[Federal Register Volume 67, Number 105 (Friday, May 31, 2002)]
[Proposed Rules]
[Pages 38025-38039]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-13578]


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 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
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  Federal Register / Vol. 67, No. 105 / Friday, May 31, 2002 / Proposed 
Rules  

[[Page 38025]]



DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-103823-99]
RIN 1545-AX12


Guidance on Cost Recovery Under the Income Forecast Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to 
deductions available to taxpayers using the income forecast method of 
depreciation under section 167(g). These proposed regulations reflect 
changes to the law made by the Small Business Job Protection Act of 
1996 and the Taxpayer Relief Act of 1997 and affect taxpayers that 
produce, own, or license films, videos, sound recordings, books, 
copyrights, patents, and certain other similar properties. This 
document also provides notice of a public hearing on these regulations.

DATES: Written comments must be received by August 29, 2002. Requests 
to speak and outlines of topics to be discussed at the public hearing 
scheduled for September 4, 2002, at 10 a.m., must be received by August 
13, 2002.

ADDRESSES: Send submissions to: CC:IT&A:RU (REG-103823-99), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered between the hours of 8 a.m. 
and 5 p.m. to: CC:IT&A:RU (REG-103823-99), Courier's Desk, Internal 
Revenue Service, 1111 Constitution Avenue NW., Washington, DC. 
Alternatively, taxpayers may submit comments directly to the IRS 
Internet site at www.irs.gov/regs. A public hearing will be held in 
room 2615, Internal Revenue Building, 1111 Constitution Avenue NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Bernard P. 
Harvey, (202) 622-3110; concerning submissions and the hearing, and/or 
to be placed on the building access list to attend the hearing, Guy R. 
Traynor, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:  

Background

    This document contains proposed amendments to 26 CFR part 1 to 
provide regulations under section 167(g) of the Internal Revenue Code 
of 1986 (Code). Section 167(g) was added to the Code by the Small 
Business Job Protection Act of 1996, Public Law 104-188, 1604 (110 
Stat. 1755, 1836) (Aug. 20, 1996), and significant amendments were made 
to the provision by the Taxpayer Relief Act of 1997, Public Law 105-34, 
1086 (111 Stat. 788, 957) (Aug. 5, 1997).

Explanation of Provisions

    The income forecast method of depreciation has been a permissible 
method for certain properties since the early 1960s. The income 
forecast method permits taxpayers to recover the depreciable basis in 
property over the anticipated income to be earned from the property. 
The income forecast method is available for interests (including 
interests involving limited rights in property) in motion picture 
films, videotapes, sound recordings, copyrights, books, and patents. 
See Rev. Rul. 60-358 (1960-2 C.B. 68); Rev. Rul. 64-273 (1964-2 C.B. 
62); Rev. Rul. 79-285 (1979-2 C.B. 91); and Rev. Rul. 89-62 (1989-1 
C.B. 78). The income forecast method is appropriate for these types of 
property because they possess unique income earning characteristics 
(for example, the income earning potential of a film may vary as a 
direct result of the film's popularity) and, therefore, the economic 
usefulness of these properties cannot be measured adequately by the 
property's physical condition or by the passage of time. In 1996, 
Congress enacted statutory income forecast rules to ensure that, for 
certain properties, the allowances for depreciation appropriately match 
the basis of an income forecast property with the income derived 
therefrom. In 1997, Congress placed limitations on the type of property 
that could be depreciated using the income forecast method.

Computation of Allowances for Depreciation

    The proposed regulations provide that, under the income forecast 
method, a taxpayer's allowance for depreciation for a given year for an 
income forecast property generally is an amount that bears the same 
relationship to the depreciable basis of the property that the 
``current year income'' for that year bears to the ``forecasted total 
income'' for the property. The proposed regulations provide a revised 
computation for computing a taxpayer's allowance for depreciation in 
years when conditions necessitate using a revised forecasted total 
income that differs from the forecasted total income used in computing 
depreciation allowances in previous years. Pursuant to these rules, 
taxpayers may revise forecasted total income and use the revised 
computation in taxable years after income forecast property is placed 
in service when information becomes available that indicates that 
forecasted total income (or revised forecasted total income) previously 
used to compute income forecast depreciation is inaccurate. Under the 
revised computation, a taxpayer's allowance for depreciation for the 
current and all future years for an income forecast property is an 
amount that bears the same relationship to the unrecovered depreciable 
basis of the property that the current year income for that year bears 
to the result obtained by subtracting from revised forecasted total 
income for the property the amounts of current year income for prior 
taxable years. Taxpayers are required to use the revised computation in 
certain situations (discussed in this preamble under the heading of 
Income From the Property).
    The proposed regulations also provide several special rules for 
computing allowances for depreciation under the income forecast method. 
A special rule applies for certain basis redeterminations whereby an 
additional ``catch up'' allowance for depreciation is allowed in the 
year that basis is redetermined. Under this special rule, the 
additional depreciation allowance is an amount equal to the cumulative 
allowances for depreciation that would have been permitted in previous 
years

[[Page 38026]]

had the basis redetermination amount been included in basis in the year 
the property was placed in service. It is intended that this additional 
allowance will ameliorate the potential back-loading of depreciation 
deductions that may otherwise occur if the additional amount were taken 
into account over the remaining income from the property and diminish 
the amount of look-back interest that may otherwise accrue. This 
special rule does not apply if the additional basis is treated as 
separate property.
    Pursuant to section 167(g)(1)(C), a taxpayer's adjusted basis in an 
income forecast property is to be recovered by the end of the tenth 
taxable year following the taxable year in which the income forecast 
property is placed in service. The proposed regulations also provide 
that generally a taxpayer may deduct the adjusted basis in income 
forecast property in the year income from the property ceases 
completely and permanently (unless the income cessation arises in 
connection with the disposition of income forecast property). If 
additional amounts are paid or incurred with respect to income forecast 
property in taxable years after either of these special rules is 
applied, the additional amounts may be deducted when paid or incurred 
unless such amounts give rise to separate property.
    Use of the income forecast method is elected on a property-by-
property basis. Once elected, the income forecast method is a method of 
accounting that may not be changed without the consent of the 
Commissioner. Modifications to forecasted total income to take into 
account information that becomes available after the property is placed 
in service in accordance with these proposed regulations is not a 
change in a method of accounting requiring the Commissioner's consent.
    Section 167(g) sets forth rules for the use of the income forecast 
method and any similar method. Thus, any method that calculates 
depreciation based on the flow of income generated by a property (or 
group of properties) is a ``similar method'' subject to the 
requirements of this regulation, including, e.g., the requirement that 
the look-back method be applied in certain circumstances. Congress did 
not identify any method that should be treated as a similar method. 
Treasury and the IRS seek comments on other methods that should be 
treated as coming within the scope of the term any similar method.
    Commentators suggested that we specifically approve a method of 
depreciation based on the application of percentages derived from 
historical patterns of income for similar properties as a similar 
method because to do so would simplify the computation of depreciation 
deductions for large groupings of properties. This suggestion has not 
been adopted because it is not clear that the historical patterns of 
income used to apply the suggested approach will accurately reflect the 
income from any particular income forecast property. Moreover, this 
suggested approach is not predicated upon the unique income earning 
characteristics of an income forecast property.

Basis Rules

    The cost of producing income forecast property is capitalized and 
recovered through an allowance for depreciation. The proposed 
regulations follow the general principles set forth in the regulations 
under sections 263, 263A, 446, and 461 for determining the basis of 
income forecast property. Commentators have written to Treasury and the 
IRS requesting guidance on various issues involving the timing of 
inclusion in basis of direct costs of income forecast property that are 
contingent upon the amount of income earned from the property (or other 
similar factors) and the means by which those costs may be deducted. In 
accordance with these requests, and in light of section 167(g)(1)(B), 
the proposed regulations address certain basis issues that are peculiar 
to the income forecast method of computing depreciation allowances.
    Section 263A applies to income forecast property produced by the 
taxpayer. Section 1.263A-1(c)(2)(ii) provides that an amount required 
to be capitalized under section 263A may not be included in basis any 
earlier than the taxable year during which the amount is incurred 
within the meaning of Sec. 1.446-1(c)(1)(ii). Section 1.446-1(c)(1)(ii) 
provides that under an accrual method of accounting a liability is 
incurred, and generally is taken into account for Federal income tax 
purposes, in the taxable year in which the ``all events test'' is 
satisfied. Sections 1.446-1(c)(1)(ii) and 1.461-1(a)(2) set forth the 
``all events test'' which provides that a liability is incurred in the 
taxable year in which: (1) All the events have occurred that establish 
the fact of liability; (2) the amount of the liability can be 
determined with reasonable accuracy; and (3) economic performance has 
occurred with respect to the liability. Because section 167(g)(1)(B) 
provides that the adjusted basis of income forecast property 
depreciated using the income forecast method includes only amounts with 
respect to which the requirements of section 461(h) are satisfied, 
these rules are specifically restated in the proposed regulations.
    The proposed regulations reiterate that contingent amounts that are 
either direct costs of the production of income forecast property or 
indirect costs properly allocable to the production of income forecast 
property are not added to basis until the taxable year in which the all 
events test, including the economic performance requirement of section 
461(h), is satisfied. Under the proposed rules, the timing of the 
inclusion of certain of these costs in basis may be affected by 
Sec. 1.461-1(a)(2)(iii)(A), Sec. 1.461-1(a)(2)(iii)(D) and section 404.
    Thus, the proposed regulations provide that contingent basis 
amounts that are either direct costs of income forecast property or 
indirect costs properly allocable to income forecast property are 
generally treated as basis redetermination amounts which increase the 
basis of income forecast property in the year paid or incurred. As 
noted above, the proposed regulations provide a special allowance 
applicable to certain basis redetermination amounts.
    Commentators have also suggested that Transamerica Corp. v. United 
States, 999 F.2d 1362 (9th Cir. 1993), supports including contingent 
amounts in the basis of income forecast property beginning in the year 
the property is placed in service. In Transamerica, the Ninth Circuit 
interpreted Rev. Rul. 60-358, supra, as it applied in taxable years 
prior to the enactment of section 167(g), the economic performance 
requirements of section 461(h), the uniform capitalization requirement 
of section 263A, and other changes. The Ninth Circuit held that 
contingent basis amounts may be included in the basis of income 
forecast property in the year that the property is placed in service so 
long as the forecasted total income used in the computation of 
depreciation under the income forecast method includes an amount of 
income from the property sufficient to indicate that the contingency 
will be satisfied. Commentators urge the continuing application of the 
Transamerica approach because this approach matches most closely the 
costs of creating an income forecast property with the income earned 
therefrom. Treasury and the IRS recognize that it may appear to be 
reasonable to include estimated amounts in the basis of income forecast 
property when the operation of the income forecast formula requires the 
use of estimated amounts in the forecasts of income that are used to

[[Page 38027]]

determine the amount of income forecast depreciation, particularly 
where the income forecasts indicate that the contingencies will be 
resolved, and resolved relatively quickly, after the property is placed 
in service. Treasury and the IRS also recognize that the historic 
operation of the income forecast formula deters taxpayers from 
increasing their forecast of income in order to increase the contingent 
basis amounts includible in the basis of income forecast property 
because the increases in forecasted total income operate to increase 
the denominator of the income forecast formula and thus diminish the 
amount of depreciation of the income forecast property. This deterrent 
effect operates in most (but not all) situations to prevent the 
cumulative amount of income forecast depreciation deductions in any 
given taxable year from exceeding the total amount actually incurred in 
any given taxable year, which is the primary concern with the inclusion 
of contingent amounts in basis. However, because Congress specifically 
provided in section 167(g)(1)(B) that the adjusted basis of income 
forecast property includes only those amounts which satisfy the 
requirements of section 461(h) and because all events that establish 
the fact of the liability for contingent amounts have not occurred, the 
proposed regulations do not follow the Transamerica approach.
    Commentators have also argued that Associated Patentees, Inc. v. 
Commissioner, 4 T.C. 979 (1945), supports an immediate deduction for 
contingent basis amounts arising from the provision of either property 
or services in the production of income forecast property that are paid 
or incurred in years after the year in which income forecast property 
is placed in service. The proposed regulations do not adopt this 
interpretation of Associated Patentees because providing a more 
favorable cost recovery rule for contingent basis amounts than for 
fixed amounts would create an unwarranted incentive for characterizing 
costs as contingent amounts. Contingent basis amounts arising from the 
provision of either property or services in the production of income 
forecast property must be capitalized into the basis of income forecast 
property in accordance with Sec. 1.263A-1(e).

Salvage Value

    The proposed regulations do not provide that the basis upon which 
depreciation is computed under the income forecast method is reduced 
for salvage value. The unique statutory scheme Congress adopted for 
income forecast property requires this departure from the rules 
generally applicable to property depreciated under section 167, and 
from the provisions of Rev. Rul. 60-358, supra, which had governed 
income forecast depreciation prior to the enactment of section 167(g). 
Based on the provisions of section 167(g), Congress intended that 
taxpayers be able to recover their entire basis in income forecast 
property within the period beginning with the year income forecast 
property is placed in service and ending with the 10th taxable year 
after the year the property is placed in service and that basis be 
recovered over the total income earned in connection with the property 
within that same time frame.
    Section 167(g)(1)(C) requires taxpayers to recover the adjusted 
basis of income forecast property as of the beginning of the 10th 
taxable year after the property is placed in service as an allowance 
for depreciation in such year. The term adjusted basis refers to the 
basis of property for purposes of determining gain or loss, which is 
determined generally by adjusting the cost or other basis in property 
prescribed by section 1012 by the adjustments required by section 1016. 
See Sec. 1.1011-1. The use of this term in section 167(g)(1)(C) 
indicates that Congress intended that the entire basis of an income 
forecast property be recovered within the period beginning with the 
year income forecast property is placed in service and ending with the 
10th taxable year after the year the property is placed in service. The 
legislative history confirms this reading of the provision, stating 
that ``(a)ny costs that are not recovered by the end of the tenth 
taxable year after the property was placed in service may be taken into 
account as depreciation in such year.'' H.R. Conf. Rep. No. 737, 104th 
Cong., 2d Sess. 299 (1996).
    Consistent with this rule, the estimated income from the property 
is all the income projected to be earned over the first eleven taxable 
years the property is used by any taxpayer. Under section 167(g)(1)(A), 
the adjusted basis of income forecast property is to be recovered 
through allowances for income forecast depreciation over the ``amount 
of income earned in connection with the property'' through the end of 
the tenth taxable year after the year in which the income forecast 
property is placed in service. The legislative history to section 
167(g)(1)(A) states that ``income to be taken into account under the 
income forecast method includes all estimated income generated by the 
property.'' H.R. Conf. Rep. No. 737, at 297. By referring to income 
generated by the property, and not to income to be earned by the 
taxpayer, Congress established a regime whereby a taxpayer using the 
income forecast method must include within forecasted total income 
amounts that are to be earned not only by the taxpayer, but also by any 
subsequent owner during the eleven year period.

Income From the Property

    The income forecast formula uses the ratio of current year income 
to forecasted total income from the property to determine the current 
allowance for depreciation. Both current year income and forecasted 
total income are to be computed in accordance with a taxpayer's method 
of accounting. Pursuant to Code section 167(g)(1)(A) and (g)(5)(C), 
forecasted total income is to include all anticipated income from any 
source through the end of the tenth taxable year following the year in 
which the income forecast property is placed in service (except, as 
discussed below, in the year of disposition of income forecast 
property). Thus, for example, in the case of a film, such income 
includes income from foreign and domestic theatrical, television, and 
other releases and syndications; income from video tape releases, 
sales, rentals, and syndications; and incidental income associated with 
the property such as income from the financial exploitation of 
characters, designs, titles, scripts, and scores, but only to the 
extent that such incidental income is earned in connection with the 
ultimate use of such items by, or the ultimate sale of merchandise to, 
persons who are not related to the taxpayer (within the meaning of 
section 267(b)). Apportionment rules are provided for situations when 
income from the exploitation of characters, designs, titles, scripts, 
scores, and other incidental income may relate to more than one income 
forecast property.
    Under the proposed regulations, taxpayers are required at the end 
of the taxable year in which income forecast property is placed in 
service to make an accurate projection of all anticipated income to be 
earned from the income forecast property based on the conditions known 
to exist at that time. This estimate is referred to as forecasted total 
income. As discussed above, forecasted total income includes not only 
the income that the taxpayer forecasts it will earn by the end of the 
tenth taxable year after the year in which the income forecast property 
is placed in service, but also income that may be earned by other 
owners of the income forecast property during that same period.

[[Page 38028]]

    The proposed regulations also require taxpayers to evaluate the 
accuracy of their forecasts annually. In order to perform these 
evaluations of forecasted total income, taxpayers must compute revised 
forecasted total income. Revised forecasted total income is the sum of 
current year income for the current taxable year and all prior taxable 
years, plus all income from the income forecast property that the 
taxpayer reasonably believes will be includible in current year income 
in taxable years after the current taxable year up to and including the 
10th taxable year after the year in which the income forecast property 
is placed in service. Taxpayers are required to use the revised 
computation if forecasted total income in the immediately preceding 
taxable year falls outside a range bounded on the low end by 90 percent 
of revised forecasted total income for the current taxable year, and on 
the upper end by 110 percent of revised forecasted total income for the 
current taxable year. (In the situation where revised forecasted total 
income was used to compute income forecast depreciation in the 
immediately preceding taxable year, this comparison is made by 
comparing the revised forecasted total income for the current taxable 
year to revised forecasted total income for the immediately preceding 
taxable year.) Taxpayers may elect to alter their computations of 
income forecast depreciation (using the revised computation detailed 
below) when revised forecasted total income differs from forecasted 
total income.
    Pursuant to Code section 167(g)(5)(B), income from the syndication 
of a television series need not be included in the income forecast 
computation prior to the fourth taxable year beginning after the date 
the first episode of the series is placed in service, unless an 
arrangement relating to future syndication exists. In such a case, 
syndication income is included in the income forecast computation at 
the time the arrangement relating to future syndication is made. This 
special rule also applies for purposes of applying the look-back 
method.
    Special rules apply if income forecast property is disposed of 
prior to the end of the 10th taxable year after the year the property 
is placed in service. In such a case, section 167(g)(5)(E) requires 
that for purposes of applying the look-back method, income from the 
disposition of the property is to be taken into account. Failure to 
apply a similar rule for purposes of computing income forecast 
depreciation in the year of disposition may permit a depreciation 
differential that would not be corrected through the operation of the 
look-back method (because the differential would arise in a year for 
which the period of time to which look-back interest would apply would 
be zero). Accordingly, the proposed regulations require taxpayers to 
take income from the disposition of income forecast property into 
account in the year of disposition in computing revised forecasted 
total income both for purposes of computing its income forecast 
depreciation and for purposes of applying the look-back method.

Income Forecast Property

    Section 167(g)(6) limits the types of property for which the income 
forecast method may be utilized. The income forecast method is 
available for interests (including interests involving limited rights 
in property) in motion picture films, video tapes, sound recordings, 
copyrights, books, and patents. In addition, section 167(g)(6)(E) 
provides the authority for Treasury and the IRS to extend the income 
forecast method to other types of property. The proposed regulations 
extend the method to theatrical productions and authorize the 
Commissioner to publish guidance designating other properties.
    The proposed regulations generally require the income forecast 
method to be applied on a property-by-property basis. In certain 
limited circumstances, interests in multiple properties may be grouped 
together and treated as a single income forecast property. The ability 
to treat multiple income forecast properties as a single property for 
purposes of applying the income forecast method of depreciation is 
limited, however, to certain episodes of a television series or to 
multiple interests in specified income forecast properties acquired for 
broadcast pursuant to a single contract. The special allowance 
applicable to certain basis redetermination amounts is not available to 
basis redetermination amounts associated with interests in multiple 
income forecast properties treated as a single income forecast property 
under these rules. Commentators have requested that broad groupings of 
dissimilar properties be permitted in accordance with historic 
financial accounting practices. Because it is not clear that income 
would be clearly reflected if broader groupings of properties were 
permitted, this suggestion has not been incorporated into the proposed 
regulations. Treasury and the IRS request comments on whether the 
proposed permitted groupings are appropriate and whether additional 
groupings should be allowed.
    Under section 167(g)(5)(A)(ii), an amount incurred after income 
forecast property is placed in service that is significant and that 
gives rise to a significant increase in income when compared to the 
previous amount of forecasted total income is treated as a separate 
income forecast property and depreciated accordingly. Under the 
proposed regulations, an amount that does not exceed the lesser of 5 
percent of the depreciable basis of the income forecast property with 
which the amount is associated or $100,000 is not considered 
significant for this purpose. An amount incurred after income forecast 
property is placed in service that is not significant or that does not 
give rise to a significant increase in income is subject to the general 
rules and is treated as a basis redetermination amount.
    In addition, a cost incurred in a taxable year following the year 
in which the taxpayer has recovered through depreciation the entire 
adjusted basis of an income forecast property is treated as a separate 
income forecast property. If it is expected to give rise to a 
significant increase in income, the amount of the cost is treated as 
income forecast property that is newly placed in service. Otherwise, it 
is deductible in the year paid or incurred.

Look-back

    In general, the look-back method applies any time property is 
depreciated using the income forecast method. A taxpayer using the 
income forecast method is required to pay, or is entitled to receive, 
interest computed under the look-back method for any year to which the 
look-back requirement applies. A taxpayer must pay look-back interest 
if deductions are accelerated due to the underestimation of total 
income expected to be earned with respect to the property. Conversely, 
a taxpayer is entitled to receive look-back interest if deductions are 
delayed as a result of overestimating total income expected to be 
earned with respect to the property. The look-back method applies 
separately to each income forecast property, unless properties are 
aggregated pursuant to special rules contained in the proposed 
regulations.
    Generally, the look-back method is applied in the third and tenth 
taxable years following the year in which the income forecast property 
is placed in service. The look-back method also applies in the year 
income from the income forecast property ceases with respect to the 
taxpayer (and with respect to all persons who would be treated as a 
single taxpayer with the taxpayer under rules similar to those in 
section 41(f)(1)).

[[Page 38029]]

    The look-back method does not apply to any income forecast property 
the basis of which is $100,000 or less in the year the look-back method 
would otherwise apply (redetermined without any reduction for 
depreciation allowed or allowable). In addition, the look-back method 
is not applicable for any year which would otherwise be a recomputation 
year if a 10 percent test is satisfied. The 10 percent test is met if 
forecasted total income (and, if applicable, revised forecasted total 
income) for each prior year is greater than 90 percent of revised 
forecasted total income for the year which would otherwise be a 
recomputation year and is less than 110 percent of revised forecasted 
total income for the year which would otherwise be a recomputation 
year. If the look-back method is applied for the third taxable year 
following the year in which income forecast property is placed in 
service, a special rule applies in determining whether the 10 percent 
test is satisfied in any subsequent year. Under the special rule, the 
amount of the forecasted total income or the revised forecasted total 
income for each taxable year up to and including the third taxable year 
following the year in which income forecast property is placed in 
service is deemed to be equal to the revised forecasted total income 
that was used for purposes of applying the look-back method in the 
third taxable year following the year in which income forecast property 
is placed in service.
    In order to apply the look-back method, prior year allowances for 
depreciation for income forecast property are recomputed using revised 
forecasted total income for the recomputation year in lieu of 
forecasted total income (or, if appropriate, revised forecasted income) 
from the property that was used in the computation of depreciation 
under the income forecast method in the prior year. If a taxpayer sells 
or otherwise disposes of income forecast property, the amount realized 
upon the disposition of the property is included in determining revised 
forecasted total income from the property in the year of disposition. 
These recomputed depreciation allowances are then used to determine 
either a hypothetical overpayment of tax or a hypothetical underpayment 
of tax.
    Generally, taxpayers must determine the hypothetical overpayment or 
underpayment of tax arising from the change in depreciation allowances 
by recomputing their tax liability. Thus, a taxpayer's tax liability 
for each prior year is recomputed by substituting the recomputed 
depreciation allowances for the depreciation allowances originally 
claimed. The recomputed tax liability is then compared to the 
taxpayer's actual liability. For purposes of this comparison, the 
taxpayer must determine the actual tax liability for each prior year 
based on the information available on the later of (1) The due date of 
the return, including extensions, (2) the date of an amended return, 
(3) the date a return is adjusted by examination, or (4) the date of 
any previous application of the look-back requirement for the income 
forecast property. The result of this comparison is a hypothetical 
overpayment or underpayment of tax for each prior year in which 
allowances for depreciation were claimed for income forecast property 
subject to the look-back method.
    Pass-through entities that are not closely-held pass-through 
entities must use a simplified method to compute their hypothetical 
overpayment or underpayment for each prior year in which allowances for 
depreciation were claimed for income forecast property subject to the 
look-back method. Under the simplified method, taxpayers apply a set 
rate (i.e., the highest rate applicable under section 1 or 11) to the 
net changes in depreciation allowances for each year. Treasury and the 
IRS considered, but did not provide, an election for other taxpayers to 
use the simplified method similar to the election set forth in 
Sec. 1.460-6(d)(4)(ii). Treasury and the IRS request comments on 
whether the use of the simplified method should be extended to 
taxpayers other than those required to use the simplified method, and 
if so, whether additional safeguards beyond the consistency rules for 
related taxpayers, the rules precluding changes from the simplified 
method without permission, and the overpayment ceiling would be 
appropriate.
    Regardless of the method used, the resulting hypothetical 
overpayments or underpayments are then used to compute interest that is 
to be charged or credited on each of these amounts. Interest is 
generally computed from the due date of the return (not including 
extensions) for the years in which changes in depreciation allowances 
occur to the due date of the recomputation year (not including 
extensions). Special rules are provided for taxpayers who do not use 
the simplified method where changes in depreciation allowances affect 
tax liability in years other than the year in which the changes in 
depreciation allowances occur. Interest is computed using the 
overpayment rate under section 6621. The amounts resulting from these 
computations are netted to arrive at look-back interest due to the 
taxpayer or payable to the government for the recomputation year. For 
purposes of computing taxable income, look-back interest is treated as 
interest on an overpayment or underpayment of tax. Under section 
167(g)(5)(D), look-back interest required to be paid is treated as a 
tax liability for penalty purposes.

Proposed Effective Date

    The regulations are proposed to apply to property placed in service 
on or after the date that final regulations are published in the 
Federal Register.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because 
these regulations do not impose on small entities a collection of 
information requirement, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis 
is not required. Pursuant to section 7805(f) of the Code, this notice 
of proposed rulemaking will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written or electronic comments (a 
signed original and eight (8) copies, if written) that are submitted 
timely (in the manner described in the ADDRESSES portion of this 
preamble) to the IRS. The IRS and the Treasury Department specifically 
request comments on the clarity of the proposed regulations and how 
they may be made easier to understand. All comments will be available 
for public inspection and copying.
    A public hearing has been scheduled for September 4, 2002, at 10 
a.m. in the Internal Revenue Service Auditorium, Internal Revenue 
Building, 1111 Constitution Avenue NW, Washington, DC. All visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 30 minutes before the hearing starts at the 
Constitution Avenue entrance. For information about having your name

[[Page 38030]]

placed on the building access list to attend the hearing, see the FOR 
FURTHER INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to this hearing. Persons 
that wish to present oral comments at the hearing must submit timely 
written comments and an outline of the topics to be discussed and the 
time to be devoted to each topic (preferably a signed original and 
eight (8) copies) by August 13, 2002.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Bernard P. Harvey, 
Office of Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Sections 1.167(n)-0 through 1.167(n)-7 are added to read 
as follows:


Sec. 1.167(n)-0  Outline of regulation sections for section 167(g).

    This section lists the major captions contained in 
Sec. 1.167(n)-1 through Sec. 1.167(n)-7

Sec. 1.167(n)-1  Income forecast method.

    (a) Overview.
    (b) Method of accounting.
    (1) In general.
    (2) Election of the income forecast method.

Sec. 1.167(n)-2  Basis.

    (a) Depreciable basis.
    (1) In general.
    (2) Timing of basis determinations and redeterminations.
    (3) Separate Property.
    (b) Basis redeterminations.
    (c) Unrecovered depreciable basis.
    (d) Example.

Sec. 1.167(n)-3  Income from the property.

    (a) Current year income.
    (1) In general.
    (2) Special rule for advance payments.
    (b) Forecasted total income.
    (c) Revised forecasted total income.
    (d) Special rules.
    (1) Disposition of the property.
    (2) Syndication income from television series.
    (3) Apportionment of income in certain circumstances.
    (4) Examples.

Sec. 1.167(n)-4  Computation of depreciation using the income forecast 
method.

    (a) Computation of depreciation allowance.
    (b) Revised computation.
    (1) Change in estimated income.
    (2) Requirement to use the revised computation.
    (c) Basis redeterminations.
    (1) Calculation of depreciation allowance.
    (2) Example.
    (d) Special rules.
    (1) Final year depreciation.
    (2) Certain basis redeterminations.
    (3) Disposition of property.
    (4) Separate property.
    (e) Examples.

Sec. 1.167(n)-5  Property for which the income forecast method may be 
used.

    (a) In general.
    (b) Specific exclusions.
    (c) Costs treated as separate property.
    (1) Costs giving rise to a significant increase in income.
    (2) Significant increase in income.
    (3) Special rule for costs paid or incurred after the end of the 
final year.
    (4) Time separate property is placed in service.
    (5) Examples.
    (d) Aggregations treated as a single income forecast property.
    (1) Multiple episodes of a television series produced in the 
same taxable year.
    (2) Multiple episodes of a television series produced in more 
than one taxable year.
    (3) Multiple interests acquired pursuant to a single contract.
    (4) Videocassettes and DVDs.

Sec. 1.167(n)-6  Look-back method.

    (a) Application of the look-back method.
    (b) Operation of the look-back method.
    (1) In general.
    (2) Property-by-property application.
    (c) Recalculation of depreciation allowances.
    (1) Computation.
    (2) Revised forecasted total income from the property.
    (3) Special rule for basis redeterminations.
    (d) Hypothetical overpayment or underpayment of tax.
    (1) In general.
    (2) Hypothetical overpayment or underpayment, actual 
recomputation.
    (3) Hypothetical overpayment or underpayment, simplified method.
    (4) Definitions.
    (e) Recomputation year.
    (1) In general.
    (2) Look-back method inapplicable in certain de minimis cases.
    (f) De minimis basis exception.
    (g) Treatment of look-back interest.
    (1) In general.
    (2) Additional interest due on interest only after tax liability 
due.
    (3) Timing of look-back interest.
    (4) Statute of limitations; compounding of interest on look-back 
interest.
    (h) Example.

Sec. 1.167(n)-7  Effective date.

Sec. 1.167(n)-1  Income forecast method.

    (a) Overview. This section and Secs. 1.167(n)-2 through 1.167(n)-7 
provide rules for computing depreciation allowances under section 167 
for property depreciated using the income forecast method. Because the 
income forecast method is only appropriate for property with unique 
income earning characteristics, only property specified in 
Sec. 1.167(n)-5 may be depreciated under the income forecast method. A 
taxpayer using the income forecast method generally computes 
depreciation allowances each year based upon the ratio of current year 
income to forecasted total income from the property as described in 
Sec. 1.167(n)-4. Current year income and forecasted total income are 
determined in accordance with the provisions of Sec. 1.167(n)-3. In 
addition, a taxpayer must determine depreciable basis for income 
forecast property in accordance with the basis rules of Sec. 1.167(n)-
2. Property depreciated under the income forecast method generally is 
subject to the look-back rules of Sec. 1.167(n)-6 whereby taxpayers 
must determine the amount of interest owed on any hypothetical 
underpayment of tax, or due on any hypothetical overpayment of tax, 
attributable to the use of estimated income in the computation of 
income forecast depreciation. Under these rules, look-back computations 
must be performed in specified recomputation years, which are generally 
the 3rd and 10th taxable years after the taxable year that the property 
is placed in service.
    (b) Method of accounting--(1) In general. The computation of 
depreciation under the income forecast method is elected on a property-
by-property basis, and is a method of accounting under section 446 that 
may not be changed without the consent of the Commissioner. However, a 
change in forecasted total income in accordance with the rules of 
Sec. 1.167(n)-4 is not a change in method of accounting requiring the 
Commissioner's consent.
    (2) Election of the income forecast method. A taxpayer elects the 
income forecast method by computing allowances for depreciation for the 
eligible property in accordance with the provisions of this section and

[[Page 38031]]

Sec. Sec. 1.167(n)-2 through Sec. 1.167(n)-6. See Sec. 1.167(n)-5 for 
rules regarding eligible property.


Sec. 1.167(n)-2  Basis.

    (a) Depreciable basis--(1) In general. The basis upon which the 
allowance for depreciation is computed with respect to income forecast 
property is the basis of the income forecast property for purposes of 
section 1011 without regard to the adjustments described in section 
1016(a)(2) and (3).
    (2) Timing of basis determinations and redeterminations. Costs paid 
or incurred in or after the taxable year in which the income forecast 
property is placed in service are taken into account in accordance with 
a taxpayer's method of accounting in redetermining the basis of income 
forecast property in the taxable year paid or incurred (i.e., when all 
events have occurred that establish the fact of the liability, the 
amount of the liability can be determined with reasonable accuracy, and 
economic performance has occurred with respect to the liability). See 
Sec. 1.446-1(c)(1)(i) and (ii), 1.461-1(a)(1) and (2), and 1.263A-1(c). 
Accordingly, contingent payments may not be included in the basis of 
income forecast property when the property is placed in service, but 
are included in the basis of income forecast property in the taxable 
year in which they are paid or incurred, even if the forecasted total 
income used in the computation of income forecast depreciation 
allowances is sufficient to indicate that the contingency will be 
satisfied.
    (3) Separate property. Certain amounts paid or incurred in taxable 
years after income forecast property is placed in service are treated 
as separate property for purposes of computing depreciation allowances 
under the income forecast method. See Sec. 1.167(n)-5(c).
    (b) Basis redeterminations. If an amount required to be capitalized 
into the basis of income forecast property is paid or incurred after 
the income forecast property is placed in service, and if the amount 
required to be capitalized is not treated as separate property in 
accordance with Sec. 1.167(n)-5(c), the basis of the income forecast 
property is redetermined and the amount required to be capitalized is 
the basis redetermination amount. The redetermined basis of the income 
forecast property is the depreciable basis of the income forecast 
property increased by the basis redetermination amount. In the year 
basis is redetermined (and in subsequent taxable years), the 
redetermined basis must be used to determine depreciation under the 
income forecast method. An additional allowance for depreciation under 
the income forecast method is allowed in the taxable year the basis of 
certain income forecast property is redetermined. See Sec. 1.167(n)-
4(c).
    (c) Unrecovered depreciable basis. For any taxable year, the 
unrecovered depreciable basis of an income forecast property is the 
depreciable basis of the property less the adjustments described in 
section 1016(a)(2) and (3).
    (d) Example. The provisions of Sec. 1.167(n)-2 are illustrated by 
the following example:

    (i) Studio contracts with Actor to star in a motion picture film 
to be produced by Studio. Both Studio and Actor are calendar year 
taxpayers; Studio is an accrual basis taxpayer and Actor is a cash 
basis taxpayer. As compensation for Actor's services, the contract 
guarantees Actor a payment of five percent of the gross income from 
the film, beginning after the film has earned a total gross income 
(net of distribution costs) of $100x. Studio estimates that the film 
will earn a total gross income of $160x by the end of the 10th 
taxable year following the taxable year that the film is placed in 
service. The film is placed in service and earns $65x of gross 
income in year one, $30x in year two, and $25x in year three. 
Because the income from the film does not exceed $100x in either 
year one or year two, Studio pays nothing under the contract to 
Actor in years one and two. In year three, the cumulative income 
from the film reaches $120x, which exceeds the $100x threshold by 
$20x. Based on this excess, Studio calculates that it owes Actor 
$1x, calculated by multiplying $20x by Actor's contractual 
percentage of five percent. Studio pays $1x to Actor 20 days after 
the end of year three.
    (ii) Studio may not include the $1x paid to Actor in the basis 
of the film in years one or two because Studio does not have a fixed 
liability to pay Actor any amount under the contract in years one 
and two. Furthermore, while Studio does have a fixed liability to 
pay Actor $1x in year three, the requirements of section 404 are not 
met in year three and Studio thus may not include the $1x in the 
basis of the film in year three. In year four, when section 404 is 
satisfied, Studio incurs the $1x in accordance with Sec. 1.263A-1(c) 
and increases its basis in the film. The $1x is treated as a basis 
redetermination amount under Sec. 1.167(n)-2(b) in year four.

Sec. 1.167(n)-3  Income from the property.

    (a) Current year income--(1) In general. Current year income is the 
income from an income forecast property for the current year (less the 
distribution costs of the income forecast property for such year), 
determined in accordance with the taxpayer's method of accounting. All 
income earned in connection with the income forecast property is 
included in current year income, except as provided in paragraph (d) of 
this section. In the case of a film, television show, or similar 
property, such income includes, but is not limited to--
    (i) Income from foreign and domestic theatrical, television, and 
other releases and syndications;
    (ii) Income from releases, sales, rentals, and syndications of 
video tape, DVD, and other media; and
    (iii) Incidental income associated with the property, such as 
income from the financial exploitation of characters, designs, titles, 
scripts, and scores, but only to the extent that such incidental income 
is earned in connection with the ultimate use of such items by, or the 
ultimate sale of merchandise to, persons who are not related to the 
taxpayer (within the meaning of section 267(b)).
    (2) Special rule for advance payments. In the year that income 
forecast property is placed in service, current year income for an 
income forecast property includes income included in gross income for 
any prior taxable year in connection with the property. This paragraph 
applies separately to any cost treated as separate property under 
Sec. 1.167(n)-5(c).
    (b) Forecasted total income. Forecasted total income is the sum of 
current year income for the year that income forecast property is 
placed in service, plus all income from the income forecast property 
that the taxpayer reasonably believes will be includible in current 
year income in subsequent taxable years (as adjusted for distribution 
costs) up to and including the 10th taxable year after the year in 
which the income forecast property is placed in service. Forecasted 
total income is based on the conditions known to exist at the end of 
the taxable year for which the income forecast property is placed in 
service.
    (c) Revised forecasted total income. If information is discovered 
in a taxable year following the year in which income forecast property 
is placed in service that indicates that forecasted total income is 
inaccurate, a taxpayer must compute revised forecasted total income for 
the taxable year. Revised forecasted total income is based on the 
conditions known to exist at the end of the taxable year for which the 
revised forecast is being made. Revised forecasted total income for the 
taxable year is the sum of current year income for the taxable year and 
all prior taxable years, plus all income from the income forecast 
property that the taxpayer reasonably believes will be includible in 
current year income in taxable years after the current taxable year up 
to and including the 10th taxable year after the year in which the 
income forecast property is placed in service. Where a taxpayer

[[Page 38032]]

computes revised forecasted total income in accordance with this 
Sec. 1.167(n)-3(c), see Sec. 1.167(n)-4(b) for the computation of the 
allowance for income forecast depreciation.
    (d) Special rules--(1) Disposition of the property. In computing 
the depreciation allowance for an income forecast property, income from 
the sale or other disposition of income forecast property is not 
included in current year income. However, if the income forecast 
property is disposed of prior to the end of the 10th taxable year 
following the taxable year in which the property is placed in service, 
income from the sale or other disposition of income forecast property 
is taken into account in calculating revised forecasted total income 
both for purposes of calculating the allowance for depreciation in the 
year of disposition and for purposes of applying look-back. See 
Sec. 1.167(n)-4(d)(3) and Sec. 1.167(n)-6(c)(2).
    (2) Syndication income from television series. (i) In the case of a 
television series produced for distribution on television networks, 
current year income and forecasted total income (or, if applicable, 
revised forecasted total income) used in the computation of the 
depreciation allowance for such property under Sec. 1.167(n)-4 need not 
include income from syndication of the television series before the 
earlier of--
    (A) The fourth taxable year beginning after the date the first 
episode in the series is placed in service; or
    (B) The earliest taxable year in which the taxpayer has an 
arrangement relating to the syndication of the series.
    (ii) For purposes of this paragraph (d)(2), an arrangement relating 
to syndication of a series of television shows means any arrangement 
other than the first run exhibition agreement. For example, an 
arrangement for exhibition of a television series by individual 
television stations is an arrangement for syndication if it results in 
an exhibition of one or more episodes of the series beginning after one 
or more episodes of the series have been exhibited on a television 
network. A first run exhibition agreement is an agreement under which 
any episode (including a pilot episode) of a television series is first 
placed in service within a particular market.
    (3) Apportionment of income in certain circumstances. When income 
from a particular source relates to more than one income forecast 
property the taxpayer must make a reasonable allocation of the income 
among those properties based on all relevant factors. Situations where 
allocation is necessary include income generated by a syndication 
arrangement involving more than one income forecast property, 
incidental income described in paragraph (a)(1)(iii) of this section 
that relates to more than one motion picture, and income associated 
with income forecast property when expenditures relating to the 
property have given rise to separate property as defined in 
Sec. 1.167(n)-5(c). For example, when a taxpayer sells or licenses 
merchandise that features the likeness of a character that has appeared 
in more than one film, relevant factors might include merchandise sales 
figures prior to the release of the subsequent film, specific 
identification of certain merchandise with one particular film, and the 
taxpayer's prior experience with similar situations.
    (4) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. C produces a motion picture film featuring the 
adventures of a fictional character. C sells merchandise using the 
character's image, enters into licensing agreements with unrelated 
parties for the use of the image, and uses the image to promote a 
ride at an amusement park that is wholly owned by C. Pursuant to 
paragraph (a)(1) of this section, income from the sales of 
merchandise by C to consumers and income from the licensing 
agreements are included in current year income. No portion of the 
admission fees for the amusement park is included in current year 
income because the amusement part is wholly owned by C.
    Example 2. Assume the same facts as in Example 1. C forecasts 
that the cumulative amount of current year income it will earn (net 
of distribution costs) from the year it places the motion picture 
film in service through the end of the 7th taxable year thereafter 
to be $345x. C also forecasts that the motion picture film will earn 
current year income of $155x from the beginning of the 8th taxable 
year through the end of the 10th taxable year after the year the 
income forecast property is placed in service. C anticipates the 
sale of the motion picture film at the end of the 7th taxable year 
after the year the property is placed in service and in fact sells 
the motion picture film for $200x on the last day of the 7th taxable 
year after the year the property is placed in service. C's 
computations of forecasted total income must reflect the fact that C 
forecasts that $500x will be earned by the motion picture film 
through the end of the 10th taxable year after the year the property 
is placed in service ($345x from the year the film is placed in 
service through the end of the 7th taxable year after the taxable 
year that the property was placed in service, plus $155x C forecasts 
from the beginning of the 8th taxable year through the end of the 
10th taxable year after the year the property is placed in service). 
Even though C only expects to earn $345x prior to the sale of the 
film, C may not use $345x as forecasted total income in computing 
its depreciation allowance under the income forecast method. 
Similarly, C may not use the combination of the amounts it expects 
to earn prior to the sale ($345x) plus the anticipated sales 
proceeds ($200x) or $545x as forecasted total income, except when 
computing its depreciation allowance for the 7th taxable year after 
the year in which the income forecast property was placed in service 
and for purposes of computing look-back interest.

Sec. 1.167(n)-4  Computation of depreciation using the income forecast 
method.

    (a) Computation of depreciation allowance. Generally, the 
depreciation allowance for an income forecast property for a given 
taxable year is computed by multiplying the depreciable or redetermined 
basis of the property (as defined in Sec. 1.167(n)-2) by a fraction, 
the numerator of which is current year income (as defined in 
Sec. 1.167(n)-3(a)) and the denominator of which is forecasted total 
income (as defined in Sec. 1.167(n)-3(b)).
    (b) Revised computation--(1) Change in estimated income. The 
depreciation allowance for an income forecast property for any taxable 
year following the year in which income forecast property is placed in 
service may be computed using the computation provided in this 
paragraph (b)(1) if revised forecasted total income differs from 
forecasted total income. Thus, for example, a taxpayer using the income 
forecast method for a motion picture may revise upward the forecast of 
total income from the motion picture (to arrive at revised forecasted 
total income) in a taxable year wherein the taxpayer discovers that the 
motion picture is more popular than originally expected, and may 
thereafter use the revised computation to compute the allowance for 
income forecast depreciation for the motion picture. Under the revised 
computation, the unrecovered depreciable basis of the income forecast 
property (as defined in Sec. 1.167(n)-2(c)) is multiplied by a 
fraction, the numerator of which is current year income and the 
denominator of which is obtained by subtracting from revised forecasted 
total income the amounts of current year income from prior taxable 
years.
    (2) Requirement to use the revised computation. The revised 
computation described in paragraph (b)(1) of this section must be used 
in any taxable year following the year in which income forecast 
property is placed in service if forecasted total income (as defined in 
Sec. 1.167(n)-3(b)) (or, if applicable, revised forecasted total income 
(as defined in Sec. 1.167(n)-3(c)) in the immediately preceding taxable 
year is either--

[[Page 38033]]

    (i) Less than 90 percent of revised forecasted total income for the 
taxable year; or
    (ii) Greater than 110 percent of revised forecasted total income 
for the taxable year.
    (c) Basis redeterminations--(1) Calculation of depreciation 
allowance. An additional depreciation allowance is available under this 
paragraph in the taxable year that basis is redetermined under 
Sec. 1.167(n)-2(b) when that taxable year is subsequent to the taxable 
year in which income forecast property is placed in service, but prior 
to the 10th taxable year following the taxable year in which the 
property is placed in service. The additional depreciation allowance is 
that portion of the basis redetermination amount that would have been 
recovered through depreciation allowances in prior taxable years if the 
basis redetermination amount had been included in depreciable basis in 
the taxable year that the property was placed in service. This 
Sec. 1.167(n)-4(c) does not apply to property treated as a single 
income forecast property pursuant to Sec. 1.167(n)-5(d)(1) through (4).
    (2) Example. The provisions of paragraph (c)(1) of this section are 
illustrated by the following example:

    Example. D, an accrual basis movie producer, enters into a 
contract with E, an author, under which D will make a film based on 
E's book. E performs no services for D, but merely permits D to use 
the book as a basis for D's film. D pays E a fixed dollar amount 
upon entry into the agreement and promises to pay E a contingent 
payment of five percent of D's income from the film, beginning after 
the film has earned $100,000 (net of distribution costs). D 
estimates that forecasted total income from the film will be 
$200,000. The film earns $65,000 of current year income in year one, 
$30,000 in year two, and $25,000 in year three. D takes allowances 
for depreciation in year one ($65,000 divided by $200,000, 
multiplied by the basis of the film) and year two ($30,000 divided 
by $200,000, multiplied by the basis of the film). In year three, 
D's liability to E becomes fixed and D pays E $1,000. The $1,000 
incurred by D is a basis redetermination amount that increases the 
basis of the film for purposes of computing D's depreciation 
allowance for the film for year three. In addition to the year three 
allowance based on current year income ($25,000 divided by $200,000 
multiplied by the basis of the film, which includes for year three 
the $1,000 basis redetermination amount), D is entitled to an 
additional allowance for depreciation for year three under paragraph 
(c)(1). This additional allowance is $475, the sum of the allowance 
of $325 that would have been allowed in year one ($65,000 divided by 
$200,000, multiplied by the $1,000 payment to E) and the allowance 
of $150 that would have been allowed in year two ($30,000 divided by 
$200,000, multiplied by $1,000) if the $1,000 had been included in 
basis in the year that the film was placed in service.

    (d) Special rules--(1) Final year depreciation. Except as provided 
in paragraphs (d)(2) and (3) of this section, a taxpayer may deduct as 
a depreciation allowance the remaining depreciable basis of income 
forecast property depreciated under the income forecast method in the 
earlier of--
    (i) The year in which the taxpayer reasonably believes, based on 
the conditions known to exist at the end of the taxable year, that no 
income from the income forecast property will be included in current 
year income in any subsequent taxable year up to and including the 10th 
taxable year following the taxable year the income forecast property is 
placed in service; or
    (ii) The 10th taxable year following the taxable year the income 
forecast property is placed in service.
    (2) Certain basis redeterminations. A taxpayer may deduct as a 
depreciation allowance the amount of any basis redetermination that 
occurs in a taxable year in which the taxpayer reasonably believes, 
based on the conditions known to exist at the end of the taxable year, 
that no income from the income forecast property will be included in 
current year income in any subsequent taxable year. In addition, a 
taxpayer may deduct as a depreciation allowance the amount of any basis 
redetermination that occurs in a taxable year following a taxable year 
in which a deduction is allowable under paragraph (d)(1) of this 
section.
    (3) Disposition of property. Paragraph (d)(1) of this section does 
not apply to income forecast property that is sold or otherwise 
disposed of before the end of the 10th taxable year following the 
taxable year that the property is placed in service. In the case of 
such a disposition, the allowance for depreciation in the year of 
disposition is calculated by multiplying the depreciable basis (or, if 
applicable, the redetermined basis) of the property by a fraction, the 
numerator of which is current year income and the denominator of which 
is the sum of the amount realized on the disposition of the property 
plus all amounts included in current year income in the year of 
disposition and in taxable years prior to the year of disposition.
    (4) Separate property. The deductions provided in paragraphs (d)(1) 
and (2) of this section apply separately to property that is treated as 
separate property under Sec. 1.167(n)-5(c).
    (e) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1. F places in service income forecast property with a 
depreciable basis of $100x, and estimates that forecasted total 
income from the property will be $200x. In taxable year one, current 
year income is $80x. The depreciation allowance for year one is 
$40x, computed by multiplying the depreciable basis of the property 
of $100x by the fraction obtained by dividing current year income of 
$80x by forecasted total income of $200x.
    Example 2. Assume the same facts as in Example 1. In year two, 
F's current year income is $40x. In addition, F computes revised 
forecasted total income to be $176x. F is required to compute its 
depreciation allowance for this property using the revised 
computation of paragraph (b)(1) of this section because forecasted 
total income in year one of $200x is greater than 110 percent of 
revised forecasted total income in year two (110 percent of $176x = 
$193.6x). The depreciation allowance for taxable year two computed 
under the revised computation is $25x, computed by multiplying the 
unrecovered depreciable basis of $60x by the fraction obtained by 
dividing current year income of $40x by $96x (revised forecasted 
total income of $176x less current year income from prior taxable 
years of $80x).
    Example 3. Assume the same facts as in Example 2. Because F used 
the revised computation in year two, the revised computation applies 
in year three. In year three, F's current year income is $32x. The 
depreciation allowance for year three computed under the revised 
computation is $20x, computed by multiplying the unrecovered 
depreciable basis of $60x by the fraction obtained by dividing 
current year income of $32x by $96x (revised forecasted total income 
of $176x less current year income from taxable years prior to the 
change in estimate taxable year of $80x).

Sec. 1.167(n)-5  Property for which the income forecast method may be 
used.

    (a) In general. The depreciation allowance under Sec. 1.167(n)-4 
may be computed under the income forecast method only with respect to 
eligible property. Eligible property is limited to an interest 
(including interests involving limited rights in property) in the 
following property--
    (1) Property described in section 168(f)(3) and (4);
    (2) Copyrights;
    (3) Books;
    (4) Patents;
    (5) Theatrical productions; and
    (6) Other property as designated in published guidance by the 
Commissioner.
    (b) Specific exclusions. The income forecast method does not apply 
to any amortizable section 197 intangible (as defined in section 197(c) 
and Sec. 1.197-2(d)).
    (c) Costs treated as separate property--(1) Costs giving rise to a 
significant increase in income--(i) In general. For purposes of 
Sec. 1.167(n)-1 through Sec. 1.167(n)-6, any amount paid or incurred 
after the income forecast

[[Page 38034]]

property is placed in service must be treated as a separate property if 
the cost is significant and gives rise to an increase in income that is 
significant and that was not included in either forecasted total income 
or revised forecasted total income in a prior taxable year.
    (ii) Exception for de minimis amounts. For purposes of this 
paragraph, a cost that is less than the lesser of 5 percent of the 
depreciable basis (as of the date the amount is paid or incurred) of 
the income forecast property to which the amount relates or $100,000 is 
not significant. Such a cost is therefore not treated as separate 
property but is instead treated as a basis redetermination amount in 
accordance with Sec. 1.167(n)-2(b).
    (2) Significant increase in income. For purposes of this paragraph, 
whether an increase in income is significant is determined by comparing 
the amount that would be considered revised forecasted total income 
from the amounts treated as separate property to the most recent 
estimate of forecasted total income or revised forecasted total income 
used in calculating an allowance for depreciation with respect to the 
income forecast property.
    (3) Special rule for costs paid or incurred after the end of the 
final year. For purposes of Sec. 1.167(n)-1 through Sec. 1.167(n)-6, 
any amount paid or incurred with respect to an income forecast property 
in a taxable year following the year in which the taxpayer claims a 
depreciation allowance in accordance with the final year depreciation 
rules of Sec. 1.167(n)-4(d)(1) is treated as a basis redetermination 
amount under Sec. 1.167(n)-2(b) provided the amount is not expected to 
give rise to a significant increase in current year income in any 
taxable year.
    (4) Time separate property is placed in service. Separate property 
is treated as placed in service in the year the amount giving rise to 
the property is paid or incurred.
    (5) Examples. The provisions of this paragraph (c) are illustrated 
in the following examples:

    Example 1. G releases a film in 2001 and begins to recover the 
depreciable basis in the film using the income forecast method in 
the year 2001. In 2003, the film is re-edited and restored, and 
director's commentary is added in order to prepare the film for 
release on DVD. The total cost of preparing the film for the DVD 
release exceeds both 5 percent of the depreciable basis of the film 
and $100,000. G did not anticipate the income from the DVD market, 
and did not include any DVD release income in the income projections 
for the film in prior years. If G anticipates that the additional 
DVD release income will be significant in relation to the forecasted 
total income used in calculating an allowance for depreciation for 
2002 (the previous taxable year), the additional amount gives rise 
to separate property and must be recovered over the forecasted total 
income from the DVD. If not, G must treat the additional amounts as 
additions to basis under Sec. 1.167(n)-2(b).
    Example 2. G releases a film in 2001 and recovers the 
depreciable basis in the film using the income forecast method in 
the years 2001 through 2011. In 2018, the film is re-edited and 
restored, and director's commentary is added in order to prepare the 
film for release on a newly discovered technology. If G anticipates 
that the additional new technology release income will be 
significant in relation to the revised forecasted total income used 
in calculating an allowance for depreciation for 2011 (the last 
taxable year for which an allowance was claimed), the cost of 
preparing the release gives rise to separate property and must be 
recovered over the forecasted total income from the new technology 
release. If not, G may deduct the cost in 2018, the year paid or 
incurred.

    (d) Aggregations treated as a single income forecast property. 
Taxpayers must apply the income forecast method on a property-by-
property basis, unless one of the aggregation rules provided in 
paragraphs (d)(1) through (4) of this section applies. If a taxpayer 
applies one of the aggregation rules provided in paragraphs (d)(1) 
through (4) of this section, costs incurred in taxable years after the 
initial income forecast property is placed in service are treated as 
basis redeterminations under Sec. 1.167(n)-2; however, the additional 
allowance for depreciation provided in Sec. 1.167(n)-4(c)(1) does not 
apply. The application of the provisions of paragraphs (d)(1) through 
(d)(4) is a method of accounting that may not be changed without the 
consent of the Commissioner. Permissible aggregations are limited to 
the following:
    (1) Multiple episodes of a television series produced in the same 
taxable year. The producer of a television series may treat multiple 
episodes of a single television series produced in the same taxable 
year as a single unit of property for purposes of the income forecast 
method.
    (2) Multiple episodes of a television series produced in more than 
one taxable year. The producer of a television series may treat 
multiple episodes of a single television series that are produced as a 
single season of episodes and placed in service over a period not in 
excess of twelve consecutive calendar months as a single unit of 
property for purposes of the income forecast method notwithstanding 
that the twelve-month period may span more than one taxable year.
    (3) Multiple interests acquired pursuant to a single contract. 
Multiple interests in specifically identified income forecast 
properties acquired for broadcast pursuant to a single contract may be 
treated as a single unit of property for purposes of the income 
forecast method.
    (4) Videocassettes and DVDs. The purchaser or licensee of 
videocassettes and DVDs for rental to the public may treat multiple 
copies of the same title purchased or licensed in the same taxable year 
as a single unit of property for purposes of the income forecast 
method.


Sec. 1.167(n)-6  Look-back method.

    (a) Application of the look-back method. If a taxpayer claims a 
depreciation deduction under the income forecast method for any 
eligible income forecast property, such taxpayer is required to pay (or 
is entitled to receive) interest computed as described in this 
paragraph for any year to which the look-back method applies (a 
recomputation year). The look-back method generally must be applied 
when income forecast property is disposed of or ceases to generate 
income. Further, the look-back method generally applies in the 3rd and 
10th taxable years following the year in which income forecast property 
is placed in service. Under the look-back method, taxpayers must pay 
interest on deductions accelerated by the underestimation of either 
forecasted total income or revised forecasted total income from income 
forecast property. Conversely, taxpayers are entitled to receive 
interest on deductions delayed by the overestimation of either 
forecasted total income or revised forecasted total income from income 
forecast property. If either forecasted total income or revised 
forecasted total income are overestimated or underestimated, interest 
may arise from basis redeterminations. The computation of adjusted tax 
liability as part of the look-back method is hypothetical; application 
of the look-back method does not require a taxpayer to adjust tax 
liability as reported on the taxpayer's tax returns, on an amended 
return, or as adjusted on examination for prior years.
    (b) Operation of the look-back method--(1) In general. Under the 
look-back method, a taxpayer must perform a series of computations to 
determine look-back interest that the taxpayer is either required to 
pay or entitled to receive. As specified in paragraph (c) of this 
section, a taxpayer must first recompute depreciation allowances using 
revised forecasted total income rather than forecasted total income 
from

[[Page 38035]]

income forecast property for the recomputation year (as defined in 
paragraph (e) of this section) and each prior year. These recomputed 
depreciation amounts are then used to determine a hypothetical tax 
liability that would have arisen had the taxpayer used revised 
forecasted total income rather than forecasted total income in 
determining depreciation allowances. The hypothetical tax liability is 
compared to the taxpayer's prior tax liability and interest is 
calculated in accordance with paragraph (d) of this section on the 
resulting hypothetical overpayments or underpayments of tax for each 
year. Reporting requirements and special rules for the resulting 
amounts of interest are specified in paragraph (g) of this section.
    (2) Property-by-property application. Except as provided in this 
section, the look-back method applies to each property for which the 
income forecast method is used. Aggregations properly treated as a 
single income forecast property pursuant to Sec. 1.167(n)-5(d) are 
treated as a single property for purposes of applying the look-back 
method.
    (c) Recalculation of depreciation allowances--(1) Computation. 
Under the look-back method, a taxpayer must compute the depreciation 
allowances for each income forecast property subject to the look-back 
method that would have been allowable under Sec. 1.167(n)-1 through 
Sec. 1.167(n)-5 for prior taxable years if the computation of the 
amounts so allowable had been made using revised forecasted total 
income as calculated at the end of the recomputation year.
    (2) Revised forecasted total income from the property--(i) In 
general. Except as provided in this paragraph (c)(2), revised 
forecasted total income is determined in accordance with Sec. 1.167(n)-
3(c).
    (ii) Syndication income from television series. Income excluded 
from forecasted total income (or, if appropriate revised forecasted 
total income) in any taxable year prior pursuant to Sec. 1.167(n)-
3(d)(2) is excluded from revised forecasted total income for purposes 
of this section for that year.
    (iii) Disposition of income forecast property. For purposes of this 
section, income from the disposition of property must be taken into 
account in determining the amount of revised forecasted total income. 
Thus, when income forecast property is disposed of prior to the end of 
the 10th taxable year following the taxable year the property is placed 
in service, revised forecasted total income from the property for the 
year of disposition is deemed to be the sum of the amount realized on 
the disposition of the property plus all amounts included in current 
year income in the year of disposition and in taxable years prior to 
the year of disposition.
    (3) Special rule for basis redeterminations. For purposes of the 
look-back calculation, any amount that is not treated as a separate 
property under Sec. 1.167(n)-5(c) that is paid or incurred with respect 
to income forecast property after the property is placed in service is 
taken into account by discounting (using the Federal mid-term rate 
determined under section 1274(d) as of the time the cost is paid or 
incurred) the amount to its value as of the date the property is placed 
in service. The taxpayer may elect for the recomputation year with 
respect to any income forecast property to have the preceding sentence 
not apply to the property by taking the amount into account in the year 
that the amount was paid or incurred in the same manner as it was taken 
into account under Sec. 1.167(n)-2.
    (d) Hypothetical overpayment or underpayment of tax--(1) In 
general--(i) Years for which a hypothetical overpayment or underpayment 
must be computed. After recalculating depreciation allowances in 
accordance with paragraph (c) of this section, a taxpayer must 
calculate a hypothetical overpayment or underpayment of tax for each 
prior taxable year for which income tax liability is affected by the 
change in depreciation allowances. A redetermination of income tax 
liability is required for every tax year for which the income tax 
liability would have been affected by a change in the allowance for 
income forecast depreciation in any year. For example, if the change in 
depreciation allowance results in a net operating loss carryforward 
that affects income tax liability in a subsequent taxable year, income 
tax liability must be recomputed for such subsequent year.
    (ii) Methods of determining a hypothetical overpayment or 
underpayment. Generally, the calculation of the hypothetical 
overpayment or underpayment of tax must be made under the method 
described in paragraph (d)(2) of this section. Certain taxpayers are 
required to use the simplified method contained in paragraph (d)(3) of 
this section.
    (iii) Cumulative determination of hypothetical income tax 
liability. The redetermination of income tax liability in any prior 
taxable year for which income tax liability is affected by the change 
in depreciation allowances must take into account all previous 
applications of the look-back calculation. Thus, for example, in 
computing the amount of a hypothetical overpayment or underpayment of 
tax for a prior taxable year for which income tax liability is affected 
by the change in depreciation allowances, the hypothetical income tax 
liability is compared to the hypothetical income tax liability for that 
year determined as of the previous application of the look-back method.
    (2) Hypothetical overpayment or underpayment, actual 
recomputation--(i) Computation of change in income tax liability. The 
hypothetical overpayment or underpayment is calculated first by 
redetermining the tax liability for each prior taxable year (either as 
originally reported, or as subsequently adjusted on examination or by 
amended return) using depreciation allowances calculated in paragraph 
(c) of this section for each prior taxable year in which depreciation 
allowances were determined under the income forecast method for the 
income forecast property (affected year). These recomputed depreciation 
allowances are then substituted for the depreciation allowances allowed 
(or allowable) for each affected year (whether originally reported, or 
as subsequently adjusted on examination or by amended return) and a 
revised taxable income is computed. A hypothetical income tax liability 
is then computed for each affected year using revised taxable income 
for that year. The hypothetical income tax liability for any affected 
year must be computed by taking into account all applicable additions 
to tax, credits, and net operating loss carrybacks and carryforwards. 
The tax, if any, imposed under section 55 (relating to alternative 
minimum tax) must be taken into account. Hypothetical income tax 
liability for each affected year is then compared to the tax liability 
determined as of the latest of the following dates--
    (A) The original due date of the return (including extensions);
    (B) The date of a subsequently amended or adjusted return; or
    (C) The date of the previous application of the look-back method, 
in which case the hypothetical income tax liability for the affected 
year used in the most recent previous application of the look-back 
method (previous hypothetical tax liability) is used.
    (ii) Determination of interest. Once the hypothetical overpayment 
or underpayment for each year is computed, the adjusted overpayment 
rate under section 460(b)(7), compounded daily, is applied to the 
overpayment or underpayment determined under paragraph (d)(2)(i) of

[[Page 38036]]

this section for the period beginning with the due date of the return 
(determined without regard to extensions) for the year in which either 
an overpayment or underpayment arises, and ending on the earlier of the 
due date of the return (determined without regard to extensions) for 
the redetermination year, or the first date by which both the income 
tax return for the filing year is filed and the tax for that year has 
been paid in full. The amounts of interest on overpayments are then 
netted against interest on underpayments to arrive at look-back 
interest that must be paid by the taxpayer or that the taxpayer is 
entitled to receive.
    (iii) Changes in the amount of a loss or credit carryback or 
carryforward. If a recomputation of income forecast depreciation 
results in an increase or decrease to a net operating loss carryback 
(but not a carryforward), the interest a taxpayer is entitled to 
receive or required to pay must be computed on the decrease or increase 
in tax attributable to the change to the carryback only from the due 
date (not including extensions) of the return for the prior taxable 
year that generated the carryback and not from the due date of the 
return for the prior taxable year in which the carryback was absorbed. 
In the case of a change in the amount of a carryforward as a result of 
applying the look-back method, interest is computed from the due date 
of the return for the years in which the carryforward was absorbed.
    (iv) Changes in the amount of income tax liability that generated a 
subsequent refund. If the hypothetical income tax liability for any 
affected year is less than the amount of the affected year tax 
liability (as reported on the taxpayer's original return, as 
subsequently adjusted on examination, as adjusted by amended return, or 
as redetermined by the last previous application of the look-back 
method), and any portion of the affected year tax liability was 
refunded as a result of a loss or credit carryback arising in a year 
subsequent to the affected year, the look-back method applies as 
follows to properly reflect the time period of the use of the tax 
overpayment. To the extent the amount of refund because of the 
carryback exceeds the hypothetical income tax liability for the 
affected year, the taxpayer is entitled to receive interest only until 
the due date (not including extensions) of the return for the year in 
which the carryback arose.
    (v) Example. The provisions of this paragraph (d)(2) are 
illustrated by the following example:

    Example. Upon the cessation of income from an income forecast 
property in 2003, the taxpayer computes a hypothetical income tax 
liability for 2001 under the look-back method. This computation 
results in a hypothetical income tax liability ($1,200x) that is 
less than the actual income tax liability the taxpayer originally 
reported ($1,500x). In addition, the taxpayer had already received a 
refund of some or all of the actual 2001 income tax liability by 
carrying back a net operating loss (NOL) that arose in 2002. The 
time period over which interest would be computed on the 
hypothetical overpayment of $300x for 2001 would depend on the 
amount of the refund generated by the carryback, as illustrated by 
the following three alternative situations:
    (i) If the amount refunded because of the NOL is $1,500x, 
interest is credited to the taxpayer on the entire hypothetical 
overpayment of $300x from the due date of the 2001 return, when the 
hypothetical overpayment occurred, until the due date of the 2002 
return, when the taxpayer received a refund for the entire amount of 
the 2001 tax, including the hypothetical overpayment.
    (ii) If the amount refunded because of the NOL is $1,000x, 
interest is credited to the taxpayer on the entire amount of the 
hypothetical overpayment of $300x from the due date of the 2001 
return, when the hypothetical overpayment occurred, until the due 
date of the 2003 return. In this situation interest is credited 
until the due date of the return for the recomputation year, rather 
than the due date of the return for the year in which the carryback 
arose, because the amount refunded was less than the hypothetical 
income tax liability of $1,200x. Therefore, no portion of the 
hypothetical overpayment is treated as having been refunded to the 
taxpayer before the recomputation year.
    (iii) If the amount refunded because of the NOL is $1,300x, 
interest is credited to the taxpayer on $100x ($1,300x-$1,200x) from 
the due date of the 2001 return until the due date of the 2002 
return because only this portion of the total hypothetical 
overpayment is treated as having been refunded to the taxpayer 
before the recomputation year. However, the taxpayer did not receive 
a refund for the remaining $200x of the overpayment at that time 
and, therefore, is credited with interest on $200x through the due 
date of the tax return for 2003, the recomputation year.

    (3) Hypothetical overpayment or underpayment, simplified method--
(i) Introduction. This paragraph provides a simplified method for 
calculating look-back interest. A pass-through entity that is not a 
closely held pass-through entity is required to apply the simplified 
method at the entity level with respect to income forecast property and 
the owners of the entity do not calculate look-back interest for the 
property. Under the simplified method, a taxpayer calculates the 
hypothetical underpayments or overpayments of tax for a prior year 
based on an assumed marginal tax rate.
    (ii) Operation of the simplified method. Under the simplified 
method, depreciation allowances for income forecast property are first 
recomputed in accordance with the procedures contained in paragraph (c) 
of this section. These recomputed depreciation allowances are then 
compared with depreciation allowances allowed (or allowable) for each 
prior taxable year (whether originally reported, as subsequently 
adjusted on examination or by amended return, or as recomputed in the 
most recent previous application of the look-back method) to arrive at 
changes in depreciation allowances for the income forecast property. 
When multiple properties are subject to the look-back method in any 
given affected year, the changes in depreciation allowances 
attributable to each income forecast property determined in accordance 
with paragraph (c) of this section for each such year are cumulated or 
netted against one another to arrive at a net change in income forecast 
depreciation for purposes of computing the hypothetical overpayment or 
underpayment attributable to the year. The hypothetical underpayment or 
overpayment of tax for each affected year is then determined by 
multiplying the applicable regular tax rate (as defined in paragraph 
(d)(3)(iv) of this section) by the increase or decrease in depreciation 
allowances.
    (iii) Determination of interest. Interest is credited to the 
taxpayer on the net overpayment and is charged to the taxpayer on the 
net underpayment for each affected year by applying the adjusted 
overpayment rate under section 460(b)(7), compounded daily, to the 
overpayment or underpayment determined under paragraph (d)(3)(ii) of 
this section for the period beginning with the due date of the return 
(determined without regard to extensions) for the affected year, and 
ending on the earlier of the due date of the return (determined without 
regard to extensions) for the recomputation year, or the first date by 
which both the income tax return for the recomputation year is filed 
and the tax for that year has been paid in full. The resulting amounts 
of interest are then netted to arrive at look-back interest that must 
be paid by the taxpayer or that the taxpayer is entitled to receive.
    (iv) Applicable tax rate. For purposes of determining hypothetical 
underpayments or overpayments of tax under the simplified method, the 
applicable regular rate is generally the highest rate of tax in effect 
for corporations under section 11. However, the applicable regular tax 
rate is the

[[Page 38037]]

highest rate of tax imposed on individuals under section 1 if, at all 
times during all affected years, more than 50 percent of the interests 
in the entity were held by individuals directly or through 1 or more 
pass-through entities. The highest rate of tax imposed on individuals 
is determined without regard to any additional tax imposed for the 
purpose of phasing out multiple tax brackets or exemptions.
    (4) Definitions--(i) Pass-through entity. For purposes of this 
section, a pass-through entity is either a partnership, an S 
corporation, an estate or a trust.
    (ii) Closely-held pass-through entity. A closely-held pass-through 
entity is a pass-through entity that, at any time during any year for 
which allowances for depreciation are recomputed, 50 percent or more 
(by value) of the beneficial interests in that entity are held 
(directly or indirectly) by or for 5 or fewer persons. For this 
purpose, the term person has the same meaning as in section 7701(a)(1), 
except that a pass-through entity is not treated as a person. In 
addition, the constructive ownership rules of section 1563(e) apply by 
substituting the term beneficial interest for the term stock and by 
substituting the term pass-through entity for the term corporation used 
in that section, as appropriate, for purposes of determining whether a 
beneficial interest in a pass-through entity is indirectly owned by any 
person.
    (e) Recomputation year--(1) In general. Except as provided in this 
paragraph (e), the term recomputation year means, with respect to any 
income forecast property--
    (i) The earlier of--
    (A) The year the income from the income forecast property ceases 
with respect to the taxpayer (and with respect to any person who would 
be treated as a single taxpayer with the taxpayer under rules similar 
to those in section 41(f)(1)); or
    (B) The 3rd taxable year beginning after the taxable year in which 
the income forecast property was placed in service; and
    (ii) The earlier of--
    (A) The year the income from the income forecast property ceases 
with respect to the taxpayer (and with respect to any person who would 
be treated as a single taxpayer with the taxpayer under rules similar 
to those in section 41(f)(1)); or
    (B) The 10th taxable year following the taxable year the income 
forecast property is placed in service.
    (2) Look-back method inapplicable in certain de minimis cases--(i) 
De minimis difference between actual and forecasted income. A taxable 
year described in paragraph (e)(1) of this section is not a 
recomputation year if forecasted total income (as defined in 
Sec. 1.167(n)-3(b)) or, where applicable, revised forecasted total 
income (as defined in Sec. 1.167(n)-3(c)), for each preceding taxable 
years is--
    (A) Greater than 90 percent of revised forecasted total income for 
the taxable year that would otherwise be a recomputation year; and
    (B) Less than 110 percent of revised forecasted total income for 
the taxable year that would otherwise be a recomputation year.
    (ii) Application of the de minimis rule where the look-back method 
was previously applied. For purposes of applying paragraph (e)(2)(i) of 
this section in any taxable year after a taxable year in which the 
look-back method has previously been applied, revised forecasted total 
income for the year the look-back method was applied, forecasted total 
income for the year the income forecast property was placed in service, 
and revised forecasted total income for all taxable years preceding the 
taxable year in which the look-back method was previously applied are 
deemed to be equal to the amount of revised forecasted total income 
that was used for purposes of applying the look-back method in the most 
recent taxable year for which the look-back method was applied.
    (f) De minimis basis exception. The look-back method does not apply 
to any income forecast property with an adjusted basis, determined in 
accordance with section 1011 but without regard to the adjustments 
described in section 1016(a)(2) and (3), as of the close of any year 
that would otherwise be a recomputation year of $100,000 or less.
    (g) Treatment of look-back interest--(1) In general. The amount of 
interest a taxpayer is required to pay is treated as an income tax 
under Subtitle A of the Internal Revenue Code, but only for purposes of 
Subtitle F of the Internal Revenue Code (other than sections 6654 and 
6655), which addresses tax procedure and administration. Thus, a 
taxpayer that fails to report look-back interest when due is subject to 
any penalties under Subtitle F of the Internal Revenue Code applicable 
to a failure to report and pay a tax liability. However, look-back 
interest to be paid is treated as interest arising from an underpayment 
of tax under Subtitle A of the Internal Revenue Code, even though it is 
treated as an income tax liability for penalty purposes. Thus, look-
back interest required to be paid by an individual, or by a pass-
through entity on behalf of an individual owner (or beneficiary) under 
the simplified method, is personal interest and, therefore, is not 
deductible in accordance with Sec. 1.163-9T(b)(2). Interest received 
under the look-back method is treated as taxable interest income for 
all purposes, and is not treated as a reduction in tax liability. The 
determination of whether interest computed under the look-back method 
is treated as income tax under Subtitle A of the Internal Revenue Code 
is determined on a net basis for each recomputation year. Thus, if a 
taxpayer computes both hypothetical overpayments of tax and 
hypothetical underpayments of tax for years prior to any given 
recomputation year, the taxpayer has an increase in tax only if the 
total interest computed on underpayments for all prior taxable years 
for which income tax liability is affected by the application of the 
look-back method exceeds the total interest computed on overpayments 
for such years, taking into account all income forecast property for 
which the look-back method is required. Interest determined at the 
entity level under the simplified method is allocated among the owners 
(or beneficiaries) for reporting purposes in the same manner that 
interest income and interest expense are allocated to owners (or 
beneficiaries) and subject to the allocation rules applicable to such 
entities.
    (2) Additional interest due on interest only after tax liability 
due. For each recomputation year, taxpayers are required to file a Form 
8866, ``Interest Computation Under the Look-back Method for Property 
Depreciated Under the Income Forecast Method,'' at the time the return 
for that recomputation year is filed to report the interest a taxpayer 
is required to pay or entitled to receive under the look-back method. 
Even if the taxpayer has received an extension to file its income tax 
return for the recomputation year, look-back interest is computed with 
respect to the hypothetical increase (or decrease) in the tax liability 
determined under the look-back method only until the initial due date 
of that return (without regard to the extension). Interest is charged, 
unless the taxpayer otherwise has a refund that fully offsets the 
amount of interest due, (or credited) with respect to the amount of 
look-back interest due (or to be refunded) under the look-back method 
from the initial due date of the return through the date the return is 
filed. No interest is charged (or credited) after the due date of the 
return with respect to the amount of the

[[Page 38038]]

hypothetical increases (or decreases) in tax liability determined under 
the look-back method.
    (3) Timing of look-back interest. For purposes of determining 
taxable income under Subtitle A of the Internal Revenue Code, any 
amount refunded to the taxpayer as a result of the application of the 
look-back method is includible in gross income in accordance with the 
taxpayer's method of accounting for interest income. Any amount 
required to be paid is taken into account as interest expense arising 
from an underpayment of income tax in the tax year it is properly taken 
into account under the taxpayer's method of accounting for interest 
expense.
    (4) Statute of limitations; compounding of interest on look-back 
interest. For guidance on the statute of limitations applicable to the 
assessment and collection of look-back interest owed by a taxpayer, see 
sections 6501 and 6502. A taxpayer's claim for credit or refund of 
look-back interest previously paid by or collected from a taxpayer is a 
claim for credit or refund of an overpayment of tax and is subject to 
the statute of limitations provided in section 6511. A taxpayer's claim 
for look-back interest (or interest payable on look-back interest) that 
is not attributable to an amount previously paid or collected from a 
taxpayer is a general claim against the federal government. For 
guidance on the statute of limitations that applies to general claims 
against the federal government, see 28 U.S.C. 2401 and 2501. For 
guidance applicable to the compounding of interest when the look-back 
interest is not paid, see sections 6601 to 6622.
    (h) Example. The provisions of this section are illustrated by the 
following example:

    Example.  (i) H, a calendar year corporation, creates a motion 
picture at a cost of $60x. H completes the motion picture in 2001 
and begins exhibition of the film that same year. Assume that $60x 
is greater than $100,000. In 2001, H anticipates that it will earn 
$200x from the motion picture (net of distribution costs). H 
therefore uses this amount as Forecasted Total Income when computing 
depreciation allowances for the motion picture.
    (ii) H earns current year income of $80x in 2001, $60x in 2002, 
and $40x in 2003. During the period from 2001 to 2004, one of the 
actors who appeared in H's film became more popular, and this 
increase in the actor's popularity increased the demand for H's 
film. In 2004, therefore, H revised its forecast of income from the 
film upward to $240x. H earns $20x in 2004 from the motion picture 
and $10x in 2005.
    (iii) Based on these facts, H's allowances for depreciation for 
the motion picture for 2001 would be $24x, computed by multiplying 
the depreciable basis of the motion picture of $60x by current year 
income of $80x divided by forecasted total income of $200x under 
Sec. 1.167(n)-4(a). Similarly, H's allowances for depreciation for 
the motion picture for 2002 would be $18x, computed by multiplying 
the depreciable basis of the motion picture of $60x by current year 
income of $60x divided by forecasted total income of $200x, and H's 
allowances for depreciation for the motion picture for 2003 would be 
$12x, computed by multiplying the depreciable basis of the motion 
picture of $60x by current year income of $40x divided by forecasted 
total income of $200x.
    (iv) In 2004, H determines revised forecasted total income of 
$240x in accordance with Sec. 1.167(n)-3(c). Because revised 
forecasted total income in 2004 of $240x is greater than 110 percent 
of forecasted total income used in computing the allowance for 
depreciation in the immediately preceding year (110 percent of $200x 
equals $220x), H is required under Sec. 1.167(n)-4(b)(2) to compute 
the allowance for depreciation in 2004 and thereafter using the 
revised computation. H first computes its unrecovered depreciable 
basis in the motion picture under Sec. 1.167(n)-2(c) of $6x by 
subtracting from the depreciable basis of $60x the depreciation 
allowances for 2001, 2002, and 2003 of $24x, $18x, and $12x. H then 
multiplies the unrecovered depreciable basis of $6x by the current 
year income for 2004 of $20x divided by $60x (revised forecasted 
total income $240x less current year income for all years prior to 
2004 ($80x + $60x + $40x or $180x), resulting in a depreciation 
allowance for 2004 of $2x.
    (v) In 2005, H is required to use the revised computation 
because H used it in 2004. Thus, H multiplies the unrecovered 
depreciable basis of $6x times current year income for 2005 of $10x 
divided by $60x (revised forecasted total income as computed in 
2004), resulting in a depreciation allowance for 2005 of $1x.
    (vi) Thus, H's allowances for depreciation may be summarized as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                Revised
                                        Current   Forecasted  forecasted  Depreciable  Unrecovered  Depreciation
                 Year                     year       total       total       basis     depreciable    allowance
                                         income     income      income                    basis
----------------------------------------------------------------------------------------------------------------
2001.................................        80x        200x  ..........         60x   ...........          24x
2002.................................        60x        200x  ..........         60x   ...........          18x
2003.................................        40x        200x  ..........         60x   ...........          12x
2004.................................        20x  ..........        240x  ...........          6x            2x
2005.................................        10x  ..........        240x  ...........          6x            1x
----------------------------------------------------------------------------------------------------------------

    (vii) Under paragraph (e)(1)(i)(B) of this section, 2004 is a 
recomputation year (because 2004 is the third taxable year after the 
year in which the motion picture was placed in service) unless a de 
minimis rule applies. The de minimis rule in paragraph (e)(2) of 
this section does not apply in 2004 because forecasted total income 
of $200x used in the computation of income forecast depreciation in 
2001, 2002 and 2003 is not greater than 90 percent of year 2004 
revised forecasted total income of $240x (90 percent of $240x = 
$216x). Thus, H must apply the look-back method for 2004.
    (viii) If H sells the motion picture in 2006 for $25x prior to 
earning any current year income from the motion picture, H would not 
be entitled to any allowance for depreciation in 2006. (The special 
rule of Sec. 1.167(n)-3(d)(1) precludes H from including income from 
the sale of the motion picture in current year income, H has no 
other current year income, and Sec. 1.167(n)-4(d)(3) precludes the 
use of the final year depreciation rule of Sec. 1.167(n)-4(d)(1).) 
Under paragraph (e)(1)(ii)(A) of this section, 2006 is a 
recomputation year (because in 2006 the income from the property to 
H ceases) unless a de minimis rule applies.
    (ix) To determine whether the de minimis rule applies, H is 
required to determine revised forecasted total income for 2006. 
Under paragraph (c)(2) of this section, revised forecasted total 
income for 2006 is deemed to be the sum of current year income for 
the years 2001-2006 of $210x ($80x + $60x + $40x + $20x + $10x + 
$0x) plus the amount realized from the sale of the motion picture of 
$25x or $235x. Revised forecasted total income for 2005 is $240x, 
and pursuant to paragraph (e)(2)(ii) of this section, revised 
forecasted total income for the years 2001-2004 is deemed (for 
purposes of determining whether 2006 is a recomputation year) to be 
the amount of revised forecasted total income used in the 2004 
application of the look-back method of $240x. Because $240x is 
greater than $212x (90 percent of $235x) and less than $259x (110 
percent of $235x), the de minimis rule applies and H is not required 
to apply the look-back method in 2006.


Sec. 1.167(n)-7  Effective date.

    The regulations under Sec. 1.167(n)-1 through Sec. 1.167(n)-6 are 
applicable for property placed in service on or after

[[Page 38039]]

the date that final regulations are published in the Federal Register.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 02-13578 Filed 5-30-02; 8:45 am]
BILLING CODE 4830-01-P