthless business debt. This paragraph
applies to taxpayers who, after December 31, 1975, enter into an
agreement in the course of their trade or business to act as (or in a
manner essentially equivalent to) a guarantor, endorser, or indemnitor
of (or other secondary obligor upon) a debt obligation. Subject to the
provisions of paragraphs (c), (d), and (e) of this section, a payment of
principal or interest made during a taxable year beginning after
December 31, 1975, by the taxpayer in discharge of part or all of the
taxpayer's obligation as a guarantor, endorser, or indemnitor is treated
as a business debt becoming worthless in the taxable year in which the
payment is made or in the taxable year described in paragraph (e)(2) of
this section. Neither section 163 (relating to interest) nor section 165
(relating to losses) shall apply with respect to such a payment.
(b) Payment treated as worthless nonbusiness debt. This paragraph
applies to taxpayers (other than corporations) who, after December 31,
1975, enter into a transaction for profit, but not in the course of
their trade or business, to act as (or in a manner essentially
equivalent to) a guarantor, endorser, or indemnitor of (or other
secondary obligor upon) a debt obligation. Subject to the provisions of
paragraphs (c), (d), and (e) of this section, a payment of principal or
interest made during a taxable year beginning after December 31, 1975,
by the taxpayer in discharge of part or all of the taxpayer's obligation
as a guarantor, endorser, or indemnitor is treated as a worthless
nonbusiness debt in the taxable year in which the payment is made or in
the taxable year described in paragraph (e)(2) of this section. Neither
section 163 nor section 165 shall apply with respect to such a payment.
(c) Obligations issued by corporations. No treatment as a worthless
debt is allowed with respect to a payment made by the taxpayer in
discharge of part or all of the taxpayer's obligation as a guarantor,
endorser, or indemnitor of an obligation issued by a corporation if, on
the basis of the facts and circumstances at the time the obligation was
entered into, the payment constitutes a contribution to capital by a
shareholder. The rule of this paragraph (c) applies to payments whenever
made (see paragraph (f) of this section).
(d) Certain payments treated as worthless debts. A payment in
discharge of part or all of taxpayer's agreement to act as guarantor,
endorser, or indemnitor of an obligation is to be treated as a worthless
debt only if--
(1) The agreement was entered into in the course of the taxpayer's
trade or business or a transaction for profit;
(2) There was an enforceable legal duty upon the taxpayer to make
the payment (except that legal action need not have been brought against
the taxpayer); and
(3) The agreement was entered into before the obligation became
worthless (or partially worthless in the case of an agreement entered
into in the course of the taxpayer's trade or business). See Sec. Sec.
1.166-2 and 1.166-3 for rules on worthless and partially worthless
debts. For purposes of this paragraph (d)(3), an agreement is considered
as entered into before the obligation became worthless (or partially
worthless) if there was a reasonable expectation on the part of the
taxpayer at the time the agreement was entered into that the taxpayer
would not be called upon to pay the debt (subject to such agreement)
without full reimbursement from the issuer of the obligation.
(e) Special rules--(1) Reasonable consideration required. Treatment
as a worthless debt of a payment made by a taxpayer in discharge of part
or all of the taxpayer's agreement to act as a guarantor, endorser, or
indemnitor of an obligation is allowed only if the taxpayer demonstrates
that reasonable consideration was received for entering into the
agreement. For purposes of this paragraph (e)(1), reasonable
consideration is not limited to direct consideration in the form of cash
or property. Thus, where a taxpayer can demonstrate that the agreement
was given without direct consideration in the form of cash or property
but in accordance with normal business practice or for a good faith
business purpose,
[[Page 373]]
worthless debt treatment is allowed with respect to a payment in
discharge of part or all of the agreement if the conditions of this
section are met. However, consideration received from a taxpayer's
spouse or any individual listed in section 152(a) must be direct
consideration in the form of cash or property.
(2) Right of subrogation. With respect to a payment made by a
taxpayer in discharge of part or all of the taxpayer's agreement to act
as a guarantor, endorser, or indemnitor where the agreement provides for
a right of subrogation or other similar right against the issuer,
treatment as a worthless debt is not allowed until the taxable year in
which the right of subrogation or other similar right becomes totally
worthless (or partially worthless in the case of an agreement which
arose in the course of the taxpayer's trade or business).
(3) Other applicable provisions. Unless inconsistent with this
section, other Internal Revenue laws concerning worthless debts, such as
section 111 relating to the recovery of bad debts, apply to any payment
which, under the provisions of this section, is treated as giving rise
to a worthless debt.
(4) Taxpayer defined. For purposes of this section, except as
otherwise provided, the term ``taxpayer'' means any taxpayer and
includes individuals, corporations, partnerships, trusts and estates.
(f) Effective date. This section applies to losses incurred on
agreements made after December 31, 1975, in taxable years beginning
after such date. However, paragraph (c) of this section also applies to
payments, regardless of the taxable year in which made, under agreements
made before January 1, 1976.
[T.D. 7657, 44 FR 68465, Nov. 29, 1979, as amended by T.D. 7920, 48 FR
50712, Nov. 3, 1983]
Sec. 1.166-10 Reserve for guaranteed debt obligations.
(a) Definitions. The following provisions apply for purposes of this
section and section 166(f):
(1) Dealer in property. A dealer in property is a person who
regularly sells property in the ordinary course of the person's trade or
business.
(2) Guaranteed debt obligation. A guaranteed debt obligation is a
legal duty of one person as a guarantor, endorser or indemnitor of a
second person to pay a third person. It does not include duties based
solely on moral or good public relations considerations that are not
legally binding. A guaranteed debt obligation typically arises where a
seller receives in payment for property or services the debt obligation
of a purchaser and sells that obligation to a third party with recourse.
However, a guaranteed debt obligation also may arise out of a sale in
respect of which there is no direct debtor-creditor relationship between
the debtor purchaser and the seller. For example, it arises where a
purchaser borrows money from a third party to make payment to the seller
and the seller guarantees the payment of the purchaser's debt.
Generally, debt obligations which are sold without recourse do not
result in any obligation of the seller as a guarantor, endorser, or
indemnitor. However, there are certain without-recourse transactions
which may give rise to a seller's liability as a guarantor or
indemnitor. For example, such a liability may arise where a holder of a
debt obligation holds money or other property of a seller which the
holder may apply, without seeking permission of the seller, against any
uncollectible debt obligations transferred to the holder by the seller
without recourse, or where the seller is under a legal obligation to
reacquire the real or tangible personal property from the holder of the
debt obligation who repossessed property in satisfaction of the debt
obligations.
(3) Real or tangible personal property. Real or tangible personal
property generally does not include other forms of property, such as
securities. However, if the sale of other property is related to the
sale of actual real or tangible personal property, the other property
will be considered to be real or tangible personal property. In order
for the sale of other property to be related, it must be--
(i) Incidental to the sale of the actual real or tangible personal
property; and
[[Page 374]]
(ii) Made under an agreement, entered into at the same time as the
sale of actual real or tangible personal property, between the dealer in
that property and the customer with respect to that property.
The other property may be charged for as a part of, or in addition to,
the sales price of the actual real or tangible personal property. If the
value of the other property is not greater than 20 percent of the total
sales price, including the value of all related services other than
financing services, the sale of the other property is related to the
sale of actual real or tangible personal property.
(4) Related services. In the case of a sale of both property and
services a determination must be made as to whether the services are
related to the property. Related services include only those services
which are--
(i) Incidental to the sale of the real or tangible personal
property; and
(ii) To be performed under an agreement, entered into at the same
time as the sale of the property, between the dealer in property and the
customer with respect to the property.
Delivery, financing installation. maintenance, repair, or instructional
services generally qualify as related services. The services may be
charged for as a part of, or in addition to, the sales price of the
property. Where the value of all services other than financing services
is not greater than 20 percent of the total of the sales price of the
property, including the value of all the services other than financing
services, all of the services are considered to be incidental to the
sale of the property. Where the value of the services is greater than 20
percent, the determination as to whether a service is a related service
in a particular case is to be made on the basis of all relevant facts
and circumstances.
(5) Examples. The following examples apply to paragraph (a)(4) of
this section:
Example 1. A. a dealer in television sets sells a television set to
B, his customer. If at the time of the sale A, for a separate charge
which is added to the sales price of the set and which is not greater
than 20 percent of the total sales price, provides a 3-year service
contract on only that television set, the service contract is a related
service agreement. However, if A does not sell the service contract to B
contemporaneously with the sale of the television set, as would be the
case if the service agreement were entered into after the sale of the
set were completed, or if the service contract includes services for a
television set in addition to the one then sold by A to B, the service
contract is not an agreement for a related service.
Example 2. C, an automobile dealer, at the time of the sale by C of
an automobile to D, agrees to made available to D driving instructions
furnished by the M driving school, the cost of which is included in the
sale price of the automobile and is not greater than 20 percent of the
total sales price. C also agrees to pay M for the driving instructions
furnished to D. Since C's agreement with D to make available driving
instructions is incidental to the sale of the automobile, is made
contemporaneously with the sale, and is charged for as part of the sales
price of the automobile, it is an agreement for a related service. In
contrast, however, because M's agreement with C is not an agreement
between the dealer in property and the customer, M's agreement with C to
provide driving instructions to C's customers is not an agreement for a
related service.
(b) Incorporation of section 166(c) rules. A reserve for section
166(f)(1)(A) guaranteed debt obligations must be established and
maintained under the rules applicable to the reserve for bad debts under
section 166(c) (with the exception of the statement requirement under
Sec. 1.166-4 (c)). For example, the rules in Sec. 1.166-4(b), relating
to what constitutes a reasonable addition to a reserve for bad debts and
to correction of errors in prior estimates, apply to a reserve for
section 166(f)(1)(A) guaranteed debt obligations as well.
(c) Special requirements. Any reserve for section 166(f)(1)(A)
guaranteed debt obligations must be established and maintained
separately from any reserve for other debt obligations. In addition, a
taxpayer who charges off direct debts when they become worthless in
whole or in part rather than maintaining a reserve for such obligations
may not maintain a reserve for section 166(f)(1)(A) guaranteed debt
obligations in the same trade or business.
(d) Requirement of statement. A taxpayer who uses the reserve method
of treating section 166(f)(1)(A) guaranteed debt obligations must attach
to his return for each taxable year, returns for which are filed after
April 17, 1986, and
[[Page 375]]
for each trade or business for which the reserve is maintained a
statement showing--
(1) The total amount of these obligations at the beginning of the
taxable year;
(2) The total amount of these obligations incurred during the
taxable year;
(3) The amount of the initial balance of the suspense account, if
any, established with respect to these obligations;
(4) The balance of the suspense account, if any, at the beginning of
the taxable year,
(5) The adjustment, if any, to that account;
(6) The adjusted balance, if any, at the close of the taxable year;
(7) The reconciliation of the beginning and closing balances of the
reserve for these obligations and the computation of the addition to the
reserve; and
(8) The taxable year for which the reserve for these obligations was
established.
(e) Computation of opening balance--(1) In general. The opening
balance of a reserve for section 166(f)(1)(A) guaranteed debt
obligations established for the first taxable year for which a taxpayer
maintains such a reserve shall be determined as if the taxpayer had
maintained such a reserve for the taxable years preceding that taxable
year. The amount of the opening balance may be determined under the
following formula:
[GRAPHIC] [TIFF OMITTED] TC14NO91.176
where--
OB = the opening balance at the beginning of the first taxable year
CG = the amount of these obligations at the close of the last preceding
taxable year
SG = the sum of the amounts of these obligations at the close of the
five preceding taxable years
SNL the sum of the amounts of net losses arising from these obligations
for the five preceding taxable years
(2) Example. The following example applies to paragraph (e)(1) of
this section.
Example. For 1977, A, a dealer in automobiles who uses the calendar
year as the taxable year, adopts in accordance with this section the
reserve method of treating section 166(f)(1)(A) guaranteed debt
obligations. A's first year in business as an automobile dealer is 1973.
For 1972, 1973, 1974, 1975, and 1976, A's records disclose the following
information with respect to these obligations:
----------------------------------------------------------------------------------------------------------------
Gross
Obligations losses from Recoveries Net losses
Year outstanding at these from these from these
close of year obligations obligations obligations
----------------------------------------------------------------------------------------------------------------
1972..................................................... $0 $0 $0 $0
1973..................................................... 780,000 9,700 1,000 8,700
1974..................................................... 795,000 8,900 1,050 7,850
1975..................................................... 850,000 8,850 850 8,000
1976..................................................... 820,000 8,300 1,400 7,900
------------------------------------------------------
Total.................................................. 3,245,000 36,750 4,300 32,450
----------------------------------------------------------------------------------------------------------------
The opening balance for 1977 of A's reserve for these obligations is
$8,200, determined as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.177
(3) More appropriate balance. A taxpayer may select a balance other
than the one produced under paragraph (e)(1) of this section if it is
more appropriate, based upon the taxpayer's actual experience, and in
the event the taxpayer's return is examined, if the balance is approved
by the district director.
(4) No losses in the five preceding taxable years. If a taxpayer is
in the taxpayer's first taxable year of a particular trade or business,
or if the taxpayer has no losses arising from section 166(f)(1)(A)
guaranteed debt obligations in a particular trade or business for any
other reason in the five preceding taxable years, then the taxpayer's
opening balance is zero for that particular trade or business.
(5) Where reserve method was used before October 22, 1965. If for a
taxable year ending before October 22, 1965, the
[[Page 376]]
taxpayer maintained a reserve for bad debts under section 166(c) which
included guaranteed debt obligations described in section 166(f)(1)(A),
and if the taxpayer is allowed a deduction referred to in paragraph
(g)(2) of this section on account of those obligations, the amount of
the opening balance of the reserve for section 166(f)(1)(A) guaranteed
debt obligations for the taxpayer's first taxable year ending after
October 21, 1965, shall be an amount equal to that portion of the
section 166(c) reserve at the close of the last taxable year which is
attributable to those debt obligations. The amount of the balance of the
section 166(c) reserve for the taxable year shall be reduced by the
amount of the opening balance of the reserve for those guaranteed debt
obligations.
(f) Suspense account--(1) Zero opening balance cases. No suspense
account shall be maintained if the opening balance of the reserve for
section 166(f)(1)(A) guaranteed debt obligations under section 166(f)(3)
is zero
(2) Example. The following example applies to section 166(f)(4)(B),
relating to adjustments to the suspense account:
Example. In 1977, A, an individual who operates an appliance store
and uses the calendar year as the taxable year, adopts the reserve
method of treating section 166(f)(1)(A) guaranteed debt obligations. The
initial balance of A's suspense account is $8,200. At the close of 1977,
1978, 1979, and 1980, the balance of A's reserve for these obligations
is $8,400, $8,250, $8,150, and $8,175, respectively, after making the
addition to the reserve for each year. The adjustments under section
166(f)(4)(B) to the suspense account at the close of each of the years
involved are as follows:
(1) Taxable year............ 1977 1978 1979 1980
------------------------------------------------------------------------
(2) Closing reserve account $8,400 $8,250 $8,150 $8,175
balance....................
(3) Opening suspense account 8,200 8,200 8,200 8,150
balance....................
(4) Line (2) less line (3).. 200 50 (50 25
(5) Adjustment to suspense 0 0 (50 25
account balance............
(6) Closing suspense account 8,200 8,200 8,150 8,175
balance (line 3 plus line
5).........................
------------------------------------------------------------------------
(g) Effective date--(1) In general. This section is generally
effective for taxable years ending after October 21, 1965.
(2) Transitional rule. Section 2(b) of the Act of November 2, 1966
(Pub. L. 89-722, 80 Stat. 1151) allows additions to section 166(c) bad
debt reserves in earlier taxable years on account of section
166(f)(1)(A) guaranteed debt obligations to be deducted for those
earlier taxable years. Paragraphs (c), (d), (e), and (f) of this section
do not apply in determining whether a deduction is allowed under section
2(b) of the Act. See Rev. Rul. 68-313 (1968-1C.B. 75) for rules relating
to that deduction.
[T.D. 8071, 51 FR 2479, Jan. 17, 1986; 51 FR 9787, Mar. 21, 1986]
Sec. 1.167(a)-1 Depreciation in general.
(a) Reasonable allowance. Section 167(a) provides that a reasonable
allowance for the exhaustion, wear and tear, and obsolescence of
property used in the trade or business or of property held by the
taxpayer for the production of income shall be allowed as a depreciation
deduction. The allowance is that amount which should be set aside for
the taxable year in accordance with a reasonably consistent plan (not
necessarily at a uniform rate), so that the aggregate of the amounts set
aside, plus the salvage value, will, at the end of the estimated useful
life of the depreciable property, equal the cost or other basis of the
property as provided in section 167(g) and Sec. 1.167(g)-1. An asset
shall not be depreciated below a reasonable salvage value under any
method of computing depreciation. However, see section 167(f) and Sec.
1.167(f)-1 for rules which permit a reduction in the amount of salvage
value to be taken into account for certain personal property acquired
after October 16, 1962. See also paragraph (c) of this section for
definition of salvage. The allowance shall not reflect amounts
representing a mere reduction in market value. See section 179 and Sec.
1.179-1 for a further description of the term ``reasonable allowance.''
(b) Useful life. For the purpose of section 167 the estimated useful
life of an asset is not necessarily the useful life
[[Page 377]]
inherent in the asset but is the period over which the asset may
reasonably be expected to be useful to the taxpayer in his trade or
business or in the production of his income. This period shall be
determined by reference to his experience with similar property taking
into account present conditions and probable future developments. Some
of the factors to be considered in determining this period are (1) wear
and tear and decay or decline from natural causes, (2) the normal
progress of the art, economic changes, inventions, and current
developments within the industry and the taxpayer's trade or business,
(3) the climatic and other local conditions peculiar to the taxpayer's
trade or business, and (4) the taxpayer's policy as to repairs,
renewals, and replacements. Salvage value is not a factor for the
purpose of determining useful life. If the taxpayer's experience is
inadequate, the general experience in the industry may be used until
such time as the taxpayer's own experience forms an adequate basis for
making the determination. The estimated remaining useful life may be
subject to modification by reason of conditions known to exist at the
end of the taxable year and shall be redetermined when necessary
regardless of the method of computing depreciation. However, estimated
remaining useful life shall be redetermined only when the change in the
useful life is significant and there is a clear and convincing basis for
the redetermination. For rules covering agreements with respect to
useful life, see section 167(d) and Sec. 1.167(d)-1. If a taxpayer
claims an investment credit with respect to an asset for a taxable year
preceding the taxable year in which the asset is considered as placed in
service under Sec. 1.167(a)-10(b) or Sec. 1.167(a)-11(e), the useful
life of the asset under this paragraph shall be the same useful life
assigned to the asset under Sec. 1.46-3(e).
(c) Salvage. (1) Salvage value is the amount (determined at the time
of acquisition) which is estimated will be realizable upon sale or other
disposition of an asset when it is no longer useful in the taxpayer's
trade or business or in the production of his income and is to be
retired from service by the taxpayer. Salvage value shall not be changed
at any time after the determination made at the time of acquisition
merely because of changes in price levels. However, if there is a
redetermination of useful life under the rules of paragraph (b) of this
section, salvage value may be redetermined based upon facts known at the
time of such redetermination of useful life. Salvage, when reduced by
the cost of removal, is referred to as net salvage. The time at which an
asset is retired from service may vary according to the policy of the
taxpayer. If the taxpayer's policy is to dispose of assets which are
still in good operating condition, the salvage value may represent a
relatively large proportion of the original basis of the asset. However,
if the taxpayer customarily uses an asset until its inherent useful life
has been substantially exhausted, salvage value may represent no more
than junk value. Salvage value must be taken into account in determining
the depreciation deduction either by a reduction of the amount subject
to depreciation or by a reduction in the rate of depreciation, but in no
event shall an asset (or an account) be depreciated below a reasonable
salvage value. See, however, paragraph (a) of Sec. 1.167(b)-2 for the
treatment of salvage under the declining balance method, and Sec.
1.179-1 for the treatment of salvage in computing the additional first-
year depreciation allowance. The taxpayer may use either salvage or net
salvage in determining depreciation allowances but such practice must be
consistently followed and the treatment of the costs of removal must be
consistent with the practice adopted. For specific treatment of salvage
value, see Sec. Sec. 1.167(b)-1, 1.167(b)-2, and 1.167(b)-3. When an
asset is retired or disposed of, appropriate adjustments shall be made
in the asset and depreciation reserve accounts. For example, the amount
of the salvage adjusted for the costs of removal may be credited to the
depreciation reserve.
(2) For taxable years beginning after December 31, 1961, and ending
after October 16, 1962, see section 167(f) and
[[Page 378]]
Sec. 1.167(f)-1 for rules applicable to the reduction of salvage value
taken into account for certain personal property acquired after October
16, 1962.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR
3653, Mar. 24, 1964; T.D. 7203, 37 FR 17133, Aug. 25, 1972]
Sec. 1.167(a)-2 Tangible property.
The depreciation allowance in the case of tangible property applies
only to that part of the property which is subject to wear and tear, to
decay or decline from natural causes, to exhaustion, and to
obsolescence. The allowance does not apply to inventories or stock in
trade, or to land apart from the improvements or physical development
added to it. The allowance does not apply to natural resources which are
subject to the allowance for depletion provided in section 611. No
deduction for depreciation shall be allowed on automobiles or other
vehicles used solely for pleasure, on a building used by the taxpayer
solely as his residence, or on furniture or furnishings therein,
personal effects, or clothing; but properties and costumes used
exclusively in a business, such as a theatrical business, may be
depreciated.
Sec. 1.167(a)-3 Intangibles.
(a) In general. If an intangible asset is known from experience or
other factors to be of use in the business or in the production of
income for only a limited period, the length of which can be estimated
with reasonable accuracy, such an intangible asset may be the subject of
a depreciation allowance. Examples are patents and copyrights. An
intangible asset, the useful life of which is not limited, is not
subject to the allowance for depreciation. No allowance will be
permitted merely because, in the unsupported opinion of the taxpayer,
the intangible asset has a limited useful life. No deduction for
depreciation is allowable with respect to goodwill. For rules with
respect to organizational expenditures, see section 248 and the
regulations thereunder. For rules with respect to trademark and trade
name expenditures, see section 177 and the regulations thereunder. See
sections 197 and 167(f) and, to the extent applicable, Sec. Sec. 1.197-
2 and 1.167(a)-14 for amortization of goodwill and certain other
intangibles acquired after August 10, 1993, or after July 25, 1991, if a
valid retroactive election under Sec. 1.197-1T has been made.
(b) Safe harbor amortization for certain intangible assets--(1)
Useful life. Solely for purposes of determining the depreciation
allowance referred to in paragraph (a) of this section, a taxpayer may
treat an intangible asset as having a useful life equal to 15 years
unless--
(i) An amortization period or useful life for the intangible asset
is specifically prescribed or prohibited by the Internal Revenue Code,
the regulations thereunder (other than by this paragraph (b)), or other
published guidance in the Internal Revenue Bulletin (see Sec.
601.601(d)(2) of this chapter);
(ii) The intangible asset is described in Sec. 1.263(a)-4(c)
(relating to intangibles acquired from another person) or Sec.
1.263(a)-4(d)(2) (relating to created financial interests);
(iii) The intangible asset has a useful life the length of which can
be estimated with reasonable accuracy; or
(iv) The intangible asset is described in Sec. 1.263(a)-4(d)(8)
(relating to certain benefits arising from the provision, production, or
improvement of real property), in which case the taxpayer may treat the
intangible asset as having a useful life equal to 25 years solely for
purposes of determining the depreciation allowance referred to in
paragraph (a) of this section.
(2) Applicability to acquisitions of a trade or business, changes in
the capital structure of a business entity, and certain other
transactions. The safe harbor useful life provided by paragraph (b)(1)
of this section does not apply to an amount required to be capitalized
by Sec. 1.263(a)-5 (relating to amounts paid to facilitate an
acquisition of a trade or business, a change in the capital structure of
a business entity, and certain other transactions).
(3) Depreciation method. A taxpayer that determines its depreciation
allowance for an intangible asset using the 15-year useful life
prescribed by paragraph (b)(1) of this section (or the 25-year useful
life in the case of an intangible asset described in Sec. 1.263(a)-
4(d)(8)) must determine the allowance
[[Page 379]]
by amortizing the basis of the intangible asset (as determined under
section 167(c) and without regard to salvage value) ratably over the
useful life beginning on the first day of the month in which the
intangible asset is placed in service by the taxpayer. The intangible
asset is not eligible for amortization in the month of disposition.
(4) Effective date. This paragraph (b) applies to intangible assets
created on or after December 31, 2003.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 8867, 65 FR 3825, Jan. 25, 2000; T.D. 9107, 69 FR 444,
Jan. 5, 2004]
Sec. 1.167(a)-4 Leased property.
(a) In general. Capital expenditures made by either a lessee or
lessor for the erection of a building or for other permanent
improvements on leased property are recovered by the lessee or lessor
under the provisions of the Internal Revenue Code (Code) applicable to
the cost recovery of the building or improvements, if subject to
depreciation or amortization, without regard to the period of the lease.
For example, if the building or improvement is property to which section
168 applies, the lessee or lessor determines the depreciation deduction
for the building or improvement under section 168. See section
168(i)(8)(A). If the improvement is property to which section 167 or
section 197 applies, the lessee or lessor determines the depreciation or
amortization deduction for the improvement under section 167 or section
197, as applicable.
(b) Effective/applicability date--(1) In general. Except as provided
in paragraph (b)(2) or (b)(3) of this section, this section applies to
taxable years beginning on or after January 1, 2014.
(2) Application of this section to leasehold improvements placed in
service after December 31, 1986, in taxable years beginning before
January 1, 2014. For leasehold improvements placed in service after
December 31, 1986, in taxable years beginning before January 1, 2014, a
taxpayer may--
(i) Apply the provisions of this section; or
(ii) Depreciate any leasehold improvement to which section 168
applies under the provisions of section 168 and depreciate or amortize
any leasehold improvement to which section 168 does not apply under the
provisions of the Code that are applicable to the cost recovery of that
leasehold improvement, without regard to the period of the lease.
(3) Application of this section to leasehold improvements placed in
service before January 1, 1987. Section 1.167(a)-4 as contained in 26
CFR part 1 edition revised as of April 1, 2011, applies to leasehold
improvements placed in service before January 1, 1987.
(4) Change in method of accounting. Except as provided in Sec.
1.446-1(e)(2)(ii)(d)(3)(i), a change to comply with this section for
depreciable assets placed in service in a taxable year ending on or
after December 30, 2003, is a change in method of accounting to which
the provisions of section 446(e) and the regulations under section
446(e) apply. Except as provided in Sec. 1.446-1(e)(2)(ii)(d)(3)(i), a
taxpayer also may treat a change to comply with this section for
depreciable assets placed in service in a taxable year ending before
December 30, 2003, as a change in method of accounting to which the
provisions of section 446(e) and the regulations under section 446(e)
apply.
[T.D. 9636, 78 FR 57706, Sept. 19, 2013]
Sec. 1.167(a)-5 Apportionment of basis.
In the case of the acquisition on or after March 1, 1913, of a
combination of depreciable and nondepreciable property for a lump sum,
as for example, buildings and land, the basis for depreciation cannot
exceed an amount which bears the same proportion to the lump sum as the
value of the depreciable property at the time of acquisition bears to
the value of the entire property at that time. In the case of property
which is subject to both the allowance for depreciation and
amortization, depreciation is allowable only with respect to the portion
of the depreciable property which is not subject to the allowance for
amortization and may be taken concurrently with the allowance for
amortization. After the close of the amortization period or after
amortization deductions have been discontinued with respect to any such
property, the unrecovered cost or other basis of the depreciable portion
of such property
[[Page 380]]
will be subject to depreciation. For adjustments to basis, see section
1016 and other applicable provisions of law. For the adjustment to the
basis of a structure in the case of a donation of a qualified
conservation contribution under section 170(h), see Sec. 1.170A-
14(h)(3)(iii).
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 8069, 51 FR 1498, Jan. 14, 1986]
Sec. 1.167(a)-5T Application of section 1060 to section 167 (temporary).
In the case of an acquisition of a combination of depreciable and
nondepreciable property for a lump sum in an applicable asset
acquisition to which section 1060 applies, the basis for depreciation of
the depreciable property cannot exceed the amount of consideration
allocated to that property under section 1060 and Sec. 1.1060-1T.
[T.D. 8215, 53 FR 27043, July 18, 1988]
Sec. 1.167(a)-6 Depreciation in special cases.
(a) Depreciation of patents or copyrights. The cost or other basis
of a patent or copyright shall be depreciated over its remaining useful
life. Its cost to the patentee includes the various Government fees,
cost of drawings, models, attorneys' fees, and similar expenditures. For
rules applicable to research and experimental expenditures, see sections
174 and 1016 and the regulations thereunder. If a patent or copyright
becomes valueless in any year before its expiration the unrecovered cost
or other basis may be deducted in that year. See Sec. 1.167(a)-14(c)(4)
for depreciation of a separately acquired interest in a patent or
copyright described in section 167(f)(2) acquired after January 25,
2000. See Sec. 1.197-2 for amortization of interests in patents and
copyrights that constitute amortizable section 197 intangibles.
(b) Depreciation in case of farmers. A reasonable allowance for
depreciation may be claimed on farm buildings (except a dwelling
occupied by the owner), farm machinery, and other physical property but
not including land. Livestock acquired for work, breeding, or dairy
purposes may be depreciated unless included in an inventory used to
determine profits in accordance with section 61 and the regulations
thereunder. Such depreciation should be determined with reference to the
cost or other basis, salvage value, and the estimated useful life of the
livestock. See also section 162 and the regulations thereunder relating
to trade or business expenses, section 165 and the regulations
thereunder relating to losses of farmers, and section 175 and the
regulations thereunder relating to soil or water conservation
expenditures.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 8867, 65 FR 3825, Jan. 25, 2000]
Sec. 1.167(a)-7 Accounting for depreciable property.
(a) Depreciable property may be accounted for by treating each
individual item as an account, or by combining two or more assets in a
single account. Assets may be grouped in an account in a variety of
ways. For example, assets similar in kind with approximately the same
useful lives may be grouped together. Such an account is commonly known
as a group account. Another appropriate grouping might consist of assets
segregated according to use without regard to useful life, for example,
machinery and equipment, furniture and fixtures, or transportation
equipment. Such an account is commonly known as a classified account. A
broader grouping, where assets are included in the same account
regardless of their character or useful lives, is commonly referred to
as a composite account. For example, all the assets used in a business
may be included in a single account. Group, classified, or composite
accounts may be further broken down on the basis of location, dates of
acquisition, cost, character, use, etc.
(b) When group, classified, or composite accounts are used with
average useful lives and a normal retirement occurs, the full cost or
other basis of the asset retired, unadjusted for depreciation or
salvage, shall be removed from the asset account and shall be charged to
the depreciation reserve. Amounts representing salvage ordinarily are
credited to the depreciation reserve. Where an asset is disposed of for
reasons other than normal retirement, the full cost or other basis of
the asset shall be removed from the asset
[[Page 381]]
account, and the depreciation reserve shall be charged with the
depreciation applicable to the retired asset. For rules with respect to
losses on normal retirements, see Sec. 1.167 (a)-8.
(c) A taxpayer may establish as many accounts for depreciable
property as he desires. Depreciation allowances shall be computed
separately for each account. Such depreciation preferably should be
recorded in a depreciation reserve account; however, in appropriate
cases it may be recorded directly in the asset account. Where
depreciation reserves are maintained, a separate reserve account shall
be maintained for each asset account. The regular books of account or
permanent auxiliary records shall show for each account the basis of the
property, including adjustments necessary to conform to the requirements
of section 1016 and other provisions of law relating to adjustments to
basis, and the depreciation allowances for tax purposes. In the event
that reserves for book purposes do not correspond with reserves
maintained for tax purposes, permanent auxiliary records shall be
maintained with the regular books of accounts reconciling the
differences in depreciation for tax and book purposes because of
different methods of depreciation, bases, rates, salvage, or other
factors. Depreciation schedules filed with the income tax return shall
show the accumulated reserves computed in accordance with the allowances
for income tax purposes.
(d) In classified or composite accounts, the average useful life and
rate shall be redetermined whenever additions, retirements, or
replacements substantially alter the relative proportion of types of
assets in the accounts. See example (2) in paragraph (b) of Sec.
1.167(b)-1 for method of determining the depreciation rate for a
classified or composite account.
(e) Applicability. Paragraphs (a), (b), and (d) of this section
apply to property for which depreciation is determined under section 167
(but not under section 168, section 1400I, section 1400L(c), section 168
prior to its amendment by the Tax Reform Act of 1986, Public Law 99-514
(100 Stat. 2121 (1986)), or under an additional first year depreciation
deduction provision of the Internal Revenue Code (for example, section
168(k) through (n), 1400L(b), or 1400N(d))). Paragraph (c) of this
section does not apply to general asset accounts as provided by section
168(i)(4), Sec. 1.168(i)-1, Sec. 1.168(i)-1T and Prop. Reg. Sec.
1.168(i)-1 (September 19, 2013).
(f) Effective/applicability date--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (f)(2) and (f)(3) of this section, Sec.
1.167(a)-7 as contained in 26 CFR part 1 edition revised as of April 1,
2011, applies to taxable years beginning before January 1, 2014.
(2) Early application of Sec. 1.167(a)-7(e). A taxpayer may choose
to apply paragraph (e) of this section to taxable years beginning on or
after January 1, 2012.
(3) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.167(a)-7T as contained in TD 9564 (76 FR 81060) December 27,
2011, to taxable years beginning on or after January 1, 2012, and before
January 1, 2014.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 9564, 76 FR 81085, Dec. 27, 2011; T.D. 9636, 78 FR
57707, Sept. 19, 2013]
Sec. 1.167(a)-8 Retirements.
(a) Gains and losses on retirements. For the purposes of this
section the term ``retirement'' means the permanent withdrawal of
depreciable property from use in the trade or business or in the
production of income. The withdrawal may be made in one of several ways.
For example, the withdrawal may be made by selling or exchanging the
asset, or by actual abandonment. In addition, the asset may be withdrawn
from such productive use without disposition as, for example, by being
placed in a supplies or scrap account. The tax consequences of a
retirement depend upon the form of the transaction, the reason therefor,
the timing of the retirement, the estimated useful life used in
computing depreciation, and whether the asset is accounted for in a
separate or multiple asset account. Upon the retirement of assets, the
rules in this section apply in determining whether gain or loss will be
recognized, the amount of such
[[Page 382]]
gain or loss, and the basis for determining gain or loss:
(1) Where an asset is retired by sale at arm's length, recognition
of gain or loss will be subject to the provisions of sections 1002,
1231, and other applicable provisions of law.
(2) Where an asset is retired by exchange, the recognition of gain
or loss will be subject to the provisions of sections 1002, 1031, 1231,
and other applicable provisions of law.
(3) Where an asset is permanently retired from use in the trade or
business or in the production of income but is not disposed of by the
taxpayer or physically abandoned (as, for example, when the asset is
transferred to a supplies or scrap account), gain will not be
recognized. In such a case loss will be recognized measured by the
excess of the adjusted basis of the asset at the time of retirement over
the estimated salvage value or over the fair market value at the time of
such retirement if greater, but only if--
(i) The retirement is an abnormal retirement, or
(ii) The retirement is a normal retirement from a single asset
account (but see paragraph (d) of this section for special rule for item
accounts), or
(iii) The retirement is a normal retirement from a multiple asset
account in which the depreciation rate was based on the maximum expected
life of the longest lived asset contained in the account.
(4) Where an asset is retired by actual physical abandonment (as,
for example, in the case of a building condemned as unfit for further
occupancy or other use), loss will be recognized measured by the amount
of the adjusted basis of the asset abandoned at the time of such
abandonment. In order to qualify for the recognition of loss from
physical abandonment, the intent of the taxpayer must be irrevocably to
discard the asset so that it will neither be used again by him nor
retrieved by him for sale, exchange, or other disposition.
Experience with assets which have attained an exceptional or unusual age
shall, with respect to similar assets, be disregarded in determining the
maximum expected useful life of the longest lived asset in a multiple
asset account. For example, if a manufacturer establishes a proper
multiple asset account for 50 assets which are expected to have an
average life of 30 years but which will remain useful to him for varying
periods between 20 and 40 years, the maximum expected useful life will
be 40 years, even though an occasional asset of this kind may last 60
years.
(b) Definition of normal and abnormal retirements. For the purpose
of this section the determination of whether a retirement is normal or
abnormal shall be made in the light of all the facts and circumstances.
In general, a retirement shall be considered a normal retirement unless
the taxpayer can show that the withdrawal of the asset was due to a
cause not contemplated in setting the applicable depreciation rate. For
example, a retirement is considered normal if made within the range of
years taken into consideration in fixing the depreciation rate and if
the asset has reached a condition at which, in the normal course of
events, the taxpayer customarily retires similar assets from use in his
business. On the other hand, a retirement may be abnormal if the asset
is withdrawn at an earlier time or under other circumstances, as, for
example, when the asset has been damaged by casualty or has lost its
usefulness suddenly as the result of extraordinary obsolescence.
(c) Basis of assets retired. The basis of an asset at the time of
retirement for computing gain or loss shall be its adjusted basis for
determining gain or loss upon a sale or other disposition as determined
in accordance with the provisions of section 1011 and the following
rules:
(1) In the case of a normal retirement of an asset from a multiple
asset account where the depreciation rate is based on average expected
useful life, the term ``adjusted basis'' means the salvage value
estimated in determining the depreciation deduction in accordance with
the provisions in paragraph (c) of Sec. 1.167(a)-1.
(2) In the case of a normal retirement of an asset from a multiple
asset account on which the depreciation rate was based on the maximum
expected life of the longest lived asset in the account, the adjustment
for depreciation
[[Page 383]]
allowed or allowable shall be made at the rate which would have been
proper if the asset had been depreciated in a single asset account
(under the method of depreciation used for the multiple asset account)
using a rate based upon the maximum expected useful life of that asset,
and
(3) In the case of an abnormal retirement from a multiple asset
account the adjustment for depreciation allowed or allowable shall be
made at the rate which would have been proper had the asset been
depreciated in a single asset account (under the method of depreciation
used for the multiple asset account) and using a rate based upon either
the average expected useful life or the maximum expected useful life of
the asset, depending upon the method of determining the rate of
depreciation used in connection with the multiple asset account.
(d) Special rule for item accounts. (1) As indicated in paragraph
(a)(3)(ii) and (iii) of this section, a loss is recognized upon the
normal retirement of an asset from a single asset account but a loss on
the normal retirement of an asset in a multiple asset account is not
allowable where the depreciation rate is based upon the average useful
life of the assets in the account. Where a taxpayer with more than one
depreciable asset chooses to set up a separate account for each such
asset and the depreciation rate is based on the average useful life of
such assets (so that he uses the same life for each account), the
question arises whether his depreciation deductions in substance are the
equivalent of those which would result from the use of multiple asset
accounts and, therefore, he should be subject to the rules governing
losses on retirements of assets from multiple asset accounts. Where a
taxpayer has only a few depreciable assets which he chooses to account
for in single asset accounts, particularly where such assets cover a
relatively narrow range of lives, it cannot be said in the usual case
that the allowance of losses on retirements from such accounts clearly
will distort income. This results from the fact that where a taxpayer
has only a few depreciable assets it is usually not possible clearly to
determine that the depreciation rate is based upon the average useful
life of such assets. Accordingly, it cannot be said that the taxpayer is
in effect clearly operating with a multiple asset account using an
average life rate so that losses should not be allowed on normal
retirements. Therefore, losses normally will be allowed upon retirement
of assets from single asset accounts where the taxpayer has only a few
depreciable assets. On the other hand, when a taxpayer who has only a
few depreciable assets chooses to account for them in single asset
accounts, using for each account a depreciation rate based on the
average useful life of such assets, and the assets cover a wide range of
lives, the likelihood that income will be distorted is greater than
where the group of assets covers a relatively narrow range of lives. In
those cases where the allowance of losses would distort income, the
rules with respect to the allowance of losses on normal retirement shall
be applied to such assets in the same manner as though the assets had
been accounted for in multiple asset accounts using a rate based upon
average expected useful life.
(2) Where a taxpayer has a large number of depreciable assets and
depreciation is based on the average useful life of such assets, then,
whether such assets are similar or dissimilar and regardless of whether
they are accounted for in individual asset accounts or multiple asset
accounts the allowance of losses on the normal retirement of such assets
would distort income. Such distortion would result from the fact that
the use of average useful life (and, accordingly, average rate) assumes
that while some assets normally will be retired before the expiration of
the average life, others normally will be retired after expiration of
the average life. Accordingly, if instead of accounting for a large
number of similar or dissimilar depreciable assets in multiple asset
accounts, the taxpayer chooses to account separately for such assets,
using a rate based upon the average life of such assets, the rules with
respect to the allowances of losses on normal retirements will be
applied to such assets in the same manner as though the assets were
accounted for in multiple asset accounts
[[Page 384]]
using a rate based upon average expected useful life.
(3) Where a taxpayer who does not have a large number of depreciable
assets (and who therefore is not subject to subparagraph (2) of this
paragraph) chooses to set up a separate account for each such asset, and
has sought to compute an average life for such assets on which to base
his depreciation deductions (so that he uses the same life for each
account), the allowance of losses on normal retirements from such
accounts may in some situations substantially distort income. Such
distortion would result from the fact that the use of average useful
life (and, accordingly, average rate) assumes that while some assets
normally will be retired before expiration of the average life, others
normally will be retired after expiration of the average life.
Accordingly, where a taxpayer chooses to account separately for such
assets instead of accounting for them in multiple asset accounts, and
the result is to substantially distort his income, the rules with
respect to the allowance of losses on normal retirements shall be
applied to such assets in the same manner as though the assets had been
accounted for in multiple asset accounts using a rate based upon average
expected useful life.
(4) Whenever a taxpayer is treated under this paragraph as though
his assets were accounted for in a multiple asset account using an
average life rate, and, therefore, he is denied a loss on retirements,
the unrecovered cost less salvage of each asset which was accounted for
separately may be amortized in accordance with the regulation stated in
paragraph (e)(1)(ii) of this section.
(e) Accounting treatment of asset retirements. (1) In the case of a
normal retirement where under the foregoing rules no loss is recognized
and where the asset is retired without disposition or abandonment, (i)
if the asset was contained in a multiple asset account, the full cost of
such asset, reduced by estimated salvage, shall be charged to the
depreciation reserve, or (ii) if the asset was accounted for separately,
the unrecovered cost or other basis, less salvage, of the asset may be
amortized through annual deductions from gross income in amounts equal
to the unrecovered cost or other basis of such asset, divided by the
average expected useful life (not the remaining useful life) applicable
to the asset at the time of retirement. For example, if an asset is
retired after six years of use and at the time of retirement
depreciation was being claimed on the basis of an average expected
useful life of ten years, the unrecovered cost or other basis less
salvage would be amortized through equal annual deductions over a period
of ten years from the time of retirement.
(2) Where multiple asset accounts are used and acquisitions and
retirements are numerous, if a taxpayer, in order to avoid unnecessarily
detailed accounting for individual retirements, consistently follows the
practice of charging the reserve with the full cost or other basis of
assets retired and of crediting it with all receipts from salvage, the
practice may be continued so long as, in the opinion of the
Commissioner, it clearly reflects income. Conversely, where the taxpayer
customarily follows a practice of reporting all receipts from salvage as
ordinary taxable income such practice may be continued so long as, in
the opinion of the Commissioner, it clearly reflects income.
(f) Cross reference. For special rules in connection with the
retirement of the last assets of a given year's acquisitions under the
declining balance method, see example (2) in paragraph (b) of Sec.
1.167 (b)-2.
(g) Applicability. This section applies to property for which
depreciation is determined under section 167 (but not under section 168,
section 1400I, section 1400L(c), section 168 prior to its amendment by
the Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 2121(1986)), or
under an additional first year depreciation deduction provision of the
Internal Revenue Code (for example, section 168(k) through (n),
1400L(b), or 1400N(d))).
(h) Effective/applicability date--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (h)(2) and (h)(3) of this section, Sec.
1.167(a)-8 as contained in 26 CFR part
[[Page 385]]
1 edition revised as of April 1, 2011, applies to taxable years
beginning before January 1, 2014.
(2) Early application of Sec. 1.167(a)-8(g). A taxpayer may choose
to apply paragraph (g) of this section to taxable years beginning on or
after January 1, 2012.
(3) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.167(a)-8T as contained in TD 9564 (76 FR 81060) December 27,
2011, to taxable years beginning on or after January 1, 2012, and before
January 1, 2014.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960, as
amended by T.D. 9564, 76 FR 81085, Dec. 27, 2011; T.D. 9636, 78 FR
57707, Sept. 19, 2013]
Sec. 1.167(a)-9 Obsolescence.
The depreciation allowance includes an allowance for normal
obsolescence which should be taken into account to the extent that the
expected useful life of property will be shortened by reason thereof.
Obsolescence may render an asset economically useless to the taxpayer
regardless of its physical condition. Obsolescence is attributable to
many causes, including technological improvements and reasonably
foreseeable economic changes. Among these causes are normal progress of
the arts and sciences, supersession or inadequacy brought about by
developments in the industry, products, methods, markets, sources of
supply, and other like changes, and legislative or regulatory action. In
any case in which the taxpayer shows that the estimated useful life
previously used should be shortened by reason of obsolescence greater
than had been assumed in computing such estimated useful life, a change
to a new and shorter estimated useful life computed in accordance with
such showing will be permitted. No such change will be permitted merely
because in the unsupported opinion of the taxpayer the property may
become obsolete. For rules governing the allowance of a loss when the
usefulness of depreciable property is suddenly terminated, see Sec.
1.167(a)-8. If the estimated useful life and the depreciation rates have
been the subject of a previous agreement, see section 167(d) and Sec.
1.167(d)-1.
Sec. 1.167(a)-10 When depreciation deduction is allowable.
(a) A taxpayer should deduct the proper depreciation allowance each
year and may not increase his depreciation allowances in later years by
reason of his failure to deduct any depreciation allowance or of his
action in deducting an allowance plainly inadequate under the known
facts in prior years. The inadequacy of the depreciation allowance for
property in prior years shall be determined on the basis of the
allowable method of depreciation used by the taxpayer for such property
or under the straight line method if no allowance has ever been claimed
for such property. The preceding sentence shall not be construed as
precluding application of any method provided in section 167(b) if
taxpayer's failure to claim any allowance for depreciation was due
solely to erroneously treating as a deductible expense an item properly
chargeable to capital account. For rules relating to adjustments to
basis, see section 1016 and the regulations thereunder.
(b) The period for depreciation of an asset shall begin when the
asset is placed in service and shall end when the asset is retired from
service. A proportionate part of one year's depreciation is allowable
for that part of the first and last year during which the asset was in
service. However, in the case of a multiple asset account, the amount of
depreciation may be determined by using what is commonly described as an
``averaging convention'', that is, by using an assumed timing of
additions and retirements. For example, it might be assumed that all
additions and retirements to the asset account occur uniformly
throughout the taxable year, in which case depreciation is computed on
the average of the beginning and ending balances of the asset account
for the taxable year. See example (3) under paragraph (b) of Sec.
1.167(b)-1. Among still other averaging conventions which may be used is
the one under which it is assumed that all additions and retirements
during the first half of a given year were made on the first day of that
year and that all additions and retirements during the second half of
the year were made on the first day of the following year.
[[Page 386]]
Thus, a full year's depreciation would be taken on additions in the
first half of the year and no depreciation would be taken on additions
in the second half. Moreover, under this convention, no depreciation
would be taken on retirements in the first half of the year and a full
year's depreciation would be taken on the retirements in the second
half. An averaging convention, if used, must be consistently followed as
to the account or accounts for which it is adopted, and must be applied
to both additions and retirements. In any year in which an averaging
convention substantially distorts the depreciation allowance for the
taxable year, it may not be used.
Sec. 1.167(a)-11 Depreciation based on class lives and asset
depreciation ranges for property placed in service after
December 31, 1970.
(a) In general--(1) Summary. This section provides an asset
depreciation range and class life system for determining the reasonable
allowance for depreciation of designated classes of assets placed in
service after December 31, 1970. The system is designed to minimize
disputes between taxpayers and the Internal Revenue Service as to the
useful life of property, and as to salvage value, repairs, and other
matters. The system is optional with the taxpayer. The taxpayer has an
annual election. Generally, an election for a taxable year must apply to
all additions of eligible property during the taxable year of election,
but does not apply to additions of eligible property in any other
taxable year. The taxpayer's election, made with the return for the
taxable year, may not be revoked or modified for any property included
in the election. Generally, the taxpayer must establish vintage accounts
for all eligible property included in the election, must determine the
allowance for depreciation of such property in the taxable year of
election, and in subsequent taxable years, on the basis of the asset
depreciation period selected and must apply the first-year convention
specified in the election to determine the allowance for depreciation of
such property. This section also contains special provisions for the
treatment of salvage value, retirements, and the costs of the repair,
maintenance, rehabilitation or improvement of property. In general, a
taxpayer may not apply any provision of this section unless he makes an
election and thereby consents to, and agrees to apply, all the
provisions of this section. A taxpayer who elects to apply this section
does, however, have certain options as to the application of specified
provisions of this section. A taxpayer may elect to apply this section
for a taxable year only if for such taxable year he complies with the
requirements of paragraph (f)(4) of this section.
(2) Definitions. For the meaning of certain terms used in this
section, see paragraphs (b)(2) (``eligible property''), (b)(3)
(``vintage account'' and ``vintage''), (b)(4) (``asset depreciation
range'', ``asset guideline class'', ``asset guideline period'', and
``asset depreciation period''), (b)(5)(iii)(c) (``used property''),
(b)(6)(i) (``public utility property''), (c)(1)(iv) (``original use''),
(c)(1)(v) (``unadjusted basis'' and ``adjusted basis''), (c)(2)(ii)
(``modified half-year convention''), (c)(2)(iii) (``half-year
convention''), (d)(1)(i) (``gross salvage value''), (d)(1)(ii)
(``salvage value''), (d)(2)(iii) (``repair allowance'', ``repair
allowance percentage'', and ``repair allowance property''), (d)(2)(vi)
(``excluded addition''), (d)(2)(vii) (``property improvement''),
(d)(3)(ii) (``ordinary retirement'' and ``extraordinary retirement''),
(d)(3)(vi) (``special basis vintage account''), and (e)(1) (``first
placed in service'') of this section.
(b) Reasonable allowance using asset depreciation ranges--(1) In
general. The allowance for depreciation of eligible property (as defined
in subparagraph (2) of this paragraph) to which the taxpayer elects to
apply this section shall be determined as provided in paragraph (c) of
this section and shall constitute the reasonable allowance for
depreciation of such property under section 167(a).
(2) Definition of eligible property. For purposes of this section,
the term ``eligible property'' means tangible property which is subject
to the allowance for depreciation provided by section 167(a) but only
if--
[[Page 387]]
(i) An asset guideline class and asset guideline period are in
effect for such property for the taxable year of election (see
subparagraph (4) of this paragraph);
(ii) The property is first placed in service (as described in
paragraph (e) (1) of this section) by the taxpayer after December 31,
1970 (but see subparagraph (7) of this paragraph for special rule where
there is a mere change in the form of conducting a trade or business);
and
(iii) The property is either--
(a) Section 1245 property as defined in section 1245(a) (3), or
(b) Section 1250 property as defined in section 1250(c).
See, however, subparagraph (6) of this paragraph for special rule for
certain public utility property as defined in section 167(l)(3)(A).
Property which meets the requirements of this subparagraph is eligible
property even if depreciation with respect to such property, determined
in accordance with this section, is allocated to or otherwise required
to be reflected in the cost of a capitalized item. The term ``eligible
property'' includes any property which meets the requirements of this
subparagraph, whether such property is new property, ``used property''
(as described in subparagraph (5)(iii)(c) of this paragraph), a
``property improvement'' (as described in paragraph (d)(2)(vii) of this
section), or an ``excluded addition'' (as described in paragraph
(d)(2)(vi) of this section). For the treatment of expenditures for the
repair, maintenance, rehabilitation or improvement of certain property,
see paragraph (d) (2) of this section.
(3) Requirement of vintage accounts--(i) In general. For purposes of
this section, a ``vintage account'' is a closed-end depreciation account
containing eligible property to which the taxpayer elects to apply this
section, first placed in service by the taxpayer during the taxable year
of election. The ``vintage'' of an account refers to the taxable year
during which the eligible property in the account is first placed in
service by the taxpayer. Such an account will consist of an asset, or a
group of assets, within a single asset guideline class established
pursuant to subparagraph (4) of this paragraph and may contain only
eligible property. Each item of eligible property to which the taxpayer
elects to apply this section, first placed in service by the taxpayer
during the taxable year of election (determined without regard to a
convention described in paragraph (c)(2) of this section) shall be
placed in a vintage account of the taxable year of election. For rule
regarding ``special basis vintage accounts'' for certain property
improvements, see paragraph (d)(2)(viii) and (3)(vi) of this section.
Any number of vintage accounts of a taxable year may be established.
More than one account of the same vintage may be established for
different assets of the same asset guideline class. See paragraph
(d)(3)(xi) of this section for special rule for treatment of certain
multiple asset and item accounts.
(ii) Special rule. Section 1245 property may not be placed in a
vintage account with section 1250 property. Property the original use of
which does not commence with the taxpayer may not be placed in a vintage
account with property the original use of which commences with the
taxpayer. Property described in section 167(f)(2) may not be placed in a
vintage account with property not described in section 167(f)(2).
Property described in section 179(d)(1) for which the taxpayer elects
the allowance for the first taxable year in accordance with section
179(c) may not be placed in a vintage account with property not
described in section 179(d)(1) or for which the taxpayer does not elect
such allowance for the first taxable year. For special rule for property
acquired in a transaction to which section 381(a) applies, see paragraph
(e)(3)(i) of this section. For additional rules with respect to
accounting for eligible property, see paragraph (e) of this section.
(4) Asset depreciation ranges and periods--(i) Selection of asset
depreciation period. The taxpayers books and records must specify for
each vintage account of the taxable year of election--
(a) In the case of vintage account for property in an asset
guideline class for which no asset depreciation range is in effect for
the taxable year, the asset depreciation period (which shall be equal to
the asset guideline period for the assets in such account), or
[[Page 388]]
(b) In the case of a vintage account for property in an asset
guideline class for which an asset depreciation range is in effect for
the taxable year, the asset depreciation period selected by the taxpayer
from the asset depreciation range for the assets in such account.
Unless otherwise expressly provided in the establishment thereof, for
purposes of this section, the term ``asset guideline class'' means a
category of assets (including ``subsidiary assets'') for which a
separate asset guideline period is in effect for the taxable year as
provided in subdivision (ii) of this subparagraph. The ``asset
depreciation range'' is a period of years which extends from 80 percent
of the asset guideline period to 120 percent of such period, determined
in each case by rounding any fractional part of a year to the nearer of
the nearest whole or half year. Except as provided in paragraph
(e)(3)(iv) of this section, in the case of an asset guideline class for
which an asset depreciation range is in effect, any period within the
asset depreciation range for the assets in a vintage account which is a
whole number of years or a whole number of years plus a half year, may
be selected. The term ``asset depreciation period'' means the period
selected from the asset depreciation range, or if no asset depreciation
range is in effect for the class, the asset guideline period. The
``asset guideline period'' is established in accordance with subdivision
(ii) of this subparagraph and is the class life under section 167(m).
See Revenue Procedure 72-10 for special rules for section 1250 property
and property predominately used outside the United States. In general,
an asset guideline period, but no asset depreciation range, is in effect
for such property.
(ii) Establishment of asset guideline classes and periods. The asset
guideline classes and the asset guideline periods, and the asset
depreciation ranges determined from such periods, in effect for taxable
years ending before the effective date of the first supplemental asset
guideline classes, asset guideline periods, and asset depreciation
ranges, established pursuant to this section are set forth in Revenue
Procedure 72-10. Asset guideline classes and periods, and asset
depreciation ranges, will from time to time be established,
supplemented, and revised with express reference to this section, and
will be published in the Internal Revenue Bulletin. The asset guideline
classes, the asset guideline periods, and the asset depreciation ranges
determined from such periods in effect as of the last day of a taxable
year of election shall apply to all vintage accounts of such taxable
year, except that neither the asset guideline period nor the lower limit
of the asset depreciation range for any such account shall be longer
than the asset guideline period or the lower limit of the asset
depreciation range, as the case may be, for such account in effect as of
the first day of the taxable year (or as of such later time in such year
as an asset guideline class first established during such year becomes
effective). Generally, the reasonable allowance for depreciation of
property for any taxable year in a vintage account shall not be changed
to reflect any supplement or revision of the asset guideline classes or
periods, and asset depreciation ranges, for the taxable year in which
the account is established, which occurs after the end of such taxable
year. However, if expressly provided in such a supplement or revision,
the taxpayer may, at his option in the manner specified therein, apply
the revised or supplemented asset guideline classes or periods and asset
depreciation ranges to such property for such taxable year and
succeeding taxable years.
(iii) Applicable guideline classes and periods in special
situations. (a) An electric or gas utility which would in accordance
with Revenue Procedure 64-21 be entitled to use a composite guideline
class basis for applying Revenue Procedure 62-21 may, solely with
respect to property for which an asset depreciation range is in effect
for the taxable year, elect to apply this section on the basis of a
composite asset guideline class and asset guideline period determined by
applying the provisions of Revenue Procedure 64-21 to such property. The
asset depreciation range for such a composite asset guideline class
shall be determined by reference to the composite asset guideline
[[Page 389]]
period at the beginning of the first taxable year to which the taxpayer
elects to apply this section and shall not be changed until such time as
major variations in the asset mix or the asset guideline classes or
periods justify some other composite asset guideline period. Except as
provided in paragraph (d)(2)(iii) of this section with respect to
buildings and other structures, for the purposes of this section, all
property in the composite asset guideline class shall be treated as
included in a single asset guideline class. If the taxpayer elects to
apply this subdivision, the election shall be made on the tax return
filed for the first taxable year for which the taxpayer elects to apply
this section. An election to apply this subdivision for any taxable year
shall apply to all succeeding taxable years to which the taxpayer elects
to apply this section, except to the extent the election to apply this
subdivision is with the consent of the Commissioner terminated with
respect to a succeeding taxable year and all taxable years thereafter.
(b) For purposes of this section, property shall be included in the
asset guideline class for the activity in which the property is
primarily used. See paragraph (e)(3)(iii) of this section for rule for
leased property. Property shall be classified according to primary use
even though the activity in which such property is primarily used is
insubstantial in relation to all the taxpayer's activities. No change in
the classification of property shall be made because of a change in
primary use after the end of the taxable year in which property is first
placed in service, including a change in use which results in section
1250 property becoming section 1245 property.
(c) An incorrect classification or characterization by the taxpayer
of property for the purposes of this section (such as under (b) of this
subdivision or under subparagraph (2) or (3) (ii) of this paragraph)
shall not cause or permit a revocation of the election to apply this
section for the taxable year in which such property was first placed in
service. The classification or characterization of such property shall
be corrected. All adjustments necessary to the correction shall be made,
including adjustments of unadjusted basis, adjusted basis, salvage
value, the reserve for depreciation of all vintage accounts affected,
and the amount of depreciation allowable for all taxable years for which
the period for assessment of tax prescribed in section 6501 has not
expired. If because of incorrect classification or characterization
property included in an election to apply this section was not placed in
a vintage account and no asset depreciation period was selected for the
property or the property was placed in a vintage account but an asset
depreciation period was selected from an incorrect asset depreciation
range, the taxpayer shall place the property in a vintage account and
select an asset depreciation period for the account from the correct
asset depreciation range.
(d) Generally, except as provided in subparagraph (5)(v)(a) of this
paragraph, a taxpayer may not compute depreciation for eligible property
first placed in service during the taxable year under a method of
depreciation not described in section 167(b) (1), (2), or (3). (If the
taxpayer computes depreciation with respect to such property under
section 167(k), or amortizes such property, the property must be
excluded from the election to apply this section.) (See subparagraph
(5)(v)(b) of this paragraph.) However, if the taxpayer establishes to
the satisfaction of the Commissioner that a method of depreciation not
described in section 167(b) (1), (2), (3), or (k) was adopted for
property in the asset guideline class on the basis of a good faith
mistake as to the proper asset guideline class for the property, then,
unless the requirements of subparagraph (5)(v)(a) of this paragraph are
met, the taxpayer must terminate (as of the beginning of the taxable
year) such method of depreciation with respect to all eligible property
in the asset guideline class which was first placed in service during
the taxable year. In such event, the taxpayer's election to apply this
section shall include eligible property in the asset guideline class
without regard to subparagraph (5)(v)(a) of this paragraph. The
provisions of (c) of this subdivision shall apply to the correction in
the classification of the property.
[[Page 390]]
(e) If the provisions of section 167(j) apply to require a change in
the method of depreciation with respect to an item of section 1250
property in a multiple asset vintage account, the asset shall be removed
from the account and placed in a separate item vintage account. The
unadjusted basis of the asset shall be removed from the unadjusted basis
of the vintage account as of the first day of the taxable year in which
the change in method of depreciation is required and the depreciation
reserve established for the account shall be reduced by the depreciation
allowable for the property computed in the manner prescribed in
paragraph (c)(1)(v)(b) of this section for determination of the adjusted
basis of property. See paragraph (d)(3)(vii)(e) of this section for
treatment of salvage value when property is removed from a vintage
account.
(iv) Examples. The principles of this subparagraph may be
illustrated by the following examples:
Example 1. Corporation X purchases a bulldozer for the use in its
construction business. The bulldozer is first placed in service in 1972.
Since the bulldozer is tangible property for which an asset guideline
class and period have been established, the bulldozer is eligible
property. The bulldozer is in asset guideline class 15.1 of Revenue
Procedure 72-10, and the asset depreciation range is 4-6 years.
Example 2. In 1972, corporation Y first places in service a factory
building. Since the factory building is tangible property for which an
asset guideline class and period have been established, it is eligible
property. The factory building is in asset guideline class 65.11 of
Revenue Procedure 72-10. Since no asset depreciation range is in effect
for the asset guideline class, the asset depreciation period is the
asset guideline period of 45 years. (See subparagraph (5)(vi) of this
paragraph for election to exclude certain section 1250 property during
transition period.)
Example 3. In January of 1971, corporation Y, a calendar year
taxpayer, pays or incurs $2,000 for the rehabilitation and improvement
of machine A which was first placed in service in 1969. On January 1,
1971, corporation Y first placed in service machines B and C, each with
an unadjusted basis of $10,000. Machines B and C are eligible property.
Machine A would be eligible property but for the fact it was first
placed in service prior to January 1, 1971 (that is, machine A is
eligible property determined without regard to subparagraph (2)(ii) of
this paragraph). Corporation Y elects to apply this section for the
taxable year, and adopts the modified half-year convention described in
paragraph (c)(2)(ii) of this section, but does not elect to apply the
asset guideline class repair allowance described in paragraph
(d)(2)(iii) of this section. Machines A, B, and C are in asset guideline
class 24.4 under Revenue Procedure 72-10 for which the asset
depreciation range is 8 to 12 years. The $2,000 expended on machine A
substantially increases its capacity and is a capital expenditure under
sections 162 and 263. The $2,000 is a property improvement (as defined
in paragraph (d)(2)(vii)(b) of this section) which is eligible property.
However, corporation Y by mistake treats the property improvement of
$2,000 as a deductible repair. Also by mistake, corporation Y includes
machine B in asset guideline class 24.3 under Revenue Procedure 72-10
for which the asset depreciation range is 5 to 7 years. Corporation Y
establishes vintage accounts for 1971, and computes depreciation for
1971 and 1972 as follows:
------------------------------------------------------------------------
Dec. 31, Dec. 31,
1972, 1972,
reserve for adjusted
depreciation basis
------------------------------------------------------------------------
Vintage account for machine B, with an asset $4,000 $6,000
depreciation period of 5 years and an
unadjusted basis of $10,000 for which
corporation Y adopts the straight line method
Vintage account for machine C, with an asset 2,500 7,500
depreciation period of 8 years and an
unadjusted basis of $10,000 for which
corporation Y adopts the straight line method
------------------------------------------------------------------------
After audit in 1973 of corporation Y's taxable years 1971 and 1972, it
is determined that the $2,000 paid in 1971 for the rehabilitation and
improvement of machine A is a capital expenditure and that machine B is
in asset guideline class 24.4. The incorrect classification is
corrected. Corporation Y places machine B and the property improvement
in a vintage account of 1971 and on its tax return filed for 1973
selects an asset depreciation period of 8 years for that account. Giving
effect to the correction in classification of the property in accordance
with subdivision (iii) (c) of this subparagraph, at the end of 1972 the
unadjusted basis, reserve for depreciation, and adjusted basis of the
vintage account for machine B and the property improvement with respect
to machine A are $12,000, $3,000, and $9,000, respectively. Corporation
Y's deduction of the $2,000 property improvement in 1971 as a repair
expense under section 162 is disallowed. For 1971 and 1972 depreciation
deductions are disallowed in the amount of $500 each year (that is, $750
excess annual depreciation on machine B
[[Page 391]]
minus $250 annual depreciation on the property improvement).
Example 4. (a) In 1971, Corporation X, a calendar year taxpayer,
first places in service machines A through M, all of which are eligible
property. All the machines except machine A are in asset guideline class
24.3 under Revenue Procedure 72-10. Machine A is in asset guideline
class 24.4 under Revenue Procedure 72-10. Machine B has an unadjusted
basis equal to 80 percent of the total unadjusted basis of machines B
through M. By good faith mistake as to proper classification,
corporation X includes both machine A and machine B in asset guideline
class 24.4. Corporation X consistently uses the machine hour method of
depreciation on all property in asset guideline class 24.4, and for 1971
computes depreciation for machines A and B under that method.
Corporation X elects to apply this section for 1971 on the assumption
that the election includes machines C through M which are in asset
guideline class 24.3. In 1973, upon audit of corporation X's taxable
years 1971 and 1972, it is determined that machine B is included in
asset guideline class 24.3 and that since for 1971 corporation X
computed depreciation on machine B under the machine hour method, in
accordance with subparagraph (5)(v)(a) of this paragraph, all property
in asset guideline class 24.3 (machines B through M) is excluded from
corporation X's election to apply this section for 1971. Although
corporation X has consistently used the machine hour method for asset
guideline class 24.4, corporation X has not in the past used the machine
hour method for machines of the type and function of machines C through
M which are in asset guideline class 24.3. Both machine A and machine B
are used in connection with the manufacture of wood products. There is
reasonable basis for corporation X having assumed that machine B is in
asset guideline class 24.4 along with machine A to which it is similar.
Corporation X establishes to the satisfaction of the Commissioner that
it used the machine hour method for machine B on the basis of a good
faith mistake as to the proper classification of the machine.
Corporation X may, at its option (see subparagraph (5)(v) of this
paragraph), terminate the machine hour method of depreciation for
machine B as of the beginning of 1971, and in that event corporation X's
election to apply this section for 1971 will apply to machines B through
M without regard to subparagraph (5)(v)(a) of this paragraph. The
adjustments provided in subdivision (iii)(c) of this subparagraph will
be made as a result of the correction in classification of property. If
corporation X does not terminate the machine hour method with respect to
machine B, machines B through M must be excluded from the election to
apply this section (see subparagraph (5)(v) of this paragraph).
(b) The facts are the same as in (a) of this example except that
machine B has an unadjusted basis equal to only 65 percent of the total
unadjusted basis of machines B through M.
In this case, corporation X must either terminate the machine hour
method of depreciation with respect to asset B (since the provisions of
subparagraph (5)(v) of this paragraph do not permit the exclusion of the
property from the election to apply this section) or otherwise comply
with the provisions of subparagraph (5)(v) of this paragraph. (See
paragraph (c)(1)(iv) for limitation on methods which may be adopted for
property included in the election to apply this section.)
(5) Requirements of election--(i) In general. Except as otherwise
provided in paragraph (d)(2) of this section dealing with expenditures
for the repair, maintenance, rehabilitation or improvement of certain
property, no provision of this section shall apply to any property other
than eligible property to which the taxpayer elects in accordance with
this section, to apply this section. For the time and manner of
election, and certain conditions to an election, see paragraph (f) of
this section. Except as otherwise provided in subparagraph (4)(iii) of
this paragraph, subdivision (v) of this subparagraph and in subparagraph
(6)(iii) of this paragraph, a taxpayer's election to apply this section
may not be revoked or modified after the last day prescribed for filing
the election. Thus, for example, after such day, a taxpayer may not
cease to apply this section to property included in the election,
establish different vintage accounts for the taxable year of election,
select a different period from the asset depreciation range for any such
account, or adopt a different first-year convention for any such
account.
(ii) Property required to be included in election. Except as
otherwise provided in subdivision (iii) of this subparagraph dealing
with certain ``used property'', in subdivision (iv) of this subparagraph
dealing with ``section 38 property'', in subdivision (v) of this
subparagraph dealing with property subject to special depreciation or
amortization, in subdivision (vi) of this subparagraph dealing with
certain section 1250 property, in subdivision (vii) of this subparagraph
dealing with certain subsidiary assets, and in paragraph (e)(3)
[[Page 392]]
(i) and (iv) of this section dealing with transactions to which section
381(a) applies, if the taxpayer elects to apply this section to any
eligible property first placed in service by the taxpayer during the
taxable year of election, the election shall apply to all such eligible
property, whether placed in service in a trade or business or held for
production of income.
(iii) Special 10 percent used property rule. (a) If (1) the
unadjusted basis of eligible used section 1245 property (as defined in
(c) of this subdivision) first placed in service by the taxpayer during
the taxable year of election, for which no specific used property asset
guideline class (as defined in (c) of this subdivision) is in effect for
the taxable year, exceeds (2) 10 percent of the unadjusted basis of all
eligible section 1245 property first placed in service during the
taxable year of election, the taxpayer may exclude all (but not less
than all) the property described in (a)(1) of this subdivision from the
election to apply this section.
(b) If (1) the unadjusted basis of eligible used section 1250
property first placed in service by the taxpayer during the taxable year
of election, for which no specific used property asset guideline class
is in effect for the taxable year, exceeds (2) 10 percent of the
unadjusted basis of all eligible section 1250 property first placed in
service during the taxable year of election, the taxpayer may exclude
all (but not less than all) the property described in (b)(1) of this
subdivision from the election to apply this section.
(c) For the purposes of this section, the term ``used property''
means property the original use of which does not commence with the
taxpayer. Solely for the purpose of determining whether the 10 percent
rule of this subdivision is satisfied, (1) eligible used property first
placed in service during the taxable year and excluded from the election
to apply this section pursuant to subdivision (v)(a) of this
subparagraph and (2) eligible property acquired during the taxable year
in a transaction to which section 381(a) applies, shall all be treated
as used property regardless of whether such property would be treated as
new property under section 167(c) and the regulations thereunder. The
term ``specific used property asset guideline class'' means a class
established in accordance with subparagraph (4) of this paragraph solely
for used property primarily used in connection with the activity to
which the class relates.
(iv) Property subject to investment tax credit. The taxpayer may
exclude from an election to apply this section all, or less than all,
units of eligible property first placed in service during the taxable
year which is--
(a) ``Section 38 property'' as defined in section 48(a) which meets
the requirements of section 49 and which is not property described in
section 50, or
(b) Property to which section 47(a)(5)(B) applies which would be
section 38 property but for section 49 and which is placed in service to
replace section 38 property (other than property described in section
50) disposed of prior to August 15, 1971.
(v) Property subject to special method of depreciation or
authorization. (a) In the case of eligible property first placed in
service in a taxable year of election (and not otherwise properly
excluded from an election to apply this section) the taxpayer may not
compute depreciation for any of such property in the asset guideline
class under a method not described in section 167(b) (1), (2), (3), or
(k) unless he (1) computes depreciation under a method or methods not so
described for eligible property first placed in service in the taxable
year in the asset guideline class with an unadjusted basis at least
equal to 75 percent of the unadjusted basis of all eligible property
first placed in service in the taxable year in the asset guideline class
and (2) agrees to continue to depreciate such property under such method
or methods until the consent of the Commissioner is obtained to a change
in method. The consent of the Commissioner must be obtained by filing
Form 3115 with the Commissioner of Internal Revenue, Washington, D.C.
20224, within the first 180 days of the taxable year for which the
change is desired. If for the taxable year of election the taxpayer
computes depreciation under any method not described in section 167(b)
(1), (2), (3), or (k) for any eligible property (other than property
otherwise properly excluded from an
[[Page 393]]
election to apply this section) first placed in service during the
taxable year, an election to apply this section for the taxable year
shall not include such property or any other eligible property in the
same asset guideline class as such property. With respect to a taxable
year beginning before January 1, 1973, if the taxpayer has adopted a
method of depreciation which is not permitted under this subdivision,
the taxpayer may under this section adopt a method of depreciation
permitted under this subdivision or otherwise comply with the provisions
of this subdivision.
(b) An election to apply this section shall not include eligible
property for which, for the taxable year of election, the taxpayer
computes depreciation under section 167(k), or computes amortization
under section 169, 184, 185, 187, 188, or paragraph (b) of Sec. 1.162-
11. If the taxpayer has elected to apply this section to eligible
property described in section 167(k), 169, 184, 185, or 187 and the
taxpayer thereafter computes depreciation or amortization for such
property for any taxable year in accordance with section 167(k), 169,
184, 185, or 187, then the election to apply this section to such
property shall terminate as of the beginning of the taxable year for
which depreciation or amortization is computed under such section.
Application of this section to the property for any period prior to the
termination date will not be affected by the termination. The unadjusted
basis of the property shall be removed as of the termination date from
the unadjusted basis of the vintage account. The depreciation reserve
established for the account shall be reduced by the depreciation
allowable for the property, computed in the manner prescribed in
paragraph (c)(1)(v)(b) of this section for determination of the adjusted
basis of the property. See paragraph (d)(3)(vii)(e) of this section for
treatment of salvage value when property is removed from a vintage
account.
(vi) Certain section 1250 property. (a) The taxpayer may exclude
from an election to apply this section all, or less than all, items of
eligible section 1250 property first placed in service during the
taxable year of election provided that--
(1) The item is first placed in service before the earlier of the
effective date of the first supplemental asset guideline class including
such property established in accordance with subparagraph (4)(ii) of
this paragraph, or January 1, 1974, and
(2) The taxpayer establishes that a useful life shorter than the
asset guideline period in effect on January 1, 1971, for such item of
property is justified for such taxable year.
A useful life shorter than the asset guideline period in effect on
January 1, 1971, will be considered justified only if such life is
justified in accordance with the provisions of Revenue Procedure 62-21
(including all modifications, amendments or supplements thereto as of
January 1, 1971), determined without application of the minimal
adjustment rule in section 4, part II, of Revenue Procedure 65-13. If an
item of section 1250 property is excluded from an election to apply this
section pursuant to this subdivision, any elevator or escalator which is
a part of such item shall also be excluded from the election.
(b) If the taxpayer excludes an item of section 1250 property from
an election to apply this section in accordance with this subdivision,
the useful life justified under Revenue Procedure 62-21 in accordance
with this subdivision for the taxable year of exclusion will be treated
as justified for such item of section 1250 property for the taxable year
of the exclusion and all subsequent taxable years.
(vii) Subsidiary assets. The taxpayer may exclude from an election
to apply this section all (but not less than all) subsidiary assets
first placed in service during the taxable year of election in an asset
guideline class, provided that--
(a) The unadjusted basis of eligible subsidiary assets first placed
in service during the taxable year in the class is as much as 3 percent
of the unadjusted basis of all eligible property first placed in service
during the taxable year in the class, and
(b) Such subsidiary assets are first placed in service by the
taxpayer before the earlier of (1) the effective date
[[Page 394]]
of the first supplemental asset guideline class including such
subsidiary assets established in accordance with subparagraph (4)(ii) of
this paragraph, or (2) January 1, 1974.
For purposes of this subdivision the term ``subsidiary assets'' includes
jigs, dies, molds, returnable containers, glassware, silverware, textile
mill cam assemblies, and other equipment included in group 1, class 5,
of Revenue Procedure 62-21. which is usually and property accounted for
separately from other property and under a method of depreciation not
expressed in terms of years.
(6) Special rule for certain public utility property--(i)
Requirement of normalization in certain cases. Under section 167(1), in
the case of public utility property (as defined in section
167(1)(3)(A)), if the taxpayer--
(a) Is entitled to use a method of depreciation other than a
``subsection (1) method'' of depreciation (as defined in section
167(1)(3)(F)) only if it uses the ``normalization method of accounting''
(as defined in section 167(1)(3)(G)) with respect to such property, or
(b) Is entitled for the taxable year to use only a ``subsection (1)
method'' of depreciation, such property shall be eligible property (as
defined in subparagraph (2) of this paragraph) only if the taxpayer
normalizes the tax deferral resulting from the election to apply this
section.
(ii) Normalization. The taxpayer will be considered to normalize the
tax deferral resulting from the election to apply this section only if
it computes its tax expense for purposes of establishing its cost of
service for ratemaking purposes and for reflecting operating results in
its regulated books of account using a period for depreciation no less
than the lesser of--
(a) 100 percent of the asset guideline period in effect in
accordance with subparagraph (4)(ii) of this paragraph for the first
taxable year to which this section applies, or
(b) The period for computing its depreciation expense for ratemaking
purposes and for reflecting operating results in its regulated books of
account, and makes adjustments to a reserve to reflect the deferral of
taxes resulting from the election to apply this section. A determination
whether the taxpayer is considered to normalize (within the meaning of
the preceding sentence) the tax deferral resulting from the election to
apply this section shall be made in a manner consistent with the
principles for determining whether a taxpayer is using the
``normalization method of accounting'' (within the meaning of section
167(1)(3)(G)). [Removed] See Sec. 1.167(1)-1(h).
(iii) Failure to normalize. If a taxpayer, which has elected to
apply this section to any eligible public utility property and is
required under subdivision (i) of this subparagraph to normalize the tax
deferral resulting from the election to apply this section to such
property, fails to normalize such tax deferral, the election to apply
this section to such property shall terminate as of the beginning of the
taxable year for which the taxpayer fails to normalize such tax
deferral. Application of this section to such property for any period
prior to the termination date will not be affected by the termination.
The unadjusted basis of the property shall be removed as of the
termination date from the unadjusted basis of the vintage account. The
depreciation reserve established for the account shall be reduced by the
depreciation allowable for the property, computed in the manner
prescribed in paragraph (c)(1)(v)(b) of this section for determination
of the adjusted basis of the property. See paragraph (d)(3)(vii)(e) of
this section for treatment of salvage value when property is removed
from a vintage account.
(iv) Examples. The principles of this subparagraph may be
illustrated by the following examples:
Example 1. Corporation A is a gas pipeline company, subject to the
jurisdiction of the Federal Power Commission, which is entitled under
section 167(1) to use a method of depreciation other than a ``subsection
(1) method'' of depreciation (as defined in section 167(1) (3) (F)) only
if it uses the ``normalization method of accounting'' (as defined in
section 167(1)(3)(G)). Corporation A elects to apply this section for
1972 with respect to all eligible property. In 1972, corporation A
places in service eligible property with an unadjusted basis of $2
million. One hundred percent of the asset guideline period for such
property is 22 years and the asset depreciation range is from 17.5 years
to 26.5 years. The taxpayer uses the double declining balance method of
[[Page 395]]
depreciation, selects an asset depreciation period of 17.5 years and
applies the half-year convention (described in paragraph (c)(2)(iii) of
this section). The depreciation allowable under this section with
respect to such property in 1972 is $114,285. The taxpayer will be
considered to normalize the tax deferral resulting from the election to
apply this section and to use the ``normalization method of accounting''
(within the meaning of section 167(1)(3)(G)) if it computes its tax
expense for purposes of determining its cost of service for rate making
purposes and for reflecting operating results in its regulated books of
account using a ``subsection (1) method'' of depreciation, such as the
straight line method, determined by using a depreciation period of 22
years (that is, 100 percent of the asset guideline period). A
depreciation allowance computed in this manner is $45,454. The
difference in the amount determined under this section ($114,285) and
the amount used in computing its tax expense for purposes of estimating
its cost of service for rate making purposes and for reflecting
operating results in its regulated books of account ($45,454) is
$68,831. Assuming a tax rate of 48 percent, the deferral of taxes
resulting from an election to apply this section and using a different
method of depreciation for tax purposes from that used for establishing
its cost of service for rate making purposes and for reflecting
operating results in its regulated books of account is 48 percent of
$68,831, or $33,039, which amount should be added to a reserve to
reflect the deferral of taxes resulting from the election to apply this
section and from the use of a different method of depreciation in
computing the allowance for depreciation under section 167 from that
used in computing its depreciation expense for purposes of establishing
its cost of service for rate making purposes and for reflecting
operating results in its regulated books of account.
Example 2. Corporation B, a telephone company subject to the
jurisdiction of the Federal Communications Commission used a ``flow-
through method of accounting'' (as defined in section 167(1)(3)(H)) for
its ``July 1969 accounting period'' (as defined in section 167(1)(3)(I))
with respect to all of its pre-1970 public utility property and did not
make an election under section 167(1)(4)(A). Thus, corporation B is
entitled under section 167(1) to use a method of depreciation other than
a ``subsection (1) method'' with respect to certain property without
using the ``normalization method of accounting.'' In 1972, corporation B
makes an election to apply this section with respect to all eligible
property. Corporation B is not required to normalize the tax deferral
resulting from the election to apply this section in the case of
property for which it is not required to use the ``normalization method
of accounting'' under section 167(1).
Example 3. Assume the same facts as in example (2) except that
corporation B made a timely election under section 167(1)(4)(A) that
section 167(1)(2)(C) not apply with respect to property which increases
the productive or operational capacity of the taxpayer. Corporation B
must normalize the tax deferral resulting from the election to apply
this section with respect to such property.
(7) Mere change in form of conducting a trade or business. Property
which was first placed in service by the transferor before January 1,
1971, shall not be eligible property if such property is first placed in
service by the transferee after December 31, 1970, by reason of a mere
change in the form of conducting a trade or business in which such
property is used. A mere change in the form of conducting a trade or
business in which such property is used will be considered to have
occurred if--
(i) The transferor (or in a case where the transferor is a
partnership, estate, trust, or corporation, the partners, beneficiaries,
or shareholders) of such property retains a substantial interest in such
trade or business, or
(ii) The basis of such property in the hands of the transferee is
determined in whole or in part by reference to the basis of such
property in the hands of the transferor.
For purposes of this subparagraph, a transferor (or in a case where the
transferor is a partnership, estate, trust, or corporation, the
partners, beneficiaries, or shareholders) shall be considered as having
retained a substantial interest in the trade or business only if, after
the change in form, his (or their) interest in such trade or business is
substantial in relation to the total interest of all persons in such
trade or business. This subparagraph shall apply to property first
placed in service prior to January 1, 1971, held for the production of
income (within the meaning of section 167(a)(2)) as well as to property
used in a trade or business. The principles of this subdivision may be
illustrated by the following examples:
Example 1. Corporation X and corporation Y are includible
corporations in an affiliated group as defined in section 1504(a). In
1971 corporation X sells property to corporation Y for cash. The
property would meet the requirements of subparagraph (2) of this
paragraph for eligible property except that it was
[[Page 396]]
first placed in service by corporation X in 1970. After the transfer,
the property is first placed in service by corporation Y in 1971. The
property is not eligible property because of the mere change in the form
of conducting a trade or business.
Example 2. In 1971, in a transaction to which section 351 applies,
taxpayer B transfers to corporation W property which would meet the
requirements of subparagraph (2) of this paragraph for eligible property
except that the property was first placed in service by B in 1969.
Corporation W first places the property in service in 1971. The property
is not eligible property because of the mere change in the form of
conducting a trade or business.
(c) Manner of determining allowance--(1) In general--(i) Computation
of allowance. (a) The allowance for depreciation of property in a
vintage account shall be determined in the manner specified in this
paragraph by using the method of depreciation adopted by the taxpayer
for the account and a rate based upon the asset depreciation period for
the account. (For limitations on methods of depreciation permitted with
respect to property, see section 167 (c) and (j) and subdivision (iv) of
this subparagraph.) In applying the method of depreciation adopted by
the taxpayer, the annual allowance for depreciation of a vintage account
shall be determined without adjustment for the salvage value of the
property in such account except that no account may be depreciated below
the reasonable salvage value of the account. (For rules regarding
estimation and treatment of salvage value, see paragraph (d)(1) and (3)
(vii) and (viii) of this section.) Regardless of the method of
depreciation adopted by the taxpayer, the depreciation allowable for a
taxable year with respect to a vintage account may not exceed the amount
by which (as of the beginning of the taxable year) the unadjusted basis
of the account exceeds (1) the reserve for depreciation established for
the account plus (2) the salvage value of the account. The unadjusted
basis of a vintage account is defined in subdivision (v) of this
subparagraph. The adjustments to the depreciation reserve are described
in subdivision (ii) of this subparagraph.
(b) The annual allowance for depreciation of a vintage account using
the straight line method of depreciation shall be determined by dividing
the unadjusted basis of the vintage account (without reduction for
salvage value) by the number of years in the asset depreciation period
selected for the account. See subdivision (iii)(b) of this subparagraph
for the manner of computing the depreciation allowance following a
change from the declining balance method or the sum of the years-digits
method to the straight line method.
(c) In the case of the sum of the years-digits method, the annual
allowance for depreciation of a vintage account shall be computed by
multiplying the unadjusted basis of the vintage account (without
reduction for salvage value) by a fraction, the numerator of which
changes each year to a number which corresponds to the years remaining
in the asset depreciation period for the account (including the year for
which the allowance is being computed) and the denominator of which is
the sum of all the year's digits corresponding to the asset depreciation
period for the account. See subdivision (iii)(c) of this subparagraph
for the manner of computing the depreciation allowance following a
change from the declining balance method to the sum of the years-digits
method.
(d) The annual allowance for depreciation of a vintage account using
a declining balance method is determined by applying a uniform rate to
the excess of the unadjusted basis of the vintage account over the
depreciation reserve established for that account. The rate under the
declining balance method may not exceed twice the straight line rate
based upon the asset depreciation period for the vintage account.
(e) The allowance for depreciation under this paragraph shall
constitute the amount of depreciation allowable under section 167. See
section 179 for additional first-year allowance for certain property.
(ii) Establishment of depreciation reserve. The taxpayer must
establish a depreciation reserve for each vintage account. The amount of
the reserve for a guideline class must be stated on each income tax
return on which depreciation with respect to such class is determined
under this section. The depreciation reserve for a vintage account
[[Page 397]]
consists of the accumulated depreciation allowable under this section
with respect to the vintage account, increased by the adjustments for
ordinary retirements prescribed by paragraph (d)(3)(iii) of this
section, by the adjustments for reduction of the salvage value of a
vintage account prescribed by paragraph (d)(3)(vii)(d) of this section,
and by the adjustments for transfers to supplies or scrap prescribed by
paragraph (d)(3)(viii)(b) of this section, and decreased by the
adjustments for extraordinary retirements and certain special
retirements as prescribed by paragraph (d)(3) (iv) and (v) of this
section, by the adjustments for the amount of the reserve in excess of
the unadjusted basis of a vintage account prescribed by paragraph
(d)(3)(ix)(a) of this section, and by the adjustments for property
removed from a vintage account prescribed by paragraphs (b)(4)(iii)(e),
(5)(v)(b) and (6)(iii) of this section. The adjustments to the
depreciation reserve for ordinary retirements during the taxable year
shall be made as of the beginning of the taxable year. The adjustments
to the depreciation reserve for extraordinary retirements shall be made
as of the date the retirement is treated as having occurred in
accordance with the first-year convention (described in subparagraph (2)
of this paragraph) adopted by the taxpayer for the vintage account. The
adjustment to the depreciation reserve for reduction of salvage value
and for transfers to supplies or scrap shall, in the case of an ordinary
retirement, be made as of the beginning of the taxable year, and in the
case of an extraordinary retirement the adjustment for reduction of
salvage value shall be made as of the date the retirement is treated as
having occurred in accordance with the first-year convention (described
in subparagraph (2) of this paragraph) adopted by the taxpayer for the
vintage account. The adjustment to the depreciation reserve for property
removed from a vintage account in accordance with paragraph
(b)(4)(iii)(e), (5)(v)(b) and (6)(iii) of this section shall be made as
of the beginning of the taxable year. The depreciation reserve of a
vintage account may not be decreased below zero.
(iii) Consent to change in method of depreciation. (a) During the
asset depreciation period for a vintage account, the taxpayer is
permitted to change under this section from a declining balance method
of depreciation to the sum of the years-digits method of depreciation
and from a declining balance method of depreciation or the sum of the
years-digits method of depreciation to the straight line method of
depreciation with respect to such account. Except as provided in section
167(j)(2)(1), and paragraph (e)(3)(i) of this section, no other changes
in the method of depreciation adopted for a vintage account will be
permitted. The provisions of Sec. 1.167(e)-1 shall not apply to any
change in depreciation method permitted under this section. The change
in method applies to all property in the vintage account and must be
adhered to for the entire taxable year of the change.
(b) When a change is made to the straight line method of
depreciation, the annual allowance for depreciation of the vintage
account shall be determined by dividing the adjusted basis of the
vintage account (without reduction for salvage value) by the number of
years remaining (at the time as of which the change is made) in the
asset depreciation period selected for the account. However, the
depreciation allowable for any taxable year following a change to the
straight line method may not exceed an amount determined by dividing the
unadjusted basis of the vintage account (without reduction for salvage
value) by the number of years in the asset depreciation period selected
for the account.
(c) When a change is made from the declining balance method of
depreciation to the sum of the years-digits method of depreciation, the
annual allowance for depreciation of a vintage account shall be
determined by multiplying the adjusted basis of the account (without
reduction for salvage value) at the time as of which the change is made
by a fraction, the numerator of which changes each year to a number
which corresponds to the number of years remaining in the asset
depreciation period selected for the account (including the year for
which the allowance is being computed), and the
[[Page 398]]
denominator of which is the sum of all the year's digits corresponding
to the number of years remaining in the asset depreciation period at the
time as of which the change is made.
(d) The number of years remaining in the asset depreciation period
selected for an account is equal to the asset depreciation period less
the number of years of depreciation previously allowed. For this
purpose, regardless of the first year convention adopted by the
taxpayer, it will be assumed that depreciation was allowed for one-half
of a year in the first year.
(e) The taxpayer shall furnish a statement setting forth the vintage
accounts for which the change is made with the income tax return filed
for the taxable year of the change.
(f) The principles of this subdivision may be illustrated by the
following examples:
Example 1. A, a calendar year taxpayer, places new section 1245
property in service in a trade or business as follows:
------------------------------------------------------------------------
Unadjusted Estimated
Asset Placed in service basis salvage
------------------------------------------------------------------------
X............................. Mar. 15, 1971.... $400 $20
Y............................. June 13, 1971.... 500 50
Z............................. July 30, 1971.... 100 0
------------------------------------------------------------------------
The property is eligible property and is properly included in a single
vintage account. The asset depreciation range for such property is 5 to
7 years and the taxpayer selects an asset depreciation period of 5\1/2\
years and adopts the 200-percent declining balance method of
depreciation. The taxpayer adopts the half-year convention described in
subparagraph (2)(iii) of this paragraph. After 3 years, A changes from
the 200-percent declining balance method to the straight line method of
depreciation. Depreciation allowances would be as follows:
----------------------------------------------------------------------------------------------------------------
Unadjusted
Year basis Rate Depreciation Reserve Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................ $1,000 0.18182 $181.82 $181.82 $818.18
1972............................ 1,000 .36363 297.52 479.34 520.66
1973............................ 1,000 .36363 189.33 668.67 331.33
1974............................ 1,000 \1\ .33333 110.44 779.11 220.89
1975............................ 1,000 .33333 110.44 889.56 110.44
1976............................ 1,000 .33333 \2\ 40.44 930.00 70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to adjusted basis of the account (without reduction by salvage) at the time as of which the
change is made to the straight line method.
\2\ The allowable depreciation is limited by estimated salvage.
Example 2. The facts are the same as in example (1) except that A
elects to use the modified half-year convention described in
subparagraph (2)(ii) of this paragraph. The depreciation allowances
would be as follows:
----------------------------------------------------------------------------------------------------------------
Unadjusted
Year basis Rate Depreciation Reserve Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................ $1,000 \1\ 0.36363 $327.27 $327.27 $672.73
1972............................ 1,000 .36363 244.63 571.90 428.10
1973............................ 1,000 .36363 155.67 727.57 272.43
1974............................ 1,000 .33333 90.81 818.38 181.62
1975............................ 1,000 .33333 90.81 909.19 90.81
1976............................ 1,000 .33333 \2\ 20.81 930.00 70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to $900, the amount of assets placed in service during the first half of the taxable year.
\2\ The allowable depreciation is limited by estimated salvage.
Example 3. The facts are the same as in example (1) except that A
adopted the sum of the years-digits method of depreciation and does not
change to the straight line method of depreciation. The depreciation
allowances would be as follows:
----------------------------------------------------------------------------------------------------------------
Unadjusted
Year basis Rate Depreciation Reserve Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................ $1,000 \1\ 2.75/18 $152.78 $152.78 $847.22
1972............................ 1,000 5/18 277.78 430.56 569.44
1973............................ 1,000 4/18 222.22 652.78 347.22
1974............................ 1,000 3/18 166.67 819.45 180.55
1975............................ 1,000 2/18 \2\ 110.55 930.00 70.00
[[Page 399]]
1976............................ 1,000 1/18 0.00 930.00 70.00
1977............................ 1,000 0.25/18 0.00 930.00 70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate is equal to one-half of 5.5/18. The denominator is equal to 5.5+4.5+3.5+2.5+1.5+0.5.
\2\ The allowable depreciation is limited by estimated salvage.
Example 4. The facts are the same as in example (3) except that A
elects to use the modified half-year convention described in
subparagraph (2) (ii) of this paragraph. The depreciation allowances
would be as follows:
----------------------------------------------------------------------------------------------------------------
Unadjusted
Year basis Rate Depreciation Reserve Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................ $1,000 \1\ 5.5/18 $275.00 $275.00 $725.00
1972............................ 1,000 5/18 277.78 552.78 447.22
1973............................ 1,000 4/18 222.22 775.00 225.00
1974............................ 1,000 3/18 \2\ 155.00 930.00 70.00
1975............................ 1,000 2/18 0.00 930.00 70.00
1976............................ 1,000 1/18 0.00 930.00 70.00
1977............................ 1,000 0.25/18 0.00 930.00 70.00
----------------------------------------------------------------------------------------------------------------
\1\ Rate applied to $900, the amount of assets placed in service during the first half of the taxable year.
\2\ The allowable depreciation is limited by estimated salvage.
Example 5. The facts are the same as in example (2) except that
after 2 years A changes from the 200-percent declining balance method to
the sum of the years-digits method of depreciation. The depreciation
allowances would be as follows:
----------------------------------------------------------------------------------------------------------------
Unadjusted
Year basis Rate Depreciation Reserve Adjusted basis
----------------------------------------------------------------------------------------------------------------
1971............................ $1,000 0.36363 $327.27 $327.27 $672.73
1972............................ 1,000 .36363 244.63 571.90 428.10
1973............................ 1,000 4/10 171.24 743.14 256.86
1974............................ 1,000 3/10 128.43 871.57 128.43
1975............................ 1,000 2/10 \1\ 58.43 930.00 70.00
1976............................ 1,000 1/10 0.00 930.00 70.00
----------------------------------------------------------------------------------------------------------------
\1\ The allowable depreciation is limited by estimated salvage.
(iv) Limitation on methods. (a) The same method of depreciation must
be adopted for all property in a single vintage account. Generally, the
method of depreciation which may be adopted is subject to the
limitations contained in section 167 (c), (j) and (l).
(b) Except as otherwise provided in section 167(j) with respect to
certain eligible section 1250 property--
(1) In the case of a vintage account for which the taxpayer has
selected an asset depreciation period of 3 years or more and which only
contains property the original use of which commences with the taxpayer,
any method of depreciation described in section 167(b) (1), (2), or (3)
may be adopted, but if the vintage account contains property the
original use of which does not commence with the taxpayer, or if the
asset depreciation period for the account is less than 3 years, a method
of depreciation described in section 167(b) (2) or (3) may not be
adopted for the account, and
(2) The declining balance method using a rate not in excess of 150
percent of the straight line rate based upon the asset depreciation
period for the vintage account may be adopted for the account even if
the original use of the property does not commence with the taxpayer
provided the asset depreciation period for the account is at least 3
years.
(c) The term ``original use'' means the first use to which the
property is put, whether or not such use corresponds to the use of such
property by the taxpayer. (See Sec. 1.167(c)-1).
(v) Unadjusted and adjusted basis. (a) For purposes of this section,
the unadjusted basis of an asset (including
[[Page 400]]
an ``excluded addition'' and a ``property improvement'' as described,
respectively, in paragraph (d)(2) (vi) and (vii) of this section) is its
cost or other basis without any adjustment for depreciation or
amortization (other than depreciation under section 179) but with other
adjustments required under section 1016 or other applicable provisions
of law. The unadjusted basis of a vintage account is the total of the
unadjusted bases of all the assets in the account. The unadjusted basis
of a ``special basis vintage account'' as described in paragraph
(d)(3)(vi) of this section is the amount of the property improvement
determined in paragraph (d)(2)(vii)(a) of this section.
(b) The adjusted basis of a vintage account is the amount by which
the unadjusted basis of the account exceeds the reserve for depreciation
for the account. The adjusted basis of an asset in a vintage account is
the amount by which the unadjusted basis of the asset exceeds the amount
of depreciation allowable for the asset under this section computed by
using the method of depreciation and the rate applicable to the account.
For purposes of this subdivision, the depreciation allowable for an
asset shall include, to the extent identifiable, the amount of proceeds
previously added to the depreciation reserve in accordance with
paragraph (d)(3)(iii) of this section upon the retirement of any portion
of such asset. (See paragraph (d)(3)(vi) of this section for election
under certain circumstances to allocate adjusted basis of an amount of
property improvement determined under paragraph (d)(2)(vii)(a) of this
section.)
(2) Conventions applied to additions and retirements--(i) In
general. The allowance for depreciation of a vintage account (whether an
item account or a multiple asset account) shall be determined by
applying one of the conventions described in subdivisions (ii) and (iii)
of this subparagraph. (For the manner of applying a convention in the
case of taxable years beginning before and ending after December 31,
1970, see subparagraph (3) of this paragraph.) The same convention must
be adopted for all vintage accounts of a taxable year, but the same
convention need not be adopted for the vintage accounts of another
taxable year. An election to apply this section must specify the
convention adopted. (See paragraph (f) of this section for information
required in making the election.) The convention adopted by the taxpayer
is a method of accounting for purposes of section 446, but the consent
of the Commissioner will be deemed granted to make an annual adoption of
either of the conventions described in subdivisions (ii) and (iii) of
this subparagraph.
(ii) Modified half-year convention. The depreciation allowance for a
vintage account for which the taxpayer adopts the ``modified half-year
convention'' shall be determined by treating: (a) All property in such
account which is placed in service during the first half of the taxable
year as placed in service on the first day of the taxable year; and (b)
all property in such account which is placed in service during the
second half of the taxable year as placed in service on the first day of
the succeeding taxable year. The depreciation allowance for a vintage
account for a taxable year in which there is an extraordinary retirement
(as defined in paragraph (d) (3) (ii) of this section) of property first
placed in service during the first half of the taxable year is
determined by treating all such retirements from such account during the
first half of the taxable year as occurring on the first day of the
taxable year and all such retirements from such account during the
second half of the taxable year as occurring on the first day of the
second half of the taxable year. The depreciation allowance for a
vintage account for a taxable year in which there is an extraordinary
retirement (as defined in paragraph (d)(3)(ii) of this section) of
property first placed in service during the second half of the taxable
year is determined by treating all such retirements from such account
during the first half of the taxable year as occurring on the first day
of the second half of the taxable year and all such retirements in the
second half of the taxable year as occurring on the first day of the
succeeding taxable year.
(iii) Half-year convention. The depreciation allowance for a vintage
account for which the taxpayer adopts the
[[Page 401]]
``half-year convention'' shall be determined by treating all property in
the account as placed in service on the first day of the second half of
the taxable year and by treating all extraordinary retirements (as
defined in paragraph (d)(3)(ii) of this section) from the account as
occurring on the first day of the second half of the taxable year.
(iv) Rules of application. (a) The first-year convention adopted for
a vintage account must be consistently applied to all additions to and
all extraordinary retirements from such account. See paragraph (d)(3)
(ii) and (iii) of this section for definition and treatment of ordinary
retirements.
(b) If the actual number of months in a taxable year is other than
12 full calendar months, depreciation is allowed only for such actual
number of months and the term ``taxable year'', for purposes of this
subparagraph, shall mean only such number of months. In such event, the
first half of such taxable year shall be deemed to expire at the close
of the last day of a calendar month which is the closest such last day
to the middle of such taxable year and the second half of such taxable
year shall be deemed to begin the day after the expiration of the first
half of such taxable year. If a taxable year consists of a period which
includes only 1 calendar month, the first half of the taxable year shall
be deemed to expire on the first day which is nearest to the midpoint of
the month, and the second half of the taxable year shall begin the day
after the expiration of the first half of the month.
(c) For purposes of this subparagraph, for property placed in
service after November 14, 1979, other than depreciable property
described in paragraph (c)(2)(iv)(e) of this section, the taxable year
of the person placing such property in service does not include any
month before the month in which the person begins engaging in a trade or
business or holding depreciable property for the production of income.
(d) For purposes of paragraph (c)(2) (iv)(c) of this section--
(1) For property placed in service after February 21, 1981, an
employee is not considered engaged in a trade or business by virtue of
employment.
(2) If a person engages in a small amount of trade or business
activity after February 21, 1981, for the purpose of obtaining a
disproportionately large depreciation deduction for assets for the
taxable year in which they are placed in service, and placing those
assets in service represents a substantial increase in the person's
level of business activity, then for purposes of depreciating those
assets the person will not be treated as beginning a trade or business
until the increased amount of business activity begins. For property
held for the production of income, the principle of the preceding
sentence applies.
(3) A person may elect to apply the rules of Sec. 1.167(a)-11
(c)(2)(iv)(d) as set forth in T.D. 7763 (``(d) rules in T.D. 7763'').
This election shall be made by reflecting it under paragraph (f)(4) of
this section in the books and records. If necessary, amended returns
shall be filed.
(4) If an averaging convention was adopted in reliance on or in
anticipation of the (d) rules in T.D. 7763, that convention may be
changed without regard to paragraph (f)(3) of this section. Similarly,
if an election is made under paragraph (c)(2)(iv)(d)(3) of this section
to apply to the (d) rules in T.D. 7763, the averaging convention adopted
for the taxable years for which the election is made may be changed. The
change shall be made by filing a timely amended return for the taxable
year for which the convention was adopted. Notwithstanding the three
preceding sentences, if an averaging convention was adopted in reliance
on or in anticipation of the (d) rules in T.D. 7763, and if an election
is made to apply those rules, the averaging convention adopted cannot be
changed except as provided in paragraph (f) of this section.
(e) The rules in paragraph (c)(2)(iv)(c) of this section do not
apply to depreciable property placed in service after November 14, 1979,
and the rules in paragraph (c)(2)(iv)(d) of this section do not apply to
depreciable property placed in service after February 21, 1981, with
respect to which substantial expenditures were paid or incurred
[[Page 402]]
prior to November 15, 1979. For purposes of the preceding sentence,
expenditures will not be considered substantial unless they exceed the
lesser of 30 percent of the final cost of the property or $10 million.
Expenditures that are not includible in the basis of the depreciable
property will be considered expenditures with respect to property if
they are directly related to a specific project involving such property.
For purposes of determining whether expenditures were paid or incurred
prior to November 15, 1979, expenditures made by a person (transferor)
other than the person placing the property in service (transferee) will
be taken into account only if the basis of the property in the hands of
the transferee is determined in whole or in part by reference to the
basis in the hands of the transferor. The principle of the preceding
sentence also applies if there are multiple transfers.
(v) Mass assets. In the case of mass assets, if extraordinary
retirements of such assets in a guideline class during the first half of
the taxable year are allocated to a particular vintage year for which
the taxpayer applied the modified half-year convention, then that
portion of the mass assets so allocated which bears the same ratio to
the total number of mass assets so allocated as the mass assets in the
same vintage and assets guideline class placed in service during the
first half of that vintage year bear to the total mass assets in the
same vintage and asset guideline class shall be treated as retired on
the first day of the taxable year. The remaining mass assets which are
subject to extraordinary retirement during the first half of the taxable
year and which are allocated to that vintage year and assets guideline
class shall be treated as retired on the first days of the second half
of the taxable year. If extraordinary retirements of mass assets in a
guideline class occur in the second half of the taxable year and are
allocated to a particular vintage year for which the taxpayer applied
the modified half-year convention, then that portion of the mass assets
so allocated which bears the same ratio to the total number of mass
assets so allocated as the mass assets in the same vintage and asset
guideline class first placed in service during the first half of that
vintage year bear to the total mass assets in the same vintage and asset
guideline class shall be treated as retired on the first day of the
second half of the taxable year. The remaining mass assets which are
subject to extraordinary retirements during the second half of the
taxable year and which are allocated to that same vintage and asset
guideline class shall be treated as retired on the first day of the
succeeding taxable year. If the taxpayer has applied the half-year
convention for the vintage year to which the extraordinary retirements
are allocated, the mass assets shall be treated as retired on the first
day of the second half of the taxable year.
(3) Taxable years beginning before and ending after December 31,
1970. In the case of a taxable year which begins before January 1, 1971,
and ends after December 31, 1970, property first placed in service after
December 31, 1970, but treated as first placed in service before January
1, 1971, by application of a convention described in subparagraph (2) of
this paragraph shall be treated as provided in this subparagraph. The
depreciation allowed (or allowable) for the taxable year shall consist
of the depreciation allowed (or allowable) for the period before January
1, 1971, determined without regard to this section plus the amount
allowable for the period after December 31, 1970, determined under this
section. However, neither the modified half-year convention described in
subparagraph (2)(ii) of this paragraph, nor the half-year convention
described in subparagraph (2)(iii) of this paragraph may for any such
taxable year be applied with respect to property placed in service after
December 31, 1970, to allow depreciation for any period prior to January
1, 1971, unless such convention is consistent with the convention
applied by the taxpayer with respect to property placed in service in
such taxable year prior to January 1, 1971.
(4) Examples. The principles of this paragraph may be illustrated by
the following examples:
Example 1. Taxpayer A, a calendar year taxpayer, places new property
in service in a trade or business as follows:
[[Page 403]]
------------------------------------------------------------------------
Unadjusted
Asset Placed in service basis
------------------------------------------------------------------------
W................................... Apr. 1, 1971.......... $5,000
X................................... June 30, 1971......... 8,000
Y................................... July 15, 1971......... 12,000
------------------------------------------------------------------------
Taxpayer A adopts the modified half-year convention described in
subparagraph (2) (ii) of this paragraph. Assets W, X, and Y are placed
in a multiple asset account for which the asset depreciation range is 8
to 12 years. A selects 8 years, the minimum asset depreciation period
with respect to such assets, and adopts the declining balance method of
depreciation using a rate twice the straight line rate (computed without
reduction for salvage). The annual rate under this method using a period
of 8 years is 25 percent. The depreciation allowance for assets W and X
for 1971 is $3,250, a full year's depreciation under the modified half-
year convention (that is, basis of $13,000 (unreduced by salvage)
multiplied by 25 percent). The depreciation allowance for asset Y for
1971 is zero under the modified half-year convention.
Example 2. The facts are the same as in example (1), except that the
taxpayer adopts the half-year convention described in subparagraph (2)
(iii) of this paragraph. The depreciation allowance with respect to
asset Y is $1,500 (that is the basis of $12,000 multiplied by 25
percent, then multiplied by \1/2\). Assets W and X are also entitled to
a depreciation allowance for only a half year. Thus, the depreciation
allowance for assets W and X for 1971 is $1,625 (that is, \1/2\ of the
$3,250 allowance computed in example (1)).
Example 3. Asset Z is placed in service by a calendar year taxpayer
on December 1, 1971. The taxpayer places asset Z in an item account and
adopts the sum of the years-digits method and the half year convention
described in subparagraph (2) (iii) of this paragraph. The asset
depreciation range for such asset is 4 to 6 years and the taxpayer
selects an asset depreciation period of 5 years. The depreciation
allowance for asset Z in 1971 is $10,000 (that is, basis of $60,000
(unreduced by salvage) multiplied by \5/15\, the appropriate fraction
using the sum of the years-digits method then multiplied by \1/2\, since
only one half year's depreciation is allowable under the convention).
Example 4. A is a calendar year taxpayer. All taxpayer A's assets
are placed in service in the first half of 1971. If the taxpayer selects
the modified half-year convention described in subparagraph (2) (ii) of
this paragraph, a full year's depreciation is allowable for all assets.
Example 5. (i) The taxpayer during his taxable year which begins
April 1, 1970, and ends March 31, 1971, places new property in service
in a trade or business as follows:
------------------------------------------------------------------------
Unadjusted
Asset Placed in service basis
------------------------------------------------------------------------
A................................... Apr. 30, 1970......... $10,000
B................................... Dec. 15, 1970......... 10,000
C................................... Jan. 1, 1971.......... 10,000
------------------------------------------------------------------------
The taxpayer adopted a convention under Sec. 1.167(a)-10(b) with
respect to assets placed in service prior to January 1, 1971, which
treats assets placed in service during the first half of the year as
placed in service on the first day of such year and assets placed in
service in the second half of the year as placed in service on the first
day of the following year. If the taxpayer selects the half-year
convention described in subparagraph (2) (iii) of this paragraph, one
year's depreciation is allowable on asset A determined without regard to
this section. No depreciation is allowable for asset B. No depreciation
is allowable for asset C for the period prior to January 1, 1971. One-
fourth year's depreciation is allowable on asset C determined under this
section.
(ii) The facts are the same as in (i) of this example except that
the taxpayer adopts the modified half-year convention described in
subparagraph (2) (ii) of this paragraph for 1971. No depreciation is
allowable for assets B and C which were placed in service in the second
half of the taxable year.
Example 6. The taxpayer during his taxable year which begins August
1, 1970, and ends July 31, 1971, places new property in service in a
trade or business as follows:
------------------------------------------------------------------------
Asset Placed in service
------------------------------------------------------------------------
A...................................... Aug. 1, 1970.
B...................................... Jan. 15, 1971.
C...................................... June 30, 1971.
------------------------------------------------------------------------
The taxpayer adopted a convention under Sec. 1.167(a)-10(b) with
respect to assets placed in service prior to January 1, 1971, which
treats all assets as placed in service at the mid-point of the taxable
year. If the taxpayer selects the half-year convention described in
subparagraph (2) (iii) of this paragraph, one-half year's depreciation
is allowable for asset A determined without regard to this section. One-
half year's depreciation is allowable for assets B and C determined
under this section.
Example 7. X, a calendar year corporation, is incorporated on July
1, 1978, and begins engaging in a trade or business in September 1979. X
purchases asset A and places it in service on November 20, 1979.
Substantial expenditures were not paid or incurred by X with respect to
asset A prior to November 15, 1979. For purposes of applying the
conventions under this section to determine depreciation for asset A,
the 1979 taxable year is treated as consisting of 4 months. The first
half of the taxable year ends on October 31, 1979, and the second half
begins on November
[[Page 404]]
1, 1979. X adopts the half-year convention. Asset A is treated as placed
in service on November 1, 1979.
Example 8. On January 20, 1982, A, B, and C enter an agreement to
form partnership P for the purpose of purchasing and leasing a ship to a
third party, Z. P uses the calendar year as its taxable year. On
December 15, 1982, P acquires the ship and leases it to Z. For purposes
of applying the conventions, P begins its leasing business in December
1982, and its taxable year begins on December 1, 1982. Assuming that P
elects to apply this section and adopts the modified half-year
convention, P depreciates the ship placed in service in 1982 for the 1-
month period beginning December 1, 1982, and ending December 31, 1982.
Example 9. A and B form partnership P on December 15, 1981, to
conduct a business of leasing small aircraft. P uses the calendar year
as its taxable year. On January 15, 1982, P acquires and places in
service a $25,000 aircraft. P begins engaging in business with only one
aircraft for the purpose of obtaining a disproportionately large
depreciation deduction for aircraft that P plans to acquire at the end
of the year. On December 10, 1982, P acquires and places in service 4
aircraft, the total purchase price of which is $250,000. For purposes of
applying the conventions to the aircraft acquired in December, P begins
its leasing business in December 1982, and P's taxable year begins
December 1, 1982, and ends December 31, 1982. Assuming that P elects to
apply this section and adopts the modified half-year convention, P
depreciates the aircraft placed in service in December 1982, for the 1-
month period beginning December 1, 1982, and ending December 31, 1982. P
depreciates the aircraft placed in service in January 1982, for the 12-
month period beginning January 1, 1982, and ending December 31, 1982.
(d) Special rules for salvage, repairs and retirements--(1) Salvage
value--(i) Definition of gross salvage value. ``Gross salvage'' value is
the amount which is estimated will be realized upon a sale or other
disposition of the property in the vintage account when it is no longer
useful in the taxpayer's trade or business or in the production of his
income and is to be retired from service, without reduction for the cost
of removal, dismantling, demolition or similar operations. If a taxpayer
customarily sells or otherwise disposes of property at a time when such
property is still in good operating condition, the gross salvage value
of such property is the amount expected to be realized upon such sale or
disposition, and under certain circumstances, as where such property is
customarily sold at a time when it is still relatively new, the gross
salvage value may constitute a relatively large proportion of the
unadjusted basis of such property.
(ii) Definition of salvage value. ``Salvage value'' means gross
salvage value less the amount, if any, by which the gross salvage value
is reduced by application of section 167(f). Generally, as provided in
section 167(f), a taxpayer may reduce the amount of gross salvage value
of a vintage account by an amount which does not exceed 10 percent of
the unadjusted basis of the personal property (as defined in section
167(f)(2)) in the account. See paragraph (b)(3)(ii) of this section for
requirement of separate vintage accounts for personal property described
in section 167(f)(2).
(iii) Estimation of salvage value. The salvage value of each vintage
account of the taxable year shall be estimated by the taxpayer at the
time the election to apply this section is made, upon the basis of all
the facts and circumstances existing at the close of the taxable year in
which the account is established. The taxpayer shall specify the amount,
if any, by which gross salvage value taken into account is reduced by
application of section 167(f). See paragraph (f)(2) of this section for
requirement that the election specify the estimated salvage value for
each vintage account of the taxable year of election. The salvage value
estimated by the taxpayer will not be redetermined merely as a result of
fluctuations in price levels or as a result of other facts and
circumstances occurring after the close of the taxable year of election.
Salvage value for a vintage account need not be established or increased
as a result of a property improvement as described in subparagraph (2)
(vii) of this paragraph. The taxpayer shall maintain records reasonably
sufficient to determine facts and circumstances taken into account in
estimating salvage value.
(iv) Salvage as limitation on depreciation. In no case may a vintage
account be depreciated below a reasonable salvage value after taking
into account any reduction in gross salvage value permitted by section
167(f).
[[Page 405]]
(v) Limitation on adjustment of reasonable salvage value. The
salvage value established by the taxpayer for a vintage account will not
be redetermined if it is reasonable. Since the determination of salvage
value is a matter of estimation, minimal adjustments will not be made.
The salvage value established by the taxpayer will be deemed to be
reasonable unless there is sufficient basis in the facts and
circumstances existing at the close of the taxable year in which the
account is established for a determination of an amount of salvage value
for the account which exceeds the salvage value established by the
taxpayer for the account by an amount greater than 10 percent of the
unadjusted basis of the account at the close of the taxable year in
which the account is established. If the salvage value established by
the taxpayer for the account is not within the 10 percent range, or if
the taxpayer follows the practice of understating his estimates of gross
salvage value to take advantage of this subdivision, and if there is a
determination of an amount of salvage value for the account which
exceeds the salvage value established by the taxpayer for the account,
an adjustment will be made by increasing the salvage value established
by the taxpayer for the account by an amount equal to the difference
between the salvage value as determined and the salvage value
established by the taxpayer for the account. For the purposes of this
subdivision, a determination of salvage value shall include all
determinations at all levels of audit and appellate proceedings, and as
well as all final determinations within the meaning of section 1313(a)
(1). This subdivision shall apply to each such determination. (See
example (3) of subdivision (vi) of this subparagraph.)
(vi) Examples. The principles of this subparagraph may be
illustrated by the following examples in which it is assumed that the
taxpayer has not followed a practice of understating his estimates of
gross salvage value:
Example 1. Taxpayer B elects to apply this section to assets Y and
Z, which are placed in a multiple asset vintage account of 1971 for
which the taxpayer selects an asset depreciation period of 8 years. The
unadjusted basis of asset Y is $50,000 and the unadjusted basis of asset
Z is $30,000. B estimates a gross salvage value of $55,000. The property
qualifies under section 167(f) (2) and B reduces the amount of salvage
taken into account by $8,000 (that is, 10 percent of $80,000 under
section 167(f)). Thus, B establishes a salvage value of $47,000 for the
account. Assume that there is not sufficient basis for determining a
salvage value for the account greater than $52,000 (that is, $60,000
minus the $8,000 reduction under section 167(f)). Since the salvage
value of $47,000 established by B for the account is within the 10
percent range, it is reasonable. Salvage value for the account will not
be redetermined.
Example 2. The facts are the same as in example (1) except that B
estimates a gross salvage value of $50,000 and establishes a salvage
value of $42,000 for the account (that is, $50,000 minus the $8,000
reduction under section 167(f)). There is sufficient basis for
determining an amount of salvage value greater than $50,000 (that is,
$58,000 minus the $8,000 reduction under section 167(f)). The salvage
value of $42,000 established by B for the account can be redetermined
without regard to the limitation in subdivision (v) of this
subparagraph, since it is not within the 10 percent range. Upon audit of
B's tax return for a taxable year for which the redetermination would
affect the amount of depreciation allowable for the account, salvage
value is determined to be $52,000 after taking into account the
reduction under section 167(f). Salvage value for the account will be
adjusted to $52,000.
Example 3. The facts are the same as in example (1) except that upon
audit of B's tax return for a taxable year the examining officer
determines the salvage value to be $58,000 (that is, $66,000 minus the
$8,000 reduction under section 167(f)), and proposes to adjust salvage
value for the vintage account to $58,000 which will result in
disallowing an amount of depreciation for the taxable year. B does not
agree with the finding of the examining officer. After receipt of a
``30-day letter'', B waives a district conference and initiates
proceedings before the Appellate Division. In consideration of the case
by the Appellate Division it is concluded that there is not sufficient
basis for determining an amount of salvage value for the account in
excess of $55,000 (that is $63,000 minus the $8,000 reduction under
section 167(f)). Since the salvage of $47,000 established by B for the
account is within the 10 percent range, it is reasonable. Salvage value
for the account will not be redetermined.
Example 4. Taxpayer C elects to apply this section to factory
building X which is placed in an item vintage account of 1971. The
unadjusted basis of factory building X is $90,000. C estimates a gross
salvage value for the account of $10,000. The property does not qualify
under section 167(f)(2). C establishes
[[Page 406]]
a salvage value of $10,000 for the account. Assume that there is not
sufficient basis for determining a salvage value for the account greater
than $18,000. Since the salvage value of $10,000 established by B for
the account is within the 10 percent range, it is reasonable. Salvage
value for the account will not be redetermined.
(2) Treatment of repairs--(i) In general. (a) Sections 162, 212, and
263 provide general rules for the treatment of certain expenditures for
the repair, maintenance, rehabilitation or improvement of property. In
general, under those sections, expenditures which substantially prolong
the life of an asset, or are made to increase its value or adapt it to a
different use are capital expenditures. If an expenditure is treated as
a capital expenditure under section 162, 212, or 263, it is subject to
the allowance for depreciation. On the other hand, in general,
expenditures which do not substantially prolong the life of an asset or
materially increase its value or adapt it for a substantially different
use may be deducted as an expense in the taxable year in which paid or
incurred. Expenditures, or a series of expenditures, may have
characteristics both of deductible expenses and capital expenditures.
Other expenditures may have the characteristics of capital expenditures,
as in the case of an ``excluded addition'' (as defined in subdivision
(vi) of this subparagraph). This subparagraph provides a simplified
procedure for determining whether expenditures with respect to certain
property are to be treated as deductible expenses or capital
expenditures.
(b) [Reserved]
(ii) Election of repair allowance. In the case of an asset guideline
class which consists of ``repair allowance property'' as defined in
subdivision (iii) of this subparagraph, subject to the provisions of
subdivision (v) of this subparagraph, the taxpayer may elect to apply
the asset guideline class repair allowance described in subdivision
(iii) of this subparagraph for any taxable year ending after December
31, 1970, for which the taxpayer elects to apply this section.
(iii) Repair allowance for an asset guideline class. For a taxable
year for which the taxpayer elects to apply this section, the ``repair
allowance'' for an asset guideline class which consists of ``repair
allowance property'' is an amount equal to--
(a) The average of (1) the unadjusted basis of all ``repair
allowance property'' in the asset guideline class at the beginning of
the taxable year, less in the case of such property in a vintage account
the unadjusted basis of all such property retired in an ordinary
retirement (as described in subparagraph (3)(ii) of this paragraph) in
prior taxable years, and (2) the unadjusted basis of all ``repair
allowance property'' in the asset guideline class at the end of the
taxable year, less in the case of such property in a vintage account the
unadjusted basis of all such property retired in an ordinary retirement
(including ordinary retirements during the taxable year), multiplied
by--
(b) The repair allowance percentage in effect for the asset
guideline class for the taxable year.
In applying the assets guideline class repair allowance to buildings
which are section 1250 property, for the purpose of this subparagraph
each building shall be treated as in a separate asset guideline class.
If two or more buildings are in the same asset guideline class
determined without regard to the preceding sentence and are operated as
an integrated unit (as evidenced by their actual operation, management,
financing and accounting), they shall be treated as a single building
for this purpose. The ``repair allowance percentages'' in effect for
taxable years ending before the effective date of the first supplemental
repair allowance percentages established pursuant to this section are
set forth in Revenue Procedure 72-10. Repair allowance percentages will
from time to time be established, supplemented and revised with express
reference to this section. These repair allowance percentages will be
published in the Internal Revenue Bulletin. The repair allowance
percentages in effect on the last day of the taxable year shall apply
for the taxable year, except that the repair allowance percentage for a
particular taxable year shall not be less than the repair allowance
percentage in effect on the first day of such taxable year (or as of
such later time in such year as
[[Page 407]]
a repair allowance percentage first established during such year becomes
effective). Generally, the repair allowance percentages for a taxable
year shall not be changed to reflect any supplement or revision of the
repair allowance percentages after the end of such taxable year.
However, if expressly provided in such a supplement or revision of the
repair allowance percentages, the taxpayer may, at his option in the
manner specified therein, apply the revised or supplemented repair
allowance percentages for such taxable year and succeeding taxable
years. For the purposes of this section, ``repair allowance property''
means eligible property determined without regard to paragraph
(b)(2)(ii) of this section (that is, without regard to whether such
property was first placed in service by the taxpayer before or after
December 31, 1970) in an asset guideline class for which a repair
allowance percentage is in effect for the taxable year. The
determination whether property is repair allowance property shall be
made without regard to whether such property is excluded, under
paragraph (b)(5) of this section, from an election to apply this
section. Property in an asset guideline class for which the taxpayer
elects to apply the asset guideline class repair allowance described in
this subdivision, which results from expenditures in the taxable year of
election for the repair, maintenance, rehabilitation, or improvement of
property in an asset guideline class shall not be ``repair allowance
property'' for such taxable year but shall be for each succeeding
taxable year provided such property is a property improvement as
described in subdivision (vii) (a) of this subparagraph and is in an
asset guideline class for which a repair allowance percentage is in
effect for such succeeding taxable year.
(iv) Application of asset guideline class repair allowance. In
accordance with the principles of sections 162, 212, and 263, if the
taxpayer pays or incurs any expenditures during the taxable year for the
repair, maintenance, rehabilitation or improvement of eligible property
(determined without regard to paragraph (b)(2)(ii) of this section), the
taxpayer must either--
(a) If such property is repair allowance property and if the
taxpayer elects to apply the repair allowance for the asset guideline
class, treat an amount of all such expenditures in such taxable year
with respect to all such property in the asset guideline class which
does not exceed in total the repair allowance for that asset guideline
class as deductible repairs, and treat the excess of all such
expenditures with respect to all such property in the asset guideline
class in the manner described for a property improvement in subdivision
(viii) of this subparagraph, or
(b) If such property is not repair allowance property or if the
taxpayer does not elect to apply the repair allowance for the asset
guideline class, treat each of such expenditures in such taxable year
with respect to all such property in the asset guideline class as either
a capital expenditure or as a deductible repair in accordance with the
principles of sections 162, 212, and 263 (without regard to (a) of this
subdivision), and treat the expenditures which are required to be
capitalized under sections 162, 212, and 263 (without regard to (a) of
this subdivision) in the manner described for a property improvement in
subdivision (viii) of this subparagraph.
For the purposes of (a) of this subdivision, expenditures for the
repair, maintenance, rehabilitation or improvement of property do not
include expenditures for an excluded addition or for which a deduction
is allowed under section 167(k). (See subdivision (viii) of this
subparagraph for treatment of an excluded addition.) The taxpayer shall
elect each taxable year whether to apply the repair allowance and treat
expenditures under (a) of this subdivision, or to treat expenditures
under (b) of this subdivision. The treatment of expenditures under this
subdivision for a taxable year for all asset guideline classes shall be
specified in the books and records of the taxpayer for the taxable year.
The taxpayer may treat expenditures under (a) of this subdivision with
respect to property in one asset guideline class and treat expenditures
under (b) of this subdivision with respect to property in some other
asset
[[Page 408]]
guideline class. In addition, the taxpayer may treat expenditures with
respect to property in an asset guideline class under (a) of this
subdivision in one taxable year, and treat expenditures with respect to
property in that asset guideline class under (b) of this subdivision in
another taxable year.
(v) Special rules for repair allowance. (a) The asset guideline
class repair allowance described in subdivision (iii) of this
subparagraph shall apply only to expenditures for the repair,
maintenance, rehabilitation or improvement of repair allowance property
(as described in subdivision (iii) of this subparagraph). The taxpayer
may apply the asset guideline class repair allowance for the taxable
year only if he maintains books and records reasonably sufficient to
determine:
(1) The amount of expenditures paid or incurred during the taxable
year for the repair, maintenance, rehabilitation or improvement of
repair allowance property in the asset guideline class, and
(2) The expenditures (and the amount thereof) with respect to such
property which are for excluded additions (such as whether the
expenditure is for an additional identifiable unit of property, or
substantially increases the productivity or capacity of an existing
identifiable unit of property or adapts it for a substantially different
use).
In general, such books and records shall be sufficient to identify the
amount and nature of expenditures with respect to specific items of
repair allowance property or groups of similar properties in the same
asset guideline class. However, in the case of such expenditures with
respect to property, part of which is in one asset guideline class and
part in another, or part of which is repair allowance property and part
of which is not, and in comparable circumstances involving property in
the same asset guideline class, to the extent books and records are not
maintained identifying such expenditures with specific items of property
or groups of similar properties and it is not practicable to do so, the
total amount of such expenditures which is not specifically identified
may be allocated by any reasonable method consistently applied. In any
case, the cost of repair, maintenance, rehabilitation or improvement of
property performed by production personnel may be allocated by any
reasonable method consistently applied and if performed incidental to
production and not substantial in amount, no allocation to repair,
maintenance, rehabilitation or improvement need be made. The types of
expenditures for which specific identification would ordinarily be made
include: Substantial expenditures such as for major parts or major
structural materials for which a work order is or would customarily be
written; expenditures for work performed by an outside contractor; or
expenditures under a specific down time program. Types of expenditures
for which specific identification would ordinarily be impractical
include: General maintenance costs of machinery, equipment, and plant in
the case of a taxpayer having assets in more than one class (or
different types of assets in the same class) which are located together
and generally maintained by the same work crew; small supplies which are
used with respect to various classes or types of property; labor costs
of personnel who work on property in different classes, or different
types of property in the same class, if the work is performed on a
routine, as needed, basis and the only identification of the property
repaired is by the personnel. Factors which will be taken into account
in determining the reasonableness of the taxpayer's allocation of
expenditures include prior experience of the taxpayer; relative bases of
the assets in the guideline class; types of assets involved; and
relationship to specifically identified expenditures.
(b) If for the taxable year the taxpayer elects to deduct under
section 263(e) expenditures with respect to repair allowance property
consisting of railroad rolling stock (other than a locomotive) in a
particular asset guideline class, the taxpayer may not, for such taxable
year, use the asset guideline class repair allowance described in
subdivision (iii) of this subparagraph for any property in such asset
guideline class.
(c)(1) If the taxpayer repairs, rehabilitates or improves property
for sale
[[Page 409]]
or resale to customers, the asset guideline class repair allowance
described in subdivision (iii) of this subparagraph shall not apply to
expenditures for the repair, maintenance, rehabilitation or improvement
of such property, or (2) if a taxpayer follows the practice of acquiring
for his own use property (in need of repair, rehabilitation or
improvement to be suitable for the use intended by the taxpayer) and of
making expenditures to repair, rehabilitate or improve such property in
order to take advantage of this subparagraph, the asset guideline class
repair allowance described in subdivision (iii) of this subparagraph
shall not apply to such expenditures. In either event, such property
shall not be ``repair allowance property'' as described in subdivision
(iii) of this subparagraph.
(vi) Definition of excluded addition. The term ``excluded addition''
means--
(a) An expenditure which substantially increases the productivity of
an existing identifiable unit of property over its productivity when
first acquired by the taxpayer;
(b) An expenditure which substantially increases the capacity of an
existing identifiable unit of property over its capacity when first
acquired by the taxpayer;
(c) An expenditure which modifies an existing identifiable unit of
property for a substantially different use;
(d) An expenditure for an identifiable unit of property if (1) such
expenditure is for an additional identifiable unit of property or (2)
such expenditure (other than an expenditure described in (e) of this
subdivision) is for replacement of an identifiable unit of property
which was retired;
(e) An expenditure for replacement of a part in or a component or
portion of an existing identifiable unit of property (whether or not
such part, component or portion is also an identifiable unit of
property) if such part, component or portion is for replacement of a
part, component or portion which was retired in a retirement upon which
gain or loss is recognized (or would be recognized but for a special
nonrecognition provision of the Code or Sec. 1.1502-13).
(f) In the case of a building or other structure (in addition to
(b), (c), (d), and (e) of this subdivision which also apply to such
property), an expenditure for additional cubic or linear space; and
(g) In the case of those units of property of pipelines, electric
utilities, telephone companies, and telegraph companies consisting of
lines, cables and poles (in addition to (a) through (e) of this
subdivision which also apply to such property), an expenditure for
replacement of a material portion of the unit of property.
Except as provided in (d) and (e) of this subdivision, notwithstanding
any other provision of this subdivision, the term ``excluded addition''
does not include any expenditure in connection with the repair,
maintenance, rehabilitation or improvement of an identifiable unit of
property which does not exceed $100. For this purpose all related
expenditures with respect to the unit of property shall be treated as a
single expenditure. For the purposes of (a), and (b) of this
subdivision, an increase in productivity or capacity is substantial only
if the increase is more than 25 percent. An expenditure which merely
extends the productive life of an identifiable unit of property is not
an increase in productivity within the meaning of (a) of this
subdivision. Under (g) of this subdivision a replacement is material
only if the portion replaced exceeds 5 percent of the unit of property
with respect to which the replacement is made. For the purposes of this
subdivision, a unit of property generally consists of each operating
unit (that is, each separate machine or piece of equipment) which
performs a discrete function and which the taxpayer customarily acquires
for original installation and retires as a unit. The taxpayer's
accounting classification of units of property will generally be
accepted for purposes of this subdivision provided the classifications
are reasonably consistent with the preceding sentence and are
consistently applied. In the case of a building the unit of property
generally consists of the building as well as its structural components;
except that each building service system (such as an elevator, an
escalator, the electrical system, or the heating and cooling system) is
an identifiable unit for the purpose of (a), (b), (c), and
[[Page 410]]
(d) of this subdivision. However, both in the case of machinery and
equipment and in the case of a building, for the purpose of applying
(d)(1) of this subdivision a unit of property may consist of a part in
or a component or portion of a larger unit of property. In the case of
property described in (g) of this subdivision (such as a pipeline), a
unit of property generally consists of each segment which performs a
discrete function either as to capacity, service, transmission or
distribution between identifiable points. Thus, for example, under this
subdivision in the case of a vintage account of five automobiles each
automobile is an identifiable unit of property (which is not merely a
part in or a component or portion of larger unit of property within the
meaning of (e) of this subdivision). Accordingly, the replacement of one
of the automobiles (which is retired) with another automobile is an
excluded addition under (d)(2) of this subdivision. Also the purchase of
a sixth automobile is an expenditure for an additional identifiable unit
of property and is an excluded addition under (d)(1) of this
subdivision. An automobile air conditioner is also an identifiable unit
of property for the purposes of (d)(1) of this subdivision, but not for
the purposes of (d)(2) of this subdivision. Accordingly, the addition of
an air conditioner to an automobile is an excluded addition under (d)(1)
of this subdivision, but the replacement of an existing air conditioner
in an automobile is not an excluded addition under (d)(2) of this
subdivision (since it is merely the replacement of a part in an existing
identifiable unit of property). The replacement of the air conditioner
may, however, be an excluded addition under (e) of this subdivision, if
the air conditioner replaced was retired in a retirement upon which gain
or loss was recognized. The principles of this subdivision may be
further illustrated by the following examples in which it is assumed
(unless otherwise stated) that (e) of this subdivision does not apply:
Example 1. For the taxable year, B pays or incurs only the following
expenditures: (1) $5,000 for general maintenance of repair allowance
property (as described in subdivision (iii) of this subparagraph) such
as inspection, oiling, machine adjustments, cleaning, and painting; (2)
$175 for replacement of bearings and gears in an existing lathe; (3)
$125 for replacement of an electric starter (of the same capacity) and
certain electrical wiring in an automatic drill press; (4) $300 for
modification of a metal fabricating machine (including replacement of
certain parts) which substantially increases its capacity; (5) $175 for
repair of the same metal fabricating machine which does not
substantially increase its capacity; (6) $800 for the replacement of an
existing lathe with a new lathe; and (7) $65 for the repair of a drill
press. Expenditures (1) through (3) are expenditures for the repair,
maintenance, rehabilitation or improvement of property to which B can
elect to apply the asset guideline class repair allowance described in
subdivision (iii) of this subparagraph. Expenditure (4) is an excluded
addition under (b) of this subdivision. Expenditure (5) is not an
excluded addition. Expenditure (6) is an excluded addition under (d)(2)
of this subdivision. Without regard to (a), (b), and (c) of this
subdivision, expenditure (7) is not an excluded addition since the
expenditure does not exceed $100.
Example 2. Corporation M operates a steel plant which produces
rails, blooms, billets, special bar sections, reinforcing bars, and
large diameter line pipe. During the taxable year, corporation M: (1)
relines an openhearth furnace; (2) places in service 20 new ingot molds;
(3) replaces one reversing roll in the blooming mill; (4) overhauls the
rail and billet mill with no increase in capacity; (5) replaces a roll
stand in the 20-inch bar mill; and (6) overhauls the 11-inch bar mill
and reducing stands increasing billet speed from 1,800 feet per minute
to 2,300 feet per minute. Assume that each expenditure exceeds $100.
Expenditure (1) is not an excluded addition. Expenditure (2) is an
excluded addition under (d)(1) of this subdivision. Expenditure (3) is
not an excluded addition since the expenditure for the reversing roll
merely replaces a part in an existing identifiable unit of property.
Expenditure (4) is not an excluded addition. Expenditure (5) is an
excluded addition under (d)(2) of this subdivision since the roll stand
is not merely a part of an existing identifiable unit of property.
Expenditure (6) is an excluded addition under (a) of this subdivision
since it increases the billet speed by more than 25 percent.
Example 3. For the taxable year, corporation X pays or incurs the
following expenditures: (1) $1,000 for two new temporary partition walls
in the company's offices; (2) $1,400 for repainting the exterior of a
terminal building; (3) $300 for repair of the roof of a warehouse; (4)
$150 for replacement of two window frames and panes in the warehouse;
and (5) $100 for plumbing repair. Expenditure (1) is an excluded
addition under (d)(1) of this subdivision. None of the other
expenditures are excluded additions.
[[Page 411]]
Example 4. For the taxable year, corporation Y pays or incurs the
following expenditures: (1) $10,000 for expansion of a loading dock from
600 square feet to 750 square feet; (2) $600 for replacement of two roof
girders in a factory building; and (3) $9,500 for replacement of columns
and girders supporting the floor of a second story loft storage area
within the factory building in order to permit storage of supplies with
a gross weight 50 percent greater than the previous capacity of the
loft. Expenditure (1) is an excluded addition under (f) of this
subdivision. Expenditure (2) is not an excluded addition. Expenditure
(3) is an excluded addition under (b) of this subdivision.
Example 5. Corporation A has an office building with an unadjusted
basis of $10 million. The building has 10 elevators, five of which are
manually operated and five of which are automatic. During 1971,
corporation A:
(1) Replaces the five manually operated elevators with highspeed
automatic elevators at a cost of $400,000;
(2) Replaces the cable in one of the existing automatic elevators at
a cost of $1,700. The replacements of the elevators are excluded
additions under (d)(2) of this subdivision. The replacement of the cable
is not an excluded addition.
Example 6. Taxpayer W, a cement manufacturer, engages in the
following modification and maintenance activities during the taxable
year: (1) Replaces eccentric-bearing, spindle, and wearing surface in a
gyratory crusher; (2) places in service a new apron feeder and hammer
mill; (3) replaces four buckets on a chain bucket elevator; (4) relines
refractory surface in the burning zone of a rotary kiln; (5) installs
additional new dust collectors; and (6) Replaces two 16-inch x 90-foot
belts on his conveyer system. Assume that there is no increase in
productivity or capacity and that each expenditure exceeds $100.
Expenditure (1) is not an excluded addition. Expenditure (2) an excluded
addition under (d)(1) of this subdivision. Expenditures (3) and (4) are
not excluded additions. Expenditures (5) is an excluded addition under
(d)(1) of this subdivision. Expenditure (6) is not an excluded addition.
Example 7. Corporation X, a gas pipeline company, has, in addition
to others, the following units of property: (1) A gathering pipeline for
a field consisting of 25 gas wells; (2) the main transmission line
between compressor stations (that is, in the case of a 500-mile main
transmission line with a compressor station every 100 miles, each one
hundred miles section between compressor stations is a separate unit of
property); (3) a lateral transmission line from the main transmission
line to a city border station; (4) a medium pressure distribution line
to the northern portion of the city; and (5) a low pressure distribution
line serving a group of approximately 200 residential customers off the
medium pressure distribution line. In 1971, corporation X pays or incurs
the following expenditures in connection with the repair, maintenance,
rehabilitation or improvement of repair allowance property: (1) replaces
a meter on a gas well; (2) in connection with the repair and
rehabilitation of a unit of property consisting of a 2-mile gathering
pipeline, replaces a 3,000-foot section of the gathering line; (3) in
connection with the repair of leaks in a unit of property consisting of
a 100-mile gas transmission line (that is, the 100 miles between
compressor stations), replaces a 2,000-foot section of pipeline at one
point; and (4) at another point replaces a 7-mile section of the same
100-mile gas transmission line. Assume that none of these expenditures
substantially increases capacity and that each expenditure exceeds $100.
Expenditure (1) is an excluded addition under (d) of this subdivision.
Expenditure (2) is an excluded addition under (g) of this subdivision
since the portion replaced is more than 5 percent of the unit of
property. Expenditure (3) is not an excluded addition. Expenditure (4)
is an excluded addition under (g) of this subdivision.
Example 8. Taxpayer Y, an electric utility company, has in addition
to others, the following units of property: (1) A high voltage
transmission circuit from the switching station (at the generating
station) to the transmission station; (2) a series of 100 poles (fully
dressed) supporting the circuit in (1); (3) a high voltage circuit from
the transmission station to the distribution substation; (4) a high
voltage distribution circuit (either radial or looped) from the
distribution substation; (5) a transformer on a distribution pole; (6) a
circuit breaker on a distribution pole; and (7) all 220 (and lower) volt
circuit (including customer service connections) off the distribution
circuit in (4). In 1971, taxpayer Y pays or incurs the following
expenditures for the repair, maintenance, rehabilitation or improvement
of repair allowance property: (1) Replaces 25 adjacent poles in a unit
of property consisting of the 300 poles supporting a radial distribution
circuit from a distribution substation; (2) replaces a transformer on
one of the poles in (1); (3) replaces a cross-arm on one of the poles in
(1); (4) replaces a 200-foot section of a 2-mile radial distribution
circuit serving 100 residential customers; and (5) replaces a 2,000-foot
section on a 10-mile high voltage circuit from a transmission station to
a distribution substation which was destroyed by a casualty which
taxpayer Y treated as an extraordinary retirement under paragraph
(d)(3)(ii) of this section. Expenditure (1) is an excluded addition
under (g) of this subdivision. Expenditure (2) is an excluded addition
under (d)(2) of this subdivision. Expenditures
[[Page 412]]
(3) and (4) are not excluded additions. Expenditure (5) is an excluded
addition under (e) of this subdivision.
Example 9. Corporation Z, a telephone company, has in addition to
others, the following units of property: (1) A buried feeder cable 3
miles in length off a local switching station; (2) a buried subfeeder
cable 1 mile in length off the feeder cable in (1); (3) all the
distribution cable (and customer service drops) off the subfeeder cable
in (2); (4) the 300 poles (fully dressed) supporting the distribution
cable in (3); (5) a 10-mile local trunk cable which interconnects two
local tandem switching stations; (6) a toll connecting trunk cable from
a local tandem switching station to a long distance tandem switching
station; (7) a toll trunk cable 50 miles in length from the access point
at one city to the access point at another city. In 1971, corporation Z
pays or incurs the following expenditures in connection with the repair,
maintenance, rehabilitation or improvement of repair allowance property:
(1) replaces 100 feet of distribution cable in a unit of property
consisting of 8 miles of local distribution cable (plus customer service
drops); (2) replaces an amplifier in the distribution system; and (3)
replaces 10 miles of a unit of property consisting of a toll trunk cable
50 miles in length. Expenditure (1) is not an excluded addition.
Expenditure (2) is an excluded addition under (d)(2) of this
subdivision. Expenditure (3) is an excluded addition under (g) of this
subdivision.
(vii) Definition of property improvement. The term ``property
improvement'' means--
(a) If the taxpayer treats expenditures for the asset guideline
class under subdivision (iv) (a) of this subparagraph, the amount of all
expenditures paid or incurred during the taxable year for the repair,
maintenance, rehabilitation or improvement of repair allowance property
in the asset guideline class, which exceeds the asset guideline class
repair allowance for the taxable year; and
(b) If the taxpayer treats expenditures for the asset guideline
class under subdivision (iv) (b) of this subparagraph, the amount of
each expenditure paid or incurred during the taxable year for the
repair, maintenance, rehabilitation or improvement of property which is
treated under sections 162, 212, and 263 as a capital expenditure.
The term ``property improvement'' does not include any expenditure for
an excluded addition.
(viii) Treatment of property improvements and excluded additions. If
for the taxable year there is a property improvement as described in
subdivision (vii) of this subparagraph or an excluded addition as
described in subdivision (vi) of this subparagraph, the following rules
shall apply--
(a) The total amount of any property improvement for the asset
guideline class determined under subdivision (vii)(a) of this
subparagraph shall be capitalized in a single ``special basis vintage
account'' of the taxable year in accordance with the taxpayer's election
to apply this section for the taxable year (applied without regard to
paragraph (b)(5)(v)(a) of this section). See subparagraph (3)(vi) of
this paragraph for definition and treatment of a ``special basis vintage
account''.
(b) Each property improvement determined under subdivision (vii)(b)
of this subparagraph, if it is eligible property, shall be capitalized
in a vintage account of the taxable year in accordance with the
taxpayer's election to apply this section for the taxable year (applied
without regard to paragraph (b)(5)(v)(a) of this section).
(c) Each excluded addition, if it is eligible property, shall be
capitalized in a vintage account of the taxable year in accordance with
the taxpayer's election to apply this section for the taxable year.
For rule as to date on which a property improvement or an excluded
addition is first placed in service, see paragraph (e)(1) (iii) and (iv)
of this section.
(ix) Examples. The principles of this subparagraph may be
illustrated by the following examples:
Example 1. For the taxable year 1972, B elects to apply this
section. B has repair allowance property (as described in subdivision
(iii) of this subparagraph) in asset guideline class 20.2 under Revenue
Procedure 72-10 with an average unadjusted basis determined as provided
in subdivision (iii) (a) of this subparagraph of $100,000 and repair
allowance property in asset guideline class 24.4 with an average
unadjusted basis of $300,000. The repair allowance percentage for asset
guideline class 20.2 is 4.5 percent and for asset guideline class 24.4
is 6.5 percent. The two asset guideline class repair allowances for 1972
are $4,500 and $19,500, respectively, determined as follows:
[[Page 413]]
Asset Guideline Class 20.2
$100,000 average unadjusted basis multiplied by 4.5 percent. $4,500
Asset Guideline Class 24.4
$300,000 average unadjusted basis multiplied by 6.5 percent. $19,500
Example 2. The facts are the same as in example (1). During the
taxable year 1972, B pays or incurs the following expenditures for the
repair, maintenance, rehabilitation or improvement of repair allowance
property in asset guideline class 20.2
General maintenance (including primarily labor costs).......... $3,000
Replacement of parts in several machines (including labor costs 4,000
of $1,650)....................................................
--------
7,000
In addition, in connection with the rehabilitation and improvement of
two other machines B pays or incurs $6,000 (including labor costs of
$2,000) which is treated as an excluded addition because the capacity of
the machines was substantially increased. For 1972, B elects to apply
this section and to apply the asset guideline class repair allowance to
asset guideline class 20.2. Since the asset guideline class repair
allowance is $4,500, B can deduct $4,500 in accordance with subdivision
(iv) (a) of this subparagraph. B must capitalize $2,500 in a special
basis vintage account in accordance with subdivisions (vii) (a) and
(viii) (a) of this subparagraph. Since the excluded addition is a
capital item and is eligible property, B must also capitalize $6,000 in
a vintage account in accordance with subdivision (viii) (c) of this
subparagraph. B selects from the asset depreciation range an asset
depreciation period of 17 years for the special basis vintage account. B
includes the excluded addition in a vintage account of 1972 for which he
also selects an asset depreciation period of 17 years.
(3) Treatment of retirements--(i) In general. The rules of this
subparagraph specify the treatment of all retirements from vintage
accounts. The rules of Sec. 1.167(a)-8 shall not apply to any
retirement from a vintage account. An asset in a vintage account is
retired when such asset is permanently withdrawn from use in a trade or
business or in the production of income by the taxpayer. A retirement
may occur as a result of a sale or exchange, by other act of the
taxpayer amounting to a permanent disposition of an asset, or by
physical abandonment of an asset. A retirement may also occur by
transfer of an asset to supplies or scrap.
(ii) Definitions of ordinary and extraordinary retirements. The term
``ordinary retirement'' means any retirement of section 1245 property
from a vintage account which is not treated as an ``extraordinary
retirement'' under this subparagraph. The retirement of an asset from a
vintage account in a taxable year is an ``extraordinary retirement''
if--
(a) The asset is section 1250 property;
(b) The asset is section 1245 property which is retired as the
direct result of fire, storm, shipwreck, or other casualty and the
taxpayer, at his option consistently applied (taking into account type,
frequency, and the size of such casualties) treats such retirements as
extraordinary; or
(c)(1) The asset is section 1245 property which is retired (other
than by transfer to supplies or scrap) in a taxable year as the direct
result of a cessation, termination, curtailment, or disposition of a
business, manufacturing, or other income producing process, operation,
facility or unit, and (2) the unadjusted basis (determined without
regard to subdivision (vi) of this subparagraph) of all such assets so
retired in such taxable year from such account as a direct result of the
event described in (c)(1) of this subdivision exceeds 20 percent of the
unadjusted basis of such account immediately prior to such event.
For the purposes of (c) of this subdivision, all accounts (other than a
special basis vintage account as described in subdivision (vi) of this
subparagraph) containing section 1245 property of the same vintage in
the same asset guideline class, and from which a retirement as a direct
result of such event occurs within the taxable year, shall be treated as
a single vintage account. See subdivision (xi) of this subparagraph for
special rule for item accounts. The principles of this subdivision may
be illustrated by the following examples:
Example 1. Taxpayer A is a processor and distributor of dairy
products. Part of taxpayer A's operation is a bottle washing facility
consisting of machines X, Y, and Z, each of which is in an item vintage
account of 1971. Each item vintage account has an unadjusted basis of
$1,000. Taxpayer A also has a 1971 multiple asset vintage account
consisting of machines E, S, and C. Machines E and S, used in processing
butter, each has an unadjusted basis of $10,000. Machine C used in
capping bottles has an unadjusted basis of $1,000. In 1975, taxpayer A
changes to
[[Page 414]]
the use of paper milk cartons and disposes of all bottle washing
machines (X, Y, and Z) as well as machine C which was used in capping
bottles. The sales of machine C, X, Y, and Z are the direct result of
the termination of a manufacturing process. However, since the total
unadjusted basis of the eligible section 1245 property retired as a
direct result of such event is only $4,000 (which is less than 20
percent of the total unadjusted basis of machines E, S, C, X, Y, and Z,
$24,000) the sales are ordinary retirements. All the assets are in the
same asset guideline class and are of the same vintage. Accordingly,
machines E, S, C, X, Y, and Z are for this purpose treated as being in a
single vintage account.
Example 2. The facts are the same as in example (1) except that in
1976, taxpayer A sells six of his 12 milk delivery trucks as a direct
result of eliminating home deliveries to customers in the suburbs.
Deliveries within the city require only six trucks. Each of the trucks
has an unadjusted basis of $3,000. Six of the taxpayer's delivery trucks
are in a multiple asset vintage account of 1974 and six are in a
multiple asset vintage account of 1972. Neither account contains any
other property. Four trucks are retired from the 1972 vintage account
and two trucks are retired from the 1974 vintage account. The sales
result from the curtailment of taxpayer A's home delivery operation. The
unadjusted basis of the four trucks retired from the 1972 vintage
exceeds 20 percent of the total unadjusted basis of the affected
account. The same is true for the two trucks retired from the 1974
vintage account. The sales of the trucks are extraordinary retirements.
(d) The asset is section 1245 property which is retired after
December 30, 1980 by a charitable contribution for which a deduction is
allowable under section 170.
(iii) Treatment of ordinary retirements. No loss shall be recognized
upon an ordinary retirement. Gain shall be recognized only to the extent
specified in this subparagraph. All proceeds from ordinary retirements
shall be added to the depreciation reserve of the vintage account from
which the retirement occurs. See subdivision (vi) of this subparagraph
for optional allocation of basis in the case of a special basis vintage
account. See subdivision (ix) of this subparagraph for recognition of
gain when the depreciation reserve exceeds the unadjusted basis of the
vintage account. The amount of salvage value for a vintage account shall
be reduced (but not below zero) as of the beginning of the taxable year
by the excess of (a) the depreciation reserve for the account, after
adjustment for depreciation allowable for such taxable year and all
other adjustments prescribed by this section (other than the adjustment
prescribed by subdivision (ix) of this subparagraph), over (b) the
unadjusted basis of the account less the amount of salvage value for the
account before such reduction. Thus, in the case of a vintage account
with an unadjusted basis of $1,000 and a salvage value of $100, to the
extent that proceeds from ordinary retirements increase the depreciation
reserve above $900, the salvage value is reduced. If the proceeds
increase the depreciation reserve for the account to $1,000, the salvage
value is reduced to zero. The unadjusted basis of the asset retired in
an ordinary retirement is not removed from the account and the
depreciation reserve for the account is not reduced by the depreciation
allowable for the retired asset. The previously unrecovered basis of the
retired asset will be recovered through the allowance for depreciation
with respect to the vintage account. See subdivision (v)(a) of this
subparagraph for treatment of retirements on which gain or loss is not
recognized in whole or in part. See subdivision (v)(b) of this
subparagraph for treatment of retirements by disposition to a member of
an affiliated group as defined in section 1504(a). See subdivision
(v)(c) of this subparagraph for treatment of transfers between members
of an affiliated group of corporations or other related parties as
extraordinary retirements.
(iv) Treatment of extraordinary retirements. (a) Unless the
transaction is governed by a special nonrecognition section of the Code
such as 1031 or 337 or is one to which subdivision (v)(b) of this
subparagraph applies, gain or loss shall be recognized upon an
extraordinary retirement in the taxable year in which such retirement
occurs subject to section 1231, section 165, and all other applicable
provisions of law such as sections 1245 and 1250. If the asset which is
retired in an extraordinary retirement is the only or last asset in the
account, the account shall terminate and no longer be an account to
which this section applies. In all other cases, the unadjusted basis of
the retired asset shall be removed from the
[[Page 415]]
unadjusted basis of the vintage account, and the depreciation reserve
established for the account shall be reduced by the depreciation
allowable for the retired asset computed in the manner prescribed in
paragraph (c) (1)(v)(b) of this section for determination of the
adjusted basis of the asset. See subdivision (ix) of this subparagraph
for recognition of gain in the case of an account containing section
1245 property when the depreciation reserve exceeds the unadjusted basis
of the vintage account. See subdivision (iii) of this subparagraph for
reduction of salvage value for such an account when the depreciation
reserve exceeds the unadjusted basis of the account minus salvage value.
See subdivision (v)(b) of this subparagraph for treatment of retirements
by disposition to a member of an affiliated group as defined in section
1504(a).
(b) The principles of this subdivision may be illustrated by the
following examples:
Example 1. Corporation X has a multiple asset vintage account of
1971 consisting of assets K, R, A, and P all of which are section 1245
property. The unadjusted basis of the account is $40,000. The unadjusted
basis of asset A is $10,000. When the reserve for depreciation for the
account is $20,000, asset A is sold in an extraordinary retirement for
$8,000 in cash. The $10,000 unadjusted basis of asset A is removed from
the account and the $5,000 depreciation allowable for asset A is removed
from the reserve for depreciation. Gain in the amount of $3,000 (to
which section 1245 applies) is recognized upon the sale of asset A.
Example 2. Corporation X has an item vintage account of 1972
consisting of residential apartment unit A. Unit A is section 1250
property. It is residential rental property and meets the requirements
of section 167(j)(2). Corporation X adopts the declining balance method
of depreciation using a rate twice the straight line rate. The asset
depreciation period is 40 years. Unit A has an unadjusted basis of
$200,000. On June 30, 1974, when the reserve for depreciation for the
account is $19,500, unit A is sold for $220,000. Since unit A is section
1250 property, the sale is an extraordinary retirement in accordance
with subdivision (ii)(a) of this subparagraph (without regard to
subdivision (ii)(b) or (c) of this subparagraph). The adjusted basis of
unit A is $180,500. Gain in the amount of $39,500 is recognized. The
``additional depreciation'' (as defined in section 1250(b)) for unit A
is $9,500. Accordingly, $9,500 is in accordance with section 1250
treated as gain from the sale or exchange of an asset which is neither a
capital asset nor property described in section 1231. The $30,000
balance of the gain from the sale of unit A may be gain to which section
1231 applies.
(v) Special rule for certain retirements. (a) In the case of an
ordinary retirement on which gain or loss is in whole or in part not
recognized because of a special nonrecognition section of the Code, such
as 1031 or 337, no part of the proceeds from such retirement shall be
added to the depreciation reserve of the vintage account in accordance
with subdivision (iii) of this subparagraph. Instead, such retirement
shall for all purposes of this section be treated as an extraordinary
retirement.
(b) The provisions of Sec. 1.1502-13 shall apply to a retirement.
In the case of an ordinary retirement to which the provisions of Sec.
1.1502-13 apply, no part of the proceeds from such retirement shall be
added to the depreciation reserve of the vintage account in accordance
with subdivision (iii) of this subparagraph. Instead, such retirement
shall for all purposes of this section be treated as an extraordinary
retirement.
(c) In a case in which property is transferred, in a transaction
which would without regard to this subdivision be treated as an ordinary
retirement, during the taxable year in which first placed in service to
a person who bears a relationship described in section 179(d)(2) (A) or
(B), such transfer shall for all purposes of this section be treated as
an extraordinary retirement.
(d)(1) If, in the case of mass assets, it is impracticable for the
taxpayer to maintain records from which he can establish the vintage of
such assets as retirements occur, and if he adopts other reasonable
recordkeeping practices, then the vintage of mass asset retirements may
be determined by use of an appropriate mortality dispersion table. Such
a mortality dispersion table may be based upon an acceptable sampling of
the taxpayer's actual experience or other acceptable statistical or
engineering techniques. Alternatively, the taxpayer may use a standard
mortality
[[Page 416]]
dispersion table prescribed by the Commissioner for this purpose. If the
taxpayer uses such standard mortality dispersion table for any taxable
year of election, it must be used for all subsequent taxable years of
election unless the taxpayer obtains the consent of the Commissioner to
change to another dispersion table or to actual identification of
retirements. For information requirements regarding mass assets, see
paragraph (f)(5) of this section.
(2) For purposes of this section, the term ``mass assets'' has the
same meaning as when used in paragraph (e)(4) of Sec. 1.47-1.
(e) The principles of this subdivision may be illustrated by the
following examples:
Example 1. Corporation X has a vintage account of 1971 consisting of
machines A, B, and C, each with an unadjusted basis of $1,000. The
unadjusted basis of the account is $3,000 and at the end of 1977 the
reserve for depreciation is $2,100. On January 1, 1978, machine A is
transferred to corporation Y solely for stock in the amount of $1,400 in
a transaction to which section 351 applies. Since the adjusted basis of
machine A is $300, a gain of $1,100 is realized, but no gain is
recognized under section 351. Even though machine A was transferred in
an ordinary retirement in accordance with (a) of this subdivision the
rules for an extraordinary retirement are applied. The proceeds are not
added to the reserve for depreciation for the account. Machine A is
removed from the account, the unadjusted basis of the account is reduced
by $1,000, and the reserve for depreciation for the account is reduced
by $700.
Example 2. The facts are the same as in example (1) except that the
consideration received for machine A is stock of corporation Y in the
amount of $1,200 and cash in the amount of $200. The result is the same
as in example (1) except that gain is recognized in the amount of $200
all of which is gain to which section 1245 applies.
Example 3. The facts are the same as in example (1) except that
machine A is sold for $1,400 cash in an ordinary retirement and
corporation X and corporation Y are includible corporations in an
affiliated group as defined in section 1504(a) which files a
consolidated return for 1978. Accordingly, (b) of this subdivision
applies. The retirement is treated as an extraordinary retirement.
Machine A is removed from the account, the unadjusted basis of the
account is reduced by $1,000, and the reserve for depreciation for the
account is reduced by $700. The gain of $1,100 is deferred gain to which
Sec. 1.1502-13 applies.
(vi) Treatment of special basis vintage accounts. A ``special basis
vintage account'' is a vintage account for an amount of property
improvement determined under subparagraph (2) (vii)(a) of this
paragraph. In general, reference in this section to a ``vintage
account'' shall include a special basis vintage account. The unadjusted
basis of a special basis vintage account shall be recovered through the
allowance for depreciation in accordance with this section over the
asset depreciation period for the account. Except as provided in this
subdivision, the unadjusted basis, adjusted basis and reserve for
depreciation of such account shall not be allocated to any specific
asset in the asset guideline class, and the provisions of this
subparagraph shall not apply to such account. However, in the event of a
sale, exchange or other disposition of ``repair allowance property'' (as
described in subparagraph (2)(iii) of this paragraph) in an
extraordinary retirement as described in subdivision (ii) of this
subparagraph (or if the asset is not in a vintage account, in an
abnormal retirement as described in Sec. 1.167(a)-8), the taxpayer may,
if consistently applied to all such retirements in the taxable year and
adequately identified in the taxpayer's books and records, elect to
allocate the adjusted basis (as of the end of the taxable year) of all
special basis vintage accounts for the asset guideline class to each
such retired asset in the proportion that the adjusted basis of the
retired asset (as of the beginning of the taxable year) bears to the
adjusted basis of all repair allowance property in the asset guideline
class at the beginning of the taxable year. The election to allocate
basis in accordance with this subdivision shall be made on the tax
return filed for the taxable year. The principles of this subdivision
may be illustrated by the following example:
Example. In addition to other property, the taxpayer has machines A,
B, and C all in the same asset guideline class and each with an adjusted
basis on January 1, 1977, of $10,000. The adjusted basis on January 1,
1977, of all repair allowance property (as described in subparagraph
(2)(iii) of this paragraph) in the asset guideline class is $90,000. The
machines are sold in an extraordinary retirement in 1977. The taxpayer
is entitled to and does
[[Page 417]]
elect to allocate basis in accordance with this subdivision. There is
also a 1972 special basis vintage account for the asset guideline class,
as follows:
------------------------------------------------------------------------
Dec. 31,
Unadjusted Reserve for 1977,
basis depreciation adjusted
basis
------------------------------------------------------------------------
1972 special basis vintage account, $2,000 $1,100 $900
for which the taxpayer selected an
asset depreciation period of 10
years, adopted the straight line
method, and used the half-year
convention.........................
------------------------------------------------------------------------
By application of this subdivision, the adjusted basis of machines A, B,
and C is increased to $10,100 each (that is, $10,000/$90,000x$900 =
$100). The unadjusted basis, reserve for depreciation and adjusted basis
of the special basis vintage account are reduced, respectively, by one-
third (that is, $300/$900=\1/3\) in order to reflect the allocation of
basis from the special basis vintage account.
(vii) Reduction in the salvage value of a vintage account. (a) A
taxpayer may apply this section without reducing the salvage value for a
vintage account in accordance with this subdivision or in accordance
with subdivision (viii) of this subparagraph (relating to transfers to
supplies or scrap). See subdivision (iii) of this subparagraph for
reduction of salvage value in certain circumstances in the amount of
proceeds from ordinary retirements.
(b) However, the taxpayer may, at his option, follow the consistent
practice of reducing, as retirements occur, the salvage value for a
vintage account by the amount of salvage value attributable to the
retired asset, or the taxpayer may consistently follow the practice of
so reducing the salvage value for a vintage account as extraordinary
retirements occur while not reducing the salvage value for the account
as ordinary retirements occur. If the taxpayer does not reduce the
salvage value for a vintage account as ordinary retirements occur, the
taxpayer may be entitled to a deduction in the taxable year in which the
last asset is retired from the account in accordance with subdivision
(ix) (b) of this subparagraph.
(c) For purposes of this subdivision, the portion of the salvage
value for a vintage account attributable to a retired asset may be
determined by multiplying the salvage value for the account by a
fraction, the numerator of which is the unadjusted basis of the retired
asset and the denominator of which is the unadjusted basis of the
account, or any other method consistently applied which reasonably
reflects that portion of the salvage value for the account originally
attributable to the retired asset.
(d) In the case of ordinary retirements the taxpayer may--
(1) In the case of retirements (other than by transfer to supplies
or scrap) follow the consistent practice of reducing the salvage value
for the account by the amount of salvage value attributable to the
retired asset and not adding the same amount to the depreciation reserve
for the account, and
(2) In the case of retirements by transfer to supplies or scrap,
follow the consistent practice of reducing the salvage value for the
account by the amount of salvage value attributable to the retired asset
and not adding the same amount to the depreciation reserve for the
account (in which case the basis in the supplies or scrap account of the
retired asset will be zero) or follow the consistent practice of
reducing the salvage value for the account by the amount of salvage
value attributable to the retired asset and adding the same amount to
the depreciation reserve for the account (up to an amount which does not
increase the depreciation reserve to an amount in excess of the
unadjusted basis of the account) in which case the basis in the supplies
or scrap account of the retired asset will be the amount added to the
depreciation reserve for the account.
Thus, for example, in the case of an ordinary retirement by transfer of
an asset to supplies or scrap, the basis of the asset in the supplies or
scrap account would either be zero or the amount added to the
depreciation reserve of the vintage account from which the retirement
occurred. When the depreciation reserve for the account equals the
unadjusted basis of the account no further adjustment to salvage value
for the account will be
[[Page 418]]
made. See subdivision (viii) of this subparagraph for special optional
rule for reduction of salvage value in the case of an ordinary
retirement by transfer of an asset to supplies or scrap.
(e) In the event of a removal of property from a vintage account in
accordance with paragraph (b)(4)(iii)(e), (5)(v)(b) or (6)(iii) of this
section the salvage value for the account may be reduced by the amount
of salvage value attributable to the asset removed determined as
provided in (c) of this subdivision.
(viii) Special optional adjustments for transfers to supplies or
scrap. If the taxpayer does not follow the consistent practice of
reducing, as ordinary retirements occur, the salvage value for a vintage
account in accordance with subdivision (vii) of this subparagraph, the
taxpayer may (in lieu of the method described in subdivision (vii) (c)
and (d) of this subparagraph) follow the consistent practice of reducing
salvage value as ordinary retirements occur by transfer of assets to
supplies or scrap and of determining the basis (in the supplies or scrap
account) as assets retired in an ordinary retirement by transfer to
supplies or scrap, in the following manner--
(a) The taxpayer may determine the value of the asset (not to exceed
its unadjusted basis) by any reasonable method consistently applied
(such as average cost, conditioned cost, or fair market value) if such
method is adequately identified in the taxpayer's books and records.
(b) The value attributable to the asset determined in accordance
with (a) of this subdivision shall be subtracted from the salvage value
for the account (to the extent thereof) and the greater of (1) the
amount subtracted from the salvage value for the vintage account and (2)
the value of the asset determined in accordance with (a) of this
subdivision, shall be added to the reserve for depreciation of this
vintage account.
(c) The amount added to the reserve for depreciation of the vintage
account in accordance with (b) of this subdivision shall be treated as
the basis of the retired asset in the supplies or scrap account.
If the taxpayer makes the adjustments in accordance with this
subdivision, the reserve for depreciation of the vintage account may
exceed the unadjusted basis of the account, and in that event gain will
be recognized in accordance with subdivision (ix) of this subparagraph.
(ix) Recognition of gain or loss in certain situations. (a) In the
case of a vintage account for section 1245 property, if at the end of
any taxable year after adjustment for depreciation allowable for such
taxable year and all other adjustments prescribed by this section, the
depreciation reserve established for such account exceeds the unadjusted
basis of the account, the entire amount of such excess shall be
recognized as gain in such taxable year. Such gain--
(1) Shall constitute gain to which section 1245 applies to the
extent that it does not exceed the total amount of depreciation
allowances in the depreciation reserve at the end of such taxable year,
reduced by gain recognized pursuant to this subdivision with respect to
the account previously treated as gain to which section 1245 applies,
and
(2) May constitute gain to which section 1231 applies to the extent
that it exceeds such total amount as so reduced.
In such event, the depreciation reserve shall be reduced by the amount
of gain recognized, so that after such reduction the amount of the
depreciation reserve is equal to the unadjusted basis of the account.
(b) In the case of an account for section 1245 property, if at the
time the last asset in the vintage account is retired the unadjusted
basis of the account exceeds the depreciation reserve for the account
(after all adjustments prescribed by this section), the entire amount of
such excess shall be recognized in such taxable year as a loss under
section 165 or as a deduction for depreciation under section 167. If the
retirement of such asset occurs by sale or exchange on which gain or
loss is recognized, the amount of such excess may constitute a loss
subject to section 1231. Upon retirement of the last asset in a vintage
account, the account shall terminate and no longer be an account to
which this section applies. See
[[Page 419]]
subdivision (xi) of this subparagraph for treatment of certain multiple
asset and item accounts.
(c) The principles of this subdivision may be illustrated by the
following example:
Example. The taxpayer has a vintage account for section 1245
property with an unadjusted basis of $1,000 and a depreciation reserve
of $700 (of which $600 represents depreciation allowances and $100
represents the proceeds of ordinary retirements from the account). If
$500 is realized during the taxable year from ordinary retirements of
assets from the account, the reserve is increased to $1,200, gain is
recognized to the extent of $200 (the amount by which the depreciation
reserve before further adjustment exceeds $1,000) and the depreciation
reserve is then decreased to $1,000. The $200 of gain constitutes gain
to which section 1245 applies. If the amount realized from ordinary
retirements during the year had been $1,100 instead of $500, the gain of
$800 would have consisted of $600 of gain to which section 1245 applies
and $200 of gain to which section 1231 may apply.
(x) Dismantling cost. The cost of dismantling, demolishing, or
removing an asset in the process of a retirement from the vintage
account shall be treated as an expense deductible in the year paid or
incurred, and such cost shall not be subtracted from the depreciation
reserve for the account.
(xi) Special rule for treatment of multiple asset and item accounts.
For the purposes of subdivision (ix)(b) of this subparagraph, all
accounts (other than a special basis vintage account as described in
subdivision (vi) of this subparagraph) of the same vintage in the same
asset guideline class for which the taxpayer has selected the same asset
depreciation period and adopted the same method of depreciation, and
which contain only section 1245 property permitted by paragraph
(b)(3)(ii) of this section to be included in the same vintage account,
shall be treated as a single multiple asset vintage account.
(4) Examples. The principles of this paragraph may be illustrated by
the following examples:
Example 1. (a)Taxpayer A has a multiple asset vintage account for
selection 1245 property with an unadjusted basis of $1,000. All the
assets were first placed in service by A on January 15, 1971. This
account contains all of A's assets in a single asset guideline class. A
elects to apply this section for 1971 and adopts the modified half-year
convention. A estimates a salvage value for the account of $100 and this
estimate is determined to be reasonable. (See subparagraph (1)(v) of
this paragraph for limitation on adjustment of reasonable salvage
value.) A adopts the straight line method of depreciation with respect
to the account and selects a 10-year asset depreciation period. A does
not follow a practice of reducing the salvage value for the account in
the amount of salvage value attributable to each retired asset in
accordance with subparagraph (3)(vii) of this paragraph. The
depreciation allowance for each of the first 4 years is $100, that is
\1/10\ multiplied by the unadjusted basis of $1,000, with reduction for
salvage.
(b) In the fifth year of the asset depreciation period, three assets
are sold in an ordinary retirement for $300. Under paragraph (c)(1)(ii)
of this section and subparagraph (3)(iii) of this paragraph, the
proceeds of the retirement are added to the depreciation reserve as of
the beginning of the fifth year. Accordingly, the reserve as of the
beginning of the fifth year is $700, that is, $400 of depreciation as of
the beginning of the year plus $300 proceeds from ordinary retirements.
The depreciation allowance for the fifth year is $100, that is \1/10\
multiplied by the unadjusted basis of $1,000, without reduction for
salvage. Accordingly, the depreciation reserve at the end of the fifth
year is $800.
(c) In the sixth year, asset X is sold in an extraordinary
retirement for $30 and gain or loss is recognized. Under the first-year
convention used by the taxpayer, the unadjusted basis of X, $300, is
removed from the unadjusted basis of the vintage account as of the
beginning of the sixth year and the depreciation reserve as of the
beginning of such year is reduced to $650 by removing the depreciation
applicable to asset X, $150 (see subparagraph (3)(iv) of this
paragraph). Since the depreciation reserve ($650) exceeds the unadjusted
basis of the account ($700) minus salvage value ($100) by $50, under
subparagraph (3)(iii) of this paragraph, salvage value is reduced by
$50. No depreciation is allowable for the sixth year.
(d) In the seventh year, an asset is sold in an ordinary retirement
for $110. This would increase the reserve as of the beginning of the
seventh year to $760 and under subparagraph (3)(iii) of this paragraph
the salvage value is reduced to zero. Under subparagraph (3)(ix)(a) of
this paragraph the depreciation reserve is then decreased to $700 (the
unadjusted basis of the account) and $60 is reported as gain, without
regard to the adjusted basis of the asset. No depreciation is allowable
for the seventh year since the depreciation reserve ($700) equals the
unadjusted basis of the account ($700).
(e)(1) In the eighth year, A elects to apply this section and to
treat expenditures during
[[Page 420]]
the year for repair, maintenance, rehabilitation or improvement under
subparagraph (2)(iii) and (iv)(a) of this paragraph (the ``guideline
class repair allowance''). This results in the treatment of $300 as a
property improvement for the asset guideline class. (See subparagraph
(2)(vii) of this paragraph for definition of a property improvement.)
The property improvement is capitalized in a special basis vintage
account of the eighth taxable year (see subparagraph (2)(viii)(a) of
this paragraph). A selects an asset depreciation period of 10 years and
adopts the straight line method for the special basis vintage account. A
adopts the modified half-year convention for the eighth year.
(2) In the eighth year, A sells asset Y in an ordinary retirement
for $175. Under paragraph (c)(1)(ii) of this section and subparagraph
(3)(iii) of this paragraph, $175 is added to the depreciation reserve
for the account as of the beginning of the taxable year. Since the
depreciation reserve for the account ($875) exceeds the unadjusted basis
of the account ($700) by $175, that amount of gain is recognized under
subparagraph (3)(ix) of this paragraph. Upon recognition of gain in the
amount of $175, the depreciation reserve for the account is reduced to
$700.
(3) No depreciation is allowable in the eighth year for the vintage
account since the depreciation reserve ($700) equals the unadjusted
basis of the account ($700). The depreciation allowable in the eighth
year for the special basis vintage account is $15, that is, unadjusted
basis of $300, multiplied by \1/10\, the asset depreciation period
selected for the special basis vintage account, but limited to $15 under
the modified half-year convention. (See paragraph (e)(1)(iv) of this
section for treatment of $150 of the property improvement as first
placed in service in the first half of the taxable year and $150 of the
property improvement as first placed in service in the last half of the
taxable year.)
Example 2. Taxpayer B has a 1971 multiple asset vintage account for
section 1245 property with an unadjusted basis of $100,000. B selects
from the asset depreciation range an asset depreciation period of 10
years and adopts the straight line method of depreciation and the
modified half-year convention. B establishes a salvage value for the
account of $10,000. All the assets in the account are first placed in
service on January 15, 1971. B follows the practice of reducing salvage
value for the account as ordinary retirements occur in accordance with
subparagraph (3)(vii) of this paragraph, but does not follow the
optional practice of determining the basis of assets transferred to
supplies or scrap in accordance with subparagraph (3)(vii) of this
paragraph. No retirements occur during the first five years. The
depreciation reserve at the beginning of the sixth year is $50,000. In
the sixth year an asset with an unadjusted basis of $20,000 is
transferred to supplies in an ordinary retirement. By application of
subparagraph (3)(vii) (c) and (d)(2) of this paragraph B determines the
reduction in salvage value for the account attributable to such asset to
be $2,000 (that is, $20,000 / $100,000 x $10,000 = $2,000).
B reduces the salvage value for the account by $2,000 and adds 2,000 to
the depreciation reserve for the account. The basis of the retired asset
in the supplies account is $2,000. The depreciation allowable for the
account for the sixth year is $10,000. The depreciation reserve for the
account at the beginning of the seventh year is $62,000. At the mid-
point of the seventh year all the remaining assets in the account are
sold in an ordinary retirement for $20,000, which is added to the
depreciation reserve as of the beginning of the seventh year, thus
increasing the reserve to $82,000. The $5,000 depreciation allowable for
the account for the seventh year (one-half of a full-year's depreciation
of $10,000) increases the depreciation reserve to $87,000. Under
subparagraph (3)(ix)(b) of this paragraph, a loss of $13,000 subject to
section 1231 is realized in the seventh year (that is, the excess of the
unadjusted basis of $100,000 over the depreciation reserve of $87,000).
No depreciation is allowable for the account after the mid-point of the
seventh year since all the assets are retired and the account has
terminated.
(e) Accounting for eligible property--(1) Definition of first placed
in service--(i) In general. The term ``first placed in service'' refers
to the time the property is first placed in service by the taxpayer, not
to the first time the property is placed in service. Property is first
placed in service when first 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. In general, the provisions of
paragraph (d)(1)(ii) and (d)(2) of Sec. 1.46-3 shall apply for the
purpose of determining the date on which property is placed in service,
but see subdivision (ii) of this subparagraph for special rule for
certain replacement parts. In the case of a building which is intended
to house machinery and equipment and which is constructed,
reconstructed, or erected by or for the taxpayer and for the taxpayer's
use, the building will ordinarily be placed in service on the date such
construction, reconstruction, or erection is substantially complete and
the building is in a condition or state of readiness and availability.
[[Page 421]]
Thus, for example, in the case of a factory building, such readiness and
availability shall be determined without regard to whether the machinery
or equipment which the building houses, or is intended to house, has
been placed in service. However, in an appropriate case, as for example
where the building is essentially an item of machinery or equipment, or
the use of the building is so closely related to the use of the
machinery or equipment that it clearly can be expected to be replaced or
retired when the property it initially houses is replaced or retired,
the determination of readiness or availability of the building shall be
made by taking into account the readiness and availability of such
machinery or equipment. The date on which depreciation begins under a
convention used by the taxpayer or under a particular method of
depreciation, such as the unit of production method or the retirement
method, shall not determine the date on which the property is first
placed in service. See paragraph (c)(2) of this section for application
of a first-year convention to determine the allowance for depreciation
of property in a vintage account.
(ii) Certain replacement parts. Property (such as replacement parts)
the cost or other basis of which is deducted as a repair expense in
accordance with the asset guideline repair allowance described in
paragraph (d)(2)(iii) of this section shall not be treated as placed in
service.
(iii) Property improvements and excluded additions. (a) Except as
provided in (b) of this subdivision, a property improvement determined
under paragraph (d)(2)(vii)(b) of this section, and an excluded addition
(other than an excluded addition referred to in the succeeding sentence)
is first placed in service when its cost is paid or incurred. The
general rule in subdivision (i) of this subparagraph applies to an
excluded addition described in paragraph (d) (2)(vi) (d), (e), (f), or
(g) of this section.
(b) If a property improvement or an excluded addition to which the
first sentence of (a) of this subdivision applies is paid or incurred in
part in one taxable year and in part in the succeeding taxable year (or
in part in the first half of a taxable year and in part in the last half
of the taxable year) the taxpayer may at his option consistently treat
such property improvements and excluded additions under the general rule
in subdivision (i) of this subparagraph.
(iv) Certain property improvements. In the case of an amount of
property improvement determined under paragraph (d)(2)(vii)(a) of this
section, one-half of such amount is first placed in service in the first
half of the taxable year in which the cost is paid or incurred and one-
half is first placed in service in the last half of such taxable year.
(v) Special rules for clearing accounts. In the case of public
utilities which consistently account for certain property through
``clearing accounts,'' the date on which such property is first placed
in service shall be determined in accordance with rules to be prescribed
by the Commissioner.
(2) Special rules for transferred property. If eligible property is
first placed in service by the taxpayer during a taxable year of
election, and the property is disposed of before the end of the taxable
year, the election for such taxable year shall include such property
unless such property is excluded in accordance with paragraph (b)(5)
(iii), (iv, (v), (vi), or (vii) of this section.
(3) Special rules in the case of certain transfers--(i) Transaction
to which section 381(a) applies. (a) In general the acquiring
corporation in a transaction to which section 381(a) applies is for the
purposes of this section treated as if it were the distributor or
transferor corporation.
(b) If the distributor or transferor corporation (including any
distributor or transferor corporation of any distributor or transferor
corporation) has made an election to apply this section to eligible
property transferred in a transaction to which section 381(a) applies,
the acquiring corporation must segregate such eligible property (to
which the distributor or transferor corporation elected to apply this
section) into vintage accounts as nearly coextensive as possible with
the vintage accounts created by the distributor or transferor
corporation identified by reference to the year the property was
[[Page 422]]
first placed in service by the distributor or transferor corporation.
The asset depreciation period for the vintage account in the hands of
the distributor or transferor corporation must be used by the acquiring
corporation. The method of depreciation adopted by the distributor or
transferor corporation, shall be used by the acquiring corporation
unless such corporation obtains the consent of the Commissioner to use
another method of depreciation in accordance with paragraph (e) of Sec.
1.446-1 or changes the method of depreciation under paragraph
(c)(1)(iii) of this section.
(c) The acquiring corporation may apply this section to the property
so acquired only if the distributor or transferor corporation elected to
apply this section to such property.
(d) See paragraph (b)(7) of this section for special rule for
certain property where there is a mere change in the form of conducting
a trade or business.
(ii) Partnerships, trusts, estates, donees, and corporations. Except
as provided in subdivision (i) of this subparagraph with respect to
transactions to which section 381(a) applies and subdivision (iv) of
this subparagraph with respect to certain transfers between members of
an affiliated group of corporations or other related parties, if
eligible property is placed in service by an individual, trust, estate,
partnership or corporation, the election to apply this section shall be
made by the individual, trust, estate, partnership or corporation
placing such property in service. For example, if a partnership places
in service property contributed to the partnership by a partner, the
partnership may elect to apply this section to such property. If the
partnership does not make the election, this section will not apply to
such property. See paragraph (b)(7) of this section for special rule for
certain property where there is mere change in the form of conducting a
trade or business.
(iii) Leased property. The asset depreciation range and the asset
depreciation period for eligible property subject to a lease shall be
determined without regard to the period for which such property is
leased, including any extensions or renewals of such period. See
paragraph (b)(5)(v) of this section for exclusion of property amortized
under paragraph (b) of Sec. 1.162-11 from an election to apply this
section. In the case of a lessor of property, unless there is an asset
guideline class in effect for lessors of such property, the asset
guideline class for such property shall be determined as if the property
were owned by the lessee. However, in the case of an asset guideline
class based upon the type of property (such as trucks or railroad cars)
as distinguished from the activity in which used, the property shall be
classified without regard to the activity of the lessee. Notwithstanding
the preceding sentence, if a lease with respect to property, which would
be includible in an asset guideline class based upon the type of
property under the preceding sentence (such as trucks or railroad cars),
is entered into after March 12, 1971, and before April 23, 1973, or a
written contract to execute such a lease is entered into during such
period and such contract is binding on April 23, 1973, and at all times
thereafter, and if the rent or rate of return is based on a
classification of such property as if it were owned by the lessee, then
such property shall be classified as if it were owned by the lessee.
However, the preceding sentence shall not apply if pursuant to the terms
or conditions of the lease or binding contract the rent or rate of
return may be adjusted to take account of a change in the period for
depreciation with respect to the property resulting from inclusion of
the property in an asset guideline class based upon the type of property
rather than in an asset guideline class based upon the activity of the
lessee. Similarly, where the terms of such a lease or contract provide
that the obligation of the taxpayer to enter into the lease is subject
to a condition that the property be included in an asset guideline class
based upon the activity of the lessee, the contract or lease will not be
considered as binding upon the taxpayer, for purposes of this
subdivision. See paragraph (b)(4)(iii)(b) of this section for general
rule for classification of property according to primary use.
(iv) Treatment of certain transfers between members of affiliated
groups or
[[Page 423]]
other related persons. If section 38 property in an asset guideline
class (determined without regard to whether the taxpayer elects to apply
this section) is transferred by the taxpayer to a person who bears a
relationship described in section 179(d)(2) (A) or (B), such property is
in the same asset guideline class in the hands of transferee, and the
transfer is neither described in section 381(a) nor treated as a
disposition or cessation within the meaning of section 47, then the
asset guideline period for such property selected by the taxpayer under
this section shall not be shorter than the period used for computing the
qualified investment with respect to the property under section 46(c).
In a case in which the asset depreciation range for the asset guideline
class which includes such property does not include the period for
depreciation used by the transferor in computing the qualified
investment with respect to such property, the transferee will not be
permitted to include such property in an election under this section.
However, in such a case, the transferor of the property may recompute
the qualified investment for the year the property was placed in service
using a period for depreciation which falls within the asset
depreciation range.
(f) Election with respect to eligible property--(1) Time and manner
of election--(i) In general. An election to apply this section to
eligible property shall be made with the income tax return filed for the
taxable year in which the property is first placed in service (see
paragraph (e)(1) of this section) by the taxpayer. In the case of an
affiliated group of corporations (as defined in section 1504(a)) which
makes a consolidated return with respect to income tax in accordance
with section 1502 and the regulations thereunder, each corporation which
joins in the making of such return may elect to apply this section for a
taxable year. An election to compute the allowance for depreciation
under this section is a method of accounting but the consent of the
Commissioner will be deemed granted to make an annual election. For
election by a partnership see section 703 (b) and paragraph (e)(3)(ii)
of this section. If the taxpayer does not file a timely return (taking
into account extensions of the time for filing) for the taxable year in
which the property is first placed in service, the election shall be
filed at the time the taxpayer files his first return for that year. The
election may be made with an amended return filed within the time
prescribed by law (including extensions) for filing the original return
for the taxable year of election. If an election is not made within the
time and in the manner prescribed in this paragraph, no election may be
made for such taxable year (by the filing of an amended return or in any
other manner) with respect to any eligible property placed in service in
the taxable year.
(ii) Other elections under this section. All other elections under
this section may be made only within the time and in the manner
prescribed by subdivision (i) of this subparagraph with respect to an
election to apply this section.
(iii) Effective date. See paragraph (f)(6) of this section for the
effective date of this paragraph.
(2) Information required. A taxpayer who elects to apply this
section must specify in the election:
(i) That the taxpayer makes such election and consents to and agrees
to apply, all the provisions of this section;
(ii) The asset guideline class for each vintage account of the
taxable year;
(iii) The first-year convention adopted by the taxpayer for the
taxable year of election;
(iv) Whether the special 10 percent used property rule described in
paragraph (b)(5)(iii) of this section has been applied to exclude used
property from the election;
(v) Whether the taxpayer elects to apply the asset guideline class
repair allowance described in paragraph (d)(2)(iii) of this section;
(vi) Whether the taxpayer elects for the taxable year to allocate
the adjusted basis of a special basis vintage account in accordance with
paragraph (d)(3)(vi) of this section;
(vii) Whether any eligible property for which the taxpayer was not
required or permitted to make an election was excluded because of the
special rules of paragraph (b)(5)(v) or (6), or paragraph (e)(3)(i) or
(iv) of this section;
[[Page 424]]
(viii) Whether any ``section 38 property'' was excluded under
paragraph (b)(5)(iv) of this section from the election to apply this
section;
(ix) If the taxpayer is an electric or gas utility, whether the
taxpayer elects to apply this section on the basis of a composite asset
guideline class in accordance with paragraph (b)(4)(iii)(a) of this
section; and
(x) Such other information as may reasonably be required.
The information required under this subparagraph may be provided in
accordance with rules prescribed by the Commissioner for reasonable
grouping of assets or accounts. Form 4832 is provided for making an
election and for submission of the information required. An election may
be made and the information submitted only in accordance with Form 4832.
An election to apply this section will not be rendered invalid under
this subparagraph so long as there is substantial compliance, in good
faith, with the requirements of this subparagraph.
(3) Irrevocable election. An election to apply this section to
eligible property for any taxable year may not be revoked or changed
after the time for filing the election prescribed under subparagraph (1)
of this paragraph has expired. No other election under this section may
be revoked or changed after such time unless expressly provided for
under this section. (See paragraph (b)(5)(v)(b) of this section for
special rule.)
(4) Special conditions to election to apply this section--(i)
Maintenance of books and records. The taxpayer may not elect to apply
this section for a taxable year unless the taxpayer maintains the books
and records required under this section. In addition to any other
information required under this section, the taxpayer's books and
records must specify--
(a) The asset depreciation period selected by the taxpayer for each
vintage account;
(b) If the taxpayer applies the modified half-year convention, the
total cost or other basis of all eligible property first placed in
service in the first half of the taxable year and the total cost or
other basis of all eligible property first placed in service in the last
half of the taxable year;
(c) The unadjusted basis and salvage value for each vintage account,
and the amount, if any, by which gross salvage value was decreased under
section 167 (f);
(d) Each asset guideline class for which the taxpayer elects to
apply the asset guideline class repair allowance described in paragraph
(d)(2)(iii) of this section;
(e) The amount of property improvement, determined under paragraph
(d)(2)(vii)(a) of this section, for each asset guideline class for which
the taxpayer elects to apply the asset guideline class repair allowance;
(f) A reasonable description of property excluded from an election
to apply this section and the basis for the exclusion;
(g) The total unadjusted basis of all assets retired during the
taxable year from each asset guideline class, and the proceeds realized
during the taxable year from such retirements; and
(h) The vintage (that is, the taxable year in which established) of
the assets retired during the year from each asset guideline class.
For purposes of paragraph (f)(4)(i) (g) and (h) of this section, all
accounts of the same vintage and asset guideline class may be treated as
a single account. The taxpayer must specify the information required
under paragraph (f)(4)(i) (g) and (h) without regard to the retirement
of an asset by transfer to a supplies account for reuse.
(ii) Response to survey. Taxpayers who elect to apply this section
must respond to infrequent data surveys conducted by the Treasury
Department. These periodic surveys, which will be conducted on the basis
of scientifically sound sampling methods, are designed to obtain data
(including industry asset acquisitions and retirements) used to keep the
asset guideline classes and periods up to date.
(iii) Effect of noncompliance. An election to apply this section
will not be rendered invalid under this subparagraph so long as there is
substantial compliance, in good faith, with the requirements of this
subparagraph.
[[Page 425]]
(5) Mass assets. In the case of mass assets, if the taxpayer assigns
retirements to vintage accounts in the manner provided in paragraph
(d)(3)(v)(c) of this section, the following information must be supplied
with form 4832:
(i) Whether the taxpayer used the standard mortality dispersion
curve or a curve based upon his own experience, and
(ii) Such other reasonable information as may be required by the
Commissioner.
(6) Effective date. The rules in this paragraph apply to elections
for taxable years ending on or after December 31, 1978. In the case of
an election for a taxable year ending before December 31, 1978, the
rules in paragraph (f) of this section, in effect before the amendments
made by T.D. 7593 approved January 11, 1979, shall apply. See 26 CFR
Sec. 1.167(a)-11(f) (1977) for paragraph (f) of this section as it
appeared before the amendments made by T.D. 7593.
(g) Relationship to other provisions--(1) Useful life--(i) In
general. Except as provided in subdivision (ii) of this subparagraph, an
election to apply this section to eligible property constitutes an
agreement under section 167(d) and this section to treat the asset
depreciation period for each vintage account as the useful life of the
property in such account for all purposes of the Code, including
sections 46, 47, 48, 57, 163(d), 167(c), 167(f)(2), 179, 312(m), 514(a),
and 4940(c). For example, since section 167(c) requires a useful life of
at least 3 years and the asset depreciation period selected is treated
as the useful life for purposes of section 167(c), the taxpayer may
adopt a method of depreciation described in section 167(b) (2) or (3)
for an account only if the asset depreciation period selected for the
account is at least 3 years.
(ii) Special rules. (a) For the purposes of paragraph (d) of this
section, the anticipated period of use (estimated at the close of the
taxable year in which the asset is first placed in service) on the basis
of which salvage value is estimated, shall be determined without regard
to the asset depreciation period for the property.
(b) For the purposes of sections 162 and 263 and the regulations
thereunder, whether an expenditure prolongs the life of an asset shall
be determined on the basis of the anticipated period of use of the asset
(estimated at the close of the taxable year in which the asset is first
placed in service) without regard to the asset depreciation period for
such asset.
(c) The determination whether a transaction with respect to
qualified property constitutes a sale or a lease of such property shall
be made without regard to the asset depreciation period for the
property.
(d) The principles of this subdivision may be illustrated by the
following example:
Example. Corporation X has assets in asset guideline class 32.3
which are used in the manufacture of stone and clay products. The asset
depreciation range for assets in asset guideline class 32.3 is from 12
to 18 years. Assume that corporation X selects 14 years as the asset
depreciation period for all assets in asset guideline class 32.3. Under
paragraph (d)(1)(i) of this section, corporation X must estimate salvage
value on the basis of the anticipated period of use of the property
(determined as of the close of the taxable year in which the property is
first placed in service). The anticipated period of use must also be
used for purposes of sections 162 and 263 in determining whether an
expenditure materially prolongs the useful life of an asset. The
anticipated period of use of an asset is determined without regard to
the asset depreciation period of 14 years. Corporation X has, among
other assets in the asset guideline class, machines A, B, and C.
Corporation X estimates the anticipated period of use of machines A, B,
and C as 8 years, 14 years, and 22 years, respectively. These estimates
are reasonable and will be used for estimating salvage value and for
purposes of sections 162 and 263.
(2) Section 167(d) agreements. If the taxpayer has, prior to January
1, 1971, entered into a section 167(d) agreement which applies to any
eligible property, the taxpayer will be permitted to withdraw the
eligible property from the agreement provided that an election is made
to apply this section to such property. The statement of intent to
withdraw eligible property from such an agreement must be made in an
election filed for the taxable year in which the property is first
placed in service. The withdrawal, in accordance with this subparagraph,
of any eligible property from a section 167(d) agreement
[[Page 426]]
shall not affect any other property covered by such an agreement.
(3) Relationship to the straight line method--(i) In general. For
purposes of determining the amount of depreciation which would be
allowable under the straight line method of depreciation, such amount
shall be computed with respect to any property in a vintage account
using the straight line method in the manner described in paragraph
(c)(1)(i) of this section and a rate based upon the period for the
vintage account selected from the asset depreciation range. Thus, for
example, section 57(a)(3) requires a taxpayer to compute an amount using
the straight line method of depreciation if the taxpayer uses an
accelerated method of depreciation. For purposes of section 57(a)(3),
the amount for property in a vintage account shall be computed using the
asset depreciation period for the vintage account selected from the
asset depreciation range. In the case of property to which the taxpayer
does not elect to apply this section, such amount computed by using the
straight line method shall be determined under Sec. 1.167(b)-1 without
regard to this section.
(ii) Examples. The principles of this subparagraph may be
illustrated by the following example:
Example. (a) Corporation X places a new asset in service to which it
elects to apply this section. The cost of the asset is $200,000 and the
estimated salvage value is zero. The taxpayer selects 9 years from the
applicable asset depreciation range of 8 to 12 years. Corporation X
adopts the double declining balance method of depreciation and thus the
rate of depreciation is 22.2 percent (twice the applicable straight line
rate). The depreciation allowance in the first year would be $44,400,
that is, 22.2 percent of $200,000.
(b) Assume that the provisions of section 57(a)(3) apply to the
property. The amount of the tax preference would be $22,200, that is,
the excess of the depreciation allowed under this section ($44,400) over
the depreciation which would have been allowable if the taxpayer had
used the period selected from the asset depreciation range and the
straight line rate ($22,200).
(Secs. 167(m), 85 Stat. 508 (26 U.S.C. 167(m) and 7805, 68A Stat. 917,
(26 U.S.C. 7805))
[T.D. 7272, 38 FR 9967, Apr. 23, 1973]
Editorial Note: For Federal Register citations affecting Sec.
1.167(a)-11, see the List of CFR Sections Affected, which appears in the
Finding Aids section of the printed volume and at www.fdsys.gov.
Sec. 1.167(a)-12 Depreciation based on class lives for property first
placed in service before January 1, 1971.
(a) In general--(1) Summary. This section provides an elective class
life system for determining the reasonable allowance for depreciation of
certain classes of assets for taxable years ending after December 31,
1970. The system applies only to assets placed in service before January
1, 1971. Depreciation for such assets during periods prior to January 1,
1971, may have been determined in accordance with Revenue Procedure 62-
21. Accordingly, rules are provided which permit taxpayers to apply the
system in taxable years ending after December 31, 1970, to such assets
without the necessity of changing or regrouping their depreciation
accounts other than as previously required by Revenue Procedure 62-21.
The system is designed to minimize disputes between taxpayers and the
Internal Revenue Service as to the useful life of assets, salvage value,
and repairs. See Sec. 1.167(a)-11 for a similar system for property
placed in service after December 31, 1970. See paragraph (d)(2) of Sec.
1.167(a)-11 for treatment of expenditures for the repair, maintenance,
rehabilitation or improvement of certain property. The system provided
by this section is optional with the taxpayer. An election under this
section applies only to qualified property in an asset guideline class
for which an election is made and only for the taxable year of election.
The taxpayer's election is made with the income tax return for the
taxable year. This section also revokes the reserve ratio test for
taxable years ending after December 31, 1970, and provides transitional
rules for taxpayers who after January 11, 1971, adopt Revenue Procedure
62-21 for a taxable year ending prior to January 1, 1971.
(2) Revocation of reserve ratio test and other matters. Except as
otherwise expressly provided in this section and in paragraph (b)(5)(vi)
of Sec. 1.167(a)-11, the provisions of Revenue Procedure 62-21 shall
not apply to any property for any taxable year ending after December 31,
1970, whether or not the taxpayer
[[Page 427]]
elects to apply this section to any property. See paragraph (f) of this
section for rules for the adoption of Revenue Procedure 62-21 for
taxable years ending prior to January 1, 1971.
(3) Definition of qualified property. The term ``qualified
property'' means tangible property which is subject to the allowance for
depreciation provided by section 167(a), but only if--
(i) An asset guideline class and asset guideline period are in
effect for such property for the taxable year, and
(ii) The property is first placed in service by the taxpayer before
January 1, 1971,
(iii) The property is placed in service before January 1, 1971, but
first placed in service by the taxpayer after December 31, 1970, and is
not includible in an election under Sec. 1.167(a)-11 by reason of Sec.
1.167(a)-11(b)(7) (property acquired as a result of a mere change in
form) or Sec. 1.167(a)-11(e)(3)(i) (certain property acquired in a
transaction to which section 381(a) applies), or
(iv) The property is acquired and first placed in service by the
taxpayer after December 31, 1970, pursuant to a binding written contract
entered into prior to January 1, 1971, and is excluded in accordance
with paragraph (b)(5)(iv) of Sec. 1.167(a)-11 from an election to apply
Sec. 1.167(a)-11.
The provisions of paragraph (e)(1) of Sec. 1.167(a)-11 apply in
determining whether property is first placed in service before January
1, 1971. See subparagraph (4)(ii) of this paragraph for special rules
for the exclusion of property from the definition of qualified property.
(4) Requirements of election--(i) In general. An election to apply
this section to qualified property must be made within the time and in
the manner specified in paragraph (e) of this section. The election must
specify that the taxpayer consents to and agrees to apply all the
provisions of this section. The election may be made separately for each
asset guideline class. Thus, a taxpayer may for the taxable year elect
to apply this section to one, more than one, or all asset guideline
classes in which he has qualified property. An election to apply this
section for a taxable year must include all qualified property in the
asset guideline class for which the election is made.
(ii) Special rules for exclusion of property from application of
this section. (a) If for the taxable year of election, the taxpayer
computes depreciation under section 167(k) or computes amortization
under sections 169, 185, 187, 188, or paragraph (b) of Sec. 1.162-11
with respect to property, such property is not qualified property for
such taxable year. If for the taxable year of election, the taxpayer
computes depreciation under any method of depreciation (other than a
method described in the preceding sentence) not permitted by
subparagraph (5)(v) of this paragraph for any property in an asset
guideline class (other than subsidiary assets excluded from an election
under (b) of this subdivision), no property in such asset guideline
class is qualified property for such taxable year.
(b) The taxpayer may exclude from an election to apply this section
all (but not less than all) subsidiary assets. Subsidiary assets so
excluded are not qualified property for such taxable year. For purposes
of this subdivision the term ``subsidiary assets'' includes jigs, dies,
molds, returnable containers, glassware, silverware, textile mill cam
assemblies, and other equipment includable in Group One, Class 5, of
Revenue Procedure 62-21 which is usually and properly accounted for
separately from other property and under a method of depreciation not
expressed in terms of years.
(iii) Special rule for certain public utility property. (a) In the
case of public utility property described in section 167(1)(3)(A)(iii)
for which no guideline life was prescribed in Revenue Procedure 62-21
(or for which reference was made in Revenue Procedure 62-21 to lives or
rates established by governmental regulatory agencies) of a taxpayer
which--
(1) Is entitled to use a method of depreciation other than a
``subsection (1) method'' of depreciation (as defined in section
167(1)(3)(F)) only if it uses the ``normalization method of accounting''
(as defined in section 167(1)(3)(G)) with respect to such property, or
(2) Is entitled for the taxable year to use only a ``subsection (1)
method'' of depreciation, such property shall be
[[Page 428]]
qualified property (as defined in subparagraph (3) of this paragraph)
only if the taxpayer normalizes the tax deferral resulting from the
election to apply this section.
(b) The taxpayer will be considered to normalize the tax deferral
resulting from the election to apply this section only if it computes
its tax expense for purposes of establishing its cost of service for
ratemaking purposes and for reflecting operating results in its
regulated books of account using a period for depreciation no less than
the period used for computing its depreciation expense for ratemaking
purposes and for reflecting operating results in its regulated books of
account for the taxable year, and the taxpayer makes adjustments to a
reserve to reflect the deferral of taxes resulting from the use of a
period for depreciation under section 167 in accordance with an election
to apply this section different from the period used for computing its
depreciation expense for ratemaking purposes and for reflecting
operating results in its regulated books of account for the taxable
year. A determination whether the taxpayer is considered to normalize
under this subdivision the tax deferral resulting from the election to
apply this section shall be made in a manner consistent with the
principles for determining whether a taxpayer is using the
``normalization method of accounting'' (within the meaning of section
167(1)(3)(G)). See Sec. 1.167(l)-1(h).
(c) If a taxpayer, which has elected to apply this section to any
qualified public utility property and is required under (a) of this
subdivision to normalize the tax deferral resulting from the election to
apply this section to such property, fails to normalize such tax
deferral, the election to apply this section to such property shall
terminate as of the beginning of the taxable year for which the taxpayer
fails to normalize such tax deferral. Application of this section to
such property for any period prior to the termination date will not be
affected by this termination.
(5) Determination of reasonable allowance for depreciation--(i) In
general. The allowance for depreciation of qualified property to which
the taxpayer elects to apply this section shall be determined in
accordance with this section. The annual allowance for depreciation is
determined by using the method of depreciation adopted by the taxpayer
and a rate based upon a life permitted by this section. In the case of
the straight-line method of depreciation, the rate of depreciation shall
be based upon the class life (or individual life if the taxpayer assigns
individual depreciable lives in accordance with subdivision (iii) of
this subparagraph) used by the taxpayer with respect to the assets in
the asset guideline class. Such rate will be applied to the unadjusted
basis of the asset guideline class (individual assets or depreciation
accounts if the taxpayer assigns individual depreciable lives). In the
case of the sum of the years-digits method of depreciation, the rate of
depreciation will be determined based upon the remaining life of the
class (or individual remaining lives if the taxpayer assigns such lives
in accordance with subdivision (iii) of this subparagraph) and is
applied to the adjusted basis of the class (or individual accounts or
assets) as of the beginning of the taxable year of election. The
remaining life of a depreciation account is determined by dividing the
unrecovered cost or other basis of the account, as computed by straight-
line depreciation, by the gross cost or unadjusted basis of the account,
and multiplying the result by the class life used with respect to the
account. In the case of the declining balance method of depreciation,
the rate of depreciation for the asset guideline class shall be based
upon the class life (or individual life if the taxpayer assigns such
lives in accordance with subdivision (iii) of this subparagraph). Such
rate is applied to the adjusted basis of the class (or individual
accounts or assets) as of the beginning of the taxable year of election.
(ii) Reasonable allowance by reference to class lives. The amount of
depreciation for all qualified property in an asset guideline class to
which the taxpayer elects to apply this section will constitute the
reasonable allowance provided by section 167(a) and the depreciation for
the asset guideline class will not be adjusted if--
[[Page 429]]
(a) The taxpayer's qualified property is accounted for in one or
more depreciation accounts which conform to the asset guideline class,
and the depreciation for each such account is determined by using a rate
based upon a life not less than the class life, or
(b) The taxpayer's qualified property is accounted for in one or
more depreciation accounts (whether or not conforming to the asset
guideline class) for which depreciation is determined at a rate based
upon the taxpayer's estimate of the lives of the assets (instead of the
class life) and the total amount of depreciation so determined for the
asset guideline class for the taxable year of election is not more than
would be permitted under (a) of this subdivision for such year using the
method of depreciation adopted by the taxpayer for the property.
See subdivision (vii) of this subparagraph for determination of
reasonable allowance if depreciation exceeds the amount permitted by
this subdivision. See paragraph (b) of this section for rules regarding
the determination of ``class life''. For rules for regrouping
depreciation accounts to conform to the asset guideline class, see
subdivision (iv) of this subparagraph.
(iii) Consistency when individual lives are used. If the taxpayer
assigns individual depreciable lives to assets in accordance with
subdivision (ii)(b) of this subparagraph, even though the total amount
of depreciation for the asset guideline class will not be adjusted, the
lives assigned to the various assets in the asset guideline class must
be reasonably in proportion to their relative expected periods of use in
the taxpayer's business. Thus, although the taxpayer who uses individual
asset lives normally has latitude in thereby allocating the depreciation
for the asset guideline class among the assets, if the lives are grossly
disproportionate (as where a short life is assigned to one asset and a
long life to another even though the expected periods of use are the
same), the taxpayer's allocation of depreciation to particular assets or
depreciation accounts may be adjusted. For example, the taxpayer's
allocation may be adjusted for purposes of determining adjusted basis
under section 1016(a) or in allocating depreciation to the 50-percent
limitation on percentage depletion provided by section 613(a). See
paragraph (d) of this section for rules regarding the use of individual
asset lives for purposes of classifying retirements as normal or
abnormal.
(iv) Regrouping depreciation accounts. Without the consent of the
Commissioner, the taxpayer may for any taxable year for which he elects
to apply this section to an asset guideline class, regroup his accounts
for that and all succeeding taxable years to conform to the asset
guideline class. Other changes in accounting, including a change from
item accounts to multiple-asset accounting, may be made with the consent
of the Commissioner. No depreciation accounts for which the straight
line or sum of the years-digits method of depreciation is adopted may be
combined under this section which would not be permitted to be combined
under part III of Revenue Procedure 65-13, as in effect on January 1,
1971. Accordingly, whether or not the taxpayer adopted the guideline
system of Revenue Procedure 62-21 for a taxable year to which part III
of Revenue Procedure 65-13 is applicable, the depreciation allowance for
any taxable year of election under this section may not exceed that
amount which would have been allowed for such year if the taxpayer had
used item accounts or year of acquisition accounts. Thus, for example,
if a calendar year taxpayer acquired a $90 asset on the first day of
each year from 1966 through 1970, placed such assets in a single
multiple asset account, adopted the sum of the years-digits method of
depreciation and used a 5-year depreciable life for such assets, and in
1971 uses the 5-year class life determined under paragraph (b) of this
section, the depreciation allowance for such assets in 1971 under this
section may not exceed $60, that is, the amount which would be allowed
if the taxpayer had used year of acquisition accounts for the assets for
the years 1966 through 1970.
For purposes of this subparagraph, a taxpayer's depreciation accounts
conform to the asset guideline class if each depreciation account
includes only assets of the same asset guideline class.
(v) Method of depreciation. The same method of depreciation must be
applied
[[Page 430]]
to all property in a single depreciation account. The method of
depreciation is subject to the limitations of section 167 (c), (j), and
(l). Except as otherwise provided in this subdivision, the taxpayer must
apply a method of depreciation described in section 167(b) (1), (2), or
(3) for qualified property to which the taxpayer elects to apply this
section. A method of depreciation permitted under section 167(b)(4) may
be used under this section if the method was used by the taxpayer with
respect to the property for his last taxable year ending before January
1, 1971, the method is expressed in terms of years, the taxpayer
establishes to the satisfaction of the Commissioner that the method is
both a reasonable and consistent method, and if the taxpayer applies
paragraph (b)(2) of this section (relating to class lives in special
situations) to determine a class life, that the method of determining
such class life is consistent with the principles of Revenue Procedure
62-21 as applied to such a method. If the taxpayer has applied a method
of depreciation with respect to the property which is not described in
section 167(b) (1), (2), (3), or (4) (as permitted under the preceding
sentence), he must change under this section to a method of depreciation
described in section 167(b) (1), (2), or (3) for the first taxable year
for which an election is made under this section. Other changes in
depreciation method may be made with the consent of the Commissioner
(see sec. 446 and the regulations thereunder). (See also sec. 167(e).)
(vi) Salvage value. In applying the method of depreciation adopted
by the taxpayer, the annual allowance for depreciation is determined
without adjustment for the salvage value of the property, except that no
depreciation account may be depreciated below a reasonable salvage value
for the account. See paragraph (c) of this section for definition and
treatment of salvage value.
(vii) Reasonable allowance when depreciation exceeds amount based on
class life. In the event that the total amount of depreciation claimed
by the taxpayer on his income tax return, in a claim for refund, or
otherwise, for an asset guideline class with respect to which an
election is made under this section for the taxable year, exceeds the
maximum amount permitted under subdivision (ii)(a) of this
subparagraph--
(a) If the excess is established to the satisfaction of the
Commissioner to be the result of a good faith mistake by the taxpayer in
determining the maximum amount permitted under subdivision (ii) (a) of
this subparagraph, the taxpayer's election to apply this section will be
treated as valid and only such excess will be disallowed, and
(b) In all other cases, the taxpayer's election to apply this
section to the asset guideline class for the taxable year is invalid and
the reasonable allowance for depreciation will be determined without
regard to this section. (See Sec. 1.167(a)-1 (b) for rules regarding
the estimated useful life of property.)
(b) Determination of class lives--(1) Class lives in general. The
class life determined under this paragraph (without regard to any range
or variance permitted with respect to class lives under Sec. 1.167(a)-
11) will be applied for purposes of determining whether the allowance
for depreciation for qualified property included in an election under
this section is subject to adjustment. The taxpayer is not required to
use the class life determined under this paragraph for purposes of
determining the allowance for depreciation. Except as provided in
subparagraph (2) of this paragraph, the class life of qualified property
to which the taxpayer elects to apply this section is the shorter of--
(i) The asset guideline period for the asset guideline class as set
forth in Revenue Procedure 72-10 as in effect on March 1, 1972 (applied
without regard to any special provision therein with respect to property
predominantly used outside the United States), or
(ii) The asset guideline period for the asset guideline class as set
forth in any supplement or revision of Revenue Procedure 72-10, but only
if and to the extent by express reference in such supplement or revision
made applicable for the purpose of changing the asset guideline period
or classification of qualified property to which this section applies.
See paragraph (e)(3)(iii) of this section for requirement that the
election for the taxable year specify the class life
[[Page 431]]
for each asset guideline class. Generally, the applicable asset
guideline class and asset guideline period for qualified property to
which the taxpayer has elected to apply this section will not be changed
for the taxable year of election to reflect any supplement or revision
thereof after the taxable year. However, if expressly provided in such a
supplement or revision, the taxpayer may, at his option in the manner
specified therein, apply the revised or supplemented asset guideline
classes or periods to such property for such taxable year and succeeding
taxable years. The principles of this subparagraph may be illustrated by
the following example:
Example. (i) Corporation X, a calendar year taxpayer, has assets in
asset guideline class 20.4 of Revenue Procedure 72-10 which were placed
in service by corporation X in 1967, 1968, and 1970. Corporation X also
has assets in asset guideline class 22.1 of Revenue Procedure 72-10
which were placed in service at various times prior to 1971. Corporation
X has no other qualified property. Corporation X elects to apply this
section for 1971 to both classes. Assume that the class lives are
determined under this subparagraph and not under subparagraph (2) of
this paragraph.
(ii) The class lives for asset guideline classes 20.4 and 22.1 are
their respective asset guideline periods of 12 years and 9 years in
Revenue Procedure 72-10.
(iii) Accordingly, in the election for the taxable year, in
accordance with paragraph (e)(3)(iii) of this section, corporation X
specifies a class life of 12 years for asset guideline class 20.4 and a
class life of 9 years for asset guideline class 22.1.
(2) Class lives in special situations. Notwithstanding subparagraph
(1) of this paragraph, for the purposes of this section the class life
for the asset guideline class determined under this subparagraph shall
be used if such class life is shorter than the class life determined
under subparagraph (1) of this paragraph. If property described in
paragraph (a)(2)(iii) of this section in an asset guideline class is
acquired by the taxpayer in a transaction to which section 381(a)
applies, for purposes of this subparagraph such property shall be
segregated from other property in the class and treated as in a separate
asset guideline class, and the class life for that asset guideline class
under this subparagraph shall be the shortest class life the transferor
was entitled to use under this section for such property on the date of
such transfer. In all other cases, the class life for the asset
guideline class for purposes of this subparagraph shall be the shortest
class life (within the meaning of sec. 4, part II, of Revenue Procedure
62-21) which can be justified by application of secs. 3.02(a), 3.03(a),
or 3.05, part II, of Revenue Procedure 62-21 (other than the portion of
such sec. 3.05 dealing with justification of a class life by reference
to facts and circumstances) for the taxpayer's last taxable year ending
prior to January 1, 1971.
A class life justified by application of section 3.03(a), Part II, of
Revenue Procedure 62-21 shall not be shorter than can be justified under
the Adjustment Table for Class Lives in Part III of such Revenue
Procedure. For purposes of this subparagraph and paragraph (f)(1)(iii)
of this section, the reserve ratio test is met only if the taxpayer's
reserve ratio does not exceed the upper limit of the appropriate reserve
ratio range or in the alternative during the transitional period there
provided does not exceed the appropriate ``transitional upper limit'' in
section 3, Part II, of Revenue Procedure 65-13. References to Revenue
Procedure 62-21 include all morifications, amendments, and supplements
thereto as of January 1, 1971. The guideline form of the reserve ratio
test, as described in Revenue Procedure 65-13, may be applied for
purposes of this subparagraph in a manner consistent with the rules
contained in section 7, Part II, of Revenue Procedure 65-13 and sections
3.02, 3.03, and 3.05, Part II, of Revenue Procedure 62-21. The
principles of this subparagraph may be illustrated by the following
examples:
Example 1. Corporation X, a calendar year taxpayer, has all its
assets in asset guideline class 20.4 of Revenue Procedure 72-10 which
were placed in service by corporation X prior to 1971. Corporation X
elects to apply this section for 1971. For taxable years 1967 through
1969, corporation X had used a class life (within the meaning of section
4, Part II, of Revenue Procedure 62-21) for asset guideline class 20.4
of 12 years. The asset guideline period in Revenue Procedure 72-10 in
effect for 1971 is also 12 years. Assume that for 1969 corporation X's
reserve ratio was below the appropriate reserve ratio lower limit.
However, corporation X could not justify a class
[[Page 432]]
life shorter than the asset guideline period of 12 years for 1970 since
corporation X had not used the 12-year class life for a period at least
equal to one-half of 12 years. (See section 3.03(a), Part II, of Revenue
Procedure 62-21.) Accordingly, the class life for asset guideline class
20.4 in 1971 is the asset guideline period of 12 years in accordance
with subparagraph (1) of this paragraph.
Example 2. The facts are the same as in example (1) except that
corporation X had used a class life of 10 years for guideline class 20.4
since 1967. Corporation X had not used the class life of 10 years for a
period at least equal to one-half of 10 years. However, in 1968
corporation X's 10-year class life was accepted on audit by the Internal
Revenue Service and corporation X met the reserve ratio test in 1970 for
guideline class 20.4 using a test life of 10 years. (See section 3.05,
Part II, of Revenue Procedure 62-21.) Accordingly, the class life of 10
years is justified for 1970 and the class life for 1971 is 10 years in
accordance with this subparagraph. If the taxpayer's class life had not
been audited and accepted for 1968, and in the absence of other
circumstances, the taxpayer could not justify a class life shorter than
the asset guideline period of 12 years since it had not used the 10-year
class life for a period at least equal to one-half of 10 years. (See
section 3.02, Part II, of Revenue Procedure 62-21.)
Example 3. Corporation Y, a calendar year taxpayer, has all its
assets in asset guideline class 13.3 of Revenue Procedure 72-10 which
were placed in service from 1960 through 1970. Corporation Y elects to
apply this section for 1971. The asset guideline period in Revenue
Procedure 72-10 in effect for 1971 is 16 years. Since 1963 corporation Y
had used a class life of 16 years for asset guideline 13.3. At the end
of 1969 corporation Y's reserve ratio for guideline class 13.3 was 36
percent. With a growth rate of 8 percent and a test life of 16 years the
appropriate reserve ratio lower limit was 37 percent. Corporation Y's
reserve ratio of 36 percent was below the lower limit of the appropriate
reserve ratio range. Corporation Y had used the 16-year class life for
at least eight years. A class life of 13.5 years for 1970 was justified
by application of section 3.03(a), Part II, of Revenue Procedure 62-21
and the Adjustment Table for Class Lives in Part III, of Revenue
Procedure 62-21. The class life for 1971 is 13.5 years in accordance
with this subparagraph.
(3) Classification of property--(i) In general. Property to which
this section applies shall be included in the asset guideline class for
the activity in which the property is primarily used in the taxable year
of election. See paragraph (d)(5) of this section for rule regarding the
classification of leased property.
(ii) Insubstantial activity. The provisions of Revenue Produce 62-21
with respect to classification of assets used in an activity which is
insubstantial may be applied under this section.
(iii) Special rule for certain public utilities. An electric or gas
utility which in accordance with Revenue Procedure 64-21 used a
composite guideline class basis for applying Revenue Procedure 62-21 for
its last taxable year prior to January 1, 1971, may apply Revenue
Procedure 72-10 and this section on the basis of such composite asset
guideline class determined as provided in Revenue Procedure 64-21. For
the purposes of this section all property in the composite guideline
class shall be treated as included in a single asset guideline class.
(c) Salvage value--(1) In general--(i) Definition of gross salvage
value. ``Gross salvage'' value is the amount (determined at or as of the
time of acquisition but without regard to the application of Revenue
Procedure 62-21) which is estimated will be realized upon a sale or
other disposition of qualified property when it is no longer useful in
the taxpayer's trade or business or in the production of his income and
is to be retired from service, without reduction for the cost of
removal, dismantling, demolition, or similar operations. ``Net salvage''
is gross salvage reduced by the cost of removal, dismantling,
demolition, or similar operations. If a taxpayer customarily sells or
otherwise disposes of property at a time when such property is still in
good operating condition, the gross salvage value of such property is
the amount expected to be realized upon such sale or disposition, and
under certain circumstances, as where such property is customarily sold
at a time when it is still relatively new, the gross salvage value may
constitute a relatively large proportion of the unadjusted basis of such
property.
(ii) Definition of salvage value. ``Salvage value'' for purposes of
this section means gross or net salvage value less the amount, if any,
by which reduced by application of section 167(f). Generally, as
provided in section 167(f), a taxpayer may reduce the gross or net
[[Page 433]]
salvage value for an account by an amount which does not exceed 10
percent of the unadjusted basis of the personal property (as defined in
section 167(f)(2)) in the account.
(2) Estimation of salvage value--(i) In general. For the first
taxable year for which he elects to apply this section, the taxpayer
must (in accordance with paragraph (e)(3)(iv)(c) of this section)
establish salvage value for all qualified property to which the election
applies. The taxpayer may (in accordance with subparagraph (1) of this
paragraph) determine either gross or net salvage, but an election under
this section does not constitute permission to change the manner of
estimating salvage. Permission to change the manner of estimating
salvage must be obtained by filing form 3115 with the Commissioner of
Internal Revenue, Washington, D.C. 20224, within the time otherwise
permitted for the taxable year or before September 6, 1973. Salvage
value in succeeding taxable years of election will be determined by
adjustments of such initial salvage value for the account, as
retirements occur. This salvage value established by the taxpayer for
the first taxable year of election will not be redetermined merely as a
result of fluctuations in price levels or as a result of other
circumstances occurring after the close of such taxable year. See
paragraph (e)(3)(iv) of this section for requirements that the taxpayer
specify in his election the aggregate amount of salvage value for an
asset guideline class and that the taxpayer maintain records reasonably
sufficient to identify the salvage value established for each
depreciation account in the class.
(ii) Salvage as limitation on depreciation. In no case may an
account be depreciated under this section below a reasonable salvage
value, after taking into account any reduction in gross or net salvage
value permitted by section 167(f). For example, if the salvage value of
an account for 1971 is $75, the unadjusted basis of the account is $500,
and the depreciation reserve is $425, no depreciation is allowable for
1971.
(iii) Special rule for first taxable year. If for a taxable year
ending prior to January 1, 1971, the taxpayer had adopted Revenue
Procedure 62-21 prior to January 12, 1971 (see paragraph (f)(2) of this
section), no adjustment in the amount of depreciation allowable for any
taxable year ending prior to January 1, 1971, shall be made solely by
reason of establishing salvage value under this paragraph for any
taxable year ending after December 31, 1970. The principles of this
subdivision may be illustrated by the following example:
Example. Taxpayer A had adopted Revenue Procedure 62-21 prior to
January 12, 1971, for taxable years prior to 1971. Taxpayer A had not
taken into account any salvage value for account No. 1 which is one of
four depreciation accounts A has in the class. The reserve ratio test
has been met for all years prior to 1971 and in accordance with Revenue
Procedure 62-21 no adjustments in depreciable lives or salvage values
were made. At the end of A's taxable year 1970, the unadjusted basis of
account No. 1 was $10,000 and the reserve for depreciation was $9,800.
Pursuant to this paragraph, A establishes a salvage value of $400 for
account No. 1 (determined at or as of the time of acquisition). This
salvage value is determined to be correct. No depreciation is allowable
for account No. 1 in 1971. No depreciation is disallowed for any taxable
year prior to 1971, solely by reason of establishing salvage value under
this paragraph.
(3) Limitation on adjustment of reasonable salvage value. The
salvage value established by the taxpayer for a depreciation account
will not be redetermined if it is reasonable. Since the determination of
salvage value is a matter of estimation, minimal adjustments will not be
made. The salvage value established by the taxpayer will be deemed to be
reasonable unless there is sufficient basis for a determination of an
amount of salvage value for the account which exceeds the salvage value
established by the taxpayer for the account by an amount greater than 10
percent of the unadjusted basis of the account at the close of such
taxable year. If the salvage value established by the taxpayer for the
account is not within the 10-percent range or if the taxpayer follows
the practice of understating his estimates of salvage to take advantage
of this subdivision, and if there is a determination of an amount of
salvage value for the account for the taxable year which exceeds the
salvage value established by the taxpayer for the account for such
taxable year, an adjustment will be made by increasing the salvage value
[[Page 434]]
established by the taxpayer for the account by an amount equal to the
difference between the salvage value as determined and the salvage value
established by the taxpayer for the account. For the purposes of this
subdivision, a determination of salvage value shall include all
determinations at all levels of audit and appellate proceedings, and as
well as all final determinations within the meaning of section
1313(a)(1). This subparagraph shall apply to each such determination.
(4) Examples. The principles of this paragraph may be illustrated by
the following examples in which it is assumed that the taxpayer has
established salvage value in accordance with this paragraph and has not
followed a practice of understating his estimates of salvage value:
Example 1. Taxpayer B elects to apply this section for 1971. Assets
Y and Z are the only assets in a multiple asset account of 1967, the
year in which the assets were acquired. The unadjusted basis of asset Y
is $50,000 and the unadjusted basis of asset Z is $30,000. B estimated a
gross salvage value of $55,000 at the time of acquisition. The property
qualified under section 167(f)(2) and B reduced the amount of salvage
taken into account by $8,000 (that is, 10 percent of $80,000, under sec.
167(f)). Thus, in accordance with this paragraph and paragraph
(e)(3)(iv)(c) of this section, B establishes a salvage value of $47,000
for the account for 1971. Assume that there is not sufficient basis for
determining a salvage value for the account greater $52,000 (that is
$60,000 minus the $8,000 reduction under sec. 167(f)). Since the salvage
value of $47,000 established by B for the account is within the 10
percent range, it is reasonable. Salvage for the account will not be
redetermined.
Example 2. The facts are the same as in example (1) except that B
estimated a gross salvage value of $50,000 and establishes a salvage
value of $42,000 for the account (that is, $50,000 minus the $8,000
reduction under section 167(f)). There is sufficient basis for
determining an amount of salvage value greater than $50,000 (that is,
$58,000 minus the $8,000 reduction under section 167(f)). The salvage
value of $42,000 established by B for the account can be redetermined
without regard to the limitation in subparagraph (3) of this paragraph,
since it is not within the 10 percent range. Upon audit of B's tax
return for 1971 (a year in which the redetermination would affect the
amount of depreciation allowable for the account), salvage value is
determined to be $52,000 after taking into account the reduction under
section 167(f). Salvage value for the account will be adjusted to
$52,000.
Example 3. The facts are the same as in example (1) except that upon
audit of B's tax return for 1971 the examining officer determines the
salvage value to be $58,000 (that is, $66,000 minus the $8,000 reduction
under section 167(f)), and proposes to adjust salvage value for the
account to $58,000 which will result in disallowing an amount of
depreciation for the taxable year. B does not agree with the finding of
the examining officer. After receipt of a ``30-day letter,'' B waives a
district conference and initiates proceedings before the Appellate
Division. In consideration of the case by the Appellate Division it is
concluded that there is not sufficient basis for determining an amount
of salvage value for the account in excess of $55,000 (that is, $63,000
minus the $8,000 reduction under section 167(f)). Since the salvage
value of $47,000 established by B for the account is within the 10
percent range, it is reasonable. Salvage value for the account will not
be redetermined.
Example 4. For 1971, taxpayer C elects to apply this section to
factory building X which is in an item account of 1965, the year in
which the building was acquired. The unadjusted basis of factory
building X is $90,000. C estimated a gross salvage value for the account
of $10,000. The property did not qualify under section 167(f)(2). Thus,
C establishes a salvage value of $10,000 for the account for 1971.
Assume that there is not sufficient basis for determining a salvage
value for the account greater than $14,000. Since the salvage value of
$10,000 established by C for the account is within the 10-percent range,
it is reasonable. Salvage value for the account will not be
redetermined.
(d) Accounting for qualified property--(1) In general. Qualified
property for which the taxpayer elects to apply this section may be
accounted for in any number of item or multiple asset accounts.
(2) Retirements of qualified property--(i) In general. The
provisions of this subparagraph and Sec. 1.167(a)-8 apply to
retirements of qualified property to which the taxpayer elects to apply
this section for the taxable year. See subdivision (iii) of this
subparagraph for special rule for normal retirements.
(ii) Adjusted basis of assets retired. In the case of a taxpayer who
depreciates qualified property in a multiple-asset account conforming to
the asset guideline class at a rate based on the class life in
accordance with paragraph (a)(5)(ii)(a) of this section, Sec. 1.167(a)-
8(c) (relating to basis of assets retired)
[[Page 435]]
shall be applied by assuming that the class life is the average expected
useful life of the assets in the account. See Sec. 1.167(a)-8,
generally, for the basis of assets retired.
(iii) Definition of normal retirements. Notwithstanding Sec.
1.167(a)-8(b), the determination whether a retirement of qualified
property is normal or abnormal shall be made in light of all the facts
and circumstances, primarily with reference to the expected period of
use of the asset in the taxpayer's business without regard to paragraph
(a)(5)(ii) of this section. A retirement is not abnormal unless the
taxpayer can show that the withdrawal of the asset was not due to a
cause which would customarily be contemplated (in light of the
taxpayer's practice and experience) in setting a depreciation rate for
the assets without regard to paragraph (a)(5)(ii) of this section. Thus,
for example, a retirement is normal if made within the range of years
which would customarily be taken into account in setting such
depreciation rate and if the asset has reached a condition at which, in
the normal course of events, the taxpayer customarily retires similar
assets from use in his business. A retirement may be abnormal if the
asset is withdrawn at an earlier time or under other circumstances, as,
for example, when the asset has been damaged by casualty or has lost its
usefulness suddenly as the result of extraordinary obsolescence.
(3) Special rules--(i) In general. The provisions of this
subparagraph shall apply to qualified property in a taxable year for
which an election to apply this section is made.
(ii) Repairs. For the purpose of sections 162 and 263 and the
regulations thereunder, whether an expenditure prolongs the life of an
asset shall be determined by reference to the expected period of use of
the asset in the taxpayer's business without regard to paragraph
(a)(5)(ii) of this section.
(iii) Sale and lease. For the purpose of comparison with the term of
a lease of such property, the remaining life of qualified property shall
be determined by reference to the expected period of use of the asset in
the taxpayer's business without regard to paragraph (a)(5)(ii) of this
section.
(4) Expected period of use. For the purposes of subparagraphs (2)
and (3) of this paragraph, the determination of the expected period of
use of an asset shall be made in light of all the facts and
circumstances. The expected period of use of a particular asset will not
necessarily coincide with the class life used for depreciation (or with
the individual asset life for depreciation under the alternative method
in paragraph (a)(5)(ii) (b) of this section for applying the class
life). Thus, for example, if the question is whether an asset has been
leased for a period less than, equal to or greater than its remaining
life, the determination shall be based on the remaining expected period
of use of the individual asset without regard to the fact that the asset
is depreciated at a rate based on the class life in accordance with
paragraph (a)(5)(ii)(a) of this section.
(5) Leased property. In the case of a lessor of qualified property,
unless there is an asset guideline class in effect for such lessors, the
asset guideline class for such property shall be determined by reference
to the activity in which such property is primarily used by the lessee.
See paragraph (b)(3) of this section for general rule for classification
of qualified property according to primary use. However, in the case of
an asset guideline class based upon the type of property (such as trucks
or railroad cars), as distinguished from the activity in which used, the
property shall be classified without regard to the activity of the
lessee.
(e) Election under this section--(1) Consent to change in method of
accounting. An election to apply this section for a taxable year ending
after December 31, 1970, is a method of accounting but the consent of
the Commissioner will be deemed granted to make an annual election.
(2) Election for taxable years ending after December 31, 1976. For
taxable years ending after December 31, 1976, the election to apply this
section for a taxable year shall be made by attaching to the income tax
return a statement that an election under this section is being made. If
the taxpayer does not file a timely return (taking into account
extensions of time for filing)
[[Page 436]]
for the taxable year, the election shall be made at the time the
taxpayer files his first return for the taxable year. The election may
be made with an amended return only if such amended return is filed no
later than the time prescribed by law (including extensions thereof) for
filing the return for the taxable year. A taxpayer who makes an election
under this subparagraph must maintain books and records reflecting the
information described in paragraph (e)(3) (ii) and (iii) of this
section.
(3) Election for taxable years ending on or before December 31,
1976. (i) For taxable years ending on or before December 31, 1976, the
election to apply this section for a taxable year may be made by filing
Form 5006 with the income tax return for the taxable year. If the
taxpayer does not file a timely return (taking into account extensions
of time for filing) for the taxable year, the election shall be filed at
the time the taxpayer files his first return for the taxable year. The
election may be made with an amended return only if such amended return
is filed no later than the later of (a) the time prescribed by law
(including extensions thereof) for filing the return for the taxable
year, or (b) November 5, 1973.
(ii) The election to apply this section for a taxable year ending on
or before December 31, 1976, will be deemed to be made if the tax return
(filed within the periods referred to in paragraph (e)(3)(i) of this
section) contains information sufficient to establish the following:
(a) Each asset guideline class for which the election is intended to
apply;
(b) The class life for each such asset guideline class and whether
the class life is determined under paragraph (b)(1) or (2) of this
section;
(c) For each asset guideline class, as of the end of the taxable
year of election, (1) the total unadjusted basis of all qualified
property, (2) the aggregate of the reserves for depreciation of all
accounts in the asset guideline class, and (3) the aggregate of the
salvage value established for all accounts in the asset guideline class;
and
(d) Whether the taxpayer is an electric or gas utility using a
composite asset guideline class basis in accordance with paragraph
(b)(3)(iii) of this section.
If an election is deemed to be made under this subdivision (ii), the
taxpayer will be deemed to have consented to apply all the provisions of
this section.
(iii) A taxpayer to whom the election applies shall maintain books
and records for each asset guideline class reasonably sufficient to
identify the unadjusted basis, reserve for depreciation and salvage
value established for each depreciation account in such asset guidelines
class.
(f) Depreciation for taxable years ending before January 1, 1971--
(1) Adoption of Revenue Procedure 62-21--(i) In general. Except as
provided in subdivision (ii) of this subparagraph, a taxpayer may elect
to be examined under the provisions of Revenue Procedure 62-21 for a
taxable year ending before January 1, 1971, only in accordance with the
rules of this paragraph. The election must specify:
(a) That the taxpayer makes such election and consents to, and
agrees to apply, all the provisions of this paragraph;
(b) Each guideline class and taxable year for which the taxpayer
elects to be examined under Revenue Procedure 62-21;
(c) The class life claimed for each such guideline class;
(d) The class life and the total amount of the depreciation for the
guideline class claimed on the last income tax return for such taxable
year filed prior to January 12, 1971 (or in case no income tax return
was filed prior to January 12, 1971, on the first income tax return
filed for such taxable year);
(e) The class life claimed and the total amount of depreciation for
the guideline class under the election to apply Revenue Procedure 62-21,
in accordance with this paragraph, for the taxable year; and
(f) If the class life or total amount of depreciation for the
guideline class is different in (d) and (e) of this subdivision, a
reasonable description of the computation of the class life in (e) of
this subdivision, the amount of difference in tax liability resulting
therefrom, and the amount of any refund or
[[Page 437]]
reduction in any deficiency in tax. The election shall be made in an
amended tax return or claim for refund (or by a supplement to the tax
return or claim) for the taxable year, and if the class life or total
amount of depreciation for the guideline class is different in
accordance with (f) of this subdivision, such difference shall be
reflected in the amended tax return or claim for refund. Forms may be
provided for making the election and submission of the information. In
the case of an election made after issuance of such forms and more than
30 days after publication of notice thereof in the Internal Revenue
Bulletin, the election may be made and the information submitted only in
accordance with such forms. An election will not otherwise be invalid
under this paragraph so long as there is substantial compliance, in good
faith, with the requirements of this paragraph.
(ii) Special rule. The provisions of this subparagraph shall not
apply to a guideline class in any taxable year for which the taxpayer
has prior to January 12, 1971, adopted Revenue Procedure 62-21 for such
class. See subparagraph (2) of this paragraph for determination of
adoption of Revenue Procedure 62-21 prior to January 12, 1971.
(iii) Justification of class life claimed and limitations on
refunds. If the taxpayer elects for a taxable year to be examined under
the provisions of Revenue Procedure 62-21 in accordance with subdivision
(i) of this subparagraph, any of the provisions of Revenue Procedure 62-
21 may be applied to justify a class life claimed on the income tax
return filed for such year or to offset an increase in tax liability for
such year. Unless it meets the reserve ratio test, no class life will be
accepted on audit which (after all other adjustments in tax liability
for such year) results in a reduction (or further reduction) in the
amount of tax liability shown on the income tax return (specified in
subdivision (i)(d) of this subparagraph) for such taxable year, or
results in an amount of loss carryback or carryover to any taxable year,
but if it is justified under Revenue Procedure 62-21 and meets the
reserve ratio test, a class life will be accepted on audit without
regard to the foregoing limitations and, for example, may produce a
refund or credit against tax. For example, if a class life of 9 years is
otherwise justified under Revenue Procedure 62-21 for 1969, but the
taxpayer does not meet the reserve ratio test for 1969 using a test life
of 9 years, a class life of 9 years (or any class life justified under
Revenue Procedure 62-21) will be accepted on audit under Revenue
Procedure 62-21 pursuant to an election in accordance with this
paragraph provided it does not result in the reduction or further
reduction in tax liability or in an amount of loss carryback or
carryover as described in the preceding sentence. On the other hand, for
example, if a class life of 10 years is justified under Revenue
Procedure 62-21 for 1969 and the taxpayer meets the reserve ratio test
for 1969 using a test life of 10 years, a class life of 10 years will be
accepted on audit under Revenue Procedure 62-21 pursuant to an election
in accordance with this paragraph even though it results in a reduction
or further reduction in tax liability or in an amount of loss carryback
or carryover as described above and produces a refund of tax. For
purposes of this section, the term ``audit'' includes examination of
claims for refund or credit against tax.
(iv) Definitions. For purposes of this paragraph, the determination
whether the reserve ratio test is met shall be made in accordance with
that portion of paragraph (b)(2) of this section which is by express
reference therein made applicable to this paragraph. In addition, the
guideline form of the reserve ratio test, as described in Revenue
Procedure 65-13, may be applied. For purposes of this paragraph,
references to Revenue Procedure 62-21 include all modifications,
amendments, and supplements thereto as of January 11, 1971. The terms
``class life'' and ``guideline class'' have the same meaning as in
Revenue Procedure 62-21.
(2) Determination whether Revenue Procedure 62-21 adopted prior to
January 12, 1971--(i) In general. For the purposes of this paragraph, a
taxpayer will be treated as having adopted prior to January 12, 1971,
Revenue Procedure 62-21 for a guideline class for a taxable year ending
before January 1, 1971, only if--
[[Page 438]]
(a) For the guideline class and taxable year, the taxpayer adopted
Revenue Procedure 62-21 by expressly so indicating on the income tax
return filed for such taxable year prior to January 12, 1971;
(b) For the guideline class and taxable year, the taxpayer adopted
Revenue Procedure 62-21 prior to January 12, 1971, by expressly so
indicating in a proceeding before the Internal Revenue Service (such as
upon examination of the income tax return for such taxable year) and
there is reasonable evidence to that effect; or
(c) There is other reasonable evidence that prior to January 12,
1971, the taxpayer adopted Revenue Procedure 62-21 for the guideline
class and taxable year.
If not treated under (b) or (c) of this subdivision as having done so
for the last taxable year ending before January 1, 1971, and if the
taxpayer files his first income tax return for such taxable year after
January 11, 1971, the taxpayer will be treated as having adopted Revenue
Procedure 62-21 prior to January 12, 1971, for a guideline class for
such taxable year if he expressly so indicated on that return, or is
treated under this subparagraph as having adopted Revenue Procedure 62-
21 prior to January 12, 1971, for that guideline class for the
immediately preceding taxable year.
(ii) Examples. The principles of this subparagraph may be
illustrated by the following examples:
Example 1. Taxpayer A, an individual who uses the calendar year as
his taxable year, has property in Group Three, Class 16(a), of Revenue
Procedure 62-21. On A's income tax return for 1968, filed prior to
January 12, 1971, he adopted Revenue Procedure 62-21 for the guideline
class by so indicating under ``Summary of Depreciation'' in the
appropriate schedule of Form 1040 for 1968. Under subdivision (i) (a) of
this subparagraph, A is treated as having adopted Revenue Procedure 62-
21 for the guideline class for 1968 prior to January 12, 1971.
Example 2. Taxpayer B, an individual who uses the calendar year as
his taxable year, has property in Group Two, Class 5, of Revenue
Procedure 62-21. B filed timely income tax returns for 1966 through 1968
but did not adopt Revenue Procedures 62-21 on any of such returns. In
1969 upon audit of B's taxable years 1966 through 1968, B exercised his
option to be examined under the provisions of Revenue Procedure 62-21.
The Revenue Agent's report shows that B was examined under Revenue
Procedure 62-21 for taxable years 1966 through 1968. B will be treated
under subdivision (ii)(b) of this subparagraph as having adopted Revenue
Procedure 62-21 for such years prior to January 12, 1971.
Example 3. The facts are the same as in example (2) except that B
did not upon examination by the Revenue Agent in 1969 exercise his
option to be examined under Revenue Procedure 62-21. B has six accounts
in the guideline class, Nos. 1 through 6. The Revenue Agent proposed to
lengthen the depreciable lives on accounts Nos. 2 and 3 from 8 years to
12 years. In proceedings before the Appellate Division in 1970, B
exercised his option to be examined under the provisions of Revenue
Procedure 62-21. This is shown by correspondence between B and the
Appellate Conferee as well as by other documents in the case before the
Appellate Division. The case was settled on that basis before the
Appellate Division without adjustment of the depreciable lives for B's
accounts Nos. 2 and 3. B will be treated under subdivision (ii) (b) of
this subparagraph as having adopted Revenue Procedure 62-21 for taxable
years 1966 through 1968 prior to January 12, 1971.
Example 4. Corporation X uses the calendar year as its taxable year
and has assets in Group Two, Class 5, of Revenue Procedure 62-21.
Beginning in 1964, corporation X used the guideline life of 10 years as
the depreciable life for all assets in the guideline class. In 1967,
corporation X's taxable years 1964 through 1966 were examined and
corporation X exercised its option to be examined under the provisions
of Revenue Procedure 62-21. Corporation X did not adopt Revenue
Procedure 62-21 on any of its income tax returns, for the years 1964
through 1970. Corporation X has not been examined since 1967, but has
continued to use the guideline life of 10 years for all property in the
guideline class including additions since 1966. Corporation X will be
treated under subdivision (ii) (c) and (d) of this subparagraph as
having adopted Revenue Procedure 62-21 prior to January 12, 1971, for
taxable years 1964 through 1970.
Example 5. Corporation Y uses the calendar year as its taxable year
and has asset in Group Two, Class 5, of Revenue Procedure 62-21. Since
1964, corporation Y has used various depreciable lives, based on the
facts and circumstances, for different accounts in the guideline class.
Corporation Y was examined in 1968 for taxable years 1965 through 1967.
Corporation Y was also examined in 1970 for taxable years 1968 and 1969.
Corporation Y did not exercise its option to be examined under the
provisions of Revenue Procedure 62-21. Corporation Y has not adopted
Revenue Procedure 62-21 on any income tax return. For taxable years 1964
through 1970,
[[Page 439]]
corporation Y's class life (within the meaning of section 4, Part II, of
Revenue Procedure 62-21) was between 12 and 14 years. In August of 1971,
corporation Y filed amended income tax returns for 1968 and 1969, and an
income tax return for 1970, using a depreciable life of 10 years (equal
to the guideline life) for all assets in the guideline class.
Corporation Y will not be treated as having adopted Revenue Procedure
62-21 prior to January 12, 1971.
Example 6. Corporation Z uses the calendar year as its taxable year
and has assets in group 2, class 5, of Revenue Procedure 62-21.
Corporation Z adopted Revenue Procedure 62-21 for this guideline class
by expressly so indicating on its tax return for 1966, which was filed
before January 12, 1971. Corporation Z computed its allowable
depreciation for 1966 as if it adopted Revenue Procedure 62-21 for this
guideline class for its taxable years 1962 through 1965, although it had
earlier filed its tax returns for those years without regard to Revenue
Procedure 62-21. The depreciation thus claimed in 1966 was less than
what would have been allowable if corporation Z first adopted Revenue
Procedure 62-21 in 1966. This was the result of certain accounts
becoming fully depreciated through use of Revenue Procedure 62-21 in
computing depreciation for 1962 through 1965. In addition, in deferred
tax accounting procedures employed before January 12, 1971, for
financial reporting purposes, corporation Z calculated its tax deferrals
on the basis that it had adopted Revenue Procedure 62-21 for the years
1962 through 1965. Corporation Z will be treated under subdivision (i)
(c) of this subparagraph as having adopted Revenue Procedure 62-21 for
taxable years 1962 through 1965 prior to January 12, 1971.
(Sec. 167(m), 85 Stat. 508 (26 U.S.C. 167))
[T.D. 7278, 38 FR 14923, June 7, 1973, as amended by T.D. 7315, 39 FR
20195, June 7, 1974; T.D. 7517, 42 FR 58934, Nov. 14, 1977]
Sec. 1.167(a)-13T Certain elections for intangible property (temporary).
For rules applying the elections under section 13261(g) (2) and (3)
of the Omnibus Budget Reconciliation Act of 1993 to intangible property
described in section 167(f), see Sec. 1.197-1T.
[59 FR 11922, Mar. 15, 1994]
Sec. 1.167(a)-14 Treatment of certain intangible property excluded
from section 197.
(a) Overview. This section provides rules for the amortization of
certain intangibles that are excluded from section 197 (relating to the
amortization of goodwill and certain other intangibles). These excluded
intangibles are specifically described in Sec. 1.197-2(c) (4), (6),
(7), (11), and (13) and include certain computer software and certain
other separately acquired rights, such as rights to receive tangible
property or services, patents and copyrights, certain mortgage servicing
rights, and rights of fixed duration or amount. Intangibles for which an
amortization amount is determined under section 167(f) and intangibles
otherwise excluded from section 197 are amortizable only if they qualify
as property subject to the allowance for depreciation under section
167(a).
(b) Computer software--(1) In general. The amount of the deduction
for computer software described in section 167(f)(1) and Sec. 1.197-
2(c)(4) is determined by amortizing the cost or other basis of the
computer software using the straight line method described in Sec.
1.167(b)-1 (except that its salvage value is treated as zero) and an
amortization period of 36 months beginning on the first day of the month
that the computer software is placed in service. Before determining the
amortization deduction allowable under this paragraph (b), the cost or
other basis of computer software that is section 179 property, as
defined in section 179(d)(1)(A)(ii), must be reduced for any portion of
the basis the taxpayer properly elects to treat as an expense under
section 179. In addition, the cost or other basis of computer software
that is qualified property under section 168(k)(2) or Sec. 1.168(k)-1,
50-percent bonus depreciation property under section 168(k)(4) or Sec.
1.168(k)-1, or qualified New York Liberty Zone property under section
1400L(b) or Sec. 1.1400L(b)-1, must be reduced by the amount of the
additional first year depreciation deduction allowed or allowable,
whichever is greater, under section 168(k) or section 1400L(b) for the
computer software. If costs for developing computer software that the
taxpayer properly elects to defer under section 174(b) result in the
development of property subject to the allowance for depreciation under
section 167, the rules of this paragraph (b) will apply to the
unrecovered costs. In addition, this paragraph (b) applies to the cost
of separately acquired computer software if the cost to acquire
[[Page 440]]
the software is separately stated and the cost is required to be
capitalized under section 263(a).
(2) Exceptions. Paragraph (b)(1) of this section does not apply to
the cost of computer software properly and consistently taken into
account under Sec. 1.162-11. The cost of acquiring an interest in
computer software that is included, without being separately stated, in
the cost of the hardware or other tangible property is treated as part
of the cost of the hardware or other tangible property that is
capitalized and depreciated under other applicable sections of the
Internal Revenue Code.
(3) Additional rules. Rules similar to those in Sec. 1.197-2
(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of
amortization deductions and the treatment of contingent amounts) apply
for purposes of this paragraph (b).
(c) Certain interests or rights not acquired as part of a purchase
of a trade or business--(1) Certain rights to receive tangible property
or services. The amount of the deduction for a right (other than a right
acquired as part of a purchase of a trade or business) to receive
tangible property or services under a contract or from a governmental
unit (as specified in section 167(f)(2) and Sec. 1.197-2(c)(6)) is
determined as follows:
(i) Amortization of fixed amounts. The basis of a right to receive a
fixed amount of tangible property or services is amortized for each
taxable year by multiplying the basis of the right by a fraction, the
numerator of which is the amount of tangible property or services
received during the taxable year and the denominator of which is the
total amount of tangible property or services received or to be received
under the terms of the contract or governmental grant. For example, if a
taxpayer acquires a favorable contract right to receive a fixed amount
of raw materials during an unspecified period, the taxpayer must
amortize the cost of acquiring the contract right by multiplying the
total cost by a fraction, the numerator of which is the amount of raw
materials received under the contract during the taxable year and the
denominator of which is the total amount of raw materials received or to
be received under the contract.
(ii) Amortization of unspecified amount over fixed period. The cost
or other basis of a right to receive an unspecified amount of tangible
property or services over a fixed period is amortized ratably over the
period of the right. (See paragraph (c)(3) of this section regarding
renewals).
(iii) Amortization in other cases. [Reserved]
(2) Rights of fixed duration or amount. The amount of the deduction
for a right (other than a right acquired as part of a purchase of a
trade or business) of fixed duration or amount received under a contract
or granted by a governmental unit (specified in section 167(f)(2) and
Sec. 1.197-2(c)(13)) and not covered by paragraph (c)(1) of this
section is determined as follows:
(i) Rights to a fixed amount. The basis of a right to a fixed amount
is amortized for each taxable year by multiplying the basis by a
fraction, the numerator of which is the amount received during the
taxable year and the denominator of which is the total amount received
or to be received under the terms of the contract or governmental grant.
(ii) Rights to an unspecified amount over fixed duration of less
than 15 years. The basis of a right to an unspecified amount over a
fixed duration of less than 15 years is amortized ratably over the
period of the right.
(3) Application of renewals. (i) For purposes of paragraphs (c) (1)
and (2) of this section, the duration of a right under a contract (or
granted by a governmental unit) includes any renewal period if, based on
all of the facts and circumstances in existence at any time during the
taxable year in which the right is acquired, the facts clearly indicate
a reasonable expectancy of renewal.
(ii) The mere fact that a taxpayer will have the opportunity to
renew a contract right or other right on the same terms as are available
to others, in a competitive auction or similar process that is designed
to reflect fair market value and in which the taxpayer is not
contractually advantaged, will generally not be taken into account in
determining the duration of such right provided that the bidding
produces a fair market value price
[[Page 441]]
comparable to the price that would be obtained if the rights were
purchased immediately after renewal from a person (other than the person
granting the renewal) in an arm's-length transaction.
(iii) The cost of a renewal not included in the terms of the
contract or governmental grant is treated as the acquisition of a
separate intangible asset.
(4) Patents and copyrights. If the purchase price of an interest
(other than an interest acquired as part of a purchase of a trade or
business) in a patent or copyright described in section 167(f)(2) and
Sec. 1.197-2(c)(7) is payable on at least an annual basis as either a
fixed amount per use or a fixed percentage of the revenue derived from
the use of the patent or copyright, the depreciation deduction for a
taxable year is equal to the amount of the purchase price paid or
incurred during the year. Otherwise, the basis of such patent or
copyright (or an interest therein) is depreciated either ratably over
its remaining useful life or under section 167(g) (income forecast
method). If a patent or copyright becomes valueless in any year before
its legal expiration, the adjusted basis may be deducted in that year.
(5) Additional rules. The period of amortization under paragraphs
(c) (1) through (4) of this section begins when the intangible is placed
in service, and rules similar to those in Sec. 1.197-2(f)(2) apply for
purposes of this paragraph (c).
(d) Mortgage servicing rights--(1) In general. The amount of the
deduction for mortgage servicing rights described in section 167(f)(3)
and Sec. 1.197-2(c)(11) is determined by using the straight line method
described in Sec. 1.167(b)-1 (except that the salvage value is treated
as zero) and an amortization period of 108 months beginning on the first
day of the month that the rights are placed in service. Mortgage
servicing rights are not depreciable to the extent the rights are
stripped coupons under section 1286.
(2) Treatment of rights acquired as a pool--(i) In general. Except
as provided in paragraph (d)(2)(ii) of this section, all mortgage
servicing rights acquired in the same transaction or in a series of
related transactions are treated as a single asset (the pool) for
purposes of determining the depreciation deduction under this paragraph
(d) and any gain or loss from the sale, exchange, or other disposition
of the rights. Thus, if some (but not all) of the rights in a pool
become worthless as a result of prepayments, no loss is recognized by
reason of the prepayment and the adjusted basis of the pool is not
affected by the unrecognized loss. Similarly, any amount realized from
the sale or exchange of some (but not all) of the mortgage servicing
rights is included in income and the adjusted basis of the pool is not
affected by the realization.
(ii) Multiple accounts. If the taxpayer establishes multiple
accounts within a pool at the time of its acquisition, gain or loss is
recognized on the sale or exchange of all mortgage servicing rights
within any such account.
(3) Additional rules. Rules similar to those in Sec. 1.197-
2(f)(1)(iii), (f)(1)(iv), and (f)(2) (relating to the computation of
amortization deductions and the treatment of contingent amounts) apply
for purposes of this paragraph (d).
(e) Effective dates--(1) In general. This section applies to
property acquired after January 25, 2000, except that Sec. 1.167(a)-
14(c)(2) (depreciation of the cost of certain separately acquired
rights) and so much of Sec. 1.167(a)-14(c)(3) as relates to Sec.
1.167(a)-14(c)(2) apply to property acquired after August 10, 1993 (or
July 25, 1991, if a valid retroactive election has been made under Sec.
1.197-1T).
(2) Change in method of accounting. See Sec. 1.197-2(l)(4) for
rules relating to changes in method of accounting for property to which
Sec. 1.167(a)-14 applies. However, see Sec. 1.168(k)-1(g)(4) or
1.1400L(b)-1(g)(4) for rules relating to changes in method of accounting
for computer software to which the third sentence in Sec. 1.167(a)-
14(b)(1) applies.
(3) Qualified property, 50-percent bonus depreciation property,
qualified New York Liberty Zone property, or section 179 property. This
section also applies to computer software that is qualified property
under section 168(k)(2) or qualified New York Liberty Zone property
under section 1400L(b) acquired by a taxpayer after September 10, 2001,
and to computer software that is 50-
[[Page 442]]
percent bonus depreciation property under section 168(k)(4) acquired by
a taxpayer after May 5, 2003. This section also applies to computer
software that is section 179 property placed in service by a taxpayer in
a taxable year beginning after 2002 and before 2010.
[T.D. 8867, 65 FR 3825, Jan. 25, 2000, as amended by T.D. 9091, 68 FR
52990, Sept. 8, 2003; T.D. 9283, 71 FR 51737, Aug. 31, 2006]
Sec. 1.167(b)-0 Methods of computing depreciation.
(a) In general. Any reasonable and consistently applied method of
computing depreciation may be used or continued in use under section
167. Regardless of the method used in computing depreciation, deductions
for depreciation shall not exceed such amounts as may be necessary to
recover the unrecovered cost or other basis less salvage during the
remaining useful life of the property. The reasonableness of any claim
for depreciation shall be determined upon the basis of conditions known
to exist at the end of the period for which the return is made. It is
the responsibility of the taxpayer to establish the reasonableness of
the deduction for depreciation claimed. Generally, depreciation
deductions so claimed will be changed only where there is a clear and
convincing basis for a change.
(b) Certain methods. Methods previously found adequate to produce a
reasonable allowance under the Internal Revenue Code of 1939 or prior
revenue laws will, if used consistently by the taxpayer, continue to be
acceptable under section 167(a). Examples of such methods which continue
to be acceptable are the straight line method, the declining balance
method with the rate limited to 150 percent of the applicable straight
line rate, and under appropriate circumstances, the unit of production
method. The methods described in section 167(b) and Sec. Sec. 1.167(b)-
1, 1.167(b)-2, 1.167(b)-3, and 1.167(b)-4 shall be deemed to produce a
reasonable allowance for depreciation except as limited under section
167(c) and Sec. 1.167(c)-1. See also Sec. 1.167(e)-1 for rules
relating to change in method of computing depreciation.
(c) Application of methods. In the case of item accounts, any method
which results in a reasonable allowance for depreciation may be selected
for each item of property, but such method must thereafter be applied
consistently to that particular item. In the case of group, classified,
or composite accounts, any method may be selected for each account. Such
method must be applied to that particular account consistently
thereafter but need not necessarily be applied to acquisitions of
similar property in the same or subsequent years, provided such
acquisitions are set up in separate accounts. See, however, Sec.
1.167(e)-1 and section 446 and the regulations thereunder, for rules
relating to changes in the method of computing depreciation, and Sec.
1.167(c)-1 for restriction on the use of certain methods. See also Sec.
1.167(a)-7 for definition of account.
Sec. 1.167(b)-1 Straight line method.
(a) In general. Under the straight line method the cost or other
basis of the property less its estimated salvage value is deductible in
equal annual amounts over the period of the estimated useful life of the
property. The allowance for depreciation for the taxable year is
determined by dividing the adjusted basis of the property at the
beginning of the taxable year, less salvage value, by the remaining
useful life of the property at such time. For convenience, the allowance
so determined may be reduced to a percentage or fraction. The straight
line method may be used in determining a reasonable allowance for
depreciation for any property which is subject to depreciation under
section 167 and it shall be used in all cases where the taxpayer has not
adopted a different acceptable method with respect to such property.
(b) Illustrations. The straight line method is illustrated by the
following examples:
Example 1. Under the straight line method items may be depreciated
separately:
------------------------------------------------------------------------
Cost or Depreciation
other Useful allowable
Year and item basis life ---------------------
less (years)
salaries 1954 1955 1956
------------------------------------------------------------------------
1954:
Asset A...................... $1,600 4 \1\ $400 $400
$200
[[Page 443]]
Asset B...................... 12,000 40 \1\ 300 300
150
------------------------------------------------------------------------
\1\ In this example it is assumed that the assets were placed in service
on July 1, 1954.
Example 2. In group, classified, or composite accounting, a number
of assets with the same or different useful lives may be combined into
one account, and a single rate of depreciation, i.e., the group,
classified, or composite rate used for the entire account. In the case
of group accounts, i.e., accounts containing assets which are similar in
kind and which have approximately the same estimated useful lives, the
group rate is determined from the average of the useful lives of the
assets. In the case of classified or composite accounts, the classified
or composite rate is generally computed by determining the amount of one
year's depreciation for each item or each group of similar items, and by
dividing the total depreciation thus obtained by the total cost or other
basis of the assets. The average rate so obtained is to be used as long
as subsequent additions, retirements, or replacements do not
substantially alter the relative proportions of different types of
assets in the account. An example of the computation of a classified or
composite rate follows:
------------------------------------------------------------------------
Estimated useful life
Cost or other basis (years) Annual depreciation
------------------------------------------------------------------------
$10,000 5 $2,000
10,000 15 667
-------------------------
20,000 ...................... 2,667
------------------------------------------------------------------------
Average rate is 13.33 percent ($2,667/$20,000) unadjusted for salvage.
Assuming the estimated salvage value is 10 percent of the cost or other
basis, the rate adjusted for salvage will be 13.33 percent minus 10
percent of 13.33 percent (13.33%-1.33%), or 12 percent.
Example 3. The use of the straight line method for group,
classified, or composite accounts is illustrated by the following
example: A taxpayer filing his returns on a calendar year basis
maintains an asset account for which a group rate of 20 percent has been
determined, before adjustment for salvage. Estimated salvage is
determined to be 6\2/3\ percent, resulting in an adjusted rate of 18.67
percent. During the years illustrated, the initial investment,
additions, retirements, and salvage recoveries, which were determined
not to change the composition of the group sufficiently to require a
change in rate, were assumed to have been made as follows:
1954--Initial investment of $12,000.
1957--Retirement $2,000, salvage realized $200.
1958--Retirement $2,000, salvage realized $200.
1959--Retirement $4,000, salvage realized $400.
1959--Additions $10,000.
1960--Retirement $2,000, no salvage realized.
1961--Retirement $2,000, no salvage realized.
Depreciable Asset Account and Depreciation Computation on Average Balances
----------------------------------------------------------------------------------------------------------------
Asset Asset
Year balance Current Current balance Average Rate Allowable
Jan. 1 additions retirements Dec. 31 balance (percent) depreciation
----------------------------------------------------------------------------------------------------------------
1954............................. ........ $12,000 ........... $12,000 $6,000 18.67 $1,120
1955............................. $12,000 ......... ........... 12,000 12,000 18.67 2,240
1956............................. 12,000 ......... ........... 12,000 12,000 18.67 2,240
1957............................. 12,000 ......... $2,000 10,000 11,000 18.67 2,054
1958............................. 10,000 ......... 2,000 8,000 9,000 18.67 1,680
1959............................. 8,000 10,000 4,000 14,000 11,000 18.67 2,054
1960............................. 14,000 ......... 2,000 12,000 13,000 18.67 2,427
1961............................. 12,000 ......... 2,000 10,000 11,000 18.67 2,054
----------------------------------------------------------------------------------------------------------------
Corresponding Depreciation Reserve Account
----------------------------------------------------------------------------------------------------------------
Depreciation
Year Depreciation Depreciation Current Salvage reserve Dec.
reserve Jan. 1 allowable retirements realized 31
----------------------------------------------------------------------------------------------------------------
1954............................ .............. $1,120 .............. .............. $1,120
1955............................ $1,120 2,240 .............. .............. 3,360
1956............................ 3,360 2,240 .............. .............. 5,600
1957............................ 5,600 2,054 $2,000 $200 5,854
1958............................ 5,854 1,680 2,000 200 5,734
1959............................ 5,734 2,054 4,000 400 4,188
1960............................ 4,188 2,427 2,000 .............. 4,615
[[Page 444]]
1961............................ 4,615 2,054 2,000 .............. 4,669
----------------------------------------------------------------------------------------------------------------
Sec. 1.167(b)-2 Declining balance method.
(a) Application of method. Under the declining balance method a
uniform rate is applied each year to the unrecovered cost or other basis
of the property. The unrecovered cost or other basis is the basis
provided by section 167(g), adjusted for depreciation previously allowed
or allowable, and for all other adjustments provided by section 1016 and
other applicable provisions of law. The declining balance rate may be
determined without resort to formula. Such rate determined under section
167(b)(2) shall not exceed twice the appropriate straight line rate
computed without adjustment for salvage. While salvage is not taken into
account in determining the annual allowances under this method, in no
event shall an asset (or an account) be depreciated below a reasonable
salvage value. However, see section 167(f) and Sec. 1.167(f)-1 for
rules which permit a reduction in the amount of salvage value to be
taken into account for certain personal property acquired after October
16, 1962. Also, see section 167(c) and Sec. 1.167(c)-1 for restrictions
on the use of the declining balance method.
(b) Illustrations. The declining balance method is illustrated by
the following examples:
Example 1. A new asset having an estimated useful life of 20 years
was purchased on January 1, 1954, for $1,000. The normal straight line
rate (without adjustment for salvage) is 5 percent, and the declining
balance rate at twice the normal straight line rate is 10 percent. The
annual depreciation allowances for 1954, 1955, and 1956 are as follows:
------------------------------------------------------------------------
Declining
balance Depreciation
Year Basis rate allowance
(percent)
------------------------------------------------------------------------
1954.............................. $1,000 10 $100
1955.............................. 900 10 90
1956.............................. 810 10 81
------------------------------------------------------------------------
Example 2. A taxpayer filing his returns on a calendar year basis
maintains a group account to which a 5 year life and a 40 percent
declining balance rate are applicable. Original investment, additions,
retirements, and salvage recoveries are the same as those set forth in
example (3) of paragraph (b) of Sec. 1.167(b)-1. Although salvage value
is not taken into consideration in computing a declining balance rate,
it must be recognized and accounted for when assets are retired.
Depreciable Asset Account and Depreciation Computation Using Average Asset and Reserve Balances
--------------------------------------------------------------------------------------------------------------------------------------------------------
Average
Asset Current Current Asset reserve Net Rate Allowable
Year balance additions retirements balance Average before depreciable (pct.) depreciation
Jan. 1 Dec. 31 depreciation balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954........................................... ........ $12,000 ........... $12,000 $6,000 ............ $6,000 40 $2,400
1955........................................... $12,000 ......... ........... 12,000 12,000 $2,400 9,600 40 3,840
1956........................................... 12,000 ......... ........... 12,000 12,000 6,240 5,760 40 2,304
1957........................................... 12,000 ......... $2,000 10,000 11,000 7,644 3,356 40 1,342
1958........................................... 10,000 ......... 2,000 8,000 9,000 7,186 1,814 40 726
1959........................................... 8,000 10,000 4,000 14,000 11,000 5,212 5,788 40 2,315
1960........................................... 14,000 ......... 2,000 12,000 13,000 4,727 8,273 40 3,309
1961........................................... 12,000 ......... 2,000 10,000 11,000 6,036 4,964 40 1,986
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 445]]
Depreciation Reserve
--------------------------------------------------------------------------------------------------------------------------------------------------------
Average
Reserve Current Salvage Reserve Dec. reserve Allowable Reserve Dec.
Year Jan. 1 retirements realized 31, before before depreciation 31, after
depreciation depreciation depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954........................................................... ........ ........... ........ ............ ............ $2,400 $2,400
1955........................................................... $2,400 ........... ........ $2,400 $2,400 3,840 6,240
1956........................................................... 6,240 ........... ........ 6,240 6,240 2,304 8,544
1957........................................................... 8,544 $2,000 $200 6,744 7,644 1,342 8,086
1958........................................................... 8,086 2,000 200 6,286 7,186 726 7,012
1959........................................................... 7,012 4,000 400 3,412 5,212 2,315 5,727
1960........................................................... 5,727 2,000 ........ 3,727 4,727 3,309 7,036
1961........................................................... 7,036 2,000 ........ 5,036 6,036 1,986 7,022
--------------------------------------------------------------------------------------------------------------------------------------------------------
Where separate depreciation accounts are maintained by year of
acquisition and there is an unrecovered balance at the time of the last
retirement, such unrecovered balance may be deducted as part of the
depreciation allowance for the year of such retirement. Thus, if the
taxpayer had kept separate depreciation accounts by year of acquisition
and all the retirements shown in the example above were from 1954
acquisitions, depreciation would be computed on the 1954 and 1959
acquisitions as follows:
1954 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Asset Asset Avg. reserve Net
Year balance Acquisitions Current balance Average before depreciable Rate Allowable
Jan. 1 retirements Dec. 31 balance depreciation balance (percent) depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954....................................... ........ $12,000 ........... $12,000 $6,000 ............ $6,000 40 $2,400
1955....................................... $12,000 ............ ........... 12,000 12,000 $2,400 9,600 40 3,840
1956....................................... 12,000 ............ ........... 12,000 12,000 6,240 5,760 40 2,304
1957....................................... 12,000 ............ $2,000 10,000 11,000 7,644 3,356 40 1,342
1958....................................... 10,000 ............ 2,000 8,000 9,000 7,186 1,814 40 726
1959....................................... 8,000 ............ 4,000 4,000 6,000 5,212 788 40 315
1960....................................... 4,000 ............ 2,000 2,000 3,000 2,727 273 40 109
1961....................................... 2,000 ............ 2,000 ........ 1,000 836 164 ......... \1\ 164
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Balance allowable as depreciation in the year of retirement of the last survivor of the 1954 acquisitions.
Depreciation Reserve for 1954 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Average
Reserve Current Salvage Reserve Dec. reserve Allowable Reserve Dec.
Year Jan. 1 retirements realized 31, before before depreciation 31, after
depreciation depreciation depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1954........................................................... ........ ........... ........ ............ ............ $2,400 $2,400
1955........................................................... $2,400 ........... ........ $2,400 $2,400 3,840 6,240
1956........................................................... 6,240 ........... ........ 6,240 6,240 2,304 8,544
1957........................................................... 8,544 $2,000 $200 6,744 7,644 1,342 8,086
1958........................................................... 8,086 2,000 200 6,286 7,186 726 7,012
1959........................................................... 7,012 4,000 400 3,412 5,212 315 3,727
1960........................................................... 3,727 2,000 ........ 1,727 2,727 109 1,836
1961........................................................... 1,836 2,000 ........ (164) 836 164 ............
--------------------------------------------------------------------------------------------------------------------------------------------------------
1959 Acquisitions
--------------------------------------------------------------------------------------------------------------------------------------------------------
Asset Asset Reserve Dec. Net Reserve Dec.
Year balance Acquisition balance Avg. 31, before depreciable Rate Allowable 31, after
Jan. 1 Dec. 31 balance depreciation balance percent depreciation depreciation
--------------------------------------------------------------------------------------------------------------------------------------------------------
1959........................................ ........ $10,000 $10,000 $5,000 None $5,000 40 $2,000 $2,000
1960........................................ $10,000 ........... 10,000 10,000 $2,000 8,000 40 3,200 5,200
1961........................................ 10,000 ........... 10,000 10,000 5,200 4,800 40 1,920 7,120
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 446]]
In the above example, the allowable depreciation on the 1954
acquisitions totals $11,200. This amount when increased by salvage
realized in the amount of $800, equals the entire cost or other basis of
the 1954 acquisitions ($12,000).
(c) Change in estimated useful life. In the declining balance method
when a change is justified in the useful life estimated for an account,
subsequent computations shall be made as though the revised useful life
had been originally estimated. For example, assume that an account has
an estimated useful life of ten years and that a declining balance rate
of 20 percent is applicable. If, at the end of the sixth year, it is
determined that the remaining useful life of the account is six years,
computations shall be made as though the estimated useful life was
originally determined as twelve years. Accordingly, the applicable
depreciation rate will be 16\2/3\ percent. This rate is thereafter
applied to the unrecovered cost or other basis.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6712, 29 FR
3653, Mar. 24, 1964]
Sec. 1.167(b)-3 Sum of the years-digits method.
(a) Applied to a single asset--(1) General rule. Under the sum of
the years-digits method annual allowances for depreciation are computed
by applying changing fractions to the cost or other basis of the
property reduced by estimated salvage. The numerator of the fraction
changes each year to a number which corresponds to the remaining useful
life of the asset (including the year for which the allowance is being
computed), and the denominator which remains constant is the sum of all
the years digits corresponding to the estimated useful life of the
asset. See section 167(c) and Sec. 1.167(c)-1 for restrictions on the
use of the sum of the years-digits method.
(i) Illustrations. Computation of depreciation allowances on a
single asset under the sum of the years-digits method is illustrated by
the following examples:
Example 1. A new asset having an estimated useful life of five years
was acquired on January 1, 1954, for $1,750. The estimated salvage is
$250. For a taxpayer filing his returns on a calendar year basis, the
annual depreciation allowances are as follows:
----------------------------------------------------------------------------------------------------------------
Cost or
other
Year basis Fraction\1\ Allowable Depreciation
less depreciation reserve
salvage
----------------------------------------------------------------------------------------------------------------
1954......................................................... $1,500 \5/15\ $500 $500
1955......................................................... 1,500 \4/15\ 400 900
1956......................................................... 1,500 \3/15\ 300 1,200
1957......................................................... 1,500 \2/15\ 200 1,400
1958......................................................... 1,500 \1/15\ 100 1,500
--------------------------------------------------
Unrecovered value (salvage).................................. ........ ........... ............ $250
----------------------------------------------------------------------------------------------------------------
\1\ The denominator of the fraction is the sum of the digits representing the years of useful life, i.e., 5, 4,
3, 2, and 1, or 15.
Example 2. Assume in connection with an asset acquired in 1954 that
three-fourths of a year's depreciation is allowable in that year. The
following illustrates a reasonable method of allocating depreciation:
----------------------------------------------------------------------------------------------------------------
Depreciation Allowable depreciation
for 12 --------------------------------
months 1954 1955 1956
----------------------------------------------------------------------------------------------------------------
1st year......................................................... $500 (\3/4\) (\1/4\)
$375 $125
2d year.......................................................... 400 ......... (\3/4\) (\1/4\)
300 $100
3d year.......................................................... 300 ......... ......... (\3/4\)
225
----------------------------------------------
Total.......................................................... ............ 375 425 325
----------------------------------------------------------------------------------------------------------------
(ii) Change in useful life. Where in the case of a single asset, a
change is justified in the useful life, subsequent computations shall be
made as though the remaining useful life at the beginning of the taxable
year of change were the useful life of a new asset acquired at such time
and with a basis equal to the unrecovered cost or other basis of the
asset at that time. For example, assume that a new asset with an
estimated useful life of ten years is purchased in 1954. At the time of
making out his return for 1959, the taxpayer finds that the asset has a
remaining useful life of seven years from January 1, 1959. Depreciation
for 1959 should then be computed as though 1959 were the first year of
the life of an asset estimated to have a useful life of seven years, and
the allowance for 1959 would be \7/28\ of the unrecovered cost or other
basis of the asset after adjustment for salvage.
(2) Remaining life--(i) Application. Under the sum of the years-
digits method, annual allowances for depreciation may also be computed
by applying changing fractions to the unrecovered cost or other basis of
the asset
[[Page 447]]
reduced by estimated salvage. The numerator of the fraction changes each
year to a number which corresponds to the remaining useful life of the
asset (including the year for which the allowance is being computed),
and the denominator changes each year to a number which represents the
sum of the digits corresponding to the years of estimated remaining
useful life of the asset. For decimal equivalents of such fractions, see
Table I of subdivision (ii) of this subparagraph. For example, a new
asset with an estimated useful life of 10 years is purchased January 1,
1954, for $6,000. Assuming a salvage value of $500, the depreciation
allowance for 1954 is $1,000 ($5,500x0.1818, the applicable rate from
Table I). For 1955, the unrecovered balance is $4,500, and the remaining
life is 9 years. The depreciation allowance for 1955 would then be $900
($4,500x0.2000, the applicable rate from Table I).
(ii) Table I. This table shows decimal equivalents of sum of the
years-digits fractions corresponding to remaining lives from 1 to 100
years.
Table I--Decimal Equivalents for Use of Sum of the Years-Digits Method,
Based on Remaining Life
------------------------------------------------------------------------
Decimal
Remaining life (years) equivalent
------------------------------------------------------------------------
100.0....................................................... 0.0198
99.9........................................................ .0198
99.8........................................................ .0198
99.7........................................................ .0199
99.6........................................................ .0199
99.5........................................................ .0199
99.4........................................................ .0199
99.3........................................................ .0199
99.2........................................................ .0200
99.1........................................................ .0200
99.0........................................................ .0200
98.9........................................................ .0200
98.8........................................................ .0200
98.7........................................................ .0201
98.6........................................................ .0201
98.5........................................................ .0201
98.4........................................................ .0201
98.3........................................................ .0201
98.2........................................................ .0202
98.1........................................................ .0202
98.0........................................................ .0202
97.9........................................................ .0202
97.8........................................................ .0202
97.7........................................................ .0203
97.6........................................................ .0203
97.5........................................................ .0203
97.4........................................................ .0203
97.3........................................................ .0203
97.2........................................................ .0204
97.1........................................................ .0204
97.0........................................................ .0204
96.9........................................................ .0204
96.8........................................................ .0204
96.7........................................................ .0205
96.6........................................................ .0205
96.5........................................................ .0205
96.4........................................................ .0205
96.3........................................................ .0206
96.2........................................................ .0206
96.1........................................................ .0206
96.0........................................................ .0206
95.9........................................................ .0206
95.8........................................................ .0207
95.7........................................................ .0207
95.6........................................................ .0207
95.5........................................................ .0207
95.4........................................................ .0207
95.3........................................................ .0208
95.2........................................................ .0208
95.1........................................................ .0208
95.0........................................................ .0208
94.9........................................................ .0209
94.8........................................................ .0209
94.7........................................................ .0209
94.6........................................................ .0209
94.5........................................................ .0209
94.4........................................................ .0210
94.3........................................................ .0210
94.2........................................................ .0210
94.1........................................................ .0210
94.0........................................................ .0211
93.9........................................................ .0211
93.8........................................................ .0211
93.7........................................................ .0211
93.6........................................................ .0211
93.5........................................................ .0212
93.4........................................................ .0212
93.3........................................................ .0212
93.2........................................................ .0212
93.1........................................................ .0213
93.0........................................................ .0213
92.9........................................................ .0213
92.8........................................................ .0213
92.7........................................................ .0213
92.6........................................................ .0214
92.5........................................................ .0214
92.4........................................................ .0214
92.3........................................................ .0214
92.2........................................................ .0215
92.1........................................................ .0215
92.0........................................................ .0215
91.9........................................................ .0215
91.8........................................................ .0216
91.7........................................................ .0216
91.6........................................................ .0216
91.5........................................................ .0216
91.4........................................................ .0216
91.3........................................................ .0217
91.2........................................................ .0217
91.1........................................................ .0217
91.0........................................................ .0217
90.9........................................................ .0218
90.8........................................................ .0218
90.7........................................................ .0218
90.6........................................................ .0218
90.5........................................................ .0219
90.4........................................................ .0219
90.3........................................................ .0219
90.2........................................................ .0219
[[Page 448]]
90.1........................................................ .0220
90.0........................................................ .0220
89.9........................................................ .0220
89.8........................................................ .0220
89.7........................................................ .0221
89.6........................................................ .0221
89.5........................................................ .0221
89.4........................................................ .0221
89.3........................................................ .0221
89.2........................................................ .0222
89.1........................................................ .0222
89.0........................................................ .0222
88.9........................................................ .0222
88.8........................................................ .0223
88.7........................................................ .0223
88.6........................................................ .0223
88.5........................................................ .0223
88.4........................................................ .0224
88.3........................................................ .0224
88.2........................................................ .0224
88.1........................................................ .0224
88.0........................................................ .0225
87.9........................................................ .0225
87.8........................................................ .0225
87.7........................................................ .0225
87.6........................................................ .0226
87.5........................................................ .0226
87.4........................................................ .0226
87.3........................................................ .0226
87.2........................................................ .0227
87.1........................................................ .0227
87.0........................................................ .0227
86.9........................................................ .0228
86.8........................................................ .0228
86.7........................................................ .0228
86.6........................................................ .0228
86.5........................................................ .0229
86.4........................................................ .0229
86.3........................................................ .0229
86.2........................................................ .0229
86.1........................................................ .0230
86.0........................................................ .0230
85.9........................................................ .0230
85.8........................................................ .0230
85.7........................................................ .0231
85.6........................................................ .0231
85.5........................................................ .0231
85.4........................................................ .0231
85.3........................................................ .0232
85.2........................................................ .0232
85.1........................................................ .0232
85.0........................................................ .0233
84.9........................................................ .0233
84.8........................................................ .0233
84.7........................................................ .0233
84.6........................................................ .0234
84.5........................................................ .0234
84.4........................................................ .0234
84.3........................................................ .0234
84.2........................................................ .0235
84.1........................................................ .0235
84.0........................................................ .0235
83.9........................................................ .0236
83.8........................................................ .0236
83.7........................................................ .0236
83.6........................................................ .0236
83.5........................................................ .0237
83.4........................................................ .0237
83.3........................................................ .0237
83.2........................................................ .0238
83.1........................................................ .0238
83.0........................................................ .0238
82.9........................................................ .0238
82.8........................................................ .0239
82.7........................................................ .0239
82.6........................................................ .0239
82.5........................................................ .0240
82.4........................................................ .0240
82.3........................................................ .0240
82.2........................................................ .0240
82.1........................................................ .0241
82.0........................................................ .0241
81.9........................................................ .0241
81.8........................................................ .0242
81.7........................................................ .0242
81.6........................................................ .0242
81.5........................................................ .0242
81.4........................................................ .0243
81.3........................................................ .0243
81.2........................................................ .0243
81.1........................................................ .0244
81.0........................................................ .0244
80.9........................................................ .0244
80.8........................................................ .0244
80.7........................................................ .0245
80.6........................................................ .0245
80.5........................................................ .0245
80.4........................................................ .0246
80.3........................................................ .0246
80.2........................................................ .0246
80.1........................................................ .0247
80.0........................................................ .0247
79.9........................................................ .0247
79.8........................................................ .0248
79.7........................................................ .0248
79.6........................................................ .0248
79.5........................................................ .0248
79.4........................................................ .0249
79.3........................................................ .0249
79.2........................................................ .0249
79.1........................................................ .0250
79.0........................................................ .0250
78.9........................................................ .0250
78.8........................................................ .0251
78.7........................................................ .0251
78.6........................................................ .0251
78.5........................................................ .0252
78.4........................................................ .0252
78.3........................................................ .0252
78.2........................................................ .0253
78.1........................................................ .0253
78.0........................................................ .0253
77.9........................................................ .0253
77.8........................................................ .0254
77.7........................................................ .0254
77.6........................................................ .0254
77.5........................................................ .0255
77.4........................................................ .0255
77.3........................................................ .0255
77.2........................................................ .0256
77.1........................................................ .0256
77.0........................................................ .0256
76.9........................................................ .0257
76.8........................................................ .0257
76.7........................................................ .0257
76.6........................................................ .0258
[[Page 449]]
76.5........................................................ .0258
76.4........................................................ .0258
76.3........................................................ .0259
76.2........................................................ .0259
76.1........................................................ .0259
76.0........................................................ .0260
75.9........................................................ .0260
75.8........................................................ .0260
75.7........................................................ .0261
75.6........................................................ .0261
75.5........................................................ .0261
75.4........................................................ .0262
75.3........................................................ .0262
75.2........................................................ .0262
75.1........................................................ .0263
75.0........................................................ .0263
74.9........................................................ .0264
74.8........................................................ .0264
74.7........................................................ .0264
74.6........................................................ .0265
74.5........................................................ .0265
74.4........................................................ .0265
74.3........................................................ .0266
74.2........................................................ .0266
74.1........................................................ .0266
74.0........................................................ .0267
73.9........................................................ .0267
73.8........................................................ .0267
73.7........................................................ .0268
73.6........................................................ .0268
73.5........................................................ .0268
73.4........................................................ .0269
73.3........................................................ .0269
73.2........................................................ .0270
73.1........................................................ .0270
73.0........................................................ .0270
72.9........................................................ .0271
72.8........................................................ .0271
72.7........................................................ .0271
72.6........................................................ .0272
72.5........................................................ .0272
72.4........................................................ .0272
72.3........................................................ .0273
72.2........................................................ .0273
72.1........................................................ .0274
72.0........................................................ .0274
71.9........................................................ .0274
71.8........................................................ .0275
71.7........................................................ .0275
71.6........................................................ .0275
71.5........................................................ .0276
71.4........................................................ .0276
71.3........................................................ .0277
71.2........................................................ .0277
71.1........................................................ .0277
71.0........................................................ .0278
70.9........................................................ .0278
70.8........................................................ .0279
70.7........................................................ .0279
70.6........................................................ .0279
70.5........................................................ .0280
70.4........................................................ .0280
70.3........................................................ .0280
70.2........................................................ .0281
70.1........................................................ .0281
70.0........................................................ .0282
69.9........................................................ .0282
69.8........................................................ .0282
69.7........................................................ .0283
69.6........................................................ .0283
69.5........................................................ .0284
69.4........................................................ .0284
69.3........................................................ .0284
69.2........................................................ .0285
69.1........................................................ .0285
69.0........................................................ .0286
68.9........................................................ .0286
68.8........................................................ .0287
68.7........................................................ .0287
68.6........................................................ .0287
68.5........................................................ .0288
68.4........................................................ .0288
68.3........................................................ .0289
68.2........................................................ .0289
68.1........................................................ .0289
68.0........................................................ .0290
67.9........................................................ .0290
67.8........................................................ .0291
67.7........................................................ .0291
67.6........................................................ .0292
67.5........................................................ .0292
67.4........................................................ .0292
67.3........................................................ .0293
67.2........................................................ .0293
67.1........................................................ .0294
67.0........................................................ .0294
66.9........................................................ .0295
66.8........................................................ .0295
66.7........................................................ .0295
66.6........................................................ .0296
66.5........................................................ .0296
66.4........................................................ .0297
66.3........................................................ .0297
66.2........................................................ .0298
66.1........................................................ .0298
66.0........................................................ .0299
65.9........................................................ .0299
65.8........................................................ .0299
65.7........................................................ .0300
65.6........................................................ .0300
65.5........................................................ .0301
65.4........................................................ .0301
65.3........................................................ .0302
65.2........................................................ .0302
65.1........................................................ .0303
65.0........................................................ .0303
64.9........................................................ .0303
64.8........................................................ .0304
64.7........................................................ .0304
64.6........................................................ .0305
64.5........................................................ .0305
64.4........................................................ .0306
64.3........................................................ .0306
64.2........................................................ .0307
64.1........................................................ .0307
64.0........................................................ .0308
63.9........................................................ .0308
63.8........................................................ .0309
63.7........................................................ .0309
63.6........................................................ .0310
63.5........................................................ .0310
63.4........................................................ .0311
63.3........................................................ .0311
63.2........................................................ .0312
63.1........................................................ .0312
63.0........................................................ .0313
[[Page 450]]
62.9........................................................ .0313
62.8........................................................ .0313
62.7........................................................ .0314
62.6........................................................ .0314
62.5........................................................ .0315
62.4........................................................ .0315
62.3........................................................ .0316
62.2........................................................ .0316
62.1........................................................ .0317
62.0........................................................ .0317
61.9........................................................ .0318
61.8........................................................ .0318
61.7........................................................ .0319
61.6........................................................ .0319
61.5........................................................ .0320
61.4........................................................ .0320
61.3........................................................ .0321
61.2........................................................ .0322
61.1........................................................ .0322
61.0........................................................ .0323
60.9........................................................ .0323
60.8........................................................ .0324
60.7........................................................ .0324
60.6........................................................ .0325
60.5........................................................ .0325
60.4........................................................ .0326
60.3........................................................ .0326
60.2........................................................ .0327
60.1........................................................ .0327
60.0........................................................ .0328
59.9........................................................ .0328
59.8........................................................ .0329
59.7........................................................ .0329
59.6........................................................ .0330
59.5........................................................ .0331
59.4........................................................ .0331
59.3........................................................ .0332
59.2........................................................ .0332
59.1........................................................ .0333
59.0........................................................ .0333
58.9........................................................ .0334
58.8........................................................ .0334
58.7........................................................ .0335
58.6........................................................ .0336
58.5........................................................ .0336
58.4........................................................ .0337
58.3........................................................ .0337
58.2........................................................ .0338
58.1........................................................ .0338
58.0........................................................ .0339
57.9........................................................ .0340
57.8........................................................ .0340
57.7........................................................ .0341
57.6........................................................ .0341
57.5........................................................ .0342
57.4........................................................ .0342
57.3........................................................ .0343
57.2........................................................ .0344
57.1........................................................ .0344
57.0........................................................ .0345
56.9........................................................ .0345
56.8........................................................ .0346
56.7........................................................ .0347
56.6........................................................ .0347
56.5........................................................ .0348
56.4........................................................ .0348
56.3........................................................ .0349
56.2........................................................ .0350
56.1........................................................ .0350
56.0........................................................ .0351
55.9........................................................ .0351
55.8........................................................ .0352
55.7........................................................ .0353
55.6........................................................ .0353
55.5........................................................ .0354
55.4........................................................ .0355
55.3........................................................ .0355
55.2........................................................ .0356
55.1........................................................ .0356
55.0........................................................ .0357
54.9........................................................ .0358
54.8........................................................ .0358
54.7........................................................ .0359
54.6........................................................ .0360
54.5........................................................ .0360
54.4........................................................ .0361
54.3........................................................ .0362
54.2........................................................ .0362
54.1........................................................ .0363
54.0........................................................ .0364
53.9........................................................ .0364
53.8........................................................ .0365
53.7........................................................ .0366
53.6........................................................ .0366
53.5........................................................ .0367
53.4........................................................ .0368
53.3........................................................ .0368
53.2........................................................ .0369
53.1........................................................ .0370
53.0........................................................ .0370
52.9........................................................ .0371
52.8........................................................ .0372
52.7........................................................ .0372
52.6........................................................ .0373
52.5........................................................ .0374
52.4........................................................ .0374
52.3........................................................ .0375
52.2........................................................ .0376
52.1........................................................ .0377
52.0........................................................ .0377
51.9........................................................ .0378
51.8........................................................ .0379
51.7........................................................ .0379
51.6........................................................ .0380
51.5........................................................ .0381
51.4........................................................ .0382
51.3........................................................ .0382
51.2........................................................ .0383
51.1........................................................ .0384
51.0........................................................ .0385
50.9........................................................ .0385
50.8........................................................ .0386
50.7........................................................ .0387
50.6........................................................ .0388
50.5........................................................ .0388
50.4........................................................ .0389
50.3........................................................ .0390
50.2........................................................ .0391
50.1........................................................ .0391
50.0........................................................ .0392
49.9........................................................ .0393
49.8........................................................ .0394
49.7........................................................ .0394
49.6........................................................ .0395
49.5........................................................ .0396
49.4........................................................ .0397
[[Page 451]]
49.3........................................................ .0398
49.2........................................................ .0398
49.1........................................................ .0399
49.0........................................................ .0400
48.9........................................................ .0401
48.8........................................................ .0402
48.7........................................................ .0402
48.6........................................................ .0403
48.5........................................................ .0404
48.4........................................................ .0405
48.3........................................................ .0406
48.2........................................................ .0406
48.1........................................................ .0407
48.0........................................................ .0408
47.9........................................................ .0409
47.8........................................................ .0410
47.7........................................................ .0411
47.6........................................................ .0411
47.5........................................................ .0412
47.4........................................................ .0413
47.3........................................................ .0414
47.2........................................................ .0415
47.1........................................................ .0416
47.0........................................................ .0417
46.9........................................................ .0418
46.8........................................................ .0418
46.7........................................................ .0419
46.6........................................................ .0420
46.5........................................................ .0421
46.4........................................................ .0422
46.3........................................................ .0423
46.2........................................................ .0424
46.1........................................................ .0425
46.0........................................................ .0426
45.9........................................................ .0426
45.8........................................................ .0427
45.7........................................................ .0428
45.6........................................................ .0429
45.5........................................................ .0430
45.4........................................................ .0431
45.3........................................................ .0432
45.2........................................................ .0433
45.1........................................................ .0434
45.0........................................................ .0435
44.9........................................................ .0436
44.8........................................................ .0437
44.7........................................................ .0438
44.6........................................................ .0439
44.5........................................................ .0440
44.4........................................................ .0440
44.3........................................................ .0441
44.2........................................................ .0442
44.1........................................................ .0443
44.0........................................................ .0444
43.9........................................................ .0445
43.8........................................................ .0446
43.7........................................................ .0447
43.6........................................................ .0448
43.5........................................................ .0449
43.4........................................................ .0450
43.3........................................................ .0451
43.2........................................................ .0452
43.1........................................................ .0453
43.0........................................................ .0455
42.9........................................................ .0456
42.8........................................................ .0457
42.7........................................................ .0458
42.6........................................................ .0459
42.5........................................................ .0460
42.4........................................................ .0461
42.3........................................................ .0462
42.2........................................................ .0463
42.1........................................................ .0464
42.0........................................................ .0465
41.9........................................................ .0466
41.8........................................................ .0467
41.7........................................................ .0468
41.6........................................................ .0469
41.5........................................................ .0471
41.4........................................................ .0472
41.3........................................................ .0473
41.2........................................................ .0474
41.1........................................................ .0475
41.0........................................................ .0476
40.9........................................................ .0477
40.8........................................................ .0478
40.7........................................................ .0480
40.6........................................................ .0481
40.5........................................................ .0482
40.4........................................................ .0483
40.3........................................................ .0484
40.2........................................................ .0485
40.1........................................................ .0487
40.0........................................................ .0488
39.9........................................................ .0489
39.8........................................................ .0490
39.7........................................................ .0491
39.6........................................................ .0493
39.5........................................................ .0494
39.4........................................................ .0495
39.3........................................................ .0496
39.2........................................................ .0497
39.1........................................................ .0499
39.0........................................................ .0500
38.9........................................................ .0501
38.8........................................................ .0502
38.7........................................................ .0504
38.6........................................................ .0505
38.5........................................................ .0506
38.4........................................................ .0508
38.3........................................................ .0509
38.2........................................................ .0510
38.1........................................................ .0511
38.0........................................................ .0513
37.9........................................................ .0514
37.8........................................................ .0515
37.7........................................................ .0517
37.6........................................................ .0518
37.5........................................................ .0519
37.4........................................................ .0521
37.3........................................................ .0522
37.2........................................................ .0524
37.1........................................................ .0525
37.0........................................................ .0526
36.9........................................................ .0528
36.8........................................................ .0529
36.7........................................................ .0530
36.6........................................................ .0532
36.5........................................................ .0533
36.4........................................................ .0525
36.3........................................................ .0536
36.2........................................................ .0538
36.1........................................................ .0539
36.0........................................................ .0541
35.9........................................................ .0542
35.8........................................................ .0543
[[Page 452]]
35.7........................................................ .0545
35.6........................................................ .0546
35.5........................................................ .0548
35.4........................................................ .0549
35.3........................................................ .0551
35.2........................................................ .0552
35.1........................................................ .0554
35.0........................................................ .0556
34.9........................................................ .0557
34.8........................................................ .0559
34.7........................................................ .0560
34.6........................................................ .0562
34.5........................................................ .0563
34.4........................................................ .0565
34.3........................................................ .0566
34.2........................................................ .0566
34.1........................................................ .0570
34.0........................................................ .0571
33.9........................................................ .0573
33.8........................................................ .0575
33.7........................................................ .0576
33.6........................................................ .0578
33.5........................................................ .0580
33.4........................................................ .0581
33.3........................................................ .0583
33.2........................................................ .0585
33.1........................................................ .0586
33.0........................................................ .0588
32.9........................................................ .0590
32.8........................................................ .0592
32.7........................................................ .0593
32.6........................................................ .0595
32.5........................................................ .0597
32.4........................................................ .0599
32.3........................................................ .0600
32.2........................................................ .0602
32.1........................................................ .0604
32.0........................................................ .0606
31.9........................................................ .0608
31.8........................................................ .0610
31.7........................................................ .0611
31.6........................................................ .0613
31.5........................................................ .0615
31.4........................................................ .0617
31.3........................................................ .0619
31.2........................................................ .0621
31.1........................................................ .0623
31.0........................................................ .0625
30.9........................................................ .0627
30.8........................................................ .0629
30.7........................................................ .0631
30.6........................................................ .0633
30.5........................................................ .0635
30.4........................................................ .0637
30.3........................................................ .0639
30.2........................................................ .0641
30.1........................................................ .0643
30.0........................................................ .0645
29.9........................................................ .0647
29.8........................................................ .0649
29.7........................................................ .0651
29.6........................................................ .0653
29.5........................................................ .0656
29.4........................................................ .0658
29.3........................................................ .0660
29.2........................................................ .0662
29.1........................................................ .0664
29.0........................................................ .0667
28.9........................................................ .0669
28.8........................................................ .0671
28.7........................................................ .0673
28.6........................................................ .0675
28.5........................................................ .0678
28.4........................................................ .0680
28.3........................................................ .0682
28.2........................................................ .0685
28.1........................................................ .0687
28.0........................................................ .0690
27.9........................................................ .0692
27.8........................................................ .0694
27.7........................................................ .0697
27.6........................................................ .0699
27.5........................................................ .0702
27.4........................................................ .0704
27.3........................................................ .0707
27.2........................................................ .0709
27.1........................................................ .0712
27.0........................................................ .0714
26.9........................................................ .0717
26.8........................................................ .0719
26.7........................................................ .0722
26.6........................................................ .0724
26.5........................................................ .0727
26.4........................................................ .0730
26.3........................................................ .0732
26.2........................................................ .0735
26.1........................................................ .0738
26.0........................................................ .0741
25.9........................................................ .0743
25.8........................................................ .0746
25.7........................................................ .0749
25.6........................................................ .0752
25.5........................................................ .0754
25.4........................................................ .0757
25.3........................................................ .0760
25.2........................................................ .0763
25.1........................................................ .0766
25.0........................................................ .0769
24.9........................................................ .0772
24.8........................................................ .0775
24.7........................................................ .0778
24.6........................................................ .0781
24.5........................................................ .0784
24.4........................................................ .0787
24.3........................................................ .0790
24.2........................................................ .0793
24.1........................................................ .0797
24.0........................................................ .0800
23.9........................................................ .0803
23.8........................................................ .0806
23.7........................................................ .0809
23.6........................................................ .0813
23.5........................................................ .0816
23.4........................................................ .0819
23.3........................................................ .0823
23.2........................................................ .0826
23.1........................................................ .0830
23.0........................................................ .0833
22.9........................................................ .0837
22.8........................................................ .0840
22.7........................................................ .0844
22.6........................................................ .0847
22.5........................................................ .0851
22.4........................................................ .0854
22.3........................................................ .0858
22.2........................................................ .0862
[[Page 453]]
22.1........................................................ .0866
22.0........................................................ .0870
21.9........................................................ .0873
21.8........................................................ .0877
21.7........................................................ .0881
21.6........................................................ .0885
21.5........................................................ .0888
21.4........................................................ .0892
21.3........................................................ .0896
21.2........................................................ .0901
21.1........................................................ .0905
21.0........................................................ .0909
20.9........................................................ .0913
20.8........................................................ .0917
20.7........................................................ .0921
20.6........................................................ .0925
20.5........................................................ .0930
20.4........................................................ .0934
20.3........................................................ .0939
20.2........................................................ .0943
20.1........................................................ .0948
20.0........................................................ .0952
19.9........................................................ .0957
19.8........................................................ .0961
19.7........................................................ .0966
19.6........................................................ .0970
19.5........................................................ .0975
19.4........................................................ .0980
19.3........................................................ .0985
19.2........................................................ .0990
19.1........................................................ .0995
19.0........................................................ .1000
18.9........................................................ .1005
18.8........................................................ .1010
18.7........................................................ .1015
18.6........................................................ .1020
18.5........................................................ .1025
18.4........................................................ .1030
18.3........................................................ .1036
18.2........................................................ .1041
18.1........................................................ .1047
18.0........................................................ .1053
17.9........................................................ .1058
17.8........................................................ .1063
17.7........................................................ .1069
17.6........................................................ .1074
17.5........................................................ .1080
17.4........................................................ .1086
17.3........................................................ .1092
17.2........................................................ .1098
17.1........................................................ .1105
17.0........................................................ .1111
16.9........................................................ .1117
16.8........................................................ .1123
16.7........................................................ .1129
16.6........................................................ .1135
16.5........................................................ .1142
16.4........................................................ .1148
16.3........................................................ .1155
16.2........................................................ .1162
16.1........................................................ .1169
16.0........................................................ .1176
15.9........................................................ .1183
15.8........................................................ .1190
15.7........................................................ .1197
15.6........................................................ .1204
15.5........................................................ .1211
15.4........................................................ .1218
15.3........................................................ .1226
15.2........................................................ .1234
15.1........................................................ .1242
15.0........................................................ .1250
14.9........................................................ .1257
14.8........................................................ .1265
14.7........................................................ .1273
14.6........................................................ .1281
14.5........................................................ .1289
14.4........................................................ .1297
14.3........................................................ .1306
14.2........................................................ .1315
14.1........................................................ .1324
14.0........................................................ .1333
13.9........................................................ .1342
13.8........................................................ .1350
13.7........................................................ .1359
13.6........................................................ .1368
13.5........................................................ .1378
13.4........................................................ .1387
13.3........................................................ .1397
13.2........................................................ .1407
13.1........................................................ .1418
13.0........................................................ .1429
12.9........................................................ .1438
12.8........................................................ .1448
12.7........................................................ .1458
12.6........................................................ .1469
12.5........................................................ .1479
12.4........................................................ .1490
12.3........................................................ .1502
12.2........................................................ .1514
12.1........................................................ .1526
12.0........................................................ .1538
11.9........................................................ .1549
11.8........................................................ .1561
11.7........................................................ .1573
11.6........................................................ .1585
11.5........................................................ .1597
11.4........................................................ .1610
11.3........................................................ .1624
11.2........................................................ .1637
11.1........................................................ .1652
11.0........................................................ .1667
10.9........................................................ .1680
10.8........................................................ .1693
10.7........................................................ .1707
10.6........................................................ .1721
10.5........................................................ .1736
10.4........................................................ .1751
10.3........................................................ .1767
10.2........................................................ .1783
10.1........................................................ .1800
10.0........................................................ .1818
9.9......................................................... .1833
9.8......................................................... .1849
9.7......................................................... .1865
9.6......................................................... .1882
9.5......................................................... .1900
9.4......................................................... .1918
9.3......................................................... .1938
9.2......................................................... .1957
9.1......................................................... .1978
9.0......................................................... .2000
8.9......................................................... .2018
8.8......................................................... .2037
8.7......................................................... .2057
8.6......................................................... .2077
[[Page 454]]
8.5......................................................... .2099
8.4......................................................... .2121
8.3......................................................... .2145
8.2......................................................... .2169
8.1......................................................... .2195
8.0......................................................... .2222
7.9......................................................... .2244
7.8......................................................... .2267
7.7......................................................... .2292
7.6......................................................... .2317
7.5......................................................... .2344
7.4......................................................... .2372
7.3......................................................... .2401
7.2......................................................... .2432
7.1......................................................... .2465
7.0......................................................... .2500
6.9......................................................... .2527
6.8......................................................... .2556
6.7......................................................... .2587
6.6......................................................... .2619
6.5......................................................... .2653
6.4......................................................... .2689
6.3......................................................... .2727
6.2......................................................... .2768
6.1......................................................... .2811
6.0......................................................... .2857
5.9......................................................... .2892
5.8......................................................... .2929
5.7......................................................... .2969
5.6......................................................... .3011
5.5......................................................... .3056
5.4......................................................... .3103
5.3......................................................... .3155
5.2......................................................... .3210
5.1......................................................... .3269
5.0......................................................... .3333
4.9......................................................... .3379
4.8......................................................... .3429
4.7......................................................... .3481
4.6......................................................... .3538
4.5......................................................... .3600
4.4......................................................... .3667
4.3......................................................... .3739
4.2......................................................... .3818
4.1......................................................... .3905
4.0......................................................... .4000
3.9......................................................... .4063
3.8......................................................... .4130
3.7......................................................... .4205
3.6......................................................... .4286
3.5......................................................... .4375
3.4......................................................... .4474
3.3......................................................... .4583
3.2......................................................... .4706
3.1......................................................... .4844
3.0......................................................... .5000
2.9......................................................... .5088
2.8......................................................... .5185
2.7......................................................... .5294
2.6......................................................... .5417
2.5......................................................... .5556
2.4......................................................... .5714
2.3......................................................... .5897
2.2......................................................... .6111
2.1......................................................... .6364
2.0......................................................... .6667
1.9......................................................... .6786
1.8......................................................... .6923
1.7......................................................... .7083
1.6......................................................... .7273
1.5......................................................... .7500
1.4......................................................... .7778
1.3......................................................... .8125
1.2......................................................... .8571
1.1......................................................... .9167
1.0......................................................... 1.0000
------------------------------------------------------------------------
Note: For determination of decimal equivalents of remaining lives
falling between those shown in the above table, the taxpayer may use the
next longest life shown in the table, interpolate from the table, or use
the following formula from which the table was derived.
D=2R/(W+2F)(W+1)
where:
D=Decimal equivalent.
R=Remaining life.
W=Whole number of years in remaining life.
F=Fractional part of a year in remaining life.
If the taxpayer desires to carry his calculations of decimal equivalents
to a greater number of decimal places than is provided in the table, he
may use the formula. The procedure adopted must be consistently followed
thereafter.
(b) Applied to group, classified, or composite accounts--(1) General
rule. The sum of the years-digits method may be applied to group,
classified, or composite accounts in accordance with the plan described
in subparagraph (2) of this paragraph or in accordance with other plans
as explained in subparagraph (3) of this paragraph.
(2) Remaining life plan. The remaining life plan as applied to a
single asset is described in paragraph (a)(2) of this section. This plan
may also be applied to group, classified, or composite accounts. Under
this plan the allowance for depreciation is computed by applying
changing fractions to the unrecovered cost or other basis of the account
reduced by estimated salvage. The numerator of the fraction changes each
year to a number which corresponds to the remaining useful life of the
account (including the year for which the allowance is being computed),
and the denominator changes
[[Page 455]]
each year to a number which represents the sum of the years digits
corresponding to the years of estimated remaining useful life of the
account. Decimal equivalents of such fractions can be obtained by use of
Table I under paragraph (a)(2)(ii) of this section. The proper
application of this method requires that the estimated remaining useful
life of the account be determined each year. This determination, of
course, may be made each year by analysis, i.e., by determining the
remaining lives for each of the components in the account, and averaging
them. The estimated remaining life of any account, however, may also be
determined arithmetically. For example, it may be computed by dividing
the unrecovered cost or other basis of the account, as computed by
straight line depreciation, by the gross cost or other basis of the
account, and multiplying the result by the average life of the assets in
the account. Salvage value is not a factor for the purpose of
determining remaining life. Thus, if a group account with an average
life of ten years had at January 1, 1958, a gross asset balance of
$12,600 and a depreciation reserve computed on the straight line method
of $9,450, the remaining life of the account at January 1, 1958, would
be computed as follows:
$12,600-$9,450/$12,600x10 years equals 2.50 years.
Example. The use of the sum of the years-digits method with group,
classified, or composite accounts under the remaining life plan is
illustrated by the following example:
A calendar year taxpayer maintains a group account to which a five-year
life is applicable. Original investment, additions, retirements, and
salvage recoveries are the same as those set forth in example (3) of
paragraph (b) of Sec. 1.167(b)-1.
[[Page 456]]
Depreciation Computations on a Group Account Under Remaining Life Plan
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1 2 3 4 5 6 7 8 9 10 11 12 13 14
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Straight Straight Remaining Asset Current Salvage Sum of the years digits depreciation
line line life balance additions realized -------------------------------------------------
amount reserve ----------- reduced reduced ---------- Accumulated Unrecovered Rate Allowable
----------------------- by by reserve Jan. 1 based on depreciation
Asset Average [Col. (1)- salvage salvage Jan. 1 ------------- Col. (7) -------------
Year balance Current Current asset Col. (6)/--------------------- ------------- from
Jan. 1 additions retirements balance Col. (5)- Col. Prior Table 1 Col. (12)x
Col. (4)/ Col. (3) (1)]x Col. Col (2)x reserve+ Col. (8)- ---------- Col. (13)+
life accumulated average (1)x (100%- Col. (14)+ Col. (11) \1/2\ Col.
Jan. 1 service (100%- 6.67%) Col. (10)- (9)xF\2\
life 6.67%) Col. (3)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1954............................. ........ $12,000 ........... $6,000 \1\ ........... 5.00 ........ $11,200 ........ ........... ........... 0.3333 $1,866
$1,200
1955............................. $12,000 ......... ........... 12,000 2,400 $1,200 4.50 $11,200 ......... ........ $1,866 $9,334 .3600 3,360
1956............................. 12,000 ......... ........... 12,000 2,400 3,600 3.50 11,200 ......... ........ 5,226 5,974 .4375 2,614
1957............................. 12,000 ......... $2,000 11,000 2,200 6,000 2.50 11,200 ......... $200 7,840 3,360 .5556 1,867
1958............................. 10,000 ......... 2,000 9,000 1,800 6,200 1.90 9,333 ......... 200 7,907 1,426 .6786 968
1959............................. 8,000 10,000 4,000 11,000 2,200 6,000 1.25 7,466 9,333 400 7,075 391 .8125 1,874
1960............................. 14,000 ......... 2,000 13,000 2,600 4,200 3.50 13,066 ......... ........ 5,349 7,717 .4375 3,376
1961............................. 12,000 ......... 2,000 11,000 2,200 4,800 3.00 11,200 ......... ........ 6,725 4,475 .5000 2,238
1962............................. ........ ......... ........... ........ ........ 5,000 ......... ........ ......... ........ 6,963
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ \1/2\ year's amount.
\2\ F=Rate based on average service life (0.3333 in this example).
[[Page 457]]
(3) Other plans for application of the sum of the years-digits
method. Taxpayers who wish to use the sum of the years-digits method in
computing depreciation for group, classified, or composite accounts in
accordance with a sum of the years digits plan other than the remaining
life plan described herein may do so only with the consent of the
Commissioner. Request for permission to use plans other than that
described shall be addressed to the Commissioner of Internal Revenue,
Washington, D.C. 20224.
Sec. 1.167(b)-4 Other methods.
(a) Under section 167(b)(4) a taxpayer may use any consistent method
of computing depreciation, such as the sinking fund method, provided
depreciation allowances computed in accordance with such method do not
result in accumulated allowances at the end of any taxable year greater
than the total of the accumulated allowances which could have resulted
from the use of the declining balance method described in section
167(b)(2). This limitation applies only during the first two-thirds of
the useful life of the property. For example, an asset costing $1,000
having a useful life of six years may be depreciated under the declining
balance method in accordance with Sec. 1.167(b)-2, at a rate of 33\1/3\
percent. During the first four years or \2/3\ of its useful life,
maximum depreciation allowances under the declining balance method would
be as follows:
------------------------------------------------------------------------
Current Accumulated
depreciation depreciation Balance
------------------------------------------------------------------------
Cost of asset................... ............ ............ $1,000
First year...................... $333 $333 667
Second year..................... 222 555 445
Third year...................... 148 703 297
Fourth year..................... 99 802 198
------------------------------------------------------------------------
An annual allowance computed by any other method under section 167(b)(4)
could not exceed $333 for the first year, and at the end of the second
year the total allowances for the two years could not exceed $555.
Likewise, the total allowances for the three years could not exceed $703
and for the four years could not exceed $802. This limitation would not
apply in the fifth and sixth years. See section 167(c) and Sec.
1.167(c)-1 for restriction on the use of certain methods.
(b) It shall be the responsibility of the taxpayer to establish to
the satisfaction of the Commissioner that a method of depreciation under
section 167(b)(4) is both a reasonable and consistent method and that it
does not produce depreciation allowances in excess of the amount
permitted under the limitations provided in such section.
Sec. 1.167(c)-1 Limitations on methods of computing depreciation
under section 167(b) (2), (3), and (4).
(a) In general. (1) Section 167(c) provides limitations on the use
of the declining balance method described in section 167(b)(2), the sum
of the years-digits method described in section 167(b)(3), and certain
other methods authorized by section 167(b)(4). These methods are
applicable only to tangible property having a useful life of three years
or more. If construction, reconstruction, or erection by the taxpayer
began before January 1, 1954, and was completed after December 31, 1953,
these methods apply only to that portion of the basis of the property
which is properly attributable to such construction, reconstruction, or
erection after December 31, 1953. Property is considered as constructed,
reconstructed, or erected by the taxpayer if the work is done for him in
accordance with his specifications. The portion of the basis of such
property attributable to construction, reconstruction, or erection after
December 31, 1953, consists of all costs of the property allocable to
the period after December 31, 1953, including the cost or other basis of
materials entering into such work. It is not necessary that such
materials be acquired after December 31, 1953, or that they be new in
use. If construction or erection by the taxpayer began after December
31, 1953, the entire cost or other basis of such construction or
erection qualifies for these methods of depreciation. In the case of
reconstruction of property, these methods do not apply to any part of
the adjusted basis of such property on December 31, 1953. For purposes
of this section, construction, reconstruction, or erection by the
taxpayer begins when physical work is
[[Page 458]]
started on such construction, reconstruction, or erection.
(2) If the property was not constructed, reconstructed, or erected
by the taxpayer, these methods apply only if it was acquired after
December 31, 1953, and if the original use of the property commences
with the taxpayer and commences after December 31, 1953. For the purpose
of the preceding sentence, property shall be deemed to be acquired when
reduced to physical possession, or control. The term ``original use''
means the first use to which the property is put, whether or not such
use corresponds to the use of such property by the taxpayer. For
example, a reconditioned or rebuilt machine acquired after December 31,
1953, will not be treated as being put to original use by the taxpayer
even though it is put to a different use, nor will a horse acquired for
breeding purposes be treated as being put to original use by the
taxpayer if prior to the purchase the horse was used for racing
purposes. See Sec. Sec. 1.167(b)-2, 1.167 (b)-3, and 1.167(b)-4 for
application of the various methods.
(3) Assets having an estimated average useful life of less than
three years shall not be included in a group, classified, or composite
account to which the methods described in Sec. Sec. 1.167 (b)-2,
1.167(b)-3, and 1.167(b)-4 are applicable. However, an incidental
retirement of an asset from such an account prior to the expiration of a
useful life of three years will not prevent the application of these
methods to such an account.
(4) See section 381(c)(6) and the regulations thereunder for rules
covering the use of depreciation methods by acquiring corporations in
the case of certain corporate acquisitions.
(5) See Sec. Sec. 1.1502-12(g) and 1.1502-13 for provisions dealing
with depreciation of property received by a member of an affiliated
group from another member of the group during a consolidated return
period.
(6) Except in the cases described in subparagraphs (4) and (5) of
this paragraph, the methods of depreciation described in Sec. Sec.
1.167(b)-2, 1.167(b-(3), and 1.167(b)-4 are not applicable to property
in the hands of a distributee, vendee, transferee, donee, or grantee
unless the original use of the property begins with such person and the
conditions required by section 167(c) and this section are otherwise
met. For example, these methods of depreciation may not be used by a
corporation with respect to property which it acquires from an
individual or partnership in exchange for its stock. Similarly, if an
individual or partnership receives property in a distribution upon
dissolution of a corporation, these methods of depreciation may not be
used with respect to property so acquired by such individual or
partnership. As a further example, these methods of depreciation may not
be used by a partnership with respect to contributed property, nor by a
partner with respect to partnership property distributed to him.
Moreover, where a partnership is entitled to use these depreciation
methods, and the optional adjustment to basis of partnership property
provided by section 743 is applicable, (i) in the case of an increase in
the adjusted basis of the partnership property under such section, the
transferee partner with respect to whom such adjustment is applicable
shall not be entitled to use such methods with respect to such increase,
and (ii) in the case of a decrease in the adjusted basis of the
partnership property under such section, the transferee partner with
respect to whom such adjustment is applicable shall include in his
income an amount equal to the portion of the depreciation deducted by
the partnership which is attributable to such decrease.
(b) Illustrations. (1) The application of these methods to property
constructed, reconstructed, or erected by the taxpayer after December
31, 1953, may be illustrated by the following examples:
Example 1. If a building with a total cost of $100,000 is completed
after December 31, 1953, and the portion attributable to construction
after December 31, 1953, is determined by engineering estimates or by
cost accounting records to be $30,000, the methods referred to in
paragraph (a)(1) of this section are applicable only to the $30,000
portion of the total.
Example 2. In 1954, a taxpayer has an old machine with an
unrecovered cost of $1,000. If he contracts to have it reconditioned, or
reconditions it himself, at a cost of an additional $5,000, only the
$5,000 may be depreciated under the methods referred to in paragraph
(a)(1) of this section, whether or not the materials used for
reconditioning are new in use.
[[Page 459]]
Example 3. A taxpayer who acquired a building in 1940 makes major
maintenance or repair expenditures in 1954 of a type which must be
capitalized. For these expenditures the taxpayer may use a method of
depreciation different from that used on the building (for example, the
methods referred to in paragraph (a)(1) of this section) only if he
accounts for such expenditures separately from the account which
contained the original building. In such case, the unadjusted basis on
any parts replaced shall be removed from the asset account and shall be
charged to the appropriate depreciation reserve account. In the
alternative he may capitalize such expenditures by charging them to the
depreciation reserve account for the building.
(2) The application of these methods to property which was not
constructed, reconstructed, or erected by the taxpayer but which was
acquired after December 31, 1953, may be illustrated by the following
examples:
Example 1. A taxpayer contracted in 1953 to purchase a new machine
which he acquired in 1954 and put into first use in that year. He may
use the methods referred to in paragraph (a)(1) of this section, in
recovering the cost of the new machine.
Example 2. A taxpayer instead of reconditioning his old machine buys
a ``factory reconditioned'' machine in 1954 to replace it. He cannot
apply the methods referred to in paragraph (a)(1) of this section, to
any part of the cost of the reconditioned machine since he is not the
first user of the machine.
Example 3. In 1954, a taxpayer buys a house for $20,000 which had
been used as a personal residence and thus had not been subject to
depreciation allowances. He makes a capital addition of $5,000 and rents
the property to another. The taxpayer may use the methods referred to in
paragraph (a)(1) of this section, only with respect to the $5,000 cost
of the addition.
(c) Election to use methods. Subject to the limitations set forth in
paragraph (a) of this section, the methods of computing the allowance
for depreciation specified in section 167(b) (2), (3), and (4) may be
adopted without permission and no formal election is required. In order
for a taxpayer to elect to use these methods for any property described
in paragraph (a) of this section, he need only compute depreciation
thereon under any of these methods for any taxable year ending after
December 31, 1953, in which the property may first be depreciated by
him. The election with respect to any property shall not be binding with
respect to acquisitions of similar property in the same year or
subsequent year which are set up in separate accounts. If a taxpayer has
filed his return for a taxable year ending after December 31, 1953, for
which the return is required to be filed on or before September 15,
1956, an election to compute the depreciation allowance under any of the
methods specified in section 167 (b) or a change in such an election may
be made in an amended return or claim for refund filed on or before
September 15, 1956.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 7244, 37 FR 28897, Dec. 30, 1972; T.D. 8560, 59 FR
41674, Aug. 15, 1994; T.D. 8597, 60 FR 36679, July 18, 1995]
Sec. 1.167(d)-1 Agreement as to useful life and rates of
depreciation.
After August 16, 1954, a taxpayer may, for taxable years ending
after December 31, 1953, enter into an agreement with respect to the
estimated useful life, method and rate of depreciation and treatment of
salvage of any property which is subject to the allowance for
depreciation. An application for such agreement may be made to the
district director for the internal revenue district in which the
taxpayer's return is required to be filed. Such application shall be
filed in quadruplicate and shall contain in such detail as may be
practical the following information:
(a) The character and location of the property.
(b) The original cost or other basis and date of acquisition.
(c) Proper adjustments to the basis including depreciation
accumulated to the first taxable year to be covered by the agreement.
(d) Estimated useful life and estimated salvage value.
(e) Method and rate of depreciation.
(f) Any other facts and circumstances pertinent to making a
reasonable estimate of the useful life of the property and its salvage
value.
The agreement must be in writing and must be signed by the taxpayer and
by the district director. The agreement must be signed in quadruplicate,
and two of the signed copies will be returned to the taxpayer. The
agreement
[[Page 460]]
shall set forth its effective date, the estimated remaining useful life,
the estimated salvage value, and rate and method of depreciation of the
property and the facts and circumstances taken into consideration in
adoption of the agreement, and shall relate only to depreciation
allowances for such property on and after the effective date of the
agreement. Such an agreement shall be binding on both parties until such
time as facts and circumstances which were not taken into account in
making the agreement are shown to exist. The party wishing to modify or
change the agreement shall have the responsibility of establishing the
existence of such facts and circumstances. Any change in the useful life
or rate specified in such agreement shall be effective only
prospectively, that is, it shall be effective beginning with the taxable
year in which notice of the intention to change, including facts and
circumstances warranting the adjustment of useful life and rate, is sent
by the party proposing the change to the other party and is sent by
registered mail, if such notice is mailed before September 3, 1958, or
is sent by certified mail or registered mail, if such notice is mailed
after September 2, 1958. A copy of the agreement (and any modification
thereof) shall be filed with the taxpayer's return for the first taxable
year which is affected by the agreement (or any modification thereof). A
signed copy should be retained with the permanent records of the
taxpayer. For rules relating to changes in method of depreciation, see
Sec. 1.167(e)-1 and section 446 and the regulations thereunder.
Sec. 1.167(e)-1 Change in method.
(a) In general. (1) Any change in the method of computing the
depreciation allowances with respect to a particular account (other than
a change in method permitted or required by reason of the operation of
former section 167(j)(2) and Sec. 1.167(j)-3(c)) is a change in method
of accounting, and such a change will be permitted only with the consent
of the Commissioner, except that certain changes to the straight line
method of depreciation will be permitted without consent as provided in
former section 167(e)(1), (2), and (3). Except as provided in paragraphs
(c) and (d) of this section, a change in method of computing
depreciation will be permitted only with respect to all the assets
contained in a particular account as defined in Sec. 1.167(a)-7. Any
change in the percentage of the current straight line rate under the
declining balance method, for example, from 200 percent of the straight
line rate to any other percent of the straight line rate, or any change
in the interest factor used in connection with a compound interest or
sinking fund method, will constitute a change in method of depreciation.
Any request for a change in method of depreciation shall be made in
accordance with section 446(e) and the regulations under section 446(e).
For rules covering the use of depreciation methods by acquiring
corporations in the case of certain corporate acquisitions, see section
381(c)(6) and the regulations under section 381(c)(6).
(2) Paragraphs (b), (c), and (d) of this section apply to property
for which depreciation is determined under section 167 (other than under
section 168, section 1400I, section 1400L(c), under section 168 prior to
its amendment by the Tax Reform Act of 1986 (100 Stat. 2121), or under
an additional first year depreciation deduction provision (for example,
section 168(k), 1400L(b), or 1400N(d))) of the Internal Revenue Code.
(b) Declining balance to straight line. In the case of an account to
which the method described in section 167(b)(2) is applicable, a
taxpayer may change without the consent of the Commissioner from the
declining balance method of depreciation to the straight line method at
any time during the useful life of the property under the following
conditions. Such a change may not be made if a provision prohibiting
such a change is contained in an agreement under section 167(d). When
the change is made, the unrecovered cost or other basis (less a
reasonable estimate for salvage) shall be recovered through annual
allowances over the estimated remaining useful life determined in
accordance with the circumstances existing at the time. With respect to
any account, this change will be permitted only if applied to all the
assets in the account as defined in
[[Page 461]]
Sec. 1.167(a)-7. If the method of depreciation described in section
167(b)(2) (the declining balance method of depreciation using a rate not
exceeding 200 percent of the straight line rate) is an acceptable method
of depreciation with respect to a particular account, the taxpayer may
elect under this paragraph to change to the straight line method of
depreciation even if with respect to that particular account the
declining balance method is permitted under a provision other than
section 167(b)(2). Thus, for example, in the case of section 1250
property to which section 167(j)(1) is applicable, section 167(b) does
not apply, but the declining balance method of depreciation using 150
percent of the straight line rate is an acceptable method of
depreciation under section 167(j)(1)(B). Accordingly, the taxpayer may
elect under this paragraph to change to the straight line method of
depreciation with respect to such property. Similarly, if the taxpayer
acquired used property before July 25, 1969, and adopted the 150 percent
declining balance method of depreciation permitted with respect to such
property under Sec. 1.167(b)-0(b), the taxpayer may elect under this
paragraph to change to the straight line method of depreciation with
respect to such property. The taxpayer shall furnish a statement with
respect to the property which is the subject of the change showing the
date of acquisition, cost or other basis, amounts recovered through
depreciation and other allowances, the estimated salvage value, the
character of the property, the remaining useful life of the property,
and such other information as may be required. The statement shall be
attached to the taxpayer's return for the taxable year in which the
change is made. A change to the straight line method must be adhered to
for the entire taxable year of the change and for all subsequent taxable
years unless, with the consent of the Commissioner, a change to another
method is permitted.
(c) Change with respect to section 1245 property. (1) In respect of
his first taxable year beginning after December 31, 1962, a taxpayer may
elect, without the consent of the Commissioner, to change the method of
depreciation of section 1245 property (as defined in section 1245(a)(3))
from any declining balance method or sum of the years-digits method to
the straight line method. With respect to any account (as defined in
Sec. 1.167(a)-7), this change may be made notwithstanding any provision
to the contrary in an agreement under section 167(d), but such change
shall constitute (as of the first day of such taxable year) a
termination of such agreement as to all property in such account. With
respect to any account, this change will be permitted only if applied to
all the section 1245 property in the account. The election shall be made
by a statement on, or attached to, the return for such taxable year
filed on or before the last day prescribed by law, including any
extensions thereof, for filing such return.
(2) When an election under this paragraph is made in respect of
section 1245 property in an account, the unrecovered cost or other basis
(less a reasonable estimate for salvage) of all the section 1245
property in the account shall be recovered through annual allowances
over the estimated remaining useful life determined in accordance with
the circumstances existing at that time. If there is other property in
such account, the other property shall be placed in a separate account
and depreciated by using the same method as was used before the change
permitted by this paragraph, but the estimated useful life of such
property shall be redetermined in accordance with Sec. 1.167(b)-2, or
1.167(b)-3, whichever is applicable. The taxpayer shall maintain records
which permit specific identification of the section 1245 property in the
account with respect to which the election is made, and any other
property in such account. The records shall also show for all the
property in the account the date of acquisition, cost or other basis,
amounts recovered through depreciation and other allowances, the
estimated salvage value, the character of the property, and the
remaining useful life of the property. A change to the straight line
method under this paragraph must be adhered to for the entire taxable
year of the change and for all subsequent taxable years unless, with the
consent of the Commissioner, a change to another method is permitted.
[[Page 462]]
(d) Change with respect to section 1250 property. (1) In respect of
his first taxable year beginning after July 24, 1969, a taxpayer may
elect, without the consent of the Commissioner, to change the method of
depreciation of section 1250 property (as defined in section 1250(c))
from any declining balance method or sum of the years-digits method to
the straight line method. With respect to any account (as defined in
Sec. 1.167(a)-7) this change may be made notwithstanding any provision
to the contrary in an agreement under section 167(d), but such change
will constitute (as of the first day of such taxable year) a termination
of such agreement as to all property in such account. With respect to
any account, this change will be permitted only if applied to all the
section 1250 property in the account. The election shall be made by a
statement on, or attached to, the return for such taxable year filed on
or before the last day prescribed by law, including extensions thereof,
for filing such return.
(2) When an election under this paragraph is made in respect of
section 1250 property in an account, the unrecovered cost or other basis
(less a reasonable estimate for salvage) of all the section 1250
property in the account shall be recovered through annual allowances
over the estimated remaining useful life determined in accordance with
the circumstances existing at that time. If there is other property in
such account, the other property shall be placed in a separate account
and depreciated by using the same method as was used before the change
permitted by this paragraph, but the estimated useful life of such
property shall be redetermined in accordance with Sec. 1.167(b)-2 or
Sec. 1.167(b)-3, whichever is applicable. The taxpayer shall maintain
records which permit specific identification of the section 1250
property in the account with respect to which the election is made and
any other property in such account. The records shall also show for all
the property in the account the date of the acquisition, cost or other
basis, amounts recovered through depreciation and other allowances, the
estimated salvage value, the character of the property, and the
estimated remaining useful life of the property. A change to the
straight line method under this paragraph must be adhered to for the
entire taxable year of the change and for all subsequent taxable years
unless, with the consent of the Commissioner, a change to another method
is permitted.
(e) Effective date. This section applies on or after December 30,
2003. For the applicability of regulations before December 30, 2003, see
Sec. 1.167(e)-1 in effect prior to December 30, 2003 (Sec. 1.167(e)-1
as contained in 26 CFR part 1 edition revised as of April 1, 2003).
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6832, 30 FR
8573, July 7, 1965; T.D. 7166, 37 FR 5245, Mar. 11, 1972; T.D. 9105, 69
FR 7, Jan. 2, 2004; T.D. 9307, 71 FR 78068, Dec. 28, 2006]
Sec. 1.167(f)-1 Reduction of salvage value taken into account for
certain personal property.
(a) In general. For taxable years beginning after December 31, 1961,
and ending after October 16, 1962, a taxpayer may reduce the amount
taken into account as salvage value in computing the allowance for
depreciation under section 167(a) with respect to ``personal property''
as defined in section 167(f)(2) and paragraph (b) of this section. The
reduction may be made in an amount which does not exceed 10 percent of
the basis of the property for determining depreciation, as of the time
as of which salvage value is required to be determined (or when salvage
value is redetermined), taking into account all adjustments under
section 1016 other than (1) the adjustment under section 1016(a)(2) for
depreciation allowed or allowable to the taxpayer, and (2) the
adjustment under section 1016(a)(19) for a credit earned by the taxpayer
under section 38, to the extent such adjustment is reflected in the
basis for depreciation. See paragraph (c) of Sec. 1.167(a)-1 for the
definition of salvage value, the time for making the determination, the
redetermination of salvage value, and the general rules with respect to
the treatment of salvage value. See also section 167(g) and Sec.
1.167(g)-1 for basis for depreciation. A reduction of the amount taken
into account as salvage value with respect to any property shall not be
binding with
[[Page 463]]
respect to other property. In no event shall an asset (or an account) be
depreciated below a reasonable salvage value after taking into account
the reduction in salvage value permitted by section 167(f) and this
section.
(b) Definitions and special rules. The following definitions and
special rules apply for purposes of section 167(f) and this section.
(1) Personal property. The term ``personal property'' shall include
only depreciable--
(i) Tangible personal property (as defined in section 48 and the
regulations thereunder) and
(ii) Intangible personal property
which has an estimated useful life (determined at the time of
acquisition) of 3 years or more and which is acquired after October 16,
1962. Such term shall not include livestock. The term ``livestock''
includes horses, cattle, hogs, sheep, goats, and mink and other
furbearing animals, irrespective of the use to which they are put or the
purpose for which they are held. The original use of the property need
not commence with the taxpayer so long as he acquired it after October
16, 1962; thus, the property may be new or used. For purposes of
determining the estimated useful life, the provisions of paragraph (b)
of Sec. 1.167(a)-1 shall be applied. For rules determining when
property is acquired, see subparagraph (2) of this paragraph. For
purposes of determining the types of intangible personal property which
are subject to the allowance for depreciation, see Sec. 1.167(a)-3.
(2) Acquired. In determining whether property is acquired after
October 16, 1962, property shall be deemed to be acquired when reduced
to physical possession, or control. Property which has not been used in
the taxpayer's trade or business or held for the production of income
and which is thereafter converted by the taxpayer to such use shall be
deemed to be acquired on the date of such conversion. In addition,
property shall be deemed to be acquired if constructed, reconstructed,
or erected by the taxpayer. If construction, reconstruction, or erection
by the taxpayer began before October 17, 1962, and was completed after
October 16, 1962, section 167(f) and this section apply only to that
portion of the basis of the property which is properly attributable to
such construction, reconstruction, or erection after October 16, 1962.
Property is considered as constructed, reconstructed, or erected by the
taxpayer if the work is done for him in accordance with his
specifications. The portion of the basis of such property attributable
to construction, reconstruction, or erection after October 16, 1962,
consists of all costs of the property allocable to the period after
October 16, 1962, including the cost or other basis of materials
entering into such work. It is not necessary that such materials be
acquired after October 16, 1962, or that they be new in use. If
construction or erection by the taxpayer began after October 16, 1962,
the entire cost or other basis of such construction or erection
qualifies for the reduction provided for by section 167(f) and this
section. In the case of reconstruction of property, section 167(f) and
this section do not apply to any part of the adjusted basis of such
property on October 16, 1962. For purposes of this section,
construction, reconstruction, or erection by the taxpayer begins when
physical work is started on such construction, reconstruction, or
erection.
(c) Illustrations. The provisions of paragraphs (a) and (b) of this
section may be illustrated by the following examples:
Example 1. Taxpayer A purchases a new asset for use in his business
on January 1, 1963, for $10,000. The asset qualifies for the investment
credit under section 38 and for the additional first-year depreciation
allowance under section 179. A is entitled to an investment credit of
$700 (7%x$10,000) and elects to take an additional first-year
depreciation allowance of $2,000 (20%x$10,000). The basis for
depreciation (determined in accordance with the provisions of section
167(g) and Sec. 1.167(g)-1) is computed as follows:
Purchase price................................................ $10,000
Less: Adjustment required for taxable years $700
beginning before Jan. 1, 1964, under section
1016(a)(19), for the investment credit.............
Adjustment required under section 1016(a)(2) for the 2,000
additional first-year depreciation allowance.......
-----------------------------------------------------
2,700
---------
Basis for depreciation for the taxable year 1963.............. 7,300
===========
[[Page 464]]
However, the basis of the property for determining depreciation as of
the time as of which salvage value is required to be determined is
$10,000, the purchase price of the property. A files his income tax
returns on a calendar year basis and uses the straight line method of
depreciation. A estimates that he will use the asset in his business for
10 years after which it will have a salvage value of $500, which is less
than $1,000 (10%x$10,000, the basis of the property for determining
depreciation as of the time as of which salvage value is required to be
determined). For the taxable year 1963 A may deduct $730 as the
depreciation allowance. As of January 1, 1964, the basis of the asset is
increased by $700 in accordance with paragraph (d) of Sec. 1.48-7. In
computing his total depreciation allowance on the asset, A may reduce
the amount taken into account as salvage value to zero and may claim
depreciation deductions (including the additional first-year
depreciation allowance) totaling $10,000. See paragraph (d) of Sec.
1.48-7 for the computation of depreciation for taxable years beginning
after December 31, 1963, where there is an increase in basis of property
subject to the investment credit.
Example 2. Assume the same facts as in example (1) except that A in
a subsequent taxable year redetermines the estimate of the useful life
of the asset and at the same time also redetermines the estimate of
salvage value. Assume also that at such time the only reductions
reflected in the basis are for depreciation allowed or allowable.
Accordingly, the reduction under section 167(f) and this section will be
computed with regard to the purchase price and not the unrecovered basis
for depreciation at the time of the redetermination.
Example 3. Assume the same facts as in example (1) except that A
estimates that the asset will have a salvage value of $1,200 at the end
of its useful life. In computing his depreciation for the asset, A may
reduce the amount to be taken into account as salvage value to $200
($1,200-$1,000). Accordingly, A may claim depreciation deductions
(including the additional first-year depreciation allowance) totaling
$9,800, i.e., the purchase price of the property ($10,000) less the
amount taken into account as salvage value ($200).
Example 4. Assume the same facts as in example (1) except that the
taxpayer had taken into account salvage value of only $200 but that the
estimated salvage value had actually been $700. The amount of salvage
value taken into account by the taxpayer is permissible since the
reduction of salvage value by $500 ($700-$200) would be within the limit
provided for in section 167 (f), i.e., $1,000 (10%x$10,000).
Example 5. On January 1, 1963, taxpayer B, a taxicab operator,
traded his old taxicab plus cash for a new one, which had an estimated
useful life of three years, in a transaction qualifying as a nontaxable
exchange. The old taxicab had an adjusted basis of $2,500. B was allowed
$3,000 for his old taxicab and paid $1,000 in cash. The basis of the new
taxicab for determining depreciation (as determined under section 167(g)
and Sec. 1.167(g)-1) is the adjusted basis of the old taxicab at the
time of trade-in ($2,500) plus the additional cash paid out ($1,000), or
$3,500. In computing his depreciation allowance on the new taxicab, B
may reduce the amount taken into account as salvage value by $350 (10%
of $3,500).
Example 6. Taxpayer C purchases a new asset for use in his business
on January 1, 1963, for $10,000. At the time of purchase, the asset has
an estimated useful life of 10 years and an estimated salvage value of
$1,500. C elects to compute his depreciation allowance for the asset by
the declining balance method of depreciation, using a rate of 20% which
is twice the normal straight line rate of 10% (without adjustment for
salvage value). C files his income tax returns on a calendar year basis.
In computing his depreciation allowance for the year 1966, C changes his
method of determining the depreciation allowance for the asset from the
declining balance method to the straight line method (in which salvage
value is accounted for in determining the annual depreciation
allowances) in accordance with the provisions of section 167(e) and
paragraph (b) of Sec. 1.167(e)-1. He also wishes to reduce the amount
of salvage value taken into account in accordance with the provisions of
section 167(f) and this section. At the close of the year 1966, the only
reductions reflected in the basis of the asset are for depreciation
allowances. Thus, C may reduce the amount of salvage value taken into
account by $1,000 (10%x$10,000, the basis of the asset when it was
acquired), and, therefore, will account for salvage value of only $500
in computing his depreciation allowance for the asset in 1966 and
subsequent years.
Example 7. Taxpayer D purchases a station wagon for his personal use
on January 1, 1962, for $4,500. On January 1, 1963, D converts the use
of the station wagon to his business, and at that time it has an
estimated useful life of 4 years, an estimated salvage value of $500,
and a basis of $3,000 (as determined under section 167 (g) and Sec.
1.167 (g)-1). Thus, for purposes of section 167 (f) and this section, D
is deemed to have acquired the station wagon on January 1, 1963. D
elects the straight line method of depreciation in computing the
depreciation allowance for the station wagon and also wishes to reduce
the amount of salvage value taken into account in accordance with the
provisions of section 167(f) and this section. Accordingly, D may reduce
the amount of salvage value taken into account by $300 (10% of $3,000).
D files his income tax returns on a calendar year
[[Page 465]]
basis. His depreciation allowance for the year 1963 would be computed as
follows:
Basis for depreciation.............................. ........ $3,000
Less:
Salvage value..................................... $500
Reduction permitted by section 167(f)............. 300
-----------
200
---------
Amount to be depreciated over the useful life................. 2,800
D's depreciation allowance on the station wagon for the year 1963 would
be $700 ($2,800 divided by 4, the remaining useful life).
[T.D. 6712, 29 FR 3654, Mar. 24, 1964, as amended by T.D. 6838, 30 FR
9064, July 20, 1965]
Sec. 1.167(g)-1 Basis for depreciation.
The basis upon which the allowance for depreciation is to be
computed with respect to any property shall be the adjusted basis
provided in section 1011 for the purpose of determining gain on the sale
or other disposition of such property. In the case of property which has
not been used in the trade or business or held for the production of
income and which is thereafter converted to such use, the fair market
value on the date of such conversion, if less than the adjusted basis of
the property at that time, is the basis for computing depreciation.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR
3653, Mar. 24, 1964]
Sec. 1.167(h)-1 Life tenants and beneficiaries of trusts and estates.
(a) Life tenants. In the case of property held by one person for
life with remainder to another person, the deduction for depreciation
shall be computed as if the life tenant were the absolute owner of the
property so that he will be entitled to the deduction during his life,
and thereafter the deduction, if any, shall be allowed to the
remainderman.
(b) Trusts. If property is held in trust, the allowable deduction is
to be apportioned between the income beneficiaries and the trustee on
the basis of the trust income allocable to each, unless the governing
instrument (or local law) requires or permits the trustee to maintain a
reserve for depreciation in any amount. In the latter case, the
deduction is first allocated to the trustee to the extent that income is
set aside for a depreciation reserve, and any part of the deduction in
excess of the income set aside for the reserve shall be apportioned
between the income beneficiaries and the trustee on the basis of the
trust income (in excess of the income set aside for the reserve)
allocable to each. For example:
(1) If under the trust instrument or local law the income of a trust
computed without regard to depreciation is to be distributed to a named
beneficiary, the beneficiary is entitled to the deduction to the
exclusion of the trustee.
(2) If under the trust instrument or local law the income of a trust
is to be distributed to a named beneficiary, but the trustee is directed
to maintain a reserve for depreciation in any amount, the deduction is
allowed to the trustee (except to the extent that income set aside for
the reserve is less than the allowable deduction). The same result would
follow if the trustee sets aside income for a depreciation reserve
pursuant to discretionary authority to do so in the governing
instrument.
No effect shall be given to any allocation of the depreciation deduction
which gives any beneficiary or the trustee a share of such deduction
greater than his pro rata share of the trust income, irrespective of any
provisions in the trust instrument except as otherwise provided in this
paragraph when the trust instrument or local law requires or permits the
trustee to maintain a reserve for depreciation.
(c) Estates. In the case of an estate the allowable deduction shall
be apportioned between the estate and the heirs legatees, and devisees
on the basis of income of the estate which is allocable to each.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR
3653, Mar. 24, 1964]
Sec. 1.167(i)-1 Depreciation of improvements in the case of mines, etc.
Property used in the trade or business or held for the production of
income which is subject to the allowance for depreciation provided in
section 611 shall be treated for all purposes of the Code as if it were
property subject to the allowance for depreciation under section 167.
The preceding sentence
[[Page 466]]
shall not limit the allowance for depreciation otherwise allowable under
section 611.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated, T.D. 6712, 29 FR
3653, Mar. 24, 1964]
Sec. 1.167(l)-1 Limitations on reasonable allowance in case of
property of certain public utilities.
(a) In general--(1) Scope. Section 167(l) in general provides
limitations on the use of certain methods of computing a reasonable
allowance for depreciation under section 167(a) with respect to ``public
utility property'' (see paragraph (b) of this section) for all taxable
years for which a Federal income tax return was not filed before August
1, 1969. The limitations are set forth in paragraph (c) of this section
for ``pre-1970 public utility property'' and in paragraph (d) of this
section for ``post-1969 public utility property.'' Under section 167(l),
a taxpayer may always use a straight line method (or other ``subsection
(l) method'' as defined in paragraph (f) of this section). In general,
the use of a method of depreciation other than a subsection (l) method
is not prohibited by section 167(l) for any taxpayer if the taxpayer
uses a ``normalization method of regulated accounting'' (described in
paragraph (h) of this section). In certain cases, the use of a method of
depreciation other than a subsection (l) method is not prohibited by
section 167(l) if the taxpayer used a ``flow-through method of regulated
accounting'' described in paragraph (i) of this section) for its ``July
1969 regulated accounting period'' (described in paragraph (g) of this
section) whether or not the taxpayer uses either a normalization or a
flow-through method of regulated accounting after its July 1969
regulated accounting period. However, in no event may a method of
depreciation other than a subsection (l) method be used in the case of
pre-1970 public utility property unless such method of depreciation is
the ``applicable 1968 method'' (within the meaning of paragraph (e) of
this section). The normalization requirements of section 167(l) with
respect to public utility property defined in section 167(l)(3)(A)
pertain only to the deferral of Federal income tax liability resulting
from the use of an accelerated method of depreciation for computing the
allowance for depreciation under section 167 and the use of straight
line depreciation for computing tax expense and depreciation expense for
purposes of establishing cost of services and for reflecting operating
results in regulated books of account. Regulations under section 167(l)
do not pertain to other book-tax timing differences with respect to
State income taxes, F.I.C.A. taxes, construction costs, or any other
taxes and items. The rules provided in paragraph (h)(6) of this section
are to insure that the same time period is used to determine the
deferred tax reserve amount resulting from the use of an accelerated
method of depreciation for cost of service purposes and the reserve
amount that may be excluded from the rate base or included in no-cost
capital in determining such cost of services. The formula provided in
paragraph (h)(6)(ii) of this section is to be used in conjunction with
the method of accounting for the reserve for deferred taxes (otherwise
proper under paragraph (h)(2) of this section) in accordance with the
accounting requirements prescribed or approved, if applicable, by the
regulatory body having jurisdiction over the taxpayer's regulated books
of account. The formula provides a method to determine the period of
time during which the taxpayer will be treated as having received
amounts credited or charged to the reserve account so that the
disallowance of earnings with respect to such amounts through rate base
exclusion or treatment as no-cost capital will take into account the
factor of time for which such amounts are held by the taxpayer. The
formula serves to limit the amount of such disallowance.
[[Page 467]]
(2) Methods of depreciation. For purposes of section 167(l), in the
case of a declining balance method each different uniform rate applied
to the unrecovered cost or other basis of the property is a different
method of depreciation. For purposes of section 167(l), a change in a
uniform rate of depreciation due to a change in the useful life of the
property or a change in the taxpayer's unrecovered cost or other basis
for the property is not a change in the method of depreciation. The use
of ``guideline lives'' or ``class lives'' for Federal income tax
purposes and different lives on the taxpayer's regulated books of
account is not treated for purposes of section 167(l) as a different
method of depreciation. Further, the use of an unrecovered cost or other
basis or salvage value for Federal income tax purposes different from
the basis or salvage value used on the taxpayer's regulated books of
account is not treated as a different method of depreciation.
(3) Application of certain other provisions to public utility
property. For rules with respect to application of the investment credit
to public utility property, see section 46(e). For rules with respect to
the application of the class life asset depreciation range system,
including the treatment of the use of ``class lives'' for Federal income
tax purposes and different lives on the taxpayer's regulated books of
account, see Sec. 1.167(a)-11 and Sec. 1.167(a)-12.
(4) Effect on agreements under section 167(d). If the taxpayer has
entered into an agreement under section 167(d) as to any public utility
property and such agreement requires the use of a method of depreciation
prohibited by section 167(l), such agreement shall terminate as to such
property. The termination, in accordance with this subparagraph, shall
not affect any other property (whether or not public utility property)
covered by the agreement.
(5) Effect of change in method of depreciation. If, because the
method of depreciation used by the taxpayer with respect to public
utility property is prohibited by section 167(l), the taxpayer changes
to a method of depreciation not prohibited by section 167(l), then when
the change is made the unrecovered cost or other basis shall be
recovered through annual allowances over the estimated remaining useful
life determined in accordance with the circumstances existing at that
time.
(b) Public utility property--(1) In general. Under section
167(l)(3)(A), property is ``public utility property'' during any period
in which it is used predominantly in a ``section 167(l) public utility
activity''. The term ``section 167(l) public utility activity'' means
the trade or business of the furnishing or sale of--
(i) Electrical energy, water, or sewage disposal services,
(ii) Gas or steam through a local distribution system,
(iii) Telephone services,
(iv) Other communication services (whether or not telephone
services) if furnished or sold by the Communications Satellite
Corporation for purposes authorized by the Communications Satellite Act
of 1962 (47 U.S.C. 701), or
(v) Transportation of gas or steam by pipeline,
if the rates for such furnishing or sale, as the case may be, are
regulated, i.e., have been established or approved by a regulatory body
described in section 167(l)(3)(A). The term ``regulatory body described
in section 167(l)(3)(A)'' means a State (including the District of
Columbia) or political subdivision thereof, any agency or
instrumentality of the United States, or a public service or public
utility commission or other body of any State or political subdivision
thereof similar to such a commission. The term ``established or
approved'' includes the filing of a schedule of rates with a regulatory
body which has the power to approve such rates, even though such body
has taken no action on the filed schedule or generally leaves
undisturbed rates filed by the taxpayer involved.
(2) Classification of property. If property is not used solely in a
section 167(l) public utility activity, such property shall be public
utility property if its predominant use is in a section 167(l) public
utility activity. The predominant use of property for any period shall
be determined by reference to the proper accounts to which expenditures
for such property are
[[Page 468]]
chargeable under the system of regulated accounts required to be used
for the period for which the determination is made and in accordance
with the principles of Sec. 1.46-3(g)(4) (relating to credit for
investment in certain depreciable property). Thus, for example, for
purposes of determining whether property is used predominantly in the
trade or business of the furnishing or sale of transportation of gas by
pipeline, or furnishing or sale of gas through a local distribution
system, or both, the rules prescribed in Sec. 1.46-3(g)(4) apply,
except that accounts 365 through 371, inclusive (Transmission Plant),
shall be added to the accounts enumerated in subdivision (i) of such
paragraph (g)(4).
(c) Pre-1970 public utility property--(1) Definition. (i) Under
section 167(l)(3)(B), the term ``pre-1970 public utility property''
means property which was public utility property at any time before
January 1, 1970. If a taxpayer acquires pre-1970 public utility
property, such property shall be pre-1970 public utility property in the
hands of the taxpayer even though such property may have been acquired
by the taxpayer in an arm's-length cash sale at fair market value or in
a tax-free exchange. Thus, for example, if corporation X which is a
member of the same controlled group of corporations (within the meaning
of section 1563(a)) as corporation Y sells pre-1970 public utility
property to Y, such property is pre-1970 public utility property in the
hands of Y. The result would be the same if X and Y were not members of
the same controlled group of corporations.
(ii) If the basis of public utility property acquired by the
taxpayer in a transaction is determined in whole or in part by reference
to the basis of any of the taxpayer's pre-1970 public utility property
by reason of the application of any provision of the code, and if
immediately after the transaction the adjusted basis of the property
acquired is less than 200 percent of the adjusted basis of such pre-1970
public utility property immediately before the transaction, the property
acquired is pre-1970 public utility property.
(2) Methods of depreciation not prohibited. Under section 167(l)(1),
in the case of pre-1970 public utility property, the term ``reasonable
allowance'' as used in section 167(a) means, for a taxable year for
which a Federal income tax return was not filed before August 1, 1969,
and in which such property is public utility property, an allowance
(allowable without regard to section 167(l)) computed under--
(i) A subsection (l) method, or
(ii) The applicable 1968 method (other than a subsection (l) method)
used by the taxpayer for such property, but only if--
(a) The taxpayer uses in respect of such taxable year a
normalization method of regulated accounting for such property,
(b) The taxpayer used a flow-through method of regulated accounting
for such property for its July 1969 regulated accounting period, or
(c) The taxpayer's first regulated accounting period with respect to
such property is after the taxpayer's July 1969 regulated accounting
period and the taxpayer used a flow-through method of regulated
accounting for its July 1969 regulated accounting period for public
utility property of the same kind (or if there is no property of the
same kind, property of the most similar kind) most recently placed in
service. See paragraph (e)(5) of this section for determination of same
(or similar) kind.
(3) Flow-through method of regulated accounting in certain cases.
See paragraph (e)(6) of this section for treatment of certain taxpayers
with pending applications for change in method of accounting as being
deemed to have used a flow-through method of regulated accounting for
the July 1969 regulated accounting period.
(4) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Corporation X, a calendar-year taxpayer subject to the
jurisdiction of a regulatory body described in section 167(l)(3)(A),
used the straight line method of depreciation (a subsection (l) method)
for all of its public utility property for which depreciation was
allowable on its Federal income tax return for 1967 (the latest taxable
year for which X, prior to August 1, 1969, filed a return). Assume that
under paragraph (e) of this section, X's applicable 1968 method is a
subsection (l) method with respect to all of its public utility
property. Thus, with respect to
[[Page 469]]
its pre-1970 public utility property, X may only use a straight line
method (or any other subsection (l) method) of depreciation for all
taxable years after 1967.
Example 2. Corporation Y, a calendar-year taxpayer subject to the
jurisdiction of the Federal Power Commission, is engaged exclusively in
the transportation of gas by pipeline. On its Federal income tax return
for 1967 (the latest taxable year for which Y, prior to August 1, 1969,
filed a return), Y used the declining balance method of depreciation
using a rate of 150 percent of the straightline rate for all of its
nonsection 1250 public utility property with respect to which
depreciation was allowable. Assume that with respect to all of such
property, Y's applicable 1968 method under paragraph (e) of this section
is such 150 percent declining balance method. Assume that Y used a
normalization method of regulated accounting for all relevant regulated
accounting periods. If Y continues to use a normalization method of
regulated accounting, Y may compute its reasonable allowance for
purposes of section 167(a) using such 150 percent declining balance
method for its nonsection 1250 pre-1970 public utility property for all
taxable years beginning with 1968, provided the use of such method is
allowable without regard to section 167(l). Y may also use a subsection
(l) method for any of such pre-1970 public utility property for all
taxable years beginning after 1967. However, because each different
uniform rate applied to the basis of the property is a different method
of depreciation, Y may not use a declining balance method of
depreciation using a rate of twice the straight line rate for any of
such pre-1970 public utility property for any taxable year beginning
after 1967.
Example 3. Assume the same facts as in example (2) except that with
respect to all of its nonsection 1250 pre-1970 public utility property
accounted for in its July 1969 regulated accounting period Y used a
flow-through method of regulated accounting for such period. Assume
further that such property is the property on the basis of which the
applicable 1968 method is established for pre-1970 public utility
property of the same kind, but having a first regulated accounting
period after the taxpayer's July 1969 regulated accounting period.
Beginning with 1968, with respect to such property Y may compute its
reasonable allowance for purposes of section 167(a) using the declining
balance method of depreciation and a rate of 150 percent of the straight
line rate, whether it uses a normalization or flow-through method of
regulated accounting after its July 1969 regulated accounting period,
provided the use of such method is allowable without regard to section
167(l).
(d) Post-1969 public utility property--(1) In general. Under section
167(l)(3)(C), the term ``post-1969 public utility property'' means any
public utility property which is not pre-1970 public utility property.
(2) Methods of depreciation not prohibited. Under section 167(l)(2),
in the case of post-1969 public utility property, the term ``reasonable
allowance'' as used in section 167(a) means, for a taxable year, an
allowance (allowable without regard to section 167(l)) computed under--
(i) A subsection (l) method,
(ii) A method of depreciation otherwise allowable under section 167
if, with respect to the property, the taxpayer uses in respect of such
taxable year a normalization method of regulated accounting, or
(iii) The taxpayer's applicable 1968 method (other than a subsection
(l) method) with respect to the property in question, if the taxpayer
used a flow-through method of regulated accounting for its July 1969
regulated accounting period for the property of the same (or similar)
kind most recently placed in service, provided that the property in
question is not property to which an election under section 167(l)(4)(A)
applies. See Sec. 1.167(l)(2) for rules with respect to an election
under section 167(l)(4)(A). See paragraph (e)(5) of this section for
definition of same (or similar) kind.
(3) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Corporation X is engaged exclusively in the trade or
business of the transportation of gas by pipeline and is subject to the
jurisdiction of the Federal Power Commission. With respect to all its
public utility property, X's applicable 1968 method (as determined under
paragraph (e) of this section) is the straight line method of
depreciation. X may determine its reasonable allowance for depreciation
under section 167(a) with respect to its post-1969 public utility
property under a straight line method (or other subsection (l) method)
or, if X uses a normalization method of regulated accounting, any other
method of depreciation, provided that the use of such other method is
allowable under section 167 without regard to section 167(l).
Example 2. Assume the same facts as in example (1) except that with
respect to all of X's post-1969 public utility property the applicable
1968 method (as determined under paragraph (e) of this section) is the
declining
[[Page 470]]
balance method using a rate of 150 percent of the straight line rate.
Assume further that all of X's pre-1970 public utility property was
accounted for in its July 1969 regulated accounting period, and that X
used a flow-through method of regulated accounting for such period. X
may determine its reasonable allowance for depreciation under section
167 with respect to its post-1969 public utility property by using the
straight line method of depreciation (or any other subsection (l)
method), by using any method otherwise allowable under section 167 (such
as a declining balance method) if X uses a normalization method of
regulated accounting, or, by using the declining balance method using a
rate of 150 percent of the straight line rate, whether or not X uses a
normalization or a flow-through method of regulated accounting.
(e) Applicable 1968 method--(1) In general. Under section
167(l)(3)(D), except as provided in subparagraphs (3) and (4) of this
paragraph, the term ``applicable 1968 method'' means with respect to any
public utility property--
(i) The method of depreciation properly used by the taxpayer in its
Federal income tax return with respect to such property for the latest
taxable year for which a return was filed before August 1, 1969,
(ii) If subdivision (i) of this subparagraph does not apply, the
method of depreciation properly used by the taxpayer in its Federal
income tax return for the latest taxable year for which a return was
filed before August 1, 1969, with respect to public utility property of
the same kind (or if there is no property of the same kind, property of
the most similar kind) most recently placed in service before the end of
such latest taxable year, or
(iii) If neither subdivision (i) nor (ii) of this subparagraph
applies, a subsection (l) method.
If, on or after August 1, 1969, the taxpayer files an amended return for
the taxable year referred to in subdivisions (i) and (ii) of this
subparagraph, such amended return shall not be taken into consideration
in determining the applicable 1968 method. The term ``applicable 1968
method'' if such new method results to any public utility property, for
the year of change and subsequent years, a method of depreciation
otherwise allowable under section 167 to which the taxpayer changes from
an applicable 1968 method if such new method results in a lesser
allowance for depreciation for such property under section 167 in the
year of change and the taxpayer secures the Commissioner's consent to
the change in accordance with the procedures of section 446(e) and Sec.
1.446-1.
(2) Placed in service. For purposes of this section, property is
placed in service on the date on which the period for depreciation
begins under section 167. See, for example, Sec. 1.167(a)-10(b) and
Sec. 1.167(a)-11(c)(2). If under an averaging convention property which
is placed in service (as defined in Sec. 1.46-3(d)(ii)) by the taxpayer
on different dates is treated as placed in service on the same date,
then for purposes of section 167(l) the property shall be treated as
having been placed in service on the date the period for depreciation
with respect to such property would begin under section 167 absent such
averaging convention. Thus, for example, if, except for the fact that
the averaging convention used assumes that all additions and retirements
made during the first half of the year were made on the first day of the
year, the period of depreciation for two items of public utility
property would begin on January 10 and March 15, respectively, then for
purposes of determining the property of the same (or similar) kind most
recently placed in service, such items of property shall be treated as
placed in service on January 10 and March 15, respectively.
(3) Certain section 1250 property. If a taxpayer is required under
section 167(j) to use a method of depreciation other than its applicable
1968 method with respect to any section 1250 property, the term
``applicable 1968 method'' means the method of depreciation allowable
under section 167(j) which is the most nearly comparable method to the
applicable 1968 method determined under subparagraph (1) of this
paragraph. For example, if the applicable 1968 method on new section
1250 property is the declining balance method using 200 percent of the
straight line rate, the most nearly comparable method allowable for new
section 1250 property under section 167(j) would be the declining
balance method using 150 percent of the straight line rate. If the
applicable 1968 method determined
[[Page 471]]
under subparagraph (1) of this paragraph is the sum of the years-digits
method, the term ``most nearly comparable method'' refers to any method
of depreciation allowable under section 167(j).
(4) Applicable 1968 method in certain cases. (i)(a) Under section
167(l)(3)(E), if the taxpayer evidenced within the time and manner
specified in (b) of this subdivision (i) the intent to use a method of
depreciation under section 167 (other than its applicable 1968 method as
determined under subparagraph (1) or (3) of this paragraph or a
subsection (l) method) with respect to any public utility property, such
method of depreciation shall be deemed to be the taxpayer's applicable
1968 method with respect to such public utility property and public
utility property of the same (or most similar) kind subsequently placed
in service.
(b) Under this subdivision (i), the intent to use a method of
depreciation under section 167 is evidenced--
(1) By a timely application for permission for a change in method of
accounting filed by the taxpayer before August 1, 1969, or
(2) By the use of such method of depreciation in the computation by
the taxpayer of its tax expense for purposes of reflecting operating
results in its regulated books of account for its July 1969 regulated
accounting period, as established in the manner prescribed in paragraph
(g)(1) (i), (ii), or (iii) of this section.
(ii)(a) If public utility property is acquired in a transaction in
which its basis in the hands of the transferee is determined in whole or
in part by reference to its basis in the hands of the transferor by
reason of the application of any provision of the Code, or in a transfer
(including any purchase for cash or in exchange) from a related person,
then in the hands of the transferee the applicable 1968 method with
respect to such property shall be determined by reference to the
treatment in respect of such property in the hands of the transferor.
(b) For purposes of this subdivision (ii), the term ``related
person'' means a person who is related to another person if either
immediately before or after the transfer--
(1) The relationship between such persons would result in a
disallowance of losses under section 267 (relating to disallowance of
losses, etc., between related taxpayers) or section 707(b) (relating to
losses disallowed, etc., between partners and controlled partnerships)
and the regulations thereunder, or
(2) Such persons are members of the same controlled group of
corporations, as defined in section 1563(a) (relating to definition of
controlled group of corporations), except that ``more than 50 percent''
shall be substituted for ``at least 80 percent'' each place it appears
in section 1563(a) and the regulations thereunder.
(5) Same or similar. The classification of property as being of the
same (or similar) kind shall be made by reference to the function of the
public utility to which the primary use of the property relates.
Property which performs the identical function in the identical manner
shall be treated as property of the same kind. The determination that
property is of a similar kind shall be made by reference to the proper
account to which expenditures for the property are chargeable under the
system of regulated accounts required to be used by the taxpayer for the
period in which the property in question was acquired. Property, the
expenditure for which is chargeable to the same account, is property of
the most similar kind. Property, the expenditure for which is chargeable
to an account for property which serves the same general function, is
property of a similar kind. Thus, for example, if corporation X, a
natural gas company, subject to the jurisdiction of the Federal Power
Commission, had property properly chargeable to account 366 (relating to
transmission plant structures and improvements) acquired an additional
structure properly chargeable to account 366, under the uniform system
of accounts prescribed for natural gas companies (class A and class B)
by the Federal Power Commission, effective September 1, 1968, the
addition would constitute property of the same kind if it performed the
identical function in the identical manner. If, however, the addition
did not perform the identical function in the identical manner, it
[[Page 472]]
would be property of the most similar kind.
(6) Regulated method of accounting in certain cases. Under section
167(l)(4)(B), if with respect to any pre-1970 public utility property
the taxpayer filed a timely application for change in method of
accounting referred to in subparagraph (4)(i)(b)(1) of this paragraph
and with respect to property of the same (or similar) kind most recently
placed in service the taxpayer used a flow-through method of regulated
accounting for its July 1969 regulated accounting period, then for
purposes of section 167(l)(1)(B) and paragraph (c) of this section the
taxpayer shall be deemed to have used a flow-through method of regulated
accounting with respect to such pre-1970 public utility property.
(7) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. Corporation X is a calendar-year taxpayer. On its Federal
income tax return for 1967 (the latest taxable year for which X, prior
to August 1, 1969, filed a return) X used a straight line method of
depreciation with respect to certain public utility property placed in
service before 1965 and used the declining balance method of
depreciation using 200 percent of the straight line rate (double
declining balance) with respect to the same kind of public utility
property placed in service after 1964. In 1968 and 1970, X placed in
service additional public utility property of the same kind. The
applicable 1968 method with respect to the above described public
utility property is shown in the following chart:
----------------------------------------------------------------------------------------------------------------
Property held in 1970 Placed in service Method on 1967 return Applicable 1968 method
----------------------------------------------------------------------------------------------------------------
Group 1.............................. Before 1965............ Straight line.......... Straight line.
Group 2.............................. After 1964 and before Double declining Double declining
1968. balance. balance.
Group 3.............................. After 1967 and before ....................... Do.
1969.
Group 4.............................. After 1968............. ....................... Do.
----------------------------------------------------------------------------------------------------------------
Example 2. Corporation Y is a calendar-year taxpayer engaged
exclusively in the trade or business of the furnishing of electrical
energy. In 1954, Y placed in service hydroelectric generators and for
all purposes Y has taken straight line depreciation with respect to such
generators. In 1960, Y placed in service fossil fuel generators and for
all purposes since 1960 has used the declining balance method of
depreciation using a rate of 150 percent of the straight line rate
(computed without reduction for salvage) with respect to such
generators. After 1960 and before 1970 Y did not place in service any
generators. In 1970, Y placed in service additional hydroelectric
generators. The applicable 1968 method with respect to the hydroelectric
generators placed in service in 1970 would be the straight line method
because it was the method used by Y on its return for the latest taxable
year for which Y filed a return before August 1, 1969, with respect to
property of the same kind (i.e., hydroelectric generators) most recently
placed in service.
Example 3. Assume the same facts as in example (2), except that the
generators placed in service in 1970 were nuclear generators. The
applicable 1968 method with respect to such generators is the declining
balance method using a rate of 150 percent of the straight line rate
because, with respect to property of the most similar kind (fossil fuel
generators) most recently placed in service, Y used such declining
balance method on its return for the latest taxable year for which it
filed a return before August 1, 1969.
(f) Subsection (l) method. Under section 167(l)(3)(F), the term
``subsection (l) method'' means a reasonable and consistently applied
ratable method of computing depreciation which is allowable under
section 167(a), such as, for example, the straight line method or a unit
of production method or machine-hour method. The term ``subsection (l)
method'' does not include any declining balance method (regardless of
the uniform rate applied), sum of the years-digits method, or method of
depreciation which is allowable solely by reason of section 167(b)(4) or
(j)(1)(C).
(g) July 1969 regulated accounting period--(1) In general. Under
section 167(l)(3)(I), the term ``July 1969 regulated accounting period''
means the taxpayer's latest accounting period ending before August 1,
1969, for which the taxpayer regularly computed, before January 1, 1970,
its tax expense for purposes of reflecting operating results in its
regulated books of account. The computation by the taxpayer of such tax
expense may be established by reference to the following:
(i) The most recent periodic report of a period ending before August
1, 1969, required by a regulatory body described in section 167(l)(3)(A)
having jurisdiction over the taxpayer's regulated books of account which
was filed with such body before January 1, 1970 (whether or not such
body has jurisdiction over rates).
[[Page 473]]
(ii) If subdivision (i) of this subparagraph does not apply, the
taxpayer's most recent report to its shareholders for a period ending
before August 1, 1969, but only if such report was distributed to the
shareholders before January 1, 1970, and if the taxpayer's stocks or
securities are traded in an established securities market during such
period. For purposes of this subdivision, the term ``established
securities market'' has the meaning assigned to such term in Sec.
1.453-3(d)(4).
(iii) If subdivisions (i) and (ii) of this subparagraph do not
apply, entries made to the satisfaction of the district director before
January 1, 1970, in its regulated books of account for its most recent
accounting period ending before August 1, 1969.
(2) July 1969 method of regulated accounting in certain
acquisitions. If public utility property is acquired in a transaction in
which its basis in the hands of the transferee is determined in whole or
in part by reference to its basis in the hands of the transferor by
reason of the application of any provision of the Code, or in a transfer
(including any purchase for cash or in exchange) from a related person,
then in the hands of the transferee the method of regulated accounting
for such property's July 1969 regulated accounting period shall be
determined by reference to the treatment in respect of such property in
the hands of the transferor. See paragraph (e)(4)(ii) of this section
for definition of ``related person''.
(3) Determination date. For purposes of section 167(l), any
reference to a method of depreciation under section 167(a), or a method
of regulated accounting, taken into account by the taxpayer in computing
its tax expense for its July 1969 regulated accounting period shall be a
reference to such tax expense as shown on the periodic report or report
to shareholders to which subparagraph (1) (i) or (ii) of this paragraph
applies or the entries made on the taxpayer's regulated books of account
to which subparagraph (1)(iii) of this paragraph applies. Thus, for
example, assume that regulatory body A having jurisdiction over public
utility property with respect to X's regulated books of account requires
X to reflect its tax expense in such books using the same method of
depreciation which regulatory body B uses for determining X's cost of
service for ratemaking purposes. If in 1971, in the course of approving
a rate change for X, B retroactively determines X's cost of service for
ratemaking purposes for X's July 1969 regulated accounting period using
a method of depreciation different from the method reflected in X's
regulated books of account as of January 1, 1970, the method of
depreciation used by X for its July 1969 regulated accounting period
would be determined without reference to the method retroactively used
by B in 1971.
(h) Normalization method of accounting--(1) In general. (i) Under
section 167(l), a taxpayer uses a normalization method of regulated
accounting with respect to public utility property--
(a) If the same method of depreciation (whether or not a subsection
(l) method) is used to compute both its tax expense and its depreciation
expense for purposes of establishing cost of service for ratemaking
purposes and for reflecting operating results in its regulated books of
account, and
(b) If to compute its allowance for depreciation under section 167
it uses a method of depreciation other than the method it used for
purposes described in (a) of this subdivision, the taxpayer makes
adjustments consistent with subparagraph (2) of this paragraph to a
reserve to reflect the total amount of the deferral of Federal income
tax liability resulting from the use with respect to all of its public
utility property of such different methods of depreciation.
(ii) In the case of a taxpayer described in section 167(l) (1) (B)
or (2) (C), the reference in subdivision (i) of this subparagraph shall
be a reference only to such taxpayer's ``qualified public utility
property''. See Sec. 1.167(l)-2(b) for definition of ``qualified public
utility property''.
(iii) Except as provided in this subparagraph, the amount of Federal
income tax liability deferred as a result of the use of different method
of depreciation under subdivision (i) of this subparagraph is the excess
(computed without regard to credits) of the amount the tax liability
would have been had a subsection (l) method been used over the amount of
the actual tax
[[Page 474]]
liability. Such amount shall be taken into account for the taxable year
in which such different methods of depreciation are used. If, however,
in respect of any taxable year the use of a method of depreciation other
than a subsection (l) method for purposes of determining the taxpayer's
reasonable allowance under section 167(a) results in a net operating
loss carryover (as determined under section 172) to a year succeeding
such taxable year which would not have arisen (or an increase in such
carryover which would not have arisen) had the taxpayer determined his
reasonable allowance under section 167(a) using a subsection (l) method,
then the amount and time of the deferral of tax liability shall be taken
into account in such appropriate time and manner as is satisfactory to
the district director.
(2) Adjustments to reserve. (i) The taxpayer must credit the amount
of deferred Federal income tax determined under subparagraph (1)(i) of
this paragraph for any taxable year to a reserve for deferred taxes, a
depreciation reserve, or other reserve account. The taxpayer need not
establish a separate reserve account for such amount but the amount of
deferred tax determined under subparagraph (1) (i) of this paragraph
must be accounted for in such a manner so as to be readily identifiable.
With respect to any account, the aggregate amount allocable to deferred
tax under section 167(l) shall not be reduced except to reflect the
amount for any taxable year by which Federal income taxes are greater by
reason of the prior use of different methods of depreciation under
subparagraph (1)(i) of this paragraph. An additional exception is that
the aggregate amount allocable to deferred tax under section 167(l) may
be properly adjusted to reflect asset retirements or the expiration of
the period for depreciation used in determining the allowance for
depreciation under section 167(a).
(ii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. Corporation X is exclusively engaged in the
transportation of gas by pipeline subject to the jurisdiction of the
Federal Power Commission. With respect to its post-1969 public utility
property, X is entitled under section 167(l)(2)(B) to use a method of
depreciation other than a subsection (l) method if it uses a
normalization method of regulated accounting. With respect to such
property, X has not made any election under Sec. 1.167(a)-11 (relating
to depreciation based on class lives and asset depreciation ranges). In
1972, X places in service public utility property with an unadjusted
basis of $2 million, and an estimated useful life of 20 years. X uses
the declining balance method of depreciation with a rate twice the
straight line rate. If X uses a normalization method of regulated
accounting, the amount of depreciation allowable under section 167(a)
with respect to such property for 1972 computed under the double
declining balance method would be $200,000. X computes its tax expense
and depreciation expense for purposes of determining its cost of service
for rate-making purposes and for reflecting operating results in its
regulated books of account using the straight line method of
depreciation (a subsection (l) method). A depreciation allowance
computed in this manner is $100,000. The excess of the depreciation
allowance determined under the double declining balance method
($200,000) over the depreciation expense computed using the straight
line method ($100,000) is $100,000. Thus, assuming a tax rate of 48
percent, X used a normalization method of regulated accounting for 1972
with respect to property placed in service that year if for 1972 it
added to a reserve $48,000 as taxes deferred as a result of the use by X
of a method of depreciation for Federal income tax purposes different
from that used for establishing its cost of service for ratemaking
purposes and for reflecting operating results in its regulated books of
account.
Example 2. Assume the same facts as in example (1), except that X
elects to apply Sec. 1.167(a)-11 with respect to all eligible property
placed in service in 1972. Assume further that all property X placed in
service in 1972 is eligible property. One hudnred percent of the asset
guideline period for such property is 22 years and the asset
depreciation range is from 17.5 years to 26.5 years. X uses the double
declining balance method of depreciation, selects an asset depreciation
period of 17.5 years, and applies the half-year convention (described in
Sec. 1.167(a)-11(c)(2)(iii)). In 1972, the depreciation allowable under
section 167(a) with respect to property placed in service in 1972 is
$114,285 (determined without regard to the normalization requirements in
Sec. 1.167(a)-11(b)(6) and in section 167(l)). X computes its tax
expense for purposes of determining its cost of service for ratemaking
purposes and for reflecting operating results in its regulated books of
account using the straight line method of depreciation (a subsection (l)
method), an estimated useful life of 22 years (that is, 100 percent of
the asset guideline period), and the
[[Page 475]]
half-year convention. A depreciation allowance computed in this manner
is $45,454. Assuming a tax rate of 48 percent, the amount that X must
add to a reserve for 1972 with respect to property placed in service
that year in order to qualify as using a normalization method of
regulated accounting under section 167(l) (3) (G) is $27,429 and the
amount in order to satisfy the normalization requirements of Sec.
1.167(a)-11(b)(6) is $5,610. X determined such amounts as follows:
(1) Depreciation allowance on tax return (determined without $114,285
regard to section 167(l) and Sec. 1.167(a)-11(b) (6))....
(2) Line (1), recomputed using a straight line method....... 57,142
-----------
(3) Difference in depreciation allowance attributable to $57,143
different methods (line (1) minus line (2))................
(4) Amount to add to reserve under this paragraph (48 27,429
percent of line (3)).......................................
===========
(5) Amount in line (2)...................................... $57,142
(6) Line (5), recomputed by using an estimated useful life 45,454
of 22 years and the half-year convention...................
-----------
(7) Difference in depreciation allowance attributable to $11,688
difference in depreciation periods.........................
(8) Amount to add to reserve under Sec. 1.167(a)-11(b) (6) 5,610
(ii) (48 percent of line (7))..............................
===========
If, for its depreciation expense for purposes of determining its cost of
service for ratemaking purposes and for reflecting operating results in
its regulated books of account, X had used a period in excess of the
asset guideline period of 22 years, the total amount in lines (4) and
(8) in this example would not be changed.
Example 3. Corporation Y, a calendar-year taxpayer which is engaged
in furnishing electrical energy, made the election provided by section
167(l) (4) (a) with respect to its ``qualified public utility property''
(as defined in Sec. 1.167(l)-2(b)). In 1971, Y placed in service
qualified public utility property which had an adjusted basis of $2
million, estimated useful life of 20 years, and no salvage value. With
respect to property of the same kind most recently placed in service, Y
used a flow-through method of regulated accounting for its July 1969
regulated accounting period and the applicable 1968 method is the
declining balance method of depreciation using 200 percent of the
straight line rate. The amount of depreciation allowable under the
double declining balance method with respect to the qualified public
utility property would be $200,000. Y computes its tax expense and
depreciation expense for purposes of determining its cost of service for
ratemaking purposes and for reflecting operating results in its
regulated books of account using the straight line method of
depreciation. A depreciation allowance with respect to the qualified
public utility property determined in this manner is $100,000. The
excess of the depreciation allowance determined under the double
declining balance method ($200,000) over the depreciation expense
computed using the straight line method ($100,000) is $100,000. Thus,
assuming a tax rate of 48 percent, Y used a normalization method of
regulated accounting for 1971 if for 1971 it added to a reserve $48,000
as tax deferred as a result of the use by Y of a method of depreciation
for Federal income tax purposes with respect to its qualified public
utility property which method was different from that used for
establishing its cost of service for ratemaking purposes and for
reflecting operating results in its regulated books of account for such
property.
Example 4. Corporation Z, exclusively engaged in a public utility
activity did not use a flow-through method of regulated accounting for
its July 1969 regulated accounting period. In 1971, a regulatory body
having jurisdiction over all of Z's property issued an order applicable
to all years beginning with 1968 which provided, in effect, that Z use
an accelerated method of depreciation for purposes of section 167 and
for determining its tax expenses for purposes of reflecting operating
results in its regulated books of account. The order further provided
that Z normalize 50 percent of the tax deferral resulting from the use
of the accelerated method of depreciation and that Z flow-through 50
percent of the tax deferral resulting therefrom. Under section 167(l),
the method of accounting provided in the order would not be a
normalization method of regulated accounting because Z would not be
permitted to normalize 100 percent of the tax deferral resulting from
the use of an accelerated method of depreciation. Thus, with respect to
its public utility property for purposes of section 167, Z may only use
a subsection (l) method of depreciation.
Example 5. Assume the same facts as in example (4) except that the
order of the regulatory body provided, in effect, that Z normalize 100
percent of the tax deferral with respect to 50 percent of its public
utility property and flow-through the tax savings with respect to the
other 50 percent of its property. Because the effect of such an order
would allow Z to flow-through a portion of the tax savings resulting
from the use of an accelerated method of depreciation, Z would not be
using a normalization method of regulated accounting with respect to any
of its properties. Thus, with respect to its public utility property for
purposes of section 167, Z may only use a subsection (l) method of
depreciation.
(3) Establishing compliance with normalization requirements in
respect of operating books of account. The taxpayer may establish
compliance with the requirement in subparagraph (l)(i) of this
[[Page 476]]
paragraph in respect of reflecting operating results, and adjustments to
a reserve, in its operating books of account by reference to the
following:
(i) The most recent periodic report for a period beginning before
the end of the taxable year, required by a regulatory body described in
section 167(l)(3)(A) having jurisdiction over the taxpayer's regulated
operating books of account which was filed with such body before the due
date (determined with regard to extensions) of the taxpayer's Federal
income tax return for such taxable year (whether or not such body has
jurisdiction over rates).
(ii) If subdivision (i) of this subparagraph does not apply, the
taxpayer's most recent report to its shareholders for the taxable year
but only if (a) such report was distributed to the shareholders before
the due date (determined with regard to extensions) of the taxpayer's
Federal income tax return for the taxable year and (b) the taxpayer's
stocks or securities are traded in an established securities market
during such taxable year. For purposes of this subdivision, the term
``established securities market'' has the meaning assigned to such term
in Sec. 1.453-3(d)(4).
(iii) If neither subdivision (i) nor (ii) of this subparagraph
applies, entries made to the satisfaction of the district director
before the due date (determined with regard to extensions) of the
taxpayer's Federal income tax return for the taxable year in its
regulated books of account for its most recent period beginning before
the end of such taxable year.
(4) Establishing compliance with normalization requirements in
computing cost of service for ratemaking purposes. (i) In the case of a
taxpayer which used a flow-through method of regulated accounting for
its July 1969 regulated accounting period or thereafter, with respect to
all or a portion of its pre-1970 public utility property, if a
regulatory body having jurisdiction to establish the rates of such
taxpayer as to such property (or a court which has jurisdiction over
such body) issues an order of general application (or an order of
specific application to the taxpayer) which states that such regulatory
body (or court) will permit a class of taxpayers of which such taxpayer
is a member (or such taxpayer) to use the normalization method of
regulated accounting to establish cost of service for ratemaking
purposes with respect to all or a portion of its public utility
property, the taxpayer will be presumed to be using the same method of
depreciation to compute both its tax expense and its depreciation
expense for purposes of establishing its cost of service for ratemaking
purposes with respect to the public utility property to which such order
applies. In the event that such order is in any way conditional, the
preceding sentence shall not apply until all of the conditions contained
in such order which are applicable to the taxpayer have been fulfilled.
The taxpayer shall establish to the satisfaction of the Commissioner or
his delegate that such conditions have been fulfilled.
(ii) In the case of a taxpayer which did not use the flow-through
method of regulated accounting for its July 1969 regulated accounting
period or thereafter (including a taxpayer which used a subsection (l)
method of depreciation to compute its allowance for depreciation under
section 167(a) and to compute its tax expense for purposes of reflecting
operating results in its regulated books of account), with respect to
any of its public utility property, it will be presumed that such
taxpayer is using the same method of depreciation to compute both its
tax expense and its depreciation expense for purposes of establishing
its cost of service for ratemaking purposes with respect to its post-
1969 public utility property. The presumption described in the preceding
sentence shall not apply in any case where there is (a) an expression of
intent (regardless of the manner in which such expression of intent is
indicated) by the regulatory body (or bodies), having jurisdiction to
establish the rates of such taxpayer, which indicates that the policy of
such regulatory body is in any way inconsistent with the use of the
normalization method of regulated accounting by such taxpayer or by a
class of taxpayers of which such taxpayer is a member, or (b) a decision
by a court having jurisdiction over such regulatory body which decision
is in any way inconsistent with the use of
[[Page 477]]
the normalization method of regulated accounting by such taxpayer or a
class of taxpayers of which such taxpayer is a member. The presumption
shall be applicable on January 1, 1970, and shall, unless rebutted, be
effective until an inconsistent expression of intent is indicated by
such regulatory body or by such court. An example of such an
inconsistent expression of intent is the case of a regulatory body which
has, after the July 1969 regulated accounting period and before January
1, 1970, directed public utilities subject to its ratemaking
jurisdiction to use a flow-through method of regulated accounting, or
has issued an order of general application which states that such agency
will direct a class of public utilities of which the taxpayer is a
member to use a flow-through method of regulated accounting. The
presumption described in this subdivision may be rebutted by evidence
that the flow-through method of regulated accounting is being used by
the taxpayer with respect to such property.
(iii) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. Corporation X is a calendar-year taxpayer and its
``applicable 1968 method'' is a straight line method of depreciation.
Effective January 1, 1970, X began collecting rates which were based on
a sum of the years-digits method of depreciation and a normalization
method of regulated accounting which rates had been approved by a
regulatory body having jurisdiction over X. On October 1, 1971, a court
of proper jurisdiction annulled the rate order prospectively, which
annulment was not appealed, on the basis that the regulatory body had
abused its discretion by determining the rates on the basis of a
normalization method of regulated accounting. As there was no
inconsistent expression of intent during 1970 or prior to the due date
of X's return for 1970, X's use of the sum of the years-digits method of
depreciation for purposes of section 167 on such return was proper. For
1971, the presumption is in effect through September 30. During 1971, X
may use the sum of the years-digits method of depreciation for purposes
of section 167 from January 1 through September 30, 1971. After
September 30, 1971, and for taxable years after 1971, X must use a
straight line method of depreciation until the inconsistent court
decision is no longer in effect.
Example 2. Assume the same facts as in example (1), except that
pursuant to the order of annulment, X was required to refund the portion
of the rates attributable to the use of the normalization method of
regulated accounting. As there was no inconsistent expression of intent
during 1970 or prior to the due date of X's return for 1970, X has the
benefit of the presumption with respect to its use of the sum of the
years-digits method of depreciation for purposes of section 167, but
because of the retroactive nature of the rate order X must file an
amended return for 1970 using a straight line method of depreciation. As
the inconsistent decision by the court was handed down prior to the due
date of X's Federal income tax return for 1971, for 1971 and thereafter
the presumption of subdivision (ii) of this subparagraph does not apply.
X must file its Federal income tax returns for such years using a
straight line method of depreciation.
Example 3. Assume the same facts as in example (2), except that the
annulment order was stayed pending appeal of the decision to a court of
proper appellate jurisdiction, X has the benefit of the presumption as
described in example (2) for the year 1970, but for 1971 and thereafter
the presumption of subdivision (ii) of this subparagraph does not apply.
Further, X must file an amended return for 1970 using a straight line
method of depreciation and for 1971 and thereafter X must file its
returns using a straight line method of depreciation unless X and the
district director have consented in writing to extend the time for
assessment of tax for 1970 and thereafter with respect to the issue of
normalization method of regulated accounting for as long as may be
necessary to allow for resolution of the appeal with respect to the
annulment of the rate order.
(5) Change in method of regulated accounting. The taxpayer shall
notify the district director of a change in its method of regulated
accounting, an order by a regulatory body or court that such method be
changed, or an interim or final rate determination by a regulatory body
which determination is inconsistent with the method of regulated
accounting used by the taxpayer immediately prior to the effective date
of such rate determination. Such notification shall be made within 90
days of the date that the change in method, the order, or the
determination is effective. In the case of a change in the method of
regulated accounting, the taxpayer shall recompute its tax liability for
any affected taxable year and such recomputation shall be made in the
form of an amended return where necessary unless the taxpayer and the
district director have consented in
[[Page 478]]
writing to extend the time for assessment of tax with respect to the
issue of normalization method of regulated accounting.
(6) Exclusion of normalization reserve from rate base. (i)
Notwithstanding the provisions of subparagraph (1) of this paragraph, a
taxpayer does not use a normalization method of regulated accounting if,
for ratemaking purposes, the amount of the reserve for deferred taxes
under section 167(l) which is excluded from the base to which the
taxpayer's rate of return is applied, or which is treated as no-cost
capital in those rate cases in which the rate of return is based upon
the cost of capital, exceeds the amount of such reserve for deferred
taxes for the period used in determining the taxpayer's tax expense in
computing cost of service in such ratemaking.
(ii) For the purpose of determining the maximum amount of the
reserve to be excluded from the rate base (or to be included as no-cost
capital) under subdivision (i) of this subparagraph, if solely an
historical period is used to determine depreciation for Federal income
tax expense for ratemaking purposes, then the amount of the reserve
account for the period is the amount of the reserve (determined under
subparagraph (2) of this paragraph) at the end of the historical period.
If solely a future period is used for such determination, the amount of
the reserve account for the period is the amount of the reserve at the
beginning of the period and a pro rata portion of the amount of any
projected increase to be credited or decrease to be charged to the
account during such period. If such determination is made by reference
both to an historical portion and to a future portion of a period, the
amount of the reserve account for the period is the amount of the
reserve at the end of the historical portion of the period and a pro
rata portion of the amount of any projected increase to be credited or
decrease to be charged to the account during the future portion of the
period. The pro rata portion of any increase to be credited or decrease
to be charged during a future period (or the future portion of a part-
historical and part-future period) shall be determined by multiplying
any such increase or decrease by a fraction, the numerator of which is
the number of days remaining in the period at the time such increase or
decrease is to be accrued, and the denominator of which is the total
number of days in the period (or future portion).
(iii) The provisions of subdivision (i) of this subparagraph shall
not apply in the case of a final determination of a rate case entered on
or before May 31, 1973. For this purpose, a determination is final if
all rights to request a review, a rehearing, or a redetermination by the
regulatory body which makes such determination have been exhausted or
have lapsed. The provisions of subdivision (ii) of this subparagraph
shall not apply in the case of a rate case filed prior to June 7, 1974
for which a rate order is entered by a regulatory body having
jurisdiction to establish the rates of the taxpayer prior to September
5, 1974, whether or not such order is final, appealable, or subject to
further review or reconsideration.
(iv) The provisions of this subparagraph may be illustrated by the
following examples:
Example 1. Corporation X is exclusively engaged in the
transportation of gas by pipeline subject to the jurisdiction of the Z
Power Commission. With respect to its post-1969 public utility property,
X is entitled under section 167(l)(2)(B) to use a method of depreciation
other than a subsection (l) method if it uses a normalization method of
regulated accounting. With respect to X the Z Power Commission for
purposes of establishing cost of service uses a recent consecutive 12-
month period ending not more than 4 months prior to the date of filing a
rate case adjusted for certain known changes occurring within a 9-month
period subsequent to the base period. X's rate case is filed on January
1, 1975. The year 1974 is the recorded test period for X's rate case and
is the period used in determining X's tax expense in computing cost of
service. The rates are contemplated to be in effect for the years 1975,
1976, and 1977. The adjustments for known changes relate only to wages
and salaries. X's rate base at the end of 1974 is $145,000,000. The
amount of the reserve for deferred taxes under section 167(l) at the end
of 1974 is $1,300,000, and the reserve is projected to be $4,400,000 at
the end of 1975, $6,500,000 at the end of 1976, and $9,800,000 at the
end of 1977. X does not use a normalization method of regulated
accounting if the Z Power Commission excludes more than $1,300,000 from
the rate base to which X's rate of return is
[[Page 479]]
applied. Similarly, X does not use a normalization method of regulated
accounting if, instead of the above, the Z Power Commission, in
determining X's rate of return which is applied to the rate base,
assigns to no-cost capital an amount that represents the reserve account
for deferred tax that is greater than $1,300,000.
Example 2. Assume the same facts as in example (1) except that the
adjustments for known changes in cost of service made by the Z Power
Commission include an additional depreciation expense that reflects the
installation of new equipment put into service on January 1, 1975.
Assume further that the reserve for deferred taxes under section 167(1)
at the end of 1974 is $1,300,000 and that the monthly net increases for
the first 9 months of 1975 are projected to be:
January 1-31................................................ $310,000
February 1-28............................................... 300,000
March 1-31.................................................. 300,000
April 1-30.................................................. 280,000
May 1-31.................................................... 270,000
June 1-30................................................... 260,000
July 1-31................................................... 260,000
August 1-31................................................. 250,000
September 1-30.............................................. 240,000
-----------
$2,470,000
For its regulated books of account X accrues such increases as of the
last day of the month but as a matter of convenience credits increases
or charges decreases to the reserve account on the 15th day of the month
following the whole month for which such increase or decrease is
accrued. The maximum amount that may be excluded from the rate base is
$2,470,879 (the amount in the reserve at the end of the historical
portion of the period ($1,300,000) and a pro rata portion of the amount
of any projected increase for the future portion of the period to be
credited to the reserve ($1,170,879)). Such pro rata portion is computed
(without regard to the date such increase will actually be posted to the
account) as follows:
$310,000x243/273 =.......................................... $275,934
300,000x215/273 =........................................... 236,264
300,000x184/273 =........................................... 202,198
280,000x154/273 =........................................... 157,949
270,000x123/273 =........................................... 121,648
260,000x93/273 =............................................ 88,571
260,000x62/273 =............................................ 59,048
250,000x31/273 =............................................ 28,388
240,000x1/273=.............................................. 879
-----------
$1,170,879
Example 3. Assume the same facts as in example (1) except that for
purposes of establishing cost of service the Z Power Commission uses a
future test year (1975). The rates are contemplated to be in effect for
1975, 1976, and 1977. Assume further that plant additions, depreciation
expense, and taxes are projected to the end of 1975 and that the reserve
for deferred taxes under section 167(l) is $1,300,000 for 1974 and is
projected to be $4,400,000 at the end of 1975. Assume also that the Z
Power Commission applies the rate of return to X's 1974 rate base of
$145,000,000. X and the Z Power Commission through negotiation arrive at
the level of approved rates. X uses a normalization method of regulated
accounting only if the settlement agreement, the rate order, or record
of the proceedings of the Z Power Commission indicates that the Z Power
Commission did not exclude an amount representing the reserve for
deferred taxes from X's rate base ($145,000,000) greater than $1,300,000
plus a pro rata portion of the projected increases and decreases that
are to be credited or charged to the reserve account for 1975. Assume
that for 1975 quarterly net increases are projected to be:
1st quarter................................................. $910,000
2nd quarter................................................. 810,000
3rd quarter................................................. 750,000
4th quarter................................................. 630,000
-----------
Total..................................................... $3,100,000
For its regulated books of account X will accrue such increases as of
the last day of the quarter but as a matter of convenience will credit
increases or charge decreases to the reserve account on the 15th day of
the month following the last month of the quarter for which such
increase or decrease will be accrued. The maximum amount that may be
excluded from the rate base is $2,591,480 (the amount of the reserve at
the beginning of the period ($1,300,000) plus a pro rata portion
($1,291,480) of the $3,100,000 projected increase to be credited to the
reserve during the period). Such portion is computed (without regard to
the date such increase will actually be posted to the account) as
follows:
$910,000x276/365=........................................... $688,110
810,000x185/365=............................................ 410,548
750,000x93/365=............................................. 191,096
630,000x1/365=.............................................. 1,726
-----------
$1,291,480
(i) Flow-through method of regulated accounting. Under section
167(l)(3)(H), a taxpayer uses a flow-through method of regulated
accounting with respect to public utility property if it uses the same
method of depreciation (other than a subsection (l) method) to compute
its allowance for depreciation under section 167 and to compute its tax
expense for purposes of reflecting operating results in its regulated
books of account unless such method is the same method used by the
taxpayer to determine its depreciation expense for purposes of
reflecting operating results in its regulated books of account. Except
as provided in the preceding sentence, the method of depreciation used
[[Page 480]]
by a taxpayer with respect to public utility property for purposes of
determining cost of service for ratemaking purposes or rate base for
ratemaking purposes shall not be considered in determining whether the
taxpayer used a flow-through method of regulated accounting. A taxpayer
may establish use of a flow-through method of regulated accounting in
the same manner that compliance with normalization requirements in
respect of operating books of account may be established under paragraph
(h)(4) of this section.
[T.D. 7315, 39 FR 20195, June 7, 1974]
Sec. 1.167(l)-2 Public utility property; election as to post-1969
property representing growth in capacity.
(a) In general. Section 167(l)(2) prescribes the methods of
depreciation which may be used by a taxpayer with respect to its post-
1969 public utility property. Under section 167(l)(2) (A) and (B) the
taxpayer may use a subsection (l) method of depreciation (as defined in
section 167(l)(3)(F)) or any other method of depreciation which is
otherwise allowable under section 167 if, in conjunction with the use of
such other method, such taxpayer uses the normalization method of
accounting (as defined in section 167(l)(3)(G)). Paragraph (2)(C) of
section 167(l) permits a taxpayer which used the flow-through method of
accounting for its July 1969 accounting period (as these terms are
defined in section 167(l)(3) (H) and (I), respectively) to use its
applicable 1968 method of depreciation with respect to certain property.
Section 167(l)(3)(D) describes the term ``applicable 1968 method''.
Accordingly, a regulatory agency is not precluded by section 167(l) from
requiring such a taxpayer subject to its jurisdiction to continue to use
the flow-through method of accounting unless the taxpayer makes the
election pursuant to section 167(l)(4)(A) and this section. Whether or
not the election is made, if such a regulatory agency permits the
taxpayer to change from the flow-through method of accounting,
subsection (l)(2) (A) or (B) would apply and such taxpayer could,
subject to the provisions of section 167(e) and the regulations
thereunder (relating to change in method), use a subsection (l) method
of depreciation or, if the taxpayer uses the normalization method of
accounting, any other method of depreciation otherwise allowable under
section 167.
(1) Election. Under subparagraph (A) of section 167(l)(4), if the
taxpayer so elects, the provisions of paragraph (2)(C) of section 167(l)
shall not apply to its qualified public utility property (as such term
is described in paragraph (b) of this section). In such case the
taxpayer making the election shall use a method of depreciation
prescribed by section 167(l)(2) (A) or (B) with respect to such
property.
(2) Property to which election shall apply. (i) Except as provided
in subdivision (ii) of this subparagraph the election provided by
section 167(l)(4)(A) shall apply to all of the qualified public utility
property of the taxpayer.
(ii) In the event that the taxpayer wishes the election provided by
section 167(l)(4)(A) to apply to only a portion of its qualified public
utility property, it must clearly identify the property to be subject to
the election in the statement of election described in paragraph (e) of
this section. Where all property which performs a certain function is
included within the election, the election shall apply to all future
acquisitions of qualified public utility property which perform the same
function. Where only certain property within a functional group of
property is included within the election, the election shall apply only
to property which is of the same kind as the included property.
(iii) The provisions of subdivision (ii) of this subparagraph may be
illustrated by the following examples:
Example 1. Corporation A, an electric utility company, wishes to
have the election provided by section 167(l)(4)(A) apply only with
respect to its production plant. A statement that the election shall
apply only with respect to production plant will be sufficient to
include within the election all of the taxpayer's qualified production
plant of any kind. All public utility property of the taxpayer other
than production plant will not be subject to the election.
Example 2. Corporation B, an electric utility company, wishes to
have the election provided by section 167(l)(4)(A) apply only with
respect to nuclear production plant. A statement which clearly indicates
that only nuclear production plant will be included in the election will
be sufficient to exclude
[[Page 481]]
from the election all public utility property other than nuclear
production plant.
(b) Qualified public utility property--(1) Definition. For purposes
of this section the term ``qualified public utility property'' means
post-1969 public utility property to which section 167(l)(2)(C) applies,
or would apply if the election described in section 167(l)(4)(A) had not
been made, to the extent that such property constitutes property which
increases the productive or operational capacity of the taxpayer with
respect to the goods or services described in section 167(l)(3)(A) and
does not represent the replacement of existing capacity. In the event
that particular assets which are post-1969 public utility property both
replace existing public utility property and increase the productive or
operational capacity of the taxpayer, only that portion of each such
asset which is properly allocable, pursuant to the provisions of
subparagraph (3)(v) of this paragraph or paragraph (c)(2) of this
section (as the case may be), to increasing the productive or
operational capacity of the taxpayer shall be qualified public utility
property.
(2) Limitation on use of formula method. A taxpayer which makes the
election with respect to all of its post-1969 public utility property
may determine the amount of its qualified public utility property by
using the formula method described in paragraph (c) of this section or,
where the taxpayer so chooses, it may use any other method based on
engineering data which is satisfactory to the Commissioner. A taxpayer
which chooses to include only a portion of its post-1969 public utility
property in the election described in paragraph (a)(1) of this section
shall, in a manner satisfactory to the Commissioner and consistent with
the provisions of subparagraph (3) of this paragraph, use a method based
on engineering data. If a taxpayer uses the formula method described in
paragraph (c) of this section, it must continue to use such method with
respect to additions made in subsequent taxable years. The taxpayer may
change from an engineering method to the formula method described in
paragraph (c) of this section by filing a statement described in
paragraph (h) of this section if it could have used such formula method
for the prior taxable year.
(3) Measuring capacity under an engineering method in the case of a
general election. (i) The provisions of this subparagraph apply in the
case of an election made with respect to all of the post-1969 public
utility property of the taxpayer.
(ii) A taxpayer which uses a method based on engineering data to
determine the portion of its additions for a taxable year which
constitutes qualified public utility property shall make such
determination with reference to its ``adjusted capacity'' as of the
first day of the taxable year during which such additions are placed in
service. For purposes of this subparagraph, the term ``adjusted
capacity'' means the taxpayer's capacity as of January 1, 1970, adjusted
upward in the manner described in subdivision (iii) of this subparagraph
for each taxable year ending after December 31, 1969, and before the
first day of the taxable year during which the additions described in
the preceding sentence are placed in service.
(iii) The adjustment described in this subdivision for each taxable
year shall be equal to the number of units of capacity by which
additions for the taxable year of public utility property with respect
to which the election had been made exceed the number of units of
capacity of retirements for such taxable year of public utility property
with respect to which the flow-through method of accounting was being
used at the time of their retirement. If for any taxable year the
computation in the preceding sentence results in a negative amount, such
negative amount shall be taken into account as a reduction in the amount
of the adjustment (computed without regard to this sentence) in
succeeding taxable years.
(iv) The provisions of this subparagraph may be illustrated by the
following table which assumes that the taxpayer's adjusted capacity as
of January 1, 1970, was 5,000 units:
[[Page 482]]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 2 3 4 5 6 7
--------------------------------------------------------------------------------------------------------------------------------------------------------
Units of
Flow-through Adjusted Actual qualified
Year Additions retirements Net additions capacity \1\ capacity additions \1
2\
--------------------------------------------------------------------------------------------------------------------------------------------------------
1970................................................... 1000 700 300 5000 5300 300
1971................................................... 300 500 (200) 5300 5100
1972................................................... 500 200 300 5300 5400 100
1973................................................... 400 800 (400) 5400 5000
1974................................................... 600 400 200 5400 5200
1975................................................... 800 300 500 5400 5700 300
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Capacity as of Jan. 1, 1970, plus amounts in column 7 for years prior to the year for which determination is being made.
\2\ Column 6 minus column 5.
(v) The qualified portion of the basis for depreciation (as defined
in section 167(g)) of each asset or group of assets (if group or
composite accounting is used by the taxpayer) subject to the election
shall be determined using the following ratio:
Qualified portion of basis of asset / Total basis of asset = Units of
qualified additions computed in column 7 on chart / Units of
capacity of additions computed in column 2 on chart.
(c) Formula method of determining amount of property subject to
election--(1) In general. The following formula method may be used to
determine the amount of qualified public utility property:
Step 1. Find the total cost (within the meaning of section 1012) to
the taxpayer of additions during the taxable year of all post-1969
public utility property with respect to which section 167(l)(2)(C) would
apply if the election had not been made.
Step 2. Aggregate the cost (within the meaning of section 1012) to
the taxpayer of all retirements during the taxable year of public
utility property with respect to which the flow-through method of
accounting was being used at the time of their retirement.
Step 3. Subtract the figure reached in step 2 from the figure
reached in step 1.
In the event that the figure reached in step 2 exceeds the figure
reached in step 1 such excess shall be carried forward to the next
taxable year and shall be aggregated with the cost (within the meaning
of section 1012) to the taxpayer of all retirements referred to in step
2 for such next taxable year.
(2) Allocation of bases. The amount of qualified public utility
property as determined in accordance with the formula method described
in subparagraph (1) of this paragraph shall be allocated to the basis
for depreciation (as defined in section 167(g)) of each asset or group
of assets (if group or composite accounting is used by the taxpayer)
subject to the election using the following ratio:
Amount of qualified additions computed in step 3 / Amount of total
additions computed in step 1 = Qualified portion of basis of
asset / Total basis of asset.
(d) Examples. The provisions of this section may be illustrated by
the following examples:
Example 1. Corporation A, a telephone company subject to the
jurisdiction of the Federal Communications Commission, elected, pursuant
to the provisions of section 167(l)(4)(A) and this section, with respect
to all of its qualified post-1969 public utility property to have the
provisions of paragraph (2) (C) of section 167(l) not apply. In 1971 the
Corporation added new underground cable with a cost (within the meaning
of section 1012) to it of $4 million to its underground cable account.
In the same year it retired public utility property with a cost (within
the meaning of section 1012) to Corporation A of $1.5 million. The flow-
through method of accounting was being used with respect to all of the
retired property at the time of retirement. Using the formula method
described in paragraph (c) of this section, the amount of qualified
underground cable would be determined as follows:
Million
Step 1. Aggregate cost of flow-through additions.............. $4.0
Step 2. Cost of all flow-through retirements.................. 1.5
---------
Step 3. Figure reached in step 1 less figure reached in step 2 2.5
The amount of qualified public utility property to which section
167(l)(2)(C) will not apply is $2.5 million. Pursuant to the provisions
of paragraph (c)(2) of this section, the amount of qualified public
utility property would be allocated to the basis for depreciation (as
defined in section 167(g)) of an asset with a total basis for
depreciation of $2 million as follows:
[[Page 483]]
$2.5 million (figure in step 3)/$4 million (figure in step 1) =
Qualified portion of basis of asset/$2 million Qualified
portion of basis of asset =$1.25 million.
Example 2. In 1972 Corporation A (the corporation described in
example (1)) added underground cable with a cost (within the meaning of
section 1012) to it of $1 million. In the same year the cost (within the
meaning of section 1012) to the corporation of retirements of public
utility property with respect to which the flow-through method of
accounting was being used was $3 million. There were no other additions
or retirements. The amount of qualified public utility property would be
determined as follows:
Million
Step 1. Aggregate cost of flow-through additions............. $1.0
Step 2. Cost of all flow-through retirements................. 3.0
----------
Step 3. Figure reached in step 1 less figure reached in step (2.0)
2...........................................................
Since retirements of flow-through public utility property for the year
1972 exceeded additions made during such year, the excess retirements,
$2.0 million, must be carried forward to be aggregated with retirements
for 1973.
Example 3. Corporation B, a gas pipeline company subject to the
jurisdiction of the Federal Power Commission, made the election provided
by section 167(l)(4)(A) and this section with respect to all of its
post-1969 public utility property. Corporation B chose to use an
engineering data method of determining which property was subject to the
election provided by this section. In 1970, the corporation replaced a
portion of its pipeline with respect to which the flow-through method of
accounting was being used at the time of its retirement which had a peak
capacity on January 1, 1970, of 100,000 thousand cubic feet (M c.f.) per
day at a pressure of 14.73 pounds per square inch absolute (p.s.i.a.)
with pipe with a capacity of 125,000 M c.f. per day at 14.73 p.s.i.a.
Assuming that there were no other additions or retirements, using an
engineering data method one-fifth of the new pipeline would be property
subject to the election of this section effective for its taxable year
beginning on January 1, 1971.
Example 4. In 1970 Corporation C (with the same characteristics as
the corporation described in example (3)) extended its pipeline 5 miles
further than it extended on January 1, 1970. Assuming that there were no
other additions or retirements, the entire extension would be property
subject to the election provided by this section effective for its
taxable year beginning on January 1, 1971.
Example 5. As a result of a change of service areas between two
corporations, in 1970 Corporation D (with the same characteristics as
the corporation described in example (3)) retired a pipeline running
north and south and replaced it with a pipeline of equal length and
capacity running east and west. No part of the pipeline running east and
west is property subject to the election.
(e) Manner of making election. The election described in paragraph
(a) of this section shall be made by filing, in duplicate, with the
Commissioner of Internal Revenue, Washington, D.C. 20224, Attention,
T:I:E, a statement of such election.
(f) Content of statement. The statement described in paragraph (e)
of this section shall indicate that an election is being made under
section 167(l) of the Internal Revenue Code of 1954, and it shall
contain the following information:
(1) The name, address, and taxpayer identification number of the
taxpayer,
(2) Whether the taxpayer will use the formula method of determining
the amount of its qualified public utility property described in
paragraph (c) of this section, or an engineering method, and
(3) Where the taxpayer wishes to include only a portion of its
public utility property in the election pursuant to the provisions of
paragraph (a)(2) of this section, a description sufficient to clearly
identify the property to be included.
(g) Time for making election. The election permitted by this section
shall be made by filing the statement described in paragraph (e) of this
section not later than Monday, June 29, 1970.
(h) Change of method of determining amount of qualified property.
Where a taxpayer which has elected pursuant to the provisions of section
167(l)(4)(A) wishes to change, pursuant to the provisions of paragraph
(b)(2) of this section, from an engineering data method of determining
which of its property is qualified public utility property to the
formula method described in paragraph (c) of this section, it may do so
by filing a statement to that effect at the time that it files its
income tax return, with the district director or director of the
regional service center, with whom the taxpayer's income tax return is
required to be filed.
(i) Revocability of election. An election made under section 167(l)
shall be irrevocable.
[[Page 484]]
(j) Effective date. The election prescribed by section 167(l)(4)(A)
and this section shall be effective for taxable years beginning after
December 31, 1970.
[T.D. 7045, 35 FR 8933, June 10, 1970. Redesignated by T.D. 7315, 39 FR
20195, June 7, 1974]
Sec. 1.167(l)-3 Multiple regulation, asset acquisitions,
reorganizations, etc.
(a) Property not entirely subject to jurisdiction of one regulatory
body--(1) In general. If a taxpayer which uses a method of depreciation
other than a subsection (l) method of depreciation is required by a
regulatory body having jurisdiction over less than all of its property
to use, or not to use, a method of regulated accounting (i.e.,
normalization or flow-through), such taxpayer shall be considered as
using, or not using, such method of regulated accounting only with
respect to property subject to the jurisdiction of such regulatory body.
In the case of property which is contained in a multiple asset account,
the provisions of Sec. 1.167(a)-7(c) and Sec. 1.167 (a)-11(c)(1)(iv)
apply to prohibit depreciating a single account by two or more different
methods.
(2) Jurisdiction of regulatory body. For purposes of this paragraph,
a regulatory body is considered to have jurisdiction over property of a
taxpayer if expenses with respect to the property are included in cost
of service as determined by the regulatory body for ratemaking purposes
or for reflecting operating results in its regulated books of account.
For example, if regulatory body A, having jurisdiction over 60 percent
of an item of X corporation's public utility property, required X to use
the flow-through method of regulated accounting in circumstances which
would bar X from using a method of depreciation under section 167(a)
other than a subsection (l) method, and if regulatory body B, having
jurisdiction over the remaining 40 percent of such item of property does
not so require X to use the flow-through method of regulated accounting
(or if the remaining 40 percent is not subject to the jurisdiction of
any regulatory body), then with respect to 60 percent of the adjusted
basis of the property X is prohibited from using a method of
depreciation for purposes of section 167(a) other than a subsection (1)
method. If in such example, A, having jurisdiction over 60 percent of
X's public utility property, had jurisdiction over 100 percent of a
particular generator, then with respect to the generator X would be
prohibited from using a method of depreciation other than a subsection
(l) method.
(3) Public utility property subject to more than one regulatory
body. If a regulatory body having jurisdiction over public utility
property with respect to the taxpayer's regulated books of account
requires the taxpayer to reflect its tax expense in such books in the
manner used by the regulatory body having jurisdiction over the public
utility property for purposes of determining the taxpayer's cost of
service for ratemaking purposes, the rules of subparagraphs (1) and (2)
of this paragraph shall apply.
(b) Leasing transactions--(1) Leased property. Public utility
property as defined in paragraph (b) of Sec. 1.167(l)-1 includes
property which is leased by a taxpayer where the leasing of such
property is part of the lessor's section 167(l) public utility activity.
Thus, such leased property qualifies as public utility property even
though the predominant use of such property by the lessee is in other
than a section 167(l) public utility activity. Further, leased property
qualifies as public utility property under section 167(l) even though
the leasing is not part of the lessor's public utility activity if the
predominant use of such property by the lessee or any sublessee is in a
section 167(l) public utility activity. However, the limitations of
section 167(l) apply to a taxpayer only if such taxpayer is subject to
the jurisdiction of a regulatory body described in a section
167(l)(3)(A). For example, if a financial institution purchases property
which it then leases to a lessee which uses such property predominantly
in a section 167(l) public utility activity, the property qualifies as
public utility property. However, because the financial institution's
rates for leasing the property are not subject to the jurisdiction of a
regulatory body described in section 167(l)(3)(A), the provisions of
section 167(l) do not apply to the depreciation deductions taken with
respect to
[[Page 485]]
the property by the financial institution. For possible application of
section 167(l) to the lessee, see subparagraph (2) of this paragraph.
(2) Certain rental payments. Under section 167(l)(5), if a taxpayer
leases property which is public utility property and the regulatory body
having jurisdiction over such property for purposes of determining the
taxpayer's operating results in its regulated books of account or for
ratemaking purposes allows only an amount of such lessee's expenses with
respect to the lease which is less than the amount which the taxpayer
deducts for purposes of its Federal income tax liability, then a portion
of the difference between such amounts shall not be allowed as a
deduction by the taxpayer for purposes of its Federal income tax
liability in such manner and time as the Commissioner or his delegate
may determine consistent with the principles of Sec. 1.167(l)-1 and
this section applicable as to when a method of depreciation other than a
subsection (1) method may be used for purposes of section 167(a).
(c) Certain partnership arrangements. Under section 167(l)(5), if
property held by a partnership is not public utility property in the
hands of the partnership but would be public utility property if an
election was made under section 761 to be excluded from partnership
treatment, then section 167(l) shall be applied by treating the partners
as directly owning the property in proportion to their partnership
interests.
(d) Cross reference. See Sec. 1.167(l)-1(c)(1) for treatment of
certain property as ``pre-1970 public utility property'' and Sec.
1.167(l)-1(e)(4)(ii) for applicable 1968 method in the case of property
acquired in certain transactions.
[T.D. 7315, 39 FR 20202, June 7, 1974]
Sec. 1.167(l)-4 Public utility property; election to use asset
depreciation range system.
(a) Application of section 167(l) to certain property subject to
asset depreciation range system. If the taxpayer elects to compute
depreciation under the asset depreciation range system described in
Sec. 1.167(a)-11 with respect to certain public utility property placed
in service after December 31, 1970, see Sec. 1.167(a)-11(b) (6).
(Sec. 167 of the Internal Revenue Code of 1954 (26 U.S.C. 167) and sec.
7805 of the Internal Revenue Code of 1954 (26 U.S.C. 7805))
[T.D. 7128, 36 FR 11939, June 23, 1971. Redesignated by T.D. 7315, 39 FR
20203, June 7, 1974]
Sec. 1.167(m)-1 Class lives.
(a) For rules regarding the election to use the class life system
authorized by section 167(m), see the provisions of Sec. 1.167(a)-11.
(Sec. 167(m), 85 Stat. 508 (26 U.S.C. 167))
[T.D. 7272, 38 FR 9986, Apr. 23, 1973]
Sec. 1.168-5 Special rules.
(a) Retirement-replacement-betterment (RRB) property--(1) RRB
replacement property placed in service before January 1, 1985. (i)
Except as provided in paragraph (a)(1)(ii) of this section, the recovery
deduction for the taxable year for retirement-replacement-betterment
(RRB) replacement property (as defined in paragraph (a)(3) of this
section) placed in service before January 1, 1985, shall be (in lieu of
the amount determined under section 168(b)) an amount determined by
applying to the unadjusted basis (as defined in section 168(d)(1) and
the regulations thereunder) of such property the applicable percentage
determined in accordance with the following table:
------------------------------------------------------------------------
And the year the property is
placed in service is:
If the recovery year is: -----------------------------------
1981 1982 1983 1984
------------------------------------------------------------------------
The applicable percentage is:
1................................... 100 50 33 25
2................................... ....... 50 45 38
3................................... ....... ....... 22 25
4................................... ....... ....... ....... 12
------------------------------------------------------------------------
(ii) The provisions of paragraph (a)(1)(i) of this section do not
apply to any taxpayer who did not use the RRB method of depreciation
under section 167 as of December 31, 1980. In such case, RRB replacement
property placed in service by the taxpayer after December 31, 1980,
shall be treated as other 5-year recovery property under section 168.
(2) RRB replacement property placed in service after December 31,
1984. RRB replacement property placed in service
[[Page 486]]
after December 31, 1984, is treated as other 5-year recovery property
under section 168.
(3) RRB replacement property defined. RRB replacement property, for
purposes of section 168, means replacement track material (including
rail, ties, other track material, and ballast) installed by a railroad
(including a railroad switching or terminal company) if--
(i) The replacement is made pursuant to a scheduled program for
replacement.
(ii) The replacement is made pursuant to observations by
maintenance-of-way personnel of specific track material needing
replacement.
(iii) The replacement is made pursuant to the detection by a rail-
test car of specific track material needing replacement, or
(iv) The replacement is made as a result of a casualty.
Replacements made as a result of a casualty shall be RRB replacement
property only to the extent that, in the case of each casualty, the
replacement cost with respect to the replacement track material exceeds
$50,000.
(4) Recovery of adjusted basis of RRB property as of December 31,
1980. The taxpayer shall recover the adjusted basis of RRB property (as
defined in section 168(g)(6)) as of December 31, 1980, over a period of
not less than 5 years and not more than 50 years, using a rate of
recovery consistent with any method described in section 167(b),
including the method described in section 167(b)(2), switching to the
method described in section 167(b)(3) at a time to maximize the
deduction. For purposes of determining the recovery allowance under this
subparagraph, salvage value shall be disregarded and, in the case of a
taxpayer that depreciated RRB property placed in service before January
1, 1981, using the RRB method consistently for all periods after
February 28, 1913, the adjusted basis of RRB property is the adjusted
basis for purposes of determining the deduction for retirements under
the RRB method, with no adjustment for depreciation sustained prior to
March 1, 1913.
(5) RRB property (which is not RRB replacement property) placed in
service after December 31, 1980. Property placed in service by the
taxpayer after December 31, 1980, which is not RRB replacement property
and which, under the taxpayer's method of depreciation as of December
31, 1980, would have been depreciated by the taxpayer under the RRB
method, is treated as other property under section 168.
(b)-(f) [Reserved]
[T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.168(a)-1 Modified accelerated cost recovery system.
(a) Section 168 determines the depreciation allowance for tangible
property that is of a character subject to the allowance for
depreciation provided in section 167(a) and that is placed in service
after December 31, 1986 (or after July 31, 1986, if the taxpayer made an
election under section 203(a)(1)(B) of the Tax Reform Act of 1986; 100
Stat. 2143). Except for property excluded from the application of
section 168 as a result of section 168(f) or as a result of a
transitional rule, the provisions of section 168 are mandatory for all
eligible property. The allowance for depreciation under section 168
constitutes the amount of depreciation allowable under section 167(a).
The determination of whether tangible property is property of a
character subject to the allowance for depreciation is made under
section 167 and the regulations under section 167.
(b) This section is applicable on and after February 27, 2004.
[T.D. 9314, 72 FR 9248, Mar. 1, 2007]
Sec. 1.168(b)-1 Definitions.
(a) Definitions. For purposes of section 168 and the regulations
under section 168, the following definitions apply:
(1) Depreciable property is property that is of a character subject
to the allowance for depreciation as determined under section 167 and
the regulations under section 167.
(2) MACRS property is tangible, depreciable property that is placed
in service after December 31, 1986 (or after July 31, 1986, if the
taxpayer made an election under section 203(a)(1)(B) of the Tax Reform
Act of 1986; 100 Stat. 2143) and subject to section 168, except
[[Page 487]]
for property excluded from the application of section 168 as a result of
section 168(f) or as a result of a transitional rule.
(3) Unadjusted depreciable basis is the basis of property for
purposes of section 1011 without regard to any adjustments described in
section 1016(a)(2) and (3). This basis reflects the reduction in basis
for the percentage of the taxpayer's use of property for the taxable
year other than in the taxpayer's trade or business (or for the
production of income), for any portion of the basis the taxpayer
properly elects to treat as an expense under section 179, section 179C,
or any similar provision, and for any adjustments to basis provided by
other provisions of the Internal Revenue Code and the regulations under
the Code (other than section 1016(a)(2) and (3)) (for example, a
reduction in basis by the amount of the disabled access credit pursuant
to section 44(d)(7)). For property subject to a lease, see section
167(c)(2).
(4) Adjusted depreciable basis is the unadjusted depreciable basis
of the property, as defined in Sec. 1.168(b)-1(a)(3), less the
adjustments described in section 1016(a)(2) and (3).
(b) Effective date. This section is applicable on or after February
27, 2004.
[T.D. 9314, 72 FR 9248, Mar. 1, 2007]
Sec. 1.168(d)-0 Table of contents for the applicable convention rules.
This section lists the major paragraphs in Sec. 1.168(d)-1.
Sec. 1.168(d)-1 Applicable conventions--Half-year and mid-quarter
conventions.
(a) In general.
(b) Additional rules for determining whether the mid-quarter
convention applies and for applying the applicable convention.
(1) Property described in section 168(f).
(2) Listed property.
(3) Property placed in service and disposed of in the same taxable
year.
(4) Aggregate basis of property.
(5) Special rules for affiliated groups.
(6) Special rule for partnerships and S corporations.
(7) Certain nonrecognition transactions.
(c) Disposition of property subject to the half-year or mid-quarter
convention.
(1) In general.
(2) Example.
(d) Effective date.
[T.D. 8444, 57 FR 48981, Oct. 29, 1992]
Sec. 1.168(d)-1 Applicable conventions--half-year and mid-quarter
conventions.
(a) In general. Under section 168(d), the half-year convention
applies to depreciable property (other than certain real property
described in section 168(d)(2)) placed in service during a taxable year,
unless the mid-quarter convention applies to the property. Under section
168(d)(3)(A), the mid-quarter convention applies to depreciable property
(other than certain real property described in section 168(d)(2)) placed
in service during a taxable year if the aggregate basis of property
placed in service during the last three months of the taxable year
exceeds 40 percent of the aggregate basis of property placed in service
during the taxable year (``the 40-percent test''). Thus, if the
depreciable property is placed in service during a taxable year that
consists of three months or less, the mid-quarter convention applies to
the property. Under section 168(d)(3)(b)(i), the depreciable basis of
nonresidential real property, residential rental property, and any
railroad grading or tunnel bore is disregarded in applying the 40-
percent test. For rules regarding property that is placed in service and
disposed of in the same taxable year, see paragraph (b)(3) of this
section. For the definition of ``aggregate basis of property,'' see
paragraph (b)(4) if this section.
(b) Additional rules for determining whether the mid-quarter
convention applies and for applying the applicable convention--(1)
Property described in section 168(f). In determining whether the 40-
percent test is testified for a taxable year, the depreciable basis of
property described in section 168(f) (property to which section 168 does
not apply) is not taken into account.
(2) Listed property. The depreciable basis of listed property (as
defined in section 280F(d)(4) and the regulations thereunder) placed in
service during a taxable year is taken into account (unless otherwise
excluded) in applying the 40-percent test.
(3) Property placed in service and disposed of in the same taxable
year. (i) Under section 168(d)(3)(B)(ii), the depreciable basis of
property placed in service and disposed of in the same taxable
[[Page 488]]
year is not taken into account in determining whether the 40-percent
test is satisfied. However, the depreciable basis of property placed in
service, disposed of, subsequently reacquired, and again placed in
service, by the taxpayer in the same taxable year must be taken into
account in applying the 40-percent test, but the basis of the property
is only taken into account on the later of the dates that the property
is placed in service by the taxpayer during the taxable year. Further,
see Sec. Sec. 1.168(i)-6(c)(4)(v)(B) and 1.168(i)-6(f) for rules
relating to property placed in service and exchanged or involuntarily
converted during the same taxable year.
(ii) The applicable convention, as determined under this section,
applies to all depreciable property (except nonresidential real
property, residential rental property, and any railroad grading or
tunnel bore) placed in service by the taxpayer during the taxable year,
excluding property placed in service and disposed of in the same taxable
year. However, see Sec. Sec. 1.168(i)-6(c)(4)(v)(A) and 1.168(i)-6(f)
for rules relating to MACRS property that has a basis determined under
section 1031(d) or section 1033(b). No depreciation deduction is allowed
for property placed in service and disposed of during the same taxable
year. However, see Sec. 1.168(k)-1(f)(1) for rules relating to
qualified property or 50-percent bonus depreciation property, and Sec.
1.1400L(b)-1(f)(1) for rules relating to qualified New York Liberty Zone
property, that is placed in service by the taxpayer in the same taxable
year in which either a partnership is terminated as a result of a
technical termination under section 708(b)(1)(B) or the property is
transferred in a transaction described in section 168(i)(7).
(4) Aggregate basis of property. For purposes of the 40-percent
test, the term ``aggregate basis of property'' means the sum of the
depreciable bases of all items of depreciable property that are taken
into account in applying the 40-percent test. ``Depreciable basis''
means the basis of depreciable property for purposes of determining gain
under sections 1011 through 1024. The depreciable basis for the taxable
year the property is placed in service reflects the reduction in basis
for--
(i) Any portion of the basis the taxpayer properly elects to treat
as an expense under section 179;
(ii) Any adjustment to basis under section 48(q); and
(iii) The percentage of the taxpayer's use of the property for the
taxable year other than in the taxpayer's trade or business (or for the
production of income), but is determined before any reduction for
depreciation under section 167(a) for that taxable year.
(5) Special rules for affiliated groups--(i) In the case of a
consolidated group (as defined in Sec. 1.1502-1(h)), all members of the
group that are included on the consolidated return are treated as one
taxpayer for purposes of applying the 40-percent test. Thus, the
depreciable bases of all property placed in service by members of a
consolidated group during a consolidated return year are taken into
account (unless otherwise excluded) in applying the 40-percent test to
determine whether the mid-quarter convention applies to property placed
in service by the members during the consolidated return year. The 40-
percent test is applied separately to the depreciable bases of property
placed in service by any member of an affiliated group that is not
included in a consolidated return of the taxable year in which the
property is placed in service.
(ii) In the case of a corporation formed by a member or members of a
consolidated group and that is itself a member of the consolidated group
(``newly-formed subsidiary''), the depreciable bases of property placed
in service by the newly-formed subsidiary in the consolidated return
year in which it is formed is included with the depreciable bases of
property placed in service during the consolidated return year by the
other members of the consolidated group in applying the 40-percent test.
If depreciable property is placed in service by a newly-formed
subsidiary during the consolidated return year in which it was formed,
the newly-formed subsidiary is considered as being in existence for the
entire consolidated return year for purposes of applying the applicable
convention to
[[Page 489]]
determine when the recovery period begins.
(iii) The provisions of paragraph (b)(5)(ii) of this section are
illustrated by the following example.
Example. Assume a member of a consolidated group that files its
return on a calendar-year basis forms a subsidiary on August 1. The
subsidiary places depreciable property in service on August 5. If the
mid-quarter convention applies to property placed in service by the
members of the consolidated group (including the newly-formed
subsidiary), the property placed in service by the subsidiary on August
5 is deemed placed in service on the mid-point of the third quarter of
the consolidated return year (i.e., August 15). If the mid-quarter
convention does not apply, the property is deemed placed in service on
the mid-point of the consolidated return year (i.e., July 1).
(iv) In the case of a corporation that joins or leaves a
consolidated group, the depreciable bases of property placed in service
by the corporation joining or leaving the group during the portion of
the consolidated return year that the corporation is a member of the
consolidated group is included with the depreciable bases of property
placed in service during the consolidated return year by the other
members in applying the 40-percent test. The depreciable bases of
property placed in service by the joining or leaving member in the
taxable year before it joins or after it leaves the consolidated group
is not taken into account by the consolidated group in applying the 40-
percent test for the consolidated return year. If a corporation leaves a
consolidated group and joins another consolidated group, each
consolidated group takes into account, in applying the 40-percent test,
the depreciable bases of property placed in service by the corporation
while a member of the group.
(v) The provisions of paragraph (b)(5)(iv) of this section are
illustrated by the following example.
Example. Assume Corporations A and B file a consolidated return on a
calendar-year basis. Corporation C, also a calendar-year taxpayer,
enters the consolidated group on July 1 and is included on the
consolidated return for that taxable year. The depreciable bases of
property placed in service by C during the period of July 1 to December
31 is included with the depreciable bases of property placed in service
by A and B during the entire consolidated return year in applying the
40-percent test. The depreciable bases of property placed in service by
C from January 1 to June 30 is not taken into account by the
consolidated group in applying the 40-percent test. If C was a member of
another consolidated group during the period from January 1 to June 30,
that consolidated group would include the depreciable bases of property
placed in service by C during that period.
(vi) A corporation that joins or leaves a consolidated group during
a consolidated year is considered as being a member of the consolidated
group for the entire consolidated return year for purposes of applying
the applicable convention to determine when the recovery period begins
for depreciable property placed in service by the corporation during the
portion of the consolidated return year that the corporation is a member
of the group.
(vii) If depreciable property is placed in service by a corporation
in the taxable year ending immediately before it joins a consolidated
group or beginning immediately after it leaves a consolidated group, the
applicable convention is applied to the property under either the full
taxable year rules or the short taxable year rules, as applicable.
(viii) The provisions of paragraphs (d)(5)(vi) and (vii) of this
section are illustrated by the following example.
Example. Assume that on July 1, C, a calendar-return corporation,
joins a consolidated group that files a return on a calendar-year basis.
The short taxable year rules apply to C for the period of January 1 to
June 30. However, in applying the applicable convention to determine
when the recovery period begins for depreciable property placed in
service for the period of July 1 to December 31, C is considered as
being a member of the consolidated group for the entire consolidated
return year. Thus, if the half-year convention applies to depreciable
property placed in service by the consolidated group (taking into
account the depreciable bases of property placed in service by C after
June 30), the property is deemed placed in service on the mid-point of
the consolidated return year (i.e., July 1, if the group did not have a
short taxable year).
(ix) In the case of a transfer of depreciable property between
members of a consolidated group, the following special rules apply for
purposes of applying the 40-percent test. Property that is placed in
service by one member of a
[[Page 490]]
consolidated group and transferred to another member of the same group
is considered as placed in service on the date that it is placed in
service by the transferor member, and the date it is placed in service
by the transferee member is disregarded. In the case of multiple
transfers of property between members of a consolidated group, the
property is considered as placed in service on the date that the first
member places the property in service, and the dates it is placed in
service by other members are disregarded. The depreciable basis of the
transferred property that is taken into account in applying the 40-
percent test is the depreciable basis of the property in the hands of
the transferor member (as determined under paragraph (b)(4) of this
section), or, in the case of multiple transfers of property between
members, the depreciable basis in the hands of the first member that
placed the property in service.
(x) The provisions of paragraph (b)(5)(ix) of this section are
illustrated by the following example.
Example. Assume the ABC consolidated group files its return on a
calendar-year basis. A, a member of the consolidated group, purchases
depreciable property costing $50,000 and places the property in service
on January 5, 1991. On December 1, 1991, the property is transferred for
$75,000 to B, another member of the consolidated group. In applying the
40-percent test to the members of the consolidated group for 1991, the
property is considered as placed in service on January 5, the date that
A placed the property in service, and the depreciable basis of the
property that is taken into account is $50,000.
(6) Special rule for partnerships and S corporations. In the case of
property placed in service by a partnership or an S corporation, the 40-
percent test is generally applied at the partnership or corporate level.
However, if a partnership or an S corporation is formed or availed of
for the principal purpose of either avoiding the application of the mid-
quarter convention or having the mid-quarter convention apply where it
otherwise would not, the 40-percent test is applied at the partner,
shareholder, or other appropriate level.
(7) Certain nonrecognition transaction--(i) Except as provided in
paragraph (b)(6) of this section, if depreciable property is transferred
in a transaction described in section 168(i)(7)(B)(i) (other than in a
transaction between members of a consolidated group) in the same taxable
year that the property is placed in service by the transferor, the 40-
percent test is applied by treating the transferred property as placed
in service by the transferee on the date of transfer. Thus, if the
aggregate basis of property (including the transferred property) placed
in service by the transferee during the last three months of its taxable
year exceeds 40 percent of the aggregate basis of property (including
the transferred property) placed in service by the transferee during the
taxable year, the mid-quarter convention applies to the transferee's
depreciable property, including the transferred property. The
depreciable basis of the transferred property is not taken into account
by the transferor in applying the 40-percent test for the taxable year
that the transferor placed the property in service.
(ii) In applying the applicable convention to determine when the
recovery period for the transferred property begins, the date on which
the transferor placed the property in service must be used. Thus, for
example, if the mid-quarter convention applies, the recovery period for
the transferred property begins on the mid-point of the quarter of the
taxable year that the transferor placed the property in service. If the
transferor placed the transferred property in service in a short taxable
year, then for purposes of applying the applicable convention and
allocating the depreciation deduction between the transferor and the
transferee, the transferor is treated as having a full 12-month taxable
year commencing on the first day of the short taxable year. The
depreciation deduction for the transferor's taxable year in which the
property was placed in service is allocated between the transferor and
the transferee based on the number of months in the transferor's taxable
year that each party held the property in service. For purposes of
allocating the depreciation deduction, the transferor takes into account
the month in which the property was placed in service but does not take
into account the
[[Page 491]]
month in which the property was transferred. The transferee is allocated
the remaining portion of the depreciation deduction for the transferor's
taxable year in which the property was transferred. For the remainder of
the transferee's current taxable year (if the transferee has a different
taxable year than the transferor) and for subsequent taxable years, the
depreciation deduction for the transferee is calculated by allocating to
the transferee's taxable year the depreciation attributable to each
recovery year, or portion thereof, that falls within the transferee's
taxable year.
(iii) If the applicable convention for the transferred property has
not been determined by the time the transferor files its income tax
return for the year of transfer because the transferee's taxable year
has not ended, the transferor may use either the mid-quarter or the
half-year convention in determining the depreciation deduction for the
property. However, the transferor must specify on the depreciation form
filed for the taxable year that the applicable convention has not been
determined for the property. If the transferee determines that a
different convention applies to the transferred property, the transferor
should redetermine the depreciation deduction on the property, and,
within the period of limitation, should file an amended income tax
return for the taxable year and pay any additional tax due plus
interest.
(iv) The provisions of the paragraph (b)(7) are illustrated by the
following example.
Example. (i) During 1991, C, a calendar-year taxpayer, purchases
satellite equipment costing $100,000, and computer equipment costing
$15,000. The satellite equipment is placed in service in January, and
the computer equipment in February. On October 1, C transfers the
computer equipment to Z Partnership in a transaction described in
section 721. During 1991, Z, a calendar-year partnership, purchases 30
office desks for a total of $15,000. The desks are placed in service in
June. These are the only items of depreciable property placed in service
by C and Z during 1991.
(ii) In applying the 40-percent test, because C transferred the
computer equipment in a transaction described in section 168(i)(7)(B)(i)
in the same taxable year that C placed it in service, the computer
equipment is treated as placed in service by the transferee, Z, on the
date of transfer, October 1. The 40-percent test is satisfied with
respect to Z, because the computer equipment is placed in service during
the last three months of Z's taxable year and its basis ($15,000)
exceeds 40 percent of the aggregate basis of property placed in service
by Z during the taxable year (desks and computer equipment with an
aggregate basis of $30,000).
(iii) In applying the mid-quarter convention to determine when the
computer equipment is deemed to be placed in service, the date on which
C placed the property in service is used. Accordingly, because C placed
the computer equipment in service during the first quarter of its
taxable year, the computer equipment is deemed placed in service on
February 15, 1991, the mid-point of the first quarter of C's taxable
year. The depreciation deduction allowable for C's 1991 taxable year,
$5,250 ($15,000x40 percentx10.\5/12\), is allocated between C and Z
based on the number of months in C's taxable year that C and Z held the
property in service. Thus, because the property was in service for 11
months during C's 1991 taxable year and C held it for 8 of those 11
months, C is allocated $3,818 (\8/11\x$5,250). Z is allocated $1,432,
the remaining \3/11\ of the $5,250 depreciation deduction for C's 1991
taxable year. For 1992, Z's depreciation deduction for the computer
equipment is $3,900, the sum of the remaining 1.5 months of depreciation
deduction for the first recovery year and 10.5 months of depreciation
deduction for the second recovery year (($15,000x40 percentx1.\5/
12\)+($9,000x40 [percentx10.\5/12\)).
(c) Disposition of property subject to the half-year or mid-quarter
convention--(1) In general. If depreciable property is subject to the
half-year (or mid-quarter) convention in the taxable year in which it is
placed in service, it also is subject to the half-year (or mid-quarter)
convention in the taxable year in which it is disposed of.
(2) Example. The provisions of paragraph (c)(1) of this section are
illustrated by the following example.
Example. In October 1991, B, a calendar-year taxpayer, purchases and
places in service a light general purpose truck costing $10,000. B does
not elect to expense any part of the cost of the truck, and this is the
only item of depreciable property placed in service by B during 1991.
The 40-percent test is satisfied and the mid-quarter convention applies,
because the truck is placed in service during the last three months of
the taxable year and no other assets are placed in service in that year.
In April 1993 (prior to the end of the truck's recovery period), B sells
the truck. The mid-quarter convention applies in
[[Page 492]]
determining the depreciation deduction for the truck in 1993, the year
of disposition.
(d) Effective dates--(1) In general. This section applies to
depreciable property placed in service in taxable years ending after
January 30, 1991. For depreciable property placed in service after
December 31, 1986, in taxable years ending on or before January 30,
1991, a taxpayer may use a method other than the method provided in this
section in applying the 40-percent test and the applicable convention,
provided the method is reasonable and is consistently applied to the
taxpayer's property.
(2) Qualified property, 50-percent bonus depreciation property, or
qualified New York Liberty Zone property. This section also applies to
qualified property under section 168(k)(2) or qualified New York Liberty
Zone property under section 1400L(b) acquired by a taxpayer after
September 10, 2001, and to 50-percent bonus depreciation property under
section 168(k)(4) acquired by a taxpayer after May 5, 2003.
(3) Like-kind exchanges and involuntary conversions. The last
sentence in paragraph (b)(3)(i) and the second sentence in paragraph
(b)(3)(ii) of this section apply to exchanges to which section 1031
applies, and involuntary conversions to which section 1033 applies, of
MACRS property for which the time of disposition and the time of
replacement both occur after February 27, 2004.
[T.D. 8444, 57 FR 48981, Oct. 29, 1992, as amended by T.D. 9091, 68 FR
52991, Sept. 8, 2003; T.D. 9115, 69 FR 9533, Mar. 1, 2004; T.D. 9283, 71
FR 51737, Aug. 31, 2006; T.D. 9314, 72 FR 9248, Mar. 1, 2007]
Sec. 1.168(f)(8)-1T Safe-harbor lease information returns concerning
qualified mass commuting vehicles (temporary).
In general. Form 6793, Safe Harbor Lease Information Return, is
obsolete for safe harbor lease agreements executed after June 30, 1985.
The parties to a safe harbor lease agreement under section 168(f)(8)
executed after June 30, 1985 must file with their timely filed
(including extensions) Federal income tax returns for the taxable year
during which the lease term begins a statement containing the following
information:
(a) The name, address, and taxpayer identification number of the
lessor and the lessee;
(b) A description of the property with respect to which safe-harbor
lease treatment is claimed;
(c) The date on which the lessee places the property in service, the
date on which the lease begins, and the term of the lease;
(d) The recovery property class of the leased property under section
168(c)(2) (for example, 5-year);
(e) The terms of the payments between the parties to the lease
transaction;
(f) The unadjusted basis of the property as defined in section
168(d)(1) and its adjusted basis as determined under Sec. 5c.168(f)(8)-
6(b)(3); and
(g) If the lessor is a partnership or grantor trust, the name,
address, and taxpayer identification number of the partners or
beneficiaries and the service center at which the income tax return of
each partner or beneficiary is filed.
The lessor's failure to file the above-described statement shall void
such agreement as a safe-harbor lease under section 168(f)(8) as of the
date of the execution of the lease agreement. For rules regarding
extensions of time for filing elections, see Sec. 1.9100-1.
[T.D. 8033, 50 FR 27224, July 2, 1985]
Sec. 1.168(h)-1 Like-kind exchanges involving tax-exempt use property.
(a) Scope. (1) This section applies with respect to a direct or
indirect transfer of property among related persons, including transfers
made through a qualified intermediary (as defined in Sec. 1.1031(k)-
1(g)(4)) or other unrelated person, (a transfer) if--
(i) Section 1031 applies to any party to the transfer or to any
related transaction; and
(ii) A principal purpose of the transfer or any related transaction
is to avoid or limit the application of the alternative depreciation
system (within the meaning of section 168(g)).
(2) For purposes of this section, a person is related to another
person if they bear a relationship specified in section 267(b) or
section 707(b)(1).
[[Page 493]]
(b) Allowable depreciation deduction for property subject to this
section--(1) In general. Property (tainted property) transferred
directly or indirectly to a taxpayer by a related person (related party)
as part of, or in connection with, a transaction in which the related
party receives tax-exempt use property (related tax-exempt use property)
will, if the tainted property is subject to an allowance for
depreciation, be treated in the same manner as the related tax-exempt
use property for purposes of determining the allowable depreciation
deduction under section 167(a). Under this paragraph (b), the tainted
property is depreciated by the taxpayer over the remaining recovery
period of, and using the same depreciation method and convention as that
of, the related tax-exempt use property.
(2) Limitations--(i) Taxpayer's basis in related tax-exempt use
property. The rules of this paragraph (b) apply only with respect to so
much of the taxpayer's basis in the tainted property as does not exceed
the taxpayer's adjusted basis in the related tax-exempt use property
prior to the transfer. Any excess of the taxpayer's basis in the tainted
property over its adjusted basis in the related tax-exempt use property
prior to the transfer is treated as property to which this section does
not apply. This paragraph (b)(2)(i) does not apply if the related tax-
exempt use property is not acquired from the taxpayer (e.g., if the
taxpayer acquires the tainted property for cash but section 1031
nevertheless applies to the related party because the transfer involves
a qualified intermediary).
(ii) Application of section 168(i)(7). This section does not apply
to so much of the taxpayer's basis in the tainted property as is subject
to section 168(i)(7).
(c) Related tax-exempt use property. (1) For purposes of paragraph
(b) of this section, related tax-exempt use property includes--
(i) Property that is tax-exempt use property (as defined in section
168(h)) at the time of the transfer; and
(ii) Property that does not become tax-exempt use property until
after the transfer if, at the time of the transfer, it was intended that
the property become tax-exempt use property.
(2) For purposes of determining the remaining recovery period of the
related tax-exempt use property in the circumstances described in
paragraph (c)(1)(ii) of this section, the related tax-exempt use
property will be treated as having, prior to the transfer, a lease term
equal to the term of any lease that causes such property to become tax-
exempt use property.
(d) Examples. The following examples illustrate the application of
this section. The examples do not address common law doctrines or other
authorities that may apply to recharacterize or alter the effects of the
transactions described therein. Unless otherwise indicated, parties to
the transactions are not related to one another.
Example 1. (i) X owns all of the stock of two subsidiaries, B and Z.
X, B and Z do not file a consolidated federal income tax return. On May
5, 1995, B purchases an aircraft (FA) for $1 million and leases it to a
foreign airline whose income is not subject to United States taxation
and which is a tax-exempt entity as defined in section 168(h)(2). On the
same date, Z owns an aircraft (DA) with a fair market value of $1
million, which has been, and continues to be, leased to an airline that
is a United States taxpayer. Z's adjusted basis in DA is $0. The next
day, at a time when each aircraft is still worth $1 million, B transfers
FA to Z (subject to the lease to the foreign airline) in exchange for DA
(subject to the lease to the airline that is a United States taxpayer).
Z realizes gain of $1 million on the exchange, but that gain is not
recognized pursuant to section 1031(a) because the exchange is of like-
kind properties. Assume that a principal purpose of the transfer of DA
to B or of FA to Z is to avoid the application of the alternative
depreciation system. Following the exchange, Z has a $0 basis in FA
pursuant to section 1031(d). B has a $1 million basis in DA.
(ii) B has acquired property from Z, a related person; Z's gain is
not recognized pursuant to section 1031(a); Z has received tax-exempt
use property as part of the transaction; and a principal purpose of the
transfer of DA to B or of FA to Z is to avoid the application of the
alternative depreciation system. Accordingly, the transaction is within
the scope of this section. Pursuant to paragraph (b) of this section, B
must recover its $1 million basis in DA over the remaining recovery
period of, and using the same depreciation method and convention as that
of, FA, the related tax-exempt use property.
(iii) If FA did not become tax-exempt use property until after the
exchange, it would still be related tax-exempt use property and
paragraph (b) of this section would apply if,
[[Page 494]]
at the time of the exchange, it was intended that FA become tax-exempt
use property.
Example 2. (i) X owns all of the stock of two subsidiaries, B and Z.
X, B and Z do not file a consolidated federal income tax return. B and Z
each own identical aircraft. B's aircraft (FA) is leased to a tax-exempt
entity as defined in section 168(h)(2) and has a fair market value of $1
million and an adjusted basis of $500,000. Z's aircraft (DA) is leased
to a United States taxpayer and has a fair market value of $1 million
and an adjusted basis of $10,000. On May 1, 1995, B and Z exchange
aircraft, subject to their respective leases. B realizes gain of
$500,000 and Z realizes gain of $990,000, but neither person recognizes
gain because of the operation of section 1031(a). Moreover, assume that
a principal purpose of the transfer of DA to B or of FA to Z is to avoid
the application of the alternative depreciation system.
(ii) As in Example 1, B has acquired property from Z, a related
person; Z's gain is not recognized pursuant to section 1031(a); Z has
received tax-exempt use property as part of the transaction; and a
principal purpose of the transfer of DA to B or of FA to Z is to avoid
the application of the alternative depreciation system. Thus, the
transaction is within the scope of this section even though B has held
tax-exempt use property for a period of time and, during that time, has
used the alternative depreciation system with respect to such property.
Pursuant to paragraph (b) of this section, B, which has a substituted
basis determined pursuant to section 1031(d) of $500,000 in DA, must
depreciate the aircraft over the remaining recovery period of FA, using
the same depreciation method and convention. Z holds tax-exempt use
property with a basis of $10,000, which must be depreciated under the
alternative depreciation system.
(iii) Assume the same facts as in paragraph (i) of this Example 2,
except that B and Z are members of an affiliated group that files a
consolidated federal income tax return. Of B's $500,000 basis in DA,
$10,000 is subject to section 168(i)(7) and therefore not subject to
this section. The remaining $490,000 of basis is subject to this
section. But see Sec. 1.1502-80(f) making section 1031 inapplicable to
intercompany transactions occurring in consolidated return years
beginning on or after July 12, 1995.
(e) Effective date. This section applies to transfers made on or
after April 20, 1995.
[T.D. 8667, 61 FR 18676, Apr. 29, 1996]
Sec. 1.168(i)-0 Table of contents for the general asset account rules.
This section lists the major paragraphs contained in Sec. 1.168(i)-
1.
Sec. 1.168(i)-1 General asset accounts.
(a) Scope.
(b) Definitions.
(1) Unadjusted depreciable basis.
(2) Unadjusted depreciable basis of the general asset account.
(3) Adjusted depreciable basis of the general asset account.
(4) Building.
(5) Expensed cost.
(6) Mass assets.
(7) Portion of an asset.
(8) Remaining adjusted depreciable basis of the general asset
account.
(9) Structural component.
(c) Establishment of general asset accounts.
(1) Assets eligible for general asset accounts.
(i) General rules.
(ii) Special rules for assets generating foreign source income.
(2) Grouping assets in general asset accounts.
(i) General rules.
(ii) Special rules.
(3) Examples.
(d) Determination of depreciation allowance.
(1) In general.
(2) Assets in general asset account are eligible for additional
first year depreciation deduction.
(3) No assets in general asset account are eligible for additional
first year depreciation deduction.
(4) Special rule for passenger automobiles.
(e) Dispositions from a general asset account.
(1) Scope and definition.
(i) In general.
(ii) Disposition of a portion of an asset.
(2) General rules for a disposition.
(i) No immediate recovery of basis.
(ii) Treatment of amount realized.
(iii) Effect of disposition on a general asset account.
(iv) Coordination with nonrecognition provisions.
(v) Manner of disposition.
(vi) Disposition by transfer to a supplies account.
(vii) Leasehold improvements.
(viii) Determination of asset disposed of.
(ix) Examples.
(3) Special rules.
(i) In general.
(ii) Disposition of all assets remaining in a general asset account.
(iii) Disposition of an asset in a qualifying disposition.
(iv) Transactions subject to section 168(i)(7).
(v) Transactions subject to section 1031 or 1033.
(vi) Technical termination of a partnership.
[[Page 495]]
(vii) Anti-abuse rule.
(f) Assets generating foreign source income.
(1) In general.
(2) Source of ordinary income, gain, or loss.
(i) Source determined by allocation and apportionment of
depreciation allowed.
(ii) Formula for determining foreign source income, gain, or loss.
(3) Section 904(d) separate categories.
(g) Assets subject to recapture.
(h) Changes in use.
(1) Conversion to any personal use.
(2) Change in use results in a different recovery period and/or
depreciation method.
(i) No effect on general asset account election.
(ii) Asset is removed from the general asset account.
(iii) New general asset account is established.
(i) Redetermination of basis.
(j) Identification of disposed or converted asset.
(k) Effect of adjustments on prior dispositions.
(l) Election.
(1) Irrevocable election.
(2) Time for making election.
(3) Manner of making election.
(m) Effective/applicability dates.
[T.D. 8566, 59 FR 51371, Oct. 11, 1994, as amended by T.D. 9115, 69 FR
9534, Mar. 1, 2004; T.D. 9132, 69 FR 33842, June 17, 2004; T.D. 9314, 72
FR 9249, Mar. 1, 2007; T.D. 9564, 76 FR 81085, Dec. 27, 2011; 77 FR
75016, Dec. 19, 2012; T.D. 9689, 79 FR 48667, Aug. 18, 2014]
Sec. 1.168(i)-1 General asset accounts.
(a) Scope. This section provides rules for general asset accounts
under section 168(i)(4). The provisions of this section apply only to
assets for which an election has been made under paragraph (l) of this
section.
(b) Definitions. For purposes of this section, the following
definitions apply:
(1) Unadjusted depreciable basis has the same meaning given such
term in Sec. 1.168(b)-1(a)(3).
(2) Unadjusted depreciable basis of the general asset account is the
sum of the unadjusted depreciable bases of all assets included in the
general asset account.
(3) Adjusted depreciable basis of the general asset account is the
unadjusted depreciable basis of the general asset account less the
adjustments to basis described in section 1016(a)(2) and (3).
(4) Building has the same meaning as that term is defined in Sec.
1.48-1(e)(1).
(5) Expensed cost is the amount of any allowable credit or deduction
treated as a deduction allowable for depreciation or amortization for
purposes of section 1245 (for example, a credit allowable under section
30 or a deduction allowable under section 179, section 179A, or section
190). Expensed cost does not include any additional first year
depreciation deduction.
(6) Mass assets is a mass or group of individual items of
depreciable assets--
(i) That are not necessarily homogenous;
(ii) Each of which is minor in value relative to the total value of
the mass or group;
(iii) Numerous in quantity;
(iv) Usually accounted for only on a total dollar or quantity basis;
(v) With respect to which separate identification is impracticable;
and
(vi) Placed in service in the same taxable year.
(7) Portion of an asset is any part of an asset that is less than
the entire asset as determined under paragraph (e)(2)(viii) of this
section.
(8) Remaining adjusted depreciable basis of the general asset
account is the unadjusted depreciable basis of the general asset account
less the amount of the additional first year depreciation deduction
allowed or allowable, whichever is greater, for the general asset
account.
(9) Structural component has the same meaning as that term is
defined in Sec. 1.48-1(e)(2).
(c) Establishment of general asset accounts--(1) Assets eligible for
general asset accounts--(i) General rules. Assets that are subject to
either the general depreciation system of section 168(a) or the
alternative depreciation system of section 168(g) may be accounted for
in one or more general asset accounts. An asset is included in a general
asset account only to the extent of the asset's unadjusted depreciable
basis. However, an asset is not to be included in a general asset
account if the asset is used both in a trade or business or for the
production of income and in a personal activity at any time during the
taxable year in which the asset is placed in service by the taxpayer or
if the asset
[[Page 496]]
is placed in service and disposed of during the same taxable year.
(ii) Special rules for assets generating foreign source income. (A)
Assets that generate foreign source income, both United States and
foreign source income, or combined gross income of a foreign sales
corporation (as defined in former section 922), domestic international
sales corporation (as defined in section 992(a)), or possession
corporation (as defined in section 936) and its related supplier may be
included in a general asset account if the requirements of paragraph
(c)(2)(i) of this section are satisfied. If, however, the inclusion of
these assets in a general asset account results in a substantial
distortion of income, the Commissioner may disregard the general asset
account election and make any reallocations of income or expense
necessary to clearly reflect income.
(B) A general asset account shall be treated as a single asset for
purposes of applying the rules in Sec. 1.861-9T(g)(3) (relating to
allocation and apportionment of interest expense under the asset
method). A general asset account that generates income in more than one
grouping of income (statutory and residual) is a multiple category asset
(as defined in Sec. 1.861-9T(g)(3)(ii)), and the income yield from the
general asset account must be determined by applying the rules for
multiple category assets as if the general asset account were a single
asset.
(2) Grouping assets in general asset accounts--(i) General rules. If
a taxpayer makes the election under paragraph (l) of this section,
assets that are subject to the election are grouped into one or more
general asset accounts. Assets that are eligible to be grouped into a
single general asset account may be divided into more than one general
asset account. Each general asset account must include only assets
that--
(A) Have the same applicable depreciation method;
(B) Have the same applicable recovery period;
(C) Have the same applicable convention; and
(D) Are placed in service by the taxpayer in the same taxable year.
(ii) Special rules. In addition to the general rules in paragraph
(c)(2)(i) of this section, the following rules apply when establishing
general asset accounts--
(A) Assets subject to the mid-quarter convention may only be grouped
into a general asset account with assets that are placed in service in
the same quarter of the taxable year;
(B) Assets subject to the mid-month convention may only be grouped
into a general asset account with assets that are placed in service in
the same month of the taxable year;
(C) Passenger automobiles for which the depreciation allowance is
limited under section 280F(a) must be grouped into a separate general
asset account;
(D) Assets not eligible for any additional first year depreciation
deduction, including assets for which the taxpayer elected not to deduct
the additional first year depreciation, provided by, for example,
section 168(k), section 168(l), section 168(m), section 168(n), section
1400L(b), or section 1400N(d), must be grouped into a separate general
asset account;
(E) Assets eligible for the additional first year depreciation
deduction may only be grouped into a general asset account with assets
for which the taxpayer claimed the same percentage of the additional
first year depreciation (for example, 30 percent, 50 percent, or 100
percent);
(F) Except for passenger automobiles described in paragraph
(c)(2)(ii)(C) of this section, listed property (as defined in section
280F(d)(4)) must be grouped into a separate general asset account;
(G) Assets for which the depreciation allowance for the placed-in-
service year is not determined by using an optional depreciation table
(for further guidance, see section 8 of Rev. Proc. 87-57, 1987-2 CB 687,
693 (see Sec. 601.601(d)(2) of this chapter)) must be grouped into a
separate general asset account;
(H) Mass assets that are or will be subject to paragraph
(j)(2)(i)(D) of this section (disposed of or converted mass asset is
identified by a mortality dispersion table) must be grouped into a
separate general asset account; and
(I) Assets subject to paragraph (h)(2)(iii)(A) of this section
(change in use results in a shorter recovery period or a more
accelerated depreciation
[[Page 497]]
method) for which the depreciation allowance for the year of change (as
defined in Sec. 1.168(i)-4(a)) is not determined by using an optional
depreciation table must be grouped into a separate general asset
account.
(3) Examples. The following examples illustrate the application of
this paragraph (c):
Example 1. In 2014, J, a proprietorship with a calendar year-end,
purchases and places in service one item of equipment that costs
$550,000. This equipment is section 179 property and also is 5-year
property under section 168(e). On its Federal tax return for 2014, J
makes an election under section 179 to expense $25,000 of the
equipment's cost and makes an election under paragraph (l) of this
section to include the equipment in a general asset account. As a
result, the unadjusted depreciable basis of the equipment is $525,000.
In accordance with paragraph (c)(1) of this section, J must include only
$525,000 of the equipment's cost in the general asset account.
Example 2. In 2014, K, a proprietorship with a calendar year-end,
purchases and places in service 100 items of equipment. All of these
items are 5-year property under section 168(e), are not listed property,
and are not eligible for any additional first year depreciation
deduction. On its Federal tax return for 2014, K does not make an
election under section 179 to expense the cost of any of the 100 items
of equipment and does make an election under paragraph (l) of this
section to include the 100 items of equipment in a general asset
account. K depreciates its 5-year property placed in service in 2014
using the optional depreciation table that corresponds with the general
depreciation system, the 200-percent declining balance method, a 5-year
recovery period, and the half-year convention. In accordance with
paragraph (c)(2) of this section, K includes all of the 100 items of
equipment in one general asset account.
Example 3. The facts are the same as in Example 2, except that K
decides not to include all of the 100 items of equipment in one general
asset account. Instead and in accordance with paragraph (c)(2) of this
section, K establishes 100 general asset accounts and includes one item
of equipment in each general asset account.
Example 4. L, a calendar-year corporation, is a wholesale
distributer. In 2014, L places in service the following properties for
use in its wholesale distribution business: Computers, automobiles, and
forklifts. On its Federal tax return for 2014, L does not make an
election under section 179 to expense the cost of any of these items of
equipment and does make an election under paragraph (l) of this section
to include all of these items of equipment in a general asset account.
All of these items are 5-year property under section 168(e) and are not
eligible for any additional first year depreciation deduction. The
computers are listed property, and the automobiles are listed property
and are subject to section 280F(a). L depreciates its 5-year property
placed in service in 2014 using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. Although the computers, automobiles, and forklifts are 5-
year property, L cannot include all of them in one general asset account
because the computers and automobiles are listed property. Further, even
though the computers and automobiles are listed property, L cannot
include them in one general asset account because the automobiles also
are subject to section 280F(a). In accordance with paragraph (c)(2) of
this section, L establishes three general asset accounts: One for the
computers, one for the automobiles, and one for the forklifts.
Example 5. M, a fiscal-year corporation with a taxable year ending
June 30, purchases and places in service ten items of new equipment in
October 2014, and purchases and places in service five other items of
new equipment in February 2015. On its Federal tax return for the
taxable year ending June 30, 2015, M does not make an election under
section 179 to expense the cost of any of these items of equipment and
does make an election under paragraph (l) of this section to include all
of these items of equipment in a general asset account. All of these
items of equipment are 7-year property under section 168(e), are not
listed property, and are property described in section 168(k)(2)(B). All
of the ten items of equipment placed in service in October 2014 are
eligible for the 50-percent additional first year depreciation deduction
provided by section 168(k)(1). All of the five items of equipment placed
in service in February 2015 are not eligible for any additional first
year depreciation deduction. M depreciates its 7-year property placed in
service for the taxable year ending June 30, 2015, using the optional
depreciation table that corresponds with the general depreciation
system, the 200-percent declining balance method, a 7-year recovery
period, and the half-year convention. Although the 15 items of equipment
are depreciated using the same depreciation method, recovery period, and
convention, M cannot include all of them in one general asset account
because some of items of equipment are not eligible for any additional
first year depreciation deduction. In accordance with paragraph (c)(2)
of this section, M establishes two general asset accounts: one for the
ten items of equipment eligible for the 50-percent additional first year
depreciation deduction and one for the five items of equipment not
eligible for any additional first year depreciation deduction.
[[Page 498]]
(d) Determination of depreciation allowance--(1) In general.
Depreciation allowances are determined for each general asset account.
The depreciation allowances must be recorded in a depreciation reserve
account for each general asset account. The allowance for depreciation
under this section constitutes the amount of depreciation allowable
under section 167(a).
(2) Assets in general asset account are eligible for additional
first year depreciation deduction. If all the assets in a general asset
account are eligible for the additional first year depreciation
deduction, the taxpayer first must determine the allowable additional
first year depreciation deduction for the general asset account for the
placed-in-service year and then must determine the amount otherwise
allowable as a depreciation deduction for the general asset account for
the placed-in-service year and any subsequent taxable year. The
allowable additional first year depreciation deduction for the general
asset account for the placed-in-service year is determined by
multiplying the unadjusted depreciable basis of the general asset
account by the additional first year depreciation deduction percentage
applicable to the assets in the account (for example, 30 percent, 50
percent, or 100 percent). The remaining adjusted depreciable basis of
the general asset account then is depreciated using the applicable
depreciation method, recovery period, and convention for the assets in
the account.
(3) No assets in general asset account are eligible for additional
first year depreciation deduction. If none of the assets in a general
asset account are eligible for the additional first year depreciation
deduction, the taxpayer must determine the allowable depreciation
deduction for the general asset account for the placed-in-service year
and any subsequent taxable year by using the applicable depreciation
method, recovery period, and convention for the assets in the account.
(4) Special rule for passenger automobiles. For purposes of applying
section 280F(a), the depreciation allowance for a general asset account
established for passenger automobiles is limited for each taxable year
to the amount prescribed in section 280F(a) multiplied by the excess of
the number of automobiles originally included in the account over the
number of automobiles disposed of during the taxable year or in any
prior taxable year in a transaction described in paragraph (e)(3)(iii)
(disposition of an asset in a qualifying disposition), paragraph
(e)(3)(iv) (transactions subject to section 168(i)(7)), paragraph
(e)(3)(v) (transactions subject to section 1031 or section 1033),
paragraph (e)(3)(vi) (technical termination of a partnership), paragraph
(e)(3)(vii) (anti-abuse rule), paragraph (g) (assets subject to
recapture), or paragraph (h)(1) (conversion to any personal use) of this
section.
(e) Dispositions from a general asset account--(1) Scope and
definition--(i) In general. This paragraph (e) provides rules applicable
to dispositions of assets included in a general asset account. For
purposes of this paragraph (e), an asset in a general asset account is
disposed of when ownership of the asset is transferred or when the asset
is permanently withdrawn from use either in the taxpayer's trade or
business or in the production of income. A disposition includes the
sale, exchange, retirement, physical abandonment, or destruction of an
asset. A disposition also occurs when an asset is transferred to a
supplies, scrap, or similar account, or when a portion of an asset is
disposed of as described in paragraph (e)(1)(ii) of this section. If a
structural component, or a portion thereof, of a building is disposed of
in a disposition described in paragraph (e)(1)(ii) of this section, a
disposition also includes the disposition of such structural component
or such portion thereof.
(ii) Disposition of a portion of an asset. For purposes of applying
paragraph (e) of this section, a disposition includes a disposition of a
portion of an asset in a general asset account as a result of a casualty
event described in section 165, a disposition of a portion of an asset
in a general asset account for which gain, determined without regard to
section 1245 or section 1250, is not recognized in whole or in part
under section 1031 or section 1033, a transfer of a portion of an asset
in a general asset account in a transaction described in section
168(i)(7)(B), a sale of a portion of an asset in a general asset
account, or a
[[Page 499]]
disposition of a portion of an asset in a general asset account in a
transaction described in paragraph (e)(3)(vii)(B) of this section. For
other transactions, a disposition includes a disposition of a portion of
an asset in a general asset account only if the taxpayer makes the
election under paragraph (e)(3)(ii) of this section to terminate the
general asset account in which that disposed portion is included or
makes the election under paragraph (e)(3)(iii) of this section for that
disposed portion.
(2) General rules for a disposition--(i) No immediate recovery of
basis. Except as provided in paragraph (e)(3) of this section,
immediately before a disposition of any asset in a general asset account
or a disposition of a portion of such asset as described in paragraph
(e)(1)(ii) of this section, the asset or the portion of the asset, as
applicable, is treated as having an adjusted depreciable basis (as
defined in Sec. 1.168(b)-1(a)(4)) of zero for purposes of section 1011.
Therefore, no loss is realized upon the disposition of an asset from the
general asset account or upon the disposition of a portion of such asset
as described in paragraph (e)(1)(ii) of this section. Similarly, where
an asset or a portion of an asset, as applicable, is disposed of by
transfer to a supplies, scrap, or similar account, the basis of the
asset or the portion of the asset, as applicable, in the supplies,
scrap, or similar account will be zero.
(ii) Treatment of amount realized. Any amount realized on a
disposition is recognized as ordinary income, notwithstanding any other
provision of subtitle A of the Internal Revenue Code (Code), to the
extent the sum of the unadjusted depreciable basis of the general asset
account and any expensed cost (as defined in paragraph (b)(5) of this
section) for assets in the account exceeds any amounts previously
recognized as ordinary income upon the disposition of other assets in
the account or upon the disposition of portions of such assets as
described in paragraph (e)(1)(ii) of this section. The recognition and
character of any excess amount realized are determined under other
applicable provisions of the Code other than sections 1245 and 1250 or
provisions of the Code that treat gain on a disposition as subject to
section 1245 or section 1250.
(iii) Effect of disposition on a general asset account. Except as
provided in paragraph (e)(3) of this section, the unadjusted depreciable
basis and the depreciation reserve of the general asset account are not
affected as a result of a disposition of an asset from the general asset
account or of a disposition of a portion of such asset as described in
paragraph (e)(1)(ii) of this section.
(iv) Coordination with nonrecognition provisions. For purposes of
determining the basis of an asset or a portion of an asset, as
applicable, acquired in a transaction, other than a transaction
described in paragraph (e)(3)(iv) (pertaining to transactions subject to
section 168(i)(7)), paragraph (e)(3)(v) (pertaining to transactions
subject to section 1031 or section 1033), and paragraph (e)(3)(vi)
(pertaining to technical terminations of partnerships) of this section,
to which a nonrecognition section of the Code applies, determined
without regard to this section, the amount of ordinary income recognized
under this paragraph (e)(2) is treated as the amount of gain recognized
on the disposition.
(v) Manner of disposition. The manner of disposition (for example,
normal retirement, abnormal retirement, ordinary retirement, or
extraordinary retirement) is not taken into account in determining
whether a disposition occurs or gain or loss is recognized.
(vi) Disposition by transfer to a supplies account. If a taxpayer
made an election under Sec. 1.162-3(d) to treat the cost of any rotable
spare part, temporary spare part, or standby emergency spare part (as
defined in Sec. 1.162-3(c)) as a capital expenditure subject to the
allowance for depreciation and also made an election under paragraph (l)
of this section to include that rotable, temporary, or standby emergency
spare part in a general asset account, the taxpayer can dispose of the
rotable, temporary, or standby emergency spare part by transferring it
to a supplies account only if the taxpayer has obtained the consent of
the Commissioner to revoke the Sec. 1.162-3(d) election. If a taxpayer
made an election under Sec. 1.162-3T(d) to treat the cost of
[[Page 500]]
any material and supply (as defined in Sec. 1.162-3T(c)(1)) as a
capital expenditure subject to the allowance for depreciation and also
made an election under paragraph (l) of this section to include that
material and supply in a general asset account, the taxpayer can dispose
of the material and supply by transferring it to a supplies account only
if the taxpayer has obtained the consent of the Commissioner to revoke
the Sec. 1.162-3T(d) election. See Sec. 1.162-3(d)(3) for the
procedures for revoking a Sec. 1.162-3(d) or a Sec. 1.162-3T(d)
election.
(vii) Leasehold improvements. The rules of paragraph (e) of this
section also apply to--
(A) A lessor of leased property that made an improvement to that
property for the lessee of the property, has a depreciable basis in the
improvement, made an election under paragraph (l) of this section to
include the improvement in a general asset account, and disposes of the
improvement, or disposes of a portion of the improvement as described in
paragraph (e)(1)(ii) of this section, before or upon the termination of
the lease with the lessee. See section 168(i)(8)(B); and
(B) A lessee of leased property that made an improvement to that
property, has a depreciable basis in the improvement, made an election
under paragraph (l) of this section to include the improvement in a
general asset account, and disposes of the improvement, or disposes of a
portion of the improvement as described in paragraph (e)(1)(ii) of this
section, before or upon the termination of the lease.
(viii) Determination of asset disposed of--(A) General rules. For
purposes of applying paragraph (e) of this section to the disposition of
an asset in a general asset account, instead of the disposition of the
general asset account, the facts and circumstances of each disposition
are considered in determining what is the appropriate asset disposed of.
The asset for disposition purposes may not consist of items placed in
service by the taxpayer on different dates, without taking into account
the applicable convention. For purposes of determining what is the
appropriate asset disposed of, the unit of property determination under
Sec. 1.263(a)-3(e) or in published guidance in the Internal Revenue
Bulletin under section 263(a) (see Sec. 601.601(d)(2) of this chapter)
does not apply.
(B) Special rules. In addition to the general rules in paragraph
(e)(2)(viii)(A) of this section, the following rules apply for purposes
of applying paragraph (e) of this section to the disposition of an asset
in a general asset account instead of the disposition of the general
asset account:
(1) Each building, including its structural components, is the
asset, except as provided in Sec. 1.1250-1(a)(2)(ii) or in paragraph
(e)(2)(viii)(B)(2) or (4) of this section.
(2) If a building has two or more condominium or cooperative units,
each condominium or cooperative unit, including its structural
components, is the asset, except as provided in Sec. 1.1250-1(a)(2)(ii)
or in paragraph (e)(2)(viii)(B)(4) of this section.
(3) If a taxpayer properly includes an item in one of the asset
classes 00.11 through 00.4 of Rev. Proc. 87-56 (1987-2 CB 674) (see
Sec. 601.601(d)(2) of this chapter) or properly classifies an item in
one of the categories under section 168(e)(3), except for a category
that includes buildings or structural components (for example, retail
motor fuels outlet, qualified leasehold improvement property, qualified
restaurant property, and qualified retail improvement property), each
item is the asset, provided that paragraph (e)(2)(viii)(B)(4) of this
section does not apply to the item. For example, each desk is the asset,
each computer is the asset, and each qualified smart electric meter is
the asset.
(4) If the taxpayer places in service an improvement or addition to
an asset after the taxpayer placed the asset in service, the improvement
or addition and, if applicable, its structural components are a separate
asset.
(ix) Examples. The following examples illustrate the application of
this paragraph (e)(2):
Example 1. A, a calendar-year partnership, maintains one general
asset account for one office building that cost $10 million. A discovers
a leak in the roof of the building and decides to replace the entire
roof. The roof is a structural component of the building. In accordance
with paragraph (e)(2)(viii)(B)(1) of this section, the office building,
including its structural components, is the asset for
[[Page 501]]
disposition purposes. The retirement of the replaced roof is not a
disposition of a portion of an asset as described in paragraph
(e)(1)(ii) of this section. Thus, the retirement of the replaced roof is
not a disposition under paragraph (e)(1) of this section. As a result, A
continues to depreciate the $10 million cost of the general asset
account. If A must capitalize the amount paid for the replacement roof
pursuant to Sec. 1.263(a)-3, the replacement roof is a separate asset
for disposition purposes pursuant to paragraph (e)(2)(viii)(B)(4) of
this section and for depreciation purposes pursuant to section
168(i)(6).
Example 2. B, a calendar-year commercial airline company, maintains
one general asset account for five aircraft that cost a total of $500
million. These aircraft are described in asset class 45.0 of Rev. Proc.
87-56. B replaces the existing engines on one of the aircraft with new
engines. Assume each aircraft is a unit of property as determined under
Sec. 1.263(a)-3(e)(3) and each engine of an aircraft is a major
component or substantial structural part of the aircraft as determined
under Sec. 1.263(a)-3(k)(6). Assume also that B treats each aircraft as
the asset for disposition purposes in accordance with paragraph
(e)(2)(viii) of this section. The retirement of the replaced engines is
not a disposition of a portion of an asset as described in paragraph
(e)(1)(ii) of this section. Thus, the retirement of the replaced engines
is not a disposition under paragraph (e)(1) of this section. As a
result, B continues to depreciate the $500 million cost of the general
asset account. If B must capitalize the amount paid for the replacement
engines pursuant to Sec. 1.263(a)-3, the replacement engines are a
separate asset for disposition purposes pursuant to paragraph
(e)(2)(viii)(B)(4) of this section and for depreciation purposes
pursuant to section 168(i)(6).
Example 3. (i) R, a calendar-year corporation, maintains one general
asset account for ten machines. The machines cost a total of $10,000 and
are placed in service in June 2014. Of the ten machines, one machine
costs $8,200 and nine machines cost a total of $1,800. Assume R
depreciates this general asset account using the optional depreciation
table that corresponds with the general depreciation system, the 200-
percent declining balance method, a 5-year recovery period, and a half-
year convention. R does not make a section 179 election for any of the
machines, and all of the machines are not eligible for any additional
first year depreciation deduction. As of January 1, 2015, the
depreciation reserve of the account is $2,000 ($10,000 x 20%).
(ii) On February 8, 2015, R sells the machine that cost $8,200 to an
unrelated party for $9,000. Under paragraph (e)(2)(i) of this section,
this machine has an adjusted depreciable basis of zero.
(iii) On its 2015 tax return, R recognizes the amount realized of
$9,000 as ordinary income because such amount does not exceed the
unadjusted depreciable basis of the general asset account ($10,000),
plus any expensed cost for assets in the account ($0), less amounts
previously recognized as ordinary income ($0). Moreover, the unadjusted
depreciable basis and depreciation reserve of the account are not
affected by the disposition of the machine. Thus, the depreciation
allowance for the account in 2015 is $3,200 ($10,000 x 32%).
Example 4. (i) The facts are the same as in Example 3. In addition,
on June 4, 2016, R sells seven machines to an unrelated party for a
total of $1,100. In accordance with paragraph (e)(2)(i) of this section,
these machines have an adjusted depreciable basis of zero.
(ii) On its 2016 tax return, R recognizes $1,000 as ordinary income
(the unadjusted depreciable basis of $10,000, plus the expensed cost of
$0, less the amount of $9,000 previously recognized as ordinary income).
The recognition and character of the excess amount realized of $100
($1,100-$1,000) are determined under applicable provisions of the Code
other than section 1245 (such as section 1231). Moreover, the unadjusted
depreciable basis and depreciation reserve of the account are not
affected by the disposition of the machines. Thus, the depreciation
allowance for the account in 2016 is $1,920 ($10,000 x 19.2%).
(3) Special rules--(i) In general. This paragraph (e)(3) provides
the rules for terminating general asset account treatment upon certain
dispositions. While the rules under paragraphs (e)(3)(ii) and (iii) of
this section are optional rules, the rules under paragraphs (e)(3)(iv),
(v), (vi), and (vii) of this section are mandatory rules. A taxpayer
elects to apply paragraph (e)(3)(ii) or (iii) of this section by
reporting the gain, loss, or other deduction on the taxpayer's timely
filed original Federal tax return, including extensions, for the taxable
year in which the disposition occurs. However, if the loss is on account
of the demolition of a structure to which section 280B and Sec. 1.280B-
1 apply, a taxpayer elects to apply paragraph (e)(3)(ii) or (iii) of
this section by ending depreciation for the structure at the time of the
disposition of the structure, taking into account the convention
applicable to the general asset account in which the demolished
structure was included, and reporting the amount of depreciation for
that structure for the taxable year in which the disposition occurs on
[[Page 502]]
the taxpayer's timely filed original Federal tax return, including
extensions, for that taxable year. A taxpayer may revoke the election to
apply paragraph (e)(3)(ii) or (iii) of this section only by filing a
request for a private letter ruling and obtaining the Commissioner's
consent to revoke the election. The Commissioner may grant a request to
revoke this election if the taxpayer acted reasonably and in good faith,
and the revocation will not prejudice the interests of the Government.
See generally Sec. 301.9100-3 of this chapter. The election to apply
paragraph (e)(3)(ii) or (iii) of this section may not be made or revoked
through the filing of an application for change in accounting method.
For purposes of applying paragraphs (e)(3)(iii) through (vii) of this
section, see paragraph (j) of this section for identifying an asset
disposed of and its unadjusted depreciable basis. Solely for purposes of
applying paragraphs (e)(3)(iii), (e)(3)(iv)(C), (e)(3)(v)(B), and
(e)(3)(vii) of this section, the term asset is:
(A) The asset as determined under paragraph (e)(2)(viii) of this
section; or
(B) The portion of such asset that is disposed of in a disposition
described in paragraph (e)(1)(ii) of this section.
(ii) Disposition of all assets remaining in a general asset
account--(A) Optional termination of a general asset account. Upon the
disposition of all of the assets, the last asset, or the remaining
portion of the last asset in a general asset account, a taxpayer may
apply this paragraph (e)(3)(ii) to recover the adjusted depreciable
basis of the general asset account rather than having paragraph (e)(2)
of this section apply. Under this paragraph (e)(3)(ii), the general
asset account terminates and the amount of gain or loss for the general
asset account is determined under section 1001(a) by taking into account
the adjusted depreciable basis of the general asset account at the time
of the disposition, as determined under the applicable convention for
the general asset account. Whether and to what extent gain or loss is
recognized is determined under other applicable provisions of the Code,
including section 280B and Sec. 1.280B-1. The character of the gain or
loss is determined under other applicable provisions of the Code, except
that the amount of gain subject to section 1245 is limited to the excess
of the depreciation allowed or allowable for the general asset account,
including any expensed cost, over any amounts previously recognized as
ordinary income under paragraph (e)(2) of this section, and the amount
of gain subject to section 1250 is limited to the excess of the
additional depreciation allowed or allowable for the general asset
account, over any amounts previously recognized as ordinary income under
paragraph (e)(2) of this section.
(B) Examples. The following examples illustrate the application of
this paragraph (e)(3)(ii):
Example 1. (i) T, a calendar-year corporation, maintains a general
asset account for 1,000 calculators. The calculators cost a total of
$60,000 and are placed in service in 2014. Assume T depreciates this
general asset account using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and a half-year
convention. T does not make a section 179 election for any of the
calculators, and all of the calculators are not eligible for any
additional first year depreciation deduction. In 2015, T sells 200 of
the calculators to an unrelated party for a total of $10,000 and
recognizes the $10,000 as ordinary income in accordance with paragraph
(e)(2) of this section.
(ii) On March 26, 2016, T sells the remaining calculators in the
general asset account to an unrelated party for $35,000. T elects to
apply paragraph (e)(3)(ii) of this section. As a result, the account
terminates and gain or loss is determined for the account.
(iii) On the date of disposition, the adjusted depreciable basis of
the account is $23,040 (unadjusted depreciable basis of $60,000 less the
depreciation allowed or allowable of $36,960). Thus, in 2016, T
recognizes gain of $11,960 (amount realized of $35,000 less the adjusted
depreciable basis of $23,040). The gain of $11,960 is subject to section
1245 to the extent of the depreciation allowed or allowable for the
account, plus the expensed cost for assets in the account, less the
amounts previously recognized as ordinary income ($36,960 + $0 - $10,000
= $26,960). As a result, the entire gain of $11,960 is subject to
section 1245.
Example 2. (i) J, a calendar-year corporation, maintains a general
asset account for one item of equipment. This equipment costs $2,000 and
is placed in service in 2014. Assume J depreciates this general asset
account using the optional depreciation table that corresponds with the
general depreciation system, the 200-percent declining balance
[[Page 503]]
method, a 5-year recovery period, and a half-year convention. J does not
make a section 179 election for the equipment, and it is not eligible
for any additional first year depreciation deduction. In June 2016, J
sells the equipment to an unrelated party for $1,000. J elects to apply
paragraph (e)(3)(ii) of this section. As a result, the account
terminates and gain or loss is determined for the account.
(ii) On the date of disposition, the adjusted depreciable basis of
the account is $768 (unadjusted depreciable basis of $2,000 less the
depreciation allowed or allowable of $1,232). Thus, in 2016, J
recognizes gain of $232 (amount realized of $1,000 less the adjusted
depreciable basis of $768). The gain of $232 is subject to section 1245
to the extent of the depreciation allowed or allowable for the account,
plus the expensed cost for assets in the account, less the amounts
previously recognized as ordinary income ($1,232 + $0 - $0 = $1,232).As
a result, the entire gain of $232 is subject to section 1245.
(iii) Disposition of an asset in a qualifying disposition--(A)
Optional determination of the amount of gain, loss, or other deduction.
In the case of a qualifying disposition (described in paragraph
(e)(3)(iii)(B) of this section) of an asset, a taxpayer may elect to
apply this paragraph (e)(3)(iii) rather than having paragraph (e)(2) of
this section apply. Under this paragraph (e)(3)(iii), general asset
account treatment for the asset terminates as of the first day of the
taxable year in which the qualifying disposition occurs, and the amount
of gain, loss, or other deduction for the asset is determined under
Sec. 1.168(i)-8 by taking into account the asset's adjusted depreciable
basis at the time of the disposition. The adjusted depreciable basis of
the asset at the time of the disposition, as determined under the
applicable convention for the general asset account in which the asset
was included, equals the unadjusted depreciable basis of the asset less
the greater of the depreciation allowed or allowable for the asset. The
allowable depreciation is computed by using the depreciation method,
recovery period, and convention applicable to the general asset account
in which the asset was included and by including the portion of the
additional first year depreciation deduction claimed for the general
asset account that is attributable to the asset disposed of. Whether and
to what extent gain, loss, or other deduction is recognized is
determined under other applicable provisions of the Code, including
section 280B and Sec. 1.280B-1. The character of the gain, loss, or
other deduction is determined under other applicable provisions of the
Code, except that the amount of gain subject to section 1245 or section
1250 is limited to the lesser of--
(1) The depreciation allowed or allowable for the asset, including
any expensed cost or, in the case of section 1250 property, the
additional depreciation allowed or allowable for the asset; or
(2) The excess of--
(i) The original unadjusted depreciable basis of the general asset
account plus, in the case of section 1245 property originally included
in the general asset account, any expensed cost; over
(ii) The cumulative amounts of gain previously recognized as
ordinary income under either paragraph (e)(2) of this section or section
1245 or section 1250.
(B) Qualifying dispositions. A qualifying disposition is a
disposition that does not involve all the assets, the last asset, or the
remaining portion of the last asset remaining in a general asset account
and that is--
(1) A direct result of a fire, storm, shipwreck, or other casualty,
or from theft;
(2) A charitable contribution for which a deduction is allowable
under section 170;
(3) A direct result of a cessation, termination, or disposition of a
business, manufacturing or other income producing process, operation,
facility, plant, or other unit, other than by transfer to a supplies,
scrap, or similar account; or
(4) A transaction, other than a transaction described in paragraph
(e)(3)(iv) (pertaining to transactions subject to section 168(i)(7)),
paragraph (e)(3)(v) (pertaining to transactions subject to section 1031
or section 1033), paragraph (e)(3)(vi) (pertaining to technical
terminations of partnerships), or paragraph (e)(3)(vii) (anti-abuse
rule) of this section, to which a nonrecognition section of the Internal
Revenue Code
[[Page 504]]
applies (determined without regard to this section).
(C) Effect of a qualifying disposition on a general asset account.
If the taxpayer elects to apply this paragraph (e)(3)(iii) to a
qualifying disposition of an asset, then--
(1) The asset is removed from the general asset account as of the
first day of the taxable year in which the qualifying disposition
occurs. For that taxable year, the taxpayer accounts for the asset in a
single asset account in accordance with the rules under Sec. 1.168(i)-
7(b);
(2) The unadjusted depreciable basis of the general asset account is
reduced by the unadjusted depreciable basis of the asset as of the first
day of the taxable year in which the disposition occurs;
(3) The depreciation reserve of the general asset account is reduced
by the greater of the depreciation allowed or allowable for the asset as
of the end of the taxable year immediately preceding the year of
disposition. The allowable depreciation is computed by using the
depreciation method, recovery period, and convention applicable to the
general asset account in which the asset was included and by including
the portion of the additional first year depreciation deduction claimed
for the general asset account that is attributable to the asset disposed
of; and
(4) For purposes of determining the amount of gain realized on
subsequent dispositions that is subject to ordinary income treatment
under paragraph (e)(2)(ii) of this section, the amount of any expensed
cost with respect to the asset is disregarded.
(D) Examples. The following examples illustrate the application of
this paragraph (e)(3)(iii):
Example 1. (i) Z, a calendar-year corporation, maintains one general
asset account for 12 machines. Each machine costs $15,000 and is placed
in service in 2014. Of the 12 machines, nine machines that cost a total
of $135,000 are used in Z's Kentucky plant, and three machines that cost
a total of $45,000 are used in Z's Ohio plant. Assume Z depreciates this
general asset account using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. Z does not make a section 179 election for any of the
machines, and all of the machines are not eligible for any additional
first year depreciation deduction. As of December 31, 2015, the
depreciation reserve for the account is $93,600.
(ii) On May 27, 2016, Z sells its entire manufacturing plant in Ohio
to an unrelated party. The sales proceeds allocated to each of the three
machines at the Ohio plant is $5,000. This transaction is a qualifying
disposition under paragraph (e)(3)(iii)(B)(3) of this section, and Z
elects to apply paragraph (e)(3)(iii) of this section.
(iii) For Z's 2016 return, the depreciation allowance for the
account is computed as follows. As of December 31, 2015, the
depreciation allowed or allowable for the three machines at the Ohio
plant is $23,400. Thus, as of January 1, 2016, the unadjusted
depreciable basis of the account is reduced from $180,000 to $135,000
($180,000 less the unadjusted depreciable basis of $45,000 for the three
machines), and, as of December 31, 2015, the depreciation reserve of the
account is decreased from $93,600 to $70,200 ($93,600 less the
depreciation allowed or allowable of $23,400 for the three machines as
of December 31, 2015). Consequently, the depreciation allowance for the
account in 2016 is $25,920 ($135,000 x 19.2%).
(iv) For Z's 2016 return, gain or loss for each of the three
machines at the Ohio plant is determined as follows. The depreciation
allowed or allowable in 2016 for each machine is $1,440 (($15,000 x
19.2%)/2). Thus, the adjusted depreciable basis of each machine under
section 1011 is $5,760 (the adjusted depreciable basis of $7,200 removed
from the account less the depreciation allowed or allowable of $1,440 in
2016). As a result, the loss recognized in 2016 for each machine is $760
($5,000 - $5,760), which is subject to section 1231.
Example 2. (i) A, a calendar-year partnership, maintains one general
asset account for one office building that cost $20 million and was
placed in service in July 2011. A depreciates this general asset account
using the optional depreciation table that corresponds with the general
depreciation system, the straight-line method, a 39-year recovery
period, and the mid-month convention. As of January 1, 2014, the
depreciation reserve for the account is $1,261,000.
(ii) In May 2014, a tornado occurs where the building is located and
damages the roof of the building. A decides to replace the entire roof.
The roof is replaced in June 2014. The roof is a structural component of
the building. Because the roof was damaged as a result of a casualty
event described in section 165, the partial disposition rule provided
under paragraph (e)(1)(ii) of this section applies to the roof. Although
the office building, including its structural components, is the asset
for disposition purposes, the partial disposition rule provides that the
retirement
[[Page 505]]
of the replaced roof is a disposition under paragraph (e)(1) of this
section. This retirement is a qualifying disposition under paragraph
(e)(3)(iii)(B)(1) of this section, and A elects to apply paragraph
(e)(3)(iii) of this section for the retirement of the damaged roof.
(iii) Of the $20 million cost of the office building, assume $1
million is the cost of the retired roof.
(iv) For A's 2014 return, the depreciation allowance for the account
is computed as follows. As of December 31, 2013, the depreciation
allowed or allowable for the retired roof is $63,050. Thus, as of
January 1, 2014, the unadjusted depreciable basis of the account is
reduced from $20,000,000 to $19,000,000 ($20,000,000 less the unadjusted
depreciable basis of $1,000,000 for the retired roof), and the
depreciation reserve of the account is decreased from $1,261,000 to
$1,197,950 ($1,261,000 less the depreciation allowed or allowable of
$63,050 for the retired roof as of December 31, 2013). Consequently, the
depreciation allowance for the account in 2014 is $487,160 ($19,000,000
x 2.564%).
(v) For A's 2014 return, gain or loss for the retired roof is
determined as follows. The depreciation allowed or allowable in 2014 for
the retired roof is $11,752 (($1,000,000 x 2.564%) x 5.5/12). Thus, the
adjusted depreciable basis of the retired roof under section 1011 is
$925,198 (the adjusted depreciable basis of $936,950 removed from the
account less the depreciation allowed or allowable of $11,752 in 2014).
As a result, the loss recognized in 2014 for the retired roof is
$925,198, which is subject to section 1231.
(vi) If A must capitalize the amount paid for the replacement roof
under Sec. 1.263(a)-3, the replacement roof is a separate asset for
depreciation purposes pursuant to section 168(i)(6). If A includes the
replacement roof in a general asset account, the replacement roof is a
separate asset for disposition purposes pursuant to paragraph
(e)(2)(viii)(B)(4) of this section. If A includes the replacement roof
in a single asset account or a multiple asset account under Sec.
1.168(i)-7, the replacement roof is a separate asset for disposition
purposes pursuant to Sec. 1.168(i)-8(c)(4)(ii)(D).
(iv) Transactions subject to section 168(i)(7)--(A) In general. If a
taxpayer transfers one or more assets, or a portion of such asset, in a
general asset account in a transaction described in section 168(i)(7)(B)
(pertaining to treatment of transferees in certain nonrecognition
transactions), the taxpayer (the transferor) and the transferee must
apply this paragraph (e)(3)(iv) to the asset or the portion of such
asset, instead of applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii)
of this section. The transferee is bound by the transferor's election
under paragraph (l) of this section for the portion of the transferee's
basis in the asset or the portion of such asset that does not exceed the
transferor's adjusted depreciable basis of the general asset account or
the asset or the portion of such asset, as applicable, as determined
under paragraph (e)(3)(iv)(B)(2) or (C)(2) of this section, as
applicable.
(B) All assets remaining in general asset account are transferred.
If a taxpayer transfers all the assets, the last asset, or the remaining
portion of the last asset in a general asset account in a transaction
described in section 168(i)(7)(B)--
(1) The taxpayer (the transferor) must terminate the general asset
account on the date of the transfer. The allowable depreciation
deduction for the general asset account for the transferor's taxable
year in which the section 168(i)(7)(B) transaction occurs is computed by
using the depreciation method, recovery period, and convention
applicable to the general asset account. This allowable depreciation
deduction is allocated between the transferor and the transferee on a
monthly basis. This allocation is made in accordance with the rules in
Sec. 1.168(d)-1(b)(7)(ii) for allocating the depreciation deduction
between the transferor and the transferee;
(2) The transferee must establish a new general asset account for
all the assets, the last asset, or the remaining portion of the last
asset, in the taxable year in which the section 168(i)(7)(B) transaction
occurs for the portion of its basis in the assets that does not exceed
the transferor's adjusted depreciable basis of the general asset account
in which all the assets, the last asset, or the remaining portion of the
last asset, were included. The transferor's adjusted depreciable basis
of this general asset account is equal to the adjusted depreciable basis
of that account as of the beginning of the transferor's taxable year in
which the transaction occurs, decreased by the amount of depreciation
allocable to the transferor for the year of the transfer, as determined
under paragraph (e)(3)(iv)(B)(1) of this section. The transferee is
treated as the transferor
[[Page 506]]
for purposes of computing the allowable depreciation deduction for the
new general asset account under section 168. The new general asset
account must be established in accordance with the rules in paragraph
(c) of this section, except that the unadjusted depreciable bases of all
the assets, the last asset, or the remaining portion of the last asset,
and the greater of the depreciation allowed or allowable for all the
assets, the last asset, or the remaining portion of the last asset,
including the amount of depreciation for the transferred assets that is
allocable to the transferor for the year of the transfer, are included
in the newly established general asset account. Consequently, this
general asset account in the year of the transfer will have a beginning
balance for both the unadjusted depreciable basis and the depreciation
reserve of the general asset account; and
(3) For purposes of section 168 and this section, the transferee
treats the portion of its basis in the assets that exceeds the
transferor's adjusted depreciable basis of the general asset account in
which all the assets, the last asset, or the remaining portion of the
last asset, were included, as determined under paragraph
(e)(3)(iv)(B)(2) of this section, as a separate asset that the
transferee placed in service on the date of the transfer. The transferee
accounts for this asset under Sec. 1.168(i)-7 or may make an election
under paragraph (l) of this section to include the asset in a general
asset account.
(C) Not all assets remaining in general asset account are
transferred. If a taxpayer transfers an asset in a general asset account
in a transaction described in section 168(i)(7)(B) and if paragraph
(e)(3)(iv)(B) of this section does not apply to this asset--
(1) The taxpayer (the transferor) must remove the transferred asset
from the general asset account in which the asset is included, as of the
first day of the taxable year in which the section 168(i)(7)(B)
transaction occurs. In addition, the adjustments to the general asset
account described in paragraphs (e)(3)(iii)(C)(2) through (4) of this
section must be made. The allowable depreciation deduction for the asset
for the transferor's taxable year in which the section 168(i)(7)(B)
transaction occurs is computed by using the depreciation method,
recovery period, and convention applicable to the general asset account
in which the asset was included. This allowable depreciation deduction
is allocated between the transferor and the transferee on a monthly
basis. This allocation is made in accordance with the rules in Sec.
1.168(d)-1(b)(7)(ii) for allocating the depreciation deduction between
the transferor and the transferee;
(2) The transferee must establish a new general asset account for
the asset in the taxable year in which the section 168(i)(7)(B)
transaction occurs for the portion of its basis in the asset that does
not exceed the transferor's adjusted depreciable basis of the asset. The
transferor's adjusted depreciable basis of this asset is equal to the
adjusted depreciable basis of the asset as of the beginning of the
transferor's taxable year in which the transaction occurs, decreased by
the amount of depreciation allocable to the transferor for the year of
the transfer, as determined under paragraph (e)(3)(iv)(C)(1) of this
section. The transferee is treated as the transferor for purposes of
computing the allowable depreciation deduction for the new general asset
account under section 168. The new general asset account must be
established in accordance with the rules in paragraph (c) of this
section, except that the unadjusted depreciable basis of the asset, and
the greater of the depreciation allowed or allowable for the asset,
including the amount of depreciation for the transferred asset that is
allocable to the transferor for the year of the transfer, are included
in the newly established general asset account. Consequently, this
general asset account in the year of the transfer will have a beginning
balance for both the unadjusted depreciable basis and the depreciation
reserve of the general asset account; and
(3) For purposes of section 168 and this section, the transferee
treats the portion of its basis in the asset that exceeds the
transferor's adjusted depreciable basis of the asset, as determined
under paragraph (e)(3)(iv)(C)(2) of this section, as a separate asset
that the transferee placed in service on the date
[[Page 507]]
of the transfer. The transferee accounts for this asset under Sec.
1.168(i)-7 or may make an election under paragraph (l) of this section
to include the asset in a general asset account.
(v) Transactions subject to section 1031 or section 1033--(A) Like-
kind exchange or involuntary conversion of all assets remaining in a
general asset account. If all the assets, the last asset, or the
remaining portion of the last asset in a general asset account are
transferred by a taxpayer in a like-kind exchange (as defined under
Sec. 1.168-6(b)(11)) or in an involuntary conversion (as defined under
Sec. 1.168-6(b)(12)), the taxpayer must apply this paragraph
(e)(3)(v)(A) instead of applying paragraph (e)(2), (e)(3)(ii), or
(e)(3)(iii) of this section. Under this paragraph (e)(3)(v)(A), the
general asset account terminates as of the first day of the year of
disposition (as defined in Sec. 1.168(i)-6(b)(5)) and--
(1) The amount of gain or loss for the general asset account is
determined under section 1001(a) by taking into account the adjusted
depreciable basis of the general asset account at the time of
disposition (as defined in Sec. 1.168(i)-6(b)(3)). The depreciation
allowance for the general asset account in the year of disposition is
determined in the same manner as the depreciation allowance for the
relinquished MACRS property (as defined in Sec. 1.168(i)-6(b)(2)) in
the year of disposition is determined under Sec. 1.168(i)-6. The
recognition and character of gain or loss are determined in accordance
with paragraph (e)(3)(ii)(A) of this section, notwithstanding that
paragraph (e)(3)(ii) of this section is an optional rule; and
(2) The adjusted depreciable basis of the general asset account at
the time of disposition is treated as the adjusted depreciable basis of
the relinquished MACRS property.
(B) Like-kind exchange or involuntary conversion of less than all
assets remaining in a general asset account. If an asset in a general
asset account is transferred by a taxpayer in a like-kind exchange or in
an involuntary conversion and if paragraph (e)(3)(v)(A) of this section
does not apply to this asset, the taxpayer must apply this paragraph
(e)(3)(v)(B) instead of applying paragraph (e)(2), (e)(3)(ii), or
(e)(3)(iii) of this section. Under this paragraph (e)(3)(v)(B), general
asset account treatment for the asset terminates as of the first day of
the year of disposition (as defined in Sec. 1.168(i)-6(b)(5)), and--
(1) The amount of gain or loss for the asset is determined by taking
into account the asset's adjusted depreciable basis at the time of
disposition (as defined in Sec. 1.168(i)-6(b)(3)). The adjusted
depreciable basis of the asset at the time of disposition equals the
unadjusted depreciable basis of the asset less the greater of the
depreciation allowed or allowable for the asset. The allowable
depreciation is computed by using the depreciation method, recovery
period, and convention applicable to the general asset account in which
the asset was included and by including the portion of the additional
first year depreciation deduction claimed for the general asset account
that is attributable to the relinquished asset. The depreciation
allowance for the asset in the year of disposition is determined in the
same manner as the depreciation allowance for the relinquished MACRS
property (as defined in Sec. 1.168(i)-6(b)(2)) in the year of
disposition is determined under Sec. 1.168(i)-6. The recognition and
character of the gain or loss are determined in accordance with
paragraph (e)(3)(iii)(A) of this section, notwithstanding that paragraph
(e)(3)(iii) of this section is an optional rule; and
(2) As of the first day of the year of disposition, the taxpayer
must remove the relinquished asset from the general asset account and
make the adjustments to the general asset account described in
paragraphs (e)(3)(iii)(C)(2) through (4) of this section.
(vi) Technical termination of a partnership. In the case of a
technical termination of a partnership under section 708(b)(1)(B), the
terminated partnership must apply this paragraph (e)(3)(vi) instead of
applying paragraph (e)(2), (e)(3)(ii), or (e)(3)(iii) of this section.
Under this paragraph (e)(3)(vi), all of the terminated partnership's
general asset accounts terminate as of the date of its termination under
section 708(b)(1)(B). The terminated partnership computes the allowable
depreciation deduction for each of its general asset accounts for the
taxable year in
[[Page 508]]
which the technical termination occurs by using the depreciation method,
recovery period, and convention applicable to the general asset account.
The new partnership is not bound by the terminated partnership's
election under paragraph (l) of this section.
(vii) Anti-abuse rule--(A) In general. If an asset in a general
asset account is disposed of by a taxpayer in a transaction described in
paragraph (e)(3)(vii)(B) of this section, general asset account
treatment for the asset terminates as of the first day of the taxable
year in which the disposition occurs. Consequently, the taxpayer must
determine the amount of gain, loss, or other deduction attributable to
the disposition in the manner described in paragraph (e)(3)(iii)(A) of
this section, notwithstanding that paragraph (e)(3)(iii)(A) of this
section is an optional rule, and must make the adjustments to the
general asset account described in paragraphs (e)(3)(iii)(C)(1) through
(4) of this section.
(B) Abusive transactions. A transaction is described in this
paragraph (e)(3)(vii)(B) if the transaction is not described in
paragraph (e)(3)(iv), (e)(3)(v), or (e)(3)(vi) of this section, and if
the transaction is entered into, or made, with a principal purpose of
achieving a tax benefit or result that would not be available absent an
election under this section. Examples of these types of transactions
include--
(1) A transaction entered into with a principal purpose of shifting
income or deductions among taxpayers in a manner that would not be
possible absent an election under this section to take advantage of
differing effective tax rates among the taxpayers; or
(2) An election made under this section with a principal purpose of
disposing of an asset from a general asset account to utilize an
expiring net operating loss or credit if the transaction is not a bona
fide disposition. The fact that a taxpayer with a net operating loss
carryover or a credit carryover transfers an asset to a related person
or transfers an asset pursuant to an arrangement where the asset
continues to be used or is available for use by the taxpayer pursuant to
a lease or otherwise indicates, absent strong evidence to the contrary,
that the transaction is described in this paragraph (e)(3)(vii)(B).
(f) Assets generating foreign source income--(1) In general. This
paragraph (f) provides the rules for determining the source of any
income, gain, or loss recognized, and the appropriate section 904(d)
separate limitation category or categories for any foreign source
income, gain, or loss recognized on a disposition (within the meaning of
paragraph (e)(1) of this section) of an asset in a general asset account
that consists of assets generating both United States and foreign source
income. These rules apply only to a disposition to which paragraph
(e)(2) (general disposition rules), paragraph (e)(3)(ii) (disposition of
all assets remaining in a general asset account), paragraph (e)(3)(iii)
(disposition of an asset in a qualifying disposition), paragraph
(e)(3)(v) (transactions subject to section 1031 or section 1033), or
paragraph (e)(3)(vii) (anti-abuse rule) of this section applies. Solely
for purposes of applying this paragraph (f), the term asset is:
(i) The asset as determined under paragraph (e)(2)(viii) of this
section; or
(ii) The portion of such asset that is disposed of in a disposition
described in paragraph (e)(1)(ii) of this section.
(2) Source of ordinary income, gain, or loss--(i) Source determined
by allocation and apportionment of depreciation allowed. The amount of
any ordinary income, gain, or loss that is recognized on the disposition
of an asset in a general asset account must be apportioned between
United States and foreign sources based on the allocation and
apportionment of the--
(A) Depreciation allowed for the general asset account as of the end
of the taxable year in which the disposition occurs if paragraph (e)(2)
of this section applies to the disposition;
(B) Depreciation allowed for the general asset account as of the
time of disposition if the taxpayer applies paragraph (e)(3)(ii) of this
section to the disposition of all assets, the last asset, or the
remaining portion of the last asset, in the general asset account, or if
all the assets, the last asset, or the remaining portion of the last
asset, in the general asset account are disposed of in a transaction
described in paragraph (e)(3)(v)(A) of this section; or
[[Page 509]]
(C) Depreciation allowed for the asset disposed of for only the
taxable year in which the disposition occurs if the taxpayer applies
paragraph (e)(3)(iii) of this section to the disposition of the asset in
a qualifying disposition, if the asset is disposed of in a transaction
described in paragraph (e)(3)(v)(B) of this section (like-kind exchange
or involuntary conversion), or if the asset is disposed of in a
transaction described in paragraph (e)(3)(vii) of this section (anti-
abuse rule).
(ii) Formula for determining foreign source income, gain, or loss.
The amount of ordinary income, gain, or loss recognized on the
disposition that shall be treated as foreign source income, gain, or
loss must be determined under the formula in this paragraph (f)(2)(ii).
For purposes of this formula, the allowed depreciation deductions are
determined for the applicable time period provided in paragraph
(f)(2)(i) of this section. The formula is:
Foreign Source Income, Gain, or Loss = Total Ordinary Income, X Allowed Depreciation
from The Disposition of an Asset. Gain, or Loss from the Deductions Allocated and
Disposition of an Asset. Apportioned to Foreign
Source Income/Total
Allowed Depreciation
Deductions for the General
Asset Account or for the
Asset Disposed of (as
applicable).
(3) Section 904(d) separate categories. If the assets in the general
asset account generate foreign source income in more than one separate
category under section 904(d)(1) or another section of the Code (for
example, income treated as foreign source income under section
904(g)(10)), or under a United States income tax treaty that requires
the foreign tax credit limitation to be determined separately for
specified types of income, the amount of foreign source income, gain, or
loss from the disposition of an asset, as determined under the formula
in paragraph (f)(2)(ii) of this section, must be allocated and
apportioned to the applicable separate category or categories under the
formula in this paragraph (f)(3). For purposes of this formula, the
allowed depreciation deductions are determined for the applicable time
period provided in paragraph (f)(2)(i) of this section. The formula is:
Foreign Source Income, Gain, or Loss in = Foreign Source Income, X Allowed Depreciation
a Separate Category. Gain, or Loss from The Deductions Allocated and
Disposition of an Asset. Apportioned to a Separate
Category/Total Allowed
Depreciation Deductions
and Apportioned to Foreign
Source Income.
(g) Assets subject to recapture. If the basis of an asset in a
general asset account is increased as a result of the recapture of any
allowable credit or deduction (for example, the basis adjustment for the
recapture amount under section 30(e)(5), 50(c)(2), 168(l)(6), 168(n)(4),
179(d)(10), 179A(e)(4), or 1400N(d)(5)), general asset account treatment
for the asset terminates as of the first day of the taxable year in
which the recapture event occurs. Consequently, the taxpayer must remove
the asset from the general asset account as of that day and must make
the adjustments to the general asset account described in paragraphs
(e)(3)(iii)(C)(2) through (4) of this section.
(h) Changes in use--(1) Conversion to any personal use. An asset in
a general asset account becomes ineligible for
[[Page 510]]
general asset account treatment if a taxpayer uses the asset in any
personal activity during a taxable year. Upon a conversion to any
personal use, the taxpayer must remove the asset from the general asset
account as of the first day of the taxable year in which the change in
use occurs (the year of change) and must make the adjustments to the
general asset account described in paragraphs (e)(3)(iii)(C)(2) through
(4) of this section.
(2) Change in use results in a different recovery period and/or
depreciation method--(i) No effect on general asset account election. A
change in the use described in Sec. 1.168(i)-4(d) (change in use
results in a different recovery period or depreciation method) of an
asset in a general asset account shall not cause or permit the
revocation of the election made under this section.
(ii) Asset is removed from the general asset account. Upon a change
in the use described in Sec. 1.168(i)-4(d), the taxpayer must remove
the asset from the general asset account as of the first day of the year
of change (as defined in Sec. 1.168(i)-4(a)) and must make the
adjustments to the general asset account described in paragraphs
(e)(3)(iii)(C)(2) through (4) of this section. If, however, the result
of the change in use is described in Sec. 1.168(i)-4(d)(3) (change in
use results in a shorter recovery period or a more accelerated
depreciation method) and the taxpayer elects to treat the asset as
though the change in use had not occurred pursuant to Sec. 1.168(i)-
4(d)(3)(ii), no adjustment is made to the general asset account upon the
change in use.
(iii) New general asset account is established--(A) Change in use
results in a shorter recovery period or a more accelerated depreciation
method. If the result of the change in use is described in Sec.
1.168(i)-4(d)(3) (change in use results in a shorter recovery period or
a more accelerated depreciation method) and adjustments to the general
asset account are made pursuant to paragraph (h)(2)(ii) of this section,
the taxpayer must establish a new general asset account for the asset in
the year of change in accordance with the rules in paragraph (c) of this
section, except that the adjusted depreciable basis of the asset as of
the first day of the year of change is included in the general asset
account. For purposes of paragraph (c)(2) of this section, the
applicable depreciation method, recovery period, and convention are
determined under Sec. 1.168(i)-4(d)(3)(i).
(B) Change in use results in a longer recovery period or a slower
depreciation method. If the result of the change in use is described in
Sec. 1.168(i)-4(d)(4) (change in use results in a longer recovery
period or a slower depreciation method), the taxpayer must establish a
separate general asset account for the asset in the year of change in
accordance with the rules in paragraph (c) of this section, except that
the unadjusted depreciable basis of the asset, and the greater of the
depreciation of the asset allowed or allowable in accordance with
section 1016(a)(2), as of the first day of the year of change are
included in the newly established general asset account. Consequently,
this general asset account as of the first day of the year of change
will have a beginning balance for both the unadjusted depreciable basis
and the depreciation reserve of the general asset account. For purposes
of paragraph (c)(2) of this section, the applicable depreciation method,
recovery period, and convention are determined under Sec. 1.168(i)-
4(d)(4)(ii).
(i) Redetermination of basis. If, after the placed-in-service year,
the unadjusted depreciable basis of an asset in a general asset account
is redetermined due to a transaction other than that described in
paragraph (g) of this section (for example, due to contingent purchase
price or discharge of indebtedness), the taxpayer's election under
paragraph (l) of this section for the asset also applies to the increase
or decrease in basis resulting from the redetermination. For the taxable
year in which the increase or decrease in basis occurs, the taxpayer
must establish a new general asset account for the amount of the
increase or decrease in basis in accordance with the rules in paragraph
(c) of this section. For purposes of paragraph (c)(2) of this section,
the applicable recovery period for the increase or decrease in basis is
the recovery period of the asset remaining as of the beginning of the
taxable year in which the increase or decrease in basis
[[Page 511]]
occurs, the applicable depreciation method and applicable convention for
the increase or decrease in basis are the same depreciation method and
convention applicable to the asset that applies for the taxable year in
which the increase or decrease in basis occurs, and the increase or
decrease in basis is deemed to be placed in service in the same taxable
year as the asset.
(j) Identification of disposed or converted asset--(1) In general.
The rules of this paragraph (j) apply when an asset in a general asset
account is disposed of or converted in a transaction described in
paragraph (e)(3)(iii) (disposition of an asset in a qualifying
disposition), paragraph (e)(3)(iv)(B) (transactions subject to section
168(i)(7)), paragraph (e)(3)(v)(B) (transactions subject to section 1031
or section 1033), paragraph (e)(3)(vii) (anti-abuse rule), paragraph (g)
(assets subject to recapture), or paragraph (h)(1) (conversion to any
personal use) of this section.
(2) Identifying which asset is disposed of or converted--(i) In
general. For purposes of identifying which asset in a general asset
account is disposed of or converted, a taxpayer must identify the
disposed of or converted asset by using--
(A) The specific identification method of accounting. Under this
method of accounting, the taxpayer can determine the particular taxable
year in which the disposed of or converted asset was placed in service
by the taxpayer;
(B) A first-in, first-out method of accounting if the taxpayer can
readily determine from its records the total dispositions of assets with
the same recovery period during the taxable year but the taxpayer cannot
readily determine from its records the unadjusted depreciable basis of
the disposed of or converted asset. Under this method of accounting, the
taxpayer identifies the general asset account with the earliest placed-
in-service year that has the same recovery period as the disposed of or
converted asset and that has assets at the beginning of the taxable year
of the disposition or conversion, and the taxpayer treats the disposed
of or converted asset as being from that general asset account. To
determine which general asset account has assets at the beginning of the
taxable year of the disposition or conversion, the taxpayer reduces the
number of assets originally included in the account by the number of
assets disposed of or converted in any prior taxable year in a
transaction to which this paragraph (j) applies;
(C) A modified first-in, first-out method of accounting if the
taxpayer can readily determine from its records the total dispositions
of assets with the same recovery period during the taxable year and the
unadjusted depreciable basis of the disposed of or converted asset.
Under this method of accounting, the taxpayer identifies the general
asset account with the earliest placed-in-service year that has the same
recovery period as the disposed of or converted asset and that has
assets at the beginning of the taxable year of the disposition or
conversion with the same unadjusted depreciable basis as the disposed of
or converted asset, and the taxpayer treats the disposed of or converted
asset as being from that general asset account. To determine which
general asset account has assets at the beginning of the taxable year of
the disposition or conversion, the taxpayer reduces the number of assets
originally included in the account by the number of assets disposed of
or converted in any prior taxable year in a transaction to which this
paragraph (j) applies;
(D) A mortality dispersion table if the asset is a mass asset
accounted for in a separate general asset account in accordance with
paragraph (c)(2)(ii)(H) of this section and if the taxpayer can readily
determine from its records the total dispositions of assets with the
same recovery period during the taxable year. The mortality dispersion
table must be based upon an acceptable sampling of the taxpayer's actual
disposition and conversion experience for mass assets or other
acceptable statistical or engineering techniques. To use a mortality
dispersion table, the taxpayer must adopt recordkeeping practices
consistent with the taxpayer's prior practices and consonant with good
accounting and engineering practices; or
(E) Any other method as the Secretary may designate by publication
in the Federal Register or in the Internal Revenue Bulletin (see Sec.
601.601(d)(2)
[[Page 512]]
of this chapter) on or after September 19, 2013. See paragraph
(j)(2)(iii) of this section regarding the last-in, first-out method of
accounting.
(ii) Disposition of a portion of an asset. If a taxpayer disposes of
a portion of an asset and paragraph (e)(1)(ii) of this section applies
to that disposition, the taxpayer may identify the asset by using any
applicable method provided in paragraph (j)(2)(i) of this section, after
taking into account paragraph (j)(2)(iii) of this section.
(iii) Last-in, first-out method of accounting. For purposes of
paragraph (j)(2) of this section, a last-in, first-out method of
accounting may not be used. Examples of a last-in, first-out method of
accounting include the taxpayer identifying the general asset account
with the most recent placed-in-service year that has the same recovery
period as the disposed of or converted asset and that has assets at the
beginning of the taxable year of the disposition or conversion, and the
taxpayer treating the disposed of or converted asset as being from that
general asset account, or the taxpayer treating the disposed portion of
an asset as being from the general asset account with the most recent
placed-in-service year that has assets that are the same as the asset of
which the disposed portion is a part.
(3) Basis of disposed of or converted asset. (i) Solely for purposes
of this paragraph (j)(3), the term asset is the asset as determined
under paragraph (e)(2)(viii) of this section or the portion of such
asset that is disposed of in a disposition described in paragraph
(e)(1)(ii) of this section. After identifying which asset in a general
asset account is disposed of or converted, the taxpayer must determine
the unadjusted depreciable basis of, and the depreciation allowed or
allowable for, the disposed of or converted asset. If it is
impracticable from the taxpayer's records to determine the unadjusted
depreciable basis of the disposed of or converted asset, the taxpayer
may use any reasonable method that is consistently applied to all assets
in the same general asset account for purposes of determining the
unadjusted depreciable basis of the disposed of or converted asset in
that general asset account. Examples of a reasonable method include, but
are not limited to, the following:
(A) If the replacement asset is a restoration (as defined in Sec.
1.263(a)-3(k)), and is not a betterment (as defined in Sec. 1.263(a)-
3(j)) or an adaptation to a new or different use (as defined in Sec.
1.263(a)-3(l)), discounting the cost of the replacement asset to its
placed-in-service year cost using the Producer Price Index for Finished
Goods or its successor, the Producer Price Index for Final Demand, or
any other index designated by guidance in the Internal Revenue Bulletin
(see Sec. 601.601(d)(2) of this chapter) for purposes of this paragraph
(j)(3);
(B) A pro rata allocation of the unadjusted depreciable basis of the
general asset account based on the replacement cost of the disposed
asset and the replacement cost of all of the assets in the general asset
account; and
(C) A study allocating the cost of the asset to its individual
components.
(ii) The depreciation allowable for the disposed of or converted
asset is computed by using the depreciation method, recovery period, and
convention applicable to the general asset account in which the disposed
of or converted asset was included and by including the additional first
year depreciation deduction claimed for the disposed of or converted
asset.
(k) Effect of adjustments on prior dispositions. The adjustments to
a general asset account under paragraph (e)(3)(iii), (e)(3)(iv),
(e)(3)(v), (e)(3)(vii), (g), or (h) of this section have no effect on
the recognition and character of prior dispositions subject to paragraph
(e)(2) of this section.
(l) Election--(1) Irrevocable election. If a taxpayer makes an
election under this paragraph (l), the taxpayer consents to, and agrees
to apply, all of the provisions of this section to the assets included
in a general asset account. Except as provided in paragraph
(c)(1)(ii)(A), (e)(3), (g), or (h) of this section or except as
otherwise expressly provided by other guidance published in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter), an election
made under this section is irrevocable and will be binding on the
taxpayer for computing taxable income
[[Page 513]]
for the taxable year for which the election is made and for all
subsequent taxable years. An election under this paragraph (l) is made
separately by each person owning an asset to which this section applies
(for example, by each member of a consolidated group, at the partnership
level and not by the partner separately, or at the S corporation level
and not by the shareholder separately).
(l)(2) Time for making election. The election to apply this section
shall be made on the taxpayer's timely filed (including extensions)
income tax return for the taxable year in which the assets included in
the general asset account are placed in service by the taxpayer.
(3) Manner of making election. In the year of election, a taxpayer
makes the election under this section by typing or legibly printing at
the top of the Form 4562, ``GENERAL ASSET ACCOUNT ELECTION MADE UNDER
SECTION 168(i)(4),'' or in the manner provided for on Form 4562 and its
instructions. The taxpayer shall maintain records (for example,
``General Asset Account 1--all 1995 additions in asset class 00.11 for
Salt Lake City, Utah facility'') that identify the assets included in
each general asset account, that establish the unadjusted depreciable
basis and depreciation reserve of the general asset account, and that
reflect the amount realized during the taxable year upon dispositions
from each general asset account. (But see section 179(c) and Sec.
1.179-5 for the recordkeeping requirements for section 179 property.)
The taxpayer's recordkeeping practices should be consistently applied to
the general asset accounts. If Form 4562 is revised or renumbered, any
reference in this section to that form shall be treated as a reference
to the revised or renumbered form.
(m) Effective/applicability dates--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014. Except
as provided in paragraphs (m)(2), (m)(3), and (m)(4) of this section,
Sec. 1.168(i)-1 as contained in 26 CFR part 1 edition revised as of
April 1, 2011, applies to taxable years beginning before January 1,
2014.
(2) Early application of this section. A taxpayer may choose to
apply the provisions of this section to taxable years beginning on or
after January 1, 2012.
(3) Early application of regulation project REG-110732-13. A
taxpayer may rely on the provisions of this section in regulation
project REG-110732-13 (2013-43 IRB 404) (see Sec. 601.601(d)(2) of this
chapter) for taxable years beginning on or after January 1, 2012.
However, a taxpayer may not rely on the provisions of this section in
regulation project REG-110732-13 for taxable years beginning on or after
January 1, 2014.
(4) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.168(i)-1T as contained in 26 CFR part 1 edition revised as of
April 1, 2014, to taxable years beginning on or after January 1, 2012.
However, a taxpayer may not apply Sec. 1.168(i)-1T as contained in 26
CFR part 1 edition revised as of April 1, 2014, to taxable years
beginning on or after January 1, 2014.
(5) Change in method of accounting. A change to comply with this
section for depreciable assets placed in service in a taxable year
ending on or after December 30, 2003, is a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply. A taxpayer also may treat a change to comply
with this section for depreciable assets placed in service in a taxable
year ending before December 30, 2003, as a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply. This paragraph (m)(5) does not apply to a
change to comply with paragraph (e)(3)(ii), (e)(3)(iii), or (l) of this
section, except as otherwise expressly provided by other guidance
published in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of
this chapter).
[T.D. 8566, 59 FR 51371, Oct. 11, 1994; 59 FR 64849, Dec. 16, 1994, as
amended by T.D. 9115, 69 FR 9534, Mar. 1, 2004; T.D. 9132, 69 FR 33842,
June 17, 2004; T.D. 9314, 72 FR 9249, Mar. 1, 2007; T.D. 9564, 76 FR
81086, Dec. 27, 2011; 77 FR 75016, Dec. 19, 2012; T.D. 9689, 79 FR
48667, Aug. 18, 2014; 79 FR 78697, Dec. 31, 2014]
Sec. 1.168(i)-2 Lease term.
(a) In general. For purposes of section 168, a lease term is
determined under
[[Page 514]]
all the facts and circumstances. Paragraph (b) of this section and Sec.
1.168(j)-1T, Q&A 17, describe certain circumstances that will result in
a period of time not included in the stated duration of an original
lease (additional period) nevertheless being included in the lease term.
These rules do not prevent the inclusion of an additional period in the
lease term in other circumstances.
(b) Lessee retains financial obligation--(1) In general. An
additional period of time during which a lessee may not continue to be
the lessee will nevertheless be included in the lease term if the lessee
(or a related person)--
(i) Has agreed that one or both of them will or could be obligated
to make a payment of rent or a payment in the nature of rent with
respect to such period; or
(ii) Has assumed or retained any risk of loss with respect to the
property for such period (including, for example, by holding a note
secured by the property).
(2) Payments in the nature of rent. For purposes of paragraph
(b)(1)(i) of this section, a payment in the nature of rent includes a
payment intended to substitute for rent or to fund or supplement the
rental payments of another. For example, a payment in the nature of rent
includes a payment of any kind (whether denominated as supplemental
rent, as liquidated damages, or otherwise) that is required to be made
in the event that--
(i) The leased property is not leased for the additional period;
(ii) The leased property is leased for the additional period under
terms that do not satisfy specified terms and conditions;
(iii) There is a failure to make a payment of rent with respect to
such additional period; or
(iv) Circumstances similar to those described in paragraph (b)(2)
(i), (ii), or (iii) of this section occur.
(3) De minimis rule. For the purposes of this paragraph (b),
obligations to make de minimis payments will be disregarded.
(c) Multiple leases or subleases. If property is subject to more
than one lease (including any sublease) entered into as part of a single
transaction (or a series of related transactions), the lease term
includes all periods described in one or more of such leases. For
example, if one taxable corporation leases property to another taxable
corporation for a 20-year term and, as part of the same transaction, the
lessee subleases the property to a tax-exempt entity for a 10-year term,
then the lease term of the property for purposes of section 168 is 20
years. During the period of tax-exempt use, the property must be
depreciated under the alternative depreciation system using the straight
line method over the greater of its class life or 25 years (125 percent
of the 20-year lease term).
(d) Related person. For purposes of paragraph (b) of this section, a
person is related to the lessee if such person is described in section
168(h)(4).
(e) Changes in status. Section 168(i)(5) (changes in status) applies
if an additional period is included in a lease term under this section
and the leased property ceases to be tax-exempt use property for such
additional period.
(f) Example. The following example illustrates the principles of
this section. The example does not address common law doctrines or other
authorities that may apply to cause an additional period to be included
in the lease term or to recharacterize a lease as a conditional sale or
otherwise for federal income tax purposes. Unless otherwise indicated,
parties to the transactions are not related to one another.
Example. Financial obligation with respect to an additional period.
(i) Facts. X, a taxable corporation, and Y, a foreign airline whose
income is not subject to United States taxation, enter into a lease
agreement under which X agrees to lease an aircraft to Y for a period of
10 years. The lease agreement provides that, at the end of the lease
period, Y is obligated to find a subsequent lessee (replacement lessee)
to enter into a subsequent lease (replacement lease) of the aircraft
from X for an additional 10-year period. The provisions of the lease
agreement require that any replacement lessee be unrelated to Y and that
it not be a tax-exempt entity as defined in section 168(h)(2). The
provisions of the lease agreement also set forth the basic terms and
conditions of the replacement lease, including its duration and the
required rental payments. In the event Y fails to secure a replacement
lease, the lease agreement requires Y to make a payment to X in an
amount determined under the lease agreement.
[[Page 515]]
(ii) Application of this section. The lease agreement between X and
Y obligates Y to make a payment in the event the aircraft is not leased
for the period commencing after the initial 10-year lease period and
ending on the date the replacement lease is scheduled to end.
Accordingly, pursuant to paragraph (b) of this section, the term of the
lease between X and Y includes such additional period, and the lease
term is 20 years for purposes of section 168.
(iii) Facts modified. Assume the same facts as in paragraph (i) of
this Example, except that Y is required to guarantee the payment of
rentals under the 10-year replacement lease and to make a payment to X
equal to the present value of any excess of the replacement lease rental
payments specified in the lease agreement between X and Y, over the
rental payments actually agreed to be paid by the replacement lessee.
Pursuant to paragraph (b) of this section, the term of the lease between
X and Y includes the additional period, and the lease term is 20 years
for purposes of section 168.
(iv) Changes in status. If, upon the conclusion of the stated
duration of the lease between X and Y, the aircraft either is returned
to X or leased to a replacement lessee that is not a tax-exempt entity
as defined in section 168(h)(2), the subsequent method of depreciation
will be determined pursuant to section 168(i)(5).
(g) Effective date--(1) In general. Except as provided in paragraph
(g)(2) of this section, this section applies to leases entered into on
or after April 20, 1995.
(2) Special rules. Paragraphs (b)(1)(ii) and (c) of this section
apply to leases entered into after April 26, 1996.
[T.D. 8667, 61 FR 18677, Apr. 29, 1996]
Sec. 1.168(i)-3 Treatment of excess deferred income tax reserve upon
disposition of deregulated public utility property.
(a) Scope--(1) In general. This section provides rules for the
application of section 203(e) of the Tax Reform Act of 1986, Public Law
99-514 (100 Stat. 2146) to a taxpayer with respect to public utility
property (within the meaning of section 168(i)(10)) that ceases, whether
by disposition, deregulation, or otherwise, to be public utility
property with respect to the taxpayer and that is not described in
paragraph (a)(2) of this section (deregulated public utility property).
(2) Exceptions. This section does not apply to the following
property:
(i) Property that ceases to be public utility property with respect
to the taxpayer on account of an ordinary retirement within the meaning
of Sec. 1.167(a)-11(d)(3)(ii).
(ii) Property transferred by the taxpayer if after the transfer the
property is public utility property of the transferee and the taxpayer's
excess tax reserve with respect to the property (within the meaning of
section 203(e) of the Tax Reform Act of 1986) is treated as an excess
tax reserve of the transferee with respect to the property.
(b) Amount of reduction. If public utility property of a taxpayer
becomes deregulated public utility property to which this section
applies, the reduction in the taxpayer's excess tax reserve permitted
under section 203(e) of the Tax Reform Act of 1986 is equal to the
amount by which the reserve could be reduced under that provision if all
such property had remained public utility property of the taxpayer and
the taxpayer had continued use of its normalization method of accounting
with respect to such property.
(c) Cross reference. See Sec. 1.46-6(k) for rules relating to the
treatment of accumulated deferred investment tax credits when utilities
dispose of regulated public utility property.
(d) Effective/applicability dates--(1) In general. Except as
provided in paragraph (d)(2) of this section, this section applies to
public utility property that becomes deregulated public utility property
after December 21, 2005.
(2) Property that becomes public utility property of the transferee.
This section does not apply to property that becomes deregulated public
utility property with respect to a taxpayer on account of a transfer on
or before March 20, 2008 if after the transfer the property is public
utility property of the transferee.
(3) Application of regulation project (REG-104385-01). A reduction
in the taxpayer's excess deferred income tax reserve will be treated as
ratable if it is consistent with the proposed rules in regulation
project (REG-104385-01) (68 FR 10190) March 4, 2003, and occurs during
the period beginning on March 5, 2003, and ending on the earlier of--
(i) The last date on which the utility's rates are determined under
the
[[Page 516]]
rate order in effect on December 21, 2005; or
(ii) December 21, 2007.
[T.D. 9387, 73 FR 14937, Mar. 20, 2008]
Sec. 1.168(i)-4 Changes in use.
(a) Scope. This section provides the rules for determining the
depreciation allowance for MACRS property (as defined in Sec. 1.168(b)-
1T(a)(2)) for which the use changes in the hands of the same taxpayer
(change in the use). The allowance for depreciation under this section
constitutes the amount of depreciation allowable under section 167(a)
for the year of change and any subsequent taxable year. For purposes of
this section, the year of change is the taxable year in which a change
in the use occurs.
(b) Conversion to business or income-producing use--(1) Depreciation
deduction allowable. This paragraph (b) applies to property that is
converted from personal use to use in a taxpayer's trade or business, or
for the production of income, during a taxable year. This conversion
includes property that was previously used by the taxpayer for personal
purposes, including real property (other than land) that is acquired
before 1987 and converted from personal use to business or income-
producing use after 1986, and depreciable property that was previously
used by a tax-exempt entity before the entity changed to a taxable
entity. Except as otherwise provided by the Internal Revenue Code or
regulations under the Internal Revenue Code, upon a conversion to
business or income-producing use, the depreciation allowance for the
year of change and any subsequent taxable year is determined as though
the property is placed in service by the taxpayer on the date on which
the conversion occurs. Thus, except as otherwise provided by the
Internal Revenue Code or regulations under the Internal Revenue Code,
the taxpayer must use any applicable depreciation method, recovery
period, and convention prescribed under section 168 for the property in
the year of change, consistent with any election made under section 168
by the taxpayer for that year (see, for example, section 168(b)(5)). See
Sec. Sec. 1.168(k)-1T(f)(6)(iii) and 1.1400L(b)-1T(f)(6) for the
additional first year depreciation deduction rules applicable to a
conversion to business or income-producing use. The depreciable basis of
the property for the year of change is the lesser of its fair market
value or its adjusted depreciable basis (as defined in Sec. 1.168(b)-
1T(a)(4)), as applicable, at the time of the conversion to business or
income-producing use.
(2) Example. The application of this paragraph (b) is illustrated by
the following example:
Example. A, a calendar-year taxpayer, purchases a house in 1985 that
she occupies as her principal residence. In February 2004, A ceases to
occupy the house and converts it to residential rental property. At the
time of the conversion to residential rental property, the house's fair
market value (excluding land) is $130,000 and adjusted depreciable basis
attributable to the house (excluding land) is $150,000. Pursuant to this
paragraph (b), A is considered to have placed in service residential
rental property in February 2004 with a depreciable basis of $130,000. A
depreciates the residential rental property under the general
depreciation system by using the straight-line method, a 27.5-year
recovery period, and the mid-month convention. Pursuant to Sec. Sec.
1.168(k)-1T(f)(6)(iii)(B) or 1.1400L(b)-1T(f)(6), this property is not
eligible for the additional first year depreciation deduction provided
by section 168(k) or section 1400L(b). Thus, the depreciation allowance
for the house for 2004 is $4,137, after taking into account the mid-
month convention (($130,000 adjusted depreciable basis multiplied by the
applicable depreciation rate of 3.636% (1/27.5)) multiplied by the mid-
month convention fraction of 10.5/12). The amount of depreciation
computed under section 168, however, may be limited under other
provisions of the Internal Revenue Code, such as, section 280A.
(c) Conversion to personal use. The conversion of MACRS property
from business or income-producing use to personal use during a taxable
year is treated as a disposition of the property in that taxable year.
The depreciation allowance for MACRS property for the year of change in
which the property is treated as being disposed of is determined by
first multiplying the adjusted depreciable basis of the property as of
the first day of the year of change by the applicable depreciation rate
for that taxable year (for further guidance, for example, see section 6
of Rev. Proc. 87-57 (1987-2 C. B. 687, 692) (see Sec.
601.601(d)(2)(ii)(b) of this chapter)).
[[Page 517]]
This amount is then multiplied by a fraction, the numerator of which is
the number of months (including fractions of months) the property is
deemed to be placed in service during the year of change (taking into
account the applicable convention) and the denominator of which is 12.
No depreciation deduction is allowable for MACRS property placed in
service and disposed of in the same taxable year. See Sec. Sec.
1.168(k)-1T(f)(6)(ii) and 1.1400L(b)-1T(f)(6) for the additional first
year depreciation deduction rules applicable to property placed in
service and converted to personal use in the same taxable year. Upon the
conversion to personal use, no gain, loss, or depreciation recapture
under section 1245 or section 1250 is recognized. However, the
provisions of section 1245 or section 1250 apply to any disposition of
the converted property by the taxpayer at a later date. For listed
property (as defined in section 280F(d)(4)), see section 280F(b)(2) for
the recapture of excess depreciation upon the conversion to personal
use.
(d) Change in the use results in a different recovery period and/or
depreciation method--(1) In general. This paragraph (d) applies to a
change in the use of MACRS property during a taxable year subsequent to
the placed-in-service year, if the property continues to be MACRS
property owned by the same taxpayer and, as a result of the change in
the use, has a different recovery period, a different depreciation
method, or both. For example, this paragraph (d) applies to MACRS
property that--
(i) Begins or ceases to be used predominantly outside the United
States;
(ii) Results in a reclassification of the property under section
168(e) due to a change in the use of the property; or
(iii) Begins or ceases to be tax-exempt use property (as defined in
section 168(h)).
(2) Determination of change in the use--(i) In general. Except as
provided in paragraph (d)(2)(ii) of this section, a change in the use of
MACRS property occurs when the primary use of the MACRS property in the
taxable year is different from its primary use in the immediately
preceding taxable year. The primary use of MACRS property may be
determined in any reasonable manner that is consistently applied to the
taxpayer's MACRS property.
(ii) Alternative depreciation system property--(A) Property used
within or outside the United States. A change in the use of MACRS
property occurs when a taxpayer begins or ceases to use MACRS property
predominantly outside the United States during the taxable year. The
determination of whether MACRS property is used predominantly outside
the United States is made in accordance with the test in Sec. 1.48-
1(g)(1)(i) for determining predominant use.
(B) Tax-exempt bond financed property. A change in the use of MACRS
property occurs when the property changes to tax-exempt bond financed
property, as described in section 168(g)(1)(C) and (g)(5), during the
taxable year. For purposes of this paragraph (d), MACRS property changes
to tax-exempt bond financed property when a tax-exempt bond is first
issued after the MACRS property is placed in service. MACRS property
continues to be tax-exempt bond financed property in the hands of the
taxpayer even if the tax-exempt bond (including any refunding issue) is
no longer outstanding or is redeemed.
(C) Other mandatory alternative depreciation system property. A
change in the use of MACRS property occurs when the property changes to,
or changes from, property described in section 168(g)(1)(B) (tax-exempt
use property) or (D) (imported property covered by an Executive order)
during the taxable year.
(iii) Change in the use deemed to occur on first day of the year of
change. If a change in the use of MACRS property occurs under this
paragraph (d)(2), the depreciation allowance for that MACRS property for
the year of change is determined as though the use of the MACRS property
changed on the first day of the year of change.
(3) Change in the use results in a shorter recovery period and/or a
more accelerated depreciation method--(i) Treated as placed in service
in the year of change--(A) In general. If a change in the use results in
the MACRS property changing to a shorter recovery period and/or a
depreciation method that is more accelerated than the method used for
the MACRS property before the change in
[[Page 518]]
the use, the depreciation allowances beginning in the year of change are
determined as though the MACRS property is placed in service by the
taxpayer in the year of change.
(B) Computation of depreciation allowance. The depreciation
allowances for the MACRS property for any 12-month taxable year
beginning with the year of change are determined by multiplying the
adjusted depreciable basis of the MACRS property as of the first day of
each taxable year by the applicable depreciation rate for each taxable
year. In determining the applicable depreciation rate for the year of
change and subsequent taxable years, the taxpayer must use any
applicable depreciation method and recovery period prescribed under
section 168 for the MACRS property in the year of change, consistent
with any election made under section 168 by the taxpayer for that year
(see, for example, section 168(b)(5)). If there is a change in the use
of MACRS property, the applicable convention that applies to the MACRS
property is the same as the convention that applied before the change in
the use of the MACRS property. However, the depreciation allowance for
the year of change for the MACRS property is determined without applying
the applicable convention, unless the MACRS property is disposed of
during the year of change. See paragraph (d)(5) of this section for the
rules relating to the computation of the depreciation allowance under
the optional depreciation tables. If the year of change or any
subsequent taxable year is less than 12 months, the depreciation
allowance determined under this paragraph (d)(3)(i) must be adjusted for
a short taxable year (for further guidance, for example, see Rev. Proc.
89-15 (1989-1 C.B. 816) (see Sec. 601.601(d)(2)(ii)(b) of this
chapter)).
(C) Special rules. MACRS property affected by this paragraph
(d)(3)(i) is not eligible in the year of change for the election
provided under section 168(f)(1), 179, or 1400L(f), or for the
additional first year depreciation deduction provided in section 168(k)
or 1400L(b). See Sec. Sec. 1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-
1T(f)(6) for other additional first year depreciation deduction rules
applicable to a change in the use of MACRS property subsequent to its
placed-in-service year. For purposes of determining whether the mid-
quarter convention applies to other MACRS property placed in service
during the year of change, the unadjusted depreciable basis (as defined
in Sec. 1.168(b)-1T(a)(3)) or the adjusted depreciable basis of MACRS
property affected by this paragraph (d)(3)(i) is not taken into account.
(ii) Option to disregard the change in the use. In lieu of applying
paragraph (d)(3)(i) of this section, the taxpayer may elect to determine
the depreciation allowance as though the change in the use had not
occurred. The taxpayer elects this option by claiming on the taxpayer's
timely filed (including extensions) Federal income tax return for the
year of change the depreciation allowance for the property as though the
change in the use had not occurred. See paragraph (g)(2) of this section
for the manner for revoking this election.
(4) Change in the use results in a longer recovery period and/or a
slower depreciation method--(i) Treated as originally placed in service
with longer recovery period and/or slower depreciation method. If a
change in the use results in a longer recovery period and/or a
depreciation method for the MACRS property that is less accelerated than
the method used for the MACRS property before the change in the use, the
depreciation allowances beginning with the year of change are determined
as though the MACRS property had been originally placed in service by
the taxpayer with the longer recovery period and/or the slower
depreciation method. MACRS property affected by this paragraph (d)(4) is
not eligible in the year of change for the election provided under
section 168(f)(1), 179, or 1400L(f), or for the additional first year
depreciation deduction provided in section 168(k) or 1400L(b). See
Sec. Sec. 1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-1T(f)(6) for other
additional first year depreciation deduction rules applicable to a
change in the use of MACRS property subsequent to its placed-in-service
year.
(ii) Computation of the depreciation allowance. The depreciation
allowances for the MACRS property for any 12-month taxable year
beginning with the
[[Page 519]]
year of change are determined by multiplying the adjusted depreciable
basis of the MACRS property as of the first day of each taxable year by
the applicable depreciation rate for each taxable year. If there is a
change in the use of MACRS property, the applicable convention that
applies to the MACRS property is the same as the convention that applied
before the change in the use of the MACRS property. If the year of
change or any subsequent taxable year is less than 12 months, the
depreciation allowance determined under this paragraph (d)(4)(ii) must
be adjusted for a short taxable year (for further guidance, for example,
see Rev. Proc. 89-15 (1989-1 C.B. 816) (see Sec. 601.601(d)(2)(ii)(b)
of this chapter)). See paragraph (d)(5) of this section for the rules
relating to the computation of the depreciation allowance under the
optional depreciation tables. In determining the applicable depreciation
rate for the year of change and any subsequent taxable year--
(A) The applicable depreciation method is the depreciation method
that would apply in the year of change and any subsequent taxable year
for the MACRS property had the taxpayer used the longer recovery period
and/or the slower depreciation method in the placed-in-service year of
the property. If the 200-or 150-percent declining balance method would
have applied in the placed-in-service year but the method would have
switched to the straight line method in the year of change or any prior
taxable year, the applicable depreciation method beginning with the year
of change is the straight line method; and
(B) The applicable recovery period is either--
(1) The longer recovery period resulting from the change in the use
if the applicable depreciation method is the 200-or 150-percent
declining balance method (as determined under paragraph (d)(4)(ii)(A) of
this section) unless the recovery period did not change as a result of
the change in the use, in which case the applicable recovery period is
the same recovery period that applied before the change in the use; or
(2) The number of years remaining as of the beginning of each
taxable year (taking into account the applicable convention) had the
taxpayer used the longer recovery period in the placed-in-service year
of the property if the applicable depreciation method is the straight
line method (as determined under paragraph (d)(4)(ii)(A) of this
section) unless the recovery period did not change as a result of the
change in the use, in which case the applicable recovery period is the
number of years remaining as of the beginning of each taxable year
(taking into account the applicable convention) based on the recovery
period that applied before the change in the use.
(5) Using optional depreciation tables--(i) Taxpayer not bound by
prior use of table. If a taxpayer used an optional depreciation table
for the MACRS property before a change in the use, the taxpayer is not
bound to use the appropriate new table for that MACRS property beginning
in the year of change (for further guidance, for example, see section 8
of Rev. Proc. 87-57 (1987-2 C.B. 687, 693) (see Sec.
601.601(d)(2)(ii)(b) of this chapter)). If a taxpayer did not use an
optional depreciation table for MACRS property before a change in the
use and the change in the use results in a shorter recovery period and/
or a more accelerated depreciation method (as described in paragraph
(d)(3)(i) of this section), the taxpayer may use the appropriate new
table for that MACRS property beginning in the year of change. If a
taxpayer chooses not to use the optional depreciation table, the
depreciation allowances for the MACRS property beginning in the year of
change are determined under paragraph (d)(3)(i) or (4) of this section,
as applicable.
(ii) Taxpayer chooses to use optional depreciation table after a
change in the use. If a taxpayer chooses to use an optional depreciation
table for the MACRS property after a change in the use, the depreciation
allowances for the MACRS property for any 12-month taxable year
beginning with the year of change are determined as follows:
(A) Change in the use results in a shorter recovery period and/or a
more accelerated depreciation method. If a change in the use results in
a shorter recovery
[[Page 520]]
period and/or a more accelerated depreciation method (as described in
paragraph (d)(3)(i) of this section), the depreciation allowances for
the MACRS property for any 12-month taxable year beginning with the year
of change are determined by multiplying the adjusted depreciable basis
of the MACRS property as of the first day of the year of change by the
annual depreciation rate for each recovery year (expressed as a decimal
equivalent) specified in the appropriate optional depreciation table.
The appropriate optional depreciation table for the MACRS property is
based on the depreciation system, depreciation method, recovery period,
and convention applicable to the MACRS property in the year of change as
determined under paragraph (d)(3)(i) of this section. The depreciation
allowance for the year of change for the MACRS property is determined by
taking into account the applicable convention (which is already factored
into the optional depreciation tables). If the year of change or any
subsequent taxable year is less than 12 months, the depreciation
allowance determined under this paragraph (d)(5)(ii)(A) must be adjusted
for a short taxable year (for further guidance, for example, see Rev.
Proc. 89-15 (1989-1 C.B. 816) (see Sec. 601.601(d)(2)(ii)(b) of this
chapter)).
(B) Change in the use results in a longer recovery period and/or a
slower depreciation method--(1) Determination of the appropriate
optional depreciation table. If a change in the use results in a longer
recovery period and/or a slower depreciation method (as described in
paragraph (d)(4)(i) of this section), the depreciation allowances for
the MACRS property for any 12-month taxable year beginning with the year
of change are determined by choosing the optional depreciation table
that corresponds to the depreciation system, depreciation method,
recovery period, and convention that would have applied to the MACRS
property in the placed-in-service year had that property been originally
placed in service by the taxpayer with the longer recovery period and/or
the slower depreciation method. If there is a change in the use of MACRS
property, the applicable convention that applies to the MACRS property
is the same as the convention that applied before the change in the use
of the MACRS property. If the year of change or any subsequent taxable
year is less than 12 months, the depreciation allowance determined under
this paragraph (d)(5)(ii)(B) must be adjusted for a short taxable year
(for further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B.
816) (see Sec. 601.601(d)(2)(ii)(b) of this chapter)).
(2) Computation of the depreciation allowance. The depreciation
allowances for the MACRS property for any 12-month taxable year
beginning with the year of change are computed by first determining the
appropriate recovery year in the table identified under paragraph
(d)(5)(ii)(B)(1) of this section. The appropriate recovery year for the
year of change is the year that corresponds to the year of change. For
example, if the recovery year for the year of change would have been
Year 4 in the table that applied before the change in the use of the
MACRS property, then the recovery year for the year of change is Year 4
in the table identified under paragraph (d)(5)(ii)(B)(1) of this
section. Next, the annual depreciation rate (expressed as a decimal
equivalent) for each recovery year is multiplied by a transaction
coefficient. The transaction coefficient is the formula (1 / (1-x))
where x equals the sum of the annual depreciation rates from the table
identified under paragraph (d)(5)(ii)(B)(1) of this section (expressed
as a decimal equivalent) for the taxable years beginning with the
placed-in-service year of the MACRS property through the taxable year
immediately prior to the year of change. The product of the annual
depreciation rate and the transaction coefficient is multiplied by the
adjusted depreciable basis of the MACRS property as of the beginning of
the year of change.
(6) Examples. The application of this paragraph (d) is illustrated
by the following examples:
Example 1. Change in the use results in a shorter recovery period
and/or a more accelerated depreciation method and optional depreciation
table is not used. (i) X, a calendar-year corporation, places in service
in 1999 equipment at a cost of $100,000 and uses this equipment from
1999 through 2003 primarily in its A business. X depreciates the
equipment for 1999 through 2003 under the general depreciation system as
7-year property by using the
[[Page 521]]
200-percent declining balance method (which switched to the straight-
line method in 2003), a 7-year recovery period, and a half-year
convention. Beginning in 2004, X primarily uses the equipment in its B
business. As a result, the classification of the equipment under section
168(e) changes from 7-year property to 5-year property and the recovery
period of the equipment under the general depreciation system changes
from 7 years to 5 years. The depreciation method does not change. On
January 1, 2004, the adjusted depreciable basis of the equipment is
$22,311. X depreciates its 5-year recovery property placed in service in
2004 under the general depreciation system by using the 200-percent
declining balance method and a 5-year recovery period. X does not use
the optional depreciation tables.
(ii) Under paragraph (d)(3)(i) of this section, X's allowable
depreciation deduction for the equipment for 2004 and subsequent taxable
years is determined as though X placed the equipment in service in 2004
for use primarily in its B business. The depreciable basis of the
equipment as of January 1, 2004, is $22,311 (the adjusted depreciable
basis at January 1, 2004). Because X does not use the optional
depreciation tables, the depreciation allowance for 2004 (the deemed
placed-in-service year) for this equipment only is computed without
taking into account the half-year convention. Pursuant to paragraph
(d)(3)(i)(C) of this section, this equipment is not eligible for the
additional first year depreciation deduction provided by section 168(k)
or section 1400L(b). Thus, X's allowable depreciation deduction for the
equipment for 2004 is $8,924 ($22,311 adjusted depreciable basis at
January 1, 2004, multiplied by the applicable depreciation rate of 40%
(200/5)). X's allowable depreciation deduction for the equipment for
2005 is $5,355 ($13,387 adjusted depreciable basis at January 1, 2005,
multiplied by the applicable depreciation rate of 40% (200/5)).
(iii) Alternatively, under paragraph (d)(3)(ii) of this section, X
may elect to disregard the change in the use and, as a result, may
continue to treat the equipment as though it is used primarily in its A
business. If the election is made, X's allowable depreciation deduction
for the equipment for 2004 is $8,924 ($22,311 adjusted depreciable basis
at January 1, 2004, multiplied by the applicable depreciation rate of
40% (1/2.5 years remaining at January 1, 2004)). X's allowable
depreciation deduction for the equipment for 2005 is $8,925 ($13,387
adjusted depreciable basis at January 1, 2005, multiplied by the
applicable depreciation rate of 66.67% (1/1.5 years remaining at January
1, 2005)).
Example 2. Change in the use results in a shorter recovery period
and/or a more accelerated depreciation method and optional depreciation
table is used. (i) Same facts as in Example 1, except that X used the
optional depreciation tables for computing depreciation for 1999 through
2003. Pursuant to paragraph (d)(5) of this section, X chooses to
continue to use the optional depreciation table for the equipment. X
does not make the election provided in paragraph (d)(3)(ii) of this
section to disregard the change in use.
(ii) In accordance with paragraph (d)(5)(ii)(A) of this section, X
must first identify the appropriate optional depreciation table for the
equipment. This table is table 1 in Rev. Proc. 87-57 because the
equipment will be depreciated in the year of change (2004) under the
general depreciation system using the 200-percent declining balance
method, a 5-year recovery period, and the half-year convention (which is
the convention that applied to the equipment in 1999). Pursuant to
paragraph (d)(3)(i)(C) of this section, this equipment is not eligible
for the additional first year depreciation deduction provided by section
168(k) or section 1400L(b). For 2004, X multiplies its adjusted
depreciable basis in the equipment as of January 1, 2004, of $22,311, by
the annual depreciation rate in table 1 for recovery year 1 for a 5-year
recovery period (.20), to determine the depreciation allowance of
$4,462. For 2005, X multiplies its adjusted depreciable basis in the
equipment as of January 1, 2004, of $22,311, by the annual depreciation
rate in table 1 for recovery year 2 for a 5-year recovery period (.32),
to determine the depreciation allowance of $7,140.
Example 3. Change in the use results in a longer recovery period
and/or a slower depreciation method. (i) Y, a calendar-year corporation,
places in service in January 2002, equipment at a cost of $100,000 and
uses this equipment in 2002 and 2003 only within the United States. Y
elects not to deduct the additional first year depreciation under
section 168(k). Y depreciates the equipment for 2002 and 2003 under the
general depreciation system by using the 200-percent declining balance
method, a 5-year recovery period, and a half-year convention. Beginning
in 2004, Y uses the equipment predominantly outside the United States.
As a result of this change in the use, the equipment is subject to the
alternative depreciation system beginning in 2004. Under the alternative
depreciation system, the equipment is depreciated by using the straight
line method and a 9-year recovery period. The adjusted depreciable basis
of the equipment at January 1, 2004, is $48,000.
(ii) Pursuant to paragraph (d)(4) of this section, Y's allowable
depreciation deduction for 2004 and subsequent taxable years is
determined as though the equipment had been placed in service in January
2002, as property used predominantly outside the United States. Further,
pursuant to paragraph (d)(4)(i) of this section, the equipment is not
eligible in 2004 for the additional first year depreciation deduction
provided by section 168(k) or section 1400L(b). In determining the
[[Page 522]]
applicable depreciation rate for 2004, the applicable depreciation
method is the straight line method and the applicable recovery period is
7.5 years, which is the number of years remaining at January 1, 2004,
for property placed in service in 2002 with a 9-year recovery period
(taking into account the half-year convention). Thus, the depreciation
allowance for 2004 is $6,398 ($48,000 adjusted depreciable basis at
January 1, 2004, multiplied by the applicable depreciation rate of
13.33% (1/7.5 years)). The depreciation allowance for 2005 is $6,398
($41,602 adjusted depreciable basis at January 1, 2005, multiplied by
the applicable depreciation rate of 15.38% (1/6.5 years remaining at
January 1, 2005)).
Example 4. Change in the use results in a longer recovery period
and/or a slower depreciation method and optional depreciation table is
used. (i) Same facts as in Example 3, except that Y used the optional
depreciation tables for computing depreciation in 2002 and 2003.
Pursuant to paragraph (d)(5) of this section, Y chooses to continue to
use the optional depreciation table for the equipment. Further, pursuant
to paragraph (d)(4)(i) of this section, the equipment is not eligible in
2004 for the additional first year depreciation deduction provided by
section 168(k) or section 1400L(b).
(ii) In accordance with paragraph (d)(5)(ii)(B) of this section, Y
must first determine the appropriate optional depreciation table for the
equipment pursuant to paragraph (d)(5)(ii)(B)(1) of this section. This
table is table 8 in Rev. Proc. 87-57, which corresponds to the
alternative depreciation system, the straight line method, a 9-year
recovery period, and the half-year convention (because Y depreciated 5-
year property in 2002 using a half-year convention). Next, Y must
determine the appropriate recovery year in table 8. Because the year of
change is 2004, the depreciation allowance for the equipment for 2004 is
determined using recovery year 3 of table 8. For 2004, Y multiplies its
adjusted depreciable basis in the equipment as of January 1, 2004, of
$48,000, by the product of the annual depreciation rate in table 8 for
recovery year 3 for a 9-year recovery period (.1111) and the transaction
coefficient of 1.200 [1/(1-(.0556 (table 8 for recovery year 1 for a 9-
year recovery period) + .1111 (table 8 for recovery year 2 for a 9-year
recovery period)))], to determine the depreciation allowance of $6,399.
For 2005, Y multiplies its adjusted depreciable basis in the equipment
as of January 1, 2004, of $48,000, by the product of the annual
depreciation rate in table 8 for recovery year 4 for a 9-year recovery
period (.1111) and the transaction coefficient (1.200), to determine the
depreciation allowance of $6,399.
(e) Change in the use of MACRS property during the placed-in-service
year--(1) In general. Except as provided in paragraph (e)(2) of this
section, if a change in the use of MACRS property occurs during the
placed-in-service year and the property continues to be MACRS property
owned by the same taxpayer, the depreciation allowance for that property
for the placed-in-service year is determined by its primary use during
that year. The primary use of MACRS property may be determined in any
reasonable manner that is consistently applied to the taxpayer's MACRS
property. For purposes of this paragraph (e), the determination of
whether the mid-quarter convention applies to any MACRS property placed
in service during the year of change is made in accordance with Sec.
1.168(d)-1.
(2) Alternative depreciation system property--(i) Property used
within and outside the United States. The depreciation allowance for the
placed-in-service year for MACRS property that is used within and
outside the United States is determined by its predominant use during
that year. The determination of whether MACRS property is used
predominantly outside the United States during the placed-in-service
year shall be made in accordance with the test in Sec. 1.48-1(g)(1)(i)
for determining predominant use.
(ii) Tax-exempt bond financed property. The depreciation allowance
for the placed-in-service year for MACRS property that changes to tax-
exempt bond financed property, as described in section 168(g)(1)(C) and
(g)(5), during that taxable year is determined under the alternative
depreciation system. For purposes of this paragraph (e), MACRS property
changes to tax-exempt bond financed property when a tax-exempt bond is
first issued after the MACRS property is placed in service. MACRS
property continues to be tax-exempt bond financed property in the hands
of the taxpayer even if the tax-exempt bond (including any refunding
issue) is not outstanding at, or is redeemed by, the end of the placed-
in-service year.
(iii) Other mandatory alternative depreciation system property. The
depreciation allowance for the placed-in-service year for MACRS property
that changes to, or changes from, property described in section
168(g)(1)(B) (tax-exempt use property) or (D) (imported property covered
by an Executive order) during
[[Page 523]]
that taxable year is determined under--
(A) The alternative depreciation system if the MACRS property is
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year; or
(B) The general depreciation system if the MACRS property is not
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year, unless other provisions of the Internal Revenue Code or
regulations under the Internal Revenue Code require the depreciation
allowance for that MACRS property to be determined under the alternative
depreciation system (for example, section 168(g)(7)).
(3) Examples. The application of this paragraph (e) is illustrated
by the following examples:
Example 1. (i) Z, a utility and calendar-year corporation, acquires
and places in service on January 1, 2004, equipment at a cost of
$100,000. Z uses this equipment in its combustion turbine production
plant for 4 months and then uses the equipment in its steam production
plant for the remainder of 2004. Z's combustion turbine production plant
assets are classified as 15-year property and are depreciated by Z under
the general depreciation system using a 15-year recovery period and the
150-percent declining balance method of depreciation. Z's steam
production plant assets are classified as 20-year property and are
depreciated by Z under the general depreciation system using a 20-year
recovery period and the 150-percent declining balance method of
depreciation. Z uses the optional depreciation tables. The equipment is
50-percent bonus depreciation property for purposes of section 168(k).
(ii) Pursuant to this paragraph (e), Z must determine depreciation
based on the primary use of the equipment during the placed-in-service
year. Z has consistently determined the primary use of all of its MACRS
properties by comparing the number of full months in the taxable year
during which a MACRS property is used in one manner with the number of
full months in that taxable year during which that MACRS property is
used in another manner. Applying this approach, Z determines the
depreciation allowance for the equipment for 2004 is based on the
equipment being classified as 20-year property because the equipment was
used by Z in its steam production plant for 8 months in 2004. If the
half-year convention applies in 2004, the appropriate optional
depreciation table is table 1 in Rev. Proc. 87-57, which is the table
for MACRS property subject to the general depreciation system, the 150-
percent declining balance method, a 20-year recovery period, and the
half-year convention. Thus, the depreciation allowance for the equipment
for 2004 is $51,875, which is the total of $50,000 for the 50-percent
additional first year depreciation deduction allowable (the unadjusted
depreciable basis of $100,000 multiplied by .50), plus $1,875 for the
2004 depreciation allowance on the remaining adjusted depreciable basis
of $50,000 [(the unadjusted depreciable basis of $100,000 less the
additional first year depreciation deduction of $50,000) multiplied by
the annual depreciation rate of .0375 in table 1 for recovery year 1 for
a 20-year recovery period].
Example 2. T , a calendar year corporation, places in service on
January 1, 2004, several computers at a total cost of $100,000. T uses
these computers within the United States for 3 months in 2004 and then
moves and uses the computers outside the United States for the remainder
of 2004. Pursuant to Sec. 1.48-1(g)(1)(i), the computers are considered
as used predominantly outside the United States in 2004. As a result,
for 2004, the computers are required to be depreciated under the
alternative depreciation system of section 168(g) with a recovery period
of 5 years pursuant to section 168(g)(3)(C). T uses the optional
depreciation tables. If the half-year convention applies in 2004, the
appropriate optional depreciation table is table 8 in Rev. Proc. 87-57,
which is the table for MACRS property subject to the alternative
depreciation system, the straight line method, a 5-year recovery period,
and the half-year convention. Thus, the depreciation allowance for the
computers for 2004 is $10,000, which is equal to the unadjusted
depreciable basis of $100,000 multiplied by the annual depreciation rate
of .10 in table 8 for recovery year 1 for a 5-year recovery period.
Because the computers are required to be depreciated under the
alternative depreciation system in their placed-in-service year,
pursuant to section 168(k)(2)(C)(i) and Sec. 1.168(k)-1T(b)(2)(ii), the
computers are not eligible for the additional first year depreciation
deduction provided by section 168(k).
(f) No change in accounting method. A change in computing the
depreciation allowance in the year of change for property subject to
this section is not a change in method of accounting under section
446(e). See Sec. 1.446-1(e)(2)(ii)(d)(3)(ii).
(g) Effective dates--(1) In general. This section applies to any
change in the use of MACRS property in a taxable year ending on or after
June 17, 2004. For any change in the use of MACRS property after
December 31, 1986, in a taxable year ending before June 17, 2004, the
Internal Revenue Service will
[[Page 524]]
allow any reasonable method of depreciating the property under section
168 in the year of change and the subsequent taxable years that is
consistently applied to any property for which the use changes in the
hands of the same taxpayer or the taxpayer may choose, on a property-by-
property basis, to apply the provisions of this section.
(2) Change in method of accounting--(i) In general. If a taxpayer
adopted a method of accounting for depreciation due to a change in the
use of MACRS property in a taxable year ending on or after December 30,
2003, and the method adopted is not in accordance with the method of
accounting for depreciation provided in this section, a change to the
method of accounting for depreciation provided in this section is a
change in the method of accounting to which the provisions of sections
446(e) and 481 and the regulations under sections 446(e) and 481 apply.
Also, a revocation of the election provided in paragraph (d)(3)(ii) of
this section to disregard a change in the use is a change in method of
accounting to which the provisions of sections 446(e) and 481 and the
regulations under sections 446(e) and 481 apply. However, if a taxpayer
adopted a method of accounting for depreciation due to a change in the
use of MACRS property after December 31, 1986, in a taxable year ending
before December 30, 2003, and the method adopted is not in accordance
with the method of accounting for depreciation provided in this section,
the taxpayer may treat the change to the method of accounting for
depreciation provided in this section as a change in method of
accounting to which the provisions of sections 446(e) and 481 and the
regulations under sections 446(e) and 481 apply.
(ii) Automatic consent to change method of accounting. A taxpayer
changing its method of accounting in accordance with this paragraph
(g)(2) must follow the applicable administrative procedures issued under
Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic
consent to a change in method of accounting (for further guidance, for
example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), (see Sec.
601.601(d)(2)(ii)(b) of this chapter)). Any change in method of
accounting made under this paragraph (g)(2) must be made using an
adjustment under section 481(a). For purposes of Form 3115, Application
for Change in Accounting Method, the designated number for the automatic
accounting method change authorized by this paragraph (g)(2) is ``88.''
If Form 3115 is revised or renumbered, any reference in this section to
that form is treated as a reference to the revised or renumbered form.
[T.D. 9132, 69 FR 33843, June 17, 2004, as amended by T.D. 9307, 71 FR
78068, Dec. 28, 2006]
Sec. 1.168(i)-5 Table of contents.
This section lists the major paragraphs contained in Sec. 1.168(i)-
6.
Sec. 1.168(i)-6 Like-kind exchanges and involuntary conversions.
(a) Scope.
(b) Definitions.
(1) Replacement MACRS property.
(2) Relinquished MACRS property.
(3) Time of disposition.
(4) Time of replacement.
(5) Year of disposition.
(6) Year of replacement.
(7) Exchanged basis.
(8) Excess basis.
(9) Depreciable exchanged basis.
(10) Depreciable excess basis.
(11) Like-kind exchange.
(12) Involuntary conversion.
(c) Determination of depreciation allowance.
(1) Computation of the depreciation allowance for depreciable
exchanged basis beginning in the year of replacement.
(i) In general.
(ii) Applicable recovery period, depreciation method, and
convention.
(2) Effect of depreciation treatment of the replacement MACRS
property by previous owners of the acquired property.
(3) Recovery period and/or depreciation method of the properties are
the same, or both are not the same.
(i) In general.
(ii) Both the recovery period and the depreciation method are the
same.
(iii) Either the recovery period or the depreciation method is the
same, or both are not the same.
(4) Recovery period or depreciation method of the properties is not
the same.
(i) Longer recovery period.
(ii) Shorter recovery period.
(iii) Less accelerated depreciation method.
(iv) More accelerated depreciation method.
(v) Convention.
[[Page 525]]
(A) Either the relinquished MACRS property or the replacement MACRS
property is mid-month property.
(B) Neither the relinquished MACRS property nor the replacement
MACRS property is mid-month property.
(5) Year of disposition and year of replacement.
(i) Relinquished MACRS property.
(A) General rule.
(B) Special rule.
(ii) Replacement MACRS property.
(A) Remaining recovery period of the replacement MACRS property.
(B) Year of replacement is 12 months.
(iii) Year of disposition or year of replacement is less than 12
months.
(iv) Deferred transactions.
(A) In general.
(B) Allowable depreciation for a qualified intermediary.
(v) Remaining recovery period.
(6) Examples.
(d) Special rules for determining depreciation allowances.
(1) Excess basis.
(i) In general.
(ii) Example.
(2) Depreciable and nondepreciable property.
(3) Depreciation limitations for automobiles.
(i) In general.
(ii) Order in which limitations on depreciation under section
280F(a) are applied.
(iii) Examples.
(4) Involuntary conversion for which the replacement MACRS property
is acquired and placed in service before disposition of relinquished
MACRS property.
(e) Use of optional depreciation tables.
(1) Taxpayer not bound by prior use of table.
(2) Determination of the depreciation deduction.
(i) Relinquished MACRS property.
(ii) Replacement MACRS property.
(A) Determination of the appropriate optional depreciation table.
(B) Calculating the depreciation deduction for the replacement MACRS
property.
(iii) Unrecovered basis.
(3) Excess basis.
(4) Examples.
(f) Mid-quarter convention.
(1) Exchanged basis.
(2) Excess basis.
(3) Depreciable property acquired for nondepreciable property.
(g) Section 179 election.
(h) Additional first year depreciation deduction.
(i) Elections.
(1) Election not to apply this section.
(2) Election to treat certain replacement property as MACRS
property.
(j) Time and manner of making election under paragraph (i)(1) of
this section.
(1) In general.
(2) Time for making election.
(3) Manner of making election.
(4) Revocation.
(k) Effective date.
(1) In general.
(2) Application to pre-effective date like-kind exchanges and
involuntary conversions.
(3) Like-kind exchanges and involuntary conversions where the
taxpayer made the election under section 168(f)(1) for the relinquished
property.
[T.D. 9314, 72 FR 9250, Mar. 1, 2007]
Sec. 1.168(i)-6 Like-kind exchanges and involuntary conversions.
(a) Scope. This section provides the rules for determining the
depreciation allowance for MACRS property acquired in a like-kind
exchange or an involuntary conversion, including a like-kind exchange or
an involuntary conversion of MACRS property that is exchanged or
replaced with other MACRS property in a transaction between members of
the same affiliated group. The allowance for depreciation under this
section constitutes the amount of depreciation allowable under section
167(a) for the year of replacement and any subsequent taxable year for
the replacement MACRS property and for the year of disposition of the
relinquished MACRS property. The provisions of this section apply only
to MACRS property to which Sec. 1.168(h)-1 (like-kind exchanges of tax-
exempt use property) does not apply. Additionally, paragraphs (c)
through (f) of this section apply only to MACRS property for which an
election under paragraph (i) of this section has not been made.
(b) Definitions. For purposes of this section, the following
definitions apply:
(1) Replacement MACRS property is MACRS property (as defined in
Sec. 1.168(b)-1(a)(2)) in the hands of the acquiring taxpayer that is
acquired for other MACRS property in a like-kind exchange or an
involuntary conversion.
(2) Relinquished MACRS property is MACRS property that is
transferred by the taxpayer in a like-kind exchange, or in an
involuntary conversion.
(3) Time of disposition is when the disposition of the relinquished
MACRS property takes place under the convention, as determined under
Sec. 1.168(d)-1,
[[Page 526]]
that applies to the relinquished MACRS property.
(4) Time of replacement is the later of--
(i) When the replacement MACRS property is placed in service under
the convention, as determined under this section, that applies to the
replacement MACRS property; or
(ii) The time of disposition of the exchanged or involuntarily
converted property.
(5) Year of disposition is the taxable year that includes the time
of disposition.
(6) Year of replacement is the taxable year that includes the time
of replacement.
(7) Exchanged basis is determined after the depreciation deductions
for the year of disposition are determined under paragraph (c)(5)(i) of
this section and is the lesser of--
(i) The basis in the replacement MACRS property, as determined under
section 1031(d) and the regulations under section 1031(d) or section
1033(b) and the regulations under section 1033(b); or
(ii) The adjusted depreciable basis (as defined in Sec. 1.168(b)-
1(a)(4)) of the relinquished MACRS property.
(8) Excess basis is any excess of the basis in the replacement MACRS
property, as determined under section 1031(d) and the regulations under
section 1031(d) or section 1033(b) and the regulations under section
1033(b), over the exchanged basis as determined under paragraph (b)(7)
of this section.
(9) Depreciable exchanged basis is the exchanged basis as determined
under paragraph (b)(7) of this section reduced by--
(i) The percentage of such basis attributable to the taxpayer's use
of property for the taxable year other than in the taxpayer's trade or
business (or for the production of income); and
(ii) Any adjustments to basis provided by other provisions of the
Internal Revenue Code (Code) and the regulations under the Code
(including section 1016(a)(2) and (3), for example, depreciation
deductions in the year of replacement allowable under section 168(k) or
1400L(b)).
(10) Depreciable excess basis is the excess basis as determined
under paragraph (b)(8) of this section reduced by--
(i) The percentage of such basis attributable to the taxpayer's use
of property for the taxable year other than in the taxpayer's trade or
business (or for the production of income);
(ii) Any portion of the basis the taxpayer properly elects to treat
as an expense under section 179; and
(iii) Any adjustments to basis provided by other provisions of the
Code and the regulations under the Code (including section 1016(a)(2)
and (3), for example, depreciation deductions in the year of replacement
allowable under section 168(k) or 1400L(b)).
(11) Like-kind exchange is an exchange of property in a transaction
to which section 1031(a)(1), (b), or (c) applies.
(12) Involuntary conversion is a transaction described in section
1033(a)(1) or (2) that resulted in the nonrecognition of any part of the
gain realized as the result of the conversion.
(c) Determination of depreciation allowance--(1) Computation of the
depreciation allowance for depreciable exchanged basis beginning in the
year of replacement--(i) In general. This paragraph (c) provides rules
for determining the applicable recovery period, the applicable
depreciation method, and the applicable convention used to determine the
depreciation allowances for the depreciable exchanged basis beginning in
the year of replacement. See paragraph (c)(5) of this section for rules
relating to the computation of the depreciation allowance for the year
of disposition and for the year of replacement. See paragraph (d)(1) of
this section for rules relating to the computation of the depreciation
allowance for depreciable excess basis. See paragraph (d)(4) of this
section if the replacement MACRS property is acquired before disposition
of the relinquished MACRS property in a transaction to which section
1033 applies. See paragraph (e) of this section for rules relating to
the computation of the depreciation allowance using the optional
depreciation tables.
(ii) Applicable recovery period, depreciation method, and
convention. The recovery period, depreciation method, and convention
determined under this paragraph (c) are the only permissible
[[Page 527]]
methods of accounting for MACRS property within the scope of this
section unless the taxpayer makes the election under paragraph (i) of
this section not to apply this section.
(2) Effect of depreciation treatment of the replacement MACRS
property by previous owners of the acquired property. If replacement
MACRS property is acquired by a taxpayer in a like-kind exchange or an
involuntary conversion, the depreciation treatment of the replacement
MACRS property by previous owners has no effect on the determination of
depreciation allowances for the replacement MACRS property in the hands
of the acquiring taxpayer. For example, a taxpayer exchanging, in a
like-kind exchange, MACRS property for property that was depreciated
under section 168 of the Internal Revenue Code of 1954 (ACRS) by the
previous owner must use this section because the replacement property
will become MACRS property in the hands of the acquiring taxpayer. In
addition, elections made by previous owners in determining depreciation
allowances for the replacement MACRS property have no effect on the
acquiring taxpayer. For example, a taxpayer exchanging, in a like-kind
exchange, MACRS property that the taxpayer depreciates under the general
depreciation system of section 168(a) for other MACRS property that the
previous owner elected to depreciate under the alternative depreciation
system pursuant to section 168(g)(7) does not have to continue using the
alternative depreciation system for the replacement MACRS property.
(3) Recovery period and/or depreciation method of the properties are
the same, or both are not the same--(i) In general. For purposes of
paragraphs (c)(3) and (c)(4) of this section in determining whether the
recovery period and the depreciation method prescribed under section 168
for the replacement MACRS property are the same as the recovery period
and the depreciation method prescribed under section 168 for the
relinquished MACRS property, the recovery period and the depreciation
method for the replacement MACRS property are considered to be the
recovery period and the depreciation method that would have applied
under section 168, taking into account any elections made by the
acquiring taxpayer under section 168(b)(5) or 168(g)(7), had the
replacement MACRS property been placed in service by the acquiring
taxpayer at the same time as the relinquished MACRS property.
(ii) Both the recovery period and the depreciation method are the
same. If both the recovery period and the depreciation method prescribed
under section 168 for the replacement MACRS property are the same as the
recovery period and the depreciation method prescribed under section 168
for the relinquished MACRS property, the depreciation allowances for the
replacement MACRS property beginning in the year of replacement are
determined by using the same recovery period and depreciation method
that were used for the relinquished MACRS property. Thus, the
replacement MACRS property is depreciated over the remaining recovery
period (taking into account the applicable convention), and by using the
depreciation method, of the relinquished MACRS property. Except as
provided in paragraph (c)(5) of this section, the depreciation
allowances for the depreciable exchanged basis for any 12-month taxable
year beginning with the year of replacement are determined by
multiplying the depreciable exchanged basis by the applicable
depreciation rate for each taxable year (for further guidance, for
example, see section 6 of Rev. Proc. 87-57 (1987-2 CB 687, 692) and
Sec. 601.601(d)(2)(ii)(b) of this chapter).
(iii) Either the recovery period or the depreciation method is the
same, or both are not the same. If either the recovery period or the
depreciation method prescribed under section 168 for the replacement
MACRS property is the same as the recovery period or the depreciation
method prescribed under section 168 for the relinquished MACRS property,
the depreciation allowances for the depreciable exchanged basis
beginning in the year of replacement are determined using the recovery
period or the depreciation method that is the same as the relinquished
MACRS property. See paragraph (c)(4) of this section to determine the
depreciation allowances when the recovery period or
[[Page 528]]
the depreciation method of the replacement MACRS property is not the
same as that of the relinquished MACRS property.
(4) Recovery period or depreciation method of the properties is not
the same. If the recovery period prescribed under section 168 for the
replacement MACRS property (as determined under paragraph (c)(3)(i) of
this section) is not the same as the recovery period prescribed under
section 168 for the relinquished MACRS property, the depreciation
allowances for the depreciable exchanged basis beginning in the year of
replacement are determined under this paragraph (c)(4). Similarly, if
the depreciation method prescribed under section 168 for the replacement
MACRS property (as determined under paragraph (c)(3)(i) of this section)
is not the same as the depreciation method prescribed under section 168
for the relinquished MACRS property, the depreciation method used to
determine the depreciation allowances for the depreciable exchanged
basis beginning in the year of replacement is determined under this
paragraph (c)(4).
(i) Longer recovery period. If the recovery period prescribed under
section 168 for the replacement MACRS property (as determined under
paragraph (c)(3)(i) of this section) is longer than that prescribed for
the relinquished MACRS property, the depreciation allowances for the
depreciable exchanged basis beginning in the year of replacement are
determined as though the replacement MACRS property had originally been
placed in service by the acquiring taxpayer in the same taxable year the
relinquished MACRS property was placed in service by the acquiring
taxpayer, but using the longer recovery period of the replacement MACRS
property (as determined under paragraph (c)(3)(i) of this section) and
the convention determined under paragraph (c)(4)(v) of this section.
Thus, the depreciable exchanged basis is depreciated over the remaining
recovery period (taking into account the applicable convention) of the
replacement MACRS property.
(ii) Shorter recovery period. If the recovery period prescribed
under section 168 for the replacement MACRS property (as determined
under paragraph (c)(3)(i) of this section) is shorter than that of the
relinquished MACRS property, the depreciation allowances for the
depreciable exchanged basis beginning in the year of replacement are
determined using the same recovery period as that of the relinquished
MACRS property. Thus, the depreciable exchanged basis is depreciated
over the remaining recovery period (taking into account the applicable
convention) of the relinquished MACRS property.
(iii) Less accelerated depreciation method--(A) If the depreciation
method prescribed under section 168 for the replacement MACRS property
(as determined under paragraph (c)(3)(i) of this section) is less
accelerated than that of the relinquished MACRS property at the time of
disposition, the depreciation allowances for the depreciable exchanged
basis beginning in the year of replacement are determined as though the
replacement MACRS property had originally been placed in service by the
acquiring taxpayer at the same time the relinquished MACRS property was
placed in service by the acquiring taxpayer, but using the less
accelerated depreciation method. Thus, the depreciable exchanged basis
is depreciated using the less accelerated depreciation method.
(B) Except as provided in paragraph (c)(5) of this section, the
depreciation allowances for the depreciable exchanged basis for any 12-
month taxable year beginning in the year of replacement are determined
by multiplying the adjusted depreciable basis by the applicable
depreciation rate for each taxable year. If, for example, the
depreciation method of the replacement MACRS property in the year of
replacement is the 150-percent declining balance method and the
depreciation method of the relinquished MACRS property in the year of
replacement is the 200-percent declining balance method, and neither
method had been switched to the straight line method in the year of
replacement or any prior taxable year, the applicable depreciation rate
for the year of replacement and subsequent taxable years is determined
by using the depreciation rate of the replacement MACRS property as if
the replacement MACRS property was
[[Page 529]]
placed in service by the acquiring taxpayer at the same time the
relinquished MACRS property was placed in service by the acquiring
taxpayer, until the 150-percent declining balance method has been
switched to the straight line method. If, for example, the depreciation
method of the replacement MACRS property is the straight line method,
the applicable depreciation rate for the year of replacement is
determined by using the remaining recovery period at the beginning of
the year of disposition (as determined under this paragraph (c)(4) and
taking into account the applicable convention).
(iv) More accelerated depreciation method--(A) If the depreciation
method prescribed under section 168 for the replacement MACRS property
(as determined under paragraph (c)(3)(i) of this section) is more
accelerated than that of the relinquished MACRS property at the time of
disposition, the depreciation allowances for the replacement MACRS
property beginning in the year of replacement are determined using the
same depreciation method as the relinquished MACRS property.
(B) Except as provided in paragraph (c)(5) of this section, the
depreciation allowances for the depreciable exchanged basis for any 12-
month taxable year beginning in the year of replacement are determined
by multiplying the adjusted depreciable basis by the applicable
depreciation rate for each taxable year. If, for example, the
depreciation method of the relinquished MACRS property in the year of
replacement is the 150-percent declining balance method and the
depreciation method of the replacement MACRS property in the year of
replacement is the 200-percent declining balance method, and neither
method had been switched to the straight line method in the year of
replacement or any prior taxable year, the applicable depreciation rate
for the year of replacement and subsequent taxable years is the same
depreciation rate that applied to the relinquished MACRS property in the
year of replacement, until the 150-percent declining balance method has
been switched to the straight line method. If, for example, the
depreciation method is the straight line method, the applicable
depreciation rate for the year of replacement is determined by using the
remaining recovery period at the beginning of the year of disposition
(as determined under this paragraph (c)(4) and taking into account the
applicable convention).
(v) Convention. The applicable convention for the exchanged basis is
determined under this paragraph (c)(4)(v).
(A) Either the relinquished MACRS property or the replacement MACRS
property is mid-month property. If either the relinquished MACRS
property or the replacement MACRS property is property for which the
applicable convention (as determined under section 168(d)) is the mid-
month convention, the exchanged basis must be depreciated using the mid-
month convention.
(B) Neither the relinquished MACRS property nor the replacement
MACRS property is mid-month property. If neither the relinquished MACRS
property nor the replacement MACRS property is property for which the
applicable convention (as determined under section 168(d)) is the mid-
month convention, the applicable convention for the exchanged basis is
the same convention that applied to the relinquished MACRS property. If
the relinquished MACRS property is placed in service in the year of
disposition, and the time of replacement is also in the year of
disposition, the convention that applies to the relinquished MACRS
property is determined under paragraph (f)(1)(i) of this section. If,
however, relinquished MACRS property was placed in service in the year
of disposition and the time of replacement is in a taxable year
subsequent to the year of disposition, the convention that applies to
the exchanged basis is the convention that applies in that subsequent
taxable year (see paragraph (f)(1)(ii) of this section).
(5) Year of disposition and year of replacement. No depreciation
deduction is allowable for MACRS property disposed of by a taxpayer in a
like-kind exchange or involuntary conversion in the same taxable year
that such property was placed in service by the taxpayer. If replacement
MACRS property is disposed of by a taxpayer during the same taxable year
that the relinquished MACRS property is placed in
[[Page 530]]
service by the taxpayer, no depreciation deduction is allowable for
either MACRS property. Otherwise, the depreciation allowances for the
year of disposition and for the year of replacement are determined as
follows:
(i) Relinquished MACRS property--(A) General rule. Except as
provided in paragraphs (c)(5)(i)(B), (c)(5)(iii), (e), and (i) of this
section, the depreciation allowance in the year of disposition for the
relinquished MACRS property is computed by multiplying the allowable
depreciation deduction for the property for that year by a fraction, the
numerator of which is the number of months (including fractions of
months) the property is deemed to be placed in service during the year
of disposition (taking into account the applicable convention of the
relinquished MACRS property), and the denominator of which is 12. In the
case of termination under Sec. 1.168(i)-1(e)(3)(v) of general asset
account treatment of an asset, or of all the assets remaining, in a
general asset account, the allowable depreciation deduction in the year
of disposition for the asset or assets for which general asset account
treatment is terminated is determined using the depreciation method,
recovery period, and convention of the general asset account. This
allowable depreciation deduction is adjusted to account for the period
the asset or assets is deemed to be in service in accordance with this
paragraph (c)(5)(i).
(B) Special rule. If, at the beginning of the year of disposition,
the remaining recovery period of the relinquished MACRS property, taking
into account the applicable convention of such property, is less than
the period between the beginning of the year of disposition and the time
of disposition, the depreciation deduction for the relinquished MACRS
property for the year of disposition is equal to the adjusted
depreciable basis of the relinquished MACRS property at the beginning of
the year of disposition. If this paragraph applies, the exchanged basis
is zero and no depreciation is allowable for the exchanged basis in the
replacement MACRS property.
(ii) Replacement MACRS property--(A) Remaining recovery period of
the replacement MACRS property. The replacement MACRS property is
treated as placed in service at the time of replacement under the
convention that applies to the replacement MACRS property as determined
under this paragraph (c)(5)(ii). The remaining recovery period of the
replacement MACRS property at the time of replacement is the excess of
the recovery period for the replacement MACRS property, as determined
under paragraph (c) of this section, over the period of time that the
replacement MACRS property would have been in service if it had been
placed in service when the relinquished MACRS property was placed in
service and removed from service at the time of disposition of the
relinquished MACRS property. This period is determined by using the
convention that applied to the relinquished MACRS property to determine
the date that the relinquished MACRS property is deemed to have been
placed in service and the date that it is deemed to have been disposed
of. The length of time the replacement MACRS property would have been in
service is determined by using these dates and the convention that
applies to the replacement MACRS property.
(B) Year of replacement is 12 months. Except as provided in
paragraphs (c)(5)(iii), (e), and (i) of this section, the depreciation
allowance in the year of replacement for the depreciable exchanged basis
is determined by--
(1) Calculating the applicable depreciation rate for the replacement
MACRS property as of the beginning of the year of replacement taking
into account the depreciation method prescribed for the replacement
MACRS property under paragraph (c)(3) of this section and the remaining
recovery period of the replacement MACRS property as of the beginning of
the year of disposition as determined under this paragraph (c)(5)(ii);
(2) Calculating the depreciable exchanged basis of the replacement
MACRS property, and adding to that amount the amount determined under
paragraph (c)(5)(i) of this section for the year of disposition; and
(3) Multiplying the product of the amounts determined under
paragraphs (c)(5)(ii)(B)(1) and (B)(2) of this section by a fraction,
the numerator of which
[[Page 531]]
is the number of months (including fractions of months) the property is
deemed to be in service during the year of replacement (in the year of
replacement the replacement MACRS property is deemed to be placed in
service by the acquiring taxpayer at the time of replacement under the
convention determined under paragraph (c)(4)(v) of this section), and
the denominator of which is 12.
(iii) Year of disposition or year of replacement is less than 12
months. If the year of disposition or the year of replacement is less
than 12 months, the depreciation allowance determined under paragraph
(c)(5)(ii)(A) of this section must be adjusted for a short taxable year
(for further guidance, for example, see Rev. Proc. 89-15 (1989-1 CB 816)
and Sec. 601.601(d)(2)(ii)(b) of this chapter).
(iv) Deferred transactions--(A) In general. If the replacement MACRS
property is not acquired until after the disposition of the relinquished
MACRS property, taking into account the applicable convention of the
relinquished MACRS property and replacement MACRS property, depreciation
is not allowable during the period between the disposition of the
relinquished MACRS property and the acquisition of the replacement MACRS
property. The recovery period for the replacement MACRS property is
suspended during this period. For purposes of paragraph (c)(5)(ii) of
this section, only the depreciable exchanged basis of the replacement
MACRS property is taken into account for calculating the amount in
paragraph (c)(5)(ii)(B)(2) of this section if the year of replacement is
a taxable year subsequent to the year of disposition.
(B) Allowable depreciation for a qualified intermediary. [Reserved]
(v) Remaining recovery period. The remaining recovery period of the
replacement MACRS property is determined as of the beginning of the year
of disposition of the relinquished MACRS property. For purposes of
determining the remaining recovery period of the replacement MACRS
property, the replacement MACRS property is deemed to have been
originally placed in service under the convention determined under
paragraph (c)(4)(v) of this section, but at the time the relinquished
MACRS property was deemed to be placed in service under the convention
that applied to it when it was placed in service.
(6) Examples. The application of this paragraph (c) is illustrated
by the following examples:
Example 1. A1, a calendar-year taxpayer, exchanges Building M, an
office building, for Building N, a warehouse in a like-kind exchange.
Building M is relinquished in July 2004 and Building N is acquired and
placed in service in October 2004. A1 did not make any elections under
section 168 for either Building M or Building N. The unadjusted
depreciable basis of Building M was $4,680,000 when placed in service in
July 1997. Since the recovery period and depreciation method prescribed
under section 168 for Building N (39 years, straight line method) are
the same as the recovery period and depreciation method prescribed under
section 168 for Building M (39 years, straight line method), Building N
is depreciated over the remaining recovery period of, and using the same
depreciation method and convention as that of, Building M. Applying the
applicable convention, Building M is deemed disposed of on July 15,
2004, and Building N is placed in service on October 15, 2004. Thus,
Building N will be depreciated using the straight line method over a
remaining recovery period of 32 years beginning in October 2004 (the
remaining recovery period of 32 years and 6.5 months at the beginning of
2004, less the 6.5 months of depreciation taken prior to the disposition
of the exchanged MACRS property (Building M) in 2004). For 2004, the
year in which the transaction takes place, the depreciation allowance
for Building M is ($120,000)(6.5/12) which equals $65,000. The
depreciation allowance for Building N for 2004 is ($120,000)(2.5/12)
which equals $25,000. For 2005 and subsequent years, Building N is
depreciated over the remaining recovery period of, and using the same
depreciation method and convention as that of, Building M. Thus, the
depreciation allowance for Building N is the same as Building M, namely
$10,000 per month.
Example 2. B, a calendar-year taxpayer, placed in service Bridge P
in January 1998. Bridge P is depreciated using the half-year convention.
In January 2004, B exchanges Bridge P for Building Q, an apartment
building, in a like-kind exchange. Pursuant to paragraph (k)(2)(i) of
this section, B decided to apply Sec. 1.168(i)-6 to the exchange of
Bridge P for Building Q, the replacement MACRS property. B did not make
any elections under section 168 for either Bridge P or Building Q. Since
the recovery period prescribed under section 168 for Building Q (27.5
years) is longer than that of Bridge P (15 years), Building Q is
depreciated as if it had
[[Page 532]]
originally been placed in service in July 1998 and disposed of in July
2004 using a 27.5 year recovery period. Additionally, since the
depreciation method prescribed under section 168 for Building Q
(straight line method) is less accelerated than that of Bridge P (150-
percent declining balance method), then the depreciation allowance for
Building Q is computed using the straight line method. Thus, when
Building Q is acquired and placed in service in 2004, its basis is
depreciated over the remaining 21.5 year recovery period using the
straight line method of depreciation and the mid-month convention
beginning in July 2004.
Example 3. C, a calendar-year taxpayer, placed in service Building
R, a restaurant, in January 1996. In January 2004, C exchanges Building
R for Tower S, a radio transmitting tower, in a like-kind exchange.
Pursuant to paragraph (k)(2)(i) of this section, C decided to apply
Sec. 1.168(i)-6 to the exchange of Building R for Tower S, the
replacement MACRS property. C did not make any elections under section
168 for either Building R or Tower S. Since the recovery period
prescribed under section 168 for Tower S (15 years) is shorter than that
of Building R (39 years), Tower S is depreciated over the remaining
recovery period of Building R. Additionally, since the depreciation
method prescribed under section 168 for Tower S (150% declining balance
method) is more accelerated than that of Building R (straight line
method), then the depreciation allowance for Tower S is also computed
using the same depreciation method as Building R. Thus, Tower S is
depreciated over the remaining 31 year recovery period of Building R
using the straight line method of depreciation and the mid-month
convention. Alternatively, C may elect under paragraph (i) of this
section to treat Tower S as though it is placed in service in January
2004. In such case, C uses the applicable recovery period, depreciation
method, and convention prescribed under section 168 for Tower S.
Example 4. (i) In February 2002, D, a calendar-year taxpayer and
manufacturer of rubber products, acquired for $60,000 and placed in
service Asset T (a special tool) and depreciated Asset T using the
straight line method election under section 168(b)(5) and the mid-
quarter convention over its 3-year recovery period. D elected not to
deduct the additional first year depreciation for 3-year property placed
in service in 2002. In June 2004, D exchanges Asset T for Asset U (not a
special tool) in a like-kind exchange. D elected not to deduct the
additional first year depreciation for 7-year property placed in service
in 2004. Since the recovery period prescribed under section 168 for
Asset U (7 years) is longer than that of Asset T (3 years), Asset U is
depreciated as if it had originally been placed in service in February
2002 using a 7-year recovery period. Additionally, since the
depreciation method prescribed under section 168 for Asset U (200-
percent declining balance method) is more accelerated than that of Asset
T (straight line method) at the time of disposition, the depreciation
allowance for Asset U is computed using the straight line method. Asset
U is depreciated over its remaining recovery period of 4.75 years using
the straight line method of depreciation and the mid-quarter convention.
(ii) The 2004 depreciation allowance for Asset T is $7,500 ($20,000
allowable depreciation deduction for 2004) x 4.5 months / 12).
(iii) The depreciation rate in 2004 for Asset U is 0.1951 (1 / 5.125
years (the length of the applicable recovery period remaining as of the
beginning of 2004)). Therefore, the depreciation allowance for Asset U
in 2004 is $2,744 (0.1951 x $22,500 (the sum of the $15,000 depreciable
exchanged basis of Asset U ($22,500 adjusted depreciable basis at the
beginning of 2004 for Asset T, less the $7,500 depreciation allowable
for Asset T for 2004) and the $7,500 depreciation allowable for Asset T
for 2004) x 7.5 months / 12).
Example 5. The facts are the same as in Example 4 except that D
exchanges Asset T for Asset U in June 2005, in a like-kind exchange.
Under these facts, the remaining recovery period of Asset T at the
beginning of 2005 is 1.5 months and, as a result, is less than the 5-
month period between the beginning of 2005 (year of disposition) and
June 2005 (time of disposition). Accordingly, pursuant to paragraph
(c)(5)(i)(B) of this section, the 2005 depreciation allowance for Asset
T is $2,500 ($2,500 adjusted depreciable basis at the beginning of 2005
($60,000 original basis minus $17,500 depreciation deduction for 2002
minus $20,000 depreciation deduction for 2003 minus $20,000 depreciation
deduction for 2004)). Because the exchanged basis of asset U is $0.00,
no depreciation is allowable for asset U.
Example 6. On January 1, 2004, E, a calendar-year taxpayer, acquired
and placed in service Canopy V, a gas station canopy. The purchase price
of Canopy V was $60,000. On August 1, 2004, Canopy V was destroyed in a
hurricane and was therefore no longer usable in E's business. On October
1, 2004, as part of the involuntary conversion, E acquired and placed in
service new Canopy W with the insurance proceeds E received due to the
loss of Canopy V. E elected not to deduct the additional first year
depreciation for 5-year property placed in service in 2004. E
depreciates both canopies under the general depreciation system of
section 168(a) by using the 200-percent declining balance method of
depreciation, a 5-year recovery period, and the half-year convention. No
depreciation deduction is allowable for Canopy V. The depreciation
deduction allowable for Canopy W for 2004 is $12,000 ($60,000 x the
annual depreciation rate of .40 x \1/2\ year). For 2005, the
depreciation deduction for Canopy W is $19,200
[[Page 533]]
($48,000 adjusted basis x the annual depreciation rate of .40).
Example 7. The facts are the same as in Example 6, except that E did
not make the election out of the additional first year depreciation for
5-year property placed in service in 2004. E depreciates both canopies
under the general depreciation system of section 168(a) by using the
200-percent declining balance method of depreciation, a 5-year recovery
period, and the half-year convention. No depreciation deduction is
allowable for Canopy V. For 2004, E is allowed a 50-percent additional
first year depreciation deduction of $30,000 for Canopy W (the
unadjusted depreciable basis of $60,000 multiplied by .50), and a
regular MACRS depreciation deduction of $6,000 for Canopy W (the
depreciable exchanged basis of $30,000 multiplied by the annual
depreciation rate of .40 x \1/2\ year). For 2005, E is allowed a regular
MACRS depreciation deduction of $9,600 for Canopy W (the depreciable
exchanged basis of $24,000 ($30,000 minus regular 2003 depreciation of
$6,000) multiplied by the annual depreciation rate of .40).
Example 8. In January 2001, F, a calendar-year taxpayer, places in
service a paved parking lot, Lot W, and begins depreciating Lot W over
its 15-year recovery period. F's unadjusted depreciable basis in Lot W
is $1,000x. On April 1, 2004, F disposes of Lot W in a like-kind
exchange for Building X, which is nonresidential real property. Lot W is
depreciated using the 150 percent declining balance method and the half-
year convention. Building X is depreciated using the straight-line
method with a 39-year recovery period and using the mid-month
convention. Both Lot W and Building X were in service at the time of the
exchange. Because Lot W was depreciated using the half-year convention,
it is deemed to have been placed in service on July 1, 2001, the first
day of the second half of 2001, and to have been disposed of on July 1,
2004, the first day of the second half of 2004. To determine the
remaining recovery period of Building X at the time of replacement,
Building X is deemed to have been placed in service on July 1, 2001, and
removed from service on July 1, 2004. Thus, Building X is deemed to have
been in service, at the time of replacement, for 3 years (36 months =
5.5 months in 2001 + 12 months in 2002 + 12 months in 2003 + 6.5 months
in 2004) and its remaining recovery period is 36 years (39 - 3). Because
Building X is deemed to be placed in service at the time of replacement,
July 1, 2004, the first day of the second half of 2004, Building X is
depreciated for 5.5 months in 2004. However, at the beginning of the
year of replacement the remaining recovery period for Building X is 36
years and 6.5 months (39 years - 2 years and 5.5 months (5.5 months in
2001 + 12 months in 2002 + 12 months in 2003)). The depreciation rate
for building X for 2004 is 0.02737 (= 1/(39-2-5.5/12)). For 2005, the
depreciation rate for Building X is 0.02814 (= 1/(39-3-5.5/12)).
Example 9. The facts are the same as in Example 8. F did not make
the election under paragraph (i) of this section for Building Y in the
initial exchange. In January 2006, F exchanges Building Y for Building
Z, an office building, in a like-kind exchange. F did not make any
elections under section 168 for either Building Y or Building Z. Since
the recovery period prescribed for Building Y as a result of the initial
exchange (39 years) is longer than that of Building Z (27.5 years),
Building Z is depreciated over the remaining 33 years of the recovery
period of Building Y. The depreciation methods are the same for both
Building Y and Building Z so F's exchanged basis in Building Z is
depreciated over 33 years, using the straight-line method and the mid-
month convention, beginning in January 2006. Alternatively, F could have
made the election under paragraph (i) of this section. If F makes such
election, Building Z is treated as placed in service by F when acquired
in January 2006 and F would recover its exchanged basis in Building Z
over 27.5 years, using the straight line method and the mid-month
convention, beginning in January 2006.
(d) Special rules for determining depreciation allowances--(1)
Excess basis--(i) In general. Any excess basis in the replacement MACRS
property is treated as property that is placed in service by the
acquiring taxpayer in the year of replacement. Thus, the depreciation
allowances for the depreciable excess basis are determined by using the
applicable recovery period, depreciation method, and convention
prescribed under section 168 for the property at the time of
replacement. However, if replacement MACRS property is disposed of
during the same taxable year the relinquished MACRS property is placed
in service by the acquiring taxpayer, no depreciation deduction is
allowable for either MACRS property. See paragraph (g) of this section
regarding the application of section 179. See paragraph (h) of this
section regarding the application of section 168(k) or 1400L(b).
(ii) Example. The application of this paragraph (d)(1) is
illustrated by the following example:
Example. In 1989, G placed in service a hospital. On January 16,
2004, G exchanges this hospital plus $2,000,000 cash for an office
building in a like-kind exchange. On January 16, 2004, the hospital has
an adjusted depreciable basis of $1,500,000. After the exchange,
[[Page 534]]
the basis of the office building is $3,500,000. Pursuant to paragraph
(k)(2)(i) of this section, G decided to apply Sec. 1.168(i)-6 to the
exchange of the hospital for the office building, the replacement MACRS
property. The depreciable exchanged basis of the office building is
depreciated in accordance with paragraph (c) of this section. The
depreciable excess basis of $2,000,000 is treated as being placed in
service by G in 2004 and, as a result, is depreciated using the
applicable depreciation method, recovery period, and convention
prescribed for the office building under section 168 at the time of
replacement.
(2) Depreciable and nondepreciable property--(i) If land or other
nondepreciable property is acquired in a like-kind exchange for, or as a
result of an involuntary conversion of, depreciable property, the land
or other nondepreciable property is not depreciated. If both MACRS and
nondepreciable property are acquired in a like-kind exchange for, or as
part of an involuntary conversion of, MACRS property, the basis
allocated to the nondepreciable property (as determined under section
1031(d) and the regulations under section 1031(d) or section 1033(b) and
the regulations under section 1033(b)) is not depreciated and the basis
allocated to the replacement MACRS property (as determined under section
1031(d) and the regulations under section 1031(d) or section 1033(b) and
the regulations under section 1033(b)) is depreciated in accordance with
this section.
(ii) If MACRS property is acquired, or if both MACRS and
nondepreciable property are acquired, in a like-kind exchange for, or as
part of an involuntary conversion of, land or other nondepreciable
property, the basis in the replacement MACRS property that is
attributable to the relinquished nondepreciable property is treated as
though the replacement MACRS property is placed in service by the
acquiring taxpayer in the year of replacement. Thus, the depreciation
allowances for the replacement MACRS property are determined by using
the applicable recovery period, depreciation method, and convention
prescribed under section 168 for the replacement MACRS property at the
time of replacement. See paragraph (g) of this section regarding the
application of section 179. See paragraph (h) of this section regarding
the application of section 168(k) or 1400L(b).
(3) Depreciation limitations for automobiles--(i) In general.
Depreciation allowances under section 179 and section 167 (including
allowances under sections 168 and 1400L(b)) for a passenger automobile,
as defined in section 280F(d)(5), are subject to the limitations of
section 280F(a). The depreciation allowances for a passenger automobile
that is replacement MACRS property (replacement MACRS passenger
automobile) generally are limited in any taxable year to the replacement
automobile section 280F limit for the taxable year. The taxpayer's basis
in the replacement MACRS passenger automobile is treated as being
comprised of two separate components. The first component is the
exchanged basis and the second component is the excess basis, if any.
The depreciation allowances for a passenger automobile that is
relinquished MACRS property (relinquished MACRS passenger automobile)
for the taxable year generally are limited to the relinquished
automobile section 280F limit for that taxable year. In the year of
disposition the sum of the depreciation deductions for the relinquished
MACRS passenger automobile and the replacement MACRS passenger
automobile may not exceed the replacement automobile section 280F limit
unless the taxpayer makes the election under Sec. 1.168(i)-6(i). For
purposes of this paragraph (d)(3), the following definitions apply:
(A) Replacement automobile section 280F limit is the limit on
depreciation deductions under section 280F(a) for the taxable year based
on the time of replacement of the replacement MACRS passenger automobile
(including the effect of any elections under section 168(k) or section
1400L(b), as applicable).
(B) Relinquished automobile section 280F limit is the limit on
depreciation deductions under section 280F(a) for the taxable year based
on when the relinquished MACRS passenger automobile was placed in
service by the taxpayer.
(ii) Order in which limitations on depreciation under section
280F(a) are applied. Generally, depreciation deductions allowable under
section 280F(a) reduce
[[Page 535]]
the basis in the relinquished MACRS passenger automobile and the
exchanged basis of the replacement MACRS passenger automobile, before
the excess basis of the replacement MACRS passenger automobile is
reduced. The depreciation deductions for the relinquished MACRS
passenger automobile in the year of disposition and the replacement
MACRS passenger automobile in the year of replacement and each
subsequent taxable year are allowable in the following order:
(A) The depreciation deduction allowable for the relinquished MACRS
passenger automobile as determined under paragraph (c)(5)(i) of this
section for the year of disposition to the extent of the smaller of the
replacement automobile section 280F limit and the relinquished
automobile section 280F limit, if the year of disposition is the year of
replacement. If the year of replacement is a taxable year subsequent to
the year of disposition, the depreciation deduction allowable for the
relinquished MACRS passenger automobile for the year of disposition is
limited to the relinquished automobile section 280F limit.
(B) The additional first year depreciation allowable on the
remaining exchanged basis (remaining carryover basis as determined under
Sec. 1.168(k)-1(f)(5) or Sec. 1.1400L(b)-1(f)(5), as applicable) of
the replacement MACRS passenger automobile, as determined under Sec.
1.168(k)-1(f)(5) or Sec. 1.1400L(b)-1(f)(5), as applicable, to the
extent of the excess of the replacement automobile section 280F limit
over the amount allowable under paragraph (d)(3)(ii)(A) of this section.
(C) The depreciation deduction allowable for the taxable year on the
depreciable exchanged basis of the replacement MACRS passenger
automobile determined under paragraph (c) of this section to the extent
of any excess over the sum of the amounts allowable under paragraphs
(d)(3)(ii)(A) and (B) of this section of the smaller of the replacement
automobile section 280F limit and the relinquished automobile section
280F limit.
(D) Any section 179 deduction allowable in the year of replacement
on the excess basis of the replacement MACRS passenger automobile to the
extent of the excess of the replacement automobile section 280F limit
over the sum of the amounts allowable under paragraphs (d)(3)(ii)(A),
(B), and (C) of this section.
(E) The additional first year depreciation allowable on the
remaining excess basis of the replacement MACRS passenger automobile, as
determined under Sec. 1.168(k)-1(f)(5) or Sec. 1.1400L(b)-1(f)(5), as
applicable, to the extent of the excess of the replacement automobile
section 280F limit over the sum of the amounts allowable under
paragraphs (d)(3)(ii)(A), (B), (C), and (D) of this section.
(F) The depreciation deduction allowable under paragraph (d) of this
section for the depreciable excess basis of the replacement MACRS
passenger automobile to the extent of the excess of the replacement
automobile section 280F limit over the sum of the amounts allowable
under paragraphs (d)(3)(ii)(A), (B), (C), (D), and (E) of this section.
(iii) Examples. The application of this paragraph (d)(3) is
illustrated by the following examples:
Example 1. H, a calendar-year taxpayer, acquired and placed in
service Automobile X in January 2000 for $30,000 to be used solely for
H's business. In December 2003, H exchanges, in a like-kind exchange,
Automobile X plus $15,000 cash for new Automobile Y that will also be
used solely in H's business. Automobile Y is 50-percent bonus
depreciation property for purposes of section 168(k)(4). Both
automobiles are depreciated using the double declining balance method,
the half-year convention, and a 5-year recovery period. Pursuant to
Sec. 1.168(k)-1(g)(3)(ii) and paragraph (k)(2)(i) of this section, H
decided to apply Sec. 1.168(i)-6 to the exchange of Automobile X for
Automobile Y, the replacement MACRS property. The relinquished
automobile section 280F limit for 2003 for Automobile X is $1,775. The
replacement automobile section 280F limit for Automobile Y is $10,710.
The exchanged basis for Automobile Y is $17,315 ($30,000 less total
depreciation allowable of $12,685 (($3,060 for 2000, $4,900 for 2001,
$2,950 for 2002, and $1,775 for 2003)). Without taking section 280F into
account, the additional first year depreciation deduction for the
remaining exchanged basis is $8,658 ($17,315 x 0.5). Because this amount
is less than $8,935 ($10,710 (the replacement automobile section 280F
limit for 2003 for Automobile Y) - $1,775 (the depreciation allowable
for Automobile X for 2003)), the additional first year depreciation
deduction for
[[Page 536]]
the exchanged basis is $8,658. No depreciation deduction is allowable in
2003 for the depreciable exchanged basis because the depreciation
deductions taken for Automobile X and the remaining exchanged basis
exceed the exchanged automobile section 280F limit. An additional first
year depreciation deduction of $277 is allowable for the excess basis of
$15,000 in Automobile Y. Thus, at the end of 2003 the adjusted
depreciable basis in Automobile Y is $23,379 comprised of adjusted
depreciable exchanged basis of $8,657 ($17,315 (exchanged basis) -
$8,658 (additional first year depreciation for exchanged basis)) and of
an adjusted depreciable excess basis of $14,723 ($15,000 (excess basis)
- $277 (additional first year depreciation for 2003)).
Example 2. The facts are the same as in Example 1, except that H
used Automobile X only 75 percent for business use. As such, the total
allowable depreciation for Automobile X is reduced to reflect that the
automobile is only used 75 percent for business. The total allowable
depreciation of Automobile X is $9,513.75 ($2,295 for 2000 ($3,060 limit
x .75), $3,675 for 2001 ($4,900 limit x .75), $2,212.50 for 2002 ($2,950
limit x .75), and $1,331.25 for 2003 ($1,775 limit x .75). However,
under Sec. 1.280F-2T(g)(2)(ii)(A), the exchanged basis is reduced by
the excess (if any) of the depreciation that would have been allowable
if the exchanged automobile had been used solely for business over the
depreciation that was allowable in those years. Thus, the exchanged
basis, for purposes of computing depreciation, for Automobile Y is
$17,315.
Example 3. The facts are the same as in Example 1, except that H
placed in service Automobile X in January 2002, and H elected not to
claim the additional first year depreciation deduction for 5-year
property placed in service in 2002 and 2003. The relinquished automobile
section 280F limit for Automobile X for 2003 is $4,900. Because the
replacement automobile section 280F limit for 2003 for Automobile Y
($3,060) is less than the relinquished automobile section 280F limit for
Automobile X for 2003 and is less than $5,388 (($30,000 (cost) - $3,060
(depreciation allowable for 2002)) x 0.4 x 6/12), the depreciation that
would be allowable for Automobile X (determined without regard to
section 280F) in the year of disposition, the depreciation for
Automobile X in the year of disposition is limited to $3,060. For 2003
no depreciation is allowable for the excess basis and the exchanged
basis in Automobile Y.
Example 4. AB, a calendar-year taxpayer, purchased and placed in
service Automobile X1 in February 2000 for $10,000. X1 is a passenger
automobile subject to section 280F(a) and is used solely for AB's
business. AB depreciated X1 using a 5-year recovery period, the double
declining balance method, and the half-year convention. As of January 1,
2003, the adjusted depreciable basis of X1 was $2,880 ($10,000 original
cost minus $2,000 depreciation deduction for 2000, minus $3,200
depreciation deduction for 2001, and $1,920 depreciation deduction for
2002). In November 2003, AB exchanges, in a like-kind exchange,
Automobile X1 plus $14,000 cash for new Automobile Y1 that will be used
solely in AB's business. Automobile Y1 is 50-percent bonus depreciation
property for purposes of section 168(k)(4) and qualifies for the
expensing election under section 179. Pursuant to paragraph Sec.
1.168(k)-1(g)(3)(ii) and paragraph (k)(2)(i) of this section, AB decided
to apply Sec. 1.168(i)-6 to the exchange of Automobile X1 for
Automobile Y1, the replacement MACRS property. AB also makes the
election under section 179 for the excess basis of Automobile Y1. AB
depreciates Y1 using a five-year recovery period, the double declining
balance method and the half-year convention. For 2003, the relinquished
automobile section 280F limit for Automobile X1 is $1,775 and the
replacement automobile section 280F limit for 2003 for Automobile Y1 is
$10,710.
(i) The 2003 depreciation deduction for Automobile X1 is $576. The
depreciation deduction calculated for X1 is $576 (the adjusted
depreciable basis of Automobile X1 at the beginning of 2003 of $2,880 x
40% x \1/2\ year), which is less than the relinquished automobile
section 280F limit and the replacement automobile section 280F limit.
(ii) The additional first year depreciation deduction for the
exchanged basis is $1,152. The additional first year depreciation
deduction of $1,152 (remaining exchanged basis of $2,304 ($2,880
adjusted basis of Automobile X1 at the beginning of 2003 minus $576) -
0.5)) is less than the replacement automobile section 280F limit minus
$576.
(iii) AB's MACRS depreciation deduction allowable in 2003 for the
remaining exchanged basis of $1,152 is $47 (the relinquished automobile
section 280F limit of $1,775 less the depreciation deduction of $576
taken for Automobile X1 less the additional first year depreciation
deduction of $1,152 taken for the exchanged basis) which is less than
the depreciation deduction calculated for the depreciable exchanged
basis.
(iv) For 2003, AB takes a $1,400 section 179 deduction for the
excess basis of Automobile Y1. AB must reduce the excess basis of
$14,000 by the section 179 deduction of $1,400 to determine the
remaining excess basis of $12,600.
(v) For 2003, AB is allowed a 50-percent additional first year
depreciation deduction of $6,300 (the remaining excess basis of $12,600
multiplied by .50).
(vi) For 2003, AB's depreciation deduction for the depreciable
excess basis is limited to $1,235. The depreciation deduction computed
without regard to the replacement automobile section 280F limit is
$1,260 ($6,300 depreciable excess basis x 0.4 x 6/12). However the
depreciation deduction for the depreciable excess basis is limited to
$1,235 ($10,710
[[Page 537]]
(replacement automobile section 280F limit) - $576 (depreciation
deduction for Automobile X1) - $1,152 (additional first year
depreciation deduction for the exchanged basis) - $47 (depreciation
deduction for exchanged basis) - 1,400 (section 179 deduction) - $6,300
(additional first year depreciation deduction for remaining excess
basis)).
(4) Involuntary conversion for which the replacement MACRS property
is acquired and placed in service before disposition of relinquished
MACRS property. If, in an involuntary conversion, a taxpayer acquires
and places in service the replacement MACRS property before the date of
disposition of the relinquished MACRS property, the taxpayer depreciates
the unadjusted depreciable basis of the replacement MACRS property under
section 168 beginning in the taxable year when the replacement MACRS
property is placed in service by the taxpayer and by using the
applicable depreciation method, recovery period, and convention
prescribed under section 168 for the replacement MACRS property at the
placed-in-service date. However, at the time of disposition of the
relinquished MACRS property, the taxpayer determines the exchanged basis
and the excess basis of the replacement MACRS property and begins to
depreciate the depreciable exchanged basis of the replacement MACRS
property in accordance with paragraph (c) of this section. The
depreciable excess basis of the replacement MACRS property continues to
be depreciated by the taxpayer in accordance with the first sentence of
this paragraph (d)(4). Further, in the year of disposition of the
relinquished MACRS property, the taxpayer must include in taxable income
the excess of the depreciation deductions allowable on the unadjusted
depreciable basis of the replacement MACRS property over the
depreciation deductions that would have been allowable to the taxpayer
on the depreciable excess basis of the replacement MACRS property from
the date the replacement MACRS property was placed in service by the
taxpayer (taking into account the applicable convention) to the time of
disposition of the relinquished MACRS property. However, see Sec.
1.168(k)-1(f)(5)(v) for replacement MACRS property that is qualified
property or 50-percent bonus depreciation property and Sec. 1.1400L(b)-
1(f)(5) for replacement MACRS property that is qualified New York
Liberty Zone property.
(e) Use of optional depreciation tables--(1) Taxpayer not bound by
prior use of table. If a taxpayer used an optional depreciation table
for the relinquished MACRS property, the taxpayer is not required to use
an optional table for the depreciable exchanged basis of the replacement
MACRS property. Conversely, if a taxpayer did not use an optional
depreciation table for the relinquished MACRS property, the taxpayer may
use the appropriate table for the depreciable exchanged basis of the
replacement MACRS property. If a taxpayer decides not to use the table
for the depreciable exchanged basis of the replacement MACRS property,
the depreciation allowance for this property for the year of replacement
and subsequent taxable years is determined under paragraph (c) of this
section. If a taxpayer decides to use the optional depreciation tables,
no depreciation deduction is allowable for MACRS property placed in
service by the acquiring taxpayer and subsequently exchanged or
involuntarily converted by such taxpayer in the same taxable year, and,
if, during the same taxable year, MACRS property is placed in service by
the acquiring taxpayer, exchanged or involuntarily converted by such
taxpayer, and the replacement MACRS property is disposed of by such
taxpayer, no depreciation deduction is allowable for either MACRS
property.
(2) Determination of the depreciation deduction--(i) Relinquished
MACRS property. In the year of disposition, the depreciation allowance
for the relinquished MACRS property is computed by multiplying the
unadjusted depreciable basis (less the amount of the additional first
year depreciation deduction allowed or allowable, whichever is greater,
under section 168(k) or section 1400L(b), as applicable) of the
relinquished MACRS property by the annual depreciation rate (expressed
as a decimal equivalent) specified in the appropriate table for the
recovery year corresponding to the year of disposition. This product is
then multiplied by a fraction, the numerator of which is the number of
months (including fractions of months) the property is
[[Page 538]]
deemed to be placed in service during the year of the exchange or
involuntary conversion (taking into account the applicable convention)
and the denominator of which is 12. However, if the year of disposition
is less than 12 months, the depreciation allowance determined under this
paragraph (e)(2)(i) must be adjusted for a short taxable year (for
further guidance, for example, see Rev. Proc. 89-15 (1989-1 CB 816) and
Sec. 601.601(d)(2)(ii)(b) of this chapter).
(ii) Replacement MACRS property--(A) Determination of the
appropriate optional depreciation table. If a taxpayer chooses to use
the appropriate optional depreciation table for the depreciable
exchanged basis, the depreciation allowances for the depreciable
exchanged basis beginning in the year of replacement are determined by
choosing the optional depreciation table that corresponds to the
recovery period, depreciation method, and convention of the replacement
MACRS property determined under paragraph (c) of this section.
(B) Calculating the depreciation deduction for the replacement MACRS
property. (1) The depreciation deduction for the taxable year is
computed by first determining the appropriate recovery year in the table
identified under paragraph (e)(2)(ii)(A) of this section. The
appropriate recovery year for the year of replacement is the same as the
recovery year for the year of disposition, regardless of the taxable
year in which the replacement property is acquired. For example, if the
recovery year for the year of disposition would have been year 4 in the
table that applied before the disposition of the relinquished MACRS
property, then the recovery year for the year of replacement is Year 4
in the table identified under paragraph (e)(2)(ii)(A) of this section.
(2) Next, the annual depreciation rate (expressed as a decimal
equivalent) for each recovery year is multiplied by a transaction
coefficient. The transaction coefficient is the formula (1 / (1 - x))
where x equals the sum of the annual depreciation rates from the table
identified under paragraph (e)(2)(ii)(A) of this section (expressed as a
decimal equivalent) corresponding to the replacement MACRS property (as
determined under paragraph (e)(2)(ii)(A) of this section) for the
taxable years beginning with the placed-in-service year of the
relinquished MACRS property through the taxable year immediately prior
to the year of disposition. The product of the annual depreciation rate
and the transaction coefficient is multiplied by the depreciable
exchanged basis (taking into account paragraph (e)(2)(i) of this
section). In the year of replacement, this product is then multiplied by
a fraction, the numerator of which is the number of months (including
fractions of months) the property is deemed to be placed in service by
the acquiring taxpayer during the year of replacement (taking into
account the applicable convention) and the denominator of which is 12.
However, if the year of replacement is the year the relinquished MACRS
property is placed in service by the acquiring taxpayer, the preceding
sentence does not apply. In addition, if the year of replacement is less
than 12 months, the depreciation allowance determined under paragraph
(e)(2)(ii) of this section must be adjusted for a short taxable year
(for further guidance, for example, see Rev. Proc. 89-15 (1989-1 CB 816)
and Sec. 601.601(d)(2)(ii)(b) of this chapter).
(iii) Unrecovered basis. If the replacement MACRS property would
have unrecovered depreciable basis after the final recovery year (for
example, due to a deferred exchange), the unrecovered basis is an
allowable depreciation deduction in the taxable year that corresponds to
the final recovery year unless the unrecovered basis is subject to a
depreciation limitation such as section 280F.
(3) Excess basis. As provided in paragraph (d)(1) of this section,
any excess basis in the replacement MACRS property is treated as
property that is placed in service by the acquiring taxpayer at the time
of replacement. Thus, if the taxpayer chooses to use the appropriate
optional depreciation table for the depreciable excess basis in the
replacement MACRS property, the depreciation allowances for the
depreciable excess basis are determined by multiplying the depreciable
excess basis by the annual depreciation rate (expressed as a decimal
equivalent) specified in the appropriate table for each taxable year.
The appropriate
[[Page 539]]
table for the depreciable excess basis is based on the depreciation
method, recovery period, and convention applicable to the depreciable
excess basis under section 168 at the time of replacement. However, If
the year of replacement is less than 12 months, the depreciation
allowance determined under this paragraph (e)(3) must be adjusted for a
short taxable year (for further guidance, for example, see Rev. Proc.
89-15 (1989-1 CB 816) and Sec. 601.601(d)(2)(ii)(b) of this chapter).
(4) Examples. The application of this paragraph (e) is illustrated
by the following examples:
Example 1. J, a calendar-year taxpayer, acquired 5-year property for
$10,000 and placed it in service in January 2001. J uses the optional
tables to depreciate the property. J uses the half-year convention and
did not make any elections for the property. In December 2003, J
exchanges the 5-year property for used 7-year property in a like-kind
exchange. Pursuant to paragraph (k)(2)(i) of this section, J decided to
apply Sec. 1.168(i)-6 to the exchange of the 5-year property for the 7-
year property, the replacement MACRS property. The depreciable exchanged
basis of the 7-year property equals the adjusted depreciable basis of
the 5-year property at the time of disposition of the relinquished MACRS
property, namely $3,840 ($10,000 less $2,000 depreciation in 2001,
$3,200 depreciation in 2002, and $960 depreciation in 2003). J must
first determine the appropriate optional depreciation table pursuant to
paragraph (c) of this section. Since the replacement MACRS property has
a longer recovery period and the same depreciation method as the
relinquished MACRS property, J uses the optional depreciation table
corresponding to a 7-year recovery period, the 200% declining balance
method, and the half-year convention (because the 5-year property was
depreciated using a half-year convention). Had the replacement MACRS
property been placed in service in the same taxable year as the placed-
in-service year of the relinquished MACRS property, the depreciation
allowance for the replacement MACRS property for the year of replacement
would be determined using recovery year 3 of the optional table. The
depreciation allowance equals the depreciable exchanged basis ($3,840)
multiplied by the annual depreciation rate for the current taxable year
(.1749 for recovery year 3) as modified by the transaction coefficient
[1 / (1 - (.1429 + .2449))] which equals 1.6335. Thus, J multiplies
$3,840, its depreciable exchanged basis in the replacement MACRS
property, by the product of .1749 and 1.6335, and then by one-half, to
determine the depreciation allowance for 2003, $549. For 2004, J
multiples its depreciable exchanged basis in the replacement MACRS
property determined at the time of replacement of $3,840 by the product
of the modified annual depreciation rate for the current taxable year
(.1249 for recovery year 4) and the transaction coefficient (1.6335) to
determine its depreciation allowance of $783.
Example 2. K, a calendar-year taxpayer, acquired used Asset V for
$100,000 and placed it in service in January 1999. K depreciated Asset V
under the general depreciation system of section 168(a) by using a 5-
year recovery period, the 200-percent declining balance method of
depreciation, and the half-year convention. In December 2003, as part of
the involuntary conversion, Asset V is involuntarily converted due to an
earthquake. In October 2005, K purchases used Asset W with the insurance
proceeds from the destruction of Asset V and places Asset W in service
to replace Asset V. Pursuant to paragraph (k)(2)(i) of this section, K
decided to apply Sec. 1.168(i)-6 to the involuntary conversion of Asset
V with the replacement of Asset W, the replacement MACRS property. If
Asset W had been placed in service when Asset V was placed in service,
it would have been depreciated using a 7-year recovery period, the 200-
percent declining balance method, and the half-year convention. K uses
the optional depreciation tables to depreciate Asset V and Asset W. For
2003 (recovery year 5 on the optional table), the depreciation deduction
for Asset V is $5,760 ((0.1152)($100,000)(1/2)). Thus, the adjusted
depreciable basis of Asset V at the time of replacement is $11,520
($100,000 less $20,000 depreciation in 1999, $32,000 depreciation in
2000, $19,200 depreciation in 2001, $11,520 depreciation in 2002, and
$5,760 depreciation in 2003). Under the table that applied to Asset V,
the year of disposition was recovery year 5 and the depreciation
deduction was determined under the straight line method. The table that
applies for Asset W is the table that applies the straight line
depreciation method, the half-year convention, and a 7-year recovery
period. The appropriate recovery year under this table is recovery year
5. The depreciation deduction for Asset W for 2005 is $1,646
(($11,520)(0.1429)(1/(1-0.5))(1/2)). Thus, the depreciation deduction
for Asset W in 2006 (recovery year 6) is $3,290 ($11,520)(0.1428)(1/(1-
0.5)). The depreciation deduction for 2007 (recovery year 7) is $3,292
(($11,520)(.1429)(1/(1-.5))). The depreciation deduction for 2008
(recovery year 8) is $3292 ($11,520 less allowable depreciation for
Asset W for 2005 through 2007 ($1,646 + $3,290 + $3,292)).
Example 3. L, a calendar-year taxpayer, placed in service used
Computer X in January 2002 for $5,000. L depreciated Computer X under
the general depreciation system of section 168(a) by using the 200-
percent declining balance method of depreciation, a 5-year
[[Page 540]]
recovery period, and the half-year convention. Computer X is destroyed
in a fire in March 2004. For 2004, the depreciation deduction allowable
for Computer X equals $480 ([($5,000)(.1920)] x (1/2)). Thus, the
adjusted depreciable basis of Computer X was $1,920 when it was
destroyed ($5,000 unadjusted depreciable basis less $1,000 depreciation
for 2002, $1,600 depreciation for 2003, and $480 depreciation for 2004).
In April 2004, as part of the involuntary conversion, L acquired and
placed in service used Computer Y with insurance proceeds received due
to the loss of Computer X. Computer Y will be depreciated using the same
depreciation method, recovery period, and convention as Computer X. L
elected to use the optional depreciation tables to compute the
depreciation allowance for Computer X and Computer Y. The depreciation
deduction allowable for 2004 for Computer Y equals $384 ([$1,920 x
(.1920)(1/(1-.52))] x (1/2)).
(f) Mid-quarter convention. For purposes of applying the 40-percent
test under section 168(d) and the regulations under section 168(d), the
following rules apply:
(1) Exchanged basis. If, in a taxable year, MACRS property is placed
in service by the acquiring taxpayer (but not as a result of a like-kind
exchange or involuntary conversion) and--
(i) In the same taxable year, is disposed of by the acquiring
taxpayer in a like-kind exchange or an involuntary conversion and
replaced by the acquiring taxpayer with replacement MACRS property, the
exchanged basis (determined without any adjustments for depreciation
deductions during the taxable year) of the replacement MACRS property is
taken into account in the year of replacement in the quarter the
relinquished MACRS property was placed in service by the acquiring
taxpayer; or
(ii) In the same taxable year, is disposed of by the acquiring
taxpayer in a like-kind exchange or an involuntary conversion, and in a
subsequent taxable year is replaced by the acquiring taxpayer with
replacement MACRS property, the exchanged basis (determined without any
adjustments for depreciation deductions during the taxable year) of the
replacement MACRS property is taken into account in the year of
replacement in the quarter the replacement MACRS property was placed in
service by the acquiring taxpayer; or
(iii) In a subsequent taxable year, disposed of by the acquiring
taxpayer in a like-kind exchange or involuntary conversion, the
exchanged basis of the replacement MACRS property is not taken into
account in the year of replacement.
(2) Excess basis. Any excess basis is taken into account in the
quarter the replacement MACRS property is placed in service by the
acquiring taxpayer.
(3) Depreciable property acquired for nondepreciable property. Both
the exchanged basis and excess basis of the replacement MACRS property
described in paragraph (d)(2)(ii) of this section (depreciable property
acquired for nondepreciable property), are taken into account for
determining whether the mid-quarter convention applies in the year of
replacement.
(g) Section 179 election. In applying the section 179 election, only
the excess basis, if any, in the replacement MACRS property is taken
into account. If the replacement MACRS property is described in
paragraph (d)(2)(ii) of this section (depreciable property acquired for
nondepreciable property), only the excess basis in the replacement MACRS
property is taken into account.
(h) Additional first year depreciation deduction. See Sec.
1.168(k)-1(f)(5) (for qualified property or 50-percent bonus
depreciation property) and Sec. 1.1400L(b)-1(f)(5) (for qualified New
York Liberty Zone property).
(i) Elections--(1) Election not to apply this section. A taxpayer
may elect not to apply this section for any MACRS property involved in a
like-kind exchange or involuntary conversion. An election under this
paragraph (i)(1) applies only to the taxpayer making the election and
the election applies to both the relinquished MACRS property and the
replacement MACRS property. If an election is made under this paragraph
(i)(1), the depreciation allowances for the replacement MACRS property
beginning in the year of replacement and for the relinquished MACRS
property in the year of disposition are not determined under this
section (except as otherwise provided in this paragraph). Instead, for
depreciation purposes only, the sum of the exchanged basis and excess
basis, if any,
[[Page 541]]
in the replacement MACRS property is treated as property placed in
service by the taxpayer at the time of replacement and the adjusted
depreciable basis of the relinquished MACRS property is treated as being
disposed of by the taxpayer at the time of disposition. While the
relinquished MACRS property is treated as being disposed of at the time
of disposition for depreciation purposes, the election not to apply this
section does not affect the application of sections 1031 and 1033 (for
example, if a taxpayer does not make the election under this paragraph
(i)(1) and does not recognize gain or loss under section 1031, this
result would not change if the taxpayer chose to make the election under
this paragraph (i)(1)). In addition, the election not to apply this
section does not affect the application of sections 1245 and 1250 to the
relinquished MACRS property. Paragraphs (c)(5)(i) (determination of
depreciation for relinquished MACRS property in the year of
disposition), (c)(5)(iii) (rules for deferred transactions), (g)
(section 179 election), and (h) (additional first year depreciation
deduction) of this section apply to property to which this paragraph
(i)(1) applies. See paragraph (j) of this section for the time and
manner of making the election under this paragraph (i)(1).
(2) Election to treat certain replacement property as MACRS
property. If the tangible depreciable property acquired by a taxpayer in
a like-kind exchange or involuntary conversion (the replacement
property) replaces tangible depreciable property for which the taxpayer
made a valid election under section 168(f)(1) to exclude it from the
application of MACRS (the relinquished property), the taxpayer may elect
to treat, for depreciation purposes only, the sum of the exchanged basis
and excess basis, if any, of the replacement property as MACRS property
that is placed in service by the taxpayer at the time of replacement. An
election under this paragraph (i)(2) applies only to the taxpayer making
the election and the election applies to both the relinquished property
and the replacement property. If an election is made under this
paragraph (i)(2), the adjusted depreciable basis of the relinquished
property is treated as being disposed of by the taxpayer at the time of
disposition. Rules similar to those provided in Sec. Sec. 1.168(i)-
6(b)(3) and (4) apply for purposes of determining the time of
disposition and time of replacement under this paragraph (i)(2). While
the relinquished property is treated as being disposed of at the time of
disposition for depreciation purposes, the election under this paragraph
(i)(2) does not affect the application of sections 1031 and 1033, and
the application of sections 1245 and 1250 to the relinquished property.
If an election is made under this paragraph (i)(2), rules similar to
those provided in paragraphs (c)(5)(iii) (rules for deferred
transactions), (g) (section 179 election), and (h) (additional first
year depreciation deduction) of this section apply to property. Except
as provided in paragraph (k)(3)(ii) of this section, a taxpayer makes
the election under this paragraph (i)(2) by claiming the depreciation
allowance as determined under MACRS for the replacement property on the
taxpayer's timely filed (including extensions) original Federal tax
return for the placed-in-service year of the replacement property as
determined under this paragraph (i)(2).
(j) Time and manner of making election under paragraph (i)(1) of
this section--(1) In general. The election provided in paragraph (i)(1)
of this section is made separately by each person acquiring replacement
MACRS property. The election is made for each member of a consolidated
group by the common parent of the group, by the partnership (and not by
the partners separately) in the case of a partnership, or by the S
corporation (and not by the shareholders separately) in the case of an S
corporation. A separate election under paragraph (i)(1) of this section
is required for each like-kind exchange or involuntary conversion. The
election provided in paragraph (i)(1) of this section must be made
within the time and manner provided in paragraph (j)(2) and (3) of this
section and may not be made by the taxpayer in any other manner (for
example, the election cannot be made through a request under section
446(e) to change the taxpayer's method of accounting), except as
provided in paragraph (k)(2) of this section.
[[Page 542]]
(2) Time for making election. The election provided in paragraph
(i)(1) of this section must be made by the due date (including
extensions) of the taxpayer's Federal tax return for the year of
replacement.
(3) Manner of making election. The election provided in paragraph
(i)(1) of this section is made in the manner provided for on Form 4562,
Depreciation and Amortization, and its instructions. If Form 4562 is
revised or renumbered, any reference in this section to that form is
treated as a reference to the revised or renumbered form.
(4) Revocation. The election provided in paragraph (i)(1) of this
section, once made, may be revoked only with the consent of the
Commissioner of Internal Revenue. Such consent will be granted only in
extraordinary circumstances. Requests for consent are requests for a
letter ruling and must be filed with the Commissioner of Internal
Revenue, Washington, DC 20224. Requests for consent may not be made in
any other manner (for example, through a request under section 446(e) to
change the taxpayer's method of accounting).
(k) Effective date--(1) In general. Except as provided in paragraph
(k)(3) of this section, this section applies to a like-kind exchange or
an involuntary conversion of MACRS property for which the time of
disposition and the time of replacement both occur after February 27,
2004.
(2) Application to pre-effective date like-kind exchanges and
involuntary conversions. For a like-kind exchange or an involuntary
conversion of MACRS property for which the time of disposition, the time
of replacement, or both occur on or before February 27, 2004, a taxpayer
may--
(i) Apply the provisions of this section. If a taxpayer's applicable
Federal tax return has been filed on or before February 27, 2004, and
the taxpayer has treated the replacement MACRS property as acquired, and
the relinquished MACRS property as disposed of, in a like-kind exchange
or an involuntary conversion, the taxpayer changes its method of
accounting for depreciation of the replacement MACRS property and
relinquished MACRS property in accordance with this paragraph (k)(2)(i)
by following the applicable administrative procedures issued under Sec.
1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic consent to
a change in method of accounting (for further guidance, see Rev. Proc.
2002-9 (2002-1 CB 327) and Sec. 601.601(d)(2)(ii)(b) of this chapter);
or
(ii) Rely on prior guidance issued by the Internal Revenue Service
for determining the depreciation deductions of replacement MACRS
property and relinquished MACRS property (for further guidance, for
example, see Notice 2000-4 (2001-1 CB 313) and Sec.
601.601(d)(2)(ii)(b) of this chapter). In relying on such guidance, a
taxpayer may use any reasonable, consistent method of determining
depreciation in the year of disposition and the year of replacement. If
a taxpayer's applicable Federal tax return has been filed on or before
February 27, 2004, and the taxpayer has treated the replacement MACRS
property as acquired, and the relinquished MACRS property as disposed
of, in a like-kind exchange or an involuntary conversion, the taxpayer
changes its method of accounting for depreciation of the replacement
MACRS property and relinquished MACRS property in accordance with this
paragraph (k)(2)(ii) by following the applicable administrative
procedures issued under Sec. 1.446-1(e)(3)(ii) for obtaining the
Commissioner's automatic consent to a change in method of accounting
(for further guidance, see Rev. Proc. 2002-9 (2002-1 CB 327) and Sec.
601.601(d)(2)(ii)(b) of this chapter).
(3) Like-kind exchanges and involuntary conversions where the
taxpayer made the election under section 168(f)(1) for the relinquished
property--(i) In general. If the tangible depreciable property acquired
by a taxpayer in a like-kind exchange or involuntary conversion (the
replacement property) replaces tangible depreciable property for which
the taxpayer made a valid election under section 168(f)(1) to exclude it
from the application of MACRS (the relinquished property), paragraph
(i)(2) of this section applies to such relinquished property and
replacement property for which the time of disposition and the time of
replacement (both as determined under paragraph (i)(2) of
[[Page 543]]
this section) both occur after February 26, 2007.
(ii) Application of paragraph (i)(2) of this section to pre-February
26, 2007 like-kind exchanges and involuntary conversions. If the
tangible depreciable property acquired by a taxpayer in a like-kind
exchange or involuntary conversion (the replacement property) replaces
tangible depreciable property for which the taxpayer made a valid
election under section 168(f)(1) to exclude it from the application of
MACRS (the relinquished property), the taxpayer may apply paragraph
(i)(2) of this section to the relinquished property and the replacement
property for which the time of disposition, the time of replacement
(both as determined under paragraph (i)(2) of this section), or both
occur on or before February 26, 2007. If the taxpayer wants to apply
paragraph (i)(2) of this section and the taxpayer's applicable Federal
tax return has been filed on or before February 26, 2007, the taxpayer
must change its method of accounting for depreciation of the replacement
property and relinquished property in accordance with this paragraph
(k)(3)(ii) by following the applicable administrative procedures issued
under Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic
consent to a change in method of accounting (for further guidance, see
Rev. Proc. 2002-9 (2002-1 CB 327) and Sec. 601.601(d)(2)(ii)(b) of this
chapter).
[T.D. 9314, 72 FR 9251, Mar. 1, 2007]
Sec. 1.168(i)-7 Accounting for MACRS property.
(a) In general. A taxpayer may account for MACRS property (as
defined in Sec. 1.168(b)-1(a)(2)) by treating each individual asset as
an account (a ``single asset account'' or an ``item account'') or by
combining two or more assets in a single account (a ``multiple asset
account'' or a ``pool''). A taxpayer may establish as many accounts for
MACRS property as the taxpayer wants. This section does not apply to
assets included in general asset accounts. For rules applicable to
general asset accounts, see Sec. 1.168(i)-1.
(b) Required use of single asset accounts. A taxpayer must account
for an asset in a single asset account if the taxpayer uses the asset
both in a trade or business or for the production of income and in a
personal activity, or if the taxpayer places in service and disposes of
the asset during the same taxable year. Also, if general asset account
treatment for an asset terminates under Sec. 1.168(i)-1(c)(1)(ii)(A),
(e)(3)(iii), (e)(3)(v), (e)(3)(vii), (g), or (h)(1), as applicable, the
taxpayer must account for the asset in a single asset account beginning
in the taxable year in which the general asset account treatment for the
asset terminates. If a taxpayer accounts for an asset in a multiple
asset account or a pool and the taxpayer disposes of the asset, the
taxpayer must account for the asset in a single asset account beginning
in the taxable year in which the disposition occurs. See Sec. 1.168(i)-
8(h)(2)(i). If a taxpayer disposes of a portion of an asset and Sec.
1.168(i)-8(d)(1) applies to that disposition, the taxpayer must account
for the disposed portion in a single asset account beginning in the
taxable year in which the disposition occurs. See Sec. 1.168(i)-
8(h)(3)(i).
(c) Establishment of multiple asset accounts or pools--(1) Assets
eligible for multiple asset accounts or pools. Except as provided in
paragraph (b) of this section, assets that are subject to either the
general depreciation system of section 168(a) or the alternative
depreciation system of section 168(g) may be accounted for in one or
more multiple asset accounts or pools.
(2) Grouping assets in multiple asset accounts or pools--(i) General
rules. Assets that are eligible to be grouped into a single multiple
asset account or pool may be divided into more than one multiple asset
account or pool. Each multiple asset account or pool must include only
assets that--
(A) Have the same applicable depreciation method;
(B) Have the same applicable recovery period;
(C) Have the same applicable convention; and
(D) Are placed in service by the taxpayer in the same taxable year.
(ii) Special rules. In addition to the general rules in paragraph
(c)(2)(i) of this section, the following rules apply when establishing
multiple asset accounts or pools--
[[Page 544]]
(A) Assets subject to the mid-quarter convention may only be grouped
into a multiple asset account or pool with assets that are placed in
service in the same quarter of the taxable year;
(B) Assets subject to the mid-month convention may only be grouped
into a multiple asset account or pool with assets that are placed in
service in the same month of the taxable year;
(C) Passenger automobiles for which the depreciation allowance is
limited under section 280F(a) must be grouped into a separate multiple
asset account or pool;
(D) Assets not eligible for any additional first year depreciation
deduction (including assets for which the taxpayer elected not to deduct
the additional first year depreciation) provided by, for example,
section 168(k) through (n), 1400L(b), or 1400N(d), must be grouped into
a separate multiple asset account or pool;
(E) Assets eligible for the additional first year depreciation
deduction may only be grouped into a multiple asset account or pool with
assets for which the taxpayer claimed the same percentage of the
additional first year depreciation (for example, 30 percent, 50 percent,
or 100 percent);
(F) Except for passenger automobiles described in paragraph
(c)(2)(ii)(C) of this section, listed property (as defined in section
280F(d)(4)) must be grouped into a separate multiple asset account or
pool;
(G) Assets for which the depreciation allowance for the placed-in-
service year is not determined by using an optional depreciation table
(for further guidance, see section 8 of Rev. Proc. 87-57, 1987-2 CB 687,
693 (see Sec. 601.601(d)(2) of this chapter)) must be grouped into a
separate multiple asset account or pool; and
(H) Mass assets (as defined in Sec. 1.168(i)-8(b)(3)) that are or
will be subject to Sec. 1.168(i)-8(g)(2)(iii) (disposed of or converted
mass asset is identified by a mortality dispersion table) must be
grouped into a separate multiple asset account or pool.
(d) Cross references. See Sec. 1.167(a)-7(c) for the records to be
maintained by a taxpayer for each account. In addition, see Sec.
1.168(i)-1(l)(3) for the records to be maintained by a taxpayer for each
general asset account.
(e) Effective/applicability dates--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014.
(2) Early application of this section. A taxpayer may choose to
apply the provisions of this section to taxable years beginning on or
after January 1, 2012.
(3) Early application of regulation project REG-110732-13. A
taxpayer may rely on the provisions of this section in regulation
project REG-110732-13 (2013-43 IRB 404) (see Sec. 601.601(d)(2) of this
chapter) for taxable years beginning on or after January 1, 2012.
However, a taxpayer may not rely on the provisions of this section in
regulation project REG-110732-13 for taxable years beginning on or after
January 1, 2014.
(4) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.168(i)-7T as contained in 26 CFR part 1 edition revised as of
April 1, 2013, to taxable years beginning on or after January 1, 2012.
However, a taxpayer may not apply Sec. 1.168(i)-7T as contained in 26
CFR part 1 edition revised as of April 1, 2013, to taxable years
beginning on or after January 1, 2014.
(5) Change in method of accounting. A change to comply with this
section for depreciable assets placed in service in a taxable year
ending on or after December 30, 2003, is a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply. A taxpayer also may treat a change to comply
with this section for depreciable assets placed in service in a taxable
year ending before December 30, 2003, as a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply.
[T.D. 9636, 78 FR 57707, Sept. 19, 2013, as amended by T.D. 9689, 79 FR
48678, Aug. 18, 2014; 79 FR 78697, Dec. 31, 2014]
Sec. 1.168(i)-8 Dispositions of MACRS property.
(a) Scope. This section provides rules applicable to dispositions of
MACRS property (as defined in Sec. 1.168(b)-1(a)(2)) or to depreciable
property (as defined in Sec. 1.168(b)-1(a)(1)) that would be MACRS
property but for an election
[[Page 545]]
made by the taxpayer either to expense all or some of the property's
cost under section 179, section 179A, section 179B, section 179C,
section 179D, or section 1400I(a)(1), or any similar provision, or to
amortize all or some of the property's cost under section 1400I(a)(2) or
any similar provision. This section also applies to dispositions
described in paragraph (d)(1) of this section of a portion of such
property. Except as provided in Sec. 1.168(i)-1(e)(3), this section
does not apply to dispositions of assets included in a general asset
account. For rules applicable to dispositions of assets included in a
general asset account, see Sec. 1.168(i)-1(e).
(b) Definitions. For purposes of this section--
(1) Building has the same meaning as that term is defined in Sec.
1.48-1(e)(1).
(2) Disposition occurs when ownership of the asset is transferred or
when the asset is permanently withdrawn from use either in the
taxpayer's trade or business or in the production of income. A
disposition includes the sale, exchange, retirement, physical
abandonment, or destruction of an asset. A disposition also occurs when
an asset is transferred to a supplies, scrap, or similar account, or
when a portion of an asset is disposed of as described in paragraph
(d)(1) of this section. If a structural component, or a portion thereof,
of a building is disposed of in a disposition described in paragraph
(d)(1) of this section, a disposition also includes the disposition of
such structural component or such portion thereof.
(3) Mass assets is a mass or group of individual items of
depreciable assets--
(i) That are not necessarily homogenous;
(ii) Each of which is minor in value relative to the total value of
the mass or group;
(iii) Numerous in quantity;
(iv) Usually accounted for only on a total dollar or quantity basis;
(v) With respect to which separate identification is impracticable;
and
(vi) Placed in service in the same taxable year.
(4) Portion of an asset is any part of an asset that is less than
the entire asset as determined under paragraph (c)(4) of this section.
(5) Structural component has the same meaning as that term is
defined in Sec. 1.48-1(e)(2).
(6) Unadjusted depreciable basis of the multiple asset account or
pool is the sum of the unadjusted depreciable bases (as defined in Sec.
1.168(b)-1(a)(3)) of all assets included in the multiple asset account
or pool.
(c) Special rules--(1) Manner of disposition. The manner of
disposition (for example, normal retirement, abnormal retirement,
ordinary retirement, or extraordinary retirement) is not taken into
account in determining whether a disposition occurs or gain or loss is
recognized.
(2) Disposition by transfer to a supplies account. If a taxpayer
made an election under Sec. 1.162-3(d) to treat the cost of any rotable
spare part, temporary spare part, or standby emergency spare part (as
defined in Sec. 1.162-3(c)) as a capital expenditure subject to the
allowance for depreciation, the taxpayer can dispose of the rotable,
temporary, or standby emergency spare part by transferring it to a
supplies account only if the taxpayer has obtained the consent of the
Commissioner to revoke the Sec. 1.162-3(d) election. If a taxpayer made
an election under Sec. 1.162-3T(d) to treat the cost of any material
and supply (as defined in Sec. 1.162-3T(c)(1)) as a capital expenditure
subject to the allowance for depreciation, the taxpayer can dispose of
the material and supply by transferring it to a supplies account only if
the taxpayer has obtained the consent of the Commissioner to revoke the
Sec. 1.162-3T(d) election. See Sec. 1.162-3(d)(3) for the procedures
for revoking a Sec. 1.162-3(d) or a Sec. 1.162-3T(d) election.
(3) Leasehold improvements. This section also applies to--
(i) A lessor of leased property that made an improvement to that
property for the lessee of the property, has a depreciable basis in the
improvement, and disposes of the improvement, or disposes of a portion
of the improvement under paragraph (d)(1) of this section, before or
upon the termination of the lease with the lessee. See section
168(i)(8)(B); and
[[Page 546]]
(ii) A lessee of leased property that made an improvement to that
property, has a depreciable basis in the improvement, and disposes of
the improvement, or disposes of a portion of the improvement under
paragraph (d)(1) of this section, before or upon the termination of the
lease.
(4) Determination of asset disposed of--(i) General rules. For
purposes of applying this section, the facts and circumstances of each
disposition are considered in determining what is the appropriate asset
disposed of. The asset for disposition purposes may not consist of items
placed in service by the taxpayer on different dates, without taking
into account the applicable convention. For purposes of determining what
is the appropriate asset disposed of, the unit of property determination
under Sec. 1.263(a)-3(e) or in published guidance in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter) under section
263(a) does not apply.
(ii) Special rules. In addition to the general rules in paragraph
(c)(4)(i) of this section, the following rules apply for purposes of
applying this section:
(A) Each building, including its structural components, is the
asset, except as provided in Sec. 1.1250-1(a)(2)(ii) or in paragraph
(c)(4)(ii)(B) or (D) of this section.
(B) If a building has two or more condominium or cooperative units,
each condominium or cooperative unit, including its structural
components, is the asset, except as provided in Sec. 1.1250-1(a)(2)(ii)
or in paragraph (c)(4)(ii)(D) of this section.
(C) If a taxpayer properly includes an item in one of the asset
classes 00.11 through 00.4 of Rev. Proc. 87-56 (1987-2 CB 674) (see
Sec. 601.601(d)(2) of this chapter) or properly classifies an item in
one of the categories under section 168(e)(3), except for a category
that includes buildings or structural components (for example, retail
motor fuels outlet, qualified leasehold improvement property, qualified
restaurant property, and qualified retail improvement property), each
item is the asset provided paragraph (c)(4)(ii)(D) of this section does
not apply to the item. For example, each desk is the asset, each
computer is the asset, and each qualified smart electric meter is the
asset.
(D) If the taxpayer places in service an improvement or addition to
an asset after the taxpayer placed the asset in service, the improvement
or addition and, if applicable, its structural components are a separate
asset.
(d) Disposition of a portion of an asset--(1) In general. For
purposes of applying this section, a disposition includes a disposition
of a portion of an asset as a result of a casualty event described in
section 165, a disposition of a portion of an asset for which gain,
determined without regard to section 1245 or section 1250, is not
recognized in whole or in part under section 1031 or section 1033, a
transfer of a portion of an asset in a transaction described in section
168(i)(7)(B), or a sale of a portion of an asset, even if the taxpayer
does not make the election under paragraph (d)(2)(i) of this section for
that disposed portion. For other transactions, a disposition includes a
disposition of a portion of an asset only if the taxpayer makes the
election under paragraph (d)(2)(i) of this section for that disposed
portion.
(2) Partial disposition election--(i) In general. A taxpayer may
make an election under this paragraph (d)(2) to apply this section to a
disposition of a portion of an asset. If the asset is properly included
in one of the asset classes 00.11 through 00.4 of Rev. Proc. 87-56, a
taxpayer may make an election under this paragraph (d)(2) to apply this
section to a disposition of a portion of such asset only if the taxpayer
classifies the replacement portion of the asset under the same asset
class as the disposed portion of the asset.
(ii) Time and manner for making election--(A) Time for making
election. Except as provided in paragraph (d)(2)(iii) or (iv) of this
section, a taxpayer must make the election specified in paragraph
(d)(2)(i) of this section by the due date, including extensions, of the
original Federal tax return for the taxable year in which the portion of
an asset is disposed of by the taxpayer.
(B) Manner of making election. Except as provided in paragraph
(d)(2)(iii) or (iv) of this section, a taxpayer must make the election
specified in paragraph (d)(2)(i) of this section by applying the
provisions of this section for the taxable year in which the portion
[[Page 547]]
of an asset is disposed of by the taxpayer, by reporting the gain, loss,
or other deduction on the taxpayer's timely filed, including extensions,
original Federal tax return for that taxable year, and, if the asset is
properly included in one of the asset classes 00.11 through 00.4 of Rev.
Proc. 87-56, by classifying the replacement portion of such asset under
the same asset class as the disposed portion of the asset in the taxable
year in which the replacement portion is placed in service by the
taxpayer. Except as provided in paragraph (d)(2)(iii) or (iv)(B) of this
section or except as otherwise expressly provided by other guidance
published in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of
this chapter), the election specified in paragraph (d)(2)(i) of this
section may not be made through the filing of an application for change
in accounting method.
(iii) Special rule for subsequent Internal Revenue Service
adjustment. This paragraph (d)(2)(iii) applies when a taxpayer deducted
the amount paid or incurred for the replacement of a portion of an asset
as a repair under Sec. 1.162-4, the taxpayer did not make the election
specified in paragraph (d)(2)(i) of this section for the disposed
portion of that asset within the time and in the manner under paragraph
(d)(2)(ii) or (iv) of this section, and as a result of an examination of
the taxpayer's Federal tax return, the Internal Revenue Service
disallows the taxpayer's repair deduction for the amount paid or
incurred for the replacement of the portion of that asset and instead
capitalizes such amount under Sec. 1.263(a)-2 or Sec. 1.263(a)-3. If
this paragraph (d)(2)(iii) applies, the taxpayer may make the election
specified in paragraph (d)(2)(i) of this section for the disposition of
the portion of the asset to which the Internal Revenue Service's
adjustment pertains by filing an application for change in accounting
method, provided the asset of which the disposed portion was a part is
owned by the taxpayer at the beginning of the year of change (as defined
for purposes of section 446(e)).
(iv) Special rules for 2012 or 2013 returns. If, under paragraph
(j)(2) of this section, a taxpayer chooses to apply the provisions of
this section to a taxable year beginning on or after January 1, 2012,
and ending on or before September 19, 2013 (applicable taxable year),
and the taxpayer did not make the election specified in paragraph
(d)(2)(i) of this section on its timely filed original Federal tax
return for the applicable taxable year, including extensions, the
taxpayer must make the election specified in paragraph (d)(2)(i) of this
section for the applicable taxable year by filing either--
(A) An amended Federal tax return for the applicable taxable year on
or before 180 days from the due date including extensions of the
taxpayer's Federal tax return for the applicable taxable year,
notwithstanding that the taxpayer may not have extended the due date; or
(B) An application for change in accounting method with the
taxpayer's timely filed original Federal tax return for the first or
second taxable year succeeding the applicable taxable year.
(v) Revocation. A taxpayer may revoke the election specified in
paragraph (d)(2)(i) of this section only by filing a request for a
private letter ruling and obtaining the Commissioner's consent to revoke
the election. The Commissioner may grant a request to revoke this
election if the taxpayer acted reasonably and in good faith, and the
revocation will not prejudice the interests of the Government. See
generally Sec. 301.9100-3 of this chapter. The election specified in
paragraph (d)(2)(i) of this section may not be revoked through the
filing of an application for change in accounting method.
(e) Gain or loss on dispositions. Solely for purposes of this
paragraph (e), the term asset is an asset within the scope of this
section or the portion of such asset that is disposed of in a
disposition described in paragraph (d)(1) of this section. Except as
provided by section 280B and Sec. 1.280B-1, the following rules apply
when an asset is disposed of during a taxable year:
(1) If an asset is disposed of by sale, exchange, or involuntary
conversion, gain or loss must be recognized under the applicable
provisions of the Internal Revenue Code.
(2) If an asset is disposed of by physical abandonment, loss must be
recognized in the amount of the adjusted depreciable basis (as defined
in Sec. 1.168(b)-
[[Page 548]]
1(a)(4)) of the asset at the time of the abandonment, taking into
account the applicable convention. However, if the abandoned asset is
subject to nonrecourse indebtedness, paragraph (e)(1) of this section
applies to the asset instead of this paragraph (e)(2). For a loss from
physical abandonment to qualify for recognition under this paragraph
(e)(2), the taxpayer must intend to discard the asset irrevocably so
that the taxpayer will neither use the asset again nor retrieve it for
sale, exchange, or other disposition.
(3) If an asset is disposed of other than by sale, exchange,
involuntary conversion, physical abandonment, or conversion to personal
use (as, for example, when the asset is transferred to a supplies or
scrap account), gain is not recognized. Loss must be recognized in the
amount of the excess of the adjusted depreciable basis of the asset at
the time of the disposition, taking into account the applicable
convention, over the asset's fair market value at the time of the
disposition, taking into account the applicable convention.
(f) Basis of asset disposed of--(1) In general. The adjusted basis
of an asset disposed of for computing gain or loss is its adjusted
depreciable basis at the time of the asset's disposition, as determined
under the applicable convention for the asset.
(2) Assets disposed of are in multiple asset accounts. (i) If the
taxpayer accounts for the asset disposed of in a multiple asset account
or pool and it is impracticable from the taxpayer's records to determine
the unadjusted depreciable basis (as defined in Sec. 1.168(b)-1(a)(3))
of the asset disposed of, the taxpayer may use any reasonable method
that is consistently applied to all assets in the same multiple asset
account or pool for purposes of determining the unadjusted depreciable
basis of assets disposed of. Examples of a reasonable method include,
but are not limited to, the following:
(A) If the replacement asset is a restoration (as defined in Sec.
1.263(a)-3(k)), and is not a betterment (as defined in Sec. 1.263(a)-
3(j)) or an adaptation to a new or different use (as defined in Sec.
1.263(a)-3(l)), discounting the cost of the replacement asset to its
placed-in-service year cost using the Producer Price Index for Finished
Goods or its successor, the Producer Price Index for Final Demand, or
any other index designated by guidance in the Internal Revenue Bulletin
(see Sec. 601.601(d)(2) of this chapter) for purposes of this paragraph
(f)(2);
(B) A pro rata allocation of the unadjusted depreciable basis of the
multiple asset account or pool based on the replacement cost of the
disposed asset and the replacement cost of all of the assets in the
multiple asset account or pool; and
(C) A study allocating the cost of the asset to its individual
components.
(ii) To determine the adjusted depreciable basis of an asset
disposed of in a multiple asset account or pool, the depreciation
allowable for the asset disposed of is computed by using the
depreciation method, recovery period, and convention applicable to the
multiple asset account or pool in which the asset disposed of was
included and by including the additional first year depreciation
deduction claimed for the asset disposed of.
(3) Disposition of a portion of an asset. (i) This paragraph (f)(3)
applies only when a taxpayer disposes of a portion of an asset and
paragraph (d)(1) of this section applies to that disposition. For
computing gain or loss, the adjusted basis of the disposed portion of
the asset is the adjusted depreciable basis of that disposed portion at
the time of its disposition, as determined under the applicable
convention for the asset. If it is impracticable from the taxpayer's
records to determine the unadjusted depreciable basis (as defined in
Sec. 1.168(b)-1(a)(3)) of the disposed portion of the asset, the
taxpayer may use any reasonable method for purposes of determining the
unadjusted depreciable basis (as defined in Sec. 1.168(b)-1(a)(3)) of
the disposed portion of the asset. If a taxpayer disposes of more than
one portion of the same asset and it is impracticable from the
taxpayer's records to determine the unadjusted depreciable basis (as
defined in Sec. 1.168(b)-1(a)(3)) of the first disposed portion of the
asset, the reasonable method used by the taxpayer must be consistently
applied to all portions of the same asset for purposes of
[[Page 549]]
determining the unadjusted depreciable basis of each disposed portion of
the asset. If the asset, a portion of which is disposed of, is in a
multiple asset account or pool and it is impracticable from the
taxpayer's records to determine the unadjusted depreciable basis (as
defined in Sec. 1.168(b)-1(a)(3)) of the disposed portion of the asset,
the reasonable method used by the taxpayer must be consistently applied
to all assets in the same multiple asset account or pool for purposes of
determining the unadjusted depreciable basis of assets disposed of or
any disposed portion of the assets. Examples of a reasonable method
include, but are not limited to, the following:
(A) If the replacement portion is a restoration (as defined in Sec.
1.263(a)-3(k)), and is not a betterment (as defined in Sec. 1.263(a)-
3(j)) or an adaptation to a new or different use (as defined in Sec.
1.263(a)-3(l)), discounting the cost of the replacement portion of the
asset to its placed-in-service year cost using the Producer Price Index
for Finished Goods or its successor, the Producer Price Index for Final
Demand, or any other index designated by guidance in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter) for purposes
of this paragraph (f)(3);
(B) A pro rata allocation of the unadjusted depreciable basis of the
asset based on the replacement cost of the disposed portion of the asset
and the replacement cost of the asset; and
(C) A study allocating the cost of the asset to its individual
components.
(ii) To determine the adjusted depreciable basis of the disposed
portion of the asset, the depreciation allowable for the disposed
portion is computed by using the depreciation method, recovery period,
and convention applicable to the asset in which the disposed portion was
included and by including the portion of the additional first year
depreciation deduction claimed for the asset that is attributable to the
disposed portion.
(g) Identification of asset disposed of--(1) In general. Except as
provided in paragraph (g)(2) or (3) of this section, a taxpayer must use
the specific identification method of accounting to identify which asset
is disposed of by the taxpayer. Under this method of accounting, the
taxpayer can determine the particular taxable year in which the asset
disposed of was placed in service by the taxpayer.
(2) Asset disposed of is in a multiple asset account. If a taxpayer
accounts for the asset disposed of in a multiple asset account or pool
and the total dispositions of assets with the same recovery period
during the taxable year are readily determined from the taxpayer's
records, but it is impracticable from the taxpayer's records to
determine the particular taxable year in which the asset disposed of was
placed in service by the taxpayer, the taxpayer must identify the asset
disposed of by using--
(i) A first-in, first-out method of accounting if the unadjusted
depreciable basis of the asset disposed of cannot be readily determined
from the taxpayer's records. Under this method of accounting, the
taxpayer identifies the multiple asset account or pool with the earliest
placed-in-service year that has the same recovery period as the asset
disposed of and that has assets at the beginning of the taxable year of
the disposition, and the taxpayer treats the asset disposed of as being
from that multiple asset account or pool;
(ii) A modified first-in, first-out method of accounting if the
unadjusted depreciable basis of the asset disposed of can be readily
determined from the taxpayer's records. Under this method of accounting,
the taxpayer identifies the multiple asset account or pool with the
earliest placed-in-service year that has the same recovery period as the
asset disposed of and that has assets at the beginning of the taxable
year of the disposition with the same unadjusted depreciable basis as
the asset disposed of, and the taxpayer treats the asset disposed of as
being from that multiple asset account or pool;
(iii) A mortality dispersion table if the asset disposed of is a
mass asset. The mortality dispersion table must be based upon an
acceptable sampling of the taxpayer's actual disposition experience for
mass assets or other acceptable statistical or engineering techniques.
To use a mortality dispersion table, the taxpayer must adopt
recordkeeping practices consistent with the
[[Page 550]]
taxpayer's prior practices and consonant with good accounting and
engineering practices; or
(iv) Any other method 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) on or after September 19, 2013. See
paragraph (g)(4) of this section regarding the last-in, first-out method
of accounting.
(3) Disposition of a portion of an asset. If a taxpayer disposes of
a portion of an asset and paragraph (d)(1) of this section applies to
that disposition, but it is impracticable from the taxpayer's records to
determine the particular taxable year in which the asset was placed in
service, the taxpayer must identify the asset by using any applicable
method provided in paragraph (g)(2) of this section, after taking into
account paragraph (g)(4) of this section.
(4) Last-in, first-out method of accounting. For purposes of this
paragraph (g), a last-in, first-out method of accounting may not be
used. Examples of a last-in, first-out method of accounting include the
taxpayer identifying the multiple asset account or pool with the most
recent placed-in-service year that has the same recovery period as the
asset disposed of and that has assets at the beginning of the taxable
year of the disposition, and the taxpayer treating the asset disposed of
as being from that multiple asset account or pool, or the taxpayer
treating the disposed portion of an asset as being from an asset with
the most recent placed-in-service year that is the same as the asset of
which the disposed portion is a part.
(h) Accounting for asset disposed of--(1) Depreciation ends.
Depreciation ends for an asset at the time of the asset's disposition,
as determined under the applicable convention for the asset. See Sec.
1.167(a)-10(b). If the asset disposed of is in a single asset account
initially or as a result of Sec. 1.168(i)-8(h)(2)(i), Sec. 1.168(i)-
8(h)(3)(i), or general asset account treatment for the asset terminated
under Sec. 1.168(i)-1(c)(1)(ii)(A), (e)(3)(iii), (e)(3)(v),
(e)(3)(vii), (g), or (h)(1), as applicable, the single asset account
terminates at the time of the asset's disposition, as determined under
the applicable convention for the asset. If a taxpayer disposes of a
portion of an asset and paragraph (d)(1) of this section applies to that
disposition, depreciation ends for that disposed portion of the asset at
the time of the disposition of the disposed portion, as determined under
the applicable convention for the asset.
(2) Asset disposed of in a multiple asset account or pool. If the
taxpayer accounts for the asset disposed of in a multiple asset account
or pool, then--
(i) As of the first day of the taxable year in which the disposition
occurs, the asset disposed of is removed from the multiple asset account
or pool and is placed into a single asset account. See Sec. 1.168(i)-
7(b);
(ii) The unadjusted depreciable basis of the multiple asset account
or pool must be reduced by the unadjusted depreciable basis of the asset
disposed of as of the first day of the taxable year in which the
disposition occurs. See paragraph (f)(2)(i) of this section for
determining the unadjusted depreciable basis of the asset disposed of;
(iii) The depreciation reserve of the multiple asset account or pool
must be reduced by the greater of the depreciation allowed or allowable
for the asset disposed of as of the end of the taxable year immediately
preceding the year of disposition. The allowable depreciation is
computed by using the depreciation method, recovery period, and
convention applicable to the multiple asset account or pool in which the
asset disposed of was included and by including the additional first
year depreciation deduction claimed for the asset disposed of; and
(iv) In determining the adjusted depreciable basis of the asset
disposed of at the time of disposition, taking into account the
applicable convention, the depreciation allowable for the asset disposed
of is computed by using the depreciation method, recovery period, and
convention applicable to the multiple asset account or pool in which the
asset disposed of was included and by including the additional first
year depreciation deduction claimed for the asset disposed of.
(3) Disposition of a portion of an asset. This paragraph (h)(3)
applies only when a taxpayer disposes of a portion of an
[[Page 551]]
asset and paragraph (d)(1) of this section applies to that disposition.
In this case--
(i) As of the first day of the taxable year in which the disposition
occurs, the disposed portion is placed into a single asset account. See
Sec. 1.168(i)-7(b);
(ii) The unadjusted depreciable basis of the asset must be reduced
by the unadjusted depreciable basis of the disposed portion as of the
first day of the taxable year in which the disposition occurs. See
paragraph (f)(3)(i) of this section for determining the unadjusted
depreciable basis of the disposed portion;
(iii) The depreciation reserve of the asset must be reduced by the
greater of the depreciation allowed or allowable for the disposed
portion as of the end of the taxable year immediately preceding the year
of disposition. The allowable depreciation is computed by using the
depreciation method, recovery period, and convention applicable to the
asset in which the disposed portion was included and by including the
portion of the additional first year depreciation deduction claimed for
the asset that is attributable to the disposed portion; and
(iv) In determining the adjusted depreciable basis of the disposed
portion at the time of disposition, taking into account the applicable
convention, the depreciation allowable for the disposed portion is
computed by using the depreciation method, recovery period, and
convention applicable to the asset in which the disposed portion was
included and by including the portion of the additional first year
depreciation deduction claimed for the asset that is attributable to the
disposed portion.
(i) Examples. The application of this section is illustrated by the
following examples:
Example 1. A owns an office building with four elevators. A replaces
one of the elevators. The elevator is a structural component of the
office building. In accordance with paragraph (c)(4)(ii)(A) of this
section, the office building, including its structural components, is
the asset for disposition purposes. A does not make the partial
disposition election provided under paragraph (d)(2) of this section for
the elevator. Thus, the retirement of the replaced elevator is not a
disposition. As a result, depreciation continues for the cost of the
building, including the cost of the retired elevator and the building's
other structural components, and A does not recognize a loss for this
retired elevator. If A must capitalize the amount paid for the
replacement elevator pursuant to Sec. 1.263(a)-3, the replacement
elevator is a separate asset for disposition purposes pursuant to
paragraph (c)(4)(ii)(D) of this section and for depreciation purposes
pursuant to section 168(i)(6).
Example 2. The facts are the same as in Example 1, except A accounts
for each structural component of the office building as a separate asset
in its fixed asset system. Although A treats each structural component
as a separate asset in its records, the office building, including its
structural components, is the asset for disposition purposes in
accordance with paragraph (c)(4)(ii)(A) of this section. Accordingly,
the result is the same as in Example 1.
Example 3. The facts are the same as in Example 1, except A makes
the partial disposition election provided under paragraph (d)(2) of this
section for the elevator. Although the office building, including its
structural components, is the asset for disposition purposes, the result
of A making the partial disposition election for the elevator is that
the retirement of the replaced elevator is a disposition. Thus,
depreciation for the retired elevator ceases at the time of its
retirement, taking into account the applicable convention, and A
recognizes a loss upon this retirement. Further, A must capitalize the
amount paid for the replacement elevator pursuant to Sec. 1.263(a)-
3(k)(1)(i), and the replacement elevator is a separate asset for
disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section
and for depreciation purposes pursuant to section 168(i)(6).
Example 4. B, a calendar-year commercial airline company, owns
several aircraft that are used in the commercial carrying of passengers
and described in asset class 45.0 of Rev. Proc. 87-56. B replaces the
existing engines on one of the aircraft with new engines. Assume each
aircraft is a unit of property as determined under Sec. 1.263(a)-
3(e)(3) and each engine of an aircraft is a major component or
substantial structural part of the aircraft as determined under Sec.
1.263(a)-3(k)(6). Assume also that B treats each aircraft as the asset
for disposition purposes in accordance with paragraph (c)(4) of this
section. B makes the partial disposition election provided under
paragraph (d)(2) of this section for the engines in the aircraft.
Although the aircraft is the asset for disposition purposes, the result
of B making the partial disposition election for the engines is that the
retirement of the replaced engines is a disposition. Thus, depreciation
for the retired engines ceases at the time of their retirement, taking
into account the applicable convention, and B recognizes a loss upon
this retirement. Further, B must capitalize the
[[Page 552]]
amount paid for the replacement engines pursuant to Sec. 1.263(a)-
3(k)(1)(i), and the replacement engines are a separate asset for
disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this section
and for depreciation purposes pursuant to section 168(i)(6).
Example 5. The facts are the same as in Example 4, except B does not
make the partial disposition election provided under paragraph (d)(2) of
this section for the engines. Thus, the retirement of the replaced
engines on one of the aircraft is not a disposition. As a result,
depreciation continues for the cost of the aircraft, including the cost
of the retired engines, and B does not recognize a loss for these
retired engines. If B must capitalize the amount paid for the
replacement engines pursuant to Sec. 1.263(a)-3, the replacement
engines are a separate asset for disposition purposes pursuant to
paragraph (c)(4)(ii)(D) of this section and for depreciation purposes
pursuant to section 168(i)(6).
Example 6. C, a corporation, owns several trucks that are used in
its trade or business and described in asset class 00.241 of Rev. Proc.
87-56. C replaces the engine on one of the trucks with a new engine.
Assume each truck is a unit of property as determined under Sec.
1.263(a)-3(e)(3) and each engine is a major component or substantial
structural part of the truck as determined under Sec. 1.263(a)-3(k)(6).
Because the trucks are described in asset class 00.241 of Rev. Proc. 87-
56, C must treat each truck as the asset for disposition purposes. C
does not make the partial disposition election provided under paragraph
(d)(2) of this section for the engine. Thus, the retirement of the
replaced engine on the truck is not a disposition. As a result,
depreciation continues for the cost of the truck, including the cost of
the retired engine, and C does not recognize a loss for this retired
engine. If C must capitalize the amount paid for the replacement engine
pursuant to Sec. 1.263(a)-3, the replacement engine is a separate asset
for disposition purposes pursuant to paragraph (c)(4)(ii)(D) of this
section and for depreciation purposes pursuant to section 168(i)(6).
Example 7. D owns a retail building. D replaces 60% of the roof of
this building. In accordance with paragraph (c)(4)(ii)(A) of this
section, the retail building, including its structural components, is
the asset for disposition purposes. Assume D must capitalize the costs
incurred for replacing 60% of the roof pursuant to Sec. 1.263(a)-
3(k)(1)(vi). D makes the partial disposition election provided under
paragraph (d)(2) of this section for the 60% of the replaced roof. Thus,
the retirement of 60% of the roof is a disposition. As a result,
depreciation for 60% of the roof ceases at the time of its retirement,
taking into account the applicable convention, and D recognizes a loss
upon this retirement. Further, D must capitalize the amount paid for the
60% of the roof pursuant to Sec. 1.263(a)-3(k)(1)(i) and (vi) and the
replacement 60% of the roof is a separate asset for disposition purposes
pursuant to paragraph (c)(4)(ii)(D) of this section and for depreciation
purposes pursuant to section 168(i)(6).
Example 8. (i) The facts are the same as in Example 7. Ten years
after replacing 60% of the roof, D replaces 55% of the roof of the
building. In accordance with paragraph (c)(4)(ii)(A) and (D) of this
section, for disposition purposes, the retail building, including its
structural components, except the replacement 60% of the roof, is an
asset and the replacement 60% of the roof is a separate asset. Assume D
must capitalize the costs incurred for replacing 55% of the roof
pursuant to Sec. 1.263(a)-3(k)(1)(vi). D makes the partial disposition
election provided under paragraph (d)(2) of this section for the 55% of
the replaced roof. Thus, the retirement of 55% of the roof is a
disposition.
(ii) However, D cannot determine from its records whether the
replaced 55% is part of the 60% of the roof replaced ten years ago or
whether the replaced 55% includes part or all of the remaining 40% of
the original roof. Pursuant to paragraph (g)(3) of this section, D
identifies which asset it disposed of by using the first-in, first-out
method of accounting. As a result, D disposed of the remaining 40% of
the original roof and 25% of the 60% of the roof replaced ten years ago.
(iii) Thus, depreciation for the remaining 40% of the original roof
ceases at the time of its retirement, taking into account the applicable
convention, and D recognizes a loss upon this retirement. Further,
depreciation for 25% of the 60% of the roof replaced ten years ago
ceases at the time of its retirement, taking into account the applicable
convention, and D recognizes a loss upon this retirement. Also, D must
capitalize the amount paid for the 55% of the roof pursuant to Sec.
1.263(a)-3(k)(1)(i) and (vi), and the replacement 55% of the roof is a
separate asset for disposition purposes pursuant to paragraph
(c)(4)(ii)(D) of this section and for depreciation purposes pursuant to
section 168(i)(6).
Example 9. (i) On July 1, 2011, E, a calendar-year taxpayer,
purchased and placed in service an existing multi-story office building
that costs $20,000,000. The cost of each structural component of the
building was not separately stated. E accounts for the building and its
structural components in its tax and financial accounting records as a
single asset with a cost of $20,000,000. E depreciates the building as
nonresidential real property and uses the optional depreciation table
that corresponds with the general depreciation system, the straight-line
method, a 39-year recovery period, and the mid-month convention. As of
January 1, 2014, the depreciation reserve for the building is
$1,261,000.
(ii) On June 30, 2014, E replaces one of the two elevators in the
office building. E did
[[Page 553]]
not dispose of any other structural components of this building in 2014
and prior years. E makes the partial disposition election provided under
paragraph (d)(2) of this section for this elevator. Although the office
building, including its structural components, is the asset for
disposition purposes, the result of E making the partial disposition
election for the elevator is that the retirement of the replaced
elevator is a disposition. Assume the replacement elevator is a
restoration under Sec. 1.263(a)-3(k), and not a betterment under Sec.
1.263(a)-3(j) or an adaptation to a new or different use under Sec.
1.263(a)-3(l). Because E cannot identify the cost of the elevator from
its records and the replacement elevator is a restoration under Sec.
1.263(a)-3(k), E determines the cost of the disposed elevator by
discounting the cost of the replacement elevator to its placed-in-
service year cost using the Producer Price Index for Final Demand. Using
this reasonable method, E determines the cost of the retired elevator by
discounting the cost of the replacement elevator to its cost in 2011
(the placed-in-service year) using the Producer Price Index for Final
Demand, resulting in $150,000 of the $20,000,000 purchase price for the
building to be the cost of the retired elevator. Using the optional
depreciation table that corresponds with the general depreciation
system, the straight-line method, a 39-year recovery period, and the
mid-month convention, the depreciation allowed or allowable for the
retired elevator as of December 31, 2013, is $9,458.
(iii) For E's 2014 Federal tax return, the loss for the retired
elevator is determined as follows. The depreciation allowed or allowable
for 2014 for the retired elevator is $1,763 ((unadjusted depreciable
basis of $150,000 x depreciation rate of 2.564% for 2014) x 5.5/12
months). Thus, the adjusted depreciable basis of the retired elevator is
$138,779 (the adjusted depreciable basis of $140,542 removed from the
building cost less the depreciation allowed or allowable of $1,763 for
2014). As a result, E recognizes a loss of $138,779 for the retired
elevator in 2014.
(iv) For E's 2014 Federal tax return, the depreciation allowance for
the building is computed as follows. As of January 1, 2014, the
unadjusted depreciable basis of the building is reduced from $20,000,000
to $19,850,000 ($20,000,000 less the unadjusted depreciable basis of
$150,000 for the retired elevator), and the depreciation reserve of the
building is reduced from $1,261,000 to $1,251,542 ($1,261,000 less the
depreciation allowed or allowable of $9,458 for the retired elevator as
of December 31, 2013). Consequently, the depreciation allowance for the
building for 2014 is $508,954 ($19,850,000 x depreciation rate of 2.564%
for 2014).
(v) E also must capitalize the amount paid for the replacement
elevator pursuant to Sec. 1.263(a)-3(k)(1). The replacement elevator is
a separate asset for disposition purposes pursuant to paragraph
(c)(4)(ii)(D) of this section and for depreciation purposes pursuant to
section 168(i)(6).
Example 10. (i) Since 2005, F, a calendar year taxpayer, has
accounted for items of MACRS property that are mass assets in pools.
Each pool includes only the mass assets that have the same depreciation
method, recovery period, and convention, and are placed in service by F
in the same taxable year. None of the pools are general asset accounts
under section 168(i)(4) and the regulations under section 168(i)(4). F
identifies any dispositions of these mass assets by specific
identification.
(ii) During 2014, F sells 10 items of mass assets with a 5-year
recovery period each for $100. Under the specific identification method,
F identifies these mass assets as being from the pool established by F
in 2012 for mass assets with a 5-year recovery period. Assume F
depreciates this pool using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. F elected not to deduct the additional first year
depreciation provided by section 168(k) for 5-year property placed in
service during 2012. As of January 1, 2014, this pool contains 100
similar items of mass assets with a total cost of $25,000 and a total
depreciation reserve of $13,000. Because all the items of mass assets in
the pool are similar, F allocates the cost and depreciation allowed or
allowable for the pool ratably among each item in the pool. This
allocation is a reasonable method because all the items of mass assets
in the pool are similar. Using this reasonable method, F allocates a
cost of $250 ($25,000 x (1/100)) to each disposed of mass asset and
depreciation allowed or allowable of $130 ($13,000 x (1/100)) to each
disposed of mass asset. The depreciation allowed or allowable in 2014
for each disposed of mass asset is $24 (($250 x 19.2%)/2). As a result,
the adjusted depreciable basis of each disposed of mass asset under
section 1011 is $96 ($250 - $130 - $24). Thus, F recognizes a gain of $4
for each disposed of mass asset in 2014, which is subject to section
1245.
(iii) Further, as of January 1, 2014, the unadjusted depreciable
basis of the 2012 pool of mass assets with a 5-year recovery period is
reduced from $25,000 to $22,500 ($25,000 less the unadjusted depreciable
basis of $2,500 for the 10 disposed of items), and the depreciation
reserve of this 2012 pool is reduced from $13,000 to $11,700 ($13,000
less the depreciation allowed or allowable of $1,300 for the 10 disposed
of items as of December 31, 2013). Consequently, as of January 1, 2014,
the 2012 pool of mass assets with a 5-year recovery period has 90 items
with a total cost of $22,500 and a depreciation reserve of $11,700.
Thus, the
[[Page 554]]
depreciation allowance for this pool for 2014 is $4,320 ($22,500 x
19.2%).
Example 11. (i) The facts are the same as in Example 10. Because of
changes in F's recordkeeping in 2015, it is impracticable for F to
continue to identify disposed of mass assets using specific
identification and to determine the unadjusted depreciable basis of the
disposed of mass assets. As a result, F files a Form 3115, Application
for Change in Accounting Method, to change to a first-in, first-out
method beginning with the taxable year beginning on January 1, 2015, on
a modified cut-off basis. See Sec. 1.446-1(e)(2)(ii)(d)(2)(vii). Under
the first-in, first-out method, the mass assets disposed of in a taxable
year are deemed to be from the pool with the earliest placed-in-service
year that has assets as of the beginning of the taxable year of the
disposition with the same recovery period as the asset disposed of. The
Commissioner of Internal Revenue consents to this change in method of
accounting.
(ii) During 2015, F sells 20 items of mass assets with a 5-year
recovery period each for $50. As of January 1, 2015, the 2008 pool is
the pool with the earliest placed-in-service year for mass assets with a
5-year recovery period, and this pool contains 25 items of mass assets
with a total cost of $10,000 and a total depreciation reserve of
$10,000. Thus, F allocates a cost of $400 ($10,000 x (1/25)) to each
disposed of mass asset and depreciation allowed or allowable of $400 to
each disposed of mass asset. As a result, the adjusted depreciable basis
of each disposed of mass asset is $0. Thus, F recognizes a gain of $50
for each disposed of mass asset in 2015, which is subject to section
1245.
(iii) Further, as of January 1, 2015, the unadjusted depreciable
basis of the 2008 pool of mass assets with a 5-year recovery period is
reduced from $10,000 to $2,000 ($10,000 less the unadjusted depreciable
basis of $8,000 for the 20 disposed of items ($400 x 20)), and the
depreciation reserve of this 2008 pool is reduced from $10,000 to $2,000
($10,000 less the depreciation allowed or allowable of $8,000 for the 20
disposed of items as of December 31, 2014). Consequently, as of January
1, 2015, the 2008 pool of mass assets with a 5-year recovery period has
5 items with a total cost of $2,000 and a depreciation reserve of
$2,000.
(j) Effective/applicability dates--(1) In general. This section
applies to taxable years beginning on or after January 1, 2014.
(2) Early application of this section. A taxpayer may choose to
apply the provisions of this section to taxable years beginning on or
after January 1, 2012.
(3) Early application of regulation project REG-110732-13. A
taxpayer may rely on the provisions of this section in regulation
project REG-110732-13 (2013-43 IRB 404) (see Sec. 601.601(d)(2) of this
chapter) for taxable years beginning on or after January 1, 2012.
However, a taxpayer may not rely on the provisions of this section in
regulation project REG-110732-13 for taxable years beginning on or after
January 1, 2014.
(4) Optional application of TD 9564. A taxpayer may choose to apply
Sec. 1.168(i)-8T as contained in 26 CFR part 1 edition revised as of
April 1, 2014, to taxable years beginning on or after January 1, 2012.
However, a taxpayer may not apply Sec. 1.168(i)-8T as contained in 26
CFR part 1 edition revised as of April 1, 2014, to taxable years
beginning on or after January 1, 2014.
(5) Change in method of accounting. A change to comply with this
section for depreciable assets placed in service in a taxable year
ending on or after December 30, 2003, is a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply. A taxpayer also may treat a change to comply
with this section for depreciable assets placed in service in a taxable
year ending before December 30, 2003, as a change in method of
accounting to which the provisions of section 446(e) and the regulations
under section 446(e) apply. This paragraph (j)(5) does not apply to a
change to comply with paragraph (d)(2) of this section, except as
provided in paragraph (d)(2)(iii) or (iv)(B) of this section or
otherwise provided by other guidance published in the Internal Revenue
Bulletin (see Sec. 601.601(d)(2) of this chapter).
[T.D. 9689, 79 FR 48678, Aug. 18,2014, as amended at 79 FR 78697, Dec.
31, 2014]
Sec. 1.168(j)-1T Questions and answers concerning tax-exempt entity
leasing rules (temporary).
The following questions and answers concern tax-exempt entity
leasing under section 168(j) of the Internal Revenue Code of 1954, as
enacted by section 31 of the Tax Reform Act of 1984 (``TRA'') (Pub. L.
98-369):
Consequences of Tax-Exempt Use Status
Q-1. If recovery property is subject to the tax-exempt entity
leasing provisions of section 168(j), how must the taxpayer compute the
property's recovery deductions?
[[Page 555]]
A-1. The taxpayer must compute the property's recovery deductions in
accordance with section 168(j) (1) and (2); that is, the taxpayer must
use the straight line method and the specified recovery period. For
property other than 18-year real property, the applicable recovery
percentages for the specified recovery period are to be determined with
reference to the tables contained in Prop. Treas. Reg. Sec. 1.168-
2(g)(3)(iv)(A). For 18-year real property for which a 40-year recovery
period is required, the applicable recovery percentages are to be
determined under the following table:
40-Year Straight Line Method (Assuming Mid-Month Convention)
----------------------------------------------------------------------------------------------------------------
And the month in the first recovery year the property is placed in service is--
If the recovery year is-- -----------------------------------------------------------------------------------
1 2 3 4 5 6 7 8 9 10 11 12
----------------------------------------------------------------------------------------------------------------
The applicable recovery percentage is--
-----------------------------------------------------------------------------------
1.......................... 2.4 2.2 2.0 1.8 1.6 1.4 1.1 0.9 0.7 0.5 0.3 0.1
2.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
3.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
4.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
5.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
6.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
7.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
8.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
9.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
10.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
11.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
12.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
13.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
14.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
15.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
16.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
17.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
18.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
19.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
20.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
21.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
22.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
23.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
24.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
25.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
26.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
27.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
28.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
29.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
30.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
31.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
32.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
33.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
34.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
35.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
36.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
37.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
38.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
39.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
40.......................... 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5
41.......................... 0.1 0.3 0.5 0.7 0.9 1.1 1.4 1.6 1.8 2.0 2.2 2.4
----------------------------------------------------------------------------------------------------------------
Q-2. If recovery property that was placed in service after December
31, 1980 by a taxable entity subsequently becomes tax-exempt use
property, how are such property's cost recovery deductions under section
168 affected?
A-2. A change to tax-exempt use property, as defined in section
168(j)(3), will cause the cost recovery deductions under the accelerated
cost recovery system (ACRS) to be recomputed. The allowable recovery
deduction for the taxable year in which the change occurs (and for
subsequent taxable years) must be determined as if the property had
originally been tax-exempt use property. Proper adjustment must be made
under the principles of Prop. Treas. Reg. Sec. 1.168-2(j)(3)(i)(B) to
account for the difference between the
[[Page 556]]
deductions allowable with respect to the property prior to the year of
change and those which would have been allowable had the taxpayer used
the recovery period and method for tax-exempt use property under section
168(j) (1) and (2). However, no adjustment is made pursuant to the
provisions of this A-2 if section 168(j)(2)(C) applies, that is, if the
taxpayer had selected a longer recovery period in the year the property
was placed in service than the recovery period prescribed for such
property under section 168(j)(1).
Example 1. On July 1, 1983, X, a calendar year taxpayer, places in
service 5-year recovery property with an unadjusted basis of $100. For
1983, X's allowable deduction is $15 (i.e., .15 x $100). In 1984, the
property becomes tax-exempt use property. Under section 168(j), assume
the prescribed recovery period is 12 years. For 1984 (and subsequent
taxable years), X's allowable deduction is determined as if the property
had been tax-exempt use property since 1983, that is, the year it was
placed in service. Thus, taxable year 1984 is the property's second
recovery year of its 12-year recovery period. Additionally, X must
account for the excess allowable recovery deduction of $11 (i.e., the
difference between the recovery allowance for 1983 ($15) and the
allowance for that year had the property been tax-exempt use property
($4)) in accordance with the principles of Prop. Treas. Reg. Sec.
1.168-2(j)(3)(i)(B). Thus, the recovery allowances in 1984 and 1985 are
$7.97, determined as follows:
Unadjusted basis multiplied by the applicable recovery $9.00
percentage for second recovery year ($100x.09................
Excess allowable recovery deduction multiplied by the -1.03
applicable recovery percentage for second recovery year
divided by the sum of the remaining unused applicable
percentages for tax-exempt use property existing as of the
taxable year of change (1984) (($11x.09)/.96)................
---------
Difference--allowable deduction for 1984...................... $7.97
=========
Unadjusted basis multiplied by the applicable recovery $9.00
percentage for third recovery year ($100x.09)................
Excess allowable recovery deduction multiplied by the -1.03
applicable recovery percentage for third recovery year
divided by the sum of the remaining unused applicable
percentages for tax-exempt use property existing as of the
taxable year of change (1984) (($11x.09)/.96)................
---------
Difference--allowable deduction for 1985...................... $7.97
=========
Additionally, X must make a similar adjustment for the taxable years
1986 through 1995, that is, his fourth through thirteenth recovery
years.
Example 2. Assume the same facts as in Example (1) except that in
1983, X elected under section 168 (b) (3) with respect to the 5-year
property to use the optional recovery percentages over a 25-year
recovery period. Based on these facts, the provisions of this A-2 do not
apply.
Definition of Tax-Exempt Use Property
Mixed Leases of Real and Personal Property
Q-3. How is a mixed lease of real property and personal property
(e.g., a building with furniture) to be treated for purposes of applying
the rules of section 168(j)(3) defining which property constitutes tax-
exempt use property?
A-3. The general rule is that 18-year real property and property
other than 18-year real property are tested separately to determine
whether each constitutes tax-exempt use property. However, if a lease of
section 1245 class property is incidental to a lease of 18-year real
property, and the 18-year real property is not tax-exempt use property,
then the section 1245 class property also does not constitute tax-exempt
use property. A lease of section 1245 class property will be considered
incidental if the adjusted basis of all section 1245 class property
leased in the same transaction is 1 percent or less of the adjusted
basis of all 18-year real property leased in such transaction.
Buildings Which Are Partially Tax-Exempt Use Property
Q-4. If part of a building is leased to a tax-exempt entity in a
disqualified lease and part of the building is leased other than to a
tax-exempt entity in a disqualified lease, to what extent do the tax-
exempt entity leasing rules apply to such building?
A-4. The taxpaper must determine the amount of the building's
unadjusted basis that is properly allocable to the portion of the
building that is tax-exempt use property; the section 168(j) rules apply
to the allocated amount. Solely for purposes of determining what
percentage of the building's basis is subject to the tax-exempt entity
leasing rules, no part of the basis is allocated to common areas.
Example. A constructs a 3-story building in 1984 at a cost of
$900,000. Each floor consists of 30,000 square feet. The only common
area (10,000 square feet) in the building is on the
[[Page 557]]
first floor. A leases the first floor (other than the common areas) to a
firm that is not a tax-exempt entity. A leases the top two floors to a
tax-exempt entity in a 25-year lease. The top two floors constitute tax-
exempt use property. Assume that square footage is the appropriate
method for allocating basis in this case. Thus, A must allocate $675,000
of the $900,000 basis to the tax-exempt use portion, determined as
follows:
[GRAPHIC] [TIFF OMITTED] TC05OC91.040
A must compute his recovery deductions on this portion of the basis
($675,000) in accordance with the rules of section 168(j) (1) and (2).
Requirement of a Lease
Q-5. Can the use of property by a party other than a tax-exempt
entity result in the property being treated as tax-exempt use property
within the meaning of section 168(j)(3)?
A-5. Yes, if based on all the facts and circumstances it is more
appropriate to characterize the transaction as a lease to a tax-exempt
entity. A transaction can be characterized as a lease to a tax-exempt
entity under section 168(j)(6)(A), which provides that ``the term
`lease' includes any grant of a right to use property''; or under the
service contract rules of section 7701(e). See Q&A 18 for rules
regarding service contracts.
Example. A trust is executed on January 1, 1984, to create a pooled
income fund (P) that meets the requirements of section 642(c)(5). A
university (U) that is tax-exempt under section 501(c)(3) is the
remainderman of the pooled income fund. P's purpose is to construct and
operate an athletic center on land adjacent to U's campus. Construction
of the athletic center, which has a 50-year useful life, was completed
and the center was placed in service on February 1, 1985. The athletic
center is managed for a fee by M, an unrelated taxable organization
which operates athletic facilities open to the public. Office space at
the facility is occupied rent-free by both the U athletic department and
M. Scheduling of activities at the center is handled jointly by members
of U's athletic department and M. General operating expenses of the
athletic center are paid by P. Although the athletic center is open to
the public for a membership fee, the majority of members are U's
students who pay membership fees as part of their tuition. These fees
are remitted by U to P. This arrangement is in substance a grant to U of
a right to use the facility, and therefore a lease to U under section
168(j)(6)(A). U, as remainderman, will have obtained title to the entire
building when the last pooled income fund donor dies. This arrangement
is a disqualified lease because either (1) U has the equivalent of a
fixed price purchase option under section 168(j)(3)(B)(ii)(II) (if U
receives title as remainderman before the end of the useful life of the
building), or (2) the lease has a term in excess of 20 years under
section 168(j)(3)(B)(ii)(III) (if U does not receive title as
remainderman until 20 years have elapsed), or both. Therefore, the
allowable recovery deductions (without regard to salvage value) must be
computed in accordance with section 168(j) (1) and (2). In addition,
because this arrangement is treated as a lease under section 168(j), the
facility is used by U for purposes of section 48(a)(4), and thus no
investment tax credit is permitted with respect to any portion of the
facility. This arrangement also may be treated as a lease to U for all
purposes of chapter 1 of the Internal Revenue Code under section 7701
(e).
``More Than 35 Percent of the Property'' Test
Q-6. How is the percentage of 18-year real property leased to a tax-
exempt entity in a disqualified lease to be determined for purposes of
the ``more than 35 percent of the property'' test of section
168(j)(3)(B)(iii)?
A-6. The phrase ``more than 35 percent of the property'' means more
than 35 percent of the net rentable floor space of the property. The net
rentable floor space in a building does not include the common areas of
the building, regardless of the terms of the lease. For purposes of the
``more than 35 percent of the property'' rule, two or
[[Page 558]]
more buildings will be treated as separate properties unless they are
part of the same project, in which case they will be treated as one
property. Two or more buildings will be treated as part of the same
project if the buildings are constructed, under a common plan, within a
reasonable time of each other on the same site and will be used in an
integrated manner.
Q-7. Are disqualified leases to different tax-exempt entities
(regardless of whether they are related) aggregated in determining
whether 18-year real property is tax-exempt use property?
A-7. Yes.
Example. A tax-exempt entity participates in industrial development
bond financing for the acquisition of a new building by a taxable
entity. The tax-exempt entity leases 60 percent of the net rentable
floor space in the building for 5 years. Sixty percent of the building
is tax-exempt use property. If the same tax-exempt entity leased only 19
percent of the net rentable floor space in the building for 5 years, no
portion of the building would be tax-exempt use property because not
more than 35 percent of the property is leased to a tax-exempt entity
pursuant to a disqualified lease. If such tax-exempt entity leased only
19 percent of the net rentable floor space in the building for 5 years
and another tax-exempt entity leased 20 percent of the net rentable
floor space in the building for a term in excess of 20 years (or a
related entity leased 20 percent of the building for 5 years), 39
percent of the building would be tax-exempt use property. See A-4
regarding the determination of the amount of the building's unadjusted
basis that is properly allocable to the portion of the building that is
tax-exempt use property.
``Predominantly Used'' Test
Q-8. What does the term ``predominantly used'' mean for purposes of
the section 168(j)(3)(D) exception to the tax-exempt use property rules?
A-8. ``Predominantly used'' means that for more than 50 percent of
the time used, as determined for each taxable year, the real or personal
property is used in an unrelated trade or business the income of which
is subject to tax under section 511 (determined without regard to the
debt-financed income rules of section 514). If only a portion of
property is predominantly used in an unrelated trade or business, the
remainder may nevertheless be tax-exempt use property.
Q-9. How is the ``predominantly used'' test of section 168(j)(3)(D)
to be applied to a building?
A-9. The ``predominantly used'' test is to be applied to a building
in the following manner:
(i) Identify the discrete portions (excluding common areas) of the
building which are leased to a tax-exempt entity in a disqualified lease
under section 168(j)(3)(B)(ii). A discrete portion of a building is an
area physically separated from other areas. An area is physically
separated from other areas if separated by permanent walls or by
partitions serving as room dividers if such partitions remain in place
throughout the taxable year. A discrete portion can be the entire
building, floors, wings, offices, rooms, or a combination thereof. For
example, a building whose entire internal space consists of a single
large room used as a gymnasium has only one discrete portion. On the
other hand, if the building has 3 stories with 10 offices on each floor,
each of the 30 offices is a discrete portion.
(ii) Determine whether each discrete portion is predominantly used
in an unrelated trade or business subject to tax under section 511. See
A-8 for the rules regarding how to make this determination.
(iii) Once the discrete portions of the building that constitute
tax-exempt use property have been identified, an appropriate allocation
of basis must be made to such discrete portions. See A-4 for rules
regarding how to make such allocation.
(iv) The application of these rules is illustrated by the following
example:
Example. A building, constructed in 1985, is leased in its entirety
to a tax-exempt entity (E) pursuant to a 25-year lease. The building has
25,000 square feet of net rentable floor space and consists of an
auditorium (15,000 square feet), a retail shop (10,000 square feet),
plus common area of 5,000 square feet. E uses the auditorium 80 percent
of the time in its exempt activity and 20 percent of the time in an
unrelated trade or business subject to tax under section 511. The retail
shop is used 90 percent of the time in an unrelated trade or business
subject to tax under section 511 and 10 percent of the time in an exempt
activity. Thus, the auditorium is tax-exempt use property; the retail
shop is not. An appropriate allocation of basis to the auditorium must
be made. See A-4.
[[Page 559]]
Definition of Tax-Exempt Entity
Q-10. What elections must be made in order to avoid the ``5-year
lookback'' rule of section 168(j)(4)(E)(i)?
A-10. Only organizations which were exempt from tax under section
501(a) as organizations described in section 501(c)(12) (and which are
no longer tax-exempt) may avoid the 5-year lookback rule of section
168(j)(4)(E)(i). In order to avoid the 5-year lookback rule with respect
to any property, two elections are required. First, the organization
must elect not to be exempt from tax under section 501(a) during the
tax-exempt use period (as defined in section 168(j)(4)(E)(ii)(II)) with
respect to the property. Second, the organization must elect to be taxed
on the exempt arbitrage profits as provided in section 31(g)(16) of the
Tax Reform Act of 1984. See Temp. Treas. Reg. Sec. 301.9100-6T(a) for
the time and manner of making these elections. These elections, once
made, are irrevocable.
Q-11. Does the term ``tax-exempt entity'' include tax-exempt plans
of deferred compensation and similar arrangements?
A-11. Yes. For purposes of section 168 (j), the term ``tax-exempt
entity'' includes trusts or other entities that are tax-qualified under
section 401 (a), individual retirement accounts, simplified employee
pensions, and other tax-exempt arrangements described in subchapter D of
chapter 1 of the Internal Revenue Code.
Special Rules for High Technology Equipment
Q-12. What effect do the tax-exempt entity leasing provisions have
on ``qualified technological equipment''?
A-12. ``Qualified technological equipment'' which is leased to a
tax-exempt entity for a term of 5 years or less shall not constitute
tax-exempt use property. If ``qualified technological equipment'' which
is leased to a tax-exempt entity for a term of more than 5 years
constitutes tax-exempt use property (as defined in section 168(j)(3))
and is not used predominantly outside the United States, the rules of
section 168(j) (1) and (2) apply except that the recovery period to be
used for such equipment shall be 5 years regardless of the length of the
lease term. For purposes of section 168(j)(5), ``qualified technological
equipment'' means (1) any computer or peripheral equipment, (2) any high
technology telephone station equipment installed on the customer's
premises, and (3) any high technology medical equipment. For definitions
of these terms, see A-13 through A-16.
Q-13. What is a ``computer'' as that term is used in section
168(j)(5)(C)(i)(I)?
A-13. Computers are electronically activated devices that are
programmable by the user and that are capable of accepting information,
applying prescribed processes to it, and supplying the results of those
processes with or without human intervention. Computers consist of a
central processing unit containing extensive storage, logic, arithmetic,
and control capabilities. A computer does not include any equipment
which is an integral part of property that is not a user-programmable
device, any video games or other devices used by the user primarily for
amusement or entertainment purposes, or any typewriters, calculators,
adding or accounting machines, copiers, duplicating equipment, or
similar equipment. A computer does not include any equipment that is not
tangible personal property.
Q-14. What is ``peripheral equipment'' as that term is used in
section 168(j)(5)(C)(i)(I)?
A-14. Peripheral equipment means tangible personal property such as
auxiliary machines, whether on-line or off-line, that are designed to be
placed under the control of the central processing unit of the computer.
Some examples of peripheral equipment are: card readers, card punches,
magnetic tape feeds, high speed printers, optical character readers,
tape cassettes, mass storage units, paper tape equipment, keypunches,
data entry devices, teleprinters, terminals, tape drives, disc drives,
disc files, disc packs, visual image projector tubes, card sorters,
plotters, and collators. Peripheral equipment does not include equipment
not included in Asset Depreciation Range (ADR) 00.12 listed in section 3
of Rev. Proc. 83-35, 1983-1 C.B. 745, 746. Peripheral equipment also
does not include any equipment that is an integral part of property that
is not a user-
[[Page 560]]
programmable device, any video games or other devices used by the user
primarily for amusement or entertainment purposes, or any typewriters,
calculators, adding or accounting machines, copiers, duplicating
equipment, or similar equipment.
Q-15. What does ``high technology telephone station equipment'' mean
as that term is used in section 168(j)(5)(C)(i)(II)?
A-15. High technology telephone station equipment includes only
tangible personal property described in asset depreciation range (ADR)
class 48.13 listed in section 3 of Rev. Proc. 83-35, 1983-1 C.B. 745,
758 that has a high technology content and which, because of such high
technology content, can reasonably be expected to become obsolete before
the expiration of its physical useful life. For example, telephone
booths and telephones which include only a standard dialing feature are
not high technology equipment. However, telephones with features such as
an abbreviated dialing short program, an automatic callback, or
conference call feature may qualify as high technology equipment. High
technology telephone station equipment may include terminal equipment
including such extra features but not terminal equipment used in
conjunction with features offered through central office capacity. There
are no current plans to utilize the regulatory authority provided in
section 168(j)(5)(C)(iv).
Q-16. What is ``high technology medical equipment'' as that term is
used in section 168 (j)(5)(C)(i)(III)?
A-16. High technology medical equipment is any electronic,
electromechanical, or computer-based high technology equipment which is
tangible personal property used in the screening, monitoring,
observation, diagnosis, or treatment of human patients in a laboratory,
medical, or hospital environment. High technology medical equipment
includes only equipment that has a high technology content and which,
because of such high technology content, can reasonably be expected to
become obsolete before the expiration of its physical useful life. High
technology medical equipment may include computer axial tomography
(C.A.T.) scanners, nuclear magnetic resonance equipment, clinical
chemistry analyzers, drug monitors, diagnostic ultrasound scanners,
nuclear cameras, radiographic and fluoroscopic systems, Holter monitors,
and bedside monitors. Incidental use of any such equipment for othe
purposes, such as research, will not prevent it from qualifying as high
technology medical equipment. There are no current plans to utilize the
regulatory authority provided in section 168(j)(5)(C)(iv).
Lease Term
Q-17. What is included in determining the length of a lease term?
A-17. (i) The lease term starts when the property is first made
available to the lessee under the lease. The lease term includes not
only the stated duration, but also any additional period of time which
is within the ``realistic contemplation of the parties at the time the
property is first put into service. Hokanson v. Commissioner, 730 F.2d
1245, 1248 (9th Cir. 1984). A subsequent period of time is included in
the term of the original lease if the circumstances indicate that the
parties, upon entering into the original lease, had informally agreed
that there would be an extension of the original lease.
(ii) With respect to personal property, the lease term includes all
periods for which the tax-exempt lessee or a related party (as defined
under section 168(j)(7)) has a legally enforceable option to renew the
lease, or the lessor has a legally enforceable option to compel its
renewal by the tax-exempt entity or a related party. This is true
regardless of the renewal terms of the lease agreement or whether the
lease is in fact renewed.
(iii) With respect to real property, the lease term includes all
periods for which the tax-exempt lessee or a related party (as defined
under section 168(j)(7)) has a legally enforceable option to renew the
lease, or the lessor has a legally enforceable option to compel its
renewal by the tax-exempt entity or a related party, unless the option
to renew is at fair market value, determined at the time of renewal. The
Hokanson facts and circumstances test (see (i) above) may cause the term
of a fair market value renewal option to be
[[Page 561]]
treated as part of the original lease term.
(iv) Successive leases that are part of the same transaction or a
series of related transactions concerning the same or substantially
similar property shall be treated as one lease. This rule applies if at
substantially the same time or as part of one arrangement the parties
enter into multiple leases covering the same or substantially similar
property, each having a different term. If so, then the original lease
term will be treated as running through the term of the lease that has
the last expiration date of the multiple leases. The multiple lease rule
will not apply merely because the parties enter into a new lease at fair
market rental value at the end of the original lease term.
(v) The application of the above rules is illustrated by the
following examples:
Example 1. On December 30, 1984, X, a taxable corporation, and Y, a
tax-exempt entity, enter into a requirements contract for a period of 3
years. The requirements contract sets the terms and conditions under
which X and Y will do business on those occasions when X actually leases
items of personal property to Y. The requirements contract imposes no
obligation on either party to actually enter into a lease agreement.
Pursuant to this requirements contract, on January 1, 1985, X and Y
enter into three separate leases. Under the leases, Y obtained the use
of three identical items of personal property, each for a term of six
months beginning on January 1, 1985. On March 1, 1985, Y entered into a
fourth lease for the use of a fourth item of personal property
substantially similar to the other three items for a term of 20 months
beginning on that date. The mere fact that all 4 leases were entered
into pursuant to the same requirements contract and involved the same or
substantially similar property does not require aggregation of the terms
of such leases under section 168(j)(6)(B).
Example 2. Assume the same facts as in example (1) except that,
instead of the 4 leases entered into in example (1), on January 1, 1985,
pursuant to the requirements contract, X and Y enter into a lease for an
item of personal property for one year. On January 10, 1986, after the
end of the one-year lease term, X and Y enter into a second lease with
respect to the same or substantially similar equipment. Assuming that
the requirements contract itself is not a lease and assuming that the
parties did not have any informal or implicit understanding (other than
the general expectation of doing some business in the future) to enter
into the second lease when the first lease was entered into, these two
leases are not aggregated. The mere fact that the parties entered into
two leases under the requirements contract does not result in the
application of the section 168(j)(6)(B) rules for successive leases.
Example 3. The facts are the same as in example (2) except that the
parties did have an understanding, informal or otherwise, at the time of
the first lease that they would enter into a second lease of the same
personal property. The terms of the leases are aggregated.
Example 4. The facts are the same as in example (2) except that,
instead of the leases entered into in example (2), on January 1, 1985, X
and Y enter into two separate leases, each for a term of one year. One
lease is for the period beginning on January 1, 1985 and ending on
December 31, 1985. The other lease is for the period beginning on
January 1, 1986 and ending on December 31, 1986. Both leases involve the
same or substantially similar personal property. Under the successive
lease rule, the terms of both leases are aggregated for purposes of
determining the term of either lease under section 168(j)(6)(B). This
result occurs because the two leases were entered into as part of the
same transaction, and they relate to the same or substantially similar
personal property.
Service Contract Issues
Q-18. How is the treatment of service contracts affected by the
service contract rules set forth in section 7701(e)?
A-18. If a contract which purports to be a service contract is
treated as a lease under section 7701(e), such contract is to be treated
as a lease for all purposes of Chapter 1 of the Internal Revenue Code
(including, for example, section 168(j) and section 48(a) (4) and (5)).
Q-19. Does a contract to provide heating, maintenance, etc. services
in low-income housing come within the low-income housing exception in
section 7701(e)(5) to the service contract rules set forth in section
7701(e)?
A-19. No. Although certain low-income housing operated by or for an
organization described in paragraphs (3) or (4) of section 501(c) is not
subject to the service contract rules in section 7701(e), a contract,
for instance, to provide heating services to low-income housing units,
such as by installing and operating a furnace, does not constitute
``low-income housing'' within the meaning of section 7701(e)(5). Thus,
the rules of section 7701(e) apply to
[[Page 562]]
such contracts in determining whether they are properly treated as
leases.
Partnership Issues
Q-20. Do the provisions applicable to property leased to
partnerships, set forth in section 168(j)(8), and the provisions
applicable to property owned by partnerships, set forth in section
168(j)(9), apply to pass-through entities other than partnerships?
A-20. Yes. Rules similar to those provided in paragraphs (8),
(9)(A), (9)(B), and (9)(C) of section 168(j) and those provided in Q &
A's 21-26 apply to pass-through entities other than partnerships.
Q-21. What rules apply to property owned by a partnership in which
one or more partners is a tax-exempt entity?
A-21. If property is owned by a partnership having both taxable and
tax-exempt entities as partners, and any allocation to a tax-exempt
entity partner is not a ``qualified allocation'' under section
168(j)(9)(B), then such entity's proportionate share of the property is
to be treated as tax-exempt use property for all purposes. However, the
property will not be tax-exempt use property if it is predominantly used
by the partnership in an activity which, with respect to the tax-exempt
entity, is an unrelated trade or business. An activity is an unrelated
trade or business with respect to a tax-exempt entity if such entity's
distributive share of the partnership's gross income from the activity
is includible in computing its unrelated business taxable income under
section 512(c) (determined without regard to the debt-financed income
rules of section 514). A tax-exempt entity partner's proportionate share
of property of a partnership equals such partner's share of that item of
the partnership's income or gain (excluding income or gain allocated
under section 704(c)) in which the tax-exempt entity has the highest
share. If the tax-exempt entity partner's share of any item of income or
gain (excluding income or gain allocated under section 704(c)) may vary
during the period it is a partner, the previous sentence shall be
applied with reference to the highest share of any such item that it may
receive at any time during such period. The application of these rules
is illustrated by the following example:
Example. A partnership (P) operates a factory, which consists of a
building and various items of machinery. P has one tax-exempt entity (E)
as a partner, and E's proportionate share is 10 percent (i.e., 10
percent is the largest share of any item of income or gain that E may
receive during the time E is a partner). Unless P's allocations to E are
qualified under section 168(j)(9)(B), 10 percent of each item of
partnership property (including the building) is tax-exempt use
property, notwithstanding the 35 percent threshold test of section
168(j)(3)(B)(iii) that is otherwise applicable to 18-year real property.
However, the property will not be tax-exempt use property if it is
predominantly used by the partnership in an activity which, with respect
to E, is an unrelated trade or business (determined without regard to
the debt-financed income rules of section 514).
Q-22. What consititutes a ``qualified allocation'' under section
168(j)(9)(B)?
A-22. (i) A ``qualified allocation'' means any allocation to a tax-
exempt entity which is consistent with such entity's being allocated the
same share (i.e., the identical percentage) of each and every item of
partnership income, gain, loss, deduction, credit, and basis during the
entire period such entity is a partner. Except as provided in A-23, an
allocation is not qualified if it does not have substantial economic
effect under section 704(b). However, for purposes of the two preceding
sentences, items allocated under section 704(c) (relating to contributed
property) are not taken into account. An allocation is not a ``qualified
allocation'' under section 168(j)(9)(B) if the partnership agreement
provides for, or the partners have otherwise formally or informally
agreed to, any change (regardless of whether such change is contingent
upon the happening of one or more events) in the tax-exempt entity's
distributive share of income, gain, loss, deduction, credit, or basis at
any time during the entire period the tax-exempt entity is a partner.
(ii) A change in a tax-exempt entity's distributive share of income,
gain, loss, deduction, credit, or basis which occurs as a result of a
sale or redemption of a partnership interest (or portion thereof) or a
contribution of cash or property to the partnership shall be disregarded
in determining whether the
[[Page 563]]
partnership allocations are qualified, provided that such transaction is
based on fair market value at the time of the transaction and that the
allocations are qualified after the change. For this purpose, the
consideration determined by the parties dealing at arm's length and with
adverse interests normally will be deemed to satisfy the fair market
value requirement. In addition, a change in a tax-exempt entity's
distributive share which occurs as a result of a partner's default
(other than a prearranged default) under the terms of the partnership
agreement will be disregarded, provided that the allocations are
qualified after the change, and that the change does not have the effect
of avoiding the restrictions of section 168(j)(9). Any of the above-
described transactions between existing partners (and parties related to
them) will be closely scrutinized.
Example 1. A, a taxable entity, and B, a tax-exempt entity, form a
partnership in 1985. A contributes $800,000 to the partnership; B
contributes $200,000. The partnership agreement allocates 95 percent of
each item of income, gain, loss, deduction, credit, and basis to A; B's
share of each of these items is 5 percent. Liquidation proceeds are,
throughout the term of the partnership, to be distributed in accordance
with the partner's capital account balances, and any partner with a
deficit in his capital account following the distribution of liquidation
proceeds is required to restore the amount of such deficit to the
partnership. Assuming that these allocations have substantial economic
effect within the meaning of section 704(b)(2), they are qualified
because B's distributive share of each item of income, gain, loss,
deduction, credit, and basis will remain the same during the entire
period that B is a partner. The fact that the liquidation proceeds may
be distributed in a ratio other than 95 percent/5 percent does not cause
the allocations not to be qualified.
Example 2. A, B, and E are members of a partnership formed on July
1, 1984. On that date the partnership places in service a building and
section 1245 class property. A and B are taxable entities; E is a tax-
exempt entity. The partnership agreement provides that during the first
5 years of the partnership, A and B are each allocated 40 percent of
each item of income, gain, loss, deduction, credit, and basis; E is
allocated 20 percent. Thereafter, A, B, and E are each allocated 33\1/3\
percent of each item of income, gain, loss, deduction, credit, and
basis. Assume that these allocations meet the substantial economic
effect test of section 704(b)(2) and E's distributive share of the
partnership's income is not unrelated trade or business income subject
to tax under section 511. The allocations to E are not qualified
allocations under section 168(j)(9)(B) because E's distributive share of
partnership items does not remain the same during the entire period that
E is a partner in the partnership. Thus, 33\1/3\ percent of the building
and 33\1/3\ percent of the section 1245 class property are tax-exempt
use property from the time each is placed in service by the partnership
and are thus subject to the cost recovery rules of section 168(j) (1)
and (2). In addition, no investment tax credit is allowed for 33\1/3\
percent of the section 1245 class property because of section 48(a)(4).
Q-23. In determining whether allocations constitute qualified
allocations, what rules are applied to test allocations that are not
governed by the substantial economic effect rules?
A-23. A-22 provides the general rules to be used in determining
whether an allocation is a qualified allocation, including the rule that
the allocation must have substantial economic effect. However, certain
allocations are not governed by the substantial economic effect rules
(e.g., an allocation of basis of an oil and gas property is generally
governed by section 613A(c)(7)(D), rather than section 704(b)), and
other allocations cannot satisfy the substantial economic effect rules
(e.g., allocations of credits, allocations of deduction and loss
attributable to nonrecourse debt, and allocations of percentage
depletion in excess of basis). Since allocations in either of these
categories cannot be tested under the substantial economic effect test,
these allocations, in order to be qualified, must comply with the
relevant Code or regulation section that governs the particular
allocation (e.g., in the case of an allocation of basis of an oil and
gas property, section 613A(c)(7)(D)).
Q-24. Will the Internal Revenue Service issue letter rulings on the
issue of whether an allocation is a ``qualified allocation'' for
purposes of section 168(j)(9)?
A-24. The Internal Revenue Service will accept requests for rulings
on the question of whether an allocation is a ``qualified allocation''
for purposes of section 168(j)(9). Such requests should be submitted in
accordance with the appropriate revenue procedure. One requirement of a
qualified allocation is
[[Page 564]]
that such allocation must have substantial economic effect under section
704(b)(2). Currently, the Service will not rule on the question of
whether an allocation has substantial economic effect under section
704(b)(2). Therefore, unless and until this policy is changed, a ruling
request regarding a qualified allocation must contain a representation
that the subject allocation has substantial economic effect (or complies
with A-23, if applicable).
Q-25. Do priority cash distributions which constitute guaranteed
payments under section 707(c) disqualify an otherwise qualified
allocation?
A-25. Priority cash distributions to partners which constitute
guaranteed payments will not disqualify an otherwise qualified
allocation if the priority cash distributions are reasonable in amount
(e.g., equal to the Federal short-term rate described in section
1274(d)) and are made in equal priorities to all partners in proportion
to their capital in the partnership. Other guaranteed payments will be
closely scrutinized and, in appropriate cases, will disqualify an
otherwise qualified allocation.
Example. A and B form Partnership AB to operate a manufacturing
business. A is a tax-exempt entity; B is a taxable person. A contributes
$500,000 to the partnership; B contributes $100,000. The partnership
agreement provides that A and B are each entitled to cash distributions
each year, in equal priority, in an amount equal to 8 percent of their
capital contribution. Assume that these payments are reasonable in
amount and constitute guaranteed payments under section 707(c). Without
taking into consideration the guaranteed payments, all allocations
constitute qualified allocations under section 168(j)(9)(B) and A-22.
These guaranteed payments will not disqualify such allocations.
Q-26. Can property be treated as tax-exempt use property under both
the general rule of section 168(j)(3) and the partnership provisions of
section 168(j)(9)?
A-26. Yes. For example, a tax-exempt entity may be a partner in a
partnership that owns a building 60 percent of which is tax-exempt use
property because it is leased to an unrelated tax-exempt entity under a
25-year lease. The status of the remaining 40 percent depends on whether
or not allocations under the partnership agreement are qualified under
section 168(j)(9). If the allocations are not qualified under section
168(j)(9), the tax-exempt entity's proportionate share (as determined
under section 168(j)(9)(C)) of the remaining 40 percent will be tax-
exempt use property. For example, if the tax-exempt entity's
proportionate share is 30 percent, then 12 percent of the remaining 40
percent (i.e., .30 times .40) is tax-exempt use property and a total of
72 percent of the property (60 percent +12 percent) is tax-exempt use
property.
Effective Date Questions
Q-27. Does an amendment to a lease (or sublease) to a tax-exempt
entity of property which, pursuant to the effective date provisions of
section 31(g) of TRA, is not subject to section 168(j) cause such
property to be subject to the provisions of section 168(j)?
A-27. An amendment to such a lease (or sublease) does not cause such
property to be subject to the provisions of section 168(j) unless the
amendment increases the term of the lease (or sublease). However, if the
amendment increases the amount of property subject to the lease, the
additional property must be tested independently under the effective
date provisions of section 31(g) of TRA. See A-31 for special rules
regarding improvements to property.
Example. On May 1, 1983, X, a taxable entity, and E, a tax-exempt
entity, enter into a lease whereby X will lease to E the top 4 floors of
a ten-story building for a lease term of 25 years. In 1985, the lease is
amended to provide that E will lease an additional floor for the balance
of the lease term. At that time the annual rent due under the lease is
increased. Pursuant to the provisions of section 31(g)(2)(A) of TRA,
section 168(j) does not apply to the lease to E of the top 4 floors of
the building. Assuming that no other provision of section 31(g) of TRA
provides otherwise, the floor added to the lease in 1985 is subject to
the provisions of section 168(j).
Q-28. If property which is not subject to section 168(j) by virtue
of the effective date provisions of section 31(g) of TRA is sold,
subject to the lease to the tax-exempt entity, what are the
consequences?
A-28. Property to which section 168(j) does not apply by virtue of
the effective date provisions set forth in section
[[Page 565]]
31(g) (2), (3), and (4) of TRA will not become subject to section 168(j)
merely by reason of a transfer of the property subject to the lease by
the lessor (or a transfer of the contract to acquire, construct,
reconstruct, or rehabilitate the property), so long as the lessee (or
party obligated to lease) does not change. For purposes of the preceding
sentence, the term ``transfer'' includes the sale-leaseback by a taxable
lessor of its interest in the property, subject to the underlying lease
to the tax-exempt entity. However, if property is transferred to a
partnership or other pass-through entity after the effective date of
section 168(j)(9) (see section 31(g) of TRA), such property is subject
to the provisions of section 168(j)(9).
Q-29. Can property which was leased to a tax-exempt entity after May
23, 1983 and acquired by a partnership before October 22, 1983 be tax-
exempt use property?
A-29. Yes. Because the property was leased to a tax-exempt entity
after May 23, 1983, it may be tax-exempt use property under section
168(j)(3) and section 31(g)(1) of TRA. However, if the partnership
included a tax-exempt entity as a partner, section 168(j)(9) would be
inapplicable under section 31(g)(3)(B) of TRA because the partnership
acquired the property before October 22, 1983.
Q-30. What is a binding contract for purposes of the transitional
rules in section 31(g) of TRA?
A-30. (i) A contract is binding only if it is enforceable under
State law against the taxpayer or a predecessor and does not limit
damages to a specified amount, as for example, by a liquidated damages
provision. A contract that limits damages to an amount equal to at least
5 percent of the total contract price will not be treated as limiting
damages for this purpose. In determining whether a contract limits
damages, the fact that there may be little or no damages because the
contract price does not significantly differ from fair market value will
not be taken into account. For example, if a taxpayer entered into an
irrevocable contract to purchase an asset for $100 and the contract
contained no provision for liquidated damages, the contract is
considered binding notwithstanding the fact that the property had a fair
market value of $99 and under local law the seller would only recover
the difference in the event the purchaser failed to perform. If the
contract provided for a refund of the purchase price in lieu of any
damages allowable by law in the event of breach or cancellation, the
contract is not considered binding.
(ii) A contract is binding even if subject to a condition, so long
as the condition is not within the control of either party or a
predecessor in interest. A contract will not be treated as ceasing to be
binding merely because the parties make insubstantial changes in its
terms or because any term is to be determined by a standard beyond the
control of either party. A contract which imposes significant
obligations on the taxpayer (or a predecessor) will be treated as
binding notwithstanding the fact that insubstantial terms remain to be
negotiated by the parties to the contract.
(iii) A binding contract to acquire a component part of a larger
piece of property will not be treated as a binding contract to acquire
the larger piece of property. For example, if a tax-exempt entity
entered into a binding contract on May 1, 1983 to acquire a new aircraft
engine, there would be a binding contract to acquire only the engine,
not the entire aircraft.
Q-31. If an improvement is made to a property that is
``grandfathered'' (i.e., property that is not subject to section 168(j)
because of the effective date provisions of section 31(g) of TRA), to
what extent will such improvement be grandfathered?
A-31. Section 31(g)(20)(B) provides that a ``substantial
improvement'' to property is treated as a separate property for purposes
of the effective date provisions of section 31(g) of TRA. As a result, a
``substantial improvement'' will not be grandfathered unless such
``substantial improvement'' is grandfathered under a provision other
than section 31(g)(20)(B). A property that is grandfathered will not
become subject to section 168(j) merely because an improvement is made
to such property, regardless of whether the improvement is a
``substantial improvement''. If an improvement other than a
``substantial
[[Page 566]]
improvement'' is made to property (other than land) that is
grandfathered, that improvement also will be grandfathered. The
determination of whether new construction constitutes an improvement to
property or the creation of a new separate property will be based on all
facts and circumstances. Furthermore, any improvement to land will be
treated as a separate property.
Example. On January 3, 1983, T, a taxable entity, entered into a
lease of a parking lot to E, a tax-exempt entity. On January 1, 1985, T
begins construction of a building for use by E on the site of the
parking lot. The building is completed and placed in service in November
1985. The building is treated as a separate property, and is thus
subject to the provisions of section 168(j), unless the building is
grandfathered under a provision other than section 31(g)(20)(B) of TRA.
Q-32. What is ``significant official governmental action'' for
purposes of the section 31(g)(4) transitional rule of TRA?
A-32. (i) ``Significant official governmental action'' involves
three separate requirements. First, the action must be an official
action. Second, the action must be specific action with respect to a
particular project. Third, the action must be taken by a governmental
entity having authority to commit the tax-exempt entity to the project,
to provide funds for it, or to approve the project under State or local
law.
(ii) The first requirement of official action means that the
governing body must adopt a resolution or ordinance, or take similar
official action, on or before November 1, 1983. The action qualifies
only if it conforms with Federal, State, and local law (as applicable)
and is a proper exercise of the powers of the governing body. Moreover,
the action must not have been withdrawn. There must be satisfactory
written evidence of the action that was in existence on or before
November 1, 1983. Satisfactory written evidence includes a formal
resolution or ordinance, minutes of meetings, and binding contracts with
third parties pursuant to which third parties are to render services in
furtherance of the project.
(iii) The second requirement of specific action is directed at the
substance of the action taken. The action must be a specific action with
respect to a particular project in which the governing body indicates an
intent to have the project (or the design work for it) proceed. This
requires that a specific project have been formulated and that the
significant official action be a step toward consummation of the
project. If the action does not relate to a specific project or merely
directs that a proposal or recommendation be formulated, it will not
qualify. The following set of actions with respect to a particular
project constitute specific action: the hiring of bond counsel or bond
underwriters necessary to assist in the issuance and sale of bonds to
finance a particular project or the adoption of an inducement resolution
relating to bonds to be issued for such a project; applying for an Urban
Development Action Grant on behalf of the project described in the
application, receiving such a grant concerning the project, or the
recommendation of a city planning authority to proceed with a project;
the enactment of a State law authorizing the sale, lease, or
construction of the property; the appropriation of funds for the
property or authorization of a feasibility study or a development
services contract with respect to it; the approval of financing
arrangements by a regulatory agency; the enactment of a State law
designed to provide funding for a project; the certification of a
building as a historic structure by a State agency and the Department of
the Interior; or the endorsement of the application for a certification
of need with respect to a medical facility by a regulatory agency other
than the agency empowered to issue such a certificate.
(iv) The third requirement for significant official governmental
action is that the action must be taken by a Federal, State, or local
governing body having authority to commit the tax-exempt entity to the
project, to provide funds for it, or to approve the project under
applicable law.
If the chief executive or another representative of a governing body has
such authority, action by such representative would satisfy the
requirement of this (iv). A governing body may have the authority to
commit the
[[Page 567]]
tax-exempt entity to a project notwithstanding the fact that the project
cannot be consummated without other governmental action being taken. For
example, a city council will be treated as having authority to commit a
city to do a sale-leaseback of its city hall notwithstanding the fact
that State law needs to be amended to permit such a transaction.
Similarly, if a local project cannot be completed without Federal
approval, either legislative or administrative, the obtaining of such
approval satisfies the requirements of this (iv).
(v) Routine governmental action at a local level will not qualify as
significant official governmental action. Routine governmental action
includes the granting of building permits or zoning changes and the
issuance of environmental impact statements.
(vi) In order to qualify under the transitional rule of TRA section
31(g)(4), a sale and leaseback pursuant to a binding contract entered
into before January 1, 1985 must be part of the project as to which
there was significant official governmental action. Except as provided
in the following sentence, where there has been significant official
governmental action on or before November 1, 1983 with respect to the
construction, reconstruction or rehabilitation of a property, the sale
and leaseback of such property pursuant to a binding contract entered
into before January 1, 1985 will be treated as part of the project which
was the subject of the significant official governmental action.
However, if the construction, reconstruction or rehabilitation was
substantially completed prior to January 1, 1983, the sale and leaseback
of such property will be treated as a separate project, unless the sale
and leaseback was contemplated at the time of the significant official
governmental action. Nevertheless, where the sale and leaseback is
treated as a separate project, section 31(g)(4) may apply if there was
significant official governmental action on or before November 1, 1983,
with respect to such sale and leaseback. The application of this
provision is illustrated by the following example:
Example. In the summer of 1927, the Board of Aldermen of City C
passed a resolution authorizing the design and contruction of a new city
hall and appropriated the funds necessary for such project. Construction
was completed in 1928. At the time of the significant official
governmental action, City C had no plan to enter into a sale-leaseback
arrangement with respect to the facility. On December 15, 1984, City C
entered into a binding sale-leaseback arrangement concerning the city
hall. This transaction will not qualify for exclusion from section
168(j) under the section 31(g)(4) of TRA since construction of the
facility in question was substantially completed before January 1, 1983.
If, however, there had been significant official governmental action on
or before November 1, 1983 with respect to the sale-leaseback project,
then the transitional rule of section 31(g)(4) of TRA would apply.
[T.D. 8033, 50 FR 27224, July 2, 1985, as amended by T.D. 8435, 57 FR
43896, Sept. 23, 1992]
Sec. 1.168(k)-0 Table of contents.
This section lists the headings that appear in Sec. 1.168(k)-1.
Sec. 1.168(k)-1 Additional first year depreciation deduction.
(a) Scope and definitions.
(1) Scope.
(2) Definitions.
(b) Qualified property or 50-percent bonus depreciation property.
(1) In general.
(2) Description of qualified property or 50-percent bonus
depreciation property.
(i) In general.
(ii) Property not eligible for additional first year depreciation
deduction.
(A) Property that is not qualified property.
(B) Property that is not 50-percent bonus depreciation property.
(3) Original use.
(i) In general.
(ii) Conversion to business or income-producing use.
(A) Personal use to business or income-producing use.
(B) Inventory to business or income-producing use.
(iii) Sale-leaseback, syndication, and certain other transactions.
(A) Sale-leaseback transaction.
(B) Syndication transaction and certain other transactions.
(C) Sale-leaseback transaction followed by a syndication transaction
and certain other transactions.
(iv) Fractional interests in property.
(v) Examples.
(4) Acquisition of property.
(i) In general.
(A) Qualified property.
(B) 50-percent bonus depreciation property.
(ii) Definition of binding contract.
[[Page 568]]
(A) In general.
(B) Conditions.
(C) Options.
(D) Supply agreements.
(E) Components.
(iii) Self-constructed property.
(A) In general.
(B) When does manufacture, construction, or production begin.
(1) In general.
(2) Safe harbor.
(C) Components of self-constructed property.
(1) Acquired components.
(2) Self-constructed components.
(iv) Disqualified transactions.
(A) In general.
(B) Related party defined.
(v) Examples.
(5) Placed-in-service date.
(i) In general.
(ii) Sale-leaseback, syndication, and certain other transactions.
(A) Sale-leaseback transaction.
(B) Syndication transaction and certain other transactions.
(C) Sale-leaseback transaction followed by a syndication transaction
and certain other transactions.
(iii) Technical termination of a partnership.
(iv) Section 168(i)(7) transactions.
(v) Example.
(c) Qualified leasehold improvement property.
(1) In general.
(2) Certain improvements not included.
(3) Definitions.
(d) Computation of depreciation deduction for qualified property or
50-percent bonus depreciation property.
(1) Additional first year depreciation deduction.
(i) In general.
(ii) Property having a longer production period.
(iii) Alternative minimum tax.
(2) Otherwise allowable depreciation deduction.
(i) In general.
(ii) Alternative minimum tax.
(3) Examples.
(e) Election not to deduct additional first year depreciation.
(1) In general.
(i) Qualified property.
(ii) 50-percent bonus depreciation property.
(2) Definition of class of property.
(3) Time and manner for making election.
(i) Time for making election.
(ii) Manner of making election.
(4) Special rules for 2000 or 2001 returns.
(5) Failure to make election.
(6) Alternative minimum tax.
(7) Revocation.
(i) In general.
(ii) Automatic 6-month extension.
(f) Special rules.
(1) Property placed in service and disposed of in the same taxable
year.
(i) In general.
(ii) Technical termination of a partnership.
(iii) Section 168(i)(7) transactions.
(iv) Examples.
(2) Redetermination of basis.
(i) Increase in basis.
(ii) Decrease in basis.
(iii) Definition.
(iv) Examples.
(3) Section 1245 and 1250 depreciation recapture.
(4) Coordination with section 169.
(5) Like-kind exchanges and involuntary conversions.
(i) Scope.
(ii) Definitions.
(iii) Computation.
(A) In general.
(B) Year of disposition and year of replacement.
(C) Property having a longer production period.
(D) Alternative minimum tax.
(iv) Sale-leasebacks.
(v) Acquired MACRS property or acquired computer software that is
acquired and placed in service before disposition of involuntarily
converted MACRS property or involuntarily converted computer software.
(A) Time of replacement.
(B) Depreciation of acquired MACRS property or acquired computer
software.
(vi) Examples.
(6) Change in use.
(i) Change in use of depreciable property.
(ii) Conversion to personal use.
(iii) Conversion to business or income-producing use.
(A) During the same taxable year.
(B) Subsequent to the acquisition year.
(iv) Depreciable property changes use subsequent to the placed-in-
service year.
(v) Examples.
(7) Earnings and profits.
(8) Limitation of amount of depreciation for certain passenger
automobiles.
(9) Section 754 election.
(10) Coordination with section 47.
(11) Coordination with section 514(a)(3).
(g) Effective date.
(1) In general.
(2) Technical termination of a partnership or section 168(i)(7)
transactions.
(3) Like-kind exchanges and involuntary conversions.
(4) Change in method of accounting.
(i) Special rules for 2000 or 2001 returns.
(ii) Like-kind exchanges and involuntary conversions.
(5) Revisions to paragraphs (b)(3)(ii)(B) and (b)(5)(ii)(B).
[[Page 569]]
(6) Rehabilitation credit.
[T.D. 9091, 68 FR 52991, Sept. 8, 2003. Redesignated and amended by T.D.
9283, 71 FR 51738, Aug. 31, 2006]
Sec. 1.168(k)-1 Additional first year depreciation deduction.
(a) Scope and definitions--(1) Scope. This section provides the
rules for determining the 30-percent additional first year depreciation
deduction allowable under section 168(k)(1) for qualified property and
the 50-percent additional first year depreciation deduction allowable
under section 168(k)(4) for 50-percent bonus depreciation property.
(2) Definitions. For purposes of section 168(k) and this section,
the following definitions apply:
(i) Depreciable property is property that is of a character subject
to the allowance for depreciation as determined under section 167 and
the regulations thereunder.
(ii) MACRS property is tangible, depreciable property that is placed
in service after December 31, 1986 (or after July 31, 1986, if the
taxpayer made an election under section 203(a)(1)(B) of the Tax Reform
Act of 1986; 100 Stat. 2143) and subject to section 168, except for
property excluded from the application of section 168 as a result of
section 168(f) or as a result of a transitional rule.
(iii) Unadjusted depreciable basis is the basis of property for
purposes of section 1011 without regard to any adjustments described in
section 1016(a)(2) and (3). This basis reflects the reduction in basis
for the percentage of the taxpayer's use of property for the taxable
year other than in the taxpayer's trade or business (or for the
production of income), for any portion of the basis the taxpayer
properly elects to treat as an expense under section 179 or section
179C, and for any adjustments to basis provided by other provisions of
the Internal Revenue Code and the regulations thereunder (other than
section 1016(a)(2) and (3)) (for example, a reduction in basis by the
amount of the disabled access credit pursuant to section 44(d)(7)). For
property subject to a lease, see section 167(c)(2).
(iv) Adjusted depreciable basis is the unadjusted depreciable basis
of the property, as defined in Sec. 1.168(k)-1(a)(2)(iii), less the
adjustments described in section 1016(a)(2) and (3).
(b) Qualified property or 50-percent bonus depreciation property--
(1) In general. Qualified property or 50-percent bonus depreciation
property is depreciable property that meets all the following
requirements in the first taxable year in which the property is subject
to depreciation by the taxpayer whether or not depreciation deductions
for the property are allowable:
(i) The requirements in Sec. 1.168(k)-1(b)(2) (description of
property);
(ii) The requirements in Sec. 1.168(k)-1(b)(3) (original use);
(iii) The requirements in Sec. 1.168(k)-1(b)(4) (acquisition of
property); and
(iv) The requirements in Sec. 1.168(k)-1(b)(5) (placed-in-service
date).
(2) Description of qualified property or 50-percent bonus
depreciation property--(i) In general. Depreciable property will meet
the requirements of this paragraph (b)(2) if the property is--
(A) MACRS property (as defined in Sec. 1.168(k)-1(a)(2)(ii)) that
has a recovery period of 20 years or less. For purposes of this
paragraph (b)(2)(i)(A) and section 168(k)(2)(B)(i)(II) and 168(k)(4)(C),
the recovery period is determined in accordance with section 168(c)
regardless of any election made by the taxpayer under section 168(g)(7);
(B) Computer software as defined in, and depreciated under, section
167(f)(1) and the regulations thereunder;
(C) Water utility property as defined in section 168(e)(5) and
depreciated under section 168; or
(D) Qualified leasehold improvement property as defined in paragraph
(c) of this section and depreciated under section 168.
(ii) Property not eligible for additional first year depreciation
deduction--(A) Property that is not qualified property. For purposes of
the 30-percent additional first year depreciation deduction, depreciable
property will not meet the requirements of this paragraph (b)(2) if the
property is--
(1) Described in section 168(f);
(2) Required to be depreciated under the alternative depreciation
system of section 168(g) pursuant to section 168(g)(1)(A) through (D) or
other provisions of the Internal Revenue Code (for
[[Page 570]]
example, property described in section 263A(e)(2)(A) if the taxpayer (or
any related person as defined in section 263A(e)(2)(B)) has made an
election under section 263A(d)(3), or property described in section
280F(b)(1)).
(3) Included in any class of property for which the taxpayer elects
not to deduct the 30-percent additional first year depreciation (for
further guidance, see paragraph (e) of this section); or
(4) Qualified New York Liberty Zone leasehold improvement property
as defined in section 1400L(c)(2).
(B) Property that is not 50-percent bonus depreciation property. For
purposes of the 50-percent additional first year depreciation deduction,
depreciable property will not meet the requirements of this paragraph
(b)(2) if the property is--
(1) Described in paragraph (b)(2)(ii)(A)(1), (2), or (4) of this
section; or
(2) Included in any class of property for which the taxpayer elects
the 30-percent, instead of the 50-percent, additional first year
depreciation deduction or elects not to deduct any additional first year
depreciation (for further guidance, see paragraph (e) of this section).
(3) Original use--(i) In general. For purposes of the 30-percent
additional first year depreciation deduction, depreciable property will
meet the requirements of this paragraph (b)(3) if the original use of
the property commences with the taxpayer after September 10, 2001. For
purposes of the 50-percent additional first year depreciation deduction,
depreciable property will meet the requirements of this paragraph (b)(3)
if the original use of the property commences with the taxpayer after
May 5, 2003. Except as provided in paragraphs (b)(3)(iii) and (iv) of
this section, original use means the first use to which the property is
put, whether or not that use corresponds to the use of the property by
the taxpayer. Thus, additional capital expenditures incurred by a
taxpayer to recondition or rebuild property acquired or owned by the
taxpayer satisfies the original use requirement. However, the cost of
reconditioned or rebuilt property does not satisfy the original use
requirement. The question of whether property is reconditioned or
rebuilt property is a question of fact. For purposes of this paragraph
(b)(3)(i), property that contains used parts will not be treated as
reconditioned or rebuilt if the cost of the used parts is not more than
20 percent of the total cost of the property, whether acquired or self-
constructed.
(ii) Conversion to business or income-producing use--(A) Personal
use to business or income-producing use. If a taxpayer initially
acquires new property for personal use and subsequently uses the
property in the taxpayer's trade or business or for the taxpayer's
production of income, the taxpayer is considered the original user of
the property. If a person initially acquires new property for personal
use and a taxpayer subsequently acquires the property from the person
for use in the taxpayer's trade or business or for the taxpayer's
production of income, the taxpayer is not considered the original user
of the property.
(B) Inventory to business or income-producing use. If a taxpayer
initially acquires new property and holds the property primarily for
sale to customers in the ordinary course of the taxpayer's business and
subsequently withdraws the property from inventory and uses the property
primarily in the taxpayer's trade or business or primarily for the
taxpayer's production of income, the taxpayer is considered the original
user of the property. If a person initially acquires new property and
holds the property primarily for sale to customers in the ordinary
course of the person's business and a taxpayer subsequently acquires the
property from the person for use primarily in the taxpayer's trade or
business or primarily for the taxpayer's production of income, the
taxpayer is considered the original user of the property. For purposes
of this paragraph (b)(3)(ii)(B), the original use of the property by the
taxpayer commences on the date on which the taxpayer uses the property
primarily in the taxpayer's trade or business or primarily for the
taxpayer's production of income.
(iii) Sale-leaseback, syndication, and certain other transactions--
(A) Sale-leaseback transaction. If new property is
[[Page 571]]
originally placed in service by a person after September 10, 2001 (for
qualified property), or after May 5, 2003 (for 50-percent bonus
depreciation property), and is sold to a taxpayer and leased back to the
person by the taxpayer within three months after the date the property
was originally placed in service by the person, the taxpayer-lessor is
considered the original user of the property.
(B) Syndication transaction and certain other transactions. If new
property is originally placed in service by a lessor (including by
operation of paragraph (b)(5)(ii)(A) of this section) after September
10, 2001 (for qualified property), or after May 5, 2003 (for 50-percent
bonus depreciation property), and is sold by the lessor or any
subsequent purchaser within three months after the date the property was
originally placed in service by the lessor (or, in the case of multiple
units of property subject to the same lease, within three months after
the date the final unit is placed in service, so long as the period
between the time the first unit is placed in service and the time the
last unit is placed in service does not exceed 12 months), and the user
of the property after the last sale during the three-month period
remains the same as when the property was originally placed in service
by the lessor, the purchaser of the property in the last sale during the
three-month period is considered the original user of the property.
(C) Sale-leaseback transaction followed by a syndication transaction
and certain other transactions. If a sale-leaseback transaction that
satisfies the requirements in paragraph (b)(3)(iii)(A) of this section
is followed by a transaction that satisfies the requirements in
paragraph (b)(3)(iii)(B) of this section, the original user of the
property is determined in accordance with paragraph (b)(3)(iii)(B) of
this section.
(iv) Fractional interests in property. If, in the ordinary course of
its business, a taxpayer sells fractional interests in property to third
parties unrelated to the taxpayer, each first fractional owner of the
property is considered as the original user of its proportionate share
of the property. Furthermore, if the taxpayer uses the property before
all of the fractional interests of the property are sold but the
property continues to be held primarily for sale by the taxpayer, the
original use of any fractional interest sold to a third party unrelated
to the taxpayer subsequent to the taxpayer's use of the property begins
with the first purchaser of that fractional interest. For purposes of
this paragraph (b)(3)(iv), persons are not related if they do not have a
relationship described in section 267(b) or 707(b) and the regulations
thereunder.
(v) Examples. The application of this paragraph (b)(3) is
illustrated by the following examples:
Example 1. On August 1, 2002, A buys from B for $20,000 a machine
that has been previously used by B in B's trade or business. On March 1,
2003, A makes a $5,000 capital expenditure to recondition the machine.
The $20,000 purchase price does not qualify for the additional first
year depreciation deduction because the original use requirement of this
paragraph (b)(3) is not met. However, the $5,000 expenditure satisfies
the original use requirement of this paragraph (b)(3) and, assuming all
other requirements are met, qualifies for the 30-percent additional
first year depreciation deduction, regardless of whether the $5,000 is
added to the basis of the machine or is capitalized as a separate asset.
Example 2. C, an automobile dealer, uses some of its automobiles as
demonstrators in order to show them to prospective customers. The
automobiles that are used as demonstrators by C are held by C primarily
for sale to customers in the ordinary course of its business. On
September 1, 2002, D buys from C an automobile that was previously used
as a demonstrator by C. D will use the automobile solely for business
purposes. The use of the automobile by C as a demonstrator does not
constitute a ``use'' for purposes of the original use requirement and,
therefore, D will be considered the original user of the automobile for
purposes of this paragraph (b)(3). Assuming all other requirements are
met, D's purchase price of the automobile qualifies for the 30-percent
additional first year depreciation deduction for D, subject to any
limitation under section 280F.
Example 3. On April 1, 2000, E acquires a horse to be used in E's
thoroughbred racing business. On October 1, 2003, F buys the horse from
E and will use the horse in F's horse breeding business. The use of the
horse by E in its racing business prevents the original use of the horse
from commencing with F. Thus, F's purchase price of the horse does not
qualify for the additional first year depreciation deduction.
[[Page 572]]
Example 4. In the ordinary course of its business, G sells
fractional interests in its aircraft to unrelated parties. G holds out
for sale eight equal fractional interests in an aircraft. On January 1,
2003, G sells five of the eight fractional interests in the aircraft to
H, an unrelated party, and H begins to use its proportionate share of
the aircraft immediately upon purchase. On June 1, 2003, G sells to I,
an unrelated party to G, the remaining unsold \3/8\ fractional interests
in the aircraft. H is considered the original user as to its \5/8\
fractional interest in the aircraft and I is considered the original
user as to its \3/8\ fractional interest in the aircraft. Thus, assuming
all other requirements are met, H's purchase price for its \5/8\
fractional interest in the aircraft qualifies for the 30-percent
additional first year depreciation deduction and I's purchase price for
its \3/8\ fractional interest in the aircraft qualifies for the 50-
percent additional first year depreciation deduction.
Example 5. On September 1, 2001, JJ, an equipment dealer, buys new
tractors that are held by JJ primarily for sale to customers in the
ordinary course of its business. On October 15, 2001, JJ withdraws the
tractors from inventory and begins to use the tractors primarily for
producing rental income. The holding of the tractors by JJ as inventory
does not constitute a ``use'' for purposes of the original use
requirement and, therefore, the original use of the tractors commences
with JJ on October 15, 2001, for purposes of paragraph (b)(3) of this
section. However, the tractors are not eligible for the additional first
year depreciation deduction because JJ acquired the tractors before
September 11, 2001.
(4) Acquisition of property--(i) In general--(A) Qualified property.
For purposes of the 30-percent additional first year depreciation
deduction, depreciable property will meet the requirements of this
paragraph (b)(4) if the property is--
(1) Acquired by the taxpayer after September 10, 2001, and before
January 1, 2005, but only if no written binding contract for the
acquisition of the property was in effect before September 11, 2001; or
(2) Acquired by the taxpayer pursuant to a written binding contract
that was entered into after September 10, 2001, and before January 1,
2005.
(B) 50-percent bonus depreciation property. For purposes of the 50-
percent additional first year depreciation deduction, depreciable
property will meet the requirements of this paragraph (b)(4) if the
property is--
(1) Acquired by the taxpayer after May 5, 2003, and before January
1, 2005, but only if no written binding contract for the acquisition of
the property was in effect before May 6, 2003; or
(2) Acquired by the taxpayer pursuant to a written binding contract
that was entered into after May 5, 2003, and before January 1, 2005.
(ii) Definition of binding contract--(A) In general. A contract is
binding only if it is enforceable under State law against the taxpayer
or a predecessor, and does not limit damages to a specified amount (for
example, by use of a liquidated damages provision). For this purpose, a
contractual provision that limits damages to an amount equal to at least
5 percent of the total contract price will not be treated as limiting
damages to a specified amount. In determining whether a contract limits
damages, the fact that there may be little or no damages because the
contract price does not significantly differ from fair market value will
not be taken into account. For example, if a taxpayer entered into an
irrevocable written contract to purchase an asset for $100 and the
contract contained no provision for liquidated damages, the contract is
considered binding notwithstanding the fact that the asset had a fair
market value of $99 and under local law the seller would only recover
the difference in the event the purchaser failed to perform. If the
contract provided for a full refund of the purchase price in lieu of any
damages allowable by law in the event of breach or cancellation, the
contract is not considered binding.
(B) Conditions. A contract is binding even if subject to a
condition, as long as the condition is not within the control of either
party or a predecessor. A contract will continue to be binding if the
parties make insubstantial changes in its terms and conditions or
because any term is to be determined by a standard beyond the control of
either party. A contract that imposes significant obligations on the
taxpayer or a predecessor will be treated as binding notwithstanding the
fact that certain terms remain to be negotiated by the parties to the
contract.
[[Page 573]]
(C) Options. An option to either acquire or sell property is not a
binding contract.
(D) Supply agreements. A binding contract does not include a supply
or similar agreement if the amount and design specifications of the
property to be purchased have not been specified. The contract will not
be a binding contract for the property to be purchased until both the
amount and the design specifications are specified. For example, if the
provisions of a supply or similar agreement state the design
specifications of the property to be purchased, a purchase order under
the agreement for a specific number of assets is treated as a binding
contract.
(E) Components. A binding contract to acquire one or more components
of a larger property will not be treated as a binding contract to
acquire the larger property. If a binding contract to acquire the
component does not satisfy the requirements of this paragraph (b)(4),
the component does not qualify for the 30-percent or 50-percent
additional first year depreciation deduction, as applicable.
(iii) Self-constructed property--(A) In general. If a taxpayer
manufactures, constructs, or produces property for use by the taxpayer
in its trade or business (or for its production of income), the
acquisition rules in paragraph (b)(4)(i) of this section are treated as
met for qualified property if the taxpayer begins manufacturing,
constructing, or producing the property after September 10, 2001, and
before January 1, 2005, and for 50-percent bonus depreciation property
if the taxpayer begins manufacturing, constructing, or producing the
property after May 5, 2003, and before January 1, 2005. Property that is
manufactured, constructed, or produced for the taxpayer by another
person under a written binding contract (as defined in paragraph
(b)(4)(ii) of this section) that is entered into prior to the
manufacture, construction, or production of the property for use by the
taxpayer in its trade or business (or for its production of income) is
considered to be manufactured, constructed, or produced by the taxpayer.
If a taxpayer enters into a written binding contract (as defined in
paragraph (b)(4)(ii) of this section) after September 10, 2001, and
before January 1, 2005, with another person to manufacture, construct,
or produce property described in section 168(k)(2)(B) (longer production
period property) or section 168(k)(2)(C) (certain aircraft) and the
manufacture, construction, or production of this property begins after
December 31, 2004, the acquisition rule in paragraph (b)(4)(i)(A)(2) or
(b)(4)(i)(B)(2) of this section is met.
(B) When does manufacture, construction, or production begin--(1) In
general. For purposes of paragraph (b)(4)(iii) of this section,
manufacture, construction, or production of property begins when
physical work of a significant nature begins. Physical work does not
include preliminary activities such as planning or designing, securing
financing, exploring, or researching. The determination of when physical
work of a significant nature begins depends on the facts and
circumstances. For example, if a retail motor fuels outlet or other
facility is to be constructed on-site, construction begins when physical
work of a significant nature commences at the site; that is, when work
begins on the excavation for footings, pouring the pads for the outlet,
or the driving of foundation pilings into the ground. Preliminary work,
such as clearing a site, test drilling to determine soil condition, or
excavation to change the contour of the land (as distinguished from
excavation for footings) does not constitute the beginning of
construction. However, if a retail motor fuels outlet or other facility
is to be assembled on-site from modular units manufactured off-site and
delivered to the site where the outlet will be used, manufacturing
begins when physical work of a significant nature commences at the off-
site location.
(2) Safe harbor. For purposes of paragraph (b)(4)(iii)(B)(1) of this
section, a taxpayer may choose to determine when physical work of a
significant nature begins in accordance with this paragraph
(b)(4)(iii)(B)(2). Physical work of a significant nature will not be
considered to begin before the taxpayer incurs (in the case of an
accrual basis taxpayer) or pays (in the case of a cash basis taxpayer)
more than 10 percent of
[[Page 574]]
the total cost of the property (excluding the cost of any land and
preliminary activities such as planning or designing, securing
financing, exploring, or researching). When property is manufactured,
constructed, or produced for the taxpayer by another person, this safe
harbor test must be satisfied by the taxpayer. For example, if a retail
motor fuels outlet or other facility is to be constructed for an accrual
basis taxpayer by another person for the total cost of $200,000
(excluding the cost of any land and preliminary activities such as
planning or designing, securing financing, exploring, or researching),
construction is deemed to begin for purposes of this paragraph
(b)(4)(iii)(B)(2) when the taxpayer has incurred more than 10 percent
(more than $20,000) of the total cost of the property. A taxpayer
chooses to apply this paragraph (b)(4)(iii)(B)(2) by filing an income
tax return for the placed-in-service year of the property that
determines when physical work of a significant nature begins consistent
with this paragraph (b)(4)(iii)(B)(2).
(C) Components of self-constructed property--(1) Acquired
components. If a binding contract (as defined in paragraph (b)(4)(ii) of
this section) to acquire a component does not satisfy the requirements
of paragraph (b)(4)(i) of this section, the component does not qualify
for the 30-percent or 50-percent additional first year depreciation
deduction, as applicable. A binding contract (as defined in paragraph
(b)(4)(ii) of this section) to acquire one or more components of a
larger self-constructed property will not preclude the larger self-
constructed property from satisfying the acquisition rules in paragraph
(b)(4)(iii)(A) of this section. Accordingly, the unadjusted depreciable
basis of the larger self-constructed property that is eligible for the
30-percent or 50-percent additional first year depreciation deduction,
as applicable (assuming all other requirements are met), must not
include the unadjusted depreciable basis of any component that does not
satisfy the requirements of paragraph (b)(4)(i) of this section. If the
manufacture, construction, or production of the larger self-constructed
property begins before September 11, 2001, for qualified property, or
before May 6, 2003, for 50-percent bonus depreciation property, the
larger self-constructed property and any acquired components related to
the larger self-constructed property do not qualify for the 30-percent
or 50-percent additional first year depreciation deduction, as
applicable. If a binding contract to acquire the component is entered
into after September 10, 2001, for qualified property, or after May 5,
2003, for 50-percent bonus depreciation property, and before January 1,
2005, but the manufacture, construction, or production of the larger
self-constructed property does not begin before January 1, 2005, the
component qualifies for the additional first year depreciation deduction
(assuming all other requirements are met) but the larger self-
constructed property does not.
(2) Self-constructed components. If the manufacture, construction,
or production of a component does not satisfy the requirements of
paragraph (b)(4)(iii)(A) of this section, the component does not qualify
for the 30-percent or 50-percent additional first year depreciation
deduction, as applicable. However, if the manufacture, construction, or
production of a component does not satisfy the requirements of paragraph
(b)(4)(iii)(A) of this section, but the manufacture, construction, or
production of the larger self-constructed property satisfies the
requirements of paragraph (b)(4)(iii)(A) of this section, the larger
self-constructed property qualifies for the 30-percent or 50-percent
additional first year depreciation deduction, as applicable (assuming
all other requirements are met) even though the component does not
qualify for the 30-percent or 50-percent additional first year
depreciation deduction. Accordingly, the unadjusted depreciable basis of
the larger self-constructed property that is eligible for the 30-percent
or 50-percent additional first year depreciation deduction, as
applicable (assuming all other requirements are met), must not include
the unadjusted depreciable basis of any component that does not qualify
for the 30-percent or 50-percent additional first year depreciation
deduction. If the manufacture, construction, or production of the larger
self-constructed property began before September 11, 2001,
[[Page 575]]
for qualified property, or before May 6, 2003, for 50-percent bonus
depreciation property, the larger self-constructed property and any
self-constructed components related to the larger self-constructed
property do not qualify for the 30-percent or 50-percent additional
first year depreciation deduction, as applicable. If the manufacture,
construction, or production of a component begins after September 10,
2001, for qualified property, or after May 5, 2003, for 50-percent bonus
depreciation property, and before January 1, 2005, but the manufacture,
construction, or production of the larger self-constructed property does
not begin before January 1, 2005, the component qualifies for the
additional first year depreciation deduction (assuming all other
requirements are met) but the larger self-constructed property does not.
(iv) Disqualified transactions--(A) In general. Property does not
satisfy the requirements of this paragraph (b)(4) if the user of the
property as of the date on which the property was originally placed in
service (including by operation of paragraphs (b)(5)(ii), (iii), and
(iv) of this section), or a related party to the user or to the
taxpayer, acquired, or had a written binding contract (as defined in
paragraph (b)(4)(ii) of this section) in effect for the acquisition of
the property at any time before September 11, 2001 (for qualified
property), or before May 6, 2003 (for 50-percent bonus depreciation
property). In addition, property manufactured, constructed, or produced
for the use by the user of the property or by a related party to the
user or to the taxpayer does not satisfy the requirements of this
paragraph (b)(4) if the manufacture, construction, or production of the
property for the user or the related party began at any time before
September 11, 2001 (for qualified property), or before May 6, 2003 (for
50-percent bonus depreciation property).
(B) Related party defined. For purposes of this paragraph
(b)(4)(iv), persons are related if they have a relationship specified in
section 267(b) or 707(b) and the regulations thereunder.
(v) Examples. The application of this paragraph (b)(4) is
illustrated by the following examples:
Example 1. On September 1, 2001, J, a corporation, entered into a
written agreement with K, a manufacturer, to purchase 20 new lamps for
$100 each within the next two years. Although the agreement specifies
the number of lamps to be purchased, the agreement does not specify the
design of the lamps to be purchased. Accordingly, the agreement is not a
binding contract pursuant to paragraph (b)(4)(ii)(D) of this section.
Example 2. Same facts as Example 1. On December 1, 2001, J placed a
purchase order with K to purchase 20 new model XPC5 lamps for $100 each
for a total amount of $2,000. Because the agreement specifies the number
of lamps to be purchased and the purchase order specifies the design of
the lamps to be purchased, the purchase order placed by J with K on
December 1, 2001, is a binding contract pursuant to paragraph
(b)(4)(ii)(D) of this section. Accordingly, the cost of the 20 lamps
qualifies for the 30-percent additional first year depreciation
deduction.
Example 3. Same facts as Example 1 except that the written agreement
between J and K is to purchase 100 model XPC5 lamps for $100 each within
the next two years. Because this agreement specifies the amount and
design of the lamps to be purchased, the agreement is a binding contract
pursuant to paragraph (b)(4)(ii)(D) of this section. Accordingly,
because the agreement was entered into before September 11, 2001, any
lamp acquired by J under this contract does not qualify for the
additional first year depreciation deduction.
Example 4. On September 1, 2001, L began constructing an electric
generation power plant for its own use. On November 1, 2002, L ceases
construction of the power plant prior to its completion. Between
September 1, 2001, and November 1, 2002, L incurred $3,000,000 for the
construction of the power plant. On May 6, 2003, L resumed construction
of the power plant and completed its construction on August 31, 2003.
Between May 6, 2003, and August 31, 2003, L incurred another $1,600,000
to complete the construction of the power plant and, on September 1,
2003, L placed the power plant in service. None of L's total
expenditures of $4,600,000 qualify for the additional first year
depreciation deduction because, pursuant to paragraph (b)(4)(iii)(A) of
this section, L began constructing the power plant before September 11,
2001.
Example 5. Same facts as Example 4 except that L began constructing
the electric generation power plant for its own use on October 1, 2001.
L's total expenditures of $4,600,000 qualify for the additional first
year depreciation deduction because, pursuant to paragraph
(b)(4)(iii)(A) of this section, L began constructing the power plant
after September 10, 2001, and placed the power plant in service before
January 1, 2005. Accordingly, the additional first year depreciation
deduction for the power plant will be
[[Page 576]]
$1,380,000, computed as $4,600,000 multiplied by 30 percent.
Example 6. On August 1, 2001, M entered into a written binding
contract to acquire a new turbine. The new turbine is a component part
of a new electric generation power plant that is being constructed on
M's behalf. The construction of the new electric generation power plant
commenced in November 2001, and the new electric generation power plant
was completed in November 2002. Because M entered into a written binding
contract to acquire a component part (the new turbine) prior to
September 11, 2001, pursuant to paragraph (b)(4)(iii)(C) of this
section, the component part does not qualify for the additional first
year depreciation deduction. However, pursuant to paragraphs
(b)(4)(iii)(A) and (C) of this section, the new plant constructed for M
will qualify for the 30-percent additional first year depreciation
deduction because construction of the new plant began after September
10, 2001, and before May 6, 2003. Accordingly, the unadjusted
depreciable basis of the new plant that is eligible for the 30-percent
additional first year depreciation deduction must not include the
unadjusted depreciable basis of the new turbine.
Example 7. Same facts as Example 6 except that M entered into the
written binding contract to acquire the new turbine on September 30,
2002, and construction of the new plant commenced on August 1, 2001.
Because M began construction of the new plant prior to September 11,
2001, pursuant to paragraphs (b)(4)(iii)(A) and (C) of this section,
neither the new plant constructed for M nor the turbine will qualify for
the additional first year depreciation deduction because self-
construction of the new plant began prior to September 11, 2001.
Example 8. On September 1, 2001, N began constructing property for
its own use. On October 1, 2001, N sold its rights to the property to O,
a related party under section 267(b). Pursuant to paragraph (b)(4)(iv)
of this section, the property is not eligible for the additional first
year depreciation deduction because N and O are related parties and
construction of the property by N began prior to September 11, 2001.
Example 9. On September 1, 2001, P entered into a written binding
contract to acquire property. On October 1, 2001, P sold its rights to
the property to Q, a related party under section 267(b). Pursuant to
paragraph (b)(4)(iv) of this section, the property is not eligible for
the additional first year depreciation deduction because P and Q are
related parties and a written binding contract for the acquisition of
the property was in effect prior to September 11, 2001.
Example 10. Prior to September 11, 2001, R began constructing an
electric generation power plant for its own use. On May 1, 2003, prior
to the completion of the power plant, R transferred the rights to own
and use this power plant to S, an unrelated party, for $6,000,000.
Between May 6, 2003, and June 30, 2003, S, a calendar-year taxpayer,
began construction, and incurred another $1,200,000 to complete the
construction, of the power plant and, on August 1, 2003, S placed the
power plant in service. Because R and S are not related parties, the
transaction between R and S will not be a disqualified transaction
pursuant to paragraph (b)(4)(iv) of this section. Accordingly, S's total
expenditures of $7,200,000 for the power plant qualify for the
additional first year depreciation deduction. S's additional first year
depreciation deduction for the power plant will be $2,400,000, computed
as $6,000,000 multiplied by 30 percent, plus $1,200,000 multiplied by 50
percent. The $6,000,000 portion of the total $7,200,000 unadjusted
depreciable basis qualifies for the 30-percent additional first year
depreciation deduction because that portion of the total unadjusted
depreciable basis was acquired by S after September 10, 2001, and before
May 6, 2003. However, because S began construction to complete the power
plant after May 5, 2003, the $1,200,000 portion of the total $7,200,000
unadjusted depreciable basis qualifies for the 50-percent additional
first year depreciation deduction.
Example 11. On September 1, 2001, T acquired and placed in service
equipment. On October 15, 2001, T sells the equipment to U, an unrelated
party, and leases the property back from U in a sale-leaseback
transaction. Pursuant to paragraph (b)(4)(iv) of this section, the
equipment does not qualify for the additional first year depreciation
deduction because T, the user of the equipment, acquired the equipment
prior to September 11, 2001. In addition, the sale-leaseback rules in
paragraphs (b)(3)(iii)(A) and (b)(5)(ii)(A) of this section do not apply
because the equipment was originally placed in service by T before
September 11, 2001.
Example 12. On July 1, 2001, KK began constructing property for its
own use. KK placed this property in service on September 15, 2001. On
October 15, 2001, KK sells the property to LL, an unrelated party, and
leases the property back from LL in a sale-leaseback transaction.
Pursuant to paragraph (b)(4)(iv) of this section, the property does not
qualify for the additional first year depreciation deduction because the
property was constructed for KK, the user of the property, and that
construction began prior to September 11, 2001.
Example 13. On June 1, 2004, MM decided to construct property
described in section 168(k)(2)(B) for its own use. However, one of the
component parts of the property had to be manufactured by another person
for MM. On August 15, 2004, MM entered into a written binding contract
with NN to acquire this component part of the property for $100,000. The
manufacture of the component part
[[Page 577]]
commenced on September 1, 2004, and MM received the completed component
part on February 1, 2005. The cost of this component part is 9 percent
of the total cost of the property to be constructed by MM. MM began
constructing the property described in section 168(k)(2)(B) on January
15, 2005, and placed this property (including all component parts) in
service on November 1, 2005. Pursuant to paragraph (b)(4)(iii)(C)(2) of
this section, the self-constructed component part of $100,000
manufactured by NN for MM is eligible for the additional first year
depreciation deduction (assuming all other requirements are met) because
the manufacturing of the component part began after September 10, 2001,
and before January 1, 2005, and the property described in section
168(k)(2)(B), the larger self-constructed property, was placed in
service by MM before January 1, 2006. However, pursuant to paragraph
(b)(4)(iii)(A) of this section, the cost of the property described in
section 168(k)(2)(B) (excluding the cost of the self-constructed
component part of $100,000 manufactured by NN for MM) is not eligible
for the additional first year depreciation deduction because
construction of the property began after December 31, 2004.
Example 14. On December 1, 2004, OO entered into a written binding
contract (as defined in paragraph (b)(4)(ii) of this section) with PP to
manufacture an aircraft described in section 168(k)(2)(C) for use in
OO's trade or business. PP begins to manufacture the aircraft on
February 1, 2005. OO places the aircraft in service on August 1, 2005.
Pursuant to paragraph (b)(4)(iii)(A) of this section, the aircraft meets
the requirements of paragraph (b)(4)(i)(B)(2) of this section because
the aircraft was acquired by OO pursuant to a written binding contract
entered into after May 5, 2003, and before January 1, 2005.
(5) Placed-in-service date--(i) In general. Depreciable property
will meet the requirements of this paragraph (b)(5) if the property is
placed in service by the taxpayer for use in its trade or business or
for production of income before January 1, 2005, or, in the case of
property described in section 168(k)(2)(B) or (C), is placed in service
by the taxpayer for use in its trade or business or for production of
income before January 1, 2006 (or placed in service by the taxpayer for
use in its trade or business or for production of income before January
1, 2007, in the case of property described in section 168(k)(2)(B) or
(C) to which section 105 of the Gulf Opportunity Zone Act of 2005 (Pub.
L. 109-135, 119 Stat. 2577) applies (for further guidance, see
Announcement 2006-29 (2006-19 I.R.B. 879) and Sec. 601.601(d)(2)(ii)(b)
of this chapter)).
(ii) Sale-leaseback, syndication, and certain other transactions--
(A) Sale-leaseback transaction. If qualified property is originally
placed in service after September 10, 2001, or 50-percent bonus
depreciation property is originally placed in service after May 5, 2003,
by a person and sold to a taxpayer and leased back to the person by the
taxpayer within three months after the date the property was originally
placed in service by the person, the property is treated as originally
placed in service by the taxpayer-lessor not earlier than the date on
which the property is used by the lessee under the leaseback.
(B) Syndication transaction and certain other transactions. If
qualified property is originally placed in service after September 10,
2001, or 50-percent bonus depreciation property is originally placed in
service after May 5, 2003, by a lessor (including by operation of
paragraph (b)(5)(ii)(A) of this section) and is sold by the lessor or
any subsequent purchaser within three months after the date the property
was originally placed in service by the lessor (or, in the case of
multiple units of property subject to the same lease, within three
months after the date the final unit is placed in service, so long as
the period between the time the first unit is placed in service and the
time the last unit is placed in service does not exceed 12 months), and
the user of the property after the last sale during this three-month
period remains the same as when the property was originally placed in
service by the lessor, the property is treated as originally placed in
service by the purchaser of the property in the last sale during the
three-month period but not earlier than the date of the last sale.
(C) Sale-leaseback transaction followed by a syndication transaction
and certain other transactions. If a sale-leaseback transaction that
satisfies the requirements in paragraph (b)(5)(ii)(A) of this section is
followed by a transaction that satisfies the requirements in paragraph
(b)(5)(ii)(B) of this section, the placed-in-service date of the
property is determined in accordance with paragraph (b)(5)(ii)(B) of
this section.
[[Page 578]]
(iii) Technical termination of a partnership. For purposes of this
paragraph (b)(5), in the case of a technical termination of a
partnership under section 708(b)(1)(B), qualified property or 50-percent
bonus depreciation property placed in service by the terminated
partnership during the taxable year of termination is treated as
originally placed in service by the new partnership on the date the
qualified property or the 50-percent bonus depreciation property is
contributed by the terminated partnership to the new partnership.
(iv) Section 168(i)(7) transactions. For purposes of this paragraph
(b)(5), if qualified property or 50-percent bonus depreciation property
is transferred in a transaction described in section 168(i)(7) in the
same taxable year that the qualified property or the 50-percent bonus
depreciation property is placed in service by the transferor, the
transferred property is treated as originally placed in service on the
date the transferor placed in service the qualified property or the 50-
percent bonus depreciation property, as applicable. In the case of
multiple transfers of qualified property or 50-percent bonus
depreciation property in multiple transactions described in section
168(i)(7) in the same taxable year, the placed in service date of the
transferred property is deemed to be the date on which the first
transferor placed in service the qualified property or the 50-percent
bonus depreciation property, as applicable.
(v) Example. The application of this paragraph (b)(5) is illustrated
by the following example:
Example. On September 15, 2004, QQ acquired and placed in service
new equipment. This equipment is not described in section 168(k)(2)(B)
or (C). On December 1, 2004, QQ sells the equipment to RR and leases the
equipment back from RR in a sale-leaseback transaction. On February 15,
2005, RR sells the equipment to TT subject to the lease with QQ. As of
February 15, 2005, QQ is still the user of the equipment. The sale-
leaseback transaction of December 1, 2004, between QQ and RR satisfies
the requirements of paragraph (b)(5)(ii)(A) of this section. The sale
transaction of February 15, 2005, between RR and TT satisfies the
requirements of paragraph (b)(5)(ii)(B) of this section. Consequently,
pursuant to paragraph (b)(5)(ii)(C) of this section, the equipment is
treated as originally placed in service by TT on February 15, 2005.
Further, pursuant to paragraph (b)(3)(iii)(C) of this section, TT is
considered the original user of the equipment. Accordingly, the
equipment is not eligible for the additional first year depreciation
deduction.
(c) Qualified leasehold improvement property--(1) In general. For
purposes of section 168(k), qualified leasehold improvement property
means any improvement, which is section 1250 property, to an interior
portion of a building that is nonresidential real property if--
(i) The improvement is made under or pursuant to a lease by the
lessee (or any sublessee) of the interior portion, or by the lessor of
that interior portion;
(ii) The interior portion of the building is to be occupied
exclusively by the lessee (or any sublessee) of that interior portion;
and
(iii) The improvement is placed in service more than 3 years after
the date the building was first placed in service by any person.
(2) Certain improvements not included. Qualified leasehold
improvement property does not include any improvement for which the
expenditure is attributable to:
(i) The enlargement of the building;
(ii) Any elevator or escalator;
(iii) Any structural component benefiting a common area; or
(iv) The internal structural framework of the building.
(3) Definitions. For purposes of this paragraph (c), the following
definitions apply:
(i) Building has the same meaning as that term is defined in Sec.
1.48-1(e)(1).
(ii) Common area means any portion of a building that is equally
available to all users of the building on the same basis for uses that
are incidental to the primary use of the building. For example,
stairways, hallways, lobbies, common seating areas, interior and
exterior pedestrian walkways and pedestrian bridges, loading docks and
areas, and rest rooms generally are treated as common areas if they are
used by different lessees of a building.
(iii) Elevator and escalator have the same meanings as those terms
are defined in Sec. 1.48-1(m)(2).
[[Page 579]]
(iv) Enlargement has the same meaning as that term is defined in
Sec. 1.48-12(c)(10).
(v) Internal structural framework has the same meaning as that term
is defined in Sec. 1.48-12(b)(3)(i)(D)(iii).
(vi) Lease has the same meaning as that term is defined in section
168(h)(7). In addition, a commitment to enter into a lease is treated as
a lease, and the parties to the commitment are treated as lessor and
lessee. However, a lease between related persons is not considered a
lease. For purposes of the preceding sentence, related persons are--
(A) Members of an affiliated group (as defined in section 1504 and
the regulations thereunder); and
(B) Persons having a relationship described in section 267(b) and
the regulations thereunder. For purposes of applying section 267(b), the
language ``80 percent or more'' is used instead of ``more than 50
percent.''
(vii) Nonresidential real property has the same meaning as that term
is defined in section 168(e)(2)(B).
(viii) Structural component has the same meaning as that term is
defined in Sec. 1.48-1(e)(2).
(d) Computation of depreciation deduction for qualified property or
50-percent bonus depreciation property--(1) Additional first year
depreciation deduction--(i) In general. Except as provided in paragraph
(f) of this section, the additional first year depreciation deduction is
allowable in the first taxable year in which the qualified property or
50-percent bonus depreciation property is placed in service by the
taxpayer for use in its trade or business or for the production of
income. Except as provided in paragraph (f)(5) of this section, the
allowable additional first year depreciation deduction for qualified
property is determined by multiplying the unadjusted depreciable basis
(as defined in Sec. 1.168(k)-1(a)(2)(iii)) of the qualified property by
30 percent. Except as provided in paragraph (f)(5) of this section, the
allowable additional first year depreciation deduction for 50-percent
bonus depreciation property is determined by multiplying the unadjusted
depreciable basis (as defined in Sec. 1.168(k)-1(a)(2)(iii)) of the 50-
percent bonus depreciation property by 50 percent. Except as provided in
paragraph (f)(1) of this section, the 30-percent or 50-percent
additional first year depreciation deduction is not affected by a
taxable year of less than 12 months. See paragraph (f)(1) of this
section for qualified property or 50-percent bonus depreciation property
placed in service and disposed of in the same taxable year. See
paragraph (f)(5) of this section for qualified property or 50-percent
bonus depreciation property acquired in a like-kind exchange or as a
result of an involuntary conversion.
(ii) Property having a longer production period. For purposes of
paragraph (d)(1)(i) of this section, the unadjusted depreciable basis
(as defined in Sec. 1.168(k)-1(a)(2)(iii)) of qualified property or 50-
percent bonus depreciation property described in section 168(k)(2)(B) is
limited to the property's unadjusted depreciable basis attributable to
the property's manufacture, construction, or production after September
10, 2001 (for qualified property), or May 5, 2003 (for 50-percent bonus
depreciation property), and before January 1, 2005.
(iii) Alternative minimum tax. The 30-percent or 50-percent
additional first year depreciation deduction is allowed for alternative
minimum tax purposes for the taxable year in which the qualified
property or the 50-percent bonus depreciation property is placed in
service by the taxpayer. In general, the 30-percent or 50-percent
additional first year depreciation deduction for alternative minimum tax
purposes is based on the unadjusted depreciable basis of the property
for alternative minimum tax purposes. However, see paragraph
(f)(5)(iii)(D) of this section for qualified property or 50-percent
bonus depreciation property acquired in a like-kind exchange or as a
result of an involuntary conversion.
(2) Otherwise allowable depreciation deduction. (i) In general.
Before determining the amount otherwise allowable as a depreciation
deduction for the qualified property or the 50-percent bonus
depreciation property for the placed-in-service year and any subsequent
taxable year, the taxpayer must
[[Page 580]]
determine the remaining adjusted depreciable basis of the qualified
property or the 50-percent bonus depreciation property. This remaining
adjusted depreciable basis is equal to the unadjusted depreciable basis
of the qualified property or the 50-percent bonus depreciation property
reduced by the amount of the additional first year depreciation allowed
or allowable, whichever is greater. The remaining adjusted depreciable
basis of the qualified property or the 50-percent bonus depreciation
property is then depreciated using the applicable depreciation
provisions under the Internal Revenue Code for the qualified property or
the 50-percent bonus depreciation property. The remaining adjusted
depreciable basis of the qualified property or the 50-percent bonus
depreciation property that is MACRS property is also the basis to which
the annual depreciation rates in the optional depreciation tables apply
(for further guidance, see section 8 of Rev. Proc. 87-57 (1987-2 C.B.
687) and Sec. 601.601(d)(2)(ii)(b) of this chapter). The depreciation
deduction allowable for the remaining adjusted depreciable basis of the
qualified property or the 50-percent bonus depreciation property is
affected by a taxable year of less than 12 months.
(ii) Alternative minimum tax. For alternative minimum tax purposes,
the depreciation deduction allowable for the remaining adjusted
depreciable basis of the qualified property or the 50-percent bonus
depreciation property is based on the remaining adjusted depreciable
basis for alternative minimum tax purposes. The remaining adjusted
depreciable basis of the qualified property or the 50-percent bonus
depreciable property for alternative minimum tax purposes is depreciated
using the same depreciation method, recovery period (or useful life in
the case of computer software), and convention that apply to the
qualified property or the 50-percent bonus depreciation property for
regular tax purposes.
(3) Examples. This paragraph (d) is illustrated by the following
examples:
Example 1. On March 1, 2003, V, a calendar-year taxpayer, purchased
and placed in service qualified property that costs $1 million and is 5-
year property under section 168(e). V depreciates its 5-year property
placed in service in 2003 using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. For 2003, V is allowed a 30-percent additional first year
depreciation deduction of $300,000 (the unadjusted depreciable basis of
$1 million multiplied by .30). Next, V must reduce the unadjusted
depreciable basis of $1 million by the additional first year
depreciation deduction of $300,000 to determine the remaining adjusted
depreciable basis of $700,000. Then, V's depreciation deduction
allowable in 2003 for the remaining adjusted depreciable basis of
$700,000 is $140,000 (the remaining adjusted depreciable basis of
$700,000 multiplied by the annual depreciation rate of .20 for recovery
year 1).
Example 2. On June 1, 2003, W, a calendar-year taxpayer, purchased
and placed in service 50-percent bonus depreciation property that costs
$126,000. The property qualifies for the expensing election under
section 179 and is 5-year property under section 168(e). W did not
purchase any other section 179 property in 2003. W makes the election
under section 179 for the property and depreciates its 5-year property
placed in service in 2003 using the optional depreciation table that
corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention. For 2003, W is first allowed a $100,000 deduction under
section 179. Next, W must reduce the cost of $126,000 by the section 179
deduction of $100,000 to determine the unadjusted depreciable basis of
$26,000. Then, for 2003, W is allowed a 50-percent additional first year
depreciation deduction of $13,000 (the unadjusted depreciable basis of
$26,000 multiplied by .50). Next, W must reduce the unadjusted
depreciable basis of $26,000 by the additional first year depreciation
deduction of $13,000 to determine the remaining adjusted depreciable
basis of $13,000. Then, W's depreciation deduction allowable in 2003 for
the remaining adjusted depreciable basis of $13,000 is $2,600 (the
remaining adjusted depreciable basis of $13,000 multiplied by the annual
depreciation rate of .20 for recovery year 1).
(e) Election not to deduct additional first year depreciation--(1)
In general. If a taxpayer makes an election under this paragraph (e),
the election applies to all qualified property or 50-percent bonus
depreciation property, as applicable, that is in the same class of
property and placed in service in the same taxable year. The rules of
this paragraph (e) apply to the following elections provided under
section 168(k):
(i) Qualified property. A taxpayer may make an election not to
deduct the 30-
[[Page 581]]
percent additional first year depreciation for any class of property
that is qualified property placed in service during the taxable year. If
this election is made, no additional first year depreciation deduction
is allowable for the property placed in service during the taxable year
in the class of property.
(ii) 50-percent bonus depreciation property. For any class of
property that is 50-percent bonus depreciation property placed in
service during the taxable year, a taxpayer may make an election--
(A) To deduct the 30-percent, instead of the 50-percent, additional
first year depreciation. If this election is made, the allowable
additional first year depreciation deduction is determined as though the
class of property is qualified property under section 168(k)(2); or
(B) Not to deduct both the 30-percent and the 50-percent additional
first year depreciation. If this election is made, no additional first
year depreciation deduction is allowable for the class of property.
(2) Definition of class of property. For purposes of this paragraph
(e), the term class of property means:
(i) Except for the property described in paragraphs (e)(2)(ii) and
(iv) of this section, each class of property described in section 168(e)
(for example, 5-year property);
(ii) Water utility property as defined in section 168(e)(5) and
depreciated under section 168;
(iii) Computer software as defined in, and depreciated under,
section 167(f)(1) and the regulations thereunder; or
(iv) Qualified leasehold improvement property as defined in
paragraph (c) of this section and depreciated under section 168.
(3) Time and manner for making election--(i) Time for making
election. Except as provided in paragraph (e)(4) of this section, any
election specified in paragraph (e)(1) of this section must be made by
the due date (including extensions) of the Federal tax return for the
taxable year in which the qualified property or the 50-percent bonus
depreciation property, as applicable, is placed in service by the
taxpayer.
(ii) Manner of making election. Except as provided in paragraph
(e)(4) of this section, any election specified in paragraph (e)(1) of
this section must be made in the manner prescribed on Form 4562,
``Depreciation and Amortization,'' and its instructions. The election is
made separately by each person owning qualified property or 50-percent
bonus depreciation property (for example, for each member of a
consolidated group by the common parent of the group, by the
partnership, or by the S corporation). If Form 4562 is revised or
renumbered, any reference in this section to that form shall be treated
as a reference to the revised or renumbered form.
(4) Special rules for 2000 or 2001 returns. For the election
specified in paragraph (e)(1)(i) of this section for qualified property
placed in service by the taxpayer during the taxable year that included
September 11, 2001, the taxpayer should refer to the guidance provided
by the Internal Revenue Service for the time and manner of making this
election on the 2000 or 2001 Federal tax return for the taxable year
that included September 11, 2001 (for further guidance, see sections
3.03(3) and 4 of Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-
50 (2003-29 I.R.B. 119), and Sec. 601.601(d)(2)(ii)(b) of this
chapter).
(5) Failure to make election. If a taxpayer does not make the
applicable election specified in paragraph (e)(1) of this section within
the time and in the manner prescribed in paragraph (e)(3) or (4) of this
section, the amount of depreciation allowable for that property under
section 167(f)(1) or under section 168, as applicable, must be
determined for the placed-in-service year and for all subsequent taxable
years by taking into account the additional first year depreciation
deduction. Thus, any election specified in paragraph (e)(1) of this
section shall not be made by the taxpayer in any other manner (for
example, the election cannot be made through a request under section
446(e) to change the taxpayer's method of accounting).
(6) Alternative minimum tax. If a taxpayer makes an election
specified in paragraph (e)(1) of this section for a class of property,
the depreciation adjustments under section 56 and the regulations under
section 56 apply to the property to which that election applies
[[Page 582]]
for purposes of computing the taxpayer's alternative minimum taxable
income.
(7) Revocation of election--(i) In general. Except as provided in
paragraph (e)(7)(ii) of this section, an election specified in paragraph
(e)(1) of this section, once made, may be revoked only with the written
consent of the Commissioner of Internal Revenue. To seek the
Commissioner's consent, the taxpayer must submit a request for a letter
ruling.
(ii) Automatic 6-month extension. If a taxpayer made an election
specified in paragraph (e)(1) of this section for a class of property,
an automatic extension of 6 months from the due date of the taxpayer's
Federal tax return (excluding extensions) for the placed-in-service year
of the class of property is granted to revoke that election, provided
the taxpayer timely filed the taxpayer's Federal tax return for the
placed-in-service year of the class of property and, within this 6-month
extension period, the taxpayer (and all taxpayers whose tax liability
would be affected by the election) files an amended Federal tax return
for the placed-in-service year of the class of property in a manner that
is consistent with the revocation of the election.
(f) Special rules--(1) Property placed in service and disposed of in
the same taxable year--(i) In general. Except as provided in paragraphs
(f)(1)(ii) and (iii) of this section, the additional first year
depreciation deduction is not allowed for qualified property or 50-
percent bonus depreciation property placed in service and disposed of
during the same taxable year. Also if qualified property or 50-percent
bonus depreciation property is placed in service and disposed of during
the same taxable year and then reacquired and again placed in service in
a subsequent taxable year, the additional first year depreciation
deduction is not allowable for the property in the subsequent taxable
year.
(ii) Technical termination of a partnership. In the case of a
technical termination of a partnership under section 708(b)(1)(B), the
additional first year depreciation deduction is allowable for any
qualified property or 50-percent bonus depreciation property placed in
service by the terminated partnership during the taxable year of
termination and contributed by the terminated partnership to the new
partnership. The allowable additional first year depreciation deduction
for the qualified property or the 50-percent bonus depreciation property
shall not be claimed by the terminated partnership but instead shall be
claimed by the new partnership for the new partnership's taxable year in
which the qualified property or the 50-percent bonus depreciation
property was contributed by the terminated partnership to the new
partnership. However, if qualified property or 50-percent bonus
depreciation property is both placed in service and contributed to a new
partnership in a transaction described in section 708(b)(1)(B) by the
terminated partnership during the taxable year of termination, and if
such property is disposed of by the new partnership in the same taxable
year the new partnership received such property from the terminated
partnership, then no additional first year depreciation deduction is
allowable to either partnership.
(iii) Section 168(i)(7) transactions. If any qualified property or
50-percent bonus depreciation property is transferred in a transaction
described in section 168(i)(7) in the same taxable year that the
qualified property or the 50-percent bonus depreciation property is
placed in service by the transferor, the additional first year
depreciation deduction is allowable for the qualified property or the
50-percent bonus depreciation property. The allowable additional first
year depreciation deduction for the qualified property or the 50-percent
bonus depreciation property for the transferor's taxable year in which
the property is placed in service is allocated between the transferor
and the transferee on a monthly basis. This allocation shall be made in
accordance with the rules in Sec. 1.168(d)-1(b)(7)(ii) for allocating
the depreciation deduction between the transferor and the transferee.
However, if qualified property or 50-percent bonus depreciation property
is both placed in service and transferred in a transaction described in
section 168(i)(7) by the transferor during the same taxable year, and if
such
[[Page 583]]
property is disposed of by the transferee (other than by a transaction
described in section 168(i)(7)) during the same taxable year the
transferee received such property from the transferor, then no
additional first year depreciation deduction is allowable to either
party.
(iv) Examples. The application of this paragraph (f)(1) is
illustrated by the following examples:
Example 1. X and Y are equal partners in Partnership XY, a general
partnership. On February 1, 2002, Partnership XY purchased and placed in
service new equipment at a cost of $30,000. On March 1, 2002, X sells
its entire 50 percent interest to Z in a transfer that terminates the
partnership under section 708(b)(1)(B). As a result, terminated
Partnership XY is deemed to have contributed the equipment to new
Partnership XY. Pursuant to paragraph (f)(1)(ii) of this section, new
Partnership XY, not terminated Partnership XY, is eligible to claim the
30-percent additional first year depreciation deduction allowable for
the equipment for the taxable year 2002 (assuming all other requirements
are met).
Example 2. On January 5, 2002, BB purchased and placed in service
new office desks for a total amount of $8,000. On August 20, 2002, BB
transferred the office desks to Partnership BC in a transaction
described in section 721. BB and Partnership BC are calendar-year
taxpayers. Because the transaction between BB and Partnership BC is a
transaction described in section 168(i)(7), pursuant to paragraph
(f)(1)(iii) of this section the 30-percent additional first year
depreciation deduction allowable for the desks is allocated between BB
and Partnership BC in accordance with the rules in Sec. 1.168(d)-
1(b)(7)(ii) for allocating the depreciation deduction between the
transferor and the transferee. Accordingly, the 30-percent additional
first year depreciation deduction allowable for the desks for 2002 of
$2,400 (the unadjusted depreciable basis of $8,000 multiplied by .30) is
allocated between BB and Partnership BC based on the number of months
that BB and Partnership BC held the desks in service. Thus, because the
desks were held in service by BB for 7 of 12 months, which includes the
month in which BB placed the desks in service but does not include the
month in which the desks were transferred, BB is allocated $1,400 (\7/
12\ x $2,400 additional first year depreciation deduction). Partnership
BC is allocated $1,000, the remaining \5/12\ of the $2,400 additional
first year depreciation deduction allowable for the desks.
(2) Redetermination of basis. If the unadjusted depreciable basis
(as defined in Sec. 1.168(k)-1(a)(2)(iii)) of qualified property or 50-
percent bonus depreciation property is redetermined (for example, due to
contingent purchase price or discharge of indebtedness) before January
1, 2005, or, in the case of property described in section 168(k)(2)(B)
or (C), is redetermined before January 1, 2006 (or redetermined before
January 1, 2007, in the case of property described in section
168(k)(2)(B) or (C) to which section 105 of the Gulf Opportunity Zone
Act of 2005 (Pub. L. 109-135, 119 Stat. 2577) applies (for further
guidance, see Announcement 2006-29 (2006-19 I.R.B. 879) and Sec.
601.601(d)(2)(ii)(b) of this chapter)), the additional first year
depreciation deduction allowable for the qualified property or the 50-
percent bonus depreciation property is redetermined as follows:
(i) Increase in basis. For the taxable year in which an increase in
basis of qualified property or 50-percent bonus depreciation property
occurs, the taxpayer shall claim an additional first year depreciation
deduction for qualified property by multiplying the amount of the
increase in basis for this property by 30 percent or, for 50-percent
bonus depreciation property, by multiplying the amount of the increase
in basis for this property by 50 percent. For purposes of this paragraph
(f)(2)(i), the 30-percent additional first year depreciation deduction
applies to the increase in basis if the underlying property is qualified
property and the 50-percent additional first year depreciation deduction
applies to the increase in basis if the underlying property is 50-
percent bonus depreciation property. To determine the amount otherwise
allowable as a depreciation deduction for the increase in basis of
qualified property or 50-percent bonus depreciation property, the amount
of the increase in basis of the qualified property or the 50-percent
bonus depreciation property must be reduced by the additional first year
depreciation deduction allowed or allowable, whichever is greater, for
the increase in basis and the remaining increase in basis of--
(A) Qualified property or 50-percent bonus depreciation property
(except for computer software described in paragraph (b)(2)(i)(B) of
this section) is depreciated over the recovery period of
[[Page 584]]
the qualified property or the 50-percent bonus depreciation property, as
applicable, remaining as of the beginning of the taxable year in which
the increase in basis occurs, and using the same depreciation method and
convention applicable to the qualified property or 50-percent bonus
depreciation property, as applicable, that applies for the taxable year
in which the increase in basis occurs; and
(B) Computer software (as defined in paragraph (b)(2)(i)(B) of this
section) that is qualified property or 50-percent bonus depreciation
property is depreciated ratably over the remainder of the 36-month
period (the useful life under section 167(f)(1)) as of the beginning of
the first day of the month in which the increase in basis occurs.
(ii) Decrease in basis. For the taxable year in which a decrease in
basis of qualified property or 50-percent bonus depreciation property
occurs, the taxpayer shall reduce the total amount otherwise allowable
as a depreciation deduction for all of the taxpayer's depreciable
property by the excess additional first year depreciation deduction
previously claimed for the qualified property or the 50-percent bonus
depreciation property. If, for such taxable year, the excess additional
first year depreciation deduction exceeds the total amount otherwise
allowable as a depreciation deduction for all of the taxpayer's
depreciable property, the taxpayer shall take into account a negative
depreciation deduction in computing taxable income. The excess
additional first year depreciation deduction for qualified property is
determined by multiplying the amount of the decrease in basis for this
property by 30 percent. The excess additional first year depreciation
deduction for 50-percent bonus depreciation property is determined by
multiplying the amount of the decrease in basis for this property by 50
percent. For purposes of this paragraph (f)(2)(ii), the 30-percent
additional first year depreciation deduction applies to the decrease in
basis if the underlying property is qualified property and the 50-
percent additional first year depreciation deduction applies to the
decrease in basis if the underlying property is 50-percent bonus
depreciation property. Also, if the taxpayer establishes by adequate
records or other sufficient evidence that the taxpayer claimed less than
the additional first year depreciation deduction allowable for the
qualified property or the 50-percent bonus depreciation property before
the decrease in basis or if the taxpayer claimed more than the
additional first year depreciation deduction allowable for the qualified
property or the 50-percent bonus depreciation property before the
decrease in basis, the excess additional first year depreciation
deduction is determined by multiplying the amount of the decrease in
basis by the additional first year depreciation deduction percentage
actually claimed by the taxpayer for the qualified property or the 50-
percent bonus depreciation property, as applicable, before the decrease
in basis. To determine the amount to reduce the total amount otherwise
allowable as a depreciation deduction for all of the taxpayer's
depreciable property for the excess depreciation previously claimed
(other than the additional first year depreciation deduction) resulting
from the decrease in basis of the qualified property or the 50-percent
bonus depreciation property, the amount of the decrease in basis of the
qualified property or the 50-percent bonus depreciation property must be
adjusted by the excess additional first year depreciation deduction that
reduced the total amount otherwise allowable as a depreciation deduction
(as determined under this paragraph) and the remaining decrease in basis
of--
(A) Qualified property or 50-percent bonus depreciation property
(except for computer software described in paragraph (b)(2)(i)(B) of
this section) reduces the amount otherwise allowable as a depreciation
deduction over the recovery period of the qualified property or the 50-
percent bonus depreciation property, as applicable, remaining as of the
beginning of the taxable year in which the decrease in basis occurs, and
using the same depreciation method and convention of the qualified
property or 50-percent bonus depreciation property, as applicable, that
applies in the taxable year in which the decrease in basis occurs. If,
for any taxable year, the reduction to the amount otherwise allowable as
a depreciation deduction
[[Page 585]]
(as determined under this paragraph (f)(2)(ii)(A)) exceeds the total
amount otherwise allowable as a depreciation deduction for all of the
taxpayer's depreciable property, the taxpayer shall take into account a
negative depreciation deduction in computing taxable income; and
(B) Computer software (as defined in paragraph (b)(2)(i)(B) of this
section) that is qualified property or 50-percent bonus depreciation
property reduces the amount otherwise allowable as a depreciation
deduction over the remainder of the 36-month period (the useful life
under section 167(f)(1)) as of the beginning of the first day of the
month in which the decrease in basis occurs. If, for any taxable year,
the reduction to the amount otherwise allowable as a depreciation
deduction (as determined under this paragraph (f)(2)(ii)(B)) exceeds the
total amount otherwise allowable as a depreciation deduction for all of
the taxpayer's depreciable property, the taxpayer shall take into
account a negative depreciation deduction in computing taxable income.
(iii) Definition. Except as otherwise expressly provided by the
Internal Revenue Code (for example, section 1017(a)), the regulations
under the Internal Revenue Code, or other guidance published in the
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this
chapter), for purposes of this paragraph (f)(2):
(A) An increase in basis occurs in the taxable year an amount is
taken into account under section 461; and
(B) A decrease in basis occurs in the taxable year an amount would
be taken into account under section 451.
(iv) Examples. The application of this paragraph (f)(2) is
illustrated by the following examples:
Example 1. (i) On May 15, 2002, CC, a cash-basis taxpayer, purchased
and placed in service qualified property that is 5-year property at a
cost of $200,000. In addition to the $200,000, CC agrees to pay the
seller 25 percent of the gross profits from the operation of the
property in 2002. On May 15, 2003, CC paid to the seller an additional
$10,000. CC depreciates the 5-year property placed in service in 2002
using the optional depreciation table that corresponds with the general
depreciation system, the 200-percent declining balance method, a 5-year
recovery period, and the half-year convention.
(ii) For 2002, CC is allowed a 30-percent additional first year
depreciation deduction of $60,000 (the unadjusted depreciable basis of
$200,000 multiplied by .30). In addition, CC's depreciation deduction
for 2002 for the remaining adjusted depreciable basis of $140,000 (the
unadjusted depreciable basis of $200,000 reduced by the additional first
year depreciation deduction of $60,000) is $28,000 (the remaining
adjusted depreciable basis of $140,000 multiplied by the annual
depreciation rate of .20 for recovery year 1).
(iii) For 2003, CC's depreciation deduction for the remaining
adjusted depreciable basis of $140,000 is $44,800 (the remaining
adjusted depreciable basis of $140,000 multiplied by the annual
depreciation rate of .32 for recovery year 2). In addition, pursuant to
paragraph (f)(2)(i) of this section, CC is allowed an additional first
year depreciation deduction for 2003 for the $10,000 increase in basis
of the qualified property. Consequently, CC is allowed an additional
first year depreciation deduction of $3,000 (the increase in basis of
$10,000 multiplied by .30). Also, CC is allowed a depreciation deduction
for 2003 attributable to the remaining increase in basis of $7,000 (the
increase in basis of $10,000 reduced by the additional first year
depreciation deduction of $3,000). The depreciation deduction allowable
for 2003 attributable to the remaining increase in basis of $7,000 is
$3,111 (the remaining increase in basis of $7,000 multiplied by .4444,
which is equal to 1/remaining recovery period of 4.5 years at January 1,
2003, multiplied by 2). Accordingly, for 2003, CC's total depreciation
deduction allowable for the qualified property is $50,911.
Example 2. (i) On May 15, 2002, DD, a calendar-year taxpayer,
purchased and placed in service qualified property that is 5-year
property at a cost of $400,000. To purchase the property, DD borrowed
$250,000 from Bank2. On May 15, 2003, Bank2 forgives $50,000 of the
indebtedness. DD makes the election provided in section 108(b)(5) to
apply any portion of the reduction under section 1017 to the basis of
the depreciable property of the taxpayer. DD depreciates the 5-year
property placed in service in 2002 using the optional depreciation table
that corresponds with the general depreciation system, the 200-percent
declining balance method, a 5-year recovery period, and the half-year
convention.
(ii) For 2002, DD is allowed a 30-percent additional first year
depreciation deduction of $120,000 (the unadjusted depreciable basis of
$400,000 multiplied by .30). In addition, DD's depreciation deduction
allowable for 2002 for the remaining adjusted depreciable basis of
$280,000 (the unadjusted depreciable basis of $400,000 reduced by the
additional first year depreciation deduction of $120,000) is $56,000
(the remaining adjusted depreciable basis of
[[Page 586]]
$280,000 multiplied by the annual depreciation rate of .20 for recovery
year 1).
(iii) For 2003, DD's deduction for the remaining adjusted
depreciable basis of $280,000 is $89,600 (the remaining adjusted
depreciable basis of $280,000 multiplied by the annual depreciation rate
.32 for recovery year 2). Although Bank2 forgave the indebtedness in
2003, the basis of the property is reduced on January 1, 2004, pursuant
to sections 108(b)(5) and 1017(a) under which basis is reduced at the
beginning of the taxable year following the taxable year in which the
discharge of indebtedness occurs.
(iv) For 2004, DD's deduction for the remaining adjusted depreciable
basis of $280,000 is $53,760 (the remaining adjusted depreciable basis
of $280,000 multiplied by the annual depreciation rate .192 for recovery
year 3). However, pursuant to paragraph (f)(2)(ii) of this section, DD
must reduce the amount otherwise allowable as a depreciation deduction
for 2004 by the excess depreciation previously claimed for the $50,000
decrease in basis of the qualified property. Consequently, DD must
reduce the amount of depreciation otherwise allowable for 2004 by the
excess additional first year depreciation of $15,000 (the decrease in
basis of $50,000 multiplied by .30). Also, DD must reduce the amount of
depreciation otherwise allowable for 2004 by the excess depreciation
attributable to the remaining decrease in basis of $35,000 (the decrease
in basis of $50,000 reduced by the excess additional first year
depreciation of $15,000). The reduction in the amount of depreciation
otherwise allowable for 2004 for the remaining decrease in basis of
$35,000 is $19,999 (the remaining decrease in basis of $35,000
multiplied by .5714, which is equal to 1/remaining recovery period of
3.5 years at January 1, 2004, multiplied by 2). Accordingly, assuming
the qualified property is the only depreciable property owned by DD, for
2004, DD's total depreciation deduction allowable for the qualified
property is $18,761 ($53,760 minus $15,000 minus $19,999).
(3) Section 1245 and 1250 depreciation recapture. For purposes of
section 1245 and the regulations thereunder, the additional first year
depreciation deduction is an amount allowed or allowable for
depreciation. Further, for purposes of section 1250(b) and the
regulations thereunder, the additional first year depreciation deduction
is not a straight line method.
(4) Coordination with section 169. The additional first year
depreciation deduction is allowable in the placed-in-service year of a
certified pollution control facility (as defined in Sec. 1.169-2(a))
that is qualified property or 50-percent bonus depreciation property,
even if the taxpayer makes the election to amortize the certified
pollution control facility under section 169 and the regulations
thereunder in the certified pollution control facility's placed-in-
service year.
(5) Like-kind exchanges and involuntary conversions--(i) Scope. The
rules of this paragraph (f)(5) apply to acquired MACRS property or
acquired computer software that is qualified property or 50-percent
bonus depreciation property at the time of replacement provided the time
of replacement is after September 10, 2001, and before January 1, 2005,
or, in the case of acquired MACRS property or acquired computer software
that is qualified property, or 50-percent bonus depreciation property,
described in section 168(k)(2)(B) or (C), the time of replacement is
after September 10, 2001, and before January 1, 2006 (or the time of
replacement is after September 10, 2001, and before January 1, 2007, in
the case of property described in section 168(k)(2)(B) or (C) to which
section 105 of the Gulf Opportunity Zone Act of 2005 (Pub. L. 109-135,
119 Stat. 2577) applies (for further guidance, see Announcement 2006-29
(2006-19 I.R.B. 879) and Sec. 601.601(d)(2)(ii)(b) of this chapter)).
(ii) Definitions. For purposes of this paragraph (f)(5), the
following definitions apply:
(A) Acquired MACRS property is MACRS property in the hands of the
acquiring taxpayer that is acquired in a transaction described in
section 1031(a), (b), or (c) for other MACRS property or that is
acquired in connection with an involuntary conversion of other MACRS
property in a transaction to which section 1033 applies.
(B) Exchanged or involuntarily converted MACRS property is MACRS
property that is transferred by the taxpayer in a transaction described
in section 1031(a), (b), or (c), or that is converted as a result of an
involuntary conversion to which section 1033 applies.
(C) Acquired computer software is computer software (as defined in
paragraph (b)(2)(i)(B) of this section) in the hands of the acquiring
taxpayer that is acquired in a like-kind exchange under section 1031 or
as a result of an involuntary conversion under section 1033.
[[Page 587]]
(D) Exchanged or involuntarily converted computer software is
computer software (as defined in paragraph (b)(2)(i)(B) of this section)
that is transferred by the taxpayer in a like-kind exchange under
section 1031 or that is converted as a result of an involuntary
conversion under section 1033.
(E) Time of disposition is when the disposition of the exchanged or
involuntarily converted MACRS property or the exchanged or involuntarily
converted computer software, as applicable, takes place.
(F) Except as provided in paragraph (f)(5)(v) of this section, the
time of replacement is the later of--
(1) When the acquired MACRS property or acquired computer software
is placed in service; or
(2) The time of disposition of the exchanged or involuntarily
converted property.
(G) Carryover basis is the lesser of:
(1) The basis in the acquired MACRS property or acquired computer
software, as applicable and as determined under section 1031(d) or
1033(b) and the regulations thereunder; or
(2) The adjusted depreciable basis of the exchanged or involuntarily
converted MACRS property or the exchanged or involuntarily converted
computer software, as applicable.
(H) Excess basis is any excess of the basis in the acquired MACRS
property or acquired computer software, as applicable and as determined
under section 1031(d) or 1033(b) and the regulations thereunder, over
the carryover basis as determined under paragraph (f)(5)(ii)(G) of this
section.
(I) Remaining carryover basis is the carryover basis as determined
under paragraph (f)(5)(ii)(G) of this section reduced by--
(1) The percentage of the taxpayer's use of property for the taxable
year other than in the taxpayer's trade or business (or for the
production of income); and
(2) Any adjustments to basis provided by other provisions of the
Code and the regulations thereunder (including section 1016(a)(2) and
(3)) for periods prior to the disposition of the exchanged or
involuntarily converted property.
(J) Remaining excess basis is the excess basis as determined under
paragraph (f)(5)(ii)(H) of this section reduced by--
(1) The percentage of the taxpayer's use of property for the taxable
year other than in the taxpayer's trade or business (or for the
production of income);
(2) Any portion of the basis the taxpayer properly elects to treat
as an expense under section 179 or section 179C;
(3) Any adjustments to basis provided by other provisions of the
Code and the regulations thereunder.
(K) Year of disposition is the taxable year that includes the time
of disposition.
(L) Year of replacement is the taxable year that includes the time
of replacement.
(iii) Computation--(A) In general. Assuming all other requirements
of section 168(k) and this section are met, the remaining carryover
basis for the year of replacement and the remaining excess basis, if
any, for the year of replacement for the acquired MACRS property or the
acquired computer software, as applicable, are eligible for the
additional first year depreciation deduction. The 30-percent additional
first year depreciation deduction applies to the remaining carryover
basis and the remaining excess basis, if any, of the acquired MACRS
property or the acquired computer software if the time of replacement is
after September 10, 2001, and before May 6, 2003, or if the taxpayer
made the election provided in paragraph (e)(1)(ii)(A) of this section.
The 50-percent additional first year depreciation deduction applies to
the remaining carryover basis and the remaining excess basis, if any, of
the acquired MACRS property or the acquired computer software if the
time of replacement is after May 5, 2003, and before January 1, 2005,
or, in the case of acquired MACRS property or acquired computer software
that is 50-percent bonus depreciation property described in section
168(k)(2)(B) or (C), the time of replacement is after May 5, 2003, and
before January 1, 2006 (or the time of replacement is after May 5, 2003,
and before January 1, 2007, in the case of 50-percent bonus depreciation
property described in section 168(k)(2)(B) or (C)
[[Page 588]]
to which section 105 of the Gulf Opportunity Zone Act of 2005 (Pub. L.
109-135, 119 Stat. 2577) applies (for further guidance, see Announcement
2006-29 (2006-19 I.R.B. 879) and Sec. 601.601(d)(2)(ii)(b) of this
chapter)). The additional first year depreciation deduction is computed
separately for the remaining carryover basis and the remaining excess
basis.
(B) Year of disposition and year of replacement. The additional
first year depreciation deduction is allowable for the acquired MACRS
property or acquired computer software in the year of replacement.
However, the additional first year depreciation deduction is not
allowable for the exchanged or involuntarily converted MACRS property or
the exchanged or involuntarily converted computer software if the
exchanged or involuntarily converted MACRS property or the exchanged or
involuntarily converted computer software, as applicable, is placed in
service and disposed of in an exchange or involuntary conversion in the
same taxable year.
(C) Property having a longer production period. For purposes of
paragraph (f)(5)(iii)(A) of this section, the total of the remaining
carryover basis and the remaining excess basis, if any, of the acquired
MACRS property that is qualified property or 50-percent bonus
depreciation property described in section 168(k)(2)(B) is limited to
the total of the property's remaining carryover basis and remaining
excess basis, if any, attributable to the property's manufacture,
construction, or production after September 10, 2001 (for qualified
property), or May 5, 2003 (for 50-percent bonus depreciation property),
and before January 1, 2005.
(D) Alternative minimum tax. The 30-percent or 50-percent additional
first year depreciation deduction is allowed for alternative minimum tax
purposes for the year of replacement of acquired MACRS property or
acquired computer software that is qualified property or 50-percent
bonus depreciation property. The 30-percent or 50-percent additional
first year depreciation deduction for alternative minimum tax purposes
is based on the remaining carryover basis and the remaining excess
basis, if any, of the acquired MACRS property or the acquired computer
software for alternative minimum tax purposes.
(iv) Sale-leaseback transaction. For purposes of this paragraph
(f)(5), if MACRS property or computer software is sold to a taxpayer and
leased back to a person by the taxpayer within three months after the
time of disposition of the MACRS property or computer software, as
applicable, the time of replacement for this MACRS property or computer
software, as applicable, shall not be earlier than the date on which the
MACRS property or computer software, as applicable, is used by the
lessee under the leaseback.
(v) Acquired MACRS property or acquired computer software that is
acquired and placed in service before disposition of involuntarily
converted MACRS property or involuntarily converted computer software.
If, in an involuntary conversion, a taxpayer acquires and places in
service the acquired MACRS property or the acquired computer software
before the time of disposition of the involuntarily converted MACRS
property or the involuntarily converted computer software and the time
of disposition of the involuntarily converted MACRS property or the
involuntarily converted computer software is after December 31, 2004,
or, in the case of property described in section 168(k)(2)(B) or (C),
after December 31, 2005 (or after December 31, 2006, in the case of
property described in section 168(k)(2)(B) or (C) to which section 105
of the Gulf Opportunity Zone Act of 2005 (Pub. L. 109-135, 119 Stat.
2577) applies (for further guidance, see Announcement 2006-29 (2006-19
I.R.B. 879) and Sec. 601.601(d)(2)(ii)(b) of this chapter)), then--
(A) Time of replacement. The time of replacement for purposes of
this paragraph (f)(5) is when the acquired MACRS property or acquired
computer software is placed in service by the taxpayer, provided the
threat or imminence of requisition or condemnation of the involuntarily
converted MACRS property or involuntarily converted computer software
existed before January 1, 2005, or, in the case of property described in
section 168(k)(2)(B) or (C), existed before January 1, 2006 (or existed
before January 1, 2007, in the case of property described in section
[[Page 589]]
168(k)(2)(B) or (C) to which section 105 of the Gulf Opportunity Zone
Act of 2005 (Pub. L. 109-135, 119 Stat. 2577) applies (for further
guidance, see Announcement 2006-29 (2006-19 I.R.B. 879) and Sec.
601.601(d)(2)(ii)(b) of this chapter)); and
(B) Depreciation of acquired MACRS property or acquired computer
software. The taxpayer depreciates the acquired MACRS property or
acquired computer software in accordance with paragraph (d) of this
section. However, at the time of disposition of the involuntarily
converted MACRS property, the taxpayer determines the exchanged basis
(as defined in Sec. 1.168(i)-6(b)(7)) and the excess basis (as defined
in Sec. 1.168(i)-6(b)(8)) of the acquired MACRS property and begins to
depreciate the depreciable exchanged basis (as defined in Sec.
1.168(i)-6(b)(9) of the acquired MACRS property in accordance with Sec.
1.168(i)-6(c). The depreciable excess basis (as defined in Sec.
1.168(i)-6(b)(10)) of the acquired MACRS property continues to be
depreciated by the taxpayer in accordance with the first sentence of
this paragraph (f)(5)(v)(B). Further, in the year of disposition of the
involuntarily converted MACRS property, the taxpayer must include in
taxable income the excess of the depreciation deductions allowable,
including the additional first year depreciation deduction allowable, on
the unadjusted depreciable basis of the acquired MACRS property over the
additional first year depreciation deduction that would have been
allowable to the taxpayer on the remaining carryover basis of the
acquired MACRS property at the time of replacement (as defined in
paragraph (f)(5)(v)(A) of this section) plus the depreciation deductions
that would have been allowable, including the additional first year
depreciation deduction allowable, to the taxpayer on the depreciable
excess basis of the acquired MACRS property from the date the acquired
MACRS property was placed in service by the taxpayer (taking into
account the applicable convention) to the time of disposition of the
involuntarily converted MACRS property. Similar rules apply to acquired
computer software.
(vi) Examples. The application of this paragraph (f)(5) is
illustrated by the following examples:
Example 1. (i) In December 2002, EE, a calendar-year corporation,
acquired for $200,000 and placed in service Canopy V1, a gas station
canopy. Canopy V1 is qualified property under section 168(k)(1) and is
5-year property under section 168(e). EE depreciated Canopy V1 under the
general depreciation system of section 168(a) by using the 200-percent
declining balance method of depreciation, a 5-year recovery period, and
the half-year convention. EE elected to use the optional depreciation
tables to compute the depreciation allowance for Canopy V1. On January
1, 2003, Canopy V1 was destroyed in a fire and was no longer usable in
EE's business. On June 1, 2003, in an involuntary conversion, EE
acquired and placed in service new Canopy W1 with all of the $160,000 of
insurance proceeds EE received due to the loss of Canopy V1. Canopy W1
is 50-percent bonus depreciation property under section 168(k)(4) and is
5-year property under section 168(e). Pursuant to paragraph (g)(3)(ii)
of this section and Sec. 1.168(i)-6(k)(2)(i), EE decided to apply Sec.
1.168(i)-6 to the involuntary conversion of Canopy V1 with the
replacement of Canopy W1, the acquired MACRS property.
(ii) For 2002, EE is allowed a 30-percent additional first year
depreciation deduction of $60,000 for Canopy V1 (the unadjusted
depreciable basis of $200,000 multiplied by .30), and a regular MACRS
depreciation deduction of $28,000 for Canopy V1 (the remaining adjusted
depreciable basis of $140,000 multiplied by the annual depreciation rate
of .20 for recovery year 1).
(iii) For 2003, EE is allowed a regular MACRS depreciation deduction
of $22,400 for Canopy V1 (the remaining adjusted depreciable basis of
$140,000 multiplied by the annual depreciation rate of .32 for recovery
year 2 x \1/2\ year).
(iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
additional first year depreciation deduction allowable for Canopy W1
equals $44,800 (.50 of Canopy W1's remaining carryover basis at the time
of replacement of $89,600 (Canopy V1's remaining adjusted depreciable
basis of $140,000 minus 2002 regular MACRS depreciation deduction of
$28,000 minus 2003 regular MACRS depreciation deduction of $22,400)).
Example 2. (i) Same facts as in Example 1, except EE elected not to
deduct the additional first year depreciation for 5-year property placed
in service in 2002. EE deducted the additional first year depreciation
for 5-year property placed in service in 2003.
(ii) For 2002, EE is allowed a regular MACRS depreciation deduction
of $40,000 for Canopy V1 (the unadjusted depreciable basis of $200,000
multiplied by the annual depreciation rate of .20 for recovery year 1).
[[Page 590]]
(iii) For 2003, EE is allowed a regular MACRS depreciation deduction
of $32,000 for Canopy V1 (the unadjusted depreciable basis of $200,000
multiplied by the annual depreciation rate of .32 for recovery year 2 x
\1/2\ year).
(iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the
additional first year depreciation deduction allowable for Canopy W1
equals $64,000 (.50 of Canopy W1's remaining carryover basis at the time
of replacement of $128,000 (Canopy V1's unadjusted depreciable basis of
$200,000 minus 2002 regular MACRS depreciation deduction of $40,000
minus 2003 regular MACRS depreciation deduction of $32,000)).
Example 3. (i) In December 2001, FF, a calendar-year corporation,
acquired for $10,000 and placed in service Computer X2. Computer X2 is
qualified property under section 168(k)(1) and is 5-year property under
section 168(e). FF depreciated Computer X2 under the general
depreciation system of section 168(a) by using the 200-percent declining
balance method of depreciation, a 5-year recovery period, and the half-
year convention. FF elected to use the optional depreciation tables to
compute the depreciation allowance for Computer X2. On January 1, 2002,
FF acquired new Computer Y2 by exchanging Computer X2 and $1,000 cash in
a like-kind exchange. Computer Y2 is qualified property under section
168(k)(1) and is 5-year property under section 168(e). Pursuant to
paragraph (g)(3)(ii) of this section and Sec. 1.168(i)-6(k)(2)(i), FF
decided to apply Sec. 1.168(i)-6 to the exchange of Computer X2 for
Computer Y2, the acquired MACRS property.
(ii) For 2001, FF is allowed a 30-percent additional first year
depreciation deduction of $3,000 for Computer X2 (unadjusted basis of
$10,000 multiplied by .30), and a regular MACRS depreciation deduction
of $1,400 for Computer X2 (the remaining adjusted depreciable basis of
$7,000 multiplied by the annual depreciation rate of .20 for recovery
year 1).
(iii) For 2002, FF is allowed a regular MACRS depreciation deduction
of $1,120 for Computer X2 (the remaining adjusted depreciable basis of
$7,000 multiplied by the annual depreciation rate of .32 for recovery
year 2 x \1/2\ year).
(iv) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 30-
percent additional first year depreciation deduction for Computer Y2 is
allowable for the remaining carryover basis at the time of replacement
of $4,480 (Computer X2's unadjusted depreciable basis of $10,000 minus
additional first year depreciation deduction allowable of $3,000 minus
2001 regular MACRS depreciation deduction of $1,400 minus 2002 regular
MACRS depreciation deduction of $1,120) and for the remaining excess
basis at the time of replacement of $1,000 (cash paid for Computer Y2).
Thus, the 30-percent additional first year depreciation deduction for
the remaining carryover basis at the time of replacement equals $1,344
($4,480 multiplied by .30) and for the remaining excess basis at the
time of replacement equals $300 ($1,000 multiplied by .30), which totals
$1,644.
Example 4. (i) In September 2002, GG, a June 30 year-end
corporation, acquired for $20,000 and placed in service Equipment X3.
Equipment X3 is qualified property under section 168(k)(1) and is 5-year
property under section 168(e). GG depreciated Equipment X3 under the
general depreciation system of section 168(a) by using the 200-percent
declining balance method of depreciation, a 5-year recovery period, and
the half-year convention. GG elected to use the optional depreciation
tables to compute the depreciation allowance for Equipment X3. In
December 2002, GG acquired new Equipment Y3 by exchanging Equipment X3
and $5,000 cash in a like-kind exchange. Equipment Y3 is qualified
property under section 168(k)(1) and is 5-year property under section
168(e). Pursuant to paragraph (g)(3)(ii) of this section and Sec.
1.168(i)-6(k)(2)(i), GG decided to apply Sec. 1.168(i)-6 to the
exchange of Equipment X3 for Equipment Y3, the acquired MACRS property.
(ii) Pursuant to paragraph (f)(5)(iii)(B) of this section, no
additional first year depreciation deduction is allowable for Equipment
X3 and, pursuant to Sec. 1.168(d)-1T(b)(3)(ii), no regular depreciation
deduction is allowable for Equipment X3, for the taxable year ended June
30, 2003.
(iii) Pursuant to paragraph (f)(5)(iii)(A) of this section, the 30-
percent additional first year depreciation deduction for Equipment Y3 is
allowable for the remaining carryover basis at the time of replacement
of $20,000 (Equipment X3's unadjusted depreciable basis of $20,000) and
for the remaining excess basis at the time of replacement of $5,000
(cash paid for Equipment Y3). Thus, the 30-percent additional first year
depreciation deduction for the remaining carryover basis at the time of
replacement equals $6,000 ($20,000 multiplied by .30) and for the
remaining excess basis at the time of replacement equals $1,500 ($5,000
multiplied by .30), which totals $7,500.
Example 5. (i) Same facts as in Example 4. GG depreciated Equipment
Y3 under the general depreciation system of section 168(a) by using the
200-percent declining balance method of depreciation, a 5-year recovery
period, and the half-year convention. GG elected to use the optional
depreciation tables to compute the depreciation allowance for Equipment
Y3. On July 1, 2003, GG acquired new Equipment Z1 by exchanging
Equipment Y3 in a like-kind exchange. Equipment Z1 is 50-percent bonus
depreciation property under section 168(k)(4) and is 5-year property
under section 168(e). Pursuant to paragraph (g)(3)(ii) of this section
and Sec. 1.168(i)-6(k)(2)(i), GG decided to apply Sec. 1.168(i)-6 to
[[Page 591]]
the exchange of Equipment Y3 for Equipment Z1, the acquired MACRS
property.
(ii) For the taxable year ending June 30, 2003, the regular MACRS
depreciation deduction allowable for the remaining carryover basis at
the time of replacement (after taking into account the additional first
year depreciation deduction) of Equipment Y3 is $2,800 (the remaining
carryover basis at the time of replacement of $20,000 minus the
additional first year depreciation deduction of $6,000, multiplied by
the annual depreciation rate of .20 for recovery year 1) and for the
remaining excess basis at the time of replacement (after taking into
account the additional first year depreciation deduction) of Equipment
Y3 is $700 (the remaining excess basis at the time of replacement of
$5,000 minus the additional first year depreciation deduction of $1,500,
multiplied by the annual depreciation rate of .20 for recovery year 1),
which totals $3,500.
(iii) For the taxable year ending June 30, 2004, the regular MACRS
depreciation deduction allowable for the remaining carryover basis
(after taking into account the additional first year depreciation
deduction) of Equipment Y3 is $2,240 (the remaining carryover basis at
the time of replacement of $20,000 minus the additional first year
depreciation deduction of $6,000, multiplied by the annual depreciation
rate of .32 for recovery year 2 x \1/2\ year) and for the remaining
excess basis (after taking into account the additional first year
depreciation deduction) of Equipment Y3 is $560 (the remaining excess
basis at the time of replacement of $5,000 minus the additional first
year depreciation deduction of $1,500, multiplied by the annual
depreciation rate of .32 for recovery year 2 x \1/2\ year), which totals
$2,800.
(iv) For the taxable year ending June 30, 2004, pursuant to
paragraph (f)(5)(iii)(A) of this section, the 50-percent additional
first year depreciation deduction for Equipment Z1 is allowable for the
remaining carryover basis at the time of replacement of $11,200
(Equipment Y3's unadjusted depreciable basis of $25,000 minus the total
additional first year depreciation deduction of $7,500 minus the total
2003 regular MACRS depreciation deduction of $3,500 minus the total 2004
regular depreciation deduction (taking into account the half-year
convention) of $2,800). Thus, the 50-percent additional first year
depreciation deduction for the remaining carryover basis at the time of
replacement equals $5,600 ($11,200 multiplied by .50).
Example 6. (i) In April 2004, SS, a calendar year-end corporation,
acquired and placed in service Equipment K89. Equipment K89 is 50-
percent bonus depreciation property under section 168(k)(4). In November
2004, SS acquired and placed in service used Equipment N78 by exchanging
Equipment K89 in a like-kind exchange.
(ii) Pursuant to paragraph (f)(5)(iii)(B) of this section, no
additional first year deduction is allowable for Equipment K89 and,
pursuant to Sec. 1.168(d)-1T(b)(3)(ii), no regular depreciation
deduction is allowable for Equipment K89, for the taxable year ended
December 31, 2004.
(iii) Equipment N78 is not qualified property under section
168(k)(1) or 50-percent bonus depreciation property under section
168(k)(4) because the original use requirement of paragraph (b)(3) of
this section is not met. Accordingly, no additional first year
depreciation deduction is allowable for Equipment N78.
(6) Change in use--(i) Change in use of depreciable property. The
determination of whether the use of depreciable property changes is made
in accordance with section 168(i)(5) and regulations thereunder.
(ii) Conversion to personal use. If qualified property or 50-percent
bonus depreciation property is converted from business or income-
producing use to personal use in the same taxable year in which the
property is placed in service by a taxpayer, the additional first year
depreciation deduction is not allowable for the property.
(iii) Conversion to business or income-producing use--(A) During the
same taxable year. If, during the same taxable year, property is
acquired by a taxpayer for personal use and is converted by the taxpayer
from personal use to business or income-producing use, the additional
first year depreciation deduction is allowable for the property in the
taxable year the property is converted to business or income-producing
use (assuming all of the requirements in paragraph (b) of this section
are met). See paragraph (b)(3)(ii) of this section relating to the
original use rules for a conversion of property to business or income-
producing use.
(B) Subsequent to the acquisition year. If property is acquired by a
taxpayer for personal use and, during a subsequent taxable year, is
converted by the taxpayer from personal use to business or income-
producing use, the additional first year depreciation deduction is
allowable for the property in the taxable year the property is converted
to business or income-producing use (assuming all of the requirements in
paragraph (b) of this section are met). For purposes of paragraphs
(b)(4) and (5) of
[[Page 592]]
this section, the property must be acquired by the taxpayer for personal
use after September 10, 2001 (for qualified property), or after May 5,
2003 (for 50-percent bonus depreciation property), and converted by the
taxpayer from personal use to business or income-producing use by
January 1, 2005. See paragraph (b)(3)(ii) of this section relating to
the original use rules for a conversion of property to business or
income-producing use.
(iv) Depreciable property changes use subsequent to the placed-in-
service year--(A) If the use of qualified property or 50-percent bonus
depreciation property changes in the hands of the same taxpayer
subsequent to the taxable year the qualified property or the 50-percent
bonus depreciation property, as applicable, is placed in service and, as
a result of the change in use, the property is no longer qualified
property or 50-percent bonus depreciation property, as applicable, the
additional first year depreciation deduction allowable for the qualified
property or the 50-percent bonus depreciation property, as applicable,
is not redetermined.
(B) If depreciable property is not qualified property or 50-percent
bonus depreciation property in the taxable year the property is placed
in service by the taxpayer, the additional first year depreciation
deduction is not allowable for the property even if a change in the use
of the property subsequent to the taxable year the property is placed in
service results in the property being qualified property or 50-percent
bonus depreciation property in the taxable year of the change in use.
(v) Examples. The application of this paragraph (f)(6) is
illustrated by the following examples:
Example 1. (i) On January 1, 2002, HH, a calendar year corporation,
purchased and placed in service several new computers at a total cost of
$100,000. HH used these computers within the United States for 3 months
in 2002 and then moved and used the computers outside the United States
for the remainder of 2002. On January 1, 2003, HH permanently returns
the computers to the United States for use in its business.
(ii) For 2002, the computers are considered as used predominantly
outside the United States in 2002 pursuant to Sec. 1.48-1(g)(1)(i). As
a result, the computers are required to be depreciated under the
alternative depreciation system of section 168(g). Pursuant to paragraph
(b)(2)(ii)(A)2) of this section, the computers are not qualified
property in 2002, the placed-in-service year. Thus, pursuant to
(f)(6)(iv)(B) of this section, no additional first year depreciation
deduction is allowed for these computers, regardless of the fact that
the computers are permanently returned to the United States in 2003.
Example 2. (i) On February 8, 2002, II, a calendar year corporation,
purchased and placed in service new equipment at a cost of $1,000,000
for use in its California plant. The equipment is 5-year property under
section 168(e) and is qualified property under section 168(k). II
depreciates its 5-year property placed in service in 2002 using the
optional depreciation table that corresponds with the general
depreciation system, the 200-percent declining balance method, a 5-year
recovery period, and the half-year convention. On June 4, 2003, due to
changes in II's business circumstances, II permanently moves the
equipment to its plant in Mexico.
(ii) For 2002, II is allowed a 30-percent additional first year
depreciation deduction of $300,000 (the adjusted depreciable basis of
$1,000,000 multiplied by .30). In addition, II's depreciation deduction
allowable in 2002 for the remaining adjusted depreciable basis of
$700,000 (the unadjusted depreciable basis of $1,000,000 reduced by the
additional first year depreciation deduction of $300,000) is $140,000
(the remaining adjusted depreciable basis of $700,000 multiplied by the
annual depreciation rate of .20 for recovery year 1).
(iii) For 2003, the equipment is considered as used predominantly
outside the United States pursuant to Sec. 1.48-1(g)(1)(i). As a result
of this change in use, the adjusted depreciable basis of $560,000 for
the equipment is required to be depreciated under the alternative
depreciation system of section 168(g) beginning in 2003. However, the
additional first year depreciation deduction of $300,000 allowed for the
equipment in 2002 is not redetermined.
(7) Earnings and profits. The additional first year depreciation
deduction is not allowable for purposes of computing earnings and
profits.
(8) Limitation of amount of depreciation for certain passenger
automobiles. For a passenger automobile as defined in section
280F(d)(5), the limitation under section 280F(a)(1)(A)(i) is increased
by--
(i) $4,600 for qualified property acquired by a taxpayer after
September 10, 2001, and before May 6, 2003; and
(ii) $7,650 for qualified property or 50-percent bonus depreciation
property acquired by a taxpayer after May 5, 2003.
[[Page 593]]
(9) Section 754 election. In general, for purposes of section 168(k)
any increase in basis of qualified property or 50-percent bonus
depreciation property due to a section 754 election is not eligible for
the additional first year depreciation deduction. However, if qualified
property or 50-percent bonus depreciation property is placed in service
by a partnership in the taxable year the partnership terminates under
section 708(b)(1)(B), any increase in basis of the qualified property or
the 50-percent bonus depreciation property due to a section 754 election
is eligible for the additional first year depreciation deduction.
(10) Coordination with section 47--(i) In general. If qualified
rehabilitation expenditures (as defined in section 47(c)(2) and Sec.
1.48-12(c)) incurred by a taxpayer with respect to a qualified
rehabilitated building (as defined in section 47(c)(1) and Sec. 1.48-
12(b)) are qualified property or 50-percent bonus depreciation property,
the taxpayer may claim the rehabilitation credit provided by section
47(a) (provided the requirements of section 47 are met)--
(A) With respect to the portion of the basis of the qualified
rehabilitated building that is attributable to the qualified
rehabilitation expenditures if the taxpayer makes the applicable
election under paragraph (e)(1)(i) or (e)(1)(ii)(B) of this section not
to deduct any additional first year depreciation for the class of
property that includes the qualified rehabilitation expenditures; or
(B) With respect to the portion of the remaining rehabilitated basis
of the qualified rehabilitated building that is attributable to the
qualified rehabilitation expenditures if the taxpayer claims the
additional first year depreciation deduction on the unadjusted
depreciable basis (as defined in paragraph (a)(2)(iii) of this section
but before the reduction in basis for the amount of the rehabilitation
credit) of the qualified rehabilitation expenditures and the taxpayer
depreciates the remaining adjusted depreciable basis (as defined in
paragraph (d)(2)(i) of this section) of such expenditures using straight
line cost recovery in accordance with section 47(c)(2)(B)(i) and Sec.
1.48-12(c)(7)(i). For purposes of this paragraph (f)(10)(i)(B), the
remaining rehabilitated basis is equal to the unadjusted depreciable
basis (as defined in paragraph (a)(2)(iii) of this section but before
the reduction in basis for the amount of the rehabilitation credit) of
the qualified rehabilitation expenditures that are qualified property or
50-percent bonus depreciation property reduced by the additional first
year depreciation allowed or allowable, whichever is greater.
(ii) Example. The application of this paragraph (f)(10) is
illustrated by the following example.
Example. (i) Between February 8, 2004, and June 4, 2004, UU, a
calendar-year taxpayer, incurred qualified rehabilitation expenditures
of $200,000 with respect to a qualified rehabilitated building that is
nonresidential real property under section 168(e). These qualified
rehabilitation expenditures are 50-percent bonus depreciation property
and qualify for the 10-percent rehabilitation credit under section
47(a)(1). UU's basis in the qualified rehabilitated building is zero
before incurring the qualified rehabilitation expenditures and UU placed
the qualified rehabilitated building in service in July 2004. UU
depreciates its nonresidential real property placed in service in 2004
under the general depreciation system of section 168(a) by using the
straight line method of depreciation, a 39-year recovery period, and the
mid-month convention. UU elected to use the optional depreciation tables
to compute the depreciation allowance for its depreciable property
placed in service in 2004. Further, for 2004, UU did not make any
election under paragraph (e) of this section.
(ii) Because UU did not make any election under paragraph (e) of
this section, UU is allowed a 50-percent additional first year
depreciation deduction of $100,000 for the qualified rehabilitation
expenditures for 2004 (the unadjusted depreciable basis of $200,000
(before reduction in basis for the rehabilitation credit) multiplied by
.50). For 2004, UU also is allowed to claim a rehabilitation credit of
$10,000 for the remaining rehabilitated basis of $100,000 (the
unadjusted depreciable basis (before reduction in basis for the
rehabilitation credit) of $200,000 less the additional first year
depreciation deduction of $100,000). Further, UU's depreciation
deduction for 2004 for the remaining adjusted depreciable basis of
$90,000 (the unadjusted depreciable basis (before reduction in basis for
the rehabilitation credit) of $200,000 less the additional first year
depreciation deduction of $100,000 less the rehabilitation credit of
$10,000) is $1,059.30 (the remaining adjusted depreciable
[[Page 594]]
basis of $90,000 multiplied by the depreciation rate of .01177 for
recovery year 1, placed in service in month 7).
(11) Coordination with section 514(a)(3). The additional first year
depreciation deduction is not allowable for purposes of section
514(a)(3).
(g) Effective date--(1) In general. Except as provided in paragraphs
(g)(2), (3), and (5) of this section, this section applies to qualified
property under section 168(k)(2) acquired by a taxpayer after September
10, 2001, and to 50-percent bonus depreciation property under section
168(k)(4) acquired by a taxpayer after May 5, 2003.
(2) Technical termination of a partnership or section 168(i)(7)
transactions. If qualified property or 50 percent bonus depreciation
property is transferred in a technical termination of a partnership
under section 708(b)(1)(B) or in a transaction described in section
168(i)(7) for a taxable year ending on or before September 8, 2003, and
the additional first year depreciation deduction allowable for the
property was not determined in accordance with paragraph (f)(1)(ii) or
(iii) of this section, as applicable, the Internal Revenue Service will
allow any reasonable method of determining the additional first year
depreciation deduction allowable for the property in the year of the
transaction that is consistently applied to the property by all parties
to the transaction.
(3)(i) Like-kind exchanges and involuntary conversions. If a
taxpayer did not claim on a federal tax return for a taxable year ending
on or before September 8, 2003, the additional first year depreciation
deduction for the remaining carryover basis of qualified property or 50-
percent bonus depreciation property acquired in a transaction described
in section 1031(a), (b), or (c), or in a transaction to which section
1033 applies and the taxpayer did not make an election not to deduct the
additional first year depreciation deduction for the class of property
applicable to the remaining carryover basis, the Internal Revenue
Service will treat the taxpayer's method of not claiming the additional
first year depreciation deduction for the remaining carryover basis as a
permissible method of accounting and will treat the amount of the
additional first year depreciation deduction allowable for the remaining
carryover basis as being equal to zero, provided the taxpayer does not
claim the additional first year depreciation deduction for the remaining
carryover basis in accordance with paragraph (g)(4)(ii) of this section.
(ii) Paragraphs (f)(5)(ii)(F)(2) and (f)(5)(v) of this section apply
to a like-kind exchange or an involuntary conversion of MACRS property
and computer software for which the time of disposition and the time of
replacement both occur after February 27, 2004. For a like-kind exchange
or an involuntary conversion of MACRS property for which the time of
disposition, the time of replacement, or both occur on or before
February 27, 2004, see Sec. 1.168(i)-6(k)(2)(ii). For a like-kind
exchange or involuntary conversion of computer software for which the
time of disposition, the time of replacement, or both occur on or before
February 27, 2004, a taxpayer may rely on prior guidance issued by the
Internal Revenue Service for determining the depreciation deductions of
the acquired computer software and the exchanged or involuntarily
converted computer software (for further guidance, see Sec. 1.168(k)-
1T(f)(5) published in the Federal Register on September 8, 2003 (68 FR
53000)). In relying on such guidance, a taxpayer may use any reasonable,
consistent method of determining depreciation in the year of disposition
and the year of replacement.
(4) Change in method of accounting--(i) Special rules for 2000 or
2001 returns. If a taxpayer did not claim on the Federal tax return for
the taxable year that included September 11, 2001, any additional first
year depreciation deduction for a class of property that is qualified
property and did not make an election not to deduct the additional first
year depreciation deduction for that class of property, the taxpayer
should refer to the guidance provided by the Internal Revenue Service
for the time and manner of claiming the additional first year
depreciation deduction for the class of property (for further guidance,
see section 4 of Rev. Proc. 2002-33 (2002-1 C.B. 963), Rev. Proc. 2003-
50 (2003-29 I.R.B. 119), and Sec. 601.601(d)(2)(ii)(b) of this
chapter).
[[Page 595]]
(ii) Like-kind exchanges and involuntary conversions. If a taxpayer
did not claim on a federal tax return for any taxable year ending on or
before September 8, 2003, the additional first year depreciation
deduction allowable for the remaining carryover basis of qualified
property or 50-percent bonus depreciation property acquired in a
transaction described in section 1031(a), (b), or (c), or in a
transaction to which section 1033 applies and the taxpayer did not make
an election not to deduct the additional first year depreciation
deduction for the class of property applicable to the remaining
carryover basis, the taxpayer may claim the additional first year
depreciation deduction allowable for the remaining carryover basis in
accordance with paragraph (f)(5) of this section either:
(A) By filing an amended return (or a qualified amended return, if
applicable (for further guidance, see Rev. Proc. 94-69 (1994-2 C.B. 804)
and Sec. 601.601(d)(2)(ii)(b) of this chapter)) on or before December
31, 2003, for the year of replacement and any affected subsequent
taxable year; or,
(B) By following the applicable administrative procedures issued
under Sec. 1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic
consent to a change in method of accounting (for further guidance, see
Rev. Proc. 2002-9 (2002-1 C.B. 327) and Sec. 601.601(d)(2)(ii)(b) of
this chapter).
(5) Revision to paragraphs (b)(3)(iii)(B) and (b)(5)(ii)(B) of this
section. The addition of ``(or, in the case of multiple units of
property subject to the same lease, within three months after the date
the final unit is placed in service, so long as the period between the
time the first unit is placed in service and the time the last unit is
placed in service does not exceed 12 months)'' to paragraphs
(b)(3)(iii)(B) and (b)(5)(ii)(B) of this section applies to property
sold after June 4, 2004.
(6) Rehabilitation credit. If a taxpayer did not claim on a Federal
tax return for any taxable year ending on or before September 1, 2006,
the rehabilitation credit provided by section 47(a) with respect to the
portion of the basis of a qualified rehabilitated building that is
attributable to qualified rehabilitation expenditures and the qualified
rehabilitation expenditures are qualified property or 50-percent bonus
depreciation property, and the taxpayer did not make the applicable
election specified in paragraph (e)(1)(i) or (e)(1)(ii)(B) of this
section for the class of property that includes the qualified
rehabilitation expenditures, the taxpayer may claim the rehabilitation
credit for the remaining rehabilitated basis (as defined in paragraph
(f)(10)(i)(B) of this section) of the qualified rehabilitated building
that is attributable to the qualified rehabilitation expenditures
(assuming all the requirements of section 47 are met) in accordance with
paragraph (f)(10)(i)(B) of this section by filing an amended Federal tax
return for the taxable year for which the rehabilitation credit is to be
claimed. The amended Federal tax return must include the adjustment to
the tax liability for the rehabilitation credit and any collateral
adjustments to taxable income or to the tax liability (for example, the
amount of depreciation allowed or allowable in that taxable year for the
qualified rehabilitated building). Such adjustments must also be made on
amended Federal tax returns for any affected succeeding taxable years.
[T.D. 9091, 68 FR 52992, Sept. 8, 2003; 68 FR 63734, Nov. 10, 2003, as
amended by T.D. 9115, 69 FR 9546, Mar. 1, 2004; 69 FR 17586, 17587, Apr.
5, 2004. Redesignated and amended by T.D. 9283, 71 FR 51738, Aug. 31,
2006; T.D. 9314, 72 FR 9261, Mar. 1, 2007]
Sec. 1.168A-1 Amortization of emergency facilities; general rule.
(a) A person (including an estate or trust (see section 642(f) and
Sec. 1.642(f)-1) and a partnership (see section 703 and Sec. 1.703-1))
is entitled, by election, to a deduction with respect to the
amortization of the adjusted basis (for determining gain) of an
emergency facility, such amortization to be based on a period of 60
months. As to the adjusted basis of an emergency facility, see Sec.
1.168A-5. The taxpayer may elect to begin the 60-month amortization
period with (1) the month following the month in which such facility was
completed or acquired, or (2) the taxable year succeeding that in which
such facility was completed or acquired (see Sec. 1.168A-2).
[[Page 596]]
The date on which, or the month within which, an emergency facility is
completed or acquired is to be determined upon the facts in the
particular case. Ordinarily, the taxpayer is in possession of all the
facts and, therefore, in a position to ascertain such date. A statement
of the date ascertained by the taxpayer, together with a statement of
the pertinent facts relied upon, should be filed with the taxpayer's
election to take amortization deductions with respect to such facility.
(b) Generally, an amortization deduction will not be allowed with
respect to an emergency facility for any taxable year unless such
facility has been certified before the date of filing of the taxpayer's
income tax return for such taxable year. However, this limitation does
not apply in the case of a certificate made after August 22, 1957, for
an emergency facility to provide primary processing for uranium ore or
uranium concentrate under a program of the Atomic Energy Commission for
the development of any sources of uranium ore or uranium concentrate, if
application for such certificate was filed either (1) before September
2, 1958, and before the expiration of six months after the beginning of
construction, reconstruction, erection, or installation or the date of
acquisition of the facility, or (2) after September 1, 1958, and on or
before December 2, 1958.
(c) In general, with respect to each month of the 60-month period
which falls within the taxable year, the amortization deduction is an
amount equal to the adjusted basis of the facility at the end of each
month divided by the number of months (including the particular month
for which the deduction is computed) remaining in the 60-month period.
The adjusted basis at the end of any month shall be computed without
regard to the amortization deduction for such month. The total
amortization deduction with respect to an emergency facility for a
particular taxable year is the sum of the amortization deductions
allowable for each month of the 60-month period which falls within such
taxable year. The amortization deduction taken for any month is in lieu
of the deduction for depreciation which would otherwise be allowable
under section 167. See, however, Sec. 1.168A-6, relating to
depreciation with respect to any portion of the emergency facility not
subject to amortization.
(d) This section may be illustrated by the following examples:
Example 1. On July 1, 1954, the X Corporation, which makes its
income tax returns on the calendar year basis, begins the construction
of an emergency facility which is completed on September 30, 1954, at a
cost of $240,000. The certificate covers the entire construction. The X
Corporation elects to take amortization deductions with respect to the
facility and to begin the 60-month amortization period with October, the
month following its completion. The adjusted basis of the facility at
the end of October is $240,000. The allowable amortization deduction
with respect to such facility for the taxable year 1954 is $12,000,
computed as follows:
Monthly amortization deductions:
October: $240,000 divided by 60............................. $4,000
November: $236,000 ($240,000 minus $4,000) divided by 59.... 4,000
December: $232,000 ($236,000 minus $4,000) divided by 58.... 4,000
---------
Total amortization deduction for 1954..................... 12,000
Example 2. The Y Corporation, which makes its income tax returns on
the basis of a fiscal year ending November 30, purchases an emergency
facility (No. 1) on July 29, 1955. On June 15, 1955, it begins the
construction of an emergency facility (No. 2) which is completed on
August 2, 1955. The entire acquisition and construction of such
facilities are covered by the certificate. The Y Corporation elects to
take amortization deductions with respect to both facilities and to
begin the 60-month amortization period in each case with the month
following the month of acquisition or completion. At the end of the
first month of the amortization period the adjusted basis of facility
No. 1 is $300,000 and the adjusted basis of facility No. 2 is $54,000.
In September 1955, facility No. 1 is damaged by fire, as a result of
which its adjusted basis is properly reduced by $25,370. The allowable
amortization deduction with respect to such facilities for the taxable
year ending November 30, 1955, is $21,410, computed as follows:
Facility No. 1
Monthly amortization deductions:
August: $300,000 divided by 60.............................. $5,000
September: $269,630 ($300,000 minus $5,000 and $25,370) 4,570
divided by 59..............................................
October: $265,060 ($269,630 minus $4,570) divided by 58..... 4,570
November: $260,490 ($265,060 minus $4,570) divided by 57.... 4,570
---------
Amortization deduction for 1955......................... 18,710
[[Page 597]]
Facility No. 2
Monthly amortization deductions:
September: $54,000 divided by 60............................ $900
October: $53,100 divided by 59.............................. 900
November: $52,200 divided by 58............................. 900
---------
Amortization deduction for 1955........................... 2,700
=========
Total amortization deduction for 1955..................... 21,410
Example 3. On June 15, 1954, the Z Corporation, which makes its
income tax returns on the calendar year basis, completes the
construction of an emergency facility at a cost of $110,000. In its
income tax return for 1954, filed on March 15, 1955, the Z Corporation
elects to take amortization deductions with respect to such facility and
to begin the 60-month amortization period with July 1954, the month
following its completion. No certificate with respect to such facility
is made until April 10, 1955, and therefore no amortization deduction
with respect to such facility is allowable for any month in the taxable
year 1954. The Z Corporation is entitled, however, to take a deduction
for depreciation of such facility for the taxable year 1954, such
deduction being assumed, for the purposes of this example, to be $2,000.
Accordingly, the adjusted basis of such facility at the end of January
1955 (without regard to the amortization deduction for such month) is
$108,000 ($110,000 minus $2,000). For the taxable year 1955, the Z
Corporation is, with respect to such facility, entitled to an
amortization deduction of $24,000, computed as follows:
Monthly amortization deductions:
January: $108,000 divided by 54............................. $2,000
February: $106,000 ($108,000 minus $2,000) divided by 53.... 2,000
March: $104,000 ($106,000 minus $2,000) divided by 52....... 2,000
For the remaining nine months (similarly computed).......... 18,000
---------
Total amortization deduction for 1955..................... 24,000
Since the Z Corporation elected in its return for 1954 to take
amortization deductions with respect to such facility and to begin the
60-month amortization period with July 1954, it must compute its
amortization deductions for the 12 months in the taxable year 1955 on
the basis of the remaining months of the established 60-month
amortization period, as indicated in the above computation.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated and amended by T.D. 8116, 51 FR 46618, Dec. 24, 1986]
Sec. 1.168A-2 Election of amortization.
(a) General rule. An election by the taxpayer to take amortization
deductions with respect to an emergency facility and to begin the 60-
month amortization period either with the month following the month in
which such facility was completed or acquired, or with the taxable year
succeeding the taxable year in which such facility was completed or
acquired, shall be made by a statement to that effect in its return for
the taxable year in which falls the first month of the 60-month
amortization period so elected. However, if the facility is described in
section 168(e)(2)(C) and an application for a certificate is filed
within the period prescribed by section 9(c) of the Technical Amendments
Act of 1958 (72 Stat. 1609) and paragraph (b) of Sec. 1.168A-1, the
election may be made by a statement in an amended income tax return for
the taxable year in which falls the first month of the 60-month
amortization period so elected. The statement and amended return in such
case must be filed not later than 90 days after the date the certificate
is made or not later than April 4, 1960, whichever is later. Amended
income tax returns or claims for credit or refund should also be filed
for other taxable years which are within such amortization period and
which precede the taxable year in which the election is made. Nothing in
this paragraph should be construed as extending the time specified in
section 6511 within which a claim for credit or refund may be filed.
(b) Election not made, in prescribed manner. If the statement of
election is not made by the taxpayer as prescribed in paragraph (a) of
this section, it may, in the discretion of the Commissioner and for good
cause shown, be made in such manner and form and within such time as may
be approved by the Commissioner.
(c) Other requirements and considerations. No method of making such
election other than those prescribed in this section and corresponding
sections of prior regulations is permitted. Any statement of election
should contain a description clearly identifying each emergency facility
for which an amortization deduction is claimed. A taxpayer which does
not elect, in the manner prescribed in this section or corresponding
sections of prior regulations, to take amortization deductions with
respect to an emergency facility
[[Page 598]]
shall not be entitled to such deductions.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated and amended by T.D. 8116, 51 FR 46618, Dec. 24, 1986]
Sec. 1.168A-3 Election to discontinue amortization.
(a) If a taxpayer has elected to take amortization deductions with
respect to an emergency facility, it may, after such election and prior
to the expiration of the 60-month amortization period, discontinue the
amortization deductions for the remainder of the 60-month period. An
election to discontinue the amortization deductions shall be made by a
notice in writing filed with the district director for the internal
revenue district in which the return of the taxpayer is required to be
filed, specifying the month as of the beginning of which the taxpayer
elects to discontinue such deductions. Such notice shall be filed before
the beginning of the month specified therein, and shall contain a
description clearly identifying the emergency facility with respect to
which the taxpayer elects to discontinue the amortization deductions. If
the taxpayer so elects to discontinue the amortization deductions, it
shall not be entitled to any further amortization deductions with
respect to such facility.
(b) A taxpayer which thus elects to discontinue amortization
deductions with respect to an emergency facility is entitled, if such
facility is depreciable property under section 167 and the regulations
thereunder, to a deduction for depreciation with respect to such
facility. The deduction for depreciation shall begin with the first
month as to which the amortization deduction is not applicable, and
shall be computed on the adjusted basis of the property as of the
beginning of such month (see section 1011 and the regulations
thereunder).
(c) This section may be illustrated by the following example:
Example. On July 1, 1954, the X Corporation, which makes its income
tax returns on the calendar year basis, purchases an emergency facility,
consisting of land with a building thereon, at a cost of $306,000 of
which $60,000 is allocable to the land and $246,000 to the building. The
certificate covers the entire acquisition. The corporation elects to
take amortization deductions with respect to the facility and to begin
the 60-month amortization period with the taxable year 1955.
Depreciation of the building in the amount of $6,000 is deducted and
allowed for the taxable year 1954. On March 25, 1956, the corporation
files notice with the district director of its election to discontinue
the amortization deductions beginning with the month of April 1956. The
adjusted basis of the facility on January 31, 1955, is $300,000, or the
cost of the facility ($306,000) less the depreciation allowed for 1954
($6,000). The amortization deductions for the taxable year 1955 and the
months of January, February, and March 1956, amount to $75,000, or
$5,000 per month for 15 months. Since, at the beginning of the
amortization period (January 1, 1955), the adjusted basis of the land
($60,000) is one-fifth of the adjusted basis of the entire facility
($300,000) and since there are no adjustments to basis other than on
account of amortization during the period, the adjusted basis of the
land should be reduced by $15,000, or one-fifth of the entire
amortization deduction, and the adjusted basis of the building should be
reduced by $60,000, or four-fifths of the entire amortization deduction.
Accordingly, the adjusted basis of the facility as of April 1, 1956, is
$225,000, of which $180,000 is allocable to the building for the purpose
of depreciation deductions under section 167, and $45,000 is allocable
to the land.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated by T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.168A-4 Definitions.
As used in the regulations under section 168, the term--
(a) ``Certifying authority'' means the certifying authority
designated by the President by Executive order.
(b) ``Emergency facility'' means any facility, land, building,
machinery, or equipment, or any part thereof, the acquisition of which
occurred after December 31, 1949, or the construction, reconstruction,
erection, or installation of which was completed after such date, and
with respect to which a certificate under section 168(e) has been made.
In the case of an application for a certificate under section 168(e)
which is filed after March 23, 1951, only the part of any such facility
which is constructed, reconstructed, erected, or installed by any person
not earlier than six months prior to the filing of such application, and
which is certified in accordance with section 168(e), shall be deemed to
be an emergency facility,
[[Page 599]]
notwithstanding that the other part of such facility was constructed,
reconstructed, erected, or installed earlier than six months prior to
the filing of such application. However, if the facility is one
described in section 168(e)(2)(C) and the application was filed after
September 1, 1958, and on or before December 2, 1958, the preceding
sentence shall not apply. The term ``emergency facility,'' as so
defined, may include, among other things, improvements of land, such as
the construction of roads, bridges, and airstrips, and the dredging of
channels.
(c) ``Emergency period'' means the period beginning on January 1,
1950, and ending on the date on which the President proclaims that the
utilization of a substantial portion of the certified emergency
facilities is no longer required in the interest of national defense.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated by T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.168A-5 Adjusted basis of emergency facility.
(a) In general. (1) The adjusted basis of an emergency facility for
the purpose of computing the amortization deduction may differ from what
would otherwise constitute the adjusted basis of such emergency facility
in that it shall be the adjusted basis for determining gain (see Part II
(section 1011 and following), Subchapter 0, Chapter 1 of the Code) and
in that it may be only a portion of what would otherwise constitute the
adjusted basis. It will be only a portion of such other adjusted basis
if only a portion of the basis (unadjusted) is attributable to certified
construction, reconstruction, erection, installation, or acquisition
taking place after December 31, 1949. Also, it will be only a portion of
what would otherwise constitute the adjusted basis of the emergency
facility if only a portion of the basis (unadjusted) is certified as
attributable to defense purposes or, in the case of a certification
after August 22, 1957, if only a portion of the basis (unadjusted) is
certified as attributable to the national defense program. It is
therefore necessary first to determine the unadjusted basis of the
emergency facility from which the adjusted basis for amortization
purposes is derived.
(2) The unadjusted basis for amortization purposes is the same as
the unadjusted basis otherwise determined only when the entire
construction, reconstruction, erection, installation, or acquisition
takes place after December 31, 1949, and is certified in its entirety by
the certifying authority.
(3) In cases in which only a portion of the construction,
reconstruction, erection, installation, or acquisition takes place after
December 31, 1949, and that portion is certified in its entirety by the
certifying authority, the unadjusted basis for the purpose of
amortization is so much of the entire unadjusted basis as is
attributable to the certified construction, reconstruction, erection,
installation, or acquisition which takes place after December 31, 1949.
For example, the X Corporation begins the construction of a facility on
November 15, 1949, and such facility is completed on April 1, 1952, at a
cost of $5,000,000, of which $4,600,000 is attributable to construction
after December 31, 1949. The entire construction after December 31,
1949, is certified by the certifying authority. The unadjusted basis of
the emergency facility for amortization purposes is therefore
$4,600,000. For depreciation of the remaining portion ($400,000) of the
cost see Sec. 1.168A-6.
(4) If the certifying authority certifies only a portion of the
construction, reconstruction, erection, installation, or acquisition of
property which takes place after December 31, 1949, the unadjusted basis
for amortization purposes is limited to such portion so certified.
Assuming the same facts as in the example in subparagraph (3) of this
paragraph, except that only 50 percent of the construction,
reconstruction, erection, installation, or acquisition after December
31, 1949, is certified, the unadjusted basis for amortization purposes
is 50 percent of $4,600,000, or $2,300,000.
(5) The adjusted basis of an emergency facility for amortization
purposes is the unadjusted basis for amortization purposes less the
adjustments
[[Page 600]]
properly applicable thereto. Such adjustments are those specified in
sections 1016 and 1017, except that no adjustments are to be taken into
account which increase the adjusted basis. (See paragraph (b) of this
section.) If the taxpayer constructs, reconstructs, erects, installs, or
acquires an emergency facility pursuant to a cost reimbursement contract
with an obligation for reimbursement by the United States of all or a
part of the cost of such facility, the unadjusted basis of such facility
for amortization purposes shall not include that part of the cost for
which the taxpayer is entitled to reimbursement, and the amount received
as reimbursement shall be treated as a capital receipt. However, amounts
received by a taxpayer which represent in fact compensation by reason of
termination of a government contract or payment for articles under such
a contract, though denominated reimbursements for all or a part of the
cost of an emergency facility, are not to be treated as capital receipts
but are to be taken into account in computing income, and are therefore
not to be applied in reduction of the basis of such facility.
(6) The following examples will illustrate the computation of the
adjusted basis of an emergency facility for amortization purposes:
Example 1. The X Corporation completes an emergency facility on July
1, 1954, the entire unadjusted basis of which is $500,000, and the
unadjusted basis of which for the purpose of amortization is $300,000.
The X Corporation elects to begin amortization as of January 1, 1955.
The only adjustment to basis for the period July 1, 1954, to January 31,
1955, other than depreciation or amortization for January 1955, is
$5,000 for depreciation for the last six months of 1954. The adjusted
basis for the purpose of amortization is therefore $300,000 less $3,000
(300,000/500,000x$5,000), or $297,000.
Example 2. On July 31, 1956, the Y Corporation has an emergency
facility (a building) which was completed on July 1, 1952, the entire
basis of which is $500,000 and the unadjusted basis of which for the
purpose of amortization is $300,000. The corporation elected to begin
amortization as of January 1, 1953, at which time it was entitled to
$5,000 depreciation for the last six months of 1952. On July 1, 1956,
the facility was damaged by fire, as the result of which its adjusted
basis is properly reduced by $200,000. The adjusted basis of the
emergency facility as of July 1956 for the purpose of amortization and
depreciation, and the adjusted basis for other purposes, are $23,849.18,
$49,250.82, and $73,100.00, respectively, computed as follows:
----------------------------------------------------------------------------------------------------------------
For For For other
amortization depreciation purposes
----------------------------------------------------------------------------------------------------------------
Unadjusted basis................................................ $300,000.00 $200,000.00 $500,000
Less depreciation to Jan. 1, 1953............................... 3,000.00 2,000.00 5,000
-----------------------------------------------
Adjusted basis January 1953................................... 297,000.00 198,000.00 495,000
Less amortization for 42 months................................. 207,900.00 .............. 207,900
Less depreciation for 42 months................................. .............. 14,000.00 14,000
-----------------------------------------------
Adjusted basis at time of fire................................ 89,100.00 184,000.00 273,100
Less fire loss (apportioned as explained below)................. 65,250.82 134,749.18 200,000
-----------------------------------------------
Adjusted basis after fire loss................................ 23,849.18 49,250.82 73,100
----------------------------------------------------------------------------------------------------------------
The $200,000 fire loss is applied against the adjusted basis for the
purpose of amortization and the adjusted basis for the purpose of
depreciation in the proportion that each such adjusted basis at the time
of the fire bears to their sum, i.e., 89,100/273,100x$200,000 or
$65,250.82, against the amortization basis, and 184,000/
273,100x$200,000, or $134,749.18 against the depreciation basis.
(b) Capital additions. (1) If, after the completion or acquisition
of an emergency facility which has been certified by the certifying
authority, further expenditures are made for construction,
reconstruction, erection, installation, or acquisition attributable to
such facility but not covered by such certification, such expenditures
shall not be added to the adjusted basis of the emergency facility for
amortization purposes under such certification. If such further
expenditures are separately certified in accordance with the provisions
of section 168(e) (1) or (2) and this section, they are treated as
certified expenditures in connection with a new and separate emergency
facility and, if proper election is made, will be
[[Page 601]]
taken into account in computing the adjusted basis of such new and
separate emergency facility for the purpose of amortization.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example. On March 1, 1954, the certifying authority certifies as an
emergency facility a heating plant proposed to be constructed by the Z
Corporation. Such facility is completed on July 1, 1954. The Z
Corporation, on August 1, 1954, begins the installation in the plant of
an additional boiler, which is not included in the certification for the
plant but is certified as a new and separate emergency facility. For
amortization purposes, the adjusted basis of the heating plant is
determined without including the cost of the additional boiler. Such
cost is taken into account in computing the adjusted basis of the new
and separate emergency facility (the boiler), as to which the taxpayer
has a separate election for amortization purposes and a separate
amortization period.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.168A-6 Depreciation of portion of emergency facility not
subject to amortization.
(a) The rule that an amortization deduction with respect to an
emergency facility is in lieu of any deduction for depreciation which
would otherwise be allowable under section 167 is subject to the
exception provided in section 168(f). Under this exception, if the
property constituting such facility is depreciable property under
section 167 and the regulations thereunder and if the adjusted basis of
such facility as computed under section 1011 for purposes other than the
amortization deductions is in excess of the adjusted basis computed for
the purpose of the amortization deductions, then the excess shall be
charged off over the useful life of the facility and recovered through
depreciation deductions. Thus, if the construction of an emergency
facility is begun on or before December 31, 1949, and completed after
such date, no amortization deductions are allowable with respect to the
amount attributable to such construction on or before such date (see
Sec. 1.168A-5). However, if the property constituting such facility is
depreciable property under section 167 and the regulations thereunder,
then the depreciation deduction provided by such section and regulations
is allowable with respect to the amount attributable to such
construction on or before December 31, 1949.
(b) Similarly, if only a portion of the construction,
reconstruction, erection, installation, or acquisition after December
31, 1949, of an emergency facility has been certified by the certifying
authority, and if such facility is depreciable property under section
167 and the regulations thereunder, then the depreciation deduction
provided by such section and regulations is allowable with respect to
the portion which has not been so certified.
(c) For illustration of the treatment of a depreciable portion of an
emergency facility, see example (2) in paragraph (a)(6) of Sec. 1.168A-
5.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.168A-7 Payment by United States of unamortized cost of facility.
(a) Section 168(g) contemplates that certain payments may be made by
the United States to a taxpayer as compensation for the unamortized cost
of an emergency facility. If any such payment is properly includible in
gross income and has been certified, as provided in section 168(g), as
having been paid under the circumstances described therein, a taxpayer
which is recovering the adjusted basis of an emergency facility through
amortization rather than depreciation may elect to take an amount equal
to such payment as an amortization deduction with respect to such
facility for the month in which such payment is so includible. Such
amortization deduction shall be in lieu of the amortization deduction
otherwise allowable with respect to such facility for such month, but it
shall not in any case exceed the adjusted basis of such facility (see
Sec. 1.168A-5) as of the end of such month (computed without regard to
any amortization deduction for such month). The election referred to in
this paragraph shall be made in the return for the taxable year in which
the amount of such payment is includible in gross income.
(b) If a taxpayer is recovering the adjusted basis of an emergency
facility
[[Page 602]]
through depreciation rather than amortization, the depreciation
deduction allowable under section 167 for the month in which the amount
of any such payment is includible in gross income shall, at the
taxpayer's election, be increased by such amount; but the total
deduction with respect to the certified portion of such facility shall
not in any case exceed the adjusted basis of such facility (computed as
provided in section 168(e) and Sec. 1.168A-5 for amortization purposes)
as of the end of such month (computed without regard to any amount
allowable for such month under section 167 or 168(g)(2)). The election
referred to in this paragraph shall be made in the return for the
taxable year in which the amount of such payment is includible in gross
income.
(c) This section may be illustrated by the following examples:
Example 1. On January 31, 1954, the X Corporation purchases an
emergency facility at a cost of $600,000. The certificate covers the
entire acquisition. The X Corporation elects to take amortization
deductions with respect to such facility and to begin the 60-month
amortization period with February 1954, the month following the month of
acquisition. On July 15, 1955, as a result of the cancellation of
certain contracts with the X Corporation, the United States makes a
payment of $300,000 to the corporation as compensation for the
unamortized cost of such facility. The $300,000 payment is includible in
the X Corporation's gross income for July 1955. The adjusted basis of
such facility for amortization purposes as of the end of July 1955,
computed without regard to any amortization deduction for such month, is
$430,000. Accordingly, the corporation is entitled to take an
amortization deduction of $300,000 for such month, in lieu of the
$10,000 amortization deduction which is otherwise allowable.
Example 2. On November 30, 1954, the Y Corporation purchases an
emergency facility, consisting of land with a building thereon, at a
cost of $500,000, of which $200,000 is allocable to the land and
$300,000 to the building. The certificate covers the entire acquisition.
The Y Corporation does not elect to take amortization deductions with
respect to such facility, but is entitled to a depreciation deduction
with respect to the building at the rate of 3 percent per annum, or $750
per month. On August 12, 1956, as a result of cancellation of certain
contracts, the United States makes a payment of $400,000 to the
corporation as compensation for the unrecovered cost of such facility.
The $400,000 is includible in the Y Corporation's gross income for
August 1956. The adjusted basis of the facility as of the end of August
1956, computed without regard to depreciation for such month, is
$485,000, of which amount $200,000 is allocable to the land and $285,000
to the building. Accordingly, the corporation is entitled to increase
the $750 depreciation deduction for August 1956 by the full amount of
the $400,000 payment.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21, 1960.
Redesignated and amended by T.D. 8116, 51 FR 46619, Dec. 24, 1986]
Sec. 1.169-1 Amortization of pollution control facilities.
(a) Allowance of deduction--(1) In general. Under section 169(a),
every person, at his election, shall be entitled to a deduction with
respect to the amortization of the amortizable basis (as defined in
Sec. 1.169-3) of any certified pollution control facility (as defined
in Sec. 1.169-2), based on a period of 60 months. Under section 169(b)
and paragraph (a) of Sec. 1.169-4, the taxpayer may further elect to
begin such 60-month period either with the month following the month in
which the facility is completed or acquired or with the first month of
the taxable year succeeding the taxable year in which such facility is
completed or acquired. Under section 169(c), a taxpayer who has elected
under section 169(b) to take the amortization deduction provided by
section 169(a) may, at any time after making such election and prior to
the expiration of the 60-month amortization period, elect to discontinue
the amortization deduction for the remainder of the 60-month period in
the manner prescribed in paragraph (b)(1) of Sec. 1.169-4. In addition,
if on or before May 18, 1971, an election under section 169(a) has been
made, consent is hereby given to revoke such election without the
consent of the Commissioner in the manner prescribed in (b)(2) of Sec.
1.169-4.
(2) Amount of deduction. With respect to each month of such 60-month
period which falls within the taxable year, the amortization deduction
shall be an amount equal to the amortizable basis of the certified
pollution control facility at the end of such month divided by the
number of months (including the month for which the deduction is
computed) remaining in such 60-month period. The amortizable basis at
the end
[[Page 603]]
of any month shall be computed without regard to the amortization
deduction for such month. The total amortization deduction with respect
to a certified pollution control facility for a taxable year is the sum
of the amortization deductions allowable for each month of the 60-month
period which falls within such taxable year. If a certified pollution
control facility is sold or exchanged or otherwise disposed of during 1
month, the amortization deduction (if any) allowable to the original
holder in respect of such month shall be that portion of the amount to
which such person would be entitled for a full month which the number of
days in such month during which the facility was held by such person
bears to the total number of days in such month.
(3) Effect on other deductions. (i) The amortization deduction
provided by section 169 with respect to any month shall be in lieu of
the depreciation deduction which would otherwise be allowable under
section 167 or a deduction in lieu of depreciation which would otherwise
be allowable under paragraph (b) of Sec. 1.162-11 for such month.
(ii) If the adjusted basis of such facility as computed under
section 1011 for purposes other than the amortization deduction provided
by section 169 is in excess of the amortizable basis, as computed under
Sec. 1.169-3, such excess shall be recovered through depreciation
deductions under the rules of section 167. See section 169(g).
(iii) See section 179 and paragraph (e)(1)(ii) of Sec. 1.179-1 and
paragraph (b)(2) of Sec. 1.169-3 for additional first-year depreciation
in respect of a certified pollution control facility.
(4) [Reserved]
(5) Special rules. (i) In the case of a certified pollution control
facility held by one person for life with the remainder to another
person, the amortization deduction under section 169(a) shall be
computed as if the life tenant were the absolute owner of the property
and shall be allowable to the life tenant during his life.
(ii) If the assets of a corporation which has elected to take the
amortization deduction under section 169(a) are acquired by another
corporation in a transaction to which section 381 (relating to
carryovers in certain corporate acquisitions) applies, the acquiring
corporation is to be treated as if it were the distributor or transferor
corporation for purposes of this section.
(iii) For the right of estates and trusts to amortize pollution
control facilities see section 642(f) and Sec. 1.642 (f)-1. For the
allowance of the amortization deduction in the case of pollution control
facilities of partnerships, see section 703 and Sec. 1.703-1.
(6) Depreciation subsequent to discontinuance or in the case of
revocation of amortization. A taxpayer which elects in the manner
prescribed under paragraph (b) (1) of Sec. 1.169-4 to discontinue
amortization deductions or under paragraph (b) (2) of Sec. 1.169-4 to
revoke an election under section 169(a) with respect to a certified
pollution control facility is entitled, if such facility is of a
character subject to the allowance for depreciation provided in section
167, to a deduction for depreciation (to the extent allowable) with
respect to such facility. In the case of an election to discontinue an
amortization deduction, the deduction for depreciation shall begin with
the first month as to which such amortization deduction is not
applicable and shall be computed on the adjusted basis of the property
as of the beginning of such month (see section 1011 and the regulations
thereunder). Such depreciation deduction shall be based upon the
remaining portion of the period authorized under section 167 for the
facility as determined, as of the first day of the first month as of
which the amortization deduction is not applicable. If the taxpayer so
elects to discontinue the amortization deduction under section 169(a),
such taxpayer shall not be entitled to any further amortization
deduction under this section and section 169(a) with respect to such
pollution control facility. In the case of a revocation of an election
under section 169(a), the deduction for depreciation shall begin as of
the time such depreciation deduction would have been taken but for the
election under section 169(a). See paragraph (b)(2) of Sec. 1.169-4 for
rules as to filing amended returns for years for which amortization
deductions have been taken.
[[Page 604]]
(7) Definitions. Except as otherwise provided in Sec. 1.169-2, all
terms used in section 169 and the regulations thereunder shall have the
meaning provided by this section and Sec. Sec. 1.169-2 through 1.169-4.
(b) Examples. This section may be illustrated by the following
examples:
Example 1. On September 30, 1970, the X Corporation, which uses the
calendar year as its taxable year, completes the installation of a
facility all of which qualifies as a certified pollution control
facility within the meaning of paragraph (a) of Sec. 1.169-2. The cost
of the facility is $120,000 and the period referred to in paragraph
(a)(6) of Sec. 1.169-2 is 10 years in accordance with the rules set
forth in paragraph (a) of Sec. 1.169-4, on its income tax return filed
for 1970, X elects to take amortization deductions under section 169(a)
with respect to the facility and to begin the 60-month amortization
period with October 1970, the month following the month in which it was
completed. The amortizable basis at the end of October 1970 (determined
without regard to the amortization deduction under section 169(a) for
that month) is $120,000. The allowable amortization deduction with
respect to such facility for the taxable year 1970 is $6,000, computed
as follows:
Monthly amortization deductions:
October: $120,000 divided by 60............................. $2,000
November: $118,000 (that is, $120,000 minus $2,000) divided 2,000
by 59......................................................
December: $116,000 (that is, $118,000 minus $2,000) divided 2,000
by 58......................................................
---------
Total amortization deduction for 1970................... 6,000
Example 2. Assume the same facts as in example (1). Assume further
that on May 20, 1972, X properly files notice of its election to
discontinue the amortization deductions with the month of June 1972. The
adjusted basis of the facility as of June 1, 1972, is $80,000, computed
as follows:
Yearly amortization deductions:
1970 (as computed in example (1))........................... $6,000
1971 (computed in accordance with example (1)).............. 24,000
1972 (for the first 5 months of 1972 computed in accordance 10,000
with example (1))..........................................
---------
Total amortization deductions for 20 months............... 40,000
---------
Adjusted basis as beginning of amortization period............ 120,000
Less: Amortization deductions................................. 40,000
---------
Adjusted basis as of June 1, 1972............................. 80,000
---------
Beginning as of June 1, 1972, the deduction for depreciation under
section 167 is allowable with respect to the property on its adjusted
basis of $80,000.
[T.D. 7116, 36 FR 9012, May 18, 1971; 36 FR 9770, May 28, 1971, as
amended by T.D. 7203, 37 FR 17133, Aug. 25, 1972]
Sec. 1.169-2 Definitions.
(a) Certified pollution control facility--(1) In general. Under
section 169 (d), the term ``certified pollution control facility'' means
a facility which--
(i) The Federal certifying authority certifies, in accordance with
the rules prescribed in paragraph (c) of this section, is a ``treatment
facility'' described in subparagraph (2) of this paragraph, and
(ii) Is ``a new identifiable facility'' (as defined in paragraph (b)
of this section).
For profitmaking abatement works limitation, see paragraph (d) of this
section.
(2) Treatment facility. For purposes of subparagraph (1)(i) of this
paragraph, a ``treatment facility'' is a facility which (i) is used to
abate or control water or atmospheric pollution or contamination by
removing, altering, disposing, or storing of pollutants, contaminants,
wastes, or heat and (ii) is used in connection with a plant or other
property in operation before January 1, 1969. Determinations under
subdivision (i) of this subparagraph shall be made solely by the Federal
certifying authority. See subparagraph (3) of this paragraph. For
meaning of the phrases ``plant or other property'' and ``in operation
before January 1, 1969,'' see subparagraphs (4) and (5), respectively,
of this paragraph.
(3) Facilities performing multiple functions or used in connection
with several plants, etc. (i) If a facility is designed to perform or
does perform a function in addition to abating or controlling water or
atmospheric pollution or contamination by removing, altering, disposing
or storing pollutants, contaminants, wastes, or heat, such facility
shall be a treatment facility only with respect to that part of the cost
thereof which is certified by the Federal certifying authority as
attributable to abating of controlling water or atmospheric pollution or
contamination. For example, if a machine which performs a function in
addition to abating water
[[Page 605]]
pollution is installed at a cost of $100,000 in, and is used only in
connection with, a plant which was in operation before January 1, 1969,
and if the Federal certifying authority certifies that $30,000 of the
cost of such machine is allocable to its function of abating water
pollution, such $30,000 will be deemed to be the adjusted basis for
purposes of determining gain for purposes of paragraph (a) of Sec.
1.169-3.
(ii) If a facility is used in connection with more than one plant or
other property, and at least one such plant or other property was not in
operation before January 1, 1969, such facility shall be a treatment
facility only to the extent of that part of the cost thereof certified
by the Federal certifying authority as attributable to abating or
controlling water or atmospheric pollution in connection with plants or
other property in operation before January 1, 1969. For example, if a
machine is constructed after December 31, 1968, at a cost of $100,000
and is used in connection with a number of plants only some of which
were in operation before January 1, 1969, and if the Federal certifying
authority certifies that $20,000 of the cost of such machine is
allocable to its function of abating or controlling water pollution in
connection with the plants or other property in operation before January
1, 1969, such $20,000 will be deemed to be the adjusted basis for
purposes of determining gain for purposes of paragraph (a) of Sec.
1.169-3. In a case in which the Federal certifying authority certifies
the percentage of a facility which is used in connection with plants or
other property in operation before January 1, 1969, the adjusted basis
for the purposes of determining gain for purposes of paragraph (a) of
Sec. 1.169-3 of the portion of the facility so used shall be the
adjusted basis for determining gain of the entire facility multiplied by
such percentage.
(4) Plant or other property. As used in subparagraph (2) of this
paragraph, the phrase ``plant or other property'' means any tangible
property whether or not such property is used in the trade or business
or held for the production of income. Such term includes, for example, a
papermill, a motor vehicle, or a furnace in an apartment house.
(5) In operation before January 1, 1969. (i) For purposes of
subparagraph (2) of this paragraph and section 169 (d), a plant or other
property will be considered to be in operation before January 1, 1969,
if prior to that date such plant or other property was actually
performing the function for which it was constructed or acquired. For
example, a papermill which is completed in July 1968, but which is not
actually used to produce paper until 1969 would not be considered to be
in operation before January 1, 1969. The fact that such plant or other
property was only operating at partial capacity prior to January 1,
1969, or was being used as a standby facility prior to such date, shall
not prevent its being considered to be in operation before such date.
(ii)(a) A piece of machinery which replaces one which was in
operation prior to January 1, 1969, and which was a part of the
manufacturing operation carried on by the plant but which does not
substantially increase the capacity of the plant will be considered to
be in operation prior to January 1, 1969. However, an additional machine
that is added to a plant which was in operation before January 1, 1969,
and which represents a substantial increase in the plant's capacity will
not be considered to have been in operation before such date. There
shall be deemed to be a substantial increase in the capacity of a plant
or other property as of the time its capacity exceeds by more than 20
percent its capacity on December 31, 1968.
(b) In addition, if the total replacements of equipment in any
single taxable year beginning after December 31, 1968, represents the
replacement of a substantial portion of a manufacturing plant which had
been in operation before such date, such replacement shall be considered
to result in a new plant which was not in operation before such date.
Thus, if a substantial portion of a plant which was in existence before
January 1, 1969, is subsequently destroyed by fire and such substantial
portion is replaced in a taxable year beginning after that date, such
replacement property shall not be considered to have been in operation
before January 1, 1969. The replacement of a substantial portion of a
plant or other
[[Page 606]]
property shall be deemed to have occurred if, during a single taxable
year, the taxpayer replaces manufacturing or production facilities or
equipment which comprises such plant or other property and which has an
adjusted basis (determined without regard to the adjustments provided in
section 1016(a) (2) and (3)) in excess of 20 percent of the adjusted
basis (so determined) of such plant or other property determined as of
the first day of such taxable year.
(6) Useful life. For purposes of section 169 and the regulations
thereunder, the terms ``useful life'' and ``actual useful life'' shall
mean the shortest period authorized under section 167 and the
regulations thereunder if an election were not made under section 169.
(b) New identifiable facility--(1) In general. For purposes of
paragraph (a)(1)(ii) of this section, the term ``new identifiable
facility'' includes only tangible property (not including a building and
its structural components referred to in subparagraph (2)(i) of this
paragraph, other than a building and its structural components which
under subparagraph (2)(ii) of this paragraph is exclusively a treatment
facility) which--
(i) Is of a character subject to the allowance for depreciation
provided in section 167,
(ii)(a) Is property the construction, reconstruction, or erection
(as defined in subparagraph (2)(iii) of this paragraph) of which is
completed by the taxpayer after December 31, 1968, or
(b) Is property acquired by the taxpayer after December 31, 1968, if
the original use of the property commences with the taxpayer and
commences after such date (see subparagraph (2)(iii) of this paragraph),
and
(iii) Is placed in service (as defined in subparagraph (2)(v) of
this paragraph) prior to January 1, 1975.
(2) Meaning of terms. (i) For purposes of subparagraph (1) of this
paragraph, the terms ``building'' and ``structural component'' shall be
construed in a manner consistent with the principles set forth in
paragraph (e) of Sec. 1.48-1. Thus, for example, the following rules
are applicable:
(a) The term ``building'' generally means any structure or edifice
enclosing a space within its walls, and usually covered by a roof, the
purpose of which is, for example, to provide shelter or housing, or to
provide working, office, parking, display, or sales space. The term
includes, for example, structures such as apartment houses, factory and
office buildings, warehouses, barns, garages, railway or bus stations,
and stores. Such term includes any such structure constructed by, or
for, a lessee even if such structure must be removed, or ownership of
such structure reverts to the lessor, at the termination of the lease.
Such term does not include (1) a structure which is essentially an item
of machinery or equipment, or (2) an enclosure which is so closely
combined with the machinery or equipment which it supports, houses, or
serves that it must be replaced, retired, or abandoned contemporaneously
with such machinery or equipment, and which is depreciated over the life
of such machinery or equipment. Thus, the term ``building'' does not
include such structures as oil and gas storage tanks, grain storage
bins, silos, fractioning towers, blast furnaces, coke ovens, brick
kilns, and coal tipples.
(b) The term ``structural components'' includes, for example,
chimneys, and other components relating to the operating or maintenance
of a building. However, the term ``structural components'' does not
include machinery or a device which serves no function other than the
abatement or control of water or atmospheric pollution.
(ii) For purposes of subparagraph (1) of this paragraph, a building
and its structural components will be considered to be exclusively a
treatment facility if its only function is the abatement or control of
air or water pollution. However, the incidental recovery of profits from
wastes or otherwise shall not be deemed to be a function other than the
abatement or control of air or water pollution. A building and its
structural components which serve no function other than the treatment
of wastes will be considered to be exclusively a treatment facility even
if it contains areas for employees to operate the treatment facility,
rest rooms for such workers, and an office for the
[[Page 607]]
management of such treatment facility. However, for example, if a
portion of a building is used for the treatment of sewage and another
portion of the building is used for the manufacture of machinery, the
building is not exclusively a treatment facility. The Federal certifying
authority will not certify as to what is a building and its structural
components within the meaning of subdivision (i) of this subparagraph.
(iii) For purposes of subparagraph (1)(ii) (a) and (b) of this
paragraph (relating to construction, reconstruction, or erection after
December 31, 1968, and original use after December 31, 1968) and
paragraph (b)(1) of Sec. 1.169-3 (relating to definition of amortizable
basis), the principles set forth in paragraph (a) (1) and (2) of Sec.
1.167(c)-1 and in paragraphs (b) and (c) of Sec. 1.48-2 shall be
applied. Thus, for example, the following rules are applicable:
(a) Property is considered as constructed, reconstructed, or erected
by the taxpayer if the work is done for him in accordance with his
specifications.
(b) The portion of the basis of property attributable to
construction, reconstruction, or erection after December 31, 1968,
consists of all costs of construction, reconstruction, or erection
allocable to the period after December 31, 1968, including the cost or
other basis of materials entering into such work (but not including, in
the case of reconstruction of property, the adjusted basis of the
property as of the time such reconstruction is commenced).
(c) It is not necessary that materials entering into construction,
reconstruction or erection be acquired after December 31, 1968, or that
they be new in use.
(d) If construction or erection by the taxpayer began after December
31, 1968, the entire cost or other basis of such construction or
erection may be taken into account for purposes of determining the
amortizable basis under section 169.
(e) Construction, reconstruction, or erection by the taxpayer begins
when physical work is started on such construction, reconstruction, or
erection.
(f) Property shall be deemed to be acquired when reduced to physical
possession or control.
(g) The term ``original use'' means the first use to which the
property is put, whether or not such use corresponds to the use of such
property by the taxpayer. For example, a reconditioned or rebuilt
machine acquired by the taxpayer after December 31, 1968, for pollution
control purposes will not be treated as being put to original use by the
taxpayer regardless of whether it was used for purposes other than
pollution control by its previous owner. Whether property is
reconditioned or rebuilt property is a question of fact. Property will
not be treated as reconditioned or rebuilt merely because it contains
some used parts.
(iv) For purposes of subparagraph (1)(iii) of this paragraph
(relating to property placed in service prior to January 1, 1975), the
principles set forth in paragraph (d) of Sec. 1.46-3 are applicable.
Thus, property shall be considered placed in service in the earlier of
the following taxable years:
(a) The taxable year in which, under the taxpayer's depreciation
practice, the period for depreciation with respect to such property
begins or would have begun; or
(b) The taxable year in which the property is placed in a condition
or state of readiness and availability for the abatement or control of
water or atmospheric pollution.
Thus, if property meets the conditions of (b) of this subdivision 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 or would have begun in a succeeding taxable year
because, for example, under the taxpayer's depreciation practice such
property is or would have been accounted for in a multiple asset account
and depreciation is or would have been computed under an ``averaging
convention'' (Sec. 1.167(a)-10), or depreciation with respect to such
property would have been computed under the completed contract method,
the unit of production method, or the retirement method. In the case of
property acquired by a taxpayer for use in his trade or business (or in
the production
[[Page 608]]
of income), property shall be considered in a condition or state of
readiness and availability for the abatement or control of water or
atmospheric pollution if, for example, equipment is acquired for the
abatement or control of water or atmospheric pollution and is
operational but is undergoing testing to eliminate any defects. However,
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 the abatement or control of water or
atmospheric pollution.
(c) Certification--(1) In general. For purposes of paragraph (a)(1)
of this section, a facility is certified in accordance with the rules
prescribed in this paragraph if--
(i) The State certifying authority (as defined in subparagraph (2)
of this paragraph) having jurisdiction with respect to such facility has
certified to the Federal certifying authority (as defined in
subparagraph (3) of this paragraph) that the facility was constructed,
reconstructed, erected, or acquired in conformity with the State program
or requirements for the abatement or control of water or atmospheric
pollution or contamination applicable at the time of such certification,
and
(ii) The Federal certifying authority has certified such facility to
the Secretary or his delegate as (a) being in compliance with the
applicable regulations of Federal agencies (such as, for example, the
Atomic Energy Commission's regulations pertaining to radiological
discharge (10 CFR Part 20)) and (b) being in furtherance of the general
policy of the United States for cooperation with the States in the
prevention and abatement of water pollution under the Federal Water
Pollution Control Act, as amended (33 U.S.C. 1151-1175) or in the
prevention and abatement of atmospheric pollution and contamination
under the Clean Air Act, as amended (42 U.S.C. 1857 et seq.).
(2) State certifying authority. The term ``state certifying
authority'' means--
(i) In the case of water pollution, the State water pollution
control agency as defined in section 23(a) of the Federal Water
Pollution Control Act, as amended (33 U.S.C. 1173(a)),
(ii) In the case of air pollution, the air pollution control agency
designated pursuant to section 302(b)(1) of the Clean Air Act, as
amended (42 U.S.C. 1857h(b)), and
(iii) Any interstate agency authorized to act in place of a
certifying authority of a State. See section 23(a) of the Federal Water
Pollution Control Act, as amended (33 U.S.C. 1173(b)) and section 302(c)
of the Clean Air Act, as amended (42 U.S.C. 1857h(c)).
(3) Federal certifying authority. The term ``Federal certifying
authority'' means the Administrator of the Environmental Protection
Agency (see Reorganization Plan No. 3 of 1970, 35 FR 15623).
(d) Profitmaking abatement works, etc.--(1) In general. Section
169(e) provides that the Federal certifying authority shall not certify
any property to the extent it appears that by reason of estimated
profits to be derived through the recovery of wastes or otherwise in the
operation of such property its costs will be recovered over the period
referred to in paragraph (a) (6) of this section for such property. The
Federal certifying authority need not certify the amount of estimated
profits to be derived from such recovery of wastes or otherwise with
respect to such facility. Such estimated profits shall be determined
pursuant to subparagraph (2) of this paragraph. However, the Federal
certifying authority shall certify--
(i) Whether, in connection with any treatment facility so certified,
there is potential cost recovery through the recovery of wastes or
otherwise, and
(ii) A specific description of the wastes which will be recovered,
or the nature of such cost recovery if otherwise than through the
recovery of wastes.
For effect on computation of amortizable basis, see paragraph (c) of
Sec. 1.169-3.
(2) Estimated profits. For purpose of this paragraph, the term
``estimated profits'' means the estimated gross receipts from the sale
of recovered wastes reduced by the sum of the (i) estimated average
annual maintenance and operating expenses, including utilities and
labor, allocable to that portion of the facility which is certified as a
[[Page 609]]
treatment facility pursuant to paragraph (a)(1)(i) of this section which
produces the recovered waste from which the gross receipts are derived,
and (ii) estimated selling expenses. However, in determining expenses to
be subtracted neither depreciation nor amortization of the facility is
to be taken into account. Estimated profits shall not include any
estimated savings to the taxpayer by reason of the taxpayer's reuse or
recycling of wastes or other items recovered in connection with the
operation of the plant or other property served by the treatment
facility.
(3) Special rules. The estimates of cost recovery required by
subparagraph (2) of this paragraph shall be based on the period referred
to in paragraph (a)(6) of this section. Such estimates shall be made at
the time the election provided for by section 169 is made and shall also
be set out in the application for certification made to the Federal
certifying authority. There shall be no redetermination of estimated
profits due to unanticipated fluctuations in the market price for wastes
or other items, to an unanticipated increase or decrease in the costs of
extracting them from the gas or liquid released, or to other
unanticipated factors or events occurring after certification.
[T.D. 7116, 36 FR 9013, May 18, 1971; 36 FR 9770, May 28, 1971]
Sec. 1.169-3 Amortizable basis.
(a) In general. The amortizable basis of a certified pollution
control facility for the purpose of computing the amortization deduction
under section 169 is the adjusted basis of the facility for purposes of
determining gain (see part II (section 1011 and following), subchapter
O, chapter 1 of the Internal Revenue Code), in conjunction with
paragraphs (b), (c), and (d) of this section. The adjusted basis for
purposes of determining gain (computed without regard to paragraphs (b),
(c), and (d) of this section) of a facility that performs a function in
addition to pollution control, or that is used in connection with more
than one plant or other property, or both, is determined under Sec.
1.169-2(a)(3). For rules as to additions and improvements to such a
facility, see paragraph (f) of this section. Before computing the
amortization deduction allowable under section 169, the adjusted basis
for purposes of determining gain for a facility that is placed in
service by a taxpayer after September 10, 2001, and that is qualified
property under section 168(k)(2) or Sec. 1.168(k)-1, 50-percent bonus
depreciation property under section 168(k)(4) or Sec. 1.168(k)-1, or
qualified New York Liberty Zone property under section 1400L(b) or Sec.
1.1400L(b)-1 must be reduced by the amount of the additional first year
depreciation deduction allowed or allowable, whichever is greater, under
section 168(k) or section 1400L(b), as applicable, for the facility.
(b) Limitation to post-1968 construction, reconstruction, or
erection. (1) If the construction, reconstruction, or erection was begun
before January 1, 1969, there shall be included in the amortizable basis
only so much of the adjusted basis of such facility for purposes of
determining gain (referred to in paragraph (a) of this section) as is
properly attributable under the rules set forth in paragraph (b)(2)(iii)
of Sec. 1.169-2 to construction, reconstruction, or erection after
December 31, 1968. See section 169 (d)(4). For example, assume a
certified pollution control facility for which the shortest period
authorized under section 167 is 10 years has a cost of $500,000, of
which $450,000 is attributable to construction after December 31, 1968.
Further, assume such facility does not perform a function in addition to
pollution control and is used only in connection with a plant in
operation before January 1, 1969. The facility would have an amortizable
basis of $450,000 (computed without regard to paragraphs (c) and (d) of
this section). For depreciation of the remaining portion ($50,000) of
the cost, see section 169(g) and paragraph (a)(3)(ii) of Sec. 1.169-1.
For the definition of the term ``certified pollution control facility''
see paragraph (a) of Sec. 1.169-2.
(2) If the taxpayer elects to begin the 60-month amortization period
with the first month of the taxable year succeeding the taxable year in
which the facility is completed or acquired and a depreciation deduction
is allowable under section 167 (including an additional first-year
depreciation allowance under former section 179; for a facility that is
acquired by the taxpayer
[[Page 610]]
after September 10, 2001, and that is qualified property under section
168(k)(2) or Sec. 1.168(k)-1 or qualified New York Liberty Zone
property under section 1400L(b) or Sec. 1.1400L(b)-1, the additional
first year depreciation deduction under section 168(k)(1) or 1400L(b),
as applicable; and for a facility that is acquired by the taxpayer after
May 5, 2003, and that is 50-percent bonus depreciation property under
section 168(k)(4) or Sec. 1.168(k)-1, the additional first year
depreciation deduction under section 168(k)(4)) with respect to the
facility for the taxable year in which it is completed or acquired, the
amount determined under paragraph (b)(1) of this section shall be
reduced by an amount equal to the amount of the depreciation deduction
allowed or allowable, whichever is greater, multiplied by a fraction the
numerator of which is the amount determined under paragraph (b)(1) of
this section, and the denominator of which is the facility's total cost.
The additional first-year allowance for depreciation under former
section 179 will be allowable only for the taxable year in which the
facility is completed or acquired and only if the taxpayer elects to
begin the amortization deduction under section 169 with the taxable year
succeeding the taxable year in which such facility is completed or
acquired. For a facility that is acquired by a taxpayer after September
10, 2001, and that is qualified property under section 168(k)(2) or
Sec. 1.168(k)-1 or qualified New York Liberty Zone property under
section 1400L(b) or Sec. 1.1400L(b)-1, see Sec. 1.168(k)-1(f)(4) or
Sec. 1.1400L(b)-1(f)(4), as applicable, with respect to when the
additional first year depreciation deduction under section 168(k)(1) or
1400L(b) is allowable. For a facility that is acquired by a taxpayer
after May 5, 2003, and that is 50-percent bonus depreciation property
under section 168(k)(4) or Sec. 1.168(k)-1, see Sec. 1.168(k)-1(f)(4)
with respect to when the additional first year depreciation deduction
under section 168(k)(4) is allowable.
(c) Modification for profitmaking abatement works, etc. If it
appears that by reason of estimated profits to be derived through the
recovery of wastes or otherwise (as determined by applying the rules
prescribed in paragraph (d) of Sec. 1.169-2) a portion or all of the
total costs of the certified pollution control facility will be
recovered over the period referred to in paragraph (a)(b) of Sec.
1.169-2, its amortizable basis (computed without regard to this
paragraph and paragraph (d) of this section) shall be reduced by an
amount equal to (1) its amortizable basis (so computed) multiplied by
(2) a fraction the numerator of which is such estimated profits and the
denominator of which is its adjusted basis for purposes of determining
gain. See section 169(e).
(d) Cases in which the period referred to in paragraph (a)(6) of
Sec. 1.169-2 exceeds 15 years. If as to a certified pollution control
facility the period referred to in paragraph (a)(6) of Sec. 1.169-2
exceeds 15 years (determined as of the first day of the first month for
which a deduction is allowable under the election made under the section
169(b) and paragraph (a) of Sec. 1.169-4), the amortizable basis of
such facility shall be an amount equal to (1) its amortizable basis
(computed without regard to this paragraph) multiplied by (2) a fraction
the numerator of which is 15 years and the denominator of which is the
number of years of such period. See section 169(f) (2)(A).
(e) Examples. This section may be illustrated by the following
example:
Example 1. The X Corporation, which uses the calendar year as its
taxable year, began the installation of a facility on November 1, 1968,
and completed the installation on June 30, 1970, at a cost of $400,000.
All of the facility qualifies as a certified pollution control facility
within the meaning of paragraph (a) of Sec. 1.169-2. $40,000 of such
cost is attributable to construction prior to January 1, 1969. The X
Corporation elects to take amortization deductions under section 169(a)
with respect to the facility and to begin the 60-month amortization
period with January 1, 1971. The corporation takes a depreciation
deduction under sections 167 and 179 of $10,000 (the amount allowable,
of which $2,000 is for additional first year depreciation under section
179) for the last 6 months of 1970. It is estimated that over the period
referred to in paragraph (a) (6) of Sec. 1.169-2 (20 years) as to such
facility, $80,000 in profits will be realized from the sale of wastes
recovered in its operation. The amortizable basis of the facility for
purposes of computing the amortization deduction as of January 1, 1971,
is $210,600, computed as follows:
(1) Portion of $400,000 cost attributable to post-1968 $360,000
construction, reconstruction, or erection...................
[[Page 611]]
(2) Reduction for portion of depreciation
deduction taken for the taxable year in which the
facility was completed:
(a) $10,000 depreciation deduction taken for $10,000
last 6 months of 1970 including $2,000 for
additional first year depreciation under
section 179....................................
(b) Multiplied by the amount in line (1) and 0.9 $9,000
divided by the total cost of the facility
($360,000/ $400,000)...........................
---------------------
(3) Subtotal................................................. $351,000
(4) Modification for profitmaking abatement works:
Multiply line (3) by estimated profits through
waste recovery ($80,000) and divide by the
adjusted basis for determining gain of the
facility ($400,000).
(5) Reduction................................................ $70,200
------------
(6) Subtotal................................................. $280,800
(7) Modification for period referred to in paragraph (a)(6) 0.75
of Sec. 1.169-2 exceeding 15 years: Multiply by 15 years
and divide by such period (determined in accordance with
paragraph (d) of this section) (20 years)...................
------------
(8) Amortizable basis........................................ $210,600
Example 2. Assume the same facts as in example (1) except that the
facility is used in connection with a number of separate plants some of
which were in operation before January 1, 1969, that the Federal
certifying authority certifies that 80 percent of the capacity of the
facility is allocable to the plants which were in operation before such
date, and that all of the waste recovery is allocable to the portion of
the facility used in connection with the plants in operation before
January 1, 1969. The amortizable basis of such facility, for purposes of
computing the amortization deduction as of January 1, 1971, is $157,950
computed as follows:
(1) Adjusted basis for purposes of determining gain: Multiply $320,000
percent certified as allocable to plants in operation before
January 1, 1969 (80 percent) by cost of entire facility
($400,000)..................................................
============
(2) Portion of adjusted basis for determining gain $288,000
attributable to post-1968 construction, reconstruction, or
rection: Multiply line (1) by portion of total cost of
facility attributable to post-1968 construction,
reconstruction, or erection ($360,000) and divide by the
total cost of the facility ($400,000).......................
(3) Reduction for portion of depreciation deduction taken for
the taxable year in which the facility was completed:
(a) $10,000 depreciation deduction taken for $10,000
last 6 months of 1970 including $2,000 for
additional first year depreciation under
section 170....................................
(b) Multiplied by the amount in line (2) and 0.72 $7,200
divided by the total cost of the facility
($288,000/$400,000)............................
---------------------
(4) Subtotal................................................. $280,800
(5) Modification for profitmaking abatement works; Multiply
line (4) by estimated profits through waste recovery
($80,000) and divide by the amount in line (1) ($320,000).
(6) Reduction................................................ $70,200
------------
(7) Subtotal................................................. $210,600
(8) Modification for period referred to in paragraph (a)(6) 0.75
of Sec. 1.169-2 exceeding 15 years: Multiply by 15 years
and divide by such period (determined in accordance with
paragraph (d) of this section) (20 years)...................
------------
(9) Amortizable basis........................................ $157,950
(f) Additions or improvements. (1) If after the completion or
acquisition of a certified pollution control facility further
expenditures are made for additional construction, reconstruction, or
improvements, the cost of such additions or improvements made prior to
the beginning of the amortization period shall increase the amortizable
basis of such facility, but the cost of additions or improvements made
after the amortization period has begun, shall not increase the
amortizable basis. See section 169(f)(2)(B).
(2) If expenditures for such additional construction,
reconstruction, or improvements result in a facility which is new and is
separately certified as a certified pollution control facility as
defined in section 169(d)(1) and paragraph (a) of Sec. 1.169-2, and, if
proper election is made, such expenditures shall be taken into account
in computing under paragraph (a) of this section the amortizable basis
of such new and separately certified pollution control facility.
(g) Effective date for qualified property, 50-percent bonus
depreciation property, and qualified New York Liberty Zone property.
This section applies to a certified pollution control facility. This
section also applies to a certified pollution control facility that is
qualified property under section 168(k)(2) or qualified New York Liberty
Zone property under section 1400L(b) acquired by a taxpayer after
September 10, 2001, and to a certified pollution control facility that
is 50-percent bonus depreciation property under section 168(k)(4)
acquired by a taxpayer after May 5, 2003.
[T.D. 7116, 36 FR 9015, May 18, 1971; 36 FR 9770, May 28, 1971, as
amended by T.D. 9091, 68 FR 53004, Sept. 8, 2003; T.D. 9283, 71 FR
51746, Aug. 31, 2006]
[[Page 612]]
Sec. 1.169-4 Time and manner of making elections.
(a) Election of amortization--(1) In general. Under section 169(b),
an election by the taxpayer to take an amortization deduction with
respect to a certified pollution control facility and to begin the 60-
month amortization period (either with the month following the month in
which the facility is completed or acquired, or with the first month of
the taxable year succeeding the taxable year in which such facility is
completed or acquired) shall be made by a statement to that effect
attached to its return for the taxable year in which falls the first
month of the 60-month amortization period so elected. Such statement
shall include the following information (if not otherwise included in
the documents referred to in subdivision (ix) of this subparagraph):
(i) A description clearly identifying each certified pollution
control facility for which an amortization deduction is claimed;
(ii) The date on which such facility was completed or acquired (see
paragraph (b)(2)(iii) of Sec. 1.169-2);
(iii) The period referred to in paragraph (a)(6) of Sec. 1.169-2
for the facility as of the date the property is placed in service;
(iv) The date as of which the amortization period is to begin;
(v) The date the plant or other property to which the facility is
connected began operating (see paragraph (a)(5) of Sec. 1.169-2);
(vi) The total costs and expenditures paid or incurred in the
acquisition, construction, and installation of such facility;
(vii) A description of any wastes which the facility will recover
during the course of its operation, and a reasonable estimate of the
profits which will be realized by the sale of such wastes whether
pollutants or otherwise, over the period referred to in paragraph (a)(6)
of Sec. 1.169-2 as to the facility. Such estimate shall include a
schedule setting forth a detailed computation illustrating how the
estimate was arrived at including every element prescribed in the
definition of estimated profits in paragraph (d)(2) of Sec. 1.169-2;
(viii) A computation showing the amortizable basis (as defined in
Sec. 1.169-3) of the facility as of the first month for which the
amortization deduction provided for by section 169(a) is elected; and
(ix)(a) A statement that the facility has been certified by the
Federal certifying authority, together with a copy of such
certification, and a copy of the application for certification which was
filed with and approved by the Federal certifying authority or (b), if
the facility has not been certified by the Federal certifying authority,
a statement that application has been made to the proper State
certifying authority (see paragraph (c)(2) of Sec. 1.169-2) together
with a copy of such application and (except in the case of an election
to which subparagraph (4) of this paragraph applies) a copy of the
application filed or to be filed with the Federal certifying authority.
If subdivision (ix)(b) of this subparagraph applies, within 90 days
after receipt by the taxpayer, the certification from the Federal
certifying authority shall be filed by the taxpayer with the district
director, or with the director of the internal revenue service center,
with whom the return referred to in this subparagraph was filed.
(2) Special rule. If the return for the taxable year in which falls
the first month of the 60-month amortization period to be elected is
filed before November 16, 1971, without making the election for such
year, then on or before December 31, 1971 (or if there is no State
certifying authority in existence on November 16, 1971, on or before the
90th day after such authority is established), the election may be made
by a statement attached to an amended income tax return for the taxable
year in which falls the first month of the 60-month amortization period
so elected. Amended income tax returns or claims for credit or refund
must also be filed at this time for other taxable years which are within
the amortization period and which are subsequent to the taxable year for
which the election is made. Nothing in this paragraph should be
construed as extending the time specified in section 6511 within which a
claim for credit or refund may be filed.
[[Page 613]]
(3) Other requirements and considerations. No method of making the
election provided for in section 169(a) other than that prescribed in
this section shall be permitted on or after May 18, 1971. A taxpayer
which does not elect in the manner prescribed in this section to take
amortization deductions with respect to a certified pollution control
facility shall not be entitled to such deductions. In the case of a
taxpayer which elects prior to May 18, 1971, the statement required by
subparagraph (1) of this paragraph shall be attached to its income tax
return for either its taxable year in which December 31, 1971, occurs or
its taxable year preceding such year.
(4) Elections filed before February 29, 1972. If a statement of
election required by subparagraph (1) of this paragraph is attached to a
return (including an amended return referred to in subparagraph (2) of
this paragraph) filed before February 29, 1972, such statement of
election need not include a copy of the Federal application to be filed
with the Federal certifying authority but a copy of such application
must be filed no later than February 29, 1972, by the taxpayer with the
district director, or with the director of the internal revenue service
center, with whom the return or amended return referred to in this
subparagraph was filed.
(b) Election to discontinue or revoke amortization--(1) Election to
discontinue. An election to discontinue the amortization deduction
provided by section 169(c) and paragraph (a)(1) of Sec. 1.169-1 shall
be made by a statement in writing filed with the district director, or
with the director of the internal revenue service center, with whom the
return of the taxpayer is required to be filed for its taxable year in
which falls the first month for which the election terminates. Such
statement shall specify the month as of the beginning of which the
taxpayer elects to discontinue such deductions. Unless the election to
discontinue amortization is one to which subparagraph (2) of this
paragraph applies, such statement shall be filed before the beginning of
the month specified therein. In addition, such statement shall contain a
description clearly identifying the certified pollution control facility
with respect to which the taxpayer elects to discontinue the
amortization deduction, and, if a certification has previously been
issued, a copy of the certification by the Federal certifying authority.
If at the time of such election a certification has not been issued (or
if one has been issued it has not been filed as provided in paragraph
(a)(1) of this section), the taxpayer shall file, with respect to any
taxable year or years for which a deduction under section 169 has been
taken, a copy of such certification within 90 days after receipt
thereof. For purposes of this paragraph, notification to the Secretary
or his delegate from the Federal certifying authority that the facility
no longer meets the requirements under which certification was
originally granted by the State or Federal certifying authority shall
have the same effect as a notice from the taxpayer electing to terminate
amortization as of the month following the month such facility ceased
functioning in accordance with such requirements.
(2) Revocation of elections made prior to May 18, 1971. If on or
before May 18, 1971, an election under section 169(a) has been made,
such election may be revoked (see paragraph (a)(1) of Sec. 1.169-1) by
filing on or before August 16, 1971, a statement of revocation of an
election under section 169(a) in accordance with the requirements in
subparagraph (1) of this paragraph for filing a notice to discontinue an
election. If such election to revoke is for a period which falls within
one or more taxable years for which an income tax return has been filed,
amended income tax returns shall be filed for any such taxable years in
which deductions were taken under section 169 on or before August 16,
1971.
[T.D. 7116, 36 FR 9016, May 18, 1971, as amended by T.D. 7135, 36 FR
14183, July 31, 1971; 36 FR 24995, Dec. 28, 1971]
[[Page 615]]
FINDING AIDS
--------------------------------------------------------------------
A list of CFR titles, subtitles, chapters, subchapters and parts and
an alphabetical list of agencies publishing in the CFR are included in
the CFR Index and Finding Aids volume to the Code of Federal Regulations
which is published separately and revised annually.
Table of CFR Titles and Chapters
Alphabetical List of Agencies Appearing in the CFR
Table of OMB Control Numbers
List of CFR Sections Affected
[[Page 617]]
Table of CFR Titles and Chapters
(Revised as of April 1, 2015)
Title 1--General Provisions
I Administrative Committee of the Federal Register
(Parts 1--49)
II Office of the Federal Register (Parts 50--299)
III Administrative Conference of the United States (Parts
300--399)
IV Miscellaneous Agencies (Parts 400--500)
Title 2--Grants and Agreements
Subtitle A--Office of Management and Budget Guidance
for Grants and Agreements
I Office of Management and Budget Governmentwide
Guidance for Grants and Agreements (Parts 2--199)
II Office of Management and Budget Guidance (Parts 200--
299)
Subtitle B--Federal Agency Regulations for Grants and
Agreements
III Department of Health and Human Services (Parts 300--
399)
IV Department of Agriculture (Parts 400--499)
VI Department of State (Parts 600--699)
VII Agency for International Development (Parts 700--799)
VIII Department of Veterans Affairs (Parts 800--899)
IX Department of Energy (Parts 900--999)
X Department of the Treasury (Parts 1000--1099)
XI Department of Defense (Parts 1100--1199)
XII Department of Transportation (Parts 1200--1299)
XIII Department of Commerce (Parts 1300--1399)
XIV Department of the Interior (Parts 1400--1499)
XV Environmental Protection Agency (Parts 1500--1599)
XVIII National Aeronautics and Space Administration (Parts
1800--1899)
XX United States Nuclear Regulatory Commission (Parts
2000--2099)
XXII Corporation for National and Community Service (Parts
2200--2299)
XXIII Social Security Administration (Parts 2300--2399)
XXIV Housing and Urban Development (Parts 2400--2499)
XXV National Science Foundation (Parts 2500--2599)
XXVI National Archives and Records Administration (Parts
2600--2699)
XXVII Small Business Administration (Parts 2700--2799)
[[Page 618]]
XXVIII Department of Justice (Parts 2800--2899)
XXIX Department of Labor (Parts 2900--2999)
XXX Department of Homeland Security (Parts 3000--3099)
XXXI Institute of Museum and Library Services (Parts 3100--
3199)
XXXII National Endowment for the Arts (Parts 3200--3299)
XXXIII National Endowment for the Humanities (Parts 3300--
3399)
XXXIV Department of Education (Parts 3400--3499)
XXXV Export-Import Bank of the United States (Parts 3500--
3599)
XXXVI Office of National Drug Control Policy, Executive
Office of the President (Parts 3600--3699)
XXXVII Peace Corps (Parts 3700--3799)
LVIII Election Assistance Commission (Parts 5800--5899)
LIX Gulf COast Ecosystem Restoration Council (Parts 5900--
5999)
Title 3--The President
I Executive Office of the President (Parts 100--199)
Title 4--Accounts
I Government Accountability Office (Parts 1--199)
II Recovery Accountability and Transparency Board (Parts
200--299)
Title 5--Administrative Personnel
I Office of Personnel Management (Parts 1--1199)
II Merit Systems Protection Board (Parts 1200--1299)
III Office of Management and Budget (Parts 1300--1399)
V The International Organizations Employees Loyalty
Board (Parts 1500--1599)
VI Federal Retirement Thrift Investment Board (Parts
1600--1699)
VIII Office of Special Counsel (Parts 1800--1899)
IX Appalachian Regional Commission (Parts 1900--1999)
XI Armed Forces Retirement Home (Parts 2100--2199)
XIV Federal Labor Relations Authority, General Counsel of
the Federal Labor Relations Authority and Federal
Service Impasses Panel (Parts 2400--2499)
XVI Office of Government Ethics (Parts 2600--2699)
XXI Department of the Treasury (Parts 3100--3199)
XXII Federal Deposit Insurance Corporation (Parts 3200--
3299)
XXIII Department of Energy (Parts 3300--3399)
XXIV Federal Energy Regulatory Commission (Parts 3400--
3499)
XXV Department of the Interior (Parts 3500--3599)
XXVI Department of Defense (Parts 3600--3699)
XXVIII Department of Justice (Parts 3800--3899)
[[Page 619]]
XXIX Federal Communications Commission (Parts 3900--3999)
XXX Farm Credit System Insurance Corporation (Parts 4000--
4099)
XXXI Farm Credit Administration (Parts 4100--4199)
XXXIII Overseas Private Investment Corporation (Parts 4300--
4399)
XXXIV Securities and Exchange Commission (Parts 4400--4499)
XXXV Office of Personnel Management (Parts 4500--4599)
XXXVII Federal Election Commission (Parts 4700--4799)
XL Interstate Commerce Commission (Parts 5000--5099)
XLI Commodity Futures Trading Commission (Parts 5100--
5199)
XLII Department of Labor (Parts 5200--5299)
XLIII National Science Foundation (Parts 5300--5399)
XLV Department of Health and Human Services (Parts 5500--
5599)
XLVI Postal Rate Commission (Parts 5600--5699)
XLVII Federal Trade Commission (Parts 5700--5799)
XLVIII Nuclear Regulatory Commission (Parts 5800--5899)
XLIX Federal Labor Relations Authority (Parts 5900--5999)
L Department of Transportation (Parts 6000--6099)
LII Export-Import Bank of the United States (Parts 6200--
6299)
LIII Department of Education (Parts 6300--6399)
LIV Environmental Protection Agency (Parts 6400--6499)
LV National Endowment for the Arts (Parts 6500--6599)
LVI National Endowment for the Humanities (Parts 6600--
6699)
LVII General Services Administration (Parts 6700--6799)
LVIII Board of Governors of the Federal Reserve System
(Parts 6800--6899)
LIX National Aeronautics and Space Administration (Parts
6900--6999)
LX United States Postal Service (Parts 7000--7099)
LXI National Labor Relations Board (Parts 7100--7199)
LXII Equal Employment Opportunity Commission (Parts 7200--
7299)
LXIII Inter-American Foundation (Parts 7300--7399)
LXIV Merit Systems Protection Board (Parts 7400--7499)
LXV Department of Housing and Urban Development (Parts
7500--7599)
LXVI National Archives and Records Administration (Parts
7600--7699)
LXVII Institute of Museum and Library Services (Parts 7700--
7799)
LXVIII Commission on Civil Rights (Parts 7800--7899)
LXIX Tennessee Valley Authority (Parts 7900--7999)
LXX Court Services and Offender Supervision Agency for the
District of Columbia (Parts 8000--8099)
LXXI Consumer Product Safety Commission (Parts 8100--8199)
LXXIII Department of Agriculture (Parts 8300--8399)
LXXIV Federal Mine Safety and Health Review Commission
(Parts 8400--8499)
LXXVI Federal Retirement Thrift Investment Board (Parts
8600--8699)
[[Page 620]]
LXXVII Office of Management and Budget (Parts 8700--8799)
LXXX Federal Housing Finance Agency (Parts 9000--9099)
LXXXIII Special Inspector General for Afghanistan
Reconstruction (Parts 9300--9399)
LXXXIV Bureau of Consumer Financial Protection (Parts 9400--
9499)
LXXXVI National Credit Union Administration (Parts 9600--
9699)
XCVII Department of Homeland Security Human Resources
Management System (Department of Homeland
Security--Office of Personnel Management) (Parts
9700--9799)
XCVII Council of the Inspectors General on Integrity and
Efficiency (Parts 9800--9899)
XCIV Military Compensation and Retirement Modernization
Commission (Parts 9900--9999)
Title 6--Domestic Security
I Department of Homeland Security, Office of the
Secretary (Parts 1--199)
X Privacy and Civil Liberties Oversight Board (Parts
1000--1099)
Title 7--Agriculture
Subtitle A--Office of the Secretary of Agriculture
(Parts 0--26)
Subtitle B--Regulations of the Department of
Agriculture
I Agricultural Marketing Service (Standards,
Inspections, Marketing Practices), Department of
Agriculture (Parts 27--209)
II Food and Nutrition Service, Department of Agriculture
(Parts 210--299)
III Animal and Plant Health Inspection Service, Department
of Agriculture (Parts 300--399)
IV Federal Crop Insurance Corporation, Department of
Agriculture (Parts 400--499)
V Agricultural Research Service, Department of
Agriculture (Parts 500--599)
VI Natural Resources Conservation Service, Department of
Agriculture (Parts 600--699)
VII Farm Service Agency, Department of Agriculture (Parts
700--799)
VIII Grain Inspection, Packers and Stockyards
Administration (Federal Grain Inspection Service),
Department of Agriculture (Parts 800--899)
IX Agricultural Marketing Service (Marketing Agreements
and Orders; Fruits, Vegetables, Nuts), Department
of Agriculture (Parts 900--999)
X Agricultural Marketing Service (Marketing Agreements
and Orders; Milk), Department of Agriculture
(Parts 1000--1199)
XI Agricultural Marketing Service (Marketing Agreements
and Orders; Miscellaneous Commodities), Department
of Agriculture (Parts 1200--1299)
[[Page 621]]
XIV Commodity Credit Corporation, Department of
Agriculture (Parts 1400--1499)
XV Foreign Agricultural Service, Department of
Agriculture (Parts 1500--1599)
XVI Rural Telephone Bank, Department of Agriculture (Parts
1600--1699)
XVII Rural Utilities Service, Department of Agriculture
(Parts 1700--1799)
XVIII Rural Housing Service, Rural Business-Cooperative
Service, Rural Utilities Service, and Farm Service
Agency, Department of Agriculture (Parts 1800--
2099)
XX Local Television Loan Guarantee Board (Parts 2200--
2299)
XXV Office of Advocacy and Outreach, Department of
Agriculture (Parts 2500--2599)
XXVI Office of Inspector General, Department of Agriculture
(Parts 2600--2699)
XXVII Office of Information Resources Management, Department
of Agriculture (Parts 2700--2799)
XXVIII Office of Operations, Department of Agriculture (Parts
2800--2899)
XXIX Office of Energy Policy and New Uses, Department of
Agriculture (Parts 2900--2999)
XXX Office of the Chief Financial Officer, Department of
Agriculture (Parts 3000--3099)
XXXI Office of Environmental Quality, Department of
Agriculture (Parts 3100--3199)
XXXII Office of Procurement and Property Management,
Department of Agriculture (Parts 3200--3299)
XXXIII Office of Transportation, Department of Agriculture
(Parts 3300--3399)
XXXIV National Institute of Food and Agriculture (Parts
3400--3499)
XXXV Rural Housing Service, Department of Agriculture
(Parts 3500--3599)
XXXVI National Agricultural Statistics Service, Department
of Agriculture (Parts 3600--3699)
XXXVII Economic Research Service, Department of Agriculture
(Parts 3700--3799)
XXXVIII World Agricultural Outlook Board, Department of
Agriculture (Parts 3800--3899)
XLI [Reserved]
XLII Rural Business-Cooperative Service and Rural Utilities
Service, Department of Agriculture (Parts 4200--
4299)
Title 8--Aliens and Nationality
I Department of Homeland Security (Immigration and
Naturalization) (Parts 1--499)
V Executive Office for Immigration Review, Department of
Justice (Parts 1000--1399)
[[Page 622]]
Title 9--Animals and Animal Products
I Animal and Plant Health Inspection Service, Department
of Agriculture (Parts 1--199)
II Grain Inspection, Packers and Stockyards
Administration (Packers and Stockyards Programs),
Department of Agriculture (Parts 200--299)
III Food Safety and Inspection Service, Department of
Agriculture (Parts 300--599)
Title 10--Energy
I Nuclear Regulatory Commission (Parts 0--199)
II Department of Energy (Parts 200--699)
III Department of Energy (Parts 700--999)
X Department of Energy (General Provisions) (Parts
1000--1099)
XIII Nuclear Waste Technical Review Board (Parts 1300--
1399)
XVII Defense Nuclear Facilities Safety Board (Parts 1700--
1799)
XVIII Northeast Interstate Low-Level Radioactive Waste
Commission (Parts 1800--1899)
Title 11--Federal Elections
I Federal Election Commission (Parts 1--9099)
II Election Assistance Commission (Parts 9400--9499)
Title 12--Banks and Banking
I Comptroller of the Currency, Department of the
Treasury (Parts 1--199)
II Federal Reserve System (Parts 200--299)
III Federal Deposit Insurance Corporation (Parts 300--399)
IV Export-Import Bank of the United States (Parts 400--
499)
V Office of Thrift Supervision, Department of the
Treasury (Parts 500--599)
VI Farm Credit Administration (Parts 600--699)
VII National Credit Union Administration (Parts 700--799)
VIII Federal Financing Bank (Parts 800--899)
IX Federal Housing Finance Board (Parts 900--999)
X Bureau of Consumer Financial Protection (Parts 1000--
1099)
XI Federal Financial Institutions Examination Council
(Parts 1100--1199)
XII Federal Housing Finance Agency (Parts 1200--1299)
XIII Financial Stability Oversight Council (Parts 1300--
1399)
XIV Farm Credit System Insurance Corporation (Parts 1400--
1499)
XV Department of the Treasury (Parts 1500--1599)
XVI Office of Financial Research (Parts 1600--1699)
XVII Office of Federal Housing Enterprise Oversight,
Department of Housing and Urban Development (Parts
1700--1799)
[[Page 623]]
XVIII Community Development Financial Institutions Fund,
Department of the Treasury (Parts 1800--1899)
Title 13--Business Credit and Assistance
I Small Business Administration (Parts 1--199)
III Economic Development Administration, Department of
Commerce (Parts 300--399)
IV Emergency Steel Guarantee Loan Board (Parts 400--499)
V Emergency Oil and Gas Guaranteed Loan Board (Parts
500--599)
Title 14--Aeronautics and Space
I Federal Aviation Administration, Department of
Transportation (Parts 1--199)
II Office of the Secretary, Department of Transportation
(Aviation Proceedings) (Parts 200--399)
III Commercial Space Transportation, Federal Aviation
Administration, Department of Transportation
(Parts 400--1199)
V National Aeronautics and Space Administration (Parts
1200--1299)
VI Air Transportation System Stabilization (Parts 1300--
1399)
Title 15--Commerce and Foreign Trade
Subtitle A--Office of the Secretary of Commerce (Parts
0--29)
Subtitle B--Regulations Relating to Commerce and
Foreign Trade
I Bureau of the Census, Department of Commerce (Parts
30--199)
II National Institute of Standards and Technology,
Department of Commerce (Parts 200--299)
III International Trade Administration, Department of
Commerce (Parts 300--399)
IV Foreign-Trade Zones Board, Department of Commerce
(Parts 400--499)
VII Bureau of Industry and Security, Department of
Commerce (Parts 700--799)
VIII Bureau of Economic Analysis, Department of Commerce
(Parts 800--899)
IX National Oceanic and Atmospheric Administration,
Department of Commerce (Parts 900--999)
XI Technology Administration, Department of Commerce
(Parts 1100--1199)
XIII East-West Foreign Trade Board (Parts 1300--1399)
XIV Minority Business Development Agency (Parts 1400--
1499)
Subtitle C--Regulations Relating to Foreign Trade
Agreements
[[Page 624]]
XX Office of the United States Trade Representative
(Parts 2000--2099)
Subtitle D--Regulations Relating to Telecommunications
and Information
XXIII National Telecommunications and Information
Administration, Department of Commerce (Parts
2300--2399)
Title 16--Commercial Practices
I Federal Trade Commission (Parts 0--999)
II Consumer Product Safety Commission (Parts 1000--1799)
Title 17--Commodity and Securities Exchanges
I Commodity Futures Trading Commission (Parts 1--199)
II Securities and Exchange Commission (Parts 200--399)
IV Department of the Treasury (Parts 400--499)
Title 18--Conservation of Power and Water Resources
I Federal Energy Regulatory Commission, Department of
Energy (Parts 1--399)
III Delaware River Basin Commission (Parts 400--499)
VI Water Resources Council (Parts 700--799)
VIII Susquehanna River Basin Commission (Parts 800--899)
XIII Tennessee Valley Authority (Parts 1300--1399)
Title 19--Customs Duties
I U.S. Customs and Border Protection, Department of
Homeland Security; Department of the Treasury
(Parts 0--199)
II United States International Trade Commission (Parts
200--299)
III International Trade Administration, Department of
Commerce (Parts 300--399)
IV U.S. Immigration and Customs Enforcement, Department
of Homeland Security (Parts 400--599)
Title 20--Employees' Benefits
I Office of Workers' Compensation Programs, Department
of Labor (Parts 1--199)
II Railroad Retirement Board (Parts 200--399)
III Social Security Administration (Parts 400--499)
IV Employees' Compensation Appeals Board, Department of
Labor (Parts 500--599)
V Employment and Training Administration, Department of
Labor (Parts 600--699)
[[Page 625]]
VI Office of Workers' Compensation Programs, Department
of Labor (Parts 700--799)
VII Benefits Review Board, Department of Labor (Parts
800--899)
VIII Joint Board for the Enrollment of Actuaries (Parts
900--999)
IX Office of the Assistant Secretary for Veterans'
Employment and Training Service, Department of
Labor (Parts 1000--1099)
Title 21--Food and Drugs
I Food and Drug Administration, Department of Health and
Human Services (Parts 1--1299)
II Drug Enforcement Administration, Department of Justice
(Parts 1300--1399)
III Office of National Drug Control Policy (Parts 1400--
1499)
Title 22--Foreign Relations
I Department of State (Parts 1--199)
II Agency for International Development (Parts 200--299)
III Peace Corps (Parts 300--399)
IV International Joint Commission, United States and
Canada (Parts 400--499)
V Broadcasting Board of Governors (Parts 500--599)
VII Overseas Private Investment Corporation (Parts 700--
799)
IX Foreign Service Grievance Board (Parts 900--999)
X Inter-American Foundation (Parts 1000--1099)
XI International Boundary and Water Commission, United
States and Mexico, United States Section (Parts
1100--1199)
XII United States International Development Cooperation
Agency (Parts 1200--1299)
XIII Millennium Challenge Corporation (Parts 1300--1399)
XIV Foreign Service Labor Relations Board; Federal Labor
Relations Authority; General Counsel of the
Federal Labor Relations Authority; and the Foreign
Service Impasse Disputes Panel (Parts 1400--1499)
XV African Development Foundation (Parts 1500--1599)
XVI Japan-United States Friendship Commission (Parts
1600--1699)
XVII United States Institute of Peace (Parts 1700--1799)
Title 23--Highways
I Federal Highway Administration, Department of
Transportation (Parts 1--999)
II National Highway Traffic Safety Administration and
Federal Highway Administration, Department of
Transportation (Parts 1200--1299)
III National Highway Traffic Safety Administration,
Department of Transportation (Parts 1300--1399)
[[Page 626]]
Title 24--Housing and Urban Development
Subtitle A--Office of the Secretary, Department of
Housing and Urban Development (Parts 0--99)
Subtitle B--Regulations Relating to Housing and Urban
Development
I Office of Assistant Secretary for Equal Opportunity,
Department of Housing and Urban Development (Parts
100--199)
II Office of Assistant Secretary for Housing-Federal
Housing Commissioner, Department of Housing and
Urban Development (Parts 200--299)
III Government National Mortgage Association, Department
of Housing and Urban Development (Parts 300--399)
IV Office of Housing and Office of Multifamily Housing
Assistance Restructuring, Department of Housing
and Urban Development (Parts 400--499)
V Office of Assistant Secretary for Community Planning
and Development, Department of Housing and Urban
Development (Parts 500--599)
VI Office of Assistant Secretary for Community Planning
and Development, Department of Housing and Urban
Development (Parts 600--699) [Reserved]
VII Office of the Secretary, Department of Housing and
Urban Development (Housing Assistance Programs and
Public and Indian Housing Programs) (Parts 700--
799)
VIII Office of the Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Section 8 Housing Assistance
Programs, Section 202 Direct Loan Program, Section
202 Supportive Housing for the Elderly Program and
Section 811 Supportive Housing for Persons With
Disabilities Program) (Parts 800--899)
IX Office of Assistant Secretary for Public and Indian
Housing, Department of Housing and Urban
Development (Parts 900--1699)
X Office of Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Interstate Land Sales
Registration Program) (Parts 1700--1799)
XII Office of Inspector General, Department of Housing and
Urban Development (Parts 2000--2099)
XV Emergency Mortgage Insurance and Loan Programs,
Department of Housing and Urban Development (Parts
2700--2799) [Reserved]
XX Office of Assistant Secretary for Housing--Federal
Housing Commissioner, Department of Housing and
Urban Development (Parts 3200--3899)
XXIV Board of Directors of the HOPE for Homeowners Program
(Parts 4000--4099) [Reserved]
XXV Neighborhood Reinvestment Corporation (Parts 4100--
4199)
Title 25--Indians
I Bureau of Indian Affairs, Department of the Interior
(Parts 1--299)
[[Page 627]]
II Indian Arts and Crafts Board, Department of the
Interior (Parts 300--399)
III National Indian Gaming Commission, Department of the
Interior (Parts 500--599)
IV Office of Navajo and Hopi Indian Relocation (Parts
700--799)
V Bureau of Indian Affairs, Department of the Interior,
and Indian Health Service, Department of Health
and Human Services (Part 900)
VI Office of the Assistant Secretary-Indian Affairs,
Department of the Interior (Parts 1000--1199)
VII Office of the Special Trustee for American Indians,
Department of the Interior (Parts 1200--1299)
Title 26--Internal Revenue
I Internal Revenue Service, Department of the Treasury
(Parts 1--End)
Title 27--Alcohol, Tobacco Products and Firearms
I Alcohol and Tobacco Tax and Trade Bureau, Department
of the Treasury (Parts 1--399)
II Bureau of Alcohol, Tobacco, Firearms, and Explosives,
Department of Justice (Parts 400--699)
Title 28--Judicial Administration
I Department of Justice (Parts 0--299)
III Federal Prison Industries, Inc., Department of Justice
(Parts 300--399)
V Bureau of Prisons, Department of Justice (Parts 500--
599)
VI Offices of Independent Counsel, Department of Justice
(Parts 600--699)
VII Office of Independent Counsel (Parts 700--799)
VIII Court Services and Offender Supervision Agency for the
District of Columbia (Parts 800--899)
IX National Crime Prevention and Privacy Compact Council
(Parts 900--999)
XI Department of Justice and Department of State (Parts
1100--1199)
Title 29--Labor
Subtitle A--Office of the Secretary of Labor (Parts
0--99)
Subtitle B--Regulations Relating to Labor
I National Labor Relations Board (Parts 100--199)
II Office of Labor-Management Standards, Department of
Labor (Parts 200--299)
III National Railroad Adjustment Board (Parts 300--399)
[[Page 628]]
IV Office of Labor-Management Standards, Department of
Labor (Parts 400--499)
V Wage and Hour Division, Department of Labor (Parts
500--899)
IX Construction Industry Collective Bargaining Commission
(Parts 900--999)
X National Mediation Board (Parts 1200--1299)
XII Federal Mediation and Conciliation Service (Parts
1400--1499)
XIV Equal Employment Opportunity Commission (Parts 1600--
1699)
XVII Occupational Safety and Health Administration,
Department of Labor (Parts 1900--1999)
XX Occupational Safety and Health Review Commission
(Parts 2200--2499)
XXV Employee Benefits Security Administration, Department
of Labor (Parts 2500--2599)
XXVII Federal Mine Safety and Health Review Commission
(Parts 2700--2799)
XL Pension Benefit Guaranty Corporation (Parts 4000--
4999)
Title 30--Mineral Resources
I Mine Safety and Health Administration, Department of
Labor (Parts 1--199)
II Bureau of Safety and Environmental Enforcement,
Department of the Interior (Parts 200--299)
IV Geological Survey, Department of the Interior (Parts
400--499)
V Bureau of Ocean Energy Management, Department of the
Interior (Parts 500--599)
VII Office of Surface Mining Reclamation and Enforcement,
Department of the Interior (Parts 700--999)
XII Office of Natural Resources Revenue, Department of the
Interior (Parts 1200--1299)
Title 31--Money and Finance: Treasury
Subtitle A--Office of the Secretary of the Treasury
(Parts 0--50)
Subtitle B--Regulations Relating to Money and Finance
I Monetary Offices, Department of the Treasury (Parts
51--199)
II Fiscal Service, Department of the Treasury (Parts
200--399)
IV Secret Service, Department of the Treasury (Parts
400--499)
V Office of Foreign Assets Control, Department of the
Treasury (Parts 500--599)
VI Bureau of Engraving and Printing, Department of the
Treasury (Parts 600--699)
VII Federal Law Enforcement Training Center, Department of
the Treasury (Parts 700--799)
VIII Office of International Investment, Department of the
Treasury (Parts 800--899)
[[Page 629]]
IX Federal Claims Collection Standards (Department of the
Treasury--Department of Justice) (Parts 900--999)
X Financial Crimes Enforcement Network, Department of
the Treasury (Parts 1000--1099)
Title 32--National Defense
Subtitle A--Department of Defense
I Office of the Secretary of Defense (Parts 1--399)
V Department of the Army (Parts 400--699)
VI Department of the Navy (Parts 700--799)
VII Department of the Air Force (Parts 800--1099)
Subtitle B--Other Regulations Relating to National
Defense
XII Defense Logistics Agency (Parts 1200--1299)
XVI Selective Service System (Parts 1600--1699)
XVII Office of the Director of National Intelligence (Parts
1700--1799)
XVIII National Counterintelligence Center (Parts 1800--1899)
XIX Central Intelligence Agency (Parts 1900--1999)
XX Information Security Oversight Office, National
Archives and Records Administration (Parts 2000--
2099)
XXI National Security Council (Parts 2100--2199)
XXIV Office of Science and Technology Policy (Parts 2400--
2499)
XXVII Office for Micronesian Status Negotiations (Parts
2700--2799)
XXVIII Office of the Vice President of the United States
(Parts 2800--2899)
Title 33--Navigation and Navigable Waters
I Coast Guard, Department of Homeland Security (Parts
1--199)
II Corps of Engineers, Department of the Army (Parts
200--399)
IV Saint Lawrence Seaway Development Corporation,
Department of Transportation (Parts 400--499)
Title 34--Education
Subtitle A--Office of the Secretary, Department of
Education (Parts 1--99)
Subtitle B--Regulations of the Offices of the
Department of Education
I Office for Civil Rights, Department of Education
(Parts 100--199)
II Office of Elementary and Secondary Education,
Department of Education (Parts 200--299)
III Office of Special Education and Rehabilitative
Services, Department of Education (Parts 300--399)
IV Office of Career, Technical and Adult Education,
Department of Education (Parts 400--499)
[[Page 630]]
V Office of Bilingual Education and Minority Languages
Affairs, Department of Education (Parts 500--599)
[Reserved]
VI Office of Postsecondary Education, Department of
Education (Parts 600--699)
VII Office of Educational Research and Improvement,
Department of Education (Parts 700--799)
[Reserved]
Subtitle C--Regulations Relating to Education
XI [Reserved]
XII National Council on Disability (Parts 1200--1299)
Title 35 [Reserved]
Title 36--Parks, Forests, and Public Property
I National Park Service, Department of the Interior
(Parts 1--199)
II Forest Service, Department of Agriculture (Parts 200--
299)
III Corps of Engineers, Department of the Army (Parts
300--399)
IV American Battle Monuments Commission (Parts 400--499)
V Smithsonian Institution (Parts 500--599)
VI [Reserved]
VII Library of Congress (Parts 700--799)
VIII Advisory Council on Historic Preservation (Parts 800--
899)
IX Pennsylvania Avenue Development Corporation (Parts
900--999)
X Presidio Trust (Parts 1000--1099)
XI Architectural and Transportation Barriers Compliance
Board (Parts 1100--1199)
XII National Archives and Records Administration (Parts
1200--1299)
XV Oklahoma City National Memorial Trust (Parts 1500--
1599)
XVI Morris K. Udall Scholarship and Excellence in National
Environmental Policy Foundation (Parts 1600--1699)
Title 37--Patents, Trademarks, and Copyrights
I United States Patent and Trademark Office, Department
of Commerce (Parts 1--199)
II U.S. Copyright Office, Library of Congress (Parts
200--299)
III Copyright Royalty Board, Library of Congress (Parts
300--399)
IV Assistant Secretary for Technology Policy, Department
of Commerce (Parts 400--599)
Title 38--Pensions, Bonuses, and Veterans' Relief
I Department of Veterans Affairs (Parts 0--199)
II Armed Forces Retirement Home (Parts 200--299)
[[Page 631]]
Title 39--Postal Service
I United States Postal Service (Parts 1--999)
III Postal Regulatory Commission (Parts 3000--3099)
Title 40--Protection of Environment
I Environmental Protection Agency (Parts 1--1099)
IV Environmental Protection Agency and Department of
Justice (Parts 1400--1499)
V Council on Environmental Quality (Parts 1500--1599)
VI Chemical Safety and Hazard Investigation Board (Parts
1600--1699)
VII Environmental Protection Agency and Department of
Defense; Uniform National Discharge Standards for
Vessels of the Armed Forces (Parts 1700--1799)
VIII Gulf Coast Ecosystem Restoration Council (Parts 1800--
1899)
Title 41--Public Contracts and Property Management
Subtitle A--Federal Procurement Regulations System
[Note]
Subtitle B--Other Provisions Relating to Public
Contracts
50 Public Contracts, Department of Labor (Parts 50-1--50-
999)
51 Committee for Purchase From People Who Are Blind or
Severely Disabled (Parts 51-1--51-99)
60 Office of Federal Contract Compliance Programs, Equal
Employment Opportunity, Department of Labor (Parts
60-1--60-999)
61 Office of the Assistant Secretary for Veterans'
Employment and Training Service, Department of
Labor (Parts 61-1--61-999)
62--100 [Reserved]
Subtitle C--Federal Property Management Regulations
System
101 Federal Property Management Regulations (Parts 101-1--
101-99)
102 Federal Management Regulation (Parts 102-1--102-299)
103--104 [Reserved]
105 General Services Administration (Parts 105-1--105-999)
109 Department of Energy Property Management Regulations
(Parts 109-1--109-99)
114 Department of the Interior (Parts 114-1--114-99)
115 Environmental Protection Agency (Parts 115-1--115-99)
128 Department of Justice (Parts 128-1--128-99)
129--200 [Reserved]
Subtitle D--Other Provisions Relating to Property
Management [Reserved]
Subtitle E--Federal Information Resources Management
Regulations System [Reserved]
Subtitle F--Federal Travel Regulation System
300 General (Parts 300-1--300-99)
301 Temporary Duty (TDY) Travel Allowances (Parts 301-1--
301-99)
[[Page 632]]
302 Relocation Allowances (Parts 302-1--302-99)
303 Payment of Expenses Connected with the Death of
Certain Employees (Part 303-1--303-99)
304 Payment of Travel Expenses from a Non-Federal Source
(Parts 304-1--304-99)
Title 42--Public Health
I Public Health Service, Department of Health and Human
Services (Parts 1--199)
IV Centers for Medicare & Medicaid Services, Department
of Health and Human Services (Parts 400--599)
V Office of Inspector General-Health Care, Department of
Health and Human Services (Parts 1000--1999)
Title 43--Public Lands: Interior
Subtitle A--Office of the Secretary of the Interior
(Parts 1--199)
Subtitle B--Regulations Relating to Public Lands
I Bureau of Reclamation, Department of the Interior
(Parts 400--999)
II Bureau of Land Management, Department of the Interior
(Parts 1000--9999)
III Utah Reclamation Mitigation and Conservation
Commission (Parts 10000--10099)
Title 44--Emergency Management and Assistance
I Federal Emergency Management Agency, Department of
Homeland Security (Parts 0--399)
IV Department of Commerce and Department of
Transportation (Parts 400--499)
Title 45--Public Welfare
Subtitle A--Department of Health and Human Services
(Parts 1--199)
Subtitle B--Regulations Relating to Public Welfare
II Office of Family Assistance (Assistance Programs),
Administration for Children and Families,
Department of Health and Human Services (Parts
200--299)
III Office of Child Support Enforcement (Child Support
Enforcement Program), Administration for Children
and Families, Department of Health and Human
Services (Parts 300--399)
IV Office of Refugee Resettlement, Administration for
Children and Families, Department of Health and
Human Services (Parts 400--499)
V Foreign Claims Settlement Commission of the United
States, Department of Justice (Parts 500--599)
[[Page 633]]
VI National Science Foundation (Parts 600--699)
VII Commission on Civil Rights (Parts 700--799)
VIII Office of Personnel Management (Parts 800--899)
X Office of Community Services, Administration for
Children and Families, Department of Health and
Human Services (Parts 1000--1099)
XI National Foundation on the Arts and the Humanities
(Parts 1100--1199)
XII Corporation for National and Community Service (Parts
1200--1299)
XIII Office of Human Development Services, Department of
Health and Human Services (Parts 1300--1399)
XVI Legal Services Corporation (Parts 1600--1699)
XVII National Commission on Libraries and Information
Science (Parts 1700--1799)
XVIII Harry S. Truman Scholarship Foundation (Parts 1800--
1899)
XXI Commission on Fine Arts (Parts 2100--2199)
XXIII Arctic Research Commission (Part 2301)
XXIV James Madison Memorial Fellowship Foundation (Parts
2400--2499)
XXV Corporation for National and Community Service (Parts
2500--2599)
Title 46--Shipping
I Coast Guard, Department of Homeland Security (Parts
1--199)
II Maritime Administration, Department of Transportation
(Parts 200--399)
III Coast Guard (Great Lakes Pilotage), Department of
Homeland Security (Parts 400--499)
IV Federal Maritime Commission (Parts 500--599)
Title 47--Telecommunication
I Federal Communications Commission (Parts 0--199)
II Office of Science and Technology Policy and National
Security Council (Parts 200--299)
III National Telecommunications and Information
Administration, Department of Commerce (Parts
300--399)
IV National Telecommunications and Information
Administration, Department of Commerce, and
National Highway Traffic Safety Administration,
Department of Transportation (Parts 400--499)
Title 48--Federal Acquisition Regulations System
1 Federal Acquisition Regulation (Parts 1--99)
2 Defense Acquisition Regulations System, Department of
Defense (Parts 200--299)
[[Page 634]]
3 Health and Human Services (Parts 300--399)
4 Department of Agriculture (Parts 400--499)
5 General Services Administration (Parts 500--599)
6 Department of State (Parts 600--699)
7 Agency for International Development (Parts 700--799)
8 Department of Veterans Affairs (Parts 800--899)
9 Department of Energy (Parts 900--999)
10 Department of the Treasury (Parts 1000--1099)
12 Department of Transportation (Parts 1200--1299)
13 Department of Commerce (Parts 1300--1399)
14 Department of the Interior (Parts 1400--1499)
15 Environmental Protection Agency (Parts 1500--1599)
16 Office of Personnel Management, Federal Employees
Health Benefits Acquisition Regulation (Parts
1600--1699)
17 Office of Personnel Management (Parts 1700--1799)
18 National Aeronautics and Space Administration (Parts
1800--1899)
19 Broadcasting Board of Governors (Parts 1900--1999)
20 Nuclear Regulatory Commission (Parts 2000--2099)
21 Office of Personnel Management, Federal Employees
Group Life Insurance Federal Acquisition
Regulation (Parts 2100--2199)
23 Social Security Administration (Parts 2300--2399)
24 Department of Housing and Urban Development (Parts
2400--2499)
25 National Science Foundation (Parts 2500--2599)
28 Department of Justice (Parts 2800--2899)
29 Department of Labor (Parts 2900--2999)
30 Department of Homeland Security, Homeland Security
Acquisition Regulation (HSAR) (Parts 3000--3099)
34 Department of Education Acquisition Regulation (Parts
3400--3499)
51 Department of the Army Acquisition Regulations (Parts
5100--5199)
52 Department of the Navy Acquisition Regulations (Parts
5200--5299)
53 Department of the Air Force Federal Acquisition
Regulation Supplement (Parts 5300--5399)
[Reserved]
54 Defense Logistics Agency, Department of Defense (Parts
5400--5499)
57 African Development Foundation (Parts 5700--5799)
61 Civilian Board of Contract Appeals, General Services
Administration (Parts 6100--6199)
63 Department of Transportation Board of Contract Appeals
(Parts 6300--6399)
99 Cost Accounting Standards Board, Office of Federal
Procurement Policy, Office of Management and
Budget (Parts 9900--9999)
[[Page 635]]
Title 49--Transportation
Subtitle A--Office of the Secretary of Transportation
(Parts 1--99)
Subtitle B--Other Regulations Relating to
Transportation
I Pipeline and Hazardous Materials Safety
Administration, Department of Transportation
(Parts 100--199)
II Federal Railroad Administration, Department of
Transportation (Parts 200--299)
III Federal Motor Carrier Safety Administration,
Department of Transportation (Parts 300--399)
IV Coast Guard, Department of Homeland Security (Parts
400--499)
V National Highway Traffic Safety Administration,
Department of Transportation (Parts 500--599)
VI Federal Transit Administration, Department of
Transportation (Parts 600--699)
VII National Railroad Passenger Corporation (AMTRAK)
(Parts 700--799)
VIII National Transportation Safety Board (Parts 800--999)
X Surface Transportation Board, Department of
Transportation (Parts 1000--1399)
XI Research and Innovative Technology Administration,
Department of Transportation (Parts 1400--1499)
[Reserved]
XII Transportation Security Administration, Department of
Homeland Security (Parts 1500--1699)
Title 50--Wildlife and Fisheries
I United States Fish and Wildlife Service, Department of
the Interior (Parts 1--199)
II National Marine Fisheries Service, National Oceanic
and Atmospheric Administration, Department of
Commerce (Parts 200--299)
III International Fishing and Related Activities (Parts
300--399)
IV Joint Regulations (United States Fish and Wildlife
Service, Department of the Interior and National
Marine Fisheries Service, National Oceanic and
Atmospheric Administration, Department of
Commerce); Endangered Species Committee
Regulations (Parts 400--499)
V Marine Mammal Commission (Parts 500--599)
VI Fishery Conservation and Management, National Oceanic
and Atmospheric Administration, Department of
Commerce (Parts 600--699)
[[Page 637]]
Alphabetical List of Agencies Appearing in the CFR
(Revised as of April 1, 2015)
CFR Title, Subtitle or
Agency Chapter
Administrative Committee of the Federal Register 1, I
Administrative Conference of the United States 1, III
Advisory Council on Historic Preservation 36, VIII
Advocacy and Outreach, Office of 7, XXV
Afghanistan Reconstruction, Special Inspector 22, LXXXIII
General for
African Development Foundation 22, XV
Federal Acquisition Regulation 48, 57
Agency for International Development 2, VII; 22, II
Federal Acquisition Regulation 48, 7
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Agriculture Department 2, IV; 5, LXXIII
Advocacy and Outreach, Office of 7, XXV
Agricultural Marketing Service 7, I, IX, X, XI
Agricultural Research Service 7, V
Animal and Plant Health Inspection Service 7, III; 9, I
Chief Financial Officer, Office of 7, XXX
Commodity Credit Corporation 7, XIV
Economic Research Service 7, XXXVII
Energy Policy and New Uses, Office of 2, IX; 7, XXIX
Environmental Quality, Office of 7, XXXI
Farm Service Agency 7, VII, XVIII
Federal Acquisition Regulation 48, 4
Federal Crop Insurance Corporation 7, IV
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Forest Service 36, II
Grain Inspection, Packers and Stockyards 7, VIII; 9, II
Administration
Information Resources Management, Office of 7, XXVII
Inspector General, Office of 7, XXVI
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
National Institute of Food and Agriculture 7, XXXIV
Natural Resources Conservation Service 7, VI
Operations, Office of 7, XXVIII
Procurement and Property Management, Office of 7, XXXII
Rural Business-Cooperative Service 7, XVIII, XLII, L
Rural Development Administration 7, XLII
Rural Housing Service 7, XVIII, XXXV, L
Rural Telephone Bank 7, XVI
Rural Utilities Service 7, XVII, XVIII, XLII, L
Secretary of Agriculture, Office of 7, Subtitle A
Transportation, Office of 7, XXXIII
World Agricultural Outlook Board 7, XXXVIII
Air Force Department 32, VII
Federal Acquisition Regulation Supplement 48, 53
Air Transportation Stabilization Board 14, VI
Alcohol and Tobacco Tax and Trade Bureau 27, I
Alcohol, Tobacco, Firearms, and Explosives, 27, II
Bureau of
AMTRAK 49, VII
American Battle Monuments Commission 36, IV
American Indians, Office of the Special Trustee 25, VII
[[Page 638]]
Animal and Plant Health Inspection Service 7, III; 9, I
Appalachian Regional Commission 5, IX
Architectural and Transportation Barriers 36, XI
Compliance Board
Arctic Research Commission 45, XXIII
Armed Forces Retirement Home 5, XI
Army Department 32, V
Engineers, Corps of 33, II; 36, III
Federal Acquisition Regulation 48, 51
Bilingual Education and Minority Languages 34, V
Affairs, Office of
Blind or Severely Disabled, Committee for 41, 51
Purchase from People Who Are
Broadcasting Board of Governors 22, V
Federal Acquisition Regulation 48, 19
Census Bureau 15, I
Centers for Medicare & Medicaid Services 42, IV
Central Intelligence Agency 32, XIX
Chemical Safety and Hazardous Investigation 40, VI
Board
Chief Financial Officer, Office of 7, XXX
Child Support Enforcement, Office of 45, III
Children and Families, Administration for 45, II, III, IV, X
Civil Rights, Commission on 5, LXVIII; 45, VII
Civil Rights, Office for 34, I
Council of the Inspectors General on Integrity 5, XCVIII
and Efficiency
Court Services and Offender Supervision Agency 5, LXX
for the District of Columbia
Coast Guard 33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage) 46, III
Commerce Department 2, XIII; 44, IV; 50, VI
Census Bureau 15, I
Economic Analysis, Bureau of 15, VIII
Economic Development Administration 13, III
Emergency Management and Assistance 44, IV
Federal Acquisition Regulation 48, 13
Foreign-Trade Zones Board 15, IV
Industry and Security, Bureau of 15, VII
International Trade Administration 15, III; 19, III
National Institute of Standards and Technology 15, II
National Marine Fisheries Service 50, II, IV
National Oceanic and Atmospheric 15, IX; 50, II, III, IV,
Administration VI
National Telecommunications and Information 15, XXIII; 47, III, IV
Administration
National Weather Service 15, IX
Patent and Trademark Office, United States 37, I
Productivity, Technology and Innovation, 37, IV
Assistant Secretary for
Secretary of Commerce, Office of 15, Subtitle A
Technology Administration 15, XI
Technology Policy, Assistant Secretary for 37, IV
Commercial Space Transportation 14, III
Commodity Credit Corporation 7, XIV
Commodity Futures Trading Commission 5, XLI; 17, I
Community Planning and Development, Office of 24, V, VI
Assistant Secretary for
Community Services, Office of 45, X
Comptroller of the Currency 12, I
Construction Industry Collective Bargaining 29, IX
Commission
Consumer Financial Protection Bureau 5, LXXXIV; 12, X
Consumer Product Safety Commission 5, LXXI; 16, II
Copyright Royalty Board 37, III
Corporation for National and Community Service 2, XXII; 45, XII, XXV
Cost Accounting Standards Board 48, 99
Council on Environmental Quality 40, V
Court Services and Offender Supervision Agency 5, LXX; 28, VIII
for the District of Columbia
Customs and Border Protection 19, I
Defense Contract Audit Agency 32, I
Defense Department 2, XI; 5, XXVI; 32,
Subtitle A; 40, VII
[[Page 639]]
Advanced Research Projects Agency 32, I
Air Force Department 32, VII
Army Department 32, V; 33, II; 36, III,
48, 51
Defense Acquisition Regulations System 48, 2
Defense Intelligence Agency 32, I
Defense Logistics Agency 32, I, XII; 48, 54
Engineers, Corps of 33, II; 36, III
National Imagery and Mapping Agency 32, I
Navy Department 32, VI; 48, 52
Secretary of Defense, Office of 2, XI; 32, I
Defense Contract Audit Agency 32, I
Defense Intelligence Agency 32, I
Defense Logistics Agency 32, XII; 48, 54
Defense Nuclear Facilities Safety Board 10, XVII
Delaware River Basin Commission 18, III
District of Columbia, Court Services and 5, LXX; 28, VIII
Offender Supervision Agency for the
Drug Enforcement Administration 21, II
East-West Foreign Trade Board 15, XIII
Economic Analysis, Bureau of 15, VIII
Economic Development Administration 13, III
Economic Research Service 7, XXXVII
Education, Department of 2, XXXIV; 5, LIII
Bilingual Education and Minority Languages 34, V
Affairs, Office of
Civil Rights, Office for 34, I
Educational Research and Improvement, Office 34, VII
of
Elementary and Secondary Education, Office of 34, II
Federal Acquisition Regulation 48, 34
Postsecondary Education, Office of 34, VI
Secretary of Education, Office of 34, Subtitle A
Special Education and Rehabilitative Services, 34, III
Office of
Career, Technical, and Adult Education, Office 34, IV
of
Educational Research and Improvement, Office of 34, VII
Election Assistance Commission 2, LVIII; 11, II
Elementary and Secondary Education, Office of 34, II
Emergency Oil and Gas Guaranteed Loan Board 13, V
Emergency Steel Guarantee Loan Board 13, IV
Employee Benefits Security Administration 29, XXV
Employees' Compensation Appeals Board 20, IV
Employees Loyalty Board 5, V
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Endangered Species Committee 50, IV
Energy, Department of 2, IX; 5, XXIII; 10, II,
III, X
Federal Acquisition Regulation 48, 9
Federal Energy Regulatory Commission 5, XXIV; 18, I
Property Management Regulations 41, 109
Energy, Office of 7, XXIX
Engineers, Corps of 33, II; 36, III
Engraving and Printing, Bureau of 31, VI
Environmental Protection Agency 2, XV; 5, LIV; 40, I, IV,
VII
Federal Acquisition Regulation 48, 15
Property Management Regulations 41, 115
Environmental Quality, Office of 7, XXXI
Equal Employment Opportunity Commission 5, LXII; 29, XIV
Equal Opportunity, Office of Assistant Secretary 24, I
for
Executive Office of the President 3, I
Environmental Quality, Council on 40, V
Management and Budget, Office of 2, Subtitle A; 5, III,
LXXVII; 14, VI; 48, 99
National Drug Control Policy, Office of 2, XXXVI; 21, III
National Security Council 32, XXI; 47, 2
Presidential Documents 3
[[Page 640]]
Science and Technology Policy, Office of 32, XXIV; 47, II
Trade Representative, Office of the United 15, XX
States
Export-Import Bank of the United States 2, XXXV; 5, LII; 12, IV
Family Assistance, Office of 45, II
Farm Credit Administration 5, XXXI; 12, VI
Farm Credit System Insurance Corporation 5, XXX; 12, XIV
Farm Service Agency 7, VII, XVIII
Federal Acquisition Regulation 48, 1
Federal Aviation Administration 14, I
Commercial Space Transportation 14, III
Federal Claims Collection Standards 31, IX
Federal Communications Commission 5, XXIX; 47, I
Federal Contract Compliance Programs, Office of 41, 60
Federal Crop Insurance Corporation 7, IV
Federal Deposit Insurance Corporation 5, XXII; 12, III
Federal Election Commission 5, XXXVII; 11, I
Federal Emergency Management Agency 44, I
Federal Employees Group Life Insurance Federal 48, 21
Acquisition Regulation
Federal Employees Health Benefits Acquisition 48, 16
Regulation
Federal Energy Regulatory Commission 5, XXIV; 18, I
Federal Financial Institutions Examination 12, XI
Council
Federal Financing Bank 12, VIII
Federal Highway Administration 23, I, II
Federal Home Loan Mortgage Corporation 1, IV
Federal Housing Enterprise Oversight Office 12, XVII
Federal Housing Finance Agency 5, LXXX; 12, XII
Federal Housing Finance Board 12, IX
Federal Labor Relations Authority 5, XIV, XLIX; 22, XIV
Federal Law Enforcement Training Center 31, VII
Federal Management Regulation 41, 102
Federal Maritime Commission 46, IV
Federal Mediation and Conciliation Service 29, XII
Federal Mine Safety and Health Review Commission 5, LXXIV; 29, XXVII
Federal Motor Carrier Safety Administration 49, III
Federal Prison Industries, Inc. 28, III
Federal Procurement Policy Office 48, 99
Federal Property Management Regulations 41, 101
Federal Railroad Administration 49, II
Federal Register, Administrative Committee of 1, I
Federal Register, Office of 1, II
Federal Reserve System 12, II
Board of Governors 5, LVIII
Federal Retirement Thrift Investment Board 5, VI, LXXVI
Federal Service Impasses Panel 5, XIV
Federal Trade Commission 5, XLVII; 16, I
Federal Transit Administration 49, VI
Federal Travel Regulation System 41, Subtitle F
Financial Crimes Enforcement Network 31, X
Financial Research Office 12, XVI
Financial Stability Oversight Council 12, XIII
Fine Arts, Commission on 45, XXI
Fiscal Service 31, II
Fish and Wildlife Service, United States 50, I, IV
Food and Drug Administration 21, I
Food and Nutrition Service 7, II
Food Safety and Inspection Service 9, III
Foreign Agricultural Service 7, XV
Foreign Assets Control, Office of 31, V
Foreign Claims Settlement Commission of the 45, V
United States
Foreign Service Grievance Board 22, IX
Foreign Service Impasse Disputes Panel 22, XIV
Foreign Service Labor Relations Board 22, XIV
Foreign-Trade Zones Board 15, IV
Forest Service 36, II
General Services Administration 5, LVII; 41, 105
Contract Appeals, Board of 48, 61
[[Page 641]]
Federal Acquisition Regulation 48, 5
Federal Management Regulation 41, 102
Federal Property Management Regulations 41, 101
Federal Travel Regulation System 41, Subtitle F
General 41, 300
Payment From a Non-Federal Source for Travel 41, 304
Expenses
Payment of Expenses Connected With the Death 41, 303
of Certain Employees
Relocation Allowances 41, 302
Temporary Duty (TDY) Travel Allowances 41, 301
Geological Survey 30, IV
Government Accountability Office 4, I
Government Ethics, Office of 5, XVI
Government National Mortgage Association 24, III
Grain Inspection, Packers and Stockyards 7, VIII; 9, II
Administration
Gulf Coast Ecosystem Restoration Council 2, LIX; 40, VIII
Harry S. Truman Scholarship Foundation 45, XVIII
Health and Human Services, Department of 2, III; 5, XLV; 45,
Subtitle A,
Centers for Medicare & Medicaid Services 42, IV
Child Support Enforcement, Office of 45, III
Children and Families, Administration for 45, II, III, IV, X
Community Services, Office of 45, X
Family Assistance, Office of 45, II
Federal Acquisition Regulation 48, 3
Food and Drug Administration 21, I
Human Development Services, Office of 45, XIII
Indian Health Service 25, V
Inspector General (Health Care), Office of 42, V
Public Health Service 42, I
Refugee Resettlement, Office of 45, IV
Homeland Security, Department of 2, XXX; 6, I; 8, I
Coast Guard 33, I; 46, I; 49, IV
Coast Guard (Great Lakes Pilotage) 46, III
Customs and Border Protection 19, I
Federal Emergency Management Agency 44, I
Human Resources Management and Labor Relations 5, XCVII
Systems
Immigration and Customs Enforcement Bureau 19, IV
Transportation Security Administration 49, XII
HOPE for Homeowners Program, Board of Directors 24, XXIV
of
Housing and Urban Development, Department of 2, XXIV; 5, LXV; 24,
Subtitle B
Community Planning and Development, Office of 24, V, VI
Assistant Secretary for
Equal Opportunity, Office of Assistant 24, I
Secretary for
Federal Acquisition Regulation 48, 24
Federal Housing Enterprise Oversight, Office 12, XVII
of
Government National Mortgage Association 24, III
Housing--Federal Housing Commissioner, Office 24, II, VIII, X, XX
of Assistant Secretary for
Housing, Office of, and Multifamily Housing 24, IV
Assistance Restructuring, Office of
Inspector General, Office of 24, XII
Public and Indian Housing, Office of Assistant 24, IX
Secretary for
Secretary, Office of 24, Subtitle A, VII
Housing--Federal Housing Commissioner, Office of 24, II, VIII, X, XX
Assistant Secretary for
Housing, Office of, and Multifamily Housing 24, IV
Assistance Restructuring, Office of
Human Development Services, Office of 45, XIII
Immigration and Customs Enforcement Bureau 19, IV
Immigration Review, Executive Office for 8, V
Independent Counsel, Office of 28, VII
Indian Affairs, Bureau of 25, I, V
Indian Affairs, Office of the Assistant 25, VI
Secretary
Indian Arts and Crafts Board 25, II
[[Page 642]]
Indian Health Service 25, V
Industry and Security, Bureau of 15, VII
Information Resources Management, Office of 7, XXVII
Information Security Oversight Office, National 32, XX
Archives and Records Administration
Inspector General
Agriculture Department 7, XXVI
Health and Human Services Department 42, V
Housing and Urban Development Department 24, XII, XV
Institute of Peace, United States 22, XVII
Inter-American Foundation 5, LXIII; 22, X
Interior Department 2, XIV
American Indians, Office of the Special 25, VII
Trustee
Endangered Species Committee 50, IV
Federal Acquisition Regulation 48, 14
Federal Property Management Regulations System 41, 114
Fish and Wildlife Service, United States 50, I, IV
Geological Survey 30, IV
Indian Affairs, Bureau of 25, I, V
Indian Affairs, Office of the Assistant 25, VI
Secretary
Indian Arts and Crafts Board 25, II
Land Management, Bureau of 43, II
National Indian Gaming Commission 25, III
National Park Service 36, I
Natural Resource Revenue, Office of 30, XII
Ocean Energy Management, Bureau of 30, V
Reclamation, Bureau of 43, I
Safety and Enforcement Bureau, Bureau of 30, II
Secretary of the Interior, Office of 2, XIV; 43, Subtitle A
Surface Mining Reclamation and Enforcement, 30, VII
Office of
Internal Revenue Service 26, I
International Boundary and Water Commission, 22, XI
United States and Mexico, United States
Section
International Development, United States Agency 22, II
for
Federal Acquisition Regulation 48, 7
International Development Cooperation Agency, 22, XII
United States
International Joint Commission, United States 22, IV
and Canada
International Organizations Employees Loyalty 5, V
Board
International Trade Administration 15, III; 19, III
International Trade Commission, United States 19, II
Interstate Commerce Commission 5, XL
Investment Security, Office of 31, VIII
James Madison Memorial Fellowship Foundation 45, XXIV
Japan-United States Friendship Commission 22, XVI
Joint Board for the Enrollment of Actuaries 20, VIII
Justice Department 2, XXVIII; 5, XXVIII; 28,
I, XI; 40, IV
Alcohol, Tobacco, Firearms, and Explosives, 27, II
Bureau of
Drug Enforcement Administration 21, II
Federal Acquisition Regulation 48, 28
Federal Claims Collection Standards 31, IX
Federal Prison Industries, Inc. 28, III
Foreign Claims Settlement Commission of the 45, V
United States
Immigration Review, Executive Office for 8, V
Offices of Independent Counsel 28, VI
Prisons, Bureau of 28, V
Property Management Regulations 41, 128
Labor Department 2, XXIX; 5, XLII
Employee Benefits Security Administration 29, XXV
Employees' Compensation Appeals Board 20, IV
Employment and Training Administration 20, V
Employment Standards Administration 20, VI
Federal Acquisition Regulation 48, 29
Federal Contract Compliance Programs, Office 41, 60
of
Federal Procurement Regulations System 41, 50
[[Page 643]]
Labor-Management Standards, Office of 29, II, IV
Mine Safety and Health Administration 30, I
Occupational Safety and Health Administration 29, XVII
Office of Workers' Compensation Programs 20, VII
Public Contracts 41, 50
Secretary of Labor, Office of 29, Subtitle A
Veterans' Employment and Training Service, 41, 61; 20, IX
Office of the Assistant Secretary for
Wage and Hour Division 29, V
Workers' Compensation Programs, Office of 20, I
Labor-Management Standards, Office of 29, II, IV
Land Management, Bureau of 43, II
Legal Services Corporation 45, XVI
Library of Congress 36, VII
Copyright Royalty Board 37, III
U.S. Copyright Office 37, II
Local Television Loan Guarantee Board 7, XX
Management and Budget, Office of 5, III, LXXVII; 14, VI;
48, 99
Marine Mammal Commission 50, V
Maritime Administration 46, II
Merit Systems Protection Board 5, II, LXIV
Micronesian Status Negotiations, Office for 32, XXVII
Military Compensation and Retirement 5, XCIV
Modernization Commission
Millennium Challenge Corporation 22, XIII
Mine Safety and Health Administration 30, I
Minority Business Development Agency 15, XIV
Miscellaneous Agencies 1, IV
Monetary Offices 31, I
Morris K. Udall Scholarship and Excellence in 36, XVI
National Environmental Policy Foundation
Museum and Library Services, Institute of 2, XXXI
National Aeronautics and Space Administration 22, XVIII; 5, LIX; 14, V
Federal Acquisition Regulation 48, 18
National Agricultural Library 7, XLI
National Agricultural Statistics Service 7, XXXVI
National and Community Service, Corporation for 2, XXII; 45, XII, XXV
National Archives and Records Administration 2, XXVI; 5, LXVI; 36, XII
Information Security Oversight Office 32, XX
National Capital Planning Commission 1, IV
National Commission for Employment Policy 1, IV
National Commission on Libraries and Information 45, XVII
Science
National Council on Disability 34, XII
National Counterintelligence Center 32, XVIII
National Credit Union Administration 5, LXXXVI; 12, VII
National Crime Prevention and Privacy Compact 28, IX
Council
National Drug Control Policy, Office of 2, XXXVI; 21, III
National Endowment for the Arts 2, XXXII
National Endowment for the Humanities 2, XXXIII
National Foundation on the Arts and the 45, XI
Humanities
National Highway Traffic Safety Administration 23, II, III; 47, VI; 49, V
National Imagery and Mapping Agency 32, I
National Indian Gaming Commission 25, III
National Institute of Food and Agriculture 7, XXXIV
National Institute of Standards and Technology 15, II
National Intelligence, Office of Director of 32, XVII
National Labor Relations Board 5, LXI; 29, I
National Marine Fisheries Service 50, II, IV
National Mediation Board 29, X
National Oceanic and Atmospheric Administration 15, IX; 50, II, III, IV,
VI
National Park Service 36, I
National Railroad Adjustment Board 29, III
National Railroad Passenger Corporation (AMTRAK) 49, VII
National Science Foundation 2, XXV; 5, XLIII; 45, VI
Federal Acquisition Regulation 48, 25
[[Page 644]]
National Security Council 32, XXI
National Security Council and Office of Science 47, II
and Technology Policy
National Telecommunications and Information 15, XXIII; 47, III, IV
Administration
National Transportation Safety Board 49, VIII
Natural Resources Conservation Service 7, VI
Natural Resource Revenue, Office of 30, XII
Navajo and Hopi Indian Relocation, Office of 25, IV
Navy Department 32, VI
Federal Acquisition Regulation 48, 52
Neighborhood Reinvestment Corporation 24, XXV
Northeast Interstate Low-Level Radioactive Waste 10, XVIII
Commission
Nuclear Regulatory Commission 2, XX; 5, XLVIII; 10, I
Federal Acquisition Regulation 48, 20
Occupational Safety and Health Administration 29, XVII
Occupational Safety and Health Review Commission 29, XX
Ocean Energy Management, Bureau of 30, V
Offices of Independent Counsel 28, VI
Office of Workers' Compensation Programs 20, VII
Oklahoma City National Memorial Trust 36, XV
Operations Office 7, XXVIII
Overseas Private Investment Corporation 5, XXXIII; 22, VII
Patent and Trademark Office, United States 37, I
Payment From a Non-Federal Source for Travel 41, 304
Expenses
Payment of Expenses Connected With the Death of 41, 303
Certain Employees
Peace Corps 2, XXXVII; 22, III
Pennsylvania Avenue Development Corporation 36, IX
Pension Benefit Guaranty Corporation 29, XL
Personnel Management, Office of 5, I, XXXV; 45, VIII
Human Resources Management and Labor Relations 5, XCVII
Systems, Department of Homeland Security
Federal Acquisition Regulation 48, 17
Federal Employees Group Life Insurance Federal 48, 21
Acquisition Regulation
Federal Employees Health Benefits Acquisition 48, 16
Regulation
Pipeline and Hazardous Materials Safety 49, I
Administration
Postal Regulatory Commission 5, XLVI; 39, III
Postal Service, United States 5, LX; 39, I
Postsecondary Education, Office of 34, VI
President's Commission on White House 1, IV
Fellowships
Presidential Documents 3
Presidio Trust 36, X
Prisons, Bureau of 28, V
Privacy and Civil Liberties Oversight Board 6, X
Procurement and Property Management, Office of 7, XXXII
Productivity, Technology and Innovation, 37, IV
Assistant Secretary
Public Contracts, Department of Labor 41, 50
Public and Indian Housing, Office of Assistant 24, IX
Secretary for
Public Health Service 42, I
Railroad Retirement Board 20, II
Reclamation, Bureau of 43, I
Recovery Accountability and Transparency Board 4, II
Refugee Resettlement, Office of 45, IV
Relocation Allowances 41, 302
Research and Innovative Technology 49, XI
Administration
Rural Business-Cooperative Service 7, XVIII, XLII, L
Rural Development Administration 7, XLII
Rural Housing Service 7, XVIII, XXXV, L
Rural Telephone Bank 7, XVI
Rural Utilities Service 7, XVII, XVIII, XLII, L
Safety and Environmental Enforcement, Bureau of 30, II
Saint Lawrence Seaway Development Corporation 33, IV
Science and Technology Policy, Office of 32, XXIV
[[Page 645]]
Science and Technology Policy, Office of, and 47, II
National Security Council
Secret Service 31, IV
Securities and Exchange Commission 5, XXXIV; 17, II
Selective Service System 32, XVI
Small Business Administration 2, XXVII; 13, I
Smithsonian Institution 36, V
Social Security Administration 2, XXIII; 20, III; 48, 23
Soldiers' and Airmen's Home, United States 5, XI
Special Counsel, Office of 5, VIII
Special Education and Rehabilitative Services, 34, III
Office of
State Department 2, VI; 22, I; 28, XI
Federal Acquisition Regulation 48, 6
Surface Mining Reclamation and Enforcement, 30, VII
Office of
Surface Transportation Board 49, X
Susquehanna River Basin Commission 18, VIII
Technology Administration 15, XI
Technology Policy, Assistant Secretary for 37, IV
Tennessee Valley Authority 5, LXIX; 18, XIII
Thrift Supervision Office, Department of the 12, V
Treasury
Trade Representative, United States, Office of 15, XX
Transportation, Department of 2, XII; 5, L
Commercial Space Transportation 14, III
Contract Appeals, Board of 48, 63
Emergency Management and Assistance 44, IV
Federal Acquisition Regulation 48, 12
Federal Aviation Administration 14, I
Federal Highway Administration 23, I, II
Federal Motor Carrier Safety Administration 49, III
Federal Railroad Administration 49, II
Federal Transit Administration 49, VI
Maritime Administration 46, II
National Highway Traffic Safety Administration 23, II, III; 47, IV; 49, V
Pipeline and Hazardous Materials Safety 49, I
Administration
Saint Lawrence Seaway Development Corporation 33, IV
Secretary of Transportation, Office of 14, II; 49, Subtitle A
Surface Transportation Board 49, X
Transportation Statistics Bureau 49, XI
Transportation, Office of 7, XXXIII
Transportation Security Administration 49, XII
Transportation Statistics Bureau 49, XI
Travel Allowances, Temporary Duty (TDY) 41, 301
Treasury Department 2, X;5, XXI; 12, XV; 17,
IV; 31, IX
Alcohol and Tobacco Tax and Trade Bureau 27, I
Community Development Financial Institutions 12, XVIII
Fund
Comptroller of the Currency 12, I
Customs and Border Protection 19, I
Engraving and Printing, Bureau of 31, VI
Federal Acquisition Regulation 48, 10
Federal Claims Collection Standards 31, IX
Federal Law Enforcement Training Center 31, VII
Financial Crimes Enforcement Network 31, X
Fiscal Service 31, II
Foreign Assets Control, Office of 31, V
Internal Revenue Service 26, I
Investment Security, Office of 31, VIII
Monetary Offices 31, I
Secret Service 31, IV
Secretary of the Treasury, Office of 31, Subtitle A
Thrift Supervision, Office of 12, V
Truman, Harry S. Scholarship Foundation 45, XVIII
United States and Canada, International Joint 22, IV
Commission
United States and Mexico, International Boundary 22, XI
and Water Commission, United States Section
U.S. Copyright Office 37, II
Utah Reclamation Mitigation and Conservation 43, III
Commission
[[Page 646]]
Veterans Affairs Department 2, VIII; 38, I
Federal Acquisition Regulation 48, 8
Veterans' Employment and Training Service, 41, 61; 20, IX
Office of the Assistant Secretary for
Vice President of the United States, Office of 32, XXVIII
Career, Technical and Adult Education, Office of 34, IV
Wage and Hour Division 29, V
Water Resources Council 18, VI
Workers' Compensation Programs, Office of 20, I
World Agricultural Outlook Board 7, XXXVIII
[[Page 647]]
Table of OMB Control Numbers
The OMB control numbers for chapter I of title 26 were consolidated into
Sec. Sec. 601.9000 and 602.101 at 50 FR 10221, Mar. 14, 1985. At 61 FR
58008, Nov. 12, 1996, Sec. 601.9000 was removed. Section 602.101 is
reprinted below for the convenience of the user.
PART 602_OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT--Table of Contents
Sec. 602.101 OMB Control numbers.
(a) Purpose. This part collects and displays the control numbers
assigned to collections of information in Internal Revenue Service
regulations by the Office of Management and Budget (OMB) under the
Paperwork Reduction Act of 1980. The Internal Revenue Service intends
that this part comply with the requirements of Sec. Sec. 1320.7(f),
1320.12, 1320.13, and 1320.14 of 5 CFR part 1320 (OMB regulations
implementing the Paperwork Reduction Act), for the display of control
numbers assigned by OMB to collections of information in Internal
Revenue Service regulations. This part does not display control numbers
assigned by the Office of Management and Budget to collections of
information of the Bureau of Alcohol, Tobacco, and Firearms.
(b) Display.
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control
No.
------------------------------------------------------------------------
1.1(h)-1(e)................................................ 1545-1654
1.23-5..................................................... 1545-0074
1.25-1T.................................................... 1545-0922
1545-0930
1.25-2T.................................................... 1545-0922
1545-0930
1.25-3T.................................................... 1545-0922
1545-0930
1.25-4T.................................................... 1545-0922
1.25-5T.................................................... 1545-0922
1.25-6T.................................................... 1545-0922
1.25-7T.................................................... 1545-0922
1.25-8T.................................................... 1545-0922
1.25A-1.................................................... 1545-1630
1.28-1..................................................... 1545-0619
1.31-2..................................................... 1545-0074
1.32-2..................................................... 1545-0074
1.32-3..................................................... 1545-1575
1.36B-5.................................................... 1545-2232
1.37-1..................................................... 1545-0074
1.37-3..................................................... 1545-0074
1.41-2..................................................... 1545-0619
1.41-3..................................................... 1545-0619
1.41-4A.................................................... 1545-0074
1.41-4 (b) and (c)......................................... 1545-0074
1.41-8(b).................................................. 1545-1625
1.41-8(d).................................................. 1545-0732
1.41-9..................................................... 1545-0619
1.42-1T.................................................... 1545-0984
1545-0988
1.42-2..................................................... 1545-1005
1.42-5..................................................... 1545-1357
1.42-6..................................................... 1545-1102
1.42-8..................................................... 1545-1102
1.42-10.................................................... 1545-1102
1.42-13.................................................... 1545-1357
1.42-14.................................................... 1545-1423
1.42-17.................................................... 1545-1357
1.42-18.................................................... 1545-2088
1.43-3(a)(3)............................................... 1545-1292
1.43-3(b)(3)............................................... 1545-1292
1.44B-1.................................................... 1545-0219
1.45D-1.................................................... 1545-1765
1.45G-1.................................................... 1545-2031
1.46-1..................................................... 1545-0123
1545-0155
1.46-3..................................................... 1545-0155
1.46-4..................................................... 1545-0155
1.46-5..................................................... 1545-0155
1.46-6..................................................... 1545-0155
1.46-8..................................................... 1545-0155
1.46-9..................................................... 1545-0155
1.46-10.................................................... 1545-0118
1.46-11.................................................... 1545-0155
1.47-1..................................................... 1545-0155
1545-0166
1.47-3..................................................... 1545-0155
1545-0166
1.47-4..................................................... 1545-0123
1.47-5..................................................... 1545-0092
1.47-6..................................................... 1545-0099
1.48-3..................................................... 1545-0155
1.48-4..................................................... 1545-0155
1545-0808
1.48-5..................................................... 1545-0155
1.48-6..................................................... 1545-0155
1.48-12.................................................... 1545-0155
1545-1783
1.50A-1.................................................... 1545-0895
1.50A-2.................................................... 1545-0895
1.50A-3.................................................... 1545-0895
1.50A-4.................................................... 1545-0895
1.50A-5.................................................... 1545-0895
1.50A-6.................................................... 1545-0895
1.50A-7.................................................... 1545-0895
1.50B-1.................................................... 1545-0895
1.50B-2.................................................... 1545-0895
1.50B-3.................................................... 1545-0895
[[Page 648]]
1.50B-4.................................................... 1545-0895
1.50B-5.................................................... 1545-0895
1.51-1..................................................... 1545-0219
1545-0241
1545-0244
1545-0797
1.52-2..................................................... 1545-0219
1.52-3..................................................... 1545-0219
1.56-1..................................................... 1545-0123
1.56(g)-1.................................................. 1545-1233
1.56A-1.................................................... 1545-0227
1.56A-2.................................................... 1545-0227
1.56A-3.................................................... 1545-0227
1.56A-4.................................................... 1545-0227
1.56A-5.................................................... 1545-0227
1.57-5..................................................... 1545-0227
1.58-1..................................................... 1545-0175
1.58-9(c)(5)(iii)(B)....................................... 1545-1093
1.58-9(e)(3)............................................... 1545-1093
1.59-1..................................................... 1545-1903
1.61-2..................................................... 1545-0771
1.61-2T.................................................... 1545-0771
1.61-4..................................................... 1545-0187
1.61-15.................................................... 1545-0074
1.62-2..................................................... 1545-1148
1.63-1..................................................... 1545-0074
1.66-4..................................................... 1545-1770
1.67-2T.................................................... 1545-0110
1.67-3..................................................... 1545-1018
1.67-3T.................................................... 1545-0118
1.71-1T.................................................... 1545-0074
1.72-4..................................................... 1545-0074
1.72-6..................................................... 1545-0074
1.72-9..................................................... 1545-0074
1.72-17.................................................... 1545-0074
1.72-17A................................................... 1545-0074
1.72-18.................................................... 1545-0074
1.74-1..................................................... 1545-1100
1.79-2..................................................... 1545-0074
1.79-3..................................................... 1545-0074
1.83-2..................................................... 1545-0074
1.83-5..................................................... 1545-0074
1.83-6..................................................... 1545-1448
1.103-10................................................... 1545-0123
1545-0940
1.103-15AT................................................. 1545-0720
1.103-18................................................... 1545-1226
1.103(n)-2T................................................ 1545-0874
1.103(n)-4T................................................ 1545-0874
1.103A-2................................................... 1545-0720
1.105-4.................................................... 1545-0074
1.105-5.................................................... 1545-0074
1.105-6.................................................... 1545-0074
1.108-4.................................................... 1545-1539
1.108-5.................................................... 1545-1421
1.108-7.................................................... 1545-2155
1.108(i)-1................................................. 1545-2147
1.108(i)-2................................................. 1545-2147
1.110-1.................................................... 1545-1661
1.117-5.................................................... 1545-0869
1.118-2.................................................... 1545-1639
1.119-1.................................................... 1545-0067
1.120-3.................................................... 1545-0057
1.121-1.................................................... 1545-0072
1.121-2.................................................... 1545-0072
1.121-3.................................................... 1545-0072
1.121-4.................................................... 1545-0072
1545-0091
1.121-5.................................................... 1545-0072
1.127-2.................................................... 1545-0768
1.132-1T................................................... 1545-0771
1.132-2.................................................... 1545-0771
1.132-2T................................................... 1545-0771
1.132-5.................................................... 1545-0771
1.132-5T................................................... 1545-0771
1545-1098
1.132-9(b)................................................. 1545-1676
1.141-1.................................................... 1545-1451
1.141-12................................................... 1545-1451
1.142-2.................................................... 1545-1451
1.142(f)(4)-1.............................................. 1545-1730
1.148-0.................................................... 1545-1098
1.148-1.................................................... 1545-1098
1.148-2.................................................... 1545-1098
1545-1347
1.148-3.................................................... 1545-1098
1545-1347
1.148-4.................................................... 1545-1098
1545-1347
1.148-5.................................................... 1545-1098
1545-1490
1.148-6.................................................... 1545-1098
1545-1451
1.148-7.................................................... 1545-1098
1545-1347
1.148-8.................................................... 1545-1098
1.148-11................................................... 1545-1098
1545-1347
1.149(e)-1................................................. 1545-0720
1.150-1.................................................... 1545-1347
1.151-1.................................................... 1545-0074
1.152-3.................................................... 1545-0071
1545-1783
1.152-4.................................................... 1545-0074
1.152-4T................................................... 1545-0074
1.162-1.................................................... 1545-0139
1.162-2.................................................... 1545-0139
1.162-3.................................................... 1545-0139
1.162-4.................................................... 1545-0139
1.162-5.................................................... 1545-0139
1.162-6.................................................... 1545-0139
1.162-7.................................................... 1545-0139
1.162-8.................................................... 1545-0139
1.162-9.................................................... 1545-0139
1.162-10................................................... 1545-0139
1.162-11................................................... 1545-0139
1.162-12................................................... 1545-0139
1.162-13................................................... 1545-0139
1.162-14................................................... 1545-0139
1.162-15................................................... 1545-0139
1.162-16................................................... 1545-0139
1.162-17................................................... 1545-0139
1.162-18................................................... 1545-0139
1.162-19................................................... 1545-0139
1.162-20................................................... 1545-0139
1.162-24................................................... 1545-2115
1.162-27................................................... 1545-1466
1.163-5.................................................... 1545-0786
1545-1132
1.163-8T................................................... 1545-0995
1.163-10T.................................................. 1545-0074
1.163-13................................................... 1545-1491
1.163(d)-1................................................. 1545-1421
1.165-1.................................................... 1545-0177
1.165-2.................................................... 1545-0177
1.165-3.................................................... 1545-0177
1.165-4.................................................... 1545-0177
1.165-5.................................................... 1545-0177
1.165-6.................................................... 1545-0177
1.165-7.................................................... 1545-0177
1.165-8.................................................... 1545-0177
1.165-9.................................................... 1545-0177
1.165-10................................................... 1545-0177
1.165-11................................................... 1545-0074
[[Page 649]]
1545-0177
1545-0786
1.165-12................................................... 1545-0786
1.166-1.................................................... 1545-0123
1.166-2.................................................... 1545-1254
1.166-4.................................................... 1545-0123
1.166-10................................................... 1545-0123
1.167(a)-5T................................................ 1545-1021
1.167(a)-7................................................. 1545-0172
1.167(a)-11................................................ 1545-0152
1545-0172
1.167(a)-12................................................ 1545-0172
1.167(d)-1................................................. 1545-0172
1.167(e)-1................................................. 1545-0172
1.167(f)-11................................................ 1545-0172
1.167(l)-1................................................. 1545-0172
1.168(d)-1................................................. 1545-1146
1.168(f)(8)-1T............................................. 1545-0923
1.168(i)-1................................................. 1545-1331
1.168-5.................................................... 1545-0172
1.169-4.................................................... 1545-0172
1.170-1.................................................... 1545-0074
1.170-2.................................................... 1545-0074
1.170-3.................................................... 1545-0123
1.170A-1................................................... 1545-0074
1.170A-2................................................... 1545-0074
1.170A-4(A)(b)............................................. 1545-0123
1.170A-8................................................... 1545-0074
1.170A-9................................................... 1545-0052
1545-0074
1.170A-11.................................................. 1545-0074
1545-0123
1545-1868
1.170A-12.................................................. 1545-0020
1545-0074
1.170A-13.................................................. 1545-0074
1545-0754
1545-0908
1545-1431
1.170A-13(f)............................................... 1545-1464
1.170A-14.................................................. 1545-0763
1.171-4.................................................... 1545-1491
1.171-5.................................................... 1545-1491
1.172-1.................................................... 1545-0172
1.172-13................................................... 1545-0863
1.173-1.................................................... 1545-0172
1.174-3.................................................... 1545-0152
1.174-4.................................................... 1545-0152
1.175-3.................................................... 1545-0187
1.175-6.................................................... 1545-0152
1.177-1.................................................... 1545-0172
1.179-2.................................................... 1545-1201
1.179-3.................................................... 1545-1201
1.179-5.................................................... 1545-0172
1545-1201
1.179B-1T.................................................. 1545-2076
1.179C-1................................................... 1545-2103
1.179C-1T.................................................. 1545-2103
1.180-2.................................................... 1545-0074
1.181-1.................................................... 1545-2059
1.181-2.................................................... 1545-2059
1.181-3.................................................... 1545-2059
1.182-6.................................................... 1545-0074
1.183-1.................................................... 1545-0195
1.183-2.................................................... 1545-0195
1.183-3.................................................... 1545-0195
1.183-4.................................................... 1545-0195
1.190-3.................................................... 1545-0074
1.194-2.................................................... 1545-0735
1.194-4.................................................... 1545-0735
1.195-1.................................................... 1545-1582
1.197-1T................................................... 1545-1425
1.197-2.................................................... 1545-1671
1.199-6.................................................... 1545-1966
1.213-1.................................................... 1545-0074
1.215-1T................................................... 1545-0074
1.217-2.................................................... 1545-0182
1.243-3.................................................... 1545-0123
1.243-4.................................................... 1545-0123
1.243-5.................................................... 1545-0123
1.248-1.................................................... 1545-0172
1.261-1.................................................... 1545-1041
1.263(a)-1................................................. 1545-2248
1.263(a)-3................................................. 1545-2248
1.263(a)-5................................................. 1545-1870
1.263(e)-1................................................. 1545-0123
1.263A-1................................................... 1545-0987
1.263A-1T.................................................. 1545-0187
1.263A-2................................................... 1545-0987
1.263A-3................................................... 1545-0987
1.263A-8(b)(2)(iii)........................................ 1545-1265
1.263A-9(d)(1)............................................. 1545-1265
1.263A-9(f)(1)(ii)......................................... 1545-1265
1.263A-9(f)(2)(iv)......................................... 1545-1265
1.263A-9(g)(2)(iv)(C)...................................... 1545-1265
1.263A-9(g)(3)(iv)......................................... 1545-1265
1.265-1.................................................... 1545-0074
1.265-2.................................................... 1545-0123
1.266-1.................................................... 1545-0123
1.267(f)-1................................................. 1545-0885
1.268-1.................................................... 1545-0184
1.274-1.................................................... 1545-0139
1.274-2.................................................... 1545-0139
1.274-3.................................................... 1545-0139
1.274-4.................................................... 1545-0139
1.274-5.................................................... 1545-0771
1.274-5A................................................... 1545-0139
1545-0771
1.274-5T................................................... 1545-0074
1545-0172
1545-0771
1.274-6.................................................... 1545-0139
1545-0771
1.274-6T................................................... 1545-0074
1545-0771
1.274-7.................................................... 1545-0139
1.274-8.................................................... 1545-0139
1.279-6.................................................... 1545-0123
1.280C-4................................................... 1545-1155
1.280F-3T.................................................. 1545-0074
1.280G-1................................................... 1545-1851
1.281-4.................................................... 1545-0123
1.302-4.................................................... 1545-0074
1.305-3.................................................... 1545-0123
1.305-5.................................................... 1545-1438
1.307-2.................................................... 1545-0074
1.312-15................................................... 1545-0172
1.316-1.................................................... 1545-0123
1.331-1.................................................... 1545-0074
1.332-4.................................................... 1545-0123
1.332-6.................................................... 1545-2019
1.336-2.................................................... 1545-2125
1.336-4.................................................... 1545-2125
1.337(d)-1................................................. 1545-1160
1.337(d)-2................................................. 1545-1160
1545-1774
1.337(d)-4................................................. 1545-1633
1.337(d)-5................................................. 1545-1672
1.337(d)-6................................................. 1545-1672
1.337(d)-7................................................. 1545-1672
1.338-2.................................................... 1545-1658
1.338-5.................................................... 1545-1658
1.338-10................................................... 1545-1658
1.338-11................................................... 1545-1990
[[Page 650]]
1.338(h)(10)-1............................................. 1545-1658
1.338(i)-1................................................. 1545-1990
1.341-7.................................................... 1545-0123
1.351-3.................................................... 1545-2019
1.355-5.................................................... 1545-2019
1.362-2.................................................... 1545-0123
1.362-4.................................................... 1545-2247
1.367(a)-1T................................................ 1545-0026
1.367(a)-2T................................................ 1545-0026
1.367(a)-3................................................. 1545-0026
1545-1478
1.367(a)-3T................................................ 1545-2183
1.367(a)-6T................................................ 1545-0026
1.367(a)-7................................................. 1545-2183
1.367(a)-7T................................................ 1545-2183
1.367(a)-8................................................. 1545-1271
1545-2056
1545-2183
1.367(b)-1................................................. 1545-1271
1.367(b)-3T................................................ 1545-1666
1.367(d)-1T................................................ 1545-0026
1.367(e)-1................................................. 1545-1487
1.367(e)-2................................................. 1545-1487
1.368-1.................................................... 1545-1691
1.368-3.................................................... 1545-2019
1.371-1.................................................... 1545-0123
1.371-2.................................................... 1545-0123
1.374-3.................................................... 1545-0123
1.381(b)-1................................................. 1545-0123
1.381(c)(4)-1.............................................. 1545-0123
1545-0152
1545-0879
1.381(c)(5)-1.............................................. 1545-0123
1545-0152
1.381(c)(6)-1.............................................. 1545-0123
1545-0152
1.381(c)(8)-1.............................................. 1545-0123
1.381(c)(10)-1............................................. 1545-0123
1.381(c)(11)-1(k).......................................... 1545-0123
1.381(c)(13)-1............................................. 1545-0123
1.381(c)(17)-1............................................. 1545-0045
1.381(c)(22)-1............................................. 1545-1990
1.381(c)(25)-1............................................. 1545-0045
1.382-1T................................................... 1545-0123
1.382-2.................................................... 1545-0123
1.382-2T................................................... 1545-0123
1.382-3.................................................... 1545-1281
1545-1345
1.382-4.................................................... 1545-1120
1.382-6.................................................... 1545-1381
1.382-8.................................................... 1545-1434
1.382-9.................................................... 1545-1120
1545-1260
1545-1275
1545-1324
1.382-11................................................... 1545-2019
1.382-91................................................... 1545-1260
1545-1324
1.383-1.................................................... 1545-0074
1545-1120
1.401-1.................................................... 1545-0020
1545-0197
1545-0200
1545-0534
1545-0710
1.401(a)-11................................................ 1545-0710
1.401(a)-20................................................ 1545-0928
1.401(a)-31................................................ 1545-1341
1.401(a)-50................................................ 1545-0710
1.401(a)(9)-1.............................................. 1545-1573
1.401(a)(9)-3.............................................. 1545-1466
1.401(a)(9)-4.............................................. 1545-1573
1.401(a)(9)-6.............................................. 1545-2234
1.401(a)(31)-1............................................. 1545-1341
1.401(b)-1................................................. 1545-0197
1.401(f)-1................................................. 1545-0710
1.401(k)-1................................................. 1545-1039
1545-1069
1545-1669
1545-1930
1.401(k)-2................................................. 1545-1669
1.401(k)-3................................................. 1545-1669
1.401(k)-4................................................. 1545-1669
1.401(m)-3................................................. 1545-1699
1.401-12(n)................................................ 1545-0806
1.401-14................................................... 1545-0710
1.402(c)-2................................................. 1545-1341
1.402(f)-1................................................. 1545-1341
1545-1632
1.402A-1................................................... 1545-1992
1.403(b)-1................................................. 1545-0710
1.403(b)-3................................................. 1545-0996
1.403(b)-7................................................. 1545-1341
1.403(b)-10................................................ 1545-2068
1.404(a)-4................................................. 1545-0710
1.404(a)-12................................................ 1545-0710
1.404A-2................................................... 1545-0123
1.404A-6................................................... 1545-0123
1.408-2.................................................... 1545-0390
1.408-5.................................................... 1545-0747
1.408-6.................................................... 1545-0203
1545-0390
1.408-7.................................................... 1545-0119
1.408(q)-1................................................. 1545-1841
1.408A-2................................................... 1545-1616
1.408A-4................................................... 1545-1616
1.408A-5................................................... 1545-1616
1.408A-7................................................... 1545-1616
1.410(a)-2................................................. 1545-0710
1.410(d)-1................................................. 1545-0710
1.411(a)-11................................................ 1545-1471
1545-1632
1.411(d)-4................................................. 1545-1545
1.411(d)-6................................................. 1545-1477
1.412(b)-5................................................. 1545-0710
1.412(c)(1)-2.............................................. 1545-0710
1.412(c)(2)-1.............................................. 1545-0710
1.412(c)(3)-2.............................................. 1545-0710
1.414(c)-5................................................. 1545-0797
1.414(r)-1................................................. 1545-1221
1.415-2.................................................... 1545-0710
1.415-6.................................................... 1545-0710
1.417(a)(3)-1.............................................. 1545-0928
1.417(e)-1................................................. 1545-1471
1545-1724
1.417(e)-1T................................................ 1545-1471
1.419A(f)(6)-1............................................. 1545-1795
1.422-1.................................................... 1545-0820
1.430(f)-1................................................. 1545-2095
1.430(g)-1................................................. 1545-2095
1.430(h)(2)-1.............................................. 1545-2095
1.436-1.................................................... 1545-2095
1.441-2.................................................... 1545-1748
1.442-1.................................................... 1545-0074
1545-0123
1545-0134
1545-0152
1545-0820
1545-1748
1.443-1.................................................... 1545-0123
1.444-3T................................................... 1545-1036
1.444-4.................................................... 1545-1591
1.446-1.................................................... 1545-0074
1545-0152
[[Page 651]]
1.446-4(d)................................................. 1545-1412
1.448-1(g)................................................. 1545-0152
1.448-1(h)................................................. 1545-0152
1.448-1(i)................................................. 1545-0152
1.448-2.................................................... 1545-1855
1.448-2T................................................... 1545-0152
1545-1855
1.451-1.................................................... 1545-0091
1.451-4.................................................... 1545-0123
1.451-5.................................................... 1545-0074
1.451-6.................................................... 1545-0074
1.451-7.................................................... 1545-0074
1.453-1.................................................... 1545-0152
1.453-2.................................................... 1545-0152
1.453-8.................................................... 1545-0152
1545-0228
1.453-10................................................... 1545-0152
1.453A-1................................................... 1545-0152
1545-1134
1.453A-2................................................... 1545-0152
1545-1134
1.453A-3................................................... 1545-0963
1.454-1.................................................... 1545-0074
1.455-2.................................................... 1545-0152
1.455-6.................................................... 1545-0123
1.456-2.................................................... 1545-0123
1.456-6.................................................... 1545-0123
1.456-7.................................................... 1545-0123
1.457-8.................................................... 1545-1580
1.458-1.................................................... 1545-0879
1.458-2.................................................... 1545-0152
1.460-1.................................................... 1545-1650
1.460-6.................................................... 1545-1031
1545-1572
1545-1732
1.461-1.................................................... 1545-0074
1.461-2.................................................... 1545-0096
1.461-4.................................................... 1545-0917
1.461-5.................................................... 1545-0917
1.463-1T................................................... 1545-0916
1.465-1T................................................... 1545-0712
1.466-1T................................................... 1545-0152
1.466-4.................................................... 1545-0152
1.468A-3................................................... 1545-1269
1545-1378
1545-1511
1.468A-3(h), 1.468A-7, and 1.468A-8(d)..................... 1545-2091
1.468A-4................................................... 1545-0954
1.468A-7................................................... 1545-0954
1545-1511
1.468A-8................................................... 1545-1269
1.468B-1................................................... 1545-1631
1.468B-1(j)................................................ 1545-1299
1.468B-2(k)................................................ 1545-1299
1.468B-2(l)................................................ 1545-1299
1.468B-3(b)................................................ 1545-1299
1.468B-3(e)................................................ 1545-1299
1.468B-5(b)................................................ 1545-1299
1.468B-9................................................... 1545-1631
1.469-1.................................................... 1545-1008
1.469-2T................................................... 1545-0712
1545-1091
1.469-4T................................................... 1545-0985
1545-1037
1.469-7.................................................... 1545-1244
1.471-2.................................................... 1545-0123
1.471-5.................................................... 1545-0123
1.471-6.................................................... 1545-0123
1.471-8.................................................... 1545-0123
1.471-11................................................... 1545-0123
1545-0152
1.472-1.................................................... 1545-0042
1545-0152
1.472-2.................................................... 1545-0152
1.472-3.................................................... 1545-0042
1.472-5.................................................... 1545-0152
1.472-8.................................................... 1545-0028
1545-0042
1545-1767
1.475(a)-4................................................. 1545-1945
1.475(b)-4................................................. 1545-1496
1.481-4.................................................... 1545-0152
1.481-5.................................................... 1545-0152
1.482-1.................................................... 1545-1364
1.482-4.................................................... 1545-1364
1.482-7.................................................... 1545-1364
1545-1794
1.482-9(b)................................................. 1545-2149
1.501(a)-1................................................. 1545-0056
1545-0057
1.501(c)(3)-1.............................................. 1545-0056
1.501(c)(9)-5.............................................. 1545-0047
1.501(c)(17)-3............................................. 1545-0047
1.501(e)-1................................................. 1545-0814
1.501(r)-3................................................. 1545-0047
1.501(r)-4................................................. 1545-0047
1.501(r)-6................................................. 1545-0047
1.503(c)-1................................................. 1545-0047
1545-0052
1.505(c)-1T................................................ 1545-0916
1.507-1.................................................... 1545-0052
1.507-2.................................................... 1545-0052
1.508-1.................................................... 1545-0052
1545-0056
1.509(a)-3................................................. 1545-0047
1.509(a)-4................................................. 1545-2157
1.509(a)-5................................................. 1545-0047
1.509(c)-1................................................. 1545-0052
1.512(a)-1................................................. 1545-0687
1.512(a)-4................................................. 1545-0047
1545-0687
1.521-1.................................................... 1545-0051
1545-0058
1.527-2.................................................... 1545-0129
1.527-5.................................................... 1545-0129
1.527-6.................................................... 1545-0129
1.527-9.................................................... 1545-0129
1.528-8.................................................... 1545-0127
1.533-2.................................................... 1545-0123
1.534-2.................................................... 1545-0123
1.542-3.................................................... 1545-0123
1.545-2.................................................... 1545-0123
1.545-3.................................................... 1545-0123
1.547-2.................................................... 1545-0045
1545-0123
1.547-3.................................................... 1545-0123
1.551-4.................................................... 1545-0074
1.552-3.................................................... 1545-0099
1.552-4.................................................... 1545-0099
1.552-5.................................................... 1545-0099
1.556-2.................................................... 1545-0704
1.561-1.................................................... 1545-0044
1.561-2.................................................... 1545-0123
1.562-3.................................................... 1545-0123
1.563-2.................................................... 1545-0123
1.564-1.................................................... 1545-0123
1.565-1.................................................... 1545-0043
1545-0123
1.565-2.................................................... 1545-0043
1.565-3.................................................... 1545-0043
1.565-5.................................................... 1545-0043
1.565-6.................................................... 1545-0043
1.585-1.................................................... 1545-0123
1.585-3.................................................... 1545-0123
[[Page 652]]
1.585-8.................................................... 1545-1290
1.586-2.................................................... 1545-0123
1.593-1.................................................... 1545-0123
1.593-6.................................................... 1545-0123
1.593-6A................................................... 1545-0123
1.593-7.................................................... 1545-0123
1.595-1.................................................... 1545-0123
1.597-2.................................................... 1545-1300
1.597-4.................................................... 1545-1300
1.597-6.................................................... 1545-1300
1.597-7.................................................... 1545-1300
1.611-2.................................................... 1545-0099
1.611-3.................................................... 1545-0007
1545-0099
1545-1784
1.612-4.................................................... 1545-0074
1.612-5.................................................... 1545-0099
1.613-3.................................................... 1545-0099
1.613-4.................................................... 1545-0099
1.613-6.................................................... 1545-0099
1.613-7.................................................... 1545-0099
1.613A-3................................................... 1545-0919
1.613A-3(e)................................................ 1545-1251
1.613A-3(l)................................................ 1545-0919
1.613A-5................................................... 1545-0099
1.613A-6................................................... 1545-0099
1.614-2.................................................... 1545-0099
1.614-3.................................................... 1545-0099
1.614-5.................................................... 1545-0099
1.614-6.................................................... 1545-0099
1.614-8.................................................... 1545-0099
1.617-1.................................................... 1545-0099
1.617-3.................................................... 1545-0099
1.617-4.................................................... 1545-0099
1.631-1.................................................... 1545-0007
1.631-2.................................................... 1545-0007
1.641(b)-2................................................. 1545-0092
1.642(c)-1................................................. 1545-0092
1.642(c)-2................................................. 1545-0092
1.642(c)-5................................................. 1545-0074
1.642(c)-6................................................. 1545-0020
1545-0074
1545-0092
1.642(g)-1................................................. 1545-0092
1.642(i)-1................................................. 1545-0092
1.645-1.................................................... 1545-1578
1.663(b)-2................................................. 1545-0092
1.664-1.................................................... 1545-0196
1.664-1(a)(7).............................................. 1545-1536
1.664-1(c)................................................. 1545-2101
1.664-2.................................................... 1545-0196
1.664-3.................................................... 1545-0196
1.664-4.................................................... 1545-0020
1545-0196
1.665(a)-0A through
1.665(g)-2A................................................ 1545-0192
1.666(d)-1A................................................ 1545-0092
1.671-4.................................................... 1545-1442
1.671-5.................................................... 1545-1540
1.701-1.................................................... 1545-0099
1.702-1.................................................... 1545-0074
1.703-1.................................................... 1545-0099
1.704-2.................................................... 1545-1090
1.706-1.................................................... 1545-0074
1545-0099
1545-0134
1.706-1T................................................... 1545-0099
1.707-3(c)(2).............................................. 1545-1243
1.707-5(a)(7)(ii).......................................... 1545-1243
1.707-6(c)................................................. 1545-1243
1.707-8.................................................... 1545-1243
1.708-1.................................................... 1545-0099
1.732-1.................................................... 1545-0099
1545-1588
1.736-1.................................................... 1545-0074
1.743-1.................................................... 1545-0074
1545-1588
1.751-1.................................................... 1545-0074
1545-0099
1545-0941
1.752-2.................................................... 1545-1905
1.752-5.................................................... 1545-1090
1.752-7.................................................... 1545-1843
1.754-1.................................................... 1545-0099
1.755-1.................................................... 1545-0099
1.761-2.................................................... 1545-1338
1.801-1.................................................... 1545-0123
1545-0128
1.801-3.................................................... 1545-0123
1.801-5.................................................... 1545-0128
1.801-8.................................................... 1545-0128
1.804-4.................................................... 1545-0128
1.811-2.................................................... 1545-0128
1.812-2.................................................... 1545-0128
1.815-6.................................................... 1545-0128
1.818-4.................................................... 1545-0128
1.818-5.................................................... 1545-0128
1.818-8.................................................... 1545-0128
1.819-2.................................................... 1545-0128
1.821-1.................................................... 1545-1027
1.821-3.................................................... 1545-1027
1.821-4.................................................... 1545-1027
1.822-5.................................................... 1545-1027
1.822-6.................................................... 1545-1027
1.822-8.................................................... 1545-1027
1.822-9.................................................... 1545-1027
1.823-2.................................................... 1545-1027
1.823-5.................................................... 1545-1027
1.823-6.................................................... 1545-1027
1.825-1.................................................... 1545-1027
1.826-1.................................................... 1545-1027
1.826-2.................................................... 1545-1027
1.826-3.................................................... 1545-1027
1.826-4.................................................... 1545-1027
1.826-6.................................................... 1545-1027
1.831-3.................................................... 1545-0123
1.831-4.................................................... 1545-0123
1.832-4.................................................... 1545-1227
1.832-5.................................................... 1545-0123
1.848-2(g)(8).............................................. 1545-1287
1.848-2(h)(3).............................................. 1545-1287
1.848-2(i)(4).............................................. 1545-1287
1.851-2.................................................... 1545-1010
1.851-4.................................................... 1545-0123
1.852-1.................................................... 1545-0123
1.852-4.................................................... 1545-0123
1545-0145
1.852-6.................................................... 1545-0123
1545-0144
1.852-7.................................................... 1545-0074
1.852-9.................................................... 1545-0074
1545-0123
1545-0144
1545-0145
1545-1783
1.852-11................................................... 1545-1094
1.853-3.................................................... 1545-2035
1.853-4.................................................... 1545-2035
1.854-2.................................................... 1545-0123
1.855-1.................................................... 1545-0123
1.856-2.................................................... 1545-0123
1545-1004
1.856-6.................................................... 1545-0123
1.856-7.................................................... 1545-0123
[[Page 653]]
1.856-8.................................................... 1545-0123
1.857-8.................................................... 1545-0123
1.857-9.................................................... 1545-0074
1.858-1.................................................... 1545-0123
1.860-2.................................................... 1545-0045
1.860-4.................................................... 1545-0045
1545-1054
1545-1057
1.860E-1................................................... 1545-1675
1.860E-2(a)(5)............................................. 1545-1276
1.860E-2(a)(7)............................................. 1545-1276
1.860E-2(b)(2)............................................. 1545-1276
1.860G-2................................................... 1545-2110
1.861-2.................................................... 1545-0089
1.861-3.................................................... 1545-0089
1.861-4.................................................... 1545-1900
1.861-8.................................................... 1545-0126
1.861-8(e)(6) and (g)...................................... 1545-1224
1.861-9T................................................... 1545-0121
1545-1072
1.861-18................................................... 1545-1594
1.863-1.................................................... 1545-1476
1.863-3.................................................... 1545-1476
1545-1556
1.863-3A................................................... 1545-0126
1.863-4.................................................... 1545-0126
1.863-7.................................................... 1545-0132
1.863-8.................................................... 1545-1718
1.863-9.................................................... 1545-1718
1.864-4.................................................... 1545-0126
1.871-1.................................................... 1545-0096
1.871-6.................................................... 1545-0795
1.871-7.................................................... 1545-0089
1.871-10................................................... 1545-0089
1545-0165
1.874-1.................................................... 1545-0089
1.881-4.................................................... 1545-1440
1.882-4.................................................... 1545-0126
1.883-0.................................................... 1545-1677
1.883-1.................................................... 1545-1677
1.883-2.................................................... 1545-1677
1.883-3.................................................... 1545-1677
1.883-4.................................................... 1545-1677
1.883-5.................................................... 1545-1677
1.884-0.................................................... 1545-1070
1.884-1.................................................... 1545-1070
1.884-2.................................................... 1545-1070
1.884-2T................................................... 1545-0126
1545-1070
1.884-4.................................................... 1545-1070
1.884-5.................................................... 1545-1070
1.892-1T................................................... 1545-1053
1.892-2T................................................... 1545-1053
1.892-3T................................................... 1545-1053
1.892-4T................................................... 1545-1053
1.892-5T................................................... 1545-1053
1.892-6T................................................... 1545-1053
1.892-7T................................................... 1545-1053
1.897-2.................................................... 1545-0123
1545-0902
1.897-3.................................................... 1545-0123
1.897-5T................................................... 1545-0902
1.897-6T................................................... 1545-0902
1.901-2.................................................... 1545-0746
1.901-2A................................................... 1545-0746
1.901-3.................................................... 1545-0122
1.902-1.................................................... 1545-0122
1545-1458
1.904-1.................................................... 1545-0121
1545-0122
1.904-2.................................................... 1545-0121
1545-0122
1.904-3.................................................... 1545-0121
1.904-4.................................................... 1545-0121
1.904-5.................................................... 1545-0121
1.904-7.................................................... 1545-2104
1.904-7T................................................... 1545-2104
1.904(f)-1................................................. 1545-0121
1545-0122
1.904(f)-2................................................. 1545-0121
1.904(f)-3................................................. 1545-0121
1.904(f)-4................................................. 1545-0121
1.904(f)-5................................................. 1545-0121
1.904(f)-6................................................. 1545-0121
1.904(f)-7................................................. 1545-1127
1.905-2.................................................... 1545-0122
1.905-3T................................................... 1545-1056
1.905-4T................................................... 1545-1056
1.905-5T................................................... 1545-1056
1.911-1.................................................... 1545-0067
1545-0070
1.911-2.................................................... 1545-0067
1545-0070
1.911-3.................................................... 1545-0067
1545-0070
1.911-4.................................................... 1545-0067
1545-0070
1.911-5.................................................... 1545-0067
1545-0070
1.911-6.................................................... 1545-0067
1545-0070
1.911-7.................................................... 1545-0067
1545-0070
1.913-13................................................... 1545-0067
1.921-1T................................................... 1545-0190
1545-0884
1545-0935
1545-0939
1.921-2.................................................... 1545-0884
1.921-3T................................................... 1545-0935
1.923-1T................................................... 1545-0935
1.924(a)-1T................................................ 1545-0935
1.925(a)-1T................................................ 1545-0935
1.925(b)-1T................................................ 1545-0935
1.926(a)-1T................................................ 1545-0935
1.927(a)-1T................................................ 1545-0935
1.927(b)-1T................................................ 1545-0935
1.927(d)-1................................................. 1545-0884
1.927(d)-2T................................................ 1545-0935
1.927(e)-1T................................................ 1545-0935
1.927(e)-2T................................................ 1545-0935
1.927(f)-1................................................. 1545-0884
1.931-1.................................................... 1545-0074
1545-0123
1.934-1.................................................... 1545-0782
1.935-1.................................................... 1545-0074
1545-0087
1545-0803
1.936-1.................................................... 1545-0215
1545-0217
1.936-4.................................................... 1545-0215
1.936-5.................................................... 1545-0704
1.936-6.................................................... 1545-0215
1.936-7.................................................... 1545-0215
1.936-10(c)................................................ 1545-1138
1.937-1.................................................... 1545-1930
1.952-2.................................................... 1545-0126
1.953-2.................................................... 1545-0126
1.954-1.................................................... 1545-1068
1.954-2.................................................... 1545-1068
1.955-2.................................................... 1545-0123
1.955-3.................................................... 1545-0123
1.955A-2................................................... 1545-0755
1.955A-3................................................... 1545-0755
[[Page 654]]
1.956-1.................................................... 1545-0704
1.956-2.................................................... 1545-0704
1.959-1.................................................... 1545-0704
1.959-2.................................................... 1545-0704
1.960-1.................................................... 1545-0122
1.962-2.................................................... 1545-0704
1.962-3.................................................... 1545-0704
1.962-4.................................................... 1545-0704
1.964-1.................................................... 1545-0126
1545-0704
1545-1072
1545-2104
1.964-3.................................................... 1545-0126
1.970-2.................................................... 1545-0126
1.985-2.................................................... 1545-1051
1545-1131
1.985-3.................................................... 1545-1051
1.988-0.................................................... 1545-1131
1.988-1.................................................... 1545-1131
1.988-2.................................................... 1545-1131
1.988-3.................................................... 1545-1131
1.988-4.................................................... 1545-1131
1.988-5.................................................... 1545-1131
1.988-6.................................................... 1545-1831
1.992-1.................................................... 1545-0190
1545-0938
1.992-2.................................................... 1545-0190
1545-0884
1545-0938
1.992-3.................................................... 1545-0190
1545-0938
1.992-4.................................................... 1545-0190
1545-0938
1.993-3.................................................... 1545-0938
1.993-4.................................................... 1545-0938
1.994-1.................................................... 1545-0938
1.995-5.................................................... 1545-0938
1.1001-1................................................... 1545-1902
1.1012-1................................................... 1545-0074
1545-1139
1.1014-4................................................... 1545-0184
1.1015-1................................................... 1545-0020
1.1017-1................................................... 1545-1539
1.1031(d)-1T............................................... 1545-1021
1.1033(a)-2................................................ 1545-0184
1.1033(g)-1................................................ 1545-0184
1.1034-1................................................... 1545-0072
1.1039-1................................................... 1545-0184
1.1041-1T.................................................. 1545-0074
1.1041-2................................................... 1545-1751
1.1042-1T.................................................. 1545-0916
1.1044(a)-1................................................ 1545-1421
1.1045-1................................................... 1545-1893
1.1060-1................................................... 1545-1658
1545-1990
1.1071-1................................................... 1545-0184
1.1071-4................................................... 1545-0184
1.1081-4................................................... 1545-0028
1545-0046
1545-0123
1.1081-11.................................................. 1545-2019
1.1082-1................................................... 1545-0046
1.1082-2................................................... 1545-0046
1.1082-3................................................... 1545-0046
1545-0184
1.1082-4................................................... 1545-0046
1.1082-5................................................... 1545-0046
1.1082-6................................................... 1545-0046
1.1083-1................................................... 1545-0123
1.1092(b)-1T............................................... 1545-0644
1.1092(b)-2T............................................... 1545-0644
1.1092(b)-3T............................................... 1545-0644
1.1092(b)-4T............................................... 1545-0644
1.1092(b)-5T............................................... 1545-0644
1.1211-1................................................... 1545-0074
1.1212-1................................................... 1545-0074
1.1221-2................................................... 1545-1480
1.1231-1................................................... 1545-0177
1545-0184
1.1231-2................................................... 1545-0177
1545-0184
1.1231-2................................................... 1545-0074
1.1232-3................................................... 1545-0074
1.1237-1................................................... 1545-0184
1.1239-1................................................... 1545-0091
1.1242-1................................................... 1545-0184
1.1243-1................................................... 1545-0123
1.1244(e)-1................................................ 1545-0123
1545-1447
1.1245-1................................................... 1545-0184
1.1245-2................................................... 1545-0184
1.1245-3................................................... 1545-0184
1.1245-4................................................... 1545-0184
1.1245-5................................................... 1545-0184
1.1245-6................................................... 1545-0184
1.1247-1................................................... 1545-0122
1.1247-2................................................... 1545-0122
1.1247-4................................................... 1545-0122
1.1247-5................................................... 1545-0122
1.1248-7................................................... 1545-0074
1.1248(f)-2................................................ 1545-2183
1.1248(f)-3T............................................... 1545-2183
1.1250-1................................................... 1545-0184
1.1250-2................................................... 1545-0184
1.1250-3................................................... 1545-0184
1.1250-4................................................... 1545-0184
1.1250-5................................................... 1545-0184
1.1251-1................................................... 1545-0184
1.1251-2................................................... 1545-0074
1545-0184
1.1251-3................................................... 1545-0184
1.1251-4................................................... 1545-0184
1.1252-1................................................... 1545-0184
1.1252-2................................................... 1545-0184
1.1254-1(c)(3)............................................. 1545-1352
1.1254-4................................................... 1545-1493
1.1254-5(d)(2)............................................. 1545-1352
1.1258-1................................................... 1545-1452
1.1272-3................................................... 1545-1353
1.1273-2(f)(9)............................................. 1545-1353
1.1273-2(h)(2)............................................. 1545-1353
1.1274-3(d)................................................ 1545-1353
1.1274-5(b)................................................ 1545-1353
1.1274A-1(c)............................................... 1545-1353
1.1275-2................................................... 1545-1450
1.1275-3................................................... 1545-0887
1545-1353
1545-1450
1.1275-4................................................... 1545-1450
1.1275-6................................................... 1545-1450
1.1287-1................................................... 1545-0786
1.1291-9................................................... 1545-1507
1.1291-10.................................................. 1545-1304
1545-1507
1.1294-1T.................................................. 1545-1002
1545-1028
1.1295-1................................................... 1545-1555
1.1295-3................................................... 1545-1555
1.1298-3................................................... 1545-1507
1.1301-1................................................... 1545-1662
1.1311(a)-1................................................ 1545-0074
1.1361-1................................................... 1545-0731
1545-1591
1545-2114
[[Page 655]]
1.1361-3................................................... 1545-1590
1.1361-5................................................... 1545-1590
1.1362-1................................................... 1545-1308
1.1362-2................................................... 1545-1308
1.1362-3................................................... 1545-1308
1.1362-4................................................... 1545-1308
1.1362-5................................................... 1545-1308
1.1362-6................................................... 1545-1308
1.1362-7................................................... 1545-1308
1.1362-8................................................... 1545-1590
1.1363-2................................................... 1545-1906
1.1366-1................................................... 1545-1613
1.1367-1(f)................................................ 1545-1139
1.1368-1(f)(2)............................................. 1545-1139
1.1368-1(f)(3)............................................. 1545-1139
1.1368-1(f)(4)............................................. 1545-1139
1.1368-1(g)(2)............................................. 1545-1139
1.1374-1A.................................................. 1545-0130
1.1377-1................................................... 1545-1462
1.1378-1................................................... 1545-1748
1.1383-1................................................... 1545-0074
1.1385-1................................................... 1545-0074
1545-0098
1.1388-1................................................... 1545-0118
1545-0123
1.1397E-1.................................................. 1545-1908
1.1398-1................................................... 1545-1375
1.1398-2................................................... 1545-1375
1.1402(a)-2................................................ 1545-0074
1.1402(a)-5................................................ 1545-0074
1.1402(a)-11............................................... 1545-0074
1.1402(a)-15............................................... 1545-0074
1.1402(a)-16............................................... 1545-0074
1.1402(b)-1................................................ 1545-0171
1.1402(c)-2................................................ 1545-0074
1.1402(e)(1)-1............................................. 1545-0074
1.1402(e)(2)-1............................................. 1545-0074
1.1402(e)-1A............................................... 1545-0168
1.1402(e)-2A............................................... 1545-0168
1.1402(e)-3A............................................... 1545-0168
1.1402(e)-4A............................................... 1545-0168
1.1402(e)-5A............................................... 1545-0168
1.1402(f)-1................................................ 1545-0074
1.1402(h)-1................................................ 1545-0064
1.1411-10(g)............................................... 1545-2227
1.1441-1................................................... 1545-1484
1.1441-2................................................... 1545-0795
1.1441-3................................................... 1545-0165
1545-0795
1.1441-4................................................... 1545-1484
1.1441-5................................................... 1545-0096
1545-0795
1545-1484
1.1441-6................................................... 1545-0055
1545-0795
1545-1484
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20.2010-2T................................................. 1545-0015
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26.6107-1.................................................. 1545-1231
31.3102-3.................................................. 1545-0029
1545-0059
1545-0065
31.3121(b)(19)-1........................................... 1545-0029
31.3121(d)-1............................................... 1545-0004
31.3121(i)-1............................................... 1545-0034
31.3121(k)-4............................................... 1545-0137
31.3121(r)-1............................................... 1545-0029
31.3121(s)-1............................................... 1545-0029
31.3121(v)(2)-1............................................ 1545-1643
31.3302(a)-2............................................... 1545-0028
31.3302(a)-3............................................... 1545-0028
31.3302(b)-2............................................... 1545-0028
31.3302(e)-1............................................... 1545-0028
31.3306(c)(18)-1........................................... 1545-0029
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31.3401(a)(6).............................................. 1545-1484
31.3401(a)(6)-1............................................ 1545-0029
1545-0096
1545-0795
31.3401(a)(7)-1............................................ 1545-0029
31.3401(a)(8)(A)-1 ........................................ 1545-0029
1545-0666
31.3401(a)(8)(C)-1 ........................................ 1545-0029
31.3401(a)(15)-1........................................... 1545-0182
31.3401(c)-1............................................... 1545-0004
31.3402(b)-1............................................... 1545-0010
31.3402(c)-1............................................... 1545-0010
31.3402(f)(1)-1............................................ 1545-0010
31.3402(f)(2)-1............................................ 1545-0010
1545-0410
31.3402(f)(3)-1............................................ 1545-0010
31.3402(f)(4)-1............................................ 1545-0010
31.3402(f)(4)-2............................................ 1545-0010
31.3402(f)(5)-1............................................ 1545-0010
1545-1435
31.3402(h)(1)-1............................................ 1545-0029
31.3402(h)(3)-1............................................ 1545-0010
1545-0029
31.3402(h)(4)-1............................................ 1545-0010
31.3402(i)-(1)............................................. 1545-0010
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31.3402(l)-(1)............................................. 1545-0010
31.3402(m)-(1)............................................. 1545-0010
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31.3402(o)-3............................................... 1545-0008
1545-0010
1545-0415
1545-0717
31.3402(p)-1............................................... 1545-0415
1545-0717
31.3402(q)-1............................................... 1545-0238
1545-0239
31.3404-1.................................................. 1545-0029
31.3405(c)-1............................................... 1545-1341
31.3406(a)-1............................................... 1545-0112
31.3406(a)-2............................................... 1545-0112
31.3406(a)-3............................................... 1545-0112
31.3406(a)-4............................................... 1545-0112
31.3406(b)(2)-1............................................ 1545-0112
31.3406(b)(2)-2............................................ 1545-0112
31.3406(b)(2)-3............................................ 1545-0112
31.3406(b)(2)-4............................................ 1545-0112
31.3406(b)(2)-5............................................ 1545-0112
31.3406(b)(3)-1............................................ 1545-0112
31.3406(b)(3)-2............................................ 1545-0112
31.3406(b)(3)-3............................................ 1545-0112
31.3406(b)(3)-4............................................ 1545-0112
[[Page 660]]
31.3406(b)(4)-1............................................ 1545-0112
31.3406(c)-1............................................... 1545-0112
31.3406(d)-1............................................... 1545-0112
31.3406(d)-2............................................... 1545-0112
31.3406(d)-3............................................... 1545-0112
31.3406(d)-4............................................... 1545-0112
31.3406(d)-5............................................... 1545-0112
31.3406(e)-1............................................... 1545-0112
31.3406(f)-1............................................... 1545-0112
31.3406(g)-1............................................... 1545-0096
1545-0112
1545-1819
31.3406(g)-2............................................... 1545-0112
31.3406(g)-3............................................... 1545-0112
31.3406(h)-1............................................... 1545-0112
31.3406(h)-2............................................... 1545-0112
31.3406(h)-3............................................... 1545-0112
31.3406(i)-1............................................... 1545-0112
31.3501(a)-1T.............................................. 1545-0771
31.3503-1.................................................. 1545-0024
31.3504-1.................................................. 1545-0029
31.6001-1.................................................. 1545-0798
31.6001-2.................................................. 1545-0034
1545-0798
31.6001-3.................................................. 1545-0798
31.6001-4.................................................. 1545-0028
31.6001-5.................................................. 1545-0798
31.6001-6.................................................. 1545-0029
1459-0798
31.6011(a)-1............................................... 1545-0029
1545-0034
1545-0035
1545-0059
1545-0074
1545-0256
1545-0718
1545-2097
31.6011(a)-2............................................... 1545-0001
1545-0002
31.6011(a)-3............................................... 1545-0028
31.6011(a)-3A.............................................. 1545-0955
31.6011(a)-4............................................... 1545-0034
1545-0035
1545-0718
1545-1413
1545-2097
31.6011(a)-5............................................... 1545-0028
1545-0718
1545-2097
31.6011(a)-6............................................... 1545-0028
31.6011(a)-7............................................... 1545-0074
31.6011(a)-8............................................... 1545-0028
31.6011(a)-9............................................... 1545-0028
31.6011(a)-10.............................................. 1545-0112
31.6011(b)-1............................................... 1545-0003
31.6011(b)-2............................................... 1545-0029
31.6051-1.................................................. 1545-0008
1545-0182
1545-0458
1545-1729
31.6051-2.................................................. 1545-0008
31.6051-3.................................................. 1545-0008
31.6053-1.................................................. 1545-0029
1545-0062
1545-0064
1545-0065
1545-1603
31.6053-2.................................................. 1545-0008
31.6053-3.................................................. 1545-0065
1545-0714
31.6053-4.................................................. 1545-0065
1545-1603
31.6060-1(a)(1)............................................ 1545-1231
31.6065(a)-1............................................... 1545-0029
31.6071(a)-1............................................... 1545-0001
1545-0028
1545-0029
31.6071(a)-1A.............................................. 1545-0955
31.6081(a)-1............................................... 1545-0008
1545-0028
31.6091-1.................................................. 1545-0028
1545-0029
31.6107-1.................................................. 1545-1231
31.6157-1.................................................. 1545-0955
31.6205-1.................................................. 1545-0029
1545-2097
31.6301(c)-1AT............................................. 1545-0035
1545-0112
1545-0257
31.6302-1.................................................. 1545-1413
31.6302-2.................................................. 1545-1413
31.6302-3.................................................. 1545-1413
31.6302-4.................................................. 1545-1413
31.6302(c)-2............................................... 1545-0001
1545-0257
31.6302(c)-2A.............................................. 1545-0955
31.6302(c)-3............................................... 1545-0257
31.6402(a)-2............................................... 1545-0256
1545-2097
31.6413(a)-1............................................... 1545-0029
1545-2097
31.6413(a)-2............................................... 1545-0029
1545-0256
1545-2097
31.6413(c)-1............................................... 1545-0029
1545-0171
31.6414-1.................................................. 1545-0029
1545-2097
32.1....................................................... 1545-0029
1545-0415
32.2....................................................... 1545-0029
35a.3406-2................................................. 1545-0112
35a.9999-5................................................. 1545-0029
36.3121(l)(1)-1............................................ 1545-0137
36.3121(l)(1)-2............................................ 1545-0137
36.3121(l)(3)-1............................................ 1545-0123
36.3121(1)(7)-1............................................ 1545-0123
36.3121(1)(10)-1........................................... 1545-0029
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40.6060-1(a)(1)............................................ 1545-1231
40.6107-1.................................................. 1545-1231
40.6302(c)-3(b)(2)(ii)..................................... 1545-1296
40.6302(c)-3(b)(2)(iii).................................... 1545-1296
40.6302(c)-3(e)............................................ 1545-1296
40.6302(c)-3(f)(2)(ii)..................................... 1545-1296
41.4481-1.................................................. 1545-0143
41.4481-2.................................................. 1545-0143
41.4483-3.................................................. 1545-0143
41.6001-1.................................................. 1545-0143
41.6001-2.................................................. 1545-0143
41.6001-3.................................................. 1545-0143
41.6060-1(a)(1)............................................ 1545-1231
41.6071(a)-1............................................... 1545-0143
41.6081(a)-1............................................... 1545-0143
41.6091-1.................................................. 1545-0143
41.6107-1.................................................. 1545-1231
41.6109-1.................................................. 1545-0143
41.6151(a)-1............................................... 1545-0143
41.6156-1.................................................. 1545-0143
41.6161(a)(1)-1............................................ 1545-0143
44.4401-1.................................................. 1545-0235
44.4403-1.................................................. 1545-0235
44.4412-1.................................................. 1545-0236
[[Page 661]]
44.4901-1.................................................. 1545-0236
44.4905-1.................................................. 1545-0236
44.4905-2.................................................. 1545-0236
44.6001-1.................................................. 1545-0235
44.6011(a)-1............................................... 1545-0235
1545-0236
44.6060-1(a)(1)............................................ 1545-1231
44.6071-1.................................................. 1545-0235
44.6091-1.................................................. 1545-0235
44.6107-1.................................................. 1545-1231
44.6151-1.................................................. 1545-0235
44.6419-1.................................................. 1545-0235
44.6419-2.................................................. 1545-0235
46.4371-4.................................................. 1545-0023
46.4374-1.................................................. 1545-0023
46.4375-1.................................................. 1545-2238
46.4376-1.................................................. 1545-2238
46.4701-1.................................................. 1545-0023
1545-0257
48.4041-4.................................................. 1545-0023
48.4041-5.................................................. 1545-0023
48.4041-6.................................................. 1545-0023
48.4041-7.................................................. 1545-0023
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48.4041-18................................................. 1545-0023
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48.4042-2.................................................. 1545-0023
48.4052-1.................................................. 1545-1418
48.4061(a)-1............................................... 1545-0023
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48.4064-1.................................................. 1545-0014
1545-0242
48.4071-1.................................................. 1545-0023
48.4073-1.................................................. 1545-0023
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1545-1074
1545-1087
48.4081-2.................................................. 1545-1270
1545-1418
48.4081-3.................................................. 1545-1270
1545-1418
1545-1897
48.4081-4(b)(2)(ii)........................................ 1545-1270
48.4081-4(b)(3)(i)......................................... 1545-1270
48.4081-4(c)............................................... 1545-1270
48.4081-6(c)(1)(ii)........................................ 1545-1270
48.4081-7.................................................. 1545-1270
1545-1418
48.4082-1T................................................. 1545-1418
48.4082-2.................................................. 1545-1418
48.4082-6.................................................. 1545-1418
48.4082-7.................................................. 1545-1418
48.4091-3.................................................. 1545-1418
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48.4216(a)-2............................................... 1545-0023
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48.4221-3.................................................. 1545-0023
48.4221-4.................................................. 1545-0023
48.4221-5.................................................. 1545-0023
48.4221-6.................................................. 1545-0023
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48.4222(a)-1............................................... 1545-0014
1545-0023
48.4223-1.................................................. 1545-0023
1545-0257
1545-0723
48.6302(c)-1............................................... 1545-0023
1545-0257
48.6412-1.................................................. 1545-0723
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1545-0723
48.6416(a)-2............................................... 1545-0723
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1545-1087
48.6416(b)(2)-4............................................ 1545-0723
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48.6416(c)-1............................................... 1545-0723
48.6416(e)-1............................................... 1545-0023
1545-0723
48.6416(f)-1............................................... 1545-0023
1545-0723
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1545-0723
48.6420-2.................................................. 1545-0162
1545-0723
48.6420-3.................................................. 1545-0162
1545-0723
48.6420-4.................................................. 1545-0162
1545-0723
48.6420-5.................................................. 1545-0162
1545-0723
48.6420-6.................................................. 1545-0162
1545-0723
48.6421-0.................................................. 1545-0162
1545-0723
48.6421-1.................................................. 1545-0162
1545-0723
48.6421-2.................................................. 1545-0162
1545-0723
48.6421-3.................................................. 1545-0162
1545-0723
48.6421-4.................................................. 1545-0162
1545-0723
48.6421-5.................................................. 1545-0162
1545-0723
48.6421-6.................................................. 1545-0162
1545-0723
48.6421-7.................................................. 1545-0162
1545-0723
48.6424-0.................................................. 1545-0723
48.6424-1.................................................. 1545-0723
48.6424-2.................................................. 1545-0723
48.6424-3.................................................. 1545-0723
[[Page 662]]
48.6424-4.................................................. 1545-0723
48.6424-5.................................................. 1545-0723
48.6424-6.................................................. 1545-0723
48.6427-0.................................................. 1545-0723
48.6427-1.................................................. 1545-0023
1545-0162
1545-0723
48.6427-2.................................................. 1545-0162
1545-0723
48.6427-3.................................................. 1545-0723
48.6427-4.................................................. 1545-0723
48.6427-5.................................................. 1545-0723
48.6427-8.................................................. 1545-1418
48.6427-9.................................................. 1545-1418
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1545-0225
1545-0226
1545-0230
1545-0257
1545-0912
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1545-1361
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1545-1361
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52.4682-5(d)............................................... 1545-1361
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1545-0196
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1545-0092
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1545-0148
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54.9815-2712T.............................................. 1545-2180
54.9815-2714T.............................................. 1545-2172
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55.6001-1.................................................. 1545-0123
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56.4911-10................................................. 1545-0052
56.6001-1.................................................. 1545-1049
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1545-1076
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1545-0257
1545-0745
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157.6161-1................................................. 1545-1824
301.6011-2................................................. 1545-0225
1545-0350
1545-0387
1545-0441
1545-0957
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301.6017-1................................................. 1545-0090
301.6034-1................................................. 1545-0092
301.6035-1................................................. 1545-0123
[[Page 663]]
301.6036-1................................................. 1545-0013
1545-0773
301.6047-1................................................. 1545-0367
1545-0957
301.6056-1................................................. 1545-2251
301.6056-2................................................. 1545-2251
301.6057-1................................................. 1545-0710
301.6057-2................................................. 1545-0710
301.6058-1................................................. 1545-0710
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301.6103(p)(2)(B)-1........................................ 1545-1757
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301.6104(a)-5.............................................. 1545-0056
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301.6104(b)-1.............................................. 1545-0094
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1545-0367
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1545-0957
1545-1461
1545-2242
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1545-0881
301.6111-2................................................. 1545-0865
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1545-1686
301.6112-1T................................................ 1545-0865
1545-1686
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1545-1484
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301.6230(e)-1.............................................. 1545-0790
301.6231(a)(1)-1........................................... 1545-0790
301.6231(a)(7)-1........................................... 1545-0790
301.6231(c)-1.............................................. 1545-0790
301.6231(c)-2.............................................. 1545-0790
301.6241-1T................................................ 1545-0130
301.6316-4................................................. 1545-0074
301.6316-5................................................. 1545-0074
301.6316-6................................................. 1545-0074
301.6316-7................................................. 1545-0029
301.6324A-1................................................ 1545-0015
301.6361-1................................................. 1545-0024
1545-0074
301.6361-2................................................. 1545-0024
301.6361-3................................................. 1545-0074
301.6402-2................................................. 1545-0024
1545-0073
1545-0091
301.6402-3................................................. 1545-0055
1545-0073
1545-0091
1545-0132
1545-1484
301.6402-5................................................. 1545-0928
301.6404-1................................................. 1545-0024
301.6404-2T................................................ 1545-0024
301.6404-3................................................. 1545-0024
301.6405-1................................................. 1545-0024
301.6501(c)-1.............................................. 1545-1241
1545-1637
301.6501(d)-1.............................................. 1545-0074
1545-0430
301.6501(o)-2.............................................. 1545-0728
301.6511(d)-1.............................................. 1545-0024
1545-0582
301.6511(d)-2.............................................. 1545-0024
1545-0582
301.6511(d)-3.............................................. 1545-0024
1545-0582
301.6652-2................................................. 1545-0092
301.6685-1................................................. 1545-0092
301.6689-1T................................................ 1545-1056
301.6707-1T................................................ 1545-0865
1545-0881
301.6708-1T................................................ 1545-0865
301.6712-1................................................. 1545-1126
301.6723-1A(d)............................................. 1545-0909
301.6903-1................................................. 1545-0013
1545-1783
301.6905-1................................................. 1545-0074
301.7001-1................................................. 1545-0123
301.7101-1................................................. 1545-1029
301.7207-1................................................. 1545-0092
301.7216-2................................................. 1545-0074
301.7216-2(o).............................................. 1545-1209
301.7425-3................................................. 1545-0854
301.7430-2(c).............................................. 1545-1356
301.7502-1................................................. 1545-1899
301.7507-8................................................. 1545-0123
301.7507-9................................................. 1545-0123
301.7513-1................................................. 1545-0429
301.7517-1................................................. 1545-0015
301.7605-1................................................. 1545-0795
301.7623-1................................................. 1545-0409
1545-1534
301.7654-1................................................. 1545-0803
301.7701-3................................................. 1545-1486
301.7701-4................................................. 1545-1465
301.7701-7................................................. 1545-1600
301.7701-16................................................ 1545-0795
301.7701(b)-1.............................................. 1545-0089
301.7701(b)-2.............................................. 1545-0089
301.7701(b)-3.............................................. 1545-0089
301.7701(b)-4.............................................. 1545-0089
301.7701(b)-5.............................................. 1545-0089
301.7701(b)-6.............................................. 1545-0089
301.7701(b)-7.............................................. 1545-0089
1545-1126
301.7701(b)-9.............................................. 1545-0089
301.7805-1................................................. 1545-0805
301.9000-5................................................. 1545-1850
301.9001-1................................................. 1545-0220
301.9100-2................................................. 1545-1488
301.9100-3................................................. 1545-1488
301.9100-4T................................................ 1545-0016
1545-0042
1545-0074
[[Page 664]]
1545-0129
1545-0172
1545-0619
301.9100-6T................................................ 1545-0872
301.9100-7T................................................ 1545-0982
301.9100-8................................................. 1545-1112
301.9100-11T............................................... 1545-0123
301.9100-12T............................................... 1545-0026
1545-0074
1545-0172
1545-1027
301.9100-14T............................................... 1545-0046
301.9100-15T............................................... 1545-0046
301.9100-16T............................................... 1545-0152
302.1-7.................................................... 1545-0024
305.7701-1................................................. 1545-0823
305.7871-1................................................. 1545-0823
404.6048-1................................................. 1545-0160
420.0-1.................................................... 1545-0710
Part 509................................................... 1545-0846
Part 513................................................... 1545-0834
Part 514................................................... 1545-0845
Part 521................................................... 1545-0848
601.104.................................................... 1545-0233
601.105.................................................... 1545-0091
601.201.................................................... 1545-0019
1545-0819
601.204.................................................... 1545-0152
601.401.................................................... 1545-0257
601.504.................................................... 1545-0150
601.601.................................................... 1545-0800
601.602.................................................... 1545-0295
1545-0387
1545-0957
601.702.................................................... 1545-0429
------------------------------------------------------------------------
(26 U.S.C. 7805)
[T.D. 8011, 50 FR 10222, Mar. 14, 1985]
Editorial Note: For Federal Register citations affecting Sec.
602.101, see the List of CFR Sections Affected, which appears in the
Finding Aids section of the printed volume and at www.fdsys.gov.
[[Page 665]]
List of CFR Sections Affected
All changes in this volume of the Code of Federal Regulations (CFR) that
were made by documents published in the Federal Register since January
1, 2010 are enumerated in the following list. Entries indicate the
nature of the changes effected. Page numbers refer to Federal Register
pages. The user should consult the entries for chapters, parts and
subparts as well as sections for revisions.
For changes to this volume of the CFR prior to this listing, consult the
annual edition of the monthly List of CFR Sections Affected (LSA). The
LSA is available at www.fdsys.gov. For changes to this volume of the CFR
prior to 2001, see the ``List of CFR Sections Affected, 1949-1963, 1964-
1972, 1973-1985, and 1986-2000'' published in 11 separate volumes. The
``List of CFR Sections Affected 1986-2000'' is available at
www.fdsys.gov.
2010
26 CFR
75 FR
Page
Chapter I
1.162-24 Added.....................................................17856
2011
26 CFR
76 FR
Page
Chapter I
1.142(a)(6)-1 Added................................................51881
(c)(2)(v) correctly revised; (h) Example 9 correctly amended
55255
1.150-1 (a)(4) added; (b) amended..................................39280
1.150-1T Added (temporary).........................................39280
1.162-3 Revised....................................................81080
1.162-3T Added (temporary).........................................81080
1.162-4 Revised....................................................81084
1.162-4T Added (temporary).........................................81084
1.162-6 Removed....................................................81084
1.162-11 (b) revised; (c) and (d) added............................81084
1.162-11T Added (temporary)........................................81084
1.165-2 (c) revised; (d) and (e) added.............................81084
1.165-2T Added (temporary).........................................81084
1.167(a)-4 Revised.................................................81085
1.167(a)-4T Added (temporary)......................................81085
1.167(a)-7 (e), (f) and (g) added..................................81085
1.167(a)-7T Added (temporary)......................................81085
1.167(a)-8 (g), (h) and (i) added..................................81085
1.167(a)-8T Added (temporary)......................................81085
1.168(i)-0 Amended.................................................81085
1.168(i)-0T Added (temporary)......................................81086
1.168(i)-1 (a) through (l)(1) revised; (m) added...................81086
1.168(i)-1T Added (temporary)......................................81086
1.168(i)-7T Added (temporary)......................................81095
1.168(i)-8T Added (temporary)......................................81096
2012
26 CFR
77 FR
Page
Chapter I
1.162-3 Correctly revised..........................................18687
1.162-3T Second (h), (i) and (j) correctly redesignated as (i),
(j) and (k); (d)(3) and new (j) correctly amended..........18687
(j) revised....................................................74584
1.162-4T (c) revised...............................................74584
1.162-11T (c) revised..............................................74584
1.163-11 Added.....................................................26699
1.163-11T Removed..................................................26699
1.165-2T (d) revised...............................................74584
1.167(a)-4T (b)(1), (2) heading and introductory text revised......74584
1.167(a)-7T (f) revised............................................74584
1.167(a)-8T (h) revised............................................74584
1.168(i)-0 Amended.................................................75016
1.168(i)-1 (l)(2) and (3) revised..................................75016
1.168(i)-1T (e)(3)(ii)(B) Example 2 and (m)(2) correctly amended
18687
[[Page 666]]
1.168(i)-1T (m)(1) revised; (m)(2) and (3) redesignated as
(m)(3) and (4); new (m)(2) added; new (m)(3) amended...............74585
1.168(i)-7T (e)(1) revised; (e)(2) and (3) redesignated as (e)(3)
and (4); new (e)(2) added..................................74585
1.168(i)-8T Second (c)(4)(ii)(E) correctly redesignated as
(c)(4)(ii)(F); (g)(3) correctly amended....................18687
(i)(1) revised; (i)(2) and (3) redesignated as (i)(3) and (4);
new (i)(2) added...................................................74585
2013
26 CFR
78 FR
Page
Chapter I
1.150-1 (a)(2) heading and (4) revised; (b) amended................54759
1.150-1T Removed...................................................54759
1.162-ndash;3 Revised..............................................57701
1.162-3T Removed...................................................57705
1.162-4 Revised....................................................57705
1.162-4T Removed...................................................57706
1.162-11 (b) revised; (c) and (d) removed..........................57706
1.162-11T Removed..................................................57706
1.165-2 (c) and (d) revised; (e) removed...........................57706
1.165-2T Removed...................................................57706
1.167(a)-4 Revised.................................................57706
1.167(a)-4T Removed................................................57707
1.167(a)-7 (e) and (f) revised; (g) removed........................57707
1.167(a)-7T Removed................................................57707
1.167(a)-8 (g) and (h) revised; (i) removed........................57707
1.167(a)-8T Removed................................................57707
1.168(i)-7 Added...................................................57707
1.168(i)-7T Removed................................................57708
2014
26 CFR
79 FR
Page
Chapter I
1.148-0 Amended....................................................67351
1.148-3 (i)(3) added...............................................67351
1.148-11 Heading revised; (l) added................................67351
1.162-3 (c)(4)(i), (ii), (d)(1), (2), (e)(1) and (j)(3) correctly
amended; (d)(3) correctly revised..........................42190
1.162-4 (a) correctly amended......................................42191
1.162-31 Added.....................................................56904
1.162-32 Added.....................................................59113
1.162(l)-1T Added..................................................43631
1.165-2 (c) amended................................................48667
1.168(i)-0 Amended.................................................48667
1.168(i)-0T Removed................................................48667
1.168(i)-1 (a) through (l)(1) and (m) revised......................48667
(c)(2)(ii)(D), (e)(3)(iii)(C)(3) and (m)(4) correctly revised;
(e)(3)(ii)(B) Example 2, (iii)(A), (v)(B)(1), (f)(3) and
(j)(3)(ii) correctly amended...............................78697
1.168(i)-1T Removed................................................48678
1.168(i)-7 (a) amended; (b), (c)(2)(ii)(H) and (e) revised.........48678
(e)(4) correctly revised.......................................78697
1.168(i)-8 Added...................................................48678
(f)(2)(ii), (3)(ii), (h)(2)(iv) and (3)(iv) correctly amended;
(h)(2)(iii) and (3)(iii) correctly revised.........................78697
1.168(i)-8T Removed................................................48684
2015
(Regulations published from January 1, 2015, through April 1, 2015)
26 CFR
80 FR
Page
Chapter I
1.162-27 (e)(2)(vi)(A), (7) Example 9, (4)(iv) and (f)(3) revised;
(j)(2)(vi) added...........................................16972
[all]