[Federal Register Volume 83, Number 248 (Friday, December 28, 2018)]
[Proposed Rules]
[Pages 67490-67610]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-26257]



[[Page 67489]]

Vol. 83

Friday,

No. 248

December 28, 2018

Part II





Department of the Treasury





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Internal Revenue Service





26 CFR Part 1





Limitation on Deduction for Business Interest Expense; Proposed Rules

  Federal Register / Vol. 83 , No. 248 / Friday, December 28, 2018 / 
Proposed Rules  

[[Page 67490]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-106089-18]
RIN 1545-BO73


Limitation on Deduction for Business Interest Expense

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking; notification of public hearing; 
and withdrawal of notice of proposed rulemaking.

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SUMMARY: This notice of proposed rulemaking provides rules regarding 
the limitation on the deduction for business interest expense after the 
enactment of recent tax legislation. Specifically, these regulations 
provide general rules and definitions. The regulations also provide 
rules for calculating the limitation in consolidated group, 
partnership, and international contexts. The regulations affect 
taxpayers that have deductible business interest expense, other than 
certain small businesses, electing real property trades or businesses, 
electing farming businesses, and certain utility businesses. This 
document also withdraws a notice of proposed rulemaking relating to the 
disallowance of a deduction for certain interest paid or accrued by a 
corporation. This document also provides notice of a public hearing on 
the proposed regulations.

DATES: Written or electronic comments must be received by February 26, 
2019. Outlines of topics to be discussed at the public hearing 
scheduled for February 27, 2019, at 10 a.m. must be received by 
February 26, 2019. If there is not sufficient time to discuss all of 
the topics on February 27, 2019, the hearing will continue the 
following day at 10 a.m. in the same location.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-106089-18), Room 
5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. 
Submissions may be hand-delivered Monday through Friday between the 
hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-106089-18), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC 20224, or sent electronically, via the Federal 
Rulemaking Portal at http://www.regulations.gov (indicate IRS and REG-
106089-18). The public hearing will be held in the Main IRS Auditorium 
beginning at 10 a.m. in the Internal Revenue Building, 1111 
Constitution Avenue NW, Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning Sec.  1.163(j)-1, Sec.  
1.163(j)-2, Sec.  1.163(j)-3, Sec.  1.163(j)-9, or Sec.  1.263A-9, 
Zachary King, (202) 317-4875, Charles Gorham, (202) 317-5091, Susie 
Bird, (202) 317-4860, Jaime Park, (202) 317-4877, or Sophia Wang, (202) 
317-4890; concerning Sec.  1.163(j)-4, Sec.  1.163(j)-5, Sec.  
1.163(j)-10, Sec.  1.163(j)-11, Sec.  1.381(c)(20)-1, Sec.  1.382-1, 
Sec.  1.382-2, Sec.  1.382-5, Sec.  1.382-6, Sec.  1.383-0, Sec.  
1.383-1, Sec.  1.1502-13, Sec.  1.1502-21, Sec.  1.1502-36, Sec.  
1.1502-79, Sec.  1.1502-91, Sec.  1.1502-95, Sec.  1.1502-98, Sec.  
1.1502-99, or Sec.  1.1504-4, Kevin M. Jacobs, (202) 317-5332, Russell 
Jones, (202) 317-5357, or John Lovelace, (202) 317-5363; concerning 
Sec.  1.163(j)-6 or Sec.  1.469-9(b)(2), Meghan Howard, (202) 317-5055, 
William Kostak, (202) 317-6852, Anthony McQuillen, (202) 317-5027, 
Adrienne Mikolashek, (202) 317-5050, or James Quinn (202) 317-5054; 
concerning Sec.  1.163(j)-7, Sec.  1.163(j)-8, or Sec.  1.882-5, Angela 
Holland, (202) 317-5474, Steve Jensen, (202) 317-6938, or Charles 
Rioux, (202) 317-6842; concerning Sec.  1.446-3, RICs, REITs, REMICs, 
and the definition of the term ``interest'', Michael Chin, (202) 317-
5846; concerning submissions of comments and outlines of topics for the 
public hearing, Regina Johnson (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under section 163(j) of the Internal 
Revenue Code (Code). Section 163(j) was amended as part of ``An Act to 
provide for reconciliation pursuant to titles II and V of the 
concurrent resolution on the budget for fiscal year 2018,'' Public Law 
115-97 (2017) (TCJA). Section 13301(a) of the TCJA amended section 
163(j) by removing prior section 163(j)(1) through (9) and adding 
section 163(j)(1) through (10). The provisions of section 163(j) as 
amended by section 13301 of the TCJA are effective for tax years 
beginning after December 31, 2017. Unless otherwise indicated, all 
references to section 163(j) in this document are references to section 
163(j) as amended by the TCJA.
    Section 163(j), prior to the amendment by the TCJA (old section 
163(j)), disallowed a deduction for ``disqualified interest'' paid or 
accrued by a corporation in a taxable year if two threshold tests were 
satisfied. The first threshold test under old section 163(j) was 
satisfied if the payor's debt-to-equity ratio exceeded 1.5 to 1.0 (safe 
harbor ratio). The second threshold test under old section 163(j) was 
satisfied if the payor's net interest expense exceeded 50 percent of 
its adjusted taxable income, generally, taxable income computed without 
regard to deductions for net interest expense, net operating losses, 
domestic production activities under section 199, depreciation, 
amortization, and depletion. Disqualified interest for purposes of old 
section 163(j) included interest paid or accrued to (1) related parties 
when no Federal income tax was imposed with respect to such interest; 
(2) unrelated parties in certain instances in which a related party 
guaranteed the debt; or (3) a real estate investment trust (REIT) by a 
taxable REIT subsidiary of that REIT. Interest amounts disallowed for 
any taxable year under old section 163(j) were treated as interest paid 
or accrued in the succeeding taxable year and could be carried forward 
indefinitely. In addition, any excess limitation, namely, the excess of 
50 percent of the adjusted taxable income of the payor over the payor's 
net interest expense, could be carried forward three years under old 
section 163(j)(2)(B). On June 18, 1991, the Department of the Treasury 
(Treasury Department) and the IRS published in the Federal Register (56 
FR 27907) a notice of proposed rulemaking (1991-2 C.B. 1040) (Prior 
Proposed Regulations) to implement the rules under old section 163(j).
    In contrast to old section 163(j), for tax years beginning after 
December 31, 2017, section 163(j) generally limits the amount of 
business interest expense that can be deducted in the current taxable 
year (also referred to in this Explanation of Provisions as the current 
year). Under section 163(j)(1), the amount allowed as a deduction for 
business interest expense is limited to the sum of (1) the taxpayer's 
business interest income for the taxable year; (2) 30 percent of the 
taxpayer's adjusted taxable income (ATI) for the taxable year; and (3) 
the taxpayer's floor plan financing interest expense for the taxable 
year. The limitation under section 163(j)(1) applies to all taxpayers, 
except for certain small businesses that meet the gross receipts test 
in section 448(c) and certain trades or businesses listed in section 
163(j)(7).
    Section 163(j)(2) provides that the amount of any business interest 
not allowed as a deduction for any taxable year as a result of the 
limitation under section 163(j)(1) is carried forward and treated as 
business interest paid or accrued in the next taxable year. In contrast 
to old section 163(j), section

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163(j) does not provide for the carryforward of any excess limitation.
    Section 163(j)(3) provides that the limitation under section 
163(j)(1) does not apply to a taxpayer, other than a tax shelter as 
defined in section 448(a)(3), with average annual gross receipts of $25 
million or less, determined under section 448(c) (including any 
adjustment for inflation under section 448(c)(4)). For taxpayers other 
than corporations or partnerships, section 163(j)(3) provides that the 
gross receipts test is determined for purposes of section 163(j) as if 
the taxpayer were a corporation or partnership.
    Section 163(j)(4) provides special rules for applying section 
163(j) in the case of partnerships and S corporations. Section 
163(j)(4)(A) requires that the limitation on the deduction for business 
interest expense be applied at the partnership level, and that a 
partner's ATI be increased by the partner's share of excess taxable 
income, as defined in section 163(j)(4)(C), but not by the partner's 
distributive share of income, gain, deduction, or loss. Section 
163(j)(4)(B) provides that the amount of partnership business interest 
expense limited by section 163(j)(1) is carried forward at the partner-
level. Section 163(j)(4)(B)(ii) provides that excess business interest 
expense allocated to a partner and carried forward is available to be 
deducted in a subsequent year only if the partnership allocates excess 
taxable income to the partner. Section 163(j)(4)(B)(iii) provides rules 
for the adjusted basis in a partnership of a partner that is allocated 
excess business interest expense. Section 163(j)(4)(D) provides that 
rules similar to the rules of section 163(j)(4)(A) and (C) apply to S 
corporations and S corporation shareholders.
    Section 163(j)(5) and (6) defines ``business interest'' and 
``business interest income,'' respectively, for purposes of section 
163(j). Generally, these terms include interest expense and interest 
includible in gross income that is properly allocable to a trade or 
business (as defined in section 163(j)(7)). The legislative history 
states that ``a corporation has neither investment interest nor 
investment income within the meaning of section 163(d). Thus, interest 
income and interest expense of a corporation is properly allocable to a 
trade or business, unless such trade or business is otherwise 
explicitly excluded from the application of the provision.'' H. Rept. 
115-466, at 386, fn. 688 (2017).
    Under section 163(j)(7), the limitation on the deduction for 
business interest expense in section 163(j)(1) does not apply to 
certain trades or businesses. The excepted trades or businesses are the 
trade or business of providing services as an employee, electing real 
property businesses, electing farming businesses, and certain regulated 
utility businesses.
    Section 163(j)(8) defines ATI as the taxable income of the taxpayer 
without regard to the following: Items not properly allocable to a 
trade or business; business interest and business interest income; net 
operating loss deductions; and deductions for qualified business income 
under section 199A. ATI also generally excludes deductions for 
depreciation, amortization, and depletion with respect to taxable years 
beginning before January 1, 2022 and includes other adjustments 
provided by the Secretary of the Treasury.
    Section 163(j)(9) defines ``floor plan financing interest'' as 
interest paid or accrued on ``floor plan financing indebtedness.'' 
These provisions allow taxpayers incurring interest expense for the 
purpose of securing an inventory of motor vehicles held for sale or 
lease to deduct the full expense without regard to the limitation under 
section 163(j)(1).
    Section 163(j)(10) provides cross references to provisions 
requiring that electing farming businesses and electing real property 
businesses excepted from the limitation under section 163(j)(1) use the 
alternative depreciation system (ADS), rather than the general 
depreciation system for certain types of property. The required use of 
ADS results in the inability of these electing trades or businesses to 
use the additional first-year depreciation deduction under section 
168(k) for those types of property.
    The Conference Report states that ``[i]n the case of a group of 
affiliated corporations that file a consolidated return, the limitation 
applies at the consolidated tax return filing level.'' H. Rept. 115-
466, at 386 (2017). Old section 163(j) treated an affiliated group as 
one taxpayer, and authorized super-affiliation rules for treating 
certain other groups as one taxpayer. Both of these provisions were 
removed by the TCJA, and no equivalent provisions are included in 
section 163(j).
    On April 16, 2018, the Treasury Department and the IRS published 
Notice 2018-28 (2018-16 I.R.B. 492) to announce an intent to issue 
proposed regulations that will provide guidance to assist taxpayers in 
complying with section 163(j). Notice 2018-28 further describes certain 
rules that those proposed regulations will include to provide taxpayers 
with interim guidance as more comprehensive guidance is developed. In 
addition, Notice 2018-28 requested comments from taxpayers about the 
application of section 163(j). Where relevant to the provisions of 
these proposed regulations, comments are addressed in the Explanation 
of Provisions section.
    Notice 2018-28 also stated the intent of the Treasury Department 
and the IRS to withdraw the Prior Proposed Regulations issued under old 
section 163(j).

Explanation of Provisions

    These proposed regulations would withdraw the Prior Proposed 
Regulations and provide guidance regarding the new limitation on the 
deduction for business interest expense under section 163(j). These 
proposed regulations also would add or amend regulations under certain 
other provisions of the Code where necessary to provide conformity 
across the Income Tax Regulations. A significant number of the terms 
used throughout these proposed regulations are defined in proposed 
Sec.  1.163(j)-1. Some of these terms are discussed in this Explanation 
of Provisions section as they relate to specific provisions of these 
proposed regulations.
    Consistent with section 163(j)(1), these proposed regulations would 
limit a taxpayer's deduction for business interest expense to the sum 
of the taxpayer's current-year business interest income, 30 percent of 
the taxpayer's ATI, and certain floor plan financing interest expense. 
These proposed regulations would provide that any amount of business 
interest expense that cannot be deducted because of the limitation 
under section 163(j)(1) (section 163(j) limitation) can be carried 
forward and treated as business interest expense in future years. These 
proposed regulations also would provide special rules related to the 
business interest expense carried forward (``disallowed business 
interest expense carryforwards'') by passthrough entities, C 
corporations, and consolidated groups. Amounts carried forward under 
old section 163(j) as disallowed disqualified interest are included as 
disallowed business interest expense carryforwards of a taxpayer to the 
extent that the amounts otherwise qualify as business interest expense 
of the taxpayer under these proposed regulations.
    These proposed regulations are organized into eleven sections, 
proposed Sec. Sec.  1.163(j)-1 through 1.163(j)-11. Proposed Sec.  
1.163(j)-1 would provide common definitions used throughout the 
proposed regulations. Proposed Sec.  1.163(j)-2 would provide general 
rules relating to the computation of a taxpayer's section 163(j) 
limitation and

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proposed Sec.  1.163(j)-3 would provide ordering and other rules 
regarding the relationship of the section 163(j) limitation and other 
provisions of the Code affecting interest. Proposed Sec.  1.163(j)-4 
would provide rules applicable to C corporations (including REITs, 
RICs, and consolidated group members) and tax-exempt corporations, 
whereas proposed Sec.  1.163(j)-5 would provide rules governing the 
disallowed business interest expense carryforwards of C corporations. 
Proposed Sec.  1.163(j)-6 would provide special rules for applying the 
section 163(j) limitation to partnerships and S corporations. Proposed 
Sec.  1.163(j)-7 would provide rules regarding the application of 
section 163(j) to foreign corporations and their shareholders, whereas 
proposed Sec.  1.163(j)-8 would provide rules regarding the application 
of section 163(j) to foreign persons with effectively connected income. 
Proposed Sec.  1.163(j)-9 would provide rules regarding elections for 
excepted trades or businesses as well as a safe harbor for certain 
REITs. Proposed Sec.  1.163(j)-10 would provide rules to allocate 
expense and income between non-excepted and excepted trades or 
businesses. Finally, proposed Sec.  1.163(j)-11 would provide certain 
transition rules relating to the application of the section 163(j) 
limitation. The remainder of this Explanation of Provisions section 
discusses these eleven sections, as well as related conforming and 
coordinating provisions set forth in these proposed regulations.

1. Proposed Sec.  1.163(j)-1: Definitions

    Proposed Sec.  1.163(j)-1 would provide definitions of terms used 
in these proposed regulations. This part 1 of the Explanation of 
Provisions section briefly discusses the most significant definitions 
contained in proposed Sec.  1.163(j)-1.

A. Adjusted Taxable Income

i. Background
    The Prior Proposed Regulations under old section 163(j) defined 
adjusted taxable income to include a number of adjustments in addition 
to those set forth in the statutory text of old section 163(j). Some of 
the additional adjustments resulted in an adjusted taxable income value 
that approximated cash flow. Two commenters to Notice 2018-28 asked if 
ATI for purposes of section 163(j) would also attempt to approximate 
cash flow. Comments on the Prior Proposed Regulations raised a number 
of administrative concerns with the additions and subtractions to ATI 
that approximated cash flow in those proposed regulations. The Prior 
Proposed Regulations were not finalized and therefore did not 
incorporate the suggestions of these comments to abandon this approach. 
In addition, because the Prior Proposed Regulations were never 
finalized, the approach of the Prior Proposed Regulations was never 
formally required or adopted. Finally, nothing in the Conference Report 
or the text of section 163(j) requires or suggests that adjustments 
should be made to ATI in order to approximate cash flow. Such a 
requirement could have been written into the statutory language or the 
discussion of section 163(j) contained in the Conference Report if 
Congress intended ATI to be adjusted in such a manner.
    As a result, these proposed regulations would not adopt a cash flow 
approach to ATI. Instead, proposed Sec.  1.163(j)-1(b)(1) would follow 
the statutory framework of section 163(j)(8) and define ATI to include 
the adjustments specified in section 163(j)(8)(A), as well as 
additional adjustments under the authority granted in section 
163(j)(8)(B) to prevent double counting and other distortions of items 
such as floor plan financing interest expense and certain deductions 
for depreciation, amortization, or depletion upon the sale or 
disposition of property.
ii. General Application of the Definition of ATI
    To compute ATI, taxpayers would first compute taxable income, as 
defined in proposed Sec.  1.163(j)-1(b)(37), in accordance with section 
63. In computing taxable income for this purpose, taxpayers would treat 
all business interest expense as deductible without regard to the 
section 163(j) limitation. Second, taxpayers would add or subtract, as 
appropriate, the items specified in these proposed regulations as 
adjustments to taxable income.
iii. Adjustments to ATI Specifically Referenced in Section 163(j)(8)(A)
    Proposed Sec.  1.163(j)-1(b)(1) includes as adjustments to taxable 
income items specifically referenced in section 163(j)(8)(A): Any item 
of income, gain, deduction, or loss which is not properly allocable to 
a trade or business; business interest and business interest income; 
net operating loss deductions under section 172; deductions for 
qualified business income under section 199A; and, deductions for 
depreciation, amortization, and depletion, but only with respect to 
taxable years beginning before January 1, 2022. Net operating losses 
under section 172 are added to taxable income in determining ATI, 
including net operating losses arising in taxable years prior to the 
effective date of these proposed regulations and carried forward. For 
purposes of computing ATI, it is intended that deductions for 
depreciation include special allowances under section 168(k). 
Additionally, to clarify an issue raised by a commenter in response to 
Notice 2018-28, the Treasury Department and the IRS note that an amount 
incurred as depreciation, amortization, or depletion, but capitalized 
to inventory under section 263A and included in cost of goods sold, is 
not a deduction for depreciation, amortization, or depletion for 
purposes of section 163(j).
iv. Other Adjustments to ATI Under Section 163(j)(8)(B)
    These proposed regulations would include a number of adjustments 
under the authority granted in section 163(j)(8)(B). For example, these 
proposed regulations would include special rules that apply in defining 
the taxable income of: A regulated investment company (RIC) or REIT in 
proposed Sec.  1.163(j)-4(b)(4)(ii); a consolidated group in proposed 
Sec.  1.163(j)-4(d)(2)(iv); a partnership in proposed Sec.  1.163(j)-
6(d)(1); an S corporation in proposed Sec.  1.163(j)-6(l)(3); and 
certain controlled foreign corporations in proposed Sec.  1.163(j)-
7(c)(1).
    Under the authority granted in section 163(j)(8)(B), proposed Sec.  
1.163(j)-1(b)(1) also includes additional adjustments to prevent double 
counting. Thus, in addition to a subtraction for any floor plan 
financing interest expense, these proposed regulations include 
adjustments for sales or dispositions of certain property for taxable 
years beginning before January 1, 2022. Proposed Sec.  1.163(j)-
1(b)(1)(i)(D), (E), and (F) would provide that in determining the 
amount of a taxpayer's ATI for a taxable year, deductions for 
depreciation under section 167 or 168, the amortization of intangibles 
and other amortized expenditures, and depletion under section 611 are 
added back to a taxpayer's taxable income. As a result, the taxpayer 
would have increased their taxable income by these amounts for section 
163(j) purposes. However, the Treasury Department and the IRS note that 
a taxpayer could receive a double benefit associated with the 
depreciation, amortization, and depletion, for ATI calculation purposes 
if the taxpayer's ATI is increased in respect of a deduction associated 
with depreciation, amortization, or depletion and then the taxpayer 
sells or otherwise disposes of the property that was depreciated, 
amortized, or depleted.

[[Page 67493]]

This double benefit would result because the amount of the gain that 
would otherwise be reflected in the ATI in respect of the sale or other 
disposition would reflect the decreased basis in such assets as a 
result of the depreciation, amortization, or depletion. Additionally, 
similar concerns are present if the property was held by either a 
partnership or a member of a consolidated group and the partnership 
interest or the stock of the member is sold or otherwise disposed of, 
because the adjusted basis in the partnership interest or member stock 
would have been reduced to reflect the depreciation, amortization, or 
depletion. As a result, these proposed regulations would eliminate the 
double benefit associated with these sales or other dispositions of 
property. See proposed Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E).
v. Other Rules for Adjusting ATI
    Taxpayers can take each adjustment into account only once for 
purposes of computing ATI; for instance, a deduction for the 
depreciation of nonbusiness property under section 167 cannot be taken 
into account as an adjustment to taxable income as both a deduction for 
depreciation and an item of deduction that is not properly allocable to 
a trade or business. For purposes of computing ATI, only the 
adjustments to taxable income that are specified in these proposed 
regulations may be made. For instance, a deduction under section 243 
for dividends received by a C corporation that is neither a RIC nor a 
REIT reduces the taxable income of the C corporation, and the C 
corporation cannot add back the amount of such deduction in computing 
ATI. Proposed Sec.  1.163(j)-4(c)(2) would provide special rules that 
affect deductions under section 243 for RICs and REITs.
    If for a taxable year a taxpayer is allowed a deduction under 
section 250(a)(1), the taxpayer should take into account the deduction 
when computing taxable income that is used to calculate ATI, but these 
proposed regulations would provide that the taxable income limitation 
in section 250(a)(2) does not apply for this purpose. Taxpayers, 
however, may be required to make adjustments adding back the section 
250(a)(1) deduction to the extent that some or all of the deduction is 
attributable to an inclusion under section 951A. See proposed Sec.  
1.163(j)-7(d).
    A separate set of proposed regulations under development will 
provide general guidance regarding section 250, including the 
computation of the section 250 deduction and the application of the 
taxable income limitation in section 250(a)(2).
vi. Comment Request Related To Ordering of Code Provisions
    The Treasury Department and the IRS are also aware that various 
Code provisions in addition to sections 163(j) and 250 (for example, 
see section 246(b)), affect the amount of taxable income of a taxpayer 
and are based on, or are limited in some fashion based upon, the 
taxable income of the taxpayer. As a result, ordering rules are 
necessary to coordinate application of all of these provisions of the 
Code with one another. The Treasury Department and the IRS request 
comments on this matter, which presents broader issues than the 
ordering of these provisions relative to the application of section 
163(j) and may therefore be addressed in guidance unrelated to these 
proposed regulations.
vii. Comment Request Related to the Computation of ATI
    The Treasury Department and the IRS request comments regarding the 
methodology for computing ATI for purposes of these proposed section 
163(j) regulations, including any items that should be included as 
additional adjustments to taxable income.

B. Interest

    There are no generally applicable regulations or statutory 
provisions addressing when financial instruments are treated as debt 
for Federal income tax purposes or when a payment is interest. As a 
result, the proposed regulations draw upon past guidance and case law 
that address the meaning of interest in the context of Federal tax law. 
As a general matter, the factors that distinguish debt from equity are 
described in Notice 94-47, 1994-1 C.B. 357, and interest is defined as 
compensation for the use or forbearance of money. Deputy v. Dupont, 308 
U.S. 488 (1940). Using these well-established principles regarding the 
meaning of interest, these proposed regulations would define interest 
to include any amount paid or accrued as compensation for the use or 
forbearance of money under the terms of an instrument or contractual 
arrangement, including a series of transactions, that is treated as a 
debt instrument for purposes of section 1275(a) and Sec.  1.1275-1(d) 
(similar to the definition of interest described in Deputy v. Dupont). 
Thus, these proposed regulations would apply to interest associated 
with conventional debt instruments, as well as transactions that are 
indebtedness in substance although not in form. See Schering-Plough 
Corp. v. U.S., 651 F.Supp. 2d 219 (N.J. Dist. Ct. 2009), aff'd sub nom. 
Merck & Co., Inc. v. U.S., 652 F.3d 475 (3d Cir. 2011); Mapco Inc. v. 
U.S., 556 F.2d 1107 (Ct. Cl. 1977). The interest definition in these 
proposed regulations also would include any amount treated as interest 
under other provisions of the Code or the regulations thereunder, such 
as original issue discount, accrued market discount, and amounts with 
respect to an integrated transaction under Sec.  1.1275-6.
    For purposes of section 163(j), these proposed regulations also 
would treat as interest certain amounts that are closely related to 
interest and that affect the economic yield or cost of funds of a 
transaction involving interest, but that may not be compensation for 
the use or forbearance of money on a stand-alone basis. Income, 
deduction, gain, or loss from a transaction used to hedge an interest 
bearing asset or liability, a substitute interest payment made on a 
debt instrument under the terms of a securities lending or a sale-
repurchase transaction, certain commitment fees, and certain debt 
issuance costs are examples of amounts that would be treated as 
interest under these proposed regulations. In addition, in order to 
prevent transactions that are essentially financing transactions from 
avoiding the application of section 163(j), these proposed regulations 
contain an anti-avoidance rule that treats as interest expense for 
purposes of section 163(j) an expense or loss predominantly incurred in 
consideration of the time value of money in a transaction or series of 
integrated or related transactions in which a taxpayer secures the use 
of funds for a period of time.
    Treating amounts that are closely related to interest as interest 
income or expense when appropriate to achieve a statutory purpose is 
not new; most of the rules treating such payments as interest in these 
proposed regulations were developed in Sec. Sec.  1.861-9T and 1.954-2. 
As a consequence of these rules, however, in some cases certain items 
could be tested under section 163(j) that are not treated as interest 
under other provisions that interpret the definition of interest more 
narrowly. Thus, for example, in certain cases, an amount that was 
previously deductible under section 162 without limitation could now be 
tested as business interest expense under section 163(j).
    As previously noted, these proposed regulations address the 
treatment of a commitment fee paid in connection with a lending 
transaction. This treatment is based on a rule in Sec.  1.954-2(h). The 
Treasury Department and the

[[Page 67494]]

IRS request comments on whether other types of fees paid in connection 
with a lending transaction that are not otherwise treated as interest 
for Federal income tax purposes should be treated as interest for 
purposes of section 163(j). As also previously noted, these proposed 
regulations would treat as interest certain amounts that are closely 
related to interest and that affect the economic yield or cost of funds 
of transactions involving interest. The Treasury Department and the IRS 
request comments on whether additional guidance is needed regarding 
amounts that are covered or not covered by this rule, specific types of 
amounts that should or should not be covered, how such amounts are 
linked to related transactions involving interest, and how such amounts 
are treated for financial reporting or other nontax purposes. More 
generally, the Treasury Department and the IRS request comments on 
whether other types of income and expense should be treated as interest 
income or interest expense for purposes of section 163(j). For example, 
should income earned by a taxpayer in a transaction in which the 
taxpayer provides the use of funds be treated as interest income of the 
taxpayer if such income is earned predominantly in consideration of the 
time value of money?
    Finally, these proposed regulations generally would treat a swap 
with significant nonperiodic payments as two separate transactions 
consisting of an on-market, level payment swap and a loan. The loan 
would be accounted for by the parties to the contract independently of 
the swap. The time value component associated with the loan, determined 
in accordance with Sec.  1.446-3(f)(2)(iii)(A), would be recognized as 
interest expense to the payor and interest income to the recipient. 
This provision in these proposed regulations would apply in the same 
manner as Sec.  1.446-3(g)(4) before it was amended on May 8, 2015, by 
T.D. 9719 (80 FR 26437, as corrected by 80 FR 61308 (October 13, 
2015)), except that this provision would not apply to a collateralized 
swap that is cleared by a derivatives clearing organization or by a 
clearing agency. The treatment of such collateralized cleared swaps is 
reserved, and these proposed regulations would not require testing the 
assets used for collateralization or condition the exception for 
collateralized cleared swaps on the extent of collateralization. The 
Treasury Department and the IRS request comments on the proper 
treatment of swaps that are cleared by a derivatives clearing 
organization or by a clearing agency, and any requirements with respect 
to collateralization that would be necessary or appropriate to identify 
swaps that could be used to effectively advance funds through the use 
of nonperiodic payments.
    The Treasury Department and the IRS considered three options with 
respect to the definition of interest. The first option considered was 
to not provide a definition of interest, and thus rely on general tax 
principles and case law for purposes of defining interest for purposes 
of section 163(j). While adopting this option might reduce the 
compliance burden for some taxpayers, not providing an explicit 
definition of interest would create its own uncertainty as neither 
taxpayers nor the IRS might have a clear sense of what types of 
payments are treated as interest income and interest expense for 
purposes of section 163(j). Such uncertainty could increase burdens to 
the IRS and taxpayers including with respect to disputes and litigation 
about whether particular payments are interest for section 163(j) 
purposes. Importantly, this option could be distortive as it could 
result in inappropriate outcomes for taxpayers that earn income that is 
economically similar to interest income but that has not historically 
been so treated under general tax principles. For example, in the case 
of the acquisition of a customer receivable at a discount, existing 
income tax principles may treat the difference between the acquisition 
price and the amount ultimately paid on the receivable as ordinary 
income that is not interest income. In addition, such an approach to 
the definition of interest would incentivize taxpayers to engage in 
transactions that provide leverage while generating deductions 
economically similar to interest but make arguments that such 
deductions fail to be described by existing principles defining 
interest expense. If successful, such strategies may greatly limit the 
application of section 163(j), contrary to the Congressional intent of 
limiting the deductibility of interest of businesses with the greatest 
levels of leverage. See House Report, H.R. 115-409 at 248. In addition, 
such an approach may ignore the statutory language of section 163(j)(1) 
``[t]he amount allowed as a deduction under this chapter for any 
taxable year for business interest . . .'' (emphasis added), which is, 
on its face, broader than merely deductions under section 163.
    The second option considered would have been to adopt a definition 
of interest but limit the scope of the definition to cover only amounts 
associated with conventional debt instruments and amounts that are 
generally treated as interest under the Code or regulations for all 
purposes prior to the passage of the TCJA. For example, this is similar 
to the definition of interest proposed in Sec.  1.163(j)-1(b)(20)(i). 
While this would bring clarity to many transactions regarding what 
would be deemed interest for the section 163(j) limitation, the 
Treasury Department and the IRS believe that this approach would 
potentially distort future financing transactions. Some taxpayers would 
choose to use financial instruments and transactions that provide a 
similar economic result to using a conventional debt instrument, but 
would avoid the label of interest expense under such a definition, 
potentially enabling these taxpayers to avoid the section 163(j) 
limitation without a substantive change in capital structure. As a 
result, the transactions discussed in the prior paragraph would 
continue to be possible and incentivized under this approach.
    In addition, there are certain transactions where under a specific 
provision of the Code and regulations, amounts could be characterized 
as ordinary income when in substance the amounts are interest income. 
For example, in the case of the acquisition of a customer receivable at 
a discount, existing income tax principles may treat the difference 
between the acquisition price and the amount ultimately paid on the 
receivable as ordinary income that is not interest income; however, 
such income would count as interest income under economic principles. 
As another example, the receipt of substitute interest paid on a 
securities loan arrangement may, under existing income tax principles, 
also be treated as ordinary income rather than interest income despite 
the fact that such income would also be treated as interest income 
under economic principles. Prior to the enactment of the section 163(j) 
interest limitation in TCJA, whether such amounts were labeled as 
ordinary income or interest income was not often material to the 
overall tax liability of most taxpayers, but now this distinction may 
have a significant impact on a large number of taxpayers.
    The final option considered and the one ultimately adopted in these 
proposed regulations is to provide a complete definition of interest 
that addresses all transactions that are commonly understood to produce 
interest income and expense, including transactions that may otherwise 
have been entered into to avoid the application of section 163(j). This 
approach has the advantage of also

[[Page 67495]]

providing rules that clearly treat amounts as interest in appropriate 
cases. Although a comprehensive definition of interest requires an 
unavoidable degree of detail, the benefits of a detailed definition 
should decidedly outweigh any complexity that results. The proposed 
regulations also reduce taxpayer burden by adopting definitions of 
interest that have already been developed and administered in 
Sec. Sec.  1.861-9T and 1.954-2, and add several definitions of 
interest income that were suggested by commenters (such as the rules 
regarding amounts on contingent payment debt instruments in Sec.  
1.163(j)-1(b)(20)(iii)(B)).
    The Treasury Department and the IRS invite comments on the 
definition of interest for purposes of section 163(j) contained in 
these proposed regulations, whether another definition of interest 
would be more appropriate in the context of section 163(j), and, 
generally, what definition of interest would be the most appropriate 
definition for purposes of section 163(j).

C. Trades or Businesses and Excepted Trades or Businesses

    While section 163(j) and the legislative history to section 163(j) 
provide that certain activities are not treated as trades or 
businesses, neither section 163(j) nor its legislative history provide 
a definition of what activities generally constitute a trade or 
business. The most established and developed definition of trade or 
business is found under section 162(a), which permits a deduction for 
ordinary and necessary expenses paid or incurred in carrying on a trade 
or business. The rules under section 162 for determining the existence 
of a trade or business are well-established, and there is a large body 
of case law and administrative guidance interpreting the meaning in 
section 162 of a trade or business. Therefore, these proposed 
regulations would define a trade or business as a trade or business 
within the meaning of section 162, and such definition should aid 
taxpayers in the proper allocation of interest expense, interest 
income, and other tax items to a trade or business and an excepted 
trade or business.
    These proposed regulations would also define excepted trades or 
businesses that are not subject to the limitation of interest expense 
deduction under section 163(j). These excepted trades or businesses are 
defined in 163(j)(7)(A), and include (1) the trade or business of 
providing services as an employee; (2) certain real property businesses 
that elect to be excepted; (3) certain farming businesses that elect to 
be excepted; and (4) certain regulated utility businesses. These 
proposed regulations would provide additional guidance with respect to 
regulated utility businesses and the allocation of interest expense to 
such businesses. See proposed Sec. Sec.  1.163(j)-1(b)(13) and 
1.163(j)-10. Proposed regulations under section 469 would provide 
additional detail with respect to the definition of a real property 
trade or business. See proposed Sec.  1.469-9(b).
    The Treasury Department and the IRS invite comments on whether 
another definition of trade or business would be preferable or 
appropriate in the context of section 163(j).

D. Electing Real Property Trade or Business

    These proposed regulations would provide that taxpayers can make an 
election to treat certain trades or businesses as an excepted trade or 
business if it is a real property trade or business under section 
469(c)(7)(C), or certain trades or businesses that are conducted by 
REITs. Definitions and special rules for REITs would be provided in 
proposed Sec.  1.163(j)-9.

E. Electing Farming Business

    These proposed regulations would provide that taxpayers can make an 
election to treat a trade or business that is a farming business as 
defined in section 263A(e)(4) or that is a farming business under Sec.  
1.263A-4(a)(4) for capitalization purposes as an excepted farming 
business for purposes of section 163(j). These proposed regulations 
would also provide that a trade or business that is a specified 
agricultural or horticultural cooperative under section 199A(g)(4) and 
regulations thereunder can elect to be an excepted farming business for 
purposes of section 163(j). The Treasury Department and the IRS note 
that section 163(j)(7)(B) cites section 199A(g)(2) for the definition 
of a specified agricultural or horticultural cooperative. However, 
after Public Law 115-141 amended section 199A, the correct citation is 
section 199A(g)(4). Additionally, the Treasury Department and the IRS 
are developing separate proposed regulations to provide additional 
guidance under section 199A(g).

F. Regulated Utility Trade or Business

    Consistent with section 163(j)(7)(A)(iv), these proposed 
regulations would provide that an excepted trade or business includes a 
regulated utility trade or business that furnishes or sells certain 
regulated items to the extent the rates for such furnishing or sale 
have been established or approved by a State or political subdivision 
thereof, by any agency or instrumentality of the United States, by a 
public service or public utility commission or other similar body of 
any State or political subdivision thereof, or by the governing or 
ratemaking body of an electric cooperative. Certain regulated items are 
electrical energy, water, or sewage disposal services; gas or steam 
through a local distribution system; or transportation of gas or steam 
by pipeline.
    Section 163(j) does not define the term ``electric cooperative'' 
either directly or by reference to other provisions of the Code. The 
tax treatment of an electric cooperative is generally governed by 
section 501(c)(12) of the Code, sections 1381 through 1388 in 
subchapter T of chapter 1 of subtitle A of the Code (subchapter T), or 
the common law applicable to cooperatives prior to the enactment of 
subchapter T. For purposes of section 163(j), the tax treatment of an 
electric cooperative is not relevant because the statutory language of 
section 163(j)(7)(A) only requires that rates be set by the ratemaking 
body of an electric cooperative and does not impose a requirement that 
the electric cooperative have any particular tax treatment. 
Accordingly, for purposes of section 163(j), the term electric 
cooperative includes an electric cooperative that is exempt from income 
tax under section 501(c)(12), an electric cooperative that is taxable 
under subchapter T, and an electric cooperative furnishing electric 
energy to persons in rural areas that is taxable under pre-subchapter T 
law.
    A commenter suggested that rules similar to those that have been 
used to define public utility property under section 168(i)(10) be used 
to determine the trade or business that qualifies as a regulated public 
utility and to distinguish between a regulated and a non-regulated 
trade or business. The statutory language of section 163(j)(7)(A)(iv) 
is very similar to that provided under section 168(i)(10) for the 
definition of a public utility property. Under section 168(i)(10), 
public utility property is defined as property that is predominately 
used in one of the enumerated trades or business, which includes the 
furnishing or sale of certain regulated items listed in section 
163(j)(7)(A)(iv), and where the rates for such furnishing or sale are 
established or approved on a cost of service and rate of return basis.
    The Treasury Department and the IRS are aware that such furnishing 
or sale of the regulated items may not have been established or 
approved on a cost of service and rate of return basis by a governing 
or ratemaking body. For

[[Page 67496]]

example, a public utility may sell some of its electrical energy output 
at market rates. In this situation, the activity related to the sales 
at market rates would not be treated as activities related to an 
excepted regulated utility trade or business under these proposed 
regulations. Thus, these proposed regulations would provide that to the 
extent a taxpayer is engaged in both excepted and non-excepted 
regulated utility trades or businesses, the taxpayer must allocate tax 
items between the trades or businesses if less than 90 percent of the 
total output is sold on a cost of service and rate of return basis. 
Some regulated utility trades or businesses with de minimis market rate 
sales, rather than pursuant to a cost of service and rate of return 
basis, are treated as entirely excepted trades or businesses. See 
proposed Sec.  1.163(j)-10(c)(3)(iii)(C)(3). Guidance related to the 
allocation methodology for regulated public utility trades or 
businesses is also provided in proposed Sec.  1.163(j)-10(c)(3)(ii)(C).

G. Floor Plan Financing Interest Expense

    These proposed regulations would provide that certain business 
interest expense paid or accrued on indebtedness used to acquire an 
inventory of motor vehicles is deductible without regard to the section 
163(j) limitation. These proposed regulations would treat all floor 
plan financing interest expense as business interest expense for 
purposes of section 163(j), regardless of whether it would otherwise be 
considered properly allocable to a trade or business that is not 
excepted under section 163(j).
    One commenter to Notice 2018-28 recommended a rule that debt 
incurred to purchase construction machinery or equipment for sale or 
lease to farmers should be considered floor plan financing indebtedness 
for purposes of section 163(j). While H.R. 1, 115th Cong. (as passed by 
the House of Representatives, November 16, 2017) included construction 
machinery and equipment in the definition of ``motor vehicle'' for 
purposes of floor plan financing indebtedness, the TCJA does not 
include such machinery and equipment in the statutory definition. The 
definition of ``motor vehicle'' for purposes of floor plan financing 
indebtedness is based on the equipment held for sale or lease, not on 
the kind of business that the purchaser or lessee is engaged in. 
Therefore, these proposed regulations do not include the rule suggested 
by the commenter and merely cross-reference the definition of ``motor 
vehicle'' as set forth in section 163(j)(9)(C).

2. Proposed Sec.  1.163(j)-2: Deduction for Business Interest Expense 
Limited

A. General Rules
    Consistent with section 163(j)(1), these proposed regulations would 
provide that the deduction for business interest expense for any 
taxpayer, other than businesses qualifying for the small business 
exemption, cannot exceed the sum of current-year business interest 
income, 30 percent of ATI, and current-year floor plan financing 
interest expense. See proposed Sec.  1.163(j)-2(b).
    To the extent that a taxpayer has business interest expense for the 
taxable year in excess of the section 163(j) limitation, these proposed 
regulations would allow the taxpayer a disallowed business interest 
expense carryforward to the next taxable year. See proposed Sec.  
1.163(j)-2(c). The limitation under section 163(j)(1) applies to the 
total amount of business interest expense of the taxpayer in a taxable 
year (including disallowed business interest expense carryforwards from 
prior taxable years) and does not directly trace to interest expense in 
respect of any particular debt obligation of the taxpayer. Similarly, 
the disallowed business interest expense carryforward allowed in a 
taxable year represents the total amount of disallowed business 
interest expense that is carried forward to the taxable year and does 
not directly trace to a particular debt obligation of a taxpayer.

B. Exemption for Certain Small Taxpayers; Aggregation; Inherently 
Personal Items

    Consistent with section 163(j)(3), these proposed regulations would 
provide that taxpayers that meet the gross receipts test of section 
448(c) are not subject to the section 163(j) limitation. Eligible 
taxpayers are those, other than tax shelters under section 448(a)(3), 
with average annual gross receipts of $25 million or less, tested for 
the three taxable years immediately preceding the current taxable year. 
Such a taxpayer is not permitted to make an election under either 
section 163(j)(7)(B) or (C) because the taxpayer is already not subject 
to the section 163(j) limitation.
    The gross receipts test of section 448(c) is an annual 
determination based on the prior three taxable years. Thus, a 
taxpayer's status as an exempt small business under section 163(j) may 
change from year to year. Because the exemption applies to the 
taxpayer, any interest paid or accrued in the taxable year in which the 
taxpayer meets the gross receipts test under section 448(c) is not 
subject to the section 163(j) limitation. Accordingly, and consistent 
with section 163(j)(2), these proposed regulations would provide that 
if a taxpayer who is subject to the limitation under section 163(j)(1) 
carries disallowed business interest expense forward to a taxable year 
in which the taxpayer qualifies for the small business exemption, the 
amount of the carryforward is not subject to the section 163(j) 
limitation in that taxable year and would be deductible in that taxable 
year unless disallowed, deferred, or capitalized under another 
provision of the Code.
    Consistent with the regulations under section 448(c), for 
organizations that are exempt from tax under section 501(a), these 
proposed regulations would provide that only gross receipts from the 
activities of such organization that constitute unrelated trades or 
businesses are taken into account in determining whether the gross 
receipts test is satisfied. The Treasury Department and the IRS request 
comments on whether additional guidance is needed in the case of any 
other exempt organizations with respect to the application of the gross 
receipts test for purposes of section 163(j).
    These proposed regulations would also provide that each partner in 
a partnership includes a share of partnership gross receipts in 
proportion to such partner's distributive share of items of gross 
income that were taken into account by the partnership under section 
703. With respect to shareholders in S corporations, these regulations 
would provide that such shareholders include a pro rata share of the S 
corporation's gross receipts. The Treasury Department and the IRS 
request comments on this approach, and also whether other approaches to 
determining the gross receipts of partners and S corporation 
shareholders for purposes of section 163(j) would more accurately 
measure the gross receipts of such partners and shareholders.
    These proposed regulations would provide that a taxpayer who is not 
subject to section 448 is treated as though it were a partnership or 
corporation when applying the section 448(c) gross receipts test for 
purposes of the section 163(j) small business exemption. The 
aggregation rules of sections 52 and 414 would apply to determine 
whether entities should be aggregated for purposes of the gross 
receipts test. For an individual taxpayer, it is intended that gross 
receipts include all items that a business entity could receive, 
including, but not limited to,

[[Page 67497]]

business receipts and investment receipts. The only items that an 
individual taxpayer may exclude from gross receipts for the purpose of 
the section 163(j) small business exemption are inherently personal 
items. Inherently personal items include Social Security benefits, 
personal injury awards and settlements, disability benefits, and wages 
received as an employee that are reported on Form W-2. Guaranteed 
payments are not generally equivalent to salaries and wages. See Rev. 
Rul. 69-187. The Treasury Department and the IRS request comments 
regarding the scope of inherently personal items.

3. Proposed Sec.  1.163(j)-3: Relationship of Business Interest 
Deduction Limitation to Other Provisions Affecting Interest

    These proposed regulations would provide ordering and operating 
rules to control the interaction of the section 163(j) limitation with 
other provisions of the Code. The legislative history to the TCJA shows 
an intent for section 163(j) to apply after other provisions that 
defer, capitalize, or disallow interest expense. See H. Rept. 115-466, 
at 387 (2017). Therefore, these proposed regulations generally would 
apply to interest expense that could be deducted without regard to the 
section 163(j) limitation; interest expense that has been disallowed, 
deferred, or capitalized in the current taxable year, or which has not 
yet been accrued, would not be taken into account for purposes of 
section 163(j). However, it is intended that, under these proposed 
regulations, section 163(j) would apply before the operation of the 
loss limitation rules in sections 465 and 469 and before the 
application of section 461(l), consistent with how taxpayers apply old 
section 163(j)(7). In addition, the Treasury Department and the IRS 
request comments regarding the interaction between section 163(j) and 
the rules addressing income from discharge of indebtedness under 
section 108.
    The Treasury Department and the IRS have received comments on the 
interaction of sections 163(j) and 59A, relating to the tax on the base 
erosion minimum tax amount. These proposed regulations reserve on the 
interaction of these provisions. The comments previously received, as 
well as any additional comments received, will be further considered in 
conjunction with separate guidance under section 59A.

4. Proposed Sec.  1.163(j)-4: General Rules Applicable to C 
Corporations (Including REITs, RICs, and Members of Consolidated 
Groups) and Tax-Exempt Corporations

    Proposed Sec.  1.163(j)-4 would provide certain rules regarding the 
computation of items of income and expense under section 163(j) for 
taxpayers that are C corporations (including members of a consolidated 
group, REITs, and RICs) and tax-exempt corporations. Proposed Sec.  
1.163(j)-4(b) would provide rules regarding the characterization of 
items of income, gain, deduction, or loss. Proposed Sec.  1.163(j)-4(c) 
would provide rules regarding adjustments to earnings and profits. 
Proposed Sec.  1.163(j)-4(d) would provide special rules applicable to 
members of a consolidated group.

A. Proposed Sec.  1.163(j)-4(b): Characterization of Items of Income, 
Gain, Deduction, or Loss

    Like other taxpayers, corporations are subject to the limitations 
on the deductibility of business interest expense in section 163(j). 
However, unlike other taxpayers, corporations are not subject to the 
limitations on the deductibility of investment interest expense in 
section 163(d). In enacting section 163(j), which excludes from the 
definition of business interest in section 163(j)(5), investment 
interest within the meaning of section 163(d), and excludes from the 
definition of business interest income, investment income within the 
meaning of section 163(d), Congress commented on the interaction 
between section 163(d) and (j) and the implications thereof for the 
application of section 163(j) to corporations. More specifically, the 
legislative history states that--

[s]ection 163(d) applies in the case of a taxpayer other than a 
corporation. Thus, a corporation has neither investment interest nor 
investment income within the meaning of section 163(d). Thus, 
interest income and interest expense of a corporation is properly 
allocable to a trade or business, unless such trade or business is 
otherwise explicitly excluded from the application of the provision.

H. Rept. 115-466, at 386, fn. 688 (2017).
    Although the foregoing language could be read to apply to both C 
corporations and S corporations, it is clear that an S corporation can 
have investment income and investment expenses within the meaning of 
section 163(d). These items are separately stated on an S corporation's 
Schedule K-1, ``Partner's Share of Income, Deductions, Credits, etc.,'' 
and they are passed through to an S corporation's shareholders. Thus, 
Congress appears to have made the foregoing statement with C 
corporations in mind.
    Consistent with congressional intent, proposed Sec.  1.163(j)-4(b) 
would provide that, solely for purposes of section 163(j), and except 
as otherwise provided in proposed Sec.  1.163(j)-10 (concerning 
allocations between excepted and non-excepted trades or businesses), 
all interest paid or accrued by a taxpayer that is a C corporation is 
treated as business interest expense, and all interest received or 
accrued by a taxpayer that is a C corporation and that is includible in 
the taxpayer's gross income is treated as business interest income. 
Thus, all of a C corporation's interest expense would be subject to 
limitation under section 163(j), and all of a C corporation's interest 
income would increase the C corporation's section 163(j) limitation, 
except to the extent such interest expense or interest income is 
allocable to an excepted trade or business under proposed Sec.  
1.163(j)-10.
    To reflect congressional intent, and to achieve consistency with 
the treatment of interest income and interest expense, proposed Sec.  
1.163(j)-4(b) would further provide that, solely for purposes of 
section 163(j), and except as otherwise provided in proposed Sec.  
1.163(j)-10, all other items of income, gain, deduction, or loss of a 
taxpayer that is a C corporation are properly allocable to a trade or 
business. As a result, such tax items would be factored into a C 
corporation's calculation of its ATI (except to the extent such items 
are allocable to an excepted trade or business).
    Although a C corporation cannot have investment interest, 
investment expenses, or investment income, within the meaning of 
section 163(d), for purposes of section 163(j), a partnership in which 
a C corporation is a partner may have such tax items. The partnership 
will allocate such tax items to its partners, including its C 
corporation partners, as separately stated items. Thus, the question 
arises how to treat investment interest, investment expenses, and 
investment income that is allocated by a partnership to a C corporation 
partner.
    To address this situation, proposed Sec.  1.163(j)-4(b) would 
recharacterize investment interest expense that a partnership allocates 
to a C corporation partner as interest expense properly allocable to a 
trade or business of the C corporation. Similarly, proposed Sec.  
1.163(j)-4(b) would treat investment income and investment expenses 
that a partnership allocates to a C corporation partner as properly 
allocable to a trade or business of the C corporation. See the

[[Page 67498]]

discussion in part 6(G) of this Explanation of Provisions section. 
However, this rule would not apply to the extent a C corporation 
partner is allocated a share of a domestic partnership's gross income 
inclusions under section 951(a) or 951A(a) that are treated as 
investment income at the partnership level. See Sec.  1.163(j)-
7(d)(1)(ii) and the discussion in part 7 of this Explanation of 
Provisions section.
    The recharacterization of investment items at the C corporation 
partner level under proposed Sec.  1.163(j)-4(b) would not affect the 
character of these items at the partnership level. It also would not 
affect the character of the investment interest, investment income, and 
investment expenses allocated to other (non-C corporation) partners.
    Investment interest expense of a partnership that is treated as 
business interest expense by the C corporation partner would not be 
treated as excess business interest expense within the meaning of 
section 163(j)(4)(b)(i) and proposed Sec.  1.163(j)-6. Similarly, 
investment interest income of a partnership that is treated as business 
interest income by the C corporation partner would not be treated as 
excess taxable income within the meaning of section 163(j)(4)(C) and 
proposed Sec.  1.163(j)-6. This is the case because these items were 
not treated as business interest expense or factored into the ATI 
calculation, respectively, at the partnership level. For a discussion 
of the rules governing excess business interest expense and excess 
taxable income, see part 6 of this Explanation of Provisions section.
    Except as otherwise provided in proposed Sec.  1.163(j)-4(b)(4)(ii) 
and (iii), the foregoing rules would apply to RICs and REITs. The 
Treasury Department and the IRS request comments on whether additional 
special rules are needed for any other entities that are generally 
taxed as C corporations, including but not limited to cooperatives (as 
defined in section 1381(a)) and publicly traded partnerships (as 
defined in section 7704(b)).
    These rules also would apply to a corporation that is subject to 
the unrelated business income tax under section 511, but only with 
respect to such corporation's items of income, gain, deduction, or loss 
that are taken into account in computing the corporation's unrelated 
business taxable income.

B. Proposed Sec.  1.163(j)-4(c): Effect on Earnings and Profits

    Distributions by a C corporation to its shareholders out of 
earnings and profits (E&P) are treated as dividends under section 
316(a). Although the Code does not define the term ``earnings and 
profits,'' the computation of E&P generally is based upon accounting 
concepts that take into account the economic realities of corporate 
transactions, in particular, their impact on the corporation's economic 
ability to pay dividends to its shareholders, and the applicable tax 
laws.
    Proposed Sec.  1.163(j)-4(c) generally would provide that the 
disallowance and carryforward of a deduction for a C corporation's 
business interest expense under proposed Sec.  1.163(j)-2 will not 
affect whether or when such business interest expense reduces the 
taxpayer's E&P. In other words, C corporations generally should not 
wait to reduce their E&P for business interest expense until the 
taxable year in which a deduction for such expense is allowed under 
section 163(j). This approach, which is the same approach used in the 
Prior Proposed Regulations under old section 163(j) (see Sec.  
1.163(j)-1(e), 56 FR 27907 (June 18, 1991)), reflects the fact that the 
payment or accrual of business interest expense generally reduces the C 
corporation's dividend-paying capacity in the year the expense is paid 
or accrued, without regard to the application of section 163(j). 
Additionally, disallowed business interest expense carryforwards are 
somewhat analogous to net operating loss (NOL) carryovers, and 
taxpayers reduce their E&P in the year the losses that give rise to an 
NOL are incurred rather than in a subsequent year in which an NOL 
carryover is absorbed.
    However, the section 163(j) regulations would contain several 
modifications to or clarifications of the general rule regarding E&P. 
First, if a taxpayer is a RIC or a REIT for the taxable year in which a 
deduction is disallowed under section 163(j), or in which the RIC or 
REIT is allocated excess business interest expense from a partnership 
under section 163(j)(4)(B)(i) and proposed Sec.  1.163(j)-6, then the 
taxpayer's E&P would not be reduced in the year the expense is paid or 
accrued without regard to the application of section 163(j). Rather, 
the taxpayer's E&P would be reduced in the taxable year(s) in which the 
business interest expense is deductible or, if earlier, in the first 
taxable year for which the taxpayer no longer is a RIC or a REIT. See 
proposed Sec.  1.163(j)-4(c)(2) and the discussion of RICs and REITs 
later in part 4(C) of this Explanation of Provisions section.
    Second, a taxpayer would not reduce its E&P in a taxable year 
beginning after December 31, 2017, to reflect any carryforwards of 
disallowed disqualified interest (within the meaning of old section 
163(j)) to the extent the taxpayer previously reduced its E&P to 
reflect those interest payments in a prior taxable year. See proposed 
Sec.  1.163(j)-11(b).
    Third, C corporations other than REITs and RICs would make special 
E&P adjustments with respect to excess business interest expense 
allocated from a partnership. In general, a C corporation partner must 
reduce its E&P to reflect expense allocations from the partnership, 
including allocations of excess business interest expense. However, 
with respect to excess business interest expense in particular, the C 
corporation partner also must increase its E&P upon the disposition of 
the partnership interest to reflect the amount of excess business 
interest expense that the partner did not take into account while it 
held the partnership interest.

C. RICs and REITs

    RICs and REITs are C corporations and are generally subject to the 
rules that apply to other C corporations, unless a provision in 
subchapter M of chapter 1 of the Code makes the rules inapplicable. 
There are no rules in subchapter M or section 163(j) that make section 
163(j) inapplicable to REITs or RICs. Therefore, under these proposed 
regulations, RICs and REITs would be subject to section 163(j). Some 
REITs may not have any business interest expense subject to limitation 
under section 163(j) because they have only electing real property 
trades or businesses described in section 163(j)(7)(B). Other REITs, 
however, will have trades or businesses for which the REIT cannot or 
will not make the election under section 163(j)(7)(B). For example, a 
mortgage REIT cannot make such an election because real property 
financing is not an activity described in section 469(c)(7)(C).
    RICs and REITs often derive a significant amount (if not all) of 
their income from property held for investment. However, under these 
proposed regulations, RICs and REITs would apply the same rules as 
other C corporations in determining which items are properly allocable 
to a trade or business. Thus, solely for purposes of 163(j), all of the 
interest expense and interest income of a RIC or REIT would be treated 
as business interest expense and business interest income, and all

[[Page 67499]]

other items of income, gain, deduction, or loss of a RIC or REIT would 
be treated as properly allocable to a trade or business under proposed 
Sec.  1.163(j)-4(b), except as otherwise provided in proposed Sec.  
1.163(j)-10.
    RICs and REITs differ from other taxpayers because the income tax 
liability of a RIC or REIT is not based directly on its taxable income. 
Instead, tax is imposed on a RIC's investment company taxable income 
(ICTI) and a REIT's real estate investment trust taxable income 
(REITTI), each of which is determined by making certain adjustments to 
taxable income. These adjustments include the allowance of the 
deduction for dividends paid and the disallowance of the special 
corporate deductions in part VIII of subchapter B of chapter 1 of the 
Code (sections 241 and following) except section 248. The special 
corporate deductions include the dividends received deduction and the 
deductions under section 250 in respect of foreign-derived intangible 
income and global intangible low-taxed income (GILTI).
    Under section 163(j)(8), a taxpayer's ATI generally is based on its 
taxable income, and there is no statutory requirement under which the 
ATI of a RIC or REIT would be based on ICTI or REITTI. Therefore, 
unless regulations provide otherwise, the ATI of a RIC or REIT does not 
reflect the deduction for dividends paid. A RIC or REIT typically pays 
dividends sufficient to eliminate all or nearly all ICTI or REITTI. As 
a result, if the ATI of a RIC or REIT took into account the deduction 
for dividends paid, the ATI of the RIC or REIT typically would be zero, 
or close to zero. It would be distortive to treat the deduction for 
dividends paid as reducing ATI because this deduction is merely the 
mechanism by which RICs and REITs shift the tax liability associated 
with their income to their shareholders, as intended pursuant to 
subchapter M of the Code. Therefore, these proposed regulations would 
not provide a rule that would cause the ATI of a RIC or REIT to take 
into account the deduction for dividends paid. The deduction for 
dividends received and the other special corporate deductions 
previously mentioned, however, are deductions that should reduce the 
ATI only of taxpayers that benefit from the deductions in determining 
tax liability. To reduce ATI for such items for taxpayers that cannot 
in fact utilize these deductions would be distortive. Therefore, under 
these proposed regulations, the ATI of a RIC or REIT would be increased 
by the amounts of these special corporate deductions, which decreased 
the RIC's or REIT's taxable income, because the deductions do not 
reduce the tax liability of RICs and REITs (or the amounts that RICs or 
REITs must distribute to eliminate entity-level tax).
    RICs and REITs must meet distribution requirements each year in 
order to be allowed the deduction for dividends paid. If interest 
expense paid or accrued by a RIC or REIT is disallowed or deferred 
under section 163(j), or if a RIC or REIT is allocated any excess 
business interest expense from a partnership, such expense will not 
reduce the entity's taxable income, the entity's ICTI or REITTI as the 
case may be, or the amount of dividends that the entity must pay from 
its earnings and profits. Therefore, the earnings and profits of the 
RIC or REIT also should not be reduced. Accordingly, these proposed 
regulations would contain a special rule for RICs and REITs under which 
their earnings and profits generally would not be reduced by a 
disallowed business interest expense deduction in the year it is 
disallowed, or by any excess business interest expense allocated from a 
partnership.

D. Proposed Sec.  1.163(j)-4(d): Special Rules for Consolidated Groups

    Section 1502 provides broad authority for the Secretary of the 
Treasury to prescribe such regulations as are necessary in order that 
the tax liability of any affiliated group of corporations filing a 
consolidated return may be returned, determined, computed, assessed, 
collected, and adjusted, in order to clearly reflect the income tax 
liability of the consolidated group and to prevent the avoidance of 
such tax liability. The legislative history of section 163(j) states 
that, ``[i]n the case of a group of affiliated corporations that file a 
consolidated return, the limitation applies at the consolidated tax 
return filing level.'' H. Rept. 115-466, at 386 (2017). Consistent with 
legislative intent, proposed Sec.  1.163(j)-4(d) generally would 
provide that a consolidated group (as defined in Sec.  1.1502-1(h)) has 
a single section 163(j) limitation. In contrast, members of an 
affiliated group that does not file a consolidated return would not be 
aggregated for purposes of applying the section 163(j) limitation. 
Additionally, partnerships that are wholly owned by members of a 
consolidated group would not be aggregated with the consolidated group 
for purposes of applying the section 163(j) limitation. The Treasury 
Department and the IRS have determined that non-consolidated entities 
should not be aggregated for purposes of applying the section 163(j) 
limitation because, whereas old section 163(j)(6)(C) expressly provided 
that ``[a]ll members of the same affiliated group (within the meaning 
of section 1504(a)) shall be treated as 1 taxpayer,'' section 163(j) no 
longer contains such language, and nothing in the legislative history 
of section 163(j) suggests that Congress intended non-consolidated 
entities to be treated as a single taxpayer for purposes of section 
163(j).
    Proposed Sec.  1.163(j)-4(d) would provide specific rules regarding 
the calculation of the section 163(j) limitation for a consolidated 
group. In particular, proposed Sec.  1.163(j)-4(d) would provide that 
the relevant taxable income in computing the group's ATI is the group's 
consolidated taxable income determined under Sec.  1.1502-11 without 
regard to any carryforwards or disallowances under section 163(j). 
Additionally, if for a taxable year a member of a consolidated group is 
allowed a deduction under section 250(a)(1) that is properly allocable 
to a non-excepted trade or business, then, for purposes of calculating 
ATI, consolidated taxable income for the taxable year is determined as 
if the deduction were not subject to the limitation in section 
250(a)(2) and the regulations thereunder. For this purpose, the amount 
of the deduction allowed under section 250(a)(1) is determined without 
regard to the application of section 163(j) and the section 163(j) 
regulations. Moreover, for purposes of calculating the group's section 
163(j) limitation, the group's current-year business interest expense 
and business interest income, respectively, would be the sum of the 
current-year business interest expense and business interest income of 
all members of the group. For purposes of this Explanation of 
Provisions and the proposed section 163(j) regulations, the term 
``current-year business interest expense'' means business interest 
expense that would be deductible in the current taxable year without 
regard to section 163(j) and that is not a disallowed business interest 
expense carryforward from a prior taxable year (see proposed Sec.  
1.163(j)-5(a)(2)(i)). Additionally, intercompany obligations (as 
defined in Sec.  1.1502-13(g)(2)(ii)) would be disregarded for purposes 
of determining a member's current-year business interest expense and 
business interest income and for purposes of calculating the 
consolidated group's ATI, and intercompany items and corresponding 
items (within the meaning of Sec.  1.1502-13(b)(2)(i) and (b)(3)(i), 
respectively) would be disregarded for purposes of calculating

[[Page 67500]]

the group's ATI to the extent those items offset in amount.
    Proposed Sec.  1.163(j)-4(d) also cross-references the rules in 
Sec.  1.1502-32(b), which govern investment adjustments within a 
consolidated group. Under those rules, if a member has current-year 
business interest expense for which a deduction is disallowed in the 
current taxable year under section 163(j), basis in the member's stock 
would be adjusted in a later taxable year when the expense is absorbed 
by the group.
    Proposed Sec.  1.163(j)-4(d) would further clarify that the 
transfer of a partnership interest in an intercompany transaction that 
does not result in the termination of the partnership is treated as a 
disposition for purposes of the basis adjustment rule in section 
163(j)(4)(B)(iii)(II), regardless of whether the transfer is one in 
which gain or loss is recognized. Several examples would be added to 
Sec.  1.1502-13(c)(7)(ii) to illustrate the application of these rules. 
The Treasury Department and the IRS have determined that intercompany 
transfers of partnership interests should be treated as dispositions 
for purposes of section 163(j)(4) because dispositions are broadly 
defined in section 163(j)(4)(B)(iii)(II), and because ignoring 
intercompany transfers of partnership interests for purposes of section 
163(j)(4) would be inconsistent with the view that an entity whose 
owners are all members of the same consolidated group can be a 
partnership. In contrast, a change in status of a member, becoming or 
ceasing to be a member of a consolidated group, would not be treated as 
a disposition for these purposes.
    The Treasury Department and the IRS request comments as to whether 
the intercompany transfer of a partnership interest in a nonrecognition 
transaction should constitute a disposition for purposes of section 
163(j)(4)(B)(iii)(II) and, if so, how Sec.  1.1502-13(c) should apply 
to such a transfer if there is excess taxable income in a succeeding 
taxable year. The Treasury Department and the IRS also request comments 
as to the treatment of the transfer of a partnership interest in an 
intercompany transaction that results in the termination of the 
partnership.
    Additionally, proposed Sec.  1.163(j)-4(d) would provide that a 
member's allocation of excess business interest expense from a 
partnership and the resulting decrease in basis in the partnership 
interest under section 163(j)(4)(B) is not a noncapital, nondeductible 
expense for purposes of Sec.  1.1502-32(b)(3)(iii). Similarly, an 
increase in a member's basis in a partnership interest under section 
163(j)(4)(B)(iii)(II) to reflect excess business interest expense not 
deducted by the consolidated group is not tax-exempt income for 
purposes of Sec.  1.1502-32(b)(3)(ii). These special rules are intended 
to ensure that the allocations and basis adjustments under proposed 
Sec.  1.163(j)-6 do not result in investment adjustments within the 
consolidated group. This result is appropriate because the application 
of the proposed Sec.  1.163(j)-6 rules does not result in a net 
reduction in the tax attributes of the member partner; rather, there is 
an exchange of one type of attribute for another (excess business 
interest expense allocated from the partnership vs. basis in the 
partnership interest). The Treasury Department and the IRS request 
comments as to whether additional rules are needed to prevent loss 
duplication upon the disposition of stock of a member holding 
partnership interests.

5. Proposed Sec.  1.163(j)-5: General Rules Governing Disallowed 
Business Interest Expense Carryforwards for C Corporations

    Proposed Sec.  1.163(j)-5 would provide certain rules regarding 
disallowed business interest expense carryforwards for taxpayers that 
are C corporations, including members of a consolidated group. Proposed 
Sec.  1.163(j)-5(b) would provide rules regarding the treatment of 
disallowed business interest expense carryforwards. Proposed Sec.  
1.163(j)-5(c) would provide cross-references to rules regarding 
disallowed business interest expense carryforwards in transactions to 
which section 381(a) applies. Proposed Sec.  1.163(j)-5(d) would 
provide rules regarding limitations on disallowed business interest 
expense carryforwards from separate return limitation years (SRLYs). 
Proposed Sec.  1.163(j)-5(e) would provide cross-references to rules 
regarding the application of section 382. Proposed Sec.  1.163(j)-5(f) 
would provide rules regarding the overlap of the SRLY limitation with 
section 382.

A. Proposed Sec.  1.163(j)-5(b): Treatment of Disallowed Business 
Interest Expense Carryforwards

    Proposed Sec.  1.163(j)-2 limits the amount of business interest 
expense for which a deduction is allowed in the taxable year. Proposed 
Sec.  1.163(j)-2 further provides that the amount of any business 
interest expense not allowed as a deduction for any taxable year as a 
result of the section 163(j) limitation is carried forward to the 
succeeding taxable year as a disallowed business interest expense 
carryforward.
    Proposed Sec.  1.163(j)-5(b)(2) generally would provide that, for a 
C corporation taxpayer that is not a member of a consolidated group, 
current-year business interest expense is deducted in the current 
taxable year before any disallowed business interest expense 
carryforwards from a prior taxable year are deducted in that year. 
Disallowed business interest expense carryforwards are then deducted in 
the order of the taxable years in which they arose, beginning with the 
earliest taxable year, subject to certain limitations (for example, the 
limitation under section 382). S corporations would be subject to 
similar rules (see proposed Sec.  1.163(j)-6(l)(5)).
    Proposed Sec.  1.163(j)-5(b)(3) would provide similar rules 
applicable to consolidated groups. In addition, disallowed business 
interest expense carryforwards from prior separate limitation years (as 
defined in Sec.  1.1502-1(e)) would be subject to the SRLY limitation. 
See the discussion of the SRLY rules in part 5(C) of this Explanation 
of Provisions section.
    There are several reasons why the Treasury Department and the IRS 
have determined that current-year business interest expense and 
disallowed business interest expense carryforwards should be 
distinguished for taxpayers that are C corporations and S corporations, 
and why current-year business interest expense should be deducted 
before carryforwards from prior taxable years.
    First, section 163(j) generally reflects an annual accounting 
approach. The section 163(j) limitation is calculated anew each year 
based on the taxpayer's taxable income for that year, and no excess 
limitation from prior taxable years carries forward to succeeding 
taxable years. By prioritizing the deduction of current-year business 
interest expense over disallowed business interest expense 
carryforwards from prior taxable years, this rule conforms to the 
annual accounting approach of section 163(j).
    Second, if taxpayers were required to deduct disallowed business 
interest expense carryforwards before or simultaneously with current-
year business interest expense, they could end up using some or all of 
their section 382 limitation on disallowed business interest expense 
carryforwards rather than on NOLs or other tax items subject to the 
section 382 limitation. For example, assume that X, a stand-alone C 
corporation, has $40x of disallowed business interest expense 
carryforwards and $30x of NOL carryovers from Year 1, both subject to a 
section 382 limitation of $35x. In Year 2, X has $50x of current-year 
business interest expense and a section 163(j) limitation

[[Page 67501]]

of $45x. If X were required to use its disallowed business interest 
expense carryforwards before its current-year business interest 
expense, such carryforwards would absorb all of X's section 382 
limitation for the current taxable year, and X would not be able to use 
any of its NOL carryovers. In contrast, under the rule in proposed 
Sec.  1.163(j)-5(b), X would use $45x of its current-year business 
interest expense and none of its disallowed business interest expense 
carryforwards, thus freeing up its section 382 limitation for its NOL 
carryovers.
    Third, taxpayers that file a consolidated return are required to 
track their losses by taxable year for purposes of applying the NOL 
carryover and carryback rules of Sec.  1.1502-21(b) and the NOL SRLY 
limitation rules of Sec.  1.1502-21(c). As noted in part 5(C) of this 
Explanation of Provisions section, similar SRLY rules would apply to 
disallowed business interest expense carryforwards. Thus, a non-
consolidated corporation must track its disallowed business interest 
expenses by the year in which such expenses are paid or accrued without 
regard to section 163(j) so that such corporation can comply with the 
SRLY limitation rules in the event the corporation joins a consolidated 
group.
    Finally, the Treasury Department and the IRS note that, under 
proposed Sec.  1.163(j)-4(c), C corporations must track their 
disallowed business interest expense carryforwards by the year in which 
such items arose (and in which an E&P adjustment was made; see the 
discussion of proposed Sec.  1.163(j)-4(c) in part 4 of this 
Explanation of Provisions section) to ensure that E&P is not further 
reduced in a subsequent year in which the carryforward is deducted. 
Thus, the Treasury Department and the IRS have determined that these 
proposed rules should not create an additional administrative burden 
for C corporations.
    Proposed Sec.  1.163(j)-5(b)(3) would further provide rules 
regarding which member's business interest expense would be deducted by 
the consolidated group in the current taxable year. If a group's 
section 163(j) limitation for the taxable year exceeds the aggregate 
amount of business interest expense, including disallowed business 
interest expense carryforwards, of all members, then each member's 
business interest expense, including carryforwards, would be fully 
deducted in that year, subject to other limitations, such as the 
section 382 limitation and the SRLY limitation. However, if the 
aggregate amount of business interest expense, including carryforwards, 
of all members exceeds the group's section 163(j) limitation for the 
year, then certain ordering rules would apply:

     Step 1: First, the consolidated group would determine 
whether its section 163(j) limitation for the current year equals or 
exceeds the members' aggregate current-year business interest 
expense. If so, then no amount of the consolidated group's current-
year business interest expense would be subject to disallowance in 
the current year under section 163(j), and the consolidated group 
would skip Steps 2 and 3 of these ordering rules. If not, then the 
consolidated group must apply Step 2.
     Step 2: If the members' aggregate current-year business 
interest expense exceeds the group's section 163(j) limitation for 
the current year, each member with current-year business interest 
expense and either current-year business interest income or floor 
plan financing interest expense would deduct its current-year 
business interest expense up to the amount of its business interest 
income and floor plan financing interest expense for the year.
     Step 3: If the consolidated group has any section 
163(j) limitation remaining after the application of Step 2 of these 
ordering rules, each member with remaining current-year business 
interest expense would deduct its current-year business interest 
expense pro rata, based on the relative amounts of remaining 
current-year business interest expense of all members.
     Step 4: If the consolidated group has any section 
163(j) limitation remaining after the application of Step 1 of these 
ordering rules, each member's disallowed business interest expense 
carryforwards from a prior taxable year would be deducted on a pro 
rata basis, beginning with the earliest year, subject to certain 
limitations such as the section 382 limitation and the SRLY 
limitation. For example, assume that P and S are the only members of 
a consolidated group with a section 163(j) limitation of $200x for 
the current year (Year 2). Further assume that the amount of 
current-year business interest expense deducted in Year 2 is $100x, 
and that P and S, respectively, have $140x and $60x of disallowed 
business interest expense carryforwards from Year 1 that are not 
otherwise subject to limitation (for example, under section 382). 
Under these facts, P would be allowed to deduct $70x of its 
carryforwards from Year 1 (($140x/($60x + $140x)) x $100) in Year 2, 
and S would be allowed to deduct $30x of its carryforwards from Year 
1 (($60x/($60x + $140x)) x $100) in Year 2.
     Step 5: Any member with remaining business interest 
expense after applying Steps 1 through 4 of these ordering rules 
would carry such expense forward to the succeeding taxable year as a 
disallowed business interest expense carryforward.

    If a corporation ceases to be a member during a consolidated return 
year, the amount of its business interest expense, including 
carryforwards from prior taxable years, that is neither deducted by the 
consolidated group in that year nor reduced under Sec.  1.1502-36(d) 
would be carried forward to the corporation's first separate return 
year.
    The foregoing rules are intended to roughly mirror the rules in 
Sec.  1.1502-21 governing the absorption of a consolidated net 
operating loss (CNOL). However, the Treasury Department and the IRS 
considered various other approaches to allocating disallowed business 
interest expense carryforwards among members of a consolidated group. 
For example, one alternative approach under consideration was a regime 
whereby disallowed business interest expense carryforwards would be 
allocated based upon the actual use of externally borrowed funds by 
each member. Under such an approach, intercompany obligations would be 
taken into account in allocating disallowed business interest expense 
carryforwards.
    The Treasury Department and the IRS do not propose to adopt such an 
approach, for several reasons. First, requiring taxpayers to trace 
externally borrowed funds to the member that ultimately uses such funds 
would create an administrative burden for taxpayers. Second, because 
money is fungible, a tracing regime would place undue importance on the 
location of intercompany obligations. Thus, this approach would permit 
significant manipulation through the creation of intercompany 
obligations for the purpose of shifting disallowed business interest 
expense carryforwards among members. Third, this approach could result 
in the non-economic allocation of disallowed business interest expense 
carryforwards to members with no business interest expense to creditors 
outside the consolidated group. This approach would result in value 
transfers among consolidated group members and require complex rules to 
account for those transfers. These proposed regulations implement the 
statute consistent with legislative intent while avoiding these 
complications.
    The Treasury Department and the IRS request comments on the rules 
in proposed Sec.  1.163(j)-5(b)(3), including comments on whether these 
rules should be revised to incorporate additional language or 
principles from the CNOL allocation rules in Sec.  1.1502-21.

B. Proposed Sec.  1.163(j)-5(c): Disallowed Business Interest Expense 
Carryforwards in Transactions To Which Section 381(a) Applies

    In the case of certain asset acquisitions, section 381(a) generally 
requires the acquiring corporation to succeed to and take into account 
the tax items described in section 381(c) of the

[[Page 67502]]

distributor or transferor corporation. In the TCJA, Congress added 
disallowed business interest expense carryforwards to the list of items 
to which the acquiring corporation succeeds in a transaction to which 
section 381(a) applies (see section 381(c)(20)).
    Sections 1.381(c)(1)-1 and 1.381(c)(1)-2 provide rules that, in 
part, limit the acquiring corporation's ability to use NOL 
carryforwards in the acquiring corporation's first taxable year ending 
after the acquisition date. The Treasury Department and the IRS have 
determined that similar rules should apply to disallowed business 
interest expense carryforwards. See proposed Sec. Sec.  1.163(j)-5(c) 
and 1.381(c)(20)-1.
    The Treasury Department and the IRS request comments as to whether 
section 381(c)(20) and proposed Sec. Sec.  1.163(j)-5(c) and 
1.381(c)(20)-1 should apply to excess business interest expense 
allocated to a corporate partner.

C. Proposed Sec.  1.163(j)-5(d): Limitations on Disallowed Business 
Interest Expense Carryforwards From Separate Return Limitation Years

    In general, the taxable income of a consolidated group is 
determined by aggregating the income and losses of each member. Thus, a 
consolidated group may offset the income earned by profitable members 
against the losses incurred by other members. However, an exception to 
this general rule applies to losses incurred by a member in a taxable 
year in which the member did not join in filing a consolidated return 
with the current group. The SRLY limitation in Sec.  1.1502-21(c) 
generally limits the amount of a member's losses arising in a SRLY that 
may be included in the consolidated group's CNOL to the amount of net 
income generated by that member. Similar rules in Sec. Sec.  1.1502-15 
and 1.1502-22(c) apply to built-in losses and net capital losses, 
respectively. Absent a SRLY limitation and other limitations, notably 
section 382, the consolidated group could reduce its consolidated 
taxable income simply by acquiring new members with built-in losses, 
NOLs, net capital losses, or disallowed business interest expense 
carryforwards.
    The Treasury Department and the IRS have determined that rules 
similar to those in Sec.  1.1502-21(c) should apply to disallowed 
business interest expense carryforwards. See proposed Sec.  1.163(j)-
5(d). However, the calculation of the SRLY limitation for disallowed 
business interest expense carryforwards would differ from the 
calculation of the SRLY limitation for NOL carryovers. The SRLY 
limitation for NOL carryovers is cumulative--in other words, it is 
based upon a member's aggregate contribution to consolidated taxable 
income, determined by reference to only the member's tax items, for all 
consolidated return years of the consolidated group in which the member 
was included in the group. As a result, a member may carry forward its 
unused SRLY limitation from one year to the next. In contrast, the SRLY 
limitation for disallowed business interest expense carryforwards would 
be calculated annually based upon a member's section 163(j) limitation, 
determined by reference to only the member's tax items, for any given 
taxable year. As a result, a member may not carry forward its unused 
section 163(j) SRLY limitation from one year to the next. The Treasury 
Department and the IRS have determined that this result is appropriate 
because Congress did not retain the excess limitation carryforward 
provisions from old section 163(j). Thus, allowing members to carry 
forward their unused section 163(j) SRLY limitation would be 
inconsistent with congressional intent.
    Proposed Sec.  1.163(j)-5(d) would provide several additional 
limitations on a member's ability to use its disallowed business 
interest expense carryforwards arising in a SRLY. First, such items 
only may be taken into account by the consolidated group in a taxable 
year to the extent the group has any remaining section 163(j) 
limitation for that year after applying the rules in proposed Sec.  
1.163(j)-5(b). Second, such items only may be taken into account to the 
extent the SRLY member's section 163(j) limitation for that year 
exceeds the amount of the member's business interest expense already 
taken into account by the group in that year under the rules in 
proposed Sec.  1.163(j)-5(b). Third, SRLY-limited disallowed business 
interest expense carryforwards would be deducted on a pro rata basis 
with non-SRLY limited disallowed business interest expense 
carryforwards from taxable years ending on the same date.
    The Treasury Department and the IRS request comments on the SRLY 
rules in proposed Sec.  1.163(j)-5(d), including whether a member's 
SRLY-limited disallowed business interest expense carryforwards should 
cease to be subject to a SRLY limitation (to the extent of the member's 
stand-alone section 163(j) limitation) in taxable years in which the 
member's stand-alone section 163(j) limitation exceeds the consolidated 
group's section 163(j) limitation.

D. Proposed Sec.  1.163(j)-5(e): Application of Section 382

    Like the SRLY limitation, the section 382 limitation limits a 
taxpayer's ability to reduce its taxable income simply by acquiring a 
loss corporation. In general, if a loss corporation experiences an 
ownership change, section 382 limits the amount of the new loss 
corporation's taxable income that can be offset by pre-change losses to 
the product of the old loss corporation's value at the time of the 
ownership change times the long-term tax-exempt rate. For a discussion 
of the regulations under sections 163(j), 382, and 383 that govern the 
applicability of section 382 to business interest expense, see parts 11 
and 14 through 16 of this Explanation of Provisions section.

E. Proposed Sec.  1.163(j)-5(f): Overlap of SRLY Limitation With 
Section 382

    As noted in parts 5(C) and 5(D) of this Explanation of Provisions 
section, both the SRLY limitation and the section 382 limitation are 
intended to prevent taxpayers from trafficking in loss corporations. 
Moreover, both of these limitations could apply to the same corporation 
as a result of the same transaction (for example, if a consolidated 
group acquires a loss corporation in a transaction that is an ownership 
change for purposes of section 382) or as a result of several 
transactions that occur within a short period of time.
    Section 1.1502-21(g) provides an overlap rule to prevent both the 
section 382 limitation and the SRLY limitation from applying to NOL 
carryovers under certain circumstances. The Treasury Department and the 
IRS have determined that a similar overlap rule should apply with 
respect to disallowed business interest expense carryforwards. Thus, 
proposed Sec.  1.163(j)-5(f) would apply the principles of Sec.  
1.1502-21(g) to disallowed business interest expense carryforwards when 
the application of the SRLY limitation would result in an overlap with 
the application of section 382.

6. Proposed Sec.  1.163(j)-6: Application of the Business Interest 
Expense Deduction Limitations to Partnerships and Subchapter S 
Corporations

A. In General

    Proposed Sec.  1.163(j)-6 would provide guidance regarding 
partnership and S corporation deductions and carryforwards under 
section 163(j). To the extent a partnership is subject to the 
limitations imposed by section 163(j), the section 163(j) limitation 
shall be applied at the partnership level and any

[[Page 67503]]

deduction for business interest expense not disallowed under section 
163(j) is taken into account in determining the nonseparately stated 
taxable income or loss of the partnership. Similar rules shall apply to 
an S corporation. See part 6(H) of this Explanation of Provisions 
section for a discussion of rules specific to S corporations.
    The phrase ``nonseparately stated taxable income or loss of the 
partnership'' has not previously been defined by statute. However, 
section 1366(a)(2) provides a definition of ``nonseparately computed 
income or loss'' as applied to S corporations. The legislative history 
of section 163(j) references ``ordinary business income or loss'' as 
reflected on Form 1065, ``U.S. Return of Partnership Income,'' and the 
partner's distributive share as reflected in Box 1 of Schedule K-1. H. 
Rept. 115-466, at 387, fn. 690 (2017).
    One commenter noted that, in general, an item of income or 
deduction that is included in nonseparately stated income of a 
partnership, as determined under section 702(a)(8), loses its tax 
character in the hands of the partner to whom the item is allocated. 
The Treasury Department and the IRS agree that for purposes of proposed 
Sec.  1.163(j)-6(a), to the extent a partnership's business interest 
expense is less than or equal to the partnership's section 163(j) 
limitation, such business interest expense loses its character as 
business interest expense at the partner's level for purposes of the 
partner's section 163(j) calculation (that is, the business interest 
expense is not subject to further limitations under section 163(j)). 
See proposed Sec.  1.163(j)-6(c).
    For purposes of the Code other than section 163(j), proposed Sec.  
1.163(j)-6(c) would provide that business interest expense and, in the 
case of a partnership, excess business interest expense, retains its 
character as business interest expense at the partner and S corporation 
shareholder-level. For purposes of section 469, such interest retains 
its characterization as either passive or non-passive when allocated to 
the partner or shareholder. Additionally, for purposes of section 469, 
business interest expense from a partnership or S corporation and, in 
the case of a partnership, excess business interest expense, remains 
interest derived from a trade or business in the hands of a partner or 
shareholder, even if the partner or shareholder does not materially 
participate in the partnership or S corporation's trade or business 
activity. See proposed Sec.  1.163(j)-3 for additional rules regarding 
the interaction among sections 461(l), 465, 469, and 163(j).
    The Treasury Department and the IRS intend to adopt rules for the 
proper treatment of business interest income and business interest 
expense with respect to lending transactions between a passthrough 
entity and an owner of the entity (self-charged lending transactions). 
Although reserved in these proposed regulations, the Treasury 
Department and the IRS intend to adopt certain rules to re-
characterize, for both the lender and the borrower, the business 
interest expense and corresponding business interest income arising 
from a self-charged lending transaction that may be allocable to the 
owner, to prevent such business interest income and expense from 
entering or affecting the section 163(j) limitation calculations for 
both the lender and the borrower in such situations. One possible 
approach is to adopt rules similar in scope as those contained in Sec.  
1.469-7, dealing with the treatment of self-charged lending 
transactions for purposes of section 469. The Treasury Department and 
the IRS request comments with respect to any potential rules that may 
be considered to achieve this result, as well as comments regarding the 
potential adverse effects that such rules may have with respect to 
other Code provisions, such as section 163(d), and any methods for 
mitigating or eliminating those effects.
    Guidance on the treatment of excess business interest expense in 
tiered partnerships has been reserved in these proposed regulations. 
Section 163(j)(4) requires the section 163(j) limitation to be taken 
into account at the entity-level and for business interest expense 
carryforwards to be allocated to partners. The Treasury Department and 
the IRS request comments regarding whether, in a tiered partnership 
arrangement, carryforwards should be allocated through upper-tier 
partnerships. Additionally, comments are requested regarding how and 
when an upper-tier partner's basis should be adjusted when a lower-tier 
partnership is subject to a section 163(j) limitation.
    Guidance regarding the application of section 163(j) to a 
partnership merger or division has been also reserved in these proposed 
regulations. The Treasury Department and the IRS request comments on 
the effect of partnership mergers and divisions on excess business 
interest expense, excess taxable income, and excepted trade or business 
elections in the context of section 163(j).

B. ATI of a Partnership

i. In General
    Proposed Sec.  1.163(j)-6(d) would provide guidance on the ATI of a 
partnership. Subject to the modifications set forth in proposed Sec.  
1.163(j)-6(d) and described in this part 6.B of this Explanation of 
Provisions section, the ATI of a partnership would be calculated in 
accordance with proposed Sec.  1.163(j)-1(b)(1). The ATI of the 
partnership would include any items described in section 703(a)(1), 
including both separately and nonseparately stated items, to the extent 
such items are otherwise included under proposed Sec.  1.163(j)-
1(b)(1).
ii. Section 743(b), Section 704(c)(1)(C), and Remedial Allocations
    The Treasury Department and the IRS considered multiple possible 
approaches to address the treatment of section 743(b) adjustments to 
the basis of partnership property upon the transfer of a partnership 
interest, built-in loss amounts with respect to partnership property 
under section 704(c)(1)(C), and remedial allocations of income, gain, 
loss or deduction to a partner pursuant to section 704(c) and Sec.  
1.704-3(d) (collectively, partner-level adjustments) under section 
163(j). One approach would disregard partner-level adjustments when 
calculating both the partnership's and the partner's ATI for purposes 
of section 163(j). This approach is consistent with section 743(b) and 
the accompanying regulations, which mandate that section 743(b) 
adjustments are not to be taken into account when determining the 
partnership's income, gain, deduction, or loss under section 703, and 
that section 743(b) adjustments are not taken into account until after 
a partner's distributive share of a deduction is determined.
    This approach could, however, lead to odd results. For example, if 
because of positive section 743(b) adjustments, no current partner 
includes gain in taxable income on the sale of the partnership 
property, but the partnership still receives the benefit of the taxable 
income in its ATI, the partners would be allowed to take a larger 
amount of business interest expense as a current-year deduction than if 
the partnership's ATI had included the section 743(b) adjustment. 
Additionally, when the transferor sells its partnership interest, it 
generally includes in taxable income the gain resulting from the sale 
and could possibly include the gain in its own ATI calculation for 
purposes of its own section 163(j) limitation calculation. This 
situation could result

[[Page 67504]]

in the double counting of the income in ATI for section 163(j) 
purposes, first by the transferor partner on the sale of the 
partnership interest and again by the partnership on a sale of 
partnership property.
    Under a second approach considered, the partnership would increase 
or decrease its ATI by the amount of the partner-level adjustments 
allocated to each partner. Essentially, the partnership would be 
required to aggregate all partner-level adjustments and take them into 
account at the partnership level for purposes of section 163(j). The 
Treasury Department and the IRS viewed taking partner-level adjustments 
into account at the partnership level as being contrary to the intent 
of section 743(b), section 704(c)(1)(C), and remedial allocations, and 
have therefore not adopted this approach.
    Under a third approach, (i) partner-level adjustments are not taken 
into account when computing ATI for purposes of the partnership's 
section 163(j) limitation; and (ii) each partner's partner-level 
adjustments are taken into account as items derived directly by the 
partner in determining its own section 163(j) limitation. This approach 
takes partner-level adjustments into account at the partner, rather 
than partnership, level when determining the partner's ATI.
    This third approach was recommended by a commenter with respect to 
section 743(b) adjustments. The commenter argued that if a rule was 
adopted requiring that a partner's section 743(b) adjustment be 
included in the computation of a partnership's ATI for purposes of 
applying section 163(j) at the partnership level, then a particular 
partner's section 743(b) adjustment could impact the deductibility of 
partnership interest by other partners, which would be inconsistent 
with the basic approach taken in the section 743(b) regulations. The 
Treasury Department and the IRS agree that this approach strikes the 
best balance between the entity-level calculation under section 163(j) 
and the aggregate nature of section 743(b) adjustments, as well as 
other partner-level adjustments. Accordingly, partner-level adjustments 
are not taken into account when the partnership determines its section 
163(j) limitation under proposed Sec.  1.163(j)-6(f). Instead, partner-
level adjustments are taken into account by the partner in determining 
the partner's ATI pursuant to proposed Sec.  1.163(j)-6(e). However, in 
keeping with the entity approach taken under section 163(j)(4), a 
partnership shall take adjustments made to the basis of its property 
pursuant to section 734(b) into account for purposes of calculating its 
ATI pursuant to proposed Sec.  1.163(j)-6(d).
    The commenter acknowledged that this approach would create 
disparities between the situation where a partnership purchases assets 
in which, until 2022, depreciation will enter into the partnership's 
ATI; and a transaction structured as a purchase of partnership 
interests, where depreciation generated by a section 743(b) basis 
adjustment or section 704(c) remedial allocation will not enter into a 
partnership's ATI. The Treasury Department and the IRS are aware of 
these concerns and request additional comments on the impact of 
partner-level adjustments on a partnership's ATI calculation under 
section 163(j), particularly as it relates to publicly traded 
partnerships.

C. ATI and Business Interest Income of Partners

i. In General
    Proposed Sec.  1.163(j)-6(e) would provide that the ATI of a 
partner shall generally be determined in accordance with proposed Sec.  
1.163(j)-1(b)(1) without regard to such partner's distributive share of 
any items of income, gain, deduction or loss of such partnership, and 
shall be increased by such partner's share of excess taxable income, as 
defined in proposed Sec.  1.163(j)-1(b)(13) and determined pursuant to 
proposed Sec.  1.163(j)-6(f). This provision prohibits the double 
counting of items in ATI by a partner in its own section 163(j) 
calculation when a partnership has already taken those items into 
account under section 163(j). To the extent a partnership has excess 
taxable income, a partner may include its share of the partnership's 
excess taxable income, as determined in proposed Sec.  1.163(j)-6(f), 
in the partner's own ATI for purposes of determining the partner's 
section 163(j) limitation. For guidance regarding the partner's 
inclusion of partner-level adjustments, see proposed Sec.  1.163(j)-
6(e). For guidance regarding the recharacterization of a partnership's 
investment interest, investment income, and investment expenses at the 
C corporation partner-level, see proposed Sec.  1.163(j)-4(b)(3).
ii. Sale of Partnership Interests
    Proposed Sec.  1.163(j)-6(e)(3) would provide guidance on the 
inclusion of the proceeds from the sale of a partnership interest in 
the selling partner's ATI. In the event a partner sells a partnership 
interest and the partnership in which the interest is being sold owns 
only non-excepted trade or business assets, as such term is defined in 
proposed Sec.  1.163(j)-6(b)(6), the gain or loss on the sale of the 
partnership interest is included in the partner's ATI. If a partner 
sells a partnership interest and the partnership in which the interest 
is being sold owns both excepted assets, as such term is defined in 
proposed Sec.  1.163(j)-6(b)(7), and non-excepted assets, the partner 
shall generally use the method set forth in proposed Sec.  1.163(j)-
10(c) in order to determine the amount properly allocable to a non-
excepted trade or business, and therefore, properly includible in the 
partner's ATI. Proposed Sec.  1.163(j)-6(e)(4) would also apply to 
tiered partnerships.
    The Treasury Department and the IRS also considered adopting a 
reasonable method standard by which a partnership could determine the 
amount properly allocable to a non-excepted trade or business, and 
therefore, properly includible in the partner's ATI. Such provisions 
would have adopted tracing rules similar to those set forth in Sec.  
1.163-8T, as modified by Notice 88-20, 1988-9 I.R.B. 5 (Feb. 9, 1988), 
Notice 88-37, 1988-15 I.R.B. 8 (Mar. 16, 1988), and Notice 89-35, 1989-
13 I.R.B. 4 (Mar. 9, 1989). The Treasury Department and the IRS request 
comments on what reasonable methods other than the method set forth in 
proposed Sec.  1.163(j)-10(c), possibly including a tracing method 
similar to Sec.  1.163-8T, would be appropriate in order to determine 
the amount properly allocable to a non-excepted trade or business and 
under what circumstances such methods would be appropriate.
iii. Double Counting of Business Interest Income Prohibited
    Notice 2018-28 stated that for purposes of calculating a partner's 
annual deduction limitation under section 163(j) for business interest 
expense paid or accrued by the partner, the partner shall only include 
business interest income from a partnership in its section 163(j)(1)(A) 
amount to the extent that business interest income exceeds business 
interest expense determined at the partnership level under section 
163(j). Additionally, a partner shall not include its share of the 
partnership's floor plan financing for purposes of determining the 
partner's annual deduction limitation for business interest expense 
under section 163(j)(1)(C). Proposed Sec.  1.163(j)-6(e)(2) would 
incorporate these limitations into these proposed regulations.

[[Page 67505]]

D. Section 163(j) Partnership Calculation

i. Allocation of Deductible Business Interest Expense and Section 
163(j) Excess Items--Made in the Same Manner as the Nonseparately 
Stated Taxable Income or Loss of the Partnership
    Section 163(j)(4)(A)(ii)(II) states that a partner's excess taxable 
income is determined in the same manner as the nonseparately stated 
taxable income or loss of the partnership. Section 163(j)(4)(B)(i)(II) 
states that excess business interest expense is allocated to each 
partner in the same manner as the nonseparately stated taxable income 
or loss of the partnership. Similarly, excess business interest income 
is allocated to each partner in the same manner as the nonseparately 
stated taxable income or loss of the partnership. The phrase 
``nonseparately stated taxable income or loss of the partnership'' is 
not defined in section 163(j), and as mentioned in part 6(A) of this 
Explanation of Provisions section, has not previously been defined by 
statute or regulations. The phrase ``in the same manner as'' is also 
undefined.
    Under the proposed regulations, the manner for allocating excess 
taxable income, excess business interest income, and excess business 
interest expense (hereinafter ``section 163(j) excess items'') must be 
consistent with the Treasury Department and the IRS's resolution of the 
following three descriptive (1 through 3) and two normative (4 through 
5) issues: (1) Section 163(j) is applied at the partnership level; (2) 
a partnership cannot have both excess taxable income (or excess 
business interest income) and excess business interest expense in the 
same taxable year; (3) parity must be preserved between a partnership's 
deductible business interest expense and section 163(j) excess items 
and the aggregate of each partner's share of deductible business 
interest expense and section 163(j) excess items from such partnership; 
(4) if in a given year a partnership has both deductible business 
interest expense and excess business interest expense, a partnership 
should not allocate excess business interest expense to a partner to 
the extent such partner was allocated the items comprising ATI (or 
business interest income) that supported the partnership's deductible 
business interest expense; and (5) if in a given year a partnership has 
excess taxable income (or excess business interest income), only 
partners allocated more items comprising ATI (or business interest 
income) than necessary to support their allocation of business interest 
expense should be allocated a share of excess taxable income (or excess 
business interest income).
    One commenter proposed a manner for allocating section 163(j) 
excess items that would require a partnership to allocate each section 
163(j) excess item (for example, excess business interest expense) in 
the same proportion as its underlying section 163(j) item (business 
interest expense). For example, if partnership AB had $30 of business 
interest income, which it allocated solely to A, and $40 of business 
interest expense, which it allocated $20 each to A and B, then A and B 
would each have $15 of deductible business interest expense and $5 of 
excess business interest expense. In situations where the partnership 
does not allocate all of its section 163(j) items pro rata, such as 
this example, this method could require a partnership to allocate its 
section 163(j) excess items in a manner inconsistent with the Treasury 
Department and the IRS's resolution of issues four and five. Because 
this approach could require a partnership to arguably allocate 
inappropriate amounts of section 163(j) excess items to its partners, 
it is not adopted in these proposed regulations.
    The calculation adopted in proposed Sec.  1.163(j)-6(f)(2) 
preserves the entity-level calculation requirement set forth in section 
163(j)(4), while also preserving the economics of the partnership and 
respecting any special allocations made by the partnership in 
accordance with section 704 and the regulations thereunder. Applying 
the method in these proposed regulations to the previous example, A 
would have $20 of deductible business interest expense, and B would 
have $10 of deductible business interest expense and $10 of excess 
business interest expense. This result is consistent with the Treasury 
Department and the IRS's interpretation of section 163(j) as previously 
discussed.
ii. Allocation of Deductible Business Interest Expense and Section 
163(j) Excess Items--General Calculation
    Proposed Sec.  1.163(j)-6(f)(2) provides that partnerships must 
allocate any section 163(j) excess items and any deductible business 
interest expense in the manner described in paragraphs (f)(2)(i) 
through (xi). In general, each paragraph (i) through (xi) is a step in 
a set of instructions that, when completed, provide the partnership 
with the proper allocation of each of its section 163(j) excess items 
to each of its partners. This resulting array of allocations is 
consistent with the Treasury Department and the IRS's resolution of the 
five key issues described in part 6(D)(i) of this Explanation of 
Provisions section. Stated otherwise, such prescribed allocations 
recognize the aggregate nature of partnerships under subchapter K of 
the Code to the greatest extent possible while remaining consistent 
with section 163(j) applying at the partnership level.
    No rule set forth in proposed Sec.  1.163(j)-6(f)(2) of this 
section prohibits a partnership from making an allocation to a partner 
of any section 163(j) item that is otherwise permitted under section 
704 and the regulations thereunder. Accordingly, any calculations in 
proposed Sec.  1.163(j)-6(f)(2)(i) through (xi) are solely for the 
purpose of determining each partner's deductible business interest 
expense and section 163(j) excess items, and do not otherwise affect 
any other provision under the Code, such as section 704(b). Proposed 
Sec.  1.163(j)-6(f)(2) creates numerous defined terms. These defined 
terms are solely for the purpose of proposed Sec.  1.163(j)-6(f)(2) and 
are meant to aid the partnership in its application of proposed Sec.  
1.163(j)-6(f)(2) by allowing the calculation to be broken into discrete 
steps.
    Proposed Sec.  1.163(j)-6(f)(2)(i) requires the partnership to 
calculate its section 163(j) deduction pursuant to proposed Sec.  
1.163(j)-2(b). This step is the entity-level calculation required by 
section 163(j)(4)(A), and it provides the partnership with its total 
amount of deductible business interest expense, excess business 
interest income, excess taxable income, and excess business interest 
expense under section 163(j) for a taxable year. The remaining steps in 
proposed Sec.  1.163(j)-6(f)(2)(ii) through (xi) determine the 
allocations a partnership must make of its deductible business interest 
expense and each section 163(j) excess item to its partners. At the 
conclusion of the eleven steps set forth in proposed Sec.  1.163(j)-
6(f)(2), the total amount of deductible business interest expense and 
section 163(j) excess items allocated to each partner will equal the 
partnership's total amount of deductible business interest expense and 
section 163(j) excess items.
    Proposed Sec.  1.163(j)-6(f)(2)(ii) begins the partner-level 
calculations. It should be noted that the calculations under proposed 
Sec.  1.163(j)-6(f)(2) do not determine a partner's allocation of 
business interest expense, business interest income or items comprising 
ATI, as these allocations are determined under section 704(b) and (c) 
and the regulations thereunder. Rather, the proposed Sec.  1.163(j)-
6(f)(2) partner-level

[[Page 67506]]

calculations determine each partner's amount of deductible business 
interest expense and amount of any section 163(j) excess items. This 
determination provides the starting point for the remainder of the 
steps in proposed Sec.  1.163(j)-6(f)(2). Only items that were taken 
into account in the partnership's section 163(j) calculation are taken 
into account for the proposed Sec.  1.163(j)-6(f)(2) partner-level 
calculation. Section 743(b) adjustments, built-in loss amounts with 
respect to partnership property under section 704(c)(1)(C), section 
704(c) remedial allocations, allocations of investment income and 
expense, and amounts determined for the partner under Sec.  1.882-5 are 
therefore not taken into account for purposes of the proposed Sec.  
1.163(j)-6(f)(2) partner-level calculation. To clarify that only 
section 163(j) items of the partnership are relevant for the 
calculations under proposed Sec.  1.163(j)-6(f)(2), paragraph 
(f)(2)(ii) defines ``allocable ATI'' as a partner's allocable share of 
the partnership's ATI, ``allocable business interest income'' as a 
partner's allocable share of the partnership's business interest 
income, and ``allocable business interest expense'' as a partner's 
allocable share of the partnership's business interest expense that is 
not floor plan financing interest expense.
    As noted previously, the primary goal of proposed Sec.  1.163(j)-
6(f)(2) is to provide the partnership with an array of allocations that 
recognizes the aggregate nature of partnerships under subchapter K of 
the Code to the greatest extent possible while still remaining 
consistent with section 163(j) applying at the partnership level. 
Proposed Sec.  1.163(j)-6(f)(2)(iii) through (v) contain the adjustment 
mechanism necessary to achieve this goal. Section 163(j) permits 
taxpayers with a sufficient amount of appropriate income (ATI and 
business interest income) to deduct their business interest expense. 
However, section 163(j) applies at the entity level with respect to 
partnerships under section 163(j)(4). Proposed Sec.  1.163(j)-
6(f)(2)(iii) recognizes this normative principle of the statute, and 
then proposed Sec.  1.163(j)-6(f)(2)(iv) and (v) reconcile the proposed 
Sec.  1.163(j)-6(f)(2)(iii) partner-level calculation with the proposed 
Sec.  1.163(j)-6(f)(2)(i) partnership-level result.
    To illustrate the mechanism at work in proposed Sec.  1.163(j)-
6(f)(2)(iii) through (v), consider the example used above. Partnership 
AB has $30 of business interest income, which it allocates solely to A, 
and $40 of business interest expense, which it allocates $20 each to A 
and B. Upon applying proposed Sec.  1.163(j)-6(f)(2)(iii), AB 
determines that A has been allocated more allocable business interest 
income than necessary to deduct its allocable business interest expense 
($10 of allocable business interest income excess), and B has not been 
allocated enough allocable business interest income to deduct its 
allocable business interest expense ($20 of allocable business interest 
income deficit). Because AB cannot have both excess business interest 
income and excess business interest expense in the same year, proposed 
Sec.  1.163(j)-6(f)(2)(iv) and (v) reconcile the proposed Sec.  
1.163(j)-6(f)(2)(iii) partner-level calculation with the proposed Sec.  
1.163(j)-6(f)(2)(i) partnership-level result. This process of 
reallocating allocable business interest income excess to partners with 
allocable business interest income deficits is broken into two steps; 
proposed Sec.  1.163(j)-6(f)(2)(iv) first proportionately reduces each 
partner's excess amount, and then proposed Sec.  1.163(j)-6(f)(2)(v) 
proportionately reduces each partner's deficit amount to reflect the 
reallocation of the benefit of the excess amounts.
    Proposed Sec.  1.163(j)-6(f)(2)(vii), (ix), and (x) contain the 
same adjustment mechanism as proposed Sec.  1.163(j)-6(f)(2)(iii) 
through (v), except for ATI instead of business interest income. To 
illustrate, if in the previous example AB had $100 of ATI which it 
allocated solely to A instead of $30 of business interest income, AB 
would perform the calculations in proposed Sec.  1.163(j)-6(f)(2)(vii), 
(ix), and (x)--which parallel the calculations in proposed Sec.  
1.163(j)-6(f)(2)(iii) through (v)--and arrive at the same result. The 
partnership must make the adjustments regarding business interest 
income (proposed Sec.  1.163(j)-6(f)(2)(iii) through (v)) before the 
adjustments regarding ATI (proposed Sec.  1.163(j)-6(f)(2)(vii), (ix), 
and (x)) due to section 163(j)(4)(C), which requires partnerships to 
first fully offset business interest expense using business interest 
income before turning to ATI.
    Finally, proposed Sec.  1.163(j)-6(f)(2)(xi) allocates section 
163(j) excess items and deductible business interest expense to the 
partners. Excess business interest income as determined in proposed 
Sec.  1.163(j)-6(f)(2)(i) is allocated dollar for dollar to the 
partners with final allocable excess business interest income 
determined pursuant to proposed Sec.  1.163(j)-6(f)(2)(iv). After 
grossing up each partner's final ATI capacity excess amount by ten-
thirds (10/3) (the multiplicative inverse of the 30 percent ATI 
limitation), excess taxable income, as determined in proposed Sec.  
1.163(j)-6(f)(2)(i), is allocated dollar for dollar to partners with 
final ATI capacity excess amounts determined pursuant to proposed Sec.  
1.163(j)-6(f)(2)(ix). It is necessary to gross up the ATI capacity 
excess amount by ten thirds in order to account for the reduction to 
ATI capacity that occurred in proposed Sec.  1.163(j)-6(f)(2)(vii). 
Excess business interest expense is allocated dollar for dollar to 
partners with final ATI capacity deficit amounts determined pursuant to 
proposed Sec.  1.163(j)-6(f)(2)(x). A partner's allocable business 
interest expense is deductible business interest expense to the extent 
it exceeds such partner's share of excess business interest expense.
iii. Allocation of Deductible Business Interest Expense and Section 
163(j) Excess Items--Steps 6 and 8
    In a given year, if a partnership does not have any partners with a 
negative allocable ATI under proposed Sec.  1.163(j)-6(f)(2)(vi) (that 
is, an allocable ATI under proposed Sec.  1.163(j)-6(f)(2)(ii) that is 
comprised of more items of deduction and loss than income and gain), 
then the partnership would not have any adjustments under proposed 
Sec.  1.163(j)-6(f)(2)(vi) and (viii). Thus, the only adjustments and 
reallocations the partnership would have to perform as part of its 
proposed Sec.  1.163(j)-6(f)(2) calculation are described in part 
6(D)(ii) of this Explanation of Provisions section. However, if a 
partnership does have a total negative allocable ATI that is greater 
than zero, then the partnership would have adjustments under proposed 
Sec.  1.163(j)-6(f)(2)(vi), and may have adjustments under proposed 
Sec.  1.163(j)-6(f)(2)(viii) as well. Proposed Sec.  1.163(j)-
6(f)(2)(vi) and (viii) are closely related. In general, proposed Sec.  
1.163(j)-6(f)(2)(viii) corrects distortions that would otherwise occur 
following certain proposed Sec.  1.163(j)-6(f)(2)(vi) adjustments.
    The purpose of proposed Sec.  1.163(j)-6(f)(2)(vi) is to address 
the situation in which a partner's allocable ATI under proposed Sec.  
1.163(j)-6(f)(2)(ii) is comprised of more items of deduction and loss 
than income and gain--that is, negative allocable ATI. For purposes of 
the section 163(j) calculation, a partnership that has ATI of less than 
zero will not be able to deduct business interest expense with respect 
to ATI under section 163(j)(1). Accordingly, for purposes of the 
proposed Sec.  1.163(j)-6(f)(2) calculation, the partnership must 
ensure that each partner has a ``final allocable ATI'' of at least zero 
before performing the ATI adjustment calculation described in proposed 
Sec.  1.163(j)-6(f)(2)(vii), (ix), and (x). This is accomplished by 
proportionately

[[Page 67507]]

reallocating positive allocable ATI from partners with positive 
allocable ATI to partners with negative allocable ATI in order to gross 
such partners up to zero. Upon completion of the calculation in 
proposed Sec.  1.163(j)-6(f)(2)(vi), the aggregate of the partners' 
final allocable ATI amounts will equal the partnership's ATI amount 
used in calculating its section 163(j) limitation under proposed Sec.  
1.163(j)-6(f)(2)(i), and no partner will have a final allocable ATI 
amount less than zero.
    A partnership must always apply proposed Sec.  1.163(j)-
6(f)(2)(vi), even if the partnership does not have any numerical 
adjustment resulting from it. For example, if a partnership has a total 
negative allocable ATI of $0 in proposed Sec.  1.163(j)-6(f)(2)(vi), 
then even though the partnership will not reallocate any positive 
allocable ATI in proposed Sec.  1.163(j)-6(f)(2)(vi), the partnership 
must still apply proposed Sec.  1.163(j)-6(f)(2)(vi) to convert each 
partner's positive allocable ATI to final allocable ATI, which is used 
in subsequent paragraphs as the successor term of allocable ATI.
    The purpose of proposed Sec.  1.163(j)-6(f)(2)(viii) is to ensure 
that any adjustments the partnership was required to make under 
proposed Sec.  1.163(j)-6(f)(2)(vi) do not result in proposed Sec.  
1.163(j)-6(f)(2) requiring the partnership to allocate deductible 
business interest expense and section 163(j) excess items in an 
inequitable manner. To illustrate, consider the following example. 
Partnership ABC has $100 of ATI, comprised of $200 of items of income 
and gain and $100 of deduction and loss, and $40 of business interest 
expense. ABC allocates the income and gain $100 each to A and C, and 
all $100 of the deduction and loss to B. ABC has $40 of business 
interest expense, which it allocates $20 each to A and B. Upon applying 
proposed Sec.  1.163(j)-6(f)(2)(i), ABC has $30 of deductible business 
interest expense and $10 of excess business interest expense.
    Given these facts and the Treasury Department and the IRS's 
interpretation of section 163(j), A is clearly entitled to treat all 
$20 of its allocable business interest expense as deductible business 
interest expense in the current year, and B should be allocated the $10 
of excess business interest expense. However, in the absence of 
proposed Sec.  1.163(j)-6(f)(2)(viii), proposed Sec.  1.163(j)-6(f)(2) 
would require ABC to make different, less equitable, allocations. The 
issue stems from proposed Sec.  1.163(j)-6(f)(2)(vi). Following the 
application of proposed Sec.  1.163(j)-6(f)(2)(vi) and (vii), A has an 
ATI capacity deficit of $5, B has an ATI capacity deficit of $20, and C 
has an ATI capacity excess of $15. The calculations in proposed Sec.  
1.163(j)-6(f)(2)(ix) and (x) reallocate ATI capacity excess to partners 
with ATI capacity deficits solely based on each partners ATI capacity 
deficit relative to the total ATI capacity deficit. Because proposed 
Sec.  1.163(j)-6(f)(2)(ix) and (x) only takes each partner's 
proportionate share of ATI capacity deficit into account when 
reallocating ATI capacity excess, proposed Sec.  1.163(j)-6(f)(2)(ix) 
and (x) always treat all of partners as though they are on equal 
footing regardless of any adjustments that may have happened in 
proposed Sec.  1.163(j)-6(f)(2)(vi). As a result, in the absence of 
proposed Sec.  1.163(j)-6(f)(2)(viii), A would be allocated deductible 
business interest expense of only $18 (instead of $20), and B would be 
allocated excess business interest expense of only $8 (instead of $10).
    The proposed Sec.  1.163(j)-6(f)(2)(viii) adjustment begins by 
filtering out partnerships that do not need to make the adjustment 
using the criteria listed in proposed Sec.  1.163(j)-6(f)(2)(viii)(A). 
This treatment is possible due to the predictability and limited 
universe of situations that require a proposed Sec.  1.163(j)-
6(f)(2)(viii) adjustment. Specifically, a proposed Sec.  1.163(j)-
6(f)(2)(viii) adjustment is always triggered when a positive allocable 
ATI partner that helped gross up a negative allocable ATI partner in 
proposed Sec.  1.163(j)-6(f)(2)(vi) is subsequently forced to compete 
with such partner for a limited amount of ATI capacity excess.
    Next, under proposed Sec.  1.163(j)-6(f)(2)(viii)(B), a partnership 
must determine each partner's priority amount. This priority amount 
represents what a partner's ATI capacity would have been if such 
partner had not been required under proposed Sec.  1.163(j)-6(f)(2)(vi) 
to offset another partner's negative allocable ATI. For purposes of 
determining whether to apply proposed Sec.  1.163(j)-6(f)(2)(viii)(C) 
or (D) and performing the calculations under the applicable paragraph, 
each partner's usable priority amount must be determined. A partner's 
usable priority amount is the lesser of its priority amount and ATI 
capacity deficit.
    A partnership must use the amounts it determined under proposed 
Sec.  1.163(j)-6(f)(2)(viii)(B) to determine whether it must perform 
the calculations in proposed Sec.  1.163(j)-6(f)(2)(viii)(C) or (D). If 
the total ATI capacity excess amount, as determined under proposed 
Sec.  1.163(j)-6(f)(2)(vii), is greater than or equal to the total 
usable priority amount, then the adjustments in proposed Sec.  
1.163(j)-6(f)(2)(viii)(C) must occur. If the total usable priority 
amount is greater than the total ATI capacity excess amount, as 
determined under proposed Sec.  1.163(j)-6(f)(2)(vii), then the 
adjustments in proposed Sec.  1.163(j)-6(f)(2)(viii)(D) must occur. The 
application of proposed Sec.  1.163(j)-6(f)(2)(viii)(C) or (D) may 
result in adjustments to the partner's ATI capacity excess (and 
deficit) amounts used in proposed Sec.  1.163(j)-6(f)(2)(ix) and (x).
    The purpose of these adjustments is to ensure that the partners who 
had a negative allocable ATI do not improperly benefit under proposed 
Sec.  1.163(j)-6(f)(2)(ix) through (xi) to the detriment of the 
partners who had a positive allocable ATI. In general, proposed Sec.  
1.163(j)-6(f)(2)(viii)(C) and (D) correct any artificial distortion of 
the economics between the partners that may have occurred under 
proposed Sec.  1.163(j)-6(f)(2)(vi) by modifying the outputs of 
proposed Sec.  1.163(j)-6(f)(2)(vii) to restore the partners' true 
economic arrangement before such outputs are used in proposed Sec.  
1.163(j)-6(f)(2)(ix) and (x). Stated otherwise, proposed Sec.  
1.163(j)-6(f)(2)(viii)(C) and (D) compensate for the assumption made by 
proposed Sec.  1.163(j)-6(f)(2)(ix) and (x) that all partners are 
always on equal footing by modifying the outputs of proposed Sec.  
1.163(j)-6(f)(2)(vii) to put all partners on equal footing before 
allowing such outputs to reach proposed Sec.  1.163(j)-6(f)(2)(ix) and 
(x).
    Turning back to the foregoing example, in accordance with proposed 
Sec.  1.163(j)-6(f)(2)(viii), ABC would first determine whether it has 
all three attributes in proposed Sec.  1.163(j)-6(f)(2)(viii)(A)(1) 
through (3). Because ABC (1) has excess business interest expense under 
proposed Sec.  1.163(j)-6(f)(2)(i); (2) has total negative allocable 
ATI greater than $0 under proposed Sec.  1.163(j)-6(f)(2)(vi); and (3) 
has a total ATI capacity excess amount greater than $0 under proposed 
Sec.  1.163(j)-6(f)(2)(vii), ABC must perform the calculations and make 
the necessary adjustments described under proposed Sec.  1.163(j)-
6(f)(2)(viii)(B) and (C) or (D). Given ABC's facts, proposed Sec.  
1.163(j)-6(f)(2)(viii)(B) would require ABC to perform the calculations 
in proposed Sec.  1.163(j)-6(f)(2)(viii)(C). As a result, A would be 
allocated deductible business interest expense of $20, and B would be 
allocated excess business interest expense of $10 and deductible 
business interest expense of $10. This result is consistent with the 
Treasury Department and the IRS's resolution of the five key issues 
described in part

[[Page 67508]]

6(D)(i) of this Explanation of Provisions section.
    The Treasury Department and the IRS request comments on the 
approach described in this part 6(D). Specifically, comments are 
requested regarding other reasonable methods to allocate deductible 
business interest expense, excess taxable income, and excess business 
interest expense in a manner that permits partners that bear the 
taxable income supporting the deductible business interest expense to 
be allocated a disproportionate share of deductible business interest 
expense and excess taxable income. Finally, comments are requested 
regarding the fungibility of publicly traded partnership interests with 
respect to the foregoing approach.

E. Business Interest Expense Carryforwards

i. In General
    Proposed Sec.  1.163(j)-6(g) would provide that to the extent a 
partnership has business interest expense in excess of its section 
163(j) limitation, such excess business interest expense shall not be 
carried forward by the partnership. Instead, such excess business 
interest expense would be allocated to the partners in accordance with 
proposed Sec.  1.163(j)-6(f).
    A commenter requested guidance regarding whether a partner will be 
permitted to use its share of the partnership's excess business 
interest income in the current taxable year to absorb the partner's 
excess business interest expense allocated from such partnership in 
prior years. The Treasury Department and the IRS believe that it is 
consistent with section 163(j) to allow excess business interest income 
allocated to a partner from a partnership to absorb the partner's 
excess business interest expenses allocated from that same partnership 
in an earlier taxable year to the extent of the excess business 
interest income allocated to the partner. This allowance places 
partners in a similar position to other taxpayers with carryforwards.
    Regarding a partner's allocation of excess taxable income, the 
Treasury Department and the IRS considered three options when drafting 
guidance on the deductibility of a partner's excess business interest 
expense carryforward as it relates to a partner's share of excess 
taxable income. Section 163(j)(4)(B)(ii)(I) provides that the 
carryforward ``shall be treated as business interest expense paid or 
accrued by the partner in the next succeeding taxable year in which the 
partner is allocated excess taxable income from such partnership, but 
only to the extent of such excess taxable income.'' The first option 
would apply a plain reading of the statutory language to treat as paid 
or accrued by the partner the amount of excess business interest 
expense carryforward from the partnership equal to the excess taxable 
income the partner is allocated from the partnership, but it would 
limit the deductibility of the excess business interest expense by a 
partner to the partner's business interest income and 30 percent of the 
partner's ATI for the taxable year. Given this interpretation is the 
most consistent with the plain meaning of the statute, proposed Sec.  
1.163(j)-6(g) would provide that to the extent a partner receives an 
allocation of excess taxable income from a partnership in a taxable 
year, such partner's excess business interest expense is treated as 
paid or accrued in that year in an amount equal to the partner's share 
of the excess taxable income. To the extent the partner's excess 
business interest expense exceeds its share of the partnership's excess 
taxable income in a taxable year, it remains excess business interest 
expense and is carried over to the following taxable year. When the 
excess business interest expense is treated as paid or accrued, it 
becomes business interest paid or accrued by the partner and may be 
deducted by the partner, subject to any partner-level section 163(j) 
limitation and any other applicable limitations.
    The second option considered would entitle a partner to deduct 
excess business interest expense only to the extent the partner can 
deduct that excess business interest expense against the excess taxable 
income received from the partnership (for example, 30 percent of excess 
taxable income which increases the partner's ATI under section 
163(j)(4)(A)(ii)(II)), regardless of any ATI or business interest 
income that the partner has from sources other than the partnership. 
This option would produce the same result as if the partnership had 
paid or accrued all the relevant income and expense in a single year. 
The legislative history can be read to suggest this result: ``The 
partner may deduct its share of the partnership's excess business 
interest in any future year, but only against excess taxable income 
attributed to the partner by the partnership the activities of which 
gave rise to the excess business interest carryforward.'' H. Rept. 115-
466, at 391 (2017). However, this interpretation does not appear to be 
consistent with the plain language of the statute, which states that 
excess business interest expense is treated as paid or accrued to the 
extent of the partner's excess taxable income.
    The third option considered would entitle a partner to fully deduct 
excess business interest expense to the extent it receives an 
allocation of excess taxable income from the same partnership (for 
example, for every dollar of excess taxable income a partner is 
allocated, the partner is able to deduct one dollar of excess business 
interest expense). This interpretation would treat all excess business 
interest expense, to the extent of excess taxable income, as interest 
deductible under section 163(a). However, this interpretation ignores 
the possibility that the partner may be subject to its own section 
163(j) limitation and ignores the 30 percent limitation on ATI that a 
partnership would be subject to had the business interest expense been 
paid or accrued in the current year. Accordingly, this option is not 
adopted in the proposed regulations.
ii. Ordering Rule
    The ordering rule in proposed Sec.  1.163(j)-6(f)(2)(iii) would 
clarify that to the extent a partner is allocated excess taxable income 
or excess business interest income from a partnership in the current 
taxable year and, in a prior year, that partner was allocated excess 
business interest expense from that same partnership that has not been 
previously treated as paid or accrued by the partner, the partner must 
treat that current-year excess taxable income and excess business 
interest income as causing the excess business interest expense carried 
forward from the partnership to be treated as paid or accrued in such 
year to the extent of the excess taxable income and excess business 
interest income. In the event a partner receives excess taxable income 
or excess business interest income from a partnership, it cannot choose 
to keep excess business interest expense as not paid or accrued in the 
current taxable year.

F. Basis Adjustments

i. Basis and Capital Account Adjustments for Excess Business Interest 
Expense Allocations
    Generally, a partner's adjusted basis in its partnership interest 
shall be reduced by allocated items of partnership loss or deduction, 
but not below zero, pursuant to Sec.  1.704-1(d)(2). Deductible 
business interest expense and excess business interest expense are 
subject to section 704(d). If a partner is subject to a limitation on 
loss under

[[Page 67509]]

section 704(d) and a partner is allocated losses from a partnership in 
a taxable year, Sec.  1.704-1(d)(2) requires that the limitation on 
losses under section 704(d) be apportioned amongst these losses based 
on the character of each loss (each grouping of losses based on 
character being a ``section 704(d) loss class''). If there are multiple 
section 704(d) loss classes in a given year, Sec.  1.704-1(d)(2) 
requires the partner to apportion the limitation on losses under 
section 704(d) to each section 704(d) loss class proportionately. For 
purposes of applying this proportionate rule, any deductible business 
interest expense (whether allocated to the partner in the current 
taxable year or suspended under section 704(d) in a prior taxable 
year), any excess business interest expense allocated to the partner in 
the current taxable year, and any excess business interest expense from 
a prior taxable year that was suspended under section 704(d) 
(``negative section 163(j) expense'') shall comprise the same section 
704(d) loss class. Once the partner determines the amount of limitation 
on losses apportioned to this section 704(d) loss class, any deductible 
business interest expense is taken into account before any excess 
business interest expense or negative section 163(j) expense.
    The adjusted basis of a partner in a partnership interest is 
reduced, but not below zero, by the amount of excess business interest 
expense allocated to the partner pursuant to proposed Sec.  1.163(j)-
6(f)(2). Negative section 163(j) expense is not treated as excess 
business interest expense in any subsequent year until such negative 
section 163(j) expense is no longer suspended under section 704(d). 
Consequently, an allocation of excess taxable income or excess business 
interest income does not result in the negative section 163(j) expense 
being treated as business interest expense paid or accrued by the 
partner. Further, unlike excess business interest expense preventing a 
partner from including excess taxable income in its ATI as described in 
section 163(j)(4)(B)(ii) flush language, negative section 163(j) 
expense does not affect, and is not affected by, any allocation of 
excess taxable income to the partner. Accordingly, any excess taxable 
income allocated to a partner from a partnership while the partner 
still has a negative section 163(j) expense will be included in the 
partner's ATI. However, once the negative section 163(j) expense is no 
longer suspended under section 704(d), it becomes excess business 
interest expense, which is subject to the general rules in proposed 
Sec.  1.163(j)-6(g). Section 163(j) has no effect on the maintenance of 
capital accounts (for example, a partner's capital account is reduced 
in the year such partner is allocated excess business interest 
expense). See Sec.  1.704-1(b)(2)(iv)(b).
    The guidance provided in proposed Sec.  1.163(j)-6(h)(2) is 
intended to address situations in which a partner is subject to a 
limitation under section 704(d) and is also allocated excess taxable 
income. Pursuant to proposed Sec.  1.163(j)-6(g), excess business 
interest expense would otherwise be treated as paid or accrued by the 
partner in an amount equal to the excess taxable income, but the 
partner's basis in the partnership does not increase in an amount equal 
to the allocated excess taxable income and, therefore, remains subject 
to the loss limitation in section 704(d). The approach taken in 
proposed Sec.  1.163(j)-6(h)(2) attempts to reconcile the competing 
deduction limitations imposed by sections 704(d) and 163(j) along with 
section 163(j) treating excess business interest expense as paid or 
accrued by the partner when the partner is allocated excess taxable 
income. The Treasury Department and the IRS request comments on this 
issue.
ii. Basis Adjustments Upon Disposition of Partnership Interests 
Pursuant to Section 163(j)(4)(B)(iii)(II)
    Proposed Sec.  1.163(j)-6(h)(3) would provide that if a partner 
disposes of all or substantially all of its partnership interest, the 
adjusted basis of the partner in the partnership interest shall be 
increased immediately before the disposition by the amount of excess, 
if any, of the amount of the basis reduction under proposed Sec.  
1.163(j)-6(h)(1) over the portion of any excess business interest 
expense allocated to the partner under proposed Sec.  1.163(j)-6(f)(2) 
which has not been previously treated under proposed Sec.  1.163(j)-
6(g) as business interest expense paid or accrued by the partner, 
regardless of whether the disposition was as a result of a taxable or 
non-taxable transaction. No deduction under section 163(j) shall be 
allowed to the transferor or transferee under chapter 1 of the Code for 
any excess business interest expense resulting in a basis increase 
under section 163(j) and these proposed regulations or for any negative 
section 163(j) expense.
    In the event a partner disposes of less than substantially all of 
its interest in a partnership, proposed Sec.  1.163(j)-6(h)(2) would 
provide that a partner shall not increase its basis in its partnership 
by the amount of any excess business interest expense that has not yet 
been treated as paid or accrued by the partner in accordance with 
proposed Sec.  1.163(j)-6(g). Any such excess business interest expense 
would remain excess business interest expense in the hands of the 
transferor partner until such time as the transferor partner is 
allocated an appropriate amount of excess taxable income or excess 
business interest income from the partnership or added to the basis of 
its partnership interest when the partner fully disposes of the 
partnership interest. Additionally, any negative section 163(j) expense 
shall remain negative section 163(j) expense of the transferor partner 
until such negative section 163(j) expense is no longer suspended under 
section 704(d). These rules are similar to the rules found under 
section 469 and the regulations thereunder relating to suspended 
passive activity loss deductions.
    The Treasury Department and the IRS considered alternate approaches 
when analyzing the effect of partial dispositions on a partner's basis. 
One alternate approach would add excess business interest expense to 
the partner's basis in the partnership interest to the extent the 
partner's capital account is reduced by the transfer or redemption. A 
second approach would increase the partner's remaining basis in the 
partnership interest by the amount of excess business interest expense 
that is proportionate to the amount of the partner's adjusted basis in 
the partnership interest that was transferred or redeemed. This method 
would require a partner to track its basis in the partnership interest 
in a manner similar to that set forth in Rev. Rul. 84-53, 1984-15 
I.R.B. 17, 1984-1 C.B. 159 (Apr. 9, 1984). The Treasury Department and 
the IRS request comments on this issue.

G. Investment Items

    Proposed Sec.  1.163(j)-6(j) would provide guidance on the 
treatment of investment income and expense items under section 163(d) 
allocated by a partnership to its partners. Notice 2018-28 stated that 
the Treasury Department and the IRS intend to issue regulations 
clarifying that, solely for purposes of section 163(j), in the case of 
a taxpayer that is a C corporation, all interest paid or accrued by the 
C corporation on indebtedness of such C corporation will be business 
interest expense within the meaning of section 163(j)(5), and all 
interest on indebtedness held by the C corporation that is includible 
in gross income of such C corporation will be business interest income 
within the meaning of section 163(j)(6). Additionally, comments were 
received

[[Page 67510]]

requesting guidance on the treatment of investment interest expense and 
investment interest income, as defined in section 163(d), allocated to 
a C corporation (corporate partner) by a partnership.
    The Treasury Department and the IRS considered two approaches to 
address this issue. Under the first approach, the investment interest 
expense would be allocated directly from the partnership to the 
corporate partner without being subject to the section 163(j) 
limitations of the partnership. This option is most consistent with a 
plain reading of the statute. The definition of business interest 
expense under section 163(j)(5) specifically excludes investment 
interest. Section 163(j)(4) requires the business interest expense 
deduction to be calculated with respect to the partnership's specific 
items of income and expense, and the statute does not require any 
partner-specific considerations to be taken into account when 
performing the calculation at the partnership level.
    The legislative history of section 163(j) indicates that a 
corporation can never have investment income and expenses, and instead, 
those items shall be treated as business interest income and expenses: 
``Section 163(d) applies in the case of a taxpayer other than a 
corporation. Thus, a corporation has neither investment interest nor 
investment income within the meaning of section 163(d). Therefore, 
interest income and interest expense of a corporation is properly 
allocable to a trade or business, unless such trade or business is 
otherwise explicitly excluded from the application of the provision.'' 
H. Rept. 115-466, at 386, fn. 688 (2017).
    This language suggests a legislative intent to transform any 
interest that would otherwise be classified as investment interest in 
the hands of the corporate partner into business interest expense, 
thereby subjecting that interest to the corporate partner's limitations 
under section 163(j).
    The second approach considered would require a partnership to 
perform a notional calculation under section 163(j) with respect to the 
investment interest that is allocated to its corporate partners. Based 
on the text and legislative history, this provision could arguably be 
interpreted to mean that investment interest expenses should be 
classified as business interest expenses at the time they are allocated 
to a corporate partner, and accordingly, the partnership should perform 
a section 163(j) calculation with respect to those items because 
section 163(j) requires a partnership to take the business interest 
expense deduction into account. Because this calculation would be done 
at the partnership level, any partnership with both corporate and non-
corporate partners would need to make two section 163(j) calculations: 
One for any corporate partners and one for non-corporate partners.
    Proposed Sec.  1.163(j)-6(j) would adopt the first approach. 
Section 163(j)(4) does not require the partnership to look beyond its 
own tax attributes to that of its partners when making a determination 
as to whether a section 163(j) calculation is necessary. Accordingly, a 
plain reading of the statute does not support the partnership treating 
investment interest as business interest expense prior to allocating 
the interest to its partners. Instead, the statute appears to require 
the corporate partner to calculate its section 163(j) limitation while 
including this investment interest as it would with all other business 
and investment interest it receives from all sources.
    It should be noted that, with respect to passthrough entities, 
including S corporations, engaged in trades or businesses that are not 
passive activities and with respect to which certain owners of the 
passthrough entities do not materially participate for purposes of 
section 469, as described in section 163(d)(5)(A)(ii) and as 
illustrated in Rev. Rul. 2008-12, the rules of section 163(j)(4) will 
apply to business interest expense allocable to such trades or 
businesses of those passthrough entities if those entities are 
otherwise subject to section 163(j). To the extent business interest 
expense of a passthrough entity is not limited under section 163(j), 
such business interest expense may still be limited by section 163(d) 
at the passthrough entity owner level in these situations. With respect 
to partnerships, to the extent that such business interest expense is 
limited under section 163(j)(4) and becomes a carryover item of 
partners who do not materially participate with respect to such trades 
or businesses, those items will be treated as items of investment 
interest expense in the hands of those owners for purposes of section 
163(d) once those carryover items are treated as paid or accrued in a 
succeeding taxable year. The Treasury Department and the IRS have 
concluded that this is the result of the statutory rules contained in 
section 163(d)(4)(B) and (d)(5)(A)(ii) and, therefore, no additional 
rules are needed in regulations to reach this result.

H. S Corporations

i. In General
    Section 163(j)(4)(D) provides that rules similar to those contained 
in section 163(j)(4)(A), relating to the entity-level treatment of the 
section 163(j) deduction, and section 163(j)(4)(C), relating to the 
definition of excess taxable income, apply to S corporations. 
Accordingly, proposed Sec.  1.163(j)-6(l) would provide that, in the 
case of any S corporation, (i) the section 163(j) deduction limitation 
would be applied at the S corporation level, and (ii) any deduction for 
business interest expense would be taken into account in determining 
the nonseparately stated taxable income or loss of the S corporation.
    An S corporation would determine its amount allowed as a deduction 
for business interest expense for the taxable year, that is, its 
section 163(j) deduction limitation, in the same manner as set forth in 
proposed Sec.  1.163(j)-2(b). Due to the fact that S corporations 
generally are required to make pro rata distributions of income, 
allocations of excess taxable income and excess business interest 
income would be made in accordance with the shareholders' respective 
interests in the S corporation after the S corporation determines its 
section 163(j) deduction limitation pursuant to proposed Sec.  
1.163(j)-2(b), in accordance with section 1366(a)(1). See section 
1361(b)(1)(D); Sec.  1.1361-1(l) (non-pro rata distributions may create 
a second class of stock). Because partner-level adjustments are not 
applicable to S corporation shareholders, the ATI of an S corporation 
generally would be determined in accordance with proposed Sec.  
1.163(j)-1(b)(1) without additional modifications.
ii. Dispositions of S Corporation Stock
    Proposed Sec. Sec.  1.163(j)-6(l)(4)(ii) and 1.163(j)-10(b)(4)(ii) 
would provide guidance regarding the inclusion of the proceeds from the 
dispositions of S corporation stock in the selling shareholder's ATI. 
Specifically, proposed Sec.  1.163(j)-6(l)(4)(ii) would provide that, 
in the event that a shareholder of an S corporation recognizes gain or 
loss upon the disposition of stock of the S corporation, and the 
corporation in which the stock is being disposed owns only non-excepted 
trade or business assets, the gain or loss on the disposition of the 
stock would be included in the shareholder's ATI. Under proposed Sec.  
1.163(j)-10(b)(4)(ii), if a shareholder recognizes gain or loss upon 
the disposition of stock in an S corporation that owns (1) non-excepted 
assets and

[[Page 67511]]

excepted assets, (2) investment assets, or (3) both, the shareholder 
would determine the proportionate share of the amount properly 
allocable to a non-excepted trade or business, in accordance with the 
allocation rules set forth in proposed Sec.  1.163(j)-
10(c)(5)(ii)(B)(3), and would include such proportionate share of gain 
or loss in the shareholder's ATI. Proposed Sec.  1.163(j)-10(b)(4)(ii) 
would also apply to tiered passthrough entities, as defined in proposed 
Sec.  1.163(j)-7(f)(13), by looking through each passthrough entity 
tier (for example, an S corporation that is the partner of the highest-
tier partnership would look through each lower-tier partnership), 
subject to proposed Sec.  1.163(j)-10(c)(5)(ii)(D).
iii Double Counting of Business Interest Income Prohibited
    Proposed Sec.  1.163(j)-6(l)(4)(iii) would incorporate the 
limitations set forth in Notice 2018-28, which the Treasury Department 
and the IRS issued ``to prevent the double counting of business 
interest income and floor plan financing interest expense for purposes 
of the deduction afforded by section 163(j).'' Notice 2018-28, section 
7. Consistent with the Notice's statement regarding the application of 
such limitations to S corporations and their shareholders, proposed 
Sec.  1.163(j)-6(l)(4)(iii) would provide that, for purposes of 
calculating an S corporation shareholder's section 163(j) limitation, 
the shareholder would not include business interest income from an S 
corporation that is subject to section 163(j) except to the extent it 
is allocated excess business interest income from that S corporation 
pursuant to proposed Sec.  1.163(j)-6(l)(1). In addition, proposed 
Sec.  1.163(j)-6(l)(4)(iii) would provide that an S corporation 
shareholder could not include its share of the S corporation's floor 
plan financing interest expense for purposes of calculating a 
shareholder's section 163(j) limitation because such floor plan 
financing interest expense would have already have been taken into 
account by the S corporation in determining its nonseparately stated 
taxable income or loss for purposes of section 163(j).
iv. Business Interest Expense Carryforwards
    Section 163(j)(4) does not indicate the manner by which disallowed 
business interest expense carryforwards should be treated by an S 
corporation and its shareholders. However, by virtue of the fact that 
section 163(j)(4)(D) references both sections 163(j)(4)(A) and (C), but 
not (B), an inference could be made that Congress intended that 
disallowed business interest expense carryforwards that arise from an S 
corporation should be treated differently than excess business interest 
expense incurred by a partnership. The legislative history appears to 
support such inference by indicating that the ``special rule for 
carryforward of disallowed partnership interest'' in section 
163(j)(4)(B) ``does not apply to S corporations and their 
shareholders.'' H. Rept. 115-466, at 391 (2017).
    In light of the statutory language and the legislative history, 
proposed Sec.  1.163(j)-6(l)(5) provides that the rules set forth in 
proposed Sec.  1.163(j)-2(c) govern the treatment of S corporation 
business interest expense carryforwards. Consequently, if an S 
corporation has a disallowed business interest expense carryforward in 
the year the S corporation terminates, such item will be carried 
forward to the succeeding C corporation taxable year. The Treasury 
Department and the IRS request comments regarding the treatment of 
disallowed business interest expense carryforwards as an attribute of 
the S corporation, subject to section 382 limitations, as opposed to 
the shareholders, and the timing for any adjustments to shareholder 
basis and the S corporation's accumulated adjustment account. By 
deferring adjustments to shareholder basis and the S corporation's 
accumulated adjustments account until any carryforwards are deductible 
at the corporate level, these proposed regulations generally would 
match the economics of these adjustments to the shareholders holding 
stock at the time the S corporation's carryforwards would become 
deductible.
    The Treasury Department and the IRS, however, have considered an 
alternative option to the rules set forth in proposed Sec.  1.163(j)-
6(l)(5). This alternative option would allocate carryforwards from an S 
corporation to its shareholders in a manner similar to proposed Sec.  
1.163(j)-6(g) for partnerships and their partners. This option would 
require shareholders to receive excess taxable income or excess 
business interest income from the S corporation in order to treat the 
disallowed business interest carryforwards as paid or accrued by the 
shareholder. The shareholder's basis and the S corporation's 
accumulated adjustment account would be reduced upon an allocation of 
excess business interest expense to the shareholders.
    This alternative option would set forth a framework that would be 
consistent with the flow-through nature of S corporations. For example, 
S corporations, similar to partnerships, allocate items of deduction 
and expense in the year that they occur, even if such items might be 
suspended at the shareholder-level under section 1366(d). In addition, 
S corporation shareholders calculate their respective bases in a manner 
similar to partners, except that S corporation shareholders do not take 
into account entity-level debt. Thus, corporate attributes generally 
are suspended at the shareholder-level under the existing subchapter S 
framework. The Treasury Department and the IRS request comments on this 
alternative approach and the authoritative support for adopting it.
v. Applicability of Section 382 to S Corporations Regarding Disallowed 
Business Interest Expense Carryforwards
    Although the Treasury Department and the IRS have determined that 
sections 381(c)(20) and 382(d)(3) and (k)(1) apply to S corporations 
with respect to disallowed business interest expense carryforwards, the 
Treasury Department and the IRS continue to consider the extent to 
which section 382 should apply to S corporations for purposes other 
than section 163(j). The application of section 382 to S corporations 
for purposes of section 163(j) should not be construed as creating any 
inference regarding the application of section 382 to S corporations 
for other purposes. The Treasury Department and the IRS seek comments 
regarding the proper integration of these two Code sections and 
subchapter S of the Code (for example, comments regarding the 
interaction between sections 382 and 1362(e)(6)(D)).

I. Partnership or S Corporation Not Subject to Section 163(j)

    Proposed Sec.  1.163(j)-6(m) would provide guidance regarding 
partnerships and S corporations not subject to section 163(j). If a 
partnership or S corporation is not subject to section 163(j) by reason 
of proposed Sec.  1.163(j)-2(d) (exempt entity), the exempt entity 
would not be required to perform the business interest expense 
limitation calculations under proposed Sec. Sec.  1.163(j)-2(b) and 
1.163(j)-6. To the extent a partner or shareholder receives business 
interest expense from an exempt entity, however, that business interest 
expense will be subject to the partner or shareholder's own section 
163(j) deduction. In the event a partner or shareholder is subject to 
section 163(j) and the S corporation or partnership is not, the 
partnership or S corporation shall provide the partner or shareholder 
with the information necessary to inform the partner or shareholder of 
the partner or

[[Page 67512]]

shareholder's share of the partnership or S corporation's business 
interest expense, business interest income, and items of ATI.
    To the extent a partnership or S corporation is not subject to 
section 163(j) by reason of proposed Sec.  1.163(j)-1(b)(38)(ii) 
because it has an excepted trade or business (excepted entity), the 
excepted entity would not have to perform the business interest expense 
limitation calculations under proposed Sec. Sec.  1.163(j)-2(b) and 
1.163(j)-6 with respect to the business interest expense that is 
allocated to such electing trade or business. To the extent a partner 
or shareholder is allocated any section 163(j) item that is allocated 
to the partnership's excepted trade or business (excepted 163(j) 
items), such excepted 163(j) items would be excluded from the partner 
or shareholder's section 163(j) deduction calculation.
    In the event a partnership allocates excess business interest 
expense to one or more of its partners, and in a later taxable year 
becomes exempt from the requirements of section 163(j)(4), proposed 
Sec.  1.163(j)-6(l) would provide that the excess business interest 
expense from the prior taxable years is treated as paid or accrued by 
the partner in such later taxable year.

7. Proposed Sec.  1.163(j)-7: Application of Section 163(j) to Foreign 
Corporations and Their Shareholders

A. Overview

    The Treasury Department and the IRS received comments requesting 
clarification on whether section 163(j) applies to a controlled foreign 
corporation (as defined in section 957) (CFC) and, if so, the manner in 
which it applies.
    These proposed regulations would provide the general rule that 
section 163(j) and the section 163(j) regulations apply to determine 
the deductibility of a CFC's business interest expense in the same 
manner as those provisions apply to determine the deductibility of a 
domestic C corporation's business interest expense. See proposed Sec.  
1.163(j)-7(b)(2). Thus, a CFC with business interest expense would 
apply section 163(j) to determine the extent to which that expense is 
deductible for purposes of computing subpart F income as defined under 
section 952, tested income as defined under section 951A(c)(2)(A), and 
income which is effectively connected with the conduct of a U.S. trade 
or business (ECI), as applicable. Additional guidance for a CFC (and 
other foreign persons) with ECI is provided in proposed Sec.  1.163(j)-
8 and discussed in part 8 of this Explanation of Provisions section.
    Notwithstanding the general applicability of section 163(j) to CFCs 
under these proposed regulations, the Treasury Department and the IRS 
have determined that it is appropriate in certain cases to modify its 
application. As discussed in part 7(B) and part 7(C) of this 
Explanation of Provisions section, these proposed regulations would, in 
certain cases, limit the amount of a CFC's business interest expense 
subject to the section 163(j) limitation and modify the computation of 
a CFC's ATI, respectively.
    The Treasury Department and the IRS continue to study whether it 
would be appropriate to provide additional modifications to the 
application of section 163(j) to CFCs and whether there are particular 
circumstances in which it may be appropriate to exempt a CFC from the 
application of section 163(j). The Treasury Department and the IRS 
request comments on this matter.

B. Computation of Amount of Business Interest Expense Subject to 
Section 163(j)

    The Treasury Department and the IRS are aware that if business 
interest expense is paid by one CFC to a related CFC, the application 
of section 163(j) could result in an inappropriate mismatch of a 
deduction and payee income item. Such mismatch could inappropriately 
impact the calculation of the tax liability of a United States 
shareholder, as defined in section 951(b), under section 951A or the 
GILTI provision. Consider an example where a United States person (USP) 
wholly owns two CFCs (CFC1 and CFC2), and CFC1 has made a loan to CFC2 
with respect to which CFC1 annually accrues $100x of business interest 
income that is included in CFC1's tested income, and CFC2 pays or 
accrues $100x of business interest expense, which absent section 
163(j), would be fully deductible in computing CFC2's tested income or 
tested loss, as applicable. Thus, the intercompany business interest 
income and business interest expense would fully offset one another for 
purposes of computing USP's inclusion under section 951A(a). To the 
extent section 163(j) were to disallow a deduction for business 
interest expense to CFC2 while the business interest income would be 
included in CFC1's tested income, the amounts would not fully offset, 
and USP's inclusion under section 951A(a) may be increased solely due 
to the use of intercompany debt between CFC1 and CFC2.
    The Treasury Department and the IRS considered the possibility of 
completely disregarding all business interest income and business 
interest expense with respect to intercompany debt between related CFCs 
for purposes of computing the section 163(j) limitation of the lender 
CFC and borrower CFC (the disregard approach). However, the disregard 
approach was rejected because it could cause inappropriate results 
where, for example, one CFC (CFC finco) borrows from a third party and 
on-lends the debt proceeds to one or more other CFCs within a group 
(funded CFCs). Assume for purposes of simplicity that a CFC finco 
charges interest on loans to the funded CFCs at the same rate that it 
is charged by the third party. If intercompany business interest income 
received by CFC finco and business interest expense paid or accrued by 
the funded CFCs were disregarded in determining each CFC's section 
163(j) limitation, then CFC finco would have no business interest 
income, and all of CFC finco's business interest expense paid to the 
third party would be subject to the section 163(j) limitation. 
Furthermore, all of the funded CFCs would have no business interest 
expense subject to the section 163(j) limitation. This would be the 
case, even though the funded CFCs have borrowed from CFC finco and have 
the use of the funds originally borrowed from the third party.
    The Treasury Department and the IRS have determined that an 
approach that better reflects the reality of borrowings by related CFCs 
is one that takes into account the principle that money is fungible 
within a group of highly related CFCs (such a group, a ``CFC group'' 
and a CFC that is a member of the group, a ``CFC group member''). 
Accordingly, these proposed regulations would provide for an election 
to apply an alternative method that would limit the amount of business 
interest expense of a CFC group member subject to the section 163(j) 
limitation to the amount of the CFC group member's allocable share of 
the CFC group's applicable net business interest expense. See proposed 
Sec.  1.163(j)-7(b)(3). The applicable net business interest expense of 
a CFC group is the excess, if any, of the sum of the amounts of 
business interest expense of each CFC group member over the sum of the 
amounts of business interest income of each CFC group member. See 
proposed Sec.  1.163(j)-7(f)(3). A CFC group member's allocable share 
is computed by multiplying the applicable net business interest expense 
of the CFC group by a fraction, the numerator of which is the CFC group 
member's net business interest expense (computed on a separate company

[[Page 67513]]

basis), and the denominator of which is the sum of the amounts of the 
net business interest expense of each CFC group member with net 
business interest expense (computed on a separate company basis). See 
proposed Sec.  1.163(j)-7(f)(1).
    Thus, if an election is made to apply the alternative method and if 
a CFC group has only intercompany debt within the CFC group, then the 
amount of the CFC group's applicable net business interest expense is 
zero, and no business interest expense of any CFC group member would be 
subject to the section 163(j) limitation. As a result, for example, 
there would be no increase in an inclusion under section 951A(a) solely 
by reason of the use of intercompany debt within a CFC group. On the 
other hand, if a CFC group has applicable net business interest 
expense, then, consistent with the principle that money is fungible, 
each CFC group member that has net business interest expense, computed 
on a separate company basis, will determine its allocable share of the 
applicable net business interest expense, and such allocable share is 
the amount of business interest expense of the CFC group member that is 
subject to the section 163(j) limitation. Using its allocable share of 
the CFC group's applicable net business interest expense, a CFC group 
member computes its section 163(j) limitation on a separate company 
basis. However, as discussed in part 7(C) of this Explanation of 
Provisions section, under these proposed regulations, for purposes of 
computing a CFC's ATI, an upper-tier CFC group member takes into 
account a proportionate share of the ``excess'' ATI of a lower-tier CFC 
group member.
    In general, for purposes of these proposed regulations, a CFC group 
means two or more CFCs, if at least 80 percent of the stock by value of 
each CFC is owned, within the meaning of section 958(a), by a single 
U.S. shareholder or, in aggregate, by related U.S. shareholders that 
own stock of each member in the same proportion. See proposed Sec.  
1.163(j)-7(f)(6). For purposes of identifying a CFC group, members of a 
consolidated group are treated as a single person, as are individuals 
filing a joint return, and stock owned by certain passthrough entities 
is treated as owned by the owners or beneficiaries of the passthrough 
entity. The Treasury Department and the IRS determined that the 
alternative method is appropriately limited to situations in which a 
payor CFC and payee CFC have substantially identical ownership by 
United States shareholders because the alternative is based on the 
principle that money is fungible. The alternative is based on the 
principle that money is fungible, but fungibility should only apply in 
cases of close relationship where borrowings essentially support the 
entire group. Furthermore, the mismatch of a deduction and a payee 
income item is most significant when the payee and payor CFC have 
substantially identical ownership by United States shareholders. These 
proposed regulations narrow the scope of foreign corporations that are 
CFCs for this purpose to those foreign corporations in which at a least 
one United States shareholder owns stock, within the meaning of section 
958. These proposed regulations refer to such a CFC as an ``applicable 
CFC.'' See proposed Sec.  1.163(j)-7(f)(2).
    If one or more CFC group members conduct a financial services 
business, the alternative method is applied by treating those entities 
as comprising a separate subgroup (such a subgroup, a ``financial 
services subgroup'' and such a member, a ``financial services subgroup 
member''). For this purpose, an entity conducts a financial services 
business if it is an eligible controlled foreign corporation, as 
defined in section 954(h)(2)(A), is a qualified insurance company, as 
defined in section 953(e)(3), or is eligible for the dealer exception 
in computing foreign personal holding company income as described in 
section 954(c)(2)(C). The Treasury Department and the IRS determined 
that it is appropriate to apply the alternative method separately for 
entities that conduct financial services businesses, because those 
businesses are typically highly leveraged with significant amounts of 
business interest income and business interest expense and could 
reasonably be expected to cause distortion if included in the 
alternative method with other, non-financial services business CFC 
group members.
    These proposed regulations generally treat a controlled partnership 
(in general, a partnership in which CFC group members own, in 
aggregate, at least 80 percent of the interests) as a CFC group member 
and the interest in the controlled partnership is treated as stock. 
Thus, for example, if a U.S. person wholly owns two applicable CFCs, 
which each own a 50-percent interest in a partnership, then, if an 
election is made to apply the alternative method, the partnership will 
also apply the alternative method. The Treasury Department and the IRS 
determined that it is appropriate to extend the relief to partnerships 
that are substantially owned by CFC group members because the principle 
that money is fungible is not limited to corporate entities. 
Furthermore, absent such a rule, a partnership could be used to 
inappropriately exclude an applicable CFC from the CFC group by having 
the partnership own the applicable CFC.
    These proposed regulations exclude from the definition of a CFC 
group member an applicable CFC that has ECI. Thus, an applicable CFC 
with ECI may not compute its section 163(j) limitation under the 
alternative method, and furthermore, the CFC group, and any financial 
services subgroup, must exclude such CFC from all group-level 
computations (for example, in determining the amount of the CFC group's 
applicable net business interest expense). The Treasury Department and 
the IRS determined that it is appropriate to exclude an applicable CFC 
with ECI from application of the alternative method so that section 
163(j) applies to a CFC with ECI in the same manner as it does to a 
domestic C corporation. However, although an applicable CFC with ECI 
cannot use the alternative method, an applicable CFC with ECI is 
treated as a CFC group member solely for purposes of determining a CFC 
group. Thus, for example, if an applicable CFC with ECI is wholly owned 
by an upper-tier CFC and the applicable CFC with ECI wholly owns a 
lower-tier CFC, the lower-tier CFC may still qualify as a CFC group 
member.
    If not all CFC group members have the same taxable year, then, if 
the election is made, these proposed regulations require that all 
group-level computations be made with respect to a majority U.S. 
shareholder taxable year. See proposed Sec.  1.163(j)-7(f)(11). Thus, 
if, for example, USP, a domestic corporation with a calendar taxable 
year, wholly owns two applicable CFCs, one with a calendar year and one 
with a November 30 fiscal year, then, with respect to USP's 2019 
calendar year, the group-level computations must be determined using 
amounts for the taxable year ending November 30, 2019, for the one 
applicable CFC, and amounts for the taxable year ending December 31, 
2019, for the other applicable CFC.
    Finally, these proposed regulations provide rules concerning the 
election (referred to as a ``CFC group election''), including the 
requirements for making the CFC group election, the manner for making 
the CFC group election, and the duration of the CFC group election. See 
proposed Sec.  1.163(j)-7(b)(5). The Treasury Department and the IRS 
determined that the alternative method should be elective, rather than 
required, because for certain situations, the

[[Page 67514]]

general application of section 163(j) may be preferable to taxpayers.

C. Rules for Computing the ATI of an Applicable CFC

    Proposed Sec.  1.163(j)-7(c) would provide rules for computing the 
ATI of an applicable CFC. The principles of Sec.  1.952-2 for 
determining the CFC's income and deductions or, for CFCs with ECI, the 
rules of section 882, apply for purposes of computing the CFC's taxable 
income. See proposed Sec.  1.163(j)-7(c)(1). The Treasury Department 
and the IRS request comments on the application of the rules under 
Sec.  1.952-2 for purposes of determining a CFC's taxable income for 
purposes of section 163(j). In particular, comments are requested as to 
whether these rules should allow a CFC a deduction, or require a CFC to 
take into account income, that is expressly limited to domestic 
corporations under the Code. For example, questions have arisen as to 
whether a CFC should be allowed a dividends-received deduction under 
section 245A, even though section 245A by its terms applies only to 
dividends received by a domestic corporation.
    To mitigate potential double-counting of income in ATI, any 
dividend received by an applicable CFC from a related person is 
subtracted from the distributee's taxable income for purposes of 
computing ATI as the dividend represents income that could be part of 
the distributing corporation's ATI. See proposed Sec.  1.163(j)-
7(c)(2).
    If a CFC group election is in effect with respect to a CFC group, 
then an upper-tier CFC group member takes into account a proportionate 
share of the ``excess'' ATI (referred to in these proposed regulations 
as ``CFC excess taxable income'') of each lower-tier member in which it 
directly owns stock for purposes of computing the upper-tier member's 
ATI. See proposed Sec.  1.163(j)-7(c)(3). The meaning of the term CFC 
excess taxable income is analogous to the meaning of the term ``excess 
taxable income'' in the context of a partnership and S corporation, 
and, in general, means the amount of a CFC group member's ATI in excess 
of the amount needed before there would be disallowed business interest 
expense. See proposed Sec.  1.163(j)-7(f)(5). A CFC group member that 
is a partnership does not have CFC excess taxable income because under 
the statute and proposed Sec.  1.163(j)-6, the partnership has excess 
taxable income and such excess taxable income is allocated to the 
partners of the partnership. For a discussion of the computation of a 
partnership's excess taxable income and the treatment of a partner's 
distributive share of any such excess taxable income, see the 
discussion in part 6 of this Explanation of Provisions section.
    The process of computing and ``rolling up'' CFC excess taxable 
income among CFC group members for purposes of computing ATI of each of 
the CFC group members begins with a lowest-tier member and continues 
through the chain of ownership to a highest-tier member of the CFC 
group (referred to in these proposed regulations as a ``specified 
highest-tier member''). Thus, a lowest-tier member computes its section 
163(j) limitation, and if the lowest-tier member has CFC excess taxable 
income, the CFC excess taxable income is taken into account 
proportionately by one or more higher-tier members that directly own 
stock of the lower-tier member for purposes of computing ATI; and, if 
such a higher-tier member has CFC excess taxable income, such CFC 
excess taxable income is taken into account by a next higher-tier 
member, and so forth.
    A higher-tier member that is a partnership may take into account a 
pro rata share of the CFC excess taxable income of a lower-tier member, 
other than a partnership, which does not have CFC excess taxable 
income, for purposes of computing the higher-tier member partnership's 
ATI and determining if the higher-tier member partnership has excess 
taxable income that may be allocated to CFC group members that are 
partners.

D. Rules for Computing ATI of a United States Shareholder

i. General Rules
    In general, a United States shareholder that owns, within the 
meaning of section 958(a), stock of a CFC is required to include in its 
gross income each year its pro rata share of the CFC's subpart F 
income, and investments in U.S. property, as defined in section 956. In 
addition, a United States shareholder that owns stock of a CFC is 
required to include in its gross income for each year its GILTI. Thus, 
these income inclusions are included in the United States shareholder's 
taxable income, and absent an exercise of regulatory authority, would 
be included in ATI.
    To avoid double counting of the taxable income of a CFC already 
taken into account to determine the CFC's section 163(j) limitation, 
proposed Sec.  1.163(j)-7(d)(1)(i) would provide the general rule (the 
double counting rule) that the ATI of a United States shareholder is 
computed without regard to any amounts included in gross income under 
sections 78, 951(a), and 951A(a) that are properly allocable to a non-
excepted trade or business of the United States shareholder (each 
amount, a ``specified deemed inclusion'' and such amounts, collectively 
``specified deemed inclusions'') and any deduction allowable under 
section 250(a)(1)(B), without regard to the taxable income limitation 
in section 250(a)(2), by reason of a specified deemed inclusion (such a 
deduction, a ``specified section 250 deduction'').
    To the extent a United States shareholder includes amounts in gross 
income under section 78, 951(a), or 951A(a) that are not properly 
allocable to a non-excepted trade or business, for example, because 
such amounts are treated as investment income, within the meaning of 
section 163(d), of the United States shareholder, then such amounts are 
not included in ATI (see proposed Sec.  1.163(j)-1(b)(1)(ii)(F)). Thus, 
for example, if a United States shareholder that is a domestic 
partnership includes amounts in gross income under section 951(a) or 
951A(a) that are treated as investment income with respect to the 
domestic partnership and therefore are not properly allocable to a 
trade or business, then such amounts are not included in the ATI of the 
domestic partnership. However, absent a special rule, to the extent 
such income inclusions are taken into account as a distributive share 
of a C corporation partner, the income inclusions would be included in 
the ATI of the C corporation partner (see proposed Sec.  1.163(j)-
4(b)(3)). This result would be contrary to the purpose of the double 
counting rule. Accordingly, to prevent income inclusions under sections 
951(a) and 951A(a) that are treated as investment income with respect 
to a domestic partnership from being included in the ATI of a corporate 
partner, these proposed regulations provide that a C corporation 
partner may not treat such amounts as properly allocable to a trade or 
business of the C corporation partner. See proposed Sec.  1.163(j)-
7(d)(1)(ii).
ii. Rules for a United States Shareholder of a CFC Group Member With a 
CFC Group Election in Effect
    If a United States shareholder owns directly or indirectly through 
one or more foreign partnerships stock of a CFC group member that is a 
specified highest-tier member for which a CFC group election is in 
effect, and the specified highest-tier member has CFC excess taxable 
income that is treated as being attributable to taxable income of the 
CFC group that resulted in the United States shareholder having 
specified income inclusions, the United

[[Page 67515]]

States shareholder may add to its taxable income an amount equal to its 
proportionate share of the ``eligible'' CFC excess taxable income of 
the specified highest-tier member and any other highest-tier members 
(the addback rule). See proposed Sec.  1.163(j)-7(d)(2). However, the 
addition to taxable income under the addback rule is limited to the 
portion of the specified deemed inclusions, all of which are subtracted 
from taxable income of any United States shareholder under the double-
counting rule, that is with respect to CFC group members, reduced by 
the portion of any specified section 250 deduction that is allowable by 
reason of such specified deemed inclusions. These proposed regulations 
refer to the portion described in the preceding sentence as ``CFC group 
inclusions'' (see proposed Sec.  1.163(j)-7(d)(2)(iii)). Furthermore, 
the limitation is computed without regard to amounts included in gross 
income by reason of section 78 with respect to CFC group members. This 
result is appropriate because section 78 requires a deemed inclusion 
only in order to carry out the purposes of the foreign tax credit 
provisions.
    To determine the amount of ``eligible'' CFC excess taxable income 
(ETI) of a specified highest-tier member (defined under proposed Sec.  
1.163(j)-7(d)(2)(ii) as ``eligible CFC group ETI''), the CFC excess 
taxable income is multiplied by the specified ETI ratio. The specified 
ETI ratio is a fraction (expressed as a percentage) that compares the 
amounts of taxable income of each specified highest-tier member and 
each specified lower-tier member of the specified highest-tier member 
to the portions of such taxable income that gave rise to inclusions 
under section 951(a) or 951A(a). The specified ETI ratio includes in 
the numerator and the denominator of the fraction only taxable income 
amounts with respect to CFC group members that have CFC excess taxable 
income without regard to the ``roll up'' of CFC excess taxable income 
from a lower-tier member. See proposed Sec.  1.163(j)-7(f)(14). The 
purpose of the specified ETI ratio is to address the fact that within 
the CFC group, income of a lower-tier member CFC that is neither 
subpart F income nor tested income to the extent of GILTI is included 
in CFC excess taxable income and may be used by an upper-tier CFC group 
member. It would be distortive for a United States shareholder to 
obtain an increase in ATI in respect of such income because this income 
is not taxed in the United States. The specified ETI ratio is intended 
to provide an estimate of the portion of CFC excess taxable income 
attributable to this income. The Treasury Department and the IRS 
determined that this formulaic approach is superior to a tracing 
approach, because a tracing approach would increase complexity and 
therefore also generally increase administrative and compliance 
burdens.
    If a United States shareholder of a CFC group member with a CFC 
group election in effect is a domestic partnership (a U.S. shareholder 
partnership), the addback rule does not apply to determine the ATI of 
the U.S. shareholder partnership. See proposed Sec.  1.163(j)-7(d)(3). 
This is because the Treasury Department and the IRS are of the view 
that if a U.S. shareholder partnership includes amounts in gross income 
under section 951(a) or 951A(a) with respect to stock of a CFC group 
member, then such amounts will, in virtually all fact patterns, be 
treated as investment income with respect to the partnership, and 
therefore interest expense of the partnership that is allocable to 
stock of a CFC group member will be treated as investment interest 
expense that is not subject to section 163(j) at the partnership-level. 
In this case, however, if a U.S. shareholder partnership has a domestic 
C corporation partner (a U.S. corporate partner), the addback rule is 
applied, with certain modifications, to the U.S. corporate partner for 
purposes of computing the U.S. corporate partner's ATI. In particular, 
for purposes of computing the amount of the addition to taxable income 
of the U.S. corporate partner allowed under the addback rule, the 
addback rule is modified to provide that the U.S. corporate partner 
takes into account not only its own specified deemed inclusions with 
respect to stock of a CFC group member, but for this purpose also its 
distributive share, if any, of amounts included in gross income under 
section 951(a) or 951A(a) of the U.S. shareholder partnership with 
respect to stock of a CFC group member. In addition, the addback rule 
is modified to provide that for purposes of determining a U.S. 
corporate partner's pro rata share of eligible CFC excess taxable 
income of a specified highest-tier member, the U.S. shareholder 
partnership is treated as if it were a foreign partnership.

E. Effect on Earnings and Profits

    Under proposed Sec.  1.163(j)-7(e), and consistent with the rules 
in proposed Sec.  1.163(j)-4(c), the disallowance and carryforward of a 
deduction for a foreign corporation's business interest expense does 
not affect whether and when such business interest expense reduces the 
corporation's earnings and profits. For example, in the case of a 
passive foreign investment company (PFIC), the disallowance and 
carryforward of a deduction will not impact the amount of inclusions of 
earnings under section 1293 if the PFIC is treated as a qualified 
electing fund. Similarly, the disallowance and carryforward of a 
deduction for an applicable CFC's business interest expense will not 
affect the limitation of subpart F income to earnings and profits under 
section 952(c).

8. Proposed Sec.  1.163(j)-8: Application of Section 163(j) to Foreign 
Persons With Effectively Connected Income

    In general, unlike U.S. citizens or residents that are subject to 
U.S. tax on their worldwide income, a nonresident alien individual or 
foreign corporation is subject to net basis income taxation only with 
respect to its income that is or is treated as effectively connected 
with a trade or business (ECI) conducted in the United States as 
provided under section 872 or 882. Deductions are allowed only to the 
extent that they are connected with such income. In certain 
circumstances, the tax liability may be reduced or eliminated by the 
provisions of an income tax treaty entered into by the United States 
with a foreign country. While a nonresident alien individual or foreign 
corporation that is not an applicable CFC (hereafter a non-CFC FC) that 
has ECI is still subject to section 163(j) and the section 163(j) 
regulations, the rules need to be modified since these foreign persons 
are only taxed on their ECI. Accordingly, the definitions for ATI, 
business interest expense, business interest income, and floor plan 
financing interest expense in Sec.  1.163(j)-1 are modified to limit 
such amounts to income which is effectively connected income and 
expenses properly allocable to effectively connected income. See 
proposed Sec.  1.163(j)-8(b).
    As discussed in part 6 of this Explanation of Provisions section, 
section 163(j)(4) provides that in the case of a partnership, section 
163(j) is applied at the partnership level. The partner's ATI is 
increased by the partnership's excess taxable income, and the 
partnership's excess business interest expense is allocated to the 
partner as disallowed business interest expense carryforward that can 
be deducted when the partners are allocated excess taxable income from 
the partnership, but only to the extent of such excess. Pursuant to 
section 163(j)(8)(B), which permits adjustments to the computation of 
ATI, a nonresident alien individual or non-CFC FC that is a partner in 
a partnership that is engaged in a U.S. trade or business modifies the 
application of the

[[Page 67516]]

general allocation rules in Sec.  1.163(j)-6 with respect to excess 
taxable income, excess business interest expense, and excess business 
interest income of the partnership to take into account the limitation 
of such foreign person's liability for U.S. tax to its ECI. The excess 
amounts of the partnership, therefore, can be used by the nonresident 
alien individual or non-CFC FC only to the extent of the partnership's 
income that would be effectively connected income with respect to the 
foreign partner. The amount of excess taxable income and excess 
business interest expense that can be used by such partner is 
determined by multiplying the amount of the excess taxable income or 
the excess business interest allocated under Sec.  1.163(j)-6 by a 
ratio equal to the ATI of the partnership, with the adjustments 
described previously to limit such amount to only effectively connected 
income or expense items, over the ATI of the partnership determined 
under Sec.  1.163(j)-6(d). The amount of excess business interest 
income that can be used by such partner is limited to ECI business 
interest income over allocable ECI business interest expense. See 
proposed Sec.  1.163(j)-8(c).
    Proposed Sec.  1.163(j)-8(e) would also include rules coordinating 
section 163(j) and Sec.  1.882-5. Section 1.882-5 provides rules for 
determining the amount of a foreign corporation's interest expense that 
is allocable under section 882(c) to ECI. These proposed regulations 
require that a foreign corporation that has ECI must first determine 
its business interest expense allocable to ECI under Sec.  1.882-5 
before applying section 163(j). The foreign corporation then applies 
section 163(j) to its business interest expense to determine if any of 
that business interest expense is disallowed business interest expense. 
If the foreign corporation is also a partner in a partnership that has 
ECI, the foreign corporation must back out that portion of the business 
interest expense determined under Sec.  1.882-5 which is deemed to have 
come from the partnership as such business interest expense has already 
been subject to section 163(j) at the partnership level and the foreign 
corporation is then left with only the non-partnership business 
interest expense. If the partnership also had disallowed business 
interest expense, a portion of the partnership-level interest expense 
that was backed out of the amount determined under Sec.  1.882-5 will 
also be disallowed business interest expense. Disallowed business 
interest expense determined at either the partner-level or partnership 
level, as appropriate, will not be taken into account for the purpose 
of determining interest expense under Sec.  1.882-5 in subsequent tax 
years, but rather will be subject to the limitations of section 163(j).
    As provided in proposed Sec.  1.163(j)-8(d), an applicable CFC (as 
defined in proposed Sec.  1.163(j)-8(g)(1)) that has ECI must first 
apply the general rules of section 163(j) and the section 163(j) 
regulations, pursuant to Sec.  1.163(j)-7(b)(2), to determine how 
section 163(j) applies to the applicable CFC. If, after applying 
section 163(j) and the section 163(j) regulations, the applicable CFC 
has disallowed business interest expense, the applicable CFC then must 
apportion a part of its disallowed business interest expense to 
interest expense allocable to effectively connected income as 
determined under Sec.  1.882-5.
    These proposed regulations also provide that disallowed business 
interest expense and disallowed business interest expense carryforwards 
will not affect the determination of effectively connected earnings and 
profits or U.S. net equity for purposes of the branch profits tax under 
section 884. These rules are consistent with the general principles of 
these proposed regulations with respect to earnings and profits. See 
proposed Sec. Sec.  1.163(j)-4(c) and 1.163(j)-8(f).

9. Proposed Sec.  1.163(j)-9: Elections for Excepted Trades or 
Businesses; Safe Harbor for Certain REITs

A. Election Procedure

    Proposed Sec.  1.163(j)-9 would provide guidance relating to the 
election to be treated as an excepted trade or business for real 
property or farming trades or businesses. These proposed regulations 
clarify that an election is made for a particular trade or business, 
not necessarily for a particular entity, and would apply for the 
taxable year that the election is made and all subsequent years.
    Proposed Sec.  1.163(j)-9 would provide the time and manner in 
which to make the election. Taxpayers making the election should attach 
an election statement to their timely filed original Federal income tax 
return, including extensions. The statement should include basic 
information of the taxpayer and the electing trade or business. Where a 
taxpayer has multiple trades or businesses that may be eligible for the 
election, an election must be made for each trade or business, and the 
election statement must specify or describe the different electing 
trades or businesses. The election statement is necessary in order for 
taxpayers and for the IRS to identify each electing trade or business. 
The Treasury Department and the IRS request comments on whether the 
information required to be included in the statement is sufficient, or 
whether additional information should be included to reduce any 
potential audit controversy.
    Because the election applies to the particular trade or business, 
the election generally terminates automatically if the taxpayer ceases 
to exist, or ceases the operation of the electing trade or business. 
However, these proposed regulations would also provide that where a 
taxpayer transfers all of the assets of an electing trade or business 
to a related party, the election does not terminate for that trade or 
business, and transfers to the related party. The purpose of this rule 
is to disregard a transaction that purports to be a termination or 
cessation of a trade or business, but is merely a change in the form of 
conducting the trade or business where the taxpayer (through a related 
party) retains a relationship to such trade or business. For this 
purpose, a related party means any person who bears a relationship to 
the taxpayer which is described in section 267(b) or 707(b)(1). 
Additional guidance may be provided detailing transactions in which an 
election might terminate.
    Additionally, these proposed regulations would contain an anti-
abuse rule to prevent a situation where the taxpayer attempts to 
terminate the election through a transfer of the assets in the trade or 
business, but with the intent of resuming a trade or business of a 
similar nature. These proposed regulations would provide that if a 
taxpayer re-acquires substantially all of the assets used in the trade 
or business, or substantially similar assets, and resumes conducting 
such prior trade or business within 60 months of ceasing the trade or 
business, the election will be revived with the resumed trade or 
business.
    The Treasury Department and the IRS request comments on the method 
by which certain taxpayers can make the election under section 
163(j)(7)(B) or (C), and the types of transactions in which the 
election should terminate.

B. Safe Harbor for Certain REITs

    Proposed Sec.  1.163(j)-9(g) provides a special safe harbor for 
REITs. For REITs that take advantage of this safe harbor, the rules 
applicable to REITs are substantially similar to the general rules 
provided for other taxpayers. However, these proposed regulations 
provide certain modifications to take into

[[Page 67517]]

account the existing rules governing REIT taxation.
    If a REIT holds real property, interests in partnerships holding 
real property, or shares in other REITs holding real property, the safe 
harbor provides that the REIT is eligible to make an election to be an 
electing real property trade or business for all or part of its assets. 
For this purpose, the term ``real property'' is defined consistently 
with the definition of real property under section 856, rather than the 
more restrictive definition set forth under the proposed section 469 
regulations.
    The term ``real property trade or business'' in section 
469(c)(7)(C) does not include real property financing and, for purposes 
of the section 163(j) regulations, any assets used in a real property 
financing trade or business are generally allocated to a non-excepted 
trade or business. Under proposed Sec.  1.163(j)-9(g), REIT real 
property financing assets include mortgages, guaranteed mortgage pass-
thru certificates, real estate mortgage investment conduit (REMIC) 
regular interests, and debt instruments issued by publicly offered 
REITs.
    If a REIT makes an election to be an electing real property trade 
or business, and the value of the REIT's real property financing assets 
is 10 percent or less of the value of the REIT's total assets, then, 
under the safe harbor, all of the REIT's assets are treated as assets 
of an excepted trade or business. This determination is based on the 
same values used for the REIT asset test under section 856(c)(4) as of 
the close of the REIT's taxable year. If a REIT makes an election to be 
an electing real property trade or business, and the value of a REIT's 
real property financing assets is more than 10 percent of the value of 
the REIT's total assets, then, under the safe harbor, the REIT's 
business interest income, business interest expense, and other items of 
expense and gross income are allocated between excepted and non-
excepted trades or businesses under the rules set forth in proposed 
Sec.  1.163(j)-10, as modified by proposed Sec.  1.163(j)-9(g)(4).
    For purposes of valuing a REIT's assets, REIT real property 
financing assets also include partnership assets that a REIT is deemed 
to hold under Sec.  1.856-3(g) and the portion of a REIT's interest in 
another REIT attributable to that other REIT's real property financing 
assets. The Treasury Department and the IRS request comments on whether 
the list of real property financing assets in these proposed 
regulations includes all direct and indirect investments that REITs 
make to finance real property.
    Under the safe harbor, the definition of real property under Sec.  
1.856-10 applies to determine whether the assets of a REIT are properly 
allocable to an excepted trade or business. If a REIT holds an interest 
in a partnership, in applying the partnership look-through rule 
described in proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2), the REIT also 
applies this definition of real property to determine whether the 
partnership's assets are allocable to an excepted trade or business.
    Under section 856(c)(5)(B), shares in other REITs qualify as real 
estate assets without regard to the portion of the REIT owned. Under 
the safe harbor, if a REIT (shareholder REIT) owns shares in another 
REIT and all of the other REIT's assets are treated as assets of an 
excepted trade or business, then all of shareholder REIT's adjusted 
basis in the shares of the other REIT is properly allocable to an 
excepted trade or business of shareholder REIT. If this is not the 
case, the safe harbor provides that shareholder REIT applies the 
partnership look-through rule described in proposed Sec.  1.163(j)-
10(c)(5)(ii)(A)(2) (as if the other REIT were a partnership) in 
determining the extent to which shareholder REIT's adjusted basis in 
the shares of the other REIT is properly allocable to an excepted trade 
or business of shareholder REIT. If shareholder REIT does not receive 
the information from the other REIT that is necessary to apply the 
look-through rule, then shareholder REIT's shares of the other REIT are 
properly allocable to a non-excepted trade or business of shareholder 
REIT.

C. Anti-Abuse Rule for Certain Real Property Trades or Businesses

    The Treasury Department and the IRS have determined that it would 
be inappropriate to allow an election to be an excepted real property 
trade or business for a trade or business that leases substantially all 
of its real property to the owner of the real property trade or 
business, or to a related party of the owner. To permit such an 
election would encourage a taxpayer to enter into non-economic 
structures where the real estate components of non-real estate 
businesses are separated from the rest of such businesses in order to 
artificially reduce the application of section 163(j) by leasing the 
real property to the taxpayer or a related party of the taxpayer and 
electing for this ``business'' to be an excepted real property trade or 
business. As a result, these proposed regulations would also contain an 
anti-abuse rule. If at least 80 percent of the business's real 
property, determined by fair market value, is leased to a trade or 
business under common control with the real property trade or business, 
the trade or business will not be eligible for the election. Common 
control in this case means that 50 percent of the direct and indirect 
ownership interests in both businesses are held by related parties 
within the meaning of sections 267(b) and 707(b). REITs that lease 
qualified lodging facilities, as defined in section 856(d)(9)(D), and 
qualified healthcare properties, as defined in section 856(e)(6)(D), 
are generally permitted pursuant to section 856(d)(8)(B) to lease these 
properties to a taxable REIT subsidiary; thus, this anti-abuse rule 
does not apply to these types of REITs. The Treasury Department and the 
IRS request comments on whether other exceptions to the anti-abuse rule 
(such as, for example, an exception for certain fact patterns where 
real property that is leased from a related party is ultimately sub-
leased to a third party) would be appropriate.

10. Proposed Sec.  1.163(j)-10: Allocation of Expense and Income to an 
Excepted Trade or Business

    As provided in section 163(j)(7) and proposed Sec.  1.163(j)-2, 
certain trades or businesses are excepted from the application of 
section 163(j), including electing real property trades or businesses, 
electing farming businesses, regulated utility trades or businesses, 
and the trade or business of performing services as an employee. 
Section 1.163(j)-10 would provide rules for determining the amount of a 
taxpayer's interest expense, interest income, and other tax items that 
is properly allocable to excepted and non-excepted trades or businesses 
for purposes of section 163(j). It is not necessary for a taxpayer to 
undertake any allocations under proposed Sec.  1.163(j)-10 if all of 
the taxpayer's items are properly allocable to non-excepted trades or 
businesses, or if all of the taxpayer's items are properly allocable to 
excepted trades or businesses.
    Proposed Sec.  1.163(j)-10(a) would provide an overview of the 
section and certain general rules, including rules regarding the 
application of the allocation rules to members of a consolidated group. 
Proposed Sec.  1.163(j)-10(b) would provide rules regarding the 
allocation of tax items other than interest expense and interest income 
between excepted and non-excepted trades or businesses. Proposed Sec.  
1.163(j)-10(c) would provide the general method of allocating interest 
expense and interest income between excepted and non-excepted trades or

[[Page 67518]]

businesses using asset basis, as well as various special rules that 
would apply under this general method. Proposed Sec.  1.163(j)-10(d) 
would describe several limited situations in which tracing rather than 
asset-based allocation is required.
    Organizations subject to tax under section 511 are required to 
compute their unrelated business taxable income separately with respect 
to each trade or business, resulting in a more granular allocation than 
is required for purposes of the section 163(j) regulations. 
Accordingly, proposed Sec.  1.163(j)-10(a)(5) would provide that such 
organizations would apply the allocation rules under section 512 and 
the regulations thereunder in determining whether items of income or 
expense are allocable to an excepted trade or business. The Treasury 
Department and the IRS request comments as to whether additional 
guidance is needed regarding the allocation of income and expenses of 
an organization subject to tax under section 511 to an excepted trade 
or business for purposes of section 163(j).

A. Proposed Sec.  1.163(j)-10(a): Overview

    Before applying the allocation rules in proposed Sec.  1.163(j)-10, 
a taxpayer first must determine whether any interest paid or accrued is 
properly allocable to a trade or business. If so, and if the taxpayer 
does not qualify for the small business exemption under section 
163(j)(3) and proposed Sec.  1.163(j)-2, the taxpayer must apply the 
allocation rules of proposed Sec.  1.163(j)-10 if the taxpayer has tax 
items from both excepted and non-excepted trades or businesses. The 
taxpayer must do so in order to determine the amount of interest 
expense that is business interest expense subject to limitation under 
section 163(j) and to determine which items are included or excluded in 
computing its section 163(j) limitation.
    For purposes of the allocation rules in proposed Sec.  1.163(j)-10, 
a taxpayer's activities are not treated as a trade or business if those 
activities do not involve the provision of services or products to a 
person other than the taxpayer. For example, if a taxpayer engaged in a 
manufacturing trade or business has in-house legal personnel that 
provide legal services solely to the taxpayer, the taxpayer is not 
treated as also engaged in the trade or business of providing legal 
services.
    Additionally, for purposes of the allocation rules in proposed 
Sec.  1.163(j)-10, a consolidated group would be treated as a single 
corporation. Thus, stock of a member that is owned by another member of 
the same group would not be treated as an asset for purposes of 
proposed Sec.  1.163(j)-10, and the transfer of member stock to a non-
member would be treated by the group as the transfer of the member's 
assets. Additionally, the group, rather than a particular member, would 
be treated as engaged in excepted or non-excepted trades or businesses. 
Intercompany obligations issued by a member borrower would not be 
considered an asset of the creditor member for purposes of allocating 
asset basis between excepted and non-excepted trades or businesses. 
Moreover, intercompany transactions would be disregarded for purposes 
of proposed Sec.  1.163(j)-10, along with the resulting offsetting 
items.
    The Treasury Department and the IRS have determined that this 
approach to consolidated groups is necessary for purposes of proposed 
Sec.  1.163(j)-10 because a particular trade or business may be 
conducted by multiple group members that also are engaged in other 
trades or businesses. Under these proposed regulations, the distinction 
between excepted and non-excepted trades or businesses applies at the 
level of the trade or business, not at the level of the group member; 
thus, the allocation rules in this section apply without regard to 
which member conducts a trade or business or possesses assets used in a 
trade or business.
    The Treasury Department and the IRS considered an approach to the 
allocation rules in proposed Sec.  1.163(j)-10 that would have taken 
into account intercompany transactions between consolidated group 
members engaged in excepted trades or businesses and members engaged in 
non-excepted trades or businesses. However, this approach would have 
resulted in different treatment for consolidated groups in which each 
member conducts a single trade or business and consolidated groups in 
which a single member engages in multiple trades or businesses. 
Moreover, if intercompany transactions were taken into account for 
purposes of proposed Sec.  1.163(j)-10, then taxpayers potentially 
could increase the amount of interest allocable to an excepted trade or 
business or increase their section 163(j) limitation by engaging in 
intercompany transactions. Thus, the Treasury Department and the IRS 
have determined that intercompany transactions should be disregarded 
for purposes of proposed Sec.  1.163(j)-10.
    After a consolidated group has determined the percentage of the 
group's interest expense that is allocable to an excepted trade or 
business and thus is not subject to limitation under section 163(j), 
this exempt percentage would be applied proportionally to each member 
that has paid or accrued interest to a person other than a group member 
during the taxable year. Thus, in general, each member with interest 
paid or accrued to a lender that is not a group member will have the 
same percentage of interest allocable to excepted trades or businesses, 
regardless of whether any particular member actually engaged in an 
excepted trade or business. For rules regarding the deduction of 
interest expense paid or accrued by group members, see the discussion 
of proposed Sec.  1.163(j)-5(b) in part 5 of this Explanation of 
Provisions section.

B. Proposed Sec.  1.163(j)-10(b): Allocating Tax Items Other Than 
Interest Income and Interest Expense

    In general, gross income other than dividends and interest income 
would be allocated to the trade or business that generated such gross 
income. The Treasury Department and the IRS request comments regarding 
this method of allocating items of income other than dividends and 
interest, including comments as to how this rule should be expanded or 
clarified.
    With regard to dividend income, the Treasury Department and the IRS 
have determined that, if a taxpayer's ownership interest in a 
corporation equals or exceeds a certain threshold, the taxpayer 
generally should look through to the business activities of the 
corporation that paid the dividend. More specifically, if a taxpayer 
owns at least 80 percent of the stock of a domestic C corporation or a 
CFC (by vote and value; see section 1504(a)(2)) that is not eligible 
for the small business exemption under section 163(j)(3) and proposed 
Sec.  1.163(j)-2(d)(1), then the taxpayer's dividend income would be 
treated as allocable to excepted or non-excepted trades or businesses 
based upon the relative amounts of the payor corporation's adjusted 
basis in the assets used in such trades or businesses. Additionally, if 
at least 90 percent of the payor corporation's adjusted basis in its 
assets is allocable to either excepted trades or businesses or non-
excepted trades or businesses, then all of the taxpayer's dividend 
income from such corporation for the taxable year would be treated as 
allocable to either excepted or non-excepted trades or businesses, 
respectively.
    If a shareholder in an S corporation looks through to the S 
corporation's basis in its assets for purposes of the basis allocation 
rules in proposed Sec.  1.163(j)-10(c), the shareholder also would be 
required to look through to the

[[Page 67519]]

S corporation's basis in its assets for purposes of characterizing any 
dividends received from the S corporation.
    If a taxpayer receives a dividend that is not investment income, 
and if the dividend look-through rule is inapplicable to the taxpayer, 
then the taxpayer would treat the dividend income as allocable to a 
non-excepted trade or business. The Treasury Department and the IRS 
request comments on this proposed rule, including whether taxpayers 
that are C corporations or tax-exempt corporations should treat 
dividend income as allocable to a non-excepted trade or business if 
they fail to meet the minimum ownership threshold for dividends from 
domestic C corporations and CFCs.
    With regard to dispositions of stock in a corporation or interests 
in a partnership, if a taxpayer recognizes gain or loss upon the 
disposition of stock in a non-consolidated C corporation that is not 
property held for investment, within the meaning of section 163(d)(5), 
and if the taxpayer looks through to the corporation's basis in its 
assets for purposes of the basis allocation rules in proposed Sec.  
1.163(j)-10(c), then the taxpayer would allocate the gain or loss to 
excepted or non-excepted trades or businesses based upon the relative 
amounts of the corporation's adjusted basis in the assets used in its 
trades or businesses, determined pursuant to proposed Sec.  1.163(j)-
10(c). If the taxpayer does not look through to the corporation's basis 
in its assets, the taxpayer would treat the gain or loss as allocable 
to a non-excepted trade or business. If a taxpayer recognizes gain or 
loss upon the disposition of interests in a partnership or stock in an 
S corporation that owns (1) non-excepted assets and excepted assets, 
(2) investment assets, or (3) both, the taxpayer would determine the 
proportionate share of the amount of basis properly allocable to a non-
excepted trade or business in accordance with the allocation rules set 
forth in proposed Sec.  1.163(j)-10(c)(5)(ii)(A) or proposed Sec.  
1.163(j)-10(c)(5)(ii)(B)(3), as appropriate, and include such 
proportionate amount of gain or loss in the taxpayer's ATI.
    With regard to expenses, losses, and deductions other than 
interest, any such items that are definitely related to a trade or 
business, within the meaning of Sec.  1.861-8(b), would be allocable to 
that trade or business. All other expenses would be ratably apportioned 
to gross income. The Treasury Department and the IRS request comments 
on this proposed method of allocating expenses other than interest 
expense, including whether this proposed rule should incorporate any of 
the special allocation rules in Sec.  1.861-8(e).

C. Proposed Sec.  1.163(j)-10(c): Allocating Interest Expense and 
Interest Income

    Proposed Sec.  1.163(j)-10(c) would set forth the general rule for 
allocating interest expense and interest income between excepted and 
non-excepted trades or businesses. Under this general rule, interest 
expense and interest income would be allocated between excepted and 
non-excepted trades or businesses based upon the relative amounts of 
the taxpayer's adjusted basis in the assets used in its excepted and 
non-excepted trades or businesses. This general method of allocation 
reflects the fact that money is fungible and the view that interest 
expense is attributable to all activities and property, regardless of 
any specific purpose for incurring an obligation on which interest is 
paid.
    Under proposed Sec.  1.163(j)-10(c), a taxpayer would determine the 
adjusted basis in its assets on a quarterly basis (each such quarterly 
period, a ``determination period'') and average those amounts to 
determine the relative amounts of asset basis for its excepted and non-
excepted trades or businesses for a taxable year. The Treasury 
Department and the IRS request comments on the frequency of asset basis 
determinations required under proposed Sec.  1.163(j)-10(c).
    Proposed Sec.  1.163(j)-10(c)(1) contains a general de minimis 
rule. Under this rule, if at least 90 percent of a taxpayer's basis in 
its assets for the taxable year is allocable to either excepted or non-
excepted trades or businesses, determined under proposed Sec.  
1.163(j)-10(c), then all of the taxpayer's interest expense and 
interest income for that year that is properly allocable to a trade or 
business would be treated as allocable to excepted or non-excepted 
trades or businesses, respectively. The Treasury Department and the IRS 
request comments as to whether the application of this de minimis rule 
should be elective.
    If an asset is used in more than one trade or business during a 
determination period, the taxpayer's basis in such asset would be 
allocated to each trade or business using the permissible methodology 
(see the following paragraph) that most reasonably reflects the use of 
the asset in each trade or business during the determination period. An 
allocation methodology most reasonably reflects the use of the asset in 
each trade or business if the methodology most properly reflects the 
proportionate benefit derived from the use of the asset in each trade 
or business.
    Proposed Sec.  1.163(j)-10(c) would provide several permissible 
methodologies for allocating basis in an asset used in more than one 
trade or business during a determination period, including the 
following: The relative amounts of gross income that an asset 
generates, has generated, or may reasonably be expected to generate 
with respect to the trades or businesses; the relative amounts of 
physical space used by each trade or business if the asset is land or 
an inherently permanent structure; and the relative amounts of output 
of each trade or business if each trade or business generates the same 
unit of output. The choice of method would be subject to de minimis 
exceptions, and taxpayers generally would not be permitted to vary 
their allocation methodology across determination periods within a 
taxable year or from one year to the next. Additionally, if none of the 
permissible methodologies reasonably reflects the use of an asset in 
each trade or business, the taxpayer's basis in the asset would not be 
taken into account for purposes of proposed Sec.  1.163(j)-10(c). The 
Treasury Department and the IRS request comments on these proposed 
methods of allocating basis in an asset used in more than one trade or 
business.
    Proposed Sec.  1.163(j)-10(c)(3)(iii) would provide that for 
utility trades or businesses, the only permissible method for 
allocating asset basis between excepted and non-excepted utility 
activities is the relative amounts of output of the trades or 
businesses. For example, if an asset is used to furnish or sell 
electric energy, and a portion of the energy is sold to wholesale 
customers where rates are not set on a cost of service and rate of 
return basis while the remaining portion is sold at a rate established 
by a ratemaking body described in proposed Sec.  1.163(j)-1(b)(13), the 
taxpayer must allocate the basis in the asset between the taxpayer's 
excepted and non-excepted trades or businesses. The Treasury Department 
and the IRS believe that other methods listed in proposed Sec.  
1.163(j)-10(c) that do not take into account the relative amounts of 
regulated and unregulated utility activities do not properly reflect 
the proportionate benefit derived from the use of the asset in each 
trade or business. The Treasury Department and the IRS request comments 
on this allocation methodology, including whether another methodology 
would more accurately reflect the extent to which a trade or business 
is an excepted utility business for this purpose.

[[Page 67520]]

    These proposed regulations also would provide a de minimis rule for 
utility trades or businesses. Under the proposed de minimis rule, if 
more than 90 percent of the output of a trade or business is sold at 
rates described in the exception for regulated utility trades or 
businesses, the taxpayer would treat the entire trade or business as an 
excepted trade or business. The Treasury Department and the IRS request 
comments with respect to the de minimis rule for assets used in a 
utility trade or business, including whether another percentage 
threshold with respect to the de minimis rule would be more 
appropriate.
    The allocation of asset basis between excepted and non-excepted 
trades or businesses under proposed Sec.  1.163(j)-10(c) would be 
subject to numerous additional special rules. First, a taxpayer's 
adjusted basis in tangible depreciable property other than inherently 
permanent structures for which a deduction is allowable under section 
167 would be determined using the alternative depreciation system under 
section 168(g). Additional first year depreciation, for example under 
section 168(k), would not be taken into account for purposes of the 
basis allocation rule in proposed Sec.  1.163(j)-10(c) due to the 
distortive effects that such depreciation would have upon the relative 
adjusted basis of assets. Further, a taxpayer's adjusted basis in 
tangible depreciable property other than inherently permanent 
structures for which a deduction is allowable under section 168 of the 
1954 Code (former section 168) would be determined using the taxpayer's 
method of computing depreciation for the property under former section 
168. Additionally, a taxpayer's adjusted basis in any intangible asset 
with respect to which a deduction is allowable under section 167 or 
section 197 would be determined in accordance with section 167 or 
section 197, as applicable. Self-created intangibles would not be taken 
into account for purposes of the allocation rules in proposed Sec.  
1.163(j)-10(c). The Treasury Department and the IRS request comments on 
these proposed rules regarding asset basis in depreciable property, 
including whether taxpayers should be permitted to use other methods of 
depreciation, such as the general depreciation system under section 
168(a), for purposes of proposed Sec.  1.163(j)-10(c).
    Second, the adjusted basis of any asset that is land, including 
nondepreciable improvements to land, or an inherently permanent 
structure used in a trade or business generally would be its unadjusted 
basis rather than its adjusted basis. This special rule, which would 
not apply to land or inherently permanent structures that fall within 
the special rule described in the following paragraph, is intended to 
provide taxpayers with a readily ascertainable figure that better 
reflects the relative underlying value of this limited class of 
assets--which, in some cases, are held for many years--than adjusted 
basis. The Treasury Department and the IRS request comments regarding 
this approach to allocating basis to land and inherently permanent 
structures, including whether this rule should be elective, and whether 
taxpayers should be able to use fair market value rather than 
acquisition basis for land or inherently permanent structures used in a 
trade or business.
    Third, assets that have been acquired or that are under development 
but that are not yet used in a trade or business would not be taken 
into account for purposes of proposed Sec.  1.163(j)-10(c). Such assets 
would include (but would not be limited to) construction works in 
progress, such as buildings, airplanes, or ships, prior to their 
completion, and land that was acquired by a taxpayer for construction 
of a building by the taxpayer to be used in a trade or business if the 
building is not yet placed in service. This rule would not apply to 
stock in a corporation or interests in a partnership. The Treasury 
Department and the IRS request comments on this special rule, including 
whether and to what extent exceptions are needed (for example, with 
respect to start-up businesses).
    Fourth, trusts required by law to fund specific liabilities (for 
example, pension trusts and plant decommissioning trusts) would not be 
taken into account for purposes of proposed Sec.  1.163(j)-10(c).
    Fifth, taxpayers generally would be permitted to look through their 
interests in partnerships or S corporations, and taxpayers that satisfy 
a minimum ownership threshold in non-consolidated domestic C 
corporations and CFCs would be required to look through their interests 
in such corporations, in determining the extent to which their basis in 
a partnership interest or corporate stock is allocable to excepted or 
non-excepted trades or businesses. For domestic C corporations and 
CFCs, the minimum ownership threshold would be 80 percent by vote and 
value (see section 1504(a)(2)). Partners that own 80 percent or more of 
the capital or profits interests in a partnership, and shareholders 
that own 80 percent or more of S corporation stock by vote and value, 
generally would be required, rather than merely permitted, to look 
through their interests in the partnership or S corporation for this 
purpose.
    These look-through rules would not apply to a taxpayer with an 
interest in a partnership or non-consolidated subsidiary that is 
eligible for the small business exemption under section 163(j)(3) and 
proposed Sec.  1.163(j)-2(d)(1). The Treasury Department and the IRS 
have determined that the look-through rules should not be available in 
these cases because of the administrative burden that would be imposed 
on small businesses from collecting and providing information to their 
shareholders or partners regarding inside asset basis when those small 
businesses are themselves exempt from the application of section 
163(j). The Treasury Department and the IRS also have determined that 
small businesses that are exempt under section 163(j)(3) and proposed 
Sec.  1.163(j)-2(d)(1) may not make an election under proposed Sec.  
1.163(j)-9.
    If a taxpayer does not look through a C corporation for purposes of 
the allocation rules in Sec.  1.163(j)-10(c), and if the taxpayer is 
not a C corporation or tax-exempt corporation, the taxpayer generally 
would treat its basis in the stock as an asset held for investment; if 
the taxpayer is a C corporation or tax-exempt corporation, the taxpayer 
would treat its entire basis in the C corporation stock as allocable to 
a non-excepted trade or business. If a taxpayer does not look through a 
partnership or S corporation, and if the taxpayer is not a C 
corporation or tax-exempt corporation, the taxpayer would generally 
treat its basis in a partnership interest or S corporation stock as 
either an investment asset or a non-excepted trade or business asset. 
If the taxpayer does not look through a partnership or S corporation, 
and if the taxpayer is a C corporation or a tax-exempt corporation, the 
taxpayer would treat its entire basis in the partnership interest or S 
corporation stock as allocable to a non-excepted trade or business.
    The Treasury Department and the IRS request comments on these 
proposed look-through rules, including whether any further adjustments 
should be made to the taxpayer's basis in its partnership interest or 
corporate stock (for example, under Sec.  1.861-12(c)(2)) and whether 
the minimum ownership threshold for nonconsolidated domestic C 
corporations and CFCs should be modified.
    Sixth, a taxpayer's basis in its customer receivables and cash and 
cash equivalents would be disregarded for purposes of proposed Sec.  
1.163(j)-10(c).

[[Page 67521]]

This rule is intended to discourage taxpayers from moving cash to 
excepted trades or businesses to increase the amount of asset basis 
therein. For these purposes, the term ``cash and cash equivalents'' 
would include cash, foreign currency, commercial paper, interests in 
certain investment companies, government obligations, derivatives that 
are substantially secured by an obligation of a government, and similar 
assets. The Treasury Department and the IRS request comments on this 
special rule, including the list of assets to which it would apply, and 
whether any exceptions should apply, such as for working capital.
    Seventh, solely for purposes of determining the amount of basis 
allocable to excepted and non-excepted trades or businesses under 
proposed Sec.  1.163(j)-10(c), an election under section 336, 338, or 
754, as applicable, would be deemed to have been made for any 
acquisition of corporate stock or partnership interests with respect to 
which the taxpayer demonstrates to the satisfaction of the Commissioner 
of the Internal Revenue Service (the Commissioner) that the taxpayer 
was eligible to make such an election but was actually or effectively 
precluded from doing so by a regulatory agency with respect to a 
regulated utility trade or business. The Treasury Department and the 
IRS have determined that such a rule is necessary to place taxpayers 
that are actually or effectively precluded from making an election 
under section 336, 338, or 754 on the same footing for purposes of the 
basis allocation rules in proposed Sec.  1.163(j)-10(c) as taxpayers 
that are not subject to such limitations. The Treasury Department and 
the IRS request comments on this special rule.
    Eighth, taxpayers would be required to comply with certain 
reporting requirements regarding their asset basis allocation under 
proposed Sec.  1.163(j)-10(c). Additionally, taxpayers would be 
required to keep books of account and other records and data as 
necessary to substantiate the taxpayer's use of an asset in an excepted 
trade or business (see Sec.  1.6001-1). If the taxpayer fails to 
provide the required information, proposed Sec.  1.163(j)-10(c) would 
permit the Commissioner to treat all of the taxpayer's interest expense 
as properly allocable to a non-excepted trade or business, unless the 
taxpayer shows that there was reasonable cause for failing to comply 
with, and the taxpayer acted in good faith with respect to, these 
reporting requirements. The Treasury Department and the IRS request 
comments on these proposed reporting requirements and the consequences 
of failing to satisfy these requirements.
    Finally, proposed Sec.  1.163(j)-10(c) would provide that a 
taxpayer's adjusted basis in an asset will not be taken into account 
for purposes of this section if one of the principal purposes for the 
acquisition, disposition, or change in use of that asset is to increase 
artificially the amount of basis allocable to excepted or non-excepted 
trades or businesses.
    The foregoing basis allocation rules would not apply to disallowed 
business interest expense carryforwards, with the exception of 
disallowed disqualified interest. Disallowed business interest expense 
carryforwards other than disallowed disqualified interest would have 
been allocated during the year in which they were first disallowed 
under section 163(j). On becoming carryforwards, these disallowed 
expenses would retain their allocation from prior taxable years and 
would not be reallocated in a subsequent taxable year. The Treasury 
Department and the IRS request comments as to how the allocation rules 
in proposed Sec.  1.163(j)-10 should apply to disallowed disqualified 
interest.
    These basis allocation rules also would not apply to floor plan 
financing interest expense. As provided in section 163(j)(1)(C) and 
proposed Sec.  1.163(j)-2, taxpayers are entitled to deduct their 
business interest expense to the full extent of their floor plan 
financing interest expense.
    The Treasury Department and the IRS considered various alternatives 
to asset basis in determining how interest expense should be allocated 
between excepted and non-excepted trades or businesses. One such 
alternative was a tracing regime whereby taxpayers would be required to 
trace disbursements of debt proceeds to specific expenditures. However, 
tracing would impose a significant administrative burden upon 
taxpayers. Further, it is not clear how taxpayers would retroactively 
apply a tracing regime to existing debt. In particular, because C 
corporations would have had no reason to trace the proceeds of any 
existing indebtedness, imposing a tracing regime on existing 
indebtedness would require corporations to reconstruct the use of funds 
within their treasury operations at the time such indebtedness was 
issued, even if the issuance occurred many years ago, and even if the 
funds were used for a myriad of purposes across a large number of 
entities. Such an approach would involve a great deal of administrative 
cost and may be impractical or even impossible for indebtedness issued 
years ago.
    Moreover, because money is fungible, the Treasury Department and 
the IRS have determined that a tracing regime would be distortive and 
subject to manipulation, and thus would not be appropriate. Although 
taxpayers are impacted from both a commercial and tax perspective by 
the amount of capital raised through the issuance of equity and 
indebtedness, any trade or business conducted by a taxpayer is 
generally indifferent to the source of funds. As a result, if taxpayers 
were allowed to use a tracing regime to allocate indebtedness to 
excepted trades or businesses, there would be an incentive to treat 
excepted trades or businesses as funded largely from indebtedness, and 
to treat non-excepted trades or businesses as funded largely from other 
types of funding, such as equity funding, despite the fact that, as an 
economic matter, all of a taxpayer's trades or businesses are funded 
based on the taxpayer's overall capital structure.
    The assumption that a trade or business is indifferent to its 
source of funds may not be appropriate in cases in which certain 
indebtedness is secured by the assets of the trade or business and cash 
flow from those assets is expected to support the payments required on 
the indebtedness. These proposed regulations would provide for a 
limited tracing rule in those cases. See the discussion of qualified 
non-recourse indebtedness in proposed Sec.  1.163(j)-10(d) in part 
10(D) of this Explanation of Provisions section.
    The Treasury Department and the IRS also considered allocating 
interest expense based upon the relative fair market value of the 
assets used in excepted and non-excepted trades or businesses. However, 
determinations of fair market value frequently are burdensome for 
taxpayers, which may have numerous assets without a readily established 
market price, and for the IRS. For this reason, disputes between 
taxpayers and the IRS over the fair market value of an asset are a 
common and costly occurrence. In the TCJA, Congress repealed the use of 
fair market value in the apportionment of interest expense under 
section 864 of the Code (see section 14502(a) of the TCJA). Thus, the 
Treasury Department and the IRS have determined that allocating 
interest expense based upon the relative fair market value of assets is 
a less viable approach than a regime based upon relative amounts of 
asset basis.
    The Treasury Department and the IRS also considered allocating 
interest expense to excepted and non-excepted trades or businesses 
based on the relative amounts of gross income

[[Page 67522]]

generated by such trades or businesses. However, gross income is more 
variable and volatile than asset basis, in part because it is based on 
an annual measurement. Methods could be developed to look at multiple 
years of gross income through an averaging or other smoothing 
methodology, but any such approach would necessarily create a number of 
difficult technical questions because the income of different trades or 
businesses may be subject to differing business cycles and the timing 
of income items may be within taxpayers' control. In the TCJA, Congress 
also repealed the use of gross income in the apportionment of interest 
expense under section 864 of the Code (see section 14502(a) of the 
TCJA).
    Thus, although allocating interest expense between excepted and 
non-excepted trades or businesses using asset basis is not without its 
shortcomings, the Treasury Department and the IRS have determined that 
this approach represents the most viable option. The Treasury 
Department and the IRS also note that various commenters recommended 
using this approach to allocate interest expense between excepted and 
non-excepted trades or businesses.
    The Treasury Department and the IRS have determined that the same 
approach should be used to allocate interest income, for several 
reasons. Such an approach is simpler to administer than applying a 
separate regime to interest income. Additionally, using the same regime 
for both interest expense and interest income reduces the likelihood 
that the IRS or taxpayers will be whipsawed. Under this rule, the 
greater the amount of basis in assets used in excepted trades or 
businesses, the greater the amount of both interest expense that is not 
subject to the section 163(j) limitation and interest income that is 
not properly allocable to a trade or business and that, as a result, is 
not factored into the taxpayer's calculation of ATI, which reduces the 
amount of interest expense that may be deducted.
    The Treasury Department and the IRS request comments on the use of 
asset basis to allocate interest expense and interest income between 
excepted and non-excepted trades or businesses, including whether other 
measures, such as gross income, should be used in addition to, or 
instead of, asset basis. The Treasury Department and the IRS also 
request comments on the special rules contained in proposed Sec.  
1.163(j)-10(c), including whether additional special rules are needed 
(for example, for financial instruments that are marked to market 
within the meaning of section 475, or additional rules contained in 
Sec.  1.861-12T).

D. Proposed Sec.  1.163(j)-10(d): Direct Allocations

    The basis allocation rules in proposed Sec.  1.163(j)-10(c) would 
not apply to interest expense and interest income in several 
circumstances. First, a taxpayer with qualified nonrecourse 
indebtedness would be required to directly allocate interest expense 
from such indebtedness to the taxpayer's assets, as provided in Sec.  
1.861-10T(b). Second, a taxpayer that is engaged in the trade or 
business of banking, insurance, financing, or a similar business would 
be required to directly allocate interest expense and interest income 
from such business to the taxpayer's assets used in that business. The 
special rule for cash and cash equivalents under proposed Sec.  
1.163(j)-10(c) would not apply to such taxpayers.
    A taxpayer to which both proposed Sec.  1.163(j)-10(c) and (d) 
apply would be required to reduce its asset basis for purposes of 
proposed Sec.  1.163(j)-10(c) to reflect assets to which interest 
expense is directly allocated under proposed Sec.  1.163(j)-10(d).
    The Treasury Department and the IRS request comments as to whether 
direct allocation should be required in any other circumstances, 
including but not limited to circumstances in which a taxpayer with 
both excepted and non-excepted trades or businesses is subject to 
significant limitations on transferring borrowed funds outside the 
excepted trade or business. The Treasury Department and the IRS also 
request comments on whether a taxpayer should be permitted to elect to 
treat all of its interest expense and interest income as properly 
allocable to non-excepted trades or businesses for purposes of section 
163(j), in lieu of applying the allocation rules in proposed Sec.  
1.163(j)-10(c) and (d).

11. Proposed Sec.  1.163(j)-11: Transition Rules

    Proposed Sec.  1.163(j)-11 would provide certain transition rules. 
Proposed Sec.  1.163(j)-11(a) would provide rules that apply if a 
corporation (S) that is subject to the section 163(j) limitation joins 
a consolidated group whose taxable year began before January 1, 2018, 
and thus is not currently subject to the section 163(j) limitation. For 
example, assume that S is a calendar-year, stand-alone C corporation, 
and that S is acquired by Acquiring Group (with a November 30 fiscal 
year) on May 31, 2018. Acquiring Group is not subject to the section 
163(j) limitation during its taxable year beginning December 1, 2017, 
but S is subject to the section 163(j) limitation for its short taxable 
year beginning January 1, 2018. Is S subject to the section 163(j) 
limitation for the taxable period beginning June 1, 2018? What happens 
to any disallowed business interest expense carryforwards from S's 
short taxable year ending May 31, 2018?
    Proposed Sec.  1.163(j)-11(a) would provide that, in those 
situations to which proposed Sec.  1.163(j)-11(a) applies, the status 
of the acquiring group will control the application of section 163(j) 
to a target during the period that the target is included in the group. 
Therefore, if S is subject to the section 163(j) limitation at the time 
of its acquisition by a consolidated group with a taxable year 
beginning before January 1, 2018, then S will not be subject to the 
section 163(j) limitation for the portion of the acquiring group's 
taxable year in which S is a member. Additionally, any disallowed 
business interest expense carryforwards from S's taxable year that 
ended on the date of S's change in status will be carried forward to 
the acquiring group's first taxable year beginning after December 31, 
2017.
    Proposed Sec.  1.163(j)-11(b) of this section would provide special 
rules for taxpayers with carryforwards under old section 163(j). Old 
section 163(j)(1)(A) disallowed a deduction to a corporation for 
disqualified interest (within the meaning of old section 163(j)(3)) 
paid or accrued by the corporation during the taxable year if old 
section 163(j) applied to such year. Old section 163(j)(1)(B) provided 
that any amount disallowed under old section 163(j)(1)(A) for any 
taxable year would be treated as disqualified interest paid or accrued 
in the succeeding taxable year.
    Proposed Sec.  1.163(j)-11(b) would provide that a taxpayer's 
interest expense for which a deduction was disallowed under old section 
163(j) is carried forward to the taxpayer's first taxable year 
beginning after December 31, 2017, and is subject to disallowance under 
section 163(j) and proposed Sec.  1.163(j)-2, except to the extent such 
interest is allocable to an excepted trade or business under proposed 
Sec.  1.163(j)-10.
    As noted in part 4(D) of this Explanation of Provisions section, 
old section 163(j) treated all members of the same affiliated group as 
a single taxpayer regardless of whether such members filed a 
consolidated return, but the section 163(j) regulations would treat 
members of the same affiliated group as one taxpayer only if such 
members file a consolidated return. Proposed Sec.  1.163(j)-11(b) would 
provide

[[Page 67523]]

rules based upon the rules in Sec.  1.163(j)-5(c)(2) of the Prior 
Proposed Regulations for allocating disallowed disqualified interest 
carryforwards among members of an affiliated group that was treated as 
a single taxpayer under old section 163(j).
    Proposed Sec.  1.163(j)-11(b) also would clarify the application of 
section 382 to disallowed disqualified interest carryforwards. For 
example, disallowed disqualified interest would not be treated as a 
pre-change loss subject to a section 382 limitation under section 
382(d)(3) with regard to an ownership change on a change date occurring 
before the date the Treasury decision adopting these regulations as 
final regulations is published in the Federal Register, unless the 
disallowed disqualified interest is carried forward under section 
163(j)(2). But see section 382(h)(6)(B) regarding built-in deduction 
items.
    Similarly, for purposes of section 382(k)(1), regarding 
determination of status as a loss corporation, disallowed disqualified 
interest would not be treated as a carryforward of disallowed interest 
described in section 381(c)(20) with regard to an ownership change on a 
change date occurring before the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register, unless the disallowed disqualified interest is carried 
forward under section 163(j)(2). But see section 382(h)(6) regarding 
built-in deductions. For a description of changes to regulations under 
section 382, see the discussion of proposed Sec. Sec.  1.382-2 and 
1.382-6 in parts 14 and 15 of this Explanation of Provisions section.
    Finally, whereas old section 163(j)(2)(B)(ii) permitted taxpayers 
with excess limitation, within the meaning of old section 
163(j)(2)(B)(iii), to carry such limitation forward, section 163(j) 
contains no such language. Thus, the Treasury Department and the IRS 
have determined that no amount of excess limitation under old section 
163(j)(2)(B) may be carried forward to taxable years beginning after 
December 31, 2017.

12. Proposed Sec.  1.263A-9

    Because of the amendments to section 163(j), a conforming amendment 
to Sec.  1.263A-9(g) is required. Proposed Sec.  1.263A-9 would update 
references to section 163(j) to reflect current law.

13. Proposed Sec.  1.381(c)(20)-1

    As noted in part 5 of this Explanation of Provisions section, 
Congress added disallowed business interest expense carryforwards to 
the list of items to which the acquiring corporation succeeds in a 
transaction to which section 381(a) applies. See section 381(c)(20). 
Sections 1.381(c)(1)-1 and 1.381(c)(1)-2 provide rules that, in part, 
limit the acquiring corporation's ability to use NOL carryforwards in 
the acquiring corporation's first taxable year ending after the 
acquisition date. The Treasury Department and the IRS have determined 
that similar rules should apply to disallowed business interest expense 
carryforwards.
    Proposed Sec.  1.381(c)(20)-1 also would provide that, for purposes 
of section 381(c)(20), the term ``carryover of disallowed business 
interest described in section 163(j)(2)'' includes disallowed 
disqualified interest.

14. Proposed Sec.  1.382-2

    In the TCJA, Congress added section 382(d)(3) and a new sentence to 
section 382(k)(1) for taxable years beginning after December 31, 2017. 
Section 1.382-2 contains certain definitions for purposes of sections 
382 and 383 and the regulations thereunder, including definitions of 
the terms ``pre-change loss'' and ``loss corporation.''
    Section 382(d)(3) provides that, for purposes of section 382, the 
term ``pre-change loss'' includes carryovers of disallowed interest 
described in section 163(j)(2) ``under rules similar to the rules'' in 
section 382(d)(1). Section 163(j)(2) provides that interest expense 
paid or accrued in a taxable year that is not allowed as a deduction 
pursuant to section 163(j)(1) is carried forward to the succeeding 
taxable year. Section 382(d)(1) treats as a ``pre-change loss'' both 
(i) net operating loss carryforwards to the taxable year in which the 
change date occurs (change year), and (ii) the net operating loss 
carryforward for the change year, to the extent such loss is allocable 
to the pre-change period. Proposed Sec.  1.382-2 would clarify the 
equivalent treatment of items under section 382(d)(1) and (3) by 
providing that a ``pre-change loss'' includes the portion of any 
disallowed business interest expense of the old loss corporation paid 
or accrued in the taxable year of the testing date that is attributable 
to the pre-change period.
    For purposes of determining the portion of disallowed business 
interest expense that is attributable to the pre-change period, 
proposed Sec.  1.382-2 would require that disallowed business interest 
expense be ratably allocated to each day in the year, regardless of 
whether the loss corporation makes a closing-of-the-books election 
under Sec.  1.382-6(b)(2) with regard to allocating its other taxable 
items to the pre-change period and the post-change period within the 
change year. This ratable allocation of disallowed business interest 
expense is consistent with the allocation of the loss corporation's 
deduction for business interest expense in the taxable year of the 
ownership change (see proposed Sec.  1.382-6). Ratable allocation also 
is consistent with the general application of the section 163(j) 
regulations, which apply without regard to any particular debt 
instrument or particular date of payment or accrual of interest. See 
the discussion in part 2(A) of this Explanation of Provisions section.
    The TCJA also modified section 382(k)(1) to provide that the term 
``loss corporation'' includes a corporation entitled to use a 
disallowed business interest expense carryforward. These proposed 
regulations would revise Sec.  1.382-2 to reflect the changes to the 
definitions of the terms ``pre-change loss'' and ``loss corporation.'' 
These provisions would be applicable with regard to ownership changes 
occurring on or after the date on which the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register.

15. Proposed Sec.  1.382-6

    When a loss corporation experiences an ownership change, Sec.  
1.382-6(a) provides that, in general, the loss corporation must 
allocate its NOL or taxable income and its net capital loss or modified 
capital gain net income for the change year between the pre-change 
period and the post-change period by ratably allocating an equal 
portion to each day in the year. However, instead of using ratable 
allocation, a loss corporation may elect to use the closing-of-the-
books method in Sec.  1.382-6(b). A closing-of-the-books election 
applies only for purposes of certain allocations, such as NOL or 
taxable income allocations, and does not terminate the loss 
corporation's taxable year as of the change date.
    Proposed Sec.  1.382-6 would clarify that, for purposes of section 
163(j), a loss corporation's current-year business interest expense may 
not be allocated under the closing-of-the-books method. Thus, even if a 
taxpayer generally has a closing-of-the-books election in effect for 
the change year, the taxpayer would be required to ratably allocate its 
current-year business interest expense for which a deduction is 
allowable under section 163(j) in that year between the pre-change 
period and the post-change period. For example, if X, a calendar-year 
loss corporation, experiences an ownership change on May 26, 2019, and 
if X has $100x of current-year business interest expense for which a 
deduction is allowable

[[Page 67524]]

under section 163(j) for that year, $40x of X's business interest 
expense deduction would be allocated to the pre-change period, and $60x 
of X's business interest expense deduction would be allocated to the 
post-change period, regardless of which of the two general allocation 
methods--ratable allocation or closing-of-the-books--X uses. Under this 
approach, taxpayers would not need to compute ATI separately for the 
pre-change and post-change periods.
    The Treasury Department and the IRS are considering publishing a 
separate notice of proposed rulemaking to address, among other issues, 
the treatment of a corporate partner's excess business interest expense 
(including negative section 163(j) expense) under section 382.

16. Proposed Sec.  1.383-1

    Section 1.383-1(d) provides ordering rules for the utilization of 
pre-change losses and pre-change credits and for the absorption of the 
section 382 limitation and the section 383 credit limitation. 
Generally, pre-change capital losses are absorbed first for these 
purposes, followed by NOLs and recognized built-in losses, other pre-
change losses and, finally, pre-change credits.
    The Treasury Department and the IRS have determined that disallowed 
business interest expense carryforwards should be absorbed after pre-
change capital losses and all recognized built-in losses, but before 
NOLs. Disallowed business interest expense carryforwards should be 
absorbed before NOLs because taxpayers must calculate their current-
year income or loss in order to determine whether and to what extent 
they can use an NOL in that year, and deductions for business interest 
expense, including carryforwards from prior taxable years, factor into 
the calculation of current-year income or loss.
    Proposed Sec.  1.383-1 would reflect the addition of disallowed 
business interest expense to the ordering rules, would make conforming 
changes to other provisions, and would update other provisions to 
reflect additional changes effectuated by the TCJA. The ordering rules 
in proposed Sec.  1.383-1 include alternative rules that reflect the 
fact that certain regulations pertaining to the interaction between 
sections 163(j) and 382 may not be applicable to all ownership changes.

17. Proposed Sec.  1.469-9(b)

    These proposed regulations would also propose amendments to Sec.  
1.469-9(b) to provide rules relating to the definition of real property 
trade or business under section 469(c)(7)(C). Specifically, these 
proposed regulations would provide guidance on the meaning of real 
property and on the types of trades or businesses that qualify as 
``real property trades or businesses'' for purposes of section 
469(c)(7).
    Section 469(a) of the Code disallows passive activity losses or 
credits. In general, a passive activity loss is the excess of the 
aggregate losses over the aggregate income from all passive activities 
in a taxable year. A passive activity is defined as any trade or 
business activity in which the taxpayer does not materially 
participate, and any rental activity subject to the exception for 
rental real estate under section 469(c)(7). Generally, under section 
469(c)(2), a rental activity is treated as a per se passive activity 
regardless of whether the taxpayer materially participates in the 
activity.
    The Omnibus Budget Reconciliation Act of 1993, Public Law 103-66, 
sec. 13143(a), added section 469(c)(7) to the Code effective for tax 
years beginning after December 31, 1993. In doing so, Congress 
expressed the belief that applying the ``per se'' passive rule to all 
rental real estate activities disadvantaged taxpayers who were 
otherwise actively engaged in real estate businesses and who also owned 
rental real estate. According to H. Rept. 103-111, 103rd Cong., 1st 
sess. (May 25, 1993), ``[t]he committee considers it unfair that a 
person who performs personal services in a real estate trade or 
business in which he materially participates may not offset losses from 
rental real estate activities against income from nonrental real estate 
activities or against other types of income such as portfolio 
investment income.'' Section 469(c)(7) was added to alleviate this 
unfair treatment.
    Section 469(c)(7) provides that the rental real estate activities 
of qualifying taxpayers who are actively engaged in real property 
trades or businesses are not subject to the ``per se'' passive rule in 
section 469(c)(2). Instead, under section 469(c)(7), a rental real 
estate activity of a qualifying taxpayer will not be a passive activity 
if the taxpayer materially participates in the rental real estate 
activity.
    In section 469(c)(7)(C), Congress defined ``real property trade or 
business'' as ``any real property development, redevelopment, 
construction, reconstruction, acquisition, conversion, rental, 
operation, management, leasing, or brokerage trade or business.'' 
However, neither section 469 nor the legislative history defines any of 
the terms contained in section 469(c)(7)(C).
    These proposed regulations would amend the regulations under 
section 469 to provide a definition of the term ``real property'' along 
with certain other terms contained in section 469(c)(7)(C). Consistent 
with ordinary usage, these proposed regulations would define ``real 
property'' to include land, buildings, and other inherently permanent 
structures that are permanently affixed to land, and exclude from the 
definition certain other items, such as machines and equipment that 
serve an active function, which may be permanently affixed to real 
property.
    Given Congress's focus in enacting section 469(c)(7) to provide 
relief to entrepreneurs in real property trades or businesses with some 
nexus to or involvement with rental real estate, these proposed 
regulations would not include trades or businesses that generally do 
not play a significant or substantial role in the creation, 
acquisition, or management of rental real estate in the definition of 
real property trade or business under section 469(c)(7)(C). Therefore, 
taxpayers engaged in trades or businesses that are not directly or 
substantially involved in the creation, acquisition, or management of 
rental real estate, or that provide personal services which are merely 
ancillary to a real property trade or business, will generally not be 
treated as engaged in real property trades or businesses for this 
purpose. In addition, machinery, equipment, and other assets or items 
that are not generally viewed as items of real property until after 
their installation or permanent affixation to real property (for 
example, HVAC systems, elevators, escalators, solar panels, glass 
fixtures, doors, windows, tiling, etc.) will not be treated as real 
property for these purposes and, accordingly, taxpayers engaged in 
trades or businesses of manufacturing, installing, operating, 
maintaining, or repairing such items generally will not be treated as 
engaged in real property trades or businesses within the meaning of 
section 469(c)(7)(C).
    As the Treasury Department and the IRS have previously recognized 
(see Notice of Proposed Rulemaking, ``Definition of Real Estate 
Investment Trust Real Property,'' published in the Federal Register (79 
FR 27508, 27510) on May 14, 2014), the term ``real property'' appears 
in numerous Code provisions, which could ordinarily imply that, absent 
specific statutory modifications, the term ``real property'' should 
have the same meaning throughout the Code. However, the context and 
legislative purpose underlying a specific Code provision may 
necessitate a broader or narrower

[[Page 67525]]

definition of the term ``real property'' than may be applied for other 
Code provisions. These proposed regulations under section 469 provide a 
definition of real property that is, for example, narrower than the one 
provided in the REIT context. The definition provided in these proposed 
regulations would apply solely for purposes of section 469(c)(7), and 
these regulations should not be construed in any way as applying to, or 
changing, the definitions in other Code provisions.
    These proposed regulations would also define ``real property 
operation'' to mean the work done on a day-to-day basis by a direct, or 
indirect, owner of the real property, in a trade or business relating 
to the maintenance and occupancy of the real property to make the 
property available to be used, or held out for use, by customers. 
Similarly, these proposed regulations would define ``real property 
management'' to mean work performed by third party managers on behalf 
of owners in a trade or business relating to the day-to-day maintenance 
and occupancy of the real property to make it available to be used, or 
held out for use, by customers. In both instances, the principal 
purpose of the trade or business must be the provision of the use of 
the real property (or physical space accorded by or within the real 
property) to one or more customers, and not the provision of other 
significant or extraordinary services to customers in conjunction with 
the customers' incidental use of the real property or physical space 
accorded by or within the real property.
    These proposed regulations would reserve on the remaining terms in 
section 469(c)(7)(C). Comments are requested as to whether further 
definitions are needed.

18. Proposed Sec.  1.860C-2

    Because REMICs are not treated as carrying on a trade or business 
for purposes of section 162 and are not C corporations, the Treasury 
Department and the IRS have determined that section 163(j) should not 
apply to REMICs, and these proposed regulations would amend Sec.  
1.860C-2 to provide that a REMIC is allowed a deduction, determined 
without regard to section 163(j), for any interest expense accrued 
during the taxable year. Section 1.860C-2(b)(2)(ii) of these proposed 
regulations would apply for taxable years beginning after December 31, 
2017. However, taxpayers may rely on proposed Sec.  1.860C-2(b)(2)(ii) 
prior to the date final regulations are published in the Federal 
Register.

19. Proposed Sec.  1.1502-36

    Section 1.1502-36 contains the unified loss rule, which limits the 
ability of a consolidated group to recognize non-economic or duplicated 
losses on subsidiary stock. The rule applies when a consolidated group 
member transfers subsidiary (S) stock that has a loss. If Sec.  1.1502-
36(d) applies to the transfer of a loss share, the attributes of S and 
its lower-tier subsidiaries are reduced as needed to prevent the 
duplication of any loss recognized on the transferred stock. Such 
attributes include capital loss carryovers, NOL carryovers, deferred 
deductions, and basis of assets other than cash and general deposit 
accounts. See Sec.  1.1502-36(d)(4).
    The Treasury Department and the IRS have determined that, for 
purposes of Sec.  1.1502-36(d), disallowed business interest expenses 
should be treated as deferred deductions. Section 1.1502-36 would be 
modified accordingly.

20. Proposed Sec. Sec.  1.1502-91 Through 1.1502-99

    As discussed in parts 11 and 14 through 16 of this Explanation of 
Provisions section, the section 163(j) regulations and Sec. Sec.  
1.382-2, 1.382-6, and 1.383-1 of these proposed regulations would 
address the application of section 382 to business interest expense, 
including disallowed business interest expense carryforwards. Sections 
1.1502-90 through 1.1502-99 contain rules applying section 382 to a 
consolidated group. These proposed regulations would add a new 
coordination rule in Sec.  1.1502-98(b) pursuant to which the rules in 
Sec. Sec.  1.1502-91 through 1.1502-96 would apply to business interest 
expense, including disallowed business interest expense carryforwards, 
of members of a consolidated group (or corporations that join or leave 
a consolidated group), with appropriate adjustments.
    The Treasury Department and the IRS request comments on the new 
coordination rule in Sec.  1.1502-98(b), including whether additional 
examples should be added to clarify the application of this rule.

21. Areas Where the Proposed Regulations Have Reserved on Issues

    The proposed regulations reserve on a number of issues, either 
where the reserved issue is expected to be addressed in other guidance, 
where comments would be helpful in determining the best manner of 
addressing an issue, or where the Treasury Department and the IRS are 
unsure whether additional guidance would be helpful.

A. Reservations Made Because Other Guidance May Address the Reserved 
Issue

    The proposed regulations reserve on the interaction of sections 
163(j) and 59A because separate guidance under section 59A is expected 
to address these issues.
    The proposed regulations under sections 382 and 383 also reserve on 
a number of paragraphs related to the treatment of a corporate 
partner's excess business interest expense (including negative section 
163(j) expense) under section 382. The Treasury Department and the IRS 
are considering publishing a separate notice of proposed rulemaking to 
address these and other issues related to section 382.

B. Reservations Made Where Comments Would Be Helpful in Determining the 
Best Manner of Addressing an Issue

    The proposed regulations reserve on the treatment of collateralized 
cleared swaps and the types of fees that should be treated as interest 
for purposes of the interest definition because comments would be 
helpful in determining the best manner of addressing these issues. The 
proposed regulations also reserve on the coordination with certain 
other statutory provisions based on or limited by the income of 
taxpayers because determining the best approach for ordering such 
provisions would benefit from comments.
    For similar reasons, the proposed regulations also reserve on the 
proper treatment of business interest income and business interest 
expense with respect to lending transactions between a passthrough 
entity and an owner of the entity (self-charged lending transactions), 
the treatment of excess business interest expense in tiered 
partnerships has been reserved in these proposed regulations, and the 
application of section 163(j) to a partnership merger or division.

C. Reservations Made Where the Treasury Department and the IRS Are 
Unsure Whether Additional Guidance Would Be Helpful

    The proposed regulations reserve on nine of the eleven terms listed 
in section 469(c)(7)(C). Comments are requested as to whether further 
definitions are needed. However, in the absence of comments requesting 
additional guidance with respect to these terms, it is unclear whether 
such additional guidance would be helpful.
    Finally, the proposed regulations also reserve on additional 
guidance in the case of certain exempt organizations with respect to 
the application of the

[[Page 67526]]

gross receipts test for purposes of section 163(j) because in the 
absence of comments it is unclear whether any such rules are necessary.

Statement of Availability of IRS Documents

    The IRS Notices and Revenue Procedures cited in this document are 
published in the Internal Revenue Bulletin (or Cumulative Bulletin) and 
are available from the Superintendent of Documents, U.S. Government 
Printing Office, Washington, DC 20402, or by visiting the IRS website 
at http://www.irs.gov.

Proposed Applicability/Effective Dates

    Except as otherwise provided in this section, the regulations are 
proposed to be effective for taxable years ending after the date the 
Treasury decision adopting these regulations as final is published in 
the Federal Register. However, taxpayers and their related parties, 
within the meaning of sections 267(b) and 707(b)(1), may apply the 
rules of these regulations to a taxable year beginning after December 
31, 2017, so long as the taxpayers and their related parties 
consistently apply the rules of Sec. Sec.  1.163(j)-1, 1.163(j)-2, 
1.163(j)-3, 1.163(j)-4, 1.163(j)-5, 1.163(j)-6, 1.163(j)-7, 1.163(j)-8, 
1.163(j)-9, 1.163(j)-10, and 1.163(j)-11, and if applicable, Sec. Sec.  
1.263A-9, 1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-
13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to 
the extent they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-
1), and 1.1504-4 to those taxable years.
    With respect to proposed Sec. Sec.  1.382-2, 1.382-5, and 1.1502-91 
through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec.  1.382-2 and 1.382-5), if applicable, the regulations are 
proposed to be effective for ownership changes occurring on or after 
the date the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may apply the rules of Sec. Sec.  1.382-2 and 1.382-5, and 
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec.  1.382-2 and 1.382-5), if applicable, to an ownership change 
that occurs in a taxable year beginning after December 31, 2017, so 
long as the taxpayers and their related parties consistently apply the 
rules of Sec. Sec.  1.163(j)-1, 1.163(j)-2, 1.163(j)-3, 1.163(j)-4, 
1.163(j)-5, 1.163(j)-6, 1.163(j)-7, 1.163(j)-8, 1.163(j)-9, 1.163(j)-
10, and 1.163(j)-11, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, and 1.1504-4 to taxable years beginning after 
Decembers 31, 2017.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Executive Orders 13771, 13563 and 12866 direct agencies to assess 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity). Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, of reducing costs, of harmonizing rules, and of promoting 
flexibility.
    These proposed regulations have been designated by the Office of 
Information and Regulatory Affairs (OIRA) as Economically Significant 
under section 1(c) of the Memorandum of Agreement (April 11, 2018) 
between the Treasury Department and the Office of Management and Budget 
(OMB) regarding review of tax regulations and thereby subject to review 
under Executive Order 12866. Accordingly, these proposed regulations 
have been reviewed by OIRA. In addition, the Treasury Department and 
the IRS expect the proposed regulations, when final, to be an Executive 
Order 13771 regulatory action and request comment on this designation. 
For more detail on the economic analysis, please refer to the following 
analysis.

A. Background and Overview

    The TCJA substantially modified the statutory rules of section 
163(j) to limit the amount of net business interest expense that can be 
deducted in the current taxable year of any taxpayer with only limited 
exceptions. As previously described in this preamble, section 163(j) 
prior to TCJA generally applied to domestic corporations with interest 
paid or accrued to related persons that were not subject to Federal 
income tax. As described in the Explanation of Provisions section, the 
amount allowed under section 163(j)(1) as a deduction for business 
interest expense is limited to the sum of (1) the taxpayer's business 
interest income for the taxable year; (2) 30 percent of the taxpayer's 
ATI for the taxable year; and (3) the taxpayer's floor plan financing 
interest expense for the taxable year. The section 163(j) limitation 
applies to all taxpayers, except for certain small businesses with 
average annual gross receipts of $25 million or less and certain trades 
or businesses. Any amount of business interest not allowed as a 
deduction for any taxable year as a result of the limitation under 
section 163(j)(1) is carried forward and treated as business interest 
paid or accrued in the next taxable year under section 163(j)(2).
    Congress modified section 163(j) under TCJA, in part, out of 
concern that prior law treated debt-financed investment more favorably 
than equity-financed investment. This debt bias generally encouraged 
taxpayers to utilize more leverage than would occur in the absence of 
the Code. Limiting the deduction of business interest is meant to 
reduce the relative favorability of debt and hence encourage a more 
efficient capital structure for firms. Congress also believed it 
necessary to apply the limit broadly across different types of 
taxpayers so as not to distort the choice of entity (see H. Rept. 115-
409, at 247 (2017)).

B. Need for the Proposed Regulations

    Because the section 163(j) limitation has been substantially 
modified, a large number of the relevant terms and necessary 
calculations that taxpayers are currently required to apply under the 
statute can benefit from greater specificity. Among other benefits, the 
clarity provided by the proposed regulations generally helps ensure 
that all taxpayers calculate the business interest expense limitation 
in a similar manner.
    For example, there is no universal definition for the term 
``interest'' under the Code. In general, because section 163(j) applies 
to limit certain deductions for interest under chapter A of the Code, 
the proposed regulations' definition of the term ``interest'' is 
relatively broad to create a balanced application of section 163(j). 
This definition limits tax-avoidance incentives for taxpayers to, in 
form, label payments as something other than interest that, in 
substance, are economically interest. At the same time, this definition 
allows taxpayers to treat certain amounts of income as business 
interest income for purposes of calculating the section 163(j) 
limitation that they may be required to, for non-tax reasons, label as 
something other than interest, so that taxpayers with such income are 
not unduly impacted by the section 163(j) limitation.
    Pursuant to section 163(j)(8)(B), the proposed regulations 
prescribe adjustments to the calculation of ATI to prevent double 
counting of deductions and to provide relief for particular types

[[Page 67527]]

of taxpayers or taxpayers in particular circumstances to ensure that 
such taxpayers are treated similarly to other taxpayers when 
calculating ATI.
    The statute applies broadly to different types of entities, 
including passthrough entities such as partnerships and S corporations. 
The statute specifies that the section 163(j) limitation applies at the 
entity level for a partnership but that items such as excess business 
interest expense and excess taxable income must be allocated to 
partners for a variety of reasons including to compute their own 163(j) 
limitation. The statute further specifies that the items should be 
allocated in the same manner as ``nonseparately stated taxable income 
or loss of the partnership''; however, this concept has not previously 
been defined by statute or regulations. Without the specified method of 
allocating these excess items provided by the proposed regulations, 
partnerships would likely have both significant flexibility but also 
uncertainty in determining which partners receive excess items. This 
flexibility could potentially lead partnerships to specially allocate 
items of income or expense such that they are separately stated to 
change the partner's allocation of excess interest expense or excess 
taxable income.
    There are a number of potential uncertainties in how taxpayers 
should apply the section 163(j) limitation to CFCs in a manner 
consistent with other provisions of the Code. For example, interest 
deductions of individual CFCs may be limited by section 163(j) but 
might not be if the interest deductions of CFCs were computed on a 
group basis. The proposed regulations provide an election for treating 
related CFCs similarly to a consolidated group for the purpose of 
calculating the amount of business interest expense for purposes of the 
section 163(j) limitation. This election also provides clarity that in 
performing a CFC group calculation, finance and non-finance businesses 
are largely treated as separate groups (because of the dual role of 
interest payments as a cost of goods or services sold as well as a 
payment for debt finance and because of possible distortions in the 
case of conglomerate companies with financial and non-financial 
businesses in their CFCs, due to financial businesses' outsize amounts 
of interest expense and income). The proposed regulations also provide 
clarity by permitting the bottom-up transfer within chains of CFCs of 
excess taxable income for electing groups of CFCs.
    Other areas where clarity is provided under the proposed 
regulations for CFCs include adjustments for partnerships held by CFCs, 
the treatment of CFCs with effectively connected income (ECI), the 
treatment of intergroup dividends (to avoid double counting of ATI), 
the effect of deemed inclusions (from branch income, Subpart F income, 
and GILTI) (also to avoid double counting of ATI), and the effect 
foreign derived intangible income (FDII) on ATI.
    For purposes of section 163(j), the statute states in section 
163(j)(7) that the term ``trade or business'' does not include certain 
regulated utilities, or an electing real property trade or business or 
an electing farming business. While the statute does reference other 
places in the Code where a farming business and a real property trade 
or business are described or defined, regulations have not previously 
been issued under section 469(c)(7)(C), the rule that section 163(j) 
refers to in order to define a real property trade or business. The 
proposed regulations provide such a definition, which clarifies whether 
a trade or business could elect as a real property trade or business to 
be excepted from section 163(j). In addition, the proposed regulations 
describe procedures for allocating income and business interest income 
and expense between excepted and non-excepted trades or businesses of 
the taxpayer. The proposed regulations provide a uniform method for 
allocating income and business interest income and expense which should 
lower administrative and compliance costs relative to no guidance being 
provided.

C. Economic Analysis

1. Baseline
    The analysis in this section compares the proposed regulations to a 
no-action baseline reflecting anticipated Federal income tax-related 
and other economic behavior in the absence of these proposed 
regulations.
2. Anticipated Benefits
a. In General
    The Treasury Department and the IRS expect that the definitions and 
guidance provided in the proposed regulations will enhance U.S. 
economic performance relative to the baseline. An economically 
efficient tax system generally aims to treat income and expense derived 
from similar economic decisions similarly in order to reduce incentives 
to make choices based on tax rather than market incentives. In this 
context, an important benefit of this part of the proposed regulations 
is to reduce taxpayer uncertainty regarding the calculation of the 
section 163(j) limitation relative to an alternative scenario in which 
no such regulations were issued and thus to help ensure that all 
taxpayers interpret the statutory rules of section 163(j) in a similar 
manner, a tenet of economic efficiency.
b. Proposed Sec. Sec.  1.163(j)-1 Through 1.163(j)-5
    The proposed regulations make several adjustments to the 
calculation of ATI. One of these adjustments prevents the double 
counting of depreciation deductions when a depreciable asset is sold 
(only relevant for taxable years beginning before January 1, 2022). 
Other adjustments apply to particular types of taxpayers, such as RICs, 
REITs, or consolidated groups. These adjustments ensure that the 
section 163(j) limitation is applied evenly across different types of 
taxpayers in a manner consistent with the Code. Without such 
adjustments, certain taxpayers may be disadvantaged relative to 
otherwise similar taxpayers. For example, if RICs and REITs included 
the dividends paid deduction when calculating ATI, then these taxpayers 
would almost always have ATI of zero or close to zero, which would 
limit the ability of such taxpayers to ever deduct business interest 
expense for Federal income tax purposes.
    In addition, the proposed regulations define the term ``interest.'' 
There are several places in the Code and regulations where interest 
expense or interest income is defined, such as in the regulations that 
allocate and apportion interest expense (Sec.  1.861-9T) and in the 
subpart F regulations (Sec.  1.954-2). However, these rules only apply 
to particular taxpayers in particular situations. As described in the 
Explanation of Provisions section, there are no generally applicable 
statutory provisions or regulations addressing when financial 
instruments are treated as debt for Federal income tax purposes or when 
a payment is interest. The approach taken to defining interest for the 
section 163(j) limitation in these proposed regulations is to (1) 
include amounts associated with conventional debt instruments and 
amounts already treated as interest for all purposes under existing 
statutory provisions or regulations; (2) add some additional amounts 
that are functionally similar to interest, such as the rules regarding 
amounts on contingent payment debt instruments in Sec.  1.163(j)-
1(b)(20)(iii)(B), which was drafted in response to comments, or amounts 
treated as interest for certain purposes, such as amounts described in 
Sec. Sec.  1.861-9T and 1.954-2; and (3) provide an anti-avoidance rule 
based on the economic principle that any expense or loss predominantly 
incurred in

[[Page 67528]]

consideration of the time value of money is treated as an interest 
expense for section 163(j). Thus, the proposed regulations would apply 
to interest associated with conventional debt instruments, as well as 
transactions that are indebtedness in substance even if not in form.
    Other options for defining interest were considered by the Treasury 
Department and the IRS but were determined to be less beneficial and 
not chosen. The first option considered would be to not provide a 
definition of interest in the proposed regulations, and thus rely on 
general tax principles and case law for purposes of defining interest 
for purposes of section 163(j). While adopting this option might reduce 
the compliance burden for some taxpayers, not providing an explicit 
definition of interest would create its own uncertainty (as neither 
taxpayers nor the IRS might have a clear sense of what types of 
payments are treated as interest income and interest expense for 
purposes of section 163(j)). Such uncertainty could increase burdens to 
the IRS and taxpayers including with respect to disputes and litigation 
about whether particular payments are interest for section 163(j) 
purposes.
    In addition, such an approach to the definition of interest could 
encourage taxpayers to engage in transactions that provide financing 
while generating deductions economically similar to interest but make 
arguments that such deductions fail to be described by existing 
principles defining interest expense. There are several reasons why 
curbing such taxpayer behavior would be beneficial. First, taxpayer use 
of such transactions is likely to be uneven and dependent in part on 
the subjective understanding of taxpayers regarding whether such 
transactions would be allowable under the statute. Second, the ability 
of taxpayers to engage in such transactions would likely be correlated 
with size of the trade or business, with large businesses more likely 
to benefit from such avoidance strategies than small businesses. Third, 
when the deciding factor for using such transactions is the tax benefit 
of avoiding a section 163(j) limitation, then such transactions would 
impose more cost or risk on the taxpayer than using a traditional debt 
instrument. Engaging in such transactions is an inefficient use of 
resources. Fourth, such avoidance strategies may also discourage 
taxpayers from shifting to a less leveraged capital structure, and thus 
would counteract the intention of the statute to reduce the prevalence 
of highly-leveraged firms and the probability of systemic financial 
distress. Fifth, greater use of financing outside of conventional debt 
instruments may make it more difficult for financial institutions to 
determine the overall level of leverage and credit risk of firms 
seeking financing, which may distort the allocation of capital across 
businesses away from firms and investments with less credit risk.
    The second option considered would have been to adopt a definition 
of interest but limit it to amounts associated with conventional debt 
instruments and amounts that were already treated as interest under the 
Code or regulations for all purposes prior to the passage of the TCJA. 
For example, this is similar to the definition of interest proposed in 
Sec.  1.163(j)-1(b)(20)(i). While this would bring clarity to many 
transactions regarding what would be deemed interest for the section 
163(j) limitation, it would potentially distort future financing 
transactions. Some taxpayers would choose to use financial instruments 
and transactions that provide a similar economic result of using a 
conventional debt instrument, but would avoid the label of business 
interest expense, potentially enabling these taxpayers to avoid the 
section 163(j) limitation without a substantive change in capital 
structure. The arguments discussed above regarding the costs of this 
situation would continue to apply.
    In addition, there are certain transactions where under a specific 
provision of the Code and regulations, amounts could be deemed ordinary 
income when in substance the amounts are interest income. For example, 
the receipt of substitute interest paid on a securities loan 
arrangement may, under existing income tax principles, be treated as 
ordinary income rather than interest income despite the fact that such 
income is economically equivalent to interest income. Prior to the 
enactment of the 163(j) interest limitation, whether the amount was 
labeled as ordinary income or interest was not material to the overall 
tax liability of the taxpayer, but now this distinction matters.
    Because of the tax-motivated financing distortions that would arise 
from a less comprehensive definition of interest, the Treasury 
Department and the IRS consider the best approach to the definition of 
interest is to expand the definition beyond Sec.  1.163(j)-1(b)(20)(i). 
Under Sec.  1.163(j)-1(b)(20)(ii) and (iii), the Treasury Department 
and the IRS identified existing financial transactions that have the 
economic substance of debt and interest, but under the existing Code 
and regulations may have been deemed ordinary income or gain or may 
have been treated as interest for limited purposes, and clarifies that 
such amounts would be considered interest income or expense for the 
purpose of the new section 163(j) limitation.
    In addition, it is difficult for the Treasury Department and the 
IRS to specifically identify every type of transaction already in 
practice or to anticipate future innovations in financial transactions, 
therefore, proposed Sec.  1.163(j)-1(b)(20)(iv) provides an anti-
avoidance rule that any expense or loss predominately incurred in 
consideration of the time value of money is treated as an interest 
expense for purposes of section 163(j). This should help limit the 
ability of taxpayers to structure transactions in such a way that would 
allow deductible expenses that are economically similar to interest and 
frustrate the application of the statute.
    In summary, the definition of interest in these proposed 
regulations provides clarity to taxpayers and the IRS regarding which 
specific transactions and types of transactions generate interest 
subject to the section 163(j) limitation, which should lower compliance 
and administrative costs relative to providing no definition or a more 
limited definition of interest. Also, the proposed definition should 
encourage a more efficient allocation of capital and use of financing 
across taxpayers.
c. Proposed Sec.  1.163(j)-6
    The proposed regulations Sec.  1.163(j)-6 provide guidance on how 
to allocate partnership excess business interest expense, excess 
business interest income, and excess taxable income to partners. The 
statute specifies that the limitation applies at the partnership level 
but that these items must be allocated to partners for their own 163(j) 
limitation and because carryforwards of these items occurs at the 
partner level. Without a specified method of allocating these excess 
items, partnerships would likely have significant freedom to determine 
which partners receive excess items. While the statute specifies that 
the items should be allocated in the same manner as ``nonseparately 
stated taxable income or loss of the partnership'', this concept has 
not previously been defined by statute or regulations. Partnerships 
have significant control over what items are separately and 
nonseparately stated for each partner and could potentially reclassify 
income to be separately stated to favorably change the partner's 
allocation of excess interest expense or excess taxable income.

[[Page 67529]]

    The allocation method detailed in the proposed regulations follows 
a number of principles. First, it ensures that the sum of the excess 
items at the partner level is equal to the partnership level. Second, 
it ensures that the partnership does not allocate excess business 
interest expense to a partner that was allocated items comprising ATI 
and business interest income that supported the partnership's 
deductible business interest expense (unless the partner was allocated 
more interest expense than its share of deductible business interest 
expense). Finally, it ensures that the partnership allocates any excess 
taxable income or excess business interest income to partners that are 
allocated more items comprising ATI or business interest income than 
necessary to support their allocation of business interest expense. The 
proposed regulations provide a method to ensure that all partnerships 
allocate these items consistently and in a way that matches income and 
interest expense, thus promoting economically efficient investment 
decisions. Equivalently, they address tax motivated allocations of 
excess items to avoid the section 163(j) limitation.
    The proposed regulations also ensure that, for owners of 
partnerships and S corporations, business interest income is used only 
once, at the entity level, in offsetting business interest expenses. 
This eliminates the incentive to create tiered partnerships purely to 
double-count interest income in order to avoid the Section 163(j) 
limitation. It also avoids exacerbating the incentive to seek out 
interest income relative to other forms of income in order to avoid the 
Section 163(j) limitation. By avoiding these incentives, the proposed 
regulations would reduce economically inefficient uses of resources.
d. Proposed Sec. Sec.  1.163(j)-7 Through 1.163(j)-8
    The Treasury Department and the IRS expect that proposed Sec. Sec.  
1.163(j)-7 through 1.163(j)-8 will implement the section 163(j) 
limitation consistent with preserving the integrity of the 
international tax system reflected in the Code after TCJA. As described 
in the Explanation of Provisions section, business interest deductions 
of individual CFCs may be limited by section 163(j) even when, if 
calculated on a group basis, business interest deductions would not be 
limited. The application of section 163(j) to CFCs on an individual 
basis can result in inappropriate results in certain cases. In 
particular, to the extent section 163(j) were to disallow a deduction 
for business interest expense to a CFC that has borrowed from a related 
CFC, the interest paid to the lender CFC would be included in the 
income of the lender CFC, the amounts would not fully offset, and the 
United States shareholder's inclusion under subpart F and GILTI may be 
increased solely due to the use of intercompany debt between these 
CFCs. Taxpayers could restructure or ``self-help'' to reduce this 
problem, but that option involves economically wasteful restructuring 
costs to the taxpayer. Another option is to ignore within-group 
interest payments (the ``disregard approach''), but that could lead to 
inappropriate results, for example, a CFC group member borrowing from a 
third party and using the loan proceeds to lend to related CFCs 
(borrowing CFCs) would not be able to have interest income from the 
loans to the borrowing CFCs offset the interest expense to the third 
party lender for purposes of the section 163(j) limitation while the 
borrowing CFCs would not have any interest expense subject to the 
section 163(j) limitation, even though they are benefiting from the 
capital provided by the third party loan. The Treasury Department and 
the IRS consider a preferable option within the authority of the 
Treasury Department and the IRS to be to allow an election to treat 
related CFCs and their U.S. shareholders as a group for purposes of 
calculating the amount of business interest expense subject to the 
section 163(j) limitation (the ``alternative method'').
e. Proposed Sec. Sec.  1.163(j)-9 Through 1.163(j)-11
    Proposed Sec.  1.163(j)-9 provides (1) guidance in applying the 
rules for farming and real property trade or business elections and (2) 
guidance in use of a safe harbor for REITs. For electing real property 
trade or business and electing farming business, the statue specifies 
that ``any such election shall be made at such time and in such manner 
as the Secretary shall prescribe, and once made, shall be 
irrevocable.'' Therefore proposed Sec.  1.163(j)-9 provides taxpayers 
with the time and manner for electing real property trades or 
businesses and electing farming businesses. In addition, proposed Sec.  
1.163(j)-9 defines the conditions under which an election terminates. 
Without these conditions specified, taxpayers may engage in behavior 
which counteracts the intention of the statute and would not otherwise 
be taken except to game the irrevocable nature of the election the 
statute specified. The conditions specified increase the likelihood 
that all similarly situated taxpayers interpret the `irrevocable' 
designation similarly and will not engage in tax-motivated behavior to 
appear to cease operations in an effort to change an irrevocable 
designation.
    Proposed Sec.  1.163(j)-9(g) provides a safe harbor for certain 
REITs to elect to be electing real property trades or businesses. In 
addition, a special rule applies to REITs for which 10 percent or less 
of the value of the REIT's assets are real property financing assets. 
Under this rule, all of the assets of the REIT are treated as real 
property trade or business assets. The benefit of the safe harbor is to 
provide REITs the same tax treatment and apply the same general rules 
as apply to other taxpayers, an economically efficient approach. The 
special rule threshold of 10 percent for real property financing assets 
has the benefit of maintaining consistency with section 856(c)(4), 
which uses the same values for the REIT asset test at the close of the 
REIT's taxable year. Taxpayers will benefit in reduced time and cost 
applying new rules if they are familiar and consistent with other rules 
that they must comply with under the Code.
    Proposed Sec.  1.163(j)-9 provides a rule that stipulates that if 
at least 80 percent of a trade or business's real property (by fair 
market value) is leased to a trade or business under common control 
with the real property trade or business, the trade or business cannot 
make an election to be an electing real trade or business. In the 
absence of such a rule, taxpayers could restructure their business such 
that real estate components of non-real estate businesses are separated 
from the rest of their business to artificially reduce the application 
of section 163(j) by leasing the real property to the taxpayer and 
electing this ``business'' to be an excepted real property trade or 
business. Therefore, the prime benefit of this rule is to preserve the 
intent of the statute of allowing elections in the real property sector 
without incentivizing other sectors of the economy to restructure their 
business for the sole intent of avoiding the section 163(j) limitation. 
This guidance ensures that taxpayers face more uniform incentives when 
making economic decisions, a tenet of economic efficiency. Rules that 
maintain consistent structuring activity across taxpayers also 
increases IRS's ability to consistently enforce the tax rules, thus 
decreasing opportunities for tax evasion.
    Proposed Sec.  1.163(j)-10 provides rules for allocations of ATI 
and interest expense and interest income between excepted and non-
excepted trades or businesses. The proposed regulations allocate 
interest expense and interest income between the related excepted

[[Page 67530]]

and non-excepted trades or businesses based upon the relative amounts 
of the taxpayer's adjusted tax basis in the assets used in its excepted 
and non-excepted trades or businesses. As discussed in the Explanation 
of Provisions section, this general method of allocation reflects the 
fact that money is fungible and the view that interest expense is 
attributable to all activities and property, regardless of any specific 
purpose for incurring an obligation on which interest is paid. Since 
any allocation method will require an increase in compliance costs for 
taxpayers, an allocation is only required when the share of the asset 
tax basis in the excepted or non-excepted business exceeds 10 percent. 
Finally, this asset basis approach provides consistency with the 
regulations under section 861. By providing taxpayer guidance that is 
already familiar to them and consistent with other parts of the Code, 
taxpayers benefit in reduced time and cost spent learning and applying 
new rules.
    The Treasury Department and the IRS considered several alternatives 
to this asset basis approach for allocating interest income and 
expense. First, a tracing approach was considered whereby taxpayers 
would be required to trace disbursements of debt proceeds to specific 
expenditures. However, tracing would impose a significant 
administrative burden upon taxpayers due to the complexity of matching 
interest income and expense among related companies. Further, it is not 
clear how taxpayers would retroactively apply a tracing regime to 
existing debt. In particular, because C corporations would have had no 
reason to trace the proceeds of any existing indebtedness, imposing a 
tracing regime on existing indebtedness would require corporations to 
reconstruct the use of funds within their treasury operations at the 
time such indebtedness was issued, even if the issuance occurred many 
years ago, and even if the funds were used for a myriad of purposes 
across a large number of entities. Such an approach would involve a 
great deal of administrative cost and may be impractical or even 
impossible for indebtedness issued years ago.
    Moreover, because money is fungible, a tracing regime would be 
distortive and subject to manipulation. Although taxpayers are impacted 
from both a commercial and tax perspective by the amount of capital 
raised through the issuance of equity and indebtedness, any trade or 
business conducted by a taxpayer is generally indifferent to the source 
of funds. As a result, if taxpayers were allowed to use a tracing 
regime to allocate indebtedness to excepted trades or businesses, there 
would be an incentive to treat excepted trades or businesses as funded 
largely from indebtedness, and to treat non-excepted trades or 
businesses as funded largely from other types of funding, such as 
equity funding, despite the fact that, as an economic matter, all of a 
taxpayer's trades or businesses are funded based on the taxpayer's 
overall capital structure.
    The Treasury Department and the IRS rejected a tracing approach 
because the complexity of such an approach could be more difficult for 
taxpayers and the IRS to administer and would create too great an 
incentive to structure financing with the sole purpose of avoiding the 
application of the statute. The assumption that a trade or business is 
indifferent to its source of funds may not be appropriate in cases in 
which certain indebtedness is secured by the assets of the trade or 
business and cash flow from those assets is expected to support the 
payments required on the indebtedness. These proposed regulations would 
provide for a limited tracing rule in those cases. See the discussion 
of qualified non-recourse indebtedness in proposed Sec.  1.163(j)-10(d) 
in part 10(D) of the Explanation of Provisions section.
    Second, the Treasury Department and the IRS also considered 
allocating interest expense based upon the relative fair market value 
of the assets used in excepted and non-excepted trades or businesses. 
However, determinations of fair market value frequently are burdensome 
for taxpayers, which may have numerous assets without a readily 
established market price, and for the IRS. For this reason, disputes 
between taxpayers and the IRS over the fair market value of an asset 
are a common and costly occurrence. In the TCJA, Congress repealed the 
use of fair market value in the apportionment of interest expense under 
section 864 of the Code (see section 14502(a) of the TCJA). Thus, the 
Treasury Department and the IRS have determined that allocating 
interest expense based upon the relative fair market value of assets is 
a less viable approach than a regime based upon relative amounts of 
asset basis.
    Third, the Treasury Department and the IRS also considered 
allocating interest expense to excepted and non-excepted trades or 
businesses based on the relative amounts of gross income generated by 
such trades or businesses. However, gross income is more variable and 
volatile than asset basis, in part because it is based on an annual 
measurement. Methods could be developed to look at multiple years of 
gross income through an averaging or other smoothing methodology, but 
any such approach would necessarily create a number of difficult 
technical questions because the income of different trades or 
businesses may be subject to differing business cycles and the timing 
of income items may be within taxpayers' control. In the TCJA, Congress 
also repealed the use of gross income in the apportionment of interest 
expense under section 864 of the Code (see section 14502(a) of the 
TCJA). The Treasury Department and the IRS request comment on the 
approaches and decisions discussed in this section.
3. Anticipated Impacts on Administrative and Compliance Costs
    The proposed regulations include requirements about how excess 
interest income, interest expense, and taxable income should be 
allocated to partners. This allocation method will require some 
partnerships to do a number of calculations to figure out the 
appropriate allocations.
    The proposed regulations as applied to CFCs involve additional tax 
calculations, such as aggregating CFC income, separating finance from 
non-finance businesses, and eliminating intra-group dividends, but 
these calculations are relatively simple and involve data that are 
already collected. Hence, the increase in compliance costs should not 
be substantial. Furthermore, because the alternative method is 
elective, the associated compliance costs would be avoided if the 
election is not made.
    As the compliance costs in both of these cases would be part of the 
cost of filing tax Form 8990, ``Limitation on Business Interest 
Expense,'' the estimate of the cost of these calculations will be 
included as part of the overall reporting burden of Form 8990, as is 
further discussed in the next section.

D. Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). An agency may not conduct or sponsor, and a person is 
not required to respond to, a collection of information unless it 
displays a valid control number assigned by the Office of Management 
and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are

[[Page 67531]]

confidential, as required by section 6103.
1. Collections of Information
    The collection of information in these proposed regulations is in 
Sec. Sec.  1.163(j)-9 and 1.163(j)-10. The collection of information in 
proposed Sec.  1.163(j)-9 is required for taxpayers to make a one-time 
election to treat their real property or farming trade or business as 
an electing real property trade or business or an electing farming 
trade or business under section 163(j)(7)(B) and (C). The collection of 
information in proposed Sec.  1.163(j)-10 is required for taxpayers to 
demonstrate how they allocated their interest expense, interest income, 
and other items of income and deduction between excepted and non-
excepted trades or businesses. It is necessary to report this 
information to the IRS to ensure that taxpayers properly report the 
amount of interest that is potentially subject to the limitation.
    The collection of information is necessary to ensure tax compliance 
but is not expected to be available as a finalized IRS form by the end 
of the calendar year. When available, draft revised versions of the 
affected IRS forms will be posted for comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.html. All of the information 
collections mentioned in Sec. Sec.  1.163(j)-9 and 1.163(j)-10 may 
eventually be reported on a form. The specific forms that are expected 
to change as a result of these proposed regulations are described in 
more detail in the next section.
2. Future Expected Modifications To Forms To Collect Information
    In order to collect necessary information, we are modifying four 
forms (Forms 1120, 1120S, 1065, and 1120-REIT) and creating one new 
form (Form 8990). We are modifying Forms 1120, 1120S, 1065, and 1120-
REIT to ask filers about the applicability of section 163(j) and the 
need to file the new Form 8990, as well as the related one-time 
election statement. When the changes to the IRS forms are finalized, 
every taxpayer who deducts business interest beginning in tax year 2018 
generally will be required to file a new tax Form 8990, ``Limitation on 
Business Interest Expense IRC 163(j),'' except for taxpayers with 
average annual gross receipts of $25 million or less for the three 
prior tax years (as determined under section 448(c) principles, and as 
adjusted for inflation starting in 2019). For purposes of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3507(d)), the reporting burden of tax 
form 8990 is associated with OMB control number 1545-0123. Tax form 
8990 is estimated to be required by fewer than 92,500 taxpayers in 
2018.
    The draft forms are available on the IRS website at:

------------------------------------------------------------------------
               Draft form                        IRS website link
------------------------------------------------------------------------
Form 1120...............................  https://www.irs.gov/pub/irs-dft/f1120-dft.pdf
                                          (Draft instructions: https://www.irs.gov/pub/irs-dft/i1120-dft.pdf)
Form 1120S..............................  https://www.irs.gov/pub/irs-dft/f1120s-dft.pdf
                                          (Draft instructions: https://www.irs.gov/pub/irs-dft/i1120s-dft.pdf)
Form 1065...............................  https://www.irs.gov/pub/irs-dft/f1065-dft.pdf
                                          (Draft instructions: https://www.irs.gov/pub/irs-dft/i1065-dft.pdf)
Form 1120-REIT..........................  https://www.irs.gov/pub/irs-dft/f1120rei-dft.pdf
                                          (Draft instructions: https://www.irs.gov/pub/irs-dft/i1120rei-dft.pdf)
Form 8990...............................  https://www.irs.gov/pub/irs-dft/f8990-dft.pdf
------------------------------------------------------------------------

    A draft of the Form 8990 instructions is not available at the time 
of the proposed rule-making. When available, a draft of the IRS Form 
8990 instructions will be posted for comment at https://www.irs.gov/pub/irs-dft/f8990-dft.pdf.
3. Burden Estimates
    The following estimates are based on the information that is 
available to the IRS. The most recently available 2015 Statistics of 
Income (SOI) tax data indicates that 80,702 firms would have 
contemplated a one-time election to opt out of the section 163(j) 
limitation as an electing real property trade or business or as an 
electing farming business were the statute then in effect. The Treasury 
Department and the IRS anticipate that these proposed regulations will 
apply to a similar proportion of taxpayers going forward. This estimate 
is based on a count of filers of Forms 1120, 1120S, 1065, and 1120-REIT 
in the real estate and farming industries that had over $25 million in 
gross receipts in taxable year 2015. Each of these forms for taxable 
years after 2017 will ask filers about the applicability of 163(j) and 
the need to file Form 8890 as well as the related one-time election. 
Similarly, using the 2015 SOI tax data, we estimate that 82,755 firms 
would have allocated interest income and expenses among multiple trades 
or businesses, some of which are excepted from the section 163(j) 
limitation and some that are not. This estimate is a count of all tax 
Forms 1120, 1120S, and 1065 in real estate, farming, and public 
utilities industries that had over $25 million in gross receipts. While 
the number of affected taxpayers will increase with growth in the 
economy, the Treasury Department and the IRS expect that the portion of 
affected taxpayers will remain approximately the same over the 
foreseeable future.
    The time and dollar compliance burden are derived from the Business 
Taxpayers Burden model provided by the IRS's Office of Research, 
Applied Analytics, and Statistics (RAAS). This model relates the time 
and out-of-pocket costs of business tax preparation, derived from 
survey data, to assets and receipts of affected taxpayers along with 
other relevant variables. See Tax Compliance Burden (John Guyton et al, 
July 2018) at https://www.irs.gov/pub/irs-soi/d13315.pdf. A respondent 
may require more or less time than the estimated burden, depending on 
the circumstances.
    The burden estimates listed in the below table attempt to capture 
only those discretionary changes made in these proposed regulations, 
and may not include burden estimates for forms associated with the 
statute. Changes made by the Act or through new information collections 
are captured separately in forthcoming published Supporting Statements 
for each of these forms and will be aggregated with the estimates 
provided below to summarize the total burden estimates for each 
information collection listed below. Those total burden estimates will 
be available for review and public comment at https://www.reginfo.gov/public/Forward?SearchTarget=PRA&textfield. The Treasury Department and 
the IRS request comment on these estimates.

[[Page 67532]]



--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                           Estimated
                                                                                                             total
                                                                                                             annual     Estimated
                                                             Estimated number of     Estimated average     reporting    monetized   Estimated  frequency
                                       Likely respondents     respondents (2015     annual burden hours      burden    burden @$95/     of  responses
                                                                   levels)             per respondent       (hours)    hour ($2017
                                                                                                             (2015       millions)
                                                                                                            levels)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sec.   1.163(j)-9 (one-time          Individuals,           80,702 business        0 to 30 minutes             20,176         $1.9  One-time.
 election statement).                 corporations, and      respondents            (estimated
                                      partnerships with      (including Forms       average:15 minutes).
                                      real property or       1120, 1120-REIT,
                                      farming trades or      1120-S, and 1065
                                      businesses with        filers).
                                      gross receipts
                                      exceeding the
                                      statutory threshold
                                      of $25 million.
Sec.   1.163(j)-10 (annual           Individuals,           82,755 business        15 minutes to 2 hours       82,755          7.9  Annually.
 allocation statement).               corporations, and      respondents           (estimated average: 1
                                      partnerships (1)       (including Forms       hour).
                                      with more than one     1120, 1120-S, and
                                      trade or business      1065 filers).
                                      (at least one of
                                      which is a real
                                      property or farming
                                      trade or business),
                                      and (2) public
                                      utilities, with
                                      gross receipts
                                      exceeding the
                                      statutory threshold
                                      of $25 million.
Sec.   1.163(j)-10.................  Same as above........  82,755...............  4 hours..............      331,020         31.4  One-time.
(one-time start-up cost to develop                                                 (start-up burden)....
 procedures for filing an annual
 allocation statement).
Three year monetized burden          .....................  .....................  .....................  ...........         19.0  Three year annual
 estimate.                                                                                                                           average.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The three-year annual average of the monetized burden for the 
information collection and resulting from discretionary requirements 
contained in this rulemaking is estimated to be 19.0 million ($2017) 
([($1.9 million+ $31.4 million) + ($7.9 million x 3)]/3). To ensure 
more accuracy and consistency across its information collections, the 
IRS is currently in the process of revising the methodology it uses to 
estimate burden and costs. Once this methodology is complete, the IRS 
will provide this information to reflect a more precise estimate of 
burdens and costs.
    The Treasury Department and the IRS request comment on the 
assumptions, methodology, and burden estimates related to this 
information collection. Comments on the collection of information 
should be sent to the Office of Management and Budget, Attn: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503, with copies to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, 
SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of 
information should be received by February 26, 2019.
    Comments are specifically requested concerning--
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the IRS, including whether the 
information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.

II. Regulatory Flexibility Act

    It is hereby certified that these proposed regulations, if adopted 
as final, will not have a significant economic impact on a substantial 
number of small entities. Although the Treasury Department and the IRS 
believe that the proposed regulations may impact small entities, the 
number of small entities impacted is low.
    Section 163(j) provides exceptions for which many small entities 
will qualify. First, under section 163(j)(3), the limitation does not 
apply to any taxpayer, other than a tax shelter under section 
448(a)(3), which meets the gross receipts test under section 448(c) for 
any taxable year. A taxpayer meets the gross receipts test under 
section 448(c) if the taxpayer has average annual gross receipts for 
the 3-taxable year period ending with the taxable year that precedes 
the current taxable year that do not exceed $25,000,000. Second, 
section 163(j) provides that certain trades or businesses are not 
subject to the limitation, including the trade or business of 
performing services as an employee, electing real property trades or 
businesses, electing farming businesses, and certain utilities as 
defined in section 163(j)(7)(A)(iv). Lastly, certain REITs, as 
described in proposed Sec.  1.163(j)-9(g), are eligible to make the 
election out of the limitation as a real property trades or businesses.
    Any economic impact on any small entities as a result of the 
requirements in this notice of proposed rulemaking are not expected to 
be significant. The small entities potentially subject to the provision 
in proposed Sec.  1.163(j)-9 are individuals, corporations, including S 
corporations, and partnerships that (1) have average annual gross 
receipts for the 3-taxable year period ending with the taxable year 
that precedes the current taxable year exceeding $25,000,000, and (2) 
want to make the election out of the limitation as an electing real 
property trade or business under section 163(j)(7)(B) or electing 
farming business under section 163(j)(7)(C). Proposed Sec.  1.163(j)-9 
requires such taxpayers to attach a one-time statement to their return 
providing the taxpayer's name, address, social security number (SSN) or 
employer identification number (EIN), a description of the taxpayer's 
electing trade or business, including the principal business activity 
code, a statement that the taxpayer acknowledges the election is 
irrevocable, and a statement that the taxpayer is making an election 
under section 163(j)(7)(B) or (C), as applicable.
    The small entities potentially subject to the requirements in 
proposed Sec.  1.163(j)-10 are individuals, corporations (including S 
corporations), and partnerships that (1) have average

[[Page 67533]]

annual gross receipts for the 3-taxable year period ending with the 
taxable year that precedes the current taxable year exceeding 
$25,000,000, and (2) have multiple trades or businesses, some of which 
are excepted from the limitation and some of which are not excepted 
from the limitation, for which the taxpayer must properly allocate 
business interest expense. Proposed Sec.  1.163(j)-10 requires such 
taxpayers to attach an annual statement to their return demonstrating 
the following: (1) The taxpayer's adjusted basis in the aggregated 
assets used in its excepted and non-excepted businesses, (2) the 
determination dates on which asset basis was measured during the 
taxable year, (3) the names and TINs of all entities for which basis 
information is being provided, (4) asset basis information for 
corporations or partnerships if the taxpayer looks through to the 
corporation's or partnership's basis in the corporation's or 
partnership's assets under proposed Sec.  1.163(j)-10(c)(5)(ii), and 
(5) a summary of the method or methods used to determine asset basis in 
property used in both excepted and non-excepted businesses.
    As discussed elsewhere in this preamble, the reporting burden for 
the one-time election statement is estimated at 0 to 30 minutes, 
depending on individual circumstances, with an estimated average of 15 
minutes for all affected entities, regardless of size. The reporting 
burden for the annual allocation statement is estimated at 15 minutes 
to 2 hours, depending on individual circumstances, with an estimated 
average of 1 hour. The estimated monetized burden for compliance is $95 
per hour.
    For these reasons, the Treasury Department and the IRS have 
determined that the collections of information in this notice of 
proposed rulemaking will not have a significant economic impact. 
Accordingly, a regulatory flexibility analysis under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) is not required. Notwithstanding 
this certification, the Treasury Department and the IRS invite comments 
from interested members of the public on both the number of entities 
affected and the economic impact on small entities.
    It is hereby certified that proposed Sec. Sec.  1.163(j)-4, 
1.163(j)-5, and 1.163(j)-6 will not have a significant economic impact 
on a substantial number of small entities. Although the Treasury 
Department and the IRS believe that the proposed regulations may affect 
small entities, the economic impact on small entities as a result of 
the notice of proposed rulemaking is not expected to be significant. In 
particular, only firms with more than $25 million in gross receipts are 
required to file a tax Form 8990. Accordingly, a regulatory flexibility 
analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is 
not required. Notwithstanding this certification, the Treasury 
Department and the IRS invite comments from interested members of the 
public on both the number of entities affected and the economic impact 
on small entities.
    Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking has been 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 comments that are submitted timely 
to the IRS in the preamble under the ADDRESSES section. The Treasury 
Department and the IRS request comments on all aspects of the proposed 
rules.
    All comments submitted will be made available at http://www.regulations.gov for public inspection and copying. A public hearing 
has been scheduled for February 27, 2019, beginning at 10 a.m. in the 
Auditorium of the Internal Revenue Building, 1111 Constitution Avenue 
NW, Washington, DC 20224. If there is not sufficient time to discuss 
all of the topics on February 27, 2019, the hearing will continue the 
following day at 10 a.m. in the same location. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, 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. For more information about having your name 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 the hearing. Persons who 
wish to present oral comments at the hearing must submit an outline of 
the topics to be discussed and the time to be devoted to each topic by 
February 26, 2019. Submit a signed paper or electronic copy of the 
outline as prescribed in this preamble under the ADDRESSES heading. 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 authors of these regulations are Susie Bird, Charles 
Gorham, Zachary King, Jaime Park, Kathy Reed, and Sophia Wang, Office 
of the Associate Chief Counsel (Income Tax and Accounting); Kevin M. 
Jacobs, Russell Jones, and John Lovelace, Office of the Associate Chief 
Counsel (Corporate); Meghan Howard, William Kostak, Anthony McQuillen, 
Adrienne Mikolashek, and James Quinn, Office of the Associate Chief 
Counsel (Passthroughs and Special Industries); Angela Holland, Steve 
Jensen, and Charles Rioux, Office of the Associate Chief Counsel 
(International); William E. Blanchard, Michael Chin, Steven Harrison, 
Andrea Hoffenson, and Diana Imholtz, Office of the Associate Chief 
Counsel (Financial Institutions and Products). Other personnel from the 
Treasury Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Withdrawal of Proposed Regulations

    Under the authority of 26 U.S.C. 7805, the notice of proposed 
rulemaking that was published in the Federal Register on Tuesday, June 
18, 1991, (56 FR 27907, as corrected by 56 FR 40285 (August 14, 1991)) 
is withdrawn.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by:
0
1. Adding entries in numerical order for Sec. Sec.  1.163(j)-1 through 
1.163(j)-11;
0
2. Revising the entry for Sec. Sec.  1.263A-8 through 1.263A-15;
0
3. Adding entries in numerical order for Sec. Sec.  1.382-1 and 1.383-
0;
0
4. Revising the entry for Sec.  1.383-1; and
0
5. Adding entries in numerical order for Sec. Sec.  1.860C-2 and 
1.1502-90.
    The additions and revisions read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
* * * * *
    Section 1.163(j)-1 also issued under 26 U.S.C. 163(j)(8)(B) and 
26 U.S.C. 1502.
    Section 1.163(j)-2 also issued under 26 U.S.C. 1502.
    Section 1.163(j)-3 also issued under 26 U.S.C. 1502.
    Section 1.163(j)-4 also issued under 26 U.S.C. 163(j)(8)(B) and 
26 U.S.C. 1502.
    Section 1.163(j)-5 also issued under 26 U.S.C. 1502.

[[Page 67534]]

    Section 1.163(j)-6 also issued under 26 U.S.C. 163(j)(8)(B) and 
26 U.S.C. 1502.
    Section 1.163(j)-7 also issued under 26 U.S.C. 163(j)(8)(B) and 
26 U.S.C. 1502.
    Section 1.163(j)-8 also issued under 26 U.S.C. 163(j)(8)(B).
    Section 1.163(j)-9 also issued under 26 U.S.C. 163(j)(7)(B) and 
(C) and 26 U.S.C. 1502.
    Section 1.163(j)-10 also issued under 26 U.S.C. 163(j)(8)(B) and 
26 U.S.C. 1502.
    Section 1.163(j)-11 also issued under 26 U.S.C. 1502.
* * * * *
    Sections 1.263A-8 through 1.263A-15 also issued under 26 U.S.C. 
263A(j).
* * * * *
    Section 1.382-1 also issued under 26 U.S.C. 382(m).
* * * * *
    Section 1.383-0 also issued under 26 U.S.C. 382(m) and 26 U.S.C. 
383.
    Section 1.383-1 also issued under 26 U.S.C. 382(m) and 26 U.S.C. 
383.
* * * * *
    Section 1.860C-2 also issued under 26 U.S.C. 860C(b)(1).
* * * * *
    Section 1.1502-90 also issued under 26 U.S.C. 382(m) and 26 
U.S.C. 1502.
* * * * *

0
Par. 2. Section 1.163(j)-0 is added to read as follows:


Sec.  1.163(j)-0  Table of contents.

    This section lists the table of contents for Sec. Sec.  
1.163(j)-1 through 1.163(j)-11.

Sec.  1.163(j)-1 Definitions.

    (a) In general.
    (b) Definitions.
    (1) Adjusted taxable income.
    (i) Additions.
    (ii) Subtractions.
    (iii) Depreciation, amortization, or depletion expenses 
capitalized to inventory under section 263A.
    (iv) Other adjustments.
    (v) Additional rules relating to adjusted taxable income in 
other sections.
    (2) Business interest expense.
    (i) In general.
    (ii) Special rules.
    (3) Business interest income.
    (i) In general.
    (ii) Special rules.
    (4) C corporation.
    (5) Cleared swap.
    (6) Consolidated group.
    (7) Consolidated return year.
    (8) Disallowed business interest expense.
    (9) Disallowed business interest expense carryforward.
    (10) Disallowed disqualified interest.
    (11) Electing farming business.
    (12) Electing real property trade or business.
    (13) Excepted regulated utility trade or business.
    (i) In general.
    (ii) Excepted and non-excepted utility trades or businesses.
    (14) Excess business interest expense.
    (15) Excess taxable income.
    (16) Floor plan financing indebtedness.
    (17) Floor plan financing interest expense.
    (18) Group.
    (19) Intercompany transaction.
    (20) Interest.
    (i) In general.
    (ii) Swaps with significant nonperiodic payments.
    (A) Non-cleared swaps.
    (B) [Reserved]
    (iii) Other amounts treated as interest.
    (A) Treatment of premium.
    (1) Issuer.
    (2) Holder.
    (B) Treatment of ordinary income or loss on certain debt 
instruments.
    (C) Substitute interest payments.
    (D) Section 1258 gain.
    (E) Amounts affecting a taxpayer's effective cost of borrowing.
    (F) Yield adjustments.
    (G) Certain amounts labeled as fees.
    (1) Commitment fees.
    (2) [Reserved]
    (H) Debt issuance costs.
    (I) Guaranteed payments.
    (J) Factoring income.
    (iv) Anti-avoidance rule for amounts predominantly associated 
with the time value of money.
    (v) Examples.
    (21) Interest expense.
    (22) Interest income.
    (23) Inventory.
    (24) Member.
    (25) Motor vehicle.
    (26) Old section 163(j).
    (27) Real estate investment trust.
    (28) Real property.
    (29) Regulated investment company.
    (30) S corporation.
    (31) Section 163(j) limitation.
    (32) Section 163(j) regulations.
    (33) Separate return limitation year.
    (34) Separate return year.
    (35) Separate taxable income.
    (36) Tax-exempt corporation.
    (37) Taxable income.
    (i) In general.
    (ii) General rules to coordinate the application of sections 
163(j) and 250.
    (iii) [Reserved]
    (iv) Special rules for defining taxable income.
    (38) Trade or business.
    (i) In general.
    (ii) Excepted trade or business.
    (iii) Non-excepted trade or business.
    (39) Unadjusted basis.
    (c) Applicability date.

Sec.  1.163(j)-2 Deduction for business interest expense limited.

    (a) Overview.
    (b) General rule.
    (c) Disallowed business interest expense carryforward.
    (1) In general.
    (2) Coordination with small business exemption.
    (3) Cross-references.
    (d) Small business exemption.
    (1) Exemption.
    (2) Application of the gross receipts test.
    (i) In general.
    (ii) Gross receipts of individuals.
    (iii) Partners and S corporation shareholders.
    (iv) Tax-exempt organizations.
    (e) REMICs.
    (f) Calculation of ATI with respect to certain beneficiaries.
    (g) Examples.
    (h) Anti-avoidance rule.
    (i) Applicability date.

Sec.  1.163(j)-3 Relationship of business interest deduction 
limitation to other provisions affecting interest.

    (a) Overview.
    (b) Coordination of section 163(j) with certain other 
provisions.
    (1) In general.
    (2) Disallowed interest provisions.
    (3) Deferred interest provisions.
    (4) At risk rules, passive activity loss provisions, and 
limitation on excess business losses of noncorporate taxpayers.
    (5) Capitalized interest expenses under sections 263A and 
263(g).
    (6) Reductions under section 246A.
    (7) Section 381.
    (8) Section 382.
    (9) Other types of interest provisions.
    (10) [Reserved]
    (c) Examples.
    (d) Applicability date.

Sec.  1.163(j)-4 General rules applicable to C corporations 
(including REITs, RICs, and members of consolidated groups) and tax-
exempt corporations.

    (a) Scope.
    (b) Characterization of items of income, gain, deduction, or 
loss.
    (1) Interest expense and interest income.
    (2) Adjusted taxable income.
    (3) Investment interest, investment income, and investment 
expenses of a partnership with a C corporation partner.
    (i) Characterization as expense or income properly allocable to 
a trade or business.
    (ii) Impact of characterization on partnership.
    (iii) Investment interest expense and investment interest income 
of a partnership not treated as excess business interest expense or 
excess taxable income of a C corporation partner.
    (4) Application to RICs and REITs.
    (i) In general.
    (ii) Taxable income for purposes of calculating the adjusted 
taxable income of RICs and REITs.
    (iii) Other adjustments to adjusted taxable income for RICs and 
REITs.
    (5) Application to tax-exempt corporations.
    (6) Examples.
    (c) Effect on earnings and profits.
    (1) In general.
    (2) Special rule for RICs and REITs.
    (3) Special rule for partners that are C corporations.
    (4) Examples.
    (d) Special rules for consolidated groups.
    (1) Scope.
    (2) Calculation of the section 163(j) limitation for members of 
a consolidated group.
    (i) In general.
    (ii) Interest.
    (iii) Calculation of business interest expense and business 
interest income for a consolidated group.
    (iv) Calculation of adjusted taxable income.

[[Page 67535]]

    (v) Treatment of intercompany obligations.
    (3) Investment adjustments.
    (4) Ownership of partnership interests by members of a 
consolidated group.
    (i) Dispositions of partnership interests.
    (ii) Basis adjustments under Sec.  1.1502-32.
    (iii) [Reserved]
    (5) Examples.
    (e) Cross-references.
    (f) Applicability date.

Sec.  1.163(j)-5 General rules governing disallowed business 
interest expense carryforwards for C corporations.

    (a) Scope and definitions.
    (1) Scope.
    (2) Definitions.
    (i) Current-year business interest expense.
    (ii) Allocable share of the consolidated group's remaining 
section 163(j) limitation.
    (iii) Consolidated group's remaining section 163(j) limitation.
    (iv) Remaining current-year interest ratio.
    (b) Treatment of disallowed business interest expense 
carryforwards.
    (1) In general.
    (2) Deduction of business interest expense.
    (3) Consolidated groups.
    (i) In general.
    (ii) Deduction of business interest expense.
    (A) General rule.
    (B) Section 163(j) limitation is equal to or exceeds the 
current-year business interest expense and disallowed business 
interest expense carryforwards from prior taxable years.
    (C) Current-year business interest expense and disallowed 
business interest expense carryforwards exceed section 163(j) 
limitation.
    (iii) Departure from group.
    (iv) Example.
    (c) Disallowed business interest expense carryforwards in 
transactions to which section 381(a) applies.
    (d) Limitations on disallowed business interest expense 
carryforwards from separate return limitation years.
    (1) General rule.
    (2) Deduction of disallowed business interest expense 
carryforwards arising in a SRLY.
    (3) Examples.
    (e) Application of section 382.
    (1) Pre-change loss.
    (2) Loss corporation.
    (3) Ordering rules for utilization of pre-change losses and for 
absorption of the section 382 limitation.
    (4) Disallowed business interest expense from the pre-change 
period in the year of a testing date.
    (f) Overlap of SRLY limitation with section 382.
    (g) Additional limitations.
    (h) Applicability date.

Sec.  1.163(j)-6 Application of the business interest deduction 
limitation to partnerships and subchapter S corporations.

    (a) Overview.
    (b) Definitions.
    (1) Section 163(j) items.
    (2) Partner basis items.
    (3) Remedial items.
    (4) Excess business interest income.
    (5) Deductible business interest expense.
    (6) Section 163(j) excess items.
    (7) Non-excepted assets.
    (8) Excepted assets.
    (c) Character of business interest expense.
    (d) Adjusted taxable income of the partnership.
    (1) Modification of adjusted taxable income for partnerships.
    (2) Section 734(b), partner basis items, and remedial items.
    (e) Adjusted taxable income and business interest income of 
partners.
    (1) Modification of adjusted taxable income for partners.
    (2) Partner basis items and remedial items.
    (3) Disposition of partnership interests.
    (4) Double counting of business interest income and floor plan 
financing interest expense prohibited.
    (f) Allocation and determination of section 163(j) excess items 
made in the same manner as nonseparately stated taxable income or 
loss of the partnership.
    (1) Overview.
    (i) In general.
    (ii) Relevance solely for purposes of section 163(j).
    (2) Steps for allocating deductible business interest expense 
and section 163(j) excess items.
    (i) Partnership-level calculation required by section 
163(j)(4)(A).
    (ii) Determination of each partner's relevant section 163(j) 
items.
    (iii) Partner-level comparison of business interest income and 
business interest expense.
    (iv) Matching partnership and aggregate partner excess business 
interest income.
    (v) Remaining business interest expense determination.
    (vi) Determination of final allocable ATI.
    (A) Positive allocable ATI.
    (B) Negative allocable ATI.
    (C) Final allocable ATI.
    (vii) Partner-level comparison of thirty percent of adjusted 
taxable income and remaining business interest expense.
    (viii) Partner priority right to ATI capacity excess 
determination.
    (ix) Matching partnership and aggregate partner excess taxable 
income.
    (x) Matching partnership and aggregate partner excess business 
interest expense.
    (xi) Final section 163(j) excess item and deductible business 
interest expense allocation.
    (g) Carryforwards.
    (1) In general.
    (2) Treatment of excess of business interest expense allocated 
to partners.
    (3) Excess taxable income and excess business interest income 
ordering rule.
    (h) Basis adjustments.
    (1) Section 704(d) ordering.
    (2) Excess business interest expense basis adjustments.
    (3) Basis adjustments upon disposition of partnership interest.
    (i) Complete disposition of partnership interest.
    (ii) Partial disposition of partnership interest.
    (i) [Reserved]
    (j) Investment items.
    (k) [Reserved]
    (l) S corporations.
    (1) In general.
    (2) Character of deductible business interest expense.
    (3) Adjusted taxable income of an S corporation.
    (4) Adjusted taxable income and business interest income of S 
corporation shareholders.
    (i) Adjusted taxable income of S corporation shareholders.
    (ii) Disposition of S corporation stock.
    (iii) Double counting of business interest income and floor plan 
financing interest expense prohibited.
    (5) Carryforwards.
    (6) Basis adjustments and disallowed business interest expense 
carryforwards.
    (7) Accumulated adjustment accounts.
    (8) Termination of qualified subchapter S subsidiary election.
    (9) Investment items.
    (m) Partnerships and S corporations not subject to section 
163(j).
    (1) Partnerships and S corporations not subject to section 
163(j) by reason of the small business exemption.
    (2) Partnerships and S corporations not subject to section 
163(j) by reason of an excepted trade or business.
    (3) Partnerships that allocated excess business interest expense 
prior to becoming not subject to section 163(j).
    (4) S corporations with disallowed business interest expense 
carryforwards prior to becoming not subject to section 163(j).
    (n) [Reserved]
    (o) Examples.
    (p) Applicability date.

Sec.  1.163(j)-7 Application of the business interest deduction 
limitation to foreign corporations and United States shareholders.

    (a) Overview.
    (b) Application of section 163(j) to an applicable CFC and 
certain partnerships.
    (1) Scope.
    (2) General application of section 163(j) to an applicable CFC 
and a partnership with at least one partner that is an applicable 
CFC.
    (3) Alternative approach for computing the deduction for 
business interest expense.
    (4) Treatment of certain partnerships as a CFC group member.
    (i) General rule.
    (ii) Exception for certain partnerships engaged in a United 
States trade or business.
    (5) CFC group election.
    (i) Manner of making a CFC group election.
    (ii) Consistency requirement.
    (iii) Duration of a CFC group election.
    (c) Rules concerning the computation of adjusted taxable income 
of an applicable CFC and certain CFC group members.
    (1) Computation of taxable income.
    (2) Treatment of certain dividends.
    (3) Treatment of CFC excess taxable income.
    (i) In general.
    (ii) Ordering rules.
    (d) Rules concerning the computation of adjusted taxable income 
of a United States shareholder.
    (1) In general.

[[Page 67536]]

    (i) Treatment of gross income inclusions that are properly 
allocable to a non-excepted trade or business.
    (ii) Treatment of deemed inclusions of a domestic partnership 
that are not allocable to any trade or business.
    (2) Additional rule after application of paragraph (d)(1) of 
this section for a United States shareholder of a CFC group member 
with a CFC group election in effect.
    (i) In general.
    (ii) Eligible CFC group ETI.
    (iii) CFC group inclusions.
    (3) Special rules if a domestic partnership is a United States 
shareholder of a CFC group member with a CFC group election in 
effect.
    (4) Inclusions under section 951A(a).
    (e) Effect on earnings and profits.
    (f) Definitions.
    (1) Allocable share.
    (i) General rule.
    (ii) Special rule if there is a financial services subgroup.
    (2) Applicable CFC.
    (3) Applicable net business interest expense.
    (4) Applicable subgroup net business interest expense.
    (5) CFC excess taxable income.
    (i) In general.
    (ii) CFC group member is a partnership.
    (6) CFC group.
    (i) In general.
    (ii) Aggregation rules.
    (7) CFC group election.
    (8) CFC group member.
    (9) Financial services subgroup.
    (10) Financial services subgroup member.
    (11) Majority U.S. shareholder taxable year.
    (12) Net business interest expense.
    (13) Passthrough entity.
    (14) Specified ETI ratio.
    (i) In general.
    (ii) Includable CFC group members.
    (iii) Numerator.
    (iv) Denominator.
    (15) Specified highest-tier member.
    (16) Specified lower-tier member.
    (17) Specified taxable year.
    (18) United States shareholder.
    (g) Examples.
    (h) Applicability date.

Sec.  1.163(j)-8 Application of the business interest deduction 
limitation to foreign persons with effectively connected income.

    (a) Overview.
    (b) Application of section 163(j) and the section 163(j) 
regulations to specified foreign persons with effectively connected 
taxable income.
    (1) In general.
    (2) Modification of adjusted taxable income.
    (3) Modification of business interest expense.
    (i) General rule.
    (ii) Exclusion of certain business interest expense of a 
specified foreign partner.
    (4) Modification of business interest income.
    (5) Modification of floor plan financing interest expense.
    (6) Modification of allocation of interest expense and interest 
income that is properly allocable to trade or business.
    (c) Partner-level modifications to Sec.  1.163(j)-6 for 
partnerships engaged in a U.S. trade or business.
    (1) Modification related to a partnership's excess taxable 
income.
    (2) Modification related to a partnership's excess business 
interest expense.
    (3) Modification related to a partnership's excess business 
interest income.
    (d) An applicable CFC with effectively connected taxable income.
    (e) Coordination of section 163(j) and Sec.  1.882-5.
    (1) General rules.
    (i) Ordering rule.
    (ii) Treatment of disallowed business interest expense 
carryforward.
    (iii) Treatment of allocable excess business interest expense.
    (iv) Scaling ratio.
    (2) Amount of interest determined under Sec.  1.882-5 that is 
disallowed business interest expense.
    (i) Foreign corporation is not a specified foreign partner.
    (ii) Foreign corporation is a specified foreign partner.
    (f) Coordination with branch profits tax.
    (1) Effect on effectively connected earnings and profits.
    (2) Effect on U.S. net equity.
    (g) Definitions.
    (1) Applicable CFC.
    (2) ECI excess business interest income.
    (3) Effectively connected taxable income.
    (4) Specified excess business interest expense.
    (5) Specified excess taxable income.
    (6) Specified foreign partner.
    (7) Specified foreign person.
    (8) Specified ratio.
    (h) Examples.
    (i) Applicability date.

Sec.  1.163(j)-9 Elections for excepted trades or businesses; safe 
harbor for certain REITs.

    (a) Overview.
    (b) Scope and effect of election.
    (1) In general.
    (2) Irrevocability.
    (c) Time and manner of making election.
    (1) In general.
    (2) Election statement contents.
    (3) Consolidated group's trade or business.
    (4) Partnership's trade or business.
    (d) Termination of election.
    (1) In general.
    (2) Taxable asset transfer defined.
    (3) Related party defined.
    (4) Anti-abuse rule.
    (e) Additional guidance.
    (f) Examples.
    (g) Safe harbor for REITs.
    (1) In general.
    (2) REITs that do not significantly invest in real property 
financing assets.
    (3) REITs that significantly invest in real property financing 
assets.
    (4) REIT real property assets, interests in partnerships, and 
shares in other REITs.
    (i) Real property assets.
    (ii) Partnership interests.
    (iii) Shares in other REITs.
    (5) Value of shares in other REITs.
    (6) Real property financing assets.
    (h) Special anti-abuse rule for certain real property trades or 
businesses.
    (1) In general.
    (2) Exception for certain REITs.
    (i) Applicability date.

Sec.  1.163(j)-10 Allocation of interest expense, interest income, 
and other items of expense and gross income to an excepted trade or 
business.

    (a) Overview.
    (1) In general.
    (i) Purposes.
    (ii) Application of section.
    (2) Coordination with other rules.
    (i) In general.
    (ii) Treatment of investment interest, investment income, and 
investment expenses of a partnership with a C corporation or tax-
exempt corporation as a partner.
    (3) Application of allocation rules to foreign corporations and 
foreign partnerships.
    (4) Application of allocation rules to members of a consolidated 
group.
    (i) In general.
    (ii) Application of excepted business percentage to members of a 
consolidated group.
    (iii) Basis in assets transferred in an intercompany 
transaction.
    (5) Tax-exempt organizations.
    (6) [Reserved]
    (7) Examples.
    (b) Allocation of tax items other than interest expense and 
interest income.
    (1) In general.
    (2) Gross income other than dividends and interest income.
    (3) Dividends.
    (i) Look-through rule.
    (ii) Inapplicability of the look-through rule.
    (4) Gain or loss from the disposition of non-consolidated C 
corporation stock, partnership interests, or S corporation stock.
    (i) Non-consolidated C corporations.
    (ii) Partnerships and S corporations.
    (5) Expenses, losses, and other deductions.
    (i) Expenses, losses, and other deductions that are definitely 
related to a trade or business.
    (ii) Other deductions.
    (6) Treatment of certain investment items of a partnership with 
a C corporation partner.
    (7) Example--Allocation of income and expense.
    (c) Allocating interest expense and interest income that is 
properly allocable to a trade or business.
    (1) General rule.
    (i) In general.
    (ii) De minimis exception.
    (2) Example.
    (3) Asset used in more than one trade or business.
    (i) General rule.
    (ii) Permissible methodologies for allocating asset basis 
between or among two or more trades or businesses.
    (iii) Special rules.
    (A) Consistent allocation methodologies.
    (1) In general.
    (2) Consent to change allocation methodology.
    (B) De minimis exceptions.
    (1) De minimis amount of gross income from trades or businesses.
    (2) De minimis amount of asset basis allocable to a trade or 
business.

[[Page 67537]]

    (C) Allocations of excepted regulated utility trades or 
businesses.
    (1) In general.
    (2) Permissible method for allocating asset basis for utility 
trades or businesses.
    (3) De minimis rule for excepted utility trades or businesses.
    (4) Example.
    (4) Disallowed business interest expense carryforwards; floor 
plan financing interest expense.
    (5) Additional rules relating to basis.
    (i) Calculation of adjusted basis.
    (A) Non-depreciable property other than land.
    (B) Depreciable property other than inherently permanent 
structures.
    (C) Special rule for land and inherently permanent structures.
    (D) Depreciable or amortizable intangible property and 
depreciable income forecast method property.
    (E) Assets not yet used in a trade or business.
    (F) Trusts established to fund specific liabilities.
    (G) Inherently permanent structure.
    (ii) Partnership interests; stock in non-consolidated domestic 
corporations.
    (A) Partnership interests.
    (1) Calculation of asset basis.
    (2) Allocation of asset basis.
    (i) In general.
    (ii) De minimis rule.
    (iii) Partnership assets not properly allocable to a trade or 
business.
    (iv) Inapplicability of partnership look-through rule.
    (B) Stock in non-consolidated domestic corporations.
    (1) In general.
    (2) Domestic non-consolidated C corporations.
    (i) Allocation of asset basis.
    (ii) De minimis rule.
    (iii) Inapplicability of corporate look-through rule.
    (3) S corporations.
    (i) Calculation of asset basis.
    (ii) Allocation of asset basis.
    (iii) De minimis rule.
    (iv) Inapplicability of S corporation look-through rule.
    (C) Stock in CFCs.
    (D) Inapplicability of look-through rule to partnerships or non-
consolidated corporations to which the small business exemption 
applies.
    (E) Tiered entities.
    (iii) Cash and cash equivalents and customer receivables.
    (iv) Deemed asset sale.
    (v) Other adjustments.
    (6) Determination dates; determination periods; reporting 
requirements.
    (i) Definitions.
    (ii) Application of look-through rules.
    (iii) Reporting requirements.
    (A) Books and records.
    (B) Information statement.
    (iv) Failure to file statement.
    (7) Ownership threshold for look-through rules.
    (i) Corporations.
    (A) Asset basis.
    (B) Dividends.
    (ii) Partnerships.
    (iii) Inapplicability of look-through rule.
    (8) Anti-abuse rule.
    (d) Direct allocations.
    (1) In general.
    (2) Financial services entities.
    (3) Assets used in more than one trade or business.
    (4) Adjustments to basis of assets to account for direct 
allocations.
    (5) Example.
    (e) Examples.
    (f) Applicability date.

Sec.  1.163(j)-11 Transition rules.

    (a) Application of section 163(j) limitation if a corporation 
joins a consolidated group with a taxable year beginning before 
January 1, 2018.
    (1) In general.
    (2) Example.
    (b) Treatment of disallowed disqualified interest.
    (1) In general.
    (2) Earnings and profits.
    (3) Disallowed disqualified interest of members of an affiliated 
group.
    (i) Scope.
    (ii) Allocation of disallowed disqualified interest to members 
of the affiliated group.
    (A) In general.
    (B) Definitions.
    (1) Allocable share of the affiliated group's disallowed 
disqualified interest.
    (2) Disallowed disqualified interest ratio.
    (3) Exempt related person interest expense.
    (iii) Treatment of carryforwards.
    (4) Application of section 382.
    (i) Ownership change occurring before the date the Treasury 
decision adopting these regulations as final regulations is 
published in the Federal Register.
    (A) Pre-change loss.
    (B) Loss corporation.
    (ii) Ownership change occurring on or after the date the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register.
    (A) Pre-change loss.
    (B) Loss corporation.
    (iii) Definitions.
    (5) [Reserved]
    (6) Treatment of excess limitation from taxable years beginning 
before January 1, 2018.
    (7) Example.
    (c) Applicability date.

0
Par. 3. Sections 1.163(j)-1 through 1.163(j)-11 are added to read as 
follows:

Sec.
* * * * *
1.163(j)-1 Definitions.
1.163(j)-2 Deduction for business interest expense limited.
1.163(j)-3 Relationship of business interest deduction limitation to 
other provisions affecting interest.
1.163(j)-4 General rules applicable to C corporations (including 
REITs, RICs, and members of consolidated groups) and tax-exempt 
corporations.
1.163(j)-5 General rules governing disallowed business interest 
expense carryforwards for C corporations.
1.163(j)-6 Application of the business interest deduction limitation 
to partnerships and subchapter S corporations.
1.163(j)-7 Application of the business interest deduction limitation 
to foreign corporations and United States shareholders.
1.163(j)-8 Application of the business interest deduction limitation 
to foreign persons with effectively connected income.
1.163(j)-9 Elections for excepted trades or businesses; safe harbor 
for certain REITs.
1.163(j)-10 Allocation of interest expense, interest income, and 
other items of expense and gross income to an excepted trade or 
business.
1.163(j)-11 Transition rules.
* * * * *


Sec.  1.163(j)-1  Definitions.

    (a) In general. This section defines terms used in the section 
163(j) regulations. For purposes of the rules sets forth in Sec. Sec.  
1.163(j)-2 through 1.163(j)-11, additional definitions for certain 
terms are provided in those sections.
    (b) Definitions--(1) Adjusted taxable income. The term adjusted 
taxable income (ATI) means the taxable income of the taxpayer for the 
taxable year, with the adjustments in this paragraph (b).
    (i) Additions. The amounts of the following items (if any) are 
added to taxable income to determine ATI--
    (A) Any business interest expense;
    (B) Any net operating loss deduction under section 172;
    (C) Any deduction under section 199A;
    (D) For taxable years beginning before January 1, 2022, any 
deduction for depreciation under section 167, section 168, or section 
168 of the Internal Revenue Code of 1954 (former section 168);
    (E) For taxable years beginning before January 1, 2022, any 
deduction for the amortization of intangibles (for example, under 
section 167 or 197) and other amortized expenditures (for example, 
under section 195(b)(1)(B), 248, or 1245(a)(2)(C));
    (F) For taxable years beginning before January 1, 2022, any 
deduction for depletion under section 611;
    (G) Any deduction for a capital loss carryback or carryover; and
    (H) Any deduction or loss that is not properly allocable to a non-
excepted trade or business (for rules governing the allocation of items 
to an excepted trade or business, see Sec. Sec.  1.163(j)-1(b)(38) and 
1.163(j)-10).
    (ii) Subtractions. The amounts of the following items (if any) are 
subtracted from taxable income to determine ATI--
    (A) Any business interest income;
    (B) Any floor plan financing interest expense for the taxable year;

[[Page 67538]]

    (C) With respect to the sale or other disposition of property, the 
lesser of:
    (1) Any gain recognized on the sale or other disposition of such 
property; and
    (2) Any depreciation, amortization, or depletion deductions for the 
taxable years beginning after December 31, 2017, and before January 1, 
2022, with respect to such property;
    (D) With respect to the sale or other disposition of stock of a 
member of a consolidated group that includes the selling member, the 
investment adjustments, as defined under Sec.  1.1502-32, with respect 
to such stock that are attributable to deductions described in 
paragraph (b)(1)(ii)(C) of this section;
    (E) With respect to the sale or other disposition of an interest in 
a partnership, the taxpayer's distributive share of deductions 
described in paragraph (b)(1)(ii)(C) of this section with respect to 
property held by the partnership at the time of such sale or other 
disposition to the extent such deductions were allowable under section 
704(d); and
    (F) Any income or gain that is not properly allocable to a non-
excepted trade or business (for rules governing the allocation of items 
to an excepted trade or business, see Sec. Sec.  1.163(j)-1(b)(38) and 
1.163(j)-10)).
    (iii) Depreciation, amortization, or depletion expenses capitalized 
to inventory under section 263A. Depreciation, amortization, or 
depletion expense that is capitalized to inventory under section 263A 
is not a depreciation, amortization, or depletion deduction for 
purposes of this paragraph (b)(1).
    (iv) Other adjustments. ATI is computed with the other adjustments 
provided in Sec. Sec.  1.163(j)-2 through 1.163(j)-11.
    (v) Additional rules relating to adjusted taxable income in other 
sections. (A) For rules governing the ATI of C corporations, see 
Sec. Sec.  1.163(j)-4(b)(2) and (3) and 1.163(j)-10(a)(2)(ii).
    (B) For rules governing the ATI of RICs and REITs, see Sec.  
1.163(j)-4(b)(4).
    (C) For rules governing the ATI of tax-exempt corporations, see 
Sec.  1.163(j)-4(b)(5).
    (D) For rules governing the ATI of consolidated groups, see Sec.  
1.163(j)-4(d)(2)(iv) and (v).
    (E) For rules governing the ATI of partnerships, see Sec.  
1.163(j)-6(d).
    (F) For rules governing the ATI of partners, see Sec.  1.163(j)-
6(e).
    (G) For rules governing partnership basis adjustments impacting 
ATI, see Sec.  1.163(j)-6(h)(2).
    (H) For rules governing the ATI of S corporations, see Sec.  
1.163(j)-6(l)(3).
    (I) For rules governing the ATI of S corporation shareholders, see 
Sec.  1.163(j)-6(l)(4).
    (J) For rules governing the ATI of applicable CFCs and certain CFC 
group members, as defined in Sec.  1.163(j)-7(f), see Sec.  1.163(j)-
7(c).
    (K) For rules governing the ATI of United States shareholders of 
applicable CFCs, including the treatment of inclusions under sections 
78, 951(a), and 951A(a), see Sec.  1.163(j)-7(d).
    (L) For rules governing the ATI of specified foreign persons, as 
defined in Sec.  1.163(j)-8(g)(7), with effectively connected income, 
see Sec.  1.163(j)-8(b)(2).
    (M) For rules governing the ATI of specified foreign partners, as 
defined in Sec.  1.163(j)-8(g)(6), other than applicable CFCs, as 
defined in Sec.  1.163(j)-8(g)(1), see Sec.  1.163(j)-8(c)(1).
    (N) For rules governing the ATI of certain beneficiaries of trusts 
and estates, see Sec.  1.163(j)-2(f).
    (2) Business interest expense--(i) In general. The term business 
interest expense means interest expense that is properly allocable to a 
non-excepted trade or business or that is floor plan financing interest 
expense. Business interest expense also includes disallowed business 
interest expense carryforwards (as defined in paragraph (b)(9) of this 
section). For the treatment of investment interest, see section 163(d); 
and for the treatment of personal interest, see section 163(h).
    (ii) Special rules. For special rules for defining business 
interest expense in certain circumstances, see Sec. Sec.  1.163(j)-
3(b)(2) (regarding disallowed interest expense), 1.163(j)-4(b) 
(regarding C corporations) and (d)(2)(iii) (regarding consolidated 
groups), and 1.163(j)-8(b)(3) (regarding foreign persons engaged in a 
U.S. trade or business).
    (3) Business interest income--(i) In general. The term business 
interest income means interest income which is properly allocable to a 
non-excepted trade or business. For the treatment of investment income, 
see section 163(d).
    (ii) Special rules. For special rules defining business interest 
income in certain circumstances, see Sec. Sec.  1.163(j)-4(b) 
(regarding C corporations) and (d)(2)(iii) (regarding consolidated 
groups) and 1.163(j)-8(b)(4) (regarding foreign persons engaged in a 
U.S. trade or business).
    (4) C corporation. The term C corporation has the meaning provided 
in section 1361(a)(2).
    (5) Cleared swap. The term cleared swap means a swap that is 
cleared by a derivatives clearing organization, as such term is defined 
in section 1a of the Commodity Exchange Act (7 U.S.C. 1a), or by a 
clearing agency, as such term is defined in section 3 of the Securities 
Exchange Act of 1934 (15 U.S.C. 78c), that is registered as a 
derivatives clearing organization under the Commodity Exchange Act or 
as a clearing agency under the Securities Exchange Act of 1934, 
respectively, if the derivatives clearing organization or clearing 
agency requires the parties to the swap to post and collect margin or 
collateral.
    (6) Consolidated group. The term consolidated group has the meaning 
provided in Sec.  1.1502-1(h).
    (7) Consolidated return year. The term consolidated return year has 
the meaning provided in Sec.  1.1502-1(d).
    (8) Disallowed business interest expense. The term disallowed 
business interest expense means the amount of business interest expense 
for a taxable year in excess of the amount allowed as a deduction for 
the taxable year under section 163(j)(1) and Sec.  1.163(j)-2(b).
    (9) Disallowed business interest expense carryforward. The term 
disallowed business interest expense carryforward means any business 
interest expense described in Sec.  1.163(j)-2(c).
    (10) Disallowed disqualified interest. The term disallowed 
disqualified interest means interest expense, including carryforwards, 
for which a deduction was disallowed under old section 163(j) (as 
defined in paragraph (b)(26) of this section) in the taxpayer's last 
taxable year beginning before January 1, 2018, and that was carried 
forward pursuant to old section 163(j).
    (11) Electing farming business. The term electing farming business 
means a trade or business that makes an election as provided in Sec.  
1.163(j)-9 or other published guidance and that is--
    (i) A farming business, as defined in section 263A(e)(4) or Sec.  
1.263A-4(a)(4); or
    (ii) Any trade or business of a specified agricultural or 
horticultural cooperative, as defined in section 199A(g)(4).
    (12) Electing real property trade or business. The term electing 
real property trade or business means a trade or business that makes an 
election as provided in Sec.  1.163(j)-9 or other published guidance 
and that is described in--
    (i) Section 469(c)(7)(C) and Sec.  1.469-9(b)(2); or
    (ii) Section 1.163(j)-9(g).
    (13) Excepted regulated utility trade or business--(i) In general. 
The term excepted regulated utility trade or business means a trade or 
business--
    (A) That furnishes or sells:
    (1) Electrical energy, water, or sewage disposal services;

[[Page 67539]]

    (2) Gas or steam through a local distribution system; or
    (3) Transportation of gas or steam by pipeline; and
    (B) To the extent that the rates for the furnishing or sale of the 
items in paragraph (b)(13)(i)(A) of this section--
    (1) Have been established or approved by a State or political 
subdivision thereof, by any agency or instrumentality of the United 
States, or by a public service or public utility commission or other 
similar body of any State or political subdivision thereof and are 
determined on a cost of service and rate of return basis; or
    (2) Have been established or approved by the governing or 
ratemaking body of an electric cooperative.
    (ii) Excepted and non-excepted utility trades or businesses. If a 
taxpayer is engaged in both an excepted trade or business and a non-
excepted trade or business described in this paragraph (b)(13), the 
taxpayer must allocate items between the trades or businesses. See 
Sec. Sec.  1.163(j)-1(b)(38) and 1.163(j)-10(c)(3)(iii)(C). Some trades 
or businesses with de minimis furnishing or sales of items described in 
paragraph (b)(13)(i)(A) of this section that are not sold pursuant to 
rates determined on a cost of service and rate of return basis as 
required in paragraph (b)(13)(i)(B)(1) of this section, or by the 
governing or ratemaking body of an electric cooperative as required in 
paragraph (b)(13)(i)(B)(2) of this section are treated as excepted 
trades or businesses. See Sec.  1.163(j)-10(c)(3)(iii)(C)(3).
    (14) Excess business interest expense. The term excess business 
interest expense means, with respect to a partnership, the amount of 
disallowed business interest expense of the partnership for a taxable 
year under section Sec.  1.163(j)-2(b), except as provided in Sec.  
1.163(j)-6(h)(2).
    (15) Excess taxable income. With respect to any partnership or S 
corporation, the term excess taxable income means the amount which 
bears the same ratio to the partnership's ATI as--
    (i) The excess (if any) of--
    (A) The amount determined for the partnership or S corporation 
under section 163(j)(1)(B); over
    (B) The amount (if any) by which the business interest expense of 
the partnership, reduced by the floor plan financing interest expense, 
exceeds the business interest income of the partnership or S 
corporation; bears to
    (ii) The amount determined for the partnership or S corporation 
under section 163(j)(1)(B).
    (16) Floor plan financing indebtedness. The term floor plan 
financing indebtedness means indebtedness--
    (i) Used to finance the acquisition of motor vehicles held for sale 
or lease; and
    (ii) Secured by the inventory so acquired.
    (17) Floor plan financing interest expense. The term floor plan 
financing interest expense means interest paid or accrued on floor plan 
financing indebtedness. For purposes of the section 163(j) regulations, 
all floor plan financing interest expense is treated as business 
interest expense. See paragraph (b)(2) of this section.
    (18) Group. The term group has the meaning provided in Sec.  
1.1502-1(a).
    (19) Intercompany transaction. The term intercompany transaction 
has the meaning provided in Sec.  1.1502-13(b)(1)(i).
    (20) Interest. The term interest means any amount described in 
paragraph (b)(20)(i), (ii), (iii), or (iv) of this section.
    (i) In general. Interest is an amount paid, received, or accrued as 
compensation for the use or forbearance of money under the terms of an 
instrument or contractual arrangement, including a series of 
transactions, that is treated as a debt instrument for purposes of 
section 1275(a) and Sec.  1.1275-1(d), and not treated as stock under 
Sec.  1.385-3, or an amount that is treated as interest under other 
provisions of the Internal Revenue Code (Code) or the regulations 
thereunder. Thus, for example, interest includes--
    (A) Original issue discount (OID), as adjusted by the holder for 
any acquisition premium or amortizable bond premium;
    (B) Qualified stated interest, as adjusted by the holder for any 
amortizable bond premium or by the issuer for any bond issuance 
premium;
    (C) Acquisition discount;
    (D) Amounts treated as taxable OID under section 1286 (relating to 
stripped bonds and stripped coupons);
    (E) Accrued market discount on a market discount bond to the extent 
includible in income by the holder under either section 1276(a) or 
1278(b);
    (F) OID includible in income by a holder that has made an election 
under Sec.  1.1272-3 to treat all interest on a debt instrument as OID;
    (G) OID on a synthetic debt instrument arising from an integrated 
transaction under Sec.  1.1275-6;
    (H) Repurchase premium to the extent deductible by the issuer under 
Sec.  1.163-7(c);
    (I) Deferred payments treated as interest under section 483;
    (J) Amounts treated as interest under a section 467 rental 
agreement;
    (K) Amounts treated as interest under section 988;
    (L) Forgone interest under section 7872;
    (M) De minimis OID taken into account by the issuer;
    (N) Amounts paid or received in connection with a sale-repurchase 
agreement treated as indebtedness under Federal tax principles; in the 
case of a sale-repurchase agreement relating to tax-exempt bonds, 
however, the amount is not tax-exempt interest;
    (O) Redeemable ground rent treated as interest under section 
163(c); and
    (P) Amounts treated as interest under section 636.
    (ii) Swaps with significant nonperiodic payments--(A) Non-cleared 
swaps. A swap other than a cleared swap with significant nonperiodic 
payments is treated as two separate transactions consisting of an on-
market, level payment swap and a loan. The loan must be accounted for 
by the parties to the contract independently of the swap. The time 
value component associated with the loan, determined in accordance with 
Sec.  1.446-3(f)(2)(iii)(A), is recognized as interest expense to the 
payor and interest income to the recipient.
    (B) [Reserved]
    (iii) Other amounts treated as interest--(A) Treatment of premium--
(1) Issuer. If a debt instrument is issued at a premium within the 
meaning of Sec.  1.163-13, any ordinary income under Sec.  1.163-
13(d)(4) is treated as interest income of the issuer.
    (2) Holder. If a taxable debt instrument is acquired at a premium 
within the meaning of Sec.  1.171-1 and the holder elects to amortize 
the premium, any amount otherwise deductible under section 171(a)(1) as 
a bond premium deduction under Sec.  1.171-2(a)(4)(i)(A) or (C) is 
treated as interest expense of the holder.
    (B) Treatment of ordinary income or loss on certain debt 
instruments. If an issuer of a contingent payment debt instrument 
subject to Sec.  1.1275-4(b), a nonfunctional currency contingent 
payment debt instrument subject to Sec.  1.988-6, or an inflation-
indexed debt instrument subject to Sec.  1.1275-7 recognizes ordinary 
income on the debt instrument in accordance with the rules in Sec.  
1.1275-4(b), Sec.  1.988-6(b)(2), or Sec.  1.1275-7(f), whichever is 
applicable, the ordinary income is treated as interest income of the 
issuer. If a holder of a contingent payment debt instrument subject to 
Sec.  1.1275-4(b), a nonfunctional currency contingent payment debt 
instrument subject to Sec.  1.988-6, or an inflation-indexed debt 
instrument subject to Sec.  1.1275-7

[[Page 67540]]

recognizes an ordinary loss on the debt instrument in accordance with 
the rules in Sec.  1.1275-4(b), Sec.  1.988-6(b)(2), or Sec.  1.1275-
7(f), whichever is applicable, the ordinary loss is treated as interest 
expense of the holder.
    (C) Substitute interest payments. A substitute interest payment 
described in Sec.  1.861-2(a)(7) is treated as interest expense to the 
payor or interest income to the recipient; in the case of a sale-
repurchase agreement or a securities lending transaction relating to 
tax-exempt bonds, however, the recipient of a substitute payment does 
not receive tax-exempt interest income.
    (D) Section 1258 gain. Any gain treated as ordinary gain under 
section 1258 is treated as interest income.
    (E) Amounts affecting a taxpayer's effective cost of borrowing. 
Income, deduction, gain, or loss from a derivative, as defined in 
section 59A(h)(4)(A), that alters a taxpayer's effective cost of 
borrowing with respect to a liability of the taxpayer is treated as an 
adjustment to interest expense of the taxpayer. For example, a taxpayer 
that is obligated to pay interest at a floating rate on a note and 
enters into an interest rate swap that entitles the taxpayer to receive 
an amount that is equal to or that closely approximates the interest 
rate on the note in exchange for a fixed amount is, in effect, paying 
interest expense at a fixed rate by entering into the interest rate 
swap. Income, deduction, gain, or loss from the swap is treated as an 
adjustment to interest expense. Similarly, any gain or loss resulting 
from a termination or other disposition of the swap is an adjustment to 
interest expense, with the timing of gain or loss subject to the rules 
of Sec.  1.446-4.
    (F) Yield adjustments. Income, deduction, gain, or loss from a 
derivative, as defined in section 59A(h)(4)(A), that alters a 
taxpayer's effective yield with respect to a debt instrument held by 
the taxpayer is treated as an adjustment to interest income by the 
taxpayer.
    (G) Certain amounts labeled as fees--(1) Commitment fees. Any fees 
in respect of a lender commitment to provide financing are treated as 
interest if any portion of such financing is actually provided.
    (2) [Reserved]
    (H) Debt issuance costs. Any debt issuance costs subject to Sec.  
1.446-5 are treated as interest expense of the issuer.
    (I) Guaranteed payments. Any guaranteed payments for the use of 
capital under section 707(c) are treated as interest.
    (J) Factoring income. The excess of the amount that a taxpayer 
collects on a factored receivable (or realizes upon the sale or other 
disposition of the factored receivable) over the amount paid for the 
factored receivable by the taxpayer is treated as interest income. For 
purposes of this paragraph (b)(20)(iii)(J), the term factored 
receivable includes any account receivable or other evidence of 
indebtedness, whether or not issued at a discount and whether or not 
bearing stated interest, arising out of the disposition of property or 
the performance of services by any person, if such account receivable 
or evidence of indebtedness is acquired by a person other than the 
person who disposed of the property or provided the services that gave 
rise to the account receivable or evidence of indebtedness.
    (iv) Anti-avoidance rule for amounts predominantly associated with 
the time value of money. Any expense or loss, to the extent deductible, 
incurred by a taxpayer in a transaction or series of integrated or 
related transactions in which the taxpayer secures the use of funds for 
a period of time is treated as interest expense of the taxpayer if such 
expense or loss is predominantly incurred in consideration of the time 
value of money.
    (v) Examples. The examples in this paragraph (b)(20)(v) illustrate 
the application of paragraphs (b)(20)(i) through (iv) of this section. 
Unless otherwise indicated, assume the following: A, B, C, D, and Bank 
are domestic C corporations that are publicly traded; the exemption for 
certain small businesses in Sec.  1.163(j)-2(d) does not apply; A is 
not engaged in an excepted trade or business; and all amounts of 
interest expense are deductible except for the potential application of 
section 163(j).

     (A) Example 1--(1) Facts. (i) A is a calendar year taxpayer 
that is engaged in a manufacturing business. In January 2019, A, 
which has an investment-grade credit rating, enters into the 
following transactions (the transactions): Bank transfers a 
portfolio of U.S. Treasury bonds (the Treasury portfolio) to A; A 
agrees to pay Bank an amount equivalent to any interest paid on the 
Treasury portfolio during the transactions and a fee for lending the 
Treasury portfolio to A; A agrees to return to Bank securities that 
are substantially identical to the Treasury portfolio upon request, 
regardless of any value increases or decreases in the market value 
of the Treasury portfolio; A rehypothecates the Treasury portfolio 
in exchange for cash, which A uses to purchase a portfolio of 
corporate bonds (the debt portfolio); and the transactions remain in 
place for the duration of the 2019 calendar year until Bank delivers 
a notice to A recalling the Treasury portfolio 5 business days 
before December 31, 2019.
    (ii) The obligations undertaken with respect to the transactions 
are not collateralized. Assume that the transactions do not result 
in a sale-repurchase agreement treated as indebtedness under Federal 
tax principles. During the course of the transactions, the debt 
portfolio generates $70x of interest income. The Treasury portfolio 
generates $60x of interest income during the course of the 
transactions and A pays $60x to Bank under its obligation to pay 
amounts equivalent to the interest paid on the Treasury portfolio.
    (2) Analysis. The transactions involving Bank and A are 
transactions described in paragraph (b)(20)(iii)(C) of this section. 
Consequently, the $60x of substitute interest payments that A paid 
to Bank in 2019 is treated as interest expense for purposes of 
section 163(j). In addition, the $70x of interest income generated 
by the debt portfolio is interest income to A.
     (B) Example 2--(1) Facts. A is a calendar year taxpayer that is 
engaged in a manufacturing business. In early 2019, A enters into 
the following transactions:
    (i) A enters into a loan obligation in which A borrows Japanese 
yen from Bank in an amount equivalent to $2000x with an interest 
rate of 1 percent (at the time of the loan, the U.S. dollar 
equivalent interest rate on a loan of $2,000x is 5 percent); and
    (ii) A enters into a foreign currency swap transaction (FX Swap) 
with Bank with a notional principal amount of $2000x under which A 
receives Japanese yen at 1 percent multiplied by the amount of 
Japanese yen borrowed from Bank (which for 2019 equals $20x) and 
pays U.S. dollars at 5 percent multiplied by a notional amount of 
$2000x ($100x per year). The FX Swap is not integrated with the loan 
obligation under Sec.  1.988-5.
    (2) Analysis. The FX Swap alters A's cost of borrowing within 
the meaning of paragraph (b)(20)(iii)(E) of this section. As a 
result, for purposes of section 163(j), the $100x paid by A to Bank 
on the FX Swap is treated by A as interest expense and the $20x paid 
by Bank to A on the FX Swap is treated by A as a reduction of 
interest expense.
     (C) Example 3--(1) Facts. A borrows from B two ounces of gold 
at a time when the spot price for gold is $500x per ounce. A agrees 
to return the two ounces of gold in six months. A sells the two 
ounces of gold to C for $1,000x. A then enters into a contract with 
D to purchase two ounces of gold six months in the future for 
$1,013x. In exchange for the use of $1,000x in cash, A has sustained 
a loss of $13x on related transactions.
    (2) Analysis. A has obtained the use of $1,000x and, in a series 
of related transactions, created a loss of $13x predominantly 
associated with the time value of money. As a result, for purposes 
of section 163(j), the loss of $13x is treated as interest expense 
under paragraph (b)(20)(iv) of this section.

    (21) Interest expense. The term interest expense means interest 
that is paid or accrued, or treated as paid or accrued, for the taxable 
year.

[[Page 67541]]

    (22) Interest income. The term interest income means interest that 
is included in gross income for the taxable year.
    (23) Inventory. The term inventory means property held for sale or 
for lease, or both, by a taxpayer in the ordinary course of its trade 
or business.
    (24) Member. The term member has the meaning provided in Sec.  
1.1502-1(b).
    (25) Motor vehicle. The term motor vehicle means a motor vehicle as 
defined in section 163(j)(9)(C).
    (26) Old section 163(j). The term old section 163(j) means section 
163(j) immediately prior to its amendment by Public Law 115-97, 131 
Stat. 2054 (2017).
    (27) Real estate investment trust. The term real estate investment 
trust (REIT) has the meaning provided in section 856.
    (28) Real property. The term real property includes--
    (i) Real property as defined in Sec.  1.469-9(b)(2); and
    (ii) Any direct or indirect right, including a license or other 
contractual right, to share in the appreciation in value of, or the 
gross or net proceeds or profits generated by, an interest in real 
property, including net proceeds or profits associated with tolls, 
rents or other similar fees.
    (29) Regulated investment company. The term regulated investment 
company (RIC) has the meaning provided in section 851.
    (30) S corporation. The term S corporation has the meaning provided 
in section 1361(a)(1).
    (31) Section 163(j) limitation. The term section 163(j) limitation 
means the limit on the amount of business interest expense that a 
taxpayer may deduct in a taxable year under section 163(j) and Sec.  
1.163(j)-2(b).
    (32) Section 163(j) regulations. The term section 163(j) 
regulations means this section and Sec. Sec.  1.163(j)-2 through 
1.163(j)-11.
    (33) Separate return limitation year. The term separate return 
limitation year (SRLY) has the meaning provided in Sec.  1.1502-1(f).
    (34) Separate return year. The term separate return year has the 
meaning provided in Sec.  1.1502-1(e).
    (35) Separate taxable income. The term separate taxable income has 
the meaning provided in Sec.  1.1502-12.
    (36) Tax-exempt corporation. The term tax-exempt corporation means 
any corporation subject to tax under section 511.
    (37) Taxable income--(i) In general. The term taxable income, with 
respect to a taxpayer and a taxable year, has the meaning provided in 
section 63, but for this purpose computed without regard to the 
application of section 163(j) and the section 163(j) regulations.
    (ii) General rules to coordinate the application of sections 163(j) 
and 250. If for a taxable year a taxpayer is allowed a deduction under 
section 250(a)(1) that is properly allocable to a non-excepted trade or 
business, then taxable income for the taxable year is determined 
without regard to the limitation in section 250(a)(2). For this 
purpose, the amount of the deduction allowed under section 250(a)(1), 
without regard to the limitation in section 250(a)(2), is determined 
without regard to the application of section 163(j) and the section 
163(j) regulations.
    (iii) [Reserved]
    (iv) Special rules for defining taxable income. (A) For special 
rules defining the taxable income of a RIC or REIT, see Sec.  1.163(j)-
4(b)(4)(ii).
    (B) For special rules defining the taxable income of consolidated 
groups, see Sec.  1.163(j)-4(d)(2)(iv).
    (C) For special rules defining the taxable income of a partnership, 
see Sec.  1.163(j)-6(d)(1).
    (D) For special rules defining the taxable income of an S 
corporation, see Sec.  1.163(j)-6(l)(3).
    (E) For special rules defining the taxable income of certain 
controlled foreign corporations, see Sec.  1.163(j)-7(c)(1).
    (38) Trade or business--(i) In general. The term trade or business 
means a trade or business within the meaning of section 162.
    (ii) Excepted trade or business. The term excepted trade or 
business means a trade or business that is described in paragraphs 
(b)(38)(ii)(A) through (D) of this section. For additional rules 
related to excepted trades or businesses, including elections made 
under section 163(j)(7)(B) and (C), see Sec.  1.163(j)-9.
    (A) The trade or business of performing services as an employee.
    (B) Any electing real property trade or business.
    (C) Any electing farming business.
    (D) Any excepted regulated utility trade or business.
    (iii) Non-excepted trade or business. The term non-excepted trade 
or business means any trade or business that is not an excepted trade 
or business.
    (39) Unadjusted basis. The term unadjusted basis means the basis as 
determined under section 1012 or other applicable sections of chapter 1 
of subtitle A of the Code, including subchapters O (relating to gain or 
loss on dispositions of property), C (relating to corporate 
distributions and adjustments), K (relating to partners and 
partnerships), and P (relating to capital gains and losses) of the 
Code. Unadjusted basis is determined without regard to any adjustments 
described in section 1016(a)(2) or (3), to any adjustments for tax 
credits claimed by the taxpayer (for example, under section 50(c)), or 
to any adjustments for any portion of the basis for which the taxpayer 
has elected to treat as an expense (for example, under section 179, 
179B, or 179C).
    (c) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99, (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-2  Deduction for business interest expense limited.

    (a) Overview. This section provides general rules regarding the 
section 163(j) limitation. Paragraph (b) of this section provides rules 
regarding the basic computation of the section 163(j) limitation. 
Paragraph (c) of this section provides rules for disallowed business 
interest expense carryforwards. Paragraph (d) of this section provides 
rules regarding the small business exemption from the section 163(j) 
limitation. Paragraph (e) of this section provides rules regarding real 
estate mortgage investment conduits (REMICs). Paragraph (f) of this 
section provides examples illustrating the application of this section. 
Paragraph (g) of this section provides an anti-avoidance rule.
    (b) General rule. Except as otherwise provided in this section or 
in Sec. Sec.  1.163(j)-3 through 1.163(j)-11, the amount allowed as a 
deduction for business interest expense for the taxable year cannot 
exceed the sum of--
    (1) The taxpayer's business interest income for the taxable year;
    (2) 30 percent of the taxpayer's ATI for the taxable year, or zero 
if the taxpayer's ATI for the taxable year is less than zero; and
    (3) The taxpayer's floor plan financing interest expense for the 
taxable year.
    (c) Disallowed business interest expense carryforward--(1) In 
general.

[[Page 67542]]

Under section 163(j)(2), any business interest expense disallowed under 
paragraph (b) of this section, or any disallowed disqualified interest 
that is properly allocable to a non-excepted trade or business under 
Sec.  1.163(j)-10, is carried forward to the succeeding taxable year as 
business interest expense that is subject to paragraph (b) of this 
section in such succeeding taxable year (a disallowed business interest 
expense carryforward).
    (2) Coordination with small business exemption. If disallowed 
business interest expense is carried forward under the rules of 
paragraph (c)(1) of this section to a taxable year in which the small 
business exemption in paragraph (d) of this section applies to the 
taxpayer, then the general rule in paragraph (b) of this section does 
not apply to limit the deduction of the disallowed business interest 
expense carryforward in that taxable year.
    (3) Cross-references--(i) For special rules regarding disallowed 
business interest expense carryforwards for taxpayers that are C 
corporations, including members of a consolidated group, see Sec.  
1.163(j)-5.
    (ii) For special rules regarding disallowed business interest 
expense carryforwards of S corporations, see Sec. Sec.  1.163(j)-
5(b)(2) and 1.163(j)-6(l)(5).
    (iii) For special rules regarding disallowed business interest 
expense carryforwards from partnerships, see Sec.  1.163(j)-6.
    (iv) For special rules regarding disallowed business interest 
expense carryforwards from partnerships engaged in a U.S. trade or 
business, see Sec.  1.163(j)-8(c)(2).
    (d) Small business exemption--(1) Exemption. The general rule in 
paragraph (b) of this section does not apply to any taxpayer, other 
than a tax shelter as defined in section 448(d)(3), in any taxable year 
if the taxpayer meets the gross receipts test of section 448(c) and the 
regulations thereunder for the taxable year.
    (2) Application of the gross receipts test--(i) In general. In the 
case of any taxpayer that is not a corporation or a partnership, and 
except as provided in paragraphs (d)(2)(ii), (iii), and (iv) of this 
section, the gross receipts test and aggregation rules of section 
448(c) and the regulations thereunder are applied in the same manner as 
if such taxpayer were a corporation or partnership.
    (ii) Gross receipts of individuals. Except as provided in paragraph 
(d)(2)(iii) of this section regarding partnership and S corporation 
interests and when the aggregation rules of section 448(c) apply, an 
individual taxpayer's gross receipts include all items specified as 
gross receipts in regulations under section 448(c), whether or not 
derived in the ordinary course of the taxpayer's trade or business. For 
purposes of section 163(j), an individual taxpayer's gross receipts do 
not include inherently personal amounts, including, but not limited to, 
personal injury awards or settlements with respect to an injury of the 
individual taxpayer, disability benefits, Social Security benefits 
received by the taxpayer during the taxable year, and wages received as 
an employee that are reported on Form W-2.
    (iii) Partners and S corporation shareholders. Except when the 
aggregation rules of section 448(c) apply, each partner in a 
partnership includes a share of partnership gross receipts in 
proportion to such partner's distributive share (as determined under 
section 704) of items of gross income that were taken into account by 
the partnership under section 703. Additionally, each shareholder in an 
S corporation includes a pro rata share of S corporation gross 
receipts.
    (iv) Tax-exempt organizations. For purposes of section 163(j), the 
gross receipts of an organization subject to tax under section 511 
includes only gross receipts taken into account in determining its 
unrelated business taxable income.
    (e) REMICs. For the treatment of interest expense by a REMIC as 
defined in section 860D, see Sec.  1.860C-2(b)(2)(ii).
    (f) Calculation of ATI with respect to certain beneficiaries. The 
ATI of a trust or estate beneficiary is reduced by any income 
(including any distributable net income) received from the trust or 
estate by the beneficiary to the extent such income supported a 
deduction for business interest expense under section 163(j)(1)(B) or 
Sec.  1.163(j)-2(b)(2) in computing the trust or estate's taxable 
income.
    (g) Examples. The examples of this paragraph (g) illustrate the 
application of section 163(j) and the provisions of this section. 
Unless otherwise indicated, assume the following: X and Y are domestic 
C corporations; C and D are U.S. resident individuals not subject to 
any foreign income tax; PRS is a domestic partnership with partners who 
are all individuals; all taxpayers use a calendar taxable year; the 
exemption for certain small businesses in section 163(j)(3) and 
paragraph (d) of this section does not apply; and the interest expense 
would be deductible but for section 163(j).

     (1) Example 1: Limitation on business interest expense 
deduction--(i) Facts. During its taxable year ending December 31, 
2019, X has ATI of $100x. X has business interest expense of $50x, 
which includes $10x of floor plan financing interest expense, and 
business interest income of $20x.
    (ii) Analysis. X's section 163(j) limitation is $60x, which is 
the sum of its business interest income ($20x), plus 30 percent of 
its ATI ($100x x 30 percent = $30x), plus its floor plan financing 
interest expense ($10x). See Sec.  1.163(j)-2(b). Because X's 
business interest expense ($50x) does not exceed X's section 163(j) 
limitation ($60x), X can deduct all $50x of its business interest 
expense for the 2019 taxable year.
     (2) Example 2: Carryforward of business interest expense--(i) 
Facts.
     The facts are the same as in Example 1 in paragraph (g)(1)(i) 
of this section, except that X has $80x of business interest 
expense, which includes $10x of floor plan financing interest 
expense.
    (ii) Analysis. As in Example 1 in paragraph (g)(1)(ii) of this 
section, X's section 163(j) limitation is $60x. Because X's business 
interest expense ($80x) exceeds X's section 163(j) limitation 
($60x), X may only deduct $60x of its business interest expense for 
the 2019 taxable year, and the remaining $20x of its business 
interest expense will be carried forward to the succeeding taxable 
year as a disallowed business interest expense carryforward. See 
Sec.  1.163(j)-2(c).
     (3) Example 3: ATI computation--(i) Facts. During the 2019 
taxable year, Y has taxable income of $30x (without regard to the 
application of section 163(j)), which includes the following: $20x 
of business interest income; $50x of business interest expense, 
which includes $10x of floor plan financing interest expense; $25x 
of net operating loss deduction under section 172; and $15x of 
depreciation deduction under section 167.
    (ii) Analysis. (A) For purposes of determining the section 
163(j) limitation, Y's ATI is $90x, calculated as follows:

                   Table 1 to Paragraph (g)(3)(ii)(A)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Taxable income:................................................     $30x
Less:
    Floor plan financing interest..............................      10x
    Business interest income...................................      20x
                                                                --------
                                                                      0x
------------------------------------------------------------------------

    (B) Plus:

                   Table 1 to Paragraph (g)(3)(ii)(B)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
    Business interest expense..................................     $50x
    Net operating loss deduction...............................      25x
    Depreciation deduction.....................................      15x
                                                                --------
    ATI........................................................      90x
------------------------------------------------------------------------

     (4) Example 4: Floor plan financing interest expense--(i) 
Facts. C is the sole proprietor of an automobile dealership that 
uses a cash method of accounting. In the 2019 taxable year, C paid 
$30x of interest on a loan that was obtained to purchase sedans for 
sale by the dealership. The indebtedness is secured by the sedans 
purchased with the

[[Page 67543]]

loan proceeds. In addition, C paid $20x of interest on a loan, 
secured by the dealership's office equipment, which C obtained to 
purchase convertibles for sale by the dealership.
    (ii) Analysis. For the purpose of calculating C's section 163(j) 
limitation, only the $30x of interest paid on the loan to purchase 
the sedans is floor plan financing interest expense. The $20x paid 
on the loan to purchase the convertibles is not floor plan financing 
interest expense for purposes of section 163(j) because the 
indebtedness was not secured by the inventory of convertibles. 
However, because under Sec.  1.163(j)-10 the interest paid on the 
loan to purchase the convertibles is properly allocable to C's 
dealership trade or business, and because floor plan financing 
interest expense is also business interest expense, C has $50x of 
business interest expense for the 2019 taxable year.
     (5) Example 5: Interest not properly allocable to non-excepted 
trade or business--(i) Facts. The facts are the same as in Example 4 
in paragraph (g)(4)(i) of this section, except that the $20x of 
interest C pays is on acquisition indebtedness obtained to purchase 
C's personal residence and not to purchase convertibles for C's 
dealership trade or business.
    (ii) Analysis. Because the $20x of interest expense is not 
properly allocable to a non-excepted trade or business, and 
therefore is not business interest expense as defined in Sec.  
1.163(j)-1(b)(2), C's only business interest expense is the $30x 
that C pays on the loan used to purchase sedans for sale in C's 
dealership trade or business. C deducts the $20x of interest related 
to his residence under the rules of section 163(h), without regard 
to section 163(j).
     (6) Example 6: Small business exemption--(i) Facts. During the 
2019 taxable year, D, the sole proprietor of a trade or business 
reported on Schedule C, has interest expense properly allocable to 
that trade or business. D also earns gross income from providing 
services as an employee that is reported on a Form W-2. Under 
section 448(c) and the regulations thereunder, D has average annual 
gross receipts of $21 million, including $1 million of wages in each 
of the three prior taxable years and $2 million of income from 
investments not related to a trade or business in each of the three 
prior taxable years. Also, in each of the three prior taxable years, 
D received $5 million in periodic payments of compensatory damages 
awarded in a personal injury lawsuit.
    (ii) Analysis. Section 163(j) does not apply to D for the 
taxable year, because D qualifies for the small business exemption 
under Sec.  1.163(j)-2(d). The wages that D receives as an employee 
and the compensatory damages that D received from D's personal 
injury lawsuit are not gross receipts, as provided in Sec.  
1.163(j)-2(d)(2)(ii). D may deduct all of its business interest 
expense for the 2019 taxable year without regard to section 163(j).
     (7) Example 7: Aggregation of gross receipts--(i) Facts. X and 
Y are domestic C corporations under common control, within the 
meaning of section 52(a) and Sec.  1.52-1(b). X's only trade or 
business is a farming business described in Sec.  1.263A-4(a)(4). 
During the taxable year ending December 31, 2019, X has average 
annual gross receipts under section 448(c) of $6 million. During the 
same taxable year, Y has average annual gross receipts under section 
448(c) of $21 million.
    (ii) Analysis. Because X and Y are under common control, they 
must aggregate gross receipts for purposes of section 448(c) and the 
small business exemption in Sec.  1.163(j)-2(d). See section 
448(c)(2). Therefore, X and Y are both considered to have $27 
million in average annual gross receipts for 2019. X and Y must 
separately apply section 163(j) to determine any limitation on the 
deduction for business interest expense. Assuming X otherwise meets 
the requirements in Sec.  1.163(j)-9 in 2019, X may elect for its 
farming business to be an excepted trade or business.

    (h) Anti-avoidance rule. Arrangements entered into with a principal 
purpose of avoiding the rules of section 163(j) or the section 163(j) 
regulations, including the use of multiple entities to avoid the gross 
receipts test of section 448(c), may be disregarded or recharacterized 
by the Commissioner of the IRS to the extent necessary to carry out the 
purposes of section 163(j).
    (i) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99, (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-3  Relationship of business interest deduction 
limitation to other provisions affecting interest.

    (a) Overview. This section contains rules regarding the 
relationship between section 163(j) and certain other provisions of the 
Code. Paragraph (b) of this section provides the general rules 
concerning the relationship between section 163(j) and certain other 
provisions of the Code. Paragraph (c) of this section provides examples 
illustrating the application of this section. For rules regarding the 
relationship between sections 163(j) and 704(d), see Sec.  1.163(j)-
6(h)(1) and (2).
    (b) Coordination of section 163(j) with certain other provisions--
(1) In general. Section 163(j) and the section 163(j) regulations 
generally apply only to business interest expense that would be 
deductible in the current taxable year without regard to section 
163(j). Except as otherwise provided in this section, section 163(j) 
applies after the application of provisions that subject interest 
expense to disallowance, deferral, capitalization, or other limitation. 
For the rules that must be applied in determining whether excess 
business interest is paid or accrued by a partner, see section 
163(j)(4)(B)(ii) and Sec.  1.163(j)-6.
    (2) Disallowed interest provisions. For purposes of section 163(j), 
business interest expense does not include interest expense that is 
permanently disallowed as a deduction under another provision of the 
Code, such as in section 163(e)(5)(A)(i), (f), (l), or (m), or section 
264(a), 265, 267A, or 279.
    (3) Deferred interest provisions. Other than sections 461(l), 465, 
and 469, Code provisions that defer the deductibility of interest 
expense, such as section 163(e)(3) and (e)(5)(A)(ii), 267(a)(2) and 
(3), 1277, or 1282, apply before the application of section 163(j). For 
purposes other than sections 465 and 469, interest expense is taken 
into account for section 163(j) purposes in the taxable year when it is 
no longer deferred under another section of the Code.
    (4) At risk rules, passive activity loss provisions, and limitation 
on excess business losses of noncorporate taxpayers. Section 163(j) 
applies before the application of sections 461(l), 465, and 469.
    (5) Capitalized interest expenses under sections 263A and 263(g). 
Sections 263A and 263(g) apply before the application of section 
163(j). Capitalized interest expense under those sections is not 
treated as business interest expense for purposes of section 163(j). 
For ordering rules that determine whether interest expense is 
capitalized under section 263A(f), see the regulations under section 
263A(f), including Sec.  1.263A-9(g).
    (6) Reductions under section 246A. Section 246A applies before 
section 163(j). Any reduction in the dividends received deduction under 
section 246A reduces the amount of business interest expense taken into 
account under section 163(j).
    (7) Section 381. Disallowed business interest expense carryforwards 
are items to which an acquiring corporation succeeds under section 
381(a). See section 381(c)(20), and Sec. Sec.  1.163(j)-5(c) and 
1.381(c)(20)-1.
    (8) Section 382. For rules governing the interaction of sections 
163(j) and 382, see section 382(d)(3) and (k)(1),

[[Page 67544]]

Sec. Sec.  1.163(j)-5(e) and 1.163(j)-11(b), the regulations under 
sections 382 and 383, and Sec. Sec.  1.1502-91 through 1.1502-99.
    (9) Other types of interest provisions. Except as otherwise 
provided in the section 163(j) regulations, provisions that 
characterize interest expense as something other than business interest 
expense under section 163(j), such as section 163(d), govern the 
treatment of that interest expense, and such interest expense will not 
be treated as business interest expense for any purpose under section 
163(j).
    (10) [Reserved]
    (c) Examples. The examples of this paragraph (c) illustrate the 
application of section 163(j) and the provisions of this section. 
Unless otherwise indicated, assume the following: X and Y are domestic 
C corporations with a calendar taxable year; D is a U.S. resident 
individual not subject to any foreign income tax; none of the taxpayers 
have floor plan financing interest expense; and the exemption for small 
businesses in Sec.  1.163(j)-2(d) does not apply.

     (1) Example 1: Disallowed interest expense--(i) Facts. In 2019, 
X has $30x of interest expense. Of X's interest expense, $10x is 
permanently disallowed under section 265. X's business interest 
income is $3x and X's ATI is $90x.
    (ii) Analysis. Under paragraph (b)(2) of this section, the $10x 
interest expense that is permanently disallowed under section 265 
cannot be taken into consideration for purposes of section 163(j) in 
the 2019 taxable year. X's section 163(j) limitation, or the amount 
of business interest expense that X may deduct is limited to $30x 
under Sec.  1.163(j)-2(b), determined by adding X's business 
interest income ($3x) and 30 percent of X's 2018 ATI ($27x). 
Therefore, in the 2019 taxable year, none of the $20x of X's 
deduction for its business interest expense is disallowed under 
section 163(j).
     (2) Example 2: Deferred interest expense--(i) Facts. In 2019, Y 
has no business interest income, $120x of ATI, and $70x of interest 
expense. Of Y's interest expense, $30x is not currently deductible 
under section 267(a)(2). Assume that the $30x expense will be 
allowed as a deduction under section 267(a)(2) in 2020.
    (ii) Analysis. Under paragraph (b)(3) of this section, section 
267(a)(2) is applied before section 163(j). Accordingly, $30x of Y's 
interest expense cannot be taken into consideration for purposes of 
section 163(j) in 2019 because it is not currently deductible under 
section 267(a)(2). Accordingly, in 2019, if the interest expense is 
properly allocable to a non-excepted trade or business, Y will have 
$4x of disallowed business interest expense because the $40x of 
business interest expense in 2019 ($70x-$30x) exceeds 30 percent of 
its ATI for the taxable year ($36x). The $30x of interest expense 
not allowed as a deduction in the 2019 taxable year under section 
267(a)(2) will be taken into account in determining the business 
interest expense deduction under section 163(j) in 2020, the taxable 
year in which it is allowed as a deduction under section 267(a)(2), 
if it is allocable to a trade or business. Additionally, the $4x of 
disallowed business interest expense in 2019 will be carried forward 
to 2020 as a disallowed business interest expense carryforward. See 
Sec.  1.163(j)-2(c).
     (3) Example 3: Passive activity loss--(i) Facts. D is engaged 
in a rental activity treated as a passive activity within the 
meaning of section 469. For tax year 2019, D receives $200x of 
rental income and incurs $300x of expenses all properly allocable to 
the rental activity, consisting of $150x of interest expense, $60x 
of maintenance expenses, and $90x of depreciation expense. D's ATI 
is $400x.
    (ii) Analysis. Under paragraph (b)(4) of this section, section 
163(j) is applied before the section 469 passive loss rules apply. 
D's section 163(j) limitation is $120x, determined by adding to D's 
business interest income ($0), floor plan financing ($0), and 30 
percent of D's ATI ($120x). See Sec.  1.163(j)-2(b). Because D's 
business interest expense of $150x exceeds D's section 163(j) 
limitation for 2019, $30x of D's business interest expense is 
disallowed under section 163(j) and will be carried forward as a 
disallowed business interest expense carryforward. See Sec.  
1.163(j)-2(c). Because the section 163(j) limitation is applied 
before the limitation under section 469, only $120x of the business 
interest expense allowable under section 163(j) is included in 
determining D's passive activity loss limitation for the 2019 tax 
year under section 469. The $30x of disallowed business interest 
expense is not an allowable deduction under section 163(j) and, 
therefore, is not a deduction under section 469 in the current 
taxable year. See Sec.  1.469-2(d)(8).
     (4) Example 4: Passive activity loss by taxpayer that also 
participates in a non-passive activity--(i) Facts. For 2019, D has 
no business interest income and ATI of $1,000x, entirely 
attributable to a passive activity within the meaning of section 
469. D has business interest expense of $1,000x, $900x of which is 
properly allocable to a passive activity and $100x of which is 
properly allocable to a non-passive activity in which D materially 
participates. D has other business deductions that are not subject 
to section 469 of $600x, and a section 469 passive loss from the 
previous year of $250x.
    (ii) Analysis. Under paragraph (b)(4) of this section, section 
163(j) is applied before the section 469 passive loss rules apply. 
D's section 163(j) limitation is $300x, determined by adding D's 
business interest income ($0), floor plan financing ($0), and 30 
percent of D's ATI ($300x)). Next, applying the limitation under 
section 469 to the $300x business interest expense deduction 
allowable under sections 163(a) and (j), $270x (a proportionate 
amount of the $300x (0.90 x $300x)) is business interest expense 
included in determining D's passive activity loss limitation under 
section 469, and $30x (a proportionate amount of the $300x (0.10 x 
$300)) is business interest expense not included in determining D's 
passive activity loss limitation under section 469. Because D's 
interest expense of $1,000x exceeds 30 percent of its ATI for 2019, 
$700x of D's interest expense is disallowed under section 163(j) and 
will be carried forward as a disallowed business interest expense 
carryforward. Section 469 does not apply to any portion of the $700x 
disallowed business interest expense because that business interest 
expense is not an allowable deduction under section 163(j) and, 
therefore, is not an allowable deduction under section 469 in the 
current taxable year. See Sec.  1.469-2(d)(8).

    (d) Applicability date. The provisions of this section apply to 
taxable years ending after the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register. However, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may apply the rules of this 
section to a taxable year beginning after December 31, 2017, so long as 
the taxpayers and their related parties consistently apply the rules of 
the section 163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-4  General rules applicable to C corporations (including 
REITs, RICs, and members of consolidated groups) and tax-exempt 
corporations.

    (a) Scope. This section provides certain rules regarding the 
computation of items of income and expense under section 163(j) for 
taxpayers that are C corporations (including members of a consolidated 
group, REITs, and RICs) and tax-exempt corporations. Paragraph (b) of 
this section provides rules regarding the characterization of items of 
income, gain, deduction, or loss. Paragraph (c) of this section 
provides rules regarding adjustments to earnings and profits. Paragraph 
(d) of this section provides special rules applicable to members of a 
consolidated group. Paragraph (e) of this section provides cross-
references to other rules within the 163(j) regulations that may be 
applicable to C corporations.
    (b) Characterization of items of income, gain, deduction, or loss--
(1) Interest expense and interest income. Solely for purposes of 
section 163(j), all interest expense of a taxpayer that is a C 
corporation is treated as properly allocable to a trade or business. 
Similarly, solely for purposes of section 163(j), all interest income 
of a taxpayer that is a C corporation is treated as properly allocable 
to a trade or business. For rules governing the allocation of interest 
expense and interest income

[[Page 67545]]

between excepted and non-excepted trades or businesses, see Sec.  
1.163(j)-10.
    (2) Adjusted taxable income. Solely for purposes of section 163(j), 
all items of income, gain, deduction, or loss of a taxpayer that is a C 
corporation are treated as properly allocable to a trade or business. 
For rules governing the allocation of tax items between excepted and 
non-excepted trades or businesses, see Sec.  1.163(j)-10.
    (3) Investment interest, investment income, and investment expenses 
of a partnership with a C corporation partner--(i) Characterization as 
expense or income properly allocable to a trade or business. For 
purposes of section 163(j), any investment interest, within the meaning 
of section 163(d), that a partnership pays or accrues and that is 
allocated to a C corporation partner is treated by the C corporation as 
interest expense that is properly allocable to a trade or business of 
that partner. Similarly, for purposes of section 163(j), except as 
provided in Sec.  1.163(j)-7(d)(1)(ii), any investment income or 
investment expenses, within the meaning of section 163(d), that a 
partnership receives, pays, or accrues and that is allocated to a C 
corporation partner is treated by the C corporation as properly 
allocable to a trade or business of that partner.
    (ii) Impact of characterization on partnership. The 
characterization of a partner's investment interest, investment income, 
or investment expenses pursuant to paragraph (b)(3)(i) of this section 
will not affect the characterization of these items as investment 
interest, investment income, or investment expenses at the partnership 
level.
    (iii) Investment interest expense and investment interest income of 
a partnership not treated as excess business interest expense or excess 
taxable income of a C corporation partner. Investment interest expense 
of a partnership that is treated as business interest expense by a C 
corporation partner is not treated as excess business interest expense. 
Investment interest income of a partnership that is treated as business 
interest income by a C corporation partner is not treated as excess 
taxable income. For rules governing excess business interest expense 
and excess taxable income, see Sec.  1.163(j)-6.
    (4) Application to RICs and REITs--(i) In general. Except as 
otherwise provided in paragraphs (b)(4)(ii) and (iii) of this section, 
the rules in this paragraph (b) apply to RICs and REITs.
    (ii) Taxable income for purposes of calculating the adjusted 
taxable income of RICs and REITs. The taxable income of a RIC or REIT 
for purposes of calculating adjusted taxable income (ATI) is the 
taxable income of the corporation, without any adjustment that would be 
made under section 852(b)(2) or 857(b)(2) to compute investment company 
taxable income or real estate investment trust taxable income, 
respectively. For example, the taxable income of a RIC or REIT is not 
reduced by the deduction for dividends paid, but is reduced by the 
dividends received deduction (DRD) and the other deductions described 
in sections 852(b)(2)(C) and 857(b)(2)(A), taking into account Sec.  
1.163(j)-1(b)(37)(ii). See paragraph (b)(4)(iii) of this section for an 
adjustment to adjusted taxable income in respect of these items.
    (iii) Other adjustments to adjusted taxable income for RICs and 
REITs. In the case of a taxpayer that, for a taxable year, is a RIC to 
which section 852(b) applies or a REIT to which section 857(b) applies, 
the taxpayer's ATI for the taxable year is increased by the amounts of 
any deductions described in section 852(b)(2)(C) or 857(b)(2)(A), 
taking into account Sec.  1.163(j)-1(b)(37)(ii).
    (5) Application to tax-exempt corporations. The rules in this 
paragraph (b) apply to a corporation that is subject to the unrelated 
business income tax under section 511 only with respect to that 
corporation's items of income, gain, deduction, or loss that are taken 
into account in computing the corporation's unrelated business taxable 
income, as defined in section 512.
    (6) Examples. The principles of this paragraph (b) are illustrated 
by the following examples. For purposes of the examples in this 
paragraph (b)(6), T is a taxable domestic C corporation whose taxable 
year ends on December 31; T is neither a consolidated group member nor 
a RIC or a REIT; neither T nor PS1, a domestic partnership, owns at 
least 80 percent of the stock of any corporation; neither T nor PS1 
qualifies for the small business exemption in Sec.  1.163(j)-2(d) or is 
engaged in an excepted trade or business; T has no floor plan financing 
expense; all interest expense is deductible except for the potential 
application of section 163(j); and the facts set forth the only 
corporate or partnership activity.

      (i) Example 1: C corporation items properly allocable to a 
trade or business--(A) Facts. In taxable year 2019, T's taxable 
income (without regard to the application of section 163(j)) is 
$320x. This amount is comprised of the following tax items: $1,000x 
of revenue from inventory sales; $500x of ordinary and necessary 
business expenses (excluding interest and depreciation); $200x of 
interest expense; $50x of interest income; $50x of depreciation 
deductions under section 168; and a $20x gain on the sale of stock.
    (B) Analysis. For purposes of section 163(j), each of T's tax 
items is treated as properly allocable to a trade or business. Thus, 
T's ATI for the 2019 taxable year is $520x ($320x of taxable income 
+ $200x business interest expense-$50x business interest income + 
$50x depreciation deductions = $520x), and its section 163(j) 
limitation for the 2019 taxable year is $206x ($50x of business 
interest income + 30 percent of its ATI (30 percent x $520x) = 
$206x). As a result, all $200x of T's interest expense is deductible 
in the 2019 taxable year under section 163(j).
    (C) Taxable year beginning in 2022. The facts are the same as in 
Example 1 in paragraph (b)(6)(i)(A) of this section, except that the 
taxable year is 2022 and therefore depreciation deductions are not 
added back to ATI under Sec.  1.163(j)-1(b)(1)(i)(E). As a result, 
T's ATI for 2022 is $470x ($320x of taxable income + $200x business 
interest expense-$50x business interest income = $470x), and its 
section 163(j) limitation for the 2022 taxable year is $191x ($50x 
of business interest income + 30 percent of its ATI (30 percent x 
$470x) = $191x). As a result, T may only deduct $191x of its 
business interest expense for the taxable year, and the remaining 
$9x will be carried forward to the 2023 taxable year as a disallowed 
business interest expense carryforward. See Sec.  1.163(j)-2(c).
     (ii) Example 2: C corporation partner--(A) Facts. T and 
individual A each own a 50 percent interest in PS1, a general 
partnership. PS1 borrows funds from a third party (Loan 1) and uses 
those funds to buy stock in publicly-traded corporation X. PS1's 
only activities are holding X stock (and receiving dividends) and 
making payments on Loan 1. In the 2019 taxable year, PS1 receives 
$150x in dividends and pays $100x in interest on Loan 1.
    (B) Analysis. For purposes of section 163(d) and (j), PS1 has 
investment interest expense of $100x and investment income of $150x, 
and PS1 has no interest expense or interest income that is properly 
allocable to a trade or business. PS1 allocates its investment 
interest expense and investment income to its two partners pursuant 
to Sec.  1.163(j)-6(j). Pursuant to paragraph (b)(3) of this 
section, T's allocable share of PS1's investment interest expense is 
treated as a business interest expense of T, and T's allocable share 
of PS1's investment income is treated as properly allocable to a 
trade or business of T. This business interest expense is not 
treated as excess business interest expense, and this income is not 
treated as excess taxable income. See paragraph (b)(3)(iii) of this 
section. T's treatment of its allocable share of PS1's investment 
interest expense and investment income as business interest expense 
and income properly allocable to a trade or business, respectively, 
does not affect the character of these items at the PS1 level and 
does not affect the character of A's allocable share of PS1's 
investment interest and investment income.
    (C) Partnership engaged in a trade or business. The facts are 
the same as in Example 2 in paragraph (b)(6)(ii)(A) of this

[[Page 67546]]

section, except that PS1 also is engaged in Business 1, and PS1 
borrows funds from a third party to finance Business 1 (Loan 2). In 
2019, Business 1 earns $150x of net income (excluding interest 
expense and depreciation), and PS1 pays $100x of interest on Loan 2. 
For purposes of Sec.  1.163-8T, the interest paid on Loan 2 is 
allocated to a trade or business (and is therefore not treated as 
investment interest expense under section 163(d)). As a result, PS1 
has investment interest expense of $100x (attributable to Loan 1), 
business interest expense of $100x (attributable to Loan 2), $150x 
of investment income, and $150x of income from Business 1. PS1's ATI 
is $150x (its net income from Business 1 excluding interest and 
depreciation), and its section 163(j) limitation is $45x (30 percent 
x $150x). Pursuant to Sec.  1.163(j)-6, PS1 has $55x of excess 
business interest expense ($100x-$45x), half of which ($27.5x) is 
allocable to T. Additionally, pursuant to paragraph (b)(3)(i) of 
this section, T's allocable share of PS1's investment interest 
expense ($50x) is treated as a business interest expense of T for 
purposes of section 163(j), and T's allocable share of PS1's 
investment income ($75x) is treated as properly allocable to a trade 
or business of T. Therefore, with respect to T's interest in PS1, T 
is treated as having $50x of business interest expense that is not 
treated as excess business interest expense, $75x of income that is 
properly allocable to a trade or business, and $27.5x of excess 
business interest expense.

    (c) Effect on earnings and profits--(1) In general. In the case of 
a taxpayer that is a C corporation, except as otherwise provided in 
paragraph (c)(2) of this section, the disallowance and carryforward of 
a deduction for the taxpayer`s business interest expense under Sec.  
1.163(j)-2 will not affect whether or when the business interest 
expense reduces the taxpayer's earnings and profits.
    (2) Special rule for RICs and REITs. In the case of a taxpayer that 
is a RIC or a REIT for the taxable year in which a deduction for the 
taxpayer's business interest expense is disallowed under Sec.  
1.163(j)-2(b), or in which the RIC or REIT is allocated any excess 
business interest expense from a partnership under section 
163(j)(4)(B)(i) and Sec.  1.163(j)-6, the taxpayer's earnings and 
profits are adjusted in the taxable year or years in which the business 
interest expense is deductible or, if earlier, in the first taxable 
year for which the taxpayer no longer is a RIC or a REIT.
    (3) Special rule for partners that are C corporations. If a 
taxpayer that is a C corporation is allocated any excess business 
interest expense from a partnership under section 163(j)(4)(B)(i) and 
Sec.  1.163(j)-6, and if any amount of the excess business interest 
expense has not yet been treated as business interest expense by the 
taxpayer at the time of the taxpayer's disposition of all or 
substantially all of its interest in the partnership, then the taxpayer 
must increase its earnings and profits by that amount immediately prior 
to its disposition of the partnership interest.
    (4) Examples. The principles of this paragraph (c) are illustrated 
by the following examples. For purposes of the examples in this 
paragraph (c)(4), except as otherwise provided in the examples, X is a 
taxable domestic C corporation whose taxable year ends on December 31; 
X is not a member of a consolidated group; X does not qualify for the 
small business exemption under Sec.  1.163(j)-2(d); X is not engaged in 
an excepted trade or business; X has no floor plan financing 
indebtedness; all interest expense is deductible except for the 
potential application of section 163(j); X has no accumulated earnings 
and profits at the beginning of the 2019 taxable year; and the facts 
set forth the only corporate activity.

     (i) Example 1: Earnings and profits of a taxable domestic C 
corporation other than a RIC or a REIT--(A) Facts. X is a 
corporation that does not intend to qualify as a RIC or a REIT for 
its 2019 taxable year. In that year, X has taxable income (without 
regard to the application of section 163(j)) of $0, which includes 
$100x of gross income and $100x of interest expense on a loan from 
an unrelated third party. X also makes a $100x distribution to its 
shareholders that year.
    (B) Analysis. The $100x of interest expense is business interest 
expense for purposes of section 163(j) (see paragraph (b)(1) of this 
section). X's ATI in the 2019 taxable year is $100x ($0 of taxable 
income computed without regard to $100x of business interest 
expense). Thus, X may deduct $30x of its $100x of business interest 
expense in the 2019 taxable year under Sec.  1.163(j)-2(b) (30 
percent x $100x), and X may carry forward the remainder ($70x) to 
X's 2020 taxable year as a disallowed business interest expense 
carryforward under Sec.  1.163(j)-2(c). Although X may not currently 
deduct all $100x of its business interest expense in the 2019 
taxable year, X must reduce its earnings and profits in that taxable 
year by the full amount of its business interest expense ($100x) in 
that taxable year. As a result, no portion of X's distribution of 
$100x to its shareholders in the 2019 taxable year is a dividend 
within the meaning of section 316(a).
     (ii) Example 2: RIC adjusted taxable income and earnings and 
profits--(A) Facts. X is a corporation that intends to qualify as a 
RIC for its 2019 taxable year. In that taxable year, X's only items 
are $100x of interest income, $50x of dividend income from C 
corporations that only issue common stock and in which X has less 
than a twenty percent interest (by vote and value), $10x of net 
capital gain, and $125x of interest expense. None of the dividends 
are received on debt financed portfolio stock under section 246A. 
The DRD determined under section 243(a) with respect to X's $50x of 
dividend income is $25x. X pays $42x in dividends to its 
shareholders, meeting the requirements of section 562 during X's 
2019 taxable year, including $10x that X reports as capital gain 
dividends in written statements furnished to X's shareholders.
    (B) Analysis. (1) Under paragraph (b) of this section, all of 
X's interest expense is considered business interest expense, all of 
X's interest income is considered business interest income, and all 
of X's other income is considered to be properly allocable to a 
trade or business. Under paragraph (b)(4)(ii) of this section, prior 
to the application of section 163(j), X's taxable income is $10x 
($100x business interest income + $50x dividend income + $10x net 
capital gain-$125x business interest expense-$25x DRD = $10x). Under 
paragraph (b)(4)(iii) of this section, X's ATI is increased by the 
DRD. As such, X's ATI for the 2019 taxable year is $60x ($10x 
taxable income + $125x business interest expense-$100x business 
interest income + $25x DRD = $60x).
    (2) X may deduct $118x of its $125x of business interest expense 
in the 2019 taxable year under section 163(j)(1) ($100x business 
interest income + (30 percent x $60x of ATI) = $118x), and X may 
carry forward the remainder ($7x) to X's taxable year ending 
December 31, 2020. See Sec.  1.163(j)-2(b) and (c).
    (3) After the application of section 163(j), X has taxable 
income of $17x ($100x interest income + $50x dividend income + $10x 
capital gain-$25x DRD-$118x allowable interest expense = $17x) for 
the 2019 taxable year. X will have investment company taxable income 
(ICTI) in the amount of $0 ($17x taxable income-$10x capital gain + 
$25x DRD-$32x dividends paid deduction for ordinary dividends = 0). 
The excess of X's net capital gain ($10x) over X's dividends paid 
deduction determined with reference to capital gain dividends ($10x) 
is also $0.
    (4) Under paragraph (c)(2) of this section, X will not reduce 
its earnings and profits by the amount of interest expense 
disallowed as a deduction in the 2019 taxable year under section 
163(j). Thus, X has current earnings and profits in the amount of 
$42x ($100x interest income + $50x dividend income + $10x capital 
gain-$118x allowable business interest expense = $42x) before giving 
effect to dividends paid during the 2019 taxable year.
     (iii) Example 3: Carryforward of disallowed interest expense--
(A) Facts. The facts are the same as the facts in Example 2 in 
paragraph (c)(4)(ii)(A) of this section for the 2019 taxable year. 
In addition, X has $50x of interest income and $20x of interest 
expense for the 2020 taxable year.
    (B) Analysis. Under paragraph (b) of this section, all of X's 
interest expense is considered business interest expense, all of X's 
interest income is considered business interest income, and all of 
X's other income is considered to be properly allocable to a trade 
or business. Because X's $50x of business interest income exceeds 
the $20x of business interest expense from the 2020 taxable year and 
the $7x of disallowed business interest expense carryforward from 
the 2019 taxable year, X may deduct $27x of business interest 
expense in the 2020 taxable year. Under paragraph (c)(2) of this 
section,

[[Page 67547]]

X must reduce its current earnings and profits for the 2020 taxable 
year by the full amount of the deductible business interest expense 
($27x).
     (iv) Example 4: REIT adjusted taxable income and earnings and 
profits--(A) Facts. X is a corporation that intends to qualify as a 
REIT for its 2019 taxable year. X is not engaged in an excepted 
trade or business and is not engaged in a trade or business that is 
eligible to make any election under section 163(j)(7). In that year, 
X's only items are $100x of mortgage interest income, $30x of 
dividend income from C corporations that only issue common stock and 
in which X has less than a ten percent interest (by vote and value) 
in each C corporation, $10x of net capital gain from the sale of 
mortgages on real property that is not property described in section 
1221(a)(1), and $125x of interest expense. None of the dividends are 
received on debt financed portfolio stock under section 246A. The 
DRD determined under section 243(a) with respect to X's $30x of 
dividend income is $15x. X pays $28x in dividends meeting the 
requirements of section 562 during X's 2019 taxable year, including 
$10x that X properly designates as capital gain dividends under 
section 857(b)(3)(B).
    (B) Analysis. (1) Under paragraph (b) of this section, all of 
X's interest expense is considered business interest expense, all of 
X's interest income is considered business interest income, and all 
of X's other income is considered to be properly allocable to a 
trade or business. Under paragraph (b)(4)(ii) of this section, prior 
to the application of section 163(j), X's taxable income is $0 
($100x business interest income + $30x dividend income + $10x net 
capital gain-$125x business interest expense-$15x DRD = $0). Under 
paragraph (b)(4)(iii) of this section, X's ATI is increased by the 
DRD. As such, X's ATI for the 2019 taxable year is $40x ($0 taxable 
income + $125x business interest expense-$100x business interest 
income + $15x DRD = $40x).
    (2) X may deduct $112x of its $125x of business interest expense 
in the 2019 taxable year under section 163(j)(1) ($100x business 
interest income + (30 percent x $40x of ATI) = $112x), and X may 
carry forward the remainder of its business interest expense ($13x) 
to X's 2020 taxable year.
    (3) After the application of section 163(j), X has taxable 
income of $13x ($100x business interest income + $30x dividend 
income + $10x capital gain-$15x DRD-$112x allowable business 
interest expense = $13x) for the 2019 taxable year. X will have real 
estate investment trust taxable income (REITTI) in the amount of $0 
($13x taxable income + $15x of DRD-$28x dividends paid deduction = 
$0).
    (4) Under paragraph (c)(2) of this section, X will not reduce 
earnings and profits by the amount of business interest expense 
disallowed as a deduction in the 2019 taxable year. Thus, X has 
current earnings and profits in the amount of $28x ($100x business 
interest income + $30x dividend income + $10x capital gain-$112x 
allowable business interest expense = $28x) before giving effect to 
dividends paid during X's 2019 taxable year.
     (v) Example 5: Carryforward of disallowed interest expense--(A) 
Facts. The facts are the same as in Example 4 in paragraph 
(c)(4)(iv)(A) of this section for the 2019 taxable year. In 
addition, X has $50x of mortgage interest income and $20x of 
interest expense for the 2020 taxable year. X has no other tax items 
for the 2020 taxable year.
    (B) Analysis. Because X's $50x of business interest income 
exceeds the $20x of business interest expense from the 2020 taxable 
year and the $13x of disallowed business interest expense 
carryforwards from the 2019 taxable year, X may deduct $33x of 
business interest expense in 2020. Under paragraph (c)(2) of this 
section, X must reduce its current earnings and profits for 2020 by 
the full amount of the deductible interest expense ($33x).

    (d) Special rules for consolidated groups--(1) Scope. This 
paragraph (d) provides certain rules applicable to members of a 
consolidated group. For all members of a consolidated group for a 
consolidated return year, the computations required by section 163(j) 
and the section 163(j) regulations are made in accordance with the 
rules of this paragraph (d) unless otherwise provided elsewhere in the 
section 163(j) regulations. For rules governing the carryforward of 
disallowed business interest expense, including rules governing the 
treatment of disallowed business interest expense carryforwards when 
members enter or leave a group, see Sec.  1.163(j)-5.
    (2) Calculation of the section 163(j) limitation for members of a 
consolidated group--(i) In general. A consolidated group has a single 
section 163(j) limitation, the absorption of which is governed by Sec.  
1.163(j)-5(b)(3)(ii).
    (ii) Interest. For purposes of determining whether amounts, other 
than amounts in respect of intercompany obligations, as defined in 
Sec.  1.1502-13(g)(2)(ii), intercompany items, as defined in Sec.  
1.1502-13(b)(2), or corresponding items, as defined in Sec.  1.1502-
13(b)(3), are treated as interest within the meaning of Sec.  1.163(j)-
1(b)(20), all members of a consolidated group are treated as a single 
taxpayer.
    (iii) Calculation of business interest expense and business 
interest income for a consolidated group. For purposes of calculating 
the section 163(j) limitation for a consolidated group, the 
consolidated group's current-year business interest expense (as defined 
in Sec.  1.163(j)-5(a)(2)(i)) and business interest income, 
respectively, are the sum of each member's current-year business 
interest expense and business interest income, including amounts 
treated as business interest expense and business interest income under 
paragraph (b)(3) of this section.
    (iv) Calculation of adjusted taxable income. For purposes of 
calculating the ATI for a consolidated group, the relevant taxable 
income is the consolidated group's consolidated taxable income, 
determined under Sec.  1.1502-11 without regard to any carryforwards or 
disallowances under section 163(j). Additionally, if for a taxable year 
a member of a consolidated group is allowed a deduction under section 
250(a)(1) that is properly allocable to a non-excepted trade or 
business, then, for purposes of calculating ATI, consolidated taxable 
income for the taxable year is determined as if the deduction were not 
subject to the limitation in section 250(a)(2). For this purpose, the 
amount of the deduction allowed under section 250(a)(1) is determined 
without regard to the application of section 163(j) and the section 
163(j) regulations. Further, for purposes of calculating the ATI of the 
group, intercompany items and corresponding items are disregarded to 
the extent that they offset in amount. Thus, for example, certain 
portions of the intercompany items and corresponding items of a group 
member engaged in a non-excepted trade or business will not be included 
in ATI to the extent that the counterparties to the relevant 
intercompany transactions are engaged in one or more excepted trades or 
businesses.
    (v) Treatment of intercompany obligations. For purposes of 
determining a member's business interest expense and business interest 
income, and for purposes of calculating the consolidated group's ATI, 
all intercompany obligations, as defined in Sec.  1.1502-13(g)(2)(ii), 
are disregarded. Therefore, interest expense and interest income from 
intercompany obligations are not treated as business interest expense 
and business interest income.
    (3) Investment adjustments. For rules governing investment 
adjustments within a consolidated group, see Sec.  1.1502-32(b).
    (4) Ownership of partnership interests by members of a consolidated 
group--(i) Dispositions of partnership interests. The transfer of a 
partnership interest in an intercompany transaction that does not 
result in the termination of the partnership is treated as a 
disposition for purposes of the basis adjustment rule in section 
163(j)(4)(B)(iii)(II), regardless of whether the transfer is one in 
which gain or loss is recognized. See Sec.  1.1502-13 for rules 
applicable to the redetermination of attributes of group members. A 
change in status of a member (becoming or ceasing to be a member) is 
not treated as a disposition

[[Page 67548]]

for purposes of section 163(j)(4)(B)(iii)(II).
    (ii) Basis adjustments under Sec.  1.1502-32. A member's allocation 
of excess business interest expense from a partnership and the 
resulting decrease in basis in the partnership interest under section 
163(j)(4)(B) is not a noncapital, nondeductible expense for purposes of 
Sec.  1.1502-32(b)(3)(iii). Additionally, an increase in a member's 
basis in a partnership interest under section 163(j)(4)(B)(iii)(II) to 
reflect excess business interest expense not deducted by the 
consolidated group is not tax-exempt income for purposes of Sec.  
1.1502-32(b)(3)(ii). Investment adjustments are made under Sec.  
1.1502-32(b)(3)(i) when the excess business interest expense from the 
partnership is absorbed by the consolidated group. See Sec.  1.1502-
32(b).
    (iii) [Reserved]
    (5) Examples. The principles of this paragraph (d) are illustrated 
by the following examples (see also Sec.  1.1502-13(c)(7)(ii)(R) and 
(S)). For purposes of the examples in this paragraph (d)(5), S is a 
member of the calendar-year consolidated group of which P is the common 
parent; the P group does not qualify for the small business exemption 
in Sec.  1.163(j)-2(d); no member of the P group is engaged in an 
excepted trade or business; all interest expense is deductible except 
for the potential application of section 163(j); and the facts set 
forth the only corporate activity.

     (i) Example 1: Calculation of the section 163(j) limitation--
(A) Facts. In the 2019 taxable year, P has $50x of separate taxable 
income after taking into account $65x of interest paid on a loan 
from a third party (without regard to any disallowance under section 
163(j)) and $35x of depreciation deductions under section 168. In 
turn, S has $40x of separate taxable income in the 2019 taxable year 
after taking into account $10x of depreciation deductions under 
section 168. S has no interest expense in the 2019 taxable year. The 
P group's consolidated taxable income for the 2019 taxable year is 
$90x, determined under Sec.  1.1502-11 without regard to any 
disallowance under section 163(j).
    (B) Analysis. As provided in paragraph (b)(1) of this section, 
P's interest expense is treated as business interest expense for 
purposes of section 163(j). If P and S were to apply the section 
163(j) limitation on a separate-entity basis, then P's ATI would be 
$150x ($50x + $65x + $35x = $150x), its section 163(j) limitation 
would be $45x (30 percent x $150x = $45x), and a deduction for $20x 
of its $65x of business interest expense would be disallowed in the 
2019 taxable year under section 163(j). However, as provided in 
paragraph (d)(2) of this section, the P group computes a single 
section 163(j) limitation, and that computation begins with the P 
group's consolidated taxable income (as determined prior to the 
application of section 163(j)), or $90x. The P group's ATI is $200x 
($50x + $40x + $65x + $35x + $10x = $200x). Thus, the P group's 
section 163(j) limitation for the 2019 taxable year is $60x (30 
percent x $200x = $60x). As a result, all but $5x of the P group's 
business interest expense is deductible in the 2019 taxable year. P 
carries over the $5x of disallowed business interest expense to the 
succeeding taxable year.
     (ii) Example 2: Intercompany obligations--(A) Facts. On January 
1, 2019, G, a corporation unrelated to P and S, lends P $100x in 
exchange for a note that accrues interest at a 10 percent annual 
rate. A month later, P lends $100x to S in exchange for a note that 
accrues interest at a 12 percent annual rate. In 2019, P accrues and 
pays $10x of interest to G on P's note, and S accrues and pays $12x 
of interest to P on S's note. For that year, the P group's only 
other items of income, gain, deduction, and loss are $40x of income 
earned by S from the sale of inventory, and a $30x deductible 
expense arising from P's payment of tort liability claims.
    (B) Analysis. As provided in paragraph (d)(2)(v) of this 
section, the intercompany obligation between P and S is disregarded 
in determining P and S's business interest expense and business 
interest income and in determining the P group's ATI. For purposes 
of section 163(j), P has $10x of business interest expense and a 
$30x deduction for the payment of tort liability claims, and S has 
$40x of income. The P group's ATI is $10x ($40x-$30x = $10x), and 
its section 163(j) limitation is $3x (30 percent x $10x = $3x). The 
P group may deduct $3x of its business interest expense in the 2019 
taxable year. A deduction for P's remaining $7x of business interest 
expense is disallowed in the 2019 taxable year, and this amount is 
carried forward to the 2020 taxable year.

    (e) Cross-references. For rules governing the treatment of 
disallowed business interest expense carryforwards for C corporations, 
see Sec.  1.163(j)-5. For rules governing the application of section 
163(j) to a C corporation or a consolidated group engaged in both 
excepted and non-excepted trades or businesses, see Sec.  1.163(j)-10.
    (f) Applicability date. The provisions of this section apply to 
taxable years ending after the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register. However, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may apply the rules of this 
section to a taxable year beginning after December 31, 2017, so long as 
the taxpayers and their related parties consistently apply the rules of 
the section 163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-5  General rules governing disallowed business interest 
expense carryforwards for C corporations.

    (a) Scope and definitions--(1) Scope. This section provides certain 
rules regarding disallowed business interest expense carryforwards for 
taxpayers that are C corporations, including members of a consolidated 
group. Paragraph (b) of this section provides rules regarding the 
treatment of disallowed business interest expense carryforwards. 
Paragraph (c) of this section provides cross-references to other rules 
regarding disallowed business interest expense carryforwards in 
transactions to which section 381(a) applies. Paragraph (d) of this 
section provides rules regarding limitations on disallowed business 
interest expense carryforwards from separate return limitation years 
(SRLYs). Paragraph (e) of this section provides cross-references to 
other rules regarding the application of section 382 to disallowed 
business interest expense carryforwards. Paragraph (f) of this section 
provides rules regarding the overlap of the SRLY limitation with 
section 382.
    (2) Definitions--(i) Current-year business interest expense. The 
term current-year business interest expense means business interest 
expense (as defined in Sec.  1.163(j)-1(b)(2)) that would be deductible 
in the current taxable year without regard to section 163(j) and that 
is not a disallowed business interest expense carryforward (as defined 
in Sec.  1.163(j)-1(b)(9)) from a prior taxable year.
    (ii) Allocable share of the consolidated group's remaining section 
163(j) limitation. The term allocable share of the consolidated group's 
remaining section 163(j) limitation means, with respect to any member 
of a consolidated group, the product of the consolidated group's 
remaining section 163(j) limitation and the member's remaining current-
year interest ratio.
    (iii) Consolidated group's remaining section 163(j) limitation. The 
term consolidated group's remaining section 163(j) limitation means the 
amount of the consolidated group's section 163(j) limitation calculated 
pursuant to Sec.  1.163(j)-4(d)(2), reduced by the amount of interest 
deducted by members of the consolidated group pursuant to paragraph 
(b)(3)(ii)(C)(2) of this section.
    (iv) Remaining current-year interest ratio. The term remaining 
current-year interest ratio means, with respect to any member of a 
consolidated group for a particular taxable year, the ratio of the

[[Page 67549]]

remaining current-year business interest expense of the member after 
applying the rule in paragraph (b)(3)(ii)(C)(2) of this section, to the 
sum of the amounts of remaining current-year business interest expense 
for all members of the consolidated group after applying the rule in 
paragraph (b)(3)(ii)(C)(2) of this section.
    (b) Treatment of disallowed business interest expense 
carryforwards--(1) In general. The amount of any business interest 
expense of a C corporation not allowed as a deduction for any taxable 
year as a result of the limitation under section 163(j)(1) and Sec.  
1.163(j)-2(b) is carried forward to the succeeding taxable year as a 
disallowed business interest expense carryforward under section 
163(j)(2) and Sec.  1.163(j)-2(c).
    (2) Deduction of business interest expense. For a taxpayer that is 
a C corporation, current-year business interest expense is deducted in 
the current taxable year before any disallowed business interest 
expense carryforwards from a prior taxable year are deducted in that 
year. Disallowed business interest expense carryforwards are deducted 
in the order of the taxable years in which they arose, beginning with 
the earliest taxable year, subject to certain limitations (for example, 
the limitation under section 382). For purposes of section 163(j), 
disallowed disqualified interest is treated as carried forward from the 
taxable year in which a deduction was disallowed under old section 
163(j).
    (3) Consolidated groups--(i) In general. A consolidated group's 
disallowed business interest expense carryforwards for the current 
consolidated return year (the current year) are the carryforwards from 
the group's prior consolidated return years plus any carryforwards from 
separate return years.
    (ii) Deduction of business interest expense--(A) General rule. All 
current-year business interest expense of members of a consolidated 
group is deducted in the current year before any disallowed business 
interest expense carryforwards from prior taxable years are deducted in 
the current year. Disallowed business interest expense carryforwards 
from prior taxable years are deducted in the order of the taxable years 
in which they arose, beginning with the earliest taxable year, subject 
to the limitations described in this section.
    (B) Section 163(j) limitation is equal to or exceeds the current-
year business interest expense and disallowed business interest expense 
carryforwards from prior taxable years. If a consolidated group's 
section 163(j) limitation for the current year is equal to or exceeds 
the aggregate amount of its members' current-year business interest 
expense and disallowed business interest expense carryforwards from 
prior taxable years that are available for deduction, then none of the 
current-year business interest expense or disallowed business interest 
expense carryforwards will be subject to disallowance in the current 
year under section 163(j). However, a deduction for the members' 
business interest expense may be subject to limitation under other 
provisions of the Code or the regulations promulgated thereunder (see, 
for example, paragraphs (c), (d), (e), and (f) of this section).
    (C) Current-year business interest expense and disallowed business 
interest expense carryforwards exceed section 163(j) limitation. If the 
aggregate amount of members' current-year business interest expense and 
disallowed business interest expense carryforwards from prior taxable 
years exceeds the consolidated group's section 163(j) limitation for 
the current year, then the following rules apply in the order provided.
    (1) The group first determines whether its section 163(j) 
limitation for the current year equals or exceeds the aggregate amount 
of the members' current-year business interest expense.
    (i) If the group's section 163(j) limitation for the current year 
equals or exceeds the aggregate amount of the members' current-year 
business interest expense, then no amount of the group's current-year 
business interest expense will be subject to disallowance in the 
current year under section 163(j). Once the group has taken into 
account its members' current-year business interest expense, the group 
applies the rules of paragraph (b)(3)(ii)(C)(4) of this section.
    (ii) If the aggregate amount of members' current-year business 
interest expense exceeds the group's section 163(j) limitation for the 
current year, then the group applies the rule in paragraph 
(b)(3)(ii)(C)(2) of this section.
    (2) If this paragraph (b)(3)(ii)(C)(2) applies (see paragraph 
(b)(3)(ii)(C)(1)(ii) of this section), then each member with current-
year business interest expense and with current-year business interest 
income or floor plan financing interest deducts current-year business 
interest expense in an amount that does not exceed the sum of the 
member's business interest income and floor plan financing interest 
expense for the current year.
    (3) After applying the rule in paragraph (b)(3)(ii)(C)(2) of this 
section, if the group has any section 163(j) limitation remaining for 
the current year, then each member with remaining current-year business 
interest expense deducts a portion of its expense based on its 
allocable share of the consolidated group's remaining section 163(j) 
limitation.
    (4) If this paragraph (b)(3)(ii)(C)(4) applies (see paragraph 
(b)(3)(ii)(C)(1)(i) of this section), and if the group has any section 
163(j) limitation remaining for the current year after applying the 
rules in paragraph (b)(3)(ii)(C)(1) of this section, then disallowed 
business interest expense carryforwards permitted to be deducted in the 
current year will be deducted in the order of the taxable years in 
which they arose, beginning with the earliest taxable year. Disallowed 
business interest expense carryforwards from taxable years ending on 
the same date that are available to offset consolidated taxable income 
for the current year generally will be deducted on a pro rata basis, 
under the principles of paragraph (b)(3)(ii)(C)(3) of this section. For 
example, assume that P and S are the only members of a consolidated 
group with a section 163(j) limitation for the current year (Year 2) of 
$200x; the amount of current-year business interest expense deducted in 
Year 2 is $100x; and P and S, respectively, have $140x and $60x of 
disallowed business interest expense carryforwards from Year 1 that are 
not subject to limitation under paragraph (c), (d), or (e) of this 
section. Under these facts, P would be allowed to deduct $70x of its 
carryforwards from Year 1 ($100x x ($140x/($60x + $140x)) = $70x), and 
S would be allowed to deduct $30x of its carryforwards from Year 1 
($100x x ($60x/($60x + $140x)) = $30x). But see Sec.  1.383-
1(d)(1)(ii), providing that, if losses subject to and not subject to 
the section 382 limitation are carried from the same taxable year, 
losses subject to the limitation are deducted before losses not subject 
to the limitation.
    (5) Each member with remaining business interest expense after 
applying the rules of this paragraph (b)(3)(ii), taking into account 
the limitations in paragraphs (c), (d), (e), and (f) of this section, 
will carry the expense forward to the succeeding taxable year as a 
disallowed business interest expense carryforward under section 
163(j)(2) and Sec.  1.163(j)-2(c).
    (iii) Departure from group. If a corporation ceases to be a member 
during a consolidated return year, the corporation's current-year 
business interest expense from the taxable period ending on the day of 
the corporation's change in status as a member, as well as the 
corporation's disallowed business interest expense carryforwards from 
prior taxable years that are available to

[[Page 67550]]

offset consolidated taxable income in the consolidated return year, are 
first made available for deduction during that consolidated return 
year. See Sec.  1.1502-76(b)(1)(i); see also Sec.  1.1502-36(d) 
(regarding reductions of deferred deductions on the transfer of loss 
shares of subsidiary stock). Only the amount that is neither deducted 
by the group in that consolidated return year nor otherwise reduced 
under the Code or regulations may be carried to the corporation's first 
separate return year after its change in status.

     (iv) Example: Deduction of interest expense--(A) Facts. (1) P 
wholly owns A, which is a member of the consolidated group of which 
P is the common parent. P and A each borrow money from Z, an 
unrelated third party. The business interest expense of P and A in 
Years 1, 2, and 3, and the P group's section 163(j) limitation for 
those years, are as follows:

                                      Table 1 to Paragraph (b)(3)(iv)(A)(1)
----------------------------------------------------------------------------------------------------------------
                                        P's business interest    A's business interest      P group's section
                 Year                          expense                  expense             163(j) limitation
----------------------------------------------------------------------------------------------------------------
1....................................                    $150x                     $50x                    $100x
2....................................                      60x                      90x                     120x
3....................................                      25x                      50x                     185x
----------------------------------------------------------------------------------------------------------------

    (2) P and A have neither business interest income nor floor plan 
financing interest expense in Years 1, 2, and 3. Additionally, the P 
group is neither eligible for the small business exemption in Sec.  
1.163(j)-2(d) nor engaged in an excepted trade or business within 
the meaning of Sec.  1.163(j)-1(b)(38)(ii).
    (B) Analysis--(1) Year 1. In Year 1, the aggregate amount of the 
P group members' current-year business interest expense ($150x + 
$50x) exceeds the P group's section 163(j) limitation ($100x). As a 
result, the rules of paragraph (b)(3)(ii)(C) of this section apply. 
Because the P group members' current-year business interest expense 
exceeds the group's section 163(j) limitation for Year 1, P and A 
must apply the rule in paragraph (b)(3)(ii)(C)(2) of this section. 
Pursuant to paragraph (b)(3)(ii)(C)(2) of this section, each of P 
and A must deduct its current-year business interest expense to the 
extent of its business interest income and floor plan financing 
interest expense. Neither P nor A has business interest income or 
floor plan financing interest expense in Year 1. Next, pursuant to 
paragraph (b)(3)(ii)(C)(3) of this section, each of P and A must 
deduct a portion of its current-year business interest expense based 
on its allocable share of the consolidated group's remaining section 
163(j) limitation ($100x). P's allocable share is $75x ($100x x 
($150x/$200x) = $75x), and A's allocable share is $25x ($100x x 
($50x/$200x) = $25x). Accordingly, in Year 1, P deducts $75x of its 
current-year business interest expense, and A deducts $25x of its 
current-year business interest expense. P has a disallowed business 
interest expense carryforward from Year 1 of $75x ($150x-$75x = 
$75x), and A has a disallowed business interest expense carryforward 
from Year 1 of $25x ($50x-$25x = $25x).
    (2) Year 2. In Year 2, the aggregate amount of the P group 
members' current-year business interest expense ($60x + $90x) and 
disallowed business interest expense carryforwards ($75x + $25x) 
exceeds the P group's section 163(j) limitation ($120x). As a 
result, the rules of paragraph (b)(3)(ii)(C) of this section apply. 
Because the P group members' current-year business interest expense 
exceeds the group's section 163(j) limitation for Year 2, P and A 
must apply the rule in paragraph (b)(3)(ii)(C)(2) of this section. 
Pursuant to paragraph (b)(3)(ii)(C)(2) of this section, each of P 
and A must deduct its current-year business interest expense to the 
extent of its business interest income and floor plan financing 
interest expense. Neither P nor A has business interest income or 
floor plan financing interest expense in Year 2. Next, pursuant to 
paragraph (b)(3)(ii)(C)(3) of this section, each of P and A must 
deduct a portion of its current-year business interest expense based 
on its allocable share of the consolidated group's remaining section 
163(j) limitation ($120x). P's allocable share is $48x (($120x x 
($60x/$150x)) = $48x), and A's allocable share is $72x (($120x x 
($90x/$150x)) = $72x). Accordingly, in Year 2, P deducts $48x of 
current-year business interest expense, and A deducts $72x of 
current-year business interest expense. P has a disallowed business 
interest expense carryforward from Year 2 of $12x ($60x-$48x = 
$12x), and A has a disallowed business interest expense carryforward 
from Year 2 of $18x ($90x-$72x = $18x). Additionally, because the P 
group has no section 163(j) limitation remaining after deducting 
current-year business interest expense in Year 2, the full amount of 
P and A's disallowed business interest expense carryforwards from 
Year 1 ($75x and $25x, respectively) also are carried forward to 
Year 3. As a result, at the beginning of Year 3, P and A's 
respective disallowed business interest expense carryforwards are as 
follows:

                                      Table 1 to Paragraph (b)(3)(iv)(B)(2)
----------------------------------------------------------------------------------------------------------------
                                          Year 1 disallowed        Year 2 disallowed         Total disallowed
                                          business interest        business interest        business interest
                                        expense carryforwards    expense carryforwards    expense carryforwards
----------------------------------------------------------------------------------------------------------------
P....................................                     $75x                     $12x                     $87x
A....................................                      25x                      18x                      43x
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Total................................                     100x                      30x                     130x
----------------------------------------------------------------------------------------------------------------

    (3) Year 3. In Year 3, the aggregate amount of the P group 
members' current-year business interest expense ($25x + $50x = $75x) 
and disallowed business interest expense carryforwards ($130x) 
exceeds the P group's section 163(j) limitation ($185x). As a 
result, the rules of paragraph (b)(3)(ii)(C) of this section apply. 
Because the P group's section 163(j) limitation for Year 3 equals or 
exceeds the P group members' current-year business interest expense, 
no amount of the members' current-year business interest expense 
will be subject to disallowance under section 163(j) (see paragraph 
(b)(3)(ii)(C)(1) of this section). After each of P and A deducts its 
current-year business interest expense, the P group has $110x of 
section 163(j) limitation remaining for Year 3 ($185x-$25x-$50x = 
$110x). Next, pursuant to paragraph (b)(3)(ii)(C)(4) of this 
section, $110x of disallowed business interest expense carryforwards 
are deducted on a pro rata basis, beginning with carryforwards from 
Year 1. Because the total amount of carryforwards from Year 1 
($100x) is less than the section 163(j) limitation remaining after 
the deduction of Year 3 business interest expense ($110x), all of 
the Year 1 carryforwards are deducted in Year 3. After current-year 
business interest expense and Year 1 carryforwards are deducted, the 
P group's remaining section 163(j) limitation in Year 3 is $10x. 
Because the Year 2 carryforwards ($30x) exceed the remaining section 
163(j) limitation ($10x), under paragraph (b)(3)(ii)(C)(4) of this 
section, each

[[Page 67551]]

of P and A will deduct a portion of its Year 2 carryforwards based 
on its allocable share of the consolidated group's remaining section 
163(j) limitation. P's allocable share is $4x (($10x x ($12x/$30x)) 
= $4x), and A's allocable share is $6x (($10x x ($18x/$30x)) = $6x). 
Accordingly, P and A may deduct $4x and $6x, respectively, of their 
Year 2 carryforwards. For Year 4, P and A have $8x and $12x of 
disallowed business interest expense carryforwards from Year 2, 
respectively.

    (c) Disallowed business interest expense carryforwards in 
transactions to which section 381(a) applies. For rules governing the 
application of section 381(c)(20) to disallowed business interest 
expense carryforwards, including limitations on an acquiring 
corporation's use of the disallowed business interest expense 
carryforwards of the transferor or distributor corporation in the 
acquiring corporation's first taxable year ending after the date of 
distribution or transfer, see Sec.  1.381(c)(20)-1.
    (d) Limitations on disallowed business interest expense 
carryforwards from separate return limitation years--(1) General rule. 
Except as provided in paragraph (f) of this section (relating to an 
overlap with section 382), the disallowed business interest expense 
carryforwards of a member arising in a separate return limitation year 
(or SRLY (see Sec.  1.1502-1(f))) that are included in the consolidated 
group's business interest expense deduction for any taxable year under 
paragraph (b) of this section may not exceed the group's section 163(j) 
limitation for that year, determined by reference only to the member's 
items of income, gain, deduction, and loss for that year (section 
163(j) SRLY limitation). For purposes of this paragraph (d), the SRLY 
subgroup principles of Sec.  1.1502-21(c)(2) apply with appropriate 
adjustments.
    (2) Deduction of disallowed business interest expense carryforwards 
arising in a SRLY. Notwithstanding paragraph (d)(1) of this section, 
disallowed business interest expense carryforwards of a member arising 
in a SRLY are available for deduction by the consolidated group in the 
current year only to the extent the group has any remaining section 
163(j) limitation for the current year after the deduction of current-
year business interest expense and disallowed business interest expense 
carryforwards from earlier taxable years that are permitted to be 
deducted in the current year (see paragraph (b)(3)(ii)(A) of this 
section), and only to the extent the section 163(j) SRLY limitation for 
the current year exceeds the amount of the member's business interest 
expense already deducted by the group in that year under paragraph 
(b)(3)(ii) of this section. SRLY-limited disallowed business interest 
expense carryforwards are deducted on a pro rata basis (under the 
principles of paragraph (b)(3)(ii)(C)(3) of this section) with non-SRLY 
limited disallowed business interest expense carryforwards from taxable 
years ending on the same date.
    (3) Examples. The principles of this paragraph (d) are illustrated 
by the following examples. For purposes of the examples in this 
paragraph (d)(3), unless otherwise stated, P, R, S, and T are taxable 
domestic C corporations that are not regulated investment companies 
(RICs) or real estate investment trusts (REITs) and that file their tax 
returns on a calendar-year basis; none of P, R, S, or T qualifies for 
the small business exemption under section 163(j)(3) or is engaged in 
an excepted trade or business; all interest expense is deductible 
except for the potential application of section 163(j); and the facts 
set forth the only corporate activity.

     (i) Example 1: Determination of SRLY limitation--(A) Facts. 
Individual A owns P. In 2019, A forms T, which pays or accrues a 
$100x business interest expense for which a deduction is disallowed 
under section 163(j) and that is carried forward to 2020. P does not 
pay or accrue business interest expense in 2019, and P has no 
disallowed business interest expense carryforwards from prior 
taxable years. At the close of 2019, P acquires all of the stock of 
T, which joins with P in filing a consolidated return beginning in 
2020. Neither P nor T pays or accrues business interest expense in 
2020, and the P group has a section 163(j) limitation of $300x in 
that year. This limitation would be $70x if determined by reference 
solely to T's items for 2020.
    (B) Analysis. T's $100x of disallowed business interest expense 
carryforwards from 2019 arose in a SRLY. P's acquisition of T was 
not an ownership change as defined by section 382(g); thus, T's 
disallowed business interest expense carryforwards are subject to 
the SRLY limitation in paragraph (d)(1) of this section. The section 
163(j) SRLY limitation for 2020 is the P group's section 163(j) 
limitation, determined by reference solely to T's items for 2020 
($70x). See paragraph (d)(1) of this section. Thus, $70x of T's 
disallowed business interest expense carryforwards are available to 
be deducted by the P group in 2020, and the remaining $30x of T's 
disallowed business interest expense carryforwards are carried 
forward to 2021.
    (C) Section 163(j) limitation of $0. The facts are the same as 
in paragraph (A) of this Example 1, except that the section 163(j) 
SRLY limitation for 2020 (computed by reference solely to T's items 
for that year) is $0. Because the amount of T's disallowed business 
interest expense carryforwards that may be deducted by the P group 
in 2020 may not exceed the section 163(j) SRLY limitation for that 
year, none of T's carryforwards from 2019 may be deducted by the P 
group in 2020.
     (ii) Example 2: Deduction of disallowed business interest 
expense carryforwards arising in a SRLY--(A) Facts. P and S are the 
only members of a consolidated group. P has neither current-year 
business interest expense nor disallowed business interest expense 
carryforwards. S has $100x of disallowed business interest expense 
carryforwards that arose in a SRLY and $150x of current-year 
business interest. The section 163(j) SRLY limitation for the 
current year (computed by reference solely to S's items for that 
year) is $200x. Assume that the P group's section 163(j) limitation 
for the current year would permit all of S's current-year business 
interest expense and disallowed business interest expense 
carryforwards to be deducted in the current year but for the rules 
of this paragraph (d).
    (B) Analysis. Under paragraph (d)(1) of this section, the 
section 163(j) SRLY limitation for the current year of $200x 
(computed by reference solely to S's items for that year) exceeds 
the amount of S's business interest expense taken into account by 
the P group in the current year under paragraph (b)(3)(ii) of this 
section ($150x) by $50x. Thus, $50x of S's disallowed business 
interest expense carryforwards that arose in a SRLY may be taken 
into account by the P group in the current year.

    (e) Application of section 382--(1) Pre-change loss. For rules 
governing the treatment of a disallowed business interest expense as a 
pre-change loss for purposes of section 382, see Sec. Sec.  1.382-2(a) 
and 1.382-6. For rules governing the application of section 382 to 
disallowed disqualified interest carryforwards, see Sec.  1.163(j)-
11(b)(4).
    (2) Loss corporation. For rules governing when a disallowed 
business interest expense causes a corporation to be a loss corporation 
within the meaning of section 382(k)(1), see Sec.  1.382-2(a). For the 
application of section 382 to disallowed disqualified interest 
carryforwards, see Sec.  1.163(j)-11(b)(4).
    (3) Ordering rules for utilization of pre-change losses and for 
absorption of the section 382 limitation. For ordering rules for the 
utilization of disallowed business interest expense, net operating 
losses, and other pre-change losses, and for the absorption of the 
section 382 limitation, see Sec.  1.383-1(d).
    (4) Disallowed business interest expense from the pre-change period 
in the year of a testing date. For rules governing the treatment of 
disallowed business interest expense from the pre-change period (within 
the meaning of Sec.  1.382-6(g)(2)) in the year of a testing date, see 
Sec.  1.382-2.
    (f) Overlap of SRLY limitation with section 382. The limitation 
provided in paragraph (d) of this section does not apply to disallowed 
business interest expense carryforwards when the

[[Page 67552]]

application of paragraph (d) of this section results in an overlap with 
the application of section 382. For purposes of applying this paragraph 
(f), the principles of Sec.  1.1502-21(g) apply with appropriate 
adjustments.
    (g) Additional limitations. Additional rules provided under the 
Code or regulations also apply to limit the use of disallowed business 
interest expense carryforwards. For rules governing the relationship 
between section 163(j) and other provisions affecting the deductibility 
of interest, see Sec.  1.163(j)-3.
    (h) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-6  Application of the business interest deduction 
limitation to partnerships and subchapter S corporations.

    (a) Overview. If a deduction for business interest expense of a 
partnership or S corporation is subject to limitation under section 
163(j), section 163(j)(4) provides that the section 163(j) limitation 
applies at the partnership or S corporation level and any deduction for 
business interest expense within the meaning of section 163(j) is taken 
into account in determining the nonseparately stated taxable income or 
loss of the partnership or S corporation. Once a partnership or S 
corporation determines its business interest expense, business interest 
income, ATI, and floor plan financing interest expense, the partnership 
or S corporation calculates its section 163(j) limitation by applying 
the rules of Sec.  1.163(j)-2(b) and this section. Paragraph (b) of 
this section provides definitions used in this section. Paragraph (c) 
of this section provides rules regarding the character of a 
partnership's deductible business interest expense and excess business 
interest expense. Paragraph (d) of this section provides rules 
regarding the calculation of a partnership's ATI and floor plan 
financing interest expense. Paragraph (e) of this section provides 
rules regarding a partner's ATI and business interest income. Paragraph 
(f) of this section provides an eleven-step computation necessary for 
properly allocating a partnership's deductible business interest 
expense and section 163(j) excess items to its partners. Paragraph (g) 
of this section applies carryforward rules at the partner level if a 
partnership has excess business interest expense, as defined in Sec.  
1.163(j)-1(b)(14). Paragraph (h) of this section provides basis 
adjustment rules and paragraph (j) of this section provides rules 
regarding investment items of a partnership. Paragraph (l) of this 
section provides rules regarding S corporations. Paragraph (m) of this 
section provides rules for partnerships and S corporations not subject 
to section 163(j). Paragraph (o) of this section provides examples 
illustrating the rules of this section. Paragraph (p) provides the 
applicability date of the rules in this section.
    (b) Definitions. In addition to the definitions contained in Sec.  
1.163(j)-1, the following definitions apply for purposes of this 
section.
    (1) Section 163(j) items. The term section 163(j) items means the 
partnership or S corporation's business interest expense, business 
interest income, and items comprising ATI, as defined in Sec.  
1.163(j)-1(b)(1).
    (2) Partner basis items. The term partner basis items means any 
items of income, gain, loss, or deduction resulting from either an 
adjustment to the basis of partnership property used in a non-excepted 
trade or business made pursuant to section 743(b) or the operation of 
section 704(c)(1)(C)(i) with respect to such property. Partner basis 
items also include section 743(b) basis adjustments used to increase or 
decrease a partner's share of partnership gain or loss on the sale of 
partnership property used in a non-excepted trade or business (as 
described in Sec.  1.743-1(j)(3)(i)) and amounts resulting from the 
operation of section 704(c)(1)(C)(i) used to decrease a partner's share 
of partnership gain or increase a partner's share of partnership loss 
on the sale of such property.
    (3) Remedial items. The term remedial items means any allocation to 
a partner of remedial items of income, gain, loss, or deduction 
pursuant to section 704(c) and Sec.  1.704-3(d).
    (4) Excess business interest income. The term excess business 
interest income means the amount by which a partnership's or S 
corporation's business interest income exceeds its business interest 
expense in a taxable year.
    (5) Deductible business interest expense. The term deductible 
business interest expense means the amount of a partnership's or S 
corporation's business interest expense that is deductible under 
section 163(j) in the current taxable year following the application of 
the limitation contained in Sec.  1.163(j)-2(b).
    (6) Section 163(j) excess items. The term section 163(j) excess 
items means the partnership's excess business interest expense, excess 
taxable income, and excess business interest income.
    (7) Non-excepted assets. The term non-excepted assets means assets 
from a trade or business other than assets from an excepted regulated 
utility trade or business, electing farming business, or electing real 
property trade or business, as such terms are defined in Sec.  
1.163(j)-1.
    (8) Excepted assets. The term excepted assets means assets from an 
excepted regulated utility trade or business, electing farming 
business, or electing real property trade or business, as such terms 
are defined in Sec.  1.163(j)-1.
    (c) Character of business interest expense. If a partnership has 
deductible business interest expense, such deductible business interest 
expense is not subject to any additional application of section 163(j) 
at the partner-level because it is taken into account in determining 
the nonseparately stated taxable income or loss of the partnership. For 
all other purposes of the Code, however, deductible business interest 
expense and excess business interest expense retain their character as 
business interest expense at the partner-level. For example, for 
purposes of section 469, such business interest expense retains its 
character as either passive or non-passive in the hands of the partner. 
Additionally, for purposes of section 469, deductible business interest 
expense and excess business interest expense from a partnership remain 
interest derived from a trade or business in the hands of a partner 
even if the partner does not materially participate in the 
partnership's trade or business activity. For additional rules 
regarding the interaction between sections 465, 469, and 163(j), see 
Sec.  1.163(j)-3.
    (d) Adjusted taxable income of the partnership--(1) Modification of 
adjusted taxable income for partnerships. The ATI of the partnership 
generally is determined in accordance with Sec.  1.163(j)-1(b)(1). For 
purposes of computing the partnership's ATI, the taxable income of the 
partnership is determined under section 703(a) and includes any items 
described

[[Page 67553]]

in section 703(a)(1) to the extent such items are otherwise included 
under Sec.  1.163(j)-1(b)(1).
    (2) Section 734(b), partner basis items, and remedial items. A 
partnership takes into account items resulting from adjustments made to 
the basis of its property pursuant to section 734(b) for purposes of 
calculating its ATI pursuant to Sec.  1.163(j)-1(b)(1). However, 
partner basis items and remedial items are not taken into account in 
determining a partnership's ATI under Sec.  1.163(j)-1(b)(1). Instead, 
partner basis items and remedial items are taken into account by the 
partner in determining the partner's ATI pursuant to Sec.  1.163(j)-
1(b)(1). See Example 8 in paragraph (o)(8) of this section.
    (e) Adjusted taxable income and business interest income of 
partners--(1) Modification of adjusted taxable income for partners. The 
ATI of a partner in a partnership generally is determined in accordance 
with Sec.  1.163(j)-1(b)(1) without regard to such partner's 
distributive share of any items of income, gain, deduction, or loss of 
such partnership, and is increased by such partner's distributive share 
of such partnership's excess taxable income determined under paragraph 
(f) of this section. For rules regarding corporate partners, see Sec.  
1.163(j)-4(b)(3).
    (2) Partner basis items and remedial items. Partner basis items and 
remedial items are taken into account as items derived directly by the 
partner in determining the partner's ATI for purposes of the partner's 
section 163(j) limitation. If a partner is allocated remedial items, 
such partner's ATI is increased or decreased by the amount of such 
items. Additionally, to the extent a partner is allocated partner basis 
items, such partner's ATI is increased or decreased by the amount of 
such item. See Example 8 in paragraph (o)(8) of this section.
    (3) Disposition of partnership interests. If a partner recognizes 
gain or loss upon the disposition of interests in a partnership, and 
the partnership in which the interest is being disposed owns only non-
excepted trade or business assets, the gain or loss on the disposition 
of the partnership interest is included in the partner's ATI. For 
dispositions of interests in partnerships that own:
    (i) Non-excepted assets and excepted assets; or
    (ii) Investment assets; or
    (iii) Both. See Sec.  1.163(j)-10(b)(4)(ii).
    (4) Double counting of business interest income and floor plan 
financing interest expense prohibited. For purposes of calculating a 
partner's section 163(j) limitation, the partner does not include--
    (i) Business interest income from a partnership that is subject to 
section 163(j) except to the extent it is allocated excess business 
interest income from that partnership pursuant to paragraph (f)(2) of 
this section; and
    (ii) The partner's allocable share of the partnership's floor plan 
financing interest expense because such floor plan financing interest 
expense has already been taken into account by the partnership in 
determining its nonseparately stated taxable income or loss for 
purposes of section 163(j).
    (f) Allocation and determination of section 163(j) excess items 
made in the same manner as nonseparately stated taxable income or loss 
of the partnership--(1) Overview--(i) In general. The purpose of this 
section is to provide guidance regarding how a partnership must 
allocate its deductible business interest expense and section 163(j) 
excess items, if any, among its partners. For purposes of section 
163(j)(4) and this section, allocations and determinations of 
deductible business interest expense and section 163(j) excess items 
are considered made in the same manner as the nonseparately stated 
taxable income or loss of the partnership if, and only if, such 
allocations and determinations are made in accordance with the eleven-
step computation set forth in paragraphs (f)(2)(i) through (xi) of this 
section. A partnership first determines its section 163(j) limitation, 
total amount of deductible business interest expense, and section 
163(j) excess items under paragraph (f)(2)(i) of this section. The 
partnership then applies paragraphs (f)(2)(ii) through (xi) of this 
section, in that order, to determine how those items of the partnership 
are allocated among its partners. At the conclusion of the eleven-step 
computation set forth in paragraphs (f)(2)(i) through (xi) of this 
section, the total amount of deductible business interest expense and 
section 163(j) excess items allocated to each partner will equal the 
partnership's total amount of deductible business interest expense and 
section 163(j) excess items.
    (ii) Relevance solely for purposes of section 163(j). No rule set 
forth in paragraph (f)(2) of this section prohibits a partnership from 
making an allocation to a partner of any item of partnership income, 
gain, loss, or deduction that is otherwise permitted under section 704 
and the regulations thereunder. Accordingly, any calculations in 
paragraphs (f)(2)(i) through (xi) of this section are solely for the 
purpose of determining each partner's deductible business interest 
expense and section 163(j) excess items, and do not otherwise affect 
any other provision under the Code, such as section 704(b). 
Additionally, floor plan financing interest expense is not allocated in 
accordance with paragraph (f)(2) of this section. Instead, floor plan 
financing interest expense of a partnership is allocated to its 
partners under section 704(b) and is taken into account as a 
nonseparately stated item of loss for purposes of section 163(j).
    (2) Steps for allocating deductible business interest expense and 
section 163(j) excess items--(i) Partnership-level calculation required 
by section 163(j)(4)(A). First, a partnership must determine its 
section 163(j) limitation pursuant to Sec.  1.163(j)-2(b). This 
calculation determines a partnership's total amounts of excess business 
interest income, excess taxable income, excess business interest 
expense (that is, the partnership's section 163(j) excess items), and 
deductible business interest expense under section 163(j) for a taxable 
year.
    (ii) Determination of each partner's relevant section 163(j) items. 
Second, a partnership must determine each partner's allocable share of 
each section 163(j) item under section 704(b) and the regulations 
thereunder including any allocations under section 704(c), other than 
remedial items as defined in paragraph (b)(3) of this section. Only 
section 163(j) items that were actually taken into account in the 
partnership's section 163(j) calculation under paragraph (f)(2)(i) of 
this section are taken into account for purposes of this paragraph 
(f)(2)(ii). Partner basis items, allocations of investment income and 
expense, remedial items, and amounts determined for the partner under 
Sec.  1.163(j)-8T are not taken into account for purposes of this 
paragraph (f)(2)(ii). For purposes of paragraphs (f)(2)(ii) through 
(xi) of this section, the term allocable ATI means a partner's 
distributive share of the partnership's ATI (i.e., a partner's 
distributive share of gross income and gain items comprising ATI less 
such partner's distributive share of gross loss and deduction items 
comprising ATI), the term allocable business interest income means a 
partner's distributive share of the partnership's business interest 
income, and the term allocable business interest expense means a 
partner's distributive share of the partnership's business interest 
expense that is not floor plan financing interest expense.
    (iii) Partner-level comparison of business interest income and 
business interest expense. Third, a partnership must compare each 
partner's allocable business interest income to such

[[Page 67554]]

partner's allocable business interest expense. Paragraphs (f)(2)(iii) 
through (v) of this section determine how a partnership must allocate 
its excess business interest income among its partners, as well as the 
amount of each partner's allocable business interest expense that is 
not deductible business interest expense after taking the partnership's 
business interest income into account. To the extent a partner's 
allocable business interest income exceeds its allocable business 
interest expense, the partner has an allocable business interest income 
excess. The aggregate of all the partners' allocable business interest 
income excess amounts is the total allocable business interest income 
excess. To the extent a partner's allocable business interest expense 
exceeds its allocable business interest income, the partner has an 
allocable business interest income deficit. The aggregate of all the 
partners' allocable business interest income deficit amounts is the 
total allocable business interest income deficit. These amounts are 
required to perform calculations in paragraphs (f)(2)(iv) and (v) of 
this section, which appropriately reallocate allocable business 
interest income excess to partners with allocable business interest 
income deficits in order to reconcile the partner-level calculation 
under paragraph (f)(2)(iii) of this section with the partnership-level 
result under paragraph (f)(2)(i) of this section.
    (iv) Matching partnership and aggregate partner excess business 
interest income. Fourth, a partnership must determine each partner's 
final allocable business interest income excess. A partner's final 
allocable business interest income excess is determined by reducing, 
but not below zero, such partner's allocable business interest income 
excess (if any) by the partner's step four adjustment amount. A 
partner's step four adjustment amount is the product of the total 
allocable business interest income deficit and the ratio of such 
partner's allocable business interest income excess to the total 
allocable business interest income excess. The rules of this paragraph 
(f)(2)(iv) ensure that, following the application of paragraph 
(f)(2)(xi) of this section, the aggregate of all the partners' 
allocations of excess business interest income equals the total amount 
of the partnership's excess business interest income as determined in 
paragraph (f)(2)(i) of this section.
    (v) Remaining business interest expense determination. Fifth, a 
partnership must determine each partner's remaining business interest 
expense. A partner's remaining business interest expense is calculated 
by reducing, but not below zero, such partner's allocable business 
interest income deficit (if any) by such partner's step five adjustment 
amount. A partner's step five adjustment amount is the product of the 
total allocable business interest income excess and the ratio of such 
partner's allocable business interest income deficit to the total 
allocable business interest income deficit. Generally, a partner's 
remaining business interest expense is a partner's allocable business 
interest income deficit adjusted to reflect a reallocation of allocable 
business interest income excess from other partners. Determining a 
partner's remaining business interest expense is necessary to perform 
an ATI calculation that begins in paragraph (f)(2)(vii) of this 
section.
    (vi) Determination of final allocable ATI. Sixth, a partnership 
must determine each partner's final allocable ATI. Paragraphs 
(f)(2)(vi) through (x) of this section determine how a partnership must 
allocate its excess taxable income and excess business interest expense 
among its partners.
    (A) Positive allocable ATI. To the extent a partner's income and 
gain items comprising its allocable ATI exceed its deduction and loss 
items comprising its allocable ATI, the partner has positive allocable 
ATI. The aggregate of all the partners' positive allocable ATI amounts 
is the total positive allocable ATI.
    (B) Negative allocable ATI. To the extent a partner's deduction and 
loss items comprising its allocable ATI exceed its income and gain 
items comprising its allocable ATI, the partner has negative allocable 
ATI. The aggregate of all the partners' negative allocable ATI amounts 
is the total negative allocable ATI.
    (C) Final allocable ATI. Any partner with a negative allocable ATI, 
or an allocable ATI of $0, has a positive allocable ATI of $0. Any 
partner with a positive allocable ATI of $0 has a final allocable ATI 
of $0. The final allocable ATI of any partner with a positive allocable 
ATI greater than $0 is such partner's positive allocable ATI reduced, 
but not below zero, by the partner's step six adjustment amount. A 
partner's step six adjustment amount is the product of the total 
negative allocable ATI and the ratio of such partner's positive 
allocable ATI to the total positive allocable ATI. The total of the 
partners' final allocable ATI amounts must equal the partnership's ATI 
amount used to compute its section 163(j) limitation pursuant to Sec.  
1.163(j)-2(b).
    (vii) Partner-level comparison of thirty percent of adjusted 
taxable income and remaining business interest expense. Seventh, a 
partnership must compare each partner's ATI capacity to such partner's 
remaining business interest expense as determined under paragraph 
(f)(2)(v) of this section. A partner's ATI capacity is the amount that 
is thirty percent of such partner's final allocable ATI as determined 
under paragraph (f)(2)(vi) of this section. A partner's final allocable 
ATI is grossed down to thirty percent prior to being compared to its 
remaining business interest expense in this calculation to parallel the 
partnership's adjustment to its ATI under section 163(j)(1)(B). To the 
extent a partner's ATI capacity exceeds its remaining business interest 
expense, the partner has an ATI capacity excess. The aggregate of all 
the partners' ATI capacity excess amounts is the total ATI capacity 
excess. To the extent a partner's remaining business interest expense 
exceeds its ATI capacity, the partner has an ATI capacity deficit. The 
aggregate of all the partners' ATI capacity deficit amounts is the 
total ATI capacity deficit. These amounts (which may be subject to 
adjustment under paragraph (f)(2)(viii) of this section) are required 
to perform calculations in paragraphs (f)(2)(ix) and (x) of this 
section, which appropriately reallocate ATI capacity excess to partners 
with ATI capacity deficits in order to reconcile the partner-level 
calculation under paragraph (f)(2)(vii) of this section with the 
partnership-level result under paragraph (f)(2)(i) of this section.
    (viii) Partner priority right to ATI capacity excess 
determination--(A) Eighth, the partnership must determine whether it is 
required to make any adjustments described in this paragraph 
(f)(2)(viii) and, if it is, make such adjustments. The rules of this 
paragraph (f)(2)(viii) are necessary to account for adjustments made to 
a partner's allocable ATI in paragraph (f)(2)(vi) of this section to 
ensure that the partners who had a negative allocable ATI do not 
inappropriately benefit under the rules of paragraphs (f)(2)(ix) 
through (xi) of this section to the detriment of the partners who had 
positive allocable ATI. The partnership must perform the calculations 
and make the necessary adjustments described under paragraphs 
(f)(2)(viii)(B) and (C) or paragraph (f)(2)(viii)(D) of this section 
if, and only if, there is--
    (1) An excess business interest expense amount greater than $0 
under paragraph (f)(2)(i) of this section;
    (2) A total negative allocable ATI amount greater than $0 under 
paragraph (f)(2)(vi) of this section; and

[[Page 67555]]

    (3) A total ATI capacity excess amount greater than $0 under 
paragraph (f)(2)(vii) of this section.
    (B) A partnership must determine each partner's priority amount and 
usable priority amount. A partner's priority amount is thirty percent 
of the amount by which a partner's positive allocable ATI under 
paragraph (f)(2)(vi)(A) of this section exceeds such partner's final 
allocable ATI under paragraph (f)(2)(vi)(C) of this section. However, 
only partners with an ATI capacity deficit as determined under 
paragraph (f)(2)(vii) of this section can have a priority amount 
greater than $0. The aggregate of all the partners' priority amounts is 
the total priority amount. A partner's usable priority amount is the 
lesser of such partner's priority amount and such partner's ATI 
capacity deficit as determined under paragraph (f)(2)(vii) of this 
section. The aggregate of all the partners' usable priority amounts is 
the total usable priority amount. If the total ATI capacity excess 
amount, as determined under paragraph (f)(2)(vii) of this section, is 
greater than or equal to the total usable priority amount, then the 
partnership must perform the adjustments described in paragraph 
(f)(2)(viii)(C) of this section. If the total usable priority amount is 
greater than the total ATI capacity excess amount, as determined under 
paragraph (f)(2)(vii) of this section, then the partnership must 
perform the adjustments described in paragraph (f)(2)(viii)(D) of this 
section.
    (C) For purposes of paragraph (f)(2)(ix) of this section, each 
partner's final ATI capacity excess amount is $0. For purposes of 
paragraph (f)(2)(x) of this section, the following terms have the 
following meanings for each partner:
    (1) Each partner's ATI capacity deficit is such partner's ATI 
capacity deficit as determined under paragraph (f)(2)(vii) of this 
section reduced by such partner's usable priority amount.
    (2) The total ATI capacity deficit is the total ATI capacity 
deficit as determined under paragraph (f)(2)(vii) of this section 
reduced by the total usable priority amount.
    (3) The total ATI capacity excess is the total ATI capacity excess 
as determined under paragraph (f)(2)(vii) of this section reduced by 
the total usable priority amount.
    (D) Any partner with a priority amount greater than $0 is a 
priority partner. Any partner that is not a priority partner is a non-
priority partner. For purposes of paragraph (f)(2)(ix) of this section, 
each partner's final ATI capacity excess amount is $0. For purposes of 
paragraph (f)(2)(x) of this section, each non-priority partner's final 
ATI capacity deficit amount is such partner's ATI capacity deficit as 
determined under paragraph (f)(2)(vii) of this section. For purposes of 
paragraph (f)(2)(x) of this section, the following terms have the 
following meanings for priority partners.
    (1) Each priority partner must determine its step eight excess 
share. A partner's step eight excess share is the product of the total 
ATI capacity excess as determined under paragraph (f)(2)(vii) of this 
section and the ratio of the partner's priority amount to the total 
priority amount.
    (2) To the extent a priority partner's step eight excess share 
exceeds its ATI capacity deficit as determined under paragraph 
(f)(2)(vii) of this section, such excess amount is the priority 
partner's ATI capacity excess for purposes of paragraph (f)(2)(x) of 
this section. The total ATI capacity excess is the aggregate of the 
priority partners' ATI capacity excess amounts as determined under this 
paragraph (f)(2)(viii)(D)(2).
    (3) To the extent a priority partner's ATI capacity deficit as 
determined under paragraph (f)(2)(vii) of this section exceeds its step 
eight excess share, such excess amount is the priority partner's ATI 
capacity deficit for purposes of paragraph (f)(2)(x) of this section. 
The total ATI capacity deficit is the aggregate of the priority 
partners' ATI capacity deficit amounts as determined under this 
paragraph (f)(2)(viii)(D)(3).
    (ix) Matching partnership and aggregate partner excess taxable 
income. Ninth, a partnership must determine each partner's final ATI 
capacity excess. A partner's final ATI capacity excess amount is 
determined by reducing, but not below zero, such partner's ATI capacity 
excess (if any) by the partner's step nine adjustment amount. A 
partner's step nine adjustment amount is the product of the total ATI 
capacity deficit and the ratio of such partner's ATI capacity excess to 
the total ATI capacity excess. The rules of this paragraph (f)(2)(ix) 
ensure that, following the application of paragraph (f)(2)(xi) of this 
section, the aggregate of all the partners' allocations of excess 
taxable income equals the total amount of the partnership's excess 
taxable income as determined in paragraph (f)(2)(i) of this section.
    (x) Matching partnership and aggregate partner excess business 
interest expense. Tenth, a partnership must determine each partner's 
final ATI capacity deficit. A partner's final ATI capacity deficit 
amount is determined by reducing, but not below zero, such partner's 
ATI capacity deficit (if any) by the partner's step ten adjustment 
amount. A partner's step ten adjustment amount is the product of the 
total ATI capacity excess and the ratio of such partner's ATI capacity 
deficit to the total ATI capacity deficit. Generally, a partner's final 
ATI capacity deficit is a partner's ATI capacity deficit adjusted to 
reflect a reallocation of ATI capacity excess from other partners. The 
rules of this paragraph (f)(2)(x) ensure that, following the 
application of paragraph (f)(2)(xi) of this section, the aggregate of 
all the partners' allocations of excess business interest expense 
equals the total amount of the partnership's excess business interest 
expense as determined in paragraph (f)(2)(i) of this section.
    (xi) Final section 163(j) excess item and deductible business 
interest expense allocation. Eleventh, a partnership must allocate 
section 163(j) excess items and deductible business interest expense to 
its partners. Excess business interest income calculated under 
paragraph (f)(2)(i) of this section, if any, is allocated dollar for 
dollar by the partnership to its partners with final allocable business 
interest income excess amounts. Excess business interest expense 
calculated under paragraph (f)(2)(i) of this section, if any, is 
allocated dollar for dollar to partners with final ATI capacity deficit 
amounts. After grossing up each partner's final ATI capacity excess 
amount by ten-thirds, excess taxable income calculated under paragraph 
(f)(2)(i) of this section, if any, is allocated dollar for dollar to 
partners with final ATI capacity excess amounts. A partner's allocable 
business interest expense is deductible business interest expense to 
the extent it exceeds such partner's share of excess business interest 
expense. See paragraphs (o)(11) through (15) of this section.
    (g) Carryforwards--(1) In general. The amount of any business 
interest expense not allowed as a deduction to a partnership by reason 
of Sec.  1.163(j)-2(b) and paragraph (f)(2) of this section for any 
taxable year is--
    (i) Not treated as business interest expense of the partnership in 
the succeeding taxable year; and
    (ii) Subject to paragraph (g)(2) of this section, treated as excess 
business interest expense which is allocated to each partner pursuant 
to paragraph (f)(2) of this section.
    (2) Treatment of excess business interest expense allocated to 
partners. If a partner is allocated excess business interest expense 
from a partnership under paragraph (f)(2) of this section for any 
taxable year--
    (i) Solely for purposes of section 163(j), such excess business 
interest expense is treated as business interest

[[Page 67556]]

expense paid or accrued by the partner in the next succeeding taxable 
year in which the partner is allocated excess taxable income or excess 
business interest income from such partnership, but only to the extent 
of such excess taxable income or excess business interest income; and
    (ii) Any portion of such excess business interest expense remaining 
after the application of paragraph (g)(2)(i) of this section is excess 
business interest expense that is subject to the limitations of 
paragraph (g)(2)(i) of this section in succeeding years, unless 
paragraph (m)(3) of this section applies. See paragraphs (o)(1) through 
(10) of this section.
    (3) Excess taxable income and excess business interest income 
ordering rule. In the event a partner has excess business interest 
expense from a prior taxable year and is allocated excess taxable 
income or excess business interest income from the same partnership in 
a succeeding taxable year, the partner must treat, for purposes of 
section 163(j), the excess business interest expense as business 
interest expense paid or accrued by the partner in an amount equal to 
the partner's share of the partnership's excess taxable income or 
excess business interest income in such succeeding taxable year. See 
paragraphs (o)(2) through (10) of this section.
    (h) Basis adjustments--(1) Section 704(d) ordering. Deductible 
business interest expense and excess business interest expense are 
subject to section 704(d). If a partner is subject to a limitation on 
loss under section 704(d) and a partner is allocated losses from a 
partnership in a taxable year, Sec.  1.704-1(d)(2) requires that the 
limitation on losses under section 704(d) be apportioned amongst these 
losses based on the character of each loss (each grouping of loses 
based on character being a ``section 704(d) loss class''). If there are 
multiple section 704(d) loss classes in a given year, Sec.  1.704-
1(d)(2) requires the partner to apportion the limitation on losses 
under section 704(d) to each section 704(d) loss class proportionately. 
For purposes of applying this proportionate rule, any deductible 
business interest expense (whether allocated to the partner in the 
current taxable year or suspended under section 704(d) in a prior 
taxable year), any excess business interest expense allocated to the 
partner in the current taxable year, and any excess business interest 
expense from a prior taxable year that was suspended under section 
704(d) (``negative section 163(j) expense'') shall comprise the same 
section 704(d) loss class. Once the partner determines the amount of 
limitation on losses apportioned to this section 704(d) loss class, any 
deductible business interest expense is taken into account before any 
excess business interest expense or negative section 163(j) expense. 
See paragraph (o)(9) of this section.
    (2) Excess business interest expense basis adjustments. The 
adjusted basis of a partner in a partnership interest is reduced, but 
not below zero, by the amount of excess business interest expense 
allocated to the partner pursuant to paragraph (f)(2) of this section. 
Negative section 163(j) expense is not treated as excess business 
interest expense in any subsequent year until such negative section 
163(j) expense is no longer suspended under section 704(d). Therefore, 
negative section 163(j) expense does not affect, and is not affected 
by, any allocation of excess taxable income to the partner. 
Accordingly, any excess taxable income allocated to a partner from a 
partnership while the partner still has negative section 163(j) expense 
will be included in the partner's ATI. However, once the negative 
section 163(j) expense is no longer suspended under section 704(d), it 
becomes excess business interest expense, which is subject to the 
general rules in paragraph (g) of this section. See paragraph (o)(10) 
of this section.
    (3) Basis adjustments upon disposition of partnership interest--(i) 
Complete disposition of partnership interest. If a partner disposes of 
all or substantially all of a partnership interest (whether by sale, 
exchange, or redemption), the adjusted basis of the partnership 
interest is increased immediately before the disposition by the amount 
of the excess (if any) of the amount of the basis reduction under 
paragraph (h)(2) of this section over the portion of any excess 
business interest expense allocated to the partner under paragraph 
(f)(2) of this section which has previously been treated under 
paragraph (g) of this section as business interest expense pair or 
accrued by the partner, regardless of whether the disposition was a 
result of a taxable or non-taxable transaction. Therefore, the adjusted 
basis of a partner in a partnership interest is not increased by any 
negative section 163(j) expense upon the disposition of a partnership 
interest. No deduction under section 163(j) is allowed to the 
transferor or transferee under chapter 1 of subtitle A of the Code for 
any excess business interest expense resulting in a basis increase 
under this section or any negative section 163(j) expense.
    (ii) Partial disposition of partnership interest. If a partner 
disposes of less than substantially all of its interest in a 
partnership (whether by sale, exchange, or redemption), a partner shall 
not increase its basis in its partnership interest by the amount of any 
excess business interest expense that has not yet been treated as 
business interest expense paid or accrued by the partner in accordance 
with paragraph (g) of this section. Any such excess business interest 
expense shall remain excess business interest expense of the transferor 
partner until such time as the transferor partner is allocated an 
appropriate amount of excess taxable income or excess business interest 
income from the partnership or the partner disposes of its partnership 
interest in accordance with paragraph (h)(2)(i) of this section. 
Additionally, any negative section 163(j) expense shall remain negative 
section 163(j) expense of the transferor partner until such negative 
section 163(j) expense is no longer suspended under section 704(d).
    (i) [Reserved]
    (j) Investment items. Any item of a partnership's income, gain, 
deduction, or loss that is investment interest income or expense 
pursuant to Sec.  1.163-8T is allocated to each partner in accordance 
with section 704(b) and the regulations thereunder and the effect of 
such allocation for purposes of section 163 is determined at the 
partner-level. See Sec.  1.163(j)-4(b)(3), section 163(d), and Sec.  
1.163-8T.
    (k) [Reserved]
    (l) S corporations--(1) In general. In the case of any S 
corporation, the section 163(j) limitation is applied at the S 
corporation level, and any deduction allowed for business interest 
expense is taken into account in determining the nonseparately stated 
taxable income or loss of the S corporation. An S corporation 
determines its section 163(j) limitation in the same manner as set 
forth in Sec.  1.163(j)-2(b). Allocations of excess taxable income and 
excess business interest income are made in accordance with the 
shareholders' respective pro rata interests in the S corporation 
pursuant to section 1366(a)(1) after determining the S corporation's 
section 163(j) limitation pursuant to Sec.  1.163(j)-2(b).
    (2) Character of deductible business interest expense. If an S 
corporation has deductible business interest expense, such deductible 
business interest expense is not subject to any additional application 
of section 163(j) at the shareholder-level because such deductible 
business interest expense is taken into account in determining the 
nonseparately stated taxable income or loss of the S corporation. For 
all other

[[Page 67557]]

purposes of the Code, however, deductible business interest expense 
retains its character as business interest expense at the shareholder-
level. For example, for purposes of section 469, such deductible 
business interest expense retains its character as either passive or 
non-passive in the hands of the shareholder. Additionally, for purposes 
of section 469, deductible business interest expense from an S 
corporation remains interest derived from a trade or business in the 
hands of a shareholder even if the shareholder does not materially 
participate in the S corporation's trade or business activity. For 
additional rules regarding the interaction between sections 465, 469, 
and 163(j), see Sec.  1.163(j)-3.
    (3) Adjusted taxable income of an S corporation. The ATI of an S 
corporation generally is determined in accordance with Sec.  1.163(j)-
1(b)(1). For purposes of computing the S corporation's ATI, the taxable 
income of the S corporation is determined under section 1363(b) and 
includes--
    (i) Any item described in section 1363(b)(1); and
    (ii) Any item described in Sec.  1.163(j)-1(b)(1), to the extent 
such item is consistent with subchapter S of the Code.
    (4) Adjusted taxable income and business interest income of S 
corporation shareholders--(i) Adjusted taxable income of S corporation 
shareholders. The ATI of an S corporation shareholder is determined in 
accordance with Sec.  1.163(j)-1(b)(1) without regard to such 
shareholder's distributive share of any items of income, gain, 
deduction, or loss of such S corporation, and is increased by such 
shareholder's distributive share of such S corporation's excess taxable 
income, as defined in Sec.  1.163(j)-1(b)(15).
    (ii) Disposition of S corporation stock. If a shareholder of an S 
corporation recognizes gain or loss upon the disposition of stock of 
the S corporation, and the corporation in which the stock is being 
disposed only owns non-excepted trade or business assets, the gain or 
loss on the disposition of the stock is included in the shareholder's 
ATI. For dispositions of stock of S corporations that own:
    (A) Non-excepted assets and excepted assets; or
    (B) Investment assets; or
    (C) Both. See Sec.  1.163(j)-10(b)(4)(ii).
    (iii) Double counting of business interest income and floor plan 
financing interest expense prohibited. For purposes of calculating an S 
corporation shareholder's section 163(j) limitation, the shareholder 
does not include--
    (A) Business interest income from an S corporation that is subject 
to section 163(j) except to the extent it is allocated excess business 
interest income from that S corporation pursuant to paragraph (l)(1) of 
this section; and
    (B) The shareholder's share of the S corporation's floor plan 
financing interest expense because such floor plan financing interest 
expense has already been taken into account by the S corporation in 
determining its nonseparately stated taxable income or loss for 
purposes of section 163(j).
    (5) Carryforwards. The amount of any business interest expense not 
allowed as a deduction for any taxable year by reason of the limitation 
contained in Sec.  1.163(j)-2(b) is carried forward in the succeeding 
taxable year as a disallowed business interest expense carryforward 
under the rules set forth in Sec.  1.163(j)-2(c) (whether to an S 
corporation or C corporation taxable year). S corporations are subject 
to:
    (i) The same ordering rules as a C corporation that is not a member 
of a consolidated group; and
    (ii) The limitation under section 382. See Sec.  1.163(j)-5(b)(2) 
and (e).
    (6) Basis adjustments and disallowed business interest expense 
carryforwards. An S corporation shareholder's adjusted basis in its S 
corporation stock is reduced, but not below zero, when a disallowed 
business interest expense carryforward becomes deductible under section 
163(j).
    (7) Accumulated adjustment accounts. The accumulated adjustment 
account of an S corporation is adjusted to take into account business 
interest expense in the year in which the S corporation treats such 
business interest expense as deductible under the section 163(j) 
limitation. See section 1368(e)(1).
    (8) Termination of qualified subchapter S subsidiary election. If a 
corporation's qualified subchapter S subsidiary election terminates and 
any disallowed business interest expense carryforward is attributable 
to the activities of the qualified subchapter S subsidiary at the time 
of termination, such disallowed business interest expense carryforward 
remains with the parent S corporation and no portion of these items is 
allocable to the former qualified subchapter S subsidiary.
    (9) Investment items. Any item of an S corporation's income, gain, 
deduction, or loss that is investment interest income or expense 
pursuant to Sec.  1.163-8T is allocated to each shareholder in 
accordance with the shareholders' pro rata interests in the S 
corporation pursuant to section 1366(a)(1). See section 163(d), Sec.  
1.163-8T.
    (m) Partnerships and S corporations not subject to section 163(j)--
(1) Partnerships and S corporations not subject to section 163(j) by 
reason of the small business exemption. If a partnership or S 
corporation is not subject to section 163(j) by reason of Sec.  
1.163(j)-2(d) (exempt entity), the exempt entity does not calculate the 
section 163(j) limitation under Sec.  1.163(j)-2 and these regulations. 
Because an exempt entity is not subject to section 163(j)(4), it does 
not take its deduction for business interest expense into account in 
determining its non-separately stated taxable income or loss within the 
meaning of section 163(j)(4)(A)(i) and retains its character as 
business interest expense. See Sec.  1.163(j)-6(c). Thus, if a partner 
or S corporation shareholder is allocated business interest expense 
from an exempt entity, that allocated business interest expense will be 
subject to the partner's or S corporation shareholder's section 163(j) 
limitations. Additionally, contrary to the general rule in Sec.  
1.163(j)-6(e)(1), a partner or S corporation shareholder includes items 
of income, gain, loss, or deduction of such exempt entity when 
calculating its ATI. Finally, business interest income of such exempt 
entity is included in the partner's or S corporation shareholder's 
section 163(j) limitation regardless of the exempt entity's business 
interest expense amount.
    (2) Partnerships and S corporations not subject to section 163(j) 
by reason of an excepted trade or business. To the extent a partnership 
or S corporation is not subject to section 163(j) because it has an 
excepted trade or business as defined in Sec.  1.163(j)-1(b)(38)(ii) 
(excepted entity), the entity does not apply its section 163(j) 
limitation under Sec.  1.163(j)-2 and this section with respect to the 
business interest expense that is allocable to such excepted trade or 
business. If a partner or S corporation shareholder is allocated any 
section 163(j) item that is allocable to the partnership's or S 
corporation's excepted trade or business (excepted 163(j) items), such 
excepted 163(j) items are excluded from the partner or shareholder's 
section 163(j) deduction calculation. See Sec.  1.163(j)-10(c) 
(regarding the allocation of items between excepted and non-excepted 
trades or businesses).
    (3) Partnerships that allocated excess business interest expense 
prior to becoming not subject to section 163(j). If a partnership 
allocates excess business interest expense to one or more of its 
partners, and in a succeeding taxable year becomes not subject to the 
requirements of section 163(j), the

[[Page 67558]]

excess business interest expense from the prior taxable years is 
treated as paid or accrued by the partner in such succeeding taxable 
year. See paragraphs (o)(6) and (7) of this section.
    (4) S corporations with disallowed business interest expense 
carryforwards prior to becoming not subject to section 163(j). If an S 
corporation has a disallowed business interest expense carryforward for 
a taxable year, and in the succeeding taxable year becomes not subject 
to the requirements of section 163(j), then such disallowed business 
interest expense carryforward--
    (i) Continues to be carried forward at the S corporation level;
    (ii) Is no longer subject to the section 163(j) limitation; and
    (iii) Is taken into account in determining the nonseparately stated 
taxable income or loss of the S corporation.
    (n) [Reserved]
    (o) Examples. The examples in this paragraph illustrate the 
provisions of section 163(j) as applied to partnerships and subchapter 
S corporations. For purposes of these examples, each partnership is 
subject to the provisions of section 163(j), was created or organized 
in the United States, and is a calendar year taxpayer. Unless stated 
otherwise, all partners are subject to the provisions of section 
163(j), are not subject to a limitation under section 704(d) or 
1366(d), have no tax items other than those listed in the example, are 
U.S. citizens, and are calendar year taxpayers. The phrase ``section 
163(j) limit'' shall equal the maximum potential deduction allowed 
under section 163(j)(1). Unless stated otherwise, business interest 
expense means business interest expense that is not floor plan 
financing interest expense. With respect to partnerships, all 
allocations are in accordance with section 704(b) and the regulations 
thereunder.
     (1) Example 1--(i) Facts. X and Y are equal partners in 
partnership PRS. In Year 1, PRS has $100 of ATI and $40 of business 
interest expense. PRS allocates the items comprising its $100 of ATI 
$50 to X and $50 to Y. PRS allocates its $40 of business interest 
expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business 
interest expense from its sole proprietorship. Y has $0 of ATI and 
$20 of business interest expense from its sole proprietorship.
    (ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 
30 percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $30 
of deductible business interest expense and $10 of excess business 
interest expense. Such $30 of deductible business interest expense 
is includable in PRS's non-separately stated income or loss, and is 
not subject to further limitation under section 163(j) at the 
partners' level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $15 of deductible business 
interest expense and $5 of excess business interest expense. At the 
end of Year 1, X and Y each have $5 of excess business interest 
expense from PRS, which is not treated as paid or accrued by the 
partner until such partner is allocated excess taxable income or 
excess business interest income from PRS in a succeeding taxable 
year. Pursuant to Sec.  1.163(j)-6(e)(1), X and Y, in computing 
their limit under section 163(j), do not increase any of their 
section 163(j) items by any of PRS's section 163(j) items. X and Y 
each increase their outside basis in PRS by $30 ($50--$20).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $100 of ATI and $20 of business interest expense 
from its sole proprietorship. X's section 163(j) limit is $30 ($100 
x 30 percent). Thus, X's $20 of business interest expense is 
deductible business interest expense. Y, in computing its limit 
under section 163(j), has $20 of business interest expense from its 
sole proprietorship. Y's section 163(j) limit is $0 ($0 x 30 
percent). Thus, Y's $20 of business interest expense is not allowed 
as a deduction and is treated as business interest expense paid or 
accrued by Y in Year 2.
     (2) Example 2--(i) Facts. The facts are the same as in Example 
1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $200 of 
ATI, $0 of business interest income, and $30 of business interest 
expense. PRS allocates the items comprising its $200 of ATI $100 to 
X and $100 to Y. PRS allocates its $30 of business interest expense 
$15 to X and $15 to Y. X has $100 of ATI and $20 of business 
interest expense from its sole proprietorship. Y has $0 of ATI and 
$20 of business interest expense from its sole proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $60 
($200 x 30 percent). Thus, PRS has $100 of excess taxable income, 
$30 of deductible business interest expense, and $0 of excess 
business interest expense. Such $30 of deductible business interest 
expense is includable in PRS's non-separately stated income or loss, 
and is not subject to further limitation under section 163(j) at the 
partners' level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $50 of excess taxable income, 
$15 of deductible business interest expense, and $0 of excess 
business interest expense. As a result, X and Y each increase their 
ATI by $50. Because X and Y are each allocated $50 of excess taxable 
income from PRS, and excess business interest expense from a 
partnership is treated as paid or accrued by a partner to the extent 
excess taxable income and excess business interest income are 
allocated from such partnership to a partner, X and Y each treat $5 
of excess business interest expense (the carryforward from Year 1) 
as paid or accrued in Year 2. X and Y each increase their outside 
basis in PRS by $85 ($100-$15).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $150 of ATI ($100 from its sole proprietorship, 
plus $50 excess taxable income) and $25 of business interest expense 
($20 from its sole proprietorship, plus $5 excess business interest 
expense treated as paid or accrued in Year 2). X's section 163(j) 
limit is $45 ($150 x 30 percent). Thus, X's $25 of business interest 
expense is deductible business interest expense. At the end of Year 
2, X has $0 of excess business interest expense from PRS ($5 from 
Year 1, less $5 treated as paid or accrued in Year 2). Y, in 
computing its limit under section 163(j), has $50 of ATI ($0 from 
its sole proprietorship, plus $50 excess taxable income) and $45 of 
business interest expense ($20 from its sole proprietorship, plus 
$20 disallowed business interest expense from Year 1, plus $5 excess 
business interest expense treated as paid or accrued in Year 2). Y's 
section 163(j) limit is $15 ($50 x 30 percent). Thus, $15 of Y's 
business interest expense is deductible business interest expense. 
The $30 of Y's business interest expense not allowed as a deduction 
($45 business interest expense, less $15 section 163(j) limit) is 
treated as business interest expense paid or accrued by Y in Year 3. 
At the end of Year 2, Y has $0 of excess business interest expense 
from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 
2).
     (3) Example 3--(i) Facts. The facts are the same as in Example 
1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $0 of 
ATI, $60 of business interest income, and $40 of business interest 
expense. PRS allocates its $60 of business interest income $30 to X 
and $30 to Y. PRS allocates its $40 of business interest expense $20 
to X and $20 to Y. X has $100 of ATI and $20 of business interest 
expense from its sole proprietorship. Y has $0 of ATI and $20 of 
business interest expense from its sole proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $60 (($0 
x 30 percent) + $60). Thus, PRS has $20 of excess business interest 
income, $0 of excess taxable income, $40 of deductible business 
interest expense, and $0 of excess business interest expense. Such 
$40 of deductible business interest expense is includable in PRS's 
non-separately stated income or loss, and is not subject to further 
limitation under section 163(j) at the partners' level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess business interest 
income, and $20 of deductible business interest expense. As a 
result, X and Y each increase their business interest income by $10. 
Because X and Y are each allocated $10 of excess business interest 
income from PRS, and excess business interest expense from a 
partnership is treated as paid or accrued by a partner to the extent 
excess taxable income and excess business interest income are 
allocated from such partnership to a partner, X and Y each treat $5 
of excess business interest expense (the carryforward from Year 1) 
as paid or accrued in Year 2. X and Y each increase their outside 
basis in PRS by $10 ($30-$20).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $100 of ATI (from its sole proprietorship), $10 
of business interest income (from the

[[Page 67559]]

allocation of $10 of excess business interest income from PRS), and 
$25 of business interest expense ($20 from its sole proprietorship, 
plus $5 excess business interest expense treated as paid or accrued 
in Year 2). X's section 163(j) limit is $40 (($100 x 30 percent) + 
$10). Thus, X's $25 of business interest expense is deductible 
business interest expense. At the end of Year 2, X has $0 of excess 
business interest expense from PRS ($5 from Year 1, less $5 treated 
as paid or accrued in Year 2). Y, in computing its limit under 
section 163(j), has $0 of ATI (from its sole proprietorship), $10 of 
business interest income, and $45 of business interest expense ($20 
from its sole proprietorship, plus $20 disallowed business interest 
expense from Year 1, plus $5 excess business interest expense 
treated as paid or accrued in Year 2). Y's section 163(j) limit is 
$10 (($0 x 30 percent) + $10). Thus, $10 of Y's business interest 
expense is deductible business interest expense. The $35 of Y's 
business interest expense not allowed as a deduction ($45 business 
interest expense, less $10 section 163(j) limit) is treated as 
business interest expense paid or accrued by Y in Year 3. At the end 
of Year 2, Y has $0 of excess business interest expense from PRS ($5 
from Year 1, less $5 treated as paid or accrued in Year 2).
      (4) Example 4--(i) Facts. The facts are the same as in Example 
1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of 
ATI, $60 of business interest income, and $40 of business interest 
expense. PRS allocates the items comprising its $100 of ATI $50 to X 
and $50 to Y. PRS allocates its $60 of business interest income $30 
to X and $30 to Y. PRS allocates its $40 of business interest 
expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business 
interest expense from its sole proprietorship. Y has $0 of ATI and 
$20 of business interest expense from its sole proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $90 
(($100 x 30 percent)) + $60). Thus, PRS has $20 of excess business 
interest income, $100 of excess taxable income, $40 of deductible 
business interest expense, and $0 of excess business interest 
expense. Such $40 of deductible business interest expense is 
includable in PRS's non-separately stated income or loss, and is not 
subject to further limitation under section 163(j) at the partners' 
level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess business interest 
income, $50 of excess taxable income, and $20 of deductible business 
interest expense. As a result, X and Y each increase their business 
interest income by $10 and ATI by $50. Because X and Y are each 
allocated $10 of excess business interest income and $50 of excess 
taxable income from PRS, and excess business interest expense from a 
partnership is treated as paid or accrued by a partner to the extent 
excess taxable income and excess business interest income are 
allocated from such partnership to a partner, X and Y each treat $5 
of excess business interest expense (the carryforward from Year 1) 
as paid or accrued in Year 2. X and Y each increase their outside 
basis in PRS by $60 ($80-$20).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $150 of ATI ($100 from its sole proprietorship, 
plus $50 excess taxable income), $10 of business interest income, 
and $25 of business interest expense ($20 from its sole 
proprietorship, plus $5 excess business interest expense treated as 
paid or accrued in Year 2). X's section 163(j) limit is $55 (($150 x 
30 percent) + $10). Thus, $25 of X's business interest expense is 
deductible business interest expense. At the end of Year 2, X has $0 
of excess business interest expense from PRS ($5 from Year 1, less 
$5 treated as paid or accrued in Year 2). Y, in computing its limit 
under section 163(j), has $50 of ATI ($0 from its sole 
proprietorship, plus $50 excess taxable income), $10 of business 
interest income, and $45 of business interest expense ($20 from its 
sole proprietorship, plus $20 disallowed business interest expense 
from Year 1, plus $5 excess business interest expense treated as 
paid or accrued in Year 2). Y's section 163(j) limit is $25 (($50 x 
30 percent) + $10). Thus, $25 of Y's business interest expense is 
deductible business interest expense. Y's $20 of business interest 
expense not allowed as a deduction ($45 business interest expense, 
less $25 section 163(j) limit) is treated as business interest 
expense paid or accrued by Y in Year 3. At the end of Year 2, Y has 
$0 of excess business interest expense from PRS ($5 from Year 1, 
less $5 treated as paid or accrued in Year 2).
     (5) Example 5--(i) Facts. The facts are the same as in Example 
1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of 
ATI, $11.20 of business interest income, and $40 of business 
interest expense. PRS allocates the items comprising its $100 of ATI 
$50 to X and $50 to Y. PRS allocates its $11.20 of business interest 
income $5.60 to X and $5.60 to Y. PRS allocates its $40 of business 
interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of 
business interest expense from its sole proprietorship. Y has $0 of 
ATI and $20 of business interest expense from its sole 
proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $41.20 
(($100 x 30 percent) + $11.20). Thus, PRS has $0 of excess business 
interest income, $4 of excess taxable income, and $40 of deductible 
business interest expense. Such $40 of deductible business interest 
expense is includable in PRS's non-separately stated income or loss, 
and is not subject to further limitation under section 163(j) at the 
partners' level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $2 of excess taxable income, $20 
of deductible business interest expense, and $0 of excess business 
interest expense. As a result, X and Y each increase their ATI by 
$2. Because X and Y are each allocated $2 of excess taxable income 
from PRS, and excess business interest expense from a partnership is 
treated as paid or accrued by a partner to the extent excess taxable 
income and excess business interest income are allocated from such 
partnership to a partner, X and Y each treat $2 of excess business 
interest expense (a portion of the carryforward from Year 1) as paid 
or accrued in Year 2. X and Y each increase their outside basis in 
PRS by $35.60 ($55.60-$20).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $102 of ATI ($100 from its sole proprietorship, 
plus $2 excess taxable income), $0 of business interest income, and 
$22 of business interest expense ($20 from its sole proprietorship, 
plus $2 excess business interest expense treated as paid or 
accrued). X's section 163(j) limit is $30.60 ($102 x 30 percent). 
Thus, X's $22 of business interest expense is deductible business 
interest expense. At the end of Year 2, X has $3 of excess business 
interest expense from PRS ($5 from Year 1, less $2 treated as paid 
or accrued in Year 2). Y, in computing its limit under section 
163(j), has $2 of ATI ($0 from its sole proprietorship, plus $2 
excess taxable income), $0 of business interest income, and $42 of 
business interest expense ($20 from its sole proprietorship, plus 
$20 disallowed business interest expense from Year 1, plus $2 excess 
business interest expense treated as paid or accrued in Year 2). Y's 
section 163(j) limit is $0.60 ($2 x 30 percent). Thus, $0.60 of Y's 
business interest expense is deductible business interest expense. 
Y's $41.40 of business interest expense not allowed as a deduction 
($42 business interest expense, less $0.60 section 163(j) limit) is 
treated as business interest expense paid or accrued by Y in Year 3. 
At the end of Year 2, Y has $3 of excess business interest expense 
from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 
2).
     (6) Example 6--(i) Facts. The facts are the same as in Example 
5 in paragraph (o)(5)(i) of this section, except in Year 2 Y becomes 
not subject to section 163(j) under section 163(j)(3).
    (ii) Partnership-level. Same analysis as Example 5 in paragraph 
(o)(5)(ii) of this section.
    (iii) Partner-level allocations. Same analysis as Example 5 in 
paragraph (o)(5)(iii) of this section.
    (iv) Partner-level computations. For X, same analysis as Example 
5 in paragraph (o)(5)(iv) of this section. Y is not subject to 
section 163(j) under section 163(j)(3). Thus, all $42 of business 
interest expense ($20 from its sole proprietorship, plus $20 
disallowed business interest expense from Year 1, plus $2 excess 
business interest expense treated as paid or accrued in Year 2) is 
not subject to limitation under Sec.  1.163(j)-2(d). At the end of 
Year 2, Y has $3 of excess business interest expense from PRS ($5 
from Year 1, less $2 treated as paid or accrued in Year 2).
     (7) Example 7--(i) Facts. The facts are the same as in Example 
5 in paragraph (o)(5)(i) of this section, except in Year 2 PRS and Y 
become not subject to section 163(j) under section 163(j)(3).
    (ii) Partnership-level. In Year 2, PRS becomes not subject to 
section 163(j)(4) by reason of section 163(j)(3). As a result, none 
of PRS's $30 of business interest expense is subject to limitation 
at the partnership level.
    (iii) Partner-level allocations. Because section 163(j) does not 
apply, PRS's $30 of business interest expense is not taken into 
account in determining its non-separately stated taxable income or 
loss. Thus, PRS's

[[Page 67560]]

$30 of business interest expense retains its character as business 
interest expense for purposes of section 163(j), and is potentially 
subject to limitation at the partners' level. As a result, X and Y 
each increase their business interest expense by $15. Further, 
because PRS is not subject to section 163(j)(4) by reason of section 
163(j)(3), the provision requiring each partner of the partnership 
to determine their ATI without regard to such partner's distributive 
share of any items of income, gain, deduction, or loss of such 
partnership (section 163(j)(4)(ii)(I)) is no longer applicable under 
Sec.  1.163(j)-6(m)(1). As a result, X and Y each increase their ATI 
by $100. Further, because PRS is not subject to section 163(j)(4) by 
reason of section 163(j)(3), the excess business interest expense 
from Year 1 is treated as paid or accrued by the partners pursuant 
to Sec.  1.163(j)-6(m)(3). As a result, X and Y each treat their $5 
of excess business interest expense from Year 1 as paid or accrued 
in Year 2, and increase their business interest expense by $5.
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $200 of ATI ($100 from its sole proprietorship, 
plus $100 ATI from PRS) and $40 of business interest expense ($20 
from its sole proprietorship, plus $15 from PRS, plus $5 of excess 
business interest expense treated as paid or accrued in Year 2). X's 
section 163(j) limit is $60 ($200 x 30 percent). Thus, $40 of X's 
business interest expense is deductible business interest expense. Y 
is not subject to section 163(j) under section 163(j)(3). As a 
result, Y's business interest expense is not subject to limitation 
under section 163(j). Thus, all $60 of Y's business interest expense 
($20 from its sole proprietorship, plus $20 disallowed from year 1, 
plus $15 from PRS from year 2, plus $5 of excess business interest 
expense treated as paid or accrued in Year 2) is not subject to 
limitation under section 163(j).
     (8) Example 8--(i) Facts. In Year 1, X, Y, and Z formed 
partnership PRS. Upon formation, X and Y each contributed $100, and 
Z contributed non-excepted and non-depreciable trade or business 
property with a basis of $0 and fair market value of $100 
(Blackacre). PRS allocates all items pro rata between its partners. 
Immediately after the formation of PRS, Z sold all of its interest 
in PRS to A for $100 (assume the interest sale is respected for U.S. 
federal income tax purposes). In connection with the interest 
transfer, PRS made a valid election under section 754. Therefore, 
after the interest sale, A had a $100 positive section 743(b) 
adjustment in Blackacre. In Year 1, PRS had $0 of ATI, $15 of 
business interest expense, and $0 of business interest income. 
Pursuant to Sec.  1.163(j)-6(f)(2), PRS allocated each of the 
partners $5 of excess business interest expense. In Year 2, PRS 
sells Blackacre for $100 which generated $100 of ATI. The sale of 
Blackacre was PRS's only item of income in Year 2. In accordance 
with section 704(c), PRS allocates all $100 of gain resulting from 
the sale of Blackacre to A. Additionally, PRS has $15 of business 
interest expense, all of which it allocates to X. A has $50 of ATI 
and $20 of business interest expense from its sole proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $15 
of deductible business interest expense and $50 of excess taxable 
income. Such $15 of deductible business interest expense is 
includable in PRS's non-separately stated income or loss, and is not 
subject to further limitation under section 163(j) at X's level.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X is allocated $15 of deductible business interest expense 
and X's outside basis in PRS is reduced by $15. A is allocated $50 
of excess taxable income and, as a result, A increases its ATI by 
$50. Because A is allocated $50 of excess taxable income, and excess 
business interest expense from a partnership is treated as paid or 
accrued by a partner to the extent excess taxable income and excess 
business interest income are allocated from such partnership to a 
partner, A treats $5 of excess business interest expense (the 
carryforward from Year 1) as paid or accrued in Year 2. PRS's $100 
of gain allocated to A in Year 2 is fully reduced by A's $100 
section 743(b) adjustment. Therefore, at the end of Year 2, there is 
no change to A's outside basis in PRS.
    (iv) Partner-level. A, in computing its limit under section 
163(j), has $0 of ATI ($50 from its sole proprietorship, plus $50 
excess taxable income, less $100 ATI reduction as a result of A's 
section 743(b) adjustment under Sec.  1.163(j)-6(e)(2)) and $25 of 
business interest expense ($20 from its sole proprietorship, plus $5 
excess business interest expense treated as paid or accrued in Year 
2). A's section 163(j) limit is $0 ($0 x 30 percent). Thus, all $25 
of A's business interest expense is not allowed as a deduction and 
is treated as business interest expense paid or accrued by A in Year 
3.
     (9) Example 9--(i) Facts. X and Y are equal partners in 
partnership PRS. At the beginning of Year 1, X and Y each have an 
outside basis in PRS of $5. In Year 1, PRS has $0 of ATI, $20 of 
business interest income, and $40 of business interest expense. PRS 
allocates its $20 of business interest income $10 to X and $10 to Y. 
PRS allocates $40 of business interest expense $20 to X and $20 to 
Y. X has $100 of ATI and $20 of business interest expense from its 
sole proprietorship. Y has $0 of ATI and $20 of business interest 
expense from its sole proprietorship.
    (ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $20 (($0 
x 30 percent) + $20). Thus, PRS has $0 of excess business interest 
income, $0 of excess taxable income, $20 of deductible business 
interest expense, and $20 of excess business interest expense. Such 
$20 of deductible business interest expense is includable in non-
separately stated income or loss of PRS, and not subject to further 
limitation under section 163(j) by the partners.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $10 of deductible business 
interest expense and $10 of excess business interest expense. After 
adjusting each partners respective basis for business interest 
income under section 705(a)(1)(A), pursuant to Sec.  1.163(j)-
6(h)(1), X and Y each take their $10 of deductible business interest 
expense into account when reducing their outside basis in PRS before 
taking the $10 of excess business interest expense into account. 
Following each partner's reduction in outside basis due to the $10 
of deductible business interest expense, each partner has $5 of 
outside basis remaining in PRS. Pursuant to Sec.  1.163(j)-6(h)(2), 
each partner has $5 of excess business interest expense and $5 of 
negative section 163(j) expense. In sum, at the end of Year 1, X and 
Y each have $5 of excess business interest expense from PRS which 
reduces each partner's outside basis to $0 (and is not treated as 
paid or accrued by the partners until such partner is allocated 
excess taxable income or excess business interest income from PRS in 
a succeeding taxable year), and $5 of negative section 163(j) 
expense (which is suspended under section 704(d) and not treated as 
excess business interest expense of the partners until such time as 
the negative section 163(j) expense is no longer subject to a 
limitation under section 704(d)).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $100 of ATI (from its sole proprietorship) and 
$20 of business interest expense (from its sole proprietorship). X's 
section 163(j) limit is $30 ($100 x 30 percent). Thus, $20 of X's 
business interest expense is deductible business interest expense. 
Y, in computing its limit under section 163(j), has $20 of business 
interest expense (from its sole proprietorship). Y's section 163(j) 
limit is $0 ($0 x 30 percent). Thus, $20 of Y's business interest 
expense is not allowed as a deduction in Year 1, and is treated as 
business interest expense paid or accrued by Y in Year 2.
     (10) Example 10--(i) Facts. The facts are the same as in 
Example 9 in paragraph (o)(9)(i) of this section. In Year 2, PRS has 
$20 of gross income that is taken into account in determining PRS's 
ATI (i.e., properly allocable to a trade or business), $30 of gross 
deductions from an investment activity, and $0 of business interest 
expense. PRS allocates the items comprising its $20 of ATI $10 to X 
and $10 to Y. PRS allocates the items comprising its $30 of gross 
deductions $15 to X and $15 to Y. X has $100 of ATI and $20 of 
business interest expense from its sole proprietorship. Y has $0 of 
ATI and $20 of business interest expense from its sole 
proprietorship.
    (ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $6 ($20 
x 30 percent). Because PRS has no business interest expense, all $20 
of its ATI is excess taxable income.
    (iii) Partner-level allocations. Pursuant to Sec.  1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess taxable income. 
Because X and Y are each allocated $10 of excess taxable income from 
PRS, X and Y each increase their ATI by $10. Pursuant to Sec.  
1.704-(1)(d)(2), each partner's limitation on losses under section 
704(d) must be allocated to its distributive share of each such 
loss. Thus, each partner reduces its adjusted basis of $10 
(attributable to the allocation of items comprising PRS's ATI in 
Year 2) by $7.50 of gross deductions from Year 2 ($10 x ($15 of 
total gross deductions from Year 2/$20 of total losses disallowed)), 
and $2.50 of excess

[[Page 67561]]

business interest expense that was carried over as negative section 
163(j) expense from Year 1 ($10 x ($5 of negative section 163(j) 
expense treated as excess business interest expense solely for the 
purposes of section 704(d)/$20 of total losses disallowed)). 
Following the application of section 704(d), each partner has $7.50 
of excess business interest expense from PRS ($5 excess business 
interest expense from Year 1, plus $2.50 of excess business interest 
expense that was formerly negative section 163(j) expense carried 
over from Year 1). Excess business interest expense from a 
partnership is treated as paid or accrued by a partner to the extent 
excess taxable income and excess business interest income are 
allocated from such partnership to the partner. As a result, X and Y 
each treat $7.50 of excess business interest expense as paid or 
accrued in Year 2.
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $110 of ATI ($100 from its sole proprietorship, 
plus $10 excess taxable income) and $27.50 of business interest 
expense ($20 from its sole proprietorship, plus $7.50 excess 
business interest expense treated as paid or accrued in Year 2). X's 
section 163(j) limit is $33 ($110 x 30 percent). Thus, $27.50 of X's 
business interest expense is deductible business interest expense. 
At the end of Year 2, X has $0 of excess business interest expense 
from PRS ($5 from Year 1, plus $2.50 treated as excess business 
interest expense in Year 2, less $7.50 treated as paid or accrued in 
Year 2), and $2.50 of negative section 163(j) expense from PRS. Y, 
in computing its limit under section 163(j), has $10 of ATI ($0 from 
its sole proprietorship, plus $10 excess taxable income) and $47.50 
of business interest expense ($20 from its sole proprietorship, plus 
$20 disallowed business interest expense from Year 1, plus $7.50 
excess business interest expense treated as paid or accrued in Year 
2). Y's section 163(j) limit is $3 ($10 x 30 percent). Thus, $3 of 
Y's business interest expense is deductible business interest 
expense. The $44.50 of Y's business interest expense not allowed as 
a deduction ($47.50 business interest expense, less $3 section 
163(j) limit) is treated as business interest expense paid or 
accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess 
business interest expense from PRS ($5 from Year 1, plus $2.50 
treated as excess business interest expense in Year 2, less $7.50 
treated as paid or accrued in Year 2), and $2.50 of negative section 
163(j) expense from PRS.
     (11) Example 11: Facts. A (an individual) and B (a corporation) 
own all of the interests in partnership PRS. In Year 1, PRS has $100 
of ATI, $10 of investment interest income, $20 of business interest 
income (BII), $60 of business interest expense (BIE), and $10 of 
floor plan financing interest expense. PRS's ATI consists of $100 of 
gross income and $0 of gross deductions. PRS allocates its items 
comprising ATI $100 to A and $0 to B. PRS allocates its business 
interest income $10 to A and $10 to B. PRS allocates its business 
interest expense $30 to A and $30 to B. PRS allocates all $10 of its 
investment interest income and all $10 of its floor plan financing 
interest expense to B. A has ATI from a sole proprietorship, 
unrelated to PRS, in the amount of $300.
    (i) First, PRS determines its limitation pursuant to Sec.  
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus 
its business interest income, or $50 (($100 x 30 percent) + $20). 
Thus, PRS has $0 of excess business interest income (EBII), $0 of 
excess taxable income, $50 of deductible business interest expense, 
and $10 of excess business interest expense. PRS takes its $10 of 
floor plan financing into account in determining its nonseparately 
stated taxable income or loss.
    (ii) Second, PRS determines each partner's allocable share of 
section 163(j) items used in its own section 163(j) calculation. B's 
$10 of investment interest income is not included in B's allocable 
business interest income amount because the $10 of investment 
interest income was not taken into account in PRS's section 163(j) 
calculation. B's $10 of floor plan financing interest expense is not 
included in B's allocable business interest expense. The $300 of ATI 
from A's sole proprietorship is not included in A's allocable ATI 
amount because the $300 was not taken into account in PRS's section 
163(j) calculation.

                                        Table 1 to Paragraph (o)(11)(ii)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................................            $100              $0            $100
Allocable BII...................................................              10              10              20
Allocable BIE...................................................              30              30              60
----------------------------------------------------------------------------------------------------------------

    (iii) Third, PRS compares each partner's allocable business 
interest income to such partner's allocable business interest 
expense. Because each partner's allocable business interest expense 
exceeds its allocable business interest income by $20 ($30-$10), 
each partner has an allocable business interest income deficit of 
$20. Thus, the total allocable business interest income deficit is 
$40 ($20 + $20). No partner has allocable business interest income 
excess because no partner has allocable business interest income in 
excess of its allocable business interest expense. Thus, the total 
allocable business interest income excess is $0.

                                        Table 1 to Paragraph (o)(11)(iii)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII...................................................             $10             $10             N/A
Allocable BIE...................................................              30              30             N/A
If allocable BII exceeds allocable BIE, then such amount =                     0               0              $0
 Allocable BII excess...........................................
If allocable BIE exceeds allocable BII, then such amount =                    20              20              40
 Allocable BII deficit..........................................
----------------------------------------------------------------------------------------------------------------

    (iv) Fourth, PRS determines each partner's final allocable 
business interest income excess. Because no partner had any 
allocable business interest income excess, each partner has final 
allocable business interest income excess of $0.
    (v) Fifth, PRS determines each partner's remaining business 
interest expense. PRS determines A's remaining business interest 
expense by reducing, but not below $0, A's allocable business 
interest income deficit ($20) by the product of the total allocable 
business interest income excess ($0) and the ratio of A's allocable 
business interest income deficit to the total business interest 
income deficit ($20/$40). Therefore, A's allocable business interest 
income deficit of $20 is reduced by $0 ($0 x 50 percent). As a 
result, A's remaining business interest expense is $20. PRS 
determines B's remaining business interest expense by reducing, but 
not below $0, B's allocable business interest income deficit ($20) 
by the product of the total allocable business interest income 
excess ($0) and the ratio of B's allocable business interest income 
deficit to the total business interest income deficit ($20/$40). 
Therefore, B's allocable business interest income deficit of $20 is 
reduced by $0 ($0 x 50 percent). As a result, B's remaining business 
interest expense is $20.

[[Page 67562]]



                                         Table 1 to Paragraph (o)(11)(v)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit...........................................             $20             $20             $40
Less: (Total allocable BII excess) x (Allocable BII deficit/                   0               0             N/A
 Total allocable BII deficit)...................................
                                                                 -----------------------------------------------
    = Remaining BIE.............................................              20              20              40
----------------------------------------------------------------------------------------------------------------

    (vi) Sixth, PRS determines each partner's final allocable ATI. 
Any partner with a negative allocable ATI, or an allocable ATI of 
$0, has a positive allocable ATI of $0. Therefore, B has a positive 
allocable ATI of $0. Because A's allocable ATI is comprised of $100 
of income and gain and $0 of deduction and loss, A has positive 
allocable ATI of $100. Thus, the total positive allocable ATI is 
$100 ($100 + $0). PRS determines A's final allocable ATI by 
reducing, but not below $0, A's positive allocable ATI ($100) by the 
product of total negative allocable ATI ($0) and the ratio of A's 
positive allocable ATI to the total positive allocable ATI ($100/
$100). Therefore, A's positive allocable ATI is reduced by $0 ($0 x 
100 percent). As a result, A's final allocable ATI is $100. Because 
B has a positive allocable ATI of $0, B's final allocable ATI is $0.

                                        Table 1 to Paragraph (o)(11)(vi)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................................            $100              $0            $100
If deduction and loss items comprising allocable ATI exceed                    0               0               0
 income and gain items comprising allocable ATI, then such
 excess amount = Negative allocable ATI.........................
If income and gain items comprising allocable ATI equal or                   100               0             100
 exceed deduction and loss items comprising allocable ATI, then
 such amount = Positive allocable ATI...........................
----------------------------------------------------------------------------------------------------------------



                                        Table 2 to Paragraph (o)(11)(vi)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........................................            $100              $0            $100
Less: (Total negative allocable ATI) x (Positive allocable ATI/                0               0             N/A
 Total positive allocable ATI)..................................
                                                                 -----------------------------------------------
    = Final allocable ATI.......................................             100               0             100
----------------------------------------------------------------------------------------------------------------

    (vii) Seventh, PRS compares each partner's ATI capacity (ATIC) 
amount to such partner's remaining business interest expense. A's 
ATIC amount is $30 ($100 x 30 percent) and B's ATIC amount is $0 ($0 
x 30 percent). Because A's ATIC amount exceeds its remaining 
business interest expense by $10 ($30-$20), A has an ATIC excess of 
$10. B does not have any ATIC excess. Thus, the total ATIC excess is 
$10 ($10 + $0). A does not have any ATIC deficit. Because B's 
remaining business interest expense exceeds its ATIC amount by $20 
($20-$0), B has an ATIC deficit of $20. Thus, the total ATIC deficit 
is $20 ($0 + $20).

                                        Table 1 to Paragraph (o)(11)(vii)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent).........................             $30              $0             N/A
Remaining BIE...................................................              20              20             N/A
If ATIC exceeds remaining BIE, then such excess = ATIC excess...              10               0              10
If remaining BIE exceeds ATIC, then such excess = ATIC deficit..               0              20              20
----------------------------------------------------------------------------------------------------------------

    (viii)(A) Eighth, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section if, and only if, PRS has:
    (1) An excess business interest expense greater than $0 under 
paragraph (f)(2)(i) of this section;
    (2) A total negative allocable ATI greater than $0 under 
paragraph (f)(2)(vi) of this section; and
    (3) A total ATIC excess amount greater than $0 under paragraph 
(f)(2)(vii) of this section.
    (B) Because PRS does not meet all three requirements in 
paragraph (o)(11)(viii)(A) of this section, PRS does not perform the 
calculations or adjustments described in paragraph (f)(2)(viii) of 
this section. In sum, the correct amounts to be used in paragraphs 
(o)(11)(ix) and (x) of this section are as follows.

                                      Table 1 to Paragraph (o)(11)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................................             $10              $0             $10
ATIC deficit....................................................               0              20              20
----------------------------------------------------------------------------------------------------------------


[[Page 67563]]

    (ix) Ninth, PRS determines each partner's final ATIC excess 
amount. Because A has an ATIC excess, PRS must determine A's final 
ATIC excess amount. A's final ATIC excess amount is A's ATIC excess 
($10), reduced, but not below $0, by the product of the total ATIC 
deficit ($20) and the ratio of A's ATIC excess to the total ATIC 
excess ($10/$10). Therefore, A has $0 of final ATIC excess ($10-($20 
x 100 percent)).

                                       Table 1 to Paragraph (o)(11)(ix)(B)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................................             $10              $0             N/A
Less: (Total ATIC deficit) x (ATIC excess/Total ATIC excess)....              20               0             N/A
                                                                 -----------------------------------------------
    = Final ATIC excess.........................................               0               0               0
----------------------------------------------------------------------------------------------------------------

    (x) Tenth, PRS determines each partner's final ATIC deficit 
amount. Because B has an ATIC deficit, PRS must determine B's final 
ATIC deficit amount. B's final ATIC deficit amount is B's ATIC 
deficit ($20), reduced, but not below $0, by the product of the 
total ATIC excess ($10) and the ratio of B's ATIC deficit to the 
total ATIC deficit ($20/$20). Therefore, B has $10 of final ATIC 
deficit ($20-($10 x 100 percent)).

                                         Table 1 to Paragraph (o)(11)(x)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................................................              $0             $20             N/A
Less: (Total ATIC excess) x (ATIC deficit/Total ATIC deficit)...               0              10             N/A
                                                                 -----------------------------------------------
    = Final ATIC deficit........................................               0              10              10
----------------------------------------------------------------------------------------------------------------

    (xi) Eleventh, PRS allocates deductible business interest 
expense and section 163(j) excess items to the partners. Pursuant to 
paragraph (f)(2)(i) of this section, PRS has $10 of excess business 
interest expense. PRS allocates the excess business interest expense 
dollar for dollar to the partners with final ATIC deficits amounts. 
Thus, PRS allocates all $10 of its excess business interest expense 
to B. A partner's allocable business interest expense is deductible 
business interest expense to the extent it exceeds such partner's 
share of excess business interest expense. Therefore, A has 
deductible business interest expense of $30 ($30 - $0) and B has 
deductible business interest expense of $20 ($30-$10).

                                        Table 1 to Paragraph (o)(11)(xi)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................................................             $30             $20             $50
EBIE allocated..................................................               0              10              10
ETI allocated...................................................               0               0               0
EBII allocated..................................................               0               0               0
----------------------------------------------------------------------------------------------------------------

    (12) Example 12: Facts. A, B, and C own all of the interests in 
partnership PRS. In Year 1, PRS has $150 of ATI, $10 of business 
interest income, and $40 of business interest expense. PRS's ATI 
consists of $200 of gross income and $50 of gross deductions. PRS 
allocates its items comprising ATI ($50) to A, $200 to B, and $0 to 
C. PRS allocates its business interest income $0 to A, $0 to B, and 
$10 to C. PRS allocates its business interest expense $30 to A, $10 
to B, and $0 to C.
    (i) First, PRS determines its limitation pursuant to Sec.  
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus 
its business interest income, or $55 (($150 x 30 percent) + $10). 
Thus, PRS has $0 of excess business interest income, $50 of excess 
taxable income, $40 of deductible business interest expense, and $0 
of excess business interest expense.
    (ii) Second, PRS determines each partner's allocable share of 
section 163(j) items used in its own section 163(j) calculation.

                                        Table 1 to Paragraph (o)(12)(ii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................           ($50)            $200              $0            $150
Allocable BII...................................               0               0              10              10
Allocable BIE...................................              30              10               0              40
----------------------------------------------------------------------------------------------------------------

    (iii) Third, PRS compares each partner's allocable business 
interest income to such partner's allocable business interest 
expense. Because A's allocable business interest expense exceeds its 
allocable business interest income by $30 ($30-$0), A has an 
allocable business interest income deficit of $30. Because B's 
allocable business interest expense exceeds its allocable business 
interest income by $10 ($10-$0), B has an allocable business 
interest income deficit of $10. C does not have any allocable 
business interest income deficit. Thus, the total allocable business 
interest income deficit is $40 ($30 + $10 + $0). A and B do not have 
any allocable business interest income excess. Because C's allocable 
business interest income exceeds its allocable business interest 
expense by $10 ($10-$0), C has an allocable business interest income 
excess of $10. Thus, the total allocable business interest income 
excess is $10 ($0 + $0 + $10).

[[Page 67564]]



                                        Table 1 to Paragraph (o)(12)(iii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII...................................              $0              $0             $10             N/A
Allocable BIE...................................              30              10               0             N/A
If allocable BII exceeds allocable BIE, then                   0               0              10             $10
 such amount = Allocable BII excess.............
If allocable BIE exceeds allocable BII, then                  30              10               0              40
 such amount = Allocable BII deficit............
----------------------------------------------------------------------------------------------------------------

    (iv) Fourth, PRS determines each partner's final allocable 
business interest income excess. Because A and B do not have any 
allocable business interest income excess, each partner has final 
allocable business interest income excess of $0. PRS determines C's 
final allocable business interest income excess by reducing, but not 
below $0, C's allocable business interest income excess ($10) by the 
product of the total allocable business interest income deficit 
($40) and the ratio of C's allocable business interest income excess 
to the total allocable business interest income excess ($10/$10). 
Therefore, C's allocable business interest income excess of $10 is 
reduced by $10 ($40 x 100 percent). As a result, C's allocable 
business interest income excess is $0.

                                        Table 1 to Paragraph (o)(12)(iv)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII excess............................              $0              $0             $10             N/A
Less: (Total allocable BII deficit) x (Allocable               0               0              40             N/A
 BII excess/Total allocable BII excess).........
                                                 ---------------------------------------------------------------
    = Final Allocable BII Excess................               0               0               0             $10
----------------------------------------------------------------------------------------------------------------

    (v) Fifth, PRS determines each partner's remaining business 
interest expense. PRS determines A's remaining business interest 
expense by reducing, but not below $0, A's allocable business 
interest income deficit ($30) by the product of the total allocable 
business interest income excess ($10) and the ratio of A's allocable 
business interest income deficit to the total business interest 
income deficit ($30/$40). Therefore, A's allocable business interest 
income deficit of $30 is reduced by $7.50 ($10 x 75 percent). As a 
result, A's remaining business interest expense is $22.50. PRS 
determines B's remaining business interest expense by reducing, but 
not below $0, B's allocable business interest income deficit ($10) 
by the product of the total allocable business interest income 
excess ($10) and the ratio of B's allocable business interest income 
deficit to the total business interest income deficit ($10/$40). 
Therefore, B's allocable business interest income deficit of $10 is 
reduced by $2.50 ($10 x 25 percent). As a result, B's remaining 
business interest expense is $7.50. Because C does not have any 
allocable business interest income deficit, C's remaining business 
interest expense is $0.

                                         Table 1 to Paragraph (o)(12)(v)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit...........................             $30             $10              $0             $40
Less: (Total allocable BII excess) x (Allocable             7.50            2.50               0             N/A
 BII deficit/Total allocable BII deficit).......
                                                 ---------------------------------------------------------------
    = Remaining BIE.............................           22.50            7.50               0             N/A
----------------------------------------------------------------------------------------------------------------

    (vi) Sixth, PRS determines each partner's final allocable ATI. 
Because A's allocable ATI is comprised of $50 of items of deduction 
and loss and $0 of income and gain, A has negative allocable ATI of 
$50. A is the only partner with negative allocable ATI. Thus, the 
total negative allocable ATI amount is $50. Any partner with a 
negative allocable ATI, or an allocable ATI of $0, has a positive 
allocable ATI of $0. Therefore, A and C have a positive allocable 
ATI of $0. Because B's allocable ATI is comprised of $200 of items 
of income and gain and $0 of deduction and loss, B has positive 
allocable ATI of $200. Thus, the total positive allocable ATI is 
$200 ($0 + $200 + $0). PRS determines B's final allocable ATI by 
reducing, but not below $0, B's positive allocable ATI ($200) by the 
product of total negative allocable ATI ($50) and the ratio of B's 
positive allocable ATI to the total positive allocable ATI ($200/
$200). Therefore, B's positive allocable ATI is reduced by $50 ($50 
x 100 percent). As a result, B's final allocable ATI is $150.

                                        Table 1 to Paragraph (o)(12)(vi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................           ($50)            $200              $0            $150
If deduction and loss items comprising allocable              50               0               0              50
 ATI exceed income and gain items comprising
 allocable ATI, then such excess amount =
 Negative allocable ATI.........................
If income and gain items comprising allocable                  0             200               0             200
 ATI equal or exceed deduction and loss items
 comprising allocable ATI, then such amount =
 Positive allocable ATI.........................
----------------------------------------------------------------------------------------------------------------


[[Page 67565]]


                                        Table 2 to Paragraph (o)(12)(vi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........................              $0            $200              $0            $200
Less: (Total negative allocable ATI) x (Positive               0              50               0             N/A
 allocable ATI/Total positive allocable ATI)....
                                                 ---------------------------------------------------------------
    = Final allocable ATI.......................               0             150               0             150
----------------------------------------------------------------------------------------------------------------

    (vii) Seventh, PRS compares each partner's ATI capacity (ATIC) 
amount to such partner's remaining business interest expense. A's 
ATIC amount is $0 ($0 x 30 percent), B's ATIC amount is $45 ($150 x 
30 percent), and C's ATIC amount is $0 ($0 x 30 percent). A does not 
have any ATIC excess. Because B's ATIC amount exceeds its remaining 
business interest expense by $37.50 ($45-$7.50), B has an ATIC 
excess amount of $37.50. C does not have any ATIC excess. Thus, the 
total ATIC excess amount is $37.50 ($0 + $37.50 + $0). Because A's 
remaining business interest expense exceeds its ATIC amount by 
$22.50 ($22.50-$0), A has an ATIC deficit of $22.50. B and C do not 
have any ATIC deficit. Thus, the total ATIC deficit is $22.50 
($22.50 + $0 + $0).

                                        Table 1 to Paragraph (o)(12)(vii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent).........              $0             $45              $0             N/A
Remaining BIE...................................           22.50            7.50               0             N/A
If ATIC exceeds remaining BIE, then such excess                0           37.50               0           37.50
 = ATIC excess..................................
If remaining BIE exceeds ATIC, then such excess            22.50               0               0           22.50
 = ATIC deficit.................................
----------------------------------------------------------------------------------------------------------------

    (viii)(A) Eighth, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section if, and only if, PRS has:
    (1) An excess business interest expense greater than $0 under 
paragraph (f)(2)(i) of this section;
    (2) A total negative allocable ATI greater than $0 under 
paragraph (f)(2)(vi) of this section; and
    (3) A total ATIC excess amount greater than $0 under paragraph 
(f)(2)(vii) of this section.
    (B) Because PRS does not meet all three requirements in 
paragraph (o)(12)(viii)(A) of this section, PRS does not perform the 
calculations or adjustments described in paragraph (f)(2)(viii) of 
this section. In sum, the correct amounts to be used in paragraphs 
(o)(12)(ix) and (x) of this section are as follows.

                                      Table 1 to Paragraph (o)(12)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................              $0          $37.50              $0          $37.50
ATIC deficit....................................           22.50               0               0           22.50
----------------------------------------------------------------------------------------------------------------

    (ix) Ninth, PRS determines each partner's final ATIC excess 
amount. Because B has ATIC excess, PRS must determine B's final ATIC 
excess amount. B's final ATIC excess amount is B's ATIC excess 
($37.50), reduced, but not below $0, by the product of the total 
ATIC deficit ($22.50) and the ratio of B's ATIC excess to the total 
ATIC excess ($37.50/$37.50). Therefore, B has $15 of final ATIC 
excess ($37.50-($22.50 x 100 percent)).

                                        Table 1 to Paragraph (o)(12)(ix)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................              $0          $37.50              $0             N/A
Less: (Total ATIC deficit) x (ATIC excess/Total                0           22.50               0             N/A
 ATIC excess)...................................
                                                 ---------------------------------------------------------------
    = Final ATIC excess.........................               0              15               0              15
----------------------------------------------------------------------------------------------------------------

    (x) Tenth, PRS determines each partner's final ATIC deficit 
amount. Because A has an ATIC deficit, PRS must determine A's final 
ATIC deficit amount. A's final ATIC deficit amount is A's ATIC 
deficit ($22.50), reduced, but not below $0, by the product of the 
total ATIC excess ($37.50) and the ratio of A's ATIC deficit to the 
total ATIC deficit ($22.50/$22.50). Therefore, A has $0 of final 
ATIC deficit ($22.50-($37.50 x 100 percent)).

                                         Table 1 to Paragraph (o)(12)(x)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................................          $22.50              $0              $0             N/A
Less: (Total ATIC excess) x (ATIC deficit/Total            37.50               0               0             N/A
 ATIC deficit)..................................
                                                 ---------------------------------------------------------------
    = Final ATIC deficit........................               0               0               0              $0
----------------------------------------------------------------------------------------------------------------


[[Page 67566]]

    (xi) Eleventh, PRS allocates deductible business interest 
expense and section 163(j) excess items to the partners. Pursuant to 
paragraph (f)(2)(i) of this section, PRS has $50 of excess taxable 
income and $40 of deductible business interest expense. After 
grossing up each partner's final ATIC excess amounts by ten-thirds, 
excess taxable income is allocated dollar for dollar to partners 
with final ATIC excess amounts. Thus, PRS allocates its excess 
taxable income (ETI) $50 to B. A partner's allocable business 
interest expense is deductible business interest expense to the 
extent it exceeds such partner's share of excess business interest 
expense (EBIE). Therefore, A has deductible business interest 
expense of $30 ($30-$0), B has deductible business interest expense 
of $10 ($10-$0), and C has deductible business interest expense of 
$0 ($0-$0).

                                        Table 1 to Paragraph (o)(12)(xi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................................             $30             $10              $0             $40
EBIE allocated..................................               0               0               0               0
ETI allocated...................................               0              50               0              50
EBII allocated..................................               0               0               0               0
----------------------------------------------------------------------------------------------------------------

     (13) Example 13: Facts. A, B, and C own all of the interests in 
partnership PRS. In Year 1, PRS has $100 of ATI, $0 of business 
interest income, and $50 of business interest expense. PRS's ATI 
consists of $200 of gross income and $100 of gross deductions. PRS 
allocates its items comprising ATI $100 to A, $100 to B, and ($100) 
to C. PRS allocates its business interest expense $0 to A, $25 to B, 
and $25 to C.
    (i) First, PRS determines its limitation pursuant to Sec.  
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus 
its business interest income, or $30 ($100 x 30 percent). Thus, PRS 
has $30 of deductible business interest expense and $20 of excess 
business interest expense.
    (ii) Second, PRS determines each partner's allocable share of 
section 163(j) items used in its own section 163(j) calculation.

                                        Table 1 to Paragraph (o)(13)(ii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................            $100            $100          ($100)            $100
Allocable BII...................................               0               0               0               0
Allocable BIE...................................               0              25              25              50
----------------------------------------------------------------------------------------------------------------

    (iii) Third, PRS compares each partner's allocable business 
interest income to such partner's allocable business interest 
expense. No partner has allocable business interest income. 
Consequently, each partner's allocable business interest income 
deficit is equal to such partner's allocable business interest 
expense. Thus, A's allocable business interest income deficit is $0, 
B's allocable business interest income deficit is $25, and C's 
allocable business interest income deficit is $25. The total 
allocable business interest income deficit is $50 ($0 + $25 + $25). 
No partner has allocable business interest income excess because no 
partner has allocable business interest income in excess of its 
allocable business interest expense. Thus, the total allocable 
business interest income excess is $0.

                                        Table 1 to Paragraph (o)(13)(iii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII...................................              $0              $0              $0             N/A
Allocable BIE...................................               0              25              25             N/A
If allocable BII exceeds allocable BIE, then                   0               0               0              $0
 such amount = Allocable BII excess.............
If allocable BIE exceeds allocable BII, then                   0              25              25              50
 such amount = Allocable BII deficit............
----------------------------------------------------------------------------------------------------------------

    (iv) Fourth, PRS determines each partner's final allocable 
business interest income excess. Because no partner had any 
allocable business interest income excess, each partner has final 
allocable business interest income excess of $0.
    (v) Fifth, PRS determines each partner's remaining business 
interest expense. Because no partner has any allocable business 
interest income excess, each partner's remaining business interest 
expense equals its allocable business interest income deficit. Thus, 
A's remaining business interest expense is $0, B's remaining 
business interest expense is $25, and C's remaining business 
interest expense is $25.

                                         Table 1 to Paragraph (o)(13)(v)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit...........................              $0             $25             $25             $50
Less: (Total allocable BII excess) x (Allocable                0               0               0             N/A
 BII deficit/Total allocable BII deficit).......
                                                 ---------------------------------------------------------------
    = Remaining BIE.............................               0              25              25             N/A
----------------------------------------------------------------------------------------------------------------


[[Page 67567]]

    (vi) Sixth, PRS determines each partner's final allocable ATI. 
Because C's allocable ATI is comprised of $100 of items of deduction 
and loss and $0 of income and gain, C has negative allocable ATI of 
$100. C is the only partner with negative allocable ATI. Thus, the 
total negative allocable ATI amount is $100. Any partner with a 
negative allocable ATI, or an allocable ATI of $0, has a positive 
allocable ATI of $0. Therefore, C has a positive allocable ATI of 
$0. Because A's allocable ATI is comprised of $100 of items of 
income and gain and $0 of deduction and loss, A has positive 
allocable ATI of $100. Because B's allocable ATI is comprised of 
$100 of items of income and gain and $0 of deduction and loss, B has 
positive allocable ATI of $100. Thus, the total positive allocable 
ATI is $200 ($100 + $100 + $0). PRS determines A's final allocable 
ATI by reducing, but not below $0, A's positive allocable ATI ($100) 
by the product of total negative allocable ATI ($100) and the ratio 
of A's positive allocable ATI to the total positive allocable ATI 
($100/$200). Therefore, A's positive allocable ATI is reduced by $50 
($100 x 50 percent). As a result, A's final allocable ATI is $50. 
PRS determines B's final allocable ATI by reducing, but not below 
$0, B's positive allocable ATI ($100) by the product of total 
negative allocable ATI ($100) and the ratio of B's positive 
allocable ATI to the total positive allocable ATI ($100/$200). 
Therefore, B's positive allocable ATI is reduced by $50 ($100 x 50 
percent). As a result, B's final allocable ATI is $50. Because C has 
a positive allocable ATI of $0, C's final allocable ATI is $0.

                                        Table 1 to Paragraph (o)(13)(vi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................................            $100            $100          ($100)            $100
If deduction and loss items comprising allocable               0               0             100             100
 ATI exceed income and gain items comprising
 allocable ATI, then such excess amount =
 Negative allocable ATI.........................
If income and gain items comprising allocable                100             100               0             200
 ATI equal or exceed deduction and loss items
 comprising allocable ATI, then such amount =
 Positive allocable ATI.........................
----------------------------------------------------------------------------------------------------------------


                                        Table 2 to Paragraph (o)(13)(vi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........................            $100            $100              $0            $200
Less: (Total negative allocable ATI) x (Positive              50              50               0             N/A
 allocable ATI/Total positive allocable ATI)....
                                                 ---------------------------------------------------------------
    = Final allocable ATI.......................              50              50               0             100
----------------------------------------------------------------------------------------------------------------

    (vii) Seventh, PRS compares each partner's ATI capacity (ATIC) 
amount to such partner's remaining business interest expense. A's 
ATIC amount is $15 ($50 x 30 percent), B's ATIC amount is $15 ($50 x 
30 percent), and C's ATIC amount is $0 ($0 x 30 percent). Because 
A's ATIC amount exceeds its remaining business interest expense by 
$15 ($15-$0), A has an ATIC excess of $15. B and C do not have any 
ATIC excess. Thus, the total ATIC excess is $15 ($15 + $0 + $0). A 
does not have any ATIC deficit. Because B's remaining business 
interest expense exceeds its ATIC amount by $10 ($25-$15), B has an 
ATIC deficit of $10. Because C's remaining business interest expense 
exceeds its ATIC amount by $25 ($25-$0), C has an ATIC deficit of 
$25. Thus, the total ATIC deficit is $35 ($0 + $10 + $25).

                                        Table 1 to Paragraph (o)(13)(vii)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent).........             $15             $15              $0             N/A
Remaining BIE...................................               0              25              25             N/A
If ATIC exceeds remaining BIE, then such excess               15               0               0              15
 = ATIC excess..................................
If remaining BIE exceeds ATIC, then such excess                0              10              25              35
 = ATIC deficit.................................
----------------------------------------------------------------------------------------------------------------

    (viii)(A) Eighth, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section if, and only if, PRS has:
    (1) An excess business interest expense greater than $0 under 
paragraph (f)(2)(i) of this section;
    (2) A total negative allocable ATI greater than $0 under 
paragraph (f)(2)(vi) of this section; and
    (3) A total ATIC excess greater than $0 under paragraph 
(f)(2)(vii) of this section. Because PRS satisfies each of these 
three requirements, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii)(B) and 
(C) or (D) of this section.
    (B) PRS must determine each partner's priority amount and usable 
priority amount. Only partners with an ATIC deficit under paragraph 
(f)(2)(vii) of this section can have a priority amount greater than 
$0. Thus, only partners B and C can have a priority amount greater 
than $0. PRS determines a partner's priority amount as thirty 
percent of the amount by which such partner's allocable positive ATI 
exceeds its final allocable ATI. Therefore, A's priority amount is 
$0, B's priority amount is $15 (($100-$50) x 30 percent), and C's 
priority amount is $0 (($0-$0) x 30 percent). Thus, the total 
priority amount is $15 ($0 + $15 + $0). Next, PRS must determine 
each partner's usable priority amount. Each partner's usable 
priority amount is the lesser of such partner's priority amount or 
ATIC deficit. Thus, A has a usable priority amount of $0, B has a 
usable priority amount of $10, and C has a usable priority amount of 
$0. As a result, the total usable priority amount is $10 ($0 + $10 + 
$0). Because the total ATIC excess under paragraph (f)(2)(vii) of 
this section ($15) is greater than the total usable priority amount 
($10), PRS must perform the adjustments described in paragraph 
(f)(2)(viii)(C) of this section.

[[Page 67568]]



                                      Table 1 to Paragraph (o)(13)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI--Final allocable ATI)...              $0             $50              $0             N/A
Multiplied by 30 percent........................      30 percent      30 percent      30 percent             N/A
                                                 ---------------------------------------------------------------
    =Priority amount............................               0              15               0              15
----------------------------------------------------------------------------------------------------------------


                                      Table 2 to Paragraph (o)(13)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Priority amount.................................              $0             $15              $0             N/A
ATIC deficit....................................               0              10              25             N/A
Lesser of priority amount or ATIC deficit =                    0              10               0              10
 Usable priority amount.........................
----------------------------------------------------------------------------------------------------------------

    (C) For purposes of paragraph (f)(2)(ix) of this section, each 
partner's final ATIC excess is $0. For purposes of paragraph 
(f)(2)(x) of this section, the following terms shall have the 
following meanings. Each partner's ATIC deficit is such partner's 
ATIC deficit as determined pursuant to paragraph (f)(2)(vii) of this 
section reduced by such partner's usable priority amount. Thus, A's 
ATIC deficit is $0 ($0-$0), B's ATIC deficit is $0 ($10-$10), and 
C's ATIC deficit is $25 ($25-$0). The total ATIC deficit is the 
total ATIC deficit determined pursuant to paragraph (f)(2)(vii) 
($35) reduced by the total usable priority amount ($10). Thus, the 
total ATIC deficit is $25 ($35-$10). The total ATIC excess is the 
total ATIC excess determined pursuant to paragraph (f)(2)(vii) of 
this section ($15) reduced by the total usable priority amount 
($10). Thus, the total ATIC excess is $5 ($15-$5).

                                      Table 1 to Paragraph (o)(13)(viii)(C)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................................              $0             $10             $25             N/A
Less: Usable priority amount....................               0              10               0             N/A
                                                 ---------------------------------------------------------------
    = ATIC deficit for purposes of paragraph                   0               0              25              25
     (f)(2)(x) of this section..................
----------------------------------------------------------------------------------------------------------------

    (D) In light of the fact that the total ATIC excess was greater 
than the total usable priority amount under paragraph 
(f)(2)(viii)(B) of this section, paragraph (f)(2)(viii)(D) of this 
section does not apply. In sum, the correct amounts to be used in 
paragraph (f)(2)(x) of this section are as follows.

                                      Table 1 to Paragraph (o)(13)(viii)(C)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................              $5              $0              $0              $5
ATIC deficit....................................               0               0              25              25
----------------------------------------------------------------------------------------------------------------

    (ix) Ninth, PRS determines each partner's final ATIC excess 
amount. Pursuant to paragraph (f)(2)(viii)(C) of this section, each 
partner's final ATIC excess amount is $0.
    (x) Tenth, PRS determines each partner's final ATIC deficit 
amount. Because C has an ATIC deficit, PRS must determine C's final 
ATIC deficit amount. C's final ATIC deficit amount is C's ATIC 
deficit ($25), reduced, but not below $0, by the product of the 
total ATIC excess ($5) and the ratio of C's ATIC deficit to the 
total ATIC deficit ($25/$25). Therefore, C has $20 of final ATIC 
deficit ($25-($5 x 100 percent)).

                                         Table 1 to Paragraph (o)(13)(x)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................................              $0              $0             $25             N/A
Less: (Total ATIC excess) x (ATIC deficit/Total                0               0               5             N/A
 ATIC deficit)..................................
                                                 ---------------------------------------------------------------
    = Final ATIC deficit........................               0               0              20              20
----------------------------------------------------------------------------------------------------------------

    (xi) Eleventh, PRS allocates deductible business interest 
expense and section 163(j) excess items to the partners. Pursuant to 
paragraph (f)(2)(i) of this section, PRS has $20 of excess business 
interest expense. PRS allocates the excess business interest expense 
dollar for dollar to the partners with final ATIC deficits. Thus, 
PRS allocates its excess business interest expense $20 to C. A 
partner's allocable business interest expense is deductible business 
interest expense to the extent it exceeds such partner's share of 
excess business interest expense. Therefore, A has deductible 
business interest expense of $0 ($0-$0), B has deductible business 
interest expense of $25 ($25-$0), and C has deductible business 
interest expense of $5 ($25-$20).

[[Page 67569]]



                                        Table 1 to Paragraph (o)(13)(xi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................................              $0             $25              $5             $30
EBIE allocated..................................               0               0              20              20
ETI allocated...................................               0               0               0               0
EBII allocated..................................               0               0               0               0
----------------------------------------------------------------------------------------------------------------

     (14) Example 14: Facts. A, B, C, and D own all of the interests 
in partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business 
interest income, and $140 of business interest expense. PRS's ATI 
consists of $600 of gross income and $400 of gross deductions. PRS 
allocates its items comprising ATI $100 to A, $100 to B, $400 to C, 
and ($400) to D. PRS allocates its business interest expense $0 to 
A, $40 to B, $60 to C, and $40 to D.
    (i) First, PRS determines its limitation pursuant to Sec.  
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus 
its business interest income, or $60 ($200 - 30 percent). Thus, PRS 
has $60 of deductible business interest expense and $80 of excess 
business interest expense.
    (ii) Second, PRS determines each partner's allocable share of 
section 163(j) items used in its own section 163(j) calculation.

                                        Table 1 to Paragraph (o)(14)(ii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................            $100            $100            $400          ($400)            $200
Allocable BII...................               0               0               0               0               0
Allocable BIE...................               0              40              60              40             140
----------------------------------------------------------------------------------------------------------------

    (iii) Third, PRS compares each partner's allocable business 
interest income to such partner's allocable business interest 
expense. No partner has allocable business interest income. 
Consequently, each partner's allocable business interest income 
deficit is equal to such partner's allocable business interest 
expense. Thus, A's allocable business interest income deficit is $0, 
B's allocable business interest income deficit is $40, C's allocable 
business interest income deficit is $60, and D's allocable business 
interest income deficit is $40. The total allocable business 
interest income deficit is $140 ($0 + $40 + $60 + $40). No partner 
has allocable business interest income excess because no partner has 
allocable business interest income in excess of its allocable 
business interest expense. Thus, the total allocable business 
interest income excess is $0.

                                        Table 1 to Paragraph (o)(14)(iii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII...................              $0              $0              $0              $0             N/A
Allocable BIE...................               0              40              60              40             N/A
If allocable BII exceeds                       0               0               0               0               0
 allocable BIE, then such amount
 = Allocable BII excess.........
If allocable BIE exceeds                       0              40              60              40             140
 allocable BII, then such amount
 = Allocable BII deficit........
----------------------------------------------------------------------------------------------------------------

    (iv) Fourth, PRS determines each partner's final allocable 
business interest income excess. Because no partner has any 
allocable business interest income excess, each partner has final 
allocable business interest income excess of $0.
    (v) Fifth, PRS determines each partner's remaining business 
interest expense. Because no partner has any allocable business 
interest income excess, each partner's remaining business interest 
expense equals its allocable business interest income deficit. Thus, 
A's remaining business interest expense is $0, B's remaining 
business interest expense is $40, C's remaining business interest 
expense is $60, and D's remaining business interest expense is $40.

                                         Table 1 to Paragraph (o)(14)(v)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit...........              $0             $40             $60             $40            $140
Less: (Total allocable BII                     0               0               0               0             N/A
 excess) x (Allocable BII
 deficit/Total allocable BII
 deficit).......................
                                 -------------------------------------------------------------------------------
    = Remaining BIE.............               0              40              60              40             N/A
----------------------------------------------------------------------------------------------------------------

    (vi) Sixth, PRS determines each partner's final allocable ATI. 
Because D's allocable ATI is comprised of $400 of items of deduction 
and loss and $0 of income and gain, D has negative allocable ATI of 
$400. D is the only partner with negative allocable ATI. Thus, the 
total negative allocable ATI amount is $400. Any partner with a 
negative allocable ATI, or an allocable ATI of $0, has a positive 
allocable ATI of $0. Therefore, D has a positive allocable ATI of 
$0. PRS determines A's final allocable ATI by reducing, but not 
below $0, A's positive allocable ATI ($100) by the product of total 
negative allocable ATI ($400) and the ratio of A's positive 
allocable ATI to the total positive allocable ATI ($100/$600). 
Therefore, A's positive allocable ATI is reduced by $66.67 ($400 x 
16.67 percent). As a result, A's final allocable ATI is $33.33. PRS 
determines B's final allocable ATI by reducing, but not below $0, 
B's positive allocable ATI ($100) by the product of total negative 
allocable ATI ($400) and the ratio of B's positive allocable ATI to 
the total positive

[[Page 67570]]

allocable ATI ($100/$600). Therefore, B's positive allocable ATI is 
reduced by $66.67 ($400 x 16.67 percent). As a result, B's final 
allocable ATI is $33.33. PRS determines C's final allocable ATI by 
reducing, but not below $0, C's positive allocable ATI ($400) by the 
product of total negative allocable ATI ($400) and the ratio of C's 
positive allocable ATI to the total positive allocable ATI ($400/
$600). Therefore, C's positive allocable ATI is reduced by $266.67 
($400 x 66.67 percent). As a result, C's final allocable ATI is 
$133.33. Because D has a positive allocable ATI of $0, D's final 
allocable ATI is $0.

                                        Table 1 to Paragraph (o)(14)(vi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................            $100            $100            $400          ($400)            $200
If deduction and loss items                    0               0               0             400             400
 comprising allocable ATI exceed
 income and gain items
 comprising allocable ATI, then
 such excess amount = Negative
 allocable ATI..................
If income and gain items                     100             100             400               0             600
 comprising allocable ATI equal
 or exceed deduction and loss
 items comprising allocable ATI,
 then such amount = Positive
 allocable ATI..................
----------------------------------------------------------------------------------------------------------------


                                        Table 2 to Paragraph (o)(14)(vi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........            $100            $100            $400              $0            $600
Less: (Total negative allocable            66.67           66.67          266.67               0             N/A
 ATI) x (Positive allocable ATI/
 Total positive allocable ATI)..
                                 -------------------------------------------------------------------------------
    = Final allocable ATI.......           33.33           33.33          133.33               0             200
----------------------------------------------------------------------------------------------------------------

    (vii) Seventh, PRS compares each partner's ATI capacity (ATIC) 
amount to such partner's remaining business interest expense. A's 
ATIC amount is $10 ($33.33 x 30 percent), B's ATIC amount is $10 
($33.33 x 30 percent), C's ATIC amount is $40 ($133.33 x 30 
percent), and D's ATIC amount is $0 ($0 x 30 percent). Because A's 
ATIC amount exceeds its remaining business interest expense by $10 
($10-$0), A has an ATIC excess of $10. B, C, and D do not have any 
ATIC excess. Thus, the total ATIC excess is $10 ($10 + $0 + $0 + 
$0). A does not have any ATIC deficit. Because B's remaining 
business interest expense exceeds its ATIC amount by $30 ($40-$10), 
B has an ATIC deficit of $30. Because C's remaining business 
interest expense exceeds its ATIC amount by $20 ($60-$40), C has an 
ATIC deficit of $20. Because D's remaining business interest expense 
exceeds its ATIC amount by $40 ($40-$0), D has an ATIC deficit of 
$40. Thus, the total ATIC deficit is $90 ($0 + $30 + $20 + $40).

                                        Table 1 to Paragraph (o)(14)(vii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30               $10             $10             $40              $0             N/A
 percent).......................
Remaining BIE...................               0              40              60              40             N/A
If ATIC exceeds remaining BIE,                10               0               0               0              10
 then such excess = ATIC excess.
If remaining BIE exceeds ATIC,                 0              30              20              40              90
 then such excess = ATIC deficit
----------------------------------------------------------------------------------------------------------------

    (viii)(A) Eighth, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section if, and only if, PRS has (1) an excess business interest 
expense greater than $0 under paragraph (f)(2)(i) of this section, 
(2) a total negative allocable ATI greater than $0 under paragraph 
(f)(2)(vi) of this section, and (3) a total ATIC excess amount 
greater than $0 under paragraph (f)(2)(vii) of this section. Because 
PRS satisfies each of these three requirements, PRS must perform the 
calculations and make the necessary adjustments described under 
paragraphs (f)(2)(viii)(B) and (C) or paragraph (f)(2)(viii)(D) of 
this section.
    (B) PRS must determine each partner's priority amount and usable 
priority amount. Only partners with an ATIC deficit under paragraph 
(f)(2)(vii) of this section can have a priority amount greater than 
$0. Thus, only partners B, C, and D can have a priority amount 
greater than $0. PRS determines a partner's priority amount as 
thirty percent of the amount by which such partner's allocable 
positive ATI exceeds its final allocable ATI. Therefore, B's 
priority amount is $20 (($100-$33.33) x 30 percent), C's priority 
amount is $80 (($400-$133.33) x 30 percent), and D's priority amount 
is $0 (($0-$0) x 30 percent). Thus, the total priority amount is 
$100 ($0 + $20 + $80 + $0). Next, PRS must determine each partner's 
usable priority amount. Each partner's usable priority amount is the 
lesser of such partner's priority amount or ATIC deficit. Thus, A 
has a usable priority amount of $0, B has a usable priority amount 
of $20, C has a usable priority amount of $20, and D has a usable 
priority amount of $0. As a result, the total usable priority amount 
is $40 ($0 + $20 + $20 + $0). Because the total usable priority 
amount ($40) is greater than the total ATIC excess under paragraph 
(f)(2)(vii) ($10), PRS must perform the adjustments described in 
paragraph (f)(2)(viii)(D) of this section.

                                      Table 1 to Paragraph (o)(14)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI-Final                 $0          $66.67         $266.67              $0             N/A
 allocable ATI).................
Multiplied by 30 percent........      30 percent      30 percent      30 percent      30 percent             N/A
                                 -------------------------------------------------------------------------------

[[Page 67571]]

 
    = Priority amount...........               0              20              80               0             100
----------------------------------------------------------------------------------------------------------------


                                      Table 2 to Paragraph (o)(14)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Priority amount.................              $0             $20             $80              $0             N/A
ATIC deficit....................               0              30              20              40             N/A
Lesser of priority amount or                   0              20              20               0              40
 ATIC deficit = Usable priority
 amount.........................
----------------------------------------------------------------------------------------------------------------

    (C) In light of the fact that the total usable priority amount 
is greater than the total ATIC excess under paragraph 
(f)(2)(viii)(B) of this section, paragraph (f)(2)(viii)(C) of this 
section does not apply.
    (D)(1) Because B and C are the only partners with priority 
amounts greater than $0, B and C are priority partners, while A and 
D are non-priority partners. For purposes of paragraph (f)(2)(ix) of 
this section, each partner's final ATIC excess amount is $0. For 
purposes of paragraph (f)(2)(x) of this section, each non-priority 
partner's final ATIC deficit amount is such partner's ATIC deficit 
determined pursuant to paragraph (f)(2)(vii) of this section. 
Therefore, A has a final ATIC deficit of $0 and D has a final ATIC 
deficit of $40. Additionally, for purposes of paragraph (f)(2)(x) of 
this section, PRS must determine each priority partner's step eight 
excess share. A priority partner's step eight excess share is the 
product of the total ATIC excess and the ratio of the partner's 
priority amount to the total priority amount. Thus, B's step eight 
excess share is $2 ($10 x ($20/$100)) and C's step eight excess 
share is $8 ($10 x ($80/$100)). To the extent a priority partner's 
step eight excess share exceeds its ATIC deficit, the excess shall 
be the partner's ATIC excess for purposes of paragraph (f)(2)(x) of 
this section. Thus, B and C each have an ATIC excess of $0, 
resulting in a total ATIC excess is $0. To the extent a priority 
partner's ATIC deficit exceeds its step eight excess share, the 
excess shall be the partner's ATIC deficit for purposes of paragraph 
(f)(2)(x) of this section. Because B's ATIC deficit ($30) exceeds 
its step eight excess share ($2), B's ATIC deficit for purposes of 
paragraph (f)(2)(x) of this section is $28 ($30-$2). Because C's 
ATIC deficit ($20) exceeds its step eight excess share ($8), C's 
ATIC deficit for purposes of paragraph (f)(2)(x) of this section is 
$12 ($20-$8). Thus, the total ATIC deficit is $40 ($28 + $12).

                                    Table 1 to Paragraph (o)(14)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Non-priority partners ATIC                    $0             N/A             N/A             $40             N/A
 deficit in paragraph
 (f)(2)(vii) = Final ATIC
 deficit for purposes of
 paragraph (f)(2)(x) of this
 section........................
----------------------------------------------------------------------------------------------------------------


                                    Table 2 to Paragraph (o)(14)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Priority partners step eight                 N/A              $2              $8             N/A             N/A
 excess share = (Total ATIC
 excess) x (Priority/Total
 priority)......................
ATIC deficit....................             N/A              30              20             N/A             N/A
If step eight excess share                   N/A               0               0             N/A               0
 exceeds ATIC deficit, then such
 excess = ATIC excess for
 purposes of paragraph (f)(2)(x)
 of this section................
If ATIC deficit exceeds step                 N/A              28              12             N/A              40
 eight excess share, then such
 excess = ATIC deficit for
 purposes of paragraph (f)(2)(x)
 of this section................
----------------------------------------------------------------------------------------------------------------

    (2) In sum, the correct amounts to be used in paragraph 
(f)(2)(x) of this section are as follows:

                                    Table 1 to Paragraph (o)(14)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................              $0              $0              $0              $0              $0
ATIC deficit....................               0              28              12               0              40
Non-priority partner final ATIC                0               0               0              40             N/A
 deficit........................
----------------------------------------------------------------------------------------------------------------

    (ix) Ninth, PRS determines each partner's final ATIC excess 
amount. Pursuant to paragraph (f)(2)(viii)(D) of this section, each 
priority and non-priority partner's final ATIC excess amount is $0.
    (x) Tenth, PRS determines each partner's final ATIC deficit 
amount. Because B has an ATIC deficit, PRS must determine B's final

[[Page 67572]]

ATIC deficit amount. B's final ATIC deficit amount is B's ATIC 
deficit ($28), reduced, but not below $0, by the product of the 
total ATIC excess ($0) and the ratio of B's ATIC deficit to the 
total ATIC deficit ($28/$40). Therefore, B has $28 of final ATIC 
deficit ($28-($0 x 70 percent)). Because C has an ATIC deficit, PRS 
must determine C's final ATIC deficit amount. C's final ATIC deficit 
amount is C's ATIC deficit ($12), reduced, but not below $0, by the 
product of the total ATIC excess ($0) and the ratio of C's ATIC 
deficit to the total ATIC deficit ($12/$40). Therefore, C has $12 of 
final ATIC deficit ($12-($0 x 30 percent)). Pursuant to paragraph 
(f)(2)(viii)(D) of this section, D's final ATIC deficit amount is 
$40.

                                         Table 2 to Paragraph (o)(14)(x)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................             N/A             $28             $12             N/A             N/A
Less: (Total ATIC excess) x                  N/A               0               0             N/A             N/A
 (ATIC deficit/Total ATIC
 deficit).......................
                                 -------------------------------------------------------------------------------
    = Final ATIC deficit........               0              28              12              40              80
----------------------------------------------------------------------------------------------------------------

    (xi) Eleventh, PRS allocates deductible business interest 
expense and section 163(j) excess items to the partners. Pursuant to 
paragraph (f)(2)(i) of this section, PRS has $80 of excess business 
interest expense. PRS allocates the excess business interest expense 
dollar for dollar to the partners with final ATIC deficits. Thus, 
PRS allocates its excess business interest expense $28 to B, $12 to 
C, and $40 to D. A partner's allocable business interest expense is 
deductible business interest expense to the extent it exceeds such 
partner's share of excess business interest expense. Therefore, A 
has deductible business interest expense of $0 ($0-$0), B has 
deductible business interest expense of $12 ($40-$28), C has 
deductible business interest expense of $48 ($60-$12), and D has 
deductible business interest expense of $0 ($40-$40).

                                        Table 1 to Paragraph (o)(14)(xi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................              $0             $12             $48              $0             $60
EBIE allocated..................               0              28              12              40              80
ETI allocated...................               0               0               0               0               0
EBII allocated..................               0               0               0               0               0
----------------------------------------------------------------------------------------------------------------

     (15) Example 15: Facts. A, B, C, and D own all of the interests 
in partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business 
interest income, and $150 of business interest expense. PRS's ATI 
consists of $500 of gross income and $300 of gross deductions. PRS 
allocates its items comprising ATI $50 to A, $50 to B, $400 to C, 
and ($300) to D. PRS allocates its business interest expense $0 to 
A, $50 to B, $50 to C, and $50 to D.
    (i) First, PRS determines its limitation pursuant to Sec.  
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus 
its business interest income, or $60 ($200 x 30 percent). Thus, PRS 
has $60 of deductible business interest expense, and $90 of excess 
business interest expense.
    (ii) Second, PRS determines each partner's allocable share of 
section 163(j) items used in its own section 163(j) calculation.

                                        Table 1 to Paragraph (o)(15)(ii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................             $50             $50            $400          ($300)            $200
Allocable BII...................               0               0               0               0               0
Allocable BIE...................               0              50              50              50             150
----------------------------------------------------------------------------------------------------------------

    (iii) Third, PRS compares each partner's allocable business 
interest income to such partner's allocable business interest 
expense. No partner has allocable business interest income. 
Consequently, each partner's allocable business interest income 
deficit is equal to such partner's allocable business interest 
expense. Thus, A's allocable business interest income deficit is $0, 
B's allocable business interest income deficit is $50, C's allocable 
business interest income deficit is $50, and D's allocable business 
interest income deficit is $50. The total allocable business 
interest income deficit is $150 ($0 + $50 + $50 + $50). No partner 
has allocable business interest income excess because no partner has 
allocable business interest income in excess of its allocable 
business interest expense. Thus, the total allocable business 
interest income excess is $0.

                                        Table 1 to Paragraph (o)(15)(iii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII...................              $0              $0              $0              $0             N/A
Allocable BIE...................               0              50              50              50             N/A
If allocable BII exceeds                       0               0               0               0               0
 allocable BIE, then such amount
 = Allocable BII excess.........
If allocable BIE exceeds                       0              50              50              50             150
 allocable BII, then such amount
 = Allocable BII deficit........
----------------------------------------------------------------------------------------------------------------


[[Page 67573]]

    (iv) Fourth, PRS determines each partner's final allocable 
business interest income excess. Because no partner has any 
allocable business interest income excess, each partner has final 
allocable business interest income excess of $0.
    (v) Fifth, PRS determines each partner's remaining business 
interest expense. Because no partner has any allocable business 
interest income excess, each partner's remaining business interest 
expense equals its allocable business interest income deficit. Thus, 
A's remaining business interest expense is $0, B's remaining 
business interest expense is $50, C's remaining business interest 
expense is $50, and D's remaining business interest expense is $50.

                                         Table 1 to Paragraph (o)(15)(v)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit...........              $0             $50             $50             $50            $150
Less: (Total allocable BII                     0               0               0               0             N/A
 excess) x (Allocable BII
 deficit/Total allocable BII
 deficit).......................
                                 -------------------------------------------------------------------------------
    = Remaining BIE.............               0              50              50              50             N/A
----------------------------------------------------------------------------------------------------------------

    (vi) Sixth, PRS determines each partner's final allocable ATI. 
Because D's allocable ATI is comprised of $300 of items of deduction 
and loss and $0 of income and gain, D has negative allocable ATI of 
$300. D is the only partner with negative allocable ATI. Thus, the 
total negative allocable ATI amount is $300. Any partner with a 
negative allocable ATI, or an allocable ATI of $0, has a positive 
allocable ATI of $0. Therefore, D has a positive allocable ATI of 
$0. PRS determines A's final allocable ATI by reducing, but not 
below $0, A's positive allocable ATI ($50) by the product of total 
negative allocable ATI ($300) and the ratio of A's positive 
allocable ATI to the total positive allocable ATI ($50/$500). 
Therefore, A's positive allocable ATI is reduced by $30 ($300 x 10 
percent). As a result, A's final allocable ATI is $20. PRS 
determines B's final allocable ATI by reducing, but not below $0, 
B's positive allocable ATI ($50) by the product of total negative 
allocable ATI ($300) and the ratio of B's positive allocable ATI to 
the total positive allocable ATI ($50/$500). Therefore, B's positive 
allocable ATI is reduced by $30 ($300 x 10 percent). As a result, 
B's final allocable ATI is $20. PRS determines C's final allocable 
ATI by reducing, but not below $0, C's positive allocable ATI ($400) 
by the product of total negative allocable ATI ($300) and the ratio 
of C's positive allocable ATI to the total positive allocable ATI 
($400/$500). Therefore, C's positive allocable ATI is reduced by 
$240 ($300 x 80 percent). As a result, C's final allocable ATI is 
$160. Because D has a positive allocable ATI of $0, D's final 
allocable ATI is $0.

                                        Table 1 to Paragraph (o)(15)(vi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI...................             $50             $50            $400          ($300)            $200
If deduction and loss items                    0               0               0             300             300
 comprising allocable ATI exceed
 income and gain items
 comprising allocable ATI, then
 such excess amount = Negative
 allocable ATI..................
If income and gain items                      50              50             400               0             500
 comprising allocable ATI equal
 or exceed deduction and loss
 items comprising allocable ATI,
 then such amount = Positive
 allocable ATI..................
----------------------------------------------------------------------------------------------------------------


                                        Table 2 to Paragraph (o)(15)(vi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........             $50             $50            $400              $0            $500
Less: (Total negative allocable               30              30             240               0             N/A
 ATI) x (Positive allocable ATI/
 Total positive allocable ATI)..
                                 -------------------------------------------------------------------------------
    = Final allocable ATI.......              20              20             160               0             200
----------------------------------------------------------------------------------------------------------------

    (vii) Seventh, PRS compares each partner's ATI capacity (ATIC) 
amount to such partner's remaining business interest expense. A's 
ATIC amount is $6 ($20 x 30 percent), B's ATIC amount is $6 ($20 x 
30 percent), C's ATIC amount is $48 ($160 x 30 percent), and D's 
ATIC amount is $0 ($0 x 30 percent). Because A's ATIC amount exceeds 
its remaining business interest expense by $6 ($6 - $0), A has an 
ATIC excess of $6. B, C, and D do not have any ATIC excess. Thus, 
the total ATIC excess amount is $6 ($6 + $0 + $0 + $0). A does not 
have any ATIC deficit. Because B's remaining business interest 
expense exceeds its ATIC amount by $44 ($50 - $6), B has an ATIC 
deficit of $44. Because C's remaining business interest expense 
exceeds its ATIC amount by $2 ($50 - $48), C has an ATIC deficit of 
$2. Because D's remaining business interest expense exceeds its ATIC 
amount by $50 ($50 - $0), D has an ATIC deficit of $50. Thus, the 
total ATIC deficit is $96 ($0 + $44 + $2 + $50).

                                        Table 1 to Paragraph (o)(15)(vii)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30                $6              $6             $48              $0             N/A
 percent).......................
Remaining BIE...................               0              50              50              50             N/A
If ATIC exceeds remaining BIE,                 6               0               0               0              $6
 then such excess = ATIC excess.

[[Page 67574]]

 
If remaining BIE exceeds ATIC,                 0              44               2              50              96
 then such excess = ATIC deficit
----------------------------------------------------------------------------------------------------------------

    (viii)(A) Eighth, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section if, and only if, PRS has:
    (1) An excess business interest expense greater than $0 under 
paragraph (f)(2)(i) of this section;
    (2) A total negative allocable ATI greater than $0 under 
paragraph (f)(2)(vi) of this section; and
    (3) A total ATIC excess amount greater than $0 under paragraph 
(f)(2)(vii) of this section. Because PRS satisfies each of these 
three requirements, PRS must perform the calculations and make the 
necessary adjustments described under paragraph (f)(2)(viii) of this 
section.
    (B) PRS must determine each partner's priority amount and usable 
priority amount. Only partners with an ATIC deficit under paragraph 
(f)(2)(vii) of this section of this section can have a priority 
amount greater than $0. Thus, only partners B, C, and D can have a 
priority amount greater than $0. PRS determines a partner's priority 
amount as thirty percent of the amount by which such partner's 
allocable positive ATI exceeds its final allocable ATI. Therefore, 
B's priority amount is $9 (($50 - $20) x 30 percent), C's priority 
amount is $72 (($400 - $160) x 30 percent), and D's priority amount 
is $0 (($0 - $0) x 30 percent). Thus, the total priority amount is 
$81 ($0 + $9 + $72 + $0). Next, PRS must determine each partner's 
usable priority amount. Each partner's usable priority amount is the 
lesser of such partner's priority amount or ATIC deficit. Thus, B 
has a usable priority amount of $9, C has a usable priority amount 
of $2, and D has a usable priority amount of $0. As a result, the 
total usable priority amount is $11 ($0 + $9 + $2 + $0). Because the 
total usable priority amount ($11) is greater than the total ATIC 
excess ($6) under paragraph (f)(2)(vii) of this section, PRS must 
perform the adjustments described in paragraph (f)(2)(viii)(D) of 
this section.

                                      Table 1 to Paragraph (o)(15)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI-Final                 $0             $30            $240              $0             N/A
 allocable ATI).................
Multiplied by 30 percent........      30 percent      30 percent      30 percent      30 percent             N/A
                                 -------------------------------------------------------------------------------
    = Priority amount...........               0               9              72               0              81
----------------------------------------------------------------------------------------------------------------


                                      Table 2 to Paragraph (o)(15)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Priority amount.................              $0              $9             $72              $0             N/A
ATIC deficit....................               0              44               2              50             N/A
Lesser of priority amount or                   0               9               2               0             $11
 ATIC deficit = Usable priority
 amount.........................
----------------------------------------------------------------------------------------------------------------

    (C) In light of the fact that the total usable priority amount 
is greater than the total ATIC excess under paragraph 
(f)(2)(viii)(B) of this section, paragraph (f)(2)(viii)(C) of this 
section does not apply.
    (D)(1) Because B and C are the only partners with priority 
amounts greater than $0, B and C are priority partners, while A and 
D are non-priority partners. For purposes of paragraph (f)(2)(ix) of 
this section, each partner's final ATIC excess amount is $0. For 
purposes of paragraph (f)(2)(x) of this section, each non-priority 
partner's final ATIC deficit amount is such partner's ATIC deficit 
determined pursuant to paragraph (f)(2)(vii) of this section. 
Therefore, A has a final ATIC deficit of $0 and D has a final ATIC 
deficit of $50. Additionally, for purposes of paragraph (f)(2)(x) of 
this section, PRS must determine each priority partner's step eight 
excess share. A priority partner's step eight excess share is the 
product of the total ATIC excess and the ratio of the partner's 
priority amount to the total priority amount. Thus, B's step eight 
excess share is $0.67 ($6 x ($9/$81)) and C's step eight excess 
share is $5.33 ($6 x ($72/$81)). To the extent a priority partner's 
step eight excess share exceeds its ATIC deficit, the excess shall 
be the partner's ATIC excess for purposes of paragraph (f)(2)(x) of 
this section. B's step eight excess share does not exceed its ATIC 
deficit. Because C's step eight excess share ($5.33) exceeds its 
ATIC deficit ($2), C's ATIC excess for purposes of paragraph 
(f)(2)(x) of this section is $3.33 ($5.33-$2). Thus, the total ATIC 
excess for purposes of paragraph (f)(2)(x) of this section is $3.33 
($0 + $3.33). To the extent a priority partner's ATIC deficit 
exceeds its step eight excess share, the excess shall be the 
partner's ATIC deficit for purposes of paragraph (f)(2)(x) of this 
section. Because B's ATIC deficit ($44) exceeds its step eight 
excess share ($0.67), B's ATIC deficit for purposes of paragraph 
(f)(2)(x) of this section is $43.33 ($44-$0.67). C's ATIC deficit 
does not exceed its step eight excess share. Thus, the total ATIC 
deficit for purposes of paragraph (f)(2)(x) of this section is 
$43.33 ($43.33 + $0).

                                    Table 1 to Paragraph (o)(15)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Non-priority partners ATIC                    $0             N/A             N/A             $50             N/A
 deficit in paragraph
 (f)(2)(vii) = Final ATIC
 deficit for purposes of
 paragraph (f)(2)(x) of this
 section........................
----------------------------------------------------------------------------------------------------------------


[[Page 67575]]


                                    Table 2 to Paragraph (o)(15)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Priority partners step eight                 N/A           $0.67           $5.33             N/A             N/A
 excess share = (Total ATIC
 excess) x (Priority/Total
 priority)......................
ATIC deficit....................             N/A              44               2             N/A             N/A
If step eight excess share                   N/A               0            3.33             N/A           $3.33
 exceeds ATIC deficit, then such
 excess = ATIC excess for
 purposes of paragraph (f)(2)(x)
 of this section................
If ATIC deficit exceeds step                 N/A           43.33               0             N/A           43.33
 eight excess share, then such
 excess = ATIC deficit for
 purposes of paragraph (f)(2)(x)
 of this section................
----------------------------------------------------------------------------------------------------------------

    (2) In sum, the correct amounts to be used in paragraph 
(f)(2)(x) of this section are as follows.

                                    Table 1 to Paragraph (o)(15)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................              $0              $0           $3.33              $0           $3.33
ATIC deficit....................               0           43.33               0               0           43.33
Non-priority partner final ATIC                0               0               0              50             N/A
 deficit........................
----------------------------------------------------------------------------------------------------------------

    (ix) Ninth, PRS determines each partner's final ATIC excess 
amount. Pursuant to paragraph (f)(2)(viii)(D) of this section, each 
priority and non-priority partner's final ATIC excess amount is $0.
    (x) Tenth, PRS determines each partner's final ATIC deficit 
amount. Because B has an ATIC deficit, PRS must determine B's final 
ATIC deficit amount. B's final ATIC deficit amount is B's ATIC 
deficit ($43.33), reduced, but not below $0, by the product of the 
total ATIC excess ($3.33) and the ratio of B's ATIC deficit to the 
total ATIC deficit ($43.33/$43.33). Therefore, B has $40 of final 
ATIC deficit ($43.33-($3.33 x 100 percent)). Pursuant to paragraph 
(f)(2)(viii)(D) of this section, D's final ATIC deficit amount is 
$40.

                                         Table 1 to Paragraph (o)(15)(x)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................              $0          $43.33              $0             N/A             N/A
Less: (Total ATIC excess) x                    0            3.33               0             N/A             N/A
 (ATIC deficit/Total ATIC
 deficit).......................
                                 -------------------------------------------------------------------------------
    = Final ATIC deficit........               0              40               0             $50             $90
----------------------------------------------------------------------------------------------------------------

    (xi) Eleventh, PRS allocates deductible business interest 
expense and section 163(j) excess items to the partners. Pursuant to 
paragraph (f)(2)(i) of this section, PRS has $90 of excess business 
interest expense. PRS allocates the excess business interest expense 
dollar for dollar to the partners with final ATIC deficits. Thus, 
PRS allocates its excess business interest expense $40 to B and $50 
to D. A partner's allocable business interest expense is deductible 
business interest expense to the extent it exceeds such partner's 
share of excess business interest expense. Therefore, A has 
deductible business interest expense of $0 ($0-$0), B has deductible 
business interest expense of $10 ($50-$40), C has deductible 
business interest expense of $50 ($50-$0), and D has deductible 
business interest expense of $0 ($50-$50).

                                        Table 1 to Paragraph (o)(15)(xi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................              $0             $10             $50              $0             $60
EBIE allocated..................               0              40               0              50              90
ETI allocated...................               0               0               0               0               0
EBII allocated..................               0               0               0               0               0
----------------------------------------------------------------------------------------------------------------

     (16) Example 16--(i) Facts. A and B are equal shareholders in 
X, a subchapter S corporation. In Year 1, X has $100 of ATI and $40 
of business interest expense. A has $100 of ATI and $20 of business 
interest expense from its sole proprietorship. B has $0 of ATI and 
$20 of business interest expense from its sole proprietorship.
    (ii) S corporation-level. In Year 1, X's section 163(j) limit is 
30 percent of its ATI, or $30 ($100 x 30 percent). Thus, X has $30 
of deductible business interest expense and $10 of disallowed 
business interest expense. Such $30 of deductible business interest 
expense is includable in X's non-separately stated income or loss, 
and is not subject to further limitation under section 163(j). X 
carries forward the $10 of disallowed business interest expense to 
Year 2 as a disallowed business interest expense carryforward under 
Sec.  1.163(j)-2(c). X may not currently deduct all $40 of its 
business interest expense in Year 1. X only reduces its accumulated 
adjustments account in Year 1 by the $30 of deductible business 
interest expense in Year 1 under Sec.  1.163(j)-6(l)(7).

[[Page 67576]]

    (iii) Shareholder allocations. A and B are each allocated $35 of 
nonseparately stated taxable income ($50 items of income or gain, 
less $15 of deductible business interest expense) from X. A and B do 
not reduce their basis in X by the $10 of disallowed business 
interest expense.
    (iv) Shareholder-level computations. A, in computing its limit 
under section 163(j), has $100 of ATI and $20 of business interest 
expense from its sole proprietorship. A's section 163(j) limit is 
$30 ($100 x 30 percent). Thus, A's $20 of business interest expense 
is deductible business interest expense. B, in computing its limit 
under section 163(j), has $20 of business interest expense from its 
sole proprietorship. B's section 163(j) limit is $0 ($0 x 30 
percent). Thus, B's $20 of business interest expense is not allowed 
as a deduction and is treated as business interest expense paid or 
accrued by B in Year 2.
     (17) Example 17--(i) Facts. The facts are the same as in 
Example 16 in paragraph (o)(16) of this section. In Year 2, X has 
$233.33 of ATI, $0 of business interest income, and $30 of business 
interest expense. A has $100 of ATI and $20 of business interest 
expense from its sole proprietorship. B has $0 of ATI and $20 of 
business interest expense from its sole proprietorship.
    (ii) S corporation-level. In Year 2, X's section 163(j) limit is 
30 percent of its ATI plus its business interest income, or $70 
($233.33 x 30 percent). Because X's section 163(j) limit exceeds X's 
$40 of business interest expense ($30 from Year 2, plus the $10 
disallowed business interest expense carryforwards from Year 1), X 
may deduct all $40 of business interest expense in Year 2. Such $40 
of deductible business interest expense is includable in X's non-
separately stated income or loss, and is not subject to further 
limitation under section 163(j). Pursuant to Sec.  1.163(j)-6(l)(7), 
X must reduce its accumulated adjustments account by $40. 
Additionally, X has $100 of excess taxable income under Sec.  
1.163(j)-1(b)(15).
    (iii) Shareholder allocations. A and B are each allocated $96.67 
of nonseparately stated taxable income ($116.67 items of income or 
gain, less $20 of deductible business interest expense) from X. 
Additionally, A and B are each allocated $50 of excess taxable 
income under Sec.  1.163(j)-6(l)(4). As a result, A and B each 
increase their ATI by $50.
    (iv) Shareholder-level computations. A, in computing its limit 
under section 163(j), has $150 of ATI ($100 from its sole 
proprietorship, plus $50 excess taxable income) and $20 of business 
interest expense (from its sole proprietorship). A's section 163(j) 
limit is $45 ($150 x 30 percent). Thus, A's $20 of business interest 
expense is deductible business interest expense. B, in computing its 
limit under section 163(j), has $50 of ATI ($0 from its sole 
proprietorship, plus $50 excess taxable income) and $40 of business 
interest expense ($20 from its sole proprietorship, plus $20 
disallowed business interest expense from its sole proprietorship in 
Year 1). B's section 163(j) limit is $15 ($50 x 30 percent). Thus, 
$15 of B's business interest expense is deductible business interest 
expense. The $25 of B's business interest expense not allowed as a 
deduction ($40 business interest expense, less $15 section 163(j) 
limit) is treated as business interest expense paid or accrued by B 
in Year 3.

    (p) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-7  Application of the business interest deduction 
limitation to foreign corporations and United States shareholders.

    (a) Overview. This section provides rules for the application of 
section 163(j) to foreign corporations with shareholders that are 
United States persons. Paragraph (b) of this section provides rules 
regarding the application of section 163(j) to certain controlled 
foreign corporations. Paragraph (c) of this section provides rules 
concerning the computation of adjusted taxable income (ATI) of certain 
controlled foreign corporations. Paragraph (d) of this section provides 
rules concerning the computation of ATI of a United States shareholder 
of certain controlled foreign corporations (CFC). Paragraph (e) of this 
section provides a rule regarding the effect of section 163(j) on the 
earnings and profits of foreign corporations. Paragraph (f) of this 
section provides definitions that apply for purposes of this section. 
Paragraph (g) of this section provides examples illustrating the 
application of this section. Paragraph (h) of this section provides 
dates of applicability.
    (b) Application of section 163(j) to an applicable CFC and certain 
partnerships--(1) Scope. This paragraph (b) provides rules regarding 
the application of section 163(j) to an applicable CFC and certain 
partnerships. Paragraph (b)(2) of this section describes the general 
application of section 163(j) to an applicable CFC and certain 
partnerships in which an applicable CFC is a partner. Paragraph (b)(3) 
of this section provides an election to use an alternative method for 
computing the deduction for business interest expense of a member of a 
CFC group. Paragraph (b)(4) of this section treats certain partnerships 
as members of a CFC group for purposes of this paragraph (b). Paragraph 
(b)(5) of this section provides the rules regarding an election to 
apply paragraph (b)(3) of this section.
    (2) General application of section 163(j) to an applicable CFC and 
a partnership with at least one partner that is an applicable CFC. 
Except as otherwise provided in this paragraph (b) or in the section 
163(j) regulations, section 163(j) and the section 163(j) regulations 
apply to determine the deductibility of an applicable CFC's business 
interest expense for purposes of computing its taxable income in the 
same manner as those provisions apply to determine the deductibility of 
a domestic C corporation's business interest expense for purposes of 
computing its taxable income. Furthermore, if an applicable CFC is a 
partner in a partnership, except as otherwise provided in this 
paragraph (b) or in the section 163(j) regulations, section 163(j) and 
the section 163(j) regulations apply to the partnership in the same 
manner as those provisions would apply if the applicable CFC were a 
domestic C corporation. If an applicable CFC has income that is, or is 
treated as, effectively connected with the conduct of a trade or 
business in the United States or if a partnership is engaged in a trade 
or business conducted in the United States, see also Sec. Sec.  
1.163(j)-8(d) and 1.882-5 for additional rules concerning the deduction 
for interest.
    (3) Alternative approach for computing the deduction for business 
interest expense. If a CFC group election is properly made and in 
effect with respect to a specified taxable year of a CFC group member 
of a CFC group, then--
    (i) The portion of the CFC group member's business interest expense 
that is subject to the general rule under Sec.  1.163(j)-2(b) is the 
amount equal to the CFC group member's allocable share of the CFC 
group's applicable net business interest expense, or, in the case in 
which the CFC group member is also a member of a financial services 
subgroup, the allocable share of the applicable subgroup net business 
interest expense; and
    (ii) The limitation provided in Sec.  1.163(j)-2(b) is applied 
without regard to Sec.  1.163(j)-2(b)(1) and (3).
    (4) Treatment of certain partnerships as a CFC group member--(i) 
General rule. If one or more CFC group members of the same CFC group, 
in the aggregate, own more than 80 percent of the

[[Page 67577]]

interests in the capital or profits in a partnership, then, except as 
provided in paragraph (b)(4)(ii) of this section, the partnership is 
treated as a CFC group member. If there is a financial services 
subgroup with respect to the CFC group, this paragraph (b)(4) will 
apply only if all of the CFC group members described in the preceding 
sentence are financial services subgroup members or none of them are 
financial services subgroup members. If a partnership is treated as a 
CFC group member, then an interest in the partnership is treated as 
stock for purposes of applying this section.
    (ii) Exception for certain partnerships engaged in a United States 
trade or business. Notwithstanding paragraph (b)(4)(i) of this section, 
a partnership is not treated as a CFC group member if the partnership 
is engaged in a trade or business in the United States, directly or 
indirectly through another passthrough entity, and one or more partners 
has income that is effectively connected with the conduct of a trade or 
business in the United States, including any income that is treated as 
effectively connected income under an applicable provision of the Code 
or regulations, and at least one of the partners is not exempt from 
U.S. tax by reason of a U.S. income tax treaty. Notwithstanding the 
preceding sentence, a partnership that, without regard to this 
paragraph (b)(4)(ii), would be treated as a CFC group member under 
paragraph (b)(4)(i) of this section, is treated as a CFC group member 
solely for purposes of determining if another entity is a CFC group 
member with respect to the CFC group.
    (5) CFC group election--(i) Manner of making a CFC group election. 
Subject to paragraph (b)(5)(ii) of this section, a CFC group election 
is made by applying paragraph (b)(3) of this section for purposes of 
computing the amount of a CFC group member's deduction for business 
interest expense. Except as otherwise provided in publications, forms, 
instructions, or other guidance, a separate statement or form 
evidencing the election need not be filed.
    (ii) Consistency requirement. An election under paragraph (b)(5)(i) 
of this section is not effective unless all CFC group members of the 
CFC group make the election. If an entity becomes a CFC group member of 
a CFC group for which a CFC group election is in effect, the entity 
must make the CFC group election.
    (iii) Duration of a CFC group election. A CFC group election is 
irrevocable. If an entity ceases to be a CFC group member of a CFC 
group for which a CFC group election is in effect, the election 
terminates solely with respect to such entity. If a CFC group ceases to 
exist, a CFC group election terminates with respect to all CFC group 
members of the CFC group.
    (c) Rules concerning the computation of adjusted taxable income of 
an applicable CFC and certain CFC group members--(1) Computation of 
taxable income. For purposes of computing taxable income of an 
applicable CFC for a taxable year, the applicable CFC's gross income 
and allowable deductions are determined under the principles of Sec.  
1.952-2 or the rules of section 882 for determining taxable income that 
is effectively connected with the conduct of a trade or business in the 
United States, as applicable.
    (2) Treatment of certain dividends. For purposes of computing the 
ATI of an applicable CFC for a taxable year, any dividend included in 
gross income that is received from a related person, within the meaning 
of section 954(d)(3), with respect to the distributee is subtracted 
from taxable income.
    (3) Treatment of CFC excess taxable income--(i) In general. If a 
CFC group election is in effect for a specified taxable year of a CFC 
group member and if the CFC group member (upper-tier member) directly 
owns stock in one or more other CFC group members (lower-tier member), 
then, for purposes of computing ATI of the upper-tier member for the 
specified taxable year, there is added to taxable income the sum of the 
products of the following amounts with respect to each lower-tier 
member--
    (A) The CFC excess taxable income (if any) of the lower-tier member 
for the lower-tier member's specified taxable year; and
    (B) The percentage (by value) of the stock of the lower-tier member 
that is directly owned by the upper-tier member on the last day of the 
lower-tier member's specified taxable year.
    (ii) Ordering rules. For purposes of applying paragraph (c)(3)(i) 
of this section, if a CFC group member is an upper-tier member with 
respect to a CFC group member and a lower-tier member with respect to 
another CFC group member, paragraph (c)(3)(i) of this section is 
applied starting with the lowest-tier CFC group member in the chain of 
ownership. If an upper-tier member is a partner in a lower-tier member 
that is a partnership, which is an entity that does not have CFC excess 
taxable income but that may have excess taxable income (as defined in 
Sec.  1.163(j)-1(b)(15)), see Sec.  1.163(j)-6(f) for determining the 
upper-tier member's share of the lower-tier member's excess taxable 
income (if any).
    (d) Rules concerning the computation of adjusted taxable income of 
a United States shareholder--(1) In general--(i) Treatment of gross 
income inclusions that are properly allocable to a non-excepted trade 
or business. If for a taxable year a United States shareholder with 
respect to one or more applicable CFCs includes amounts in gross income 
under section 78, 951(a), or 951A(a) that are properly allocable to a 
non-excepted trade or business (each amount, a specified deemed 
inclusion and such amounts, collectively specified deemed inclusions), 
then, for purposes of computing ATI of the United States shareholder, 
there is subtracted from taxable income an amount equal to the 
specified deemed inclusions, reduced by the portion of the deduction 
allowed under section 250(a)(1), without regard to the taxable income 
limitation of section 250(a)(2), by reason of the specified deemed 
inclusions (such a deduction, a specified section 250 deduction). For 
rules concerning inclusions under sections 78, 951(a), and 951A(a) and 
deductions allowable under section 250 that are not properly allocable 
to a non-excepted trade or business, see Sec.  1.163(j)-1(b)(1)(ii)(F) 
and (b)(1)(i)(H), respectively.
    (ii) Treatment of deemed inclusions of a domestic partnership that 
are not allocable to any trade or business. If a United States 
shareholder that is a domestic partnership includes amounts in gross 
income under section 951(a) or 951A(a) that are not properly allocable 
to trade or business of the domestic partnership, then, notwithstanding 
Sec.  1.163(j)-4(b)(3), to the extent a C corporation partner, 
including an indirect partner in the case of tiered partnerships, takes 
such amounts into account as a distributive share in accordance with 
section 702 and Sec.  1.702-1(a)(8)(ii), the C corporation partner may 
not treat such amounts as properly allocable to a trade or business of 
the C corporation partner.
    (2) Additional rule after application of paragraph (d)(1) of this 
section for a United States shareholder of a CFC group member with a 
CFC group election in effect--(i) In general. Subject to paragraph 
(d)(3) of this section, if for a taxable year, a United States 
shareholder owns directly, or indirectly through one or more foreign 
pass-through entities, stock of one or more CFC group members of a CFC 
group for which a CFC group election is in effect for the specified 
taxable year of each CFC group member that ends with or within the 
taxable year of the United States shareholder, then, for purposes of 
computing ATI of the United States shareholder, in addition to the

[[Page 67578]]

subtraction described in paragraph (d)(1) of this section, there is 
added to taxable income the amount equal to the sum of the amounts of 
eligible CFC group ETI, as defined in paragraph (d)(2)(ii) of this 
section, with respect to each specified highest-tier member of the 
United States shareholder, but not in excess of the amount of the CFC 
group inclusions, as defined in paragraph (d)(2)(iii) of this section, 
of the United States shareholder for the taxable year. For purposes of 
this paragraph (d)(2)(i), members of a consolidated group are treated 
as a single United States shareholder.
    (ii) Eligible CFC group ETI. The term eligible CFC group ETI means, 
with respect to a specified highest-tier member and a specified taxable 
year, the amount equal to the product of the following three amounts--
    (A) The specified highest-tier member's CFC excess taxable income 
for the specified taxable year, taking into account the application of 
paragraph (c)(3) of this section;
    (B) The specified highest-tier member's specified ETI ratio for the 
specified taxable year; and
    (C) The percentage, by value, of the stock of the specified 
highest-tier member that is owned directly, or indirectly through one 
or more foreign passthrough entities, by the United States shareholder 
on the last day of the specified taxable year.
    (iii) CFC group inclusions. The term CFC group inclusions means, 
with respect to a United States shareholder and a taxable year, the 
amounts of the specified deemed inclusions subtracted from taxable 
income under paragraph (d)(1)(i) of this section that are with respect 
to CFC group members, other than amounts included in gross income by 
reason of section 78, reduced by the portion of any specified section 
250 deduction described in paragraph (d)(1)(i) of this section that is 
allowable by reason of such specified deemed inclusions.
    (3) Special rules if a domestic partnership is a United States 
shareholder of a CFC group member with a CFC group election in effect. 
Paragraph (d)(2) of this section does not apply with respect to a 
United States shareholder described in paragraph (d)(2) of this section 
that is a domestic partnership (such a partnership, a U.S. shareholder 
partnership). If a U.S. shareholder partnership has a domestic C 
corporation partner, including an indirect partner in the case of 
tiered partnerships, (such a partner, a U.S. corporate partner), then, 
for purposes of computing ATI of the U.S. corporate partner, paragraph 
(d)(2) of this section is applied by treating the U.S. shareholder 
partnership, and in case of tiered partnerships, any tiered partnership 
that is a domestic partnership, as if it were a foreign partnership and 
by making the following modifications--
    (i) The term ``U.S. corporate partner'' is substituted for the term 
``United States shareholder'' each place it appears in paragraph (d)(2) 
of this section; and
    (ii) If a U.S. shareholder partnership includes an amount in gross 
income under section 951(a) or 951(A) with respect to a CFC group 
member, then to the extent the amount is taken into account by a U.S. 
corporate partner as a distributive share in accordance with section 
702 and Sec.  1.702-1(a)(8)(ii), such amount is treated as a specified 
deemed inclusion of the U.S. corporate partner with respect to the CFC 
group member for purposes of applying paragraph (d)(2)(iii) of this 
section.
    (4) Inclusions under section 951A(a). For purposes of applying 
paragraph (d) of this section, the portion of a United States 
shareholder's inclusion under section 951A(a) treated as being with 
respect to a CFC group member is determined under section 951A(f)(2) 
and Sec.  1.951A-6(b)(2).
    (e) Effect on earnings and profits. In the case of a foreign 
corporation, the disallowance and carryforward of a deduction for the 
corporation's business interest expense under Sec.  1.163(j)-2 will not 
affect whether and when such business interest expense reduces the 
corporation's earnings and profits. Thus, for example, if a United 
States person has elected under section 1295 to treat a passive foreign 
investment company (as defined in section 1297) (PFIC) as a qualified 
electing fund, then the disallowance and carryforward of a deduction 
for the PFIC's business interest expense under Sec.  1.163(j)-2 will 
not affect whether or when such business interest expense reduces the 
PFIC's earnings and profits. Similarly, the disallowance and 
carryforward of a deduction for an applicable CFC's business interest 
expense will not affect the earnings and profits limitation for subpart 
F income under section 952(c). See also Sec.  1.163(j)-4(c).
    (f) Definitions. The following definitions apply for purposes of 
this section.
    (1) Allocable share--(i) General rule. The term allocable share 
means, with respect to a CFC group member of a CFC group and a 
specified taxable year, the amount equal to the product of the CFC 
group's applicable net business interest expense (multiplicand), if 
any, and a fraction, the numerator of which is equal to the amount of 
the CFC group member's net business interest expense, and the 
denominator of which is equal to the sum of the amounts of the net 
business interest expense of each CFC group member.
    (ii) Special rule if there is a financial services subgroup. If 
there is a financial services subgroup with respect to a CFC group, 
then paragraph (f)(1)(i) of this section is applied with the following 
modifications--
    (A) With respect to a CFC group member that is also a financial 
services subgroup member--
    (1) The multiplicand is equal to the amount of the applicable 
subgroup net business interest expense; and
    (2) The denominator of the fraction is determined by replacing the 
term ``CFC group member'' with the term ``financial services subgroup 
member.''
    (B) With respect to a CFC group member this is not a financial 
services subgroup member--
    (1) The multiplicand is reduced by the amount of the applicable 
subgroup net business interest expense; and
    (2) The denominator of the fraction is reduced by the sum of the 
amounts of the net business interest expense of each financial services 
subgroup member.
    (2) Applicable CFC. The term applicable CFC means a controlled 
foreign corporation described in section 957, but only if the foreign 
corporation has at least one United States shareholder that owns, 
within the meaning of section 958(a), stock of the foreign corporation.
    (3) Applicable net business interest expense. The term applicable 
net business interest expense means, with respect to a CFC group and a 
majority U.S. shareholder taxable year, the excess, if any, of the sum 
of the amounts of the business interest expense of each CFC group 
member for the specified taxable year, over the sum of the amounts of 
the business interest income of each CFC group member for the specified 
taxable year.
    (4) Applicable subgroup net business interest expense. The term 
applicable subgroup net business interest expense means, with respect 
to a financial services subgroup of a CFC group and a majority U.S. 
shareholder taxable year, the excess, if any, of the sum of the amounts 
of the business interest expense of each financial services subgroup 
member for the specified taxable year, over the sum of the amounts of 
the business interest income of each financial services subgroup member 
for the specified taxable year.
    (5) CFC excess taxable income--(i) In general. The term CFC excess 
taxable income means, with respect to a CFC

[[Page 67579]]

group member, other than a partnership described in paragraph (b)(4)(i) 
of this section, and a specified taxable year, the amount which bears 
the same ratio to the CFC group member's ATI, as--
    (A) The excess (if any) of--
    (1) The amount determined for the CFC group member under Sec.  
1.163(j)-2(b)(2); over
    (2) The CFC group member's allocable share of either the applicable 
net business interest expense or the applicable subgroup net business 
interest expense, as applicable; bears to
    (B) The amount determined for the CFC group member under Sec.  
1.163(j)-2(b)(2).
    (ii) CFC group member is a partnership. If a CFC group member is a 
partnership, see Sec.  1.163(j)-1(b)(15) for determining the extent to 
which the partnership has excess taxable income. For rules concerning a 
partner's share of a partnership's excess taxable income, see Sec.  
1.163(j)-6(f).
    (6) CFC group--(i) In general. The term CFC group means two or more 
applicable CFCs if 80 percent or more of the total value of shares of 
all classes of stock of each applicable CFC is owned, within the 
meaning of section 958(a), either by a single United States shareholder 
or by multiple U.S. shareholders that are related persons, within the 
meaning of section 267(b) or 707(b)(1), (each a related United States 
shareholder and collectively related United States shareholders), 
provided the stock of each applicable CFC is owned in the same 
proportion by each related United States shareholder.
    (ii) Aggregation rules. The following rules apply for the purpose 
of applying paragraph (f)(6)(i) of this section--
    (A) Members of a consolidated group and individuals described in 
section 318(a)(1)(A)(i) who file a joint tax return are treated as a 
single person; and
    (B) If a single United States person, as defined in section 957(c), 
taking into account the application of paragraph (f)(6)(ii)(A) of this 
section, owns, directly or indirectly through one or more passthrough 
entities, more than 80 percent of the interests in a pass-through 
entity that is a United States shareholder that owns, within the 
meaning of section 958(a), stock in an applicable CFC, then that United 
States person is treated as owning the stock of the applicable CFC that 
is owned by the passthrough entity. For purposes of applying the 80-
percent threshold described in the preceding sentence, if the pass-
through entity is a partnership, then the 80-percent threshold is 
satisfied if the United States person owns at least 80 percent of the 
interests in the capital or the profits of the partnership, and if the 
passthrough entity is not a partnership, then the 80-percent threshold 
is satisfied if the United States person owns at least 80 percent of 
the value of all interests of the passthrough entity.
    (7) CFC group election. The term CFC group election means an 
election to apply paragraph (b)(3) of this section.
    (8) CFC group member. The term CFC group member means, with respect 
to a CFC group, an entity included in the CFC group. An entity that 
has, including through ownership of an interest in a passthrough 
entity, income which is effectively connected with a trade or business 
conducted in the United States, including any income that is treated as 
effectively connected income under an applicable provision of the Code 
or regulations, and not exempt from U.S. tax by reason of a U.S. income 
tax treaty is not treated as a member of a CFC group, other than solely 
for purposes of determining if another entity is a CFC group member 
with respect to the CFC group.
    (9) Financial services subgroup. The term financial services 
subgroup means, with respect to a CFC group, a group comprised of each 
CFC group member of the CFC group that is an eligible controlled 
foreign corporation (as defined in section 954(h)(2)(A)), a qualified 
insurance company (as defined in section 953(e)(3)), or eligible for 
the dealer exception in computing foreign personal holding company 
income (as described in section 954(c)(2)(C)).
    (10) Financial services subgroup member. The term financial 
services subgroup member means, with respect to a financial services 
subgroup of a CFC group, a CFC group member that is also a member of 
the financial services subgroup.
    (11) Majority U.S. shareholder taxable year. The term majority U.S. 
shareholder taxable year means, with respect to a CFC group, one of the 
following taxable years, applied sequentially--
    (i) If there is a single United States shareholder of the CFC group 
for purposes of paragraph (f)(6)(i) of this section, then the taxable 
year of the United States shareholder;
    (ii) If paragraph (f)(11)(i) of this section does not apply and a 
related United States shareholder owns, within the meaning of section 
958(a), more stock of the members of the CFC group, by value, than is 
owned, within the meaning of section 958(a), by any other related 
United States shareholder, then the taxable year of the first-mentioned 
related United States shareholder;
    (iii) If paragraphs (f)(11)(i) and (ii) of this section do not 
apply and if one or more related United States shareholders with the 
same taxable year, in aggregate, own, within the meaning of section 
958(a), more stock of the members of the CFC group (by value) than is, 
in aggregate, owned, within the meaning of section 958(a), by other 
related United States shareholders with the same taxable year, then the 
taxable year of the first-mentioned related United States shareholders; 
and
    (iv) If paragraphs (f)(11)(i), (ii), and (iii) of this section do 
not apply, then the calendar year.
    (12) Net business interest expense. The term net business interest 
expense means, with respect to a CFC group member of a CFC group and a 
specified taxable year, the excess, if any, of the amount of the CFC 
group member's business interest expense over the amount of the CFC 
group member's business interest income, in each case determined 
without regard to section 163(j) and the section 163(j) regulations.
    (13) Passthrough entity. The term passthrough entity means a 
partnership, S corporation, or any other entity (domestic or foreign) 
that is not a corporation if all items of income and deduction of the 
entity are included in the income of its owners or beneficiaries. An 
interest in a passthrough entity means an interest in the capital or 
profits of the entity or stock of an S corporation, as applicable.
    (14) Specified ETI ratio--(i) In general. The term specified ETI 
ratio means, with respect to a specified highest-tier member of a CFC 
group and a specified taxable year, the ratio computed as a fraction 
(expressed as a percentage), the numerator of which is the sum of the 
amounts described in paragraph (f)(14)(iii) of this section with 
respect to each CFC group member described in paragraph (f)(14)(ii) of 
this section, and the denominator of which is the sum of the amounts 
described in paragraph (f)(14)(iv) of this section with respect to each 
CFC group member described in paragraph (f)(14)(ii) of this section 
that has amounts included in the numerator. The specified ETI ratio may 
not exceed 100 percent. If the numerator and the denominator of the 
fraction are not both greater than zero, the specified ETI ratio is 
treated as being equal to zero.
    (ii) Includable CFC group members. For purposes of applying 
paragraph (f)(14)(i) of this section, a CFC group member is described 
in this paragraph (f)(14)(ii) if--
    (A) The CFC group member is the specified highest-tier member or a 
specified lower-tier member with

[[Page 67580]]

respect to the specified highest-tier member; and
    (B) The CFC group member has CFC excess taxable income without 
regard to paragraph (c)(3) of this section.
    (iii) Numerator. For purposes of applying (f)(14)(i) of this 
section, the amount described in this paragraph (f)(14)(iii) is, with 
respect to a CFC group member and a specified taxable year, the sum of 
the amounts included in gross income under sections 951(a) and 951A(a) 
of each United States shareholder with respect to the CFC group member 
for the taxable years of the United States shareholders in which or 
with which the specified taxable year of the CFC group member ends. For 
purposes of this paragraph (f)(14)(iii), the portion of a United States 
shareholder's inclusion under section 951A(a) treated as being with 
respect to a CFC group member is determined under section 951A(f)(2) 
and Sec.  1.951A-6(b)(2).
    (iv) Denominator. For purposes of applying (f)(14)(i) of this 
section, the amount described in this paragraph (f)(14)(iv) is, with 
respect to a CFC group member and a specified taxable year, the taxable 
income of the CFC group member for the specified taxable year.
    (15) Specified highest-tier member. The term specified highest-tier 
member means, with respect to a CFC group, a CFC group member in which 
a United States shareholder owns directly, or indirectly through one or 
more foreign passthrough entities, stock of the CFC group member.
    (16) Specified lower-tier member. The term specified lower-tier 
member means, with respect to a specified highest-tier member of a CFC 
group, a CFC group member in which the specified highest-tier member 
owns stock directly or indirectly through a chain of ownership.
    (17) Specified taxable year. The term specified taxable year means, 
with respect to a CFC group member of a CFC group, the taxable year 
that ends with or within a majority U.S. shareholder year.
    (18) United States shareholder. The term United States shareholder 
has the meaning provided in section 951(b).
    (g) Examples. The following examples illustrate the application of 
this section. For each example, unless otherwise stated, the referenced 
business interest expense is deductible but for the application of 
section 163(j), no exemptions from the application of section 163(j) 
are available, none of the business interest expense is floor plan 
financing interest expense, and no foreign corporation has income that 
is effectively connected with a trade or business conducted in the 
United States or is an entity described in paragraph (f)(9) of this 
section (regarding entities that provide certain types of financial 
services).

     (1) Example 1: Computation of section 163(j) limitation of CFC 
group members--(i) Facts. USP, a domestic C corporation, wholly owns 
US1 and US2, each of which is a domestic C corporation. USP, US1, 
and US2 are members of a consolidated group of which USP is the 
common parent (USP group). US1 wholly owns CFC1, a foreign 
corporation, and US2 wholly owns CFC2 and CFC3, each of which is a 
foreign corporation. The USP group has a calendar year taxable year. 
For U.S. tax purposes, CFC1, CFC2, and CFC3 each have a fiscal 
taxable year ending on November 30. CFC1 has an outstanding loan of 
$1,000x from a third-party (CFC1 note). CFC1 has a receivable of 
$500x from each of CFC2 and CFC3 (CFC2 note and CFC3 note, 
respectively). Interest on all debt is paid and accrued annually on 
November 30. During the taxable year ending November 30, 2019, CFC1 
has business interest expense of $90x attributable to CFC1 note and 
business interest income of $100x attributable to CFC2 note and CFC3 
note, and CFC2 and CFC3 each have $50x of business interest expense 
attributable to CFC2 note and CFC3 note, respectively. Assume that 
each of CFC1, CFC2, and CFC3 has ATI of $100x computed on a separate 
company basis for the taxable year ending November 30, 2019. The USP 
group has no business interest expense.
    (ii) Analysis--(A) Determination of CFC group. US1 owns (within 
the meaning of section 958(a)) all of the stock of CFC1, and US2 
owns (within the meaning of section 958(a)) all of the stock of each 
of CFC2 and CFC3. Under paragraph (f)(2) of this section, each of 
CFC1, CFC2, and CFC3 is an applicable CFC. Under paragraph 
(f)(6)(ii)(A) of this section, because US1 and US2 are members of a 
consolidated group, US1 and US2 are treated as a single person for 
purposes determining a CFC group under paragraph (f)(6)(i) of this 
section. Therefore, because 80 percent or more of the stock of each 
of CFC1, CFC2, and CFC3 is owned (within the meaning of section 
958(a)) by a single United States shareholder, under paragraph 
(f)(6)(i) of this section, CFC1, CFC2, and CFC3 are members of a CFC 
group (USP CFC group).
    (B) CFC group election is made. Assume a CFC group election is 
properly made. Under paragraph (f)(11)(i) of this section, because 
there is a single United States shareholder of the USP CFC group 
with a calendar taxable year, the majority U.S. shareholder taxable 
year with respect to the USP CFC group ends on December 31, 2019. 
Under paragraph (f)(17) of this section, the specified taxable year 
of each of CFC1, CFC2, and CFC3 is November 30, 2019, which is the 
taxable year that ends with or within the majority U.S. shareholder 
taxable year ending on December 31, 2019. Under paragraph (f)(3) of 
this section, the applicable net business interest expense of the 
USP CFC group is $90x. The $90x is the excess of $190x, which is the 
sum of the amounts of the business interest expense of each of CFC1, 
CFC2, and CFC3 ($90x, $50x, and $50x, respectively), over $100x, 
which is the sum of the amounts of the business interest income of 
each of CFC1, CFC2, and CFC3 ($100x, $0, and $0, respectively). 
Under paragraph (f)(12) of this section, CFC1 has $0 of net business 
interest expense ($90x business interest expense does not exceed 
$100x of business interest income), and CFC2 and CFC3 each have $50x 
of net business interest expense (each has $50x business interest 
expense and $0 business interest income). Because CFC2 and CFC3 each 
has net business interest expense, under paragraph (f)(1) of this 
section, each has an allocable share of the applicable net business 
interest expense of the USP CFC group. The allocable share of each 
of CFC2 and CFC3 is $45x, computed as $90x (the applicable net 
business interest expense) multiplied by the fraction equal to $50x/
$100x (the net business interest expense of the member and the sum 
of the amounts of net business interest expense of all members, 
respectively). Under paragraph (b)(3)(i) of this section, none of 
CFC1's $90x of business interest expense and $45x of each of CFC2's 
and CFC3's $50x of business interest expense is subject to the 
general rule under Sec.  1.163(j)-2(b) (and $5x of each of CFC2's 
and CFC3's business interest expense is not subject to limitation 
under Sec.  1.163(j)-2(b)), and, under paragraph (b)(3)(ii) of this 
section, the general rule under Sec.  1.163(j)-2(b), as applied to 
CFC2 and CFC3, is computed without regard to Sec.  1.163(j)-2(b)(1) 
and (3). Thus, under Sec.  1.163(j)-2(b), CFC2's limitation is $30x 
($100x ATI computed on a separate company basis x 30 percent). The 
amount of CFC2's business interest expense subject to limitation 
under paragraph (b)(3) of this section, $45x, exceeds CFC2's 
limitation under Sec.  1.163(j)-2(b), $30x. Accordingly, $35x ($5x 
not subject to limitation + $30x) of CFC2's business interest 
expense is deductible, and under Sec.  1.163(j)-2(c), the remaining 
$15x of business interest expense is not deductible and will be 
carried forward as a disallowed business interest expense 
carryforward. The analysis for CFC3 is the same as for CFC2. Because 
the USP group has no business interest expense, the application of 
paragraph (d) of this section is not relevant.
    (C) CFC group election is not made. Instead, assume a CFC group 
election is not made. In this case, each of CFC1, CFC2, and CFC3 
must compute its interest deduction limitation under Sec.  1.163(j)-
2(b), without regard to paragraph (b)(3) of this section. CFC1's 
business interest expense of $90x is deductible because it has 
business interest income of $100x. CFC2's business interest expense 
limitation is $30x ($100x ATI computed on a separate company basis x 
30 percent). Accordingly, $30x of CFC2's business interest expense 
is deductible, and under Sec.  1.163(j)-2(c), the remaining $20x of 
business interest expense is disallowed business interest expense 
and will be carried forward as a disallowed business interest 
expense carryforward. The analysis for CFC3 is the same as for CFC2.
     (2) Example 2: Computation and allocation of CFC excess taxable 
income--(i) Facts. USP, a domestic C corporation, wholly owns CFC1, 
a foreign corporation. CFC1 wholly owns CFC2, a foreign corporation, 
and CFC2

[[Page 67581]]

wholly owns each of CFC3 and CFC4, both of which are foreign 
corporations (CFC1, CFC2, CFC3, and CFC4, collectively, the USP CFC 
group). All entities have a calendar year for U.S. tax purposes. For 
Year 1, assume the following additional facts: Prior to the 
application of section 163(j), CFC1 has no items of income, gain, 
deduction, or loss; CFC2 has a taxable loss of $5x (including $5x of 
business interest expense); CFC3 has taxable income of $85x 
(including $15x of business interest expense); CFC4 has $60x of 
taxable income (including $40x of business interest expense); a CFC 
group election is in effect for the CFC group; there is no 
intercompany debt between any CFC group member; 50 percent of CFC3's 
items of income and gain are subpart F income (as defined in section 
952), and 50 percent of CFC3's items of deduction and loss are 
properly allocable to subpart F income, and with respect to the 
remaining portion of CFC3's items of income, gain, deduction, and 
loss, no portion is taken into account in computing tested income 
(as defined in section 951A(c)(2)(A)) or tested loss (as defined in 
section 951A(c)(2)(B)) of CFC3; CFC4's items of income and gain are 
all tested income, and CFC4's items of deduction are all properly 
allocable to such income; no portion of CFC2's items of income, 
gain, deduction, or loss is taken into account in computing tested 
income or tested loss; no CFC group member has qualified business 
asset investment (as defined in section 951A(d)); for purposes of 
computing ATI, there are no subtractions or additions to taxable 
income described in Sec.  1.163(j)-1(b)(1) with respect to any CFC 
group member of the USP CFC group other than for business interest 
expense; for simplicity, no foreign income taxes are paid by any CFC 
group member of the USP CFC group; in addition to the inclusions in 
gross income under sections 951(a)(1) and 951A(a) with respect to 
the CFC group members of the USP CFC group, USP has business 
interest expense of $20x.
    (ii) Analysis--(A) Application of section 163(j) to CFC group 
members of the USP CFC group; computation of USP CFC group's 
applicable net business interest expense. Under paragraph (f)(3) of 
this section, the USP CFC group's applicable net business interest 
expense is $60x ($0 + $5x + $15x + $40x with respect to CFC1, CFC2, 
CFC3, and CFC4, respectively). Because there is no debt between the 
CFC group members of the USP CFC group, under paragraph (b)(3) of 
this section, each of the CFC group members allocable share of the 
$60x is equal to its separate company business interest expense. In 
particular, CFC1's allocable share of the USP CFC group's applicable 
net interest expense is zero, CFC2's allocable share is $5x, CFC3's 
allocable share is $15x, and CFC4's allocable share is $40x.
    (B) Application of section 163(j) to CFC4. Under Sec.  1.163(j)-
1(b)(1), CFC4's ATI is $100x ($60x taxable income + $40x business 
interest expense). Under Sec.  1.163(j)-2(b), CFC4's limitation is 
$30x ($100x ATI computed on a separate company basis x 30 percent). 
The amount of CFC4's business interest expense subject to 
limitation, $40x, exceeds CFC4's limitation, $30x. Accordingly, 
under Sec.  1.163(j)-2(c), $10x of business interest expense is not 
deductible and will be carried forward as a disallowed business 
interest expense carryforward. Because $10x of business interest 
expense is not currently deductible, CFC4's tested income is $70x 
($60x taxable income prior to application of section 163(j), 
increased by $10x of disallowed business interest expense).
    (C) Application of section 163(j) to CFC3. Under Sec.  1.163(j)-
1(b)(1), CFC3's ATI is $100x ($85x taxable income + 15x business 
interest expense). Under Sec.  1.163(j)-2(b), CFC3's limitation is 
$30x ($100x ATI computed on a separate company basis x 30 percent). 
Because the amount of CFC3's business interest expense subject to 
limitation, $15x, does not exceed CFC3's limitation, $30x, all of 
CFC3's business interest expense is currently deductible. 
Accordingly, CFC3's subpart F income is $42.50x ($85x taxable income 
x 50 percent). Furthermore, CFC3 has CFC excess taxable income of 
$50x ($100x x ($15x/$30x)).
    (D) Application of section 163(j) to CFC2. Under Sec.  1.163(j)-
1(b)(1), taking into account the application of paragraph (c)(3) of 
this section, CFC2's ATI is $50x (($5x) taxable loss + $5x business 
interest expense + $50x (100 percent x $50x of CFC3's excess taxable 
income)). Under Sec.  1.163(j)-2(b), CFC2's limitation is $15x ($50x 
ATI x 30 percent). Because the amount of CFC2's business interest 
expense subject to limitation, $5x, does not exceed CFC2's 
limitation, $15x, all of CFC2's business interest expense is 
currently deductible. Furthermore, CFC2 has CFC excess taxable 
income of $33.33x ($50x x ($10x/$15x)).
    (E) Application of section 163(j) to CFC1. Under Sec.  1.163(j)-
1(b)(1), taking into account the application of paragraph (c)(3) of 
this section, CFC1's ATI is $33.33x ($0 taxable income + $33.33x 
(100 percent x $33.33x of CFC2's excess taxable income)). CFC1 has 
no business interest expense subject to limitation and therefore 
CFC1 has CFC excess taxable income of $33.33x.
    (F) Application of section 163(j) to USP. Under section 
951(a)(1), USP includes $42.50x in gross income with respect to 
CFC3. Under section 951A(a), USP includes $70x in gross income, all 
of which is allocable to CFC4 under section 951A(f)(2), and under 
section 250(a)(1)(B), USP is allowed a deduction of $35x. Thus, the 
amount of USP's CFC group inclusions is $77.50x ($42.50 + $70x -
$35x), and USP's taxable income prior to the application of section 
163(j) is $57.50x ($77.50x - $20x business interest expense). Under 
Sec.  1.163(j)-1(b)(1), taking into account the application of 
paragraph (d)(2) of this section, USP's ATI is $16.67x. USP's ATI, 
$16.67x, is equal to $57.50x of taxable income + $20x of business 
interest expense - $77.50x of CFC group inclusions + $16.67x of 
eligible CFC group ETI. The eligible CFC group ETI, $16.67x, is 
determined as $33.33x (CFC1's excess taxable income) x 50 percent 
(CFC1's specified ETI ratio) x 100 percent (percentage of stock of 
CFC1 owned directly by USP)). Under paragraph (f)(14) of this 
section, the specified ETI ratio of CFC1 is 50 percent ($42.50x/
$85x). The numerator of the fraction, $42.50x, is equal to the 
amount of USP's gross income inclusion under section 951(a) with 
respect to CFC3. The denominator of the fraction, $85x, is equal to 
the amount of the taxable income of CFC3. The numerator and the 
denominator of the fraction do not include amounts with respect to 
CFC1, CFC2, and CFC4, because none of them has CFC excess taxable 
income without regard to the application of paragraph (c)(3) of this 
section. Furthermore, USP includes no amounts in gross income under 
section 951(a) or 951A(a) with respect to CFC1 or CFC2. Under Sec.  
1.163(j)-2(b), USP's section 163(j) limitation is $5x ($16.67x ATI x 
30 percent). The amount of USP's business interest expense, $20x, 
exceeds USP's section 163(j) limitation, $5x. Accordingly, under 
Sec.  1.163(j)-2(c), $15x of business interest expense is not 
deductible and is carried forward as a disallowed business interest 
expense carryforward.

    (h) Applicability date. This section applies to a taxable year of a 
foreign corporation ending after the date the Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register and to a taxable year of a shareholder of the foreign 
corporation ending with or within the taxable year of the foreign 
corporation. However, a foreign corporation and its shareholders and 
their related parties, within the meaning of sections 267(b) and 
707(b)(1), may apply this section to a taxable year of the foreign 
corporation beginning after December 31, 2017, and to a taxable year of 
a shareholder of the foreign corporation ending with or within the 
taxable year of the foreign corporation, if the foreign corporation and 
its shareholders and their related parties consistently apply all of 
the section 163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-8  Application of the business interest deduction 
limitation to foreign persons with effectively connected income.

    (a) Overview. This section provides rules concerning the 
application of section 163(j) to foreign persons engaged in a trade or 
business in the United States. Paragraph (b) of this section modifies 
the application of section 163(j) for specified foreign persons with 
effectively connected taxable income. Paragraph (c) of this section 
modifies the application of section 163(j) for specified foreign 
partners in a partnership engaged in a trade or business in the United 
States. Paragraph (d) of this section provides rules for certain 
controlled foreign corporations

[[Page 67582]]

with effectively connected taxable income. Paragraph (e) of this 
section coordinates the application of section 163(j) and Sec.  1.882-
5. Paragraph (f) of this section provides a coordination rule for 
determining effectively connected earnings and profits for purposes of 
the branch profits tax under section 884. Paragraph (g) of this section 
provides definitions that apply for purposes of this section. Paragraph 
(h) of this section provides examples that illustrate the application 
of this section. Paragraph (i) of this section provides dates of 
applicability.
    (b) Application of section 163(j) and the section 163(j) 
regulations to specified foreign persons with effectively connected 
taxable income--(1) In general. If a taxpayer is a specified foreign 
person, then the modifications described in this paragraph (b) are made 
to the application of section 163(j) and the section 163(j) 
regulations. If a specified foreign person is also a specified foreign 
partner, then the modifications described in this paragraph (b) are 
subject to the partner-level modifications described in paragraph (c) 
of this section.
    (2) Modification of adjusted taxable income. ATI for a specified 
foreign person for a taxable year means the specified foreign person's 
effectively connected taxable income for the taxable year, adjusted for 
the items described in Sec.  1.163(j)-1(b)(1)(i) through (iv) that are 
taken into account in determining effectively connected taxable income.
    (3) Modification of business interest expense--(i) General rule. 
Business interest expense for a specified foreign person means interest 
described in Sec.  1.163(j)-1(b)(2) that is determined under Sec.  
1.882-5, in the case of a foreign corporation, or under Sec.  1.861-
9T(d)(2), in the case of a non-resident alien individual, and allocable 
to income which is effectively connected taxable income.
    (ii) Exclusion of certain business interest expense of a specified 
foreign partner. If a foreign corporation is a specified foreign 
partner in a partnership engaged in a trade or business in the United 
States, then, for purposes of paragraph (b)(3)(i) of this section, 
business interest expense excludes the portion of interest expense 
determined under Sec.  1.882-5 that is attributable to interest on U.S. 
booked liabilities of the partnership determined under Sec.  1.882-
5(d)(2)(vii).
    (4) Modification of business interest income. The business interest 
income of a specified foreign person means interest described in Sec.  
1.163(j)-1(b)(3) that is effectively connected taxable income.
    (5) Modification of floor plan financing interest expense. The 
floor plan financing interest expense of a specified foreign person 
means interest described Sec.  1.163(j)-1(b)(17) that is allocable to 
income which is effectively connected taxable income.
    (6) Modification of allocation of interest expense and interest 
income that is properly allocable to a trade or business. For purposes 
of Sec.  1.163(j)-10(c), a specified foreign person's interest expense 
and interest income that is properly allocable to a trade or business 
is only allocated to the specified foreign person's excepted or non-
excepted trades or business that have effectively connected taxable 
income. If the specified foreign person is also a specified foreign 
partner, this rule only applies to the trades or business not in the 
partnership.
    (c) Partner-level modifications to Sec.  1.163(j)-6 for 
partnerships engaged in a U.S. trade or business--(1) Modification 
related to a partnership's excess taxable income. If for a taxable year 
a specified foreign partner, other than an applicable CFC, has 
allocable excess taxable income with respect to a partnership, then, 
for purposes of computing the specified foreign partner's ATI for the 
taxable year, the excess, if any, of the amount of the allocable excess 
taxable income over the amount of the specified excess taxable income 
is subtracted from ATI.
    (2) Modification related to a partnership's excess business 
interest expense. If for a taxable year a specified foreign partner, 
other than an applicable CFC, has allocable excess business interest 
expense with respect to a partnership, then, for purposes of 
determining the specified foreign partner's business interest expense 
for a succeeding taxable year, the amount of the allocable excess 
business interest expense treated as disallowed business interest 
expense carryforward under Sec.  1.163(j)-6(f) is determined by taking 
into account only the portion of allocable excess business interest 
expense that is specified excess business interest expense and such 
excess business interest expense is limited to the portion of allocable 
excess taxable income for the succeeding taxable year that is specified 
excess taxable income.
    (3) Modification related to a partnership's excess business 
interest income. If for a taxable year a specified foreign partner, 
other than an applicable CFC, has allocable excess business interest 
income (as defined in Sec.  1.163(j)-6(b)(4)) with respect to a 
partnership, then, for purposes of determining the specified foreign 
partner's section 163(j) limitation, the amount of allocable excess 
business interest income that can be used by the specified foreign 
partner cannot exceed the amount of ECI excess business interest 
income.
    (d) An applicable CFC with effectively connected taxable income. If 
an applicable CFC has effectively connected taxable income for a 
taxable year in which the applicable CFC has disallowed business 
interest expense, then a portion of the disallowed business interest 
expense is treated as being with respect to the applicable CFC's 
interest expense determined under Sec.  1.882-5. That portion is equal 
to the amount of the applicable CFC's disallowed business interest 
expense multiplied by a fraction, the numerator of which is the 
applicable CFC's effectively connected taxable income for the taxable 
year, adjusted for the items described in Sec.  1.163(j)-1(b)(1)(i) 
through (iv) that are taken into account in determining effectively 
connected taxable income, and the denominator of which is the 
applicable CFC's ATI for the taxable year. However, in no case will 
such portion exceed the amount of interest expense determined under 
Sec.  1.882-5. See also Sec.  1.163(j)-7(b)(2) (concerning the general 
application of section 163(j) to an applicable CFC).
    (e) Coordination of section 163(j) and Sec.  1.882-5--(1) General 
rules--(i) Ordering rule. A foreign corporation first determines its 
interest expense under Sec.  1.882-5 and then determines the amount of 
disallowed business interest expense.
    (ii) Treatment of disallowed business interest expense 
carryforward. If a foreign corporation has a disallowed business 
interest expense carryforward from a taxable year, then such 
carryforward is not taken into account for purposes of determining 
interest expense under Sec.  1.882-5 in the succeeding taxable year.
    (iii) Treatment of allocable excess business interest expense. If a 
foreign corporation has allocable excess business interest expense from 
a taxable year that is treated under Sec.  1.163(j)-6(g)(2) as 
disallowed business interest expense carryforward, such interest is not 
taken into account for purposes of determining interest expense under 
Sec.  1.882-5 in the succeeding taxable year.
    (iv) Scaling ratio. If a foreign corporation determines its 
interest expense under the method described in Sec.  1.882-5(b) through 
(d) and has U.S. booked liabilities in excess of U.S. connected 
liabilities, the foreign corporation must apply the scaling ratio

[[Page 67583]]

(as defined in Sec.  1.882-5(d)(4)(ii)) pro rata to all interest 
expense paid or accrued by the foreign corporation consistent with 
Sec.  1.882-5(d)(4)(i), including for purposes of paragraph (b)(3)(ii) 
of this section.
    (2) Amount of interest determined under Sec.  1.882-5 that is 
disallowed business interest expense--(i) Foreign corporation is not a 
specified foreign partner. If a foreign corporation is not a specified 
foreign partner for a taxable year, then the amount of the foreign 
corporation's interest expense determined under Sec.  1.882-5 for which 
a deduction is disallowed for the taxable year is either--
    (A) The amount of disallowed business interest expense computed 
under Sec.  1.163(j)-2(b) with respect to business interest expense 
described in paragraph (b)(3)(i) of this section, in the case of a 
foreign corporation that is not an applicable CFC; or
    (B) The amount of disallowed business interest expense determined 
under paragraph (d) of this section, in the case of an applicable CFC.
    (ii) Foreign corporation is a specified foreign partner. If a 
foreign corporation is a specified foreign partner with respect to one 
or more partnerships engaged in a trade or business in the United 
States for a taxable year, then the portion of the foreign 
corporation's business interest expense determined under Sec.  1.882-5 
for which a deduction is disallowed for the taxable year is equal to 
the sum of the following amounts--
    (A) Either--
    (1) The amount described in paragraph (e)(2)(i)(A) of this section, 
in the case of a foreign corporation that is not an applicable CFC; or
    (2) The amount described in paragraph (e)(2)(i)(B) of this section, 
in the case of an applicable CFC; and
    (B) With respect to each partnership that has excess business 
interest expense for the taxable year that ends with or within the 
foreign corporation's taxable year, the amount of the foreign 
corporation's specified excess business interest expense.
    (f) Coordination with branch profits tax--(1) Effect on effectively 
connected earnings and profits. The disallowance and carryforward of 
business interest expense under Sec.  1.163(j)-2(b) and (c) will not 
affect when such business interest expense reduces the effectively 
connected earnings and profits of a foreign corporation, as defined in 
Sec.  1.884-1(f).
    (2) Effect on U.S. net equity. The disallowance and carryforward of 
business interest expense under Sec.  1.163(j)-2(b) and (c) will not 
affect the computation of the U.S. net equity of a foreign corporation, 
as defined in Sec.  1.884-1(c).
    (g) Definitions. The following definitions apply for purposes of 
this section.
    (1) Applicable CFC. The term applicable CFC means a foreign 
corporation described in section 957, but only if the foreign 
corporation has at least one United States shareholder that owns, 
within the meaning of section 958(a), stock of the foreign corporation.
    (2) ECI excess business interest income. The term ECI excess 
business interest income means, with respect to a specified foreign 
partner and a partnership, the excess, if any, of the specified foreign 
partner's allocable business interest income (as defined in Sec.  
1.163(j)-6(f)(2)(ii)) over its allocable business interest expense (as 
defined in Sec.  1.163(j)-6(f)(2)(ii)), but, for purposes of 
determining a specified foreign partner's allocable business interest 
income and allocable business interest expense, taking into account 
only the portion of the partnership's business interest income 
determined under paragraph (b)(4) of this section as if the partnership 
were a specified foreign person, over the business interest expense on 
the U.S. booked liabilities of the partnership as determined under 
Sec.  1.882-5(d)(2)(vii).
    (3) Effectively connected taxable income. The term effectively 
connected taxable income means taxable income of a person that is, or 
is treated as. effectively connected with the conduct of a trade 
business in the United States under an applicable provision of the Code 
or regulations or, if an income tax treaty applies, business profits 
attributable to a U.S. permanent establishment of a tax treaty resident 
eligible for benefits under an income tax treaty between the United 
States and the treaty country.
    (4) Specified excess business interest expense. The term specified 
excess business interest expense means, with respect to a specified 
foreign partner and a partnership, the amount determined by multiplying 
the specified foreign partner's allocable excess business interest 
expense (as determined under Sec.  1.163(j)-6(f)) by the partnership's 
specified ratio for the taxable year.
    (5) Specified excess taxable income. The term specified excess 
taxable income means, with respect to a specified foreign partner and a 
partnership, the amount determined by multiplying the amount of the 
specified foreign partner's allocable excess taxable income (as 
determined under Sec.  1.163(j)-6(f)) by the amount of the 
partnership's specified ratio for the taxable year.
    (6) Specified foreign partner. The term specified foreign partner 
means, with respect to a partnership that is engaged in a U.S. trade or 
business, a partner that is a specified foreign person or an applicable 
CFC.
    (7) Specified foreign person. The term specified foreign person 
means a nonresident alien individual, as defined in section 7701(b) and 
the regulations thereunder, or a foreign corporation other than an 
applicable CFC.
    (8) Specified ratio. The term specified ratio means, with respect 
to a partnership, a fraction (expressed as a percentage), the numerator 
of which is the ATI for the partnership determined under paragraph 
(b)(2) of this section as if the partnership were a specified foreign 
person, and the denominator of which is the ATI for the partnership 
determined under Sec.  1.163(j)-6(d).
    (h) Examples. The following examples illustrate the application of 
this section. For all examples, assume that all referenced interest 
expense is deductible but for the application of section 163(j), the 
small business exemption under Sec.  1.163(j)-2(d) is not available, no 
party is engaged in an excepted trade or business, and no business 
interest expense is floor plan financing interest expense.

    (1) Example 1: Limitation on business interest deduction of a 
foreign corporation--(i) Facts. FC, a foreign corporation that is 
not an applicable CFC, has $100x of gross income that is effectively 
connected income. FC has $60x of other income which is not 
effectively connected income. FC has total expenses of $100x. Assume 
that under Sec.  1.882-5, FC has $30x of interest expense allocable 
to income which is effectively connected income. Under section 
882(c) and the regulations thereunder, FC has $40x of other expenses 
properly allocated and apportioned to income which is effectively 
connected taxable income. FC does not have any business interest 
income.
    (ii) Analysis. FC is a specified foreign person under paragraph 
(g)(7) of this section. Under paragraph (e)(2) of this section, the 
amount of FC's interest expense determined under Sec.  1.882-5 that 
is disallowed is the disallowed business interest expense computed 
under Sec.  1.163(j)-2(b) with respect to interest expense described 
in paragraph (b)(3) of this section. Under Sec.  1.163(j)-4(b)(1), 
all interest paid or accrued by FC is properly allocable to a trade 
or business and therefore under paragraph (b)(3) of this section, FC 
has business interest expense of $30x. FC has $30x of effectively 
connected taxable income described in paragraph (g)(3) of this 
section ($100x - $30x - $40x). Under paragraph (b)(2) of this 
section, FC has ATI of $60x, determined as $30x of effectively 
connected taxable income, increased by $30x of business interest 
expense. Accordingly, FC's section 163(j) limitation is $18x ($60x x 
30

[[Page 67584]]

percent). Because FC's business interest expense ($30x) exceeds the 
section 163(j) limitation ($18x), FC may only deduct $18x of 
business interest expense. Under Sec.  1.163(j)-2(c), the remaining 
$12x is disallowed business interest expense carryforward and under 
paragraph (e)(1)(ii) of this section, the $12x is not taken into 
account for purposes of applying Sec.  1.882-5 in the succeeding 
taxable year.
    (2) Example 2: Use of a disallowed business interest expense 
carryforward--(i) Facts. The facts are the same as in Example 1 in 
paragraph (h)(1)(i) of this section except that FC has $300x of 
gross income which is all effectively connected income. Furthermore 
assume that FC has a disallowed business interest expense 
carryforward of $25x from the prior taxable year.
    (ii) Analysis. Under paragraph (e)(1)(ii) of this section, FC's 
$25x of disallowed business interest expense carryforward is not 
taken into account for purposes of determining FC's interest under 
Sec.  1.882-5. Therefore, FC has $30x of business interest expense 
determined under Sec.  1.882-5. Under paragraph (g)(3) of this 
section, FC has effectively connected taxable income of $205x ($300x 
gross income - $55x interest expense ($30x + $25x) - $40x other 
expenses). Under paragraph (b)(2) of this section, FC has ATI of 
$260x, determined as $205x of effectively connected taxable income, 
increased by $55x of business interest expense. Accordingly, FC's 
section 163(j) limitation is $78x ($260x x 30 percent). Under 
paragraph (b)(3) of this section, FC has business interest expense 
of $55x ($30x + $25x disallowed interest carryforward) for the 
taxable year. Because FC's business interest expense ($55x) does not 
exceed the section 163(j) limitation ($78x), FC may deduct all $55x 
of business interest expense.
    (3) Example 3: Foreign corporation is engaged in a U.S. trade or 
business and a specified foreign partner in a partnership engaged in 
a U.S. trade or business--(i) Facts. FC, a foreign corporation that 
is not an applicable CFC, owns a 50-percent interest in ABC, a 
foreign partnership that is engaged in a trade or business in the 
United States. ABC has two lines of businesses, Business A and 
Business B. Business A produces $120x of taxable income (including 
interest expense) and Business B produces $80x of taxable income. FC 
is allocated 50 percent of all items of income and expense of 
Business A and Business B. Business A has business interest expense 
of $20x on $400x of liabilities but has no business interest income. 
Business B does not have any business interest expense or business 
interest income. With respect to FC, only Business A produces 
effectively connected income. FC has an outside basis of $500x in 
the ABC partnership for purposes of Sec.  1.882-5(b), step 1. All of 
the liabilities of Business A are U.S. booked liabilities for 
purposes of Sec.  1.882-5(d). In addition to owning a 50-percent 
interest in ABC, FC conducts a separate business that is engaged in 
a trade or business in the United States (Business X). Business X 
has effectively connected taxable income of $50x, U.S. assets with 
an adjusted basis of $300x, U.S. booked liabilities of $160x, and 
interest on U.S. booked liabilities of $15x. FC computes its 
interest expense under the three-step method described in Sec.  
1.882-5(b) through (d) and uses the fixed ratio of 50 percent for 
purposes of Sec.  1.882-5(c), step 2. Assume the interest rate on 
excess U.S. connected liabilities is 5 percent. For the taxable 
year, FC has total interest expense of 500x for purposes of Sec.  
1.882-5(a)(3).
    (ii) Analysis--(A) Application of section 163(j) to ABC. Under 
Sec.  1.163(j)-6(a), ABC computes a section 163(j) limitation at the 
partnership level. Under Sec.  1.163(j)-6(d), ABC has ATI of $220x, 
determined as $200x of taxable income ($120x from Business A + $80x 
from Business B), increased by $20x of business interest expense of 
Business A. Under Sec.  1.163(j)-2(b), ABC's section 163(j) 
limitation is $66x ($220x x 30 percent). Because ABC's business 
interest expense ($20x) does not exceed the section 163(j) 
limitation ($66x), ABC can deduct all of its business interest 
expense for the taxable year. Under Sec.  1.163(j)-1(b)(15), ABC has 
excess taxable income of $153.33x ($220x x ($46x/$66x)). Under Sec.  
1.163(j)-6(f), FC is allocated 50 percent of the $153.33x of ABC's 
excess taxable income, or $76.67x of allocable excess taxable 
income, but, under paragraph (c)(1) of this section, the amount by 
which the allocable excess taxable income exceeds FC's specified 
excess taxable income (as defined in paragraph (g)(5) of this 
section) is a subtraction from FC's ATI. Under paragraph (g)(5) of 
this section, FC's specified excess taxable income is $48.79x, which 
is equal to the product of $76.67x and ABC's specified ratio of 
63.64 percent. Under paragraph (g)(8) of this section, ABC's 
specified ratio of 63.64 percent is determined as $140x/$220x (where 
the numerator of $140x is the ATI of ABC determined under paragraph 
(b)(2) of this section as if ABC were a specified foreign person 
($120x taxable income of Business A, increased by $20x of business 
interest expense), and the denominator of $220x is the ATI of ABC 
under Sec.  1.163(j)-6(d)). FC's allocable excess taxable income 
($76.67x) exceeds its specified excess taxable income ($48.79x) by 
$27.88x.
    (B) Application of Sec.  1.882-5 to FC. FC is a specified 
foreign partner under paragraph (g)(6) of this section. Under 
paragraph (e)(1) of this section, FC first determines its interest 
expense under Sec.  1.882-5 and then determines its disallowed 
business interest expense. Under Sec.  1.882-5(b), step 1, FC has 
U.S. assets of $800x ($500x (FC's basis in its interest in ABC) + 
$300x (FC's basis in Business X assets). Under Sec.  1.882-5(c), 
step 2, applying the 50-percent safe harbor in Sec.  1.882-5 for a 
non-banking business, FC has U.S. connected liabilities of $400x 
($800x x 50 percent). Under Sec.  1.882-5(d), step 3, FC has U.S. 
booked liabilities of $360x ($200x (50-percent share of Business A 
liabilities of ABC of $400x) + $160x (Business X liabilities) and 
interest on U.S. booked liabilities of $25x ($10x (50-percent share 
of $20x interest expense of Business A) + $15x (interest expense of 
Business X)). FC has excess U.S. connected liabilities of $40x 
($400x - $360x) and interest on such excess liabilities of $2x ($40x 
x 5 percent). FC's interest expense determined under Sec.  1.882-5 
is $27x ($25x + $2x).
    (C) Application of section 163(j) to FC. Under paragraph 
(e)(2)(ii) of this section, the amount of business interest expense 
that is disallowed for FC is equal to only the amount of interest 
described in paragraph (b)(3) of this section that is disallowed 
because there is no specified excess business interest expense with 
respect to ABC. Under paragraph (b)(3) of this section, FC's 
business interest expense (at the corporate level) is $17x, the 
amount determined under Sec.  1.882-5 ($27x) less the amount of 
interest on U.S. booked liabilities from ABC determined under Sec.  
1.882-5(d)(2)(vii) ($10x), which was subject to the section 163(j) 
limitation at the ABC partnership level. Under Sec.  1.163(j)-
6(e)(1), FC's ATI is determined under Sec.  1.163(j)-1(b)(1) without 
regard to FC's distributive share of any items of income, gain, 
deduction, or loss of ABC. Under paragraph (b)(2) of this section, 
taking into account the application of paragraph (c)(1) of this 
section, FC's ATI is $115.77x ($50x effectively connected taxable 
income with respect to Business X, + $17x (business interest expense 
under Sec.  1.882-5 of 27x less the amount of interest on U.S. 
booked liabilities from ABC determined under Sec.  1.882-
5(d)(2)(vii) of $10x) + $76.65x (excess taxable income from ABC) - 
$27.88x (amount excess taxable income exceeds specified excess 
taxable income)). FC's section 163(j) limitation is $34.73x 
($115.77x x 30 percent). Because FC's business interest expense 
($17x) is less than FC's section 163(j) limitation ($34.73x) and all 
of its share of ABC's interest is deductible, FC may deduct all $27x 
of interest determined under Sec.  1.882-5.
    (4) Example 4: Scaleback of interest expense under Sec.  1.882-
5--(i) Facts. Assume the same facts in Example 3 in paragraph 
(h)(3)(i) of this section except that Business X has U.S. booked 
liabilities of $300x and interest on U.S. booked liabilities of 
$20x.
    (ii) Analysis--(A) Application of section 163(j) to ABC. The 
analysis is the same as Example 3 in paragraph (h)(3)(ii)(A) of this 
section.
    (B) Application of Sec.  1.882-5 to FC. Under Sec.  1.882-5(b), 
step 1, FC has U.S. assets of $800x ($500x (FC's basis in its 
interest in ABC) + $300x (FC's basis in Business X assets)). Under 
Sec.  1.882-5(c), step 2, applying the 50-percent safe harbor in 
Sec.  1.882-5 for a non-banking business, FC has U.S. connected 
liabilities of $400x ($800x x 50 percent). Under Sec.  1.882-5(d), 
step 3, FC has U.S. booked liabilities of $500x ($200x (50-percent 
share of Business A liabilities of ABC of $400x) + $300x (Business X 
liabilities) and interest on U.S. booked liabilities of $30x ($10x 
(50-percent share of $20x interest expense of Business A) + $20x 
(interest expense of Business X)). FC has excess U.S. booked 
liabilities of $100x ($500x - $400x) and the interest expense on 
U.S. booked liabilities must be reduced by the scaling ratio as 
provided in Sec.  1.882-5(d)(4). FC's interest expense determined 
under Sec.  1.882-5 is $24x ($30x x (400/500 scaling ratio)).
    (C) Application of section 163(j) to FC. Under paragraph (b)(3) 
of this section, FC's business interest expense is $16x, the amount 
determined under Sec.  1.882-5 ($24x) less the amount of interest on 
U.S. booked liabilities

[[Page 67585]]

from ABC determined under Sec.  1.882-5(d)(2)(vii) after applying 
the scaling ratio ($8x, determined as interest expense of Business A 
of $10x x scaling ratio of 400/500), which was subject to the 
section 163(j) limitation at the ABC partnership level. Under Sec.  
1.163(j)-6(e)(1), FC's ATI is determined under Sec.  1.163(j)-
1(b)(1) without regard to FC's distributive share of any items of 
income, gain, deduction, or loss of ABC. Under paragraph (b)(2) of 
this section, taking into account the application of paragraph 
(c)(1) of this section, FC's ATI is $114.79x ($50x effectively 
connected taxable income with respect to Business X + $16x (business 
interest expense under Sec.  1.882-5 of 24x less the amount of 
interest on U.S. booked liabilities from ABC determined under Sec.  
1.882-5(d)(2)(vii), after applying the scaleback, of $8x) + $76.67x 
(excess taxable income from ABC) - $27.88x (amount excess taxable 
income exceeds specified excess taxable income)). FC's section 
163(j) limitation is $34.44x ($114.79x x 30 percent). Because FC's 
business interest expense ($16x) is less than FC's section 163(j) 
limitation ($34.44x) and all of ABC's interest is deductible, FC may 
deduct all $24x of interest determined under Sec.  1.882-5.
    (5) Example 5: Separate currency pools method--(i) Facts. Assume 
the same facts in Example 3 in paragraph (h)(3)(i) of this section 
except that FC does not conduct Business X; the value of FC's 
interest in ABC for purposes of Sec.  1.882-5(e)(i), step 1, is 
$1,000x; and FC computes its interest expense under the separate 
currency pools method in Sec.  1.882-5(e) and for purposes of 
applying such method, the prescribed interest rate is 5 percent.
    (ii) Analysis--(A) Application of section 163(j) to ABC. The 
analysis is the same as in Example 3 in paragraph (h)(1)(ii)(A) of 
this section.
    (B) Application of Sec.  1.882-5 to FC. Under Sec.  1.882-
5(e)(i), step 1, FC has U.S. assets of $1,000x (FC's basis in its 
partnership interest in ABC). Under Sec.  1.882-5(e)(1)(ii), step 2, 
FC has U.S. connected liabilities of $500x ($1,000x x 50 percent) 
applying the 50 percent safe harbor for non-banking business. Under 
Sec.  1.882-5(e)(1)(iii), step 3, the interest expense under Sec.  
1.882-5 is $25x ($500x x 5 percent).
    (C) Application of section 163(j) to FC. Under paragraph (b)(3) 
of this section, FC's business interest expense is $15x, the amount 
determined under Sec.  1.882-5 ($25x) less the amount of interest on 
U.S. booked liabilities from ABC determined under Sec.  1.882-
5(d)(2)(vii) of $10x, which was subject to the section 163(j) 
limitation at the ABC partnership level. Under Sec.  1.163(j)-
6(e)(1), FC's ATI is determined under Sec.  1.163(j)-1(b)(1) without 
regard to FC's distributive share of any items of income, gain, 
deduction, or loss of ABC. Under paragraph (b)(2) of this section, 
taking into account the application of paragraph (c)(1) of this 
section, FC's ATI is $48.79x ($76.67x (excess taxable income from 
ABC) - $27.88x (amount excess taxable income exceeds specified 
excess taxable income)). FC's section 163(j) limitation is $14.64x 
($48.79x x 30 percent). Because FC's business interest expense 
($15x) exceeds the 163(j) limitation ($14.64x), FC may only deduct 
$14.64x of its business interest expense. Under Sec.  1.163(j)-2(c), 
the remaining $0.36x is disallowed business interest expense 
carryforward and under paragraph (e)(1)(ii) of this section, the 
$0.36x is not taken into account for purposes of applying Sec.  
1.882-5 in the succeeding taxable year. Accordingly, FC may deduct 
24.64x of the $25x interest determined under Sec.  1.882-5.
    (6) Example 6: Specified foreign partner with excess business 
interest expense--(i) Facts--Year 1. FC, a foreign corporation that 
is not an applicable CFC, owns a 50-percent interest in XYZ, a 
foreign partnership that is engaged in a trade or business in the 
United States. XYZ has two lines of businesses, Business S and 
Business T. Business S produces $50x of taxable income (including 
interest expense), and Business T produces $40x of taxable income 
(including interest expense). FC is allocated 50 percent of all 
items of income and expenses of Business S and Business T. Business 
S has business interest expense of $30x on $500x of liabilities but 
has no business interest income. Business T has business interest 
expense of $50x on $500x of liabilities but has no business interest 
income. With respect to FC, only Business S produces effectively 
connected income. FC has an adjusted basis of $500x in XYZ for 
purposes of Sec.  1.882-5(b), step 1. All of the liabilities of 
Business S are U.S. booked liabilities for purposes of Sec.  1.882-
5(d). FC computes its interest expense under the three-step method 
described in Sec.  1.882-5(b) through (d) and uses the fixed ratio 
of 50 percent for purposes of Sec.  1.882-5(c), step 2.
    (ii) Analysis with respect to Year 1--(A) Application of section 
163(j) to XYZ. Under Sec.  1.163(j)-6(a), XYZ computes a section 
163(j) limitation at the partnership-level. Under Sec.  1.163(j)-
6(d), XYZ has ATI of $170x, determined as $90x of taxable income 
($50x from Business S + $40x from Business T), increased by $80x of 
business interest expense ($30x from Business S + $50x from Business 
T). Under Sec.  1.163(j)-2(b), XYZ's section 163(j) limitation is 
$51x ($170x x 30 percent). Because XYZ's business interest expense 
($80x) exceeds the section 163(j) limitation ($51x), XYZ may only 
deduct $51x of business interest expense and $29x is disallowed 
under section 163(j). Under Sec.  1.163(j)-6(f), FC is allocated 
$14.5x of excess business interest expense (50 percent x $29x). 
Under paragraph (c)(2) of this section, the amount of allocable 
business interest expense that can be used by FC is equal to the 
amount of specified excess business interest, and the amount of such 
interest that is treated as paid or accrued by FC in the succeeding 
taxable year is limited to the amount of FC's specified excess 
taxable income allocated to FC in the succeeding taxable year.
    (B) Application of Sec.  1.882-5 to FC. FC is a specified 
foreign partner under paragraph (g)(6) of this section. Under 
paragraph (e)(1) of this section, FC first determines its interest 
expense under Sec.  1.882-5 and then determines its disallowed 
business interest expense. Under Sec.  1.882-5(b), step 1, FC has 
U.S. assets of $500x (FC's adjusted basis in its interest in XYZ). 
Under Sec.  1.882-5(c), step 2, applying the 50-percent fixed ratio 
in Sec.  1.882-5 for a non-banking business, FC has U.S. connected 
liabilities of $250x ($500x x 50 percent). Under Sec.  1.882-5(d), 
step 3, FC has U.S. booked liabilities of $250x ($500x x 50-percent 
share of Business S liabilities of XYZ) and interest on U.S. booked 
liabilities of $15x (50 percent share of $30x interest expense of 
Business S). Because FC has U.S. connected liabilities equal to its 
U.S. booked liabilities, its interest expense under Sec.  1.882-5 is 
$15x (the amount of interest expense on its U.S. booked 
liabilities).
    (C) Application of section 163(j) to FC. Under paragraph 
(e)(2)(ii) of this section, the amount of business interest expense 
that is disallowed for FC is equal to the sum of the amount of 
interest described in paragraph (b)(3) of this section that is 
disallowed plus the amount of FC's specified excess business 
interest expense. FC's business interest expense (at the corporate 
level) under paragraph (b)(3) of this section is $0, the amount 
determined under Sec.  1.882-5 ($15x) less the amount of interest on 
U.S. booked liabilities from XYZ determined under Sec.  1.882-
5(d)(2)(vii) ($15x), which was subject to the section 163(j) 
limitation at the XYZ partnership level. Because FC (at the 
corporate level) has no business interest expense, there is no 
business interest expense subject to the section 163(j) limitation. 
However, because FC has excess business interest expense with 
respect to XYZ, a deduction for a portion of the $15x of interest on 
U.S. booked liabilities from XYZ determined under Sec.  1.882-
5(d)(2)(vii) will be disallowed for the taxable year. The amount of 
such interest that is limited is equal to the amount of the FC's 
specified excess business interest expense determined under 
paragraph (g)(4) of this section. The specified excess business 
interest expense is $6.82x, determined by multiplying FC's 
distributive share of excess business interest expense ($14.5x) by 
XYZ's specified ratio of 47.06 percent, determined under paragraph 
(g)(8) of this section. The specified ratio of 47.06 percent is 
determined by dividing $80x ATI determined under paragraph (b)(2) of 
the section as if XYZ were a specified foreign person (determined as 
$50x taxable income from Business S + $30x business interest expense 
from Business S) by $170x of XYZ ATI. FC may only deduct $8.18x 
($15x - $6.82x) of business interest expense. Under Sec.  1.163(j)-
2(c), the remaining $6.82x is disallowed business interest expense 
carryforward and under paragraph (e)(1)(ii) of this section, the 
$6.82x is not taken into account for purposes of applying Sec.  
1.882-5 in the succeeding taxable year.
    (iii) Facts--Year 2. During Year 2, Business S produces $170x of 
taxable income (including interest expense) and Business T produces 
$150x (including interest expense) of taxable income. Business S has 
business interest expense of $30x on $500x of liabilities but has no 
business interest income. Business T has business interest expense 
of $50x on $500x of liabilities but no business interest income. 
With respect to FC, only Business S produces effectively connected 
taxable income. FC has an adjusted basis of $600x in XYZ for 
purposes of Sec.  1.882-5(b), step 1. All of the liabilities

[[Page 67586]]

of Business S are U.S. booked liabilities for purposes of Sec.  
1.882-5(d). FC computes its interest expense under the three-step 
method described in Sec.  1.882-5(b) through (d) and uses the fixed 
ratio of 50 percent for purposes of Sec.  1.882-5(c), step 2. The 
interest rate on excess U.S. connected liabilities is 5 percent. For 
the taxable year, FC has total interest expense of $1,000x for 
purposes of Sec.  1.882-5(a)(3).
    (iv) Analysis with respect to Year 2--(A) Application of section 
163(j) to XYZ. Under Sec.  1.163(j)-6(a), XYZ computes a section 
163(j) limitation at the partnership-level. Under Sec.  1.163(j)-
6(d), XYZ has ATI of $400x, determined as $320x of taxable income 
($170x from Business S + $150x from Business T), increased by $80x 
of business interest expense ($30x from Business S + $50x from 
Business T). Under Sec.  1.163(j)-2(b), XYZ's section 163(j) 
limitation is $120x ($400x x 30 percent). Because XYZ's business 
interest expense ($80x) does not exceed the section 163(j) 
limitation ($120x), XYZ can deduct all of its business interest 
expense for the taxable year. Under Sec.  1.163(j)-1(b)(15), XYZ has 
excess taxable income of $133.30x ($400x x ($40x/$120x)). Under 
Sec.  1.163(j)-6(f), FC is allocated 50 percent of the $133.33x of 
XYZ's excess taxable income, or $66.66x of allocable excess taxable 
income, but, under paragraph (c)(1) of this section, the amount by 
which the allocable excess taxable income exceeds FC's specified 
excess taxable income (as defined in paragraph (g)(5) of this 
section) is a subtraction from FC's ATI. Under paragraph (g)(5) of 
this section, FC's specified excess taxable income is $33.33x, which 
is equal to the product of FC's allocable excess taxable income of 
$66.66x and XYZ's specified ratio of 50 percent. Under paragraph 
(g)(8) of this section, XYZ's specified ratio of 50 percent is 
determined as $200x/$400x (where the numerator of $200x is the ATI 
of XYZ determined under paragraph (b)(2) of this section as if XYZ 
were a specified foreign person ($170x taxable income of Business S, 
increased by $30x of business interest expense), and the denominator 
of $400x is the ATI of XYZ under Sec.  1.163(j)-6(d)). FC's 
allocable excess taxable income ($66.66x) exceeds its specified 
excess taxable income ($33.33x) by $33.33x.
    (B) Treatment of excess business interest expense from Year 1. 
In Year 1, XYZ had disallowed business interest expense of $29x and 
under Sec.  1.163(j)-6(f), FC's allocable excess business interest 
expense was $14.50x. Under paragraph (c)(2) of this section, FC may 
use its allocable excess business interest expense in a succeeding 
taxable year only to the extent of its specified excess business 
interest expense, which, in this case, was determined to be $6.82x, 
and, with respect to Year 2, the amount of specified excess business 
interest expense treated as paid or accrued by FC is limited to FC's 
specified excess taxable income ($33.33x). Thus, FC can treat the 
entire $6.82x as business interest expense paid or accrued in Year 
2.
    (C) Application of Sec.  1.882-5 to FC. Under Sec.  1.882-5(b), 
step 1, FC has U.S. assets of $600x (FC's adjusted basis in its 
interest in XYZ). Under Sec.  1.882-5(c), step 2, applying the 50 
percent fixed ratio in Sec.  1.882-5 for a non-banking business, FC 
has U.S. connected liabilities of $300x ($600x x 50 percent). Under 
Sec.  1.882-5(d), step 3, FC has U.S. booked liabilities of $250x 
($500x x 50-percent share of Business S liabilities of XYZ) and 
interest on U.S. booked liabilities of $15x (50 percent share of 
$30x interest expense of Business S). FC has excess U.S. connected 
liabilities of $50x ($300x - $250x) and interest on such excess 
liabilities of $2.5x ($50x x 5 percent). FC's interest expense 
determined under Sec.  1.882-5 is $17.5x ($15x + $2.5x).
    (D) Application of section 163(j) to FC. Under paragraph 
(e)(2)(ii) of this section, the amount of business interest expense 
that is disallowed for FC is equal to only the amount of interest 
described in paragraph (b)(3) of this section that is disallowed 
because there is no excess business interest expense with respect to 
XYZ. FC's business interest expense (at the corporate level) under 
paragraphs (b)(3) and (e)(1) of this section is $9.32x, determined 
as the sum of $2.50x (the amount determined under Sec.  1.882-5 
($17.50x) less the amount of interest on U.S. booked liabilities 
from XYZ determined under Sec.  1.882-5(d)(2)(vii) ($15x) that is 
excluded under paragraph (b)(3)(ii) of this section) + $6.82x 
(allocable business interest expense from Year 1 treated as paid or 
accrued in Year 2). Under Sec.  1.163(j)-6(e)(1), FC's ATI is 
determined under Sec.  1.163(j)-1(b)(1) without regard to FC's 
distributive share of any items of income, gain, deduction, or loss 
of XYZ. Under paragraph (b)(2) of this section, taking into account 
the application of paragraph (c)(1) of this section, FC's ATI is 
$33.33x, determined as $66.66x (excess taxable income from XYZ) - 
$33.33x (amount excess taxable income exceeds specified excess 
taxable income). FC's section 163(j) limitation is $10x ($33.33x x 
30 percent). Because FC's business interest expense (at the 
corporate level) of $9.32x is less than FC's section 163(j) 
limitation of $10x, FC may deduct all $9.32x of business interest 
expense ($2.50x from Year 2 and $6.82x from Year 1). Because all of 
XYZ's business interest expense is deductible, FC may also deduct 
the $15x of business interest expense on U.S. booked liabilities of 
XYZ for Year 2.
    (7) Example 7: Coordination of section 163(j) and branch profits 
tax--(i) Facts. FC, a foreign corporation that is not an applicable 
CFC, uses cash that is treated as a U.S. asset under Sec.  1.884-
1(d) in order to pay interest described in paragraph (b)(3) of this 
section for which a deduction for such interest is disallowed under 
Sec.  1.163(j)-2(b).
    (ii) Analysis. Assuming that FC's U.S. assets otherwise remain 
constant during the year, the U.S. assets of FC will have decreased 
by the amount of cash used to pay the interest expense, and the U.S. 
net equity of FC will be computed accordingly.

    (i) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply this section to a taxable year 
beginning after December 31, 2017, if the taxpayers and their related 
parties consistently apply all of the section 163(j) regulations, and 
if applicable, Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.382-6, 1.383-1, 
1.469-9, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 
through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec.  1.382-6 and 1.383-1), and 1.1504-4 to those taxable years.


Sec.  1.163(j)-9  Elections for excepted trades or businesses; safe 
harbor for certain REITs.

    (a) Overview. This section provides rules and procedures for making 
an election under section 163(j)(7)(B) to be an electing real property 
trade or business, as defined in Sec.  1.163(j)-1(b)(12), and an 
election under section 163(j)(7)(C) to be an electing farming business, 
as defined in Sec.  1.163(j)-1(b)(11).
    (b) Scope and effect of election--(1) In general. An election under 
this section is made with respect to each eligible trade or business of 
the taxpayer and applies only to such trade or business for which the 
election is made. An election under this section applies to the taxable 
year in which the election is made and to all subsequent taxable years, 
except as otherwise provided in this section.
    (2) Irrevocability. An election under this section is irrevocable.
    (c) Time and manner of making election--(1) In general. Subject to 
paragraph (e) of this section, a taxpayer makes an election under this 
section by attaching an election statement to the taxpayer's timely 
filed original Federal income tax return, including extensions. A 
taxpayer may make elections for multiple trades or businesses on a 
single election statement.
    (2) Election statement contents. The election statement should be 
titled ``Section 1.163(j)-9 Election'' and must contain the following 
information for each trade or business:
    (i) The taxpayer's name;
    (ii) The taxpayer's address;
    (iii) The taxpayer's social security number (SSN) or employer 
identification number (EIN);
    (iv) A description of the taxpayer's electing trade or business, 
including the principal business activity code; and
    (v) A statement that the taxpayer is making an election under 
section 163(j)(7)(B) or (C), as applicable.
    (3) Consolidated group's trade or business. For a consolidated 
group's trade or business, the election under this section is made by 
the agent for the group, as defined in Sec.  1.1502-77, on

[[Page 67587]]

behalf of itself and members of the consolidated group. Only the name 
and taxpayer identification number (TIN) of the agent for the group, as 
defined in Sec.  1.1502-77, must be provided on the election statement.
    (4) Partnership's trade or business. An election for a partnership 
must be made on the partnership's return with respect to any trade or 
business that the partnership conducts. An election by a partnership 
does not apply to a trade or business conducted by a partner outside 
the partnership.
    (d) Termination of election--(1) In general. An election under this 
section automatically terminates if a taxpayer ceases to engage in the 
electing trade or business. A taxpayer is considered to cease to engage 
in an electing trade or business if the taxpayer sells or transfers 
substantially all of the assets of the electing trade or business to an 
acquirer that is not a related party in a taxable asset transfer. A 
taxpayer is also considered to cease to engage in an electing trade or 
business if the taxpayer terminates its existence for Federal income 
tax purposes or ceases operation of the electing trade or business, 
except to the extent that such termination or cessation results in the 
sale or transfer of substantially all of the assets of the electing 
trade or business to an acquirer that is a related party, or in a 
transaction that is not a taxable asset transfer.
    (2) Taxable asset transfer defined. For purposes of this paragraph 
(d), the term taxable asset transfer means a transfer in which the 
acquirer's basis or adjusted basis in the assets is not determined, 
directly or indirectly, in whole or in part, by reference to the 
transferor's basis in the assets.
    (3) Related party defined. For purposes of this paragraph (d), the 
term related party means any person who bears a relationship to the 
taxpayer which is described section 267(b) or 707(b)(1).
    (4) Anti-abuse rule. If, within 60 months of a sale or transfer of 
assets described in paragraph (d)(1) of this section, the taxpayer or a 
related party reacquires substantially all of the assets that were used 
in the taxpayer's prior electing trade or business, or substantially 
similar assets, and resumes conducting such prior electing trade or 
business, the taxpayer's previously terminated election under this 
section is reinstated and is effective on the date the prior electing 
trade or business is reacquired.
    (e) Additional guidance. The rules and procedures regarding the 
time and manner of making an election under this section and the 
election statement contents in paragraph (c) of this section may be 
modified through other guidance (see Sec. Sec.  601.601(d) and 601.602 
of this chapter). Additional situations in which an election may 
terminate under paragraph (d) of this section may be provided through 
guidance published in the Federal Register or in the Internal Revenue 
Bulletin (see Sec.  601.601(d) of this chapter).
    (f) Examples. The examples of this paragraph (f) illustrate the 
application of this section. Unless otherwise indicated, assume the 
following: X and Y are domestic C corporations; D and E are U.S. 
resident individuals not subject to any foreign income tax; and the 
exemption for certain small businesses in Sec.  1.163(j)-2(d) does not 
apply.

    (1) Example 1: Scope of election--(i) Facts. During her taxable 
year ending December 31, 2019, D, a sole proprietor, owned and 
operated a dairy farm and a tree farm as separate farming businesses 
described in section 263A(e)(4). D filed its original Federal income 
tax return for the 2019 taxable year on August 1, 2020, and included 
with the return an election statement meeting the requirements of 
paragraph (c)(2) of this section. The election statement identified 
D's dairy farm business as an electing trade or business under this 
section. On March 1, 2021, D sold some but not all or substantially 
all of the assets from her dairy farm business to her neighbor, E, 
who is unrelated to D. After the sale, D continued to operate the 
dairy farm trade or business.
    (ii) Analysis. D's election under this section was properly made 
and is effective for the 2019 taxable year and subsequent years. D's 
dairy farm business is an excepted trade or business because D made 
the election with her timely filed Federal income tax return. D's 
tree farm business is a non-excepted trade or business. The sale of 
some but not all or substantially all of the assets from D's dairy 
farm business has no impact on D's election under this section.
    (2) Example 2: Cessation of entire trade or business--(i) Facts. 
X has a real property trade or business for which X made an election 
under this section by attaching an election statement to A's 2019 
Federal income tax return. On March 1, 2020, X sold all of the 
assets used in its real property trade or business to Y, an 
unrelated party, and ceased to engage in the electing trade or 
business. On June 1, 2027, X started a new real property trade or 
business that was substantially similar to X's prior electing trade 
or business.
    (ii) Analysis. X's election under this section terminated on 
March 1, 2020, under paragraph (d)(1) of this section. X may choose 
whether to make an election under this section for X's new real 
property trade or business that A started in 2027.
    (3) Example 3: Anti-abuse rule--(i) Facts. The same facts are 
the same as in Example 2 in paragraph (f)(2)(i) of this section, 
except that X re-started her previous real property trade or 
business on February 1, 2021, when X reacquired substantially all of 
the assets that X had sold on March 1, 2020.
    (ii) Analysis. X's election under this section terminated on 
March, 1, 2020, under paragraph (d)(1) of this section. On February 
1, 2021, X's election was reinstated under paragraph (d)(4) of this 
section. X's new real property trade or business is treated as a 
resumption of X's prior electing trade or business and is therefore 
treated as an electing real property trade or business.
    (4) Example 4: Trade or business continuing after acquisition--(i) 
Facts. X has a farming business for which X made an election under this 
section by attaching an election statement to X's timely filed 2019 
Federal income tax return. Y, unrelated to X, also has a farming 
business, but Y has not made an election under this section. On July 1, 
2020, X transferred all of its assets to Y in a transaction described 
in section 368(a)(1)(D) (a ``D reorganization''). After the transfer, Y 
continues to operate the farming trade or business acquired from X.
    (ii) Analysis. Under paragraph (d)(1) of this section, Y is subject 
to X's election under this section for the trade or business that uses 
X's assets because the sale or transfer was not in a taxable 
transaction. Y cannot revoke X's election, but X's election has no 
effect on Y's existing farming business for which Y has not made an 
election under this section.
    (5) Example 5: Trade or business merged after acquisition--(i) 
Facts. The facts are the same as in Example 4 in paragraph (f)(4)(i) of 
this section, except that Y uses the assets acquired from X in a trade 
or business that is neither a farming business (as defined in section 
263A(e)(4) or Sec.  1.263A-4(a)(4)) nor a trade or business of a 
specified agricultural or horticultural cooperative (as defined in 
section 199A(g)(4)).
    (ii) Analysis. Y is not subject to X's election for Y's farming 
business because the farming trade or business ceased to exist after 
the acquisition.

    (g) Safe harbor for REITs--(1) In general. If a REIT holds real 
property, as defined in Sec.  1.856-10, interests in partnerships 
holding real property, as defined in Sec.  1.856-10, or shares in other 
REITs holding real property, as defined in Sec.  1.856-10, the REIT is 
eligible to make the election described in paragraph (b)(1) of this 
section to be an electing real property trade or business for purposes 
of sections 163(j)(7)(B) and 168(g)(1)(F) for all or part of its 
assets. The portion of the REIT's assets eligible for this election is 
determined under paragraph (g)(2) or (3) of this section.
    (2) REITs that do not significantly invest in real property 
financing assets. If a REIT makes an election described in paragraph 
(g)(1) of this section and the value of the REIT's real property

[[Page 67588]]

financing assets, as defined in paragraphs (g)(5) and (6) of this 
section, at the close of the taxable year is 10 percent or less of the 
value of the REIT's total assets at the close of the taxable year, as 
determined under section 856(c)(4)(A), then all of the REIT's assets 
are treated as assets of an excepted trade or business.
    (3) REITs that significantly invest in real property financing 
assets. If a REIT makes an election described in paragraph (g)(1) of 
this section and the value of the REIT's real property financing 
assets, as defined in paragraphs (g)(5) and (6) of this section, at the 
close of the taxable year is more than 10 percent of the value of the 
REIT's total assets at the close of the taxable year, as determined 
under section 856(c)(4)(A), then for allocation of interest expense, 
interest income, and other items of expense and gross income to 
excepted and non-excepted trades or businesses, the REIT must apply the 
rules set forth in Sec.  1.163(j)-10 as modified by paragraph (g)(4) of 
this section.
    (4) REIT real property assets, interests in partnerships, and 
shares in other REITs--(i) Real property assets. Assets held by a REIT 
described in paragraph (g)(3) of this section that meet the definition 
of real property under Sec.  1.856-10 are treated as assets of an 
excepted trade or business.
    (ii) Partnership interests. If a REIT described in paragraph (g)(3) 
of this section holds an interest in a partnership, in applying the 
partnership look-through rule described in Sec.  1.163(j)-
10(c)(5)(ii)(A)(2), the REIT treats assets of the partnership that meet 
the definition of real property under Sec.  1.856-10 as assets of an 
excepted trade or business. This application of the definition of real 
property under Sec.  1.856-10 does not affect the characterization of 
the partnership's assets at the partnership level or for any non-REIT 
partner.
    (iii) Shares in other REITs. If a REIT (shareholder REIT) described 
in paragraph (g)(3) of this section holds an interest in another REIT, 
then for purposes of applying the allocation rules in Sec.  1.163(j)-
10, the partnership look-through rule described in Sec.  1.163(j)-
10(c)(5)(ii)(A)(2) applies to the assets of the other REIT (as if the 
other REIT were a partnership) in determining the extent to which 
shareholder REIT's adjusted basis in the shares of the other REIT is 
allocable to an excepted or non-excepted trade or business of 
shareholder REIT. However, no portion of the adjusted basis of 
shareholder REIT's shares in the other REIT is allocated to a non-
excepted trade or business if all of the other REIT's assets are 
treated as assets of an excepted trade or business under paragraph 
(g)(2) of this section. If shareholder REIT does not receive from the 
other REIT the information necessary to determine whether and the 
extent that the assets of the other REIT are investments in real 
property financing assets, then shareholder REIT's shares in the other 
REIT are treated as assets of a non-excepted trade or business under 
Sec.  1.163(j)-10(c).
    (5) Value of shares in other REITs. If a REIT (shareholder REIT) 
holds shares in another REIT, then for purposes of applying the value 
tests under paragraphs (g)(2) and (3) of this section, the value of 
shareholder REIT's real property financing assets includes the portion 
of the value of shareholder REIT's shares in the other REIT that is 
attributable to the other REIT's investments in real property financing 
assets. However, no portion of the value of shareholder REIT's shares 
in the other REIT is included in the value of shareholder REIT's real 
property financing assets if all of the other REIT's assets are treated 
as assets of an excepted trade or business under paragraph (g)(2) of 
this section. If shareholder REIT does not receive from the other REIT 
the information necessary to determine whether and the extent that the 
assets of the other REIT are investments in real property financing 
assets, then shareholder REIT's shares in the other REIT are treated as 
real property financing assets for purposes of paragraphs (g)(2) and 
(3) of this section.
    (6) Real property financing assets. For purposes of this paragraph 
(g), real property financing assets include interests, including 
participation interests, in the following: Mortgages, deeds of trust, 
and installment land contracts; mortgage pass-thru certificates 
guaranteed by Government National Mortgage Association (GNMA), Federal 
National Mortgage Association (FNMA), Federal Home Loan Mortgage 
Corporation (FHLMC), or Canada Mortgage and Housing Corporation (CMHC); 
REMIC regular interests; other interests in investment trusts 
classified as trusts under Sec.  301.7701-4(c) of this chapter that 
represent undivided beneficial ownership in a pool of obligations 
principally secured by interests in real property and related assets 
that would be permitted investments if the investment trust were a 
REMIC; obligations secured by manufactured housing treated as single 
family residences under section 25(e)(10), without regard to the 
treatment of the obligations or the properties under state law; and 
debt instruments issued by publicly offered REITs.
    (h) Special anti-abuse rule for certain real property trades or 
businesses--(1) In general. Except as provided in paragraph (h)(2) of 
this section, a real property trade or business does not constitute a 
trade or business eligible for an election described in paragraph 
(b)(1) of this section to be an electing real property trade or 
business if at least 80 percent, determined by fair market value, of 
the business's real property is leased, whether or not the arrangement 
is pursuant to a written lease or pursuant to a service contract or 
another agreement that is not denominated as a lease, to a trade or 
business under common control with the real property trade or business. 
For purposes of this paragraph (h), two trades or businesses are under 
common control if 50 percent of the direct and indirect ownership of 
both businesses are held by related parties within the meaning of 
sections 267(b) and 707(b).
    (2) Exception for certain REITs. The special anti-abuse rule in 
paragraph (h)(1) does not apply to REITs that lease qualified lodging 
facilities, as defined in section 856(d)(9)(D), and qualified health 
care properties, as defined in section 856(e)(6)(D).
    (i) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-10  Allocation of interest expense, interest income, and 
other items of expense and gross income to an excepted trade or 
business.

    (a) Overview--(1) In general--(i) Purposes. This section provides 
the exclusive rules for allocating tax items that are properly 
allocable to a trade or business between excepted trades or businesses 
and non-excepted trades or businesses for purposes of section 163(j). 
The amount of a taxpayer's interest expense that is properly allocable 
to excepted trades or

[[Page 67589]]

businesses is not subject to limitation under section 163(j). The 
amount of a taxpayer's other items of income, gain, deduction, or loss, 
including interest income, that is properly allocable to excepted 
trades or businesses is excluded from the calculation of the taxpayer's 
section 163(j) limitation. See section 163(j)(6) and (j)(8)(A)(i); see 
also Sec.  1.163(j)-1(b)(1)(i)(H), (b)(1)(ii)(F), and (b)(3). The 
general method of allocation set forth in paragraph (c) of this section 
is based on the approach that money is fungible and that interest 
expense is attributable to all activities and property, regardless of 
any specific purpose for incurring an obligation on which interest is 
paid. In no event may the amount of interest expense allocated under 
this section exceed the amount of interest paid or accrued, or treated 
as paid or accrued, by the taxpayer within the taxable year.
    (ii) Application of section. The amount of a taxpayer's tax items 
properly allocable to a trade or business, other than interest expense 
and interest income, that is properly allocable to excepted trades or 
businesses for purposes of section 163(j) is determined as set forth in 
paragraph (b) of this section. The amount of a taxpayer's interest 
expense and interest income that is properly allocable to excepted 
trades or businesses for purposes of section 163(j) generally is 
determined as set forth in paragraph (c) of this section, except as 
otherwise provided in paragraph (d) of this section. For purposes of 
this section, a taxpayer's activities are not treated as a trade or 
business if those activities do not involve the provision of services 
or products to a person other than the taxpayer. For example, if a 
taxpayer engaged in a manufacturing trade or business has in-house 
legal personnel that provide legal services solely to the taxpayer, the 
taxpayer is not treated as also engaged in the trade or business of 
providing legal services.
    (2) Coordination with other rules--(i) In general. The rules of 
this section apply after a taxpayer has determined whether any interest 
expense or interest income paid, received, or accrued is properly 
allocable to a trade or business. Similarly, the rules of this section 
apply to other tax items after a taxpayer has determined whether those 
items are properly allocable to a trade or business. For instance, a 
taxpayer must apply Sec.  1.163-8T to determine which items of interest 
expense are investment interest under section 163(d) before applying 
the rules in paragraph (c) of this section to allocate interest expense 
between excepted and non-excepted trades or businesses. After 
determining whether its tax items are properly allocable to a trade or 
business, a taxpayer that is engaged in both excepted and non-excepted 
trades or businesses must apply the rules of this section to determine 
the amount of interest expense that is business interest expense 
subject to limitation under section 163(j) and to determine which items 
are included or excluded in computing its section 163(j) limitation.
    (ii) Treatment of investment interest, investment income, and 
investment expenses of a partnership with a C corporation or tax-exempt 
corporation as a partner. For rules governing the treatment of 
investment interest, investment income, and investment expenses of a 
partnership with a C corporation or tax-exempt corporation as a 
partner, see Sec. Sec.  1.163(j)-4(b)(3) and 1.163(j)-6(j).
    (3) Application of allocation rules to foreign corporations and 
foreign partnerships. The rules of this section apply to foreign 
corporations and foreign partnerships. See Sec. Sec.  1.163(j)-7 and 
1.163(j)-8.
    (4) Application of allocation rules to members of a consolidated 
group--(i) In general. As provided in Sec.  1.163(j)-4(d), the 
computations required by section 163(j) and the section 163(j) 
regulations generally are made for a consolidated group on a 
consolidated basis. In this regard, for purposes of applying the 
allocation rules of this section, all members of a consolidated group 
are treated as one corporation. Therefore, the rules of this section 
apply to the activities conducted by the group as if those activities 
were conducted by a single corporation. For example, the group (rather 
than a particular member) is treated as engaged in excepted or non-
excepted trades or businesses. In the case of intercompany obligations, 
within the meaning of Sec.  1.1502-13(g)(2)(ii), for purposes of 
allocating asset basis between excepted and non-excepted trades or 
businesses, the obligation of the member borrower is not considered an 
asset of the creditor member. Similarly, intercompany transactions, 
within the meaning of Sec.  1.1502-13(b)(1)(i), are disregarded for 
purposes of this section, as are the resulting offsetting items, and 
property is not treated as used in a trade or business to the extent 
the use of such property in that trade or business derives from an 
intercompany transaction. Further, stock of a group member that is 
owned by another member of the same group is not treated as an asset 
for purposes of this section, and the transfer of any amount of member 
stock to a non-member is treated by the group as a transfer of the 
member's assets proportionate to the amount of member stock 
transferred. Additionally, stock of a corporation that is not a group 
member is treated as owned by the group.
    (ii) Application of excepted business percentage to members of a 
consolidated group. After a consolidated group has determined the 
percentage of the group's interest expense allocable to excepted trades 
or businesses for the taxable year (and thus not subject to limitation 
under section 163(j)), this exempt percentage is applied to the 
interest paid or accrued by each member during the taxable year to any 
lender that is not a group member. Therefore, except to the extent 
paragraph (d) of this section (providing rules for certain qualified 
nonrecourse indebtedness) applies, an identical percentage of the 
interest paid or accrued by each member of the group to any lender that 
is not a group member will be treated as allocable to excepted trades 
or businesses, regardless of whether any particular member actually 
engaged in an excepted trade or business.
    (iii) Basis in assets transferred in an intercompany transaction. 
For purposes of allocating interest expense and interest income under 
paragraph (c) of this section, the basis of property does not include 
any gain or loss realized with respect to the property by another 
member in an intercompany transaction, as defined in Sec.  1.1502-
13(b), whether or not the gain or loss is deferred.
    (5) Tax-exempt organizations. For organizations subject to tax 
under section 511, section 512 and the regulations thereunder determine 
the rules for allocating all income and expenses among multiple trades 
or businesses.
    (6) [Reserved]
    (7) Examples. The following examples illustrate the principles of 
this paragraph (a).

     (i) Example 1: Items properly allocable to a trade or 
business--(A) Facts. Individual T operates Business X, a non-
excepted trade or business, as a sole proprietor. In Year 1, T pays 
or accrues $40x of interest expense and receives $100x of gross 
income with respect to Business X that is not eligible for a section 
199A deduction. T borrows money to buy a car for personal use, and T 
pays or accrues $20x of interest expense with respect to the car 
loan. T also invests in corporate bonds, and, in Year 1, T receives 
$50x of interest income on those bonds.
    (B) Analysis. Under paragraphs (a)(1) and (2) of this section, T 
must determine which items of income and expense, including items of 
interest income and interest expense, are properly allocable to a 
trade or business. T's $100x of gross income and T's $40x of 
interest expense with respect to Business X are properly allocable 
to a trade

[[Page 67590]]

or business. However, the interest expense on T's car loan is 
personal interest within the meaning of section 163(h)(2) rather 
than interest properly allocable to a trade or business. Similarly, 
T's interest income from corporate bonds is not properly allocable 
to a trade or business because it is interest from investment 
activity. See section 163(d)(4)(B).
     (ii) Example 2: Intercompany transaction--(A) Facts. S is a 
member of a consolidated group of which P is the common parent. P 
conducts an electing real property trade or business (Business X), 
and S conducts a non-excepted trade or business (Business Y). P 
leases Building V (which P owns) to S for use in Business Y.
    (B) Analysis. Under paragraph (a)(4)(i) of this section, a 
consolidated group is treated as a single corporation for purposes 
of applying the allocation rules of this section, and the 
consolidated group (rather than a particular member of the group) is 
treated as engaged in excepted and non-excepted trades or 
businesses. Thus, intercompany transactions are disregarded for 
purposes of this section. As a result, the lease of Building V by P 
to S is disregarded. Moreover, because Building V is used in 
Business Y, basis in this asset is allocated to Business Y rather 
than Business X for purposes of these allocation rules, regardless 
of which member (P or S) owns the building.

    (b) Allocation of tax items other than interest expense and 
interest income--(1) In general. For purposes of calculating ATI, tax 
items other than interest expense and interest income are allocated to 
a particular trade or business in the manner described in this 
paragraph (b). It is not necessary to allocate items under this 
paragraph (b) for purposes of calculating ATI if all of the taxpayer's 
items subject to allocation under this paragraph (b) are allocable to 
excepted trades or businesses, or if all of those items are allocable 
to non-excepted trades or businesses.
    (2) Gross income other than dividends and interest income. A 
taxpayer's gross income other than dividends and interest income is 
allocated to the trade or business that generated the gross income.
    (3) Dividends--(i) Look-through rule. If a taxpayer receives a 
dividend, within the meaning of section 316, that is not investment 
income, within the meaning of section 163(d), and if the taxpayer looks 
through to the assets of the payor corporation under paragraph 
(c)(5)(ii) of this section for the taxable year, then, solely for 
purposes of allocating amounts received as a dividend during the 
taxable year to excepted or non-excepted trades or businesses under 
this paragraph (b), the dividend income is treated as allocable to 
excepted or non-excepted trades or businesses based upon the relative 
amounts of the payor corporation's adjusted basis in the assets used in 
its trades or businesses, determined pursuant to paragraph (c) of this 
section. If at least 90 percent of the payor corporation's adjusted 
basis in its assets during the taxable year, determined pursuant to 
paragraph (c) of this section, is allocable to either excepted trades 
or businesses or to non-excepted trades or businesses, all of the 
taxpayer's dividend income from the payor corporation for the taxable 
year is treated as allocable to either excepted or non-excepted trades 
or businesses, respectively.
    (ii) Inapplicability of the look-through rule. If a taxpayer 
receives a dividend that is not investment income, within the meaning 
of section 163(d), and if the taxpayer does not look through to the 
assets of the payor corporation under paragraph (c)(5)(ii) of this 
section for the taxable year, then the taxpayer must treat the dividend 
as allocable to a non-excepted trade or business.
    (4) Gain or loss from the disposition of non-consolidated C 
corporation stock, partnership interests, or S corporation stock--(i) 
Non-consolidated C corporations. If a taxpayer recognizes gain or loss 
upon the disposition of stock in a non-consolidated C corporation that 
is not property held for investment, within the meaning of section 
163(d)(5), and if the taxpayer looks through to the assets of the C 
corporation under paragraph (c)(5)(ii) of this section for the taxable 
year, then the taxpayer must allocate gain or loss from the disposition 
of stock to excepted or non-excepted trades or businesses based upon 
the relative amounts of the corporation's adjusted basis in the assets 
used in its trades or businesses, determined pursuant to paragraph (c) 
of this section. However, if a taxpayer recognizes gain or loss upon 
the disposition of stock in a non-consolidated C corporation that is 
not property held for investment, within the meaning of section 
163(d)(5), and if the taxpayer does not look through to the assets of 
the C corporation under paragraph (c)(5)(ii) of this section for the 
taxable year, then the taxpayer must treat the gain or loss from the 
disposition of stock as allocable to a non-excepted trade or business. 
For rules governing the transfer of stock of a member of a consolidated 
group, see paragraph (a)(4)(i) of this section.
    (ii) Partnerships and S corporations. (A) If a taxpayer recognizes 
gain or loss upon the disposition of interests in a partnership or 
stock in an S corporation that owns:
    (1) Non-excepted assets and excepted assets;
    (2) Investment assets; or
    (3) Both;
    (B) The taxpayer determines a proportionate share of the amount 
properly allocable to a non-excepted trade or business in accordance 
with the allocation rules set forth in paragraph (c)(5)(ii)(A) or 
(c)(5)(ii)(B)(3) of this section, as appropriate, and includes such 
proportionate share of gain or loss in the taxpayer's ATI. This rule 
also applies to tiered passthrough entities, as defined in Sec.  
1.163(j)-7(f)(13), by looking through each passthrough entity tier (for 
example, an S corporation that is the partner of the highest-tier 
partnership would look through each lower-tier partnership), subject to 
paragraph (c)(5)(ii)(D) of this section. With respect to a partner that 
is a C corporation or tax-exempt corporation, a partnership's 
investment assets are taken into account and treated as non-excepted 
trade or business assets.
    (5) Expenses, losses, and other deductions--(i) Expenses, losses, 
and other deductions that are definitely related to a trade or 
business. Expenses (other than interest expense), losses, and other 
deductions (collectively, deductions for purposes of this paragraph 
(b)(5)) that are definitely related to a trade or business are 
allocable to the trade or business to which they relate. A deduction is 
considered definitely related to a trade or business if the item giving 
rise to the deduction is incurred as a result of, or incident to, an 
activity of the trade or business or in connection with property used 
in the trade or business (see Sec.  1.861-8(b)(2)). If a deduction is 
definitely related to one or more excepted trades or businesses and one 
or more non-excepted trades or businesses, the deduction is apportioned 
between the excepted and non-excepted trades or businesses based upon 
the relative amounts of the taxpayer's adjusted basis in the assets 
used in those trades or businesses, as determined under paragraph (c) 
of this section.
    (ii) Other deductions. Deductions that are not described in 
paragraph (b)(5)(i) of this section are ratably apportioned to all 
gross income.
    (6) Treatment of certain investment items of a partnership with a C 
corporation partner. Any investment income or investment expenses that 
a partnership receives, pays, or accrues and that is treated as 
properly allocable to a trade or business of a C corporation partner 
under Sec.  1.163(j)-4(b)(3)(i) is treated as properly allocable to a 
non-excepted trade or business of the C corporation partner.

     (7) Example: Allocation of income and expense. The following 
example illustrates the principles of this paragraph (b):

[[Page 67591]]

    (i) Facts. T conducts an electing real property trade or 
business (Business Y), which is an excepted trade or business. T 
also operates a lumber yard (Business Z), which is a non-excepted 
trade or business. In Year 1, T receives $100x of gross rental 
income from real property leasing activities. T also pays or accrues 
$60x of expenses in connection with its real property leasing 
activities and $20x of legal services performed on behalf of both 
Business Y and Business Z. T receives $60x of gross income from 
lumber yard customers and pays or accrues $50x of expenses related 
to the lumber yard business. For purposes of expense allocations 
under paragraphs (b) and (c) of this section, T has $240x of 
adjusted basis in its Business Y assets and $80x of adjusted basis 
in its Business Z assets.
    (ii) Analysis. Under paragraph (b)(2) of this section, for Year 
1, $100x of rental income is allocated to Business Y, and $60x of 
income from lumber yard customers is allocated to Business Z. Under 
paragraph (b)(5)(i) of this section, $60x of expenses paid or 
accrued in connection with real property leasing activities are 
allocated to Business Y, and $50x of expenses related to the lumber 
yard are allocated to Business Z. The $20x of remaining expenses for 
legal services performed on behalf of both Business Y and Business Z 
are allocated according to the relative amounts of T's basis in the 
assets used in each business. The total amount of T's basis in the 
assets used in Businesses Y and Z is $320x, of which 75 percent 
($240x/$320x) is used in Business Y and 25 percent ($80x/$320x) is 
used in Business Z. Accordingly, $15x of the expenses for legal 
services are allocated to Business Y and $5x are allocated to 
Business Z.

    (c) Allocating interest expense and interest income that is 
properly allocable to a trade or business--(1) General rule--(i) In 
general. Except as otherwise provided in this section, the amount of a 
taxpayer's interest expense and interest income that is properly 
allocable to a trade or business is allocated to the taxpayer's 
excepted or non-excepted trades or businesses for purposes of section 
163(j) based upon the relative amounts of the taxpayer's adjusted basis 
in the assets, as determined under paragraph (c)(5) of this section, 
used in its excepted or non-excepted trades or businesses. The taxpayer 
must determine the adjusted basis in its assets as of the close of each 
determination date, as defined in paragraph (c)(6) of this section, in 
the taxable year and average those amounts to determine the relative 
amounts of asset basis for its excepted and non-excepted trades or 
businesses for that year. It is not necessary to allocate interest 
expense or interest income under this paragraph (c) for purposes of 
determining a taxpayer's business interest expense and business 
interest income if all of the taxpayer's interest income and expense is 
allocable to excepted trades or businesses (in which case the taxpayer 
is not subject to the section 163(j) limitation) or if all of the 
taxpayer's interest income and expense is allocable to non-excepted 
trades or businesses.
    (ii) De minimis exception. If 90 percent or more of the taxpayer's 
basis in its assets for the taxable year is allocable to either 
excepted or non-excepted trades or businesses pursuant to this 
paragraph (c), then all of the taxpayer's interest expense and interest 
income for that year that is properly allocable to a trade or business 
is treated as allocable to either excepted or non-excepted trades or 
businesses, respectively.
    (2) Example. The following example illustrates the principles of 
paragraph (c)(1) of this section: T is a calendar-year C corporation 
engaged in an electing real property trade or business, the business of 
selling wine, and the business of selling hand-carved wooden furniture. 
In Year 1, T has $100x of interest expense that is deductible except 
for the potential application of section 163(j). Based upon 
determinations made on the determination dates of March 31, June 30, 
September 30, and December 31, T's average adjusted basis in the assets 
used in the electing real property trade or business (an excepted trade 
or business) in Year 1 is $800x, and T's total average adjusted basis 
in the assets used in the other two businesses in Year 1 is $200x. 
Thus, $80x (($800x/($800x + $200x)) x $100x) of T's interest expense 
for Year 1 is allocable to T's electing real property trade or business 
and is not business interest expense subject to limitation under 
section 163(j). The remaining $20x of T's interest expense is business 
interest expense for Year 1 that is subject to limitation under section 
163(j).
    (3) Asset used in more than one trade or business--(i) General 
rule. If an asset is used in more than one trade or business during a 
determination period, as defined in paragraph (c)(6) of this section, 
the taxpayer's adjusted basis in the asset is allocated to each trade 
or business using the permissible methodology under this paragraph 
(c)(3) that most reasonably reflects the use of the asset in each trade 
or business during that determination period. An allocation methodology 
most reasonably reflects the use of the asset in each trade or business 
if it most properly reflects the proportionate benefit derived from the 
use of the asset in each trade or business. If none of the permissible 
methodologies set forth in paragraph (c)(3)(ii) of this section 
reasonably reflects the use of the asset in each trade or business, the 
taxpayer's basis in the asset is not taken into account for purposes of 
this paragraph (c).
    (ii) Permissible methodologies for allocating asset basis between 
or among two or more trades or businesses. Subject to the special rules 
in paragraphs (c)(3)(iii) and (c)(5) of this section, a taxpayer's 
basis in an asset used in two or more trades or businesses during a 
determination period may be allocated to those trades or businesses 
based upon--
    (A) The relative amounts of gross income that an asset generates, 
has generated, or may reasonably be expected to generate, within the 
meaning of Sec.  1.861-9T(g)(3), with respect to the trades or 
businesses;
    (B) If the asset is land or an inherently permanent structure, the 
relative amounts of physical space used by the trades or businesses; or
    (C) If the trades or businesses generate the same unit of output, 
the relative amounts of output of those trades or businesses (for 
example, if an asset is used in two trades or businesses, one of which 
is an excepted regulated utility trade or business, and the other of 
which is a non-excepted regulated utility trade or business, the 
taxpayer may allocate basis in the asset based upon the relative 
amounts of kilowatt-hours generated by each trade or business).
    (iii) Special rules--(A) Consistent allocation methodologies--(1) 
In general. Except as otherwise provided in paragraph (c)(3)(iii)(A)(2) 
of this section, a taxpayer may not vary its allocation methodology 
from one determination period to the next within a taxable year or from 
one taxable year to the next.
    (2) Consent to change allocation methodology. If a taxpayer 
determines that a different allocation methodology properly reflects 
the proportionate benefit derived from the use of assets in its trades 
or businesses, the taxpayer may change its method of allocation under 
paragraphs (c)(3)(i) and (ii) of this section with the consent of the 
Commissioner. To obtain consent, a taxpayer must submit a request for a 
letter ruling under the applicable administrative procedures, and 
consent only will be granted in extraordinary circumstances.
    (B) De minimis exceptions--(1) De minimis amount of gross income 
from trades or businesses. If at least 90 percent of gross income that 
an asset generates, has generated, or may reasonably be expected to 
generate, within the meaning of Sec.  1.861-9T(g)(3), during a 
determination period is with respect to either excepted trades or

[[Page 67592]]

businesses or non-excepted trades or businesses, the taxpayer's entire 
basis in the asset for the determination period must be allocated to 
either excepted or non-excepted trades or businesses, respectively.
    (2) De minimis amount of asset basis allocable to a trade or 
business. If 90 percent or more of the taxpayer's basis in an asset 
would be allocated to either excepted trades or businesses or non-
excepted trades or businesses during a determination period pursuant to 
this paragraph (c)(3), the taxpayer's entire basis in the asset for the 
determination period must be allocated to either excepted or non-
excepted trades or businesses, respectively.
    (C) Allocations of excepted regulated utility trades or 
businesses--(1) In general. Except as provided in the de minimis rule 
in paragraph (c)(3)(iii)(C)(3) of this section, if a taxpayer is 
engaged in the trade or business of the furnishing or sale of items 
described in Sec.  1.163(j)-1(b)(13)(i)(A), the taxpayer is engaged in 
an excepted regulated utility trade or business only to the extent the 
rates for the items furnished and sold are described in Sec.  1.163(j)-
1(b)(13)(i)(B). Thus, for example, electricity sold at market rates 
rather than on a cost of service and rate of return basis must be 
treated as electricity sold by a non-excepted regulated utility trade 
or business. The taxpayer must allocate under this paragraph (c) the 
basis of assets used in the utility trade or business between its 
excepted and non-excepted trades or businesses.
    (2) Permissible method for allocating asset basis for utility 
trades or businesses. In the case of a utility trade or business 
described in paragraph (c)(3)(iii)(C)(1) of this section, and except as 
provided in the de minimis rule in paragraph (c)(3)(iii)(C)(3) of this 
section, the method described in paragraph (c)(3)(ii)(C) of this 
section is the only permissible method for allocating the taxpayer's 
basis in assets used in the trade or business between the taxpayer's 
excepted and non-excepted trades or businesses of selling or furnishing 
the items described in Sec.  1.163(j)-1(b)(13)(i)(A).
    (3) De minimis rule for excepted utility trades or businesses. If a 
taxpayer is engaged in a utility trade or business described in 
paragraph (c)(3)(iii)(C)(1) of this section, and if more than 90 
percent of the items described in Sec.  1.163(j)-1(b)(13)(i)(A) are 
furnished or sold at rates determined in the manner described in Sec.  
1.163(j)-1(b)(13)(i)(B), the taxpayer's entire trade or business is an 
excepted regulated utility trade or business, and paragraph 
(c)(3)(iii)(C)(2) of this section does not apply.

     (4) Example. The following example illustrates the principles 
of this paragraph (c)(3)(iii)(C):
    (i) Facts. X, a C corporation, is engaged in the trade or 
business of generating electrical energy. During each determination 
period in the taxable year, 80 percent of the kilowatts generated in 
the electricity generation trade or business is sold at rates 
established by a public utility commission on a rate of return 
basis. The remaining 20 percent of the kilowatts is sold on the 
wholesale markets at rates not established on a rate of return basis 
or by the governing or ratemaking body of an electric cooperative. 
None of the assets used in X's utility generation trade or business 
are used in any other trade or business.
    (ii) Analysis. For purposes of section 163(j), under paragraph 
(c)(3)(iii)(C)(1) of this section, 80 percent of X's electricity 
generation business is an excepted regulated utility trade or 
business, and the remaining 20 percent of X's business is a non-
excepted utility trade or business. Under paragraph 
(c)(3)(iii)(C)(2) of this section, X must allocate 80 percent of the 
basis of the assets used in its utility business to excepted trades 
or business and the remaining 20 percent of the basis in its assets 
to non-excepted trades or businesses.

    (4) Disallowed business interest expense carryforwards; floor plan 
financing interest expense. Disallowed business interest expense 
carryforwards (which were treated as allocable to a non-excepted trade 
or business in a prior taxable year) are not re-allocated between non-
excepted and excepted trades or businesses in a succeeding taxable 
year. Instead, the carryforwards continue to be treated as allocable to 
a non-excepted trade or business. Floor plan financing interest expense 
also is not subject to allocation between excepted and non-excepted 
trades or businesses (see Sec.  1.163(j)-1(b)(17)) and is always 
treated as allocable to non-excepted trades or businesses.
    (5) Additional rules relating to basis--(i) Calculation of adjusted 
basis--(A) Non-depreciable property other than land. Except as 
otherwise provided in paragraph (c)(5)(i)(E) of this section, for 
purposes of this section, the adjusted basis of an asset other than 
land with respect to which no deduction is allowable under section 167, 
section 168 of the Internal Revenue Code of 1954 (former section 168), 
or section 197, as applicable, is the adjusted basis of the asset for 
determining gain or loss from the sale or other disposition of that 
asset as provided in Sec.  1.1011-1. Self-created intangible assets are 
not taken into account for purposes of this paragraph (c).
    (B) Depreciable property other than inherently permanent 
structures. For purposes of this section, the adjusted basis of any 
tangible asset with respect to which a deduction is allowable under 
section 167, other than inherently permanent structures, is determined 
by using the alternative depreciation system under section 168(g) 
before any application of the additional first-year depreciation 
deduction (for example, under section 168(k) or (m)), and the adjusted 
basis of any tangible asset with respect to which a deduction is 
allowable under former section 168, other than inherently permanent 
structures, is determined by using the taxpayer's method of computing 
depreciation for the asset under former section 168. The depreciation 
deduction with respect to the property described in this paragraph 
(c)(5)(i)(B) is allocated ratably to each day during the period in the 
taxable year to which the depreciation relates.
    (C) Special rule for land and inherently permanent structures. 
Except as otherwise provided in paragraph (c)(5)(i)(E) of this section, 
for purposes of this section, the adjusted basis of any asset that is 
land, including nondepreciable improvements to land, or an inherently 
permanent structure is its unadjusted basis.
    (D) Depreciable or amortizable intangible property and depreciable 
income forecast method property. For purposes of this section, the 
adjusted basis of any intangible asset with respect to which a 
deduction is allowable under section 167 or 197, as applicable, is 
determined in accordance with section 167 or 197, as applicable, and 
the adjusted basis of any asset described in section 167(g)(6) for 
which the deduction allowable under section 167 is determined by the 
taxpayer under section 167(g), is determined in accordance with section 
167(g). The depreciation or amortization deduction with respect to the 
property described in this paragraph (c)(5)(i)(D) is allocated ratably 
to each day during the period in the taxable year to which the 
depreciation or amortization relates.
    (E) Assets not yet used in a trade or business. Assets that have 
been acquired or that are under development but that are not yet used 
in a trade or business are not taken into account for purposes of this 
paragraph (c). For example, construction works in progress (such as 
buildings, airplanes, or ships) are not taken into account for purposes 
of this paragraph (c). Similarly, land acquired by a taxpayer for 
construction of a building by the taxpayer to be used in a trade or 
business is not taken into account for purposes of this paragraph (c) 
until the building is placed in service. This rule does not apply to

[[Page 67593]]

interests in a partnership or stock in a corporation.
    (F) Trusts established to fund specific liabilities. Trusts 
required by law to fund specific liabilities (for example, pension 
trusts and plant decommissioning trusts) are not taken into account for 
purposes of this paragraph (c).
    (G) Inherently permanent structure. For purposes of this section, 
the term inherently permanent structure has the meaning provided in 
Sec.  1.856-10(d)(2).
    (ii) Partnership interests; stock in non-consolidated domestic 
corporations--(A) Partnership interests--(1) Calculation of asset 
basis. For purposes of this section, a partner's interest in a 
partnership is treated as an asset of the partner. For these purposes, 
the partner's adjusted basis in a partnership interest is reduced, but 
not below zero, by the partner's share of partnership liabilities, as 
determined under section 752, and is further reduced as provided in 
paragraph (c)(5)(ii)(A)(2)(iii) of this section.
    (2) Allocation of asset basis--(i) In general. For purposes of 
determining the extent to which a partner's adjusted basis in its 
partnership interest is allocable to an excepted or non-excepted trade 
or business, the partner may look through to such partner's share of 
the partnership's basis in the partnership's assets, taking into 
account any adjustments under sections 734(b) and 743(b), and adjusted 
to the extent required under paragraph (d)(4) of this section, except 
as otherwise provided in paragraph (c)(5)(ii)(D) of this section. For 
purposes of the preceding sentence, such partner's share of partnership 
assets is determined using a reasonable method taking into account 
special allocations under section 704(b). Notwithstanding paragraph 
(c)(7) of this section, if a partner's direct and indirect interest in 
a partnership is greater than or equal to 80 percent of the 
partnership's capital or profits, the partner must apply the rules in 
this paragraph (c)(5)(ii)(A) to look through to the partnership's basis 
in the partnership's assets.
    (ii) De minimis rule. If, after applying paragraph 
(c)(5)(ii)(A)(2)(iii) of this section, at least 90 percent of a 
partner's share of a partnership's basis in its assets (including 
adjustments under sections 734(b) and 743(b)) is allocable to either 
excepted trades or businesses or non-excepted trades or businesses, 
without regard to assets not properly allocable to a trade or business, 
the partner's entire basis in its partnership interest is treated as 
allocable to either excepted or non-excepted trades or businesses, 
respectively. For purposes of the preceding sentence, such partner's 
share of partnership assets is determined using a reasonable method 
taking into account special allocations under section 704(b).
    (iii) Partnership assets not properly allocable to a trade or 
business. For purposes of applying paragraphs (c)(5)(ii)(A)(2)(i) and 
(ii) of this section with respect to a partner that is a C corporation 
or tax-exempt corporation, such partner's share of a partnership's 
assets that are not properly allocable to a trade or business is 
treated as properly allocable to an excepted or non-excepted trade or 
business with respect to such partner in the same manner that such 
assets would be treated if held directly by such partner. With respect 
to a partner other than a C corporation or tax-exempt corporation, a 
partnership's assets that are not properly allocable to a trade or 
business are treated as neither excepted nor non-excepted trade or 
business assets, and such partner's adjusted basis in its partnership 
interest is reduced by that partner's share of the partnership's asset 
basis with respect to those assets. For purposes of this paragraph 
(c)(5)(ii)(A)(2)(iii), such partner's share of a partnership's assets 
is determined under a reasonable method taking into account special 
allocations under section 704(b).
    (iv) Inapplicability of partnership look-through rule. If a 
partner, other than a C corporation or a tax-exempt corporation, 
chooses not to look through to the partnership's basis in the 
partnership's assets under paragraph (c)(5)(ii)(A)(2)(i) of this 
section or is precluded by paragraph (c)(5)(ii)(D) of this section from 
applying such partnership look-through rule, the partner generally will 
treat its basis in the partnership interest as either an asset held for 
investment or a non-excepted trade or business asset as determined 
under section 163(d). If a partner that is a C corporation or a tax-
exempt corporation chooses not to look through to the partnership's 
basis in the partnership's assets under paragraph (c)(5)(ii)(A)(2)(i) 
of this section or is precluded by paragraph (c)(5)(ii)(D) of this 
section from applying such partnership look-through rule, the taxpayer 
must treat its entire basis in the partnership interest as allocable to 
a non-excepted trade or business.
    (B) Stock in non-consolidated domestic corporations--(1) In 
general. For purposes of this section, if a taxpayer owns stock in a 
domestic C corporation that is not a member of the taxpayer's 
consolidated group, or if the taxpayer owns stock in an S corporation, 
the stock is treated as an asset of the taxpayer.
    (2) Domestic non-consolidated C corporations--(i) Allocation of 
asset basis. If a shareholder satisfies the minimum ownership threshold 
in paragraph (c)(7) of this section, then, for purposes of determining 
the extent to which the shareholder's basis in its stock in the 
domestic non-consolidated C corporation is allocable to an excepted or 
non-excepted trade or business, the shareholder must look through to 
the corporation's basis in the corporation's assets, adjusted to the 
extent required under paragraph (d)(4) of this section, except as 
otherwise provided in paragraph (c)(5)(ii)(D) of this section.
    (ii) De minimis rule. If at least 90 percent of the domestic non-
consolidated C corporation's basis in the corporation's assets is 
allocable to either excepted trades or businesses or non-excepted 
trades or businesses, the shareholder's entire interest in the 
corporation's stock is treated as allocable to either excepted or non-
excepted trades or businesses, respectively.
    (iii) Inapplicability of corporate look-through rule. If a 
shareholder other than a C corporation or a tax-exempt corporation does 
not satisfy the minimum ownership threshold in paragraph (c)(7) of this 
section or is precluded by paragraph (c)(5)(ii)(D) of this section from 
applying the corporation look-through rule of paragraph 
(c)(5)(ii)(B)(2)(i) of this section, the shareholder generally will 
treat its entire basis in the corporation's stock as an asset held for 
investment. If a shareholder that is a C corporation or a tax-exempt 
corporation does not satisfy the minimum ownership threshold in 
paragraph (c)(7) of this section or is precluded by paragraph 
(c)(5)(ii)(D) of this section from applying the corporation look-
through rule of paragraph (c)(5)(ii)(B)(2)(i) of this section, the 
shareholder must treat its entire basis in the corporation's stock as 
allocable to a non-excepted trade or business.
    (3) S corporations--(i) Calculation of asset basis. For purposes of 
this section, a shareholder's share of stock in an S corporation is 
treated as an asset of the shareholder. Additionally, for these 
purposes, the shareholder's adjusted basis in a share of S corporation 
stock is adjusted to take into account the modifications in paragraph 
(c)(5)(i)(A) of this section with respect to the assets of the S 
corporation (for example, a shareholder's adjusted basis in its S 
corporation stock is increased by the shareholder's share of 
depreciation with respect to an inherently permanent structure owned by 
the S corporation).

[[Page 67594]]

    (ii) Allocation of asset basis. For purposes of determining the 
extent to which a shareholder's basis in its stock of an S corporation 
is allocable to an excepted or non-excepted trade or business, the 
shareholder may look through to such shareholder's share of the S 
corporation's basis in the S corporation's assets, allocated on a pro 
rata basis, adjusted to the extent required under paragraph (d)(4) of 
this section, except as otherwise provided in paragraph (c)(5)(ii)(D) 
of this section. Notwithstanding paragraph (c)(7) of this section, if a 
shareholder's direct and indirect interest in an S corporation is 
greater than or equal to 80 percent of the S corporation's stock by 
vote and value, the shareholder must apply the rules in this paragraph 
(c)(5)(ii)(B)(3) to look through to the S corporation's basis in the S 
corporation's assets.
    (iii) De minimis rule. If at least 90 percent of a shareholder's 
share of an S corporation's basis in its assets is allocable to either 
excepted trades or businesses or non-excepted trades or businesses, the 
shareholder's entire basis in its S corporation stock is treated as 
allocable to either excepted or non-excepted trades or businesses, 
respectively.
    (iv) Inapplicability of S corporation look-through rule. If a 
shareholder chooses not to look through to the S corporation's basis in 
the S corporation's assets under paragraph (c)(5)(ii)(B)(3)(ii) of this 
section or is precluded by paragraph (c)(5)(ii)(D) of this section from 
applying such S corporation look-through rule, the shareholder 
generally will treat its basis in the S corporation stock as either an 
asset held for investment or a non-excepted trade or business asset as 
determined under section 163(d).
    (C) Stock in CFCs. The rules applicable to domestic non-
consolidated C corporations in paragraph (c)(5)(ii)(B) of this section 
also apply to CFCs.
    (D) Inapplicability of look-through rule to partnerships or non-
consolidated corporations to which the small business exemption 
applies. A taxpayer may not apply the look-through rules in paragraphs 
(b)(3) and (c)(5)(ii)(A), (B), and (C) of this section to a 
partnership, S corporation, or non-consolidated corporation that is 
eligible for the small business exemption under section 163(j)(3) and 
Sec.  1.163(j)-2(d)(1).
    (E) Tiered entities. If a taxpayer applies the look-through rules 
of this paragraph (c)(5)(ii), the taxpayer must do so for all lower-
tier entities with respect to which the taxpayer satisfies, directly or 
indirectly, the minimum ownership threshold in paragraph (c)(7) of this 
section, subject to the limitation in paragraph (c)(5)(ii)(D) of this 
section, beginning with the lowest-tier entity.
    (iii) Cash and cash equivalents and customer receivables. Except as 
otherwise provided in paragraph (d)(2) of this section, a taxpayer's 
basis in its cash and cash equivalents and customer receivables is not 
taken into account for purposes of this paragraph (c). This rule also 
applies to a lower-tier entity if a taxpayer looks through to the 
assets of that entity under paragraph (c)(5)(ii) of this section. For 
purposes of this paragraph (c)(5)(iii), the term cash and cash 
equivalents includes cash, foreign currency, commercial paper, any 
interest in an investment company registered under the Investment 
Company Act of 1940 (1940 Act) and regulated as a money market fund 
under 17 CFR 270.2a-7 (Rule 2a-7 under the 1940 Act), any obligation of 
a government, and any derivative that is substantially secured by an 
obligation of a government, or any similar asset. For purposes of this 
paragraph (c)(5)(iii), a derivative is a derivative described in 
section 59A(h)(4)(A), without regard to section 59A(h)(4)(C). For 
purposes of this paragraph (c)(5)(iii), the term government means the 
United States or any agency or instrumentality of the United States; a 
State or any political subdivision thereof, including the District of 
Columbia and any possession or territory of the United States, within 
the meaning of section 103 and Sec.  1.103-1; or any foreign 
government, any political subdivision of a foreign government, or any 
wholly owned agency or instrumentality of any one of the foregoing 
within the meaning of Sec.  1.1471-6(b).
    (iv) Deemed asset sale. Solely for purposes of determining the 
amount of basis allocable to excepted and non-excepted trades or 
businesses under this section, an election under section 336, 338, or 
754, as applicable, is deemed to have been made for any acquisition of 
corporate stock or partnership interests with respect to which the 
taxpayer demonstrates to the satisfaction of the Commissioner, in the 
information statement required by paragraph (c)(6)(iii)(B) of this 
section, that the taxpayer was eligible to make an election but was 
actually or effectively precluded from doing so by a regulatory agency 
with respect to an excepted regulated utility trade or business. Any 
additional basis taken into account under this rule is reduced ratably 
over a 15-year period beginning with the month of the acquisition and 
is not subject to the anti-abuse rule in paragraph (c)(8) of this 
section.
    (v) Other adjustments. The Commissioner may make appropriate 
adjustments to prevent a taxpayer from intentionally and artificially 
increasing its basis in assets attributable to an excepted trade or 
business.
    (6) Determination dates; determination periods; reporting 
requirements--(i) Definitions. For purposes of this section, the term 
determination date means the last day of each quarter of the taxpayer's 
taxable year (and the last day of the taxpayer's taxable year, if the 
taxpayer has a short taxable year), and the term determination period 
means the period beginning the day after one determination date and 
ending on the next determination date.
    (ii) Application of look-through rules. If a taxpayer that applies 
the look-through rules of paragraph (c)(5)(ii) of this section has a 
different taxable year than the partnership or non-consolidated 
corporation to which the taxpayer is applying those rules, then, for 
purposes of this paragraph (c)(6), the taxpayer must use the most 
recent quarterly figures from the partnership or non-consolidated 
corporation. For example, assume that PS1 is a partnership with a May 
31 taxable year, and that C (a calendar-year C corporation) is a 
partner whose ownership interest satisfies the ownership threshold in 
paragraph (c)(7) of this section. PS1's determination dates are 
February 28, May 31, August 31, and November 30. In turn, C's 
determination dates are March 31, June 30, September 30, and December 
31. If C looks through to PS1's basis in its assets under paragraph 
(c)(5)(ii) of this section, then, for purposes of determining the 
amount of C's asset basis that is attributable to its excepted and non-
excepted businesses on March 31, C must use PS1's asset basis 
calculations for February 28.
    (iii) Reporting requirements--(A) Books and records. A taxpayer 
must maintain books of account and other records and data as necessary 
to substantiate the taxpayer's use of an asset in an excepted trade or 
business and to substantiate the adjustments to asset basis for 
purposes of applying paragraph (c) of this section. One indication 
demonstrating that a particular asset is used in a particular trade or 
business is if the taxpayer maintains separate books and records for 
all of its excepted and non-excepted trades or businesses, and can show 
the asset in the books and records of a particular excepted or non-
excepted trade or business. For rules governing record retention, see 
Sec.  1.6001-1.
    (B) Information statement. Except as otherwise provided in 
publications, forms, instructions, or other guidance,

[[Page 67595]]

each taxpayer that is making an allocation under this paragraph (c) 
must prepare a statement containing the information described in this 
paragraph (c)(6)(iii) and must attach the statement to its timely filed 
Federal income tax return for the taxable year. The statement, which 
must be titled ``Section 163(j) Asset Basis Calculations,'' must 
include the following information:
    (1) The taxpayer's adjusted basis in the assets used in its 
excepted and non-excepted businesses, determined on a quarterly basis 
as set forth in this section, including detailed information for the 
different groups of assets identified in paragraphs (c)(5)(i), 
(c)(5)(ii), and (d) of this section;
    (2) The determination dates on which asset basis was measured 
during the taxable year;
    (3) The names and taxpayer identification numbers (TINs) of all 
entities for which basis information is being provided, including 
partnerships and corporations if the taxpayer that owns an interest in 
a partnership or corporation looks through to the partnership's or 
corporation's basis in the partnership's or corporation's assets under 
paragraph (c)(5)(ii) of this section. If the taxpayer is a member of a 
consolidated group, the name and TIN of the agent for the group, as 
defined in Sec.  1.1502-77, must be provided, but the taxpayer need not 
provide the names and TINs of all other consolidated group members;
    (4) Asset basis information for corporations or partnerships if the 
taxpayer looks through to the corporation's or partnership's basis in 
the corporation's or partnership's assets under paragraph (c)(5)(ii) of 
this section; and
    (5) A summary of the method or methods used to determine asset 
basis in property used in both excepted and non-excepted businesses, as 
well as information regarding any deemed sale under paragraph 
(c)(5)(iv) of this section.
    (iv) Failure to file statement. If a taxpayer fails to file the 
statement described in paragraph (c)(6)(iii) of this section or files a 
statement that does not comply with the requirements of paragraph 
(c)(6)(iii) of this section, the Commissioner may treat the taxpayer as 
if all of its interest expense is properly allocable to a non-excepted 
trade or business, unless the taxpayer shows that there was reasonable 
cause for failing to comply with, and the taxpayer acted in good faith 
with respect to, the requirements of paragraph (c)(6)(iii) of this 
section, taking into account all pertinent facts and circumstances.
    (7) Ownership threshold for look-through rules--(i) Corporations--
(A) Asset basis. A shareholder must look through to the assets of a 
non-consolidated domestic C corporation or a CFC under paragraph 
(c)(5)(ii) of this section for purposes of allocating the shareholder's 
basis in its stock in the corporation between excepted and non-excepted 
trades or businesses if the shareholder's direct and indirect interest 
in the corporation satisfies the ownership requirements of section 
1504(a)(2). A shareholder may look through to the assets of an S 
corporation under paragraph (c)(5)(ii) of this section for purposes of 
allocating the shareholder's basis in its stock in the S corporation 
between excepted and non-excepted trades or businesses regardless of 
the shareholder's direct and indirect interest in the S corporation.
    (B) Dividends. A shareholder must look through to the activities of 
a non-consolidated domestic C corporation or a CFC under paragraph 
(b)(3) of this section if the shareholder's direct and indirect 
interest in the corporation satisfies the ownership requirements of 
section 1504(a)(2). A shareholder may look through to the activities of 
an S corporation under paragraph (b)(3) of this section regardless of 
the shareholder's direct and indirect interest in the S corporation.
    (ii) Partnerships. A partner may look through to the assets of a 
partnership under paragraph (c)(5)(ii) of this section for purposes of 
allocating the partner's basis in its partnership interest between 
excepted and non-excepted trades or businesses regardless of the 
partner's direct and indirect interest in the partnership.
    (iii) Inapplicability of look-through rule. For circumstances in 
which a taxpayer that satisfies the ownership threshold in this 
paragraph (c)(7) may not apply the look-through rules in paragraphs 
(b)(3) and (c)(5)(ii) of this section, see paragraph (c)(5)(ii)(D) of 
this section.
    (8) Anti-abuse rule. If a principal purpose for the acquisition, 
disposition, or change in use of an asset was to artificially shift the 
amount of basis allocable to excepted or non-excepted trades or 
businesses on a determination date, the additional basis or change in 
use will not be taken into account for purposes of this section. For 
example, if an asset is used in a non-excepted trade or business for 
most of the taxable year, and if the taxpayer begins using the asset in 
an excepted trade or business towards the end of the year with a 
principal purpose of shifting the amount of basis in the asset that is 
allocable to the excepted trade or business, the change in use is 
disregarded for purposes of this section. A purpose may be a principal 
purpose even though it is outweighed by other purposes (taken together 
or separately). In determining whether a taxpayer has a principal 
purpose described in this paragraph (c)(8), factors to be considered 
include, for example, the following: the business purpose for the 
acquisition, disposition, or change in use; the length of time the 
asset was used in a trade or business; whether the asset was acquired 
from a related person; and whether the taxpayer's aggregate basis in 
its assets increased or decreased temporarily on or around a 
determination date. A principal purpose is presumed to be present in 
any case in which the acquisition, disposition, or change in use lacks 
a substantial business purpose and increases the taxpayer's basis in 
assets used in its excepted trades or businesses by more than 10 
percent during the taxable year.
    (d) Direct allocations--(1) In general. For purposes of this 
section, a taxpayer with qualified nonrecourse indebtedness, within the 
meaning of Sec.  1.861-10T(b), must directly allocate interest expense 
from the indebtedness to the taxpayer's assets in the manner and to the 
extent provided in Sec.  1.861-10T(b).
    (2) Financial services entities. For purposes of this section, a 
taxpayer that is engaged in the trade or business of banking, within 
the meaning of section 581, insurance, financing, or a similar business 
that derives active financing income as described in Sec.  1.904-
4(e)(2) (an active financing business) must directly allocate interest 
expense and interest income from that business to the taxpayer's assets 
used in that business. The special rule for cash and cash equivalents 
in paragraph (c)(5)(iii) of this section does not apply to an entity 
that qualifies as a financial services entity as described in Sec.  
1.904-4(e)(3).
    (3) Assets used in more than one trade or business. If an asset is 
used in more than one trade or business, the taxpayer must apply the 
rules in paragraph (c)(3) of this section to determine the extent to 
which interest that is directly allocated under this paragraph (d) is 
allocable to excepted or non-excepted trades or businesses.
    (4) Adjustments to basis of assets to account for direct 
allocations. In determining the amount of a taxpayer's basis in the 
assets used in its excepted and non-excepted trades or businesses for 
purposes of paragraph (c) of this section, adjustments must be made to 
reflect direct allocations under this paragraph (d). These adjustments

[[Page 67596]]

consist of reductions in the amount of the taxpayer's basis in its 
assets for purposes of paragraph (c) of this section to reflect assets 
to which interest expense is directly allocated under this paragraph 
(d). These adjustments must be made before the taxpayer averages the 
adjusted basis in its assets as determined on each determination date 
during the taxable year.

     (5) Example: Direct allocation of interest expense--(i) Facts. 
T conducts an electing real property trade or business (Business X) 
and operates a retail store that is a non-excepted trade or business 
(Business Y). In Year 1, T issues Note A to a third party in 
exchange for $1,000x for the purpose of acquiring Building B. Note A 
is qualified nonrecourse indebtedness (within the meaning of Sec.  
1.861-10T(b)) secured by Building B. T then uses those funds to 
acquire Building B for $1,200x, and T uses Building B in Business X. 
During Year 1, T pays $500x of interest, of which $100x is interest 
payments on Note A. For Year 1, T's basis in its assets used in 
Business X (as determined under paragraph (c) of this section) is 
$3,600x (excluding cash and cash equivalents), and T's basis in its 
assets used in Business Y (as determined under paragraph (c) of this 
section) is $800x (excluding cash and cash equivalents). Each of 
Business X and Business Y also has $100x of cash and cash 
equivalents.
    (ii) Analysis. Because Note A is qualified nonrecourse 
indebtedness that is secured by Building B, in allocating interest 
expense between Businesses X and Y, T first must directly allocate 
the $100x of interest expense it paid with respect to Note A to 
Business X in accordance with paragraph (d)(1) of this section. 
Thereafter, T must allocate the remaining $400x of interest expense 
between Businesses X and Y under paragraph (c) of this section. 
After excluding T's $1,200x cost basis in Building B (see paragraph 
(d)(4) of this section), and without regard to T's $200x of cash and 
cash equivalents (see paragraph (c)(5)(iv) of this section), T's 
basis in assets used in Businesses X and Y is $2,400x and $800x (75 
percent and 25 percent), respectively. Thus, $300x of the remaining 
$400x of interest expense would be allocated to Business X, and 
$100x would be allocated to Business Y.

    (e) Examples. The examples in this paragraph (e) illustrate the 
principles of this section. For purposes of these examples, assume that 
no taxpayer is eligible for the small business exemption under section 
163(j)(3) and Sec.  1.163(j)-2(d), no taxpayer has floor plan financing 
interest expense, and no taxpayer has qualified nonrecourse 
indebtedness within the meaning of Sec.  1.861-10T(b).

     (1) Example 1: Interest allocation within a consolidated 
group--(i) Facts. S is a member of a consolidated group of which P 
is the common parent. P conducts an electing real property trade or 
business (Business X), and S conducts a non-excepted trade or 
business (Business Y). In Year 1, P pays or accrues (without regard 
to section 163(j)) $35x of interest expense and receives $10x of 
interest income, and S pays or accrues (without regard to section 
163(j)) $115x of interest expense and receives $5x of interest 
income (for a total of $150x of interest expense and $15x of 
interest income). For purposes of this example, assume that, 
pursuant to paragraph (c) of this section, $30x of the P group's 
interest expense and $3x of the P group's interest income is 
allocable to Business X, and the remaining $120x of interest expense 
and $12x of interest income is allocable to Business Y.
    (ii) Analysis. Under paragraph (a)(4) of this section, 20 
percent of the P group's Year 1 interest expense ($30x/$150x) and 
interest income ($3x/$15x) is allocable to an excepted trade or 
business. Thus, $7x ($35x x 20 percent) of P's interest expense and 
$2x ($10x x 20 percent) of P's interest income is allocable to an 
excepted trade or business. The remaining $28x of P's interest 
expense is business interest expense subject to limitation under 
section 163(j), and the remaining $8x of P's interest income is 
business interest income that increases the group's section 163(j) 
limitation. In turn, $23x ($115x x 20 percent) of S's interest 
expense and $1x ($5x x 20 percent) of S's interest income is 
allocable to an excepted trade or business. The remaining $92x of 
S's interest expense is business interest expense subject to 
limitation under section 163(j), and the remaining $4x of S's 
interest income is business interest income that increases the 
group's section 163(j) limitation.
     (2) Example 2: Interest allocation within a consolidated group 
with assets used in more than one trade or business--(i) Facts. S is 
a member of a consolidated group of which P is the common parent. P 
conducts an electing real property trade or business (Business X), 
and S conducts a non-excepted trade or business (Business Y). In 
Year 1, P pays or accrues (without regard to section 163(j)) $50x of 
interest expense, and S pays or accrues $100x of interest expense 
(without regard to section 163(j)). P leases 40 percent of space in 
Building V (which P owns) to S for use in Business Y, and P leases 
the remaining 60 percent of space in Building V to third parties. 
For purposes of allocating interest expense under paragraph (c) of 
this section, the P group's basis in its assets (excluding Building 
V) used in Businesses X and Y is $180x and $620x, respectively. The 
P group's basis in Building V for purposes of allocating interest 
expense under paragraph (c) of this section is $200x.
    (ii) Analysis. Under paragraph (c)(3)(ii) of this section, the P 
group's basis in Building V ($200x) is allocated to excepted and 
non-excepted trades or businesses in accordance with the use of 
space by Business Y (40 percent) and Business X (the remainder, or 
60 percent). Accordingly, $120x of the basis in Building V is 
allocated to excepted trades or businesses (60 percent x $200x), and 
$80x is allocated to non-excepted trades or businesses (40 percent x 
$200x). After allocating the basis in Building V, the P group's 
total basis in the assets used in excepted and non-excepted trades 
or businesses is $300x and $700x, respectively. Under paragraphs 
(a)(4) and (c) of this section, 30 percent ($300x/$1000x) of the P 
group's Year 1 interest expense is properly allocable to an excepted 
trade or business. Thus, $15x ($50x x 30 percent) of P's interest 
expense is properly allocable to an excepted trade or business, and 
the remaining $35x of P's interest expense is business interest 
expense subject to limitation under section 163(j). In turn, $30x 
($100x x 30 percent) of S's interest expense is properly allocable 
to an excepted trade or business, and the remaining $70x of S's 
interest expense is business interest expense subject to limitation 
under section 163(j).
     (3) Example 3: Application of look-through rules--(i) Facts. 
(A) A and B are unrelated individual taxpayers. A owns 100 percent 
of the stock of Corp 1, a calendar-year domestic C corporation. The 
basis of A's stock in Corp 1 is $500x. Corp 1 owns 10 percent of the 
interests in PS1 (a domestic partnership), and B owns the remaining 
90 percent. Corp 1's basis in its PS1 interests is $25x, and B's 
basis in its PS1 interests is $225x. PS1 owns 100 percent of the 
stock of Corp 2, a calendar-year domestic C corporation. PS1 has a 
basis of $1000x in its Corp 2 stock.
    (B) In 2020, Corp 1 was engaged solely in a non-excepted trade 
or business. That same year, PS1's only activity was holding Corp 2 
stock. In turn, Corp 2 was engaged in both an electing farming 
business and a non-excepted trade or business. Under the allocation 
rules in paragraph (c) of this section, 50 percent of Corp 2's asset 
basis in 2020 was allocable to the electing farming business. The 
remaining 50 percent was allocable to the non-excepted trade or 
business.
    (C) Individuals A and B each paid or accrued (without regard to 
section 163(j)) $150x of interest expense allocable to a trade or 
business under Sec.  1.163-8T (along with personal interest and 
investment interest). A's trade or business was an excepted trade or 
business, and B's trade or business was a non-excepted trade or 
business. A's basis in the assets used in its trade or business was 
$100x, and B's basis in the assets used in its trade or business was 
$112.5x.
    (ii) Analysis. (A) As provided in paragraph (c)(5)(ii)(E) of 
this section, if a taxpayer applies the look-through rules of 
paragraph (c)(5)(ii) of this section, the taxpayer must begin with 
the lowest-tier entity to which it is eligible to apply the look-
through rules. A directly owns 100 percent of the stock of Corp 1; 
thus, A satisfies the 80 percent minimum ownership threshold with 
respect to Corp 1. A also owns 10 percent of the interests in PS1. 
There is no minimum ownership threshold for partnerships; thus, A 
may apply the look-through rules to PS1. However, A does not 
directly or indirectly own at least 80 percent of the stock of Corp 
2; thus, A may not look through its indirect interest in Corp 2. In 
turn, B directly owns 90 percent of the interests in PS1, and B 
indirectly owns at least 80 percent of the stock of Corp 2. Thus, B 
may apply the look-through rules to both PS1 and Corp 2.
    (B) From A's perspective, PS1 is not engaged in a trade or 
business for purposes of section 163(j); instead, PS1 is merely 
holding its Corp 2 stock as an investment. Under paragraph 
(c)(5)(ii)(A)(2) of this

[[Page 67597]]

section, if a partnership is not engaged in a trade or business, 
then its C corporation partner must treat its entire basis in the 
partnership interest as allocable to a non-excepted trade or 
business. Thus, for purposes of A's application of the look-through 
rules, Corp 1's entire basis in its PS1 interest ($25x) is allocable 
to a non-excepted trade or business. Corp 1's basis in its other 
assets also is allocable to a non-excepted trade or business (the 
only trade or business in which Corp 1 is engaged). Thus, under 
paragraph (c) of this section, A's $500x basis in its Corp 1 stock 
is allocable entirely to a non-excepted trade or business. A's $100x 
basis in its other business assets is allocable to an excepted trade 
or business. Thus, \5/6\ (or $125x) of A's $150x of interest expense 
is properly allocable to a non-excepted trade or business and is 
business interest expense subject to limitation under section 
163(j), and the remaining $25x of A's $150x of interest expense is 
allocable to an excepted trade or business and is not subject to 
limitation under section 163(j).
    (C) From B's perspective, PS1 must look through its stock in 
Corp 2 to determine the extent to which PS1's basis in the stock is 
allocable to an excepted or non-excepted trade or business. Half of 
Corp 2's basis in its assets is allocable to an excepted trade or 
business, and the other half is allocable to a non-excepted trade or 
business. Thus, from B's perspective, $500x of PS1's basis in its 
Corp 2 stock (PS1's only asset) is allocable to an excepted trade or 
business, and the other half is allocable to a non-excepted trade or 
business. B's basis in its PS1 interests is $225x. Applying the 
look-through rules to B's PS1 interests, $112.5x of B's basis in its 
PS1 interests is allocable to an excepted trade or business, and 
$112.5x of B's basis in its PS1 interests is allocable to a non-
excepted trade or business. Since B's basis in the assets used in 
its non-excepted trade or business also was $112.5x, two-thirds of 
B's interest expense ($100x) is properly allocable to a non-excepted 
trade or business and is business interest expense subject to 
limitation under section 163(j), and one-third of B's interest 
expense ($50x) is allocable to an excepted trade or business and is 
not subject to limitation under section 163(j).
     (4) Example 4: Excepted and non-excepted trades or businesses 
in a consolidated group--(i) Facts. P is the common parent of a 
consolidated group of which A and B are the only other members. A 
conducts an electing real property trade or business (Business X), 
and B conducts a non-excepted trade or business (Business Y). In 
Year 1, A pays or accrues (without regard to section 163(j)) $50x of 
interest expense and earns $70x of gross income in the conduct of 
Business X, and B pays or accrues (without regard to section 163(j)) 
$100x of interest expense and earns $150x of gross income in the 
conduct of Business Y. B owns Building V, which it uses in Business 
Y. For purposes of allocating the P group's Year 1 business interest 
expense between excepted and non-excepted trades or businesses under 
paragraph (c) of this section, the P group's basis in its assets 
(other than Building V) used in Businesses X and Y is $180x and 
$620x, respectively, and the P group's basis in Building V is $200x. 
At the end of Year 1, B sells Building V to a third party and 
realizes a gain of $60x in addition to the $150x of gross income B 
earned that year from the conduct of Business Y.
    (ii) Analysis. (A) Under paragraphs (a)(4) and (c) of this 
section, the P group's basis in its assets used in its trades or 
businesses is allocated between the P group's excepted trade or 
business (Business X) and its non-excepted trade or business 
(Business Y) as though these trades or businesses were conducted by 
a single corporation. Under paragraph (c) of this section, the P 
group's basis in its assets used in Businesses X and Y is $180x and 
$820x, respectively. Accordingly, 18 percent ($180x/$1,000x) of the 
P group's total interest expense ($150x) is properly allocable to an 
excepted trade or business ($27x), and the remaining 82 percent of 
the P group's total interest expense is business interest expense 
properly allocable to a non-excepted trade or business ($123x).
    (B) To determine the P group's section 163(j) limitation, 
paragraph (a) of this section requires that certain items of income 
and deduction be allocated to the excepted and non-excepted trades 
or businesses of the P group as though these trades or businesses 
were conducted by a single corporation. In Year 1, the P group's 
excepted trade or business (Business X) has gross income of $70x, 
and the P group's non-excepted trade or business (Business Y) has 
gross income of $150x. Because Building V was used exclusively in 
Business Y, the $60x of gain from the sale of Building V in Year 1 
is attributed to Business Y under paragraph (b)(2) of this section. 
The P group's section 163(j) limitation is $63x (30 percent x 
$210x), which allows the P group to deduct $63x of its $123x of 
business interest expense allocated to the P group's non-excepted 
trades or businesses. The group's $27x of interest expense that is 
allocable to excepted trades or businesses may be deducted without 
limitation under section 163(j).
    (iii) Intercompany transaction. The facts are the same as in 
Example 4 in paragraph (e)(4)(i) of this section, except that A owns 
Building V and leases it to B in Year 1 for $20x for use in Business 
Y, and A sells Building V to a third party for a $60 gain at the end 
of Year 1. Under paragraphs (a)(4) and (c) of this section, all 
members of the P group are treated as a single corporation. As a 
result, the P group's basis in its assets used in its trades or 
businesses is allocated between the P group's excepted trade or 
business (Business X) and its non-excepted trade or business 
(Business Y) as though these trades or businesses were conducted by 
a single corporation. A lease between two divisions of a single 
corporation would produce no rental income or expense. Thus, the 
$20x of rent paid by B to A does not affect the P group's ATI. 
Moreover, under paragraph (c) of this section, Building V is an 
asset used in the P group's non-excepted trade or business (Business 
Y). Accordingly, although A owns Building V, the basis in Building V 
is added to the P group's basis in assets used in Business Y for 
purposes of allocating interest expense under paragraph (c) of this 
section. In the same vein, when A sells Building V to a third party 
at a gain of $60x, the gain is included in the P group's ATI because 
Building V was used in a non-excepted trade or business of the P 
group (Business Y) prior to its sale.
     (5) Example 5: Captive activities--(i) Facts. S and T are 
members of a consolidated group of which P is the common parent. P 
conducts an electing real property trade or business (Business X), S 
conducts a non-excepted trade or business (Business Y), and T 
provides transportation services to Businesses X and Y but does not 
have any customers outside of the P group. For Year 1, T provides 
transportation services using a single bus with a basis of $120x.
    (ii) Analysis. Under paragraph (a)(4) of this section, 
activities conducted by a consolidated group are treated as though 
those activities were conducted by a single corporation. Because the 
activities of T are limited to providing intercompany transportation 
services, T does not conduct a trade or business for purposes of 
section 163(j). Under paragraph (c)(3) of this section, business 
interest expense is allocated to excepted and non-excepted trades or 
businesses based on the relative basis of the assets used in those 
businesses. The basis in T's only asset, a bus, is therefore 
allocated between Business X and Business Y according to the use of 
T's bus by these businesses. Business X uses one-third of T's 
services, and Business Y uses two-thirds of T's services. Thus, $40x 
of the basis of T's bus is allocated to Business X, and $80x of the 
basis of T's bus is allocated to Business Y.

    (f) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.


Sec.  1.163(j)-11  Transition rules.

    (a) Application of section 163(j) limitation if a corporation joins 
a consolidated group with a taxable year beginning before January 1, 
2018--(1) In general. If a corporation (S) joins a consolidated group 
whose taxable year began before January 1, 2018, and if S is subject to 
the section 163(j) limitation at the time of its change in status, then 
section 163(j) will apply to S's short taxable year that ends on the 
day of S's change in status, but section 163(j) will

[[Page 67598]]

not apply to S's short taxable year that begins the next day (when S is 
a member of the acquiring consolidated group). Any business interest 
expense paid or accrued (without regard to section 163(j)) by S in its 
short taxable year ending on the day of S's change in status for which 
a deduction is disallowed under section 163(j) will be carried forward 
to the acquiring group's first taxable year beginning after December 
31, 2017. Those disallowed business interest expense carryforwards may 
be subject to limitation under other provisions of these regulations 
(see, for example, Sec.  1.163(j)-5(c), (d), (e), and (f)).
    (2) Example. Acquiring Group is a consolidated group with a fiscal 
year end of November 30; Target is a stand-alone calendar-year C 
corporation. On May 31, 2018, Acquiring Group acquires Target in a 
transaction that is not an ownership change for purposes of section 
382. Acquiring Group is not subject to the section 163(j) limitation 
during its taxable year beginning December 1, 2017. As a result of the 
acquisition, Target has a short taxable year beginning January 1, 2018 
and ending May 31, 2018. Target is subject to the section 163(j) 
limitation during this short taxable year. However, Target (as a member 
of Acquiring Group) is not subject to the section 163(j) limitation 
during Acquiring Group's taxable year ending November 30, 2018. Any 
disallowed business interest expense carryforwards from Target's 
taxable year ending May 31, 2018, will not be available for use in 
Acquiring Group's taxable year ending November 30, 2018. However, that 
disallowed business interest expense is carried forward to Acquiring 
Group's taxable year beginning December 1, 2018, and can be deducted by 
the group, subject to the separate return limitation year (SRLY) 
limitation. See Sec.  1.163(j)-5(d).
    (b) Treatment of disallowed disqualified interest--(1) In general. 
Disallowed disqualified interest is carried forward to the taxpayer's 
first taxable year beginning after December 31, 2017, and is subject to 
disallowance as a disallowed business interest expense carryforward 
under section 163(j) and Sec.  1.163(j)-2, except to the extent the 
interest is properly allocable to an excepted trade or business under 
Sec.  1.163(j)-10. See Sec.  1.163(j)-10(a)(6).
    (2) Earnings and profits. A taxpayer may not reduce its earnings 
and profits in a taxable year beginning after December 31, 2017, to 
reflect any disallowed disqualified interest carryforwards to the 
extent the payment or accrual of the disallowed disqualified interest 
reduced the earnings and profits of the taxpayer in a prior taxable 
year.
    (3) Disallowed disqualified interest of members of an affiliated 
group--(i) Scope. This paragraph (b)(3)(i) applies to corporations that 
were treated as a single taxpayer under old section 163(j)(6)(C) and 
that had disallowed disqualified interest.
    (ii) Allocation of disallowed disqualified interest to members of 
the affiliated group--(A) In general. Each member of the affiliated 
group is allocated its allocable share of the affiliated group's 
disallowed disqualified interest as provided in paragraph (b)(3)(ii)(B) 
of this section.
    (B) Definitions. The following definitions apply for purposes of 
paragraph (b)(3)(ii) of this section.
    (1) Allocable share of the affiliated group's disallowed 
disqualified interest. The term allocable share of the affiliated 
group's disallowed disqualified interest means, with respect to any 
member of an affiliated group for the member's last taxable year 
beginning before January 1, 2018, the product of the total amount of 
the disallowed disqualified interest of all members of the affiliated 
group under old section 163(j)(6)(C) and the member's disallowed 
disqualified interest ratio.
    (2) Disallowed disqualified interest ratio. The term disallowed 
disqualified interest ratio means, with respect to any member of an 
affiliated group for the member's last taxable year beginning before 
January 1, 2018, the ratio of the exempt related person interest 
expense of the member for the last taxable year beginning before 
January 1, 2018, to the sum of the amounts of exempt related person 
interest expense for all members of the affiliated group.
    (3) Exempt related person interest expense. The term exempt related 
person interest expense means interest expense that is, or is treated 
as, paid or accrued by a domestic C corporation, or by a foreign 
corporation with income, gain, or loss that is effectively connected, 
or treated as effectively connected, with the conduct of a trade or 
business in the United States, to--
    (i) Any person related to the taxpayer, within the meaning of 
sections 267(b) or 707(b)(1), applying the constructive ownership and 
attribution rules of section 267(c), if no U.S. tax is imposed with 
respect to the interest under subtitle A of the Internal Revenue Code, 
determined without regard to net operating losses or net operating loss 
carryovers, and taking into account any applicable treaty obligation of 
the United States. For this purpose, interest that is subject to a 
reduced rate of tax under any treaty obligation of the United States 
applicable to the recipient is treated as in part subject to the 
statutory tax rate under sections 871 or 881 and in part not subject to 
tax, based on the proportion that the rate of tax under the treaty 
bears to the statutory tax rate. Thus, for purposes of section 163(j), 
if the statutory tax rate is 30 percent, and pursuant to a treaty U.S. 
tax is instead limited to a rate of 10 percent, two-thirds of the 
interest is considered interest not subject to U.S. tax under subtitle 
A of the Internal Revenue Code;
    (ii) A person that is not related to the taxpayer, within the 
meaning of sections 267(b) or 707(b)(1), applying the constructive 
ownership and attribution rules of section 267(c), with respect to 
indebtedness on which there is a disqualified guarantee, within the 
meaning of paragraph (6)(D) of old section 163(j), of such 
indebtedness, and no gross basis U.S. tax is imposed with respect to 
the interest. For purposes of this paragraph (b)(3)(ii)(B)(3)(ii), a 
gross basis U.S. tax means any tax imposed by this subtitle A of the 
Internal Revenue Code that is determined by reference to the gross 
amount of any item of income without any reduction for any deduction 
allowed by subtitle A of the Internal Revenue Code. Interest that is 
subject to a gross basis U.S. tax that is eligible for a reduced rate 
of tax under any treaty obligation of the United States applicable to 
the recipient is treated as, in part, subject to the statutory tax rate 
under sections 871 or 881 and, in part, not subject to a gross basis 
U.S. tax, based on the proportion that the rate of tax under the treaty 
bears to the statutory tax rate. Thus, for purposes of section 163(j), 
if the statutory tax rate is 30 percent, and pursuant to a treaty U.S. 
tax is instead limited to a rate of 10 percent, two-thirds of the 
interest is considered interest not subject to a gross basis U.S. tax 
under subtitle A of the Internal Revenue Code; or
    (iii) A REIT, directly or indirectly, to the extent that the 
domestic C corporation, or a foreign corporation with income, gain, or 
loss that is effectively connected, or treated as effectively 
connected, with the conduct of a trade or business in the United 
States, is a taxable REIT subsidiary, as defined in section 856(l), 
with respect to the REIT.
    (iii) Treatment of carryforwards. The amount of disallowed 
disqualified interest allocated to a taxpayer pursuant to paragraph 
(b)(3)(ii) of this section is treated in the same manner as described 
in paragraph (b)(1) of this section.
    (4) Application of section 382--(i) Ownership change occurring 
before the date the Treasury decision adopting these regulations as 
final regulations is

[[Page 67599]]

published in the Federal Register--(A) Pre-change loss. For purposes of 
section 382(d)(3), unless the rules of Sec.  1.382-2(a)(7) apply, 
disallowed disqualified interest is not a pre-change loss under Sec.  
1.382-2(a) subject to a section 382 limitation with regard to an 
ownership change on a change date occurring before the date the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register. But see section 382(h)(6)(B) 
(regarding built-in deduction items).
    (B) Loss corporation. For purposes of section 382(k)(1), unless the 
rules of Sec.  1.382-2(a)(7) apply, disallowed disqualified interest is 
not a carryforward of disallowed interest described in section 
381(c)(20) with regard to an ownership change on a change date 
occurring before the date the Treasury decision adopting these 
regulations as final regulations is published in the Federal Register. 
But see section 382(h)(6) (regarding built-in deductions).
    (ii) Ownership change occurring on or after the date the Treasury 
decision adopting these regulations as final regulations is published 
in the Federal Register--(A) Pre-change loss. For rules governing the 
treatment of disallowed disqualified interest as a pre-change loss for 
purposes of section 382 with regard to an ownership change on a change 
date occurring on or after the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register, see Sec. Sec.  1.382-2(a)(2) and 1.382-6(c)(3).
    (B) Loss corporation. For rules governing when disallowed 
disqualified interest causes a corporation to be a loss corporation 
with regard to an ownership change occurring on or after the date the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register, see Sec.  1.382-2(a)(1)(i)(A).
    (iii) Definitions. For purposes of this paragraph (b)(4), the terms 
ownership change and change date have the meanings provided in section 
382 and the regulations thereunder.
    (5) [Reserved]
    (6) Treatment of excess limitation from taxable years beginning 
before January 1, 2018. No amount of excess limitation under old 
section 163(j)(2)(B) may be carried forward to taxable years beginning 
after December 31, 2017.
    (7) Example: Members of an affiliated group--(i) Facts. A, B, and C 
are calendar-year domestic C corporations that are members of an 
affiliated group (within the meaning of section 1504(a)) that was 
treated as a single taxpayer under old section 163(j)(6)(C) and the 
proposed regulations thereunder (see formerly proposed Sec.  1.163(j)-
5). For the taxable year ending December 31, 2017, the separately 
determined amounts of exempt related person interest expense of A, B, 
and C were $0, $600x, and $150x, respectively (for a total of $750x). 
The affiliated group has $200x of disallowed disqualified interest in 
that year.
    (ii) Analysis. The affiliated group's disallowed disqualified 
interest expense for the 2017 taxable year ($200x) is allocated among 
A, B, and C based on the ratio of each member's exempt related person 
interest expense to the group's exempt related person interest expense. 
Because A has no exempt related person interest expense, no disallowed 
disqualified interest is allocated to A. Disallowed disqualified 
interest of $160x is allocated to B (($600x/$750x) x $200x), and 
disallowed disqualified interest of $40x is allocated to C (($150x/
$750x) x $200x). Thus, B and C have $160x and $40x, respectively, of 
disallowed disqualified interest that is carried forward to the first 
taxable year beginning after December 31, 2017. No excess limitation 
that was allocated to A, B, or C under old section 163(j) will carry 
forward to the first taxable year beginning after December 31, 2017.
    (iii) Carryforward of disallowed disqualified interest to 2018 
taxable year. The facts are the same as in the Example in paragraph 
(b)(7)(i) of this section, except that, for the taxable year ending 
December 31, 2018, A, B, and C are members of a consolidated group that 
has a section 163(j) limitation of $140x, current-year business 
interest expense (as defined in Sec.  1.163(j)-5(a)(2)(i)) of $80x, and 
no excepted trade or business. Under paragraph (b)(1) of this section, 
disallowed disqualified interest is carried to the taxpayer's first 
taxable year beginning after December 31, 2017, and is subject to 
disallowance under section 163(j) and Sec.  1.163(j)-2. Under Sec.  
1.163(j)-5(b)(3)(ii)(D)(1), a consolidated group that has section 
163(j) limitation remaining for the current year after deducting all 
current-year business interest expense deducts each member's disallowed 
disqualified interest carryforwards from prior taxable years, starting 
with the earliest taxable year, on a pro rata basis (subject to certain 
limitations). In accordance with paragraph (b)(1) of this section, the 
rule in Sec.  1.163(j)-5(b)(3)(ii)(D)(1) applies to disallowed 
disqualified interest carried forward to the taxpayer's first taxable 
year beginning after December 31, 2017. Accordingly, after deducting 
$80x of current-year business interest expense in 2018, the group may 
deduct $60x of its $200x disallowed disqualified interest 
carryforwards. Under paragraph (b)(3) of this section, B has $160x of 
disallowed disqualified interest carryforwards, and C has $40x of 
disallowed disqualified interest carryforwards. Thus, $48x (($160x/
$200x) x $60x) of B's disallowed disqualified interest carryforwards, 
and $12x (($40x/$200x) x $60x) of C's disallowed disqualified interest 
carryforwards, are deducted by the consolidated group in the 2018 
taxable year.
    (c) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent 
they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), and 
1.1504-4 to those taxable years.
0
Par. 4. Section 1.263A-9 is amended by revising the first and third 
sentences of paragraph (g)(1)(i) to read as follows:


Sec.  1.263A-9  The avoided cost method.

* * * * *
    (g) * * *
    (1) * * *
    (i) Interest must be capitalized under section 263A(f) before the 
application of section 163(d) (regarding the investment interest 
limitation), section 163(j) (regarding the limitation on business 
interest expense), section 266 (regarding the election to capitalize 
carrying charges), section 469 (regarding the limitation on passive 
losses), and section 861 (regarding the allocation of interest to 
United States sources). * * * However, in applying section 263A(f) with 
respect to the excess expenditure amount, the taxpayer must capitalize 
all interest that is neither investment interest under section 163(d), 
business interest expense under section 163(j), nor passive interest 
under section 469 before capitalizing any interest that is either 
investment interest, business interest expense, or passive interest. * 
* *
* * * * *
0
Par. 5. Section 1.381(c)(20)-1 is added to read as follows:

[[Page 67600]]

Sec.  1.381(c)(20)-1  Carryforward of disallowed business interest.

    (a) Carryover requirement. Section 381(c)(20) provides that the 
acquiring corporation in a transaction described in section 381(a) will 
succeed to and take into account the carryover of disallowed business 
interest described in section 163(j)(2) to taxable years ending after 
the date of distribution or transfer.
    (b) Carryover of disallowed business interest described in section 
163(j)(2). For purposes of section 381(c)(20) and this section, the 
term carryover of disallowed business interest described in section 
163(j)(2) means the disallowed business interest expense carryforward 
(within the meaning of Sec.  1.163(j)-1(b)(9)), including any 
disallowed disqualified interest (within the meaning of Sec.  1.163(j)-
1(b)(10)), and including the distributor or transferor corporation's 
disallowed business interest expense from the taxable year that ends on 
the date of distribution or transfer. For the application of section 
382 to disallowed business interest expense described in section 
163(j)(2), see the regulations under section 382, including but not 
limited to Sec.  1.382-2.
    (c) Limitation on use of disallowed business interest expense 
carryforwards in the acquiring corporation's first taxable year ending 
after the date of distribution or transfer--(1) In general. In 
determining the extent to which the acquiring corporation may use 
disallowed business interest expense carryforwards in its first taxable 
year ending after the date of distribution or transfer, the principles 
of Sec. Sec.  1.381(c)(1)-1 and 1.381(c)(1)-2 apply with appropriate 
adjustments, including but not limited to the adjustments described in 
paragraphs (c)(2) and (3) of this section.
    (2) One date of distribution or transfer within the acquiring 
corporation's taxable year. If the acquiring corporation succeeds to 
the disallowed business interest expense carryforwards of one or more 
distributor or transferor corporations on a single date of distribution 
or transfer within one taxable year of the acquiring corporation, then, 
for the acquiring corporation's first taxable year ending after the 
date of distribution or transfer, that part of the acquiring 
corporation's business interest expense deduction (if any) that is 
attributable to the disallowed business interest expense carryforwards 
of the distributor or transferor corporation is limited under this 
paragraph (c) to an amount equal to the post-acquisition portion of the 
acquiring corporation's section 163(j) limitation, as defined in 
paragraph (c)(4) of this section.
    (3) Two or more dates of distribution or transfer in the taxable 
year. If the acquiring corporation succeeds to the disallowed business 
interest expense carryforwards of two or more distributor or transferor 
corporations on two or more dates of distribution or transfer within 
one taxable year of the acquiring corporation, the limitation to be 
applied under this paragraph (c) is determined by applying the 
principles of Sec.  1.381(c)(1)-2(b) to the post-acquisition portion of 
the acquiring corporation's section 163(j) limitation, as defined in 
paragraph (c)(4) of this section.
    (4) Definition. For purposes of this paragraph (c), the term post-
acquisition portion of the acquiring corporation's section 163(j) 
limitation means the amount that bears the same ratio to the acquiring 
corporation's section 163(j) limitation (within the meaning of Sec.  
1.163(j)-1(b)(31)) (or, if the acquiring corporation is a member of a 
consolidated group, the consolidated group's section 163(j) limitation) 
for the first taxable year ending after the date of distribution or 
transfer (taking into account items to which the acquiring corporation 
succeeds under section 381, other than disallowed business interest 
expense carryforwards) as the number of days in that year after the 
date of distribution or transfer bears to the total number of days in 
that year.
    (5) Examples. For purposes of this paragraph (c)(5), unless 
otherwise stated, X, Y, and Z are taxable domestic C corporations that 
were incorporated on January 1, 2018 and that file their tax returns on 
a calendar-year basis; none of X, Y, or Z is a member of a consolidated 
group; the small business exemption in Sec.  1.163(j)-2(d) does not 
apply; interest expense is deductible except to the extent of the 
potential application of section 163(j); and the facts set forth the 
only corporate activity. The principles of this paragraph (c) are 
illustrated by the following examples.

     (i) Example 1: Transfer before last day of acquiring 
corporation's taxable year--(A) Facts. On October 31, 2019, X 
transferred all of its assets to Y in a statutory merger to which 
section 361 applies. For the 2018 taxable year, X had $400x of 
disallowed business interest expense, and Y had $0 of disallowed 
business interest expense. For the taxable year ending October 31, 
2019, X had an additional $350x of disallowed business interest 
expense (X did not deduct any of its 2018 carryforwards in its 2019 
taxable year). For the taxable year ending December 31, 2019, Y had 
business interest expense of $100x, business interest income of 
$200x, and adjusted taxable income (ATI) of $1,000x. Y's section 
163(j) limitation for the 2019 taxable year was $500x ($200x + (30 
percent x $1,000x) = $500x).
    (B) Analysis. Pursuant to Sec.  1.163(j)-5(b)(2), Y deducts its 
$100x of current-year business interest expense (as defined in Sec.  
1.163(j)-5(a)(2)(i)) before any disallowed business interest expense 
carryforwards (including X's carryforwards) from a prior taxable 
year are deducted. The aggregate disallowed business interest 
expense of X carried forward under section 381(c)(20) to Y's taxable 
year ending December 31, 2019, is $750x. However, pursuant to 
paragraph (c)(2) of this section, for Y's first taxable year ending 
after the date of distribution or transfer, the maximum amount of 
X's disallowed business interest expense carryforwards that Y can 
deduct is equal to the post-acquisition portion of Y's section 
163(j) limitation. Pursuant to paragraph (c)(4) of this section, the 
post-acquisition portion of Y's section 163(j) limitation means Y's 
section 163(j) limitation times the ratio of the number of days in 
the taxable year after the date of distribution or transfer to the 
total number of days in that year. Therefore, only $84x of the 
aggregate amount ($500x x (61/365) = $84x) may be deducted by Y in 
that year, and the remaining $666x ($750x - $84x = $666x) is carried 
forward to the succeeding taxable year.
    (C) Transfer on last day of acquiring corporation's taxable 
year. The facts are the same as in Example 1 in paragraph 
(c)(5)(i)(A) of this section, except that X's transfer of its assets 
to Y occurred on December 31, 2019. For the taxable year ending 
December 31, 2019, X had an additional $350x of disallowed business 
interest expense (X did not deduct any of its 2018 carryforwards in 
its 2019 taxable year). For the taxable year ending December 31, 
2020, Y had business interest expense of $100x, business interest 
income of $200x, and ATI of $1,000x. Y's section 163(j) limitation 
for the 2020 taxable year was $500x ($200x + (30 percent x $1,000x) 
= $500x). The aggregate disallowed business interest expense of X 
carried under section 381(c)(20) to Y's taxable year ending December 
31, 2020, is $750x. Paragraph (c)(2) of this section does not limit 
the amount of X's disallowed business interest expense carryforwards 
that may be deducted by Y in the 2020 taxable year. Since the amount 
of Y's section 163(j) limit for the 2020 taxable year was $500x, Y 
may deduct the full amount ($100x) of its own business interest 
expense for the 2020 taxable year, along with $400x of X's 
disallowed business interest expense carryforwards.
     (ii) Example 2: Multiple transferors on same date--(A) Facts. 
On October 31, 2019, X and Y transferred all of their assets to Z in 
statutory mergers to which section 361 applies. For the 2018 taxable 
year, X had $300x of disallowed business interest expense, Y had 
$200x, and Z had $0. For the taxable year ending October 31, 2019, 
each of X and Y had an additional $125x of disallowed business 
interest expense (neither X nor Y deducted any of its 2018 
carryforwards in 2019). For the taxable year ending December 31, 
2019, Z had business interest expense of $100x, business interest 
income of $200x, and ATI of $1,000x. Z's section 163(j) limitation 
for the 2019 taxable year was $500x ($200x + (30 percent x $1,000x) 
= $500x).

[[Page 67601]]

    (B) Analysis. The aggregate disallowed business interest expense 
of X and Y carried under section 381(c)(20) to Z's taxable year 
ending December 31, 2019, is $750x. However, pursuant to paragraph 
(c)(2) of this section, only $84x of the aggregate amount ($500x x 
(61/365) = $84x) may be deducted by Z in that year. Moreover, under 
paragraph (b)(2) of this section, this amount only may be deducted 
by Z in that year after Z has deducted its $100 of current-year 
business interest expense (as defined in Sec.  1.163(j)-5(a)(2)(i)).

    (d) Applicability date. This section applies to taxable years 
ending after the date the Treasury decision adopting these regulations 
as final regulations is published in the Federal Register. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of this section, the 
section 163(j) regulations (within the meaning of Sec.  1.163(j)-
1(b)(32)), and if applicable, Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 
1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 
1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate 
the rules of Sec. Sec.  1.382-6 and 1.383-1), and 1.1504-4 to those 
taxable years.
0
Par. 6. Section 1.382-1 is amended by:
0
1. Adding entries for Sec.  1.382-2(a)(7) and (8);
0
2. Revising the entry for Sec.  1.382-2(b)(3);
0
3. Adding entries for Sec.  1.382-6(b)(4), (b)(4)(i), and (b)(4)(ii);
0
4. Revising the entry for Sec.  1.382-6(h); and
0
5. Adding entries for Sec.  1.382-6(h)(1) and (2).
    The additions and revisions read as follows:


Sec.  1.382-1  Table of contents.

* * * * *

Sec.  1.382-2 General rules for ownership change.

    (a) * * *
    (7) Section 382 disallowed business interest carryforward.
    (8) Testing period.
    (b) * * *
    (3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv), 
and (v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8) of 
this section.
* * * * *

Sec.  1.382-6 Allocation of income and loss to periods before and after 
the change date for purposes of section 382.

* * * * *
    (b) * * *
    (4) Allocation of business interest expense.
    (i) In general.
    (ii) Example.
* * * * *
    (h) Applicability date.
    (1) In general.
    (2) Paragraphs (b)(1) and (4) of this section.
* * * * *
0
Par. 7. Section 1.382-2 is amended by:
0
1. Revising paragraph (a)(1)(i)(A);
0
2. Removing ``, or'' and adding ``; or'' in its place at the end of 
paragraph (a)(1)(i)(B);
0
3. Revising paragraphs (a)(1)(ii) introductory text and (a)(1)(ii)(A);
0
4. Removing ``, and'' and adding ``; and'' in its place at the end of 
paragraph (a)(1)(ii)(B);
0
5. Removing the last sentence in paragraphs (a)(1)(iv) and (v);
0
6. Removing the commas and adding semicolons in their place at the end 
of paragraphs (a)(2)(i) and (iii);
0
7. Removing the period and adding a semicolon in its place at the end 
of paragraph (a)(2)(ii);
0
8. Removing ``, and'' and adding a semicolon in its place at the end of 
paragraph (a)(2)(iv);
0
9. Removing ``1.383-1T(c)(3).'' and adding ``Sec.  1.383-1T(c)(3); 
and'' in its place in paragraph (a)(2)(v);
0
10. Adding paragraph (a)(2)(vi);
0
11. Removing the last sentence in paragraphs (a)(3)(i), (a)(4)(i), and 
(a)(5) and (6);
0
12. Adding paragraphs (a)(7) and (8); and
0
13. Revising paragraph (b)(3).
    The revisions and additions read as follows:


Sec.  1.382-2  General rules for ownership change.

    (a) * * *
    (1) * * *
    (i) * * *
    (A) Is entitled to use a net operating loss carryforward, a capital 
loss carryover, a carryover of excess foreign taxes under section 
904(c), a carryforward of a general business credit under section 39, a 
carryover of a minimum tax credit under section 53, or a section 382 
disallowed business interest carryforward described in paragraph (a)(7) 
of this section;
* * * * *
    (ii) Distributor or transferor loss corporation in a transaction 
under section 381. Notwithstanding that a loss corporation ceases to 
exist under state law, if its disallowed business interest expense 
carryforwards, net operating loss carryforwards, excess foreign taxes, 
or other items described in section 381(c) are succeeded to and taken 
into account by an acquiring corporation in a transaction described in 
section 381(a), such loss corporation shall be treated as continuing in 
existence until--
    (A) Any pre-change losses (excluding pre-change credits described 
in Sec.  1.383-1(c)(3)), determined as if the date of such transaction 
were the change date, are fully utilized or expire under section 
163(j), 172, or 1212;
* * * * *
    (2) * * *
    (vi) Any section 382 disallowed business interest carryforward.
* * * * *
    (7) Section 382 disallowed business interest carryforward. The term 
section 382 disallowed business interest carryforward includes the 
following items:
    (i) The loss corporation's disallowed business interest expense 
carryforwards, as defined in Sec.  1.163(j)-1(b)(9), including 
disallowed disqualified interest, within the meaning of Sec.  1.163(j)-
1(b)(10), as of the ownership change.
    (ii) The carryforward of the loss corporation's disallowed business 
interest expense (within the meaning of Sec.  1.163(j)-1(b)(8)) paid or 
accrued (without regard to section 163(j)) in the pre-change period 
(within the meaning of Sec.  1.382-6(g)(2)) in the year of the testing 
date, determined by allocating an equal portion of the disallowed 
business interest expense paid or accrued (without regard to section 
163(j)) in the year of the testing date to each day in that year, 
regardless of whether the loss corporation has made a closing-of-the-
books election under Sec.  1.382-6(b)(2).
    (8) Testing period. Notwithstanding the temporal limitations 
provided in Sec.  1.382-2T(d)(3)(i), the testing period for a loss 
corporation can begin as early as the first day of the first taxable 
year from which there is a section 382 disallowed business interest 
carryforward to the first taxable year ending after the testing date.
    (b) * * *
    (3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv), 
and (v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8) of 
this section. The rules provided in paragraphs (a)(1)(i)(A), 
(a)(1)(ii), (iv), and (v), (a)(2)(iv) through (vi), (a)(3)(i), and 
(a)(4) through (8) of this section apply to testing dates occurring on 
or after the date the Treasury decision adopting these regulations as 
final regulations is published in the Federal Register. For

[[Page 67602]]

loss corporations that have testing dates occurring before the date the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register, see Sec.  1.382-2 as contained in 26 
CFR part 1, revised April 1, 2018. However, taxpayers and their related 
parties, within the meaning of sections 267(b) and 707(b)(1), may apply 
the rules of this section to testing dates occurring during a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of this section, the 
section 163(j) regulations (within the meaning of Sec.  1.163(j)-
1(b)(32)), Sec. Sec.  1.382-5, 1.382-6, and 1.383-1, and if applicable, 
Sec. Sec.  1.263A-9, 1.381(c)(20-1, 1.469-9, 1.882-5, 1.1502-13, 
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec. Sec.  1.382-2, 1.382-5, 1.382-
6, and 1.383-1), and 1.1504-4 to taxable years beginning after December 
31, 2017.
0
Par. 8. Section 1.382-5 is amended by revising the first and second 
sentences of paragraph (d)(1) and by adding three sentences to the end 
of paragraph (f) to read as follows:


Sec.  1.382-5  Section 382 limitation.

* * * * *
    (d) * * *
    (1) * * * If a loss corporation has two (or more) ownership 
changes, any losses or section 382 disallowed business interest 
carryforwards (within the meaning of Sec.  1.382-2(a)(7)) attributable 
to the period preceding the earlier ownership change are treated as 
pre-change losses with respect to both ownership changes. Thus, the 
later ownership change may result in a lesser (but never in a greater) 
section 382 limitation with respect to such pre-change losses. * * *
* * * * *
    (f) * * * Paragraph (d)(1) of this section applies with respect to 
an ownership change occurring on or after the date the Treasury 
decision adopting these regulations as final regulations is published 
in the Federal Register. For loss corporations that have undergone an 
ownership change before or after the date the Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register, see Sec.  1.382-5 as contained in 26 CFR part 1, 
revised April 1, 2018. However, taxpayers and their related parties, 
within the meaning of sections 267(b) and 707(b)(1), may apply the 
rules of this section to testing dates occurring during a taxable year 
beginning after December 31, 2017, so long as the taxpayers and their 
related parties consistently apply the rules of this section, the 
section 163(j) regulations (within the meaning of Sec.  1.163(j)-
1(b)(32)), Sec. Sec.  1.382-2, 1.382-6, and 1.383-1, and if applicable, 
Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.882-5, 1.1502-13, 
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec. Sec.  1.382-2, 1.382-5, 1.382-
6, and 1.383-1), and 1.1504-4 to taxable years beginning after December 
31, 2017.
0
Par. 9. Section 1.382-6 is amended by:
0
1. Removing ``Subject to paragraphs (b)(3)(ii) and (d)'' in the first 
sentence of paragraph (b)(1) and adding ``Subject to paragraphs 
(b)(3)(ii), (b)(4), and (d)'' in its place;
0
2. Adding paragraph (b)(4); and
0
3. Revising paragraph (h).
    The addition and revision read as follows:


Sec.  1.382-6  Allocation of income and loss to periods before and 
after the change date for purposes of section 382.

* * * * *
    (b) * * *
    (4) Allocation of business interest expense--(i) In general. 
Regardless of whether a loss corporation has made a closing-of-the-
books election pursuant to paragraph (b) of this section, for purposes 
of calculating the taxable income of a loss corporation attributable to 
the pre-change period, the amount of the loss corporation's deduction 
for current-year business interest expense, within the meaning of Sec.  
1.163(j)-5(a)(2)(i), is calculated based on a single tax year and is 
allocated between the pre-change period and the post-change period by 
ratably allocating an equal portion to each day in the year.
    (ii) Example--(A) Facts. X is a calendar-year C corporation that is 
not a member of a consolidated group. On May 26, 2019, X is acquired by 
Z (an unrelated third-party) in a transaction that qualifies as an 
ownership change under section 382(g). For calendar year 2019, X has 
paid or accrued $100x of current-year business interest expense (within 
the meaning of Sec.  1.163(j)-5(a)(2)(i)) and has an $81x section 
163(j) limitation (within the meaning of Sec.  1.163(j)-1(b)(31)).
    (B) Analysis. Pursuant to paragraph (b)(4)(i) of this section, 
regardless of whether X has made a closing-of-the-books election 
pursuant to paragraph (b) of this section, X's business interest 
expense deduction is ratably allocated between the pre-change and post-
change periods. For calendar year 2019, X may deduct $81x of business 
interest expense (see Sec.  1.163(j)-2(b)), of which $32.4x ($81x x 
(146 days/365 days) = $32.4x) is allocable to the pre-change period. 
The remaining $19x of interest that was paid or accrued in calendar 
year 2019 is disallowed business interest expense, of which $7.6x ($19x 
x (146 days/365 days) = $7.6x) is allocable to the pre-change period. 
The $7.6x of disallowed business interest expense is treated as a 
section 382 disallowed business interest carryforward (see Sec.  1.382-
2(a)(7)), and thus is a pre-change loss within the meaning of Sec.  
1.382-2(a)(2).
* * * * *
    (h) Applicability date--(1) In general. This section applies to 
ownership changes occurring on or after June 22, 1994.
    (2) Paragraphs (b)(1) and (4) of this section. Paragraphs (b)(1) 
and (4) of this section apply with respect to an ownership change 
occurring during a taxable year ending after the date the Treasury 
decision adopting these regulations as final regulations is published 
in the Federal Register. For ownership changes occurring during a 
taxable year ending before the date the Treasury decision adopting 
these regulations is published in the Federal Register, see Sec.  
1.382-6 as contained in 26 CFR part 1, revised April 1, 2018. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may apply the rules of this section to testing 
dates occurring during a taxable year beginning after December 31, 
2017, so long as the taxpayers and their related parties consistently 
apply the rules of this section, and the section 163(j) regulations 
(within the meaning of Sec.  1.163(j)-1(b)(32)) and Sec.  1.383-1, and 
if applicable, Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.882-5, 
1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 
(to the extent they effectuate the rules of Sec. Sec.  1.382-6 and 
1.383-1), and 1.1504-4 to taxable years beginning after December 31, 
2017.
0
Par. 10. Section 1.383-0 is amended by revising paragraph (a) to read 
as follows:


Sec.  1.383-0  Effective date.

    (a) The regulations under section 383 (other than the regulations 
described in paragraph (b) of this section) reflect the amendments made 
to sections 382 and 383 by the Tax Reform Act of 1986 and the 
amendments made to section 382 by the Tax Cuts and Jobs Act of 2017. 
See Sec.  1.383-1(j) for effective date rules.
* * * * *
0
Par. 11. Section 1.383-1 is amended by:
0
1. In paragraph (a):

[[Page 67603]]

0
a. Adding entries for paragraphs (d)(1)(i) and (ii);
0
b. Revising the entries for paragraphs (e)(3) and (j);
0
c. Adding entries for paragraphs (j)(1) and (2); and
0
d. Removing the entry for paragraph (k).
0
2. Removing ``(iv)'' and adding ``(v)'' in its place in paragraph 
(c)(6)(i)(B).
0
3. Revising paragraphs (c)(6)(ii) and (d)(1).
0
4. Removing the commas and adding semicolons in their place at ends of 
paragraphs (d)(2)(i) through (vi).
0
5. Revising paragraph (d)(2)(iii).
0
6. Redesignating paragraphs (d)(2)(iv) through (vii) as paragraphs 
(d)(2)(v) through (viii), respectively.
0
7. Adding a new paragraph (d)(2)(iv).
0
8. Revising newly redesignated paragraph (d)(2)(v) and paragraph 
(d)(3)(ii).
0
9. Removing ``(iv)'' and adding ``(v)'' in its place in paragraph 
(e)(1).
0
10. In paragraph (e)(2):
0
a. Removing ``sections 11(b)(2) and (15)'' and adding ``section 15'' in 
its place in the fourth sentence; and
0
b. Removing the last two sentences.
0
11. Removing and reserving paragraph (e)(3).
0
12. In paragraph (f):
0
a. Removing Example 4;
0
b. Designating Examples 1 through 3 as paragraphs (f)(1) through (3), 
respectively; and
0
c. Revising newly designated paragraphs (f)(2) and (3).
0
13. In the last sentence of paragraph (g), removing ``(e.g., 0.34 for 
taxable years beginning in 1989)''.
0
14. In paragraph (j):
0
a. Revising the paragraph heading;
0
b. Designating the text of paragraph (j) as paragraph (j)(1) and adding 
a heading to newly designated paragraph (j)(1); and
0
c. Adding paragraph (j)(2).
0
15. Removing paragraph (k).
    The revisions and additions read as follows:


Sec.  1.383-1  Special limitations on certain capital losses and excess 
credits.

    (a) * * *
* * * * *
    (d) * * *
    (1) * * *
    (i) In general.
    (ii) Ordering rule for losses or credits from same taxable year.
* * * * *
    (e) * * *
    (3) [Reserved]
* * * * *
    (j) Applicability date.
    (1) In general.
    (2) Interaction with section 163(j).
* * * * *
    (c) * * *
    (6) * * *
    (ii) Example. L, a new loss corporation, is a calendar-year 
taxpayer. L has an ownership change on December 31, 2019. For 2020, L 
has taxable income (prior to the use of any pre-change losses) of 
$100,000. In addition, L has a section 382 limitation of $25,000, a 
pre-change net operating loss carryover of $12,000, a pre-change 
general business credit carryforward under section 39 of $50,000, and 
no items described in Sec.  1.383-1(d)(2)(i) through (iv). L's section 
383 credit limitation for 2020 is the excess of its regular tax 
liability computed after allowing a $12,000 net operating loss 
deduction (taxable income of $88,000; regular tax liability of 
$18,480), over its regular tax liability computed after allowing an 
additional deduction in the amount of L's section 382 limitation 
remaining after the application of paragraphs (d)(2)(i) through (v) of 
this section, or $13,000 (taxable income of $75,000; regular tax 
liability of $15,750). L's section 383 credit limitation is therefore 
$2,730 ($18,480 minus $15,750).
    (d) * * *
    (1) In general--(i) In general. The amount of taxable income of a 
new loss corporation for any post-change year that may be offset by 
pre-change losses shall not exceed the amount of the section 382 
limitation for the post-change year. The amount of the regular tax 
liability of a new loss corporation for any post-change year that may 
be offset by pre-change credits shall not exceed the amount of the 
section 383 credit limitation for the post-change year.
    (ii) Ordering rule for losses or credits from same taxable year. A 
loss corporation's taxable income is offset first by losses subject to 
a section 382 limitation, to the extent the section 382 limitation for 
that taxable year has not yet been absorbed, before being offset by 
losses of the same type from the same taxable year that are not subject 
to a section 382 limitation. For example, assume that Corporation X has 
an ownership change in Year 1 and carries over disallowed business 
interest expense within the meaning of Sec.  1.163(j)-1(b)(8), some of 
which constitutes a section 382 disallowed business interest 
carryforward, from Year 1 to Year 2. To the extent of its section 
163(j) limitation, within the meaning of Sec.  1.163(j)-1(b)(31), and 
its remaining section 382 limitation, Corporation X offsets its Year 2 
income with the section 382 disallowed business interest carryforward 
before using any of the disallowed business interest expense that is 
not a section 382 disallowed business interest carryforward. Similar 
principles apply to the use of tax credits.
    (2) * * *
    (iii) Pre-change losses that are described in Sec.  1.382-
2(a)(2)(iii), other than losses that are pre-change capital losses, 
that are recognized and are subject to the section 382 limitation in 
such post-change year;
    (iv)(A) With respect to an ownership change date occurring prior to 
the date the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register, but during the 
taxable year which includes the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register, the pre-change loss described in section 382(d)(3);
    (B) With respect to an ownership change date occurring on or after 
the date the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register, section 382 
disallowed business interest carryforwards (within the meaning of Sec.  
1.382-2(a)(7));
    (v) Pre-change losses not described in paragraphs (d)(2)(i) through 
(iv) of this section;
* * * * *
    (3) * * *
    (ii) Example. L, a calendar-year taxpayer, has an ownership change 
on December 31, 2019. For 2020, L has taxable income of $300,000 and a 
regular tax liability of $63,000. L has no pre-change losses, but it 
has a business credit carryforward from 2018 of $25,000. L has a 
section 382 limitation for 2020 of $50,000. L's section 383 credit 
limitation is $10,500, an amount equal to the excess of L's regular tax 
liability ($63,000) over its regular tax liability calculated by 
allowing an additional deduction of $50,000 ($52,500). Pursuant to the 
limitation contained in section 38(c), however, L is entitled to use 
only $9,500 (($63,000 - $25,000) x 25 percent) of its business credit 
carryforward in 2020. The unabsorbed portion of L's section 382 
limitation (computed pursuant to paragraph (e) of this section) is 
carried forward under section 382(b)(2). The unused portion of L's 
business credit carryforward, $1,000, is carried forward to the extent 
provided in section 39.
* * * * *
    (f) * * *

     (2) Example 2--(i) Facts. L, a calendar-year taxpayer, has an 
ownership change on December 31, 2019. For 2020, L has $750,000

[[Page 67604]]

of ordinary taxable income (before the application of carryovers) 
and a section 382 limitation of $1,500,000. L's only carryovers are 
from pre-2019 taxable years and consist of a $500,000 net operating 
loss (NOL) carryover, and a $200,000 foreign tax credit carryover 
(all of which may be used under the section 904 limitation). The NOL 
carryover is a pre-change loss, and the foreign tax credit carryover 
is a pre-change credit. L has no other pre-change losses or credits 
that can be used in 2020.
    (ii) Analysis. The following computation illustrates the 
application of this section for 2020:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
1. Taxable income before carryovers.....................        $750,000
2. Pre-change NOL carryover.............................         500,000
3. Section 382 limitation...............................       1,500,000
4. Amount of pre-change NOL carryover that can be used           500,000
 (least of line 1, 2, or 3).............................
5. Taxable income (line 1 minus line 4).................         250,000
6. Section 382 limitation remaining (line 3 minus line         1,000,000
 4).....................................................
7. Pre-change credit carryover..........................         200,000
8. Regular tax liability (line 5 x section 11 rates)....          52,500
9. Modified tax liability (line 5 minus line 6 (but not                0
 less than zero) x section 11 rates)....................
10. Section 383 credit limitation (line 8 minus line 9).          52,500
11. Amount of pre-change credits that can be used in              52,500
 2020 (lesser of line 7 or line 10).....................
12. Amount of pre-change credits to be carried over to           147,500
 2021 under section 904(c) (line 7 minus line 11).......
13. Section 383 credit reduction amount: $52,500/0.21...         250,000
14. Section 382 limitation to be carried to 2021 under           750,000
 section 382(b)(2) (line 6 minus line 13)...............
------------------------------------------------------------------------

      (3) Example 3--(i) Facts. L, a calendar-year taxpayer, has an 
ownership change on December 31, 2019. L has $80,000 of ordinary 
taxable income (before the application of carryovers) and a section 
382 limitation of $25,000 for 2020, a post-change year. L's only 
carryover is from a pre-2019 taxable year and is a general business 
credit carryforward under section 39 in the amount of $10,000 (no 
portion of which is attributable to the investment tax credit under 
section 46). The general business credit carryforward is a pre-
change credit. L has no other credits which can be used in 2020.
    (ii) Analysis. The following computation illustrates the 
application of this section:

------------------------------------------------------------------------
 
------------------------------------------------------------------------
1. Taxable income before carryovers.....................         $80,000
2. Section 382 limitation...............................          25,000
3. Pre-change credit carryover..........................          10,000
4. Regular tax liability (line 1 x section 11 rates)....          16,800
5. Modified tax liability ((line 1 minus line 2) x                11,550
 section 11 rates)......................................
6. Section 383 credit limitation (line 4 minus line 5)..           5,250
7. Amount of pre-change credits that can be used (lesser           5,250
 of line 3 or line 6)...................................
8. Amount of pre-change credits to be carried over to              4,750
 2021 under sections 39 and 382(l)(2) (line 3 minus line
 7).....................................................
9. Regular tax payable (line 4 minus line 7)............          11,550
10. Section 383 credit reduction amount: $5,250/0.21....          25,000
11. Section 382 limitation to be carried to 2021 under                 0
 section 382(b)(2) (line 2 minus line 10)...............
------------------------------------------------------------------------

* * * * *
    (j) Applicability date--(1) In general. * * *
    (2) Interaction with section 163(j). Paragraphs (c)(6)(i)(B) and 
(c)(6)(ii), (d)(1), (d)(2)(iii) through (viii), (d)(3)(ii), (e)(1) 
through (3), (f), and (g) of this section apply with respect to 
ownership changes occurring during a taxable year ending after the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register. For loss corporations that have 
undergone an ownership change during a taxable year ending before the 
date the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register, see Sec.  1.383-1 as 
contained in 26 CFR part 1, revised April 1, 2018. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may apply the rules of this section to an ownership change 
occurring during a taxable year beginning after December 31, 2017, so 
long as the taxpayers and their related parties consistently apply 
either the rules of this section, except paragraph (d)(2)(iv)(B) of 
this section, the section 163(j) regulations, within the meaning of 
Sec.  1.163(j)-1(b)(32), and Sec.  1.382-6, and if applicable, 
Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.882-5, 1.1502-13, 
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec. Sec.  1.382-6 and 1.383-1), 
and 1.1504-4; or the rules of this section (except paragraph 
(d)(2)(iv)(A) of this section), the section 163(j) regulations, within 
the meaning of Sec.  1.163(j)-1(b)(32), and Sec. Sec.  1.382-2, 1.382-
5, 1.382-6, and 1.383-1, and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 
1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate 
the rules of Sec. Sec.  1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 
1.1504-4, to those ownership changes.
0
Par. 12. Section 1.446-3 is amended by revising paragraphs (g)(4) and 
(j)(2) to read as follows:


Sec.  1.446-3  Notional principal contracts.

* * * * *
    (g) * * *
    (4) Swaps with significant nonperiodic payments. For swaps with 
significant nonperiodic payments, see Sec.  1.163(j)-1(b)(20)(ii).
* * * * *
    (j) * * *
    (2) The rules provided in paragraph (g)(4) of this section apply to 
notional principal contracts entered into on or after the date of 
publication of a Treasury decision adopting these rules as final 
regulations in the Federal Register. Taxpayers may apply the rules 
provided in paragraph (g)(4) of this section to notional principal 
contracts entered into before the date of publication of a Treasury 
decision adopting these rules as final regulations in the Federal 
Register.
0
Par. 13. Section 1.469-9 is amended by revising paragraph (b)(2) to 
read as follows:


Sec.  1.469-9  Rules for certain rental real estate activities.

* * * * *
    (b) * * *
    (2) Real property trade or business. The following terms have the 
following meanings in determining whether a trade or business is a real 
property trade or business for purposes of section 469(c)(7)(C) and 
this section.
    (i) Real property--(A) In general. The term real property includes 
land, buildings, and other inherently permanent structures that are 
permanently affixed to land. Any interest in real property, including 
fee ownership, co-ownership, a leasehold, an option, or a similar 
interest is real property under this section. Tenant improvements to 
land, buildings, or other structures that are inherently permanent or 
otherwise classified as real property within the meaning of this 
section are real property for purposes of section 469(c)(7)(C). 
However, property produced for sale that is not real property in the 
hands of the producing taxpayer or a related person, but that may be 
incorporated into real property by an unrelated person, is not treated 
as real property of the producing taxpayer for purposes of section 
469(c)(7)(C) and this section (for example, bricks, nails, paint, and 
windowpanes).

[[Page 67605]]

    (B) Land. The term land includes water and air space superjacent to 
land and natural products and deposits that are unsevered from the 
land. Natural products and deposits, such as plants, crops, trees, 
water, ores, and minerals, cease to be real property when they are 
harvested, severed, extracted, or removed from the land. Accordingly, 
any trade or business that involves the cultivation and harvesting of 
plants, crops, or trees, or severing, extracting, or removing natural 
products or deposits from land is not a real property trade or business 
for purposes of section 469(c)(7)(C) and this section. The storage or 
maintenance of severed or extracted natural products or deposits, such 
as plants, crops, trees, water, ores, and minerals, in or upon real 
property does not cause the stored property to be recharacterized as 
real property, and any trade or business relating to or involving such 
storage or maintenance of severed or extracted natural products or 
deposits is not a real property trade or business, even though such 
storage or maintenance otherwise may occur upon or within real 
property.
    (C) Inherently permanent structure. The term inherently permanent 
structure means any permanently affixed building or other permanently 
affixed structure. If the affixation is reasonably expected to last 
indefinitely, based on all the facts and circumstances, the affixation 
is considered permanent. However, an asset that serves an active 
function, such as an item of machinery or equipment (for example, HVAC 
system, elevator or escalator), is not a building or other inherently 
permanent structure, and therefore is not real property for purposes of 
section 469(c)(7)(C) and this section, even if such item of machinery 
or equipment is permanently affixed to or becomes incorporated within a 
building or other inherently permanent structure. Accordingly, a trade 
or business that involves the manufacture, installation, operation, 
maintenance, or repair of any asset that serves an active function will 
not be a real property trade or business, or a unit or component of 
another real property trade or business, for purposes of section 
469(c)(7)(C) and this section.
    (D) Building--(1) In general. A building encloses a space within 
its walls and is generally covered by a roof or other external upper 
covering that protects the walls and inner space from the elements.
    (2) Types of buildings. Buildings include the following assets if 
permanently affixed to land: Houses; townhouses; apartments; 
condominiums; hotels; motels; stadiums; arenas; shopping malls; factory 
and office buildings; warehouses; barns; enclosed garages; enclosed 
transportation stations and terminals; and stores.
    (E) Other inherently permanent structures--(1) In general. Other 
inherently permanent structures include the following assets if 
permanently affixed to land: Parking facilities; bridges; tunnels; 
roadbeds; railroad tracks; pipelines; storage structures such as silos 
and oil and gas storage tanks; and stationary wharves and docks.
    (2) Facts and circumstances determination. The determination of 
whether an asset is an inherently permanent structure is based on all 
the facts and circumstances. In particular, the following factors must 
be taken into account:
    (i) The manner in which the asset is affixed to land and whether 
such manner of affixation allows the asset to be easily removed from 
the land;
    (ii) Whether the asset is designed to be removed or to remain in 
place indefinitely on the land;
    (iii) The damage that removal of the asset would cause to the asset 
itself or to the land to which it is affixed;
    (iv) Any circumstances that suggest the expected period of 
affixation is not indefinite (for example, a lease that requires or 
permits removal of the asset from the land upon the expiration of the 
lease); and
    (v) The time and expense required to move the asset from the land.
    (ii) Other definitions--(A) through (G) [Reserved]
    (H) Real property operation. The term real property operation means 
handling, by a direct or indirect owner of the real property, the day-
to-day operations of a trade or business, within the meaning of 
paragraph (b)(1) of this section, relating to the maintenance and 
occupancy of the real property that affect the availability and 
functionality of that real property used, or held out for use, by 
customers where payments received from customers are principally for 
the customers' use of the real property. The principal purpose of such 
business operations must be the provision of the use of the real 
property, or physical space accorded by or within the real property, to 
one or more customers, and not the provision of other significant or 
extraordinary personal services, within the meaning of Sec.  1.469-
1T(e)(3)(iv) and (v), to customers in conjunction with the customers' 
incidental use of the real property or physical space. If the real 
property or physical space is provided to a customer to be used to 
carry on the customer's trade or business, the principal purpose of the 
business operations must be to provide the customer with exclusive use 
of the real property or physical space in furtherance of the customer's 
trade or business, and not to provide other significant or 
extraordinary personal services to the customer in addition to or in 
conjunction with the use of the real property or physical space, 
regardless of whether the customer pays for the services separately. 
However, other incidental personal services may be provided to the 
customer in conjunction with the use of real property or physical 
space, as long as such services are insubstantial in relation to the 
customer's use of the real property or physical space and the receipt 
of such services is not a significant factor in the customer's decision 
to use the real property or physical space.
    (I) Real property management. The term real property management 
means handling, by a professional manager, the day-to-day operations of 
a trade or business, within the meaning of paragraph (b)(1) of this 
section, relating to the maintenance and occupancy of real property 
that affect the availability and functionality of that property used, 
or held out for use, by customers where payments received from 
customers are principally for the customers' use of the real property. 
The principal purpose of such business operations must be the provision 
of the use of the real property, or physical space accorded by or 
within the real property, to one or more customers, and not the 
provision of other significant or extraordinary personal services, 
within the meaning of Sec.  1.469-1T(e)(3)(iv) and (v), to customers in 
conjunction with the customers' incidental use of the real property or 
physical space. If the real property or physical space is provided to a 
customer to be used to carry on the customer's trade or business, the 
principal purpose of the business operations must be to provide the 
customer with exclusive use of the real property or physical space in 
furtherance of the customer's trade or business, and not to provide 
other significant or extraordinary personal services to the customer in 
addition to or in conjunction with the use of the real property or 
physical space, regardless of whether the customer pays for the 
services separately. However, other incidental personal services may be 
provided to the customer in conjunction with the use of real property 
or physical space, as long as such services are insubstantial in 
relation to the customer's use of the real property or physical space 
and the

[[Page 67606]]

receipt of such services is not a significant factor in the customer's 
decision to use the real property or physical space. A professional 
manager is a person responsible, on a full-time basis, for the overall 
management and oversight of the real property or properties and who is 
not a direct or indirect owner of the real property or properties.
    (J) and (K) [Reserved]
    (iii) Examples. The following examples illustrate the operation of 
this paragraph (b)(2):

     (A) Example 1. A owns farmland and uses the land in A's farming 
business to grow and harvest crops of various kinds. As part of this 
farming business, A utilizes a greenhouse that is an inherently 
permanent structure to grow certain crops during the winter months. 
Under the rules of this section, any trade or business that involves 
the cultivation and harvesting of plants, crops, or trees is not a 
real property trade or business for purposes of section 469(c)(7)(C) 
and this section, even though the cultivation and harvesting of 
crops occurs upon or within real property. Accordingly, under these 
facts, A is not engaged in a real property trade or business for 
purposes of section 469(c)(7)(C) and this section.
     (B) Example 2. B is a retired farmer and owns farmland that B 
rents exclusively to C to operate a farm. The arrangement between B 
and C is a trade or business (within the meaning of paragraph (b)(1) 
of this section) where payments by C are principally for C's use of 
B's real property. B also provides certain farm equipment for C's 
use. However, C is solely responsible for the maintenance and repair 
of the farm equipment along with any costs associated with operating 
the equipment. B also occasionally provides oral advice to C 
regarding various aspects of the farm operation, based on B's prior 
experience as a farmer. Other than the provision of this occasional 
advice, B does not provide any significant or extraordinary personal 
services to C in connection with the rental of the farmland to C. 
Under these facts, B is engaged in a real property trade or business 
(which does not include the use or deemed rental of any farm 
equipment) for purposes of section 469(c)(7)(C) and this section, 
and B's oral advice is an incidental personal service that B 
provides in conjunction with C's use of the real property. 
Nevertheless, under these facts, C is not engaged in a real property 
trade or business for purposes of section 469(c)(7)(C) and this 
section because C is engaged in the business of farming.
     (C) Example 3. D owns a building in which D operates a 
restaurant and bar. Even though D provides customers with use of the 
physical space inside the building, D is not engaged in a trade or 
business where payments by customers are principally for the use of 
real property or physical space. Instead, the payments by D's 
customers are principally for the receipt of significant or 
extraordinary personal services (within the meaning of Sec.  1.469-
1T(e)(3)(iv) and (v)), mainly food and beverage preparation and 
presentation services, and the use of the physical space by 
customers is incidental to the receipt of these personal services. 
Under the rules of this section, any trade or business that involves 
the provision of significant or extraordinary personal services to 
customers in conjunction with the customers' incidental use of real 
property or physical space is not a real property trade or business, 
even though the business operations occur upon or within real 
property. Accordingly, under these facts, D is not engaged in a real 
property trade or business for purposes of section 469(c)(7)(C) and 
this section.
     (D) Example 4. E owns a majority interest in an S corporation, 
X, that is engaged in the trade or business of manufacturing 
industrial cooling systems for installation in commercial buildings 
and for other uses. E also owns a majority interest in an S 
corporation, Y, that purchases the industrial cooling systems from X 
and that installs, maintains, and repairs those systems in both 
existing commercial buildings and commercial buildings under 
construction. Under the rules of this section, any trade or business 
that involves the manufacture, installation, operation, maintenance, 
or repair of any machinery or equipment that serves an active 
function will not be a real property trade or business (or a unit or 
component of another real property trade or business) for purposes 
of section 469(c)(7)(C) and this section, even though the machinery 
or equipment will be permanently affixed to real property once it is 
installed. In this case, the industrial cooling systems are 
machinery or equipment that serves an active function. Accordingly, 
under these facts, E, X and Y will not be treated as engaged in one 
or more real property trades or businesses for purposes of section 
469(c)(7)(C) and this section.
     (E) Example 5. (1) F owns an interest in P, a limited 
partnership. P owns and operates a luxury hotel. In addition to 
providing rooms and suites for use by customers, the hotel offers 
many additional amenities such as in-room food and beverage service, 
maid and linen service, parking valet service, concierge service, 
front desk and bellhop service, dry cleaning and laundry service, 
and in-room barber and hairdresser service. P contracted with M to 
provide maid and janitorial services to P's hotel. M is an S 
corporation principally engaged in the trade or business of 
providing maid and janitorial services to various types of 
businesses, including hotels. G is a professional manager employed 
by M who handles the day-to-day business operations relating to M's 
provision of maid and janitorial services to M's various customers, 
including P.
    (2) Even though the personal services that P provides to the 
customers of its hotel are significant personal services within the 
meaning of Sec.  1.469-1T(e)(3)(iv), the principal purpose of P's 
hotel business operations is the provision of use of the hotel's 
rooms and suites to customers, and not the provision of the 
significant personal services to P's customers in conjunction with 
the customers' incidental use of those rooms or suites. The 
provision of these significant personal services by P to P's 
customers is incidental to the customers' use of the hotel's real 
property. Accordingly, under these facts, F and P are treated as 
engaged in a real property trade or business for purposes of section 
469(c)(7)(C) and this section.
    (3) With respect to the maid and janitorial services provided by 
M, M's operations affect the availability and functionality of real 
property used, or held out for use, by customers in a trade or 
business where payments by customers are principally for the use of 
real property (in this case, P's hotel). However, M does not operate 
or manage real property. Instead, M is engaged in a trade or 
business of providing maid and janitorial services to customers, 
such as P, that are engaged in real property trades or businesses. 
Thus, M's business operations are merely ancillary to real property 
trades or businesses. Therefore, M is not engaged in real property 
operations or management as defined in this section. Accordingly, 
under these facts, M is not engaged in a real property trade or 
business within the meaning of section 469(c)(7)(C) and this 
section.
    (4) With respect to the day-to-day business operations that G 
handles as a professional manager of M, the business operations that 
G manages is not the provision of use of P's hotel rooms and suites 
to customers. G does not operate or manage real property. Instead, G 
manages the provision of maid and janitorial services to customers, 
including P's hotel. Therefore, G is not engaged in real property 
management as defined in this section. Accordingly, under these 
facts, G is not engaged in a real property trade or business within 
the meaning of section 469(c)(7)(C) and this section.

* * * * *
0
Par. 14. Section 1.469-11 is amended by:
0
1. Removing the period at the end of paragraph (a)(1) and adding a 
semicolon in its place;
0
2. Revising paragraph (a)(3);
0
3. Redesignating paragraphs (a)(4) and (5) as paragraphs (a)(5) and 
(6), respectively; and
0
4. Adding a new paragraph (a)(4).
    The revision and addition read as follows:


Sec.  1.469-11  Effective date and transition rules.

    (a) * * *
    (3) The rules contained in Sec.  1.469-9, other than paragraph 
(a)(4) of this section, apply for taxable years beginning on or after 
January 1, 1995, and to elections made under Sec.  1.469-9(g) with 
returns filed on or after January 1, 1995, and the rules contained in 
Sec.  1.469-11(a)(4) apply for taxable years beginning on or after the 
date of the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register;
    (4) The rules contained in Sec.  1.469-9(b)(2) apply to taxable 
years beginning after December 31, 2018. Paragraph (b) of this section 
applies to loss corporations that have undergone an

[[Page 67607]]

ownership change during a taxable year ending after the date of the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register. However, taxpayers and their related 
parties, within the meaning of sections 267(b) and 707(b)(1), may rely 
on the rules of this section if applied consistently by the taxpayers 
and their related parties, until the date the Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register;
* * * * *
0
Par. 15. Section 1.860C-2 is amended by revising paragraph (b)(2) to 
read as follows:


Sec.  1.860C-2  Determination of REMIC taxable income or net loss.

* * * * *
    (b) * * *
    (2) Deduction allowable under section 163--(i) A REMIC is allowed a 
deduction, determined without regard to section 163(d), for any 
interest expense accrued during the taxable year.
    (ii) For taxable years beginning after December 31, 2017, a REMIC 
is allowed a deduction, determined without regard to section 163(j), 
for any interest expense accrued during the taxable year.
* * * * *
0
Par. 16. Section 1.882-5 is amended by adding a sentence to the end of 
paragraph (a)(5) to read as follows:


Sec.  1.882-5  Determination of interest deduction.

    (a) * * *
    (5) * * * For rules regarding the coordination of this section and 
section 163(j), see Sec.  1.163(j)-8(e).
* * * * *
0
Par. 17. Section 1.1502-13 is amended by--
0
1. In paragraph (a)(6)(ii)--
0
a. Under the heading ``Matching rule. (Sec.  1.1502-13(c)(7)(ii))'':
0
i. Designating Examples 1 through 17 as entries (A) through (Q).
0
ii. Adding entries (R) and (S).
0
b. Under the heading ``Anti-avoidance rules. (Sec.  1.1502-13(h)(2))'':
0
i. Designating Examples 1 through 5 as entries (i) through (v).
0
ii. Adding an entry (vi).
0
2. In paragraph (c)(7)(ii):
0
a. Designating Examples 1 through 17 as paragraphs (c)(7)(ii)(A) 
through (Q), respectively.
0
b. In newly designated paragraphs (c)(7)(ii)(A) through (Q):
0
i. Redesignating paragraphs (c)(7)(ii)(A)(a) through (i) as paragraphs 
(c)(7)(ii)(A)(1) through (9).
0
ii. Redesignating paragraphs (c)(7)(ii)(B)(a) and (b) as paragraphs 
(c)(7)(ii)(B)(1) and (2).
0
iii. Redesignating paragraphs (c)(7)(ii)(C)(a) through (d) as 
paragraphs (c)(7)(ii)(C)(1) through (4).
0
iv. Redesignating paragraphs (c)(7)(ii)(D)(a) through (e) as paragraphs 
(c)(7)(ii)(D)(1) through (5).
0
v. Redesignating paragraphs (c)(7)(ii)(E)(a) through (f) as paragraphs 
(c)(7)(ii)(E)(1) through (6).
0
vi. Redesignating paragraphs (c)(7)(ii)(F)(a) through (d) as paragraphs 
(c)(7)(ii)(F)(1) through (4).
0
v. Redesignating paragraphs (c)(7)(ii)(G)(a) through (d) as paragraphs 
(c)(7)(ii)(G)(1) through (4).
0
vi. Redesignating paragraphs (c)(7)(ii)(I)(a) through (e) as paragraphs 
(c)(7)(ii)(I)(1) through (5).
0
vii. Redesignating paragraphs (c)(7)(ii)(J)(a) through (d) as 
paragraphs (c)(7)(ii)(J)(1) through (4).
0
viii. Redesignating paragraphs (c)(7)(ii)(K)(a) through (d) as 
paragraphs (c)(7)(ii)(K)(1) through (4).
0
ix. Redesignating paragraphs (c)(7)(ii)(L)(a) and (b) as paragraphs 
(c)(7)(ii)(L)(1) and (2).
0
x. Redesignating paragraphs (c)(7)(ii)(N)(a) through (c) as paragraphs 
(c)(7)(ii)(N)(1) through (3).
0
xi. Redesignating paragraphs (c)(7)(ii)(O)(a) through (d) as paragraphs 
(c)(7)(ii)(O)(1) through (4).
0
xii. Redesignating paragraphs (c)(7)(ii)(P)(a) and (b) as paragraphs 
(c)(7)(ii)(P)(1) and (2).
0
xiii. Redesignating paragraphs (c)(7)(ii)(Q)(a) through (c) as 
paragraphs (c)(7)(Q)(1) through (3).
    c. In the table below, for each newly redesignated paragraph listed 
in the ``Paragraph'' column, remove the text indicated in the 
``Remove'' column and add in its place the text indicated in the 
``Add'' column:

------------------------------------------------------------------------
            Paragraph                   Remove               Add
------------------------------------------------------------------------
(c)(7)(ii)(A)(5).................  paragraph (a)    Example 1 in
                                    of this          paragraph
                                    Example 1.       (c)(7)(ii)(A)(1) of
                                                     this section.
(c)(7)(ii)(A)(5).................  paragraphs (c)   Example 1 in
                                    and (d) of       paragraphs
                                    this Example 1.  (c)(7)(ii)(A)(3)
                                                     and (4) of this
                                                     section.
(c)(7)(ii)(A)(6).................  paragraph (a)    Example 1 in
                                    of this          paragraph
                                    Example 1.       (c)(7)(ii)(A)(1) of
                                                     this section.
(c)(7)(ii)(A)(7).................  paragraph (a)    Example 1 in
                                    of this          paragraph
                                    Example 1.       (c)(7)(ii)(A)(1) of
                                                     this section.
(c)(7)(ii)(A)(8).................  paragraph (a)    Example 1 in
                                    of this          paragraph
                                    Example 1.       (c)(7)(ii)(A)(1) of
                                                     this section.
(c)(7)(ii)(A)(9).................  paragraph (a)    Example 1 in
                                    of this          paragraph
                                    Example 1.       (c)(7)(ii)(A)(1) of
                                                     this section.
(c)(7)(ii)(C)(3).................  paragraph (a)    Example 3 in
                                    of this          paragraph
                                    Example 3.       (c)(7)(ii)(C)(1) of
                                                     this section.
(c)(7)(ii)(C)(4).................  paragraph (c)    Example 3 in
                                    of this          paragraph
                                    Example 3.       (c)(7)(ii)(C)(3) of
                                                     this section.
(c)(7)(ii)(C)(4).................  paragraph (b)    Example 3 in
                                    of this          paragraph
                                    Example 3.       (c)(7)(ii)(C)(2) of
                                                     this section.
(c)(7)(ii)(D)(5).................  paragraph (a)    Example 4 in
                                    of this          paragraph
                                    Example 4.       (c)(7)(ii)(D)(1) of
                                                     this section.
(c)(7)(ii)(D)(5).................  paragraphs (c)   Example 4 in
                                    and (d) of       paragraphs
                                    this Example 4.  (c)(7)(ii)(D)(3)
                                                     and (4) of this
                                                     section.
(c)(7)(ii)(E)(3).................  paragraph (a)    Example 5 in
                                    of this          paragraph
                                    Example 5.       (c)(7)(ii)(E)(1) of
                                                     this section.
(c)(7)(ii)(E)(4).................  paragraph (a)    Example 5 in
                                    of this          paragraph
                                    Example 5.       (c)(7)(ii)(E)(1) of
                                                     this section.
(c)(7)(ii)(E)(5).................  paragraph (a)    Example 5 in
                                    of this          paragraph
                                    Example 5.       (c)(7)(ii)(E)(1) of
                                                     this section.
(c)(7)(ii)(E)(6).................  paragraph (a)    Example 5 in
                                    of this          paragraph
                                    Example 5.       (c)(7)(ii)(E)(1) of
                                                     this section.
(c)(7)(ii)(F)(3).................  paragraph (a)    Example 6 in
                                    of this          paragraph
                                    Example 6.       (c)(7)(ii)(F)(1) of
                                                     this section.
(c)(7)(ii)(F)(4).................  paragraph (a)    Example 6 in
                                    of this          paragraph
                                    Example 6.       (c)(7)(ii)(F)(1) of
                                                     this section.
(c)(7)(ii)(G)(4).................  paragraph (a)    Example 7 in
                                    of this          paragraph
                                    Example 7.       (c)(7)(ii)(G)(1) of
                                                     this section.
(c)(7)(ii)(G)(4).................  paragraph (c)    Example 7 in
                                    of this          paragraph
                                    Example 7.       (c)(7)(ii)(G)(3) of
                                                     this section.
(c)(7)(ii)(I)(3).................  paragraph (a)    Example 9 in
                                    of this          paragraph
                                    Example 9.       (c)(7)(ii)(I)(1) of
                                                     this section.
(c)(7)(ii)(I)(4).................  paragraph (a)    Example 9 in
                                    of this          paragraph
                                    Example 9.       (c)(7)(ii)(I)(1) of
                                                     this section.
(c)(7)(ii)(I)(5).................  paragraph (d)    Example 9 in
                                    of this          paragraph
                                    Example 9.       (c)(7)(ii)(I)(4) of
                                                     this section.
(c)(7)(ii)(J)(3).................  paragraph (a)    Example 10 in
                                    of this          paragraph
                                    Example 10.      (c)(7)(ii)(J)(1) of
                                                     this section.
(c)(7)(ii)(J)(4).................  paragraph (a)    Example 10 in
                                    of this          paragraph
                                    Example 10.      (c)(7)(ii)(J)(1) of
                                                     this section.
(c)(7)(ii)(K)(4).................  paragraph (a)    Example 11 in
                                    of this          paragraph
                                    Example 11.      (c)(7)(ii)(K)(1) of
                                                     this section.
(c)(7)(ii)(N)(2).................  paragraph (a)    Example 14 in
                                    of this          paragraph
                                    Example 14.      (c)(7)(ii)(N)(1) of
                                                     this section.
(c)(7)(ii)(O)(4).................  paragraph (a)    Example 15 in
                                    of this          paragraph
                                    Example 15.      (c)(7)(ii)(O)(1) of
                                                     this section.
(c)(7)(ii)(Q)(1).................  Example 16.....  Example 16 in
                                                     paragraph
                                                     (c)(7)(ii)(P) of
                                                     this section.

[[Page 67608]]

 
(c)(7)(ii)(Q)(2).................  paragraph        Example 2 in
                                    (f)(7),          paragraph (f)(7) of
                                    Example 2 of     this section.
                                    this section.
(c)(7)(iii)(A)...................  Paragraphs       Paragraphs
                                    (c)(6)(ii)(C),   (c)(6)(ii)(C) and
                                    (c)(6)(ii)(D),   (D) of this
                                    and              section, Example 16
                                    (c)(7)(ii),      in paragraph
                                    Examples 16      (c)(7)(ii)(P) of
                                    and 17 of this   this section, and
                                    section.         Example 17 in
                                                     paragraph
                                                     (c)(7)(ii)(Q) of
                                                     this section.
------------------------------------------------------------------------

0
d. Adding paragraphs (c)(7)(ii)(R) and (S).
0
3. In paragraph (h)(2):
0
a. Designating Examples 1 through 5 as paragraphs (h)(2)(i) through 
(v), respectively.
0
b. In newly designated paragraphs (h)(2)(i) through (v):
0
i. Redesignating paragraphs (h)(2)(i)(a) and (b) as paragraphs 
(h)(2)(i)(A) and (B).
0
ii. Redesignating paragraphs (h)(2)(ii)(a) and (b) as paragraphs 
(h)(2)(ii)(A) and (B).
0
iii. Redesignating paragraphs (h)(2)(iii)(a) and (b) as paragraphs 
(h)(2)(iii)(A) and (B).
0
iv. Redesignating paragraphs (h)(2)(iv)(a) and (b) as paragraphs 
(h)(2)(iv)(A) and (B).
0
v. Redesiganting paragraphs (h)(2)(v)(a) and (b) as paragraphs 
(h)(2)(iv)(A) and (B).
0
c. Adding paragraph (h)(2)(vi).
    The additions read as follows:


Sec.  1.1502-13  Intercompany transactions.

    (a) * * *
    (6) * * *
    (ii) * * *
    Matching rule. (Sec.  1.1502-13(c)(7)(ii))
* * * * *
    (R) Example 18. Transfer of partnership interests in an 
intercompany sale.
    (S) Example 19. Intercompany transfer of partnership interests in a 
non-recognition transaction.
* * * * *
    Anti-avoidance rules. (Sec.  1.1502-13(h)(2))
* * * * *
    (vi) Example 6. Section 163 interest limitation.
* * * * *
    (c) * * *
    (7) * * *
    (ii) * * *

     (R) Example 18: Transfer of partnership interests in an 
intercompany sale--(1) Facts. P wholly owns S and B, both of which 
are members of the consolidated group of which P is the common 
parent. S and A (an unrelated third party) are equal partners in 
PS1, which was formed in Year 1. At the end of Year 1, the fair 
market value of PS1 is $200x, and S's adjusted basis in its 
partnership interest is $100x. During Year 2, PS1 borrows money, 
pays $100x of business interest expense, and repays the debt. PS1's 
section 163(j) limitation is $0; thus, the $100x of Year 2 business 
interest expense is disallowed as a deduction to PS1, is 
characterized as excess business interest expense, and is allocated 
proportionally to PS1's partners. S reduces its basis in its PS1 
interest under Sec.  1.163(j)-6(h) to reflect the $50x of excess 
business interest expense allocated to S, but the reduction is not 
treated as a noncapital, nondeductible expense (see Sec.  1.163(j)-
4(d)(4)(ii)). On the last day of Year 2, S sells its PS1 partnership 
interest to B for $50x. S has not used any of the excess business 
interest expense allocated from PS1; thus, immediately before the 
sale, S's basis in its PS1 interest is increased by $50x (to $100x) 
under Sec.  1.163(j)-6(h). This basis increase is not treated as 
tax-exempt income (see Sec.  1.163(j)-4(d)(4)(ii)). During Year 3, 
PS1 earns $50x of income, all of which is reported to the partners 
as excess taxable income, and $25x of which is allocated to B. B's 
basis in its PS1 interest is increased accordingly. Additionally, 
during Year 3, B earns $25x of business interest income and has no 
business interest expense other than its allocation of business 
interest expense from PS1. At the close of business on the last day 
of Year 4, B sells its PS1 partnership interest to Z (an unrelated 
third party) for $85x. At the time of the sale, B's basis in its PS1 
interest is $75x.
    (2) Definitions. Under paragraph (b)(1) of this section, S's 
sale of its PS1 interest to B in Year 2 is an intercompany 
transaction, with S as the selling member and B as the buying 
member. S's $50x capital loss on the sale is an intercompany item 
within the meaning of paragraph (b)(2)(i) of this section. B's $25 
of ordinary income in Year 3 and its $10x gain on the sale of the 
PS1 interest to Z in Year 4 are both corresponding items within the 
meaning of paragraph (b)(3)(i) of this section.
    (3) Timing and attributes. S takes its $50x loss into account to 
reflect the difference in each consolidated return year between B's 
corresponding items taken into account for the year and the 
recomputed corresponding item for the year. If S and B were 
divisions of a single corporation and the intercompany sale were a 
transfer between divisions, the single entity would have had zero 
income inclusion in Year 3, as the $25x of excess taxable income 
attributable to the single entity's interest in PS1 would have 
allowed the single entity to use $25x of the excess business 
interest expense allocation from PS1 in Year 2. However, on a 
separate entity basis, B's corresponding item for Year 3 is $25x of 
ordinary income (the excess taxable income from PS1). As a result, 
under Sec.  1.1502-13(c)(ii), S takes into account $25x of its loss 
in Year 3, the difference between the recomputed corresponding item 
and B's corresponding item in Year 3 ($0--$25x = -$25x). Under 
paragraphs (c)(1)(i) and (c)(4)(i)(A) of this section, the $25x is 
redetermined to be ordinary. The remaining $25x of S's loss 
continues to be deferred. The recomputed corresponding item in Year 
4 is a $15x capital loss ($85x of sales proceeds minus $100x basis 
(the original $100x basis, minus a $50 reduction in basis under 
Sec.  1.163(j)-6(h), plus a $25x increase for its allocable share of 
PS1's income, plus a $25x increase under Sec.  1.163(j)-6(h)). B's 
corresponding item is a $10x capital gain ($85x sales proceeds minus 
$75x basis). Accordingly, the remaining $25x of S's $50x Year 2 
capital loss is taken into account in Year 4.
     (S) Example 19: Intercompany transfer of partnership interests 
in a non-recognition transaction--(1) Facts. P wholly owns B, which 
is a member of the consolidated group of which P is the common 
parent. P and A (an unrelated third party) are equal partners in 
PS1, which was formed in Year 1. At the end of Year 1, the fair 
market value of PS1 is $200x, and P's adjusted basis in its 
partnership interest is $100x. At the beginning of Year 2, PS1 
borrows money and purchases inventory. During Year 2, PS1 pays $100x 
of business interest expense, sells inventory for $100x (net of cost 
of goods sold), and repays the debt in full. PS1's section 163(j) 
limitation for Year 2 is $30x (30 percent x $100x). Thus, $70x of 
PS1's Year 2 business interest expense is disallowed as a deduction 
to PS1, is characterized as excess business interest, and is 
allocated proportionally to PS1's partners. P reduces its basis in 
its PS1 interest under Sec.  1.163(j)-6(h) to reflect the $35x of 
excess business interest allocated to P. P's basis in its PS1 
interest also is increased to reflect the $35x of income allocated 
to P, leaving P with a basis in its PS1 interest of $100x at the end 
of Year 2. On the first day of Year 3, P contributes its PS1 
partnership interest to B in exchange for B stock in a non-
recognition exchange under section 351. At the time, P had not used 
any of the excess business interest expense allocated from PS1. 
During Year 4, B sells its PS1 partnership interest to Z (an 
unrelated third party) for $200x.
    (2) Analysis. P's transfer of its interest in PS1 to B is an 
intercompany transaction. The transfer also is a disposition for 
purposes of Sec.  1.163(j)-6(h). Therefore, immediately before the 
transfer, P increases its $100x basis in its PS1 interest by $35x 
(the amount of P's unused excess business interest expense). Under 
section 362, B receives a carryover basis of $135x in the PS1 
interest. P has no intercompany item, but B's $65x of capital gain 
from its sale of the PS1 interest to Z is a corresponding item 
because the PS1 interest was acquired in an intercompany

[[Page 67609]]

transaction. B takes the $65x of capital gain into account in Year 
4.

* * * * *
    (h) * * *
    (2) * * *

     (vi) Example 6: Section163(j) interest limitation--(A) Facts. 
S1 and S2 are members of a consolidated group of which P is the 
common parent. S1 is engaged in an excepted trade or business, and 
S2 is engaged in a non-excepted trade or business. If S1 were to 
lend funds directly to S2 in an intercompany transaction, under 
Sec.  1.163(j)-10(a)(4)(i), the intercompany obligation of S2 would 
not be considered an asset of S1 for purposes of Sec.  1.163(j)-10 
(concerning allocations of interest and other taxable items between 
excepted and non-excepted trades or businesses for purposes of 
section 163(j)). With a principal purpose of avoiding treatment of a 
lending transaction between S1 and S2 as an intercompany transaction 
(and increasing the P group's basis in its assets allocable to 
excepted trades or businesses), S1 lends funds to X (an unrelated 
third party). X then on-lends funds to S2 on substantially similar 
terms.
    (B) Analysis. A principal purpose of the steps undertaken was to 
avoid treatment of a lending transaction between S1 and S2 as an 
intercompany transaction. Therefore, under paragraph (h)(1) of this 
section, appropriate adjustments are made, and the X obligation in 
the hands of S1 is not treated as an asset of S1 for purposes of 
Sec.  1.163(j)-10, to the extent of the loan from X to S2.

* * * * *
0
Par. 18. Section 1.1502-21 is amended by revising paragraph (d) to read 
as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (d) Cross-reference. For rules governing the application of a SRLY 
limitation to business interest expense for which a deduction is 
disallowed under section 163(j), see Sec.  1.163(j)-5(d) and (f).
* * * * *
0
Par. 19. Section 1.1502-36 is amended by:
0
1. Revising the second sentence of paragraph (f)(2);
0
2. Revising the paragraph (h) heading;
0
3. Designating the text of paragraph (h) as paragraph (h)(1) and adding 
a heading to newly designated paragraph (h)(1); and
0
4. Adding paragraph (h)(2).
    The revisions and addition read as follows:


Sec.  1.1502-36  Unified loss rule.

* * * * *
    (f) * * *
    (2) * * * Such provisions include, for example, sections 163(j), 
267(f), and 469, and Sec.  1.1502-13. * * *
* * * * *
    (h) Applicability date--(1) In general. * * *
    (2) Definition in paragraph (f)(2) of this section. Paragraph 
(f)(2) of this section applies to taxable years ending after the date 
of the Treasury decision adopting these regulations as final 
regulations is published in the Federal Register. For taxable years 
ending before the date of the Treasury decision adopting these 
regulations as final regulations is published in the Federal Register, 
see Sec.  1.1502-36 as contained in 26 CFR part 1, revised April 1, 
2018. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may apply the rules of this section 
to a taxable year beginning after December 31, 2017, so long as the 
taxpayers and their related parties consistently apply the rules of 
this section, the section 163(j) regulations (within the meaning of 
Sec.  1.163(j)-1(b)(32)), and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-79, 
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of 
Sec. Sec.  1.382-6 and 1.383-1), and 1.1504-4 to those taxable years.
0
Par. 20. Section 1.1502-79 is amended by adding paragraph (f) to read 
as follows:


Sec.  1.1502-79  Separate return years.

* * * * *
    (f) Disallowed business interest expense carryforwards. For the 
treatment of disallowed business interest expense carryforwards (within 
the meaning of Sec.  1.163(j)-1) of a member arising in a separate 
return limitation year, see Sec.  1.163(j)-5(d) and (f).
0
Par. 21. Section 1.1502-90 is amended by revising the entry for Sec.  
1.1502-98 and adding an entry for Sec.  1.1502-99(d) to read as 
follows:


Sec.  1.1502-90  Table of contents.

* * * * *

Sec.  1.1502-98 Coordination with sections 383 and 163(j).

Sec.  1.1502-99 Effective dates.

* * * * *
    (d) Application to section 163(j).
0
Par. 22. Section 1.1502-91 is amended by revising paragraph (e)(2) to 
read as follows:


Sec.  1.1502-91  Application of section 382 with respect to a 
consolidated group.

* * * * *
    (e) * * *
     (2) Example--(i) Facts. The L group has a consolidated net 
operating loss arising in Year 1 that is carried over to Year 2. The 
L loss group has an ownership change at the beginning of Year 2.
    (ii) Analysis. The net operating loss carryover of the L loss 
group from Year 1 is a pre-change consolidated attribute because the 
L group was entitled to use the loss in Year 2 and therefore the 
loss was described in paragraph (c)(1)(i) of this section. Under 
paragraph (a)(2)(i) of this section, the amount of consolidated 
taxable income of the L group for Year 2 that may be offset by this 
loss carryover may not exceed the consolidated section 382 
limitation of the L group for that year. See Sec.  1.1502-93 for 
rules relating to the computation of the consolidated section 382 
limitation.
    (iii) Business interest expense. The facts are the same as in 
the Example in paragraph (e)(2)(i) of this section, except that, 
rather than a consolidated net operating loss, a member of the L 
group pays or accrues a business interest expense in Year 1 for 
which a deduction is disallowed in that year under section 163(j) 
and Sec.  1.163(j)-2(b). The disallowed business interest expense is 
carried over to Year 2 under section 163(j)(2) and Sec.  1.163(j)-
2(c). Thus, the disallowed business interest expense carryforward is 
a pre-change loss. Under section 163(j), the L loss group is 
entitled to deduct the carryforward in Year 2; however, the amount 
of consolidated taxable income of the L group for Year 2 that may be 
offset by this carryforward may not exceed the consolidated section 
382 limitation of the L group for that year. See Sec.  1.1502-98(b) 
(providing that Sec. Sec.  1.1502-91 through 1.1502-96 apply section 
382 to business interest expense, with appropriate adjustments).

* * * * *
0
Par. 23. Section 1.1502-95 is amended in paragraph (b)(4) by:
0
1. Designating Examples 1 and 2 as paragraphs (b)(4)(i) and (ii), 
respectively;
0
2. In newly designated paragraph (b)(4)(i), redesignating paragraphs 
(b)(4)(i)(i) and (ii) as paragraphs (b)(4)(i)(A) and (B), respectively;
0
3. In newly designated paragraph (b)(4)(ii), redesignating paragraphs 
(b)(4)(ii)(i) and (ii) as paragraphs (b)(4)(ii)(A) and (B), 
respectively; and
0
4. Adding two sentences at the end of newly redesignated paragraph 
(b)(4)(ii)(B).
    The additions read follows:


Sec.  1.1502-95  Rules on ceasing to be a member of a consolidated 
group (or loss subgroup).

* * * * *
    (b) * * *
    (4) * * *
    (ii) * * *
     (B) * * * The analysis would be similar if the L loss group had 
an ownership change under Sec.  1.1502-92 in Year 2 with respect to 
disallowed business interest expense paid or accrued by L2 in Year 1 
and carried forward under section 163(j)(2) to Year 2 and Year 3. 
See Sec.  1.1502-98(b) (providing that Sec. Sec.  1.1502-91 through 
1.1502-96 apply section 382 to

[[Page 67610]]

business interest expense, with appropriate adjustments).

* * * * *
0
Par. 24. Section 1.1502-98 is amended by:
0
1. Revising the section heading;
0
2. Designating the undesignated text as paragraph (a) and adding a 
heading for newly designated paragraph (a); and
0
3. Adding paragraph (b).
    The revision and additions read as follows:


Sec.  1.1502-98  Coordination with sections 383 and 163(j).

    (a) Coordination with section 383. * * *
    (b) Application to section 163(j)--(1) In general. The regulations 
under sections 163(j), 382, and 383 contain rules governing the 
application of section 382 to interest expense governed by section 
163(j) and the regulations thereunder. See, for example, Sec. Sec.  
1.163(j)-11(b), 1.382-2, 1.382-6, and 1.383-1. The rules contained in 
Sec. Sec.  1.1502-91 through 1.1502-96 apply these rules to members of 
a consolidated group, or corporations that join or leave a consolidated 
group, with appropriate adjustments. For example, for purposes of 
Sec. Sec.  1.1502-91 through 1.1502-96, the term loss group includes a 
consolidated group in which any member is entitled to use a disallowed 
business interest expense carryforward, within the meaning of Sec.  
1.163(j)-1(b)(9), that did not arise, and is not treated as arising, in 
a SRLY with regard to that group. Additionally, a reference to net 
operating loss carryovers in Sec. Sec.  1.1502-91 through 1.1502-96 
generally includes a reference to disallowed business interest expense 
carryforwards. References to a loss or losses in Sec. Sec.  1.1502-91 
through 1.1502-96 include references to disallowed business interest 
expense carryforwards or section 382 disallowed business interest 
carryforwards, within the meaning of Sec.  1.382-2(a)(7), as 
appropriate.
    (2) Appropriate adjustments. For purposes of applying the rules in 
Sec. Sec.  1.1502-91 through 1.1502-96 to current-year business 
interest expense (within the meaning of Sec.  1.163(j)-5(a)(2)(i)), 
disallowed business interest expense carryforwards, and section 382 
disallowed business interest carryforwards, appropriate adjustments are 
required.
0
Par. 25. Section 1.1502-99 is amended by adding paragraph (d) to read 
as follows:


Sec.  1.1502-99  Effective/applicability dates.

* * * * *
    (d) Application to section 163(j)--(1) Sections 1.382-2 and 1.382-
5. To the extent the rules of Sec. Sec.  1.1502-91 through 1.1502-99 
effectuate the rules of Sec. Sec.  1.382-2 and 1.382-5, the provisions 
apply with respect to ownership changes occurring on or after the date 
the Treasury decision adopting these regulations as final regulations 
is published in the Federal Register. For loss corporations that have 
ownership changes occurring before the date the Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register, see Sec. Sec.  1.1502-91 through 1.1502-99 as 
contained in 26 CFR part 1, revised April 1, 2018. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may apply the rules of Sec. Sec.  1.1502-91 through 1.1502-
99 to the extent they apply the rules of Sec. Sec.  1.382-2 and 1.382-
5, to ownership changes occurring during a taxable year beginning after 
December 31, 2017, as well as consistently applying the rules of the 
Sec. Sec.  1.1502-91 through 1.1502-99 to the extent they effectuate 
the rules of Sec. Sec.  1.382-2, 1.382-5, 1.382-6, and 1.383-1, the 
section 163(j) regulations (within the meaning of Sec.  1.163(j)-
1(b)(32)), and if applicable, Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 
1.469-9, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, and 
1.1504-4 to taxable years beginning after December 31, 2017.
    (2) Sections 1.382-6 and 1.383-1. To the extent the rules of 
Sec. Sec.  1.1502-91 through 1.1502-98 effectuate the rules of 
Sec. Sec.  1.382-6 and 1.383-1, the provisions apply with respect to 
ownership changes occurring during a taxable year ending after the date 
the Treasury decision adopting these regulations as final regulations 
is published in the Federal Register. For the application of these 
rules to an ownership change with respect to an ownership change 
occurring during a taxable year ending before the date the Treasury 
decision adopting these regulations as final regulations is published 
in the Federal Register, see Sec. Sec.  1.1502-91 through 1.1502-99 as 
contained in 26 CFR part 1, revised April 1, 2018. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may apply the rules of Sec. Sec.  1.1502-91 through 1.1502-
99 (to the extent that those rules effectuate the rules of Sec. Sec.  
1.382-6 and 1.383-1), to ownership changes occurring during a taxable 
year beginning after December 31, 2017, so long as the taxpayers and 
their related parties consistently apply the rules of the section 
163(j) regulations (within the meaning of Sec.  1.163(j)-1(b)(32)), and 
if applicable, Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.882-5, 
1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, and 1.1504-4 to taxable 
years beginning after December 31, 2017.
0
Par. 26. Section 1.1504-4 is amended by:
0
1. Removing ``163(j), 864(e),'' from paragraph the first sentence of 
paragraph (a)(2) and adding ``864(e)'' in its place; and
0
2. Adding two sentences at the end of paragraph (i).
    The addition reads as follows:


Sec.  1.1504-4  Treatment of warrants, options, convertible 
obligations, and other similar interests.

* * * * *
    (i) * * * Paragraph (a)(2) of this section applies with respect to 
taxable years ending after the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register. However, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may apply the rules of this 
section to a taxable year beginning after December 31, 2017, so long as 
the taxpayers and their related parties consistently apply the rules of 
this section, the section 163(j) regulations (within the meaning of 
Sec.  1.163(j)-1(b)(32)), and if applicable, Sec. Sec.  1.263A-9, 
1.381(c)(20)-1, 1.382-6, 1.383-1, 1.469-9, 1.882-5, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, and 1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec. Sec.  1.382-6, and 1.383-1), 
to those taxable years.

    Dated: October 4, 2018.
Douglas W. O'Donnell,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-26257 Filed 12-20-18; 4:15 pm]
 BILLING CODE 4830-01-P