[Federal Register Volume 85, Number 178 (Monday, September 14, 2020)]
[Rules and Regulations]
[Pages 56686-56845]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16531]



[[Page 56685]]

Vol. 85

Monday,

No. 178

September 14, 2020

Part II





Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





Limitation on Deduction for Business Interest Expense; Limitation on 
Deduction for Business Interest Expense; Allocation of Interest Expense 
by Passthrough Entities; Dividends Paid by Regulated Investment 
Companies; Application of Limitation on Deduction for Business Interest 
Expense to United States Shareholders of Controlled Foreign 
Corporations and to Foreign Persons With Effectively Connected Income; 
Final Rule and Proposed Rule

  Federal Register / Vol. 85 , No. 178 / Monday, September 14, 2020 / 
Rules and Regulations  

[[Page 56686]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9905]
RIN 1545-BO73; RIN 1545-BP07


Limitation on Deduction for Business Interest Expense

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing guidance 
about the limitation on the deduction for business interest expense 
after amendment of the Internal Revenue Code (Code) by the provisions 
commonly known as the Tax Cuts and Jobs Act, which was enacted on 
December 22, 2017, and the Coronavirus Aid, Relief, and Economic 
Security Act, which was enacted on March 27, 2020. The regulations 
provide guidance to taxpayers on how to calculate the limitation, what 
constitutes interest for purposes of the limitation, which taxpayers 
and trades or businesses are subject to the limitation, and how the 
limitation applies in consolidated group, partnership, international, 
and other contexts.

DATES: 
    Effective date: The regulations are effective on November 13, 2020. 
Sections 1.163(j)-1 through 1.163(j)-11 are generally applicable to 
taxable years beginning on or after November 13, 2020.
    Applicability dates: For dates of applicability, see Sec. Sec.  
1.163(j)-1(c), 1.163(j)-2(k), 1.163(j)-3(d), 1.163(j)-4(g), 1.163(j)-
5(h), 1.163(j)-6(p), 1.163(j)-9(k), 1.163(j)-10(f), 1.163(j)-11(d), 
1.263A-15(a), 1.381(c)(20)-1(d), 1.382-2(b)(3), 1.382-5(f), 1.382-6(h), 
1.383-1(j), 1.446-3(j)(2), 1.469-11(a)(3) and (4), 1.1502-36(h)(2), 
1.1502-99(d), and 1.1504-4(i).
    Pursuant to section 7805(b)(7), taxpayers and their related 
parties, within the meaning of sections 267(b) and 707(b)(1), may apply 
the rules set forth in Sec. Sec.  1.163(j)-1 through 1.163(j)-11, in 
their entirety, to a taxable year beginning after December 31, 2017, 
and before November 13, 2020, so long as the taxpayers and their 
related parties consistently apply these rules, and, if applicable, 
Sec. Sec.  1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 
1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1,469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-90, 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 that taxable year. However, see Sec.  
1.163(j)-1(c) for the applicability date rules relating to notional 
principal contracts and the interest anti-avoidance rule; see also part 
II(E)(2) (relating to notional principal contracts) and part II(E)(4) 
(relating to the interest anti-avoidance rule) of the Summary of 
Comments and Revisions section of this preamble.
    Alternatively, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may rely on proposed 
Sec. Sec.  1.163(j)-1 through 1.163(j)-11, which were issued in a 
notice of proposed rulemaking (REG-106089-18) and published on December 
28, 2018, in the Federal Register (83 FR 67490), in their entirety, for 
a taxable year beginning after December 31, 2017, and before November 
13, 2020, so long as the taxpayers and their related parties 
consistently apply proposed Sec. Sec.  1.163(j)-1 through -11, and, if 
applicable, proposed Sec. Sec.  1.263A-9, 1.381(c)(20)-1, 1.382-1, 
1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-
11, 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 
that taxable year. Notwithstanding the preceding sentence, taxpayers 
applying the provisions in the notice of proposed rulemaking may apply 
Sec.  1.163(j)-1(b)(1)(iii) in these final regulations for taxable 
years beginning after December 31, 2017.
    With respect to Sec.  1.382-2 and, if applicable, Sec. Sec.  
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of 
Sec.  1.382-2), and with respect to Sec.  1.382-5 and, if applicable, 
Sec. Sec.  1.1502-91 through 1.1502-99 (to the extent they effectuate 
the rules of Sec.  1.382-5), the regulations apply to testing dates and 
ownership changes, respectively, occurring on or after November 13, 
2020.
    Taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to apply the rules of Sec.  1.382-2 
and, if applicable, Sec. Sec.  1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec.  1.382-2), and Sec.  1.382-5 
and, if applicable, Sec. Sec.  1.1502-91 through 1.1502-99 (to the 
extent they effectuate the rules of Sec.  1.382-5), to a testing date 
or an ownership change, respectively, that occurs in a taxable year 
beginning after December 31, 2017, and before November 13, 2020, so 
long as the taxpayers and their related parties consistently apply the 
rules of Sec. Sec.  1.163(j)-1 through -11, 1.382-1, 1.382-2, 1.382-5, 
1.382-6, 1.382-7, 1.383-0, and 1.383-1, and, if applicable, Sec. Sec.  
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 
1.1502-79, 1.1502-90, 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 that taxable year.
    Alternatively, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may rely on the rules of 
proposed Sec.  1.382-2 and, if applicable, Sec. Sec.  1.1502-91 through 
1.1502-99 (to the extent they effectuate the rules of Sec.  1.382-2), 
and Sec.  1.382-5 and, if applicable, Sec. Sec.  1.1502-91 through 
1.1502-99 (to the extent they effectuate the rules of Sec.  1.382-5), 
which were issued in a notice of proposed rulemaking (REG-106089-18) 
and published on December 28, 2018, in the Federal Register (83 FR 
67490), with respect to a testing date or an ownership change, 
respectively, that occurs in a taxable year beginning after December 
31, 2017, and before November 13, 2020, so long as the taxpayers and 
their related parties consistently apply the rules of proposed 
Sec. Sec.  1.163(j)-1 through -11, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 
1.382-7, 1.383-0, and 1.383-1, and, if applicable, proposed Sec. Sec.  
1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.882-5, 1.1502-13, 
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-90, 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 that taxable year. As noted 
previously, taxpayers relying on the provisions in the notice of 
proposed rulemaking may apply Sec.  1.163(j)-1(b)(1)(iii) in these 
final regulations for taxable years ending after December 31, 2017.

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, Sec.  1.263A-9, or 
Sec.  1.263A-15, Sophia Wang, (202) 317-4890 or Justin Grill, (202) 
317-4850; 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.  1.382-7, 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.  1.1502-90, Sec.  1.1502-91, Sec.  1.1502-95, 
Sec.  1.1502-98, Sec.  1.1502-99, or Sec.  1.1504-4, Russell Jones, 
(202) 317-5357, John Lovelace, (202) 317-5363, Aglaia Ovtchinnikova, 
(202) 317-6975, or Marie C. Milnes-Vasquez, (202) 317-3181; concerning 
Sec.  1.163(j)-6, Sec.  1.469-9(b)(2), Sec.  1.469-11, Sec.  1.704-1, 
Sec.  1.1362-3, Sec.  1.1368-1, or

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Sec.  1.1377-1, William Kostak, (202) 317-6852, Anthony McQuillen, 
(202) 317-5027, or Adrienne Mikolashek, (202) 317-5050; concerning 
Sec.  1.163(j)-7, Sec.  1.163(j)-8, or Sec.  1.882-5, Azeka Abramoff, 
(202) 317-3800, Angela Holland, (202) 317-5474, or Steve Jensen, (202) 
317-6938; concerning Sec.  1.446-3, Sec.  1.860C-2, RICs, REITs, 
REMICs, and the definition of the term ``interest'', Michael Chin, 
(202) 317-5846 (not toll-free numbers).

ADDRESSES: Submit electronic submissions to the Federal eRulemaking 
Portal at http://www.regulations.gov (indicate IRS and REG-106089-18) 
by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The Department of the Treasury (Treasury Department) and 
the Internal Revenue Service (IRS) will publish for public availability 
any comment received to its public docket, whether submitted 
electronically or in hard copy. Send hard copy submissions to 
CC:PA:LPD:PR (REG-106089-18), Room 5203, Internal Revenue Service, P.O. 
Box 7604, Ben Franklin Station, Washington, DC 20044.

SUPPLEMENTARY INFORMATION:

Background

Table of Contents

I. Overview
II. Comments on and Changes to Proposed Sec.  1.163(j)-1: 
Definitions
    A. Definition and Calculation of Adjusted Taxable Income (ATI)--
Proposed Sec.  1.163(j)-1(b)(1)
    1. Taxable Income and Tentative Taxable Income
    2. Adjustments to ATI for Amounts Incurred as Depreciation, 
Amortization, and Depletion
    3. ATI and Floor Plan Financing Interest
    4. Adjustments to Taxable Income in Computing ATI Under Section 
163(j)(8)(A)
    5. Certain Adjustments to Tentative Taxable Income in Computing 
ATI Under Section 163(j)(8)(B)
    6. Adjustments to Adjusted Taxable Income in Respect of United 
States Shareholders of CFCs
    B. Definition of Business Interest Expense--Proposed Sec.  
1.163(j)-1(b)(2)
    C. Definition of Excepted Regulated Utility Trade or Business--
Proposed Sec.  1.163(j)-1(b)(13)
    D. Definition of Floor Plan Financing Interest Expense--Proposed 
Sec.  1.163(j)-1(b)(17)
    E. Definition of Interest--Proposed Sec.  1.163(j)-1(b)(20)
    1. In General
    2. Swaps With Significant Nonperiodic Payments
    3. Other Amounts Treated as Interest
    i. Items Relating to Premium, Ordinary Income or Loss on Certain 
Debt Instruments, Section 1258 Gain, and Factoring Income
    ii. Substitute Interest Payments
    iii. Commitment Fees
    iv. Debt Issuance Costs
    v. Guaranteed Payments
    vi. Hedging Transactions
    vii. Other Items
    a. Dividends From Regulated Investment Company (RIC) Shares
    b. MMF Income
    c. Negative Interest
    d. Leases
    4. Anti-Avoidance Rule for Amounts Predominantly Associated With 
the Time Value of Money
    5. Authority Comments
    F. Definition of Motor Vehicle--Proposed Sec.  1.163(j)-1(b)(25)
    G. Definition of Taxable Income--Proposed Sec.  1.163(j)-
1(b)(37)
    1. Calculation of Taxable Income
    2. Interaction With Section 250
    3. When Disallowed Business Interest Expense is ``Paid or 
Accrued''
    4. Interaction With Sections 461(l), 465, and 469--Proposed 
Sec.  1.163(j)-1(b)(37)
    H. Definition of Trade or Business--Proposed Sec.  1.163(j)-
1(b)(38)
    1. In General
    2. Multiple Trades or Businesses Within an Entity
    3. Rental Real Estate Activities as a Trade or Business
    4. Separate Entities
    I. Applicability Dates
III. Comments on and Changes to Proposed Sec.  1.163(j)-2: Deduction 
for Business Interest Expense Limited
    A. Whether the Section 163(j) Limitation Is a Method of 
Accounting
    B. General Gross Receipts Test and Aggregation
    C. Small Business Exemption and Single Employer Aggregation 
Rules--Proposed Sec. Sec.  1.163(j)-2(d) and 1.52-1(d)(1)(i)
    D. Small Business Exemption and Tax Shelters--Proposed Sec.  
1.163(j)-2(d)(1)
    E. Gross Receipts for Partners in Partnerships and Shareholders 
of S Corporation Stock--Proposed Sec.  1.163(j)-2(d)(2)(iii)
IV. Comments on and Changes to Section Proposed Sec.  1.163(j)-3: 
Relationship of Section 163(j) Limitation to Other Provisions 
Affecting Interest
    A. Capitalized Interest
    B. Provisions That Characterize Interest Expense as Something 
Other Than Business Interest Expense
    C. Section 108
    D. Sections 461(l), 465, and 469
V. Comments on and Changes to Proposed Sec.  1.163(j)-4: General 
Rules Applicable to C Corporations (Including Real Estate Investment 
Trusts (REITs), RICs, and Members of Consolidated Groups) and Tax-
Exempt Corporations
    A. Aggregating Affiliated but Non-Consolidated Entities
    B. Intercompany Transactions and Intercompany Obligations
    C. Repurchase Premium on Obligations That Are Deemed Satisfied 
and Reissued
    D. Intercompany Transfers of Partnership Interests
    1. Overview of Proposed Sec.  1.163(j)-4(d)(4)
    2. Intercompany Transfers of Partnership Interests Treated as 
Dispositions; Single-Entity Treatment; Application of Sec.  1.1502-
13
    3. Possible Approach to Intercompany Partnership Interest 
Transfers
    4. Offsetting Excess Business Interest Expense and Adjusted 
Taxable Income Within the Consolidated Group
    5. Intercompany Nonrecognition Transactions
    6. Basis Adjustments Under Sec.  1.1502-32
    7. Partnership Terminations
    E. Application of Sec.  1.1502-36 to Excess Business Interest 
Expense
    F. Calculating ATI for Cooperatives
    G. Calculating ATI for a Consolidated Group
    H. Application of Section 163(j) to Life-Nonlife Groups
    I. Application of Section 163(j) to Tax-Exempt Entities
    J. Partnership Investment Income and Corporate Partners
    K. Earnings and Profits of a Corporate Partner
VI. Comments on and Changes to Proposed Sec.  1.163(j)-5: General 
Rules Governing Disallowed Business Interest Expense Carryforwards 
for C Corporations
    A. Absorption of Disallowed Business Interest Expense 
Carryforwards Before Use of NOLs in Life-Nonlife Groups
    B. Carryforwards from Separate Return Limitation Years
    C. Offsetting Business Interest Expense With Business Interest 
Income and Floor Plan Financing Interest Expense at the Member Level
VII. Comments on and Changes to Section 1.163(j)-6: Application of 
the Business Interest Expense Deduction Limitations to Partnerships 
and Subchapter S Corporations
    A. Partnership-Level Calculation and Allocation of Section 
163(j) Excess Items
    1. Nonseparately Stated Taxable Income or Loss of the 
Partnership
    2. Requested Clarifications and Modifications
    3. Recommended Alternative Methods
    4. Publicly Traded Partnerships
    5. Pro Rata Exception
    B. Basis Adjustments
    1. Basis and Capital Account Adjustments for Excess Business 
Interest Expense Allocations
    2. Basis Adjustments Upon Disposition of Partnership Interests 
Pursuant to Section 163(j)(4)(B)(iii)(II)
    3. Intercompany Transfer of a Partnership Interest
    C. Debt-Financed Distributions
    D. Trading Partnerships
    E. Treatment of Excess Business Interest Expense in Tiered 
Partnerships
    F. Partnership Mergers and Divisions
    G. Applicability of Section 382 to S Corporations Regarding 
Disallowed Business Interest Expense Carryforwards
    H. Separate Application of Section 163(j) Limitation to Short 
Taxable Years of S Corporation
    I. Partnership or S Corporation Not Subject to Section 163(j)

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    J. Trusts
    K. Qualified Expenditures
    L. CARES Act Partnership Rules
VIII. Comments on and Changes to Proposed Sec.  1.163(j)-7: 
Application of the Section 163(j) Limitation to Foreign Corporations 
and United States Shareholders
IX. Comments on and Changes to Section 1.163(j)-8: Application of 
the Section 163(j) Limitation to Foreign Persons with Effectively 
Connected Taxable Income.
X. Comments on and Changes to Proposed Sec.  1.163(j)-9: Elections 
for Excepted Trades or Businesses; Safe Harbor for Certain REITs
    A. Protective Elections
    B. One-Time Late Election or Withdrawal of Election Procedures
    C. The Anti-Abuse Rule Under Proposed Sec.  1.163(j)-9(h)
    D. Residential Living Facilities and Notice With Proposed 
Revenue Procedure
    E. Safe Harbor for Certain REITs
    F. Real Property Trade or Business
XI. Comments on and Changes to Proposed 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. General Method of Allocation: Asset Basis
    B. Allocation Between Trades or Businesses and Non-Trades or 
Businesses
    C. Consolidated Groups
    1. Overview
    2. Intercompany Transactions
    3. Use of Property Derives From an Intercompany Transaction
    4. Purchase of Member Stock From a Nonmember
    5. Inclusion of Income From Excepted Trades or Businesses in 
Consolidated ATI
    6. Engaging in Excepted or Non-Excepted Trades or Businesses as 
a ``Special Status''
    D. Quarterly Asset Testing
    E. De Minimis Rules
    1. Overview
    2. Order in Which the De Minimis Rules Apply
    3. Mandatory Application of De Minimis Rules
    4. De Minimis Threshold for Electric Cooperatives
    5. Standardization of 90 Percent De Minimis Tests
    6. Overlapping De Minimis Tests
    F. Assets Used in More Than One Trade or Business
    1. Overview
    2. Consistency Requirement
    3. Changing a Taxpayer's Allocation Methodology
    4. Mandatory Use of Relative Output for Utility Trades or 
Businesses
    G. Exclusions From Basis Calculations
    H. Look-Through Rules
    1. Ownership Thresholds; Direct and Indirect Ownership Interests
    2. Application of Look-Through Rules to Partnerships
    i. In General
    ii. Coordination of Look-Through Rule and Basis Determination 
Rules
    iii. Applying the Look-Through Rule and Determining Share of 
Partnership Basis
    iv. Investment Asset Basis Reduction Rule
    v. Coordination of Section 752 Basis Reduction Rule and 
Investment Asset Basis Reduction Rule
    vi. Allocating Basis in a Partnership Interest Between Excepted 
and Non-Excepted Trades or Businesses
    3. Additional Limitation on Application of Look-Through Rules to 
C Corporations
    4. Dispositions of Stock in Non-Consolidated C Corporations
    5. Application of Look-Through Rules to Small Businesses
    6. Application of the Look-Through Rules to Foreign Utilities
    I. Deemed Asset Sale
    J. Carryforwards of Disallowed Disqualified Interest
    K. Anti-Abuse Rule
    L. Direct Allocation
    1. Overview
    2. Expansion of the Direct Allocation Rule
    3. Basis Reduction Requirement for Qualified Nonrecourse 
Indebtedness
    4. Direct Allocation Rule for Financial Services Businesses
XII. Comments on Proposed Changes to Sec.  1.382-2: General Rules 
for Ownership Change
XIII. Comments on Proposed Changes to Sec.  1.382-6: Allocation of 
Income and Loss to Periods Before and After the Change Date for 
Purposes of Section 382
XIV. Comments on and Changes to Proposed Sec.  1.383-1: Special 
Limitations on Certain Capital Losses and Excess Credits
XV. Other Comments about Section 382
    A. Application of Section 382(l)(5)
    B. Application of Section 382(e)(3)
    C. Application of Section 382(h)(6)
XVI. Definition of Real Property Trade or Business

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 163(j) of the Code. The final regulations 
reflect amendments to section 163(j) made by Public Law 115-97, 131 
Stat. 2054 (December 22, 2017), commonly referred to as the Tax Cuts 
and Jobs Act (the TCJA) and the Coronavirus Aid, Relief, and Economic 
Security Act, Public Law 116-136 (2020) (the CARES Act). 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) and 
significantly changed the limitation for deducting interest on certain 
indebtedness. The provisions of section 163(j) as amended by section 
13301 of the TCJA are effective for tax years beginning after December 
31, 2017. The CARES Act further amended section 163(j) by redesignating 
section 163(j)(10), as amended by the TCJA, as new section 163(j)(11), 
and adding a new section 163(j)(10) providing special rules for 
applying section 163(j) to taxable years beginning in 2019 or 2020. All 
references to ``old section 163(j)'' in this document are references to 
section 163(j) prior to amendment by the TCJA and the CARES Act, and 
all references to ``section 163(j)'' are references to section 163(j) 
as amended by the TCJA and the CARES Act.
    Old section 163(j) generally disallowed a deduction for 
``disqualified interest'' paid or accrued by a corporation in a taxable 
year if the payor's debt-to-equity ratio exceeded 1.5 to 1.0, and if 
the payor's net interest expense exceeded 50 percent of its adjusted 
taxable income. Disqualified interest 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) certain real estate 
investment trusts (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, the excess of the 
taxpayer's net interest expense over 50 percent of its adjusted taxable 
income, could be carried forward three years. The interest limitation 
under old section 163(j) was designed to prevent a taxpayer from 
deducting interest from its U.S. taxable income without a corresponding 
inclusion in U.S. taxable income by the recipient, or to prevent the 
stripping of earnings from the U.S. tax system.
    In contrast, section 163(j) now applies broadly to all business 
interest expense regardless of whether the related indebtedness is 
between related parties or incurred by a corporation, and regardless of 
the taxpayer's debt-to-equity ratio. Section 163(j) provides an 
entirely new limitation on the deduction for ``business interest 
expense'' of all taxpayers, including, for example, individuals, 
corporations, partnerships, S corporations, unless a specific exclusion 
applies under section 163(j). Although certain terms are used in both 
old section 163(j) and section 163(j), such as ``adjusted taxable 
income,'' such terms have been updated in the final regulations to 
reflect the new limitation under section 163(j).
    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 preamble 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 (30 percent

[[Page 56689]]

ATI limitation); and (3) the taxpayer's floor plan financing interest 
expense for the taxable year. As further described later in this 
Background section, section 163(j)(10), as amended by the CARES Act, 
provides special rules relating to the 30 percent ATI limitation for 
taxable years beginning in 2019 or 2020. The section 163(j) limitation 
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 
section 163(j) limitation is carried forward and treated as business 
interest paid or accrued in the next taxable year. In contrast to old 
section 163(j), section 163(j) does not allow the carryforward of any 
excess limitation.
    Section 163(j)(3) provides that the section 163(j) limitation does 
not apply to a taxpayer, other than a tax shelter as described 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 the partnership's 
excess taxable income, as defined in section 163(j)(4)(C), but not by 
the partner's distributive share of the partnership's income, gain, 
deduction, or loss. Section 163(j)(4)(B)(i) 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, and to the extent, the partnership allocates excess taxable income 
to the partner. As further described later in this Background section, 
section 163(j)(10)(A)(ii)(II), as amended by the CARES Act, provides a 
special rule for excess business interest expense allocated to a 
partner in a taxable year beginning in 2019. Section 163(j)(4)(B)(iii) 
provides basis adjustment rules for 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)) and do not include 
investment income or investment expense within the meaning of section 
163(d). 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 (excepted 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 (NOL) 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 it 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 section 163(j) 
limitation.
    Under section 163(j)(10)(A)(i), the amount of business interest 
that is deductible under section 163(j)(1) for taxable years beginning 
in 2019 or 2020 is computed using 50 percent, rather than 30 percent, 
of the taxpayer's ATI for the taxable year (50 percent ATI limitation). 
A taxpayer may elect not to apply the 50 percent ATI limitation to any 
taxable year beginning in 2019 or 2020, and instead apply the 30 
percent ATI limitation. The election must be made separately for each 
taxable year. Once the taxpayer makes the election, the election may 
not be revoked without the consent of the Secretary of the Treasury or 
his delegate. See section 163(j)(10)(A)(iii).
    Sections 163(j)(10)(A)(ii)(I) and 163(j)(10)(A)(iii) provide that, 
in the case of a partnership, the 50 percent ATI limitation does not 
apply to partnerships for taxable years beginning in 2019, and the 
election to not apply the 50 percent ATI limitation may be made only 
for taxable years beginning in 2020. This election may be made only by 
the partnership and may not be revoked without the consent of the 
Secretary of the Treasury or his delegate. Under section 
163(j)(10)(A)(ii)(II), however, a partner treats 50 percent of its 
allocable share of a partnership's excess business interest expense for 
2019 as a business interest expense in the partner's first taxable year 
beginning in 2020 that is not subject to the section 163(j) limitation 
(50 percent EBIE rule). The remaining 50 percent of the partner's 
allocable share of the partnership's excess business interest expense 
remains subject to the section 163(j) limitation applicable to excess 
business interest expense carried forward at the partner level. A 
partner may elect out of the 50 percent EBIE rule.
    Section 163(j)(10)(B)(i) allows a taxpayer to elect to use its ATI 
for the last taxable year beginning in 2019 for the taxpayer's ATI in 
determining the taxpayer's section 163(j) limitation for any taxable 
year beginning in 2020.
    Section 163(j)(11) provides cross-references to provisions 
requiring that electing farming businesses and electing real property 
businesses excepted from the section 163(j) limitation 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.
    On December 28, 2018, the Treasury Department and the IRS (1) 
published proposed regulations under section 163(j) in a notice of 
proposed rulemaking (REG-106089-18) (proposed regulations) in the 
Federal Register (83 FR 67490), and (2) withdrew the notice of proposed 
rulemaking (1991-2 C.B. 1040) published in the Federal Register

[[Page 56690]]

on June 18, 1991 (56 FR 27907) (as corrected by 56 FR 40285 (August 14, 
1991)) to implement rules under old section 163(j) (1991 Proposed 
Regulations). The proposed regulations were issued following guidance 
announcing and describing regulations intended to be issued under 
section 163(j). See Notice 2018-28, 2018-16 I.R.B. 492.
    A public hearing was held on February 27, 2019. The Treasury 
Department and the IRS received written comments responding to the 
notice of proposed rulemaking. Comments received before the final 
regulations were substantially developed, including all comments 
received on or before the deadline for comments on February 26, 2019, 
were carefully considered in developing the final regulations.
    Copies of the comments received are available for public inspection 
at http://www.regulations.gov or upon request. After consideration of 
the comments received and the testimony at the public hearing, this 
Treasury decision adopts the proposed regulations as revised in 
response to such comments and testimony as described in the Summary of 
Comments and Explanation of Revisions section. The revisions are 
discussed in this preamble. Concurrently with the publication of the 
final regulations, the Treasury Department and the IRS are publishing 
in the Proposed Rule section of this edition of the Federal Register 
(RIN 1545-BO76) a notice of proposed rulemaking providing additional 
proposed regulations under section 163(j) (REG-107911-18) (Concurrent 
NPRM). The Concurrent NPRM includes proposed regulations relating to 
changes made to section 163(j) under the CARES Act.
    On September 10, 2019, the Treasury Department and the IRS 
published proposed regulations under section 382(h) (REG-125710-18) in 
the Federal Register (84 FR 47455) (the September 2019 section 382 
proposed regulations). The September 2019 section 382 proposed 
regulations included a rule to clarify that section 382 disallowed 
business interest carryforwards are not treated as recognized built-in 
losses (RBILs). No formal comments were received on this rule during 
the comment period for the September 2019 section 382 proposed 
regulations.
    On April 10, 2020, the Treasury Department and the IRS released 
Revenue Procedure 2020-22, 2020-18 I.R.B. 745, to provide the time and 
manner of making a late election, or withdrawing an election under 
section 163(j)(7)(B) to be an electing real property trade or business, 
or under section 163(j)(7)(C) to be an electing farming business, for 
taxable years beginning in 2018, 2019, or 2020. Revenue Procedure 2020-
22 also provides the time and manner of making or revoking elections 
provided by the CARES Act under section 163(j)(10) for taxable years 
beginning in 2019 or 2020. As described earlier in this Background 
section, these elections are: (1) To not apply the 50 percent ATI 
limitation under section 163(j)(10)(A)(iii); (2) to use the taxpayer's 
ATI for the last taxable year beginning in 2019 to calculate the 
taxpayer's section 163(j) limitation in 2020 under section 
163(j)(10)(B); and (3) for a partner to elect out of the 50 percent 
EBIE rule under section 163(j)(10)(A)(ii)(II).

Summary of Comments and Explanation of Revisions

I. Overview

    The Treasury Department and the IRS received approximately 120 
written comments in response to the notice of proposed rulemaking. Most 
of the comments addressing the proposed regulations are summarized in 
this Summary of Comments and Explanation of Revisions section. However, 
comments merely summarizing or interpreting the proposed regulations or 
recommending statutory revisions generally are not discussed in this 
preamble. Additionally, comments outside the scope of this rulemaking 
are generally not addressed in this Summary of Comments and Explanation 
of Revisions section.
    The Treasury Department and the IRS continue to study comments on 
certain issues related to section 163(j), including issues that are 
beyond the scope of the final regulations (or the Concurrent NPRM in 
the Proposed Rules section of this issue of the Federal Register), and 
may discuss those comments if future guidance on those issues is 
published.
    The final regulations retain the same basic structure as the 
proposed regulations, with certain revisions.

II. Comments on and Changes to Proposed Sec.  1.163(j)-1: Definitions

    Section 1.163(j)-1 provides definitions of the terms used in the 
final regulations. The following discussion addresses comments relating 
to proposed Sec.  1.163(j)-1.
A. Definition and Calculation of Adjusted Taxable Income (ATI)--
Proposed Sec.  1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable Income
    Consistent with section 163(j)(8), proposed Sec.  1.163(j)-1(b)(1) 
defines ATI as the ``taxable income'' of the taxpayer for the taxable 
year, with certain specified adjustments. Thus, in calculating ATI, the 
proposed regulations begin with taxable income as the amount to which 
adjustments are made when calculating ATI. Proposed Sec.  1.163(j)-
1(b)(37)(i) generally provides that the term ``taxable income'' has the 
meaning provided in section 63, but for purposes of section 163(j), is 
computed without regard to the application of section 163(j) and the 
section 163(j) regulations. However, in some instances in the section 
163(j) regulations the term ``taxable income'' is used to indicate the 
amount calculated under section 63 for purposes other than calculating 
ATI.
    To prevent confusion from using the term ``taxable income'' in 
different contexts (in determining ATI, and for purposes other than 
determining ATI), the final regulations use a new term, ``tentative 
taxable income,'' to refer to the amount to which adjustments are made 
in calculating ATI. See Sec.  1.163(j)-1(b)(43). Tentative taxable 
income is generally determined in the same manner as taxable income 
under section 63, but is computed without regard to the application of 
the section 163(j) limitation, and without regard to any disallowed 
business interest expense carryforwards. This definitional change 
avoids confusion with section 63 taxable income, avoids creating an 
iterative loop that takes into account the section 163(j) limitation, 
and ensures that disallowed business interest expense carryforwards are 
taken into account only once in testing business interest expense 
against the limitation.
    Therefore, ``tentative taxable income'' is used in the final 
regulations and, where appropriate, in this Summary of Comments and 
Explanation of Provisions section, to describe the starting point for 
the calculation of ATI in the final regulations. See part II(G)(1) of 
this Summary of Comments and Explanation of Revisions section.
2. Adjustments to ATI for Amounts Incurred as Depreciation, 
Amortization, and Depletion
    Section 163(j)(8)(A)(v) defines ATI as the taxable income of the 
taxpayer computed without regard to certain items, including any 
deduction allowable for depreciation, amortization, or depletion for 
taxable

[[Page 56691]]

years beginning before January 1, 2022. Consistent with section 
163(j)(8)(A)(v), proposed Sec.  1.163(j)-1(b)(1)(i) requires an addback 
to taxable income of deductions for depreciation, amortization, and 
depletion for taxable years beginning before January 1, 2022. In 
general, section 263A requires certain taxpayers that manufacture or 
produce inventory to capitalize all direct costs and certain indirect 
costs into the basis of the property produced or acquired for resale. 
Depreciation, amortization or depletion that is capitalized into 
inventory under section 263A is recovered through cost of goods sold as 
an offset to gross receipts in computing gross income; cost of goods 
sold reduces the amount realized upon the sale of goods that is used to 
calculate gross income and is technically not a deduction that is 
applied against gross income in determining taxable income. See 
Sec. Sec.  1.61-3(a) and 1.263A-1(e)(3)(ii)(I) and (J). Thus, proposed 
Sec.  1.163(j)-1(b)(1)(iii) provides that depreciation, amortization, 
or depletion expense capitalized into inventory under section 263A is 
not a depreciation, amortization, or depletion deduction, that may be 
added back to taxable income in computing ATI. The preamble to the 
proposed regulations further noted that an amount that is incurred as 
depreciation, amortization, or depletion, but that is capitalized to 
inventory under section 263A and included in costs of goods sold, is 
not a deduction for depreciation, amortization, or depletion for 
purposes of section 163(j).
    Many commenters raised questions and concerns regarding proposed 
Sec.  1.163(j)-1(b)(1)(iii) and requested that the addback of 
deductions for depreciation, amortization, and depletion include any 
amount that is required to be capitalized into inventory under section 
263A. First, commenters stated that the provision does not reflect 
congressional intent, which was to determine ATI using earnings before 
interest, tax, depreciation, and amortization (EBITDA) through taxable 
year 2021 and using earnings before interest and tax (EBIT) thereafter. 
Commenters noted that the proposed rule would eliminate this 
distinction for certain manufacturers or producers of property for 
sale. Commenters pointed out that capital-intensive businesses that 
manufacture or produce inventory are at a disadvantage in comparison to 
other types of businesses because the manufacturers or producers would 
have to compute ATI without an addback for a substantial amount of 
their depreciation, and that neither section 163(j) nor its legislative 
history indicates an intent by Congress to treat manufacturers or 
producers of inventory differently from other trades or businesses. 
Commenters also contrasted the language in section 163(j)(8)(A)(iv), 
which allows an addback of ``the amount of any deduction allowed under 
section 199A,'' with section 163(j)(8)(A)(v), which allows an addback 
of ``any deduction allowable for depreciation, amortization, or 
depletion'' (emphasis added).
    The phrase ``allowed or allowable'' is used in other Code 
provisions. Section 1016(a)(2) provides that, in calculating tax basis, 
adjustments are required for depreciation to the extent such amounts 
are allowed as deductions in computing taxable income but not less than 
the amounts allowable. Some commenters noted that depreciation 
allowable as a deduction for purposes of section 1016(a)(2) should be 
read consistently with depreciation allowable as a deduction for 
purposes of section 163(j), and that section 1016(a)(2) treats 
depreciation capitalized into inventory under section 263A as 
deductions allowable. As provided in section 263A(a)(2) and Sec.  
1.263A-1(c)(2), an amount is not subject to capitalization under 
section 263A unless such cost may be taken into account in computing 
taxable income.
    The Treasury Department and the IRS have reconsidered proposed 
Sec.  1.163(j)-1(b)(1)(iii). Accordingly, under the final regulations, 
the amount of any depreciation, amortization, or depletion that is 
capitalized into inventory under section 263A during taxable years 
beginning before January 1, 2022, is added back to tentative taxable 
income as a deduction for depreciation, amortization, or depletion when 
calculating ATI for that taxable year, regardless of the period in 
which the capitalized amount is recovered through cost of goods sold. 
For example, if a taxpayer capitalized an amount of depreciation to 
inventory under section 263A in the 2020 taxable year, but the 
inventory is not sold until the 2021 taxable year, the entire 
capitalized amount of depreciation is added back to tentative taxable 
income in the 2020 taxable year, and such capitalized amount of 
depreciation is not added back to tentative taxable income when the 
inventory is sold and recovered through cost of goods sold in the 2021 
taxable year. Under such facts, the entire capitalized amount is deemed 
to be included in the calculation of the taxpayer's tentative taxable 
income for the 2020 taxable year, regardless of the period in which the 
capitalized amount is actually recovered. See Sec. Sec.  1.163(j)-
1(b)(1)(iii) and 1.163(j)-2(h)(3).
    Further, in order to treat similarly situated taxpayers similarly, 
the final regulations allow taxpayers, and their related parties within 
the meaning of sections 267(b) and 707(b)(1), otherwise relying on the 
proposed regulations in their entirety under Sec.  1.163(j)-1(c) to 
alternatively choose to follow Sec.  1.163(j)-1(b)(1)(iii) rather than 
proposed Sec.  1.163(j)-1(b)(1)(iii). See Sec.  1.163(j)-1(c).
    The Treasury Department and the IRS note that neither proposed 
Sec.  1.163(j)-1(b)(1) nor Sec.  1.163(j)-1(b)(1) determines the amount 
of allowed or allowable depreciation, amortization, or depletion for 
purposes of any other Code section (for example, sections 167(c), 
1016(a)(2), 1245, and 1250). Accordingly, no inference should be drawn 
regarding the determination of the amount of allowed or allowable 
depreciation, amortization, or depletion under any other Code section 
based on proposed Sec.  1.163(j)-1(b)(1) or Sec.  1.163(j)-1(b)(1).
    In addition to comments about whether depreciation, amortization, 
and depletion include amounts recovered through cost of goods sold, a 
commenter requested clarification that section 179 deductions are 
depreciation deductions for purposes of section 163(j)(8)(A)(v) and 
proposed Sec.  1.163(j)-1(b)(1)(i)(D). Section 179 deductions are 
allowed to be added back as amortization under proposed Sec.  1.163(j)-
1(b)(1)(i)(E), which allows an addback of 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)), for taxable years beginning before January 1, 
2022. Section 1245(a)(2)(C) provides ``any deduction allowable under 
sections 179, 179B, 179C, 179D, 179E, 181, 190, 193, or 194 shall be 
treated as if it were a deduction allowable for amortization.'' Because 
section 179 deductions are included as amortization under proposed 
Sec.  1.163(j)-1(b)(1)(i)(E), rather than as depreciation under 
proposed Sec.  1.163(j)-1(b)(1)(i)(D), no clarification is necessary in 
the final regulations. See Sec.  1.163(j)-1(b)(1)(i)(E).
3. ATI and Floor Plan Financing Interest
    Consistent with section 163(j)(8)(A)(ii), the proposed regulations 
provide that any business interest expense or business interest income 
is added back to (in the case of business interest expense) or 
subtracted from (in the case of business interest income) taxable 
income in computing ATI. Because business interest expense includes 
floor plan financing interest expense, ATI is further adjusted by

[[Page 56692]]

subtracting from it any floor plan financing interest expense under 
proposed Sec.  1.163(j)-1(b)(1)(ii)(B). Floor plan financing interest 
expense is also separately included in the section 163(j) limitation as 
provided in section 163(j)(1)(C).
    One commenter suggested that floor plan financing interest expense 
should not be subtracted from ATI because such adjustment is 
inconsistent with the statute and the ordering implied by section 
168(k)(9)(B). The addition of floor plan financing interest expense as 
business interest in the calculation of ATI is consistent with section 
163(j)(8)(A)(ii). The purpose of subtracting floor plan financing 
interest expense from tentative taxable income to compute ATI is to 
avoid the double benefit that would result upon separately including 
floor plan financing interest expense in the computation of the section 
163(j) limitation. If floor plan financing interest expense were 
included in ATI without a corresponding subtraction, thus resulting in 
an increased ATI, taxpayers with such expense would be able to increase 
their section 163(j) limitation not only by the separately stated floor 
plan financing interest under section 163(j)(1)(C), but also by the 
inclusion of such amount in ATI, which would permit a deduction of 
$1.30 (or $1.50, if the 50 percent ATI limitation is applicable) of 
business interest expense for each $1 of floor plan financing interest 
expense. Although it is clear that Congress did not intend to limit the 
deduction for floor plan financing interest expense under section 
163(j), there is no indication that Congress also intended to provide 
the additional benefit of an increased ATI related to floor plan 
financing interest expense. Therefore, under the authority granted in 
section 163(j)(8)(B), the final regulations adopt the proposed rule 
without change to include a subtraction of floor plan financing 
interest expense from tentative taxable income in computing ATI.
    Several commenters also requested clarification and submitted 
recommendations on the interaction between section 168(k)(9) and 
section 163(j). Section 168(k)(9)(B) provides that the additional 
first-year depreciation deduction is not allowed for any property used 
in a trade or business that has had floor plan financing indebtedness 
(as defined in section 163(j)(9)), if the floor plan financing interest 
related to such indebtedness was taken into account under section 
163(j)(1)(C).
    First, commenters requested that floor plan financing indebtedness 
not be treated as taken into account if the sum of business interest 
income and 30 percent of ATI (the sum of section 163(j)(1)(A) and 
section 163(j)(1)(B)) is greater than the business interest expense 
paid or accrued in the taxable year. Second, if the sum of business 
interest income and 30 percent of ATI is less than the business 
interest expense paid or accrued in the taxable year, commenters 
requested that taxpayers be given the option to either include floor 
plan financing interest to increase the section 163(j) limitation, or 
to forgo the use of floor plan financing interest to increase the 
section 163(j) limitation (any forgone floor plan financing interest 
would be included in the disallowed business interest expense 
carryforward under proposed Sec.  1.163(j)-2(c)) in order to utilize 
the additional first-year depreciation deduction under section 168(k).
    Section 163(j) does not provide any guidance on the availability of 
section 168(k) for taxpayers that have had floor plan financing 
interest expense. As these comments relate to the operation of section 
168(k)(9), taxpayers should look to Treasury Department or IRS guidance 
provided under section 168(k) for clarification. On September 24, 2019, 
the Treasury Department and the IRS published in the Federal Register 
final regulations (TD 9874, 84 FR 50108) and proposed regulations (REG-
106808-19, 84 FR 50152) under section 168(k). The rules regarding when 
floor plan financing interest expense is ``taken into account'' for 
purposes of 168(k) are in the proposed regulations under Sec.  
1.168(k)-2(b)(2)(ii)(G). Accordingly, these final regulations do not 
address the interaction between section 163(j) and section 168(k)(9) 
regarding floor plan financing interest expense.
4. Adjustments to Taxable Income in Computing ATI Under Section 
163(j)(8)(A)
    Section 163(j)(8)(A) provides that ATI means taxable income 
``computed without regard to'' the specified adjustments. The purpose 
of the adjustments listed in section 163(j)(8)(A) is to keep certain 
items, such as deductions for depreciation, amortization, depletion, or 
NOL carryforward amounts, from directly increasing or decreasing the 
amount of the deduction for business interest expense. Therefore, the 
Treasury Department and the IRS have determined that the adjustments 
listed in section 163(j)(8)(A) should adjust tentative taxable income 
for purposes of calculating ATI under Sec.  1.163(j)-1(b)(1) only to 
the extent that they have been reflected (or deemed reflected, as in 
the case of certain amounts capitalized into inventory under section 
263A as discussed in part II(A)(2) of this Summary of Comments and 
Explanation of Revisions section) in tentative taxable income under 
Sec.  1.163(j)-1(b)(43).
    A commenter requested that the definition of ATI not include some 
of the adjustments listed in section 163(j)(8)(A), such as the 
adjustments for NOL deductions and deductions under section 199A. The 
Treasury Department and the IRS do not have authority to ignore these 
clear and unambiguous statutory adjustments. Thus, the final 
regulations do not incorporate the commenter's suggestion.
5. Certain Adjustments to Tentative Taxable Income in Computing ATI 
Under Section 163(j)(8)(B)
    Under the authority granted in section 163(j)(8)(B), the proposed 
regulations include several adjustments to taxable income in computing 
ATI to address certain sales or other dispositions of depreciable 
property, stock of a consolidated group member, or interests in a 
partnership. Proposed Sec.  1.163(j)-1(b)(1)(ii)(C) provides that, if 
property is sold or otherwise disposed of, the lesser of the amount of 
gain on the disposition or the amount of depreciation, amortization, or 
depletion deductions (collectively, depreciation deductions) with 
respect to the property for the taxable years beginning after December 
31, 2017 and before January 1, 2022 (such years, the EBITDA period) is 
subtracted from taxable income to determine ATI. Proposed Sec.  
1.163(j)-1(b)(1)(ii)(D) provides that, 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 (see Sec.  
1.1502-32) with respect to such stock that are attributable to 
deductions described in proposed Sec.  1.163(j)-1(b)(1)(ii)(C) are 
subtracted from taxable income. In turn, proposed Sec.  1.163(j)-
1(b)(1)(ii)(E) provides that, with respect to the sale or other 
disposition of an interest in a partnership, the taxpayer's 
distributive share of deductions described in proposed Sec.  1.163(j)-
1(b)(1)(ii)(C) with respect to property held by the partnership at the 
time of such disposition is subtracted from taxable income to the 
extent such deductions were allowable under section 704(d).
    In general, when a taxpayer takes depreciation deductions with 
respect to an asset, the taxpayer must reduce its adjusted basis in the 
asset accordingly. As a result, the taxpayer will realize additional 
gain (or less loss) upon the

[[Page 56693]]

subsequent disposition of the asset than the taxpayer would have 
realized absent depreciation deductions. Thus, except with regard to 
timing (and, in some cases, character), depreciation deductions should 
have no net effect on a taxpayer's taxable income.
    In order to mitigate the effects of the section 163(j) limitation 
during the EBITDA period, Congress provided an adjustment to taxable 
income for depreciation deductions. More specifically, as discussed in 
part II(A)(2) of this Summary of Comments and Explanation of Revisions 
section, depreciation deductions are added back to taxable income 
during the EBITDA period, thereby increasing a taxpayer's ATI and its 
section 163(j) limitation. Congress intended this adjustment to be a 
timing provision that delays the inclusion of depreciation deductions 
in calculating a taxpayer's section 163(j) limitation. Stated 
differently, Congress intended to allow taxpayers to accelerate the 
recognition of gain attributable to depreciation deductions when 
computing ATI.
    However, if a taxpayer were to sell its depreciable property after 
making the foregoing adjustment to ATI, the taxpayer would realize 
additional gain (or less loss) on the disposition as a result of its 
depreciation deductions, and the taxpayer's ATI would be increased yet 
again. Similarly, if the depreciable property were held by a member of 
a consolidated group (S), and if another member of the group were to 
sell S's stock after making negative adjustments to its basis in S's 
stock under Sec.  1.1502-32 to reflect S's depreciation deductions, the 
consolidated group's ATI would be increased yet again. A similar double 
benefit would arise with respect to interests in a partnership if, 
after the partner's basis in its partnership interest is reduced by 
depreciation deductions associated with the depreciable property, ATI 
were to reflect that reduced basis upon a subsequent sale of the 
partnership interest.
    Proposed Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E) were intended 
to address these situations and ensure that the positive adjustment for 
depreciation deductions during the EBITDA period merely defers (rather 
than permanently excludes) depreciation deductions from a taxpayer's 
calculation of the section 163(j) limitation.
    Commenters submitted various questions and comments about these 
provisions. First, a commenter questioned whether these proposed 
subtractions from taxable income are an advisable exercise of the 
authority granted in section 163(j)(8)(B) in light of congressional 
silence on the issue. However, the 1991 Proposed Regulations contained 
similar subtractions from taxable income in computing ATI. The 1991 
Proposed Regulations had been outstanding for more than 25 years when 
Congress enacted the TCJA. Thus, Congress likely was well aware of 
these adjustments when it granted the Secretary of the Treasury the 
authority to make adjustments in new section 163(j)(8)(B). Moreover, 
there is no indication that Congress intended to preclude the Secretary 
from making adjustments similar to those in the 1991 Proposed 
Regulations.
    Second, commenters asked why the subtraction from taxable income in 
proposed Sec.  1.163(j)-1(b)(1)(ii)(D) does not include a ``lesser of'' 
calculation similar to proposed Sec.  1.163(j)-1(b)(1)(ii)(C), and they 
questioned whether the ``lesser of'' calculation in proposed Sec.  
1.163(j)-1(b)(1)(ii)(C) captures the correct amount. For example, if a 
taxpayer purchased property for $100x, fully depreciated the property, 
and then sold the property for $60x, should the amount that is backed 
out under proposed Sec.  1.163(j)-1(b)(1)(ii)(C) be $60x or $100x? 
Commenters also stated that the presence of a ``lesser of'' limitation 
in proposed Sec.  1.163(j)-1(b)(1)(ii)(C) and the absence of such a 
limitation in proposed Sec.  1.163(j)-1(b)(1)(ii)(D) can yield 
discontinuities. For example, if S (a member of P's consolidated group) 
uses $50x to purchase an asset that it fully depreciates under section 
168(k) (resulting in a $50x reduction in P's basis in its S stock under 
Sec.  1.1502-32), and if S sells the depreciated asset for $25x the 
following year, the P group would have to subtract $25x from taxable 
income under proposed Sec.  1.163(j)-1(b)(1)(ii)(C), whereas the group 
would have had to reduce its taxable income by $50x under proposed 
Sec.  1.163(j)-1(b)(1)(ii)(D) if P had sold its S stock instead. 
Commenters recommended several solutions to address this discontinuity, 
including eliminating the ``lesser of'' test.
    Proposed Sec.  1.163(j)-1(b)(1)(ii)(D) does not include a ``lesser 
of'' calculation because such a calculation would require consolidated 
groups to value their assets each time there is a sale of member stock. 
However, the Treasury Department and the IRS recognize the discrepancy 
in taxable income adjustments between asset dispositions and member 
stock dispositions under the proposed regulations. To eliminate this 
discrepancy, the final regulations revise proposed Sec.  1.163(j)-
1(b)(1)(ii)(C) by eliminating the ``lesser of'' standard and requiring 
taxpayers to back out depreciation deductions that were allowed or 
allowable during the EBITDA period with respect to sales or 
dispositions of property. This revised approach is consistent with the 
adjustment for asset sales in the 1991 Proposed Regulations, is simpler 
for taxpayers to administer than the ``lesser of'' approach in the 
proposed regulations, and renders moot questions as to whether that 
``lesser of'' calculation captures the correct amount. However, the 
Treasury Department and the IRS also recognize that, in certain cases, 
a ``lesser of'' computation would not be difficult to administer. Thus, 
the Concurrent NPRM provides taxpayers the option to apply the ``lesser 
of'' standard, so long as they do so consistently. See proposed Sec.  
1.163(j)-1(b)(1)(iv)(E) of the Concurrent NPRM.
    Third, commenters asked whether the application of proposed Sec.  
1.163(j)-1(b)(1)(ii)(C) and (D) to the same consolidated group member 
would result in an inappropriate double inclusion if the asset sale 
precedes the stock sale, and whether proposed Sec.  1.163(j)-
1(b)(1)(ii)(C) should continue to apply to a group member if the sale 
of member stock precedes the asset sale. For example, S (a member of 
P's consolidated group) takes a $50x depreciation deduction in 2020 
with respect to asset X, P's basis in its S stock is reduced 
accordingly under Sec.  1.1502-32, and $50x is added back to the P 
group's tentative taxable income in computing its 2020 ATI. In 2021, S 
realizes a $50x gain upon the sale of asset X, P's basis in its S stock 
is increased accordingly by $50x under Sec.  1.1502-32, and the P group 
subtracts $50x from its tentative taxable income under proposed Sec.  
1.163(j)-1(b)(1)(ii)(C) in computing its 2021 ATI. Then, in 2022, P 
sells the S stock to an unrelated buyer. Must P subtract another $50x 
from its tentative taxable income under proposed Sec.  1.163(j)-
1(b)(1)(ii)(D)? What if the order of sales were reversed (with P 
selling its S stock to a member of another consolidated group in 2021 
and S selling asset X in 2022)--would both consolidated groups be 
required to subtract $50x from tentative taxable income in computing 
ATI? To prevent duplicative adjustments under proposed Sec.  1.163(j)-
1(b)(1)(ii)(C) and (D), commenters recommended that these rules ``turn 
off'' further subtractions once a subtraction already has been made 
under either provision, and that the application of proposed Sec.  
1.163(j)-1(b)(1)(ii)(C) be limited to the group in which the 
depreciation deductions accrued.

[[Page 56694]]

    The Treasury Department and the IRS agree that the application of 
Sec.  1.163(j)-1(b)(1)(ii)(C) and (D) to the same consolidated group 
member would result in an inappropriate double inclusion, and that 
proposed Sec.  1.163(j)-1(b)(1)(ii)(C) should not apply to a former 
group member with respect to depreciation deductions claimed by the 
member in a former group. Thus, Sec.  1.163(j)-1(b)(1)(iv)(D) provides 
anti-duplication rules to ensure that neither Sec.  1.163(j)-
1(b)(1)(ii)(C) nor Sec.  1.163(j)-1(b)(1)(ii)(D) applies if a 
subtraction for the same economic amount already has been required 
under either provision.
    For example, assume that P wholly owns S1, which wholly owns S2, 
which owns depreciable asset Q, and that S1 and S2 are members of P's 
consolidated group. Further assume that S2's depreciation deductions 
with respect to asset Q have resulted in investment adjustments in S1's 
stock in S2 and in P's stock in S1. If S1 were to sell its S2 stock to 
a third party, adjustments to the P group's tentative taxable income 
would be required under proposed Sec.  1.163(j)-1(b)(1)(ii)(D). If P 
later were to sell its S1 stock to a third party, an additional 
adjustment under proposed Sec.  1.163(j)-1(b)(1)(ii)(D) would not be 
required with respect to investment adjustments attributable to asset 
Q.
    Fourth, commenters observed that these proposed subtractions from 
taxable income in computing ATI are required even if the disposition of 
the depreciable property, member stock, or partnership interest occurs 
many years after the EBITDA period. Commenters expressed concern that 
tracking depreciation deductions for purposes of these adjustments 
could become burdensome, and a commenter questioned the appropriateness 
in proposed Sec.  1.163(j)-1(b)(1)(ii)(C) of treating all gain upon the 
disposition of property after the EBITDA period as attributable to 
depreciation deductions during the EBITDA period.
    Commenters are correct in observing that these proposed adjustments 
to taxable income in computing ATI must be made even if the relevant 
depreciable asset, member stock, or partnership interest is disposed of 
after the EBITDA period. However, the Treasury Department and the IRS 
note that members of consolidated groups already must track 
depreciation deductions to calculate separate taxable income (see Sec.  
1.1502-12) and to preserve the location of tax items (see Sec.  1.1502-
13). Additionally, all taxpayers must track depreciation deductions on 
an asset-by-asset basis for purposes of section 1245. Thus, the 
Treasury Department and the IRS have determined that the adjustments 
proposed in Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E) should not 
impose a significant administrative burden in many situations. The 
Treasury Department and the IRS further note that eliminating the 
``lesser of'' standard in proposed Sec.  1.163(j)-1(b)(1)(ii)(C) (see 
the response to the second comment in this part of the Summary of 
Comments and Explanation of Revisions section) will render moot the 
commenter's concern about the calculation of gain.
    Fifth, a commenter asked whether the term ``sale or other 
disposition'' in proposed Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E) 
is intended to apply to the transfer of stock of a consolidated group 
member in an intercompany transaction (within the meaning of Sec.  
1.1502-13(b)(1)(i)) or to the transfer of assets in a nonrecognition 
transaction to which section 381 applies (a section 381 transaction).
    As provided in proposed Sec.  1.163(j)-4(d)(2), a consolidated 
group has a single section 163(j) limitation, and intercompany items 
and corresponding items are disregarded for purposes of calculating the 
group's ATI to the extent they offset in amount. The Treasury 
Department and the IRS have determined that regarding intercompany 
items and corresponding items for purposes of Sec.  1.163(j)-
1(b)(1)(ii)(C) and (D) would be inconsistent with this general 
approach. Thus, Sec.  1.163(j)-1(b)(1)(iv)(A)(2) provides that an 
intercompany transaction should not be treated as a ``sale or other 
disposition'' for purposes of Sec.  1.163(j)-1(b)(1)(ii)(C) and (D).
    In turn, the transfer of depreciable assets in a section 381 
transaction generally should not be treated as a ``sale or other 
disposition'' because the transfer does not affect ATI and because the 
transferee corporation is the successor to the transferor corporation. 
Thus, the final regulations generally provide that a transfer of an 
asset to an acquiring corporation in a transaction to which section 
381(a) applies is not treated as a ``sale or other disposition'' for 
purposes of Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E). However, if a 
member leaves a consolidated group, that transaction generally is 
treated as a sale or other disposition under the final regulations for 
purposes of Sec.  1.163(j)-1(b)(1)(ii)(C) and (D), regardless of 
whether the transaction is a section 381 transaction, because the 
adjustment to ATI under these provisions should be reflected on the tax 
return of the group that received the benefit of the earlier increase 
in ATI.
    Sixth, a commenter asked for clarification as to when the 
adjustment in proposed Sec.  1.163(j)-1(b)(1)(ii)(D) is required and 
which investment adjustments under Sec.  1.1502-32 are treated as 
``attributable to'' depreciation deductions for purposes of this 
provision. For example, P wholly and directly owns both S and S1 
(members of P's consolidated group). In 2021, S purchases asset X for 
$100x and fully depreciates asset X under section 168(k), and P reduces 
its basis in its S stock by $100x under Sec.  1.1502-32. In 2022, P 
contributes the stock of S to S1 in an intercompany transaction (which, 
as noted previously, is not treated as a ``sale or other disposition'' 
for purposes of proposed Sec.  1.163(j)-1(b)(1)(ii)(C) and (D)). If P 
later sells the S1 stock, is the adjustment in proposed Sec.  1.163(j)-
1(b)(1)(ii)(D) required even though no adjustment to P's basis in the 
S1 stock under Sec.  1.1502-32 is ``attributable to'' the $100x of 
depreciation deductions taken with respect to asset X?
    The Treasury Department and the IRS have determined that the 
adjustment to tentative taxable income in proposed Sec.  1.163(j)-
1(b)(1)(ii)(D) should apply in the foregoing situation. The final 
regulations have been revised to provide that, for these purposes, P's 
stock in S1 would be treated as a successor asset (within the meaning 
of Sec.  1.1502-13(j)(1)) to P's stock in S.
    Seventh, commenters stated that there should be no adjustments to 
taxable income under proposed Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and 
(E) if and to the extent that adding back depreciation deductions 
pursuant to section 163(j)(8)(A)(v) and proposed Sec.  1.163(j)-
1(b)(1)(i) did not increase the amount of business interest expense the 
taxpayer could have deducted in the year the deductions were incurred. 
For example, in 2021, corporation C has $500x of ATI (computed by 
adding back $50x of depreciation deductions with respect to asset X) 
and $100x of business interest expense. Without adding back the 
depreciation deductions, C's ATI would have been $450x, C's section 
163(j) limitation would have been $135x ($450x x 30 percent), and C 
still could have deducted all $100x of its business interest expense in 
that year. In 2022, C has $90x of business interest expense and $300x 
of ATI. C sells asset X for a $50x gain in that year. If C were 
required to reduce its ATI by $50x (from $300x to $250x) in 2022 under 
proposed Sec.  1.163(j)-1(b)(1)(ii)(C), its section 163(j) limitation 
would be reduced to $75x ($250x x 30 percent), and C would not be able 
to deduct all $90x of its business interest expense in 2022 even though 
C derived no benefit from adding back its depreciation deductions to 
taxable income in 2021.

[[Page 56695]]

    The Treasury Department and the IRS have determined that 
predicating the application of proposed Sec.  1.163(j)-1(b)(1)(ii)(C), 
(D), and (E) upon whether a taxpayer derived a benefit under section 
163(j) from adding back its depreciation deductions to taxable income 
would involve significant additional complexity. In addition, this 
approach would have an effect similar to allowing a carryforward of 
these amounts to the taxable year in which gain on the related items is 
recognized on a sale or other disposition. Such a carryforward is 
inconsistent with the general approach of section 163(j), which does 
not permit a carryforward of excess ATI to later taxable years. As 
noted earlier in this part II(A)(5) of this Summary of Comments and 
Explanation of Revisions section, depreciation deductions should have 
no net effect on the amount of a taxpayer's taxable income (except with 
respect to timing and, perhaps, character). Thus, if a taxpayer sells 
an asset with respect to which the taxpayer has taken depreciation 
deductions, the increase in gain (or decrease in loss) upon the sale 
should be reversed under proposed Sec.  1.163(j)-1(b)(1)(ii)(C).
6. Adjustments to Adjusted Taxable Income in Respect of United States 
Shareholders of CFCs
    Some commenters argued that United States shareholders, as defined 
in section 951(b) (U.S. shareholders), of controlled foreign 
corporations, as defined in section 957(a) (CFCs), should be allowed to 
include in their ATI the amounts included in gross income under section 
951(a) (subpart F inclusions), section 951A(a) global intangible low-
taxed income (GILTI) inclusions, and section 78 ``gross-up'' inclusions 
(collectively, CFC income inclusions) attributable to non-excepted 
trades or businesses. Because section 163(j) applies to CFCs, the 
Treasury Department and the IRS have determined that allowing a U.S. 
shareholder to include its CFC income inclusions in its ATI would not 
be appropriate. The income of the CFC that gives rise to such income is 
taken into account in computing the ATI of the CFC for purposes of 
determining its section 163(j) limitation, and allowing the same income 
to also be taken into account in computing the ATI of a U.S. 
shareholder would result in an inappropriate double-counting of income.
    Furthermore, the Treasury Department and the IRS question the 
premise of several comments that, if the business interest expense of a 
CFC were excluded from the application of section 163(j), including the 
income of a CFC in a U.S. shareholder's ATI would be appropriate. Even 
if section 163(j) did not apply to CFCs, CFCs are entities that also 
may be leveraged. Thus, permitting the income of the CFC that gives 
rise to CFC income inclusions attributable to non-excepted trades or 
businesses of CFCs to be included in the ATI of U.S. shareholders would 
be inconsistent with the principles of section 163(j).
    In particular, consider a case in which a CFC has interest expense 
of $100x, trade or business gross income of $300x treated as subpart F 
income, and no foreign tax liability. In such a case, a U.S. 
shareholder that wholly owns the CFC would have a subpart F inclusion 
of $200x (if section 163(j) did not apply to CFCs). If the $200x 
subpart F inclusion were included in the ATI of the U.S. shareholder, 
the U.S. shareholder could deduct an additional $60x of business 
interest expense ($200x x 30 percent). As a result, $300x of gross 
income could support $160x of interest expense deductions rather than 
the $90x permitted under section 163(j)(1).
    Finally, under the final regulations (and consistent with proposed 
Sec.  1.163(j)-7(d)(1)(ii)), if a domestic partnership includes amounts 
in gross income under sections 951(a) and 951A(a) with respect to an 
applicable CFC and such amounts are investment income to the 
partnership, then, a domestic C corporation partner's distributive 
share of such amounts that are properly allocable to a non-excepted 
trade or business of the domestic C corporation by reason of Sec. Sec.  
1.163(j)-4(b)(3) and 1.163(j)-10(c) are excluded from the domestic C 
corporation partner's ATI.
B. Definition of Business Interest Expense--Proposed Sec.  1.163(j)-
1(b)(2)
    The proposed regulations provide that business interest expense 
includes interest expense allocable to a non-excepted trade or 
business, floor plan financing interest expense, and disallowed 
business interest expense carryforwards. The Treasury Department and 
the IRS received informal questions about the interaction between 
section 163(j) and sections 465 and 469, which may operate to disallow 
a deduction for business interest expense even if such expense was 
allowable after the application of section 163(j). More specifically, 
questions have arisen regarding how to treat amounts of business 
interest expense that are disallowed under section 465 or 469, 
including which amounts carry forward to subsequent taxable years but 
keep their character as interest expense, and which amounts, if any, 
are business interest expense in such subsequent taxable years.
    If amounts of business interest expense that are disallowed under 
section 465 or 469 are treated as business interest expense in 
subsequent taxable years, the section 163(j) limitation could operate 
to disallow a deduction even though such amounts were allowable in the 
prior taxable year after application of the section 163(j) limitation. 
The Treasury Department and the IRS do not intend such a result. 
Therefore, the final regulations clarify that amounts allowable as a 
deduction after application of the section 163(j) limitation but 
disallowed by section 465 or 469 are not business interest expense 
subject to the section 163(j) limitation in subsequent taxable years.
C. Definition of Excepted Regulated Utility Trade or Business--Proposed 
Sec.  1.163(j)-1(b)(13)
    Numerous comments were submitted concerning the definition of an 
``excepted regulated utility trade or business'' under proposed Sec.  
1.163(j)-1(b)(13). Proposed Sec.  1.163(j)-1(b)(13), which implements 
the exception in section 163(j)(7)(A)(iv) to the definition of a 
``trade or business,'' generally provides that an excepted regulated 
utility trade or business is a trade or business that sells or 
furnishes the items listed in section 163(j)(7)(A)(iv) at rates that 
are established or approved by certain regulatory bodies described in 
proposed Sec.  1.163(j)-1(b)(13)(i)(B)(1) and (2).
    The proposed regulations provide that utilities that sell or 
furnish the regulated items at rates that are established or approved 
by a regulatory body described in proposed Sec.  1.163(j)-
1(b)(13)(i)(B)(1), other than an electric cooperative, are considered 
to be excepted only to the extent that such rates are determined on a 
``cost of service and rate of return'' basis. The ``cost of service and 
rate of return'' requirement was intended to provide certainty to 
taxpayers because many utilities are familiar with the definition of 
``cost of service and rate of return,'' which is used to determine 
whether a public utility company must use a normalization method of 
accounting under section 168 for certain properties.
    However, several commenters questioned whether a ``cost of service 
and rate of return'' requirement would be satisfied in specific fact 
patterns. Commenters questioned whether certain negotiated rates are 
established or approved on a ``cost of service and rate of return'' 
basis if (1) the applicable regulatory body has the authority to

[[Page 56696]]

impose a cost-based rate instead of the negotiated rate, (2) the rates 
are computed with reference to cost but discounted from the recourse 
(or maximum) rate allowed by the regulatory body, or (3) the rates are 
computed with reference to cost and a set rate of return but are 
subject to a market-based cap. Commenters also asked whether the 
inclusion of certain amounts in determining ``cost of service,'' 
specifically the costs of affiliates and some revenues attributable to 
market-rate sales, would affect the determination of whether rates are 
established or approved on a ``cost of service and rate of return'' 
basis.
    One commenter noted that the normalization rules operate logically 
only in the ``cost of service and rate of return'' context. The 
commenter stated that, because section 163(j)(7)(A)(iv) does not 
reference the normalization rules, there is no need to include the 
``cost of service and rate of return'' requirement in the section 
163(j) regulations.
    The Treasury Department and the IRS note that, in private letter 
rulings and informal guidance related to section 168(i)(9) and (10), 
the IRS has stated that, for purposes of applying the normalization 
rules, the definition of ``public utility property'' must contain the 
requirement that the regulated rates be established or approved on a 
``rate of return'' basis. In this guidance, the IRS explained that the 
normalization method, which must be used for public utility property to 
be eligible for the depreciation allowance available under section 168, 
is defined in terms of the method the taxpayer uses in computing its 
tax expense in establishing its ``cost of service'' for ratemaking 
purposes and reflecting operating results in its regulated books of 
account. Furthermore, the IRS has issued numerous private letter 
rulings regarding whether under the specific facts of the taxpayer, the 
cost of service and rate of return requirement has been met for 
purposes of section 168(i). Thus, it is clear that, in the context of 
section 168, the ``cost of service and rate of return'' requirement is 
necessary.
    Neither the text of section 163(j) nor the legislative history 
specifically references the normalization rules or the ``cost of 
service and rate of return'' requirement under section 168(i)(10). With 
the omission of such references, the exception in section 163(j) for 
regulated utility trade or business could be applied broadly without 
reference to specific requirements applicable in the normalization 
rules. However, the Treasury Department and the IRS note that under 
section 168(k)(9), the additional first-year depreciation deduction is 
not available to any property that is primarily used in an excepted 
regulated utility trade or business. Therefore, to ease the 
administrative burden of determining whether businesses qualify as 
excepted regulated utility trades or businesses, and to allow taxpayers 
the option of claiming the additional first-year depreciation deduction 
under section 168(k) in lieu of being treated as an excepted regulated 
utility trade or business, the final regulations retain the ``cost of 
service and rate of return'' requirement from the proposed regulations, 
and also allow taxpayers to make an election to be an excepted 
regulated utility trade or business to the extent that the rates for 
the furnishing or sale of the items described in Sec.  1.163(j)-
1(b)(15)(i)(A)(1) have been established or approved by a regulatory 
body described in Sec.  1.163(j)-1(b)(15)(i)(A)(2), if the rates are 
not determined on a ``cost of service and rate of return'' basis. See 
Sec.  1.163(j)-1(b)(15)(i) and (iii).
    For purposes of the election, the focus of section 163(j)(7)(A)(iv) 
is the phrase ``established or approved'' in section 163(j)(7)(A)(iv), 
which describes the authority of the regulatory body described in Sec.  
1.163(j)-1(b)(15)(i)(A)(2). Ratemaking programs similar to those 
described by commenters and discussed previously in this part II(C) of 
this Summary of Comments and Explanation of Revisions section, 
including discounted rates, negotiated rates, and regulatory rate caps, 
are established or approved by a regulatory body if the taxpayer files 
a schedule of such rates with a regulatory body that has the power to 
approve, disapprove, alter the rates, or substitute a rate determined 
in an alternate manner.
    Similar to elections for electing real property trades or 
businesses and electing farming businesses, the election to be an 
excepted regulated utility trade or business is irrevocable. Taxpayers 
making the election to be an excepted regulated utility trade or 
business are not required to allocate items between regulated utility 
trades or businesses that are described in Sec.  1.163(j)-1(b)(15)(i) 
and trades or businesses that are described in Sec.  1.163(j)-
1(b)(15)(iii)(A) as to which the taxpayer makes an election because 
they are treated as operating an entirely excepted regulated utility 
trade or business. Electing taxpayers cannot claim the additional 
first-year depreciation deduction under section 168(k).
    The rules set forth in the final regulations are limited solely to 
the determination of an ``excepted regulated utility trade or 
business'' for purposes of section 163(j)(7)(A)(iv). As a result of 
this limited application, the rules in the final regulations are not 
applicable to the determination of ``public utility property'' or the 
application of the normalization rules within the meaning of section 
46(f), as in effect on the day before the date of the enactment of the 
Revenue Reconciliation Act of 1990, section 168(i)(9) and (10) and the 
regulations thereunder, or to the determination of any depreciation 
allowance available under sections 167 and 168.
    Comments also were received on the application of the rules for 
excepted regulated utility trades or businesses to electric 
cooperatives. The definition of an ``excepted regulated utility trade 
or business'' under proposed Sec.  1.163(j)-1(b)(13) includes trades or 
businesses that sell or furnish the items listed in section 
163(j)(7)(A)(iv) at rates established or approved by an electric 
cooperative. Unlike utility businesses regulated by public authorities, 
utilities that sell items at rates regulated by a cooperative are not 
described in section 168(i)(10). However, there is a long-standing body 
of law regulating the taxation of electric cooperatives. Electric 
cooperatives described in section 501(c)(12) are generally exempt from 
income tax but are subject to taxation under section 511. The 
application of section 163(j) and the section 163(j) regulations with 
respect to exempt electric cooperatives is governed by proposed Sec.  
1.163(j)-4(b)(5). Other electric cooperatives are subject to taxation 
under sections 1381 through 1388 in subchapter T of chapter 1 of 
subtitle A of the Code (subchapter T), except for certain rural 
electric cooperatives specifically excluded from subchapter T by 
section 1381(a)(2)(C).
    Generally, the exception in section 163(j)(7)(A)(iv) for the trade 
or business of selling or furnishing items at rates established or 
approved by the governing or ratemaking body of an electric cooperative 
applies both to sales and furnishing by an electric cooperative and to 
sales and furnishing to an electric cooperative by another utility 
provider, as long as the rates for the sale or furnishing have been 
established or approved in the manner required by section 163(j). Thus, 
an electric cooperative exempt from Federal income tax under section 
501(c)(12) may not be subject to section 163(j) for the sale or 
furnishing of electricity due to the operation of proposed Sec.  
1.163(j)-4(b)(5), and another utility provider may be in an excepted 
regulated utility trade or business to the extent that it sells 
electricity to the

[[Page 56697]]

section 501(c)(12) cooperative at rates established or approved by the 
governing or ratemaking body of the cooperative.
    A commenter asked whether proposed Sec.  1.163(j)-1(b)(13) requires 
that, for sales involving electric cooperatives to qualify as an 
excepted regulated utility trade or business, the rates for the sales 
be established or approved by the governing or ratemaking body of an 
electric cooperative on a ``cost of service and rate of return'' basis, 
or if all sales made subject to a contract or tariff approved by an 
electric cooperative's governing or ratemaking body would qualify. 
Under the proposed regulations, the specific requirement that rates for 
the sale or furnishing of items listed in proposed Sec.  1.163(j)-
1(b)(13)(i)(A) be established or approved on a ``cost of service and 
rate of return'' basis did not extend to rates established or approved 
by the governing or ratemaking body of an electric cooperative. These 
regulations adopt the proposed rule, and do not impose a requirement 
that rates for the sale or furnishing of items listed in Sec.  
1.163(j)-1(b)(15)(i)(A) by an electric cooperative be established or 
approved on a ``cost of service and rate of return'' basis.
    Comments also were submitted regarding the allocation of tax items 
between excepted regulated utility trades or businesses and non-
excepted trades or businesses. These comments are discussed with other 
comments on proposed Sec.  1.163(j)-10 in part XI of this Summary of 
Comments and Explanation of Revisions section.
D. Definition of Floor Plan Financing Interest Expense--Proposed Sec.  
1.163(j)-1(b)(17)
    Commenters recommended that interest paid on commercial financing 
liabilities or trade financing (in which a taxpayer borrows to fund the 
purchase or transport of commodities and then sells the inventory to 
pay off the debt) should not be subject to section 163(j). Commenters 
noted that trade financing is different from normal financing because 
it is short-term and backed by inventory that is monetizable (rather 
than plant and equipment). Thus, commenters suggested that section 
163(j) should not apply to trade financing because there is no 
depreciation trade-off for inventory purchased with trade financing. 
Commenters compared trade financing to floor plan financing (because 
both are used to finance the purchase of inventory), and they noted 
that the 1991 Proposed Regulations under old section 163(j) excluded 
commercial financing liabilities from debt taken into account for 
purposes of applying the debt-equity ratio under old section 163(j). 
See 1991 Proposed Regulations Sec.  1.163(j)-3(b)(2)(ii).
    The Treasury Department and the IRS decline to exclude commercial 
financing liabilities from the section 163(j) limitation. Section 
163(j) does not contain a provision analogous to the debt-equity ratio 
safe harbor that was present in old section 163(j) and for which rules 
were proposed in the 1991 Proposed Regulations. In addition, because 
Congress specifically excluded interest paid on floor plan financing 
from the section 163(j) limitation, but not all commercial financing 
liabilities and trade financing, Congress does not appear to have 
intended to exclude all commercial financing liabilities from the 
section 163(j) limitation.
E. Definition of Interest--Proposed Sec.  1.163(j)-1(b)(20)
1. In General
    Commenters submitted numerous comments on the definition of 
``interest'' in the proposed regulations. Proposed Sec.  1.163(j)-
1(b)(20) contains a relatively broad definition of the term 
``interest'' for purposes of section 163(j). This definition was 
proposed to provide a complete definition of interest that addresses 
all transactions that are commonly understood to produce interest 
income and expense, including transactions that otherwise may have been 
entered into to avoid the application of section 163(j).
    Under the proposed regulations, the term ``interest'' means any 
amount described in one of four categories. First, proposed Sec.  
1.163(j)-1(b)(20)(i) generally provides that 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, or an amount that is treated as interest under other 
provisions of the Code or the Income Tax Regulations. For example, this 
category includes qualified stated interest, original issue discount 
(OID), and accrued market discount. Commenters agree that this 
definition of interest has long been accepted, is consistent with 
longstanding precedent, and reduces the risk of inconsistency within 
the Code and regulations. No commenters requested any changes to this 
category, and the final regulations adopt this category in the 
definition of the term ``interest'' without any substantive changes.
    Second, proposed Sec.  1.163(j)-1(b)(20)(ii) treats a swap (other 
than a cleared swap) with significant nonperiodic payments as two 
separate transactions consisting of an on-market, level payment swap 
and a loan. Under the proposed regulations, the time value component of 
the loan is recognized as interest expense to the payor and as interest 
income to the recipient. Several comments were received on this 
category in the definition and are described in part II(E)(2) of this 
Summary of Comments and Explanation of Revisions section.
    Third, proposed Sec.  1.163(j)-1(b)(20)(iii) treats 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. For example, this category includes 
substitute interest payments, debt issuance costs, commitment fees, and 
hedging gains and losses that affect the yield of a debt instrument. 
Numerous comments were received on this category and are described in 
part II(E)(3) of this Summary of Comments and Explanation of Revisions 
section.
    Fourth, proposed Sec.  1.163(j)-1(b)(20)(iv) provides an anti-
avoidance rule. Under this rule, 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 is treated as interest 
expense for purposes of section 163(j). Numerous comments were received 
on this category and are described in part II(E)(4) of this Summary of 
Comments and Explanation of Revisions section.
2. Swaps With Significant Nonperiodic Payments
    The proposed regulations treat a non-cleared swap with significant 
nonperiodic payments as two separate transactions consisting of an on-
market, level payment swap and a loan (the embedded loan rule). The 
embedded loan rule did not apply to a collateralized swap that was 
cleared by a derivatives clearing organization or by a clearing agency 
(a cleared swap) because the treatment of cleared swaps was reserved. 
In the preamble to the proposed regulations, the Treasury Department 
and the IRS requested comments on the proper treatment of 
collateralized swaps under the embedded loan rule.
    One commenter recommended that the final regulations provide an

[[Page 56698]]

exception to the embedded loan rule for cleared swaps and for non-
cleared swaps that are substantially collateralized. This commenter 
further suggested that the final regulations not include any specific 
rules regarding the type of collateral that is required to be posted to 
qualify for the exception. The commenter also recommended that the 
final regulations provide objective rules for determining if a 
nonperiodic payment is ``significant'' and if a financial instrument is 
treated as a ``swap'' for purposes of these rules.
    Another commenter agreed with the embedded loan rule, including use 
of the ``significant'' standard, and also recommended exceptions to the 
embedded loan rule for both cleared swaps and non-cleared swaps that 
are required to be fully collateralized by the terms of the swap 
contract or by a federal regulator. However, this commenter interpreted 
the embedded loan rule in the proposed regulations to apply solely for 
purposes of section 163(j) and recommended that the embedded loan rule, 
as well as timing and character rules for nonperiodic payments on 
swaps, be issued under section 446. Until that guidance is issued, the 
commenter requested that the application of the embedded loan rule for 
purposes of section 163(j) be delayed. The proposed regulations provide 
that the time value component of the embedded loan is determined in 
accordance with Sec.  1.446-3(f)(2)(iii)(A). This commenter questioned 
the reference to Sec.  1.446-3(f)(2)(iii)(A) because, under that rule, 
the time value component is not treated as interest; rather, the time 
value component is only used to compute the amortization of the 
nonperiodic payment.
    As a result of the cross-reference in proposed Sec.  1.446-3(g)(4) 
to proposed Sec.  1.163(j)-1(b)(20)(ii), the embedded loan rule set 
forth in the proposed regulations applies for purposes of both sections 
163(j) and 446. In addition, and as noted in the preamble to the 
proposed regulations, the embedded loan rule set forth in the proposed 
regulations applies in the same manner that former Sec.  1.446-3(g)(4) 
applied before it was amended by the now expired temporary regulations 
in T.D. 9719 (80 FR 26437) (May 8, 2015) (as corrected by 80 FR 61308 
(October 13, 2015)). The Treasury Department and the IRS do not adopt 
commenters' suggestions to delay finalizing the embedded loan rule or 
to provide guidance on determining if a nonperiodic payment is 
``significant'' because the same embedded loan rule applied in the 
context of section 446 for over 20 years from 1993 to 2015. See T.D. 
8491 (58 FR 53125) (October 14, 1993). Instead, subject to the 
exceptions discussed in this part II(E)(2) of this Summary of Comments 
and Explanation of Revisions section, the final regulations adopt the 
embedded loan rule without change. The final regulations retain the 
reference to Sec.  1.446-3(f)(2)(iii)(A), which provides a known method 
for computing the time value component associated with the loan 
component that is treated as interest under Sec. Sec.  1.163(j)-
1(b)(22)(ii) and 1.446-3(g)(4).
    Further, to eliminate the possibility of confusion regarding the 
application of the embedded loan rule for purposes of sections 163(j) 
and 446, the final regulations add the substantive text of the embedded 
loan rule and the exceptions to that rule to both Sec. Sec.  1.446-
3(g)(4) and 1.163(j)-1(b)(22)(ii) instead of merely including a cross-
reference in Sec.  1.446-3(g)(4) to Sec.  1.163(j)-1(b)(22)(ii).
    In response to comments, the final regulations add two exceptions 
to the embedded loan rule. Specifically, the final regulations add 
exceptions for cleared swaps and for non-cleared swaps that require the 
parties to meet the margin or collateral requirements of a federal 
regulator or that provide for margin or collateral requirements that 
are substantially similar to a cleared swap or a non-cleared swap 
subject to the margin or collateral requirements of a federal 
regulator. For purposes of this exception, the term ``federal 
regulator'' means the Securities and Exchange Commission (SEC), the 
Commodity Futures Trading Commission (CFTC), or a prudential regulator, 
as defined in section 1a(39) of the Commodity Exchange Act (7 U.S.C. 
1a), as amended by section 721 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act of 2010, Public Law 111-203, 124 Stat. 1376, 
Title VII (the Dodd-Frank Act). Because federal regulators have adopted 
final requirements for non-cleared swaps that permit netting of swap 
exposures and specify the types of collateral required to be posted, 
the final regulations do not address netting or require that the margin 
or collateral be paid or received in cash.
    In addition, Sec.  1.163(j)-1(c)(3)(i) delays the applicability 
date of the embedded loan rule for purposes of section 163(j) to allow 
taxpayers additional time to develop systems to implement these rules 
(the delayed applicability date), though taxpayers may choose to apply 
the rules to swaps entered into before the delayed applicability date. 
See also Sec.  1.446-3(j)(2), which provides applicability date rules 
similar to those in Sec.  1.163(j)-1(c)(3)(i). However, the delayed 
applicability date does not apply for purposes of the anti-avoidance 
rules in Sec.  1.163(j)-1(b)(22)(iv) (described in part II(E)(4) of 
this Summary of Comments and Explanation of Revisions section). 
Instead, the applicability date in Sec.  1.163(j)-1(c)(3)(ii) applies. 
As a result, the anti-avoidance rules in Sec.  1.163(j)-1(b)(22)(iv) 
apply to a notional principal contract entered into on or after 
September 14, 2020. However, for a notional principal contract entered 
into before September 14, 2021, the anti-avoidance rules in Sec.  
1.163(j)-1(b)(22)(iv) apply without regard to the references in those 
rules to Sec.  1.163(j)-1(b)(22)(ii). For example, if a taxpayer enters 
into a swap with a significant nonperiodic payment that does not meet 
the exceptions in Sec.  1.163(j)-1(b)(22)(ii)(B) or (C) before the 
delayed applicability date, and a principal purpose of the taxpayer is 
to reduce the amount that otherwise would be interest expense, the 
anti-avoidance rules apply and the taxpayer must treat the time value 
component associated with the loan component of the swap as interest 
expense.
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary Income or Loss on Certain Debt 
Instruments, Section 1258 Gain, and Factoring Income
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(A) treats any bond issuance 
premium treated as ordinary income under Sec.  1.163-13(d)(4) as 
interest income of the issuer and any amount deductible as a bond 
premium deduction under Sec.  1.171-2(a)(4)(i)(A) or (C) as interest 
expense of the holder. Proposed Sec.  1.163(j)-1(b)(20)(iii)(B) treats 
any ordinary income recognized by an issuer of a debt instrument, and 
any ordinary loss recognized by a holder of a debt instrument, under 
the rules for a contingent payment debt instrument, a nonfunctional 
currency contingent payment debt instrument, or an inflation-indexed 
debt instrument, as interest income of the issuer and as interest 
expense of the holder, respectively. Proposed Sec.  1.163(j)-
1(b)(20)(iii)(D) treats any ordinary gain under section 1258 as 
interest income. Commenters supported treating the amounts in proposed 
Sec.  1.163(j)-1(b)(20)(iii)(A), (B), and (D) as interest income or 
interest expense for purposes of section 163(j). Accordingly, the final 
regulations adopt the rules in the proposed regulations for these three 
items without any substantive changes.
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(J) treats factoring income as 
interest income. Several commenters supported treating factoring income 
as interest

[[Page 56699]]

income. However, one commenter questioned the differences between the 
provisions related to the inclusion of factoring income and Sec.  
1.954-2(h)(4). The inclusion of factoring income in the definition of 
interest is generally supported by the commenters, is a taxpayer-
favorable rule, is generally consistent with the rules in Sec.  1.954-
2(h)(4), and is consistent with the treatment of other types of 
discount, such as acquisition discount and market discount. 
Accordingly, the final regulations adopt the rules in the proposed 
regulations for factoring income without any substantive changes. In 
the case of a factoring transaction with a principal purpose of 
artificially increasing a taxpayer's business interest income, the 
anti-avoidance rules in Sec.  1.163(j)-1(b)(22)(iv) (described in part 
II(E)(4) of this Summary of Comments and Explanation of Revisions 
section) would not permit the taxpayer to treat factoring income as 
interest income for purposes of section 163(j).
ii. Substitute Interest Payments
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(C) generally provides that a 
substitute interest payment described in Sec.  1.861-2(a)(7) and made 
in connection with a sale-repurchase or securities lending transaction 
is treated as interest expense to the payor and interest income to the 
recipient. In general, substitute interest payments are economically 
equivalent to interest. A few commenters questioned the inclusion of 
substitute interest payments in the definition of interest in the 
proposed regulations. Commenters stated that treating these amounts as 
interest would be contrary to longstanding tax law, including the 
holding in Deputy v. Du Pont, 308 U.S. 488, 498 (1940). However, 
commenters recommended that, if the Treasury Department and the IRS 
decide to include substitute interest payments in the definition of 
interest in the final regulations, the inclusion be limited to the 
extent the substitute interest payments relate to transactions that are 
economically similar to a borrowing. Commenters recommended that the 
following factors be taken into consideration in making this 
determination: (a) Whether the taxpayer posted (or has received) 
collateral consisting of cash or liquid assets; (b) whether the 
borrowed security is due to mature shortly after the scheduled 
termination date of the securities borrowing; (c) the type of security 
being lent (for example, Treasury bonds as compared to riskier 
corporate bonds); and (d) whether the securities borrowing was entered 
into in the ordinary course of the taxpayer's trade or business.
    The final regulations retain substitute interest payments in the 
definition of interest because the payments generally are economically 
equivalent to interest and should be treated as such for purposes of 
section 163(j). However, in response to comments, the final regulations 
provide that a substitute interest payment is treated as interest 
expense to the payor only if the payment relates to a sale-repurchase 
or securities lending transaction that is not entered into by the payor 
in the payor's ordinary course of business, and that a substitute 
interest payment is treated as interest income to the recipient only if 
the payment relates to a sale-repurchase or securities lending 
transaction that is not entered into by the recipient in the 
recipient's ordinary course of business. The final regulations do not 
adopt the other suggested factors because the Treasury Department and 
the IRS have determined that the ordinary course rule in the final 
regulations provides an appropriate and effective limit on the scope of 
the definition. Specifically, the Treasury Department and the IRS have 
determined that these transactions are rarely entered into outside the 
payor's ordinary course of business, and that any such non-ordinary 
course transactions likely would involve an intention to avoid section 
163(j).
iii. Commitment Fees
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(G)(1) treats any fees in 
respect of a lender commitment to provide financing as interest if any 
portion of such financing is actually provided. Commenters recommended 
that commitment fees and other debt-related fees not be included in the 
definition of interest until general substantive guidance is provided 
on the treatment of the fees in the separate fee-related project on the 
Office of Tax Policy and IRS 2019-2020 Priority Guidance Plan (REG-
132517-17). According to the commenters, uncertainty exists as to 
whether to characterize these fees for Federal income tax purposes as 
fees for services or property or for compensation for the use or 
forbearance of money. In addition, under existing guidance, commitment 
fees are treated differently by the borrower (similar to an option 
premium) and the lender (service income). See Rev. Rul. 81-160, 1981-1 
C.B. 312, and Rev. Rul. 70-540, 1970-2 C.B. 101, Situation (3). Some 
taxpayers, however, argue that a commitment fee should be treated as 
creating or increasing discount on a debt instrument and that the fee 
should be treated consistently by both the borrower and the lender. If 
commitment fees are included in the definition of interest in the final 
regulations, commenters recommended that only the portion of the 
commitment fee that is proportionate to the amount drawn be treated as 
interest.
    In response to comments, the final regulations do not include 
commitment fees in the definition of interest. The treatment of 
commitment fees and other fees paid in connection with lending 
transactions will be addressed in future guidance that applies for all 
purposes of the Code.
iv. Debt Issuance Costs
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(H) treats debt issuance costs 
as interest expense of the issuer. Commenters argued that debt issuance 
costs should not be treated as interest expense because these costs are 
paid to third parties in connection with the issuance of debt and are 
not paid or incurred for the use or forbearance of money under a debt 
instrument. For tax purposes, these costs are capitalized by the issuer 
and are treated as deductible under section 162 over the term of the 
debt instrument as if the costs adjust the instrument's yield by 
reducing the instrument's issue price by the amount of the costs. See 
Sec.  1.446-5.
    In response to comments, the final regulations exclude debt 
issuance costs from the definition of interest.
v. Guaranteed Payments
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(I) provides that any 
guaranteed payments for the use of capital under section 707(c) are 
treated as interest. Some commenters stated that a guaranteed payment 
for the use of capital should not be treated as interest for purposes 
of section 163(j) unless the guaranteed payment was structured with a 
principal purpose of circumventing section 163(j). Other commenters 
stated that section 163(j) never should apply to guaranteed payments 
for the use of capital.
    In response to comments, the final regulations do not explicitly 
include guaranteed payments for the use of capital under section 707(c) 
in the definition of interest. However, consistent with the 
recommendations of some commenters, the anti-avoidance rules in Sec.  
1.163(j)-1(b)(22)(iv) (described in part II(E)(4) of this Summary of 
Comments and Explanation of Revisions section) include an example of a 
situation in which a guaranteed payment for the use of capital is 
treated as interest expense and interest income for purposes of section 
163(j). See Sec.  1.163(j)-1(b)(22)(v)(E), Example 5.

[[Page 56700]]

vi. Hedging Transactions
    Proposed Sec.  1.163(j)-1(b)(20)(iii)(E) generally treats income, 
deduction, gain, or loss from a derivative that alters a taxpayer's 
effective cost of borrowing with respect to a liability of the taxpayer 
as an adjustment to the taxpayer's interest expense. Proposed Sec.  
1.163(j)-1(b)(20)(iii)(F) generally treats income, deduction, gain, or 
loss from a derivative that alters a taxpayer's effective yield with 
respect to a debt instrument held by the taxpayer as an adjustment to 
the taxpayer's interest income. The rules in the two provisions are 
referred to as the ``hedging rules'' in this preamble.
    Numerous comments were received on the hedging rules. The 
commenters questioned the administrability of the broad hedging rules, 
especially if the taxpayer hedges on a macro (that is, on an aggregate) 
basis. Also, the commenters noted that it is not clear how to apply the 
rules in certain situations, including a situation in which the hedge 
relates to non-debt items (for example, if the taxpayer hedges the 
mismatch or ``gap'' between its assets and liabilities), the debt 
instrument is not subject to section 163(j), or the debt instrument is 
subject to other interest deferral provisions for Federal tax purposes. 
In addition, the commenters noted that the proposed regulations 
effectively would require integration, even if the hedge otherwise 
would not be integrated with the debt instrument for Federal tax 
purposes and the income, deduction, gain, and loss from the hedge 
ordinarily would be accounted for separately, which the commenters 
suggested would require taxpayers to maintain two sets of books. 
Moreover, the commenters stated that, under the proposed regulations, 
any gain or loss on the underlying debt instrument (for example, due to 
changes in interest rates) would not be treated as an adjustment to 
interest income or expense, whereas the corresponding loss or gain on 
the hedge would be treated as an adjustment to interest expense or 
income. Some commenters stated that the yield on third-party borrowings 
reflects the true cost of the borrowing, and that hedges are not 
relevant to the cost of the borrowing.
    Commenters recommended that, if the hedging rules are retained in 
the final regulations as a separate item, the final regulations 
precisely define (a) what standard is used to include a derivative in 
section 163(j) (for example, a primary purpose or principal motivation 
standard), and (b) the standard for determining whether the effect of a 
derivative on the cost of borrowing or effective yield is sufficiently 
significant for the income, deduction, gain, or loss from the 
derivative to be included in the computation. Commenters noted that one 
approach would be to apply the hedging rules only to derivatives that 
qualify for integration under Sec.  1.988-5 or Sec.  1.1275-6. Another 
approach would be to apply the hedging rules to derivatives that have a 
sufficiently close connection with the liability to qualify as hedging 
transactions under Sec. Sec.  1.446-4 and 1.1221-2. Some commenters 
indicated that the hedging rules could apply if the derivative is 
treated as a hedge of a borrowing or liability for financial reporting 
purposes, and that the hedging rules should not apply to broker-
dealers, active traders in derivatives, and financial institutions 
acting in the ordinary course of business.
    One commenter recommended that section 163(j) not alter the timing 
of taxable items from hedging transactions that are subject to Sec.  
1.446-4, regardless of whether interest expense on the hedged item is 
deferred under section 163(j). Other commenters noted that the proposed 
regulations do not provide guidance on the interaction between the 
hedging rules and the straddle rules.
    With respect to foreign currency hedging transactions, a commenter 
noted that foreign currency gain or loss is due to the time value of 
money only to a limited extent; thus, the commenter recommended that 
section 163(j) not apply to a taxpayer's foreign currency hedging 
transactions (other than an integrable transaction under Sec.  1.988-
5).
    In response to comments, the final regulations do not include the 
hedging rules in the definition of interest. However, in certain 
circumstances, the anti-avoidance rules in Sec.  1.163(j)-1(b)(22)(iv) 
(described in part II(E)(4) of this Summary of Comments and Explanation 
of Revisions section) may apply to require income, deduction, gain, or 
loss from a hedging transaction to be taken into account for purposes 
of section 163(j).
vii. Other Items
    Commenters recommended other items to be included in, or excluded 
from, the definition of interest as follows:
a. Dividends From Regulated Investment Company (RIC) Shares
    Some commenters recommended that dividend income from a RIC be 
treated as interest income for a shareholder in a RIC, to the extent 
that the dividend is attributable to interest income earned by the RIC. 
To address this comment, in the Concurrent NPRM, the Treasury 
Department and the IRS have proposed rules under which a RIC that earns 
business interest income may pay section 163(j) interest dividends that 
certain shareholders may treat as interest income for purposes of 
section 163(j). See paragraphs (b)(22)(iii)(F) and (b)(35) in proposed 
Sec.  1.163(j)-1 in the Concurrent NPRM.
b. MMF Income
    A few commenters recommended that the final regulations allow look-
through treatment for earnings from certain foreign entities, such as 
foreign money market funds (MMFs), so that dividends from foreign MMFs 
would be treated as interest income to the extent the underlying income 
derived by a foreign MMF was interest income. According to the 
commenters, this treatment would alleviate issues for a CFC that 
borrows money from related parties and invests in foreign MMFs. In 
general, the commenters stated that any interest limitation under 
section 163(j) could lead to unexpected results in this situation, such 
as section 952(c) recapture accounts solely generated by the section 
163(j) interest expense limitation.
    The final regulations do not adopt this recommendation because it 
is beyond the scope of the final regulations and because there are 
significant differences between the rules governing income inclusions 
in respect of passive foreign investment companies (PFICs), such as 
foreign MMFs, and RICs. These differences make it difficult to adopt a 
rule that would provide for look-through treatment in the context of 
dividends or inclusions from a PFIC. In particular, the regime for 
taxing income from a PFIC that shareholders have elected to treat as a 
qualified electing fund (QEF) under section 1295 generally focuses only 
on inclusions related to ordinary income or net capital gain income and 
does not separately report amounts of interest income for Federal 
income tax purposes. In the case of a PFIC for which a QEF election has 
not been made, there would be no information about the underlying 
taxable income of the PFIC and no reason or ability to treat an 
interest in the PFIC differently from the treatment of stock held in 
other C corporations.
c. Negative Interest
    One commenter requested clarification on the treatment of negative 
interest (an amount that a depositor may owe a bank in a negative 
interest rate environment) and inquired whether such payments are more 
similar to payments for custodial or service fees rather than for 
interest. The final

[[Page 56701]]

regulations do not address this issue because it is beyond the scope of 
the final regulations. However, in certain cases (for example, a 
Treasury bill acquired with a negative yield), a payment may be treated 
as bond premium subject to the rules in section 171, including the 
rules in Sec.  1.171-2(a)(4)(i)(C).
d. Leases
    A commenter recommended that the Treasury Department and the IRS 
adopt rules that clearly describe the circumstances in which fleet 
leases are treated as generating interest for purposes of section 
163(j). The commenter noted that there is a time-value-of-money portion 
of a fleet lease payment similar to the time-value-of-money portion of 
other items treated as interest under the proposed regulations, such as 
guaranteed payments, commitment fees, debt issuance costs, and items of 
income or loss from a derivative instrument that alters a taxpayer's 
effective yield or effective cost of borrowing. In addition, to the 
extent that the anti-avoidance rule in the proposed regulations is 
retained, the commenter asked that the final regulations clearly define 
the circumstances (if any) in which the anti-avoidance rule would 
operate to recharacterize any portion of a fleet lease payment as 
interest expense, and modify the anti-avoidance rule to apply to both 
interest expense of the fleet lessee and interest income of the fleet 
lessor.
    The Treasury Department and the IRS do not adopt the commenter's 
suggestions in the final regulations because the suggestions generally 
are no longer relevant after the revisions made to the definition of 
interest in the final regulations. For example, as explained in this 
part II(E)(3) of this Summary of Comments and Explanation of Revisions 
section, no portion of the items generally cited by the commenter is 
explicitly treated as interest in the final regulations. Moreover, 
there are explicit provisions in the Code that determine whether a 
portion of a lease payment is treated as interest for Federal income 
tax purposes depending on the terms of a lease, such as sections 467 
and 483. In addition, as explained in part II(E)(4) of this Summary of 
Comments and Explanation of Revisions section, the anti-avoidance rule 
in the final regulations is revised to include a principal purpose test 
and to generally align the treatment of income and expense, which 
should address the commenter's concerns.
4. Anti-Avoidance Rule for Amounts Predominantly Associated With the 
Time Value of Money
    Proposed Sec.  1.163(j)-1(b)(20)(iv) provides that 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. Numerous comments 
were received on this anti-avoidance rule in the proposed regulations. 
Most commenters recommended that any anti-avoidance rule in the final 
regulations contain a requirement that the taxpayer have a principal 
purpose to avoid section 163(j). Several commenters asserted that the 
anti-avoidance rule should cover only transactions that are 
economically equivalent to interest and should set forth examples of 
transactions that are and are not covered. Most commenters recommended 
that the anti-avoidance rule be symmetrical and apply to income or 
gain, as well as to expense or loss. One commenter suggested that, 
based on section 1258 concepts, the anti-avoidance rule should apply 
only if, at the time of the relevant transaction or series of 
transactions that secure the use of funds for a period of time for the 
taxpayer, substantially all of the expense or loss was expected to be 
attributable to the time value of money. In addition, commenters noted 
that it should be clear when a taxpayer should test whether a 
transaction falls within the anti-avoidance rule. Other commenters 
requested specific rules coordinating this anti-avoidance rule with the 
general anti-avoidance rule in proposed Sec.  1.163(j)-2(h).
    Some commenters stated that an interest anti-avoidance rule should 
not be included in the final regulations because, for example, the rule 
would impose substantial compliance costs, the Treasury Department and 
the IRS have other tools to combat any abuse, and there already is a 
general anti-avoidance rule in proposed Sec.  1.163(j)-2(h). Commenters 
also noted that the interest anti-avoidance rule in the proposed 
regulations has the potential to capture ordinary market transactions 
that possess a time value component but that are not generally treated 
as financings with disguised interest for tax purposes.
    In response to comments, the Treasury Department and the IRS have 
modified the anti-avoidance rule in the final regulations. Under Sec.  
1.163(j)-1(b)(22)(iv)(A)(1), any expense or loss economically 
equivalent to interest is treated as interest expense for purposes of 
section 163(j) if a principal purpose of structuring the transaction(s) 
is to reduce an amount incurred by the taxpayer that otherwise would 
have been interest expense or treated as interest expense under Sec.  
1.163(j)-1(b)(22)(i) through (iii). For this purpose, the fact that the 
taxpayer has a business purpose for obtaining the use of funds does not 
affect the determination of whether the manner in which the taxpayer 
structures the transaction(s) is with a principal purpose of reducing 
the taxpayer's interest expense. In addition, the fact that the 
taxpayer has obtained funds at a lower pre-tax cost based on the 
structure of the transaction(s) does not affect the determination of 
whether the manner in which the taxpayer structures the transaction(s) 
is with a principal purpose of reducing the taxpayer's interest 
expense.
    For purposes of Sec.  1.163(j)-1(b)(22)(iv)(A)(1), any expense or 
loss is economically equivalent to interest to the extent that the 
expense or loss is (1) deductible by the taxpayer; (2) incurred by the 
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; (3) substantially incurred in consideration of the time 
value of money; and (4) not described in Sec.  1.163(j)-1(b)(22)(i), 
(ii), or (iii).
    Under Sec.  1.163(j)-1(b)(22)(iv)(A)(2), if a taxpayer knows that 
an expense or loss is treated by the payor as interest expense under 
Sec.  1.163(j)-1(b)(22)(iv)(A)(1), the taxpayer provides the use of 
funds for a period of time in the transaction(s) subject to Sec.  
1.163(j)-1(b)(22)(iv)(A)(1), the taxpayer earns income or gain with 
respect to the transaction(s), and such income or gain is substantially 
earned in consideration of the time value of money provided by the 
taxpayer, such income or gain is treated as interest income for 
purposes of section 163(j) to the extent of the expense or loss treated 
by the payor as interest expense under Sec.  1.163(j)-
1(b)(22)(iv)(A)(1).
    Under Sec.  1.163(j)-1(b)(22)(iv)(B), notwithstanding Sec.  
1.163(j)-1(b)(22)(i) through (iii), any income realized by a taxpayer 
in a transaction or series of integrated or related transactions is not 
treated as interest income of the taxpayer for purposes of section 
163(j) if and to the extent that a principal purpose for structuring 
the transaction(s) is to artificially increase the taxpayer's business 
interest income. For this purpose, the fact that the

[[Page 56702]]

taxpayer has a business purpose for holding interest-generating assets 
does not affect the determination of whether the manner in which the 
taxpayer structures the transaction(s) is with a principal purpose of 
artificially increasing the taxpayer's business interest income.
    For purposes of the foregoing anti-avoidance rules, Sec.  1.163(j)-
1(b)(22)(iv)(C) provides that whether a transaction or a series of 
integrated or related transactions is entered into with a principal 
purpose depends on all the facts and circumstances related to the 
transaction(s), except that the fact that the taxpayer has obtained 
funds at a lower pre-tax cost based on the structure of the 
transaction(s) or the fact that the taxpayer has a business purpose 
related to the item is ignored for this purpose. A purpose may be a 
principal purpose even though it is outweighed by other purposes taken 
together or separately. Factors to be taken into account in determining 
whether one of the taxpayer's principal purposes for entering into the 
transaction(s) include the taxpayer's normal borrowing rate in the 
taxpayer's functional currency, whether the taxpayer would enter into 
the transaction(s) in the ordinary course of the taxpayer's trade or 
business, whether the parties to the transaction(s) are related persons 
(within the meaning of section 267(b) or section 707(b)), whether there 
is a significant and bona fide business purpose for the structure of 
the transaction(s), whether the transactions are transitory, for 
example, due to a circular flow of cash or other property, and the 
substance of the transaction(s).
    In response to comments, Sec.  1.163(j)-1(b)(22)(iv)(D) provides 
that the anti-avoidance rules in Sec.  1.163(j)-1(b)(22)(iv), rather 
than the general anti-avoidance rules in Sec.  1.163(j)-2(j), apply to 
determine whether an item is treated as interest expense or interest 
income.
    Section 1.163(j)-1(b)(22)(v) contains examples illustrating the 
application of the interest anti-avoidance rules in a number of 
situations, including examples relating to a hedging transaction 
involving a foreign currency swap transaction, a forward contract 
involving gold, a loan guaranteed by a related party in which the 
related party receives guarantee fees, and guaranteed payments for the 
use of capital. However, these examples are not intended to represent 
the only situations in which the anti-avoidance rules might apply.
    The anti-avoidance rules in Sec.  1.163(j)-1(b)(22)(iv) apply to 
transactions entered into on or after September 14, 2020. See Sec.  
1.163(j)-1(c)(2).
5. Authority Comments
    Most of the commenters on the definition of interest in the 
proposed regulations questioned whether the Treasury Department and the 
IRS have the authority to expand the definition of interest for 
purposes of section 163(j) to include ``interest equivalents'' (the 
items listed in proposed Sec.  1.163(j)-1(b)(20)(iii) and the expenses 
or losses subject to the anti-avoidance rule in proposed Sec.  
1.163(j)-1(b)(20)(iv)). The commenters asserted that the term 
``business interest'' in section 163(j)(5) means any interest paid or 
accrued on indebtedness properly allocable to a trade or business, and 
that expanding the definition to include interest equivalents would 
capture amounts that do not fall within the scope of the general rule 
in section 163(a) that ``[t]here shall be allowed as a deduction all 
interest paid or accrued within the taxable year on indebtedness.'' 
Even though section 163(j)(1) refers to an ``amount allowed as a 
deduction under this chapter for business interest'' when describing 
the amounts limited by section 163(j), the commenters argued that the 
deduction otherwise allowed must be with respect to ``business 
interest'' (which is defined in section 163(j)(5)) and that the phrase 
``deduction under this chapter'' does not and should not modify the 
definition of ``business interest'' in section 163(j)(5).
    The commenters noted that section 163(j), as amended by the TCJA, 
does not contain a specific delegation of regulatory authority to 
expand the definition of interest. The commenters further asserted that 
the Treasury Department and the IRS may issue only ``interpretive 
regulations'' under section 7805, and that any such regulations may not 
go beyond the stated meaning of the statutory language. The commenters 
noted that old section 163(j)(9) provided broad regulatory authority to 
prescribe regulations, including regulations appropriate to prevent the 
avoidance of old section 163(j). In addition, the commenters noted that 
the legislative history for old section 163(j) indicated that the 
Treasury Department could issue guidance treating ``items not 
denominated as interest but appropriately characterized as equivalent 
to interest'' as interest income or interest expense. The commenters 
stated that there is no similar regulatory authority or legislative 
history relating to section 163(j) as amended by the TCJA.
    Commenters also noted that, when Congress has chosen to expand the 
definition of interest in other parts of the Code, Congress has done so 
explicitly. For example, section 263(g) provides that, ``[for purposes 
of section 263(g)(2)(A)], the term `interest' includes any amount paid 
or incurred in connection with personal property used in a short 
sale.'' As noted in the preamble to the proposed regulations, most of 
the rules treating interest equivalent items as interest income or 
expense in proposed Sec.  1.163(j)-1(b)(20)(iii) were developed in 
Sec. Sec.  1.861-9T and 1.954-2. However, commenters argued that the 
use of the interest equivalent provisions in Sec. Sec.  1.861-9T and 
1.954-2 by analogy to define interest for purposes of section 163(j) is 
inappropriate because different policy considerations underlie those 
sections, there is statutory or regulatory authority to address 
interest equivalents under those sections (unlike section 163(j)), and 
those sections apply only for limited purposes (for example, for 
sourcing purposes).
    In addition, because the broad definition of interest in the 
proposed regulations applies only for purposes of section 163(j), 
commenters asserted that there will be additional compliance burdens 
and costs for taxpayers to separately track amounts treated as interest 
for purposes of section 163(j) and for other purposes. Commenters 
asserted that the broad definition of interest for purposes of section 
163(j) in the proposed regulations may create uncertainty and confusion 
for taxpayers with respect to other sections of the Code.
    Contrary to the assertions made by many of the commenters, the 
Treasury Department and the IRS have the authority to prescribe rules 
relating to interest equivalents and an anti-avoidance rule. As noted 
in the preamble to the proposed regulations, there are no generally 
applicable regulations or statutory provisions addressing when 
financial instruments are treated as indebtedness for Federal income 
tax purposes or when a payment is ``interest.'' Therefore, a regulatory 
definition of interest is needed in order to implement the statutory 
language of section 163(j).
    In addition, it would be inconsistent with the purpose of section 
163(j) to allow transactions that are essentially financing 
transactions to avoid the application of section 163(j). Thus, an anti-
avoidance rule is needed to address situations in which a taxpayer's 
principal purpose in structuring a transaction or series of 
transactions is to artificially reduce the taxpayer's business interest 
expense or to increase the taxpayer's business interest income. 
Moreover, at least one commenter suggested the inclusion of the type of

[[Page 56703]]

anti-avoidance rule that is included in the final regulations and that 
the Treasury Department and the IRS have the authority to include such 
a rule.
    Section 7805(a) provides the Treasury Department and the IRS with 
the authority to prescribe all rules and regulations needed for 
enforcement of the Code, including all rules and regulations as may be 
necessary by reason of any alteration of law in relation to internal 
revenue. Providing a regulatory definition of interest for purposes of 
section 163(j) and the anti-avoidance rule falls within this authority. 
The statutory language of section 163(j)(1) (``The amount allowed as a 
deduction under this chapter for any taxable year for business interest 
. . .'') (emphasis added) also supports the application of section 
163(j) to more items than merely items traditionally deducted under 
section 163(a).
    Although the Treasury Department and the IRS have the authority to 
prescribe regulations addressing interest equivalents and anti-
avoidance transactions, as noted earlier in parts II(E)(3) and (4) of 
this Summary of Comments and Explanation of Revisions section, in 
response to comments, the final regulations nevertheless limit the 
interest equivalent items to those items commenters agreed should be 
treated as interest expense or interest income, substitute interest 
payments made in connection with a sale-repurchase agreement or 
securities lending transaction that is not entered into by the taxpayer 
in the taxpayer's ordinary course of business, and certain amounts 
relating to transaction(s) entered into by a taxpayer with a principal 
purpose of artificially reducing interest expense or increasing 
interest income.

F. Definition of Motor Vehicle--Proposed Sec.  1.163(j)-1(b)(25)

    Proposed Sec.  1.163(j)-1(b)(25) provides that the term ``motor 
vehicle'' means a motor vehicle as defined in section 163(j)(9)(C). 
Under section 163(j)(9)(C), a motor vehicle means any self-propelled 
vehicle designed for transporting persons or property on a public 
street, highway, or road; a boat; and farm machinery or equipment. A 
few commenters questioned whether towed recreational vehicles and 
trailers are included in the definition of ``motor vehicle.'' One 
commenter requested that the final regulations define motor vehicle to 
include any trailer or camper that is designed to provide temporary 
living quarters for recreational, camping, travel, or seasonal use and 
is designed to be towed by, or affixed to, a motor vehicle. Another 
commenter recommended allowing motor vehicle dealers to deduct floor 
plan financing interest on both motor vehicles and trailers that are 
offered for sale in integrated or related businesses.
    Because section 163(j)(9)(C) specifically defines motor vehicles as 
self-propelled vehicles, the Treasury Department and the IRS do not 
have the authority to expand the definition of motor vehicles in the 
final regulations to include vehicles that are not self-propelled, such 
as towed recreational vehicles and trailers. For this reason, the 
Treasury Department and the IRS decline to adopt these comments in the 
final regulations. Therefore, the definition of motor vehicles in the 
final regulations continues to incorporate the definition in section 
163(j)(9)(C) by cross-reference.

G. Definition of Taxable Income--Proposed Sec.  1.163(j)-1(b)(37)

1. Calculation of Taxable Income
    Proposed Sec.  1.163(j)-1(b)(1)(i)(A) provides that business 
interest expense is added to taxable income to determine ATI. Some 
commenters noted that this provision could be construed as distorting 
ATI if a taxpayer has a disallowed business interest expense 
carryforward from a prior taxable year. Under such facts, the proposed 
regulations would not have reduced taxable income by the amount of the 
carryforward, because proposed Sec.  1.163(j)-1(b)(37) disregards the 
carryforward as part of section 163(j) and the section 163(j) 
regulations. However, in calculating ATI, taxpayers might argue that 
taxable income should be increased by the amount of the disallowed 
business interest expense carryforward because the term ``business 
interest expense'' in the proposed regulations includes disallowed 
business interest expense carryforwards.
    The Treasury Department and the IRS did not intend to create a net 
positive adjustment to ATI for disallowed business interest expense 
carryforwards. To address this potential distortion, the final 
regulations clarify that tentative taxable income is computed without 
regard to the section 163(j) limitation, and that disallowed business 
interest expense carryforwards are not added to tentative taxable 
income in computing ATI under Sec.  1.163(j)-1(b)(1).
2. Interaction With Section 250
    Proposed Sec.  1.163(j)-1(b)(37)(ii) provides a rule to coordinate 
the application of sections 163(j) and 250. Section 250(a)(1) generally 
provides a deduction based on the amount of a domestic corporation's 
foreign-derived intangible income and GILTI. Section 250(a)(2) limits 
the amount of this deduction based on the taxpayer's taxable income--
the greater the amount of a taxpayer's taxable income for purposes of 
section 250(a)(2), the greater the amount of the taxpayer's allowable 
deduction under section 250(a)(1).
    In particular, proposed Sec.  1.163(j)-1(b)(37)(ii) provides that, 
if a taxpayer is allowed a deduction for a taxable year under section 
250(a)(1) that is properly allocable to a non-excepted trade or 
business, then the taxpayer's taxable income for that year is 
determined without regard to the limitation in section 250(a)(2). Some 
commenters observed that this proposed rule results in a lower ATI and 
section 163(j) limitation for the taxpayer than if the limitation in 
section 250(a)(2) were taken into account. Commenters also stated that 
the rationale for this approach (which does not reflect the taxpayer's 
actual taxable income) is unclear, and they recommended that this 
provision be withdrawn or made elective for taxpayers.
    The Treasury Department and the IRS have determined that further 
study is required to determine the appropriate rule for coordinating 
sections 250(a)(2), 163(j), and other Code provisions (such as sections 
170(b)(2) and 172(a)(2)) that limit the availability of deductions 
based, directly or indirectly, upon a taxpayer's taxable income 
(taxable income-based provisions). Therefore, the final regulations do 
not contain the rule in proposed Sec.  1.163(j)-1(b)(37)(ii). Until 
such additional guidance is effective, taxpayers may choose any 
reasonable approach (which could include an ordering rule or the use of 
simultaneous equations) for coordinating taxable income-based 
provisions as long as such approach is applied consistently for all 
relevant taxable years. For this purpose, the ordering rule contained 
in proposed Sec. Sec.  1.163(j)-1(b)(37)(ii) (83 FR 67490 (Dec. 28, 
2018)) and 1.250(a)-1(c)(4) (contained in 84 FR 8188 (March 6, 2019)) 
is treated as a reasonable approach for coordinating sections 163(j) 
and 250. Comments are welcome on what rules should be provided, and 
whether an option to use simultaneous equations in lieu of an ordering 
rule would be appropriate in order to coordinate taxable income-based 
provisions.
3. When Disallowed Business Interest Expense Is ``Paid or Accrued''
    As noted in the Background section of this preamble, section 
163(j)(2) provides that the amount of any business interest not allowed 
as a deduction for any

[[Page 56704]]

taxable year under section 163(j)(1) is treated as business interest 
``paid or accrued'' in the succeeding taxable year. Commenters asked 
for clarification as to whether disallowed business interest expense 
should be treated as ``paid or accrued'' in the taxable year in which 
such expense is taken into account for Federal income tax purposes 
(without regard to section 163(j)), or whether such expense instead 
should be treated as paid or accrued in the succeeding taxable year in 
which the expense can be deducted by the taxpayer under section 163(j).
    For purposes of section 163(j) and the section 163(j) regulations, 
the term ``paid or accrued'' in section 163(j)(2) must be construed in 
such a way as to further congressional intent. Although the use of this 
term in section 163(j)(2) provides a mechanism for disallowed business 
interest expense to be carried forward to and deducted in a subsequent 
taxable year, it does not mean that a disallowed business interest 
expense carryforward is treated as paid or accrued in a subsequent year 
for all purposes. In certain contexts, a disallowed business interest 
expense must be treated as paid or accrued in the year the expense was 
paid or accrued without regard to section 163(j) to give effect to 
congressional intent. For example, if a disallowed business interest 
expense were treated as paid or accrued only in a future taxable year 
in which such expense could be deducted after the application of 
section 163(j), then section 382 never would apply to such expense 
(because disallowed business interest expense carryforwards never would 
be pre-change losses). This outcome is clearly contrary to 
congressional intent (see section 382(d)(3)). Similarly, if a 
disallowed business interest expense were treated as paid or accrued in 
a future taxable year for purposes of section 163(j)(8)(A)(ii), then 
such expense would be added back to tentative taxable income in 
determining ATI for that taxable year (and for all future taxable years 
to which such expense is carried forward under section 163(j)(2)), 
thereby artificially increasing the taxpayer's section 163(j) 
limitation. (See part II(A) of this Summary of Comments and Explanation 
of Revisions section.) This outcome also is inconsistent with 
congressional intent. However, in other contexts, a disallowed business 
interest expense must be treated as paid or accrued in a succeeding 
taxable year to allow for the deduction of the carryforward in that 
year.
    The definition of ``disallowed business interest expense'' has been 
revised in the final regulations to reflect that, solely for purposes 
of section 163(j) and the section 163(j) regulations, disallowed 
business interest expense is treated as ``paid or accrued'' in the 
taxable year in which the expense is taken into account for Federal 
income tax purposes (without regard to section 163(j)), or in a 
succeeding taxable year in which the expense can be deducted by the 
taxpayer under section 163(j), as the context may require.
4. Interaction With Sections 461(l), 465, and 469--Proposed Sec.  
1.163(j)-1(b)(37)
    The Treasury Department and the IRS received questions asking for 
clarification of the interaction between proposed Sec.  1.163(j)-
1(b)(37) and the limitations in sections 461(l), 465, and 469. The 
final regulations clarify that sections 461(l), 465, and 469 are taken 
into account when determining tentative taxable income. Then, as 
provided in proposed Sec.  1.163(j)-3(b)(4), sections 461(l), 465, and 
469 are applied after the application of the section 163(j) limitation. 
See part II(B) of this Summary of Comments and Explanation of Revisions 
section.

H. Definition of Trade or Business--Proposed Sec.  1.163(j)-1(b)(38)

1. In General
    The section 163(j) limitation applies to taxpayers with ``business 
interest,'' which is defined in section 163(j)(5) as any interest 
properly allocable to a trade or business. Neither section 163(j) nor 
the legislative history defines the term ``trade or business.'' 
However, section 163(j)(7) provides that the term ``trade or business'' 
does not include the trade or business of performing services as an 
employee, as well as electing real property, electing farming, and 
certain utility trades or businesses.
    As described in the preamble to the proposed regulations, the 
proposed regulations define the term ``trade or business'' by reference 
to section 162. Section 162(a) permits a deduction for all the ordinary 
and necessary expenses paid or incurred in carrying on a trade or 
business. Commenters requested additional guidance in determining 
whether an activity constitutes a section 162 trade or business.
    The rules under section 162 for determining the existence of a 
trade or business are well-established and illustrated through a large 
body of case law and administrative guidance. Additionally, whether an 
activity is a section 162 trade or business is inherently a factual 
question. Higgins v. Commissioner, 312 U.S. 212, 217 (1941) 
(determining ``whether the activities of a taxpayer are `carrying on a 
business' requires an examination of the facts in each case'').
    The courts have developed two definitional requirements. One, in 
relation to profit motive, requires the taxpayer to enter into and 
carry on the activity with a good-faith intention to make a profit or 
with the belief that a profit can be made from the activity. The 
second, in relation to the scope of the activities, requires 
considerable, regular, and continuous activity. See generally 
Commissioner v. Groetzinger, 480 U.S. 23 (1987). In the seminal case of 
Groetzinger, the Supreme Court stated that, ``[w]e do not overrule or 
cut back on the Court's holding in Higgins when we conclude that if 
one's gambling activity is pursued full time, in good faith, and with 
regularity, to the production of income for a livelihood, and is not a 
mere hobby, it is a trade or business within the meaning of the 
statutes with which we are here concerned.'' Id. at 35.
2. Multiple Trades or Businesses Within an Entity
    Commenters also suggested there should be factors to determine how 
to delineate separate section 162 trades or businesses within an entity 
and when an entity's combined activities should be considered a single 
section 162 trade or business for purposes of section 163(j). One 
commenter suggested adopting the rules for separate trades or 
businesses provided in section 446 and the regulations thereunder.
    The Treasury Department and the IRS decline to adopt these 
recommendations because specific guidance under section 162 is beyond 
the scope of the final regulations. Further, Sec.  1.446-1(d) does not 
provide guidance on when trades or businesses will be considered 
separate and distinct. Instead, it provides that a taxpayer may use 
different methods of accounting for separate and distinct trades or 
businesses, and it specifies two circumstances in which trades or 
businesses will not be considered separate and distinct. For example, 
Sec.  1.446-1(d)(2) provides that no trade or business will be 
considered separate and distinct unless a complete and separable set of 
books and records is kept for such trade or business.
    The Treasury Department and the IRS recognize that an entity can 
conduct more than one trade or business under section 162. This 
position is inherent in the allocation rules detailed in proposed Sec.  
1.163(j)-10(c)(3), which require a taxpayer with an asset used in more 
than one trade or business to allocate its adjusted basis in the asset 
to each trade or business using the permissible methodology described 
therein. In this

[[Page 56705]]

context, the final regulations provide, consistent with the proposed 
regulations, that maintaining separate books and records for all 
excepted and non-excepted trades or businesses is one indication that a 
particular asset is used in a particular trade or business.
    Whether an entity has multiple trades or businesses is a factual 
determination, and numerous court decisions that define the meaning of 
``trade or business'' also provide taxpayers guidance in determining 
whether more than one trade or business exists. See Groetzinger, 480 
U.S. at 35. For example, some court decisions discuss whether the 
activities have separate books and records, facilities, locations, 
employees, management, and capital structures, and whether the 
activities are housed in separate legal entities.
    Accordingly, the final regulations define ``trade or business'' as 
a trade or business within the meaning of section 162, which should aid 
taxpayers in the proper allocation of interest expense, interest 
income, and other tax items to a trade or business and to an excepted 
or non-excepted trade or business.
3. Rental Real Estate Activities as a Trade or Business
    See the discussion of elections for real property trades or 
businesses that may not qualify as section 162 trades or businesses in 
part X of this Summary of Comments and Explanation of Revisions 
section.
4. Separate Entities
    One commenter requested clarification that the determination of 
whether an entity generates interest attributable to a trade or 
business within the meaning of section 162 is made at the entity level 
without regard to the classification of the entity's owners. Except in 
the context of a consolidated group, or if Sec.  1.163(j)-10 provides 
otherwise, the determination of whether an entity generates interest 
and whether such interest is properly allocable to a trade or business 
is determined at the entity level, without regard to the classification 
of the entity's owners. See also the discussion of trading partnerships 
and CFC groups in the Concurrent NPRM.
I. Applicability Dates
    The proposed regulations provide generally that the final 
regulations would apply to taxable years ending after the date that 
this Treasury Decision is published in the Federal Register. The 
proposed applicability date has been changed in the final regulations 
to avoid the application of the changes reflected in the final 
regulations to a taxpayer at the end of the taxable year, which may 
result in unexpected effects on the taxpayer under section 163(j). 
Accordingly, the final regulations generally apply to taxable years 
beginning on or after the date that is 60 days after the date that this 
Treasury Decision is published in the Federal Register.

III. Comments on and Changes to Proposed Sec.  1.163(j)-2: Deduction 
for Business Interest Expense Limited

    Proposed Sec.  1.163(j)-2 provides general rules regarding the 
section 163(j) limitation, including rules on how to calculate the 
limitation, how to treat disallowed business interest expense 
carryforwards, and how the small business exemption and the aggregation 
rules apply with the limitation. The following discussion addresses 
comments relating to proposed Sec.  1.163(j)-2.

A. Whether the Section 163(j) Limitation Is a Method of Accounting

    A few commenters requested clarification that the section 163(j) 
limitation is not a method of accounting under section 446 and the 
regulations thereunder. The commenters requested clarification on 
whether the application of the section 163(j) limitation is a method of 
accounting because the rules under section 163(j) appear to defer, 
rather than permanently disallow, a deduction for disallowed business 
interest expense and disallowed disqualified interest (as defined in 
proposed Sec.  1.163(j)-1(b)(10)). Specifically, section 163(j)(2) and 
proposed Sec.  1.163(j)-2(c) allow the carryforward of disallowed 
business interest expense, and proposed Sec.  1.163(j)-2(c) allows the 
carryforward of disallowed disqualified interest, to succeeding taxable 
years.
    Section 1.446-1(a)(1) defines the term ``method of accounting'' to 
include not only the overall method of accounting of a taxpayer, but 
also the accounting treatment of any item of gross income or deduction. 
Under Sec.  1.446-1(e)(2)(ii)(a), an accounting method change includes 
a change in the overall plan of accounting for gross income or 
deductions or a change in the treatment of any material item used in 
such overall plan of accounting. Moreover, Sec.  1.446-1(e)(2)(ii)(a) 
provides that a ``material item'' is any item that involves the proper 
time for the inclusion of the item in income or the taking of a 
deduction. The key characteristic of a material item ``is that it 
determines the timing of income or deductions.'' Knight-Ridder 
Newspapers, Inc. v. United States, 743 F.2d 781, 798 (11th Cir. 1984). 
Once a taxpayer has established a method of accounting for an item of 
income or expense, the taxpayer must obtain the consent of the 
Commissioner under section 446(e) before changing to a different method 
of accounting for that item.
    For purposes of Sec.  1.446-1(e)(2)(ii)(a), if there is a change in 
the application of the section 163(j) limitation, the item involved is 
the taxpayer's deduction for business interest expense. The taxpayer is 
not changing its treatment of this item; instead, the taxpayer is 
changing the limitation placed upon that specific item. The effect of 
removing the section 163(j) limitation is that the taxpayer would be 
able to recognize the full amount of the interest expense that is 
otherwise deductible under its accounting method in a given taxable 
year before it was limited by section 163(j).
    The Treasury Department and the IRS do not view the section 163(j) 
limitation as a method of accounting under section 446(e) and the 
regulations thereunder. The determination of whether a taxpayer is 
subject to the section 163(j) limitation is determined for each taxable 
year. The carryover rules in section 163(j)(2) and proposed Sec.  
1.163(j)-2(c) provide that disallowed business interest expense and 
disallowed disqualified interest may be carried forward to a future 
taxable year. However, section 163(j) does not provide a mechanism to 
ensure that, in every situation, a taxpayer will be able to deduct the 
business interest expense that the taxpayer was not permitted to deduct 
in one taxable year and was required to carry forward to succeeding 
taxable years. Thus, the section 163(j) limitation is not a method of 
accounting under Sec.  1.446-1(e)(2)(ii)(a) because the change in 
practice may result in a permanent change in the taxpayer's lifetime 
taxable income. Further, the section 163(j) limitation does not involve 
an ``item'' as it is not a recurring element of income or expense.
B. General Gross Receipts Test and Aggregation
    As noted in the preamble to the proposed regulations, section 
163(j)(3) exempts certain small businesses from the section 163(j) 
limitation. See proposed Sec.  1.163(j)-2(d). Under section 163(j), a 
small business taxpayer is one that meets the gross receipts test in 
section 448(c) and is not a tax shelter under section 448(a)(3). The 
gross receipts test is met if a taxpayer has average annual gross 
receipts for the three taxable years prior to the current taxable year 
of $25 million or less. For

[[Page 56706]]

taxable years beginning after December 31, 2018, the gross receipts 
threshold reflects an annual adjustment for inflation as provided for 
in section 448(c)(4); thus, the gross receipts threshold for taxable 
years beginning in 2020 is $26 million. See section 3.31 of Rev. Proc. 
2019-44, 2019-47 I.R.B.1093. Section 448(c)(2) aggregates the gross 
receipts of multiple taxpayers that are treated as a single employer 
under sections 52(a) and (b) and 414(m) and (o). The gross receipts 
test under section 448(c) normally applies only to corporations and to 
partnerships with C corporation partners. However, section 163(j)(3) 
and proposed Sec.  1.163(j)-2(d)(2)(i) provide that, for a taxpayer 
that is not a corporation or a partnership, the gross receipts test of 
section 448(c) applies as if the taxpayer were a corporation or a 
partnership.
    Some commenters noted that the aggregation rules in sections 52(a) 
and (b) and sections 414(m) and (o) could be difficult to apply in 
certain instances due to their complexity. Other commenters asked that 
the final regulations clarify the application of the aggregation rules 
to the gross receipts test under section 448(c). Addressing the 
application of the aggregation rules to the gross receipts test is 
beyond the scope of the final regulations. The section 52(a) and (b) 
aggregation rules were enacted as part of the work opportunity tax 
credit, but have also been applied to numerous Code provisions, 
including sections 45A, 45S, 264, 280C and 448. The affiliated service 
group rules under section 414(m) were enacted to address certain abuses 
related to qualified retirement plans, but also have been applied to 
several other Code provisions, including sections 45R, 162(m), 414(t), 
4980H, and 4980I.
    However, the Treasury Department and the IRS are aware that the 
aggregation rules set forth in sections 52(a) and (b) and sections 
414(m) and (o) are complex. Therefore, Frequently Asked Questions that 
explain the basic operation of these rules are provided on http://irs.gov/newsroom. See FAQs Regarding the Aggregation Rules Under 
Section 448(c)(2) that Apply to the Section 163(j) Small Business 
Exemption. The Treasury Department and the IRS continue to study the 
application of the aggregation rules to the gross receipts test, and 
request comments on issues relating to such application, taking into 
account the application of the aggregation rules beyond the gross 
receipts test.
    The Treasury Department and the IRS continue to review and consider 
issues relating to the affiliated service group rules under section 
414(m), and a guidance project regarding the aggregation rules under 
section 414(m) is listed on the 2019-2020 Priority Guidance Plan (RIN 
1545-BO34). As guidance is published relating to the affiliated service 
group rules, the FAQs will be updated, taking into account the various 
Code provisions to which these aggregation rules apply.
    In addition, the Treasury Department and the IRS recognize that 
proposed Sec.  1.163(j)-2(d)(2)(i) may generate confusion with respect 
to the aggregation rules. Although section 448(c) applies only to 
corporations and to partnerships with a C corporation partner, sections 
52(a), 52(b), 414(m), and 414(o) apply to a broader array of entities. 
These statutes contain different ownership thresholds for different 
types of entities that apply in determining whether multiple entities 
are treated as a single employer. To resolve potential confusion, the 
final regulations remove the reference to the aggregation rules from 
proposed Sec.  1.163(j)-2(d)(2)(i). Taxpayers that are not a 
corporation or a partnership with a C corporation partner must apply 
section 448(c) as if they were a corporation or a partnership in 
accordance with section 163(j)(3) and proposed Sec.  1.163(j)-
2(d)(2)(i). However, taxpayers should treat themselves as the type of 
entity that they actually are in applying sections 52(a), 52(b), 
414(m), and 414(o).
C. Small Business Exemption and Single Employer Aggregation Rules--
Proposed Sec. Sec.  1.163(j)-2(d) and 1.52-1(d)(1)(i)
    Section 52(b) treats trades or businesses under common control as a 
single employer. Section 1.52-1(b) through (d) defines ``trades or 
businesses under common control'' to include parent-subsidiary groups 
and brother-sister groups. Commenters noted that the version of Sec.  
1.52-1(d)(1)(i) in effect at the time of the proposed regulations 
defined ``brother-sister groups'' to include entities a controlling 
interest in which is owned by the same 5 or fewer people who are 
individuals, estates, or trusts (directly and with the application of 
Sec.  1.414(c)-4(b)(1)).
    Section 1.414(c)-4(b)(1) provides that, if a person has an option 
to purchase an interest in an organization, the person is deemed to own 
an interest in that organization. Other provisions under Sec.  
1.414(c)-4 apply attribution on a broader scale, such as through 
familial relationships and for closely held partnerships and S 
corporations.
    Commenters questioned whether the cross-reference in Sec.  1.52-
1(d)(1)(i) was correct, and whether the cross-reference should have 
been to Sec.  1.414(c)-4 instead of Sec.  1.414(c)-4(b)(1). The 
Treasury Department and the IRS agree that there is no discernible 
reason why Sec.  1.52-1(d)(1)(i) aggregation should be limited solely 
to options holders. Taxpayers need to know how to aggregate gross 
receipts properly in order to know if they are subject to section 
163(j).
    On July 11, 2019, a correcting amendment to T.D. 8179 was published 
in the Federal Register to clarify that the cross-reference in Sec.  
1.52-1(d)(1)(i) should be to Sec.  1.414(c)-4. See 84 FR 33002. This 
correcting amendment should eliminate uncertainty for taxpayers that 
need to determine how to aggregate gross receipts in the context of a 
brother-sister group under common control.
D. Small Business Exemption and Tax Shelters--Proposed Sec.  1.163(j)-
2(d)(1)
    Consistent with section 163(j)(3), proposed Sec.  1.163(j)-2(d)(1) 
provides that the exemption for certain small businesses that meet the 
gross receipts test of section 448(c) does not apply to a tax shelter 
as defined in section 448(d)(3). Several commenters requested 
clarification on the application of the small business exemption under 
section 163(j)(3) to a tax shelter.
    Section 448(d)(3) defines a tax shelter by cross-reference to 
section 461(i)(3), which defines a tax shelter, in relevant part, as a 
syndicate within the meaning of section 1256(e)(3)(B). Section 1.448-
1T(b)(3) provides, in part, that a syndicate is a partnership or other 
entity (other than a C corporation) if more than 35 percent of its 
losses during the taxable year are allocated to limited partners or 
limited entrepreneurs, whereas section 1256(e)(3)(B) refers to losses 
that are allocable to limited partners or limited entrepreneurs. As a 
result, the scope of the small business exemption in section 163(j)(3) 
is unclear. Commenters requested that an entity be a syndicate in a 
taxable year only if it has net losses in that year and more than 35 
percent of those net losses are actually allocated to limited partners 
or limited entrepreneurs. To provide a consistent definition of the 
term ``syndicate'' for purposes of sections 163(j), 448, and 1256, the 
Treasury Department and the IRS propose to define the term 
``syndicate'' using the actual allocation rule from the definition in 
Sec.  1.448-1T(b)(3). This definition is also consistent with the 
definition used in a number of private letter rulings under section 
1256. See proposed Sec.  1.1256(e)-2(a) in the Concurrent NPRM.

[[Page 56707]]

    Commenters also requested specific relief for small business 
taxpayers from the definition of a syndicate based on the ``active 
management'' exception under section 1256(e)(3)(C). Section 
1256(e)(3)(C) lists several examples of interests in an entity that 
``shall not be treated as held by a limited partner or a limited 
entrepreneur,'' thus excluding the entity from the definition of a 
syndicate. In particular, section 1256(e)(3)(C)(v) allows the Secretary 
to determine (by regulations or otherwise) ``that such interest should 
be treated as held by an individual who actively participates in the 
management of such entity, and that such entity and such interest are 
not used (or to be used) for tax-avoidance purposes.''
    The commenters requested that the Treasury Department use its 
authority under section 1256(e)(3)(C)(v) to provide relief from the 
definition of a syndicate to small business entities that (1) qualify 
under the gross receipts test of section 448(c), (2) meet the 
definition of a syndicate, and (3) do not qualify to make an election 
as an electing real property business or electing farming business. If 
a small business satisfies these three conditions, the commenters 
requested that the Treasury Department and the IRS provide a rule that 
all interests in the entity are treated as held by partners or owners 
who actively participate in the management of such entity.
    The Treasury Department and the IRS have determined that the 
request deeming limited partners in small partnerships to be active 
participants even if those owners would not be treated as active 
participants under section 1256(e)(3)(C) is contrary to the statutory 
language and legislative history in section 163(j)(3). Therefore, the 
Treasury Department and the IRS decline to adopt the comments.
    Another commenter asked for clarification on how to compute the 
amount of loss to be tested under Sec.  1.448-1T(b)(3) and section 
1256(e)(3)(B). The commenter provided a particular fact pattern in 
which a small business would be caught in an iterative loop of (a) of 
having net losses due to a business interest deduction, (b) which would 
trigger disallowance of the exemption for small businesses in section 
163(j)(3) if more than 35 percent of the losses were allocated to a 
limited partner, (c) which would trigger the application of the section 
163(j)(1) limitation to reduce the amount of the interest deduction, 
(d) which would then lead to the taxpayer having no net losses and 
therefore being eligible for the application of the exemption for small 
businesses under section 163(j)(3). To address this fact pattern, in 
the Concurrent NPRM, the Treasury Department and the IRS have added an 
ordering rule providing that, for purposes of section 1256(e)(3)(B) and 
Sec.  1.448-1T(b)(3), losses are determined without regard to section 
163(j). See proposed Sec.  1.1256(e)-2(b) and the example provided in 
proposed Sec.  1.1256(e)-2(c) in the Concurrent NPRM.
E. Gross Receipts for Partners in Partnerships and Shareholders of S 
Corporation Stock--Proposed Sec.  1.163(j)-2(d)(2)(iii)
    Proposed Sec.  1.163(j)-2(d)(iii) provides that, in determining 
whether a taxpayer meets the gross receipts test of section 448(c), 
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. Similarly, shareholders of S corporations include a pro 
rata share of the S corporation's gross receipts. See Rev. Rul. 71-455, 
1971-2 C.B. 318 (holding that a partner's distributive share of the 
partnership's gross receipts is used in applying the passive investment 
income test under section 1372(e)(5)).
    This approach would be applicable only in situations in which the 
partner and the partnership (or a shareholder and the S corporation) 
are not treated as one person under the aggregation rules of sections 
52(a) and (b) and 414(m) and (o). The Treasury Department and the IRS 
requested comments in the preamble to the proposed regulations on this 
approach and on whether other approaches to determining the gross 
receipts of partners and S corporation shareholders for purposes of 
section 163(j) would measure the gross receipts of such partners and 
shareholders more accurately.
    In response, several commenters suggested different approaches for 
determining the gross receipts of partners and S corporation 
shareholders. One commenter recommended that a taxpayer should include 
gross receipts only from entities eligible for the small business 
exemption (exempt entities). In other words, the commenter recommended 
that a taxpayer's gross receipts should not include gross receipts from 
(1) any electing real property trade or business or electing farming 
business; (2) any entities utilizing the floor plan financing interest 
exception under section 163(j)(1)(C); and (3) any other entities 
subject to section 163(j). The commenter noted that this modification 
would simplify the computation of gross receipts and prevent the same 
gross receipts from being double-counted both at the entity level and 
the partner or S corporation shareholder level. However, the 
determination of gross receipts generally is not affected by whether 
any other entity is subject to section 163(j).
    One commenter noted that passthrough entities generally do not 
provide information regarding gross receipts to their partners. As it 
is difficult for partners to determine the partnership's gross 
receipts, the commenter suggested various approaches, such as a de 
minimis rule whereby a less-than-10 percent owner of a passthrough 
entity may use the taxable income from such entity rather than gross 
receipts; use the current-year gross receipts as a reasonable estimate 
of the past three years; or not exclude the gross receipts of the 
exempt entity in certain situations.
    Another commenter recommended that, in situations in which a 
partner and a partnership are not subject to the aggregation rules of 
section 448(c), a partner should not be required to include any share 
of partnership gross receipts when determining its partner-level 
eligibility for the small business exemption. The commenter noted that 
section 163(j) is applied at the partnership level. The commenter 
stated it is inconsistent to take an aggregate view of partnerships for 
purposes of the small business exemption without a specific rule under 
section 163(j) requiring such attribution or aggregation. The commenter 
also stated that requiring a partner to include a share of partnership 
gross receipts would discourage taxpayers who operate small businesses 
from investing in partnerships.
    The Treasury Department and the IRS understand that passthrough 
entities might not have reported gross receipts to their partners or 
shareholders in the past. However, the statute is clear that a taxpayer 
must meet the gross receipts test of section 448(c), and that, if the 
taxpayer is not subject to section 448(c), the section 448(c) rules 
must be applied in the same manner as if such taxpayer were a 
corporation or partnership. The alternatives presented either do not 
have universal application or do not adequately reflect a passthrough 
entity's gross receipts.
    Additionally, there is no authority under section 448 and the 
regulations thereunder to substitute taxable income for gross receipts 
or to estimate gross receipts. Accordingly, the Treasury Department and 
the IRS do not adopt the suggested approaches, and the

[[Page 56708]]

proposed rules are finalized without any change.

IV. Comments on and Changes to Section Proposed Sec.  1.163(j)-3: 
Relationship of Section 163(j) Limitation to Other Provisions Affecting 
Interest

    Proposed Sec.  1.163(j)-3 provides ordering and operating rules 
that control the interaction of the section 163(j) limitation with 
other provisions of the Code that defer, capitalize or disallow 
interest expense. The ordering and operating rules provide that section 
163(j) applies before the operation of the loss limitation rules in 
section 465 and 469, and before the application of section 461(l), and 
after other provisions of the Code that defer, capitalize, or disallow 
interest expense. The ordering and operating rules in proposed Sec.  
1.163(j)-3 apply only in determining the amount of interest expense 
that could be deducted without regard to the section 163(j) limitation, 
and not for other purposes, such as the calculation of ATI. The 
following discussion addresses comments relating to proposed Sec.  
1.163(j)-3.
A. Capitalized Interest
    Proposed Sec.  1.163(j)-3(b)(5) provides that provisions that 
require interest to be capitalized, such as sections 263A and 263(g), 
apply before section 163(j). Commenters suggested that this section is 
too restrictive by referring solely to sections 263(A) and 263(g), and 
that other provisions could require interest to be capitalized. The 
Treasury Department and the IRS agree with this comment, and an 
appropriate revision has been made in the final regulations to account 
for any possible additional provisions that could require interest to 
be capitalized.
B. Provisions That Characterize Interest Expense as Something Other 
Than Business Interest Expense
    Proposed Sec.  1.163(j)-3(b)(9) generally provides that provisions 
requiring interest expense to be treated as something other than 
business interest expense, such as section 163(d) governing investment 
interest expense, govern the treatment of the interest expense. 
Commenters expressed confusion with the provision, suggesting that, by 
virtue of the statute and the proposed regulations, if interest expense 
is treated as something other than business interest expense, there is 
no need to consult proposed Sec.  1.163(j)-3. The Treasury Department 
and the IRS generally agree with the comment and have removed this 
section from the final regulations.
C. Section 108
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments on the interaction between 
section 163(j) and the rules addressing income from the discharge of 
indebtedness under section 108. In response, commenters noted, for 
example, that it is unclear whether cancellation of indebtedness income 
under section 61(a)(11) arises when the taxpayer only receives a 
benefit in the form of a disallowed business interest expense 
carryforward, or whether any exclusions, such as sections 108(e)(2) or 
111, or any tax benefit principles, should apply. In light of the 
complex and novel issues raised in these comments, the Treasury 
Department and the IRS have determined that the interaction between 
section 163(j) and section 108 requires further consideration and may 
be the subject of future guidance.
D. Sections 461(l), 465, and 469
    The proposed regulations provide that sections 461(l), 465, and 469 
apply after the application of section 163(j). The Treasury Department 
and the IRS received informal questions about the effect of these 
sections on the calculation of ATI. Therefore, the final regulations 
clarify whether and how sections 461(l), 465, and 469 are applied when 
determining tentative taxable income. The final regulations also 
include examples to demonstrate the calculation of ATI if a loss 
tentatively is suspended in the calculation of tentative taxable 
income, and if a loss is carried forward from a prior taxable year 
under section 469.

V. Comments on and Changes to Proposed Sec.  1.163(j)-4: General Rules 
Applicable to C Corporations (Including Real Estate Investment Trusts 
(REITs), RICs, and Members of Consolidated Groups) and Tax-Exempt 
Corporations

    Section 1.163(j)-4 provides 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. The following discussion addresses 
comments relating to proposed Sec.  1.163(j)-4.
A. Aggregating Affiliated but Non-Consolidated Entities
    Under the proposed regulations, members of a consolidated group are 
aggregated for purposes of section 163(j), and the consolidated group 
has a single section 163(j) limitation. In contrast, partnerships that 
are wholly owned by members of a consolidated group are not aggregated 
with the group for purposes of section 163(j), and members of an 
affiliated group that do not file a consolidated return are not 
aggregated with each other for purposes of section 163(j).
    Several commenters recommended that aggregation rules be applied to 
related taxpayers other than consolidated group members. For example, 
one commenter recommended that aggregation rules similar to those 
provided under section 199A be applied for purposes of the section 
163(j) limitation to obviate the need for related entities to shift 
debt or business assets around to avoid this limitation. Several other 
commenters noted that the 1991 Proposed Regulations applied section 
163(j) to an affiliated group of corporations (including all domestic 
corporations controlled by the same parent, whether consolidated or 
not) and recommended that this ``super-affiliation rule'' be retained 
so that affiliated but non-consolidated groups are not disadvantaged 
under the section 163(j) regulations. In contrast, another commenter 
agreed with the approach taken in the proposed regulations with respect 
to affiliated but non-consolidated groups, in part because the 
allocation of the section 163(j) limitation among non-consolidated 
affiliates can become quite complex.
    Commenters also recommended that a partnership owned by members of 
an affiliated group (controlled partnership) be treated as an aggregate 
rather than an entity so that the section 163(j) limitation would not 
apply separately at the partnership level. Instead, each partner would 
include its allocable share of the controlled partnership's tax items 
in determining its own section 163(j) limitation, and transactions 
between the controlled partnership and its controlling partners would 
be disregarded. Some commenters would apply this approach to 
partnerships wholly owned by members of a controlled group of 
corporations (as defined in section 1563). Others would apply this 
approach to partnerships wholly owned (or at least 80 percent-owned) by 
members of a consolidated group in order to reduce compliance 
complexity, to ensure that similarly situated taxpayers (namely, 
consolidated groups that conduct business activities directly and those 
that conduct such activities through a controlled partnership) are 
treated similarly, and to discourage consolidated groups from creating 
a controlled partnership to obtain a better result under section 
163(j). Commenters observed that the proposed regulations

[[Page 56709]]

apply an aggregate approach to certain controlled partnerships that own 
CFCs (see proposed Sec.  1.163(j)-7(f)(6)(ii)(B)), and they recommended 
applying this principle more broadly.
    As explained in the preamble to the proposed regulations, the 
Treasury Department and the IRS have determined that non-consolidated 
entities generally should not be aggregated for purposes of applying 
the section 163(j) limitation. 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). See the Concurrent NPRM for a 
discussion of a proposed exception to this general rule for CFCs. 
Moreover, the Treasury Department and the IRS have determined that 
controlled partnerships generally should not be treated as aggregates 
because section 163(j) clearly applies at the partnership level. See 
section 163(j)(4). In other words, Congress decided that partnerships 
should be treated as entities rather than aggregates for purposes of 
section 163(j). Additionally, revising the regulations to treat 
controlled partnerships as aggregates would not necessarily achieve the 
objectives sought by commenters because the controlling partners 
effectively could ``elect'' entity or aggregate treatment for the 
partnership simply by selling or acquiring interests therein (thereby 
causing the partnership to satisfy or fail the ownership requirement 
for aggregate treatment).
    However, the Treasury Department and the IRS are concerned that the 
application of section 163(j) on an entity-by-entity basis outside the 
consolidated group context could create the potential for abuse in 
certain situations by facilitating the separation of excepted and non-
excepted trades or businesses. For example, a consolidated group that 
is engaged in both excepted and non-excepted trades or businesses could 
transfer its excepted trades or businesses to a controlled partnership, 
which in turn could borrow funds from a third party and distribute 
those funds to the consolidated group tax-free under section 731 
(unless the debt is recharacterized as debt of the consolidated group 
in substance; see Plantation Patterns, Inc. v. Commissioner, 462 F.2d 
712 (5th Cir. 1972)). Similarly, an individual taxpayer that is engaged 
in both excepted and non-excepted trades or businesses could transfer 
its excepted trades or businesses to a controlled corporation, which in 
turn could borrow funds from a third party and distribute those funds 
to the individual tax-free under section 301(c)(2) (assuming the 
corporation has no earnings and profits). Additionally, a partnership 
with two trades or businesses--one that generates ATI, and another that 
generates losses--could separate the two trades or businesses into a 
tiered partnership structure solely for the purpose of borrowing 
through the partnership that generates ATI and avoiding a section 
163(j) limitation.
    The anti-avoidance rule in proposed Sec.  1.163(j)-2(h) and the 
anti-abuse rule in proposed Sec.  1.163(j)-10(c)(8) would preclude 
taxpayers from undertaking the foregoing transfers in certain 
circumstances. The final regulations add an example illustrating the 
application of the anti-avoidance rule in proposed Sec.  1.163(j)-2(h) 
to the use of a controlled corporation to avoid the section 163(j) 
limitation, as well as an example illustrating the application of this 
anti-avoidance rule to the use of a lower-tier partnership to avoid the 
section 163(j) limitation in a similar manner.
    Commenters further requested that the Treasury Department and the 
IRS simplify the rules applicable to controlled partnerships if the 
final regulations do not treat such partnerships as aggregates rather 
than entities. For example, commenters recommended (i) eliminating 
steps 3 through 10 in proposed Sec.  1.163(j)-6(f)(2) for such 
partnerships, (ii) applying the principles of the Sec.  1.469-7 self-
charged interest rules to partnership interest expense and income owed 
to or from consolidated group members by treating all members of the 
group as a single taxpayer, or (iii) allowing excess taxable income 
(ETI) that is allocated by a partnership to one consolidated group 
member to offset excess business interest expense allocated by that 
partnership to another group member.
    The final regulations do not adopt these recommendations. For a 
discussion of steps 3 through 10 in proposed Sec.  1.163(j)-6(f)(2), 
see part VII(A)(3) of this Summary of Comments and Explanation of 
Revisions section. For a discussion of the self-charged interest rules, 
see the Concurrent NPRM. For a discussion of the proposal to allow ETI 
allocated by a partnership to one member of a consolidated group to 
offset excess business interest expense allocated by that partnership 
to another group member, see part V(D)(4) of this Summary of Comments 
and Explanation of Revisions section.
B. Intercompany Transactions and Intercompany Obligations
    Proposed Sec.  1.163(j)-4(d)(2) contains rules governing the 
calculation of the section 163(j) limitation for members of a 
consolidated group. These rules provide, in part, that: (i) A 
consolidated group has a single section 163(j) limitation; (ii) for 
purposes of calculating the group's ATI, the relevant taxable income is 
the consolidated group's consolidated taxable income, and intercompany 
items and corresponding items are disregarded to the extent they offset 
in amount; and (iii) for purposes of calculating the group's ATI and 
determining the business interest expense and business interest income 
of each member, all intercompany obligations (as defined in Sec.  
1.1502-13(g)(2)(ii)) are disregarded (thus, interest expense and 
interest income from intercompany obligations are not treated as 
business interest expense and business interest income for purposes of 
section 163(j)).
    In turn, proposed Sec.  1.163(j)-5(b)(3) contains rules governing 
the treatment of disallowed business interest expense carryforwards for 
consolidated groups. These rules provide, in part, that if the 
aggregate amount of members' business interest expense (including 
disallowed business interest expense carryforwards) exceeds the group's 
section 163(j) limitation, then: (i) Each member with current-year 
business interest expense and either current-year business interest 
income or floor plan financing interest expense deducts current-year 
business interest expense to the extent of its current-year business 
interest income and floor plan financing interest expense; (ii) if the 
group has any remaining section 163(j) limitation, each member with 
remaining current-year business interest expense deducts a pro rata 
portion of its expense; (iii) if the group has any remaining section 
163(j) limitation, disallowed business interest expense carryforwards 
are deducted on a pro rata basis in the order of the taxable years in 
which they arose; and (iv) each member whose business interest expense 
is not fully absorbed by the group in the current taxable year carries 
the expense forward to the succeeding taxable year as a disallowed 
business interest expense carryforward.
    Commenters posed several questions and comments with regard to 
these proposed rules. One commenter expressed concern that these 
provisions would create noneconomic and distortive allocations of 
disallowed business interest expense within consolidated groups. For 
example, assume P (the parent of a consolidated

[[Page 56710]]

group) acts as a group's sole external borrower, and P on-lends the 
loan proceeds to S (a member of P's consolidated group) for use in S's 
business operations. Under the proposed regulations, any disallowed 
business interest expense would be allocated to P even though S is the 
economic user of the borrowed funds and may generate the income that 
supports the external debt. The commenter also expressed concern that, 
under the proposed regulations, consolidated groups effectively may 
decide which member will carry forward disallowed business interest 
expense by having that member borrow funds from third parties, 
regardless of whether that member actually uses the funds. The 
commenter raised similar concerns about business interest income, 
noting that a group may choose which member will loan funds outside the 
group and thereby affect which member's business interest expense is 
absorbed within the group.
    To address the foregoing concerns, the commenter suggested that the 
final regulations (i) take intercompany interest income and expense 
into account for purposes of section 163(j), (ii) allocate current-year 
disallowed business interest expense to members without regard to 
whether the interest expense results from intercompany obligations or 
external borrowings, and (iii) de-link disallowed business interest 
expenses from intercompany interest income for purposes of the rules 
under Sec.  1.1502-13. However, the commenter acknowledged that this 
approach could introduce unwarranted complexity. Alternatively, the 
commenter suggested that taxpayers be permitted to apply any reasonable 
approach (apart from tracing) consistent with the economics, subject to 
a narrowly tailored anti-avoidance rule.
    In the proposed regulations, the Treasury Department and the IRS 
determined that intercompany obligations should be disregarded for 
purposes of section 163(j) for several reasons. First, section 163(j) 
is concerned with interest expense paid to external lenders, not 
internal borrowing between divisions of a single corporation (or 
between members of a consolidated group). In this regard, the Treasury 
Department and the IRS note that treating a member with intercompany 
debt but no external debt as having business interest expense could 
lead to strange results.
    Second, the approach taken in the proposed regulations results in 
application of the section 163(j) limitation at the consolidated group 
level, consistent with the expressed intent of Congress (see H. Rept. 
115-466, at 386 (2017)).
    Third, such an approach is simpler for taxpayers to administer than 
an approach that would require consolidated groups to track disallowed 
business interest expense with regard to intercompany obligations 
across taxable years, as further discussed in the following paragraph. 
Allowing taxpayers to apply any reasonable approach (and to ignore or 
take into account interest expense on intercompany obligations as they 
determine to be appropriate) also would further complicate rather than 
simplify tax administration, particularly with regard to the 
application of section 163(j) to consolidated groups.
    Fourth, as the commenter acknowledged, taking intercompany 
obligations into account for purposes of section 163(j) would 
complicate the application of Sec.  1.1502-13. Section 1.1502-13 
achieves single-entity treatment for a consolidated group by preventing 
intercompany transactions from creating, accelerating, avoiding, or 
deferring consolidated taxable income or liability. To this end, Sec.  
1.1502-13(c) ``matches'' the tax items of the members that are parties 
to an intercompany transaction. In the case of intercompany interest, 
income and deductions do not affect consolidated taxable income or 
liability because each side of the transaction ``nets out'' the other 
in each taxable year. If section 163(j) applied to intercompany 
payments of business interest expense, and if a consolidated group's 
section 163(j) limitation did not permit the deduction of all of the 
group's intercompany business interest expense, the interest income and 
expense would not net out each other. Thus, the group would need to 
separately track both the intercompany borrower's non-deductible 
expense and the intercompany lender's non-includible income through 
future taxable years.
    The Treasury Department and the IRS acknowledge that disregarding 
intercompany obligations may lead to results in some circumstances that 
are less economically accurate than a regime that takes such 
obligations into account, but the Treasury Department and the IRS 
considered administrability as well as economic accuracy when 
promulgating the proposed regulations. Moreover, although disregarding 
intercompany obligations may grant consolidated groups the latitude to 
decide which member will incur business interest expense, consolidated 
groups also would have significant flexibility to allocate business 
interest expense within a group using intercompany obligations if such 
obligations were regarded for purposes of section 163(j).
    Although the proposed rules in the Concurrent NPRM concerning CFC 
group elections do regard inter-CFC group net interest expense in 
allocating CFC group disallowed business interest expense, the CFC 
group setting is materially different from that of a consolidated 
group. First, in the context of a CFC group, neither Sec.  1.1502-13 
nor similar rules apply. Second, the location of disallowed business 
interest expense may have more effect on tax liability. In particular, 
disallowed business interest expense may affect the calculation of 
foreign tax credits and the amount of qualified business asset 
investment within the meaning of section 951A(d)(1) (QBAI) taken into 
account in determining a U.S. shareholder's tax liability under section 
951A. This effect depends entirely on the particular CFC group member 
affected by disallowed business interest expense. Although the location 
of disallowed business interest expense has an effect on consolidated 
groups, this effect often will be less than in the CFC group context.
    For the foregoing reasons, the final regulations do not apply 
section 163(j) to business interest expense or business interest income 
incurred on intercompany obligations, with one limited exception 
related to repurchase premium on obligations that are deemed satisfied 
and reissued, which is described in part V(C) of this Summary of 
Comments and Explanation of Revisions section.
    Commenters also expressed concern that consolidated groups may have 
difficulty determining which member is the borrower on external debt if 
other group members are co-obligors or guarantors on the debt, and 
that, as a result, each member may have difficulty calculating its 
business interest expense for each taxable year. Commenters voiced 
similar concerns about the lack of parameters for determining the 
appropriate location of business interest income and floor plan 
financing interest expense within the group.
    The Treasury Department and the IRS do not find this comment 
persuasive. Consolidated groups (and other related parties) are 
required to determine which member is entitled to a deduction for 
interest expense. Specifically, a consolidated group must use this 
information for purposes of computing consolidated taxable income under 
Sec. Sec.  1.1502-11 and 1.1502-12 and making stock basis adjustments 
in members under Sec.  1.1502-32. Moreover, consolidated groups must 
determine which member has incurred business

[[Page 56711]]

interest expense for purposes of applying section 382 and the separate 
return limitation year (SRLY) rules. Consolidated groups must look to 
existing law to determine which member should be treated as incurring 
business interest expense or business interest income for purposes of 
section 163(j).
C. Repurchase Premium on Obligations That Are Deemed Satisfied and 
Reissued
    As discussed in part V(B) of this Summary of Comments and 
Explanation of Revisions section, interest expense on intercompany 
obligations generally is disregarded for purposes of section 163(j). 
Thus, commenters asked whether repurchase premium that is treated as 
interest with respect to intercompany obligations should be subject to 
the section 163(j) limitation. In general, if debt that is not an 
intercompany obligation becomes an intercompany obligation (for 
example, if a member of a consolidated group acquires another member's 
debt from a non-member), the debt is treated for all Federal income tax 
purposes, immediately after it becomes an intercompany obligation, as 
having been satisfied by the issuer for cash in an amount equal to the 
holder's basis in the note and as having been reissued as a new 
intercompany obligation for the same amount of cash. See Sec.  1.1502-
13(g)(5)(ii)(A). Additionally, if a debt instrument is repurchased by 
the issuer for a price in excess of its adjusted issue price (as 
defined in Sec.  1.1275-1(b)), the excess (repurchase premium) 
generally is deductible as interest for the taxable year in which the 
repurchase occurs. See Sec.  1.163-7(c).
    For example, S is a member of P's consolidated group, and S has 
borrowed $100x from unrelated X. At a time when S's note has increased 
in value to $130x due to a decline in prevailing interest rates, P 
purchases the note from X for $130x. Under Sec.  1.1502-13(g)(5)(ii), 
S's note is treated as satisfied for $130x immediately after it becomes 
an intercompany obligation. As a result of the deemed satisfaction of 
the note, P has no gain or loss, and S has $30x of repurchase premium 
that is deductible as interest. See Sec.  1.1502-13(g)(7)(ii), Example 
10. Similarly, if S were to repurchase its note from X for $130x, S 
would have $30x of repurchase premium that is deductible as interest.
    If S were to repurchase its note from X at a premium, the interest 
(in the form of repurchase premium) paid on that note would be subject 
to the section 163(j) limitation. See Sec.  1.163(j)-1(b)(22)(i)(H) 
(treating repurchase premium that is deductible under Sec.  1.163-7(c) 
as interest for purposes of section 163(j)). If section 163(j) does not 
apply to repurchase premium paid by S to P after P purchases S's note 
from X, the P group would obtain a different (and better) result than 
if S were to repurchase its own note. The Treasury Department and the 
IRS have determined that achieving different results under section 
163(j) depending on which member repurchases external debt would be 
inconsistent with treating a consolidated group as a single entity for 
purposes of section 163(j) and would undermine the purpose of Sec.  
1.1502-13. Thus, the final regulations provide that, for purposes of 
section 163(j), if any member of a consolidated group purchases a 
member's note from a third party at a premium, the repurchase premium 
that is deductible under Sec.  1.163-7(c) is treated as interest 
expense for purposes of section 163(j), regardless of whether the 
repurchase premium is treated as paid on intercompany indebtedness.
D. Intercompany Transfers of Partnership Interests
1. Overview of Proposed Sec.  1.163(j)-4(d)(4)
    Proposed Sec.  1.163(j)-4(d)(4) provides 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 section 163(j)(4)(B)(iii)(II), regardless 
of whether the transfer is one in which gain or loss is recognized. 
Thus, the transferor member's excess business interest expense is 
eliminated rather than transferred to the transferee member. Proposed 
Sec.  1.163(j)-4(d)(4) further provides that neither the allocation of 
excess business interest expense to a member from a partnership (and 
the resulting decrease in basis in the partnership interest) nor the 
elimination of excess business interest expense of a member upon a 
disposition of the partnership interest (and the resulting increase in 
basis in the partnership interest) affects basis in the member's stock 
for purposes of Sec.  1.1502-32(b)(3)(ii). Instead, 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).
2. Intercompany Transfers of Partnership Interests Treated as 
Dispositions; Single-Entity Treatment; Application of Sec.  1.1502-13
    Commenters posed various questions and comments about the treatment 
of intercompany transfers of partnership interests as dispositions for 
purposes of section 163(j). For example, commenters asked why, in 
applying section 163(j) to consolidated groups, the proposed 
regulations treat such transfers as dispositions, rather than simply 
disregard the transfers, given that the proposed regulations generally 
treat consolidated groups as a single entity and disregard intercompany 
transactions for purposes of section 163(j).
    The proposed regulations provide that intercompany transfers of 
partnership interests are treated as dispositions for purposes of 
section 163(j) because each member's separate ownership of interests in 
a partnership generally is respected (otherwise, a partnership whose 
interests are wholly owned by members of a consolidated group would be 
treated as a disregarded entity), and because the term ``disposition'' 
in section 163(j)(4)(B)(iii)(II) has broad application (for example, it 
applies to nonrecognition transactions). Moreover, if an intercompany 
transfer of partnership interests were not treated as a disposition 
(and if, as a result, basis were not restored to the transferor 
member), the amount of the transferor member's gain or loss on the 
intercompany transfer would be incorrect. Special rules also would be 
needed to account for the transfer of excess business interest expense 
from one member to another in a manner consistent with the purposes of 
Sec.  1.1502-13 and to comply with the directive of section 1502 to 
clearly reflect the income of each member of the group.
    Several commenters also noted problems with the approach in 
proposed Sec. Sec.  1.163(j)-4(d)(4) and 1.1502-13(c)(7)(ii)(R), 
Example 18. These commenters pointed out that the approach in the 
proposed regulations does not achieve single-entity treatment because 
one member's transfer of its partnership interest to another member 
causes the transferor's excess business interest expense to be 
eliminated; thus, an intercompany transaction may alter the amount of 
business interest expense that is absorbed by the group. One commenter 
suggested a different approach under which the transferee could claim 
deductions for excess business interest expense to the extent the 
transferee is allocated excess taxable income from the same 
partnership. However, the commenter acknowledged that this approach 
would require additional rules under Sec.  1.1502-13.
    Another commenter suggested that intercompany transfers in which 
the transferee is the successor to the

[[Page 56712]]

transferor (for example, in transactions to which section 381(a) 
applies, or in which the transferee's basis in the partnership interest 
is determined by reference to the transferor's basis) should not be 
treated as dispositions for purposes of section 163(j)(4)(B)(iii)(II). 
However, this approach would not result in an increase in the 
transferor member's (S's) basis in its partnership interest immediately 
before the transfer; thus, this approach would be inconsistent with 
Sec.  1.1502-13, which requires the clear reflection of income at the 
level of the consolidated group member. This approach also would be 
inconsistent with section 163(j)(4)(B)(iii)(II), which clearly treats 
``a transaction in which gain is not recognized in whole or in part'' 
as a disposition for purposes of that section.
    Still another commenter observed that the analysis in proposed 
Sec.  1.1502-13(c)(7)(ii)(R), Example 18, does not work in certain 
other fact patterns. In proposed Sec.  1.1502-13(c)(7)(ii)(R), Example 
18, P wholly owns S and B, both of which are members of P's 
consolidated group. S and A (an unrelated third party) are equal 
partners in PS1, which allocates $50x of excess business interest 
expense to each partner in Year 2. At the end of Year 2, S sells its 
PS1 interest to B at a $50x loss (S's excess business interest expense 
is eliminated, and S's basis in its PS1 interest is increased by $50x 
immediately before the sale). In Year 3, PS1 allocates $25x of excess 
taxable income to B. At the end of Year 4, B sells its PS1 interest to 
Z (an unrelated third party) for a $10x gain. The example concludes 
that S takes into account $25x of its loss in Year 3 as an ordinary 
loss, which matches B's inclusion of $25x of ordinary income in Year 3. 
The remaining $25x of S's $50x capital loss is taken into account in 
Year 4. The commenter noted that, although the analysis in proposed 
Sec.  1.1502-13(c)(7)(ii)(R), Example 18, works under the facts 
presented, it would not work if, for example, S were to sell the PS1 
interest to B at a gain (because S's gain and B's income could not be 
offset).
    The Treasury Department and the IRS acknowledge the concerns raised 
by these commenters. The Treasury Department and the IRS are continuing 
to study the proper treatment of intercompany transfers of partnership 
interests that do not result in the termination of the partnership 
(intercompany partnership interest transfers), including whether such 
transfers should be treated as dispositions for purposes of section 
163(j)(4)(B)(iii)(II). The final regulations reserve on issues relating 
to intercompany partnership interest transfers, and the Treasury 
Department and the IRS welcome further comments on such issues.
3. Possible Approach to Intercompany Partnership Interest Transfers
    The Treasury Department and the IRS are considering various 
possible approaches to intercompany partnership interest transfers. 
Under one possible approach, such a transfer would be treated as a 
disposition by S; thus, S's excess business interest expense would be 
eliminated (and its basis in its partnership interest would be 
increased accordingly immediately before the transfer), as would S's 
negative section 163(j) expense (within the meaning of Sec.  1.163(j)-
6(h)(1)). However, unlike the approach in proposed Sec.  1.163(j)-
4(d)(4), B would be treated as if B had been allocated excess business 
interest expense or negative section 163(j) interest expense from the 
partnership in an amount equal to the amount of S's excess business 
interest expense or negative section 163(j) expense, respectively, 
immediately before the transfer. B's basis in its partnership interest 
would be adjusted under section 163(j)(4)(B)(iii)(I) and Sec.  
1.163(j)-6(h) to reflect the deemed allocation of excess business 
interest expense from the partnership. Similar rules would apply to 
intercompany transfers of partnership interests in nonrecognition 
transactions.
    The foregoing approach would attempt to approximate single-entity 
treatment while treating the intercompany transfer of a partnership 
interest as a disposition for purposes of section 
163(j)(4)(B)(iii)(II). To ensure that B has the same amount of excess 
business interest expense, negative section 163(j) expense, and 
disallowed business interest expense carryforwards as if S and B were 
divisions of a single corporation, this approach also would include 
special basis rules. For example, if S transfers its partnership 
interest to B at a gain, the excess of B's basis in the partnership 
interest at any time after the transfer over S's basis in the 
partnership interest immediately before the transfer would not be 
available to convert negative section 163(j) expense into excess 
business interest expense in the hands of B or to prevent excess 
business interest expense from converting into negative section 163(j) 
expense in the hands of B. Additionally, if adjustments to B's basis in 
its partnership interest under section 163(j)(4)(B)(iii)(I) and Sec.  
1.163(j)-6(h) (upon the deemed allocation of excess business interest 
expense from the partnership) would exceed B's basis, B would be 
treated as having a suspended negative basis adjustment in the 
partnership interest (similar to an excess loss account within the 
meaning of Sec.  1.1502-19(a)(2)(i)).
    The Treasury Department and the IRS request comments on possible 
approaches to intercompany partnership interest transfers, including 
the approach outlined in this part V(D)(3) of this Summary of Comments 
and Explanation of Revisions section.
4. Offsetting Excess Business Interest Expense and Adjusted Taxable 
Income Within the Consolidated Group
    A commenter also recommended that, if the section 163(j) 
regulations do not treat partnerships wholly owned by members of the 
same consolidated group as aggregates rather than as entities (see part 
V(A) of this Summary of Comments and Explanation of Revisions section), 
the rules applicable to such partnerships should be simplified. For 
example, the excess taxable income allocated to one member partner 
could be made available to offset excess business interest expense 
allocated to another member partner.
    The commenter's recommendation presents several issues. For 
example, the commenter's recommendation would entail disregarding the 
location of excess business interest expense and excess taxable income 
within a consolidated group. Such an approach would not fully respect 
each member's separate interest in a partnership and would not clearly 
reflect the taxable income of the members of the group. See section 
1502; see also part V(D)(2) of this Summary of Comments and Explanation 
of Revisions section. Further, to the extent the ownership structure of 
the group is altered by an intercompany transfer of the partnership 
interest, substantial additional rules under Sec.  1.1502-13 would be 
required.
5. Intercompany Nonrecognition Transactions
    In proposed Sec. Sec.  1.163(j)-4(d)(4) and 1.1502-13(c)(7)(ii)(S), 
Example 19, the intercompany transfer of a partnership interest in a 
nonrecognition transaction is treated as a disposition for purposes of 
section 163(j)(4)(B)(iii)(II). In the preamble to the proposed 
regulations, the Treasury Department and the IRS requested comments as 
to whether such transfers should constitute dispositions for purposes 
of section 163(j)(4)(B)(iii)(II) and, if so, how Sec.  1.1502-13(c) 
should apply if there is excess taxable income in a succeeding taxable 
year. In such a case, S would have no intercompany item from the 
intercompany transfer, and B would take a carryover basis in the 
partnership

[[Page 56713]]

interest (this amount would include any basis increase to reflect S's 
unused excess business interest expense under section 
163(j)(4)(B)(iii)(II)).
    One commenter agreed that, based on the plain language of section 
163(j)(4)(B)(iii)(II), intercompany transfers that are nonrecognition 
transactions should be treated as dispositions. Another commenter 
stated that such transfers generally should not be treated as 
dispositions (if the transferee is the successor to the transferor, as 
previously discussed), but that, if such transfers are treated as 
dispositions, no redeterminations should be made under Sec.  1.1502-
13(c) with respect to S unless S recognizes gain in the intercompany 
transfer.
    The Treasury Department and the IRS continue to study the proper 
treatment of intercompany partnership interest transfers and welcome 
further comments on this issue.
6. Basis Adjustments Under Sec.  1.1502-32
    A commenter stated that the approach to basis adjustments under 
Sec.  1.1502-32 in the proposed regulations may lead to temporary 
inside/outside basis disparities. Although the commenter generally 
described this approach as reasonable and consistent with the 
application of both section 163(j) and Sec.  1.1502-32, the commenter 
suggested that it may lead to anomalous results in certain cases. The 
commenter requested an example to illustrate the application of the 
matching and acceleration rules in the case of an intercompany transfer 
of an interest in a partnership with disallowed business interest 
expense.
    When S (a member of a consolidated group that is not the common 
parent) is allocated excess business interest expense from a 
partnership, S's basis in the partnership is reduced under section 
163(j)(4)(B)(iii)(I). Although S's basis in the partnership is reduced, 
S has excess business interest expense in the same amount, and S's 
overall inside attribute amount is unchanged. Because there is no net 
change to S's inside attribute amount, Sec.  1.1502-32 does not apply 
to reduce other members' basis in S's stock, and there is no inside/
outside disparity. Moreover, nothing in the final regulations affects 
the operation of Sec.  1.1502-32(a), which generally requires 
adjustments to a member's basis in its S stock to reflect S's 
distributions and S's items of income, gain, deduction, and loss that 
are taken into account by the group while S is a member. Thus, the 
final regulations make no changes in response to this comment.
7. Partnership Terminations
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments on the treatment of the 
transfer of a partnership interest in an intercompany transaction that 
results in the termination of the partnership. Some commenters 
recommended that the transfer be treated as a disposition for purposes 
of section 163(j)(4)(B)(iii)(II) and proposed Sec.  1.163(j)-6(h)(3). 
Other commenters recommended that, under Revenue Ruling 99-6, 1999-1 
C.B. 432, if the transferee member (B) also were a partner in the 
partnership before the intercompany transfer, B should be viewed as (i) 
receiving a distribution of assets from the terminating partnership 
with respect to its partnership interest, and (ii) purchasing the 
partnership's assets deemed distributed to the transferor member (S).
    The Treasury Department and the IRS are continuing to study the 
proper treatment of intercompany transfers of partnership interests 
that result in the termination of the partnership. But see Sec.  
1.163(j)-6(h)(3) with respect to partnership terminations generally.
E. Application of Sec.  1.1502-36 to Excess Business Interest Expense
    Under proposed Sec.  1.163(j)-4(d)(4), a partner's change in status 
as a member of a consolidated group is not treated as a disposition for 
purposes of section 163(j)(4)(B)(iii)(II) and proposed Sec.  1.163(j)-
6(h)(3). In other words, if a corporation becomes or ceases to be a 
member of a consolidated group, and if that corporation is a partner in 
a partnership, that corporation's entry into or departure from a 
consolidated group does not trigger basis adjustments under section 
163(j)(4)(B)(iii)(II). However, in the preamble to the proposed 
regulations, the Treasury Department and the IRS requested comments as 
to whether additional rules are needed to prevent loss duplication upon 
the disposition of stock of a subsidiary member (S) holding partnership 
interests.
    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 the transfer of S stock. The rule applies when a group member 
transfers a loss share of S stock. If Sec.  1.1502-36(d) applies to the 
transfer of a loss share, the attributes of S and its lower-tier 
subsidiaries generally 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 in assets other than cash and general deposit accounts. See 
Sec.  1.1502-36(d)(4).
    As noted in the preamble to the proposed regulations, the Treasury 
Department and the IRS have determined that disallowed business 
interest expenses should be treated as deferred deductions for purposes 
of Sec.  1.1502-36 (see proposed Sec.  1.1502-36(f)(2)). A commenter 
recommended that excess business interest expense also be treated as a 
deferred deduction in determining the net inside attribute amount for 
purposes of Sec.  1.1502-36(c) and (d). Additionally, the commenter 
recommended that a consolidated group be permitted to elect to 
reattribute excess business interest expense from S to the common 
parent under Sec.  1.1502-36(d)(6) if the common parent also is a 
partner in the partnership that allocated excess business interest 
expense to S.
    The Treasury Department and the IRS agree that excess business 
interest expense should be treated as an attribute that is taken into 
account in determining the net inside attribute amount for purposes of 
Sec.  1.1502-36(c) and (d). However, the Treasury Department and the 
IRS have determined that excess business interest expense is more akin 
to basis (a Category D attribute) than to deferred deductions (a 
Category C attribute) (see Sec.  1.1502-36(d)(4)(i)). Section 1.163(j)-
4(e)(4) reflects this conclusion.
    The Treasury Department and the IRS also have determined that 
excess business interest expense should not be eligible for 
reattribution under Sec.  1.1502-36(d)(6) because the election is not 
available with respect to Category D attributes. Thus, the final 
regulations do not adopt this recommendation.
F. Calculating ATI for Cooperatives
    Proposed Sec.  1.163(j)-1(b)(1) defines ATI as the taxable income 
of the taxpayer for the taxable year, with certain adjustments. 
Proposed Sec.  1.163(j)-4(b)(4) provides a special rule for calculating 
the ATI of a RIC or REIT, allowing the RIC or REIT not to reduce its 
taxable income by the amount of any deduction for dividends paid. The 
preamble to the proposed regulations also requested comments on whether 
additional special rules are needed for specific types of taxpayers, 
including cooperatives.
    A commenter asked that the final regulations include a special rule 
for calculating the ATI of cooperatives subject to taxation under 
subchapter T of the Code. Under this special rule, taxable income would 
not be reduced by amounts deducted under section

[[Page 56714]]

1382(b)(1) (patronage dividends), section 1382(b)(2) (amounts paid in 
redemption of nonqualified written notices of allocation distributed as 
patronage dividends), or section 1382(c) (certain amounts incurred by 
farm cooperatives described in sections 521 and 1381(a)(1)). The 
commenter reasoned that such amounts are earnings passed on to members 
and are therefore analogous to dividends paid by a RIC or REIT to its 
investor.
    The Treasury Department and the IRS agree that, for purposes of 
section 163(j), amounts deducted by cooperatives under sections 
1382(b)(1), (b)(2), and (c) are similar to amounts deducted by RICs and 
REITs for dividends paid to their investors. The final regulations 
adopt a rule providing that, for purposes of calculating ATI, the 
tentative taxable income of a cooperative subject to taxation under 
sections 1381 through 1388 is not reduced by such amounts. In order to 
provide similar treatment to similarly situated taxpayers, the final 
regulations also provide that, for purposes of calculating ATI, the 
tentative taxable income of cooperatives not subject to taxation under 
subchapter T of the Code is not reduced by the amount of deductions 
equivalent to the amounts deducted by cooperatives under sections 
1382(b)(1), (b)(2), and (c).
G. Calculating ATI for a Consolidated Group
    Proposed Sec.  1.163(j)-1(b)(1) defines ATI as the taxable income 
of the taxpayer for the taxable year, with certain adjustments. For 
example, ATI is computed without regard to the amount of any NOL 
deduction under section 172. See proposed Sec.  1.163(j)-1(b)(1)(i)(B).
    As noted in part V(B) of this Summary of Comments and Explanation 
of Revisions section, for purposes of calculating the ATI of a 
consolidated group, the relevant taxable income is the group's 
consolidated taxable income, determined under Sec.  1.1502-11 without 
regard to any carryforwards or disallowances under section 163(j). See 
proposed Sec.  1.163(j)-4(d)(2)(iv). Commenters asked for clarification 
that a consolidated group's ATI does not take into account any NOL 
deductions available under section 172 and Sec.  1.1502-11(a)(2) that 
result from either the carryback or carryforward of NOLs.
    Proposed Sec.  1.163(j)-4(d)(2)(iv) does not expressly mention the 
adjustments made to ATI in proposed Sec.  1.163(j)-1(b)(1) because 
those adjustments are generally applicable (for example, the adjustment 
for NOLs applies to all taxpayers to whom section 172 applies, 
regardless of whether such taxpayers file a consolidated return). 
Moreover, there is no exception in proposed Sec.  1.163(j)-4(d)(2)(iv) 
to the adjustment for NOLs in proposed Sec.  1.163(j)-1(b)(1)(i)(B). 
Thus, under these provisions, a consolidated group's ATI would not take 
into account any NOL deductions resulting from the carryback or 
carryforward of NOLs. The Treasury Department and the IRS have 
determined that no change to proposed Sec.  1.163(j)-4(d)(2)(iv) is 
needed to effectuate this result.
H. Application of Section 163(j) to Life-Nonlife Groups
    Proposed Sec.  1.163(j)-4(d)(2) provides that a consolidated group 
has a single section 163(j) limitation and that, for purposes of 
calculating the group's ATI, the relevant taxable income is the group's 
consolidated taxable income. However, Sec.  1.1502-47 requires 
consolidated groups whose members include life insurance companies and 
other companies (life-nonlife groups) to adopt a subgroup method to 
determine consolidated taxable income. (One subgroup is the group's 
nonlife companies; the other subgroup is the group's life insurance 
companies.) Under the subgroup method, each subgroup initially computes 
its own consolidated taxable income, and there are limitations on a 
life-nonlife group's ability to offset one subgroup's income with the 
other subgroup's loss.
    In light of the apparent tension between proposed Sec.  1.163(j)-
4(d)(2) and the subgroup method in Sec.  1.1502-47, one commenter asked 
for clarification that there are not separate section 163(j) 
limitations for each subgroup in a life-nonlife group.
    The subject matter of this comment is beyond the scope of the final 
regulations. The Treasury Department and the IRS expect to issue future 
guidance regarding the interaction of section 163(j) and Sec.  1.1502-
47 and welcome further comments on this topic.
I. Application of Section 163(j) to Tax-Exempt Entities
    Proposed Sec.  1.163(j)-1(b)(36) defines a tax-exempt corporation 
but does not define other types of tax-exempt organizations. Thus, a 
commenter asked for clarification as to whether section 163(j) applies 
solely to tax-exempt corporations or whether it also applies to other 
entities subject to tax under section 511. The final regulations 
clarify that section 163(j) applies to all entities that are subject to 
tax under section 511.
    The commenter also suggested that section 163(j) should not apply 
to state colleges and universities described in section 511(a)(2)(B). 
The Treasury Department and the IRS have found nothing in the statute 
or legislative history to suggest that Congress intended special 
treatment for state colleges and universities to the extent such 
organizations are subject to tax under section 511. Therefore, the 
final regulations do not adopt this recommendation.
J. Partnership Investment Income and Corporate Partners
    Under the proposed regulations, a partnership's investment interest 
income and investment expense are allocated to each partner in 
accordance with section 704(b), and the effect of the allocation is 
determined at the partner level. In general, any investment interest, 
investment income, and investment expense allocated by a partnership to 
a C corporation partner is treated by the partner as allocable to a 
non-excepted trade or business of the partner for purposes of section 
163(j). See proposed Sec. Sec.  1.163(j)-4(b)(3)(i) and 1.163(j)-
10(b)(6).
    In light of the statutory restriction against including investment 
income in a partner's ATI (see section 163(j)(8)(A)(i)), a commenter 
requested confirmation that a partnership's investment income is 
treated as properly allocable to a trade or business of (and thus is 
included in the ATI of) a corporate partner, perhaps by adding an 
example to illustrate the application of this rule.
    Proposed Sec.  1.163(j)-10(b)(6) provides that 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 proposed 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. Thus, if a partnership incurs 
investment interest expense, any portion of that expense that is 
allocable to a C corporation partner is treated as a business interest 
expense of that partner that is subject to the section 163(j) 
limitation. However, if the partnership also has investment interest 
income, any portion thereof that is allocable to a C corporation 
partner is treated as business interest income of the partner, and any 
other investment income of the partnership that is allocable to the C 
corporation partner increases the partner's ATI. See Sec.  1.163(j)-
4(b)(7)(ii), Example 2.
    To the extent that an investment item or other item of a 
partnership is with respect to property for which an election has been 
made by the partnership to treat as an electing real

[[Page 56715]]

property trade or business or electing farming business, such item is 
treated as properly allocable to an excepted trade or business. This 
rule is necessary because the final regulations permit elections for 
some assets and activities to be an excepted trade or business even 
when such assets and activities are not trades or businesses for 
section 162 purposes. See part X(A) of this Summary of Comments and 
Explanation of Revisions section.
    The final regulations also expand proposed Sec.  1.163(j)-
4(b)(3)(i) to cover not only a partnership's items of investment 
interest, investment income, and investment expense, but also a 
partnership's other separately stated tax items that are subject to 
neither section 163(j) nor section 163(d). Such items might include tax 
items allocable to rental activities that do not rise to the level of a 
section 162 trade or business that otherwise give rise to allowable 
deductions (such as under section 212 as it existed under prior law) 
that are subject to section 469. Thus, such items are treated as 
properly allocable to a trade or business of a C corporation partner as 
well.
K. Earnings and Profits of a Corporate Partner
    Proposed Sec.  1.163(j)-4(c)(1) generally provides that the 
disallowance and carryforward of a deduction for a C corporation's 
business interest expense under proposed Sec.  1.163(j)-2 does not 
affect whether or when the business interest expense reduces the 
corporation's earnings and profits. Some commenters suggested that, if 
the business interest expense in question is incurred by a partnership 
rather than by the C corporation partner, the partner should reduce its 
earnings and profits twice with respect to that expense--once when the 
expense is allocated from the partnership to the partner, and again 
when the partner claims a deduction with respect to that expense (after 
the excess business interest expense allocated to that partner is 
treated as business interest expense and deducted by that partner).
    The Treasury Department and the IRS have determined that the 
proposed regulations do not permit a C corporation partner to reduce 
its earnings and profits twice with respect to business interest 
expense incurred by a partnership. The final regulations are modified 
to clarify this point.
    Proposed Sec.  1.163(j)-4(c)(3) also provides a special earnings 
and profits rule for C corporations (other than REITs or RICs) with 
respect to excess business interest expense allocated from a 
partnership. Under this rule, the C corporation partner must increase 
its earnings and profits 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. The Treasury Department and the IRS have determined that the 
same rule should apply with respect to negative section 163(j) expense, 
and the final regulations have been modified accordingly.

VI. Comments on and Changes to Proposed Sec.  1.163(j)-5: General Rules 
Governing Disallowed Business Interest Expense Carryforwards for C 
Corporations

    Section 1.163(j)-5 provides rules regarding disallowed business 
interest expense carryforwards for taxpayers that are C corporations, 
including members of a consolidated group. The following discussion 
addresses comments relating to proposed Sec.  1.163(j)-5.
A. Absorption of Disallowed Business Interest Expense Carryforwards 
Before Use of NOLs in Life-Nonlife Groups
    Proposed Sec.  1.163(j)-5(b)(3) provides rules regarding the 
treatment of disallowed business interest expense carryforwards of a 
consolidated group. Commenters asked for confirmation that, in the 
context of a life-nonlife group, such carryforwards are factored into 
taxable income at the subgroup level before NOLs are carried forward 
and limited under section 1503(c)(1).
    In general, a consolidated group must determine the amount of 
business interest expense (whether current-year or carryforwards) that 
can be absorbed in a particular taxable year before determining whether 
NOLs can be carried forward or back to that taxable year. However, the 
specific subject matter of this comment is beyond the scope of the 
final regulations. The Treasury Department and the IRS expect to issue 
future guidance regarding the interaction of section 163(j) and Sec.  
1.1502-47 and welcome further comments in this regard.
B. Carryforwards From Separate Return Limitation Years
    Proposed Sec.  1.163(j)-5(d) contains rules for consolidated groups 
regarding disallowed business interest expense carryforwards from a 
separate return limitation year (a SRLY; see Sec.  1.1502-1(f)). Under 
these rules, the disallowed business interest expense carryforwards of 
a member arising in a SRLY that are included in a group's business 
interest expense deduction for any taxable year may not exceed the 
group's section 163(j) limitation for that year, determined by 
reference only to the member's tax items for that year (the section 
163(j) SRLY limitation). See proposed Sec.  1.163(j)-5(d)(1). 
Additionally, disallowed business interest expense carryforwards of a 
member arising in a SRLY would be available for deduction by the 
consolidated group in the current year only to the extent the group had 
remaining section 163(j) limitation after deducting current-year 
business interest expense and disallowed business interest expense 
carryforwards from earlier taxable years, and only to the extent the 
section 163(j) SRLY limitation for the current year exceeded the amount 
of the member's business interest expense already deducted by the group 
in that year. In addition, SRLY-limited disallowed business interest 
expense carryforwards must be deducted on a pro rata basis with non-
SRLY limited disallowed business interest expense carryforwards from 
taxable years ending on the same date. See proposed Sec.  1.163(j)-
5(d)(2).
    Commenters asked several questions about the SRLY rules in proposed 
Sec.  1.163(j)-5(d). In particular, commenters asked why the section 
163(j) SRLY limitation is calculated annually rather than on an 
aggregate or cumulative basis, as is the case for NOLs. (Section 
1.1502-21(c)(1)(i) generally limits the amount of a member's NOL 
carryforwards and carrybacks from a SRLY that may be included in the 
group's consolidated net operating loss deduction to the member's 
aggregate contribution to the group's consolidated taxable income for 
the entire period the member has been a group member, not just for the 
taxable year in question). More specifically, a commenter noted that 
the SRLY rules in Sec.  1.1502-21(c) were designed to produce a result 
that roughly approximates the absorption that would have occurred if 
the SRLY member had not joined a consolidated group. In contrast, the 
annual section 163(j) limitation in proposed Sec.  1.163(j)-5(d) could 
put the SRLY member in a worse position than if such member had not 
joined a consolidated group.
    For example, if S were a standalone corporation with $100x of 
disallowed business interest expense carryforwards at the start of Year 
2, and if S's section 163(j) limitation were $30 in Year 2, S could 
deduct $30x of its carryforwards. In comparison, if S joined a 
consolidated group at the start of Year 2, and if the group's section 
163(j) limitation were $0 in Year 2, S could not deduct any of its 
$100x of carryforwards in Year 2 even if S's standalone section 163(j) 
limitation

[[Page 56716]]

were $30x in that year. This result is correct for the P group for Year 
2 given Congress's intent that the section 163(j) limitation apply at 
the consolidated group level. However, under the annual measurement 
approach in the proposed regulations, S also could not deduct any of 
its carryforwards in Year 3 if S had a standalone section 163(j) 
limitation of $0 in that year, even if the group's section 163(j) 
limitation were positive in that year. Thus, S would be in a worse 
position (with respect to the deduction of its disallowed business 
interest expense carryforwards) than if S had not joined a consolidated 
group.
    To put S in roughly the same position as if S were a standalone 
corporation, commenters recommended the creation of a cumulative 
section 163(j) register under which the amount of a member's SRLY 
carryforwards that may be absorbed by the consolidated group in a 
taxable year may not exceed (i) the member's contributions (positive 
and negative) to the group's section 163(j) limitation in all 
consolidated return years, less (ii) the member's business interest 
expense (including carryforwards) absorbed by the group in all 
consolidated return years. For these purposes, and unlike the general 
rule in section 163(j)(1) and proposed Sec.  1.163(j)-2(b)(2), the 
adjustment to a member's cumulative section 163(j) SRLY register for 
any taxable year or its total register for any taxable year could be 
less than zero.
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS stated that applying an aggregate or cumulative 
approach to the section 163(j) SRLY limitation would be inconsistent 
with congressional intent because Congress did not retain the excess 
limitation carryforward provisions from old section 163(j). One 
commenter expressed agreement with this conclusion. However, other 
commenters noted that applying a cumulative section 163(j) SRLY 
register would not effectuate the carryforward of excess limitation at 
the level of the consolidated group. In other words, although the SRLY 
member would be able to deduct its SRLY disallowed business interest 
expense carryforwards in a taxable year to the extent of that member's 
cumulative (rather than annual) contribution to the group's section 
163(j) limitation, the SRLY member's ability to deduct such 
carryforwards still would be subject to the group's annual section 
163(j) limitation.
    After considering the comments received, the Treasury Department 
and the IRS have determined that a cumulative section 163(j) SRLY 
register would better approximate the results under section 163(j) if 
the SRLY member had not joined a consolidated group, and that this 
approach is not inconsistent with congressional intent. Therefore, the 
final regulations adopt a cumulative section 163(j) SRLY register.
    The cumulative section 163(j) SRLY register operates in a manner 
similar to, but is separate and distinct from, the cumulative register 
for NOLs described in Sec.  1.1502-21(c). In computing a member's 
section 163(j) SRLY register, the intercompany transaction rules of 
Sec.  1.1502-13 generally continue to apply; thus, for example, 
intercompany income items and intercompany deductions and losses (to 
the extent absorbed by the group) generally are taken into account in 
computing the section 163(j) SRLY register. However, interest income 
and expense from intercompany obligations are not taken into account in 
computing the section 163(j) SRLY register. This approach approximates 
the SRLY member's capacity to utilize carryforwards on a standalone 
basis while harmonizing with the single-entity application of section 
163(j) to consolidated groups. Under this approach, intercompany 
interest income and expense items will neither increase nor decrease 
the SRLY register.
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments on another alternative to 
both an annual register and a cumulative register--removing the SRLY 
limitation from a member's SRLY-limited disallowed business interest 
expense carryforwards, to the extent of the member's standalone section 
163(j) limitation, in taxable years in which the member's standalone 
section 163(j) limitation exceeds the consolidated group's section 
163(j) limitation. A commenter endorsed this approach. However, other 
commenters expressed concern that this approach would be more 
distortive than a cumulative register approach. The Treasury Department 
and the IRS agree that a cumulative register more closely approximates 
the results on a standalone basis than this alternative approach. Thus, 
the final regulations adopt a cumulative register approach rather than 
this alternative approach.
    Commenters also expressed concern that proposed Sec.  1.163(j)-
5(d)(2) would treat SRLY carryforwards as available for deduction only 
to the extent the amount of the SRLY member's business interest expense 
already deducted by the group in the current year does not exceed the 
member's annual section 163(j) SRLY limitation. The adoption of the 
cumulative section 163(j) SRLY limitation mechanism, with the 
associated reduction to reflect all business interest expense of that 
member that is absorbed by the group, obviates the issues highlighted 
in the comment. The final regulations retain the other SRLY limitations 
in proposed Sec.  1.163(j)-5(d)(2).
C. Offsetting Business Interest Expense With Business Interest Income 
and Floor Plan Financing Interest Expense at the Member Level
    As described in part V(B) of this Summary of Comments and 
Explanation of Revisions section, proposed Sec.  1.163(j)-5(b)(3) 
provides, in part, that if the aggregate amount of members' business 
interest expense (including carryforwards) exceeds the consolidated 
group's section 163(j) limitation for the current year, then each 
member with current-year business interest expense and current-year 
business interest income or floor plan financing interest expense 
deducts current-year business interest expense to the extent of its 
current-year business interest income and floor plan financing interest 
expense. Thereafter, if the group has any remaining section 163(j) 
limitation, each member with remaining current-year business interest 
expense deducts a pro rata portion thereof.
    A commenter stated that offsetting business interest expense with 
business interest income or floor plan financing interest expense at 
the member level seems inconsistent with the single-entity principles 
adopted by the proposed regulations. Moreover, the commenter expressed 
concern that a consolidated group could choose where to incur business 
interest income within a group and thereby affect which member has 
disallowed business interest expense carryforwards. In addition, the 
commenter asserted that a group may have difficulty determining which 
member has incurred business interest income and floor plan financing 
interest expense (see the discussion in part V(B) of this Summary of 
Comments and Explanation of Revisions section). Thus, the commenter 
recommended an alternative approach that does not require such 
offsetting at the member level.
    The Treasury Department and the IRS acknowledge that netting 
business interest income and floor plan financing interest expense 
against business interest expense at the member level deviates from a 
``pure'' single-entity approach. This approach was adopted in the 
proposed regulations to give effect to section 163(j)(1) (which allows 
taxpayers to deduct business interest expense to the full extent of 
business interest income and floor plan financing

[[Page 56717]]

interest expense) and to ensure that income tax liability is clearly 
reflected at the member level in accordance with section 1502 and Sec.  
1.1502-13. Further, because consolidated groups are under common 
control by definition (see section 1504), a consolidated group largely 
has control over the location of interest expense, even before the 
application of section 163(j). With regard to the comment regarding the 
difficulty of determining which member actually has incurred an 
interest expense, section 61 provides that interest income is 
includible in gross income, and section 163 provides rules by which 
interest expense is deductible in computing the taxable income. Section 
1.1502-12 also requires consolidated group members to report interest 
income and expense at the member level for purposes of computing 
separate taxable income. Thus, the final regulations do not adopt the 
commenter's recommendation.

VII. Comments on and Changes to Section 1.163(j)-6: Application of the 
Business Interest Expense Deduction Limitations to Partnerships and 
Subchapter S Corporations

    As discussed in the preamble to the proposed regulations, Sec.  
1.163(j)-6 provides general rules regarding the application of section 
163(j)(4) to partnerships, S corporations, and their owners, including 
rules on how to calculate the limitation and how to treat disallowed 
business interest expense carryforwards. The following discussion 
addresses comments relating to proposed Sec.  1.163(j)-6.
A. Partnership-Level Calculation and Allocation of Section 163(j) 
Excess Items
1. 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 non-separately 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.
    As highlighted in the proposed regulations, the phrase 
``nonseparately stated taxable income or loss of the partnership'' is 
not defined in section 163(j), and it has not previously been defined 
by statute or regulations.\1\ The phrase ``in the same manner as'' is 
also undefined. The proposed regulations interpreted the phrase 
``nonseparately stated taxable income or loss,'' as it is used in 
sections 163(j)(4)(A)(ii)(II) and 163(j)(4)(B)(i)(II), as meaning the 
items comprising adjusted taxable income, business interest income, and 
business interest expense of the partnership. The legislative history 
and structure of the statute suggest the purpose of the phrase 
``nonseparately stated taxable income or loss of the partnership'' is 
to help coordinate the section 163(j) limit imposed at the partnership 
and partner levels.
---------------------------------------------------------------------------

    \1\ Sections 163(j)(4)(A)(i) and (B)(i)(II) use the word 
``nonseparately'' (no hyphen), but section 163(j)(4)(A)(ii)(II) uses 
the word ``non-separately'' (hyphen). For purposes of consistency, 
these final regulations use ``nonseparately'' when discussing the 
phrase at issue.
---------------------------------------------------------------------------

    Section 163(j)(4)(A)(i) uses this phrase when describing business 
interest expense that already has been tested at the partnership level. 
In general, an item included in nonseparately stated taxable income or 
loss of a partnership under section 702(a)(8) loses its tax character 
in the hands of the partner to whom it is allocated. By providing that 
such business interest expense is treated as a nonseparately stated 
item, section 163(j)(4)(A)(i) causes such business interest expense to 
lose its character as business interest expense, thus preventing it 
from being subject to retesting at the partner level under section 
163(j). Although it does not use the same phrase, section 
163(j)(4)(A)(ii)(I), in conjunction with section 163(j)(4)(C), 
similarly provides that, to the extent the partnership's adjusted 
taxable income was used in its section 163(j) calculation, such 
adjusted taxable income is not included in a partner's section 163(j) 
calculation. Consistent with this principle, proposed Sec.  1.163(j)-
6(e)(4) provided similar rules to prevent the double counting of 
business interest income. Therefore, interpreting the phrase 
``nonseparately stated taxable income or loss of the partnership,'' as 
it is used in section 163(j)(4) as meaning the items comprising 
adjusted taxable income, business interest income, and business 
interest expense of the partnership (hereinafter, ``section 163(j) 
items'') is supported by the statute, which requires each of these 
items to be taken into account at the partnership level and prohibits 
the double counting of such items in the partner's section 163(j) 
calculation.
    To allocate excess taxable income, excess business interest income, 
and excess business interest expense (hereinafter, ``section 163(j) 
excess items'') ``in the same manner'' as the ``nonseparately stated 
taxable income or loss of the partnership'' (that is, the section 
163(j) items), proposed Sec.  1.163(j)-6(f)(2) provided an 11-step 
calculation that, when completed by the partnership, provides the 
partnership with an 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 
three descriptive (1 through 3) and two normative (4 through 5) issues 
outlined in part 6(D)(1) of the Explanation of Provisions section in 
the proposed regulations: (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).
    In general, the 11-step calculation preserves the entity-level 
calculation required in section 163(j)(4) while also preserving the 
economics of the partnership, including respecting any special 
allocations made in accordance with section 704 and the regulations 
under section 704 of the Code. Stated otherwise, the allocations of 
section 163(j) excess items prescribed by the 11-step calculation 
attempt to reflect the aggregate nature of partnerships under 
subchapter K of the Code while remaining consistent with the 
application of section 163(j) at the partnership level.
    The Treasury Department and the IRS requested comments on the 11-
step calculation in the preamble to the

[[Page 56718]]

proposed regulations. Specifically, the Treasury Department and the IRS 
requested comments regarding alternative methods for allocating 
deductible business interest expense and section 163(j) excess items 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.
2. Requested Clarifications and Modifications
    Commenters requested several clarifications of and modifications to 
the 11-step calculation. First, commenters requested confirmation that 
a partnership's allocations of section 163(j) excess items pursuant to 
the 11-step calculation will be considered to meet the requirements of 
section 704(b). The final regulations confirm that allocations pursuant 
to the 11-step calculation meet the requirements of section 704(b). 
Nothing in the 11-step calculation 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 the 11-step calculation are solely for 
the purpose of determining each partner's section 163(j) excess items, 
and do not otherwise affect any other provision under the Code, such as 
section 704(b). Further, the statement in the proposed regulations that 
the 11-step calculation is solely for section 163(j) purposes and does 
not apply for any other purposes of the Code does not mean that section 
163(j) excess items have no effect on either outside basis or capital 
accounts. To illustrate this point, Sec.  1.163(j)-6(o)(17), Example 17 
has been revised to show the beginning and ending outside basis and 
capital accounts after applying the 11-step calculation.
    To further clarify that the allocation of section 163(j) excess 
items pursuant to the 11-step calculation will be sustained under 
section 704, a special rule has been added to Sec.  1.704-1(b)(4). The 
allocation of deductible and nondeductible business interest expense 
does not have economic effect because classifying a portion of the 
interest expense as nondeductible merely changes the tax character of 
the item. Accordingly, Sec.  1.704-1(b)(4)(xi) is added to clarify 
that, if Sec.  1.163(j)-6(f) is satisfied, the allocation of section 
163(j) excess items will be deemed to be in accordance with the 
partners' interests in the partnership.
    Second, commenters recommended the 11-step calculation take 
remedial allocations into account. Commenters noted that the exclusion 
of remedial allocations from the partnership-level computation could 
frustrate the ability of the 11-step calculation to reach the most 
equitable result given its purpose. The Treasury Department and the IRS 
acknowledge that taking remedial allocations into account in the 11-
step calculation after 2021 might produce an equitable result. However, 
because remedial income would not always be offset by remedial losses 
prior to 2022 for purposes of computing ATI, the Treasury Department 
and that IRS have determined that taking remedial allocations into 
account in the 11-step calculation would not achieve appropriate 
results in all circumstances. Therefore, the Treasury Department and 
the IRS decline to accept the recommendation.
    Third, a commenter recommended that the final regulations allow 
partnerships to make remedial allocations of excess taxable income. 
Under this recommended modification to the 11-step calculation, if a 
partner receives an allocation of taxable income in excess of such 
partner's allocation of excess taxable income, the partnership could 
elect to create positive remedial excess taxable income in the amount 
of the excess and allocate such positive remedial excess taxable income 
to the affected partner. The partnership also would create an 
offsetting negative remedial excess taxable income item in an equal 
amount that would be allocated to the other partners. The Treasury 
Department and the IRS do not adopt this recommendation in the final 
regulations in light of the fact that the definition of ``excess 
taxable income'' is statutory and the statute does not appear to 
contemplate negative excess taxable income.
3. Recommended Alternative Methods
    Commenters recommended the final regulations retain the 11-step 
calculation. Additionally, commenters recommended that the final 
regulations provide alternative methods for allocating section 163(j) 
excess items in addition to the 11-step calculation. The commenters 
seeking an alternative method expressed concern about the complexity of 
the 11-step calculation--specifically, that the required computations 
and recordkeeping are excessive for many taxpayers. Commenters argued 
that the attempted precision of the 11-step calculation should be 
weighed against its complexity and compared to the reduced precision 
that could be achieved through simpler methods.
    As an alternative to the 11-step calculation, commenters 
recommended the final regulations allow taxpayers to adopt any 
reasonable method for allocating section 163(j) excess items, provided 
the method does not produce results inconsistent with the Treasury 
Department and the IRS's resolution of the five issues articulated in 
the preamble to the proposed regulations. See part VII(A)(1) of this 
Summary of Comments and Explanation of Revisions section. Commenters 
provided multiple examples of reasonable methods, and they recommended 
that the final regulations treat section 163(j) excess item allocations 
as reasonable if the allocations are: (1) Reasonably consistent with 
the allocations of the corresponding items under section 704(b); (2) in 
proportion to the allocation of the underlying section 163(j) item; (3) 
in proportion to the manner in which the partners bear liability for 
the debt or, in the case of non-recourse debt, in proportion to the 
manner in which profits will be allocated in order to repay the debt; 
or (4) the result of arms-length bargaining among partners with adverse 
tax interests.
    The Treasury Department and the IRS do not adopt any of these 
alternatives in the final regulations. Each of the alternatives 
recommended by commenters requires an application of section 163(j) at 
the partnership level, a determination of each partner's share of the 
partnership's section 163(j) items, and a final determination of each 
partner's section 163(j) excess items that takes into account each 
partner's share of the partnership's section 163(j) items. These three 
determinations mirror steps 1, 2, and 11 (respectively) of the 11-step 
calculation. The Treasury Department and the IRS recognize the 
complexity of the computations and recordkeeping imposed by the statute 
on partnerships, but the Treasury Department and the IRS have concluded 
that the computations and recordkeeping associated with steps 1, 2, and 
11 of the 11-step calculation are unavoidable under any approach. As 
such, the commenters' recommendation is, in effect, that the final 
regulations allow alternatives to steps 3 through 10 of the 11-step 
calculation.
    With respect to steps 3 through 10, the Treasury Department and the 
IRS agree that these computations add to the complexity already 
required by the statute; thus, a worksheet and multiple examples have 
been provided to aid in the completion of these computations. However, 
the Treasury Department and the IRS have concluded that these 
computations are not overly

[[Page 56719]]

burdensome given that the partnerships required to perform these 
calculations already are experienced with handling the complexities 
associated with special allocations or section 704(c) allocations. In 
terms of recordkeeping, taxpayers are not required to keep records of 
steps 3 through 10 because compliance with the 11-step calculation can 
be determined solely based on the records associated with steps 1, 2, 
and 11. Moreover, in terms of accuracy, the alternatives fall short of 
achieving the purpose of steps 3 through 10, which is to align 
deductible business interest expense with the ATI and business interest 
income that supported such deduction at the partnership level.
    For example, consider the recommended alternative of allocating 
section 163(j) excess items in proportion to the allocation of the 
underlying section 163(j) item. If partnership AB's sole items of 
income, gain, loss, and deduction were $30 of business interest income, 
which it allocated solely to A, and $40 of business interest expense, 
which it allocated $20 to each of A and B, then A and B each would have 
$15 of deductible business interest expense and $5 of excess business 
interest expense. In situations where, as in this case, the partnership 
does not allocate all of its section 163(j) items pro rata 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. See part VII(A)(1) of this Summary 
of Comments and Explanation of Revisions section.
    Applying the 11-step calculation 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 resolution of the five issues described in 
part VII(A)(1) of this Summary of Comments and Explanation of Revisions 
section. Because the alternative of allocating section 163(j) excess 
items in proportion to the allocation of the underlying section 163(j) 
item could require a partnership to allocate section 163(j) excess 
items to its partners in a manner that does not attempt to align 
deductible business interest expense with the ATI and business interest 
income that supported it at the partnership level (which is 
inconsistent with the resolution of the five issues described in part 
VII(A)(1) of this Summary of Comments and Explanation of Revisions 
section), this alternative is not adopted in the final regulations. 
Other commenters' similar alternatives were considered and were 
rejected on the same grounds based on the foregoing analysis.
    One commenter recommended another alternative method that, in a 
more general way than the 11-step calculation, attempts to align 
deductible business interest expense with the ATI and business interest 
income that supported such deduction at the partnership level. The 
commenter stated that this objective could be accomplished as follows. 
For each partner that is allocated business interest expense, determine 
the portion of the business interest expense allocated to such partner 
that would be considered deductible business interest expense, taking 
into account only the business interest income and ATI allocated to 
such partner. If the aggregate amount determined for all partners is 
equal to, or less than, the amount of the partnership's deductible 
business interest expense, then each partner would be allocated 
deductible business interest expense in the amount determined in the 
first step. If the first step produced deductible business interest 
expense in excess of the limitation determined at the partnership 
level, each partner's allocation of deductible business interest 
expense would equal the proportion of the partnership's total 
deductible business interest expense that the deductible amount 
determined in the first step for such partner constitutes of the 
deductible amount determined for all partners. Also, any deductible 
business interest expense as determined at the partnership level that 
is not allocated through the first step then would be allocated among 
the partners that have been allocated business interest deductions in 
proportion to the amount of business interest expense of each partner 
remaining after the first step.
    The Treasury Department and the IRS do not adopt this alternative 
method in the final regulations. The commenter's approach provides a 
method for allocating excess business interest expense, but it does not 
provide any guidance on allocating excess taxable income or excess 
business interest income. Further, it is not possible to infer a manner 
for allocating excess taxable income and excess business interest 
income from this approach because it fails to distinguish each 
partner's ATI from its business interest income. By comingling ATI and 
business interest income in its first step, this method fails to 
account for the ordering of ATI and business interest income in the 
partnership context as required by the statute. Section 163(j)(4)(C) 
provides that partnership ATI does not begin offsetting partnership 
business interest expense until partnership business interest income 
has been fully utilized. Because this method is only capable of 
addressing fact patterns in which there is excess business interest 
expense, it is not adopted in the final regulations.
    Moreover, the Treasury Department and the IRS have concluded that 
this method for allocating excess business interest expense does not 
sufficiently reduce taxpayer burden given the trade-off in precision 
and administrability. To illustrate, the commenter applied its 
recommended method to the facts of Example 14 of Sec.  1.163(j)-6(o) of 
the proposed regulations. In that example, partnership PRS has $140 of 
business interest expense, $200 of ATI, and no business interest 
income. Accordingly, PRS has $60 of deductible business interest 
expense. PRS allocates its items of ATI such that A, B, and C have 
income of $100, $100, and $400 respectively, while D has a loss of 
$400. PRS allocates its business interest expense $40 to B, $60 to C, 
and $40 to D.
    Under the suggested method, PRS first would determine for each of 
B, C, and D the amount of the business interest expense allocated to 
each partner that would be deductible under section 163(j) taking into 
account solely the ATI and business interest income allocated to such 
partner. In this case, the entire $60 of business interest expense 
allocated to C would have been deductible, $30 of the business interest 
expense allocated to B would have been deductible, and no amount of 
business interest expense allocable to D would have been deductible. 
The total amount of business interest expense determined in the first 
step (or $90) exceeds the total amount deductible under section 163(j) 
applied at the partnership level (or $60). PRS then would determine the 
proportion of the business interest expense allocated to each partner 
that is determined to be deductible in the first step and allocate the 
total deduction in those proportions. Thus, C would be entitled to two-
thirds ($60/$90) of the $60 deduction ($40 of deductible business 
interest expense) and B would be entitled to one-third ($30/$90) of the 
$60 deduction ($20 of deductible business interest expense). D would 
not be entitled to any business interest expense deduction. 
Accordingly, B would have $20 of excess business interest expense, C 
would have $20 of excess business interest expense, and D would have 
$40 of excess business interest expense.

[[Page 56720]]

    In contrast, applying the 11-step calculation to the same example 
results in an allocation of more deductible business interest expense 
to C ($48) than to B ($12) because C was allocated more ATI ($400) from 
PRS than B ($100). Unlike the commenter's method, the 11-step 
calculation increases a partner's amount of deductible business 
interest expense in response to an increased allocation of ATI and 
business interest income. The commenter's method allocates deductible 
business interest expense based on a ratio that does not take into 
account the fact that C was allocated significantly more ATI from PRS 
than B. To illustrate this point, consider what would happen in the 
previous example if the facts were changed so that C was allocated 
$1,100 of ATI and D was allocated ($1,100) of ATI. Applying the 11-step 
calculation, C would have $55 of deductible business interest expense. 
Applying the commenter's method, C's increased allocation of ATI from 
PRS would have no effect on C's deductible business interest expense--C 
still would have $40 of deductible business interest expense and $20 of 
excess business interest expense.
    The Treasury Department and the IRS have determined that the 11-
step calculation produces the result that is most consistent with the 
normative principle in the statute that the amount of business interest 
expense a taxpayer is capable of deducting should increase as its ATI 
and business interest income increase. Further, the Treasury Department 
and the IRS view methods that do not increase a partner's amount of 
deductible business interest expense in response to an increased 
allocation of ATI from the partnership as less intuitive, and therefore 
more burdensome in application. Therefore, the final regulations do not 
adopt commenters' suggested alternative methods.
4. Publicly Traded Partnerships
    The Treasury Department and the IRS received comments raising 
concerns about the continued fungibility of publicly traded partnership 
(PTP) units if PTPs are required to allocate section 163(j) excess 
items pursuant to the 11-step calculation. The effect of section 163(j) 
on the fungibility of PTP units is being addressed in the Concurrent 
NPRM. Therefore, these issues are not addressed in the final 
regulations.
5. Pro Rata Exception
    Multiple commenters recommended that partnerships that allocate all 
items of income and expense on a pro rata basis (similar to S 
corporations) be exempt from the 11-step calculation. Commenters stated 
that these partnerships by nature do not make the kinds of allocations 
the 11-step calculation is designed to address. Commenters asserted 
that simplifying the 11-step calculation for these pro-rata 
partnerships would reduce complexity and reduce their administrative 
burden.
    The Treasury Department and the IRS agree with these comments. 
Accordingly, the final regulations provide an exception (pro rata 
exception) from steps 3 through 11 of the 11-step calculation for 
partnerships that allocate all section 163(j) items in step 2 
proportionately. This pro rata exception will not result in allocations 
of section 163(j) excess items that vary from the array of allocations 
of section 163(j) excess items that would have resulted had steps 3 
through 11 been performed. See Sec.  1.163(j)-6(f)(2)(ii) and Example 1 
through Example 16 of Sec.  1.163(j)-6(o).
B. Basis Adjustments
1. Basis and Capital Account Adjustments for Excess Business Interest 
Expense Allocations
    Pursuant to proposed Sec.  1.163(j)-6(f)(2), the adjusted basis of 
a partner's interest in a partnership is reduced, but not below zero, 
by the amount of excess business interest expense allocated to the 
partner. If a partner is subject to a loss limitation under section 
704(d) and the partner is allocated losses from a partnership in a 
taxable year, the limited losses are grouped based on the character of 
each loss (each grouping of losses based on character, a ``section 
704(d) loss class''). If there are multiple section 704(d) loss classes 
in a given year, the partner apportions the limitation to each section 
704(d) loss class proportionately. For purposes of applying this 
proportionate rule, any deductible business interest expense and 
business interest expense of an exempt entity (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) makes up the 
same section 704(d) loss class (section 163(j) loss class). Moreover, 
once the partner determines the amount of limitation on losses 
apportioned to the section 163(j) loss class, any deductible business 
interest expense is taken into account before any excess business 
interest expense or negative section 163(j) expense.
    Proposed Sec.  1.163(j)-6(h)(2) provides that 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, which prevents 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).
    Commenters noted that the rule in proposed Sec.  1.163(j)-6(h)(2) 
is helpful and should be retained in the final regulations. However, 
commenters further noted that partners with no business interest 
expense from other sources generally would prefer to treat their 
negative section 163(j) expense as deductible business interest expense 
suspended under section 704(d) and utilize excess taxable income in the 
current year for that purpose, even though the resulting deductible 
business interest expense would continue to be non-deductible because 
of a section 704(d) limit. Thus, commenters recommended allowing a 
partner to use excess taxable income to treat negative section 163(j) 
expense as deductible business interest expense suspended under section 
704(d) instead of using it to increase partner ATI.
    The final regulations do not adopt this recommendation. No 
precedent exists for allowing items suspended under section 704(d) to 
preemptively clear limitations that apply after section 704(d) while 
remaining suspended under section 704(d). For example, in the section 
469 context, a non-materially participating partner allocated passive 
income cannot use such passive income to recharacterize passive losses 
allocated in a previous year as non-passive while those losses remain 
suspended under section 704(d).

[[Page 56721]]

    One commenter also recommended adopting a silo approach under 
section 704(d). Under this approach, if a partner had a section 704(d) 
limitation, it could bifurcate its items between non-excepted and 
excepted partnership business items. If the non-excepted portion was 
net positive, none of the excess business interest expense allocated 
from the partnership would be negative section 163(j) expense.
    However, this approach would be a significant departure from the 
current rule under section 704(d), which generally requires the 
limitation on losses under section 704(d) to be allocated to a 
partner's distributive share of each loss proportionately, regardless 
of whether such loss is from an excepted or non-excepted trade or 
business under section 163(j). Moreover, nothing in section 163(j) 
indicates Congress intended to give excess business interest expense 
suspended under section 704(d) a better result than any other 
partnership losses suspended under section 704(d). For that reason, the 
final regulations do not adopt this recommendation.
2. Basis Adjustments Upon Disposition of Partnership Interests Pursuant 
to Section 163(j)(4)(B)(iii)(II)
    Under the proposed regulations, if a partner disposes of all or 
substantially all of its partnership interest, the adjusted basis of 
the partnership interest is increased immediately before the 
disposition by the entire amount of the remaining excess business 
interest expense. Following such a disposition, no deduction is 
permitted to either the transferor or the transferee with respect to 
the excess business interest expense resulting in the basis increase. 
If a partner disposes of less than substantially all of its interest in 
a partnership, the partner cannot increase its basis by any portion of 
the remaining excess business interest expense. The Treasury Department 
and the IRS requested comments on this approach in the preamble to the 
proposed regulations.
    Commenters cited multiple concerns with the approach adopted in the 
proposed regulations. First, commenters claimed that the absence of an 
excess business interest expense basis addback for a partial 
disposition of a partnership interest could result in tax gain in 
excess of economic gain in connection with the sale of a partial 
interest, while the addition of the entire adjustment to outside basis 
in connection with a complete disposition could result in economic gain 
in excess of tax gain. Commenters suggested this timing difference 
between economic gain and tax gain inappropriately disconnects taxable 
income from economic income. Second, commenters expressed concern that, 
because a partial disposition would result in a partner holding a 
smaller interest in a partnership than it held prior to the partial 
disposition, the partner would receive smaller allocations of excess 
taxable income (and excess business interest income) in subsequent 
years. If none of the excess business interest expense of the partner 
is affected by the partial disposition, this could extend the amount of 
time needed for a partner to convert its excess business interest 
expense to business interest expense treated as paid or accrued. Third, 
commenters noted that, in the event of a partial disposition of a 
partnership interest, the proposed regulations may cause a discrepancy 
between the capital accounts of the transferor and the transferee and 
the excess business interest expense associated with each partner's 
interest.
    Commenters stated that neither the statute nor its policy of 
limiting business interest expense deductions calls for the potentially 
harsh results that could be imposed by the approach provided in the 
proposed regulations. The main purpose of the excess business interest 
expense carryover rule is to limit the partner's ability to claim a 
business interest expense deduction that exceeds the statutory 
threshold under section 163(j)(1). Commenters stated that this 
statutory purpose can be accomplished by denying the business interest 
expense deduction and eliminating the carryforward upon a partial 
disposition of the partnership interest. In other words, to the extent 
that a partner foregoes its business interest expense deduction, the 
purpose of the statute is fulfilled. Thus, a proportionate approach 
would fulfill the purpose of the statute while not subjecting taxpayers 
to outcomes that are not plainly contemplated by the statue.
    As a solution, commenters recommended that a partial disposition of 
a partnership interest trigger a proportionate excess business interest 
expense basis addback and corresponding decrease in such partner's 
excess business interest expense carryover (proportionate approach). 
Under the proportionate approach, the partner would be required to 
track its basis in its partnership interest in a manner similar to that 
set forth in Revenue Ruling 84-53, 1984-1 C.B. 159 (April 9, 1984). 
Commenters advocating for a proportionate addback rule varied in their 
recommendations regarding where the addback should occur. In general, 
commenters suggested three options: (1) Increase the basis of the 
partnership interest retained; (2) apportion the basis increase 
proportionally between the partnership interest retained and the 
partnership interest being disposed of; and (3) increase the basis of 
the partnership interest being disposed of.
    As described in the preamble to the proposed regulations, the 
Treasury Department and the IRS originally considered and rejected the 
proportionate approach. One reason the Treasury Department and the IRS 
adopted the all or substantially all approach in the proposed 
regulations over the proportionate approach was because the former 
appeared more taxpayer-favorable in certain circumstances. Under the 
all or substantially all approach in the proposed regulations, the 
excess business interest expense basis addback is delayed for the 
maximum amount of time (until a partner disposes of all or 
substantially all of its interest), giving taxpayers more time to 
receive excess taxable income (and excess business interest income) and 
thus potentially take an ordinary deduction. However, as commenters 
pointed out, a smaller partnership interest likely will result in a 
correspondingly smaller allocation of excess taxable income (and excess 
business interest income) from the partnership. For this reason, 
commenters did not perceive the proposed approach as taxpayer-favorable 
for preserving the possibility of a future ordinary deduction, but 
rather as taxpayer-unfavorable for delaying what likely will be a 
capital loss.
    Accordingly, the Treasury Department and the IRS adopt the 
recommended proportionate approach in the final regulations. In the 
preamble to the proposed regulations, the Treasury Department and the 
IRS indicated that, if final regulations were to adopt a proportionate 
approach, such approach would increase the basis of the partnership 
interest being retained by the amount of the excess business interest 
expense basis addback. However, upon further consideration, the 
Treasury Department and the IRS agree with commenters that the basis 
addback should instead increase the basis of the partnership interest 
being disposed of. Thus, the final regulations adopt a proportionate 
approach that increases the basis of the partnership interest being 
disposed of.
    For purposes of Sec.  1.163(j)-6(h)(3), a disposition includes a 
distribution of money or other property by the partnership to a partner 
in complete liquidation of its interest in the

[[Page 56722]]

partnership. The Treasury Department and the IRS request comments on 
whether a current distribution of money or other property by the 
partnership to a continuing partner as consideration for an interest in 
the partnership should also trigger an addback and, if so, how to 
determine the appropriate amount of the addback. Additionally, the 
final regulations clarify that each partner is considered to have 
disposed of its partnership interest within the meaning of Sec.  
1.163(j)-6(h)(3) if the partnership terminates under section 708(b)(1).
    The proportionate rule adopted in the final regulations applies the 
equitable apportionment principles of Sec.  1.61-6 (referenced in 
Revenue Ruling 84-53) to determine the amount of excess business 
interest expense attributable to the partner's interest sold. In 
Example 1 of Sec.  1.61-6, basis is apportioned among properties based 
on the fair market value of the property and is treated as equitably 
apportioned. Similarly, in Situations 1 and 3 of Revenue Ruling 84-53, 
the IRS ruled that a selling partner's basis in the transferred portion 
of the interest generally equals an amount that bears the same relation 
to the partner's basis in the partner's entire interest as the fair 
market value of the transferred portion of the interest bears to the 
fair market value of the entire interest (the pro rata approach to 
equitable apportionment). However, if a partnership has liabilities, 
special adjustments must be made to take into account the effect of the 
liabilities on the basis of the partner's interest. Accordingly, the 
final regulations adopt the pro rata approach to equitable 
apportionment and generally provide that the adjusted basis of the 
partnership interest being disposed of is increased immediately before 
the disposition by the amount of the excess business interest expense 
that is proportionate to the interest disposed of in the transaction.
    The Treasury Department and the IRS also received comments 
recommending the final regulations treat a sale of all or substantially 
all of a partnership's assets as a deemed disposition of each partner's 
interest in the partnership within the meaning of section 
163(j)(4)(B)(iii)(II). Because the statute requires a disposition of a 
partnership interest to trigger the basis adjustment described in 
section 163(j)(4)(B)(iii)(II), the final regulations do not adopt this 
recommendation.
3. Intercompany Transfer of a Partnership Interest
    For a discussion of comments received on intercompany transfers of 
partnership interests, see part V(D) of this Summary of Comments and 
Explanation of Revisions section.
C. Debt-Financed Distributions
    The treatment of interest expense associated with debt incurred by 
a partnership or S corporation to finance distributions to owners 
(debt-financed distributions) is being addressed in the Concurrent 
NPRM. Therefore, these issues are not addressed in the final 
regulations.
D. Trading Partnerships
    The preamble to the proposed regulations stated that the business 
interest expense of certain passthrough entities, including S 
corporations, that are engaged in trades or businesses that are per se 
non-passive activities and in which one or more owners of the entities 
do not materially participate within the meaning of section 469, as 
described in section 163(d)(5)(A)(ii) and as illustrated in Revenue 
Ruling 2008-12, 2008-1 C.B. 520 (March 10, 2008), will be subject to 
section 163(j) at the entity level (even if the interest expense is 
also subject to limitation under section 163(d) at the individual 
partner level). 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. This rule does not 
apply to corporate partners.
    The Treasury Department and the IRS received multiple comments 
questioning this interpretation of section 163(j)(5) and its 
interaction with section 163(d)(5)(A)(ii). The interaction of section 
163(j)(5) with section 163(d)(5)(A)(ii) is being addressed in the 
Concurrent NPRM. Therefore, this issue is not addressed in the final 
regulations.
E. Treatment of Excess Business Interest Expense in Tiered Partnerships
    The preamble to the proposed regulations requested comments 
regarding the application of section 163(j) to tiered partnership 
structures, and the proposed regulations reserved on this topic. 
Specifically, the preamble requested comments on whether excess 
business interest expense should be allocated through upper-tier 
partnerships and how or when an upper-tier partner's basis should be 
adjusted when a lower-tier partnership is subject to a section 163(j) 
limitation. This issue is being addressed in the Concurrent NPRM. 
Therefore, this issue is not addressed in the final regulations.
F. Partnership Mergers and Divisions
    The proposed regulations reserve on guidance regarding the 
application of section 163(j) to partnership mergers and divisions, and 
the Treasury Department and the IRS requested comments in the preamble 
to the proposed regulations 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).
    In response to this request, one commenter recommended that: (i) 
The carryforward rule in proposed Sec.  1.163(j)-6(g) apply to partners 
of a partnership treated as a continuing partnership in a partnership 
merger or division; (ii) the disposition rule of proposed Sec.  
1.163(j)-6(h)(3)(i) apply to partnership interests that are treated as 
liquidated in a partnership merger or division; and (iii) the final 
regulations confirm, perhaps through examples, the application of the 
excepted trade or business election and termination rules in proposed 
Sec.  1.163(j)-9 in the context of a partnership merger or division.
    The partnership merger and division rules under section 708 may 
treat a partnership as terminating or continuing, and the regulations 
under Sec.  1.708-1(c) and (d) provide a construct for analyzing the 
tax effects of a partnership merger or division. The Treasury 
Department and the IRS have determined that, in most situations, a 
partnership merger or division can be analyzed appropriately under the 
rules of Sec.  1.708-1(c) and (d). As a result, the Treasury Department 
and the IRS are not providing special rules in the final regulations to 
analyze the consequences of a partnership merger or division in the 
context of section 163(j) at this time. However, the Treasury 
Department and the IRS continue to study these issues.
G. Applicability of Section 382 to S Corporations Regarding Disallowed 
Business Interest Expense Carryforwards
    The proposed regulations provide that sections 381(c)(20) and 
382(d)(3) and (k)(1) apply to S corporations with respect to disallowed 
business expense carryforwards. Proposed Sec.  1.163(j)-6(l)(5) 
provides that the amount of any business interest expense not allowed 
as a deduction for any taxable year by reason of the section 163(j) 
limitation is carried forward in the succeeding taxable year as a 
disallowed business interest expense carryforward. Proposed

[[Page 56723]]

Sec.  1.163(j)-6(l)(1) provides that any disallowed business interest 
expense is not allocated to the S corporation's shareholders until such 
business interest expense is allowed as a deduction under section 
163(j). Similarly, under proposed Sec.  1.163(j)-6(l)(6) and (7), an S 
corporation shareholder's stock basis is reduced, but not below zero, 
and an S corporation's accumulated adjustments account (AAA) balance is 
adjusted, when a disallowed business interest expense becomes 
deductible under section 163(j).
    The preamble to the proposed regulations requested comments 
regarding the proper integration of section 163(j) and section 382 and 
subchapter S of the Code (subchapter S). In addition, the preamble to 
the proposed regulations requested comments regarding the treatment of 
disallowed business interest expense carryforwards as an attribute of 
the S corporation subject to the section 382 limitation, as opposed to 
an attribute of the shareholders, and regarding the timing for any 
adjustments to shareholder basis and the corporation's AAA.
    In response, one commenter recommended that the final regulations 
retain the approach as set forth in the proposed regulations. In 
particular, the commenter recommended that section 382 (and the 
comparable provisions of section 383) be applied only to those 
attributes that are carried forward and taken into account at the 
corporate level. The commenter contended that it would be appropriate 
to treat disallowed business interest expense of an S corporation as a 
``pre-change loss'' such that the corporation would be a loss 
corporation pursuant to section 382(k)(1).
    The Treasury Department and the IRS agree with the commenter. 
Because disallowed business interest expense is treated as an attribute 
of the S corporation, the S corporation's disallowed business interest 
expense carryforwards will be treated as pre-change losses subject to a 
section 382 limitation under section 382(d)(3) following an S 
corporation's ownership change (within the meaning of section 382(g)).
    Accordingly, consistent with the treatment of C corporations under 
section 382, the final regulations provide that a disallowed business 
interest expense carryforward of an S corporation is treated as pre-
change loss and will be subject to a section 382 limitation only if an 
S corporation undergoes an ownership change within the meaning of 
section 382(g). For example, under the final regulations, a 
``qualifying disposition'' by a shareholder that results in a 20-
percent ownership change of the S corporation, on its own, will not 
cause section 382 to apply to an S corporation upon such qualifying 
disposition. See Sec.  1.1368-1(g)(2)(i)(A). See also Sec.  1.1368-
1(g)(2) (defining the term ``qualifying disposition'').
    A commenter also recommended that section 382 not be applied to any 
item of deduction, loss, or credit that is allocated to shareholders on 
a current basis and taken into account at the shareholder level. As 
expressed in the preamble to the proposed regulations, 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 continue to seek comments 
regarding the proper integration of these two Code sections and 
subchapter S.
H. Separate Application of Section 163(j) Limitation to Short Taxable 
Years of S Corporation
    An S corporation's items of income and loss generally are allocated 
on a pro rata, per-day basis to all shareholders that hold the 
corporation's stock during the corporation's taxable year. See section 
1377(a)(1). However, subchapter S provides limited exceptions to that 
general allocation rule. For example, in the event that a shareholder 
completely terminates its interest, the S corporation and affected 
shareholders can elect to treat its taxable year ``as if the taxable 
year consisted of 2 taxable years the first of which ends on the date 
of the termination'' (each, a hypothetical short taxable year). Section 
1377(a)(2)(A). In addition, an S corporation may make such an election 
if a shareholder has made a qualifying disposition. See Sec.  1.1368-
1(g)(2). With regard to each of these instances, the S corporation may 
elect to ``close the books'' even though the corporation will file one 
Federal income tax return for the taxable year covering both separate 
taxable periods.
    Subchapter S also specifies instances in which an S corporation may 
elect, or is required, to file a Federal income tax return for a short 
taxable year (actual short taxable year). For example, an S corporation 
may elect to determine taxable income or loss based on a closing-of-
the-books method with respect to an S termination year. See section 
1362(e)(3) (providing an election to have items assigned to each short 
taxable year under normal Federal income tax accounting rules). 
However, if a sale or exchange of at least 50 percent of the S 
corporation's stock occurs during that S termination year, the S 
corporation must utilize the closing-of-the-books method. See section 
1362(e)(6)(D). See also section 1362(e)(6)(C) (requiring the use of the 
closing-of-the-books method with respect to any item resulting from the 
application of section 338).
    Based on a request from a commenter, the Treasury Department and 
the IRS have considered whether the section 163(j) limitation should 
apply separately with respect to each hypothetical or actual short 
taxable year. Specifically, the commenter recommended that, if an S 
corporation (1) has an actual short taxable year, or (2) determines its 
taxable income or loss as if its taxable year consisted of separate 
taxable years (that is, hypothetical short taxable years), the final 
regulations should clarify that a separate section 163(j) limitation 
should be calculated for, and applied to, each actual or hypothetical 
short taxable year. To support that recommendation, the commenter 
emphasized ``sound policy reasons'' for ensuring that owners of the 
corporation during the first short taxable period are not affected by 
the fortunes of the corporation during the second short period, and 
vice versa.
    The Treasury Department and the IRS agree that a separate section 
163(j) limitation should be calculated for, and applied to, each actual 
or hypothetical short taxable year. Section 163(j)(1) limits the amount 
of business interest expense allowed as a deduction ``for any taxable 
year.'' Accordingly, the Treasury Department and the IRS have 
determined that a separate section 163(j) limitation should apply to 
each actual short taxable year. See Sec.  1.1362-3(c)(3) (setting forth 
the general rule that ``the S and C short years are treated as two 
separate years for purposes of all provisions of the Internal Revenue 
Code''). In addition, subchapter S and the regulations in this part 
under subchapter S explicitly treat hypothetical short taxable years as 
separate taxable years. See section 1377(a)(2)(A) (providing that an S 
corporation can treat its taxable year ``as if the taxable year 
consisted of 2 taxable years'') and Sec.  1.1368-1(g)(1) (providing 
that the ``section applies as if the taxable year consisted of separate 
taxable years''). As a result, the Treasury Department and the IRS also 
have determined that a separate section 163(j) limitation should apply 
to each

[[Page 56724]]

hypothetical short taxable year and sections 1.1362-3(c), 1.1368-
1(g)(2), and 1.1377-1(b)(3) have been amended accordingly.
I. Partnership or S Corporation Not Subject to Section 163(j)
    Under proposed Sec.  1.163(j)-6(m)(1), 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. Commenters recommended that proposed Sec.  1.163(j)-
6(m)(1) be modified so that business interest expense incurred by a 
partnership that is an exempt entity is not subject to section 163(j) 
at the partner level. Commenters argued that proposed Sec.  1.163(j)-
6(m)(1) was inconsistent with section 163(j)(4)(A), which requires the 
testing of partnership-level business interest expense at the 
partnership level, not the partner level. The Treasury Department and 
the IRS agree, and have determined that the same argument naturally 
should apply to S corporations and their shareholders. See section 
163(j)(4)(D) (in relevant part, providing that rules similar to section 
163(j)(4)(A) shall apply with respect to any S corporation and its 
shareholders). Accordingly, the final regulations provide that business 
interest expense of an exempt partnership, or exempt S corporation, 
pursuant to section 163(j)(3) does not retain its character as business 
interest expense and, as a result, is not subject to the section 163(j) 
limitation at the partner or S corporation shareholder level.
    One commenter requested clarification as to whether proposed Sec.  
1.163(j)-6(m)(3) applies only to exempt entities or also could apply to 
trades or businesses that become not subject to the requirements of 
section 163(j) by reason of engaging in excepted trades or businesses. 
The final regulations clarify that Sec.  1.163(j)-6(m)(3) does not 
apply when a partnership engages in excepted trades or businesses. 
Accordingly, if a partner is allocated excess business interest expense 
from a partnership and, in a succeeding taxable year, such partnership 
engages in excepted trades or businesses, then the partner shall not 
treat any of its excess business interest expense that was previously 
allocated from such partnership as business interest expense paid or 
accrued by the partner in such succeeding taxable year by reason of the 
partnership engaging in excepted trades or businesses. Rather, such 
excess business interest expense shall remain as excess business 
interest expense until such time as it is treated as business interest 
expense paid or accrued by the partner pursuant to Sec.  1.163(j)-
6(g)(2) or by reason of the partnership becoming an exempt entity. The 
final regulations provide a similar clarification for S corporations in 
Sec.  1.163(j)-6(m)(4).
J. Trusts
    For purposes of determining ATI for trusts, one commenter noted 
that the definition of ATI does not contain an addback for deductible 
trust distributions. Trusts and decedents' estates taxable under 
section 641 are permitted to deduct under sections 651 and 661 certain 
distributions made to beneficiaries. The commenter suggested that 
section 163(j) should apply before a trust takes a deduction for 
distributions to beneficiaries, and that, if a deductible trust or 
estate distribution is added back to the trust's ATI and thus is taken 
into account in determining the amount of interest expense allowable to 
the trust under section 163(j), such trust or estate distribution 
should be excluded from the recipient beneficiaries' calculation of 
ATI. Thus, under the commenter's approach, a beneficiary of a trust or 
a decedent's estate would not be able to utilize a trust distribution 
to deduct additional business interest expense at the beneficiary 
level.
    The Treasury Department and the IRS agree with this comment. 
Proposed Regulation Sec.  1.163(j)-2(f) is consistent with this result. 
However, in order to clarify that trusts and decedents' estates taxable 
under section 641 compute ATI without regard to deductions under 
sections 651 and 661, the final regulations explicitly provide for this 
positive ATI adjustment. Additionally, the Treasury Department and the 
IRS have determined that a similar rule should apply for charitable 
deductions of a trust or a decedent's estate under section 642(c).
K. Qualified Expenditures
    The ATI of a partnership is generally determined in accordance with 
proposed Sec.  1.163(j)-1(b)(1). Partnership ATI is therefore reduced 
by deductions claimed under sections 173 (relating to circulation 
expenditures), 174(a) (relating to research and experimental 
expenditures), 263(c) (relating to intangible drilling and development 
expenditures), 616(a) (relating to mine development expenditures), and 
617(a) (relating to mining exploration expenditures) (collectively, 
``qualified expenditures''). As a result, deductions for qualified 
expenditures will reduce a partnership's section 163(j) limitation 
pursuant to proposed Sec.  1.163(j)-2(b). Deductions for those items 
also will reduce the amount of excess taxable income that may be 
allocated to the partners and thus reduce the amount by which partner-
level ATI may be increased under proposed Sec.  1.163(j)-6(e)(1).
    A partner may elect to capitalize its distributive share of any 
qualified expenditures of a partnership under section 59(e)(4)(C) or 
may be required to capitalize a portion of its distributive share of 
certain qualified expenditures of a partnership under section 291(b). 
As a result, the taxable income reported by a partner in a taxable year 
attributable to the ownership of a partnership interest may exceed the 
amount of taxable income reported to the partner on a Schedule K-1.
    Commenters recommended that a distributive share of partnership 
deductions capitalized by a partner under section 59(e) or section 
291(b) increase the ATI of the partner because qualified expenditures 
reduce both partnership ATI and excess taxable income but may not 
reduce the taxable income of a partner. Commenters suggested two 
different approaches for achieving this result: (1) Adjust the excess 
taxable income of the partnership, resulting in an increase to partner 
ATI; and (2) increase the ATI of the partner directly, without making 
any adjustments to partnership excess taxable income. The interaction 
of qualified expenditures with section 163(j)(4) is being addressed in 
the Concurrent NPRM. Therefore, this issue is not addressed in the 
final regulations.
L. CARES Act Partnership Rules
    As discussed in the Background section to this preamble, section 
163(j)(10), as amended by the CARES Act, provides a special rule for 
excess business interest expense allocated to a partner in a taxable 
year beginning in 2019 (50 percent EBIE Rule). See section 
163(j)(10)(a)(ii). The 50 percent EBIE rule is addressed in proposed 
Sec.  1.163(j)-6(g)(4) of the Concurrent NPRM. The application of the 
2019 ATI rule, as provided in section 163(j)(10)(B), in the partnership 
context is also addressed in proposed Sec.  1.163(j)-6(g)(4) of the 
Concurrent NPRM. Therefore, the 50 percent EBIE rule and the 
application of the 2019 ATI rule to partnerships are not addressed in 
the final regulations.

[[Page 56725]]

VIII. Comments on and Changes to Proposed Sec.  1.163(j)-7: Application 
of the Section 163(j) Limitation to Foreign Corporations and United 
States Shareholders

    Section 1.163(j)-7 provides general rules regarding the application 
of the section 163(j) limitation to foreign corporations and U.S. 
shareholders. The following discussion addresses comments relating to 
proposed Sec.  1.163(j)-7.
    The proposed regulations generally apply section 163(j) and the 
section 163(j) regulations to determine the deductibility of an 
applicable CFC's business interest expense in the same manner as these 
provisions apply to determine the deductibility of a domestic C 
corporation's business interest expense. See proposed Sec.  1.163(j)-
7(b)(2). The proposed regulations define an applicable CFC as a CFC in 
which at least one U.S. shareholder owns stock, within the meaning of 
section 958(a). However, in certain cases, the proposed regulations 
limit the amount of an applicable CFC's business interest expense 
subject to the section 163(j) limitation and modify the computation of 
an applicable CFC's ATI, respectively. Thus, under the proposed 
regulations, an applicable CFC with business interest expense applies 
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 that is effectively connected with the conduct of a U.S. trade 
or business (ECI), as applicable. The proposed regulations provide 
additional guidance for an applicable CFC (and other foreign persons) 
with ECI in proposed Sec.  1.163(j)-8, as discussed in part IX of this 
Summary of Comments and Explanation of Revisions section.
    The Treasury Department and the IRS requested comments in the 
preamble to the proposed regulations regarding whether it would be 
appropriate to provide additional modifications to the application of 
section 163(j) to applicable CFCs and whether there are particular 
circumstances in which it may be appropriate to exempt an applicable 
CFC from the application of section 163(j).
    Some commenters recommended that section 163(j) generally should 
not apply to applicable CFCs. Other commenters suggested that section 
163(j) should apply to applicable CFCs only to the extent that they 
have ECI or, if an income tax treaty applies, business profits 
attributable to a United States permanent establishment, or to the 
extent that debt was introduced to an applicable CFC with a principal 
purpose of avoiding U.S. income taxes. Some commenters argued that the 
Treasury Department and the IRS lack the authority to apply section 
163(j) to applicable CFCs because section 163(j) applies to taxpayers 
and, they argue, applicable CFCs are not taxpayers. Furthermore, some 
commenters argued that old section 163(j) did not apply to applicable 
CFCs and that Congress expressed no intent to change that. Some 
commenters also argued that applying section 163(j) to applicable CFCs 
creates significant complexity and an administrative burden. 
Furthermore, some commenters suggested that applying section 163(j) to 
applicable CFCs may have a limited effect on tax revenue or that 
applying section 163(j) to applicable CFCs could, in some cases, result 
in a net tax benefit to U.S. shareholders.
    The Treasury Department and the IRS have determined that, under 
current law, section 163(j) applies to applicable CFCs and other 
foreign corporations whose income is relevant for U.S. tax purposes. As 
a general matter, application of U.S. tax principles to a foreign 
corporation for purposes of determining its income for U.S. tax 
purposes is within the authority of the Treasury Department and the 
IRS. For example, a U.S. shareholder of an applicable CFC takes into 
account its pro rata share of the subpart F income and net tested 
income of an applicable CFC. Accordingly, in order to determine the 
U.S. shareholder's pro rata share, the income of the applicable CFC 
must be determined. Section 1.952-2(a)(1) provides that, ``[e]xcept as 
provided in subparagraph (2) of this paragraph [relating to insurance 
gross income], the gross income of a foreign corporation for any 
taxable year shall, subject to the special rules of paragraph (c) of 
this section, be determined by treating such foreign corporation as a 
domestic corporation taxable under section 11 and by applying the 
principles of section 61 and the regulations thereunder.'' Neither 
Sec.  1.952-2(a)(2) nor (c) implicates section 163(j). Accordingly, 
pursuant to Sec.  1.952-2, a foreign corporation is treated as a 
domestic corporation for U.S. tax purposes when calculating its taxable 
income, including by application of section 163(j).
    The exclusion of CFCs from the application of old section 163(j) 
under the 1991 Proposed Regulations is not determinative as to whether 
applicable CFCs and other foreign corporations should be excluded from 
the application of section 163(j). Although both old section 163(j) and 
section 163(j) limit deductions for business interest expense, the 
policies of each provision are significantly different. Old section 
163(j) was a narrower provision that limited a corporation's ability to 
use interest expense deductions to move earnings out of the United 
States tax base. Section 163(j) focuses on limiting the potential tax 
benefit of overleveraged businesses. Because Congress wholly repealed 
and replaced old section 163(j), the provisions of old section 163(j) 
and the 1991 Proposed Regulations are not determinative as to the 
application of section 163(j).
    Furthermore, nothing in the Code or legislative history indicates 
that Congress intended to exclude applicable CFCs or other foreign 
corporations from the application of section 163(j). Congress expressly 
provided that section 163(j) should not apply to certain small 
businesses or to certain excepted trades or businesses. Congress did 
not exempt applicable CFCs or other foreign corporations from the 
application of section 163(j).
    Accordingly, the final regulations clarify that section 163(j) 
applies to foreign corporations whose income is relevant for U.S. tax 
purposes, other than by reason of section 881 or 882 (relevant foreign 
corporations). Section 1.163(j)-7(b). Furthermore, no comments were 
received on the application of Sec.  1.952-2 or section 882 for 
purposes of determining the income, including ECI, of an applicable CFC 
or on the reduction of an applicable CFC's taxable income by the amount 
of any dividend received from a related person for purposes of 
determining ATI. In addition to clarifying that these rules apply to 
all relevant foreign corporations, the final regulations otherwise 
adopt these rules unchanged. Sec.  1.163(j)-7(g)(1).
    The Treasury Department and the IRS acknowledge that the 
application of section 163(j) to applicable CFCs and other relevant 
foreign corporations, like many other tax provisions, will increase the 
complexity of determining the taxable income of a relevant foreign 
corporation. Similarly, section 163(j) may have a significant effect on 
the amount of taxable income of some relevant foreign corporations and 
have limited or no effect on the amount of taxable income of others. 
The Treasury Department and the IRS do not view the complexity of a 
provision of the Code or its net effect on tax revenue as determinative 
as to whether the provision applies to CFCs. Nonetheless, the Treasury 
Department and the IRS have determined that it is appropriate to

[[Page 56726]]

reduce the compliance and administrative burdens of applying section 
163(j) to certain applicable CFCs.
    Accordingly, the Treasury Department and the IRS have developed new 
rules, taking into account comments received, that substantially modify 
the rules contained in proposed Sec.  1.163(j)-7. The Treasury 
Department and the IRS anticipate that, in many cases, these 
modifications will significantly reduce the compliance and 
administrative burdens of applying section 163(j) to applicable CFCs. 
However, because the operation of these new rules is sufficiently 
different from the operation of the rules in proposed Sec.  1.163(j)-7, 
the Treasury Department and the IRS have determined that these rules 
should be proposed in order to provide taxpayers the opportunity to 
comment before their finalization. These rules and a discussion of 
their operation are contained in the Concurrent NPRM.

IX. Comments on and Changes to Section 1.163(j)-8: Application of the 
Section 163(j) Limitation to Foreign Persons With Effectively Connected 
Taxable Income.

    Proposed Sec.  1.163(j)-8 provides rules for applying section 
163(j) to a nonresident alien individual or foreign corporation with 
ECI. Although no comments were received on proposed Sec.  1.163(j)-8, 
the Treasury Department and the IRS continue to study methods of 
determining the amount of deductible business interest expense and 
disallowed business interest expense carryforwards that are allocable 
to ECI. Accordingly, the final regulations reserve on the application 
of the business interest expense deduction limitation to foreign 
persons with ECI.
    In the Concurrent NPRM, the Treasury Department and the IRS are 
proposing rules for determining the amount of deductible business 
interest expense and disallowed business interest expense carryforward 
of a nonresident alien, foreign corporation, or partnership that is 
properly allocable to ECI. The Treasury Department and the IRS request 
comments on appropriate methods of making this determination. These 
comments should consider the appropriate method for determining the 
extent to which business interest expense determined under Sec.  1.882-
5 should be treated as attributable to a partnership and subject to the 
section 163(j) limitation at the partnership level.

X. Comments on and Changes to Proposed Sec.  1.163(j)-9: Elections for 
Excepted Trades or Businesses; Safe Harbor for Certain REITs

    Section 1.163(j)-9 provides general rules and procedures for making 
an election for a trade or business to be an electing real property 
trade or business under section 163(j)(7)(B) and an election for a 
trade or business to be an electing farming business under section 
163(j)(7)(C). The following discussion addresses some of the provisions 
in Sec.  1.163(j)-9 and the comments received.
A. Protective Elections
    Section 163(j)(3) provides that the section 163(j) limitation does 
not apply to taxpayers that meet the gross receipts test of section 
448(c). The small business exemption applies automatically if the 
requirements are met; thus, no election is necessary to ensure that the 
section 163(j) limitation does not apply. However, for real property 
trades or businesses under section 163(j)(7)(B), and for farming 
businesses under section 163(j)(7)(C), the section 163(j) limitation 
does not apply only if the taxpayer is eligible for and makes an 
election.
    The preamble to the proposed regulations provides that a taxpayer 
that qualifies for the small business exemption is not eligible to make 
an election for a trade or business to be an electing real property 
trade or business or an electing farming business, in part because the 
taxpayer is already not subject to the section 163(j) limitation, and 
in part because an electing real property trade or business or an 
electing farming business is required to use ADS for certain types of 
property under section 163(j)(10) and cannot claim the additional 
first-year depreciation deduction under section 168(k) for those types 
of property. The Treasury Department and the IRS were concerned that 
certain small business taxpayers might make the election without 
realizing that the election could have adverse effects on their 
deduction for depreciation expense and their method of accounting for 
depreciation.
    Commenters suggested that, in some situations, making an annual 
gross receipts determination, to determine whether a taxpayer should 
make an election or is already exempt from the limitation, could be 
burdensome. For example, a taxpayer that has to request the average 
annual gross receipts of numerous unrelated entities under section 448 
aggregation principles in order to make the gross receipts 
determination may choose to forgo making that determination if the 
taxpayer knows that its trade or business qualifies to be an electing 
real property trade or business or an electing farming business. These 
commenters requested that taxpayers be allowed to make such an election 
without regard to whether the gross receipts test of section 448(c) has 
been tested or is met, notwithstanding the potentially adverse 
depreciation expense implications.
    The Treasury Department and the IRS agree with the commenters. 
Accordingly, the final regulations provide that taxpayers may make an 
election for a trade or business to be an electing real property trade 
or business or an electing farming business, provided that they qualify 
to make such elections, even if the gross receipts test under section 
448(c) may be satisfied by the electing trades or businesses in the 
taxable year in which the election is made. As is the case for all 
other electing real property trades or businesses and electing farming 
businesses, the elections are irrevocable and affect depreciation as 
provided in section 163(j)(11). However, this rule also benefits 
taxpayers subject to section 163(j) that are owners of small businesses 
because treating these small businesses as engaged in an excepted trade 
or business may result in the allocation of more owner interest expense 
to excepted trades or businesses under Sec.  1.163(j)-10(c).
    Commenters also requested a protective election for taxpayers 
engaged in rental real estate activities if it is unclear whether the 
activities rise to the level of a trade or business under section 162. 
The protective election is necessary, according to some commenters, 
because the definition of an ``electing real property trade or 
business'' in section 163(j)(7)(B) and proposed Sec.  1.163(j)-1(b)(14) 
allows a trade or business described in section 469(c)(7)(C) to make 
the election, and a real property trade or business as defined in 
section 469(c)(7)(C) can include rental real estate that does not rise 
to the level of a section 162 trade or business.
    Generally, interest expense associated with an activity that does 
not rise to the level of a section 162 trade or business is not subject 
to the section 163(j) limitation. The section 163(j) limitation applies 
to taxpayers with business interest, which is defined under section 
163(j)(5) as any interest properly allocable to a trade or business. 
Proposed Sec.  1.163(j)-1(b)(38) defines a ``trade or business'' as a 
trade or business under section 162. In contrast, an electing real 
property trade or business must be described in section 469(c)(7)(C). 
Section 1.469-9(b)(1)

[[Page 56727]]

provides that, for purposes of section 469(c)(7), the term ``trade or 
business'' is defined as ``any trade or business determined by treating 
the types of activities in Sec.  1.469-4(b)(1) as if they involved the 
conduct of a trade or business; and any interest in rental real estate, 
including any interest in rental real estate that gives rise to 
deductions under section 212.''
    Thus, section 469(c)(7)(C) includes all rental real estate (as 
defined in Sec.  1.469-9(b)(3)) and adopts a broader definition of a 
``trade or business'' than section 162. Under this broader definition, 
taxpayers with rental real estate may be able to qualify as ``real 
estate professionals'' through work performed in their rental real 
estate, even if the rental real estate activities otherwise do not rise 
to the level of a section 162 trade or business.
    For example, for purposes of section 469(c)(7)(C), a taxpayer who 
owns real property and rents to tenants under a triple net lease 
arrangement will be treated as engaged in a real property trade or 
business even though the renting under the terms of a triple net lease 
arrangement may not rise to the level of a section 162 trade or 
business. The triple net lease arrangement is included in the broader 
definition of a trade or business under Sec.  1.469-9(b)(1) because the 
arrangement represents an interest in rental real estate. Accordingly, 
renting real property under a triple net lease arrangement generally 
will fall within the definition of a ``rental real property trade or 
business'' in section 469(c)(7)(C) and proposed Sec.  1.469-9(b)(2). As 
a result, the taxpayer with such a rental arrangement should be able to 
make an election to treat this activity as an electing real property 
trade or business, if the taxpayer so chooses, even though the renting 
of real property under a triple net lease arrangement might not be a 
section 162 trade or business. This result is simply a consequence of 
Congress cross-referencing the broader section 469 definition of a 
``real property trade or business'' for purposes of section 163(j).
    Thus, the commenters stated that, although taxpayers who are 
certain they are not engaged in a section 162 trade or business do not 
need to make an election out of the section 163(j) limitation because 
they are not subject to this limitation, taxpayers engaged in rental 
real estate activities who are not certain whether their rental real 
estate activities rise to the level of a section 162 trade or business 
should be given the ability to obtain certainty by making a protective 
election to treat their rental real estate activities as an electing 
real property trade or business.
    The Treasury Department and the IRS agree with the recommendation 
for a protective election under these circumstances. Thus, the final 
regulations provide that an election to treat rental real estate 
activities as an electing real property trade or business is available 
regardless of whether the taxpayer making the election is engaged in a 
trade or business within the meaning of section 162. Under the 
protective election, a taxpayer engaged in activities described in 
section 469(c)(7)(C) and Sec.  1.469-9(b)(2), as required in proposed 
Sec.  1.163(j)-1(b)(14)(i), but unsure whether its activities rise to 
the level of a section 162 trade or business, may make an election for 
a trade or business to be an electing real property trade or business.
    As with all other electing real property trades or businesses, once 
the election is made, all other consequences of the election outlined 
in Sec.  1.163(j)-9 apply, such as the irrevocability of the election 
and the required use of the alternative depreciation system for certain 
assets.
B. One-Time Late Election or Withdrawal of Election Procedures
    Commenters requested a one-time automatic extension of time for 
certain taxpayers to file an election under section 163(j)(7)(B) or 
section 163(j)(7)(C) due to uncertainty about the effect of a decision 
to make or not make such an election and about which taxpayers are 
eligible to make such an election prior to the publication of the final 
regulations. Additionally, commenters requested a one-time opportunity 
to withdraw an election made under section 163(j)(7)(B) or section 
163(j)(7)(C) prior to the publication of the final regulations. The 
Treasury Department and the IRS agree with the commenters' concerns. 
Thus, in order to address the commenters' concerns, and to provide 
immediate transition guidance under section 163(j) for taxpayers 
affected by the various amendments to the Code made by the CARES Act 
(including, for example, the technical corrections to section 168(e) of 
the Code relating to the classification of qualified improvement 
property), Revenue Procedure 2020-22 was issued to provide an automatic 
extension of time to make, or an opportunity to withdraw, an election 
for taxable years beginning in 2018, 2019, or 2020. The revenue 
procedure also provides the time and manner of making or revoking the 
three elections provided by the CARES Act under section 163(j)(10) for 
taxable years beginning in 2019 or 2020.
C. The Anti-Abuse Rule Under Proposed Sec.  1.163(j)-9(h)
    Numerous comments were received concerning the anti-abuse rule in 
proposed Sec.  1.163(j)-9(h)(1) (proposed -9(h) anti-abuse rule). The 
proposed -9(h) anti-abuse rule prohibits an otherwise qualifying real 
property trade or business from making an election under section 
163(j)(7)(B) 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 (that is, 50 percent of the direct and indirect 
ownership of both businesses is held by related parties within the 
meaning of sections 267(b) and 707(b)) with the real property trade or 
business. Proposed Sec.  1.163(j)-9(h)(2) provides an exception to the 
proposed -9(h) anti-abuse rule for REITs that lease qualified lodging 
facilities (defined in section 856(d)(9)(D)) and qualified health care 
properties (defined in section 856(e)(6)(D)) (REIT exception).
    The preamble to the proposed regulations explains that it would be 
inappropriate to allow an election under section 163(j)(7)(B) 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.'' The preamble further explains the reasoning for the 
REIT exception by stating that, because REITs that lease qualified 
lodging facilities and qualified healthcare properties are generally 
permitted (pursuant to section 856(d)(8)(B)) to lease these properties 
to a taxable REIT subsidiary (TRS), this anti-abuse rule does not apply 
to these types of REITs. The Treasury Department and the IRS requested 
comments in the preamble to the proposed regulations 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.

[[Page 56728]]

    Commenters suggested eliminating or modifying the proposed -9(h) 
anti-abuse rule because of the concern that, as currently written, this 
rule applies to non-abusive lease arrangements between commonly 
controlled trades or businesses. Specifically, commenters raised 
concerns about the applicability of the proposed -9(h) anti-abuse rule 
to specific types of business structures where the real property is 
owned by one legal entity (referred to as property company, or PropCo) 
and leased to a separate but commonly controlled legal entity that 
operates and manages a business (referred to as operating company, or 
OpCo). According to commenters, this PropCo/OpCo structure has valid 
business protection, lending, and regulatory purposes in certain 
industries. Commenters also claimed that this structure was in 
existence for many years prior to the enactment of the section 163(j) 
limitation and was not created in an attempt to circumvent application 
of the section 163(j) limitation.
    For example, the PropCo/OpCo structure is used by some hotels in 
the following manner: PropCo generally owns the real property subject 
to significant debt, services such debt, and leases the real property 
to OpCo, which operates a real property trade or business by licensing 
the property to unrelated third parties (guests). This structure is 
used to limit legal liability, manage state and local tax burdens, plan 
for family wealth transfers, and for other business objectives. One 
commenter recommended a ``look-through'' exception to the proposed -
9(h) anti-abuse rule where the real property is ultimately leased (or 
licensed) to unrelated third parties in a PropCo/OpCo structure. This 
exception would allow a real property trade or business owning real 
property, or PropCo, to make an election to be an electing real 
property trade or business if it leases real property to a commonly 
controlled real property trade or business, or OpCo, if OpCo subleases 
(or licenses) the real property to unrelated third parties.
    Similarly, commenters noted that the property ownership, mortgage, 
and resulting interest expense for trades or businesses described as 
nursing homes, continuing care retirement communities, independent 
living facilities, assisted living facilities, memory care facilities, 
and skilled nursing facilities (collectively, ``residential living 
facilities'') is often contained in one legal entity, or PropCo, and 
the operation and management of the residential living facility is 
contained in another, commonly controlled legal entity, or OpCo. 
Commenters explained that the Department of Housing and Urban 
Development, which is a major lender in the residential living 
industry, and many other lenders often require the use of single-asset 
or separate legal entities for lending purposes.
    To prevent the application of the proposed -9(h) anti-abuse rule to 
a PropCo that leases real property to a residential living facility, 
some commenters suggested that the anti-abuse rule should not apply to 
a trade or business that leases real property to a residential living 
facility (1) regardless of whether the lessor and lessee are under 
common control, or (2) if both the lessor trade or business and the 
commonly controlled lessee independently qualify as electing real 
property trades or businesses. Commenters noted that the proposed -9(h) 
anti-abuse rule should not apply to situations where the entities, if 
combined or aggregated and without taking the lease into account, would 
each qualify as real property trades or businesses. Without 
modification to the proposed -9(h) anti-abuse rule, the PropCo in a 
PropCo/OpCo structure would be prohibited from making a real property 
trade or business election even though all of its lease income is 
derived from a real property trade or business. Commenters suggested 
that proposed Sec.  1.163(j)-9(h)(2), which provides an exception for 
REITs, should apply to similarly situated taxpayers that are privately 
owned but use a commonly controlled entity in a PropCo/OpCo structure 
rather than a REIT.
    Other suggestions made by commenters include (1) eliminating the 
proposed -9(h) anti-abuse rule and instead relying on the more general 
proposed Sec.  1.163(j)-2(h) anti-avoidance rule to disregard or 
recharacterize the types of non-economic structures targeted by the 
proposed -9(h) anti-abuse rule, (2) clarifying that the proposed -9(h) 
anti-abuse rule would apply only if there is a ``principal purpose of 
tax avoidance,'' (3) providing exceptions to the proposed -9(h) anti-
abuse rule if the taxpayer demonstrates a substantial economic purpose 
for the PropCo/OpCo structures unrelated to avoiding section 163(j), or 
if the PropCo/OpCo structure was in place prior to enactment of the 
TCJA, and (4) expanding the REIT exception to include all real property 
trades or businesses that lease to residential living facilities.
    The operation of two separate, but commonly controlled, legal 
entities is also common in the cattle and beef industry--one entity 
owns all of the land and the buildings used by the operating entity, 
whereas the operating entity owns inventory (cattle or crops) and 
equipment and operates the farm, ranch, or feed yard. Commenters 
recommended providing an exception from the proposed -9(h) anti-abuse 
rule for farming businesses or, alternatively, clarifying that the 
allocation rules under proposed Sec.  1.163(j)-10 do not apply to 
separate out the real property to real property businesses included 
under the proposed -9(h) anti-abuse rule.
    The Treasury Department and the IRS agree with commenters that 
certain exceptions should be added to the proposed -9(h) anti-abuse 
rule. The final regulations provide two additional exceptions to the 
anti-abuse rule. Under the first exception, if at least 90 percent of a 
lessor's real property, determined by fair market rental value, is 
leased to a related party that operates an excepted trade or business 
and/or to unrelated parties, the lessor is eligible to make an election 
to be an electing real property trade or business for its entire trade 
or business (de minimis exception). The de minimis exception 
accommodates taxpayers that, by law or for valid business reasons, 
divide their real property holding and leasing activities from their 
operating trade or business that qualifies as an excepted trade or 
business, while still maintaining an anti-abuse rule to prevent non-
economic business structures designed to circumvent the section 163(j) 
limitation. See Sec.  1.163(j)-9(j).
    The second exception is a look-through rule that modifies the 
proposed -9(h) anti-abuse rule by allowing taxpayers to make an 
election for a certain portion of their real property trade or business 
(look-through exception). Under the look-through exception, if a lessor 
trade or business leases to a trade or business under common control 
(lessee), the lessor is eligible to make an election to be an electing 
real property trade or business to the extent that the lessor leases to 
an unrelated party or to an electing trade or business under common 
control with the lessor or lessee, and to the extent that the lessee 
trade or business under common control subleases (or licenses) to 
unrelated third parties and/or related parties that operate an excepted 
trade or business. Accordingly, the lessor can make an election for the 
portion of its trade or business that is equivalent to the portion of 
the real property that is ultimately leased to unrelated parties and/or 
related parties that operate an excepted trade or business. A lessor 
that makes an election under the look-through exception must allocate 
the basis of assets used in its trades or

[[Page 56729]]

businesses under the rules provided in Sec.  1.163(j)-10(c)(3)(iii)(D).
D. Residential Living Facilities and Notice With Proposed Revenue 
Procedure
    The PropCo/OpCo structure, discussed previously in part X(C) of 
this Summary of Comments and Explanation of Revisions section, is used 
extensively by certain residential living facilities that provide 
residential housing along with supplemental assistive, nursing, and 
other routine medical services. The commonly controlled lessees in the 
PropCo/OpCo structure expressed concern about whether the residential 
living facility trades or businesses qualify as real property trades or 
businesses under section 469 and Sec.  1.469-9(b)(2), and are thus 
eligible to make an election under section 163(j)(7)(B), because of the 
supplemental services that they provide. Accordingly, Notice 2020--
[INSERT NOTICE #], 2020--[INSERT CB/IRB GUIDANCE NUMBERS], released 
concurrently with these final regulations, provides notice of a 
proposed revenue procedure detailing a proposed safe harbor under which 
a taxpayer engaged in a trade or business that manages or operates a 
residential living facility and that also provides supplemental 
assistive, nursing, and other routine medical services may elect to 
treat such trade or business as a real property trade or business 
within the meaning of section 469(c)(7)(C), solely for purposes of 
qualifying as an electing real property trade or business under section 
163(j)(7)(B). Thus, if a lessor leases real property to a commonly 
controlled lessee that operates a residential living facility, which 
qualifies as and makes an election to be an excepted trade or business 
under the proposed safe harbor in Notice 2020--[INSERT NOTICE #], the 
lessor may qualify to use the de minimis exception or the look-through 
exception.
    The Treasury Department and the IRS request comments in Notice 
2020--[INSERT NOTICE #] on the proposed revenue procedure. Interested 
parties are invited to submit comments on the proposed revenue 
procedure by [INSERT DATE 90 DAYS AFTER PUBLICATION of Notice 2020--
[INSERT NOTICE #] IN the IRB].
    The proposed revenue procedure is proposed to apply to taxpayers 
with taxable years ending after December 31, 2017. Until such time that 
the proposed revenue procedure is published in final form, taxpayers 
may use the safe harbor described in the proposed revenue procedure for 
purposes of determining whether a residential living facility, as 
defined in the proposed revenue procedure, may be treated as a real 
property trade or business solely for purposes of section 163(j).
    Future guidance might be needed to determine whether a particular 
trade or business can make an election. Accordingly, the definitions of 
electing real property trade or business in Sec.  1.163(j)-1(b)(14) and 
electing farming business in Sec.  1.163(j)-1(b)(13) include a new 
provision noting that the Secretary may issue guidance on whether a 
trade or business can be an electing real property trade or business or 
electing farming business.
E. Safe Harbor for Certain REITs
    Proposed Sec.  1.163(j)-9(g) provides a special safe harbor for 
REITs. The safe harbor provides that, if a REIT holds real property, 
interests in partnerships holding real property, or shares in other 
REITs holding real property, the REIT is eligible to make an election 
to be an electing real property trade or business for all or part of 
its assets. If a REIT makes an election to be an electing real property 
trade or business, and if the value of the REIT's real property 
financing assets (as defined in proposed Sec.  1.163(j)-9(g)(5) and 
(6)) 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, 
then, under the safe harbor in the proposed regulations, all of the 
REIT's assets are treated as assets of an excepted trade or business. 
If a REIT makes an election to be an electing real property trade or 
business, and if the value of the REIT's real property financing assets 
at the close of the taxable year is more than 10 percent of the value 
of the REIT's total assets, then, under the safe harbor in the proposed 
regulations, 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). The safe harbor also allows REITs to use Sec.  1.856-
10 for the definition of ``real property'' in determining which assets 
are assets of an excepted trade or business. The final regulations 
generally adopt the safe harbor for REITs in the proposed regulations, 
with modifications in response to comments discussed in this part X(E) 
of the Summary of Comments and Explanation of Revisions section.
    One commenter recommended that the Treasury Department and the IRS 
revise proposed Sec.  1.163(j)-9(g)(1) to clarify that a REIT may make 
the safe harbor election if the REIT owns an interest in one or more 
partnerships holding real property or stock in one or more REITs 
holding real property. The commenter indicated that the use of the 
plural ``interests in partnerships'' and ``shares in other REITs'' 
could imply that a REIT cannot make the safe harbor election if the 
REIT owns an interest in a single partnership or shares in a single 
REIT. The Treasury Department and the IRS agree that the regulations 
should not preclude a REIT that owns an interest in a single 
partnership or shares in a single REIT from applying the safe harbor.
    This commenter also recommended that the final regulations clarify 
that the safe harbor election may be made if the electing REIT owns a 
direct interest in a partnership or lower-tier REIT that does not 
directly hold real property, but that holds an interest in another 
partnership or lower-tier REIT that directly holds real property.
    The determination of whether a REIT is eligible to make the safe 
harbor election under the proposed regulations was intended to mirror 
the determination of whether the REIT holds real property (as defined 
under Sec.  1.856-10) when testing the value of the REIT's real estate 
assets under section 856(c)(4)(A). If a REIT is a partner in a 
partnership that holds real property (as defined under Sec.  1.856-10), 
the REIT is deemed to own its proportionate share of the partnership's 
real property for purposes of section 856(c)(4). The Treasury 
Department and the IRS also recognize that, for purposes of section 
856(c)(4), a REIT is deemed to own a share of real property from any 
partnership interest held through an upper-tier partnership.
    Moreover, under section 856(c)(5)(B), shares in other REITs qualify 
as real estate assets. Although a REIT (shareholder REIT) that holds 
shares in another REIT would not need to determine whether the other 
REIT holds real property for purposes of testing the value of the 
shareholder REIT's real estate assets under section 856(c)(4), the 
proposed regulations allowed the shareholder REIT to make the safe 
harbor election as long as it determines that the other REIT holds real 
property. The Treasury Department and the IRS recognize that the other 
REIT in this situation may not necessarily hold real property but 
instead may hold shares in a lower-tier REIT (which is a real estate 
asset in the hands of the other REIT).
    Because the shareholder REIT can hold shares in another REIT that 
holds shares in a lower-tier REIT that holds real property, the 
Treasury Department and the IRS have concluded that a shareholder REIT 
may make the safe harbor election if it determines that it

[[Page 56730]]

holds an indirect interest in a REIT that holds real property. 
Accordingly, the final regulations clarify that a REIT may elect to be 
an electing real property trade or business if the REIT holds real 
property, interests in one or more partnerships holding real property 
either directly or indirectly through interests in other partnerships 
or shares in other REITs, or shares in one or more other REITs holding 
real property either directly or indirectly through interests in 
partnerships or shares in other REITs.
    Several commenters also requested that certain partnerships with a 
REIT as a partner be allowed to apply the REIT safe harbor election at 
the partnership level. Commenters noted that many REITs own interests 
in partnerships that directly or indirectly hold real property, and 
these partnerships incur the debt that is secured by the real property 
and claim the interest expense deductions. Commenters recommended that 
the REIT safe harbor election be made available to partnerships if: (1) 
At least one partner is a REIT that owns, directly or indirectly, at 
least 50 percent of the partnership's capital or profits; (2) the 
partnership meets the requirements of section 856(c)(2), (3), and (4) 
as if the partnership were a REIT; and (3) the partnership satisfies 
the requirements of proposed Sec.  1.163(j)-9(g)(1) as if the 
partnership were a REIT.
    The Treasury Department and the IRS agree that a partnership that 
is controlled by a REIT or REITs and that would meet the REIT gross 
income and asset tests in section 856(c)(2), (3), and (4) (as if the 
partnership were a REIT) is sufficiently similar to a REIT for this 
purpose. Accordingly, the final regulations provide that a partnership 
may apply the REIT safe harbor election at the partnership level if one 
or more REITs own, directly or indirectly, at least 50 percent of the 
partnership's capital and profits, the partnership meets the 
requirements of section 856(c)(2), (3), and (4) as if the partnership 
were a REIT, and the partnership satisfies the requirements described 
in Sec.  1.163(j)-9(h)(1) as if the partnership were a REIT.
    A commenter also recommended that the REIT exception to the 
proposed Sec.  1.163(j)-9(h) anti-abuse rule be clarified to apply to 
any partnership in which a REIT owns a 50 percent or greater direct or 
indirect capital or profits interest, if the partnership leases a 
qualified lodging facility or qualified health care property to a TRS 
or a partnership in which a TRS is a 50 percent or greater direct or 
indirect partner. The REIT exception was intended to allow REITs that 
lease qualified lodging facilities and qualified healthcare properties 
pursuant to the related party rental exception in section 856(d)(8)(B) 
to make a real property trade or business election because these leases 
are explicitly authorized by the Code. In response to comments, the 
final regulations clarify that the REIT exception also applies to 
partnerships making the REIT safe harbor election that lease qualified 
lodging facilities and qualified healthcare properties. However, the 
final regulations do not specify the related party to which the REIT 
must lease the qualified lodging facility or qualified healthcare 
property in order to qualify for the REIT exception and, therefore, 
Treasury and the IRS did not include a provision for partnerships in 
which a TRS is a partner.
    A commenter requested clarification regarding the application of 
the real property trade or business election to a rental real estate 
partnership and its REIT partners if the partnership holds real 
property and is not engaged in a trade or business within the meaning 
of section 162. Part XVI of this Summary of Comments and Explanation of 
Revision section clarifies that taxpayers engaged in rental real estate 
activities that do not necessarily rise to the level of a section 162 
trade or business nevertheless are treated as engaged in real property 
trades or businesses within the meaning of section 469(c)(7)(C) (and 
for purposes of section 163(j) by reference). As such, a partnership 
engaged in a rental real estate activity (regardless of whether that 
activity rises to the level of a section 162 trade or business) will be 
permitted to make the election under section 163(j)(7)(B) with respect 
to the rental real estate activity to be an electing real property 
trade or business for purposes of section 163(j), and any interest 
expense that is allocable to that rental real estate activity and that 
is allocable to a REIT partner will not be investment interest (within 
the meaning of section 163(d)) that is treated as interest expense 
allocable to a trade or business of a C corporation partner under Sec.  
1.163(j)-4(b)(3).
    For purposes of valuing a REIT's assets, the proposed regulations 
provide that REIT real property financing assets also include the 
portion of a shareholder REIT's interest in another REIT attributable 
to that other REIT's real property financing assets. The final 
regulations clarify that this rule also applies in the context of 
tiered-REIT structures.
    The proposed regulations provide that no portion of the value of a 
shareholder REIT's shares in another REIT is included in the value of 
the 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 proposed Sec.  1.163-9(g)(2). The proposed regulations 
provide that if a 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 the shareholder REIT's shares in the other REIT are 
treated as real property financing assets.
    A commenter requested that the final regulations clarify how a 
shareholder REIT determines whether the value of the other REIT's real 
property financing assets is 10 percent or less of the other REIT's 
total asset value for purposes of determining whether the electing 
shareholder REIT must allocate interest expense between excepted and 
non-excepted businesses. The commenter recommended that the final 
regulations provide an example to clarify this point or specify that 
the shareholder REIT may make this determination based on all of the 
facts available to the shareholder REIT. The commenter proposed that a 
shareholder REIT that makes an incorrect determination in good faith 
that the other REIT qualifies under proposed Sec.  1.163-9(g)(2) 
nevertheless be permitted to treat all of the value of the lower REIT's 
shares as assets other than real property financing assets.
    In response to this comment, the final regulations allow a 
shareholder REIT to use an applicable financial statement (within the 
meaning of section 451(b)) of the other REIT to determine whether and 
the extent that the assets of the other REIT are investments in real 
property financing assets (rather than having to receive the 
information directly from the other REIT). However, the final 
regulations do not permit a shareholder REIT to treat the shares in the 
other REIT as assets other than real property financing assets when the 
shareholder REIT's determination is based on information other than an 
applicable financial statement or information received directly from 
the other REIT.
    In the event that a REIT is required to allocate its interest 
expense between excepted and non-excepted trades or businesses under 
Sec.  1.163(j)-10, a commenter requested clarification regarding the 
application of the look-through rules to tiered entities. Under the 
proposed regulations, if a REIT holds an interest in a partnership, in 
applying the partnership look-through rule in proposed Sec.  1.163(j)-
10(c)(5)(ii)(A)(2), the REIT also applies

[[Page 56731]]

the definition of real property under Sec.  1.856-10 to determine 
whether the partnership's assets are allocable to an excepted trade or 
business. In addition, under the proposed regulations, if a shareholder 
REIT holds shares in another REIT and all of the other REIT's assets 
are not treated as assets of an excepted trade or business, the 
proposed regulations provide that the shareholder REIT applies the same 
partnership look-through rule (as if the other REIT were a partnership) 
in determining the extent to which the shareholder REIT's adjusted 
basis in the shares of the other REIT is properly allocable to an 
excepted trade or business of the shareholder REIT.
    In response to comments, the final regulations provide that, when 
applying the partnership look-through rule in the case of tiered 
entities, a REIT applies the definition of real property in Sec.  
1.856-10 to each partnership in the chain to determine whether the 
partnership's assets are allocable to an excepted trade or business. 
Furthermore, because shares in other REITs qualify as real estate 
assets under section 856(c)(5)(B), the final regulations provide that, 
when applying the look-through rule to REITs within a tiered-entity 
structure, a shareholder REIT may apply the partnership look-through 
rule in Sec.  1.163(j)-10(c)(5)(ii)(A)(2) to all REITs in the chain.
    In response to an informal inquiry, the final regulations also 
clarify that a REIT or a partnership that is eligible but chooses not 
to apply the REIT safe harbor election may still elect, under Sec.  
1.163(j)-9(b)(1), for one or more of its trades or businesses to be an 
electing real property trade or business, provided that such trade or 
business is otherwise eligible to elect under Sec.  1.163(j)-9(b)(1). A 
REIT or partnership that makes the election under Sec.  1.163(j)-
9(b)(1) without utilizing the REIT safe harbor provisions may not rely 
on any portion of Sec.  1.163(j)-9(h)(1) through (7).
F. Real Property Trade or Business
    Proposed Sec.  1.163(j)-10(a)(1)(i) provides that the amount of a 
taxpayer's interest expense that is properly allocable to excepted 
trades or businesses is not subject to the section 163(j) limitation, 
and 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. Commenters suggested that, for 
purposes of allocating interest between a non-excepted trade or 
business and an excepted trade or business, a corporate partner in a 
partnership that conducts a real property trade or business should be 
allowed to treat its share of the partnership's real property trade or 
business as an electing real property trade or business even if the 
partnership does not make the election.
    The Treasury Department and the IRS have rejected this comment 
because an election under section 163(j)(7)(B) has certain 
consequences--for example, the use of ADS rather than the general 
depreciation system for certain types of property, which results in the 
inability of electing real property trades or businesses to claim the 
additional first-year depreciation deduction under section 168(k) for 
those types of property. Therefore, the Treasury Department and the IRS 
have determined that a corporate partner in a partnership that conducts 
a real property trade or business should be allowed to treat its share 
of the partnership's real property trade or business as an electing 
real property trade or business only if the partnership makes the 
election. However, see part X(A) of this Summary of Comments and 
Explanation of Revisions section regarding taxpayers that are eligible 
to make an election to be an electing real property trade or business 
but are not certain whether they are engaged in a trade or business 
under section 162.

XI. Comments on and Changes To Proposed 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.

    Section 1.163(j)-10 provides 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 following discussion addresses comments relating to 
proposed Sec.  1.163(j)-10.
A. General Method of Allocation: Asset Basis
    Proposed Sec.  1.163(j)-10(c) sets 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 is 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 trades or 
businesses. As noted in the preamble to the proposed regulations, 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. Many commenters expressed support 
for this proposed allocation method.
    However, some commenters argued that taxpayers should be permitted 
to allocate interest expense and income between excepted and non-
excepted trades or businesses based on the earnings or gross income of 
each business, for various reasons. For example, some commenters 
posited that asset basis may bear little connection to a corporation's 
borrowing capacity, whereas earnings or revenue are useful indicators 
of a taxpayer's ability to meet its debt obligations, and earnings are 
a key factor in determining the amount of debt the taxpayer may borrow 
and the interest rate the taxpayer will be charged. These commenters 
also noted that an asset-basis allocation method could yield 
inconsistent results across industries (for example, industries whose 
asset mix is heavily skewed towards self-created intangibles will have 
low asset basis) or within similarly situated industries (if assets are 
purchased at different times). One commenter also suggested that an 
earnings-based approach would be easier for the IRS and taxpayers to 
administer because ATI already must be calculated by each taxpayer that 
is subject to a section 163(j) limitation.
    Although the foregoing arguments have merit, adopting an earnings-
based approach would raise many additional considerations, such as 
taxpayers' ability to time income recognition to affect allocation and 
create other distortions (as in the case of a trade or business that 
requires capital investment for a period of years before earning 
significant gross income). Thus, after further consideration, the 
Treasury Department and the IRS have decided to retain the asset-basis 
allocation approach contained in proposed Sec.  1.163(j)-10(c). 
However, the Treasury Department and the IRS continue to study these 
comments and may provide future guidance on this issue.
B. Allocation Between Trades or Businesses and Non-Trades or Businesses
    Proposed Sec.  1.163(j)-10(a)(2)(i) coordinates the rules under 
proposed Sec.  1.163(j)-10 with other Federal income tax rules. For 
example, proposed Sec.  1.163(j)-10(a)(2)(i) provides that, before a 
taxpayer may determine the amount of interest expense, interest income, 
or other tax items that is properly allocable to excepted or non-
excepted trades or businesses, the

[[Page 56732]]

taxpayer first must apply Sec.  1.163-8T to determine which tax items 
are allocable to non-trades or businesses rather than to trades or 
businesses. Some commenters recommended that non-corporate partners be 
permitted to allocate tax items between a trade or business and a non-
trade or business based on an approach that looks to the earnings of 
the trade or business and non-trade or business. The commenters argued 
that an earnings-based approach to determining when debt is properly 
allocable between a trade or business and a non-trade or business is 
consistent with determining whether the earnings of a taxpayer can 
support the level of debt incurred.
    After further consideration, the Treasury Department and the IRS 
have decided to retain the Sec.  1.163-8T tracing approach contained in 
proposed Sec.  1.163(j)-10(a)(2)(i). However, the Treasury Department 
and the IRS continue to study these comments and may provide future 
guidance on this issue. Additionally, the Treasury Department and the 
IRS are considering issuing additional guidance related to the 
allocation of interest expense by partnerships or S corporations. See 
proposed Sec.  1.163-14 in the Concurrent NPRM.
    Commenters also recommended that no allocation between business and 
nonbusiness interest expense be required when a partnership is wholly 
owned by corporate partners because a corporation can have only 
business interest income and expense and cannot have investment 
interest income and expense (see proposed Sec.  1.163(j)-4(b)(3)(i)). 
The Treasury Department and the IRS have rejected this comment because 
the recommended approach is inconsistent with the entity approach taken 
with respect to partnerships in section 163(j)(4). Moreover, a separate 
rule for partnerships that are wholly owned by corporate partners is 
subject to manipulation because the partnership could alter the rules 
to which it is subject simply by admitting a non-corporate partner with 
a small economic interest in the partnership.
C. Consolidated Groups
1. Overview
    As provided in proposed Sec.  1.163(j)-10(a)(4)(i), the 
computations required by section 163(j) and the section 163(j) 
regulations generally are made for a consolidated group on a 
consolidated basis. Thus, for purposes of applying the allocation rules 
of proposed Sec.  1.163(j)-10, all members of a consolidated group are 
treated as a single corporation. For example, the group (rather than a 
particular member) is treated as engaged in excepted or non-excepted 
trades or businesses. Moreover, intercompany transactions (as defined 
in Sec.  1.1502-13(b)(1)(i)) are disregarded for purposes of these 
allocation rules, 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. Additionally, stock 
of a member that is owned by another member of the same consolidated 
group is not treated as an asset for purposes of Sec.  1.163(j)-10, 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.
    After a consolidated group has determined the percentage of the 
group's interest expense allocable to excepted trades or businesses for 
the taxable year, 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. Thus, except to the extent proposed Sec.  
1.163(j)-10(d) (providing rules for direct allocation in certain 
limited circumstances) applies, the same percentage of interest paid or 
accrued by each member to a lender that is not a member is treated as 
allocable to excepted trades or businesses, regardless of whether any 
particular member actually engaged in an excepted trade or business.
2. Intercompany Transactions
    Commenters observed that ignoring all intercompany transactions and 
intercompany obligations for purposes of proposed Sec.  1.163(j)-10 is 
theoretically simple and generally furthers the single-entity approach 
adopted elsewhere in the proposed regulations. However, a commenter 
recommended that taxpayers be permitted to take into account basis from 
certain intercompany transactions, so long as adequate safeguards are 
put in place against abuse (for example, to prevent taxpayers from 
using intercompany transactions to increase the consolidated group's 
ATI or to shift asset basis to excepted trades or businesses), in order 
to reduce the administrative burden of tracking asset basis separately 
for purposes of section 163(j). The commenter also recommended that the 
Treasury Department and the IRS reconsider whether, in certain 
circumstances, items from intercompany transactions (other than 
business interest expense and business interest income) should affect 
the amount of the consolidated group's ATI.
    The Treasury Department and the IRS acknowledge that the approach 
in proposed Sec.  1.163(j)-10(a)(4)(i) creates an administrative burden 
for members of consolidated groups. However, this approach is 
consistent with Sec.  1.1502-13, the stated purpose of which is to 
prevent intercompany transactions from creating, accelerating, 
avoiding, or deferring consolidated taxable income or consolidated tax 
liability (see Sec.  1.1502-13(a)(1)). Allowing tax items from 
intercompany transactions to affect the calculation of a consolidated 
group's tentative taxable income and ATI would be inconsistent with the 
single-entity principles of Sec.  1.1502-13(a). Moreover, taxpayers 
already must track asset basis information for purposes of Sec.  
1.1502-13. Additionally, giving effect to intercompany transactions for 
purposes of section 163(j) would create other administrative burdens 
for consolidated group members. See the discussion in part V(B) of this 
Summary of Comments and Explanation of Revisions section. Thus, the 
final regulations continue to disregard intercompany transactions for 
purposes of the allocation rules in proposed Sec.  1.163(j)-10.
3. Use of Property Derives From an Intercompany Transaction
    A commenter observed that the meaning of the phrase ``property is 
not treated as used in a trade or business to the extent the use of 
such property derives from an intercompany transaction'' is unclear. 
For example, one member of a consolidated group (S) leases property to 
another member of the group (B), which uses the property in its trade 
or business. B's lease with S entitles B to use the property. Should 
B's use of the property in its trade or business be disregarded for 
purposes of proposed Sec.  1.163(j)-10 because such use ``derives from 
an intercompany transaction''?
    The Treasury Department and the IRS did not intend for B's use of 
the property in the foregoing scenario to be disregarded for purposes 
of the allocation rules in proposed Sec.  1.163(j)-10. If S and B were 
treated as disregarded entities owned by the same corporation, the 
lease would be ignored, and the leased property would be treated as an 
asset used in B's trade or business. The final regulations clarify 
proposed Sec.  1.163(j)-10(a)(4)(i) to better reflect this intended 
result.
    The commenter also requested confirmation that the same allocation 
principle applies to third-party costs incurred by members of the group 
(in other words, that such costs are allocated based on the use of 
assets in excepted or non-excepted trades or

[[Page 56733]]

businesses). However, proposed Sec.  1.163(j)-10(b)(5) already provides 
special rules for the allocation of expenses other than interest 
expenses. Thus, the final regulations do not adopt this recommendation.
4. Purchase of Member Stock From a Nonmember
    A commenter recommended that a purchase by one consolidated group 
member (S) of stock of another member (or of an entity that becomes a 
member as a result of the purchase) (in either case, T) from a non-
member (X) be treated as a purchase of a proportionate amount of T's 
assets for purposes of proposed Sec.  1.163(j)-10. Although the 
proposed regulations treat the transfer of the stock of a member to a 
non-member as a transfer of a proportionate amount of the member's 
assets, the proposed regulations do not expressly address the 
acquisition of the stock of a member (or of a corporation that becomes 
a member as a result of the acquisition). The commenter noted that, if 
such acquisitions are not treated as asset purchases, the amount of 
adjusted basis allocated to an excepted or non-excepted trade or 
business may differ significantly depending on whether S and T file a 
consolidated return.
    For example, T (which is engaged solely in an excepted trade or 
business) has assets with a fair market value of $100x and $0 adjusted 
basis, and $0 liabilities. S (which is engaged solely in a non-excepted 
trade or business) has $100x adjusted basis in its assets. S purchases 
100 percent of T's stock from X for $100x, and S and T do not file a 
consolidated tax return. As a result, S's stock in T is treated as an 
asset (under proposed Sec.  1.163(j)-10(c)(5)(ii)(B)) with a basis of 
$100x. In contrast, if S and T were to file a consolidated return, S's 
stock in T would not be treated as an asset under proposed Sec.  
1.163(j)-10(a)(4). Moreover, it is unclear how much adjusted basis the 
group could take into account for purposes of the allocation rules. 
Would the group's adjusted basis in T's assets equal T's basis in its 
assets immediately before the acquisition (here, $0)? Or would all or 
some portion of the amount paid by S to acquire T's stock be taken into 
account? The commenter argued that S should have the same amount of 
adjusted basis in T's assets regardless of whether S and T file a 
consolidated return, and that there is no legislative history revealing 
congressional intent to treat members of a consolidated group and non-
consolidated corporations differently in this regard. Thus, according 
to the commenter, S should be able to take into account the amount paid 
for its T stock for purposes of the allocation rules in proposed Sec.  
1.163(j)-10.
    Although Congress did not expressly address this issue, Congress 
did make clear that the section 163(j) limitation applies at the 
consolidated group level (see H. Rept. 115-466, at 386 (2017)). 
Moreover, section 1502 provides broad authority for the Secretary of 
the Treasury to prescribe regulations to determine the tax liability of 
a consolidated group in a manner that clearly reflects the income tax 
liability of the group and that prevents the avoidance of tax 
liability. Consistent with legislative intent regarding section 163(j) 
and with the broad grant of authority under section 1502, the proposed 
regulations treat a consolidated group as a single corporation for 
purposes of the allocation rules of Sec.  1.163(j)-10, and they 
disregard the stock of members for purposes of this section.
    Additionally, the Treasury Department and the IRS have questions 
and concerns about treating the acquisition of stock of a member (or of 
an entity that becomes a member) as an asset sale. How would the 
purchase price be added to the group's basis in the member's assets, 
and how would the additional basis added to these assets be 
depreciated? Would this approach deem the transaction to be an asset 
acquisition for all Federal income tax purposes or just for purposes of 
section 163(j), and what complications would arise from treating the 
transaction as an asset purchase for purposes of section 163(j) but as 
a stock purchase for other purposes?
    Due to concerns about these and other issues, the final regulations 
do not adopt the commenter's recommendation. However, the Treasury 
Department and the IRS continue to study the issue raised by the 
commenter and may address the issue in future guidance.
5. Inclusion of Income From Excepted Trades or Businesses in 
Consolidated ATI
    A commenter noted that, because every member of a consolidated 
group is treated as engaged in every trade or business of the group for 
purposes of proposed Sec.  1.163(j)-10, a member engaged solely in an 
excepted regulated utility trade or business that incurs interest 
expense related to its business activities will be subject to the 
section 163(j) limitation if other group members are engaged in non-
excepted trades or businesses. The commenter suggested that this 
outcome is contrary to the policy rationale for the exception for 
regulated utility trades or businesses. The commenter further noted 
that the gross income of the excepted trade or business is not included 
in the group's ATI calculation, and that this outcome could produce 
anomalous results. The commenter thus recommended that a proportionate 
share of the gross income of the excepted trade or business be included 
as an adjustment to consolidated ATI.
    The Treasury Department and the IRS do not agree that the results 
under proposed Sec.  1.163(j)-10(a)(4) are inconsistent with 
congressional intent or lead to anomalous results. As noted in part 
XI(C)(4) of this Summary of Comments and Explanation of Revisions 
section, Congress expressly stated that the section 163(j) limitation 
applies at the consolidated group level. Thus, the treatment of a 
consolidated group as a single corporation, and the treatment of every 
member as engaged in every trade or business of the group, is 
consistent with congressional intent. Moreover, if the section 163(j) 
limitation were inapplicable to group members engaged in excepted 
trades or businesses, consolidated groups could readily avoid the 
section 163(j) limitation by concentrating their external borrowing in 
such members. Furthermore, although a portion of the interest expense 
of a member engaged solely in an excepted trade or business will be 
subject to the section 163(j) limitation if the group is otherwise 
engaged in non-excepted trades or businesses, a portion of the interest 
expense of a member engaged solely in a non-excepted trade or business 
will not be subject to the section 163(j) limitation if the group is 
otherwise engaged in excepted trades or businesses--and all of that 
member's income will factor into the group's ATI calculation. Finally, 
as the commenter acknowledged, section 163(j)(8)(A)(i) specifically 
excludes from the determination of ATI any item of income, gain, 
deduction, or loss that is allocable to an excepted trade or business.
    For the foregoing reasons, the Treasury Department and the IRS have 
determined that no changes to the final regulations are needed with 
respect to this comment.
6. Engaging in Excepted or Non-Excepted Trades or Businesses as a 
``Special Status''
    One commenter suggested that the Treasury Department and the IRS 
consider whether engaging in an excepted trade or business should be 
treated as a ``special status'' under Sec.  1.1502-13(c)(5) for 
purposes of applying the intercompany transaction rules of Sec.  
1.1502-13.

[[Page 56734]]

    The intercompany transaction rules apply for purposes of 
redetermining and allocating attributes under Sec.  1.1502-13(c)(1)(i) 
in order to reach a ``single entity'' answer under the matching rule of 
Sec.  1.1502-13(c). For example, one member of a consolidated group is 
a dealer in securities under section 475 (dealer) and sells a security 
to a second member that is not a dealer; that second member then sells 
the security to a nonmember in a later year. The matching rule can 
apply to ensure that the taxable items of the two members harmonize 
with regard to timing and character in order to reach the same overall 
tax treatment that would be given to a single corporation whose two 
operating divisions engaged in those transactions. See Sec.  1.1502-
13(c)(7)(i), Example 11.
    However, if one member has ``special status'' under Sec.  1.1502-
13(c)(5) but the other does not, then attributes of the item would not 
be redetermined under the matching rule. For example, if S (a bank to 
which section 582(c) applies) and B (a nonbank) are members of a 
consolidated group, and if S sells debt securities at a gain to B, the 
character of S's intercompany gain is ordinary (as required under 
section 582(c)), but the character of B's corresponding item is 
determined under Sec.  1.1502-13(c)(1)(i) without the application of 
section 582(c). See Sec.  1.1502-13(c)(5).
    The ``special status'' rules of Sec.  1.1502-13(c)(5) are 
applicable to entities, such as banks or insurance companies, that are 
subject to a separate set of Federal income tax rules. Although there 
are special tax rules for farming, real estate, and utilities, an 
entity engaged in such trades or businesses also may be engaged in 
other trades or businesses to which such special tax rules would not 
apply. Further, the entity's farming, real estate, or utility trade or 
business need not be its primary trade or business. Moreover, the 
treatment of excepted trades or businesses as a special status 
effectively would result in additional tracing of specific items for 
purposes of Sec.  1.1502-13. As noted in the preamble to the proposed 
regulations, the Treasury Department and the IRS have decided not to 
apply a tracing regime to allocate interest expense and income between 
excepted and non-excepted trades or businesses. Thus, the final 
regulations do not treat engaging in an excepted trade or business as a 
special status.
D. Quarterly Asset Testing
    Under proposed Sec.  1.163(j)-10(c)(6), a taxpayer must determine 
the adjusted basis in its assets on a quarterly basis 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. In 
the preamble to the proposed regulations, the Treasury Department and 
the IRS requested comments on the frequency of asset basis 
determinations required under proposed Sec.  1.163(j)-10(c).
    In response, commenters stated that this quarterly determination 
requirement is administratively burdensome, and that such a burden is 
unwarranted because, in many circumstances, measuring asset basis less 
frequently would produce similar results. Thus, commenters recommended 
that taxpayers be permitted to allocate asset basis for a taxable year 
based on the average of adjusted asset basis at the beginning and end 
of the year. As a result, the ``determination date'' would be the last 
day of the taxpayer's taxable year, and the ``determination period'' 
would begin on the first day of the taxpayer's taxable year and end on 
the last day of the year.
    Several commenters recommended that this approach be modeled on the 
interest valuation provisions in Sec.  1.861-9T(g)(2)(i). Under these 
rules, taxpayers generally must compute the value of assets based on an 
average of asset values at the beginning and end of the year. However, 
if a ``substantial distortion'' of asset values would result from this 
approach (for example, if there is a major acquisition or disposition), 
the taxpayer must use a different method of asset valuation that more 
clearly reflects the average value of assets.
    Other commenters suggested that their proposed approach could be 
limited to cases in which there is no more than a de minimis change in 
asset basis between the beginning and end of the taxable year. For 
example, this approach could be available for a taxable year only if 
the taxpayer demonstrates that its total adjusted basis (as measured in 
accordance with the rules in proposed Sec.  1.163(j)-10(c)(5)) at the 
end of the year in its assets used in its excepted trades or 
businesses, as a percentage of the taxpayer's total adjusted basis at 
the end of such year in all of its assets used in a trade or business, 
does not differ by more than 10 percent from such percentage at the 
beginning of the year.
    The Treasury Department and the IRS acknowledge that determining 
asset basis on a quarterly basis would impose an administrative burden. 
The Treasury Department and the IRS also agree with commenters that a 
safeguard is needed to account for episodic events, such as 
acquisitions, dispositions, or changes in business, that could affect 
average values. Thus, the final regulations permit a taxpayer to 
compute asset basis in its excepted and non-excepted trades or 
businesses by averaging asset basis at the beginning and end of the 
year, so long as the taxpayer falls under a 20 percent de minimis 
threshold.
E. De Minimis Rules
1. Overview
    The proposed regulations provide a number of de minimis rules to 
simplify the application of Sec.  1.163(j)-10. For example, proposed 
Sec.  1.163(j)-10(c)(3)(iii)(C)(3) provides that a utility trade or 
business is treated entirely as an excepted regulated utility trade or 
business if more than 90 percent of the items described in proposed 
Sec.  1.163(j)-1(b)(15) are furnished or sold at rates qualifying for 
the excepted regulated utility trade or business exception. Proposed 
Sec.  1.163(j)-10(c)(3)(iii)(B)(2) provides that, if 90 percent or more 
of the basis in an asset would be allocated under proposed Sec.  
1.163(j)-10(c)(3) to either excepted or non-excepted trades or 
businesses, then the entire basis in the asset is allocated to either 
excepted or non-excepted trades or businesses, respectively. In turn, 
proposed Sec.  1.163(j)-10(c)(1)(ii) provides that, if 90 percent or 
more of a taxpayer's basis in its assets is allocated under proposed 
Sec.  1.163(j)-10(c) to either excepted or non-excepted trades or 
businesses, then all of the taxpayer's interest expense and interest 
income are allocated to either excepted or non-excepted trades or 
businesses, respectively.
2. Order in Which the De Minimis Rules Apply
    A commenter recommended that these de minimis rules be applied in 
the order in which they are listed in the foregoing paragraph. In other 
words, a taxpayer first should determine the extent to which its 
utility businesses are excepted regulated utility trades or businesses. 
The taxpayer then should determine the extent to which the basis of any 
assets used in both excepted and non-excepted trades or businesses 
should be wholly allocated to either excepted or non-excepted trades or 
businesses. Only then should the taxpayer determine whether all of its 
interest expense and interest income should be wholly allocated to 
either excepted or non-excepted trades or businesses. The Treasury 
Department and the IRS agree that the order recommended by the 
commenter is the most reasonable application of these de minimis rules, 
and the final regulations adopt language confirming this ordering.

[[Page 56735]]

3. Mandatory Application of De Minimis Rules
    Commenters also requested that the final regulations continue to 
mandate the application of the foregoing de minimis rules rather than 
make such de minimis rules elective. The commenters expressed concern 
that creating an election to use the de minimis rules in Sec.  
1.163(j)-10(c)(1) and (3) would create uncertainty for taxpayers, and 
they argued that mandatory application of the de minimis rules would 
simplify the rules for taxpayers. The Treasury Department and the IRS 
agree that mandatory application of the de minimis rules simplifies the 
application of Sec.  1.163(j)-10 and eases the burdens of compliance 
and administration. Therefore, the final regulations continue to 
mandate the application of the de minimis rules in Sec.  1.163(j)-
10(c)(1) and (3).
4. De Minimis Threshold for Electric Cooperatives
    A commenter requested that the de minimis threshold for utilities 
in proposed Sec.  1.163(j)-10(c)(3)(iii)(C)(3) be lowered from 90 
percent to 85 percent for electric cooperatives. The commenter argued 
that a different threshold is appropriate for electric cooperatives 
because, under section 501(c)(12), 85 percent or more of an electric 
cooperative's income (with adjustments) must consist of amounts 
collected from members for the sole purpose of meeting losses and 
expenses in order for the cooperative to be exempt from Federal income 
tax.
    The Treasury Department and the IRS have determined that the final 
regulations should provide the same de minimis threshold for electric 
cooperatives as for other utility trades or businesses. The 85 percent 
threshold under section 501(c)(12) measures a cooperative's income, 
with adjustments that are specific to section 501. Moreover, an 
electric cooperative is not required to qualify for tax exemption under 
section 501(c)(12) to be engaged in an excepted regulated utility trade 
or business. Therefore, the Treasury Department and the IRS have 
determined that the nexus between section 501(c)(12) and proposed Sec.  
1.163(j)-10 is insufficient to justify lowering the utility de minimis 
threshold to 85 percent for electric cooperatives, and the final 
regulations do not incorporate the commenter's suggestion.
5. Standardization of 90 Percent De Minimis Tests
    The terminology used in the 90 percent de minimis tests in proposed 
Sec.  1.163(j)-10 is not consistent. For example, proposed Sec.  
1.163(j)-10(c)(3)(iii)(C)(3) uses a ``more than 90 percent'' standard, 
whereas proposed Sec.  1.163(j)-10(c)(3)(iii)(B)(2) uses a ``90 percent 
or more'' standard. For the sake of consistency, and in order to 
minimize confusion, the final regulations standardize the language used 
in these tests.
6. Overlapping De Minimis Tests
    In addition to the de minimis tests previously described in this 
part XI(E) of the Summary of Comments and Explanation of Revisions 
section, proposed Sec.  1.163(j)-10(c)(3)(iii)(B)(1) also contains 
another de minimis rule. Under this rule, if at least 90 percent of 
gross income generated by an asset during a determination period is 
with respect to either excepted or non-excepted trades or businesses, 
then the entire basis in the asset is allocated to either excepted or 
non-excepted trades or businesses, respectively.
    The Treasury Department and the IRS have determined that this rule 
not only overlaps with, but also may yield results inconsistent with, 
the de minimis rule in Sec.  1.163(j)-10(c)(3)(iii)(B)(2). Thus, the 
final regulations eliminate the de minimis rule in proposed Sec.  
1.163(j)-10(c)(3)(iii)(B)(1).
F. Assets Used in More Than One Trade or Business
1. Overview
    Proposed Sec.  1.163(j)-10(c)(3) contains special rules for 
allocating basis in assets used in more than one trade or business. In 
general, if an asset is used in more than one trade or business during 
a determination period, the taxpayer's adjusted basis in the asset must 
be allocated to each trade or business using one of three permissible 
methodologies, depending on which methodology most reasonably reflects 
the use of the asset in each trade or business during that 
determination period. These three methodologies are: (i) 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; (ii) if the asset 
is land or an inherently permanent structure, the relative amounts of 
physical space used by the trades or businesses; and (iii) if the 
trades or businesses generate the same unit of output, the relative 
amounts of output of those trades or businesses. However, taxpayers 
must use the relative output methodology to allocate the basis of 
assets used in both excepted and non-excepted utility trades or 
businesses.
    As described in part XI(E)(1) of this Summary of Comments and 
Explanation of Revisions section, a taxpayer's allocation of basis in 
assets used in more than one trade or business is subject to several de 
minimis rules (see proposed Sec.  1.163(j)-10(c)(3)(iii)).
2. Consistency Requirement
    A commenter requested clarification that the consistency 
requirement in proposed Sec.  1.163(j)-10(c)(3)(iii)(A) does not 
require a taxpayer to use a single methodology for different categories 
of assets, because a methodology that is reasonable for one type of 
asset (for example, office buildings) may not be reasonable for another 
(for example, intangibles). The Treasury Department and the IRS agree 
with this comment, and the final regulations have been clarified 
accordingly.
3. Changing a Taxpayer's Allocation Methodology
    The Treasury Department and the IRS have determined that requiring 
taxpayers to obtain consent from the Commissioner to change their 
allocation methodology would impose an undue burden. Thus, the final 
regulations permit a taxpayer to change its allocation methodology 
after a period of five taxable years without obtaining consent from the 
Commissioner. A taxpayer that seeks to change its allocation 
methodology more frequently must obtain consent from the Commissioner.
    The Treasury Department and the IRS also have determined that an 
allocation methodology is not a method of accounting because there is 
no guarantee that a taxpayer will be able to deduct a disallowed 
business interest expense carryforward in future taxable years (as a 
result, there could be a permanent disallowance). See the discussion in 
part III(A) of this Summary of Comments and Explanation of Revisions 
section.
4. Mandatory Use of Relative Output for Utility Trades or Businesses
    A commenter requested that the final regulations allow electric 
cooperatives to use methodologies other than relative output to 
allocate the basis of assets used in both excepted and non-excepted 
utility trades or businesses. The commenter noted that alternative 
methods, such as allocations based on dollars of sales (or sales less 
the cost of sales), have been allowed by the IRS in

[[Page 56736]]

the context of allocating expenses between patronage and non-patronage 
sales. The commenter also stated that economic realities facing 
electric cooperatives operating on a not-for-profit basis would not be 
accurately reflected by a relative output methodology.
    The Treasury Department and the IRS have concluded that relative 
output most reasonably reflects the use of assets in excepted and non-
excepted utility trades or businesses because Sec.  1.163(j)-
1(b)(15)(i)(A) divides utility businesses into excepted regulated 
utility trades or businesses and non-excepted utility businesses on the 
same basis. To the extent that items described in Sec.  1.163(j)-
1(b)(15)(i)(A) are sold at rates described in Sec.  1.163(j)-
1(b)(15)(i)(B), and to the extent that the trade or business is an 
electing regulated utility trade or business under Sec.  1.163(j)-
1(b)(15)(iii), a utility trade or business is an excepted trade or 
business. The Treasury Department and the IRS do not agree that the 
final regulations should apply one methodology for differentiating 
excepted and non-excepted utility trades or businesses under Sec.  
1.163(j)-1 and a different methodology to determine the allocation of 
an asset's basis between such businesses. Therefore, the final 
regulations do not incorporate the commenter's suggestion.
    Another commenter recommended that the rule mandating the use of 
relative output for the allocation of asset basis under proposed Sec.  
1.163(j)-10(c)(3)(iii)(C)(2) not be used either to allocate assets used 
exclusively in excepted or non-excepted utility trades or businesses or 
to apply the de minimis test of proposed Sec.  1.163(j)-10(c)(1)(ii).
    The special rule in proposed Sec.  1.163(j)-10(c)(3)(iii)(C)(2) 
mandates the use of relative output only for the purpose of allocating 
the basis of assets used in both excepted and non-excepted utility 
trades or businesses. Therefore, the rule does not mandate the use of 
relative output to allocate the basis of an asset that is used solely 
in either an excepted regulated utility trade or business or a non-
excepted utility trade or business, except to the extent the de minimis 
rule in proposed Sec.  1.163(j)-10(c)(3)(iii)(C)(3) treats a taxpayer's 
entire trade or business as either an excepted trade or business or a 
non-excepted trade or business. The language proposed by the commenter 
still subjects assets to the de minimis rule in proposed Sec.  
1.163(j)-10(c)(3)(iii)(C)(3). Because the proposed regulations achieve 
the result requested by the commenter, the final regulations do not 
adopt the recommended change.
    The de minimis rule in proposed Sec.  1.163(j)-10(c)(1)(ii) applies 
only after the basis of assets has been allocated between excepted and 
non-excepted trades or businesses. This de minimis rule treats all of a 
taxpayer's trades or businesses as either excepted or non-excepted 
trades or businesses based on such allocation. Because the rule of 
proposed Sec.  1.163(j)-10(c)(1)(ii) does not apply the methodologies 
listed in proposed Sec.  1.163(j)-10(c)(3), including the relative 
output methodology, no change to the proposed regulations is necessary 
to achieve the result requested by the commenter with respect to 
proposed Sec.  1.163(j)-10(c)(1)(ii).
G. Exclusions From Basis Calculations
    For purposes of allocating interest expense and interest income 
under the asset-basis allocation method in proposed Sec.  1.163(j)-
10(c), a taxpayer's basis in certain types of assets generally is not 
taken into account. These assets include cash and cash equivalents (see 
proposed Sec.  1.163(j)-10(c)(5)(iii)). As noted in the preamble to the 
proposed regulations, this rule is intended to discourage taxpayers 
from moving cash to excepted trades or businesses to increase the 
amount of asset basis therein. In the preamble to the proposed 
regulations, the Treasury Department and the IRS requested comments on 
this special rule, including whether any exceptions should apply (such 
as for working capital).
    In response, commenters recommended that working capital be 
included in the basis allocation determination, along with collateral 
that secures derivatives that hedge business assets and liabilities 
within the meaning of Sec.  1.1221-2.
    The Treasury Department and the IRS have concluded that the 
inclusion of working capital in the basis allocation determination 
could lead to frequent disputes between taxpayers and the IRS over the 
amount of cash that comprises ``working capital'' and the allocation of 
such amount between and among a taxpayer's excepted and non-excepted 
trades or businesses. Thus, the final regulations do not adopt this 
recommendation.
    The Treasury Department and the IRS also have concluded that the 
inclusion of collateral that secures derivatives that hedge business 
assets and liabilities within the meaning of Sec.  1.1221-2 could lead 
to frequent disputes between taxpayers and the IRS for reasons similar 
to those for working capital. For example, it is not always clear which 
business asset or liability is being hedged, especially in the case of 
an aggregate hedging transaction. In addition, taxpayers could use this 
rule as a planning opportunity for purposes of allocating the 
collateral to excepted trades or businesses. Thus, the final 
regulations also do not adopt this recommendation.
H. Look-Through Rules
1. Ownership Thresholds; Direct and Indirect Ownership Interests
    Proposed Sec.  1.163(j)-10(c)(5)(ii) provides, in part, that if a 
taxpayer owns an interest in a partnership or stock in a corporation 
that is not a member of the taxpayer's consolidated group, the 
partnership interest or stock is treated as an asset of the taxpayer 
for purposes of the allocation rules of proposed Sec.  1.163(j)-10.
    For purposes of allocating a partner's basis in its partnership 
interest between excepted and non-excepted trades or businesses under 
proposed Sec.  1.163(j)-10, the partner generally may look through to 
its share of the partnership's basis in the partnership's assets (with 
certain modifications and limitations) regardless of the extent of the 
partner's ownership interest in the partnership. However, the partner 
must apply this look-through rule if its direct and indirect interest 
in the partnership is greater than or equal to 80 percent. Similar 
rules apply to shareholders of S corporations. See proposed Sec.  
1.163(j)-10(c)(5)(ii)(A)(2)(i) and (c)(5)(ii)(B)(3)(ii).
    For purposes of allocating a shareholder's stock basis between 
excepted and non-excepted trades or businesses, a shareholder of a 
domestic non-consolidated C corporation or a CFC also must look through 
to the assets of the corporation if the shareholder's direct and 
indirect interest therein satisfies the ownership requirements of 
section 1504(a)(2). Shareholders of domestic non-consolidated C 
corporations and CFCs may not look through their stock in such 
corporations if they do not satisfy this ownership threshold. See 
proposed Sec.  1.163(j)-10(c)(5)(ii)(B)(2)(i) and (c)(7)(i)(A).
    If a shareholder receives a dividend that is not investment income, 
and if the shareholder looks through to the assets of the payor 
corporation under proposed Sec.  1.163(j)-10(c)(5)(ii) for the taxable 
year, the shareholder also must look through to the activities of the 
payor corporation to allocate the dividend between the shareholder's 
excepted and non-excepted trades or businesses. See proposed Sec.  
1.163(j)-10(b)(3) and (c)(7)(i)(B).
    Commenters recommended that taxpayers be afforded greater 
flexibility to look through their stock in domestic

[[Page 56737]]

non-consolidated C corporations and CFCs. For example, one commenter 
suggested that the look-through threshold for CFCs be lowered to 50 
percent (analogous to the look-through threshold for related CFCs in 
section 954(c)(6)). Another commenter recommended that a taxpayer be 
allowed to look through its stock in a domestic non-consolidated C 
corporation if the taxpayer owns at least 80 percent of such stock by 
value, regardless of whether the taxpayer also owns 80 percent of such 
stock by vote. Yet another commenter recommended that a taxpayer be 
allowed to look through its stock in a domestic non-consolidated C 
corporation (or be allowed to allocate its entire basis in such stock 
to an excepted trade or business) if (i) the taxpayer and the C 
corporation are engaged in the same excepted trade or business, and 
(ii) the taxpayer either (A) owns at least 50 percent of the stock of 
the C corporation, or (B) owns at least 20 percent of the stock of the 
C corporation and exercises a significant degree of control over the 
corporation's trade or business. Another commenter recommended that the 
ownership threshold for looking through domestic non-consolidated C 
corporations and CFCs be eliminated entirely so that interest expense 
paid or accrued on debt incurred to finance the acquisition of a real 
estate business is exempt from the section 163(j) limitation (if the 
business qualifies for and makes an election under proposed Sec.  
1.163(j)-9), regardless of whether that business is held directly or 
through a subsidiary.
    The Treasury Department and the IRS have determined that a de 
minimis ownership threshold is appropriate for domestic non-
consolidated C corporations and CFCs because, unlike a partnership, a 
corporation generally is respected as an entity separate from its 
owner(s) for tax purposes. See, for example, Moline Properties v. 
Commissioner, 319 U.S. 436 (1943). The look-through rule for non-
consolidated C corporations provides a limited exception to this 
general rule. Moreover, unlike S corporations, domestic C corporations 
are not taxed as flow-through entities. Thus, the final regulations 
retain an 80 percent ownership threshold for looking through a domestic 
non-consolidated C corporation or a CFC.
    However, the final regulations permit a taxpayer to look through 
its stock in a domestic non-consolidated C corporation or a CFC if the 
taxpayer owns at least 80 percent of such stock by value, regardless of 
whether the taxpayer also owns at least 80 percent of such stock by 
vote. Corresponding changes have been made to the look-through rule for 
dividends.
    Additionally, the final regulations permit a shareholder that meets 
the ownership requirements for looking through the stock of a domestic 
non-consolidated C corporation (determined without applying the 
constructive ownership rules of section 318(a)) to look through to such 
shareholder's pro rata share of the C corporation's basis in its assets 
for purposes of Sec.  1.163(j)-10(c) (asset basis look-through 
approach). If a shareholder applies the asset basis look-through 
approach, it must do so for all domestic non-consolidated C 
corporations for which the shareholder is eligible to use this 
approach, and it must continue to use the asset basis look-through 
approach in all future taxable years in which the shareholder is 
eligible to use this approach.
    Commenters also asked for clarification as to the meaning of an 
``indirect'' interest for purposes of these look-through rules. For 
example, commenters asked what the term ``indirect'' means in the 
context of the look-through rule for dividends. Commenters further 
noted that, because section 1504(a)(2) does not contain constructive 
ownership rules, there is uncertainty as to when a shareholder's 
indirect ownership in a corporation is counted for purposes of the 
ownership requirement in the look-through rule. Commenters also 
requested specific constructive ownership rules, as well as examples to 
illustrate the application of the ``direct or indirect'' ownership 
threshold.
    The Treasury Department and the IRS have determined that, for 
purposes of applying the ownership thresholds in Sec.  1.163(j)-
10(c)(5)(ii)(B)(2)(i), (c)(5)(ii)(B)(3)(ii), and (c)(7)(i)(A) to 
shareholders of domestic non-consolidated C corporations, CFCs, and S 
corporations, as applicable, the constructive ownership rules of 
section 318(a) should apply. For example, assume A, B, and C are all 
non-consolidated C corporations; A wholly and directly owns B; A and B 
each directly own 50 percent of C; A and B both conduct a non-excepted 
trade or business; and C conducts an excepted trade or business. Under 
section 318(a)(2)(C), A is considered to own the stock owned by B. As a 
result, A is considered to own 100 percent of the stock of C, and the 
look-through rule of proposed Sec.  1.163(j)-10(c)(5)(ii)(B)(2)(i) and 
(c)(7)(i)(A) applies to A's stock in C. Thus, although the Treasury 
Department and the IRS have determined that the ownership threshold for 
non-consolidated C corporations should remain at 80 percent, the 
constructive ownership rules of section 318 will broaden the 
availability of the look-through rules to shareholders of such 
corporations.
    In contrast, the Treasury Department and the IRS have determined 
that the constructive ownership rules of section 318(a) should not 
apply for purposes of applying the ownership threshold in proposed 
Sec.  1.163(j)-10(b)(3) and (c)(7)(i)(B) to the receipt of dividends 
from domestic C corporations and CFCs because dividends are not paid to 
indirect shareholders. To avoid confusion in this regard, the final 
regulations remove the word ``indirect'' from the ownership threshold 
for the dividend look-through rule.
2. Application of Look-Through Rules to Partnerships
i. In General
    For purposes of proposed Sec.  1.163(j)-10(c), a partnership 
interest is treated as an asset of the partner. Pursuant to proposed 
Sec.  1.163(j)-10(c)(5)(ii)(A)(1), the partner's adjusted basis in its 
partnership interest is reduced, but not below zero, by the partner's 
share of partnership liabilities as determined under section 752 
(section 752 basis reduction rule). Pursuant to proposed Sec.  
1.163(j)-10(c)(5)(ii)(A)(2)(iii), a partner other than a C corporation 
or tax-exempt corporation must further reduce its adjusted basis in its 
partnership interest by its share of the tax basis of partnership 
assets that is not properly allocable to a trade or business 
(investment asset basis reduction rule).
    As noted in part XI(H)(1) of this Summary of Comments and 
Explanation of Revisions section, a partner may determine what portion 
of its adjusted tax basis in a partnership interest is attributable to 
an excepted or non-excepted trade or business by reference to its share 
of the partnership's basis in the partnership's assets (look-through 
rule). Under proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2)(i), a partner 
generally may choose whether to apply the look-through rule without 
regard to its ownership percentage, with two exceptions. First, if a 
partner's direct or 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 look-through rule. Second, if the partnership is 
eligible for the small business exemption under section 163(j)(3) and 
proposed Sec.  1.163(j)-2(d)(1), a partner may not apply the look-
through rule.
    Proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2)(ii) provides that if, 
after applying the investment asset basis

[[Page 56738]]

reduction rule, 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 or non-excepted 
trades or businesses, the partner's entire basis in its partnership 
interest is treated as allocable to such excepted or non-excepted 
trades or businesses.
    Pursuant to proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2)(iv), if a 
partner, other than a C corporation or a tax-exempt corporation, does 
not apply the 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).
ii. Coordination of Look-Through Rule and Basis Determination Rules
    Outside of the partnership context, proposed Sec.  1.163(j)-
10(c)(5)(i) provides rules regarding the computation of adjusted basis 
for purposes of allocating business interest expense between excepted 
and non-excepted trades or businesses (collectively, the ``basis 
determination rules''). For example, proposed Sec.  1.163(j)-
10(c)(5)(i)(A) generally provides that the adjusted basis of non-
depreciable property other than land is the adjusted basis of the asset 
used for determining gain or loss from the sale or other disposition of 
that asset as provided in Sec.  1.1011-1, and proposed Sec.  1.163(j)-
10(c)(5)(i)(C) generally provides that the adjusted basis of land and 
inherently permanent structures is its unadjusted basis. For purposes 
of applying the look-through rule, the Treasury Department and the IRS 
intended the basis determination rules to require adjustments to the 
partnership's basis in its assets and the partner's basis in its 
partnership interest to the extent of the partner's share of any 
adjustments to the basis of the partnership's assets. Accordingly, the 
final regulations explicitly provide that such is the case.
    Multiple commenters noted that the proposed regulations do not 
specify whether a partner that does not apply the look-through rule 
should use the adjusted tax basis in its partnership interest or should 
adjust its tax basis to reflect what its basis would be if the 
partnership applied the basis determination rules to its assets. 
Because all partnerships are not subject to section 163(j) and cannot 
provide all partners with the information necessary to adjust the tax 
basis of their partnership interests consistent with the basis 
determination rules, the Treasury Department and the IRS have 
determined that the basis determination rules should not apply to the 
basis of a partnership interest if a partner does not apply the look-
through rule.
iii. Applying the Look-Through Rule and Determining Share of 
Partnership Basis
    Proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2)(i) provides that, for 
purposes of the look-through rule, a partner's share of a partnership's 
assets is determined using a reasonable method, taking into account 
special allocations under section 704(b), adjustments under sections 
734(b) and 743(b), and direct adjustments relating to assets subject to 
qualified nonrecourse indebtedness under proposed Sec.  1.163(j)-
10(d)(4). Commenters argued that this language does not provide 
adequate guidance regarding how a partner should determine its share of 
the tax basis of a specific partnership asset when applying the look-
through rule. The commenters stated that, by indicating that sections 
743(b) and 704(b) should be taken into account, the proposed 
regulations imply that a partner's share of the partnership's basis in 
an asset is determined by reference to the future depreciation 
deductions that a partner would be allocated with regard to such asset 
or the amount of basis to be taken into account by that partner in 
determining its allocable share of gain or loss on the partnership's 
disposition of the asset. The commenters also requested that final 
regulations address whether and how allocations under section 704(c) 
affect a partner's share of the partnership's basis in its assets. 
After further consideration, the Treasury Department and the IRS have 
decided to retain the rule in proposed Sec.  1.163(j)-
10(c)(5)(ii)(A)(2)(i).
iv. Investment Asset Basis Reduction Rule
    Under proposed Sec.  1.163(j)-10(c)(5)(ii)(A)(2)(iii), for purposes 
of applying the investment asset basis reduction rule, a partner's 
share of a partnership's assets is determined under a reasonable 
method, taking into account special allocations under section 704(b). A 
commenter recommended clarifying whether the investment asset basis 
reduction should be made in accordance with a partner's share of the 
partnership's actual adjusted basis in an asset or in accordance with 
the partner's share of the partnership's basis in an asset as 
determined pursuant to the basis determination rules. The commenter 
further recommended that the approach adopted on this issue should be 
consistent with the approach adopted for purposes of determining a 
partner's adjusted basis in its partnership interest.
    The Treasury Department and the IRS agree that these two rules 
should be applied consistently. After further consideration, the 
Treasury Department and the IRS have decided to retain the rule that 
allows a partner's share of a partnership's investment assets to be 
determined using a reasonable method, taking into account special 
allocations under section 704(b). However, if a partner elects to apply 
the look-through rule, then the partner also must apply the basis 
determination rules. If a partner elects not to apply, or is precluded 
from applying, the look-through rule, then the approach the partner 
uses for purposes of the investment asset basis reduction rule must be 
consistent with the approach the partner uses to determine the 
partner's adjusted basis in its partnership interest.
v. Coordination of Section 752 Basis Reduction Rule and Investment 
Asset Basis Reduction Rule
    Multiple commenters noted that the combined effect of the section 
752 basis reduction rule and the investment asset basis reduction rule 
could require a partner, other than a C corporation or a tax-exempt 
corporation, in a partnership that holds investment assets funded by 
partnership liabilities to reduce the adjusted tax basis of its 
partnership interest twice--once for the partnership's basis in its 
investment assets, and a second time for the liabilities that funded 
their purchase. The Treasury Department and the IRS have determined 
that this result would be inappropriate. Accordingly, the final 
regulations amend the investment asset basis reduction rule by 
providing that, with respect to a partner other than a C corporation or 
tax-exempt corporation, the partner's adjusted basis in its partnership 
interest is decreased by the partner's share of the excess of (a) the 
partnership's asset basis with respect to those assets over (b) the 
partnership's debt that is traced to such assets in accordance with 
Sec.  1.163-8T. In order to neutralize the effect of any cost recovery 
deductions associated with a partnership's investment assets funded by 
partnership liabilities (for example, non-trade or business property 
held for the production of income), the final regulations also amend 
the investment asset basis reduction rule by providing that, with 
respect to a partner other than a C corporation or tax-exempt 
corporation, the partner's adjusted basis in its partnership interest 
is increased by the partner's share of the excess of (a) the 
partnership's debt that is traced to

[[Page 56739]]

such assets in accordance with Sec.  1.163-8T over (b) the 
partnership's asset basis with respect to those assets.
vi. Allocating Basis in a Partnership Interest Between Excepted and 
Non-Excepted Trades or Businesses
    A commenter requested explicit confirmation that, under the look-
through rule, a partner allocates the basis of its partnership interest 
between excepted and non-excepted trades or businesses in the same 
proportion as the partner's share of the partnership's adjusted tax 
basis in its trade or business assets is allocated between excepted and 
non-excepted trades or businesses. The final regulations explicitly 
state that this is the rule.
    Commenters also stated that the proposed regulations do not address 
how a partner should allocate business interest expense and business 
interest income under proposed Sec.  1.163(j)-10(c) to the extent the 
partner (i) has zero basis in all partnership interests for purposes of 
section 163(j), and (ii) owns no other trade or business assets. The 
Treasury Department and the IRS have determined that these facts would 
be rare, particularly given the adjustments to partnership basis 
provided for in Sec.  1.163(j)-10. Therefore, the final regulations do 
not include a rule addressing this fact pattern. However, the Treasury 
Department and the IRS request comments on how frequently this fact 
pattern would occur and how best to address such a situation.
3. Additional Limitation on Application of Look-Through Rules to C 
Corporations
    A commenter noted that the look-through rules may be distortive if 
an individual (A) that is directly engaged in a trade or business also 
owns stock in a C corporation (with its own trade or business) that 
satisfies the section 1504(a)(2) ownership requirements. A's interest 
expense that is attributable to A's investment in the C corporation 
under Sec.  1.163-8T retains its character as investment interest 
expense. Moreover, if A also has business interest expense, the 
allocation of that expense between excepted and non-excepted trades or 
businesses would appear to take into account A's investment in the C 
corporation on a look-through basis as well. Thus, A's shares in the C 
corporation may be double-counted insofar as they affect the character 
of both the directly attributable investment interest expense and the 
unrelated business interest expense.
    To address the possible distortive effects of the look-through 
rules when applied to stock of a non-consolidated C corporation that is 
held as an investment, the final regulations provide that the look-
through rule in Sec.  1.163(j)-10(c)(5)(ii)(B)(2)(i) is available only 
if dividends paid on the stock would not be included in the taxpayer's 
investment income under section 163(d)(4)(B). Because corporations 
cannot have investment income under section 163(d)(4)(B), this 
additional requirement does not otherwise affect their ability to look-
through the stock of a non-consolidated C corporation.
4. Dispositions of Stock in Non-Consolidated C Corporations
    Under proposed Sec.  1.163(j)-10(b)(4)(i), if a shareholder 
recognizes gain or loss upon the disposition of its stock in a non-
consolidated C corporation, if such stock is not property held for 
investment, and if the taxpayer looks through to the assets of the C 
corporation under proposed Sec.  1.163(j)-10(c)(5)(ii)(B), then the 
taxpayer must allocate gain or loss from the stock disposition 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. This rule is analogous to the look-through rule 
for dividends in proposed Sec.  1.163(j)-10(b)(3).
    However, the dividend look-through rule also provides that, if at 
least 90 percent of the payor corporation's adjusted basis in its 
assets during the taxable year is allocable to either excepted or non-
excepted trades or businesses, then all of the taxpayer's dividend 
income from the payor corporation for the taxable year is treated as 
allocable to excepted or non-excepted trades or businesses, 
respectively. Commenters asked why the rule regarding the disposition 
of non-consolidated C corporation stock is not subject to a 90 percent 
de minimis rule analogous to the rule for dividends.
    The Treasury Department and the IRS have determined that the rule 
regarding the disposition of stock in a non-consolidated C corporation 
(including a CFC) should be subject to a 90 percent de minimis rule. 
The final regulations have modified proposed Sec.  1.163(j)-10(b)(4)(i) 
accordingly.
5. Application of Look-Through Rules to Small Businesses
    Under proposed Sec.  1.163(j)-10(c)(5)(ii)(D), a taxpayer may not 
apply the look-through rules in proposed Sec.  1.163(j)-10(b)(3) and 
(c)(5)(ii)(A), (B), and (C) to an entity that is eligible for the small 
business exemption. As described in the preamble to the proposed 
regulations, the Treasury Department and the IRS determined that these 
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 preamble 
to the proposed regulations also provides that a taxpayer that is 
eligible for the small business exemption may not make an election 
under proposed Sec.  1.163(j)-9.
    Commenters requested that entities that qualify for the small 
business exemption be allowed to make an election under proposed Sec.  
1.163(j)-9, and that such an electing entity's shareholders or partners 
be permitted to apply the look-through rules. Absent such a rule, 
shareholders and partners of a small business entity that conducts an 
excepted trade or business could be worse off than shareholders and 
partners of a larger entity (ineligible for the small business 
exemption) that conducts an excepted trade or business.
    As noted in part X(A) of this Summary of Comments and Explanation 
of Revisions section, the Treasury Department and the IRS have 
determined that entities eligible for the small business exemption 
should be permitted to make a protective election under proposed Sec.  
1.163(j)-9. Accordingly, the final regulations also allow taxpayers to 
apply the look-through rules to entities that qualify for the small 
business exemption and that make a protective election under proposed 
Sec.  1.163(j)-9.
6. Application of the Look-Through Rules to Foreign Utilities
    Section 163(j)(7)(A)(iv) does not treat utilities that are 
exclusively regulated by foreign regulators (and not by a State 
government, a political subdivision of a State government, an agency or 
instrumentality of the United States, or the governing or ratemaking 
body of a domestic electric cooperative) (foreign-regulated utility) as 
excepted trades or businesses. As a result, under the interest 
allocation rules of proposed Sec.  1.163(j)-10(c), a U.S. corporation 
that looks through to the assets of a CFC that operates a foreign-
regulated utility must allocate its entire basis in its CFC stock to a 
non-excepted trade or business, even if all of the CFC's operating 
assets are used in a foreign-regulated utility business. Moreover, if 
the U.S. corporation has significant basis in its CFC stock, a 
significant portion of the U.S. corporation's business interest expense 
will be subject to the section

[[Page 56740]]

163(j) limitation, even if the U.S. corporation is solely or primarily 
engaged in an excepted utility trade or business.
    A commenter noted that, if the U.S. corporation does not have 
sufficient income from non-excepted trades or businesses, the 
corporation might never be able to deduct its disallowed business 
interest expense. The commenter thus recommended that stock in a CFC 
engaged in a foreign-regulated utility trade or business be treated as 
having zero basis for purposes of the interest allocation rules in 
proposed Sec.  1.163(j)-10(c).
    The final regulations do not adopt the commenter's recommendation. 
However, the Treasury Department and the IRS have determined that, if a 
taxpayer applies the look-through rule to a CFC, the taxpayer may 
allocate its basis in its CFC stock to an excepted trade or business to 
the extent the CFC is engaged in either (i) an excepted trade or 
business, or (ii) a foreign-regulated utility trade or business that 
would be treated as an excepted trade or business if the utility meets 
certain requirements related to regulation by a foreign government. The 
final regulations have been modified accordingly. See Sec.  1.163(j)-
10(c)(5)(ii)(C)(2).
I. Deemed Asset Sale
    Proposed Sec.  1.163(j)-10(c)(5)(iv) provides that, 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, 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 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. As explained in the preamble to the proposed regulations, 
this deemed asset sale rule is intended to place taxpayers that are 
actually or effectively precluded from making an election under section 
336, section 338, or section 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.
    Commenters pointed out that, as a practical matter, a basis step-up 
election generally cannot be made if the acquired entity has a 
regulatory liability for deferred taxes on its books because, in that 
case, the election may cause customer bills to increase. In other 
words, deferred tax liabilities typically lower a utility's rate base 
(which is used to compute the rates charged to customers). An election 
under section 336, section 338, or section 754 would eliminate this 
deferred tax liability, thereby increasing the rate base and 
potentially increasing the rates charged to customers. As a result, 
regulatory agencies frequently do not approve a basis step-up election 
made in connection with the sale or purchase of a regulated utility. 
Commenters argued that even broaching the possibility of such a basis 
step-up could create concerns for the regulatory agency regarding a 
proposed acquisition. Commenters also queried how taxpayers that do not 
raise this issue with the regulatory agency can ``demonstrate'' that 
they were ``effectively precluded'' by the agency from making the 
election. In short, commenters claimed that the ``demonstration'' 
requirement in proposed Sec.  1.163(j)-10(c)(5)(iv) would be 
impractical, result in unnecessary requests to regulatory agencies, 
lead to controversy, create uncertainty, and limit the effectiveness of 
this provision.
    To address the foregoing concerns, the final regulations provide 
that a taxpayer that acquired or acquires an interest in a regulated 
entity should be deemed to have made an election to step up the tax 
basis of the assets of the acquired entity if the taxpayer can 
demonstrate that (a) the acquisition qualified for an election under 
section 336, 338, or 754, and (b) immediately before the acquisition, 
the acquired entity had a regulatory liability for deferred taxes on 
its books with respect to property predominantly used in an excepted 
regulated utility trade or business.
J. Carryforwards of Disallowed Disqualified Interest
    Proposed Sec.  1.163(j)-1(b)(10) defines the term ``disallowed 
disqualified interest'' to mean interest expense, including 
carryforwards, for which a deduction was disallowed under old section 
163(j) in the taxpayer's last taxable year beginning before January 1, 
2018, and that was carried forward under old section 163(j). Under the 
proposed regulations, disallowed disqualified interest that is properly 
allocable to a non-excepted trade or business is subject to the section 
163(j) limitation as a disallowed business interest expense 
carryforward. See proposed Sec. Sec.  1.163(j)-2(c)(1) and 1.163(j)-
11(b)(1). In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments as to how the allocation 
rules in proposed Sec.  1.163(j)-10 should apply to disallowed 
disqualified interest.
    Commenters recommended several possible approaches to allocating 
disallowed disqualified interest between excepted and non-excepted 
trades or businesses. Under one approach (historical approach), a 
taxpayer would apply the allocation rules of proposed Sec.  1.163(j)-10 
to disallowed disqualified interest in the taxable year in which such 
interest expense was incurred. Although this approach would be 
consistent with the allocation rules for other business interest 
expense, it likely would be administratively burdensome for many 
taxpayers because such interest expense may have been incurred years 
(if not decades) ago.
    Under another approach (effective date approach), a taxpayer would 
apply the allocation rules of proposed Sec.  1.163(j)-10 to disallowed 
disqualified interest in the taxpayer's first taxable year beginning 
after December 31, 2017, as if the disallowed disqualified interest 
expense were incurred in that year. Although this approach would be 
less administratively burdensome than the historical approach, it might 
not accurately represent the taxpayer's circumstances in the year(s) in 
which the disallowed disqualified interest actually was incurred.
    Under a third approach, taxpayers would be permitted to use any 
reasonable method to allocate disallowed disqualified interest between 
excepted and non-excepted trades or businesses, provided the method is 
applied consistently to disallowed disqualified interest that arose in 
the same taxable year. This approach also might include the effective 
date approach as a safe harbor. However, this approach could prove to 
be administratively burdensome for the IRS.
    To reduce the administrative burden for both taxpayers and the IRS, 
the final regulations permit taxpayers to use either the historical 
approach or the effective date approach.
    A commenter also pointed out that proposed Sec.  1.163(j)-11(b)(1) 
could be construed as permitting only disallowed disqualified interest 
that is properly allocable to a non-excepted trade or business to be 
carried forward to the taxpayer's first taxable year beginning after 
December 31, 2017. The commenter requested confirmation that disallowed 
disqualified interest that is properly allocable to an excepted trade 
or business also is carried forward. The final regulations confirm this 
point. See Sec.  1.163(j)-11(c)(1).
K. Anti-Abuse Rule
    Proposed Sec.  1.163(j)-10(c)(8) provides an anti-abuse rule to 
discourage

[[Page 56741]]

taxpayers from manipulating the allocation of business interest expense 
and business interest income between non-excepted and excepted trades 
or businesses. Pursuant to this provision, 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 is not taken into account for purposes of Sec.  
1.163(j)-10.
    A commenter expressed support for this rule but suggested that the 
final regulations eliminate the ``principal purpose'' standard and rely 
instead on a rule based on asset acquisitions, dispositions, or changes 
in use that do not have ``a substantial business purpose.''
    The Treasury Department and the IRS have determined that using ``a 
substantial business purpose'' as the threshold for applying the anti-
abuse rule would limit the effectiveness of this rule because taxpayers 
generally would be able to provide an ostensible business purpose for 
the acquisition, disposition, or transfer of an asset. Thus, the anti-
abuse rule in the final regulations retains the ``principal purpose'' 
standard.
L. Direct Allocation
1. Overview
    As previously noted, proposed Sec.  1.163(j)-10(c) generally 
requires interest expense and interest income to be allocated between 
excepted and non-excepted trades or businesses according to the 
relative amounts of basis in the assets used in such trades or 
businesses. However, proposed Sec.  1.163(j)-10(d) contains several 
exceptions to this general rule.
    First, a taxpayer with qualified nonrecourse indebtedness is 
required to directly allocate interest expense from such indebtedness 
to the taxpayer's assets in the manner and to the extent provided in 
Sec.  1.861-10T(b) (see proposed Sec.  1.163(j)-10(d)(1)). Section 
1.861-10T(b) defines the term ``qualified nonrecourse indebtedness'' to 
mean any borrowing (other than borrowings excluded by Sec.  1.861-
10T(b)(4)) that satisfies certain requirements, including the 
requirements that (i) the creditor can look only to the identified 
property (or any lease or other interest therein) as security for 
payment of the principal and interest on the loan, and (ii) the cash 
flow from the property is reasonably expected to be sufficient to 
fulfill the terms and conditions of the loan agreement. For these 
purposes, the term ``cash flow from the property'' does not include 
revenue if a significant portion thereof is derived from activities 
such as sales or the use of other property. Thus, revenue derived from 
the sale or lease of inventory or similar property, including plant or 
equipment used in the manufacture and sale or lease, or purchase and 
sale or lease, of such inventory or similar property, does not 
constitute cash flow from the property. See Sec.  1.861-10T(b)(3)(i).
    Second, a taxpayer that is engaged in the trade or business of 
banking, insurance, financing, or a similar business is required to 
directly allocate interest expense and interest income from such 
business to the taxpayer's assets used in that business (see proposed 
Sec.  1.163(j)-10(d)(2)).
    Additionally, for purposes of the general allocation rule in 
proposed Sec.  1.163(j)-10(c), taxpayers are required to reduce their 
asset basis by the entire amount of the basis in the assets to which 
interest expense is directly allocated pursuant to proposed Sec.  
1.163(j)-10(d)(1) or (2). See proposed Sec.  1.163(j)-10(d)(4).
2. Expansion of the Direct Allocation Rule
    Some commenters recommended that the direct allocation rule in 
proposed Sec.  1.163(j)-10(d) be applied in circumstances other than 
those set forth in proposed Sec.  1.163(j)-10(d)(1) and (2). For 
example, a commenter queried whether a borrowing could be considered 
qualified nonrecourse indebtedness for purposes of proposed Sec.  
1.163(j)-10(d) even if the loan document doesn't require the creditor 
to look exclusively to an asset as security for payment of principal 
and interest on a loan (as required by Sec.  1.861-10T(b)(2)(iii)). 
Other commenters asked that direct allocation be applied to debt 
directly incurred by an excepted regulated utility trade or business. 
These commenters argued that, because such debt must be approved by a 
regulatory agency and relates directly to the underlying needs of that 
trade or business, such debt should be viewed as ``properly allocable'' 
to that trade or business. Moreover, they claimed that the definition 
of ``qualified nonrecourse indebtedness'' in Sec.  1.861-10T(b) is too 
narrow to include either debt directly incurred by an excepted 
regulated utility trade or business or debt incurred to purchase stock 
of a corporation or interests in a partnership primarily engaged in an 
excepted regulated utility trade or business.
    In contrast, other commenters supported the decision to limit the 
availability of tracing to the limited circumstances in proposed Sec.  
1.163(j)-10(d).
    As noted in part XI(L)(1) of this Summary of Comments and 
Explanation of Revisions section, a borrowing is not considered 
qualified nonrecourse indebtedness under Sec.  1.861-10T(b) unless the 
creditor can look only to the identified property (or any interest 
therein) as security for the loan. By definition, the creditor on a 
non-recourse loan may not seek to recover the borrower's other assets; 
in other words, the creditor has no further recourse. The Treasury 
Department and the IRS decline to expand the exception in proposed 
Sec.  1.163(j)-10(d)(1) to include unsecured debt because, by 
definition, such debt is supported by all of the assets of the 
borrower.
    The Treasury Department and the IRS also have determined that the 
definition of qualified nonrecourse indebtedness should not be expanded 
to encompass indebtedness incurred to acquire stock or partnership 
interests in an entity primarily engaged in an excepted trade or 
business because such an approach is akin to tracing. As noted in the 
preamble to the proposed regulations, money is fungible, and the 
Treasury Department and the IRS have determined that a tracing regime 
would be inappropriate, with limited exceptions. The Treasury 
Department and the IRS have determined that the definition of qualified 
nonrecourse indebtedness should not be expanded to encompass all 
indebtedness directly incurred by regulated utility trades or 
businesses, for similar reasons.
    However, the Treasury Department and the IRS appreciate that it is 
difficult for utility trades or businesses to avail themselves of the 
direct allocation rule in proposed Sec.  1.163(j)-10(d)(1) given the 
definition of qualified nonrecourse debt in Sec.  1.861-10T(b). In 
particular, the Treasury Department and the IRS understand that the 
exclusion of inventory revenue from the calculation of ``cash flow from 
the property'' effectively precludes many utilities from using direct 
allocation under proposed Sec.  1.163(j)-10(d)(1). Thus, solely for 
purposes of the allocation rules in proposed Sec.  1.163(j)-10, the 
final regulations create an exception to the definition of qualified 
nonrecourse indebtedness in Sec.  1.861-10T(b) to allow for the 
inclusion of revenue from the sale or lease of inventory for utility 
trades or businesses.
    Another commenter recommended that, for taxpayers engaged in 
excepted regulated utility trades or businesses, the basis in certain 
grants and contributions in aid of construction should be directly 
allocated to non-

[[Page 56742]]

excepted trades or businesses if the costs have not been taken into 
account by a regulatory body in determining the cost of the utility's 
service for ratemaking purposes. As discussed in part II of this 
Summary of Comments and Explanation of Revisions section, the final 
regulations do not require the rates for the sale or furnishing of 
utility items to be established or approved on a cost of service and 
rate of return basis in order for a utility trade or business to 
qualify as an excepted regulated utility trade or business. Without 
such a requirement, the Treasury Department and the IRS do not find a 
significant nexus between a regulatory body's determination of a 
utility trade or business's cost of service and the allocation of the 
basis in grants and contributions in aid of construction. Therefore, 
the final regulations do not adopt the commenter's recommendation.
3. Basis Reduction Requirement for Qualified Nonrecourse Indebtedness
    Commenters noted that, as drafted, the basis reduction requirement 
in proposed Sec.  1.163(j)-10(d)(4) would lead to inappropriate results 
for assets that are acquired using both equity financing and qualified 
nonrecourse indebtedness (or using both recourse and nonrecourse 
indebtedness) because this requirement would remove asset basis that 
was not financed by qualified nonrecourse indebtedness.
    Commenters also observed that this requirement could lead to 
significant distortions because a small amount of qualified nonrecourse 
indebtedness would cause an entire property to be removed from a 
taxpayer's basis allocation computation. For example, assume a taxpayer 
has (i) $500,000 of unsecured debt, (ii) property used in an excepted 
trade or business with a basis of $10 million and $100,000 of qualified 
nonrecourse indebtedness (Asset A), and (iii) a non-excepted trade or 
business whose assets have a basis of $1 million. Under proposed Sec.  
1.163(j)-10(d)(4), Asset A would be entirely excluded from the basis 
allocation computation in proposed Sec.  1.163(j)-10(c). As a result, 
all interest expense on the $500,000 of unsecured debt would be subject 
to the section 163(j) limitation.
    Commenters further noted that taxpayers could take advantage of 
this basis adjustment rule to minimize the application of section 
163(j). In other words, taxpayers could incur a relatively small amount 
of nonrecourse debt to acquire assets used in non-excepted trades or 
businesses, thereby reducing the amount of asset basis allocated to 
such trades or businesses for purposes of the general allocation rule 
in proposed Sec.  1.163(j)-10(c).
    To eliminate these distortions and inappropriate results, 
commenters recommended that basis in the assets securing qualified 
nonrecourse indebtedness be reduced (but not below zero) for purposes 
of the general allocation rule solely by the amount of such qualified 
nonrecourse indebtedness. The Treasury Department and the IRS agree 
with this recommendation, and the final regulations have been modified 
accordingly.
4. Direct Allocation Rule for Financial Services Businesses
    Commenters asked for clarification of the direct allocation rule 
for financial services entities in proposed Sec.  1.163(j)-10(d)(2). 
For example, commenters noted that, because the definition in Sec.  
1.904-4(e)(2) includes income from certain services (including 
investment advisory services), this rule may apply to taxpayers that 
are not doing much actual financing, and commenters queried whether the 
direct allocation rule should apply to such taxpayers. Commenters also 
asked whether proposed Sec.  1.163(j)-10(d)(2) is intended to cover all 
of a bank's activities or only part of them and, if the answer is the 
latter, whether a bank must bifurcate its activities for purposes of 
proposed Sec.  1.163(j)-10.
    Commenters also questioned the basis reduction rule in proposed 
Sec.  1.163(j)-10(d)(4) for financial services businesses. Commenters 
noted that, unlike the case of qualified nonrecourse indebtedness, it 
may not be possible to trace all interest expense related to a 
financial services business to specific assets. Moreover, requiring a 
taxpayer to fully eliminate its basis in the assets of a financial 
services business under proposed Sec.  1.163(j)-10(d)(4) could be 
distortive because the taxpayer's general debt obligations likely 
support at least some portion of the taxpayer's financial services 
business assets.
    Given the uncertainty surrounding the proper scope of the direct 
allocation rule for financial services businesses in proposed Sec.  
1.163(j)-10(d)(2) and the proper application of the basis reduction 
rule to such businesses in proposed Sec.  1.163(j)-10(d)(4), the 
Treasury Department and the IRS have decided to remove proposed Sec.  
1.163(j)-10(d)(2). To ensure that financial services entities are not 
unduly affected by the rule (in proposed Sec.  1.163(j)-10(c)(5)(iii)) 
that excludes cash and cash equivalents from the general asset basis 
allocation rule in proposed Sec.  1.163(j)-10(c), the final regulations 
have retained the exception in proposed Sec.  1.163(j)-10(c)(5)(iii) 
for financial services entities.

XII. Comments on Proposed Changes to Sec.  1.382-2: General Rules for 
Ownership Change

    As described in the preamble to the proposed regulations, section 
382(k)(1) provides that, for purposes of section 382, the term ``loss 
corporation'' includes a corporation entitled to use a carryforward of 
disallowed interest described in section 381(c)(20), which refers to 
carryovers of disallowed business interest described in section 
163(j)(2). Section 163(j)(2) permits business interest expense for 
which a deduction is disallowed under section 163(j)(1) to be carried 
forward to the succeeding taxable year.
    In turn, section 382(d)(3) provides that the term ``pre-change 
loss'' includes disallowed business interest expense carryforwards 
``under rules similar to the rules'' in section 382(d)(1). 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 changes to Sec.  1.382-2 clarified 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, and that a 
``loss corporation'' includes a corporation that is entitled to use a 
carryforward of such a disallowed business interest expense.
    Commenters noted that, viewed in isolation, section 382(k)(1) would 
not appear to apply to a corporation that has only a current-year 
disallowed business interest expense. Some commenters also claimed that 
the inclusion of current-year disallowed business interest expense in 
the definition of a ``loss corporation'' is inconsistent with the 
statutory language of section 382(k)(1).
    The Treasury Department and the IRS have determined that section 
382 should apply to current-year disallowed business interest expense 
(to the extent such expense is allocable to the pre-change period) 
because this approach is consistent with the statutory treatment of 
NOLs. See section 382(k)(1) (providing, in part, that the term ``loss 
corporation'' means a corporation ``having a net operating loss for the 
taxable year in which the ownership change occurs''). Moreover, as a 
policy matter, current-year attributes that relate

[[Page 56743]]

to the period before an ownership change should be subject to section 
382. The exclusion of these items would permit trafficking in losses, 
which is contrary to the stated policy underlying section 382 of 
preventing ``exploit[ation] by persons other than those who incurred 
the loss.'' H. Rept. 83-1337, at 42 (1954). Thus, no changes to the 
final regulations have been made in response to these comments. 
However, the final regulations revise the definition of a ``section 382 
disallowed business interest carryforward'' (which includes both 
disallowed business interest expense carryforwards and current-year 
disallowed business interest expense allocable to the pre-change 
period) in Sec.  1.382-2(a)(7) to reflect changes to the allocation 
rules discussed in part XIII of this Summary of Comments and 
Explanation of Revisions section.

XIII. Comments on Proposed Changes to Sec.  1.382-6: Allocation of 
Income and Loss to Periods Before and After the Change Date for 
Purposes of Section 382

    Section 1.382-6 provides rules for the allocation of income and 
loss to periods before and after the change date for purposes of 
section 382. Section 1.382-6(a) generally provides that a loss 
corporation must allocate its net operating loss or taxable income, and 
its net capital loss or modified capital gain net income, for the 
change year between the pre-change and post-change periods by ratably 
allocating an equal portion to each day in the year. Section 1.382-
6(b), which contains an exception to this general rule, permits a loss 
corporation to elect to allocate the foregoing items for the change 
year between the pre-change and post-change periods as if the loss 
corporation's books were closed on the change date. Such an election 
does not terminate the loss corporation's taxable year as of the change 
date (in other words, the change year is still treated as a single tax 
year for Federal income tax purposes).
    The proposed regulations revise Sec.  1.382-6 to address the 
treatment of business interest expense. More specifically, the proposed 
regulations provide that, regardless of whether a loss corporation has 
made a closing-of-the-books election under Sec.  1.382-6(b), the amount 
of the corporation's deduction for current-year business interest 
expense is calculated based on ratable allocation for purposes of 
calculating the corporation's taxable income attributable to the pre-
change period.
    Commenters objected to the mandatory use of ratable allocation for 
business interest expense in Sec.  1.382-6. For example, commenters 
argued that this approach is distortive (and taxpayer-unfavorable) in 
situations in which the loss corporation incurs minimal interest 
expense in the pre-change period but makes highly leveraged 
acquisitions in the post-change period. Another commenter noted that 
this approach is distortive (and taxpayer-favorable) in situations in 
which the loss corporation incurs significant business interest expense 
in the pre-change period and allocates a portion of that expense to the 
post-change period. To avoid these distortions and complications, 
commenters recommended that a closing-of-the-books election also be 
allowed for business interest expense.
    The Treasury Department and the IRS acknowledge that a ratable 
allocation approach may lead to distortions and administrative burdens 
in certain situations. Thus, the final regulations permit a loss 
corporation to allocate current-year business interest expense between 
the pre-change and post-change periods using the closing-of-the-books 
method set forth in Sec.  1.382-6(b)(4) if the loss corporation makes a 
closing-of-the-books election under Sec.  1.382-6(b). Section 1.382-
6(b)(4) also provides correlative rules for the allocation of 
disallowed business interest expense carryforwards to the pre-change 
and post-change periods when a closing-of-the-books election is made. 
In turn, section 1.382-6(a)(2) clarifies the amount of business 
interest expense, disallowed business interest expense, and disallowed 
business interest expense carryforwards that are allocable to the pre-
change and post-change periods if no closing-of-the-books election is 
made.

XIV. Comments on and Changes to Proposed Sec.  1.383-1: Special 
Limitations on Certain Capital Losses and Excess Credits

    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. Under 
proposed changes to Sec.  1.383-1(d), a taxpayer's section 382 
limitation would be absorbed by disallowed business interest expense 
carryforwards before being absorbed by NOLs. As described in the 
preamble to the proposed regulations, the Treasury Department and the 
IRS prioritized the use of disallowed business interest expense 
carryforwards over 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.''
    Although commenters described the foregoing ordering rule as 
understandable and fairly simple to administer, they noted that pre-
2018 NOLs (unlike disallowed business interest expense carryforwards) 
have a limited carryforward period, and that such NOLs may expire 
without use as a result of this ordering rule. Commenters thus 
recommended allowing taxpayers to elect an alternative ordering rule 
with respect to pre-2018 NOLs.
    The Treasury Department and the IRS have decided not to adopt this 
recommended approach, for several reasons. First, as commenters also 
noted, such an approach would add complexity. Second, as stated in the 
preamble to the proposed regulations, deductions for business interest 
expense (including disallowed business interest expense carryforwards) 
factor into the determination whether and to what extent a taxpayer can 
use an NOL in a taxable year. Thus, no changes have been made to 
proposed Sec.  1.383-1(d) in the final regulations.

XV. Other Comments About Section 382

A. Application of Section 382(l)(5)
    Section 382(l)(5) provides an exception to the general loss 
limitation rule under section 382(a) for an old loss corporation in 
Title 11 proceedings or in similar cases if the historic shareholders 
and creditors of such corporation own at least 50 percent of the stock 
of the new loss corporation as a result of being shareholders or 
creditors immediately before the ownership change. If this exception 
applies, the corporation's pre-change losses and excess credits that 
may be carried over to a post-change year must be ``computed as if no 
deduction was allowable under this chapter for the interest paid or 
accrued'' on debt converted into stock under Title 11 (or in a similar 
case) during the 3-year period preceding the year of the ownership 
change (change year) or during the pre-change period in the change 
year. Section 382(l)(5)(B). In other words, because the old loss 
corporation gets the benefit of treating certain creditors as 
shareholders for purposes of determining whether the corporation has 
undergone an ownership change within the meaning of section 382(g), the 
corporation must treat the debt held by such creditors as equity for 
Federal income tax purposes. As a result, the corporation must treat

[[Page 56744]]

the interest payments as non-deductible distributions on equity.
    As provided in proposed Sec.  1.382-2, section 382 disallowed 
business interest carryforwards are pre-change losses. Because a 
deduction for such carryforwards is ``allowable'' in a future year, 
commenters asked whether such carryforwards must be recomputed under 
section 382(l)(5)(B).
    The Treasury Department and the IRS have determined that no 
clarification of the rule is necessary. Because section 382 disallowed 
business interest carryforwards are pre-change losses, if a corporation 
has such a carryforward from any taxable year ending during the 3-year 
period preceding the change year (or during the pre-change period in 
the change year), and if section 382(l)(5) applies to an ownership 
change, the corporation must recompute the amount of such carryforwards 
as if the business interest expense that generated such carryforwards 
were not interest.
B. Application of Section 382(e)(3)
    A commenter also recommended that the final regulations address the 
application of section 382(e)(3) to foreign corporations with section 
382 disallowed business interest carryforwards. Section 382(e)(3) 
provides that, except as otherwise provided in regulations, only items 
treated as connected with the conduct of a U.S. trade or business are 
taken into account in determining the value of an old loss corporation 
that is a foreign corporation if an ownership change occurs. Thus, if a 
foreign corporation is not engaged in a U.S. trade or business, that 
corporation's section 382 limitation is zero. As a result, if a foreign 
corporation with no U.S. trade or business undergoes a section 382 
ownership change, section 382(e)(3) appears to limit the corporation's 
section 382 disallowed business interest carryforwards to $0. The 
commenter described this result as onerous and unintended and 
recommended that, for purposes of applying section 382 to such 
carryforwards, a foreign corporation's value be treated as the total 
value of its stock.
    The Treasury Department and the IRS are aware of this issue and 
other issues relating to the application of section 382 to CFCs. The 
Treasury Department and the IRS continue to study the application of 
section 382 to CFCs and may address this issue in future guidance. The 
Treasury Department and the IRS welcome further comments on the 
application of section 382 to CFCs.
C. Application of Section 382(h)(6)
    As noted in the Background section, the September 2019 section 382 
proposed regulations included a rule expressly providing that section 
382 disallowed business interest carryforwards are not treated as 
RBILs, thus precluding a double detriment under section 382 with 
respect to such carryforwards. This conclusion might have been reached 
by application of the general anti-duplication principles reflected in 
the current regulations under section 382. See, for example, Sec.  
1.382-8(d) (regarding duplicative reductions in value of loss 
corporations). However, because of the complexity of this area, the 
Treasury Department and the IRS included the clarification to prevent 
possible confusion and to provide certainty to taxpayers that there is 
no double detriment with respect to section 382 disallowed business 
interest carryforwards. Although no formal comments were received on 
this rule during the comment period for the September 2019 section 382 
proposed regulations, informal comments from practitioners active in 
the field have been uniformly positive and have confirmed that this 
rule is a welcome, taxpayer-beneficial addition to the regulations 
under section 382.
    Due to the uncontroversial nature of this rule, the Treasury 
Department and the IRS have determined that finalization of this 
portion of the September 2019 section 382 proposed regulations is 
warranted at this time. The Treasury Department and the IRS continue to 
actively study the remainder of the rules in the September 2019 section 
382 proposed regulations.

XVI. Definition of Real Property Trade or Business

    Commenters suggested that the definition of a ``real property trade 
or business'' should be clarified to include all rental real estate, 
even if the rental real estate does not rise to the level of a section 
162 trade or business. The Treasury Department and the IRS have 
determined that modifications to the rules in the proposed regulations 
are not necessary to make this point clear. Section 1.469-9(b)(1) 
provides that the definition of a ``trade or business'' (for purposes 
of section 469(c)(7)(C)) includes interests in rental real estate even 
if the rental real estate gives rise to deductions under section 212. 
The definition of real property trade or business in Sec.  1.469-
9(b)(2) (for purposes of section 469(c)(7)(C)) necessarily would 
encompass or include the definition of a trade or business as provided 
in Sec.  1.469-9(b)(1). Accordingly, taxpayers engaged in rental real 
estate activities that do not necessarily rise to the level of a 
section 162 trade or business nevertheless will be treated as engaged 
in real property trades or businesses for purposes of section 
469(c)(7)(C) (and section 163(j) by reference), and such taxpayers will 
be permitted to make the election for a trade or business to be an 
electing real property trade or business for purposes of section 
163(j).
    Commenters also requested clarification that a trade or business 
should not be required to have a direct nexus or relationship to rental 
real estate in order to qualify as a real property trade or business 
under section 469(c)(7)(C). The Treasury Department and the IRS agree 
that businesses involving real property construction, reconstruction, 
development, redevelopment, conversion, acquisition, or brokerage 
should not necessarily be required to have a direct nexus or 
relationship to rental real estate to be treated as a real property 
trade or business under section 469(c)(7)(C). The proposed regulations 
provide definitions for the terms ``real property management'' and 
``real property operations'' while reserving the remaining nine terms 
in section 469(c)(7)(C) as undefined. The statement in the preamble to 
the proposed regulations regarding a nexus or relationship to rental 
real estate was intended as the rationale for the decision to limit the 
definition of the two terms to the management and operation of rental 
real estate. Without these limiting definitions, the Treasury 
Department and the IRS were concerned that these two terms could be 
read so broadly as to allow virtually any type of business to qualify 
as a real property trade or business. The other nine terms in section 
469(c)(7)(C) currently remain undefined, although the Treasury 
Department and the IRS intend to issue additional guidance in the 
future to provide definitions for these terms.
    The Treasury Department and the IRS generally agree with the 
observation that real property construction, reconstruction, 
development, redevelopment, conversion, acquisition, or brokerage 
businesses should not necessarily be required to have a direct nexus or 
relationship to rental real estate in order to be treated as real 
property trades or businesses. However, the expectation nevertheless 
remains that the end products or final objectives of such businesses 
should at least have the potential to be used as rental real estate or 
as integral components in rental real estate activities.

[[Page 56745]]

    Several commenters requested clarification regarding whether 
timberlands will qualify as real property trades or businesses. The 
Treasury Department and the IRS have concluded that unharvested or 
unsevered timber clearly fall within the definition of ``real 
property'' as provided in the proposed regulations. The question is 
whether the activity of holding of timberlands falls within the 
definition of a ``real property trade or business.'' The Treasury 
Department and the IRS have concluded that the maintenance and 
management of timberlands generally does not meet the intended meaning 
of any of the eleven terms in section 469(c)(7)(C), and that the owners 
of timberlands were not intended recipients for relief from the per se 
passive rule for rental real estate when section 469(c)(7) originally 
was enacted. However, as set forth in the Concurrent NPRM, such 
activities might constitute the development of real estate within the 
meaning of section 469(c)(7)(C). See proposed Sec.  1.469-
9(b)(2)(ii)(A) and (B) contained in the Concurrent NPRM.
    One commenter requested an example illustrating that the management 
or operation of a pipeline or transmission line will meet the 
definition of a real property trade or business. In addition, another 
commenter requested an example illustrating that the operation of a 
bridge, tunnel, toll road, or airport qualifies as a real property 
trade or business.
    Although the Treasury Department and the IRS generally agree that 
the operation of a pipeline, bridge, tunnel, toll road, or airport may 
meet the definition of a real property trade or business under certain 
and specific facts and circumstances, the answers to these questions 
will remain dependent on the facts and circumstances of each case. The 
Treasury Department and the IRS expect that such examples generally 
will provide very limited guidance to most taxpayers because any such 
examples likely will be viewed as inapplicable for taxpayers with any 
differing facts and circumstances.
    Additionally, one commenter recommended removing the reference to 
the term ``customers'' from the definitions of the terms ``real 
property management'' and ``real property operation'' because, in 
certain situations, the party paying for the use of the property or for 
other services may be a governmental agency providing services to the 
general public or for the public good. The Treasury Department and the 
IRS have determined that this modification is unnecessary because the 
term ``customer'' for this purpose is broad enough to include 
governmental entities.
    One commenter also requested that the definition of a real property 
trade or business be revised to include broadband, street lighting, 
telephone poles, parking meters, and rolling stock. The Treasury 
Department and the IRS decline to revise the definition of real 
property trade or business in section 469(c)(7)(C) in this manner 
because the maintenance and management of these types of assets 
generally do not meet the intended meaning of any of the eleven terms 
in section 469(c)(7)(C), and the owners of such assets were not 
intended recipients for relief from the per se passive rule for rental 
real estate when section 469(c)(7) originally was enacted.
    One commenter requested that the final regulations remove the last 
sentence in the definition of each of the terms ``real property 
management'' and ``real property operation.'' The commenter stated that 
these sentences create confusion regarding whether incidental services 
provided along with rental real estate will cause the business to fail 
to qualify as a real property trade or business. In response to this 
comment, the Treasury Department and the IRS have revised these 
sentences to clarify that incidental services, even if significant, do 
not disqualify a business as a real property trade or business.

Statement of Availability of IRS Documents

    The IRS Notices, Revenue Rulings, 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 Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at http://www.irs.gov.

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.
    The final regulations have been designated as subject to review 
under Executive Order 12866 pursuant to the Memorandum of Agreement 
(April 11, 2018) between the Treasury Department and the Office of 
Management and Budget (OMB) regarding review of tax regulations. OMB 
has designated this final regulation as economically significant under 
section 1(c) of the Memorandum of Agreement. Accordingly, the final 
regulations have been reviewed by OMB's Office of Information and 
Regulatory Affairs. For purposes of E.O. 13771 this rule is regulatory.
A. Need for the Final Regulations
    The Tax Cuts and Jobs Act (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. As a 
result of those changes, a number of the relevant terms and necessary 
calculations that taxpayers are required to apply under the statute can 
benefit from greater specificity. The Treasury Department and the IRS 
issued proposed regulations related to section 163(j) on December 28, 
2018 (proposed regulations). The comments to the proposed regulations 
demonstrate a variety of opinions on how to define terms and on how 
section 163(j) interacts with other sections of the Code and 
corresponding regulations.
    Based on these considerations, the final regulations are needed to 
bring clarity to instances where the meaning of the statute was unclear 
and to respond to comments received on the proposed regulations. Among 
other benefits, the clarity provided by the final regulations generally 
helps ensure that all taxpayers calculate the business interest expense 
limitation in a similar manner.
B. 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 limited 
exceptions. As described in the preamble to the proposed regulations 
(83 FR 67490), 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. With the enactment of 
TCJA, 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 adjusted taxable income (ATI) for the taxable year; and (3) 
the taxpayer's floor plan financing interest expense for the taxable 
year. As

[[Page 56746]]

described in the Background section earlier, the Coronavirus Aid, 
Relief, and Economic Security Act (CARES Act) amended section 163(j) to 
provide special rules relating to the ATI limitation for taxable years 
beginning in 2019 or 2020. The section 163(j) limitation applies to all 
taxpayers, except for certain small businesses with average annual 
gross receipts of $25 million or less (adjusted for inflation) and 
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. 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 the TCJA, in part, out of 
concern that prior law treated debt-financed investment more favorably 
than equity-financed investment. According to Congress, this debt bias 
generally encouraged taxpayers to utilize more leverage than they would 
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.R. Rep. 
No. 115-409, at 247 (2017)).
C. Economic Analysis
1. Baseline
    The Treasury Department and the IRS have assessed the economic 
effects of the final regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these final regulations.
2. Summary of Economic Effects
    The final regulations provide certainty and clarity to taxpayers 
regarding terms and calculations that are contained in section 163(j), 
which was substantially modified by TCJA. In the absence of this 
clarity, the likelihood that different taxpayers would interpret the 
rules regarding the deductibility of business interest expense 
differently would be exacerbated. In general, overall economic 
performance is enhanced when businesses face more uniform signals about 
tax treatment. Certainty and clarity over tax treatment also reduce 
compliance costs for taxpayers. For those situations where taxpayers 
would generally adopt similar interpretations of the statute even in 
the absence of guidance, the final regulations provide value by helping 
to ensure that those interpretations are consistent with the intent and 
purpose of the statute. For example, the final regulations may specify 
a tax treatment that few or no taxpayers would adopt in the absence of 
specific guidance but that nonetheless advances Congressional intent.
    The Treasury Department and the IRS project that the final 
regulations will have an annual economic effect greater than $100 
million ($2020). This determination is based on the substantial volume 
of business interest payments in the economy \2\ and the general 
responsiveness of business investment to effective tax rates,\3\ one 
component of which is the deductibility of interest expense. Based on 
these two magnitudes, even modest changes in the deductibility of 
interest payments (and in the certainty of that deductibility) provided 
by the final regulations, relative to the no-action baseline, can be 
expected to have annual effects greater than $100 million. This claim 
is particularly likely to hold for the first set of general 163(j) 
guidance that is promulgated following major legislation, such as TCJA.
---------------------------------------------------------------------------

    \2\ Interest deductions in tax year 2013 for corporations, 
partnerships, and sole proprietorships were approximately $800 
billion.
    \3\ See E. Zwick and J. Mahon, ``Tax Policy and Heterogeneous 
Investment Behavior,'' at American Economic Review 2017, 107(1): 
217-48 and articles cited therein.
---------------------------------------------------------------------------

    The Treasury Department and the IRS have not undertaken more 
precise estimates of the economic effects of changes in business 
activity stemming from these final regulations. The Treasury Department 
and the IRS do not have readily available data or models that predict 
with reasonable precision the decisions that taxpayers would make under 
the final regulations versus alternative regulatory approaches, 
including the no-action baseline. Nor do they have readily available 
data or models that would measure with reasonable precision the loss or 
gain in economic surplus resulting from those business decisions 
relative to the decisions that would be made under an alternative 
regulatory approach. Such estimates would be necessary to quantify the 
economic effects of the final regulations versus alternative 
approaches.
    In the absence of such quantitative estimates, the Treasury 
Department and the IRS have undertaken a qualitative analysis of the 
economic effects of the final regulations relative to the no-action 
baseline and relative to alternative regulatory approaches. This 
analysis is presented in the next two sections of this Special 
Analyses.
3. Economic Effects of Provisions Substantially Revised From the 
Proposed Regulations
a. Calculation of ATI
    Similar to the proposed regulations, the final regulations 
prescribe various adjustments to the calculation of ATI to prevent 
double counting of deductions and to provide relief for particular 
types of taxpayers or taxpayers in particular circumstances to ensure 
that all taxpayers are treated equitably when calculating ATI. One of 
these adjustments prevents the double counting of depreciation 
deductions when a depreciable asset is sold (only relevant for 
depreciation deductions in taxable years beginning after December 31, 
2017, and before January 1, 2022). Other adjustments apply to 
particular types of taxpayers, such as regulated investment companies 
(RICs), real estate investment trusts (REITs), or consolidated groups.
    As an alternative, the Treasury Department and the IRS considered 
not providing such adjustments. Without such adjustments, however, 
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 entities would almost always 
have ATI of zero or close to zero. This outcome would limit the ability 
of such taxpayers to ever deduct business interest expense for Federal 
income tax purposes even when their financing profile was similar to 
other entities that could deduct similar net business interest expense.
    Based on calculations using the IRS's Statistics of Income (SOI) 
sample of corporate taxpayers for 2017, the Treasury Department and the 
IRS estimate that approximately $13.5 billion of net business interest 
expense is potentially affected by the dividends paid deduction 
adjustment to ATI provided to RICs and REITs in the final regulations. 
This net business interest expense is the amount of interest expense 
that is greater than interest income for RICs and REITs with gross 
receipts greater than $25 million.
    The final regulations make one notable change compared to the 
proposed regulations regarding the ATI calculation for taxpayers that 
manufacture or produce inventory. Under the proposed regulations, the

[[Page 56747]]

amount of any depreciation, amortization, or depletion that is 
capitalized into inventory under section 263A during a taxable year 
beginning before January 1, 2022 was not added back to taxable income 
when calculating ATI for that taxable year. Under the final 
regulations, such amounts are added back to tentative taxable income, 
regardless of the period in which the capitalized amount is recovered 
through cost of goods sold.
    Without the final regulations, a taxpayer with depreciation, 
amortization, or depletion expense that is subject to capitalization 
would have lower ATI (and potentially a higher tax liability due to 
smaller net interest deductions) than a similarly situated taxpayer 
with depreciation, amortization, or depletion expense that is not 
subject to capitalization. Thus, the effect of the final regulations 
for the calculation of ATI is to prevent economic distortions by having 
the net interest limitation apply more stringently for certain types of 
taxpayers than others. The final regulations achieve this outcome more 
effectively that alternative regulatory approaches, including the 
proposed regulations and the no-action baseline.
    Number of Affected Taxpayers. The Treasury Department and the IRS 
estimate that roughly 61,000 entities are both (i) subject to 
calculating their section 163(j) net interest limitation and (ii) 
required by the Code to capitalize any expenses, including 
depreciation, amortization, or depletion expenses. This estimate is an 
upper bound estimate of the number of taxpayers potentially affected by 
the definition of ATI prescribed under the regulations because 
capitalized depreciation, amortization, or depletion expenses are not 
separately reported and this tax return item includes other types of 
capitalized expenses.
b. Definition of Interest
    The statute limits the amount of deductible interest expense for a 
taxpayer but, as described in the Explanation of Provisions section of 
the proposed regulations, 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 
counted as interest. While 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), 
these rules only apply to particular taxpayers in particular 
situations.
    The proposed regulations defined interest for the purpose of the 
section 163(j) limitation as (1) amounts associated with conventional 
debt instruments and amounts already treated as interest for all 
purposes under existing statutory provisions or regulations; (2) 
additional amounts that are functionally similar to interest but not 
currently labeled as interest under the Code, or amounts treated as 
interest for certain purposes, such as amounts described in Sec. Sec.  
1.861-9T and 1.954-2; and (3) any deductible expense or loss 
predominantly incurred in consideration of the time value of money as 
part of an anti-avoidance rule. Thus, the proposed regulations applied 
to interest associated with conventional debt instruments as well as 
generally to transactions that are indebtedness in substance even if 
not in form.
    The Treasury Department and the IRS proposed this definition of 
interest, rather than leaving the term interest undefined for purposes 
of section 163(j). In the absence of this clarity, the likelihood that 
different taxpayers would reach different conclusions over whether a 
particular business expense was deductible business interest expense 
would be exacerbated. In general, overall economic performance is 
enhanced when businesses face more uniform signals about tax treatment. 
Another concern about not defining the term at all is that taxpayer 
uncertainty over whether certain transactions are considered interest 
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.
    A further concern, over providing a narrower definition of 
interest, is that it could encourage taxpayers to engage in 
transactions that provide financing while generating deductions 
economically similar to interest but that were not defined as interest 
for the purposes of section 163(j). There are several reasons why 
curbing such taxpayer behavior would be beneficial. First, the ability 
of taxpayers to engage in such transactions is correlated with the size 
of the trade or business, with large businesses more likely to benefit 
from such avoidance strategies than small businesses. Second, 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. Third, such avoidance strategies may 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. Fourth, 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 final regulations prescribe a definition of interest that is 
similar to the definition of interest in the proposed regulations 
although with changes made in response to comments.\4\ There are three 
general types of changes: (1) Changes are made to the proposed 
regulations that modify, and generally limit, to what extent certain 
amounts are included under the definition of interest for the purposes 
of section 163(j). (2) Several items deemed to be interest for the 
purpose of section 163(j) under proposed Sec.  1.163(j)-1(b)(20)(iii) 
are not included in the final regulations. (3) The anti-avoidance rule 
in proposed Sec.  1.163-1(b)(20)(iv) is modified to include a principal 
purpose test and now also applies to situations where a taxpayer seeks 
to artificially increase the amount of interest income.
---------------------------------------------------------------------------

    \4\ The proposed regulations represent the regulatory 
alternative to which the final regulations are compared in the 
following analysis.
---------------------------------------------------------------------------

    To the extent that these changes narrow the definition of interest 
that is subject to the section 163(j) limitation relative to the 
proposed regulations, they are expected to (i) reduce the cost of 
financing for taxpayers, an effect that is expected to increase 
investment by these taxpayers, and (ii) increase the proportion of that 
financing that might generally be considered debt-financed. The first 
effect occurs because taxpayers can deduct without limitation costs 
from a larger set of financial instruments under the final regulations, 
relative to the proposed regulations. They will choose these 
instruments only if the cost of obtaining funds through those 
instruments is lower than what would have been available under the 
proposed regulations. By extension, this change lowers the overall cost 
of financing for taxpayers. A lower cost of financing is associated 
with greater investment by taxpayers, all other things equal. The 
second effect occurs because the larger set of financial instruments 
for which taxpayers can deduct expense without limitation (under the 
final regulations,

[[Page 56748]]

relative to the proposed regulations) generally consists of instruments 
that have a greater share of debt characteristics, rather than equity 
characteristics. To the extent that taxpayers use these instruments to 
a greater degree under the final regulations relative to the proposed 
regulations, the share of debt-financing will increase. Congress has 
generally expressed the view that excessive debt-financing may be a 
less efficient capital structure for firms. See Senate Budget 
Explanation of the Bill at 165.
    Because the final regulations define interest based on the intent 
and purpose of the statute and generally treat similar taxpayers 
similarly and similar economic activity similarly, the Treasury 
Department and the IRS have determined that the net result under these 
final regulations is a more efficient allocation of capital across 
taxpayers relative to regulatory alternatives, within the context of 
the intent and purpose of the statute.
    The Treasury Department and the IRS have not undertaken 
quantitative estimates of the change in the level or nature of economic 
activity arising from the final regulations relative to the proposed 
regulations due to limitations on available data, but to the extent 
possible has provided further below an estimate of the quantity of 
potentially affected taxpayers and volume of transactions. Consider, 
for example, the treatment of guaranteed payments for the use of 
capital provided by a partner to a partnership, a financial arrangement 
that has both equity and debt characteristics. The proposed regulations 
included guaranteed payments to capital in the definition of interest 
while the final regulations do not, except to the extent that they are 
covered by other provisions of the final regulations. The Treasury 
Department and the IRS have not undertaken quantitative estimates of 
this regulatory decision because we do not have readily available data 
or models to measure with sufficient precision: (i) The volume and 
nature of guaranteed payments to capital and other financial 
instruments that taxpayers might use if the final regulations were in 
effect; (ii) the volume and nature of guaranteed payments and other 
financial instruments that taxpayers might have used if the proposed 
regulations were in effect; and (iii) the types of economic activities 
that partnerships might undertake under these two financial portfolios. 
Regarding item (iii), the Treasury Department and the IRS do not have 
readily available data or models to predict how economic activity might 
differ under debt-financed versus equity-financed investment for the 
sets of instruments affected by these final regulations.
    Compliance costs are also expected to be lower for those 
transactions that are not subject to the section 163(j) limitation 
under the final regulations and that would be subject to the limitation 
under the proposed regulations. Generally, this is because taxpayers 
would be less likely to need to calculate the section 163(j) limitation 
and less likely to need to track unused interest deductions that are 
carried forward to future tax years. For most taxpayers, this impact on 
compliance costs is expected to be relatively small. However, for 
certain taxpayers using hedging transactions, calculating the amount of 
interest associated with the transactions would be burdensome and not 
including such transactions in the definition of interest lowers 
compliance costs to a greater degree. The Treasury Department and the 
IRS have not estimated the reduction in compliance costs for these 
taxpayers (under the final regulations, relative to the proposed 
regulations) because we do not have data or models that are suitable 
for this estimation.
    The specific changes made with regard to items (1), (2), and (3) 
are discussed in further detail here.
    (1) The final regulations change (relative to the proposed 
regulations) how amounts from certain transactions will be considered 
interest for the purposes of section 163(j). There are two main forms 
of transactions that are affected:
    Treatment of swaps. The proposed regulations treated a non-cleared 
swap with significant non-periodic payments as two separate 
transactions consisting of an on-market, level payment swap and a loan 
(the embedded loan rule).\5\ The time value component associated with 
the embedded loan is recognized as interest expense to the payor and 
interest income to the recipient. The treatment of cleared swaps was 
not specified in the proposed regulations. The final regulations add 
two exceptions to the embedded loan rule. Specifically, the final 
regulations add exceptions for cleared swaps and for those non-cleared 
swaps that require the parties to meet the margin or collateral 
requirements of a federal regulator (or requirements that are 
substantially similar to a federal regulator). Relative to the proposed 
regulations this treatment will discourage taxpayers from using swaps 
that are unregulated and dissimilar to regulated swaps, because under 
the final regulations only such swaps will require the time value 
component associated with the embedded loan to be treated as interest. 
One reason for excepting both regulated and non-regulated 
collateralized swaps from the definition of interest is that the 
repayment risk of using such transactions is small, while the non-
collateralized swaps are more risky as individual transactions and 
would be likely to contribute to the overall riskiness of the financial 
system.
---------------------------------------------------------------------------

    \5\ A cleared swap is a collateralized swap that was cleared by 
a derivatives clearing organization or by a clearing agency. A non-
cleared swap is a swap that has not been so cleared.
---------------------------------------------------------------------------

    Substitute interest payments. The proposed regulations provided 
that certain substitute interest payments will be treated as interest 
for the purposes of section 163(j).\6\ The final regulations modify the 
treatment of substitute interest payments by only including such 
transactions as interest when the transaction is not part of the 
ordinary course of business of the taxpayer. The Treasury Department 
and the IRS have determined that the ordinary course rule in the final 
regulations provides an appropriate and effective limit on the 
treatment of substitute interest as interest for section 163(j) 
purposes. This change has the effect of reducing the amount of 
substitute interest payments that will be deemed interest for the 
purpose of section 163(j) relative to the proposed regulations.
---------------------------------------------------------------------------

    \6\ A substitute interest payment is a payment, made to the 
transferor of a security in a securities lending transaction or a 
sale-repurchase transaction, of an amount equivalent to an interest 
payment which the owner of the transferred security is entitled to 
receive during the term of the transaction. This provision applies 
to substitute interest payments as described in Sec.  1.861-2(a)(7).
---------------------------------------------------------------------------

    For taxpayers that use substitute interest payments in the ordinary 
course of business, the final regulations may lower the after-tax cost 
of such transactions and such taxpayers are more likely to use 
transactions with substitute interest payments relative to the proposed 
regulations. The Treasury Department and the IRS do not have readily 
available data or models to estimate either (i) the change in financing 
arrangements, including both substitute interest payments and other 
financial instruments, that will be used by taxpayers under this 
provision of the final regulations relative to the proposed 
regulations, or (ii) the change in the volume or nature of economic 
activity by these taxpayers given these financing arrangements.
    (2) The items removed by the final regulations from the definition 
of interest in the proposed regulations include debt issuance costs, 
guaranteed payments for the use of capital provided

[[Page 56749]]

by a partner to a partnership, and hedging transactions.\7\ Under the 
final regulations, these items can still be considered interest under 
the anti-avoidance rule. These items share some characteristics with 
interest, but comments received on the proposed regulations indicate 
there is not a consensus that such items should always be defined as 
interest. Removing these items from the definition of interest lowers 
compliance costs for taxpayers in some cases relative to the proposed 
regulations. However, not including these items in the definition of 
interest increases uncertainty regarding whether amounts from certain 
transactions will be treated as interest under the anti-avoidance rule, 
and more disputes are likely to arise between taxpayers and the IRS.
---------------------------------------------------------------------------

    \7\ Commitment fees are also not included in the definition of 
interest in the final regulations, but may be addressed as part of 
another guidance project on the treatment of fees relating to debt 
instruments and other securities in the future.
---------------------------------------------------------------------------

    The final regulations do not include debt issuance costs, such as 
legal fees for document preparation, in the definition of interest. 
Debt issuance costs are usually small relative to total interest 
payments in a lending transaction and often the payments are made to a 
third-party who is not the lender. Hence, there is limited ability for 
taxpayers to be able to disguise interest payments as debt issuance 
costs. The primary effect of not including debt issuance costs in the 
definition of interest is to decrease the after-tax cost of debt 
financing.
    The final regulations do not include hedging transactions in the 
definition of interest. Taxpayers could have multiple reasons for 
engaging in hedging transactions other than just to lower the amount of 
interest expense, such as a reduction in risk. Not including hedging 
transactions in the definition of interest should decrease 
administration and compliance costs compared to the treatment in the 
proposed regulations since it can be difficult to separate the time 
value component from the insurance aspects of a hedging transaction. 
Under the final regulations, taxpayers are more likely to use hedging 
relative to the proposed regulations due to the decline in compliance 
costs and due to the reduced after-tax cost of using hedges.
    The final regulations do not include guaranteed payments in the 
definition of interest. Guaranteed payments for the use of capital 
provided by a partner to a partnership have both equity and debt 
characteristics. The partner who provided the capital is an owner of 
the business, but also receives payments that are similar to interest. 
Removing guaranteed payments from the definition of interest lowers the 
after-tax cost of such financing for some taxpayers and may lead these 
taxpayers to increase the fraction of financing through capital with 
guaranteed payments relative to other financial instruments. The 
Treasury Department and the IRS do not have readily available data or 
models to project the change in the volume or nature of businesses' 
economic activities that would arise as a consequence of this change in 
the tax treatment of guaranteed payments to capital, relative to the 
proposed regulations.
    (3) The final regulations also modify the anti-avoidance rule found 
in proposed Sec.  1.163-1(b)(20)(iv) relative to the proposed rule. One 
change is that the anti-avoidance rule not only applies to financing 
transactions used to avoid the classification of financing expense as 
interest expense, but also excludes transactions that artificially 
increase the taxpayer's interest income from being included as interest 
income. The final regulations also add a principal purpose condition to 
the anti-avoidance rule. That is, the anti-avoidance rule in the final 
regulations only applies to amounts where a principal purpose of the 
taxpayer for engaging in a transaction is to artificially reduce the 
amount of net business interest expense, whether this stems from a 
decrease in the amounts reported as interest expense or an increase in 
the amounts reported as interest income. This symmetric anti-avoidance 
rule adopted under the final regulations, applying to both interest 
income and interest expense, increases the number of transactions to 
which the rule could potentially apply compared to the proposed 
regulations. However, including a principal purpose test in the anti-
avoidance rule will decrease how often the rule would potentially apply 
to transactions relative to the proposed rule.
    The anti-avoidance rule is an important component of the definition 
of interest because it is difficult for the Treasury Department and the 
IRS to specifically categorize every type of transaction already in 
practice or to anticipate future innovations in financial transactions. 
Relative to regulatory alternatives, the anti-avoidance rule will 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 the final 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 narrower definition of 
interest. The Treasury Department and the IRS further have determined 
that the definition of interest specified under the final regulations 
will encourage a more efficient allocation of capital and use of 
financing across taxpayers relative to the no-action baseline, within 
the context of the intent and purpose of the statute.
    Number of Affected Taxpayers. The Treasury Department and the IRS 
estimate that the number of partnerships potentially affected by the 
change in treatment to guaranteed payments for the use of capital 
provided by a partner to a partnership is 6,000. This is the number of 
partnerships in tax year 2017 with more than $25 million in gross 
receipts that also report paying deductible guaranteed payments. The 
amount of total guaranteed payments reported by these partnerships is 
approximately $30 billion. However, it is not known to what extent 
these guaranteed payments are made to capital or labor, as the tax form 
for that tax year did not distinguish between the two types of 
guaranteed payments. Beginning in 2019, Form 1065 will separately 
report those two types of guaranteed payments.
    It is not possible to provide a meaningful estimate of the number 
of taxpayers potentially affected by the final regulations that have 
deductible debt issuance costs, substitute interest payments, or 
amounts from swaps or hedging transactions, because those amounts are 
not reported separately on a tax return.
4. Economic Effects of Provisions Not Substantially Revised From the 
Proposed Regulations
a. Calculation of Excess Business Interest Expense, Excess Business 
Interest Income, and Excess Taxable Income for Partnerships and S 
Corporations
    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

[[Page 56750]]

that the items should be allocated in the same manner as 
``nonseparately stated taxable income or loss of the partnership''; 
however, this concept had not previously been defined by statute or 
regulations prior to the proposed regulations. In the absence of 
guidance, partnerships would have significant uncertainty in 
determining which partners receive excess items. This uncertainty could 
lead one partnership to undertake an activity that another partnership 
might decline to take based solely on different expectations about tax 
treatment of interest income rather than underlying productivity 
differences or economic signals.
    The final regulations provide guidance on how to allocate 
partnership excess business interest expense, excess business interest 
income, and excess taxable income to partners. The allocation method 
detailed in the final regulations follows a number of principles. 
First, it ensures that the sum of the excess items at the partner level 
is equal to the total at the partnership level. Second, it ensures that 
the partnership does not allocate excess business interest expense to a 
partner that was allocated items that include 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 final regulations thus 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 across taxpayers and across financing 
options, relative to the no-action baseline.
b. Interest Income Inclusion for Owners of Partnerships and S 
Corporations
    The final regulations 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. It thereby avoids 
exacerbating the incentive to seek out interest income relative to 
other forms of less economically productive income in order to avoid 
the section 163(j) limitation, relative to the no-action baseline.
c. Rules Related to Excepted Businesses
    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. The final regulations clarify whether a 
trade or business could elect as a farming business or a real property 
trade or business and thus be excepted from section 163(j). 
Specifically, Sec.  1.163(j)-9 provides guidance in applying the rules 
for farming and real property trade or business elections. For an 
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 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, the final 
regulations define the conditions under which an election terminates.
    In the absence of specific guidance, taxpayers may engage in 
behavior that counteracts the intent and purpose of the statute and 
would not otherwise be taken except to avoid the irrevocable nature of 
the election the statute specified. The final regulations increase the 
likelihood that taxpayers interpret the `irrevocable' designation 
similarly and do not engage in tax-motivated behavior by appearing to 
cease operations in an effort to change an irrevocable designation.
    In addition, Sec.  1.163(j)-9(h) provides a safe harbor for certain 
REITs to elect to be electing real property trades or businesses. 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 compliance time and 
cost in applying new rules if the rules are consistent with other rules 
that they must comply with under the Code. An estimate of the 
compliance cost savings that would be due to this cross-code 
consistency, relative to regulatory alternatives, is beyond the 
capabilities of the IRS's compliance model.
    In addition, the final regulations provide 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.
    The Treasury Department and the IRS received no comments requesting 
that the percentage amounts be changed.
    Number of Affected Taxpayers. The Treasury Department and the IRS 
project that nearly 3,500 REITs are potentially affected by the 
provision in the final regulations that allows REITs for which 10 
percent or less of the value of the REIT's assets are real property 
financing assets to elect to treat all of its assets as allocable to an 
excepted real property trade or business. This estimate is based the 
number of REITs in the SOI sample of corporate taxpayers for 2017 that 
identify as an Equity REIT. An Equity REIT is identified by a check-box 
on form 1120-REIT where the choice is Equity REIT or Mortgage REIT. The 
Mortgage REIT category should be chosen by the taxpayer if the primary 
source of gross receipts is derived from mortgage interest and fees. 
These Equity REITs reported $1.7 trillion in total assets.
    The Treasury Department and the IRS project that roughly 2.8 
million filers are potentially affected by provisions of the final 
regulations that affect electing real property trades or businesses or 
electing farm businesses. This estimate is based on a count of all 
filers with NAICS codes starting with 111 or 112 (farming), and 531 
(real property) with at least $10 million in gross receipts in taxable 
year 2017.
d. Allocation Rules Between Excepted and Non-Excepted Trades or 
Businesses
    The statute is silent over how ATI, interest income, and expense 
should be allocated between excepted and non-

[[Page 56751]]

excepted trades or businesses. Thus, the Treasury Department and the 
IRS decided to provide taxpayers with an allocation method. Because 
allocation, by whatever method, is costly for taxpayers, the final 
regulations further provide that allocation is only required when the 
share of the asset tax basis in both the excepted and the non-excepted 
trades or businesses exceeds 10 percent. In other words, if the share 
for either excepted or non-excepted trades or businesses is 10 percent 
or less, allocation is not required. The Treasury Department and the 
IRS received no comments that addressed the 10 percent threshold 
provided in this provision.
    In terms of the allocation method, the Treasury Department and the 
IRS decided in the final regulations to require taxpayers to allocate 
interest expense and interest income between related excepted and non-
excepted trades or businesses based on 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 of the proposed regulations, 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. This asset basis approach is consistent with the 
regulations under section 861. Because this approach is familiar to 
taxpayers and consistent with other parts of the Code, taxpayers 
benefit in reduced time and cost spent learning and applying the rules, 
relative to alternative regulatory approaches. An estimate of the 
compliance cost savings that would be due to this familiarity and 
cross-code consistency, relative to regulatory alternatives, is beyond 
the capabilities of the IRS's compliance model.
    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 compliance 
burden on 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 impose substantial compliance costs 
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, relative to the final regulations. 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. The final regulations provide for a limited tracing rule 
in those cases.
    The Treasury Department and the IRS also considered allocating 
interest expense based on 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. 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) and claimed that the ability to 
elect to allocate interest expense under section 864 on the basis of 
fair market value of assets has led to inappropriate results and 
needless complexity. See Senate Budget Explanation of the Bill at 400. 
Thus, the Treasury Department and the IRS have determined that 
allocating interest expense based on relative amounts of asset basis is 
more appropriate than a regime based on the relative fair market value 
of assets.
    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 taxpayers may exert 
control over the timing of income items, which may lead taxpayers to 
make tax-driven business decisions with no accompanying general 
economic benefit. 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, the Treasury 
Department and the IRS have determined that allocating interest expense 
based on relative amounts of asset basis is more appropriate than a 
regime based on the relative amounts of gross income.
    Number of Affected Taxpayers. The Treasury Department and the IRS 
estimate that roughly 83,000 firms had allocated interest income and 
expenses among multiple trades or businesses in tax year 2015 and thus 
are potentially affected by provisions of the final regulations that 
affect the annual allocation statement. This estimate is based on a 
count of all Forms 1120, 1120S, and 1065 in tax year 2015 in real 
estate, farming, and public utilities industries that had over $25 
million in gross receipts.

II. Paperwork Reduction Act

    The collections of information contained in the final regulations 
have been submitted to the Office of Management and Budget for review 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.

[[Page 56752]]

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 confidential, as required by section 6103.
A. Collections of Information Imposed by the Regulations
    The collections of information imposed directly by these 
regulations are contained in Sec. Sec.  1.163(j)-1(b)(15)(iii), 
1.163(j)-2(b)(2)(ii), 1.163(j)-2(b)(3), 1.163(j)-9 and 1.163(j)-10.
    The collection of information in Sec. Sec.  1.163(j)-1(b)(15)(iii) 
and 1.163(j)-9, the election statement, is required for taxpayers to 
make a one-time election to treat their regulated utility trade or 
business, real property trade or business or farming trade or business 
as an electing excepted regulated utility trade or business, electing 
real property trade or business under section 163(j)(7)(B) or an 
electing farming business under section 163(j)(7)(C). The election to 
be an excepted regulated utility trade or business was not in the 
proposed regulations. The scope of taxpayers eligible to make an 
election to be an excepted real property or farming trade or business 
has changed from the proposed regulations. As discussed in part X of 
the Summary of Comments and Explanation of Revisions section, under the 
proposed regulations, taxpayers that met the small business exemption 
test under section 448(c) were not able to make an election for their 
trade or business to be an electing real property trade or business or 
an electing farming business because they were already not subject to 
the limitation. Under the final regulations, those taxpayers are 
eligible to make a protective election. Additionally, under the 
proposed regulations, it was unclear whether taxpayers that were unsure 
of whether their activity constitutes a trade or business under section 
162 could make an election. The final regulations clarify that a 
taxpayer that is unsure whether its activity constitutes a trade or 
business under section 162 is eligible to make an election.
    The collections of information in Sec. Sec.  1.163(j)-2(b)(2)(ii) 
and 1.163(j)-2(b)(3) are required to make two elections relating to 
changes made to section 163(j)(10) by the CARES Act. The election under 
Sec.  1.163(j)-2(b)(2)(ii) is for a taxpayer to use the 30 percent ATI 
limitation instead of the 50 percent ATI limitation when calculating 
the taxpayer's section 163(j) limitation for a 2019 or 2020 taxable 
year, as provided in section 163(j)(10)(A)(i) and (iii). The election 
under Sec.  1.163(j)-2(b)(2) is for a taxpayer to use the taxpayer's 
ATI for the last taxable beginning in 2019 as its ATI for any taxable 
year beginning in 2020, as provided in section 163(j)(10)(B). Revenue 
Procedure 2020-22 describes the time and manner for making these 
elections. See also Sec.  1.163(j)-2(b)(4).
    Taxpayers make the elections by timely filing a Federal income tax 
return or Form 1065, including extensions, an amended Federal income 
tax return, amended Form 1065, or administrative adjustment request, as 
applicable. More specifically, taxpayers complete the Form 8990, 
Limitation on Business Interest Expense under Section 163(j), using the 
30 percent ATI limitation and/or using the taxpayer's 2019 ATI, as 
applicable. No formal statements are required to make these elections. 
Accordingly, for Paperwork Reduction Act purposes, the reporting burden 
associated with the collections of information in Sec. Sec.  1.163(j)-
2(b)(2)(ii) and 1.163(j)-2(b)(3) will be reflected in the IRS Form 8990 
Paperwork Reduction Act Submissions (OMB control number 1545-0123).
    The collection of information in Sec.  1.163(j)-10, the allocation 
statement, 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. The 
mechanics of the allocation statement, and the scope of taxpayers 
required to file the allocation statement, have not changed from the 
proposed regulations.
    Section 1.163(j)-10 in the final regulations contains another 
collection of information, an allocation methodology change request, 
requiring taxpayers to request the Commissioner's permission to change 
a methodology for allocating the basis in an asset that is used in 
multiple trades or businesses if the request is being made within five 
years of any prior change. This requirement does not create a new 
burden because the allocation methodology change request is made by 
following the procedures for requesting a letter ruling in section 7.01 
of Revenue Procedure 2020-1, 2020-1 IRB 1. Revenue Procedure 2020-1 was 
approved by the Office of Management and Budget in accordance with the 
Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-
0123.
    In 2018, the Treasury Department and the IRS considered developing 
a form election and allocation statement under Sec. Sec.  1.163(j)-9 
and 1.163(j)-10 for taxpayers to make the one-time election and to 
demonstrate their interest allocation. To minimize taxpayer burden, the 
Treasury Department and the IRS decided that, for now, taxpayers should 
be allowed to use their own election form and allocation statement. In 
the future, if the Treasury Department and the IRS develop election or 
allocation form, the draft versions of the forms will be posted for 
comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.html.
    Certain forms have been modified with simple questions to signal 
whether the taxpayer is subject to section 163(j). The Treasury 
Department and the IRS are considering modifying certain forms with a 
checkbox to note that a taxpayer has made an election for a trade or 
business to be an electing real property trade or business or electing 
farming business.
    For the allocation methodology change request in Sec.  1.163(j)-10, 
the Treasury Department and the IRS initially determined that taxpayers 
should file a change request any time there is a change in methodology. 
However, a change in allocation methodology presents a burden for 
taxpayers. The disadvantages of changing an allocation methodology 
regularly, including the administrative and accounting costs associated 
with any such change, outweigh the advantages of changing an allocation 
methodology regularly. Accordingly, the Treasury Department and the IRS 
do not anticipate taxpayers using the allocation methodology change 
request regularly. The final regulations require the request to be made 
only if a change has not been made in the past 5 years. To minimize any 
compliance burden, the procedures in Revenue Procedure 2020-1, which 
are familiar to taxpayers, apply for the allocation methodology change 
request.
B. Burden Estimates
    The following burden estimates are based on the information that is 
available to the IRS, and have been updated from the proposed 
regulations to take into account the new election for certain regulated 
utility trades or businesses, the increased scope of potential filers 
for the election statement and to use 2017 Statistics of Income (SOI) 
tax data where available.
    The most recently available 2017 SOI tax data indicates that 
approximately 8,208 filers are possible for the one-time election to 
opt out of the section 163(j) limitation as an electing excepted

[[Page 56753]]

regulated utility trade or business. This estimate was based on a count 
of Form 1065, 1065B, 1120 and 1120-S filers with NAICS codes starting 
with 2211 (electric power generation, transmission and distribution), 
2212 (natural gas distribution), and 2213 (water, sewage and other 
systems).
    The 2017 SOI tax data indicates that approximately 2,838,981 filers 
are possible for the 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. This 
estimate is based on a count of all filers with NAICS codes starting 
with 111 or 112 (farming), and 531 (real property) with at least $10 
million in gross receipts in taxable year 2017. The increase in 
potential filers from the number provided in the proposed regulations 
is due exclusively to the fact that the final regulations provide that 
taxpayers that satisfy the small business exemption are eligible to 
file an election.
    For the election to use the 30 percent ATI limitation for a 2019 or 
2020 taxable year under Sec.  1.163(j)-2(b)(ii), while any taxpayer 
subject to the section 163(j) limitation is eligible to make the 
election, the Treasury Department and the IRS estimate that only 
taxpayers that actively want to reduce their deductions will make this 
election. The application of the base erosion minimum tax under section 
59A depends, in part, on the amount of a taxpayer's deductions. 
Accordingly, the Treasury Department and the IRS estimate that 
taxpayers that are subject to both the base erosion minimum tax under 
section 59A and section 163(j) are the potential filers of this 
election. Using the 2017 SOI tax data, the Treasury Department estimate 
that 3,376 firms will make the election. This estimate was determined 
by examining the number of C corporations with at least $500,000,000 in 
gross receipts, that do not have an NAICS code associated with a trade 
or business that is generally not subject to the section 163(j) 
limitation (2211 (electric power generation, transmission and 
distribution), 2212 (natural gas distribution), 2213 (water, sewage and 
other systems), 111 or 112 (farming), 531 (real property)).
    For the election to use the taxpayer's 2019 ATI in 2020 under Sec.  
1.163(j)-2(b)(3), the Treasury Department and the IRS estimate that 
72,608 firms will make the election. This figure was determined, using 
2017 SOI tax data, by examining Form 1040, Form 1120, Form 1120S, and 
Form 1065 filers with more than $26M in gross receipts, that have 
reported interest expense, and do not have an NAICS code associated 
with any trade or business that is generally not subject to the section 
163(j) limitation.
    The Treasury Department and the IRS continue to estimate the same 
number of filers, 82,755, for the annual allocation statement as was 
projected in the proposed regulations. Using the 2015 SOI tax data, the 
Treasury Department and the IRS estimate that 82,755 firms will 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.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              Estimated average                         Estimated
                                                           Estimated number      annual burden    Estimated total   monetized  burden      Estimated
                                    Likely respondents      of  respondents       hours per       annual reporting      @$95/hour         frequency of
                                                                                  respondent       burden (hours)      ($millions)         responses
--------------------------------------------------------------------------------------------------------------------------------------------------------
Section 1.163(j)-1(b)(15)(iii)   Corporations and         8,028 business      0 to 30 minutes    2,007............  $190,665.........  One-time.
 (one-time election statement     partnerships with        respondents         (estimated
 (2017 Levels).                   regulated utility        (including Forms    average: 15
                                  trades or businesses.    1120, 1120-S, and   minutes).
                                                           1065 filers).
Section 1.163(j)-2(b)(ii)        C corporations with      3,376 business      See Form 8990....  See Form 8990....  See Form 8990....  See Form 8990.
 (election to apply the 30        more than $500 M in      respondents (Form
 percent ATI percentage).         gross receipts.          1120 filers).
Section 1.163(j)-2(b)(3)         Individuals,             72,608 business     See Form 8990....  See Form 8990....  See Form 8990....  See Form 8990.
 (election to use 2019 ATI as     corporations, and        respondents
 2020 ATI).                       partnerships with more   (including Form
                                  than $26 M in gross      1120, Form 1120-
                                  receipts and not part    S, and Form 1065
                                  of an excepted trade     filers).
                                  or business.

[[Page 56754]]

 
Section 1.163(j)-9 (one-time     Individuals,             2,838,981 business  0 to 30 minutes    70,746...........  67.4.............  One-time.
 election statement) (2017        corporations, and        respondents (all    (estimated
 Levels).                         partnerships with real   filers).            average:15
                                  property or farming                          minutes).
                                  trades or businesses
                                  with gross receipts
                                  exceeding $10 million.
Section 1.163(j)-10 (annual      Individuals,             82,755 business     15 minutes to 2    82,755...........  7.9..............  Annually.
 allocation statement) (2015      corporations, and        respondents         hours (estimated
 Levels).                         partnerships (1) with    (including Forms    average: 1 hour).
                                  more than one trade or   1120, 1120-S, and
                                  business (at least one   1065 filers).
                                  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.
Section 1.163(j)-10 (change in   Individuals,             See Rev. Proc.      See Rev. Proc.     See Rev. Proc.     See Rev. Proc.     On occasion.
 allocation methodology           corporations, and        2020-1.             2020-1.            2020-1.            2020-1.
 request).                        partnerships that want
                                  to change their
                                  methodology for
                                  allocating basis among
                                  two or more trades or
                                  businesses, and (1)
                                  with more than one
                                  trade or business (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.
Section 1.163(j)-10 (one-time    Same as above..........  82,755............  4 hours (start-up  331,020..........  31.4.............  One-time.
 start-up cost to develop                                                      burden).
 procedures for filing an
 annual allocation statement)
 (2017 Levels).
Three year monetized burden      .......................  ..................  .................  .................  40.8.............  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 40.9 million ($2017) 
([($190, 665) + ($67.4 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.
C. Forms
    The IRS has developed Form 8990, ``Limitation on Business Interest 
Expense Under Section 163(j),'' to facilitate reporting of the 
limitation. The form is posted at https://www.irs.gov/pub/irs-access/f8990_accessible.pdf. The Form 8990 instructions are posted at https://www.irs.gov/pub/irs-pdf/i8990.pdf. The Form 1120 series and the Form 
1065 have been revised to include a question to alert taxpayers of the 
need to file a Form 8990. The instructions to those and other forms 
have been revised to include information about the Form 8990.
    As described previously, the reporting burdens associated with the 
information collections in the proposed regulations are included in the 
aggregated burden estimates for OMB control number 1545-0123 (in the 
case of filers of Form 1120, Form 1065 and Form 8990), 1545-0074 (in 
the case of individual filers), and 1545-0123 (in the case of filers 
under Revenue Procedure 2020-1).
    The Treasury Department and the IRS request comment on all aspects 
of information collection burdens related to these regulations, 
including estimates for how much time it would take to comply with the 
paperwork burdens described previously for each relevant form and ways 
for the IRS to minimize the paperwork burden. In addition, when 
available, drafts of IRS forms are posted for comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.

----------------------------------------------------------------------------------------------------------------
       Form/revenue procedure             Type of filer            OMB No(s).                   Status
----------------------------------------------------------------------------------------------------------------
                                     Business (NEW Model)..  1545-0123.............  Published in the Federal
                                                                                      Register on 10/8/18.
                                                                                      Public comment period
                                                                                      closed on 12/10/18.
                                    ----------------------------------------------------------------------------
                                     Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
----------------------------------------------------------------------------------------------------------------

[[Page 56755]]

 
                                     Individual (NEW Model)  1545-0074.............  Limited scope submission
                                                                                      (1040 only) on 10/11/18 at
                                                                                      OIRA for review. Full ICR
                                                                                      submission for all forms
                                                                                      in 2019.
                                    ----------------------------------------------------------------------------
                                     Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031.
----------------------------------------------------------------------------------------------------------------
Revenue Procedure 20201............  IRS Research estimates  1545-0123.............  Published in the Internal
                                                                                      Revenue Bulletin on
                                                                                      January 2, 2020.
                                    ----------------------------------------------------------------------------
                                     Link: https://www.irs.gov/irb/2020-01_IRB.
----------------------------------------------------------------------------------------------------------------

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that the final regulations will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(small entities). This certification can be made because the Treasury 
Department and the IRS have determined that the regulations may affect 
a substantial number of small entities but have also concluded that the 
economic effect on small entities as a result of these regulations is 
not expected to be significant.
    When enacted, the section 163(j) limitation generally applied to 
taxpayers with average annual gross receipts exceeding $25 million. The 
gross receipts threshold for general applicability of the section 
163(j) limitation increased to $26 million in 2020. The threshold will 
be adjusted annually for inflation. However, under the final 
regulations, small taxpayers operating regulated utility trades or 
businesses, real property trades or businesses and farming trades or 
businesses are now eligible to protectively elect out of the election. 
Accordingly, the regulations in Sec. Sec.  1.163(j)-1 and -9 may apply 
to small business filers that operate regulated utility trades or 
businesses, real property trades or businesses or farming trades or 
businesses. Those taxpayers may choose to make a protective election, 
such that they are not subject to the limitation if their average 
annual gross receipts for the three prior tax years eventually exceeds 
$26 million (for 2020). Although the exact number of small entities 
that will make an election is unknown, an upper bound on the number of 
potentially affected entities is 10.5 million. This number was 
determined by looking at, for the 2017 taxable year, the number of Form 
1120, 1120-S, 1120-REIT, 1065, and individual business filers with more 
than $10M in gross receipts that have NAICS codes commonly associated 
with real property trades or businesses or farming businesses.
    If a taxpayer chooses to make the election for its trades or 
businesses, the taxpayer must attach to its tax return a statement 
identifying and describing the trade or business for which the election 
is being made, and must provide other information as the Commissioner 
may require in forms, instructions, or other published guidance. The 
election is not required. The election is potentially beneficial to 
businesses with business interest, but is detrimental to businesses 
that have assets for which bonus depreciation is desired.
    The reporting burden is estimated at 0-30 minutes, depending on 
individual circumstances, with an estimated average of 0.25 hours for 
all affected entities, regardless of size. The burden on small entities 
is expected to be the same as other entities because the requirements 
to make the election apply equally to all taxpayers. Using the IRS's 
taxpayer compliance cost estimates, the monetization rate is $95 per 
hour. Thus, the average annual burden is $23.75 per business.
    For the section 163(j)(10) elections under Sec. Sec.  1.163(j)-
2(b)(ii) or 1.163(j)-2(b)(3), most small business taxpayers do not need 
the elections because, as discussed earlier, they are not subject to 
the section 163(j) limitation. For small taxpayers that are subject to 
the limitation, the cost to implement the elections is low. Pursuant to 
Revenue Procedure 2020-22, these taxpayers simply complete the Form 
8990 as if the election has been made. Accordingly, the burden of 
complying with the elections, if needed, is no different than for 
taxpayers that do not make the elections.
    Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking preceding this regulation was submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
effect on small business, and no comments were received.

IV. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) 
requires that agencies assess anticipated costs and benefits and take 
certain actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
section, of $100 million in 1995 dollars, update annually for 
inflation. This rule does not include any Federal mandate that may 
result in expenditures by state, local, or tribal governments, or by 
the private section in excess of that threshold.

V. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This final rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive Order.

VI. Congressional Review Act

    The Administrator of the Office of Information and Regulatory 
Affairs of the Office of Management and Budget has determined that this 
is a major rule for purposes of the Congressional Review Act (5 U.S.C. 
801 et seq.) (CRA). Under section 801(3) of the CRA, a major rule takes 
effect 60 days after the rule is published in the Federal Register. 
Notwithstanding this requirement, section 808(2) of the CRA allows 
agencies to dispense with the requirements of 801 when the agency for 
good cause finds that such procedure would be impracticable, 
unnecessary, or contrary to the public interest and the rule shall take 
effect at such time as the agency promulgating the rule determines.
    The Treasury Department and the IRS have determined that the rules 
in this Treasury decision shall take effect for

[[Page 56756]]

taxable years beginning on or after November 13, 2020. Pursuant to 
section 808(2) of the CRA, however, the Treasury Department and the IRS 
find, for good cause, that a 60-day delay in the effective and the 
applicability date for the anti-avoidance rules in Sec.  1.163(j)-
1(b)(22)(iv) is unnecessary and contrary to the public interest. 
Section 1.163(j)-1(b)(22)(iv) serves an anti-abuse function and, 
because Sec.  1.163(j)-1(b)(22)(iv) provides a clear scope of abusive 
transactions that could otherwise be executed prior to the effective 
date of the section, immediate application of Sec.  1.163(j)-
1(b)(22)(iv) is necessary as of the publication of this final 
regulation.

Drafting Information

    The principal authors of these regulations are Susie Bird, Charles 
Gorham, Justin Grill, Zachary King, Jaime Park, Kathy Reed, Joanna 
Trebat and Sophia Wang, Office of the Associate Chief Counsel (Income 
Tax and Accounting); Kevin M. Jacobs, Russell Jones, John Lovelace, 
Marie Milnes-Vasquez, Aglaia Ovtchinnikova, and Julie Wang, Office of 
the Associate Chief Counsel (Corporate); William Kostak, Anthony 
McQuillen, and Adrienne Mikolashek, Office of the Associate Chief 
Counsel (Passthroughs and Special Industries); Azeka Abramoff, Angela 
Holland, and Steve Jensen, 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.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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 entries 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 as follows:

    Authority:  26 U.S.C. 7805, unless otherwise noted.
* * * * *
    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.
    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) and 
860G(e).
* * * * *
    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 capitalized under 
section 263A.
    (iv) Application of Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E).
    (A) Sale or other disposition.
    (1) In general.
    (2) Intercompany transactions.
    (3) Deconsolidations.
    (B) Deductions by members of a consolidated group.
    (C) Successor assets.
    (D) Anti-duplication rule.
    (1) In general.
    (2) Adjustments following deconsolidation.
    (v) Other adjustments.
    (vi) Additional rules relating to adjusted taxable income in other 
sections.
    (vii) ATI cannot be less than zero.
    (viii) Examples.
    (2) Applicable CFC.
    (3) Business interest expense.
    (i) In general.
    (ii) Special rules.
    (4) Business interest income.
    (i) In general.
    (ii) Special rules.
    (5) C corporation.
    (6) Cleared swap.
    (7) Consolidated group.
    (8) Consolidated return year.
    (9) Current-year business interest expense.
    (10) Disallowed business interest expense.
    (11) Disallowed business interest expense carryforward.
    (12) Disallowed disqualified interest.
    (13) Electing farming business.
    (14) Electing real property trade or business.
    (15) Excepted regulated utility trade or business.
    (i) In general.
    (A) Automatically excepted regulated utility trades or businesses.
    (B) Electing regulated utility trades or businesses.
    (C) Designated excepted regulated utility trades or businesses.
    (ii) Depreciation and excepted and non-excepted utility trades or 
businesses.
    (A) Depreciation.
    (B) Allocation of items.
    (iii) Election to be an excepted regulated utility trade or 
business.
    (A) In general.
    (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 or partnership's trade or business.
    (4) Termination of election.
    (5) Additional guidance.
    (16) Excess business interest expense.
    (17) Excess taxable income.
    (18) Floor plan financing indebtedness.
    (19) Floor plan financing interest expense.
    (20) Group.
    (21) Intercompany transaction.
    (22) Interest.
    (i) In general.
    (ii) Swaps with significant nonperiodic payments.
    (A) In general.
    (B) Exception for cleared swaps.

[[Page 56757]]

    (C) Exception for non-cleared swaps subject to margin or collateral 
requirements.
    (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) Factoring income.
    (F) [Reserved]
    (iv) Anti-avoidance rules.
    (A) Principal purpose to reduce interest expense.
    (1) Treatment as interest expense.
    (2) Corresponding treatment of amounts as interest income.
    (B) Interest income artificially increased.
    (C) Principal purpose.
    (D) Coordination with anti-avoidance rule in Sec.  1.163(j)-2(j).
    (v) Examples.
    (23) Interest expense.
    (24) Interest income.
    (25) Member.
    (26) Motor vehicle.
    (27) Old section 163(j).
    (28) Ownership change.
    (29) Ownership date.
    (30) Real estate investment trust.
    (31) Real property.
    (32) Regulated investment company.
    (33) Relevant foreign corporation.
    (34) S corporation.
    (35) [Reserved]
    (36) Section 163(j) limitation.
    (37) Section 163(j) regulations.
    (38) Separate return limitation year.
    (39) Separate return year.
    (40) Separate tentative taxable income.
    (41) Tax-exempt corporation.
    (42) Tax-exempt organization.
    (43) Tentative taxable income.
    (i) In general.
    (ii) [Reserved]
    (iii) Special rules for defining tentative taxable income.
    (44) Trade or business.
    (i) In general.
    (ii) Excepted trade or business.
    (iii) Non-excepted trade or business.
    (45) Unadjusted basis.
    (46) United States shareholder.
    (c) Applicability date.
    (1) In general.
    (2) Anti-avoidance rules.
    (3) Swaps with significant nonperiodic payments.
    (i) In general.
    (ii) Anti-avoidance rule.
    Sec.  1.163(j)-2 Deduction for business interest expense limited.
    (a) Overview.
    (b) General rule.
    (1) In general.
    (2) 50 percent ATI limitation for taxable years beginning in 2019 
or 2020.
    (3) Election to use 2019 ATI in 2020.
    (4) Time and manner of making or revoking the elections.
    (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) Trusts.
    (i) Calculation of ATI with respect to certain trusts and estates.
    (ii) Calculation of ATI with respect to certain beneficiaries.
    (g) Tax-exempt organizations.
    (h) Examples.
    (i) [Reserved]
    (j) Anti-avoidance rule.
    (1) In general.
    (2) Examples.
    (k) Applicability date.
    Sec.  1.163(j)-3 Relationship of the section 163(j) 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.
    (6) Reductions under section 246A.
    (7) Section 381.
    (8) Section 382.
    (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, investment expenses, 
and certain other tax items of a partnership with a C corporation 
partner.
    (i) Characterization as expense or income properly allocable to a 
trade or business.
    (ii) Effect of characterization on partnership.
    (iii) Separately stated interest expense and interest income of a 
partnership not treated as excess business interest expense or excess 
taxable income of a C corporation partner.
    (iv) Treatment of deemed inclusions of a domestic partnership that 
are not allocable to any trade or business.
    (4) Application to RICs and REITs.
    (i) In general.
    (ii) Tentative taxable income of RICs and REITs.
    (iii) Other adjustments to adjusted taxable income for RICs and 
REITs.
    (5) Application to tax-exempt corporations.
    (6) Adjusted taxable income of cooperatives.
    (7) 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.
    (v) Treatment of intercompany obligations.
    (A) In general.
    (B) Repurchase premium.
    (3) Investment adjustments.
    (4) Examples.
    (e) Ownership of partnership interests by members of a consolidated 
group.
    (1) [Reserved]
    (2) Change in status of a member.
    (3) Basis adjustments under Sec.  1.1502-32.
    (4) Excess business interest expense and Sec.  1.1502-36.
    (f) Cross-references.
    (g) Applicability date.
    (1) In general.
    (2) [Reserved]
    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) Allocable share of the consolidated group's remaining section 
163(j) limitation.
    (ii) Consolidated group's remaining section 163(j) limitation.

[[Page 56758]]

    (iii) 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 equals 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: Deduction of interest expense.
    (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.
    (A) Cumulative section 163(j) SRLY limitation.
    (B) Subgrouping.
    (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.
    (5) Recognized built-in loss.
    (f) Overlap of SRLY limitation with section 382.
    (g) Additional limitations.
    (h) Applicability date.
    Sec.  1.163(j)-6 Application of the section 163(j) 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) Business interest income and business interest expense of the 
partnership.
    (1)-(2) [Reserved]
    (3) Character of business interest expense.
    (d) Adjusted taxable income of a partnership.
    (1) Tentative taxable income of a partnership.
    (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 30 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 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) Partner basis adjustment upon disposition of partnership 
interest.
    (4)-(5) [Reserved]
    (i)-(j) [Reserved]
    (k) Investment items and certain other items.
    (l) S corporations.
    (1) In general.
    (i) Corporate level limitation.
    (ii) Short taxable periods.
    (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.
    (10) Application of section 382.
    (m) Partnerships and S corporations not subject to section 163(j).
    (1) Exempt partnerships and S corporations.
    (2) Partnerships and S corporations engaged in excepted trades or 
businesses.
    (3) Treatment of excess business interest expense from partnerships 
that are exempt entities in a succeeding taxable year.
    (4) S corporations with disallowed business interest expense 
carryforwards prior to becoming exempt entities.
    (n) [Reserved]
    (o) Examples.
    (p) Applicability date.
    Sec.  1.163(j)-7 Application of the section 163(j) limitation to 
foreign corporations and United States shareholders.
    (a) Overview.
    (b) General rule regarding the application of section 163(j) to 
relevant foreign corporations.
    (c)-(f) [Reserved]
    (g) Rules concerning the computation of adjusted taxable income of 
a relevant foreign corporation.
    (1) Tentative taxable income.
    (2) Treatment of certain dividends.
    (h)-(l) [Reserved]
    (m) Applicability date.
    Sec.  1.163(j)-8 [Reserved]
    Sec.  1.163(j)-9 Elections for excepted trades or businesses; safe 
harbor for certain REITs.

[[Page 56759]]

    (a) Overview.
    (b) Availability of election.
    (1) In general.
    (2) Special rules.
    (i) Exempt small businesses.
    (ii) Section 162 trade or business not required for electing real 
property trade or business.
    (c) Scope and effect of election.
    (1) In general.
    (2) Irrevocability.
    (3) Depreciation.
    (d) 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.
    (e) Termination of election.
    (1) In general.
    (2) Taxable asset transfer defined.
    (3) Related party defined.
    (4) Anti-abuse rule.
    (f) Additional guidance.
    (g) Examples.
    (h) 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.
    (A) In general.
    (B) Information necessary.
    (iv) Tiered entities.
    (5) Value of shares in other REITs.
    (i) In general.
    (ii) Information necessary.
    (iii) Tiered REITs.
    (6) Real property financing assets.
    (7) Application of safe harbor for partnerships controlled by 
REITS.
    (8) REITs or partnerships controlled by REITs that do not apply the 
safe harbor.
    (i) [Reserved]
    (j) Special anti-abuse rule for certain real property trades or 
businesses.
    (1) In general.
    (2) Exceptions.
    (i) De minimis exception.
    (ii) Look-through exception.
    (iii) Inapplicability of exceptions to consolidated groups.
    (iv) Exception for certain REITs.
    (3) Allocations.
    (4) Examples.
    (k) 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, 
investment expenses, and certain other tax items 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) Application of allocation rules to disallowed disqualified 
interest.
    (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 investment items and certain other items of a 
partnership with a C corporation partner.
    (7) Examples: 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 exception.
    (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.
    (D) Special allocation rule for real property trades or business 
subject to special anti-abuse rule.
    (1) In general.
    (2) Allocation methodology for real property.
    (3) 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 C 
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 domestic non-consolidated 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.
    (iv) Use of inside basis for purposes of C corporation 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 relevant foreign corporations.
    (1) In general.
    (2) Special rule for CFC utilities.
    (D) Inapplicability of look-through rule to partnerships or non-
consolidated

[[Page 56760]]

C 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) Determination dates and determination periods.
    (A) Quarterly determination periods.
    (B) Annual determination periods.
    (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) Qualified nonrecourse indebtedness.
    (3) Assets used in more than one trade or business.
    (4) Adjustments to basis of assets to account for direct 
allocations.
    (5) Example: Direct allocation of interest expense.
    (e) Examples.
    (f) Applicability date.
    Sec.  1.163(j)-11 Transition rules.
    (a) Overview.
    (b) Application of section 163(j) limitation if a corporation joins 
a consolidated group during a taxable year of the group beginning 
before January 1, 2018.
    (1) In general.
    (2) Example
    (c) 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 November 13, 2020.
    (A) Pre-change loss.
    (B) Loss corporation.
    (ii) Ownership change occurring on or after November 13, 2020.
    (A) Pre-change loss.
    (B) Loss corporation.
    (5) Treatment of excess limitation from taxable years beginning 
before January 1, 2018.
    (6) Example: Members of an affiliated group.
    (d) 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 the section 163(j) 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 section 163(j) limitation to 
partnerships and subchapter S corporations.
1.163(j)-7 Application of the section 163(j) limitation to foreign 
corporations and United States shareholders.
1.163(j)-8 [Reserved]
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. The definitions provided in this section apply for 
purposes of the section 163(j) regulations. For purposes of the rules 
set 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 tentative taxable income of the taxpayer 
for the taxable year, with the adjustments in this paragraph (b)(1).
    (i) Additions. The amounts of the following items that were 
included in the computation of the taxpayer's tentative taxable income 
(if any) are added to tentative taxable income to determine ATI--
    (A) Any business interest expense, other than disallowed business 
interest expense carryforwards;
    (B) Any net operating loss deduction under section 172;
    (C) Any deduction under section 199A;
    (D) Subject to paragraph (b)(1)(iii) of this section, for taxable 
years beginning before January 1, 2022, any depreciation under section 
167, section 168, or section 168 of the Internal Revenue Code (Code) of 
1954 (former section 168);
    (E) Subject to paragraph (b)(1)(iii) of this section, for taxable 
years beginning before January 1, 2022, any amortization of intangibles 
(for example, under section 167 or 197) and other amortized 
expenditures (for example, under section 174(b), 195(b)(1)(B), 248, or 
1245(a)(2)(C));
    (F) Subject to paragraph (b)(1)(iii) of this section, for taxable 
years beginning before January 1, 2022, any 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)(44) and 
1.163(j)-10).
    (ii) Subtractions. The amounts of the following items (if any) are 
subtracted from the taxpayer's tentative taxable income to determine 
ATI --
    (A) Any business interest income that was included in the 
computation of the taxpayer's tentative taxable income;
    (B) Any floor plan financing interest expense for the taxable year 
that was included in the computation of the taxpayer's tentative 
taxable income;
    (C) With respect to the sale or other disposition of property, the 
greater of the allowed or allowable depreciation, amortization, or 
depletion of the property, as provided under section 1016(a)(2), for 
the taxpayer (or, if the taxpayer is a member of a consolidated group, 
the consolidated group) 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 by another member, the investment 
adjustments 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);

[[Page 56761]]

    (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)(44) and 
1.163(j)-10)) and that was included in the computation of the 
taxpayer's tentative taxable income; and
    (G) An amount equal to the sum of any specified deemed inclusions 
that were included in the computation of the taxpayer's tentative 
taxable income, reduced by the portion of the deduction allowed under 
section 250(a) by reason of the specified deemed inclusions. For this 
purpose, a specified deemed inclusion is the inclusion of an amount by 
a United States shareholder (as defined in section 951(b)) in gross 
income under section 78, 951(a), or 951A(a) with respect to an 
applicable CFC (as defined in Sec.  1.163(j)-1(b)(2)) that is properly 
allocable to a non-excepted trade or business. Furthermore, a specified 
deemed inclusion includes any amounts included in a domestic 
partnership's gross income under section 951(a) or 951A(a) with respect 
to an applicable CFC to the extent such amounts are attributable to 
investment income of the partnership and are allocated to a domestic C 
corporation that is a direct (or indirect partner) and treated as 
properly allocable to a non-excepted trade or business of the domestic 
C corporation under Sec. Sec.  1.163(j)-4(b)(3) and 1.163(j)-10. To 
determine the amount of a specified deemed inclusion described in this 
paragraph (b)(1)(ii)(G), the portion of a United States shareholder's 
inclusion under section 951A(a) treated as being with respect to an 
applicable CFC is determined under section 951A(f)(2) and Sec.  1.951A-
6(b)(2).
    (iii) Depreciation, amortization, or depletion capitalized under 
section 263A. For purposes of paragraph (b)(1)(i) of this section, 
amounts of depreciation, amortization, or depletion that are 
capitalized under section 263A during the taxable year are deemed to be 
included in the computation of the taxpayer's tentative taxable income 
for such taxable year, regardless of the period in which the 
capitalized amount is recovered. See Example 3 in Sec.  1.163(j)-
2(h)(3).
    (iv) Application of Sec.  1.163(j)-1(b)(1)(ii)(C), (D), and (E)--
(A) Sale or other disposition--(1) In general. For purposes of 
paragraphs (b)(1)(ii)(C), (D), and (E) of this section, except as 
otherwise provided in this paragraph (b)(1)(iv)(A), the term sale or 
other disposition does not include a transfer of an asset to an 
acquiring corporation in a transaction to which section 381(a) applies.
    (2) Intercompany transactions. For purposes of paragraphs 
(b)(1)(ii)(C) and (D) of this section, the term sale or other 
disposition excludes all intercompany transactions, within the meaning 
of Sec.  1.1502-13(b)(1)(i).
    (3) Deconsolidations. Notwithstanding any other rule in this 
paragraph (b)(1)(iv)(A), any transaction in which a member leaves a 
consolidated group is treated as a sale or other disposition for 
purposes of paragraphs (b)(1)(ii)(C) and (D) of this section unless the 
transaction is described in Sec.  1.1502-13(j)(5)(i)(A).
    (B) Deductions by members of a consolidated group. If paragraph 
(b)(1)(ii)(C), (D), or (E) of this section applies to adjust the 
tentative taxable income of a taxpayer, the amount of the adjustment 
under paragraph (b)(1)(ii)(C) of this section equals the greater of the 
allowed or allowable depreciation, amortization, or depletion of the 
property, as provided under section 1016(a)(2), for any member of the 
consolidated group for the taxable years beginning after December 31, 
2017, and before January 1, 2022, with respect to such property.
    (C) Successor assets. This paragraph (b)(1)(iv)(C) applies if 
deductions described in paragraph (b)(1)(ii)(C) of this section are 
allowed or allowable to a consolidated group member (S) and either the 
depreciable property or S's stock is subsequently transferred to 
another member (S1) in an intercompany transaction in which the 
transferor receives S1 stock. If this paragraph (b)(1)(iv)(C) applies, 
and if the transferor's basis in the S1 stock received in the 
intercompany transaction is determined, in whole or in part, by 
reference to its basis in the S stock, the S1 stock received in the 
intercompany transaction is treated as a successor asset to S's stock 
for purposes of paragraph (b)(1)(ii)(D) of this section. Thus, except 
as otherwise provided in paragraph (b)(1)(iv)(D) of this section, the 
subsequent disposition of either the S1 stock or the S stock gives rise 
to an adjustment under paragraph (b)(1)(ii)(D) of this section.
    (D) Anti-duplication rule--(1) In general. The aggregate of the 
subtractions from tentative taxable income of a consolidated group 
under paragraphs (b)(1)(ii)(C) and (D) of this section with respect to 
an item of property (including with regard to dispositions of successor 
assets described in paragraph (b)(1)(iv)(C) of this section) cannot 
exceed the aggregate amount of the consolidated group members' 
deductions described in paragraph (b)(1)(ii)(C) of this section with 
respect to such item of property. For example, if an adjustment to the 
tentative taxable income of a consolidated group is made under 
paragraph (b)(1)(ii)(C) of this section with respect to the sale or 
other disposition of property by a consolidated group member (S) to an 
unrelated person, and if a member of the group subsequently sells or 
otherwise disposes of S's stock, no further adjustment to the group's 
tentative taxable income is made under paragraph (b)(1)(ii)(D) of this 
section in relation to the same property with respect to that stock 
disposition.
    (2) Adjustments following deconsolidation. Depreciation, 
amortization, or depletion deductions allowed or allowable for a 
corporation for a consolidated return year of a group are disregarded 
in applying this paragraph (b)(1)(iv)(D) to any year that constitutes a 
separate return year (as defined in Sec.  1.1502-1(e)) of that 
corporation. For example, assume that S deconsolidates from a group 
(Group 1) after holding property for which depreciation, amortization, 
or depletion deductions were allowed or allowable in Group 1. On the 
deconsolidation, S and Group 1 would adjust tentative taxable income 
with regard to that property under paragraphs (b)(1)(ii)(D) and 
(b)(1)(iv)(A)(3) of this section. If, following the deconsolidation, S 
sells the property referred to in the previous sentence, no subtraction 
from tentative taxable income is made under paragraph (b)(1)(ii)(C) of 
this section during S's separate return year with regard to the amounts 
included in Group 1 under paragraphs (b)(1)(ii)(C) and (b)(1)(iv)(A)(3) 
of this section.
    (v) Other adjustments. ATI is computed with the other adjustments 
provided in Sec. Sec.  1.163(j)-2 through 1.163(j)-11.
    (vi) 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. Sec.  
1.163(j)-6(e) and 1.163(j)-6(m)(1) and (2).
    (G) For rules governing partnership basis adjustments affecting 
ATI, see Sec.  1.163(j)-6(h)(2).

[[Page 56762]]

    (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 certain beneficiaries of trusts 
and estates, see Sec.  1.163(j)-2(f).
    (vii) ATI cannot be less than zero. If the ATI of a taxpayer would 
be less than zero, the ATI of the taxpayer is zero.
    (viii) Examples. The examples in this paragraph (b)(1)(viii) 
illustrate the application of paragraphs (b)(1)(ii), (iii), and (iv) of 
this section. Unless otherwise indicated, A, B, P, S, and T are 
calendar-year domestic C corporations; P is the parent of a 
consolidated group of which S and T are members; the exemption for 
certain small businesses in Sec.  1.163(j)-2(d) does not apply; no 
entity is engaged in an excepted trade or business; no entity has 
business interest income or floor plan financing interest expense; and 
all amounts of interest expense are deductible except for the potential 
application of section 163(j).
    (A) Example 1--(1) Facts. In 2021, A purchases a depreciable asset 
(Asset X) for $100x and fully depreciates Asset X under section 168(k). 
For the 2021 taxable year, A's ATI (after adding back A's depreciation 
deductions with respect to Asset X under paragraph (b)(1)(i)(D) of this 
section) is $150x. A incurs $45x of business interest expense in 2021. 
In 2024, A sells Asset X to an unrelated third party.
    (2) Analysis. A's section 163(j) limitation for 2021 is $45x ($150x 
x 30 percent). Thus, all $45x of A's business interest expense incurred 
in 2021 is deductible in that year. However, under paragraph 
(b)(1)(ii)(C) of this section, A must subtract $100x from its tentative 
taxable income in computing its ATI for its 2024 taxable year. A would 
be required to subtract $100x from its tentative taxable income in 
computing its ATI for its 2024 taxable year even if A's ATI in 2021 was 
$150x before adding back A's depreciation deductions with respect to 
Asset X.
    (3) Transfer of assets in a nonrecognition transaction to which 
section 381 applies. The facts are the same as in paragraph 
(b)(1)(viii)(A)(1) of this section, except that, rather than sell Asset 
X to an unrelated third party in 2024, A merges with and into an 
unrelated third party in 2024 in a transaction described in section 
368(a)(1)(A) in which no gain is recognized. As provided in paragraph 
(b)(1)(iv)(A) of this section, the merger transaction is not treated as 
a ``sale or other disposition'' for purposes of paragraph (b)(1)(ii)(C) 
of this section. Thus, no adjustment to tentative taxable income is 
required in 2024 under paragraph (b)(1)(ii)(C) of this section.
    (4) Transfer of assets in a nonrecognition transaction to which 
section 351 applies. The facts are the same as in paragraph 
(b)(1)(viii)(A)(1) of this section, except that, rather than sell Asset 
X to an unrelated third party in 2024, A transfers Asset X to B (A's 
wholly owned subsidiary) in 2024 in a transaction to which section 351 
applies. The section 351 transaction is treated as a ``sale or other 
disposition'' for purposes of paragraph (b)(1)(ii)(C) of this section. 
Thus, A must subtract $100x from its tentative taxable income in 
computing its ATI for its 2024 taxable year.
    (B) Example 2--(1) Facts. In 2021, S purchases a depreciable asset 
(Asset Y) for $100x and fully depreciates Asset Y under section 168(k). 
P reduces its basis in its S stock by $100x under Sec.  1.1502-32 to 
reflect S's depreciation deductions. For the 2021 taxable year, the P 
group's ATI (after adding back S's depreciation deductions with respect 
to Asset Y under paragraph (b)(1)(i)(D) of this section) is $150x. The 
P group incurs $45x of business interest expense in 2021. In 2024, P 
sells all of its S stock to an unrelated third party.
    (2) Analysis. The P group's section 163(j) limitation for 2021 is 
$45x ($150x x 30 percent). Thus, all $45x of the P group's business 
interest expense incurred in 2021 is deductible in that year. However, 
under paragraph (b)(1)(ii)(D) of this section, the P group must 
subtract $100x from its tentative taxable income in computing its ATI 
for its 2024 taxable year. The answer would be the same if the P 
group's ATI in 2021 were $150x before adding back S's depreciation 
deductions with respect to Asset Y.
    (3) Disposition of less than all member stock. The facts are the 
same as in paragraph (b)(1)(viii)(B)(1) of this section, except that, 
in 2024, P sells half of its S stock to an unrelated third party. 
Pursuant to paragraph (b)(1)(ii)(D) of this section, the P group must 
subtract $100x from its tentative taxable income in computing its ATI 
for its 2024 taxable year.
    (4) Transfer in an intercompany transaction. The facts are the same 
as in paragraph (b)(1)(viii)(B)(1) of this section, except that, rather 
than sell S's stock to an unrelated third party in 2024, P transfers 
S's stock to another member of the P group in an intercompany 
transaction (as defined in Sec.  1.1502-13(b)(1)(i)) in 2024. As 
provided in paragraph (b)(1)(iv)(A) of this section, the intercompany 
transaction is not treated as a ``sale or other disposition'' for 
purposes of paragraph (b)(1)(ii)(D) of this section. Thus, no 
adjustment to tentative taxable income is required in 2024 under 
paragraph (b)(1)(ii)(D) of this section.
    (5) Disposition of successor assets. The facts are the same as in 
paragraph (b)(1)(viii)(B)(1) of this section, except that, rather than 
sell S's stock to an unrelated third party in 2024, P transfers S's 
stock to T in 2024 in a transaction to which section 351 applies and, 
in 2025, P sells all of its T stock to an unrelated third party. 
Pursuant to paragraph (b)(1)(iv)(A) of this section, P's intercompany 
transfer of S's stock to T is not a ``sale or other disposition'' for 
purposes of paragraph (b)(1)(ii)(D) of this section. However, pursuant 
to paragraph (b)(1)(iv)(C) of this section, P's stock in T is treated 
as a successor asset for purposes of paragraph (b)(1)(ii)(D) of this 
section. Thus, the P group must subtract $100x from its tentative 
taxable income in computing its ATI for its 2025 taxable year.
    (C) Example 3--(1) Facts. In 2021, S purchases a depreciable asset 
(Asset Z) for $100x and fully depreciates Asset Z under section 168(k). 
P reduces its basis in its S stock by $100x under Sec.  1.1502-32 to 
reflect S's depreciation deductions. For the 2021 taxable year, the P 
group's ATI (after adding back S's depreciation deductions with respect 
to Asset Z under paragraph (b)(1)(i)(D) of this section) is $150x. The 
P group incurs $45x of business interest expense in 2021. In 2024, S 
sells Asset Z to an unrelated third party. In 2025, P sells all of its 
S stock to a member of another consolidated group.
    (2) Analysis. Under paragraph (b)(1)(ii)(C) of this section, the P 
group must subtract $100x from its tentative taxable income in 
computing its ATI for its 2024 taxable year. The answer would be the 
same if the P group's ATI in 2021 were $150x before adding back S's 
depreciation deductions with respect to Asset Z. P's sale of all of its 
S stock in 2025 is a ``sale or other disposition'' for purposes of 
paragraph (b)(1)(ii)(D) of this section. However, pursuant to paragraph 
(b)(1)(iv)(D)(1) of this section, no further adjustment to the P 
group's tentative taxable income is required in 2025 under paragraph 
(b)(1)(ii)(D) of this section.
    (3) Disposition of S stock prior to S's asset disposition. The 
facts are the same as in paragraph (b)(1)(viii)(C)(1) of this section, 
except that, in 2024, P sells all of its S stock to a member of another 
consolidated group and, in 2025, S sells Asset Z to an unrelated third 
party. Pursuant to paragraph (b)(1)(ii)(D) of this section, the P group 
must subtract $100x from its tentative taxable income

[[Page 56763]]

in computing its ATI for its 2024 taxable year. Pursuant to paragraph 
(b)(1)(iv)(D)(2) of this section, no adjustment to the acquiring 
group's tentative taxable income is required in 2025 under paragraph 
(b)(1)(ii)(C) of this section.
    (4) Transfer of S stock in nonrecognition transaction. The facts 
are the same as in paragraph (b)(1)(vii)(C)(3) of this section, except 
that, rather than sell all of S's stock to a member of another 
consolidated group, P causes S to merge with and into a member of 
another consolidated group in a transaction described in section 
368(a)(1)(A). As provided in paragraph (b)(1)(iv)(A) of this section, 
the merger transaction is treated as a ``sale or other disposition'' 
for purposes of paragraph (b)(1)(ii)(D) of this section because S 
leaves the P group. Thus, the results are the same as in paragraph 
(b)(1)(vii)(C)(3) of this section.
    (D) Example 4--(1) Facts. P wholly owns T, which wholly owns S. In 
2021, S purchases a depreciable asset (Asset AA) for $100x and fully 
depreciates Asset AA under section 168(k). T reduces its basis in its S 
stock, and P reduces its basis in its T stock, by $100x under Sec.  
1.1502-32 to reflect S's depreciation deductions. For the 2021 taxable 
year, the P group's ATI (after adding back S's depreciation deductions 
with respect to Asset AA under paragraph (b)(1)(i)(D) of this section) 
is $150x. The P group incurs $45x of business interest expense in 2021. 
In 2024, T sells all of its S stock to a member of another consolidated 
group. In 2025, P sells all of its T stock to a member of another 
consolidated group.
    (2) Analysis. Pursuant to paragraph (b)(1)(ii)(D) of this section, 
the P group must subtract $100x from its tentative taxable income in 
computing its ATI for its 2024 taxable year. Pursuant to paragraph 
(b)(1)(iv)(D)(1) of this section, no adjustment to the P group's 
tentative taxable income is required in 2025 under paragraph 
(b)(1)(ii)(D) of this section.
    (2) 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.
    (3) 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)(11) of this 
section). However, business interest expense does not include amounts 
of interest expense carried forward to the taxable year from a prior 
taxable year due to the application of section 465 or section 469, 
which apply after the application of section 163(j). 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 1.163(j)-4(d)(2)(iii) (regarding 
consolidated groups), 1.163(j)-1(b)(9) (regarding current-year business 
interest expense), and 1.163(j)-6(c) (regarding partnerships and S 
corporations).
    (4) Business interest income--(i) In general. The term business 
interest income means interest income includible in the gross income of 
a taxpayer for the taxable year 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), 1.163(j)-4(d)(2)(iii) (regarding 
consolidated groups), and 1.163(j)-6(c) (regarding partnerships and S 
corporations).
    (5) C corporation. The term C corporation has the meaning provided 
in section 1361(a)(2).
    (6) 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.
    (7) Consolidated group. The term consolidated group has the meaning 
provided in Sec.  1.1502-1(h).
    (8) Consolidated return year. The term consolidated return year has 
the meaning provided in Sec.  1.1502-1(d).
    (9) Current-year business interest expense. 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.
    (10) 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). For 
purposes of section 163(j) and the regulations in this part under 
section 163(j) of the Internal Revenue Code (Code) disallowed business 
interest expense is treated as ``paid or accrued'' in the taxable year 
in which the expense is deductible for Federal income tax purposes 
(without regard to section 163(j)) or in the taxable year in which a 
deduction for the business interest expense is permitted under section 
163(j), as the context may require.
    (11) 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).
    (12) 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)(27) 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).
    (13) 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);
    (ii) Any trade or business of a specified agricultural or 
horticultural cooperative, as defined in section 199A(g)(4); or
    (iii) Specifically designated by the Secretary in guidance 
published in the Federal Register or the Internal Revenue Bulletin (see 
Sec.  601.601(d) of this chapter) as a farming business for purposes of 
section 163(j).
    (14) 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--
    (i) A real property trade or business described in section 
469(c)(7)(C) and Sec.  1.469-9(b)(2); or
    (ii) A REIT that qualifies for the safe harbor described in Sec.  
1.163(j)-9(h); or
    (iii) A trade or business specifically designated by the Secretary 
in guidance published in the Federal Register or the

[[Page 56764]]

Internal Revenue Bulletin (see Sec.  601.601(d) of this chapter) as a 
real property trade or business for purposes of section 163(j).
    (15) Excepted regulated utility trade or business--(i) In general. 
The term excepted regulated utility trade or business means:
    (A) Automatically excepted regulated utility trades or businesses. 
A trade or business--
    (1) That furnishes or sells--
    (i) Electrical energy, water, or sewage disposal services;
    (ii) Gas or steam through a local distribution system; or
    (iii) Transportation of gas or steam by pipeline; but only
    (2) To the extent that the rates for the furnishing or sale of the 
items in paragraph (b)(15)(i)(A)(1) of this section--
    (i) 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
    (ii) Have been established or approved by the governing or 
ratemaking body of an electric cooperative; or
    (B) Electing regulated utility trades or businesses. A trade or 
business that makes a valid election under paragraph (b)(15)(iii) of 
this section; or
    (C) Designated excepted regulated utility trades or businesses. A 
trade or business that is specifically designated by the Secretary in 
guidance published in the Federal Register or the Internal Revenue 
Bulletin as an excepted regulated utility trade or business (see Sec.  
601.601(d) of this chapter) for section 163(j) purposes.
    (ii) Depreciation and excepted and non-excepted utility trades or 
businesses.
    (A) Depreciation. Taxpayers engaged in an excepted trade or 
business described in paragraph (b)(15)(i) of this section cannot claim 
the additional first-year depreciation deduction under section 168(k) 
for any property that is primarily used in the excepted regulated 
utility trade or business.
    (B) Allocation of items. If a taxpayer is engaged in one or more 
excepted trades or businesses, as described in paragraph (b)(15)(i) of 
this section, and one or more non-excepted trades or businesses, the 
taxpayer must allocate items between the excepted and non-excepted 
utility trades or businesses. See Sec. Sec.  1.163(j)-1(b)(44) 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)(15)(i)(A)(1) of 
this section that are not sold pursuant to rates that are determined on 
a cost of service and rate of return basis or established or approved 
by the governing or ratemaking body of an electric cooperative, and are 
not subject to an election in paragraph (b)(15)(iii), are treated as 
excepted trades or businesses. See Sec.  1.163(j)-10(c)(3)(iii)(C)(3). 
For look-through rules applicable to certain CFCs that furnish or sell 
items described in paragraph (b)(15)(i)(A)(1) of this section that are 
not sold pursuant to rates that are determined on a cost of service and 
rate of return basis or established or approved by the governing or 
ratemaking body of an electric cooperative as described in paragraph 
(b)(15)(i)(A)(2) of this section, see Sec.  1.163(j)-10(c)(5)(ii)(C).
    (iii) Election to be an excepted regulated utility trade or 
business. (A) In general. A trade or business that is not an excepted 
regulated utility trade or business described in paragraph 
(b)(15)(i)(A) or (C) of this section and that furnishes or sells items 
described in paragraph (b)(15)(i)(A)(1) of this section is eligible to 
make an election to be an excepted regulated utility trade or business 
to the extent that the rates for furnishing or selling the items 
described in paragraph (b)(15)(i)(A)(1) of this section have been 
established or approved by a regulatory body described in paragraph 
(b)(15)(i)(A)(2)(i) of this section.
    (B) Scope and effect of election--(1) In general. An election under 
paragraph (b)(15)(iii) of this section is made with respect to each 
eligible trade or business of the taxpayer and applies only to the 
trade or business for which the election is made. An election under 
paragraph (b)(15)(iii) of this section applies to the taxable year in 
which the election is made and to all subsequent taxable years.
    (2) Irrevocability. An election under paragraph (b)(15)(iii) of 
this section is irrevocable.
    (C) Time and manner of making election--(1) In general. Subject to 
paragraph (b)(15)(iii)(C)(5) of this section, a taxpayer makes an 
election under paragraph (b)(15)(iii) 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)-1(b)(15)(iii) 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 
sufficient to demonstrate qualification for an election under this 
section, including the principal business activity code; and
    (v) A statement that the taxpayer is making an election under 
section 1.163(j)-1(b)(15)(iii).
    (3) Consolidated group's or partnership's trade or business. The 
rules in Sec.  1.163(j)-9(d)(3) and (4) apply with respect to an 
election under paragraph (b)(15)(iii) of this section for a 
consolidated group's or partnership's trade or business.
    (4) Termination of election. The rules in Sec.  1.163(j)-9(e) apply 
to determine when an election under paragraph (b)(15)(iii) of this 
section terminates.
    (5) Additional guidance. The rules and procedures regarding the 
time and manner of making an election under paragraph (b)(15)(iii) of 
this section and the election statement contents in paragraph 
(b)(15)(iii)(C)(2) 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 (b)(15)(iii)(C)(4) 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).
    (16) Excess business interest expense. For any partnership, the 
term excess business interest expense means the amount of disallowed 
business interest expense of the partnership for a taxable year under 
section Sec.  1.163(j)-2(b). With respect to a partner, see Sec.  
1.163(j)-6(g) and (h).
    (17) 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).
    (18) Floor plan financing indebtedness. The term floor plan

[[Page 56765]]

financing indebtedness means indebtedness--
    (i) Used to finance the acquisition of motor vehicles held for sale 
or lease; and
    (ii) Secured by the motor vehicles so acquired.
    (19) 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)(3) of this section.
    (20) Group. The term group has the meaning provided in Sec.  
1.1502-1(a).
    (21) Intercompany transaction. The term intercompany transaction 
has the meaning provided in Sec.  1.1502-13(b)(1)(i).
    (22) Interest. The term interest means any amount described in 
paragraph (b)(22)(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 Code or the Income Tax Regulations. Thus, interest 
includes, but is not limited to, the following:
    (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) (determined without regard to section 163(j));
    (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; 
however, in the case of a sale-repurchase agreement relating to tax-
exempt bonds, 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) In general. 
Except as provided in paragraphs (b)(22)(ii)(B) and (C) of this 
section, a 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) Exception for cleared swaps. Paragraph (b)(22)(ii)(A) of this 
section does not apply to a cleared swap (as defined in paragraph 
(b)(6) of this section).
    (C) Exception for non-cleared swaps subject to margin or collateral 
requirements. Paragraph (b)(22)(ii)(A) of this section does not apply 
to a non-cleared swap that requires the parties to meet the margin or 
collateral requirements of a federal regulator or that provides for 
margin or collateral requirements that are substantially similar to a 
cleared swap or a non-cleared swap subject to the margin or collateral 
requirements of a federal regulator. For purposes of this paragraph 
(b)(22)(ii)(C), the term federal regulator means the Securities and 
Exchange Commission (SEC), the Commodity Futures Trading Commission 
(CFTC), or a prudential regulator, as defined in section 1a(39) of the 
Commodity Exchange Act (7 U.S.C. 1a), as amended by section 721 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 
Public Law 111-203, 124 Stat. 1376, Title VII.
    (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 deductible as a bond premium deduction under 
section 171(a)(1) and 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 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 only if the payment relates to a sale-repurchase agreement or a 
securities lending transaction that is not entered into by the payor in 
the ordinary course of the payor's business. A substitute interest 
payment described in Sec.  1.861-2(a)(7) is treated as interest income 
to the recipient only if the payment relates to a sale-repurchase 
agreement or a securities lending transaction that is not entered into 
by the recipient in the ordinary course of the recipient's business; 
however, in the case of a sale-repurchase agreement or a securities 
lending transaction relating to tax-exempt bonds, the recipient of a 
substitute payment does not receive tax-exempt interest income. This 
paragraph (b)(22)(iii)(C) does not apply to an amount described in 
paragraph (b)(22)(i)(N) of this section.
    (D) Section 1258 gain. Any gain treated as ordinary gain under 
section 1258 is treated as interest income.
    (E) Factoring income. The excess of the amount that a taxpayer 
collects on a factored receivable (or realizes upon

[[Page 56766]]

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)(22)(iii)(E), 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. This paragraph (b)(22)(iii)(E) does not apply to an 
amount described in paragraph (b)(22)(i)(C) or (E) of this section.
    (F) [Reserved]
    (iv) Anti-avoidance rules--(A) Principal purpose to reduce interest 
expense--(1) Treatment as interest expense. Any expense or loss 
economically equivalent to interest is treated as interest expense if a 
principal purpose of structuring the transaction(s) is to reduce an 
amount incurred by the taxpayer that otherwise would have been 
described in paragraph (b)(22)(i), (ii), or (iii) of this section. For 
this purpose, the fact that the taxpayer has a business purpose for 
obtaining the use of funds does not affect the determination of whether 
the manner in which the taxpayer structures the transaction(s) is with 
a principal purpose of reducing the taxpayer's interest expense. In 
addition, the fact that the taxpayer has obtained funds at a lower pre-
tax cost based on the structure of the transaction(s) does not affect 
the determination of whether the manner in which the taxpayer 
structures the transaction(s) is with a principal purpose of reducing 
the taxpayer's interest expense. For purposes of this paragraph 
(b)(22)(iv)(A)(1), any expense or loss is economically equivalent to 
interest to the extent that the expense or loss is--
    (i) Deductible by the taxpayer;
    (ii) Incurred by the 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;
    (iii) Substantially incurred in consideration of the time value of 
money; and
    (iv) Not described in paragraph (b)(22)(i), (ii), or (iii) of this 
section.
    (2) Corresponding treatment of amounts as interest income. If a 
taxpayer knows that an expense or loss is treated by the payor as 
interest expense under paragraph (b)(22)(iv)(A)(1) of this section, the 
taxpayer provides the use of funds for a period of time in the 
transaction(s) subject to paragraph (b)(22)(iv)(A)(1) of this section, 
the taxpayer earns income or gain with respect to the transaction(s), 
and such income or gain is substantially earned in consideration of the 
time value of money provided by the taxpayer, such income or gain is 
treated as interest income to the extent of the expense or loss treated 
by the payor as interest expense under paragraph (b)(22)(iv)(A)(1) of 
this section.
    (B) Interest income artificially increased. Notwithstanding 
paragraphs (b)(22)(i) through (iii) of this section, any income 
realized by a taxpayer in a transaction or series of integrated or 
related transactions is not treated as interest income of the taxpayer 
if and to the extent that a principal purpose for structuring the 
transaction(s) is to artificially increase the taxpayer's business 
interest income. For this purpose, the fact that the taxpayer has a 
business purpose for holding interest generating assets does not affect 
the determination of whether the manner in which the taxpayer 
structures the transaction(s) is with a principal purpose of 
artificially increasing the taxpayer's business interest income.
    (C) Principal purpose. Whether a transaction or a series of 
integrated or related transactions is entered into with a principal 
purpose described in paragraph (b)(22)(iv)(A) or (B) of this section 
depends on all the facts and circumstances related to the 
transaction(s), except for those facts described in paragraph 
(b)(22)(iv)(A) or (B) of this section. A purpose may be a principal 
purpose even though it is outweighed by other purposes (taken together 
or separately). Factors to be taken into account in determining whether 
one of the taxpayer's principal purposes for entering into the 
transaction(s) include the taxpayer's normal borrowing rate in the 
taxpayer's functional currency, whether the taxpayer would enter into 
the transaction(s) in the ordinary course of the taxpayer's trade or 
business, whether the parties to the transaction(s) are related persons 
(within the meaning of section 267(b) or section 707(b)), whether there 
is a significant and bona fide business purpose for the structure of 
the transaction(s), whether the transactions are transitory, for 
example, due to a circular flow of cash or other property, and the 
substance of the transaction(s).
    (D) Coordination with anti-avoidance rule in Sec.  1.163(j)-2(j). 
The anti-avoidance rules in paragraphs (b)(22)(iv)(A) through (C) of 
this section, rather than the anti-avoidance rules in Sec.  1.163(j)-
2(j), apply to determine whether an item is treated as interest expense 
or interest income.
    (v) Examples. The examples in this paragraph (b)(22)(v) illustrate 
the application of paragraph (b)(22)(iv) of this section. Unless 
otherwise indicated, 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. A is engaged in a manufacturing business 
and uses the calendar year as its annual accounting period. A's 
functional currency is the U.S. dollar and A conducts virtually all of 
its business in the U.S. dollar. A has no connection to Japan or the 
Japanese yen in the ordinary course of business. A projects that it 
will have business interest expense of $100x on an existing loan 
obligation with a stated principal amount of $2,000x (Loan 1) and no 
business interest income in its taxable year ending December 31, 2021. 
In early 2021, A enters into the following transactions, which A would 
not have entered into in the ordinary course of A's trade or business:
    (i) A enters into a loan obligation in which A borrows Japanese yen 
from Bank in an amount equivalent to $2,000x with an interest rate of 1 
percent (Loan 2) (at the time of the loan, the U.S. dollar equivalent 
interest rate on a loan of $2,000x is 5 percent);
    (ii) A enters into a foreign currency swap transaction (FX Swap) 
with Bank with a notional principal amount of $2,000x under which A 
receives Japanese yen at 1 percent multiplied by the amount of Japanese 
yen borrowed from Bank (which for 2021 equals $20x) and pays U.S. 
dollars at 5 percent multiplied by a notional amount of $2,000x ($100x 
per year);
    (iii) The FX Swap is not integrated with Loan 2 under Sec.  1.988-
5; and
    (iv) A enters into a spot transaction with Bank to convert the 
proceeds of Loan 2 into $2,000x U.S. dollars and A uses the U.S. 
dollars to repay Loan 1.
    (2) Analysis. A principal purpose of A entering into the 
transactions with Bank was to try to reduce the amount incurred by A 
that otherwise would be interest expense; in effect, A sought to alter 
A's cost of borrowing by converting a substantial portion of its 
interest expense deductions on Loan 1 into

[[Page 56767]]

section 165 deductions on the FX Swap ($100x interest expense related 
to Loan 1 compared to $20x interest expense related to Loan 2 and $80x 
section 165 deduction). A's functional currency is the U.S. dollar and 
A conducts virtually all of its business in the U.S. dollar. A has no 
connection to Japan or the Japanese yen and would not have entered into 
the transactions in the ordinary course of A's trade or business. The 
section 165 deductions related to the FX Swap were incurred by A in a 
series of transactions in which A secured the use of funds for a period 
of time and were substantially incurred in consideration of the time 
value of money. As a result, under paragraph (b)(22)(iv)(A)(1) of this 
section, for purposes of section 163(j), the $80x paid by A to Bank on 
the FX Swap is treated by A as interest expense.
    (B) Example 2--(1) Facts. A is engaged in a manufacturing business 
and uses the calendar year as its annual accounting period. A does not 
use gold in its manufacturing business. In 2021, A expects to borrow 
$1,000x for six months. In January 2021, 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 for six months, A has sustained 
a loss of $13x in connection with these related transactions. A would 
not have entered into the gold transactions in the ordinary course of 
A's trade or business.
    (2) Analysis. In a series of related transactions, A has obtained 
the use of $1,000x for six months and created a loss of $13x 
substantially incurred in consideration of the time value of money. A 
would not have entered into the gold transactions in the ordinary 
course of A's trade or business. A entered into the transactions with a 
principal purpose of structuring the transactions to reduce its 
interest expense (in effect, A sought to convert what otherwise would 
be interest expense into a loss through the transactions). As a result, 
under paragraph (b)(22)(iv)(A)(1) of this section, for purposes of 
section 163(j), the loss of $13x is treated by A as interest expense.
    (C) Example 3--(1) Facts. A is engaged in a manufacturing business 
and uses the calendar year as its annual accounting period. A's 
functional currency is the U.S. dollar and A conducts virtually all of 
its business in the U.S. dollar. A has no connection to Argentina or 
the Argentine peso as part of its ordinary course of business. As of 
January 1, 2021, A expects to have adjusted taxable income (as defined 
in paragraph (b)(1) of this section) of $200x in the taxable year 
ending December 31, 2021. A also projects that it will have business 
interest expense of $70x on an existing loan in 2021. A has cash 
equivalents of $100x on which A expects to earn $5x of business 
interest income. In early 2021, A enters into the following 
transactions, which A would not have entered into in the ordinary 
course of A's trade or business:
    (i) A enters into a spot transaction with Bank to convert the $100x 
of cash equivalents into an amount in Argentine pesos equivalent to 
$100x and A uses the Argentine pesos to purchase an Argentine peso note 
(Note) issued by a subsidiary of Bank for the Argentine peso equivalent 
of $100x; the Note pays interest at a 10 percent rate; and
    (ii) A enters into a foreign currency swap transaction (FX Swap) 
with Bank with a notional principal amount of $100x under which A pays 
Argentine pesos at 10 percent multiplied by the amount of Argentine 
peso principal amount on the Note (which for 2021 equals $10x) and 
receives U.S. dollars at 5 percent multiplied by a notional amount of 
$100x ($5x per year).
    (2) Analysis. A principal purpose of A entering into the 
transactions was to increase the amount of business interest income 
received by A; in effect, A increased its business interest income by 
separately accounting for its net deduction of $5x per year on the FX 
Swap. A's functional currency is the U.S. dollar and A conducts 
virtually all of its business in the U.S. dollar. A has no connection 
to Argentina or the Argentine peso and would not have entered into the 
transactions in the ordinary course of A's trade or business. The FX 
Swap was incurred by A as a part of a transaction that A entered into 
with a principal purpose of artificially increasing its business 
interest income. As a result, under paragraph (b)(22)(iv)(B) of this 
section, for purposes of section 163(j), the $10x business interest 
income earned on the Note by A is reduced by $5x (the net $5x paid by A 
on the FX Swap).
    (D) Example 4--(1) Facts. A is wholly owned by FC, a foreign 
corporation organized in foreign country X. A uses the calendar year 
for its annual accounting period. FC has a better credit rating than A. 
A needs to borrow $2,000x in the taxable year ending December 31, 2021, 
to fund its business operations. A also projects that, if it borrows 
$2,000x on January 1, 2021, and pays a market rate of interest, it will 
have business interest expense of $100x in its taxable year ending 
December 31, 2021. In early 2021, A enters into the following 
transactions:
    (i) A enters into a loan obligation in which A borrows $2,000x from 
Bank with an interest rate of 3 percent (Loan 1);
    (ii) FC and Bank enter into a guarantee arrangement (Guarantee) 
under which FC agrees to guarantee Bank that Bank will be timely paid 
all of the amounts due on Loan 1; and
    (iii) A enters into a guarantee fee agreement with FC (Guarantee 
Fee Agreement) under which A agrees to pay FC $40x in return for FC 
entering into the Guarantee, which was not an agreement that A would 
have entered into in the ordinary course of A's trade or business.
    (2) Analysis. A principal purpose of A entering into the 
transactions was to reduce the amount incurred by A that otherwise 
would be interest expense; in effect, A sought to convert a substantial 
portion of its interest expense deductions on Loan 1 into section 162 
deductions on the Guarantee Fee Agreement ($100x interest expense had A 
borrowed without the Guarantee compared to $60x interest expense 
related to Loan 1 and $40x section 162 deduction). A would not have 
entered into the Guarantee Fee Agreement in the ordinary course of A's 
trade or business. The $40x section 162 deductions related to the 
Guarantee Fee Agreement were incurred by A in a series of transactions 
in which A secured the use of funds for a period of time and were 
substantially incurred in consideration of the time value of money. As 
a result, under paragraph (b)(22)(iv)(A)(1) of this section, for 
purposes of section 163(j), the $40x paid by A to FC on the Guarantee 
Fee Agreement is treated by A as interest expense.
    (E) Example 5--(1) Facts. A, B, and C are equal partners in ABC 
partnership. ABC is considering acquiring an additional loan from a 
third-party lender to expand its business operations. However, ABC 
already has significant debt and interest expense. For the purpose of 
reducing the amount of additional interest expense ABC would have 
otherwise incurred by borrowing, A agrees to make an additional 
contribution to ABC for use in its business operations in exchange for 
a guaranteed payment for the use of capital under section 707(c).
    (2) Analysis. The guaranteed payment is deductible by ABC, incurred 
by ABC in a transaction in which ABC secures the use of funds for a 
period of time, substantially incurred in consideration of the time 
value of money, and not

[[Page 56768]]

described in paragraph (b)(22)(i), (ii), or (iii) of this section. As a 
result, the guaranteed payment to A is economically equivalent to the 
interest that ABC would have incurred on an additional loan from a 
third-party lender. A principal purpose of A making a contribution in 
exchange for a guaranteed payment for the use of capital was to reduce 
the amount incurred by ABC that otherwise would be interest expense. As 
a result, under paragraph (b)(22)(iv)(A)(1) of this section, for 
purposes of section 163(j), such guaranteed payment is treated as 
interest expense of ABC for purposes of section 163(j). In addition, 
under paragraph (b)(22)(iv)(A)(2) of this section, if A knows that the 
guaranteed payment is treated as interest expense of ABC, because A 
provides the use of funds for a period of time in a transaction subject 
to paragraph (b)(22)(iv)(A)(1) of this section, A earns income or gain 
with respect to the transaction, and such income or gain is 
substantially earned in consideration of the time value of money 
provided by A, the guaranteed payment is treated as interest income of 
A for purposes of section 163(j).
    (23) Interest expense. The term interest expense means interest 
that is paid or accrued, or treated as paid or accrued, for the taxable 
year.
    (24) Interest income. The term interest income means interest that 
is included in gross income for the taxable year.
    (25) Member. The term member has the meaning provided in Sec.  
1.1502-1(b).
    (26) Motor vehicle. The term motor vehicle means a motor vehicle as 
defined in section 163(j)(9)(C).
    (27) 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).
    (28) Ownership change. The term ownership change has the meaning 
provided in section 382 and the regulations in this part under section 
382 of the Code.
    (29) Ownership date. The term ownership date has the meaning 
provided in section 382 and the regulations in this part under section 
382 of the Code.
    (30) Real estate investment trust. The term real estate investment 
trust (REIT) has the meaning provided in section 856.
    (31) 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.
    (32) Regulated investment company. The term regulated investment 
company (RIC) has the meaning provided in section 851.
    (33) Relevant foreign corporation. The term relevant foreign 
corporation means any foreign corporation whose classification is 
relevant under Sec.  301.7701-3(d)(1) for a taxable year, other than 
solely pursuant to section 881 or 882.
    (34) S corporation. The term S corporation has the meaning provided 
in section 1361(a)(1).
    (35) [Reserved]
    (36) 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).
    (37) 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.
    (38) Separate return limitation year. The term separate return 
limitation year (SRLY) has the meaning provided in Sec.  1.1502-1(f).
    (39) Separate return year. The term separate return year has the 
meaning provided in Sec.  1.1502-1(e).
    (40) Separate tentative taxable income. The term separate tentative 
taxable income with respect to a taxpayer and a taxable year has the 
meaning provided in Sec.  1.1502-12, but for this purpose computed 
without regard to the application of the section 163(j) limitation and 
with the addition of the adjustments made in paragraph (b)(43)(ii) of 
this section and Sec.  1.163(j)-4(d)(2)(iv).
    (41) Tax-exempt corporation. The term tax-exempt corporation means 
any tax-exempt organization that is organized as a corporation.
    (42) Tax-exempt organization. The term tax-exempt organization 
means any entity subject to tax under section 511.
    (43) Tentative taxable income--(i) In general. The term tentative 
taxable income, with respect to a taxpayer and a taxable year, 
generally is determined in the same manner as taxable income under 
section 63 but for this purpose computed without regard to the 
application of the section 163(j) limitation. Tentative taxable income 
is computed without regard to any disallowed business interest expense 
carryforwards.
    (ii) [Reserved]
    (iii) Special rules for defining tentative taxable income. (A) For 
special rules defining the tentative taxable income of a RIC or REIT, 
see Sec.  1.163(j)-4(b)(4)(ii).
    (B) For special rules defining the tentative taxable income of 
consolidated groups, see Sec.  1.163(j)-4(d)(2)(iv).
    (C) For special rules defining the tentative taxable income of a 
partnership, see Sec.  1.163(j)-6(d)(1).
    (D) For special rules defining the tentative taxable income of an S 
corporation, see Sec.  1.163(j)-6(l)(3).
    (E) For special rules clarifying that tentative taxable income 
takes sections 461(l), 465, and 469 into account, see Sec.  1.163(j)-
3(b)(4).
    (F) For special rules clarifying that tentative taxable income 
takes sections 461(l), 465, and 469 into account, see Sec.  1.163(j)-
3(b)(4).
    (G) For special rules clarifying that tentative taxable income 
takes sections 461(l), 465, and 469 into account, see Sec.  1.163(j)-
3(b)(4).
    (44) 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 the trade or business of performing services as an 
employee, an electing real property trade or business, an electing 
farming business, or an excepted regulated utility trade or business. 
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.
    (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.
    (45) 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), any adjustments for tax credits 
claimed by the taxpayer (for example, under section 50(c)), or any 
adjustments for any portion of the basis that the taxpayer has elected 
to treat as an expense (for example, under section 179, 179B, or 179C).

[[Page 56769]]

    (46) United States shareholder. The term United States shareholder 
has the meaning provided in section 951(b).
    (c) Applicability date--(1) In general. Except as provided in 
paragraphs (c)(2) and (3) of this section, this section applies to 
taxable years beginning on or after November 13, 2020. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to apply the rules of this section to 
a taxable year beginning after December 31, 2017, and before November 
13, 2020 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, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 
1.382-2, 1.382-5, 1.382-6, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 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 that taxable year. Additionally, taxpayers 
and their related parties within the meaning of sections 267(b) and 
707(b)(1), otherwise relying on the notice of proposed rulemaking that 
was published on December 28, 2018, in the Federal Register (83 FR 
67490) in its entirety under Sec.  1.163(j)-1(c), may alternatively 
choose to follow Sec.  1.163(j)-1(b)(1)(iii), rather than proposed 
Sec.  1.163(j)-1(b)(1)(iii).
    (2) Anti-avoidance rules. The anti-avoidance rules in paragraph 
(b)(22)(iv) of this section apply to transactions entered into on or 
after September 14, 2020.
    (3) Swaps with significant nonperiodic payments--(i) In general. 
Except as provided in paragraph (c)(3)(ii) of this section, the rules 
provided in paragraph (b)(22)(ii) of this section apply to notional 
principal contracts entered into on or after September 14, 2021. 
However, taxpayers may choose to apply the rules provided in paragraph 
(b)(22)(ii) of this section to notional principal contracts entered 
into before September 14, 2021.
    (ii) Anti-avoidance rule. The anti-avoidance rules in paragraph 
(b)(22)(iv) of this section (applied without regard to the references 
to paragraph (b)(22)(ii) of this section) apply to a notional principal 
contract entered into on or after September 14, 2020.


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 that is part of provides 
rules regarding real estate mortgage investment conduits (REMICs). 
Paragraph (f) of this section provides rules regarding the calculation 
of ATI with respect to certain beneficiaries. Paragraph (g) of this 
section provides rules regarding tax-exempt organizations. Paragraph 
(h) of this section provides examples illustrating the application of 
this section. Paragraph (i) of this section is reserved. Paragraph (j) 
of this section provides an anti-avoidance rule.
    (b) General rule--(1) In general. 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--
    (i) The taxpayer's business interest income for the taxable year;
    (ii) 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
    (iii) The taxpayer's floor plan financing interest expense for the 
taxable year.
    (2) 50 percent ATI limitation for taxable years beginning in 2019 
or 2020--(i) In general. Except as otherwise provided in section 
163(j)(10) and paragraph (b)(2) of this section, for any taxable year 
beginning in 2019 or 2020, paragraph (b)(1)(ii) of this section is 
applied by substituting 50 percent for 30 percent. The 50 percent ATI 
limitation does not apply to partnerships for taxable years beginning 
in 2019. Further, for a partnership taxable year beginning in 2020 for 
which an election out of section 163(j)(10)(A)(i) has not been made, 
Sec.  1.163(j)-6(f)(2)(xi) is applied by substituting two for ten-
thirds when grossing up each partner's final ATI capacity excess 
amount.
    (ii) Election out of the 50 percent ATI limitation. A taxpayer may 
elect to not have paragraph (b)(2)(i) of this section apply for any 
taxable year beginning in 2019 or 2020. In the case of a partnership, 
the election must be made by the partnership and may be made only for 
taxable years beginning in 2020.
    (3) Election to use 2019 ATI in 2020--(i) In general. Subject to 
paragraph (b)(3)(ii), a taxpayer may elect to use the taxpayer's ATI 
for the last taxable year beginning in 2019 (2019 ATI) as the ATI for 
any taxable year beginning in 2020.
    (ii) Short taxable years. If an election is made under paragraph 
(b)(3)(i) of this section for a taxable year beginning in 2020 that is 
a short taxable year, the ATI for such taxable year is equal to the 
amount that bears the same ratio to 2019 ATI as the number of months in 
the short taxable year bears to 12.
    (4) Time and manner of making or revoking the elections. The rules 
and procedures regarding the time and manner of making, or revoking, an 
election under paragraphs (b)(2) and (3) of this section are provided 
in Revenue Procedure 2020-22, 2020-18 I.R.B. 745, or in other guidance 
that may be issued (see Sec. Sec.  601.601(d) and 601.602 of this 
chapter).
    (c) Disallowed business interest expense carryforward--(1) In 
general. 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 a 
disallowed business interest expense carryforward, and is therefore 
business interest expense that is subject to paragraph (b) of this 
section in such succeeding taxable year. Disallowed business interest 
expense carryforwards 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. See Sec.  1.163(j)-10(c)(4).
    (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 of the taxpayer in that taxable year. See Sec.  
1.163(j)-6(m)(3) for rules applicable to the treatment of excess 
business interest expense from a partnership that is not subject to 
section 163(j) in a succeeding taxable year, and see Sec.  1.163(j)-
6(m)(4) for rules applicable to S corporations with disallowed business 
interest expense carryforwards that are not subject to section 163(j) 
in a succeeding 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.

[[Page 56770]]

    (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)-(v) [Reserved]
    (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 
in which the taxpayer meets the gross receipts test of section 448(c) 
and the regulations in this part under section 448 of the Code for the 
taxable year. See Sec.  1.163(j)-9(b) for elections available under 
section 163(j)(7)(B) and 163(j)(7)(C) for real property trades or 
businesses or farming businesses that also may be exempt small 
businesses. See Sec.  1.163(j)-6(m) for rules applicable to 
partnerships and S corporations not subject to section 163(j).
    (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 of section 448(c) and the regulations 
in this part under section 448 of the Code 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), 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 a tax-exempt organization include 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) Trusts--(i) Calculation of ATI with respect to certain trusts 
and estates. The ATI of a trust or a decedent's estate taxable under 
section 641 is computed without regard to deductions under sections 
642(c), 651, and 661.
    (ii) Calculation of ATI with respect to certain beneficiaries. The 
ATI of a beneficiary (including a tax-exempt beneficiary) of a trust or 
a decedent's estate is reduced by any income (including any 
distributable net income) received from the trust or estate by the 
beneficiary to the extent such income was necessary to permit a 
deduction under section 163(j)(1)(B) and Sec.  1.163(j)-2(b) for any 
business interest expense of the trust or estate that was in excess of 
any business interest income of the trust or estate.
    (g) Tax-exempt organizations. Except as provided in paragraph (d) 
of this section, the section 163(j) limitation applies to tax-exempt 
organizations for purposes of computing their unrelated business 
taxable income under section 512. For rules on determining the gross 
receipts of a tax-exempt organization for purposes of the small 
business exemption, see paragraph (d)(2)(iv) of this section. For 
special rules applicable to tax-exempt beneficiaries of a trust or a 
decedent's estate, see Sec.  1.163(j)-2(f). For special rules 
applicable to tax-exempt corporations, see Sec.  1.163(j)-4. For 
special allocation rules applicable to tax-exempt organizations, see 
Sec.  1.163(j)-10(a)(5).
    (h) Examples. The examples in this paragraph (h) illustrate the 
application of section 163(j) and the provisions of this section. 
Unless otherwise indicated, 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, 2021, 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. For the 2021 taxable year, 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 2021 taxable year.
    (2) Example 2: Carryforward of business interest expense--(i) 
Facts. The facts are the same as in Example 1 in paragraph (h)(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 (h)(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 2021 
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 2020 taxable 
year, Y has tentative taxable income of $30x, which is determined 
without regard to the application of the section 163(j) limitation on 
business interest expense. Y's tentative taxable income 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 under section 167, of which $10x is capitalized to 
inventory under section 263A. Of the $10x capitalized to inventory, 
only $7x is recovered through cost of goods sold during the 2020 
taxable year and $3x remains in ending inventory at the end of the 2020 
taxable year. The $3x of ending inventory is recovered through cost of 
goods sold during the 2021 taxable year. Y also has a disallowed 
business interest expense carryforward from the prior year of $8x.
    (ii) Analysis. (A) For purposes of determining the section 163(j) 
limitation for 2020, Y's disallowed business interest expense 
carryforward is not taken into account in determining tentative taxable 
income or ATI. Y's ATI is $90x, calculated as follows:

[[Page 56771]]



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

    (B) Plus:

                   Table 2 to Paragraph (h)(3)(ii)(B)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Business interest expense                                           $50x
Net operating loss deduction                                         25x
Depreciation                                                         15x
                                                              ----------
ATI                                                                  90x
------------------------------------------------------------------------

    (C) For Y's 2021 taxable year, the $3x of ending inventory that is 
recovered through cost of goods sold in 2021 is not added back to 
tentative taxable income (TTI) in determining ATI because it was 
already included as an addback in ATI in Y's 2020 taxable year. See 
Sec.  1.163(j)-1(b)(1)(iii).
    (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 2021 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 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 2021 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 (h)(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, 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 2021 
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 does not conduct an electing real property trade or 
business or an electing farming 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 in this part under section 
448, 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 2021 taxable 
year without regard to section 163(j).
    (7) Example 7: Partnership with excess business interest expense 
qualifies for the small business exemption in a succeeding taxable 
year--(i) Facts. X and Y are equal partners in partnership PRS. In 
addition to being partners in PRS, X and Y each operate their own sole 
proprietorships. For the taxable year ending December 31, 2021, PRS is 
subject to section 163(j) and has excess business interest expense of 
$10x. For the taxable year ending December 31, 2022, PRS has $40x of 
business interest expense, and X and Y have $20x of business interest 
expense from their respective sole proprietorships. For the taxable 
year ending December 31, 2022, PRS and Y qualify for the small business 
exemption under Sec.  1.163(j)-2(d), while X is subject to section 
163(j) and has a section 163(j) limitation of $22x.
    (ii) Partnership-level analysis. For the 2021 taxable year, PRS 
allocates the $10x of excess business interest expense equally to X and 
Y ($5x each). See Sec.  1.163(j)-6(f)(2). For the 2022 taxable year, 
section 163(j) does not apply to PRS because PRS qualifies for the 
small business exemption. As a result, none of PRS's $40x of business 
interest expense for the 2022 taxable year is subject to the section 
163(j) limitation at the partnership level.
    (iii) Partner-level analysis. For the 2022 taxable year, each 
partner treats its $5x of excess business interest expense from PRS as 
paid or accrued in that year. See Sec.  1.163(j)-6(m)(3). This amount 
becomes business interest expense that each partner must subject to its 
own section 163(j) limitation, if any. With this $5x, each partner has 
$25x of business interest expense for the 2022 taxable year ($20x from 
its sole proprietorship, plus $5x of excess business interest expense 
treated as paid or accrued in the 2020 taxable year). X deducts $22x of 
its business interest expense pursuant to its section 163(j) limitation 
and carries forward the remainder ($3x) as a disallowed business 
interest expense carryforward to the taxable year ending December 31, 
2023. Y is not subject to section 163(j) because Y qualifies for the 
small business exemption. Y therefore deducts all $25x of its business 
interest expense for the 2022 taxable year.
    (8) Example 8: 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, 2020, 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 2020. 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 2020, X may elect for its farming business to be an 
excepted trade or business.
    (i) [Reserved]
    (j) Anti-avoidance rule--(1) In general. Arrangements entered into 
with a principal purpose of avoiding the

[[Page 56772]]

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).
    (2) Examples. The examples in this paragraph (j)(2) illustrate the 
application of this section.
    (i) Example 1--(A) Facts. Individual A operates an excepted trade 
or business (Business X) and a non-excepted trade or business (Business 
Y). With a principal purpose of avoiding the rules of section 163(j) or 
the regulations in this part under section 163(j) of the Code, A 
contributes Business X to newly-formed C corporation B in exchange for 
stock; A then causes B to borrow funds from a third party and 
distributes a portion of the borrowed funds to A for use in Business Y. 
B takes the position that its interest payments on the debt are not 
subject to the section 163(j) limitation because B is engaged solely in 
an excepted trade or business.
    (B) Analysis. A has entered into an arrangement with a principal 
purpose of avoiding the rules of section 163(j) or the regulations in 
this part under section 163(j). Thus, under paragraph (j)(1) of this 
section, the Commissioner of the IRS may disregard or recharacterize 
this transaction to the extent necessary to carry out the purposes of 
section 163(j). In this case, payments of interest on the debt may be 
recharacterized as payments of interest properly allocable to a non-
excepted trade or business subject to the section 163(j) limitation.
    (ii) Example 2--(A) Facts. Partnership UTP has two non-excepted 
trades or businesses. Business A has gross income of $1000x and gross 
deductions of $200x. Business B has gross income of $100x and gross 
deductions of $600x. With a principal purpose of avoiding the rules in 
section 163(j) or the regulations in this part under section 163(j), 
UTP and a partner of UTP form partnership LTP and UTP contributes 
Business B to LTP prior to borrowing funds. UTP takes the position that 
it does not take its share of LTP gross deductions into account when 
computing its ATI.
    (B) Analysis. UTP has entered into an arrangement with a principal 
purpose of avoiding the rules of section 163(j) or the regulations in 
this part under section 163(j). Thus, under paragraph (j)(1) of this 
section, the Commissioner of the IRS may disregard or recharacterize 
this transaction to the extent necessary to carry out the purposes of 
section 163(j). In this case, UTP's share of gross deductions from LTP 
may be recharacterized as gross deductions incurred directly by UTP 
solely for purposes of computing UTP's ATI.
    (k) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.


Sec.  1.163(j)-3  Relationship of the section 163(j) 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 regulations in this part under 
section 163(j) of the Code generally apply only to business interest 
expense that would be deductible in the current taxable year without 
regard to section 163(j). Thus, for example, a taxpayer must apply 
Sec.  1.163-8T, if applicable, to determine which items of interest 
expense are investment interest under section 163(d) before applying 
the rules in this section to interest expense. 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).
    (4) At risk rules, passive activity loss provisions, and limitation 
on excess business losses of noncorporate taxpayers. Section 163(j) 
generally applies to limit the deduction for business interest expense 
before the application of sections 461(l), 465, and 469. However, in 
determining tentative taxable income for purposes of computing ATI, 
sections 461(l), 465, and 469 are taken into account.
    (5) Capitalized interest expenses. Section 163(j) applies after the 
application of provisions that require the capitalization of interest, 
such as sections 263A and 263(g). 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 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), Sec. Sec.  1.163(j)-
5(e) and 1.163(j)-11(c), the regulations in this part under sections 
382 and 383 of the Code, and Sec. Sec.  1.1502-91 through 1.1502-99.
    (c) Examples. The examples in this paragraph (c) illustrate the 
application of section 163(j) and the provisions of this section. 
Unless otherwise indicated, X and Y are calendar-year domestic C 
corporations; 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 certain small

[[Page 56773]]

businesses in Sec.  1.163(j)-2(d) does not apply.
    (1) Example 1: Disallowed interest expense--(i) Facts. In 2021, 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 2021 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 2019 ATI ($27x). Therefore, in the 2021 
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 2021, 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). The $30x expense is allowed as a deduction 
under section 267(a)(2) in 2022.
    (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 2021 because it is not currently deductible under 
section 267(a)(2). Accordingly, in 2021, 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 2021 ($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 2021 taxable year under section 267(a)(2) will be 
taken into account in determining the business interest expense 
deduction under section 163(j) in 2022, 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 2021 will be carried forward to 2022 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 the 2021 taxable year, 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, 
except that section 469 is taken into account in the determination of 
tentative taxable income for purposes of computing ATI. 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 2021, $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 
2021 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 2021, 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 section 
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 2021, $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).
    (5) Example 5: ATI calculation with passive activity loss--(i) 
Facts. D is an individual who engages in a trade or business, V, as a 
sole proprietorship. D relies on employees to perform most of the work 
and, as a result, D does not materially participate in V. Therefore, V 
is a passive activity of D. V is not an excepted trade or business. In 
Year 1, V generates $500x of passive income, $400x of business interest 
expense, and $600x of ordinary and necessary expenses deductible under 
section 162 (not including any interest described in Sec.  1.163(j)-
1(b)(22)). No disallowed business interest expense carryforward has 
been carried to Year 1 from a prior year, and no amounts have been 
carried over to Year 1 from a prior year under either section 465(a)(2) 
or section 469(b).
    (ii) Tentative taxable income. Under Sec.  1.163(j)-1(b)(43), 
tentative taxable income is determined as though all business interest 
expense was not subject to the section 163(j) limitation. Sections 
461(l), 465, and 469 apply in the determination of tentative taxable 
income. For year 1, D has $500x of allowable deductions and a $500x 
tentative passive activity loss under section 469, because D's $1000x 
of passive expenses exceeds D's $500x of passive income from V. The 
tentative disallowance of $500x is generally allocated pro rata between 
D's passive expenses under Sec.  1.469-1T(f)(2)(ii)(A). In this case, 
fifty percent ($500x of passive activity loss divided by $1000x of 
total passive expenses) of each category of passive expense is 
tentatively disallowed: $200x of business interest expense and $300x of 
section 162 expense. D's tentative taxable income is $0 (zero), which 
is determined by reducing $500x of gross income by the remaining $200x 
of business interest expense and $300x of section 162 expense ($500x-
$200x-$300x).
    (iii) ATI. Under section Sec.  1.163(j)-1(b)(1), to determine ATI, 
D must add

[[Page 56774]]

business interest expense to tentative taxable income, but only to the 
extent that the business interest expense reduced tentative taxable 
income, or $200x. The $200x of business interest expense that was 
tentatively disallowed under section 469 is not added to tentative 
taxable income to determine ATI. D's ATI is $200x, which is determined 
by adding the $200x of business interest expense that reduced tentative 
taxable income to D's tentative taxable income, or $0 (0 + $200x).
    (iv) Section 163(j) limitation. D's section 163(j) limitation in 
Year 1 is D's business interest income, or $0, plus 30 percent of ATI, 
or $60x (30 percent x $200x ATI), plus D's floor plan financing, or $0, 
for a total of $60x ($0 + $60x + $0). Before the application of section 
469, D has $60x of deductible business interest expense and $340x of 
disallowed business interest expense carryforward under Sec.  1.163(j)-
2(c).
    (v) Passive activity loss. Because D's passive deductions exceed 
the passive income from V, and D does not have any passive income from 
other sources, section 469 applies to limit D's passive loss from V. 
Having first applied section 163(j), D has $660x of passive expenses, 
determined by adding D's $60x of business interest expense that is 
allowed by section 163(j) as a deduction and $600x of section 162 
expense ($60x + $600x). D offsets $500x of the passive expenses against 
$500x of passive income; therefore, D has a passive activity loss of 
$160x in Year 1, determined as the excess of D's total passive expenses 
over D's passive income ($660x-$500x). The amount of D's loss from the 
passive activity that is disallowed under section 469 ($160x) is 
generally ratably allocated to each of D's passive activity deductions 
under Sec.  1.469-1T(f)(2)(ii)(A). As a general rule, each deduction is 
multiplied by the ratio of the total passive loss to total passive 
expenses (160x/660x). Of D's $60x business interest expense, $14.55x 
(($160x/$660x) x $60x) is disallowed in Year 1. Additionally, of D's 
$600x section 162 expense, $145.45x (($160x/$660x) x $600x) is 
disallowed. The amounts disallowed under section 469(a)(1) and Sec.  
1.469-2T(f)(2) are carried over to the succeeding taxable year under 
section 469(b) and Sec.  1.469-1(f)(4).
    (6) Example 6: Effect of passive activity loss carryforwards--(i) 
Facts. The facts are the same as in Example 5 in paragraph (c)(5)(i) of 
this section. In Year 2, V generates $500x of passive income, $100x of 
business interest expense, and $0 (zero) of other deductible expenses. 
D is not engaged in any other trade or business activities. A 
disallowed business interest expense carryforward of $340x has been 
carried to Year 2 from Year 1. Under section 469, D has a suspended 
loss from Year 1 that includes $14.55x of business interest expense and 
$145.45x of section 162 expense. These amounts are treated as passive 
activity deductions in Year 2.
    (ii) Tentative taxable income. To determine D's tentative taxable 
income, D must first determine D's allowable deductions. In year 2, D 
has $260x of allowable deductions, which includes $100x of business 
interest expense generated Year 2, $14.55x of business interest expense 
disallowed in Year 1 by section 469, and $145.45x of section 162 
expense disallowed in Year 1 by section 469 ($100x + $14.55x + 
$145.45x)). D's disallowed business interest expense carryforward from 
Year 1 is not taken into account in determining tentative taxable 
income. See Sec.  1.163(j)-1(b)(43). Additionally, the $14.55x of 
business interest expense disallowed in Year 1 by section 469 is not 
business interest expense in Year 2 because it was deductible after the 
application of section 163(j) (but before the application of section 
469) in Year 1. D does not have a tentative passive activity loss in 
Year 2, because D's $500x of passive income from V exceeds D's $260x of 
tentative passive expenses. Therefore, D's tentative taxable income in 
Year 2 is $240x, which is determined by subtracting D's allowable 
deductions other than disallowed business interest expense 
carryforwards, or $260x, from D's gross income, or $500x ($500x-$260x).
    (iii) ATI. D's ATI in Year 2 is $340x, which is determined by 
adding D's business interest expense, or $100x, to D's tentative 
taxable income, or $240x ($240x + $100x). Because disallowed business 
interest expense carryforwards are not taken into account in 
determining tentative taxable income, there is no corresponding 
adjustment for disallowed business interest expense carryforwards in 
calculating ATI. Therefore, there is no adjustment for D's $340x of 
disallowed business interest expense carryforward in calculating D's 
ATI. D has no other adjustments to determine ATI.
    (iv) Section 163(j) limitation. D's section 163(j) limitation in 
Year 2 is $102x, which is determined by adding D's business interest 
income, or $0, 30 percent of D's ATI for year 2, $102 ($340x x 30 
percent), and D's floor plan financing for Year 2, or $0 ($0 + ($102x) 
+ $0). Accordingly, before the application of section 469 in Year 2, 
$102x of D's $440x of total business interest expense (determined by 
adding $340x of disallowed business interest expense carryforward from 
Year 1 and $100x of business interest expense in Year 2) is deductible. 
D has $338x of disallowed business interest expense carryforward that 
will carry forward to subsequent taxable years under Sec.  1.163(j)-
2(c), determined by subtracting D's deductible business interest 
expense in Year 2, or $102x, from D's total business interest expense 
in Year 2, or $440x ($440x-$102x).
    (v) Section 469. After applying the section 163(j) limitation, D 
applies section 469 to determine if any amount of D's expense is a 
disallowed passive activity loss. For Year 2, D has $262x of passive 
expenses, determined by adding D's business interest expense deduction 
allowed by section 163(j) ($102x), D's section 162 expense carried 
forward from Year 1 under section 469 ($145.45x), and D's interest 
expense carried forward from Year 1 under section 469 which is not 
business interest expense in Year 2, or $14.55x ($102x + $145.45x + 
$14.55x). Therefore, D has $238x of net passive income in Year 2, 
determined by reducing D's total passive income in Year 2 ($500x), by 
D's disallowed passive activity loss, or $262x ($500x-$262x). D does 
not have a passive activity loss in Year 2, and no part of D's $262x of 
passive expenses is disallowed in Year 2 under section 469.
    (7) Example 7: Capitalized interest expense--(i) Facts. In 2020, X 
has $50x of interest expense. Of X's interest expense, $10x is required 
to be capitalized under section 263A. X capitalizes this interest 
expense to a depreciable asset. X's business interest income is $9x and 
X's ATI is $80x. X makes the election in Sec.  1.163(j)-2(b)(2)(ii) to 
use 30 percent, rather than 50 percent, of ATI in determining X's 
section 163(j) limitation for the 2020 taxable year.
    (ii) Analysis. Under paragraph (b)(5) of this section, section 263A 
is applied before section 163(j). Accordingly, $10x of X's interest 
expense cannot be taken into consideration for purposes of section 
163(j) in 2020. Additionally, under paragraph (b)(5) of this section, 
X's $10 of capitalized interest expense is not business interest 
expense for purposes of section 163(j). As a result, when X recovers 
its capitalized interest expense through depreciation deductions, such 
capitalized interest expense will not be taken into account as business 
interest expense in determining X's section 163(j) limitation. X's 
section 163(j) limitation in 2020, or the amount of business interest 
expense that X may deduct, is limited to $33x under Sec.  1.163(j)-
2(b), determined by adding X's business

[[Page 56775]]

interest income ($9x) and 30 percent of X's 2020 ATI ($24x). X 
therefore has $7x of disallowed business interest expense in 2020 that 
will be carried forward to 2021 as a disallowed business interest 
expense carryforward.
    (d) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.


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 rules regarding the computation of 
items of income and expense under section 163(j) for taxpayers that are 
C corporations, including, for example, members of a consolidated 
group, REITs, RICs, tax-exempt corporations, and cooperatives. 
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 rules 
applicable to members of a consolidated group. Paragraph (e) of this 
section provides rules governing the ownership of partnership interests 
by members of a consolidated group. Paragraph (f) 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 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, investment expenses, 
and certain other tax items 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, investment income, or investment expense (within the meaning 
of section 163(d)) that a partnership pays, receives, or accrues and 
that is allocated to a C corporation partner as a separately stated 
item is treated by the C corporation partner as properly allocable to a 
trade or business of that partner. Similarly, for purposes of section 
163(j), any other tax items of a partnership that are neither properly 
allocable to a trade or business of the partnership nor described in 
section 163(d) and that are allocated to a C corporation partner as 
separately stated items are treated as properly allocable to a trade or 
business of that partner.
    (ii) Effect of characterization on partnership. The 
characterization of a partner's tax items pursuant to paragraph 
(b)(3)(i) of this section does not affect the characterization of these 
items at the partnership level.
    (iii) Separately stated interest expense and interest income of a 
partnership not treated as excess business interest expense or excess 
taxable income of a C corporation partner. Investment interest expense 
and other interest expense of a partnership that is treated as business 
interest expense by a C corporation partner under paragraph (b)(3)(i) 
of this section is not treated as excess business interest expense of 
the partnership. Investment interest income and other interest income 
of a partnership that is treated as business interest income by a C 
corporation partner under paragraph (b)(3)(i) of this section is not 
treated as excess taxable income of the partnership. For rules 
governing excess business interest expense and excess taxable income, 
see Sec.  1.163(j)-6.
    (iv) 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 sections 951(a) or 951A(a) that are not properly allocable 
to a trade or business of the domestic partnership, then, 
notwithstanding paragraph (b)(3)(i) of this section, 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.
    (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) Tentative taxable income of RICs and REITs. The tentative 
taxable income of a RIC or REIT for purposes of calculating ATI is the 
tentative 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 tentative 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). See 
paragraph (b)(4)(iii) of this section for an adjustment to ATI 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).
    (5) Application to tax-exempt corporations. The rules in this 
paragraph (b) apply to a tax-exempt corporation 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) Adjusted taxable income of cooperatives. Solely for purposes of 
computing the ATI of a cooperative under Sec.  1.163(j)-1(b)(1), 
tentative taxable income is not reduced by the amount of any patronage 
dividend under section 1382(b)(1) or by any amount paid in redemption 
of nonqualified written notices of allocation distributed as patronage 
dividends under section 1382(b)(2) (for cooperatives subject to 
taxation under sections 1381 through 1388), any amount described in 
section 1382(c) (for

[[Page 56776]]

cooperatives described in section 1381(a)(1) and section 521), or any 
equivalent amount deducted by an organization that operates on a 
cooperative basis but is not subject to taxation under sections 1381 
through 1388.
    (7) Examples. The principles of this paragraph (b) are illustrated 
by the following examples. For purposes of the examples in this 
paragraph (b)(7) of this section, 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 2021, T's tentative 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 2021 taxable year is $520x ($320x of tentative taxable income + 
$200x business interest expense-$50x business interest income + $50x 
depreciation deductions = $520x), and its section 163(j) limitation for 
the 2021 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 2021 taxable year 
under section 163(j).
    (C) Taxable year beginning in 2022. The facts are the same as in 
Example 1 in paragraph (b)(7)(i)(A) of this section, except that the 
taxable year begins in 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 tentative 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 is 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 2021 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 equally to its two partners pursuant to 
Sec.  1.163(j)-6(k). 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)(7)(ii)(A) of this 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 2021, Business 1 earns 
$150x of net income (excluding interest expense and depreciation), and 
PS1 pays $100x of interest on Loan 2. For purposes of section 163(d) 
and (j), PS1 treats the interest paid on Loan 2 as properly allocable 
to a trade or business. 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 domestic C corporation, except as otherwise 
provided in paragraph (c)(2) of this section, the disallowance and 
carryforward under Sec.  1.163(j)-2 (and Sec.  1.163(j)-5, in the case 
of a taxpayer that is a consolidated group member) of a deduction for 
business interest expense of the taxpayer or of a partnership in which 
the taxpayer is a partner does not affect whether or when the business 
interest expense reduces the taxpayer's 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 does 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 does not affect whether or when such business 
interest expense reduces the PFIC'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

[[Page 56777]]

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, and if all or a portion 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 a portion of its interest in the partnership, the 
taxpayer must increase its earnings and profits immediately prior to 
the disposition by an amount equal to the amount of the basis 
adjustment required under section 163(j)(4)(B)(iii)(II) and Sec.  
1.163(j)-6(h)(3).
    (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 2021 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 2021 taxable 
year. In that year, X has tentative 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 2021 taxable year is $100x ($0 of tentative 
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 2021 taxable year under Sec.  1.163(j)-2(b) (30 percent 
x $100x), and X may carry forward the remainder ($70x) to X's 2022 
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 2021 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 2021 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 2021 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 2021 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 tentative 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 2021 taxable year is $60x ($10x tentative 
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 2021 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 2022 taxable year. 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 2021 
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 2021 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 2021 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 2021 taxable year. In addition, X 
has $50x of interest income and $20x of interest expense for the 2022 
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 2022 taxable year and the $7x of 
disallowed business interest expense carryforward from the 2021 taxable 
year, X may deduct $27x of business interest expense in the 2022 
taxable year. Under paragraph (c)(2) of this section, X must reduce its 
current earnings and profits for the 2022 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 2021 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), $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)

[[Page 56778]]

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 2021 
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 tentative 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 2021 taxable year is $40x ($0 tentative 
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 2021 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 2022 
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 2021 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 2021 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 2021 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 2021 taxable year. In addition, X 
has $50x of mortgage interest income and $20x of interest expense for 
the 2022 taxable year. X has no other tax items for the 2022 taxable 
year.
    (B) Analysis. Because X's $50x of business interest income exceeds 
the $20x of business interest expense from the 2022 taxable year and 
the $13x of disallowed business interest expense carryforwards from the 
2021 taxable year, X may deduct $33x of business interest expense in 
2022. Under paragraph (c)(2) of this section, X must reduce its current 
earnings and profits for 2022 by the full amount of the deductible 
interest expense ($33x).
    (d) Special rules for consolidated groups--(1) Scope. This 
paragraph (d) provides 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 
regulations in this part under section 163(j) 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 
ownership of partnership interests by members of a consolidated group, 
see paragraph (e) of this section.
    (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)(22), 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 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 tentative taxable 
income is the consolidated group's consolidated taxable income, 
determined under Sec.  1.1502-11 but without regard to any 
carryforwards or disallowances under section 163(j). 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--(A) In general. Except 
as otherwise provided in paragraph (d)(2)(v)(B) of this section, 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, except as 
otherwise provided in paragraph (d)(2)(v)(B) of this section, interest 
expense and interest income from intercompany obligations are not 
treated as business interest expense and business interest income.
    (B) Repurchase premium. This paragraph (d)(2)(v)(B) applies if a 
member of a consolidated group purchases an obligation of another 
member of the same consolidated group in a transaction to which Sec.  
1.1502-13(g)(5) applies. Notwithstanding the general rule of paragraph 
(d)(2)(v)(A) of this section, if, as a result of the deemed 
satisfaction of the obligation under Sec.  1.1502-13(g)(5)(ii), the 
debtor member has repurchase premium that is deductible under Sec.  
1.163-7(c), such repurchase premium is treated as interest that is 
subject to the section 163(j) limitation. See Sec.  1.163(j)-
1(b)(22)(i)(H).
    (3) Investment adjustments. For rules governing investment 
adjustments within a consolidated group, see Sec.  1.1502-32(b).
    (4) Examples. The principles in this paragraph (d) are illustrated 
by the following examples. For purposes of the examples in this 
paragraph (d)(4), 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 2021 taxable year, P has $50x of separate tentative 
taxable income after taking into account $65x of interest paid

[[Page 56779]]

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 tentative taxable income in the 2021 
taxable year after taking into account $10x of depreciation deductions 
under section 168. S has no interest expense in the 2021 taxable year. 
The P group's tentative taxable income the 2021 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 2021 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 tentative 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 2021 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 2021 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, 
2021, 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 2021, 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 2021 taxable year. A deduction 
for P's remaining $7x of business interest expense is disallowed in the 
2021 taxable year, and this amount is carried forward to the 2022 
taxable year.
    (e) Ownership of partnership interests by members of a consolidated 
group.
    (1) [Reserved]
    (2) Change in status of a member. A change in status of a member 
(that is, becoming or ceasing to be a member of the group) is not 
treated as a disposition for purposes of section 163(j)(4)(B)(iii)(II) 
and Sec.  1.163(j)-6(h)(3).
    (3) 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)(iii)(I) 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 converted into business interest 
expense, deducted, and absorbed by the consolidated group. See Sec.  
1.1502-32(b).
    (4) Excess business interest expense and Sec.  1.1502-36. Excess 
business interest expense is a Category D asset within the meaning of 
Sec.  1.1502-36(d)(4)(i).
    (f) Cross-references. For rules governing the treatment of 
disallowed business interest expense carryforwards for C corporations, 
including rules governing the treatment of disallowed business interest 
expense carryforwards when members enter or leave a consolidated group, 
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.
    (g) Applicability date--(1) In general. This section applies to 
taxable years beginning on or after November 13, 2020. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to 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, 
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 
1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 
1.1368-1, 1.1377-1, 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 
that taxable year.
    (2) [Reserved]


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 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 a cross-reference 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 a cross-reference to other rules regarding the overlap of the 
SRLY limitation with section 382. Paragraph (g) of this section 
references additional rules that may limit the deductibility of 
interest or the use of disallowed business interest expense 
carryforwards.
    (2) Definitions--(i) 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.
    (ii) 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

[[Page 56780]]

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.
    (iii) 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 
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 section 163(j) limitation 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 equals 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 equals 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 is 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 Income Tax Regulations (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 is 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 expense 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 
(including under paragraph (d)(1)(A) of this section) in the current 
year are to 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 tentative taxable income for the 
current year generally are to 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, 
carries the expense forward to the succeeding taxable year as a 
disallowed business interest expense

[[Page 56781]]

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 offset tentative 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    A's business      P group's
                              Year                                   interest        interest     section 163(j)
                                                                      expense         expense        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.
    (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 2 to Paragraph (b)(3)(iv)(B)(2)
----------------------------------------------------------------------------------------------------------------
                                                                      Year 1          Year 2           Total
                                                                    disallowed      disallowed      disallowed
                                                                     business        business        business
                                                                     interest        interest        interest
                                                                      expense         expense         expense
                                                                   carryforwards   carryforwards   carryforwards
----------------------------------------------------------------------------------------------------------------
P...............................................................            $75x            $12x            $87x
A...............................................................             25x             18x             43x
                                                                 -----------------------------------------------

[[Page 56782]]

 
    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 is 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 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--
(A) Cumulative section 163(j) SRLY limitation. This paragraph (d) 
applies to disallowed business interest expense carryforwards of a 
member arising in a SRLY (see Sec.  1.1502-1(f))) or treated as arising 
in a SRLY under the principles of Sec.  1.1502-21(c) and (g). The 
amount of the carryforwards described in the preceding sentence 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 aggregate section 163(j) limitation for all consolidated 
return years of the group, determined by reference only to the member's 
items of income, gain, deduction, and loss, and reduced (including 
below zero) by the member's business interest expense (including 
disallowed business interest expense carryforwards) absorbed by the 
group in all consolidated return years (cumulative section 163(j) SRLY 
limitation). For purposes of computing the member's cumulative section 
163(j) SRLY limitation, intercompany items referred to in Sec.  
1.163(j)-4(d)(2)(iv) are included, with the exception of interest items 
with regard to intercompany obligations. See Sec.  1.163(j)-4(d)(2)(v). 
Thus, for purposes of this paragraph (d), income and expense items 
arising from intercompany transactions (other than interest income and 
expense with regard to intercompany obligations) are included in the 
calculation of the cumulative section 163(j) SRLY limitation. In 
addition, items of interest expense with regard to intercompany 
obligations are not characterized as business interest expense for 
purposes of the reduction described in the second sentence of this 
paragraph (d)(1)(A).
    (B) Subgrouping. For purposes of this paragraph (d), the SRLY 
subgroup principles of Sec.  1.1502-21(c)(2)(i) (with regard to 
carryovers of SRLY losses) 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 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). 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. See also Sec.  1.1502-21(b)(1).
    (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 RICs or 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 2021, 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 2022. P does not pay or 
accrue business interest expense in 2021, and P has no disallowed

[[Page 56783]]

business interest expense carryforwards from prior taxable years. At 
the close of 2021, P acquires all of the stock of T, which joins with P 
in filing a consolidated return beginning in 2022. Neither P nor T pays 
or accrues business interest expense in 2022, 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 all 
consolidated return years of the P group.
    (B) Analysis. T's $100x of disallowed business interest expense 
carryforwards from 2021 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. T's cumulative section 
163(j) SRLY limitation for 2022 is the P group's section 163(j) 
limitation, determined by reference solely to T's items for all 
consolidated return years of the P group ($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 2022, and 
the remaining $30x of T's disallowed business interest expense 
carryforwards are carried forward to 2023. After the P group deducts 
$70x of T's disallowed business interest expense carryforwards, T's 
cumulative section 163(j) SRLY limitation is reduced by $70x to $0.
    (C) Cumulative section 163(j) SRLY limitation of $0. The facts are 
the same as in Example 1 in paragraph (d)(3)(i)(A) of this section, 
except that T's cumulative section 163(j) SRLY limitation for 2022 is 
$0. Because the amount of T's disallowed business interest expense 
carryforwards that may be deducted by the P group in 2022 may not 
exceed T's cumulative section 163(j) SRLY limitation, none of T's 
carryforwards from 2021 may be deducted by the P group in 2022. Because 
none of T's disallowed business interest expense carryforwards are 
absorbed by the P group in 2022, T's cumulative section 163(j) SRLY 
limitation remains at $0 entering 2023.
    (ii) Example 2: Cumulative section 163(j) SRLY limitation less than 
zero--(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. For the current year, the P 
group has a section 163(j) limitation of $150x, $25x of which is 
attributable to P, and $125x of which is attributable to S. S has $100x 
of disallowed business interest expense carryforwards that arose in a 
SRLY and $150x of current-year business interest expense. S's 
cumulative section 163(j) SRLY limitation entering the current year 
(computed by reference solely to S's items for all consolidated return 
years of the P group) is $0.
    (B) Analysis. Under paragraph (d)(1) of this section, S's 
cumulative section 163(j) SRLY limitation is increased by $125x to 
reflect S's tax items for the current year. The P group's section 
163(j) limitation permits the P group to deduct all $150x of S's 
current-year business interest expense. S's cumulative section 163(j) 
SRLY limitation is reduced by the $150x of S's business interest 
expense absorbed by the P group in the current year, which results in a 
-$25x balance. Thus, none of S's SRLY'd disallowed business interest 
expense carryforwards may be deducted by the P group in the current 
year. Entering the subsequent year, S's cumulative section 163(j) SRLY 
limitation remains -$25x.
    (iii) Example 3: Pro rata absorption of SRLY-limited disallowed 
business interest expense carryforwards--(A) Facts. P, R, and S are the 
only members of a consolidated group, and no member has floor plan 
financing or business interest income. P has $60x of current-year 
business interest expense and $40x of disallowed business interest 
expense carryforwards from the previous year, which was not a separate 
return year. R has $120x of current-year business interest expense and 
$80x of disallowed business interest expense carryforwards from the 
previous year, which was not a separate return year. S has $70x of 
current-year business interest expense and $30x of disallowed business 
interest expense carryforwards from the previous year, which was a 
separate return year. The P group has a section 163(j) limitation of 
$300x, $50x of which is attributable to P, $90x to R, and $160x to S. 
S's cumulative section 163(j) SRLY limitation entering the current year 
(computed by reference solely to S's items for all consolidated return 
years of the P group) is $0.

                                       Table 3 to Paragraph (d)(3)(iii)(A)
----------------------------------------------------------------------------------------------------------------
                                                                                    Disallowed
                                                                                     business
                                                                   Current-year      interest
                                                                     business         expense     Section 163(j)
                                                                     interest      carryforwards     limitation
                                                                      expense       from prior
                                                                                   taxable year
----------------------------------------------------------------------------------------------------------------
P...............................................................            $60x            $40x            $50x
R...............................................................            120x             80x             90x
S...............................................................             70x      (SRLY) 30x            160x
                                                                 -----------------------------------------------
    Total.......................................................            250x            150x            300x
----------------------------------------------------------------------------------------------------------------

    (B) Analysis. Under paragraph (d)(1) of this section, S's 
cumulative section 163(j) SRLY limitation is increased in the current 
year by $160x. The P group's section 163(j) limitation permits the P 
group to deduct all $70x of S's current-year business interest expense 
(and all $180x of P and R's current-year business interest expense). 
S's cumulative section 163(j) SRLY limitation is reduced by the $70x of 
S's business interest expense absorbed by the P group in the current 
year, resulting in a $90x balance. Because the P group has $50x of 
section 163(j) limitation remaining after the absorption of current-
year business interest expense, the P group can absorb $50x of its 
members' disallowed business interest expense carryforwards. Under 
paragraph (d)(2) of this section, SRLY-limited disallowed business 
interest expense carryforwards are deducted on a pro rata basis with 
other disallowed business interest expense carryforwards from the same 
taxable year. Accordingly, the P group can deduct $10x ($50x x ($30x/
$150x)) of S's SRLY-limited disallowed business interest expense 
carryforwards. S's cumulative section 163(j) SRLY limitation is reduced 
(to $80x) by the $10x of SRLY-limited disallowed business interest 
carryforwards

[[Page 56784]]

absorbed by the P group in the current year.
    (C) Cumulative section 163(j) SRLY limitation of -$75x. The facts 
are the same as in Example 3 in paragraph (d)(3)(iii)(A) of this 
section, except that S's cumulative section 163(j) SRLY limitation 
entering the current year is -$75x. After adjusting for S's tax items 
for the current year ($160x) and the P group's absorption of S's 
current-year business interest expense ($70x), S's cumulative section 
163(j) SRLY limitation is $15x (-$75x + $160x-$70x). Because S's 
cumulative section 163(j) SRLY limitation ($15x) is less than the 
amount of S's SRLY-limited disallowed business interest expense 
carryforwards ($30x), the pro rata calculation under paragraph (d)(2) 
of this section is applied to $15x (rather than $30x) of S's 
carryforwards. Accordingly, the P group can deduct $5.56x ($50x x 
($15x/$135x)) of S's SRLY-limited disallowed business interest expense 
carryforwards. S's cumulative section 163(j) SRLY limitation is reduced 
(to $9.44x) by the $5.56x of SRLY-limited disallowed business interest 
carryforwards absorbed 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(c)(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(c)(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.
    (5) Recognized built-in loss. For a rule providing that a section 
382 disallowed business interest carryforward (as defined in Sec.  
1.382-2(a)(7)) is not treated as a recognized built-in loss for 
purposes of section 382, see Sec.  1.382-7(d)(5).
    (f) Overlap of SRLY limitation with section 382. For rules 
governing the overlap of the application of section 382 and the 
application of the SRLY rules, see Sec.  1.1502-21(g).
    (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 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.


Sec.  1.163(j)-6   Application of the section 163(j) limitation to 
partnerships and subchapter S corporations.

    (a) Overview. If a deduction for business interest expense of a 
partnership or an S corporation is subject to the section 163(j) 
limitation, 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 is taken into account in 
determining the nonseparately stated taxable income or loss of the 
partnership or S corporation. Once a partnership or an 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. Paragraph (h) of this 
section provides basis adjustment rules, and paragraph (k) 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.
    (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.
    (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

[[Page 56785]]

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 non-excepted trade or business.
    (8) Excepted assets. The term excepted assets means assets from an 
excepted trade or business.
    (c) Business interest income and business interest expense of a 
partnership--
    (1)-(2) [Reserved]
    (3) 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. 
However, for all other purposes of the Code, 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 a partnership--(1) Tentative taxable 
income of a partnership. For purposes of computing a partnership's ATI 
under Sec.  1.163(j)-1(b)(1), the tentative taxable income of a 
partnership is the partnership's taxable income determined under 
section 703(a), but computed without regard to the application of the 
section 163(j) limitation.
    (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 6 in paragraph (o)(6) 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, except as provided for in paragraph (m) of this 
section, 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 items. See Example 6 in paragraph (o)(6) 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. See Sec.  
1.163(j)-10(b)(4)(ii) for dispositions of interests in partnerships 
that own--
    (i) Non-excepted assets and excepted assets; or
    (ii) Investment assets; or
    (iii) Both.
    (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 the partner 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 already has 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 
paragraph 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 under section 704 of the Code. 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

[[Page 56786]]

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 under 
section 704 of the Code, including any allocations under section 
704(c), other than remedial items. 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.  1.163-8T 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 (that 
is, 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. If the partnership determines that each partner has a pro rata 
share of allocable ATI, allocable business interest income, and 
allocable business interest expense, then the partnership may bypass 
paragraphs (f)(2)(iii) through (xi) of this section and allocate its 
section 163(j) excess items in the same proportion. See Example 1 
through Example 16 in paragraphs (o)(1) through (16), respectively. 
This pro-rata exception does not result in allocations of section 
163(j) excess items that vary from the array of allocations of section 
163(j) excess items that would have resulted had paragraphs (f)(2)(iii) 
through (xi) been applied.
    (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 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 determined 
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

[[Page 56787]]

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 30 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 30 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 30 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
    (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 30 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 or 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

[[Page 56788]]

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 Example 17 through Example 21 in paragraphs (o)(17) 
through (21) of this section, respectively.
    (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 and the excess business interest expense is treated as 
such under paragraph (h)(2) of this section--
    (i) Solely for purposes of section 163(j), such excess business 
interest expense is 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 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 taxable years, unless 
paragraph (m)(3) of this section applies. See Example 1 through Example 
16 in paragraphs (o)(1) through (16) of this section, respectively.
    (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 
Example 2 through Example 16 in paragraphs (o)(2) through (16) of this 
section, respectively.
    (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 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 and business interest expense of an exempt 
entity (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 Example 7 in paragraph 
(o)(7) 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 Example 8 in 
paragraph (o)(8) of this section.
    (3) Partner basis adjustment upon disposition of partnership 
interest. If a partner (transferor) disposes of an interest in a 
partnership, the adjusted basis of the partnership interest being 
disposed of (transferred 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 transferor 
under paragraph (f)(2) of this section which has previously been 
treated under paragraph (g) of this

[[Page 56789]]

section as business interest expense paid or accrued by the transferor, 
multiplied by the ratio of the fair market value of the transferred 
interest to the total fair market value of the transferor's partnership 
interest immediately prior to the disposition. Therefore, the adjusted 
basis of the transferred interest is not increased immediately before 
the disposition by any allocation of excess business interest expense 
from the partnership that did not reduce the transferor's adjusted 
basis in its partnership interest pursuant to paragraph (h) of this 
section prior to the disposition, or by any excess business interest 
expense that was treated under paragraph (g) of this section as 
business interest expense paid or accrued by the transferor prior to 
the disposition. If the transferor disposes of all of its 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 or negative section 163(j) 
expense. If the transferor disposes of a portion of its 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 
the amount of excess business interest expense proportionate to the 
transferred interest. The amount of excess business interest expense 
proportionate to the partnership interest retained by the transferor 
shall remain as excess business interest expense of the transferor 
until such time as such excess business interest expense is treated as 
business interest expense paid or accrued by the transferor pursuant to 
paragraph (g) of this section. Further, if the transferor disposes of a 
portion of its partnership interest, 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). For purposes of this paragraph, a 
disposition includes a distribution of money or other property by the 
partnership to a partner in complete liquidation of its interest in the 
partnership. Further, solely for purposes of this section, each partner 
is considered to have disposed of its partnership interest if the 
partnership terminates under section 708(b)(1). See Example 9 and 
Example 10 in paragraphs (o)(9) and (o)(10) of this section, 
respectively.
    (i)-(j) [Reserved]
    (k) Investment items and certain other 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, and any other 
tax item of a partnership that is neither properly allocable to a trade 
or business of the partnership nor described in section 163(d), is 
allocated to each partner in accordance with section 704(b) and the 
regulations under section 704 of the Code, 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.
    (l) S corporations--(1) In general--(i) Corporate level limitation. 
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' 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). See Example 22 and Example 
23 in paragraphs (o)(22) and (23) of this section, respectively.
    (ii) Short taxable periods. For rules on applying the section 
163(j) limitation where an S corporation has a two short taxable 
periods or where its taxable year consists of two separate taxable 
years see Sec. Sec.  1.1362-3(c), 1.1368-1(g), and 1.1377-1(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. 
However, for all other purposes of the Code, 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 
tentative 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, except as provided in 
paragraph (m), and is increased by such shareholder's distributive 
share of such S corporation's excess taxable income.
    (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 the stock of which is being 
disposed of 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. See Sec.  1.163(j)-10(b)(4)(ii) for dispositions of 
stock of S corporations that own--
    (A) Non-excepted assets and excepted assets; or
    (B) Investment assets; or
    (C) Both.
    (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 the shareholder 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 already has been taken into account by the S corporation in 
determining its nonseparately stated taxable income or loss for 
purposes of section 163(j).

[[Page 56790]]

    (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 taxable year or a C corporation taxable year). For purposes 
of applying section 163(j), S corporations are subject to the same 
ordering rules as a C corporation that is not a member of a 
consolidated group. See Sec.  1.163(j)-5(b)(2).
    (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) and 
Sec.  1.163-8T.
    (10) Application of section 382. In the event of an ownership 
change, within the meaning of section 382(g), the S corporation's 
business interest expense is subject to section 382. Therefore, the 
allocation of the S corporation's business interest expense between the 
pre-change period (as defined in Sec.  1.382-6(g)(2)) and the post-
change period (as defined in Sec.  1.382-6(g)(3)), and the 
determination of the amount that is deducted and carried forward, is 
determined pursuant to Sec.  1.382-6. If the date of the ownership 
change is also the date of a qualifying disposition (as defined in 
Sec.  1.1368-1(g)(2)) or the date for a termination of shareholder 
interest (as defined in Sec.  1.1377-1(b)(4)), then--
    (i) The rules of this paragraph govern the S corporation's business 
interest expense;
    (ii) The S corporation must make an election under Sec.  1.382-6(b) 
with respect to such date if it also makes an election under Sec.  
1.1368-1(g)(2) or a shareholder termination election to apply normal 
tax accounting rules, as applicable, with respect to such date; and
    (iii) The S corporation may not make an election under Sec.  1.382-
6(b) with respect to such date if it does not make an election under 
Sec.  1.1368-1(g)(2) or a termination election under Sec.  1.1377-
1(b)(1), as applicable, with respect to such date.
    (m) Partnerships and S corporations not subject to section 163(j)--
(1) Exempt partnerships and S corporations. If the small business 
exemption in Sec.  1.163(j)-2(d) applies to a partnership or an S 
corporation in a taxable year (exempt entity), the general rule in 
Sec.  1.163(j)-2 and this section does not apply to limit the deduction 
for business interest expense of the exempt entity in that taxable 
year. Additionally, if a partner or S corporation shareholder is 
allocated business interest expense from an exempt entity, such 
business interest expense is not subject to the section 163(j) 
limitation at the partner's or S corporation shareholder's level. 
However, see paragraph (h)(1) of this section. Further, a partner or S 
corporation shareholder of an exempt entity includes its share of non-
excepted trade or business items of income, gain, loss, and deduction 
(including business interest expense and business interest income) of 
such exempt entity when calculating its ATI. However, if a partner's or 
S corporation shareholder's allocations of non-excepted trade or 
business items of loss and deduction from an exempt entity exceed its 
allocations of non-excepted trade or business items of income and gain 
from such exempt entity (net loss allocation), then such net loss 
allocation will not reduce a partner's or S corporation shareholder's 
ATI. See Example 11 and Example 12 in paragraphs (o)(11) and (12) of 
this section, respectively.
    (2) Partnerships and S corporations engaged in excepted trades or 
businesses. To the extent a partnership or an S corporation is engaged 
in an excepted trade or business, the general rule in Sec.  1.163(j)-2 
and this section does not apply to limit the deduction for 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 an excepted trade or business of the 
partnership or S corporation (excepted 163(j) items), such excepted 
163(j) items are excluded from the partner's 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). See also Example 13 in paragraph (o)(13) of this section.
    (3) Treatment of excess business interest expense from partnerships 
that are exempt entities in a succeeding taxable year. If a partner is 
allocated excess business interest expense from a partnership and, in a 
succeeding taxable year, such partnership is an exempt entity, then the 
partner shall treat any of its excess business interest expense that 
was previously allocated from such partnership as business interest 
expense paid or accrued by the partner in such succeeding taxable year, 
which is potentially subject to limitation at the partner level under 
section 163(j). However, if a partner is allocated excess business 
interest expense from a partnership and, in a succeeding taxable year, 
such partnership engages in excepted trades or businesses, then the 
partner shall not treat any of its excess business interest expense 
that was previously allocated from such partnership as business 
interest expense paid or accrued by the partner in such succeeding 
taxable year by reason of the partnership engaging in excepted trades 
or businesses. See Example 14 through Example 16 in paragraphs (o)(14) 
through (o)(16) of this section, respectively. For rules regarding the 
treatment of excess business interest expense from a partnership that 
terminates under section 708(b)(1), see paragraph (h)(3) of this 
section.
    (4) S corporations with disallowed business interest expense 
carryforwards prior to becoming exempt entities. If an S corporation 
has a disallowed business interest expense carryforward for a taxable 
year and, in a succeeding taxable year, such S corporation is an exempt 
entity, 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, unless

[[Page 56791]]

stated otherwise, each partnership and S corporation is subject to the 
provisions of section 163(j), is only engaged in non-excepted trades or 
businesses, was created or organized in the United States, and uses the 
calendar year for its annual accounting period. Unless stated 
otherwise, all partners and shareholders 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 use the calendar year for their annual 
accounting period. 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 in this part under section 704 of the Code.
    (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 nonseparately 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 nonseparately 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 
nonseparately 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

[[Page 56792]]

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 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 
nonseparately 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 nonseparately 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).

[[Page 56793]]

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. 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 
nonseparately 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.
    (7) Example 7--(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 nonseparately 
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 partner's 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.
    (8) Example 8--(i) Facts. The facts are the same as in Example 7 in 
paragraph (o)(7)(i) of this section. In Year 2, PRS has $20 of gross 
income that is taken into account in determining PRS's ATI (in other 
words, 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

[[Page 56794]]

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 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.
    (9) Example 9--(i) Facts. X and Y are equal partners in partnership 
PRS, and are not members of a consolidated group. At the beginning of 
Year 1, X and Y each have $120 of outside basis in PRS. Neither X nor 
Y's share of partnership liabilities exceeds the adjusted basis of its 
entire interest. In Year 1, X is allocated $20 of excess business 
interest expense, which reduces its outside basis from $120 to $100. In 
Year 2, X sells 80 percent of its interest in PRS to Z for $160. 
Immediately prior to the sale, X's entire PRS interest had a fair 
market value of $200 and the transferred portion of the interest had a 
fair market value of $160.
    (ii) Basis adjustment. Immediately before the sale to Z, X 
increases its basis in the portion of the interest sold by 80 percent 
of the amount of the excess of the amount of the basis reduction under 
paragraph (h)(2) of this section ($20) over the portion of any excess 
business interest expense allocated the partner under paragraph (f)(2) 
of this section that has previously been treated under paragraph (g) of 
this section as business interest expense paid or accrued by X ($0). 
Therefore, X's basis in the portion of its interest sold is $96 (($100 
x 80%) + ($20 x 80%)), and X's gain is $64 ($160-$96). Following the 
sale, X has $20 of outside basis in its remaining partnership interest 
and $4 of excess business interest expense.
    (10) Example 10--(i) Facts. X and Y are equal partners in 
partnership PRS, and are not members of a consolidated group. At the 
beginning of Year 1, X and Y each have an outside basis in PRS of $10. 
Neither X nor Y's share of partnership liabilities exceeds the adjusted 
basis of its entire interest. In Year 1, X is allocated $8 of excess 
business interest expense and $12 of loss from PRS. As a result, X has 
$4 of excess business interest expense, $4 of negative section 163(j) 
expense, $6 of allowable loss, $6 of loss suspended under section 
704(d), and $0 of outside basis in PRS at the end of Year 1. In Year 2, 
X sells 50 percent of its interest in PRS to Z for $20. Immediately 
prior to the sale, X's entire partnership interest had a fair market 
value of $40 and the transferred portion of the interest had a fair 
market value of $20.
    (ii) Basis adjustment. Immediately before the sale to Z, X 
increases its basis in the portion of the interest sold by 50 percent 
of the amount of the excess of the amount of the basis reduction under 
paragraph (h)(2) of this section ($4) over the portion of any excess 
business interest expense allocated the partner under paragraph (f)(2) 
of this section that has previously been treated under paragraph (g) of 
this section as business interest expense paid or accrued by X ($0). 
Therefore, X's basis in the portion of its interest sold is $2 (($0 x 
50%) + $2), and X's gain is $18 ($20-$2). Following the sale, X has $0 
of outside basis in its remaining partnership interest, $2 of excess 
business interest expense, $4 of negative section 163(j) expense, and 
$6 of loss suspended under section 704(d).
    (11) Example 11--(i) Facts. X (a corporation), Y (an individual), 
and Z (an individual) are equal partners in partnership PRS. X, Y, and 
Z are subject to section 163(j). PRS is not subject to section 163(j) 
under section 163(j)(3). In 2021, PRS has $150 of trade or business 
income (not taking into account business interest income or business 
interest expense), $30 of business interest income, and $45 of business 
interest expense. PRS also has $75 of investment income and $60 of 
investment interest expense. PRS allocates its items of income, gain, 
loss, and deduction equally among its partners. X, Y, and Z each have 
$10 of business interest expense from their respective businesses.
    (ii) Partnership-level. PRS is not subject to section 163(j) by 
reason of section 163(j)(3). As a result, none of PRS's $45 of business 
interest expense is subject to the section 163(j) limitation.
    (iii) Partner-level allocations. Because PRS is not subject to 
section 163(j) by reason of section 163(j)(3), PRS's $45 of business 
interest expense does not retain its character as business interest 
expense for purposes of section 163(j). As a result, such business 
interest expense is not subject to the section 163(j) limitation at the 
level of either the partnership or partner. Additionally,

[[Page 56795]]

pursuant to Sec.  1.163(j)-6(m)(1), each partner includes its share of 
non-excepted trade or business items of income, gain, loss, and 
deduction (including business interest expense and business interest 
income) of PRS when calculating its ATI. As a result, each partner 
increases its ATI by $45 (one third of $150 + $30-$45). Also, X 
increases its ATI by an additional $25 because its items of investment 
income and loss from PRS are recharacterized as non-excepted trade or 
business income and loss at its level pursuant to Sec. Sec.  1.163(j)-
4(b)(3)(i) and 1.163(j)-10(b)(6). Further, X increases its business 
interest expense by its $20 allocation of investment interest expense 
from PRS pursuant to Sec. Sec.  1.163(j)-4(b)(3)(i) and 1.163(j)-
10(b)(6).
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $70 of ATI and $30 of business interest expense. 
X's section 163(j) limit is $21 ($70 x 30 percent). Thus, X has $21 of 
deductible business interest expense. X's $9 of business interest 
expense not allowed as a deduction is treated as business interest 
expense paid or accrued by X in 2020. Y and Z, in computing their 
respective limits under section 163(j), each have $45 of ATI and $10 of 
business interest expense. Y and Z each have a section 163(j) limit of 
$13.50 ($45-30 percent). Thus, Y and Z each have $10 of deductible 
business interest expense.
    (12) Example 12--(i) Facts. The facts are the same as in Example 11 
in paragraph (o)(11)(i) of this section, except PRS has $200 of 
depreciation deductions in addition to its other items of income, gain, 
loss, and deduction.
    (ii) Partnership-level. Same analysis as Example 11 in paragraph 
(o)(11)(ii) of this section.
    (iii) Partner-level allocations. Because PRS is not subject to 
section 163(j) by reason of section 163(j)(3), PRS's $45 of business 
interest expense does not retain its character as business interest 
expense for purposes of section 163(j). As a result, such business 
interest expense is not subject to the section 163(j) limitation at the 
level of either the partnership or partner. Additionally, pursuant to 
Sec.  1.163(j)-6(m)(1), each partner includes its share of non-excepted 
trade or business items of income, gain, loss, and deduction (including 
business interest expense and business interest income) of PRS when 
calculating its ATI; however, a net loss allocation of trade or 
business items from an exempt entity does not reduce a partner's ATI. 
Because each of the partners has a net loss allocation of trade or 
business items from PRS, none of the partners adjust their ATI for the 
trade or business items of PRS. X, the corporate partner, increases its 
ATI by $25 because its items of investment income and loss from PRS are 
recharacterized as trade or business income and loss at its level 
pursuant to Sec. Sec.  1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6). 
Further, X increases its business interest expense by its $20 
allocation of investment interest expense from PRS pursuant to 
Sec. Sec.  1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6).
    (iv) Partner-level computations. In computing its limit under 
section 163(j), each partner has $0 of ATI and $10 of business interest 
expense. Each partner's section 163(j) limit is $0 ($0 x 30 percent). 
Thus, each partner's $10 of business interest expense is not allowed as 
a deduction and is treated as business interest expense paid or accrued 
by the partner in 2020. X, in computing its limit under section 163(j), 
has $25 of ATI and $30 of business interest expense. X's section 163(j) 
limit is $7.50 ($25 x 30 percent). Thus, X has $7.50 of deductible 
business interest expense. X's $22.50 of business interest expense not 
allowed as a deduction is treated as business interest expense paid or 
accrued by X in 2020. Y and Z, in computing their respective limits 
under section 163(j), each have $0 of ATI and $10 of business interest 
expense. Thus, Y and Z each have $10 of business interest expense not 
allowed as a deduction that is treated as business interest expense 
paid or accrued in 2020.
    (13) Example 13--(i) Facts. X, Y, and Z are equal partners in 
partnership PRS. X, Y, and Z are each individuals subject to section 
163(j). PRS is not subject to section 163(j) under section 163(j)(3). 
PRS has one excepted and one non-excepted trade or business. In Year 1, 
PRS has $200 of income and $10 of business interest expense from its 
excepted trade or business, and $60 of business interest income and $30 
of business interest expense from its non-excepted trade or business. 
PRS allocates its items of income, gain, loss, and deduction equally 
among its partners. X, Y, and Z each have $10 of business interest 
expense from their respective businesses.
    (ii) Partnership-level. PRS is not subject to section 163(j) by 
reason of section 163(j)(3). As a result, none of PRS's business 
interest expense is subject to the section 163(j) limitation.
    (iii) Partner-level allocations. Because PRS's business interest 
expense is not subject to the section 163(j) limitation, such business 
interest expense is not subject to the section 163(j) limitation at the 
level of either the partnership or partner. Additionally, pursuant to 
Sec.  1.163(j)-6(m)(1), each partner includes its share of non-excepted 
trade or business items of income, gain, loss, and deduction (including 
business interest expense and business interest income) of PRS when 
calculating its ATI. Therefore, each partner increases its ATI by $10 
(each partner's share of $20 of non-excepted income less each partner's 
share of $10 of non-excepted loss).
    (iv) Partner-level computations. In computing its limit under 
section 163(j), each partner has $10 of ATI and $10 of business 
interest expense. Each partner's section 163(j) limit is $3 ($10 x 30 
percent). Thus, each partner has $3 of deductible business interest 
expense. Each partner has $7 of business interest expense not allowed 
as a deduction that is treated as business interest expense paid or 
accrued by the partner in Year 2.
    (14) Example 14--(i) Facts. The facts are the same as in Example 5 
in paragraph (o)(5)(i) of this section, except in Year 2 Y is 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).
    (15) Example 15--(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) by reason of section 163(j)(3).
    (ii) Partnership-level. In Year 2, PRS is not subject to section 
163(j) by reason of section 163(j)(3). As a result, none of PRS's $40 
of business interest expense is subject to the section 163(j) 
limitation at the level of either the partnership or partner.
    (iii) Partner-level allocations. Because PRS is not subject to 
section 163(j) by reason of section 163(j)(3), PRS's $40 of business 
interest expense does not retain its character as business interest 
expense for purposes of section 163(j).

[[Page 56796]]

As a result, such business interest expense is not subject to the 
section 163(j) limitation at the level of either the partnership or 
partner. Additionally, pursuant to Sec.  1.163(j)-6(m)(1), each partner 
includes its share of non-excepted trade or business items of income, 
gain, loss, and deduction (including business interest expense and 
business interest income) of PRS when calculating its ATI. As a result, 
X and Y each increase their ATI by $35.60. Further, because PRS is not 
subject to section 163(j) 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 $135.60 of ATI ($100 from its sole proprietorship, 
plus $35.60 ATI from PRS) and $25 of business interest expense ($20 
from its sole proprietorship, plus $5 of excess business interest 
expense treated as paid or accrued in Year 2). X's section 163(j) limit 
is $40.68 ($135.60 x 30 percent). Thus, $25 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 the section 163(j) limitation. Thus, 
all $45 of Y's business interest expense ($20 from its sole 
proprietorship, plus $20 disallowed from year 1, plus $5 of excess 
business interest expense treated as paid or accrued in Year 2) is not 
subject to the section 163(j) limitation.
    (16) Example 16--(i) Facts. The facts are the same as in Example 1 
in paragraph (o)(1)(i) of this section, except that PRS's only trade or 
business is a real property trade or business for which PRS does not 
make the election provided for in section 163(j)(7)(B). In Year 2, when 
PRS's only trade or business is still its real property trade or 
business, PRS makes the election provided for in section 163(j)(7)(B). 
Further, in Year 2, PRS has $100 of income and $40 of business interest 
expense. PRS allocates its items of income, gain, deduction, and loss 
equally between X and 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 is not subject to section 
163(j) because its only trade or business is an excepted trade or 
business. As a result, none of PRS's $40 of business interest expense 
is subject to the section 163(j) limitation at the level of either the 
partnership or partner.
    (iii) Partner-level allocations. Because PRS is not subject to 
section 163(j), PRS's $40 of business interest expense does not retain 
its character as business interest expense for purposes of section 
163(j). As a result, such business interest expense is not subject to 
the section 163(j) limitation at the partners' level. Pursuant to Sec.  
1.163(j)-6(m)(1), the partners do not include their respective $50 
shares of income from PRS when calculating their own ATI because such 
$50 is excepted trade or business income.
    (iv) Partner-level computations. X, in computing its limit under 
section 163(j), has $100 of ATI ($100 from its sole proprietorship) and 
$20 of business interest expense ($20 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. At 
the end of Year 2, X has $5 of excess business interest expense from 
PRS ($5 from Year 1). Y, in computing its limit under section 163(j), 
has $0 of ATI and $40 of business interest expense ($20 from its sole 
proprietorship, plus $20 disallowed business interest expense from Year 
1). Y's section 163(j) limit is $0. Thus, Y's $40 of business interest 
expense not allowed as a deduction is treated as business interest 
expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $5 
of excess business interest expense from PRS ($5 from Year 1).
    (17) Example 17: Facts. A (an individual) and B (a corporation) own 
all of the interests in partnership PRS. At the beginning of Year 1, A 
and B each have $100 section 704(b) capital account and $100 of basis 
in 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)(17)(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

[[Page 56797]]

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 2 to Paragraph (o)(17)(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.

                                         Table 3 to Paragraph (o)(17)(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 4 to Paragraph (o)(17)(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 5 to Paragraph (o)(17)(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).

[[Page 56798]]



                                        Table 6 to Paragraph (o)(17)(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)(17)(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)(17)(ix) and (x) 
of this section are as follows.

                                      Table 7 to Paragraph (o)(17)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
ATIC excess.....................................................             $10              $0             $10
ATIC deficit....................................................               0              20              20
----------------------------------------------------------------------------------------------------------------

    (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 8 to Paragraph (o)(17)(ix)
----------------------------------------------------------------------------------------------------------------
                                                                         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 9 to Paragraph (o)(17)(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). As a result of its allocations from PRS, A 
increases its section 704(b) capital account and basis in PRS by $80 to 
$180. As a result of its allocations from PRS, B decreases its capital 
account and basis in PRS by $20 to $80.

                                        Table 10 to Paragraph (o)(17)(xi)
----------------------------------------------------------------------------------------------------------------
                                                                         A               B             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................................................             $30             $20             $50

[[Page 56799]]

 
EBIE allocated..................................................               0              10              10
ETI allocated...................................................               0               0               0
EBII allocated..................................................               0               0               0
----------------------------------------------------------------------------------------------------------------

    (18) Example 18: 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 11 to Paragraph (o)(18)(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).

                                        Table 12 to Paragraph (o)(18)(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 13 to Paragraph (o)(18)(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

[[Page 56800]]

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 14 to Paragraph (o)(18)(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 15 to Paragraph (o)(18)(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.........................
----------------------------------------------------------------------------------------------------------------


                                        Table 16 to Paragraph (o)(18)(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 17 to Paragraph (o)(18)(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.................................
----------------------------------------------------------------------------------------------------------------


[[Page 56801]]

    (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)(18)(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)(18)(ix) and (x) 
of this section are as follows.

                                      Table 18 to Paragraph (o)(18)(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 19 to Paragraph (o)(18)(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 20 to Paragraph (o)(18)(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
----------------------------------------------------------------------------------------------------------------

    (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 $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. 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 21 to Paragraph (o)(18)(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
----------------------------------------------------------------------------------------------------------------

    (19) Example 19: 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

[[Page 56802]]

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 22 to Paragraph (o)(19)(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 23 to Paragraph (o)(19)(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 24 to Paragraph (o)(19)(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
----------------------------------------------------------------------------------------------------------------

    (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.

[[Page 56803]]



                                        Table 25 to Paragraph (o)(19)(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 26 to Paragraph (o)(19)(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 27 to Paragraph (o)(19)(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 paragraphs (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 30 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.

                                      Table 28 to Paragraph (o)(19)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI--Final allocable ATI)...              $0             $50              $0             N/A
Multiplied by 30 percent........................             30%             30%             30%             N/A
= Priority amount...............................              $0             $15              $0             $15
----------------------------------------------------------------------------------------------------------------


[[Page 56804]]


                                      Table 29 to Paragraph (o)(19)(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 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 30 to Paragraph (o)(19)(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)(1) 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.
    (2) In sum, the correct amounts to be used in paragraphs 
(o)(19)(ix) and (x) of this section are as follows.

                                    Table 31 to Paragraph (o)(19)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
                                                         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 32 to Paragraph (o)(19)(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).

                                        Table 33 to Paragraph (o)(19)(xi)
----------------------------------------------------------------------------------------------------------------
                                                         A               B               C             Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE..................................              $0             $25              $5             $30
EBIE allocated..................................               0               0              20              20
ETI allocated...................................               0               0               0               0

[[Page 56805]]

 
EBII allocated..................................               0               0               0               0
----------------------------------------------------------------------------------------------------------------

    (20) Example 20: 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 x 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 34 to Paragraph (o)(20)(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 35 to Paragraph (o)(20)(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 36 to Paragraph (o)(20)(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

[[Page 56806]]

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 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 37 to Paragraph (o)(20)(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 38 to Paragraph (o)(20)(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 39 to Paragraph (o)(20)(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 30 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

[[Page 56807]]

than the total ATIC excess under paragraph (f)(2)(vii) of this section 
($10), PRS must perform the adjustments described in paragraph 
(f)(2)(viii)(D) of this section.

                                      Table 40 to Paragraph (o)(20)(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%             30%             30%             30%             N/A
= Priority amount...............               0              20              80               0            $100
----------------------------------------------------------------------------------------------------------------


                                      Table 41 to Paragraph (o)(20)(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 
will 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 
will 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 42 to Paragraph (o)(20)(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 43 to Paragraph (o)(20)(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 paragraphs 
(o)(20)(ix) and (x) of this section are as follows.

[[Page 56808]]



                                    Table 44 to Paragraph (o)(20)(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               0             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 
($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 45 to Paragraph (o)(20)(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 46 to Paragraph (o)(20)(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
----------------------------------------------------------------------------------------------------------------

    (21) Example 21: 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 47 to Paragraph (o)(21)(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

[[Page 56809]]

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 48 to Paragraph (o)(21)(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........
----------------------------------------------------------------------------------------------------------------

    (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 49 to Paragraph (o)(21)(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 50 to Paragraph (o)(21)(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 51 to Paragraph (o)(21)(vi)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI..........             $50             $50            $400              $0            $500

[[Page 56810]]

 
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 52 to Paragraph (o)(21)(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.
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 
30 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 53 to Paragraph (o)(21)(viii)(B)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI-Final                 $0             $30            $240              $0             N/A
 allocable ATI).................
Multiplied by 30 percent........             30%             30%             30%             30%             N/A
= Priority amount...............              $0              $9             $72              $0             $81
----------------------------------------------------------------------------------------------------------------


                                      Table 54 to Paragraph (o)(21)(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.........................
----------------------------------------------------------------------------------------------------------------


[[Page 56811]]

    (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 
will 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 will 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 55 to Paragraph (o)(21)(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........................
----------------------------------------------------------------------------------------------------------------


                                    Table 56 to Paragraph (o)(21)(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 paragraphs 
(o)(21)(ix) and (x) of this section are as follows.

                                    Table 57 to Paragraph (o)(21)(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 58 to Paragraph (o)(21)(x)
----------------------------------------------------------------------------------------------------------------
                                         A               B               C               D             Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit....................              $0          $43.33              $0             N/A             N/A

[[Page 56812]]

 
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 59 to Paragraph (o)(21)(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
----------------------------------------------------------------------------------------------------------------

    (22) Example 22--(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 nonseparately 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).
    (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.
    (23) Example 23--(i) Facts. The facts are the same as in Example 22 
in paragraph (o)(22)(i) 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 nonseparately 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)(17).
    (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.

[[Page 56813]]

    (p) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.


Sec.  1.163(j)-7   Application of the section 163(j) limitation to 
foreign corporations and United States shareholders.

    (a) Overview. This section provides rules for the application of 
section 163(j) to relevant foreign corporations with shareholders that 
are United States persons. Paragraph (b) of this section describes the 
general rule regarding the application of section 163(j) to relevant 
foreign corporations. Paragraphs (c) through (f) of this section are 
reserved. Paragraph (g) of this section provides rules concerning the 
computation of ATI of a relevant foreign corporation. Paragraphs (h) 
through (k) of this section are reserved.
    (b) General rule regarding the application of section 163(j) to 
relevant foreign corporations. Except as otherwise provided in this 
section, section 163(j) and the section 163(j) regulations apply to 
determine the deductibility of a relevant foreign corporation's 
business interest expense for purposes of computing its taxable income 
for U.S. income tax purposes (if any) 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. See also Sec.  1.952-2. If a relevant foreign 
corporation is a direct or indirect partner in a partnership, see Sec.  
1.163(j)-6 (concerning the application of section 163(j) to 
partnerships).
    (c)-(f) [Reserved]
    (g) Rules concerning the computation of adjusted taxable income of 
a relevant foreign corporation--(1) Tentative taxable income. For 
purposes of computing the tentative taxable income of a relevant 
foreign corporation for a taxable year, the relevant foreign 
corporation's gross income and allowable deductions are determined 
under the principles of Sec.  1.952-2 or under the rules of section 882 
for determining income that is, or deductions that are allocable to, 
effectively connected income, as applicable.
    (2) Treatment of certain dividends. For purposes of computing the 
ATI of a relevant foreign corporation 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 tentative taxable income.
    (h)-(l) [Reserved]
    (m) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.


Sec.  1.163(j)-8.   [Reserved]


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

    (a) Overview. The limitation in section 163(j) applies to business 
interest, which is defined under section 163(j)(5) as interest properly 
allocable to a trade or business. The term trade or business does not 
include any electing real property trade or business or any electing 
farming business. See section 163(j)(7). This section provides the 
rules and procedures for taxpayers to follow in making an election 
under section 163(j)(7)(B) for a trade or business to be an electing 
real property trade or business and an election under section 
163(j)(7)(C) for a trade or business to be an electing farming 
business.
    (b) Availability of election--(1) In general. An election under 
section 163(j)(7)(B) for a real property trade or business to be an 
electing real property trade or business is available to any trade or 
business that is described in Sec.  1.163(j)-1(b)(14)(i), (ii), or 
(iii), and an election under section 163(j)(7)(C) for a farming 
business to be an electing farming business is available to any trade 
or business that is described in Sec.  1.163(j)-1(b)(13)(i), (ii), or 
(iii).
    (2) Special rules--(i) Exempt small businesses. An election 
described in paragraph (b)(1) of this section is available regardless 
of whether the real property trade or business or farming business 
making the election also meets the requirements of the small business 
exemption in section 163(j)(3) and Sec.  1.163(j)-2(d). See paragraph 
(c)(2) of this section for the effect of the election relating to 
depreciation.
    (ii) Section 162 trade or business not required for electing real 
property trade or business. An election described in paragraph (b)(1) 
of this section to be an electing real property trade or business is 
available regardless of whether the trade or business with respect to 
which the election is made is a trade or business under section 162. 
For example, a taxpayer engaged in activities described in section 
469(c)(7)(C) and Sec.  1.469-9(b)(2), as required in Sec.  1.163(j)-
1(b)(14)(i), may make an election for a trade or business to be an 
electing real property trade or business, regardless of whether its 
activities rise to the level of a section 162 trade or business.
    (c) 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. 
See paragraph (e) of this section for terminations of elections.
    (2) Irrevocability. An election under this section is irrevocable.
    (3) Depreciation. Taxpayers making an election under this section 
are required to use the alternative depreciation system for certain 
types of property under section 163(j)(11) and cannot claim the 
additional first-year depreciation deduction under section 168(k) for 
those types of property.
    (d) Time and manner of making election--(1) In general. Subject to 
paragraph (f) 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:

[[Page 56814]]

    (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 
sufficient to demonstrate qualification for an election under this 
section, 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 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 for a 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.
    (e) 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 
(e), 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 (e), the 
term related party means any person who bears a relationship to the 
taxpayer which is described in 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 (e)(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.
    (f) 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 (d) 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 (e) 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).
    (g) Examples. The examples in this paragraph (g) illustrate the 
application of this section. Unless otherwise indicated, 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. For the taxable year 
ending December 31, 2021, D, a sole proprietor, owned and operated a 
dairy farm and an orchard as separate farming businesses described in 
section 263A(e)(4). D filed an original Federal income tax return for 
the 2021 taxable year on August 1, 2022, and included with the return 
an election statement meeting the requirements of paragraph (d)(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, 2023, 
D sold some but not all or substantially all of the assets from D's 
dairy farm business to D's 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 2021 taxable year and subsequent years. D's 
dairy farm business is an excepted trade or business because D made the 
election with D's timely filed Federal income tax return. D's orchard 
business is a non-excepted trade or business, because D did not make an 
election for the orchard business to be an excepted trade or business. 
The sale of some but not all or substantially all of the assets from 
D's dairy farm business does not affect D's election under this 
section.
    (2) Example 2: Availability of election--(i) Facts. E, an 
individual, operates a dairy business that is a farming business under 
section 263A and also owns real property that is not part of E's dairy 
business that E leases to an unrelated party through a triple net 
lease. E's average gross receipts, excluding inherently personal 
amounts, for the three years prior to 2021 are approximately $25 
million, but E is unsure of the exact amount.
    (ii) Analysis. Under paragraph (b)(2)(i) of this section, E may 
make an election under this section for the dairy business to be an 
electing farming business, even though E is unsure whether the small 
business exemption of Sec.  1.163(j)-2(d) applies. Additionally, under 
paragraph (b)(2)(ii) of this section, assuming the requirements of 
section 163(j)(7)(C) and this section are otherwise satisfied, E may 
make an election under this section for its triple net lease property 
to be an electing real property trade or business, even though E may 
not be engaged in a trade or business under section 162 with respect to 
the real property.
    (3) Example 3: 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 2021 
Federal income tax return. On March 1, 2022, 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, 2022, under paragraph (e)(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.
    (4) Example 4: Anti-abuse rule--(i) Facts. The facts are the same 
as in Example 3 in paragraph (g)(3)(i) of this section, except that X 
re-started its previous real property trade or business on February 1, 
2023, when X reacquired substantially all of the assets that X had sold 
on March 1, 2022.
    (ii) Analysis. X's election under this section terminated on March, 
1, 2022, under paragraph (e)(1) of this section. On February 1, 2023, 
X's election was reinstated under paragraph (e)(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.

[[Page 56815]]

    (5) Example 5: 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 2021 
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, 
2022, X transferred all of its assets to Y in a transaction described 
in section 368(a)(1)(D). After the transfer, Y continues to operate the 
farming trade or business acquired from X.
    (ii) Analysis. Under paragraph (e)(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.
    (6) Example 6: Trade or business merged after acquisition--(i) 
Facts. The facts are the same as in Example 5 in paragraph (g)(5)(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.
    (h) Safe harbor for REITs--(1) In general. If a REIT holds real 
property, as defined in Sec.  1.856-10, interests in one or more 
partnerships directly or indirectly holding real property (through 
interests in other partnerships or shares in other REITs), as defined 
in Sec.  1.856-10, or shares in one or more other REITs directly or 
indirectly holding real property (through interests in partnerships or 
shares in other REITs), 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 (h)(2) or (3) of this section.
    (2) REITs that do not significantly invest in real property 
financing assets. If a REIT makes the election under paragraph (h)(1) 
of this section and the value of the REIT's real property financing 
assets, as defined in paragraphs (h)(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 the election under paragraph (h)(1) of this 
section and the value of the REIT's real property financing assets, as 
defined in paragraphs (h)(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 the 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 (h)(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 (h)(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 (h)(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. However, no portion of the adjusted basis of the REIT's 
interest in the partnership is allocated to a non-excepted trade or 
business if the partnership makes an election under paragraph (h)(7) of 
this section and if all of the partnership's assets are treated as 
assets of an excepted trade or business under paragraph (h)(2) of this 
section.
    (iii) Shares in other REITs--(A) In general. If a REIT (shareholder 
REIT) described in paragraph (h)(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), as modified by paragraph (h)(4)(ii) of 
this section, applies to the assets of the other REIT (as if the other 
REIT were a partnership) in determining the portion of shareholder 
REIT's adjusted basis in the shares of the other REIT that 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 (h)(2) of this section.
    (B) Information necessary. If shareholder REIT does not receive, 
either directly from the other REIT or indirectly through the analysis 
of an applicable financial statement (within the meaning of section 
451(b)(3)) of the other REIT, the information necessary to determine 
whether and to what extent 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).
    (iv) Tiered entities. In applying Sec.  1.163(j)-10(c)(5)(ii)(E), 
the rules in paragraphs (h)(4)(ii) and (h)(4)(iii)(A) and (B) of this 
section apply to any partnerships and other REITs within the tier.
    (5) Value of shares in other REITs--(i) In general. If a REIT 
(shareholder REIT) holds shares in another REIT, then solely for 
purposes of applying the value tests under paragraphs (h)(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 (h)(2) of this section.
    (ii) Information necessary. If shareholder REIT does not receive, 
either directly from the other REIT or indirectly through the analysis 
of an applicable financial statement (within the meaning of section 
451(b)(3)) of the other REIT, the information necessary to determine 
whether and to what extent 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 (h)(2) and (3) of this section.
    (iii) Tiered REITs. The rules in paragraphs (h)(5)(i) and (ii) of 
this section apply successively to the extent that the other REIT, and 
any other REIT in the tier, holds shares in another REIT.

[[Page 56816]]

    (6) Real property financing assets. For purposes of this paragraph 
(h), real property financing assets include interests, including 
participation interests, in the following: Mortgages, deeds of trust, 
and installment land contracts; mortgage pass-through 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.
    (7) Application of safe harbor for partnerships controlled by 
REITs. A partnership is eligible to make the election under paragraph 
(h)(1) of this section if one or more REITs own directly or indirectly 
at least 50 percent of the partnership's capital and profits, the 
partnership meets the requirements of section 856(c)(2), (3), and (4) 
as if the partnership were a REIT, and the partnership satisfies the 
requirements described in paragraph (h)(1) of this section as if the 
partnership were a REIT. The portion of the partnership's assets 
eligible for this election is determined under paragraph (h)(2) or (3) 
of this section, treating the partnership as if it were a REIT.
    (8) REITs or partnerships controlled by REITs that do not apply the 
safe harbor. A REIT or a partnership that is eligible but chooses not 
to apply the safe harbor provisions of paragraph (h)(1) or (7) of this 
section, respectively, may still elect, under paragraph (b)(1) of this 
section, for one or more of its trades or businesses to be an electing 
real property trade or business, provided that such trade or business 
is otherwise eligible to elect under paragraph (b)(1) of this section. 
A REIT or partnership that makes the election under paragraph (b)(1) of 
this section without utilizing the safe harbor provisions of paragraph 
(h) of this section may not rely on any portion of paragraphs (h)(1) 
through (7) of this section.
    (i) [Reserved]
    (j) Special anti-abuse rule for certain real property trades or 
businesses--(1) In general. Except as provided in paragraph (j)(2) of 
this section, a trade or business (lessor) 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 rental value, of the real 
property used in the business is leased to a trade or business (lessee) 
under common control with the lessor, regardless of whether the 
arrangement is pursuant to a written lease or pursuant to a service 
contract or another agreement that is not denominated as a lease. For 
purposes of this paragraph (j), fair market rental value is the amount 
of rent that a prospective lessee that is unrelated to the lessor would 
be willing to pay for a rental interest in real property, taking into 
account the geographic location, size, and type of the real property. 
For purposes of this paragraph (j), 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) Exceptions--(i) De minimis exception. The limitation in 
paragraph (j)(1) of this section does not apply, and the lessor is 
eligible to make an election under paragraph (b)(1) of this section, if 
the lessor leases, regardless of whether the arrangement is pursuant to 
a written lease or pursuant to a service contract or another agreement 
that is not denominated as a lease, at least 90 percent of the lessor's 
real property, determined by fair market rental value, to one or more 
of the following:
    (A) A party not under common control with the lessor or lessee;
    (B) A party under common control with the lessor or lessee that has 
made an election described in paragraph (b)(1) of this section for a 
trade or business to be an electing real property trade or business or 
electing farming business, but only to the extent that the real 
property is used as part of its electing real property trade or 
business or electing farming business; or
    (C) A party under common control with the lessor or lessee that is 
an excepted regulated utility trade or business, but only to the extent 
that the real property is used as part of its excepted regulated 
utility trade or business.
    (ii) Look-through exception. If the de minimis exception in 
paragraph (j)(2)(i) of this section does not apply because less than 90 
percent of the lessor's real property is leased to parties described in 
paragraphs (j)(2)(i)(A), (B), and (C), the lessor is eligible to make 
the election under paragraph (b)(1) of this section to the extent that 
the lessor leases the real property to parties described in paragraph 
(j)(2)(A), (B), or (C), and to the extent that the lessee subleases (or 
lessees ultimately sublease) the real property to:
    (A) A party not under common control with the lessor or lessee;
    (B) A party under common control with the lessor or lessee that has 
made an election described in paragraph (b)(1) of this section for a 
trade or business to be an electing real property trade or business or 
electing farming business to the extent that the real property is used 
as part of its electing real property trade or business or electing 
farming business; or
    (C) A party under common control with the lessor or lessee that is 
an excepted regulated utility trade or business to the extent that the 
real property is used as part of its excepted regulated utility trade 
or business.
    (iii) Inapplicability of exceptions to consolidated groups. The 
exceptions in paragraphs (j)(2)(i) and (ii) of this section do not 
apply when the lessor and lessee are members of the same consolidated 
group.
    (iv) Exception for certain REITs. The special anti-abuse rule in 
paragraph (j)(1) of this section does not apply to REITs or to 
partnerships making an election under paragraph (h)(7) of this section 
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).
    (3) Allocations. See Sec.  1.163(j)-10(c)(3)(iii)(D) for rules 
related to the allocation of the basis of assets used in lessor trades 
or businesses described in paragraphs (j)(1) and (j)(2)(i) of this 
section.
    (4) Examples. The examples in this paragraph (j)(4) illustrate the 
application of paragraphs (j)(1), (2), and (3) of this section. Unless 
otherwise indicated, the parties are all domestic entities and are not 
members of a single consolidated group within the meaning of Sec.  
1.1502-1(h).
    (i) Example 1: Related party lease of hotel--(A) Facts. X and Y are 
under common control, as defined in paragraph (j)(1) of this section. X 
owns one piece of real property, a hotel, that X leases to Y. Y 
operates the hotel and provides hotel rooms and associated amenities to 
third party guests of the hotel. The form of the arrangement with third 
party hotel guests is a license to use rooms in the hotel and 
associated amenities. Y is a real property trade or

[[Page 56817]]

business that has made an election under paragraph (b)(1) of this 
section.
    (B) Analysis. Because X leases at least 80 percent of X's real 
property to a party under common control, X is subject to the anti-
abuse rule in paragraph (j)(1) of this section. However, under the de 
minimis exception under paragraph (j)(2)(i) of this section, 100 
percent of the fair market rental value of the building is leased to a 
party under common control that has made an election to be an electing 
real property trade or business. Accordingly, X is eligible to make the 
election described in paragraph (b)(1) of this section for its entire 
trade or business.
    (ii) Example 2--(A) Facts. The facts are the same as in Example 1 
in paragraph (j)(4)(i)(A) of this section, except that Y has not made 
an election under paragraph (b)(1) of this section, and is not 
otherwise using the real property in an excepted trade or business.
    (B) Analysis. Because X leases at least 80 percent of X's real 
property, determined by fair market rental value, to Y, a party under 
common control, X is subject to the anti-abuse rule in paragraph (j)(1) 
of this section. X is not eligible for the de minimis exception under 
paragraph (j)(2)(i) of this section because X does not lease at least 
90 percent of its real property to a party under common control, as 
defined in paragraph (j)(1) of this section, such as Y, and Y is not 
using the property in an otherwise excepted trade or business. However, 
X is eligible for the look-through exception under paragraph (j)(2)(ii) 
of this section because X leases 100 percent of its real property to Y, 
a party that is under common control, and Y subleases 100 percent of 
the real property to parties that are not under common control with X 
or Y. The fact that the license provided to hotel guests is not 
denominated as a lease does not prevent these licenses from being 
treated as a lease for purposes of paragraph (j) of this section. 
Accordingly, under the look-through exception under paragraph 
(j)(2)(ii) of this section, X is eligible to make the election 
described in paragraph (b)(1) of this section with regard to its entire 
trade or business.
    (iii) Example 3: Sublease to related party and unrelated third 
party--(A) Facts. X owns one piece of real property that X leases to Y, 
a party under common control, as defined in paragraph (j)(1) of this 
section. Y does not operate an excepted trade or business. Y subleases 
80 percent of the real property, determined by the fair market rental 
value, to a party under common control with Y that does not operate an 
excepted trade or business and 20 percent of the real property, 
determined by the fair market rental value, to an unrelated third 
party.
    (B) Analysis. Because X leases at least 80 percent of X's real 
property, determined by fair market rental value, to a party under 
common control, X is subject to the anti-abuse rule in paragraph (j)(1) 
of this section. X is not eligible for the de minimis exception in 
paragraph (j)(2)(i) of this section because X is not leasing at least 
90 percent of the real property, determined by fair market rental 
value, to a party under common control that operates an excepted trade 
or business and/or unrelated parties. Under the look-through exception 
under paragraph (j)(2)(ii) of this section, X is eligible to make the 
election described in paragraph (b)(1) of this section with respect to 
the 20 percent of the fair market rental value of the real property 
subleased to an unrelated party because X is treated as directly 
leasing this portion to an unrelated party. X is not eligible to make 
the election described in paragraph (b)(1) of this section with respect 
to the 80 percent of the building subleased to a party under common 
control because X is still treated as directly leasing this portion to 
a related party. Under Sec.  1.163(j)-10(c)(3)(iii)(D), X must allocate 
80 percent of the basis in the real property as a non-excepted trade or 
business and 20 percent of the basis in the real property as an 
excepted trade or business.
    (iv) Example 4: Multiple subleases--(A) Facts. X owns a building 
that X leases to Y, a party under common control as defined in 
paragraph (j)(1) of this section. Y does not operate an excepted trade 
or business. Y subleases 80 percent of the building, determined by fair 
market rental value, to Z, a party under common control with both X and 
Y. Y subleases the remaining 20 percent of the building, determined by 
fair market rental value, to unrelated parties. Z subleases 50 percent 
of its leasehold interest, determined by fair market rental value, to 
parties unrelated to X, Y and Z, and uses the remaining leasehold 
interest in its retail business. Z does not operate an excepted trade 
or business.
    (B) Analysis. Because X leases at least 80 percent of X's real 
property, determined by fair market rental value, to a party under 
common control, X is subject to the anti-abuse rule in paragraph (j)(1) 
of this section. X is not eligible for the de minimis exception in 
paragraph (j)(2)(i) because X is not leasing at least 90 percent of the 
building, determined by fair market rental value, to a party under 
common control that operates an excepted trade or business and/or 
unrelated parties. Under the look-through exception under paragraph 
(j)(2)(ii) of this section, X is eligible to make the election 
described in paragraph (b)(1) of this section with respect to the 60 
percent of the building that is subleased to unrelated parties, 
determined by adding 40 percent (50 percent of the 80 percent leasehold 
interest) from Z's sublease to an unrelated party and 20 percent from 
Y's sublease to unrelated parties (40 + 20). X is not eligible to make 
the election described in paragraph (b)(1) of this section with respect 
to the 40 percent of the building subleased to Z, because Z is a 
related party that does not operate an excepted trade or business.
    (v) Example 5: Lessee's Trade or Business--(A) Facts. X owns a 
building that X leases to W, a party under common control as defined in 
paragraph (j)(1) of this section. W operates the building as a widget 
manufacturing plant and does not sublease any portion of the building.
    (B) Analysis. X is not eligible to make the election described in 
paragraph (b)(1) of this section because X leases the entire building 
to a party under common control. X is not eligible for the de minimis 
exception in paragraph (j)(2)(i) of this section because X is not 
leasing at least 90 percent of the real property to a party under 
common control that operates an excepted trade or business and/or 
unrelated parties. W's trade or business cannot be an electing real 
property trade or business. X is not eligible for the look-through 
exception under paragraph (j)(2)(ii) of this section because W is not 
subleasing any part of the building.
    (k) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.

[[Page 56818]]

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. Except as provided in 
Sec.  1.163(j)-6(m) or Sec.  1.163(j)-9(h), 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 businesses is not subject to the section 163(j) 
limitation. 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 separate 
trade or business to the extent those activities involve the provision 
of real property, goods, or services to a trade or business of the 
taxpayer (or, if the taxpayer is a member of a consolidated group, the 
consolidated group). For example, if a taxpayer engaged in a 
manufacturing trade or business has in-house legal personnel that 
provide legal services solely with respect to the taxpayer's 
manufacturing business, the taxpayer is not treated as also engaged in 
the trade or business of providing legal services. Similarly, if the 
taxpayer described in the previous sentence constructs or acquires real 
property solely for use by the taxpayer's manufacturing business, the 
taxpayer is not treated as also engaged in a real property trade or 
business.
    (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, if applicable, 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 the section 163(j) limitation and 
to determine which items are included or excluded in computing its 
section 163(j) limitation.
    (ii) Treatment of investment interest, investment income, 
investment expenses, and certain other tax items of a partnership with 
a C corporation or tax-exempt corporation as a partner. For rules 
governing the treatment of investment interest, investment income, 
investment expenses, and certain other separately stated tax items 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(k).
    (3) Application of allocation rules to foreign corporations and 
foreign partnerships. The rules of this section apply to foreign 
corporations and foreign partnerships.
    (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 regulations in this 
part under section 163(j) of the Code 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 allocated to a trade or 
business based on the activities of the group as if the members of the 
group were divisions of a single corporation. 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 the section 
163(j) limitation), 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 is 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 tax-exempt organizations, section 
512 and the regulations in this part under section 512 of the Code 
determine the rules for allocating all income and expenses among 
multiple trades or businesses.

[[Page 56819]]

    (6) Application of allocation rules to disallowed disqualified 
interest. A taxpayer may apply the allocation rules of this section to 
disallowed disqualified interest by either:
    (i) Applying the allocation rules of this section to all of the 
taxpayer's disallowed disqualified interest in the taxable year(s) in 
which the disallowed disqualified interest was paid or accrued (the 
historical approach); or
    (ii) Treating all of the taxpayer's disallowed disqualified 
interest as if it were paid or accrued in the taxpayer's first taxable 
year beginning after December 31, 2017 (the effective date approach).
    (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 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.
    (iii) Example 3: Intercompany sale of natural gas--(A) Facts. S is 
a member of a consolidated group of which P is the common parent. S 
drills for natural gas and is not an excepted regulated utility trade 
or business. S sells most of its natural gas production to P, which 
produces electricity at its natural gas-fired power plants, and S sells 
the rest of its natural gas production to third parties at market 
rates. P is an excepted regulated utility trade or business to the 
extent that it is engaged in a trade or business described in Sec.  
1.163(j)-1(b)(15)(i).
    (B) Analysis. Intercompany transactions are disregarded for 
purposes of this section. As a result, the intercompany sales of 
natural gas by S to P are disregarded. Moreover, the assets of S and P 
are allocated between the excepted and non-excepted trades or 
businesses of the P group based on the assets used in each trade or 
business. Assets of S may be allocated to the P group's excepted trade 
or business to the extent those assets are used in the trade or 
business of the furnishing or sale of electrical energy. Likewise, 
assets of P may be allocated to the P group's non-excepted trade or 
business to the extent those assets are used in the trade or business 
of natural gas production.
    (iv) Example 4: Disallowed disqualified interest--(A) Facts. S is a 
member of a consolidated group of which P is the common parent. P and S 
are the only members of an affiliated group under old section 
163(j)(6)(C). S operates a farm equipment leasing business (Business X) 
that is not an excepted trade or business. P is engaged in an electing 
farming business (Business Y). Entering its first taxable year 
beginning after December 31, 2017, the P group has disallowed 
disqualified interest of $120x, all of which the P group paid or 
accrued in earlier taxable years in which it only operated Business X. 
The P group also incurs $100x of interest expense during its 2018 
taxable year, of which $25x (25 percent of $100x) is business interest 
expense properly allocable to Business X and $75x (75 percent of $100x) 
is properly allocable to Business Y under paragraph (c) of this 
section.
    (B) Analysis. Under paragraph (a)(6) of this section, the P group 
may allocate disallowed disqualified interest to Business X and 
Business Y by either applying the allocation rules of this section in 
the taxable years in which the disallowed disqualified interest was 
paid or accrued (the historical approach) or by treating such interest 
as though it were paid or accrued in the P group's first taxable year 
beginning after December 31, 2017 (the effective date approach). 
Accordingly, if the P group chooses to rely on the historical approach, 
it allocates all $120x of disallowed disqualified interest to Business 
X (a non-excepted trade or business), and all $120x of disallowed 
disqualified interest is subject to the section 163(j) limitation. If, 
instead, the P group chooses to rely on the effective date approach, it 
allocates its $120x of disallowed disqualified interest in the same 
proportion as its $100x of business interest expense that was paid or 
accrued in its 2018 taxable year. Of the $120x of disallowed 
disqualified interest, $30x (25 percent of $120x) is allocated to 
Business X and $90x (75 percent of $120x) is allocated to Business Y. 
The $90x of disallowed disqualified interest that is properly allocable 
to Business Y (an excepted trade or business) is not subject to the 
section 163(j) limitation.
    (b) Allocation of tax items other than interest expense and 
interest income--(1) In general. Except as otherwise provided in Sec.  
1.163(j)-6(m) or Sec.  1.163(j)-9(h), 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 
satisfies the minimum ownership threshold in paragraph (c)(7) of this 
section, then, solely for purposes of allocating amounts received as a 
dividend during the taxable year to excepted or non-excepted trades or

[[Page 56820]]

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 satisfy the minimum 
ownership threshold in paragraph (c)(7) of this section, 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. (A) 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 C 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 C 
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 gain or loss from the disposition is 
treated as allocable to either excepted or non-excepted trades or 
businesses, respectively.
    (B) 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.
    (C) 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. However, if 
at least 90 percent of the partnership's or S 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 gain or loss from the disposition is treated as allocable to 
either excepted or non-excepted trades or businesses, respectively. 
This rule also applies to tiered passthrough entities 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. For 
purposes of this paragraph, a 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.
    (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 based on 
the gross income of each trade or business.
    (6) Treatment of investment items and certain other items of a 
partnership with a C corporation partner. Any investment income, 
investment expense, or other item 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, except that any item with respect to 
property or activities for which an election has been made by the 
partnership under Sec.  1.163(j)-9(b) is treated as properly allocable 
to an excepted trade or business. See, for example, an election for 
activities described in Sec.  1.163(j)-9(b)(2)(ii) or an election under 
Sec.  1.163(j)-9(h).
    (7) Examples: Allocation of income and expense. The following 
examples illustrate the principles of this paragraph (b):
    (i) Example 1: Allocation of income and expense between excepted 
and non-excepted trades or businesses--(A) 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.

[[Page 56821]]

    (B) 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.
    (ii) Example 2: Allocation of partnership items from investment 
activity--(A) Facts. U, a domestic C corporation, directly conducts an 
electing real property trade or business. U also has an interest in 
PRS, a partnership that holds real property for investment. PRS's 
investment in real property is not a trade or business under section 
162 or a real property trade or business under section 469. During the 
taxable year, PRS sells some of its real property to third parties and 
allocates $80x of income to U from these sales. In addition, PRS incurs 
deductible expenses related to its investment in real property and 
allocates $9x of these deductible expenses to U.
    (B) Analysis. Under paragraph (b)(6) of this section, any 
investment income or investment expense that a partnership receives, 
pays, or accrues and that is treated as properly allocable to a trade 
or business of a C corporation partner is treated as properly allocable 
to a non-excepted trade or business of the C corporation partner. 
Because PRS generates its income and expense from investment activity 
that is not a trade or business under section 162 or a real property 
trade or business under section 469, U's allocation of $80x of income 
and $9x of deductible expense from PRS is treated as properly allocable 
to a non-excepted trade or business.
    (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, Sec.  1.163(j)-
6(m), or Sec.  1.163(j)-9(h), 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 at least 90 percent 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:
    (i) Facts. 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 in Year 1, 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 (which 
are non-excepted trades or businesses) in Year 1 is $200x.
    (ii) Analysis. $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 the 
section 163(j) limitation. The remaining $20x of T's interest expense 
is business interest expense for Year 1 that is subject to the section 
163(j) limitation.
    (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. A taxpayer is not required 
to use the same allocation methodology for each type of asset used in a 
trade a business. Instead, a taxpayer may use different allocation 
methodologies for different types of assets used in a 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

[[Page 56822]]

section, a taxpayer must maintain the same allocation methodology for a 
period of at least five taxable years.
    (2) Consent to change allocation methodology. If a taxpayer has 
used the same allocation methodology for at least five taxable years, 
the taxpayers may change its method of allocation under paragraphs 
(c)(3)(i) and (ii) of this section without the consent of the 
Commissioner. If a taxpayer has used the same allocation methodology 
for less than five taxable years, and if the 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 only 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 will be 
granted only in extraordinary circumstances.
    (B) De minimis exception. If at least 90 percent 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. This rule 
applies before the application of paragraph (c)(1)(ii) of this section.
    (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, a taxpayer is engaged 
in an excepted regulated utility trade or business only to the extent 
that the taxpayer is engaged in an excepted regulated utility trade or 
business described in Sec.  1.163(j)-1(b)(15)(i)(A), (B), or (C), and 
any remaining utility trade or business is a non-excepted trade or 
business. Thus, for example, electricity sold by a utility trade or 
business at rates not established or approved by an entity described in 
Sec.  1.163(j)-1(b)(15)(i)(A)(2) and not subject to an election under 
Sec.  1.163(j)-1(b)(15)(iii) 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 under this paragraph (c)(3) for 
allocating the taxpayer's basis in assets used in both the excepted and 
non-excepted trades or businesses of selling or furnishing the items 
described in Sec.  1.163(j)-1(b)(15)(i)(A)(1).
    (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 at least 90 percent 
of the items described in Sec.  1.163(j)-1(b)(15)(i)(A)(1) are 
furnished or sold by trades or businesses described in Sec.  1.163(j)-
1(b)(15)(i)(A), (B) or (C), 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. This rule applies 
before the application of paragraph (c)(3)(iii)(B) of this section.
    (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 megawatt-hours generated in the 
electricity generation trade or business is sold at rates negotiated 
with the purchaser, and with respect to which X filed a schedule of 
rates with a public utility commission. The public utility commission 
has the authority to take action on the filed schedule of rates, but if 
no action is taken, the rules governing the public utility commission 
explicitly state that the public utility commission is deemed to have 
approved the rates. The public utility has taken no action with respect 
to the negotiated rate. The remaining 20 percent of the megawatt-hours 
is sold on the wholesale market at rates not established or subject to 
approval by a regulator described in Sec.  1.163(j)-1(b)(15)(i)(A)(2). 
X has not made an election under Sec.  1.163(j)-1(b)(15)(iii). 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, 
because the rate for the sale of the electricity was subject to 
approval by a regulator described in Sec.  1.163(j)-1(b)(15)(i)(A)(2). 
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 the assets to non-excepted trades or businesses.
    (D) Special allocation rule for real property trades or businesses 
subject to special anti-abuse rule--(1) In general. In the case of a 
trade or business that leases real property subject to an arrangement 
described in Sec.  1.163(j)-9(j)(1), including trades or businesses to 
which the look-through exception in Sec.  1.163(j)-9(j)(2)(ii) applies, 
the taxpayer must allocate under this paragraph (c)(3) the basis of 
property used in both the excepted and non-excepted portions of its 
trade or business, as determined under Sec.  1.163(j)-9(j)(3).
    (2) Allocation methodology for real property. For purposes of this 
paragraph (c)(3)(iii)(D), a taxpayer must allocate the basis of real 
property leased under an arrangement described in Sec.  1.163(j)-
9(j)(1) or (j)(2)(i) between the excepted and non-excepted portions of 
the real property trade or business based on the relative fair market 
rental value of the real property that is attributable to the excepted 
and non-excepted portions of the trade or business, respectively.
    (3) Example. The following example illustrates the principles of 
this paragraph (c)(3)(iii)(D):
    (i) Facts. X and Y are domestic C corporations under common control 
within the meaning of section 267(b), but neither X nor Y are members 
of a consolidated group. The small business exemption in Sec.  
1.163(j)-2(d) does not apply to X or Y. X owns an office building and 
leases the entire building to Y. Y subleases 80 percent of the office 
building, measured by fair market rental value, to a related party. Y 
subleases the remaining 20 percent of the building to unrelated third 
parties. X also owns depreciable scaffolding equipment, which it uses 
to clean all of the building's windows as part of its leasing 
arrangement with Y.
    (ii) Analysis. Under Sec.  1.163(j)-9(j)(2)(ii), X is eligible to 
make an election for 20 percent of its business of leasing the office 
building to be an electing real property trade or business. Assuming X 
makes such an election, X must allocate the basis of assets used in 
both the excepted and non-excepted portions of its leasing trade or 
business under this paragraph (c). Under paragraph (c)(3)(iii)(D)(2) of 
this section, X must allocate the basis of the office building based on 
the relative fair market value attributable to the excepted and non-
excepted portions of its leasing business. Therefore, X must allocate 
20 percent of the basis of the

[[Page 56823]]

building to the excepted portion of its leasing business, and it must 
allocate the remaining 80 percent of the building to the non-excepted 
portion of its leasing business. Under paragraph (c)(3)(iii)(D)(2) of 
this section, X may use one of the allocation methods described in 
paragraph (c)(3)(ii) of this section to allocate the basis of its 
scaffolding equipment between the excepted and non-excepted portions of 
its leasing trade or business.
    (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)(19)) 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, 
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. A change to the 
alternative depreciation system should be determined in a manner 
similar to that in Sec.  1.168(i)-4(d)(4) or (d)(5)(ii)(B), as 
applicable.
    (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 a deduction is allowable under section 167 is determined in 
accordance with section 167(g). The adjusted basis of any intangible 
asset under this paragraph (c)(5)(i)(D) is determined before any 
application of the additional first-year depreciation deduction. 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 under this paragraph 
(c) until the building is placed in service. This rule does not apply 
to interests in a partnership or stock in a corporation.
    (F) Trusts established to fund specific liabilities. Trusts 
required to fund specific liabilities (for example, pension trusts, and 
nuclear decommissioning funds (including, but not limited to, those 
funds for which an election is made under section 468A)) 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 C 
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. If a partner elects or 
is required to apply the rules in this paragraph (c)(5)(ii)(A) to look 
through to a partnership's basis in the partnership's assets, the 
partner's basis in the partnership interest is adjusted to the extent 
of the partner's share of any adjustments to the basis of the 
partnership's assets required pursuant to the rules in paragraph 
(c)(5)(i) 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)(2) to look through to the partnership's 
basis in the partnership's assets. If a partner elects or is required 
to apply the rules in this paragraph (c)(5)(ii)(A)(2) to look through 
to a partnership's basis in the partnership's assets, the partner 
allocates the basis of its partnership interest between excepted and 
non-excepted trades or businesses based on the ratio in which the 
partner's share of the partnership's adjusted tax basis in its trade or 
business assets is allocated between excepted and non-excepted trade or 
business 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

[[Page 56824]]

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 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 a non-excepted trade or business of such partner. However, 
if the partnership made an election under Sec.  1.163(j)-9(b) or Sec.  
1.163(j)-9(h) with respect to an asset or activity, the assets (or 
assets related to such activities) are treated as properly allocable to 
an excepted trade or business of such partner. See, for example, an 
election under Sec.  1.163(j)-9(h) for an asset or an election under 
Sec.  1.163(j)-9(b) with respect to activities described in Sec.  
1.163(j)-9(b)(2)(ii). For 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; instead, such partner's adjusted 
basis in its partnership interest is decreased by that partner's share 
of the excess of the partnership's basis in those assets over the 
partnership's debt that is traced to such assets in accordance with 
Sec.  1.163-8T, and it is increased by that partner's share of the 
excess of the partnership's debt that is traced to such assets in 
accordance with Sec.  1.163-8T over the partnership's basis in those 
assets. For purposes of the preceding sentence, the partnership's asset 
basis in property not allocable to a trade or business is adjusted 
pursuant to the rules in paragraph (c)(5)(i) of this section. 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 domestic non-consolidated 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 for stock in a domestic non-
consolidated C corporation, and if dividends paid on such stock would 
not be included in the shareholder's investment income under section 
163(d)(4)(B), then, for purposes of determining the extent to which the 
shareholder's basis in the stock 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. If a shareholder 
does not satisfy the minimum ownership threshold in paragraph (c)(7) of 
this section for stock in a domestic non-consolidated C corporation, 
but the shareholder's direct and indirect interest in such corporation 
is greater than or equal to 80 percent by value, and if dividends paid 
on such stock would not be included in the shareholder's investment 
income under section 163(d)(4)(B), then, for purposes of determining 
the extent to which the shareholder's basis in the stock is allocable 
to an excepted or non-excepted trade or business, the shareholder may 
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. For purposes of the preceding sentence, indirect stock 
ownership is determined by applying the constructive ownership rules of 
section 318(a).
    (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 is 
ineligible to look through or chooses not to look through to a 
corporation's basis in its assets under 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 is 
ineligible to look through or chooses not to look through to a 
corporation's basis in its assets under 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.
    (iv) Use of inside basis for purposes of C corporation look-through 
rule. This paragraph (c)(5)(ii)(B)(2)(iv) applies if a shareholder 
meets the requirements to look through the stock of a domestic non-
consolidated C corporation under paragraph (c)(5)(ii)(B)(2)(i) of this 
section, determined without applying the constructive ownership rules 
of section 318(a). If this paragraph (c)(5)(ii)(B)(2)(iv) applies, then 
solely for purposes of allocating asset basis under paragraph 
(c)(5)(ii)(B)(2)(i) of this section, and except as otherwise provided 
in paragraph (c)(5)(ii)(D) of this section, the shareholder may look 
through to such shareholder's pro rata share of the C corporation's 
basis in its assets, taking into account the modifications in paragraph 
(c)(5)(i) of this section with respect to the C corporation's assets, 
and adjusted to the extent required under paragraph (d)(4) of this 
section (asset basis look-through approach). If a shareholder applies 
the asset basis look-through approach, it must do so for all domestic 
non-consolidated C corporations for which the shareholder is eligible 
to use this approach, and it must report its use of this approach on 
the information statement described in paragraph

[[Page 56825]]

(c)(6)(iii) of this section. The shareholder also must continue to use 
the asset basis look-through approach in all future taxable years in 
which the shareholder is eligible to use this approach.
    (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) 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).
    (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. For these purposes, indirect stock ownership is 
determined by applying the constructive ownership rules of section 
318(a).
    (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 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 relevant foreign corporations--(1) In general. The 
rules applicable to domestic non-consolidated C corporations in 
paragraph (c)(5)(ii)(B) of this section also apply to relevant foreign 
corporations (as defined in Sec.  1.163(j)-1(b)(33)).
    (2) Special rule for CFC utilities. Solely for purposes of applying 
the rules in paragraph (c)(5)(ii)(B) of this section, a utility trade 
or business conducted by an applicable CFC is treated as an excepted 
regulated utility trade or business, but only to the extent that the 
applicable CFC sells or furnishes the items described in Sec.  
1.163(j)-1(b)(15)(i)(A)(1) pursuant to rates established or approved by 
an entity described in Sec.  1.163(j)-1(b)(15)(i)(A)(2), a foreign 
government, a public service or public utility commission or other 
similar body of any foreign government, or the governing or ratemaking 
body of a foreign electric cooperative. For purposes of this paragraph 
(c)(5)(ii)(C)(2), the term foreign government means 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).
    (D) Inapplicability of look-through rule to partnerships or non-
consolidated C 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 C corporation that is 
eligible for the small business exemption under section 163(j)(3) and 
Sec.  1.163(j)-2(d)(1), unless the partnership, S corporation, or non-
consolidated C corporation elects under Sec.  1.163(j)-9 for a trade or 
business to be an electing real property trade or business or an 
electing farming business.
    (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 the last sentence of this paragraph (c)(5)(iii), 
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, a territory, a possession of the United States, the District of 
Columbia, or any political subdivision thereof 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). This paragraph (c)(5)(iii) does not apply to an entity 
that qualifies as a financial services entity as described in Sec.  
1.904-4(e)(3).
    (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, in the information statement required by 
paragraph (c)(6)(iii)(B) of this section, that the acquisition 
qualified for such an election and that, immediately before the 
acquisition, the acquired entity had a regulatory liability for 
deferred taxes recorded on its books with respect to property 
predominantly used in 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.

[[Page 56826]]

    (6) Determination dates; determination periods; reporting 
requirements--(i) Determination dates and determination periods--(A) 
Quarterly determination periods. For purposes of this section, and 
except as otherwise provided in paragraph (c)(6)(i)(B) 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.
    (B) Annual determination periods. If a taxpayer satisfies the 
requirements of the last sentence of this paragraph (c)(6)(i)(B), the 
taxpayer may allocate asset basis for a taxable year based on the 
average of adjusted asset basis at the beginning of the year and the 
end of the year (annual determination method). For these purposes, the 
term determination date means the last day of the taxpayer's taxable 
year, and the term determination period has the same meaning as 
provided in paragraph (c)(6)(i)(A) of this section. A taxpayer may use 
the annual determination method for a taxable year only if the taxpayer 
demonstrates that its total adjusted basis (as determined under 
paragraph (c)(5) of this section) at the end of the year in its assets 
used in its excepted trades or businesses, as a percentage of the 
taxpayer's total adjusted basis at the end of such year in all of its 
assets used in a trade or business, does not differ by more than 20 
percent from such percentage at the beginning of the year.
    (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 C 
corporation to which the taxpayer is applying those rules, then, for 
purposes of this paragraph (c)(6), the taxpayer must use the most 
recent asset basis figures from the partnership or non-consolidated C 
corporation. For example, assume that PS1 is a partnership with a May 
31 taxable year, and that C (a calendar-year C corporation that is 
ineligible to use the annual determination method for the taxable year) 
is a partner in PS1. 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 any adjustments to asset basis for 
purposes of applying this paragraph (c). One indication 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, each taxpayer 
that is making an allocation under this paragraph (c), including any 
taxpayer that satisfies the de minimis rule in paragraph (c)(1)(ii) of 
this section, must prepare a statement titled ``Section 163(j) Asset 
Basis Calculations'' containing the information described in paragraphs 
(c)(6)(iii)(B)(1) through (7) of this section and must attach the 
statement to its timely filed Federal income tax return for the taxable 
year:
    (1) The taxpayer's adjusted basis in the assets used in its 
excepted and non-excepted businesses, determined as set forth in this 
section, including detailed information for the different groups of 
assets identified in paragraphs (c)(5)(i) and (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;
    (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;
    (6) Whether the taxpayer used the historical approach or the 
effective date approach for all of its disallowed disqualified 
interest; and
    (7) If the taxpayer changed its methodology for allocating asset 
basis between or among two or more trades or businesses under paragraph 
(c)(3)(ii) of this section, a statement that the taxpayer has changed 
the allocation methodology and a description of the new methodology or, 
if the taxpayer is required to request consent for the allocation 
methodology change under paragraph (c)(3)(iii)(A)(2) of this section, a 
statement that the request has been or will be filed and a description 
of the methodology change.
    (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. For purposes of this section, a shareholder must look 
through to the assets of a domestic non-consolidated C corporation or a 
relevant foreign corporation under paragraph (c)(5)(ii) of this section 
if the shareholder's direct and indirect interest in the corporation 
satisfies the ownership requirements of section 1504(a)(2). For 
purposes of this paragraph (c)(7)(i)(A), indirect stock ownership is 
determined by applying the constructive ownership rules of section 
318(a). 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 domestic non-consolidated C

[[Page 56827]]

corporation or a relevant foreign corporation under paragraph (b)(3) of 
this section if the shareholder's direct interest in the corporation 
satisfies the ownership requirements of section 1504(a)(2). A 
shareholder may look through to the activities of a domestic non-
consolidated C corporation or an applicable CFC under paragraph (b)(3) 
of this section if the shareholder's direct interest in the corporation 
is greater than or equal to 80 percent by value. 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 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. It is not necessary to 
allocate interest expense under this paragraph (d) if all of the 
taxpayer's interest expense is allocable to excepted trades or 
businesses or if all of the taxpayer's interest expense is allocable to 
non-excepted trades or businesses.
    (2) Qualified nonrecourse indebtedness. For purposes of this 
section, a taxpayer with qualified nonrecourse indebtedness 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). For purposes of this paragraph (d)(2), the term qualified 
nonrecourse indebtedness has the meaning provided in Sec.  1.861-
10T(b), except that the term cash flow from the property (within the 
meaning of Sec.  1.861-10T(b)(3)(i)) includes revenue derived from the 
sale or lease of inventory or similar property with respect to an 
excepted regulated utility trade or business or a non-excepted 
regulated utility trade or business.
    (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 
consist of reductions in 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). The 
amount of the taxpayer's basis in these assets must be reduced, but not 
below zero, by the amount of qualified nonrecourse indebtedness secured 
by these assets. 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)(2) 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 $1,000x of 
T's basis in Building B to reflect the amount of Note A (see paragraph 
(d)(4) of this section), and without regard to T's $200x of cash and 
cash equivalents (see paragraph (c)(5)(iii) of this section), T's basis 
in its assets used in Businesses X and Y is $2,600x and $800x (76.5 
percent and 23.5 percent), respectively. Thus, $306x of the remaining 
$400x of interest expense would be allocated to Business X, and $94x 
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, 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

[[Page 56828]]

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 the section 163(j) limitation, 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 the section 163(j) limitation, 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/$1,000x) 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 the section 
163(j) limitation. 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 the section 163(j) limitation.
    (3) Example 3: Application of look-through rules--(i) Facts. (A) 
Each of Corp A, Corp B, Corp C, and Corp D is a domestic calendar-year 
corporation that is not a member of a consolidated group. Corp A owns 
100 percent of the stock of Corp C; the basis of Corp A's stock in Corp 
C is $500x. Corp C owns 10 percent of the interests in PS1 (a domestic 
partnership), and Corp B owns the remaining 90 percent. Corp C's basis 
in its PS1 interests is $25x; Corp B's basis in its PS1 interests is 
$225x. PS1 owns 100 percent of the stock of Corp D; the basis of PS1's 
stock in Corp D is $1,000x. Corp A and Corp B are owned by unrelated, 
non-overlapping shareholders.
    (B) In 2021, Corp C was engaged solely in a non-excepted trade or 
business. That same year, PS1's only activity was holding Corp D stock. 
In turn, Corp D 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 D's asset basis in 2021 was 
allocable to the electing farming business, and the remaining 50 
percent was allocable to the non-excepted trade or business.
    (C) Corp A and Corp B each paid or accrued (without regard to 
section 163(j)) $150x of interest expense allocable to a trade or 
business. Corp A's trade or business was an excepted trade or business, 
and Corp B's trade or business was a non-excepted trade or business. 
Corp A's basis in the assets used in its trade or business was $100x, 
and Corp 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. 
Corp A directly owns 100 percent of the stock of Corp C; thus, Corp A 
satisfies the 80 percent minimum ownership threshold with respect to 
Corp C. Corp A also owns 10 percent of the interests in PS1. There is 
no minimum ownership threshold for partnerships; thus, Corp A may apply 
the look-through rules to PS1. However, Corp A does not directly or 
indirectly own at least 80 percent of the stock of Corp D; thus, Corp A 
cannot look through its indirect interest in Corp D. In turn, Corp B 
directly owns 90 percent of the interests in PS1, and Corp B indirectly 
owns at least 80 percent of the stock of Corp D. Thus, Corp B must 
apply the look-through rules to PS1 and Corp D.
    (B) From Corp 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 D stock as an investment. Under paragraph (c)(5)(ii)(A)(2) of 
this 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 Corp A's application of the look-through rules, 
Corp C's entire basis in its PS1 interest ($25x) is allocable to a non-
excepted trade or business. Corp C's basis in its other assets also is 
allocable to a non-excepted trade or business (the only trade or 
business in which Corp C is engaged). Thus, under paragraph (c) of this 
section, Corp A's $500x basis in its Corp C stock is allocable entirely 
to a non-excepted trade or business. Corp A's $100x basis in its other 
business assets is allocable to an excepted trade or business. Thus, 
\5/6\ (or $125x) of Corp A's $150x of interest expense is properly 
allocable to a non-excepted trade or business and is business interest 
expense subject to the section 163(j) limitation, and the remaining 
$25x of Corp A's $150x of interest expense is allocable to an excepted 
trade or business and is not subject to the section 163(j) limitation.
    (C) From Corp B's perspective, PS1 must look through its stock in 
Corp D to determine the extent to which PS1's basis in the stock is 
allocable to an excepted or non-excepted trade or

[[Page 56829]]

business. Half of Corp D'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 Corp B's perspective, $500x of 
PS1's basis in its Corp D 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. Corp B's basis in its PS1 interests is 
$225x. Applying the look-through rules to Corp B's PS1 interests, 
$112.5x of Corp B's basis in its PS1 interests is allocable to an 
excepted trade or business, and $112.5x of Corp B's basis in its PS1 
interests is allocable to a non-excepted trade or business. Since Corp 
B's basis in the assets used in its non-excepted trade or business also 
was $112.5x, two-thirds of Corp B's interest expense ($100x) is 
properly allocable to a non-excepted trade or business and is business 
interest expense subject to the section 163(j) limitation, and one-
third of Corp B's interest expense ($50x) is allocable to an excepted 
trade or business and is not subject to the section 163(j) limitation.
    (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.
    (6) Example 6: Constructive ownership--(i) Facts. P, S, T, and U 
are domestic C corporations that are not members of a consolidated 
group. P directly owns 80 percent of the stock of each of S and T as 
measured by total voting power and value; an unrelated third party, X, 
owns the remaining 20 percent. In turn, S and T directly own 15 percent 
and 80 percent, respectively, of the stock of U as measured by total 
voting power and value; P directly owns the remaining 5 percent. P 
conducts both excepted and non-excepted trades or businesses. S and T 
conduct only non-excepted trades or businesses, and U conducts both 
excepted and non-excepted trades or businesses.
    (ii) Analysis. Under paragraph (c)(7)(i)(A) of this section, a 
shareholder must look through to the assets of a domestic non-
consolidated C corporation for purposes of allocating the shareholder's 
basis in its stock in the corporation between excepted and non-excepted 
trades or businesses if the

[[Page 56830]]

shareholder's direct and indirect interest in the corporation satisfies 
the ownership requirements of section 1504(a)(2). For purposes of 
paragraph (c)(7)(i)(A) of this section, a shareholder's stock ownership 
is determined by applying the constructive ownership rules of section 
318(a). P directly owns 80 percent of each of S and T as measured by 
total voting power and value; thus, P must look through to the assets 
of S and T when allocating the basis in its stock of S and T. P 
directly owns 5 percent of the stock of U as measured by total voting 
power and value, and P constructively owns the other 95 percent; thus, 
P also must look through to U's assets when allocating the basis in its 
U stock. S directly owns 15 percent of the stock of U, and S 
constructively owns only 5 percent through P; thus, S cannot look 
through to U's assets when allocating the basis in its U stock. T 
directly owns 80 percent of the stock of U, and T constructively owns 
an additional 5 percent; thus, T must look through to U's assets when 
allocating the basis in its U stock.
    (iii) Dividend. The facts are the same as in paragraph (e)(6)(i) of 
this section, except that U distributes a $160x dividend pro rata to 
its shareholders. Thus, P receives $8x (5 percent of $160x) of the U 
dividend, S receives $24x (15 percent of $160x), and T receives $128x 
(80 percent of $160x). Under paragraph (c)(7)(i)(B) of this section, if 
a shareholder's direct interest in a corporation satisfies the 
ownership requirements of section 1504(a)(2), the shareholder must look 
through to the activities of a domestic non-consolidated C corporation 
in determining whether dividend income is from an excepted or non-
excepted trade or business. The constructive ownership rules do not 
apply in allocating dividends under paragraph (c)(7)(i)(B) of this 
section. P directly owns 5 percent of the stock of U as measured by 
vote and value, and S directly owns 15 percent of the stock of U as 
measured by vote and value; thus, neither P nor S is required to apply 
the look-through rules in allocating its dividend income from U, and 
all such income is allocable to non-excepted trades or businesses. T 
directly owns 80 percent of the stock of U as measured by vote and 
value; thus, T must allocate its U dividend in accordance with the 
activities of U's excepted and non-excepted trades or businesses.
    (7) Example 7: Dispositions with a principal purpose of shifting 
basis--(i) Facts. U and V are members of a consolidated group of which 
P is the common parent. U conducts an electing farming business 
(Business F), and V conducts a farm equipment leasing business 
(Business L) that is a non-excepted trade or business. After the end of 
a farming season, the P group, with a principal purpose of shifting 
basis from Business L to Business F, has V sell to U all off-lease 
farming equipment that previously was leased out as part of Business L. 
Immediately before the start of the next season, U sells the farming 
equipment back to V for use in Business L.
    (ii) Analysis. Under paragraph (c)(8) of this section, in the case 
of a disposition of assets undertaken with a principal purpose of 
artificially shifting 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. Because V's sale 
of farming equipment to U for storage in Business F's facilities is 
undertaken with a principal purpose of shifting basis from Business L 
to Business F, the additional basis Business F receives from these 
transactions will not be taken into account for purposes of this 
section. Instead, the basis of the farming equipment will be allocated 
as though the farming equipment continued to be used in Business L.
    (f) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year. 
Accordingly, for purposes of Sec.  1.163(j)-10(c)(5), taxpayers make 
any change to the alternative depreciation system as of November 13, 
2020, or if relying on the provisions of Sec.  1.163(j)-10 in 
regulation project REG-106089-18 (83 FR 67490), as of December 28, 
2018.


Sec.  1.163(j)-11  Transition rules.

    (a) Overview. This section provides transition rules regarding the 
section 163(j) limitation. Paragraph (b) of this section provides rules 
regarding the application of the section 163(j) limitation to a 
corporation that joins a consolidated group during a taxable year of 
the group beginning before January 1, 2018 and is subject to the 
section 163(j) limitation at the time of its change in status. 
Paragraph (c) of this section provides rules regarding the treatment of 
carryforwards of disallowed disqualified interest.
    (b) Application of section 163(j) limitation if a corporation joins 
a consolidated group during a taxable year of the group beginning 
before January 1, 2018--(1) In general. If a corporation (S) joins a 
consolidated group during a taxable year of the group beginning 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 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

[[Page 56831]]

separate return limitation year (SRLY) limitation. See Sec.  1.163(j)-
5(d).
    (c) 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. Disallowed 
disqualified interest is subject to disallowance as a disallowed 
business interest expense carryforward under section 163(j) and Sec.  
1.163(j)-2 to the extent the interest is properly allocable to a non-
excepted trade or business under Sec.  1.163(j)-10. Disallowed 
disqualified interest that is properly allocable to an excepted trade 
or business is not subject to the section 163(j) limitation. See Sec.  
1.163(j)-10(a)(6) for rules governing the allocation of disallowed 
disqualified interest between excepted and non-excepted trades or 
businesses.
    (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 (c)(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 (c)(3)(ii)(B) 
of this section.
    (B) Definitions. The following definitions apply for purposes of 
paragraph (c)(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 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 Code;
    (ii) A person that is not related to the taxpayer, within the 
meaning of section 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 (c)(3)(ii)(B)(3)(ii), a 
gross basis U.S. tax means any tax imposed by this subtitle A of the 
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 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 section 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 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 
(c)(3)(ii) of this section is treated in the same manner as described 
in paragraph (c)(1) of this section.
    (4) Application of section 382--(i) Ownership change occurring 
before November 13, 2020--(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 November 13, 2020. 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 November 13, 2020. But see section 382(h)(6) 
(regarding built-in deductions).
    (ii) Ownership change occurring on or after November 13, 2020--(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 November 13, 2020, 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 November 13, 
2020, see Sec.  1.382-2(a)(1)(i)(A).
    (5) 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.

[[Page 56832]]

    (6) 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 in this part under old section 163(j) (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 a 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 
(c)(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)-1(b)(9)) of $80x, and no 
excepted trade or business. Under paragraph (c)(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 (c)(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 (c)(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.
    (d) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to 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, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.
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 1.263A-15 is amended by adding paragraph (a)(4) to read 
as follows:


Sec.  1.263A-15  Effective dates, transitional rules, and anti-abuse 
rules.

    (a) * * *
    (4) Section 1.263A-9(g)(1)(i) applies to taxable years beginning on 
or after November 13, 2020. However, taxpayers and their related 
parties, within the meaning of sections 267(b) and 707(b)(1), may 
choose to apply the rules of that 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 
(as defined in Sec.  1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.  
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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 that taxable year.
* * * * *

0
Par. 6. Section 1.381(c)(20)-1 is added to read as follows:


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 
(as defined in Sec.  1.163(j)-1(b)(11)), including any disallowed 
disqualified interest (as defined in Sec.  1.163(j)-1(b)(12)), 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 in this part under section 382 of the Code, 
including but not limited to Sec.  1.382-2.

[[Page 56833]]

    (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, 2021 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, 2022, X transferred all of its 
assets to Y in a statutory merger to which section 361 applies. For the 
2021 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, 2022, X had an additional $350x of disallowed 
business interest expense (X did not deduct any of its 2021 
carryforwards in its 2022 taxable year). For the taxable year ending 
December 31, 2022, 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 2022 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)-1(b)(9)) 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, 2022, 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, 2022. For the taxable year ending December 31, 2022, X had 
an additional $350x of disallowed business interest expense (X did not 
deduct any of its 2021 carryforwards in its 2022 taxable year). For the 
taxable year ending December 31, 2023, 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 2023 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, 2023, 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 2023 taxable 
year. Since the amount of Y's section 163(j) limit for the 2023 taxable 
year was $500x, Y may deduct the full amount ($100x) of its own 
business interest expense for the 2023 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, 2022, X and Y transferred all of their assets to Z in 
statutory mergers to which section 361 applies. For the 2021 taxable 
year, X had $300x of disallowed business interest expense, Y had $200x, 
and Z had $0. For the taxable year ending October 31, 2022, each of X 
and Y had an additional $125x of disallowed business interest expense 
(neither X nor Y deducted any of its 2021 carryforwards in 2022). For 
the taxable year ending December 31, 2022, 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 2022 taxable year was 
$500x ($200x + (30 percent x $1,000x) = $500x).
    (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, 2022, 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

[[Page 56834]]

Z has deducted its $100x of current-year business interest expense (as 
defined in Sec.  1.163(j)-1(b)(9)).
    (d) Applicability date. This section applies to taxable years 
beginning on or after November 13, 2020. However, taxpayers and their 
related parties, within the meaning of sections 267(b) and 707(b)(1), 
may choose to apply the rules of this section to ta axable 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 (as defined in Sec.  1.163(j)-1(b)(37)), and, if 
applicable, Sec. Sec.  1.263A-9, 1.263A-15, 1.382-1, 1.382-2, 1.382-5, 
1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 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 that taxable year.

0
Par. 7. Section 1.382-1 is amended by:
0
1. Adding an entry for Sec.  1.382-2(a)(1)(vi) and (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(a)(1) and (2) and (b)(4);
0
4. Revising the entry for Sec.  1.382-6(h); and
0
5. Adding an entry for Sec.  1.382-7(c), (d), (d)(1) through (5), (e) 
through (g), and (g)(1) through (4).
    The additions and revisions read as follows:


Sec.  1.382-1  Table of contents.

* * * * *
Sec.  1.382-2 General rules for ownership change.

    (a) * * *
    (1) * * *
    (vi) Any section 382 disallowed business interest carryforward.
* * * * *
    (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.

    (a) * * *
    (1) In general.
    (2) Allocation of business interest expense.
    (i) Scope.
    (ii) Deductibility of business interest expense.
* * * * *
    (b) * * *
    (4) Allocation of business interest expense.
    (i) Scope.
    (ii) Deductibility of business interest expense.
    (iii) Example.
* * * * *
    (h) Applicability date.
    (1) In general.
    (2) Paragraphs (a) and (b)(1) and (4) of this section.
* * * * *
Sec.  1.382-7
* * * * *
    (c) [Reserved]
    (d) Special rules.
    (1)-(4) [Reserved]
    (5) Section 382 disallowed business interest carryforwards.
    (e)-(f) [Reserved]
    (g) Applicability dates.
    (1)-(3) [Reserved]
    (4) Paragraph (d)(5) of this section.
* * * * *

0
Par. 8. 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 the period and adding ``; and'' in its place at the end of 
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 will 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)(11)), including 
disallowed disqualified interest (as defined in Sec.  1.163(j)-
1(b)(12)), as of the date of the ownership change.
    (ii) The loss corporation's current-year business interest expense 
(as defined in Sec.  1.163(j)-1(b)(9)) in the change year (as defined 
in Sec.  1.382-6(g)(1)) that is allocable to the pre-change period (as 
defined in Sec.  1.382-6(g)(2)) under Sec.  1.382-6(a) or (b) and that 
becomes disallowed business interest expense (as defined in Sec.  
1.163(j)-1(b)(10)).
    (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

[[Page 56835]]

occurring on or after November 13, 2020. For loss corporations that 
have testing dates occurring before November 13, 2020, see Sec.  1.382-
2 as contained in 26 CFR part 1, revised April 1, 2019. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to apply the rules of this section to 
testing dates occurring during a taxable year beginning after December 
31, 2017, and before November 13, 2020, so long as the taxpayers and 
their related parties consistently apply the rules of this section, the 
section 163(j) regulations (as defined in Sec.  1.163(j)-1(b)(37)), 
Sec. Sec.  1.382-1, 1.382-5, 1.382-6, 1.382-7, 1.383-0, and 1.383-1, 
and, if applicable, Sec. Sec.  1.263A-9, 1.263A-15, 1.381(c)(20)-1, 
1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 
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 that taxable year.

0
Par. 9. 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 November 13, 2020. For loss 
corporations that have undergone an ownership change before or after 
November 13, 2020, see Sec.  1.382-5 as contained in 26 CFR part 1, 
revised April 1, 2019. However, taxpayers and their related parties, 
within the meaning of sections 267(b) and 707(b)(1), may choose to 
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 (as defined in Sec.  
1.163(j)-1(b)(37)), Sec. Sec.  1.382-1, 1.382-2, 1.382-6, 1.382-7, 
1.383-0, and 1.383-1, and, if applicable, Sec. Sec.  1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 
1.1368-1, 1.1377-1, 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 
that taxable year.

0
Par. 10. Section 1.382-6 is amended by:
0
1. Redesignating the text of paragraph (a) as paragraph (a)(1);
0
2. Adding a subject heading to newly redesignated paragraph (a)(1);
0
3. Adding paragraph (a)(2);
0
4. Removing the language ``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
5. Adding paragraph (b)(4); and
0
6. Revising paragraph (h).
    The additions 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.

    (a) * * *
    (1) In general. * * *
    (2) Allocation of business interest expense--(i) Scope. Except as 
provided in paragraph (b)(4) of this section, this paragraph (a)(2) 
applies if a loss corporation has business interest expense (as defined 
in Sec.  1.163(j)-1(b)(3)) in the change year. The rules of this 
paragraph (a)(2) apply to determine the amount of current-year business 
interest expense (as defined in Sec.  1.163(j)-1(b)(9)) that is 
deducted in the change year. These rules also apply to determine the 
amount of any current-year business interest expense that is 
characterized as disallowed business interest expense (as defined in 
Sec.  1.163(j)-1(b)(10)) allocable to the pre-change period and the 
post-change period, and to allocate disallowed business interest 
expense carryforwards (as defined in Sec.  1.163(j)-1(b)(11)) to the 
change year for deduction in the pre-change period and the post-change 
period.
    (ii) Deductibility of business interest expense. The rules of this 
paragraph (a)(2)(ii) apply in the following order.
    (A) First, the loss corporation calculates its section 163(j) 
limitation (as defined in Sec.  1.163(j)-1(b)(36)) for the change year.
    (B) Second, the loss corporation calculates its deductible current-
year BIE and deducts this amount in determining its taxable income or 
net operating loss for the change year. For purposes of this paragraph 
(a)(2)(ii), the term deductible current-year BIE means the loss 
corporation's current-year business interest expense (including its 
floor plan financing interest expense, as defined in Sec.  1.163(j)-
1(b)(19)), to the extent of its section 163(j) limitation.
    (C) Third, if the loss corporation has disallowed business interest 
expense paid or accrued (without regard to section 163(j)) in the 
change year that is carried forward to post-change years, it allocates 
an equal portion of that disallowed business interest expense to each 
day in the change year. Any amount of disallowed business interest 
expense that is allocated to the pre-change period pursuant to this 
paragraph (a)(2)(ii)(C) is carried forward subject to section 
382(d)(3). Any amount of disallowed business interest expense that is 
allocated to the post-change period pursuant to this paragraph 
(a)(2)(ii)(C) is carried forward and is not subject to section 
382(d)(3).
    (D) Fourth, if the loss corporation has excess section 163(j) 
limitation, then the loss corporation calculates its deductible 
disallowed business interest expense carryforward and allocates an 
equal portion to each day in the change year. For purposes of this 
paragraph (a)(2)(ii), the term excess section 163(j) limitation means 
the excess, if any, of the loss corporation's section 163(j) limitation 
over its deductible current-year BIE, and the term deductible 
disallowed business interest expense carryforward means the loss 
corporation's disallowed business interest expense carryforward to the 
extent of its excess section 163(j) limitation.
    (E) Fifth, the loss corporation deducts its deductible disallowed 
business interest expense carryforward that was allocated to the pre-
change period under paragraph (a)(2)(ii)(D) of this section. Subject to 
the application of sections 382(b)(3)(B) and 382(d)(3), the loss 
corporation deducts its deductible disallowed business interest expense 
carryforward that was allocated to the post-change period under 
paragraph (a)(2)(ii)(D) of this section. Any amount of disallowed 
business interest expense carryforward that is not deducted pursuant to 
this paragraph (a)(2)(ii)(E) is carried forward subject to section 
382(d)(3).
* * * * *
    (b) * * *
    (4) Allocation of business interest expense--(i) Scope. This 
paragraph (b)(4) applies if a loss corporation makes a closing-of-the-
books election pursuant to paragraph (b) of this section and has 
business interest expense in the change year. The rules of this 
paragraph (b)(4)

[[Page 56836]]

apply to determine the amount of deductible current-year business 
interest expense that is allocable to the pre-change period and the 
post-change period for purposes of the allocations referred to in 
paragraph (b)(1) of this section. These rules also apply to determine 
the amount of any current-year business interest expense that is 
characterized as disallowed business interest expense allocable to the 
pre-change period and the post-change period, and to allocate 
disallowed business interest expense carryforwards to the change year 
between the pre-change period and the post-change period for deduction.
    (ii) Deductibility of business interest expense. The rules of this 
paragraph (b)(4)(ii) apply in the order provided.
    (A) The loss corporation calculates its ATI limit, which is the 
product of its ATI (as defined in Sec.  1.163(j)-1(b)(1)) for the 
change year and 30 percent. For purposes of this paragraph (b)(4)(ii), 
the terms pre-change ATI limit and post-change ATI limit mean the 
amount of ATI limit allocated to the pre-change period or the post-
change period, respectively, computed by allocating an equal portion of 
the ATI limit to each day in the change year.
    (B) Pursuant to paragraph (b)(1) of this section, the loss 
corporation allocates its current-year business interest expense 
(including its floor plan financing interest expense) and its business 
interest income (as defined in Sec.  1.163(j)-1(b)(4)) to the pre-
change and post-change periods as if the loss corporation's books were 
closed on the change date. For purposes of this paragraph (b)(4)(ii), 
the terms pre-change BIE and post-change BIE mean the amount of the 
loss corporation's current-year business interest expense that is 
allocated to the pre-change period or the post-change period, 
respectively, under this paragraph (b)(4)(ii)(B).
    (C) The loss corporation deducts its pre-change BIE to the extent 
of its pre-change section 163(j) limit, and the loss corporation 
deducts its post-change BIE to the extent of its post-change section 
163(j) limit. For purposes of this paragraph (b)(4)(ii), the term pre-
change section 163(j) limit means the sum of the pre-change ATI and the 
amount of business interest income and floor plan financing interest 
expense allocated to the pre-change period; the term post-change 
section 163(j) limit means the sum of the post-change ATI limit and the 
amount of business interest income and floor plan financing interest 
expense allocated to the post-change period.
    (D) If any pre-change BIE or post-change BIE has not been deducted 
under paragraph (b)(4)(ii)(C) of this section, the loss corporation 
deducts either any pre-change BIE that has not been deducted to the 
extent of its surplus post-change section 163(j) limit or any post-
change BIE that has not been deducted to the extent of its surplus pre-
change section 163(j) limit. For purposes of this paragraph (b)(4)(ii), 
the term surplus pre-change section 163(j) limit means the amount by 
which the pre-change section 163(j) limit exceeds the amount of pre-
change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this 
section; the term surplus post-change section 163(j) limit means the 
amount by which the post-change section 163(j) limit exceeds the amount 
of post-change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this 
section.
    (E) If the loss corporation has any excess pre-change section 
163(j) limit or excess post-change section 163(j) limit, the loss 
corporation allocates its disallowed business interest expense 
carryforward, if any, ratably between the pre-change and post-change 
periods based upon the relative amounts of excess pre-change section 
163(j) limit and excess post-change section 163(j) limit. For purposes 
of this paragraph (b)(4)(ii), the term excess pre-change section 163(j) 
limit means the amount by which the surplus pre-change section 163(j) 
limit exceeds the amount of post-change BIE deducted pursuant to 
paragraph (b)(4)(ii)(D) of this section; the term excess post-change 
section 163(j) limit means the amount by which the surplus post-change 
section 163(j) limit exceeds the amount of pre-change BIE deducted 
pursuant to paragraph (b)(4)(ii)(D) of this section.
    (F) The loss corporation deducts its disallowed business interest 
expense carryforward that was allocated to the pre-change period under 
paragraph (b)(4)(ii)(E) of this section to the extent of its excess 
pre-change section 163(j) limit. Subject to the application of sections 
382(b)(3)(B) and 382(d)(3), the loss corporation deducts its disallowed 
business interest expense carryforward that was allocated to the post-
change period under paragraph (b)(4)(ii)(E) of this section to the 
extent of its excess post-change section 163(j) limit. Any amount of 
disallowed business interest expense carryforward that is not deducted 
pursuant to this paragraph (b)(4)(ii)(F) is subject to section 
382(d)(3) irrespective of the period to which it was allocated pursuant 
to paragraph (b)(4)(ii)(E) of this section.
    (iii) Example 1--(A) Facts. X is a calendar-year domestic C 
corporation that is not a member of a consolidated group. As of January 
1, 2021, X has no disallowed business interest expense carryforwards. 
On October 19, 2021, X experiences an ownership change under section 
382(g). For calendar year 2021, X's ATI is $500. For the period 
beginning on January 1, 2021 and ending on October 19, 2021, X pays or 
accrues $250 of current-year business interest expense that is 
deductible but for the potential application of section 163(j), 
including $50 of floor plan financing interest expense, and X has $60 
of business interest income. For the period beginning on October 20, 
2021 and ending on December 31, 2021, X pays or accrues $100 of 
current-year business interest expense that is deductible but for the 
potential application of section 163(j), including $40 of floor plan 
financing interest expense, and X has $70 of business interest income. 
X makes a closing-of-the-books election pursuant to paragraph (b) of 
this section.
    (B) Analysis--(1) Calculation and allocation of ATI limit. For 
purposes of allocating its net operating loss or taxable income for the 
change year between the pre-change period and the post-change period 
under Sec.  1.382-6, X applies paragraph (b)(4) of this section to 
allocate items related to section 163(j). X's ATI for calendar year 
2021 is $500x. Therefore, pursuant to paragraph (b)(4)(ii)(A) of this 
section, X's ATI limit is $150 ($500 x 30 percent). Additionally, 
pursuant to paragraph (b)(4)(ii)(A) of this section, X's pre-change ATI 
limit is $120 ($150 x (292 days/365 days)), and X's post-change ATI 
limit is $30 ($150 x (73 days/365 days)).
    (2) Determination of pre-change BIE and post-change BIE. Pursuant 
to paragraph (b)(4)(ii)(B) of this section, X's pre-change BIE and 
post-change BIE are $250 and $100, respectively.
    (3) Determination of pre-change section 163(j) limit and post-
change section 163(j) limit. Pursuant to paragraph (b)(4)(ii)(C) of 
this section, X's pre-change section 163(j) limit is $230 ($120 (X's 
pre-change ATI limit) + $60 (X's business interest income allocated to 
the pre-change period) + $50 (X's floor plan financing interest expense 
allocated to the pre-change period)). Additionally, pursuant to 
paragraph (b)(4)(ii)(C) of this section, X's post-change section 163(j) 
limit is $140 ($30 (X's post-change ATI limit) + $70 (X's business 
interest income allocated to the post-change period) + $40 (X's floor 
plan financing interest expense allocated to the post-change period)).
    (4) Initial deduction of BIE. Pursuant to paragraph (b)(4)(ii)(C) 
of this section,

[[Page 56837]]

X deducts $230 (its pre-change section 163(j) limit) of its $250 pre-
change BIE and all $100 (less than its $140 post-change section 163(j) 
limit) of its post-change BIE.
    (5) Deduction of BIE due to surplus post-change section 163(j) 
limit. After applying paragraph (b)(4)(ii)(C) of this section, X has 
$20 of pre-change BIE that has not been deducted ($250-$230) and a 
surplus post-change section 163(j) limit of $40 ($140-$100). As a 
result, pursuant to paragraph (b)(4)(ii)(D) of this section, X deducts 
its remaining $20 of pre-change BIE. (If, after applying paragraph 
(b)(4)(ii)(C) of this section, X instead had $20 of post-change BIE 
that had not yet been deducted and a $40 surplus pre-change section 
163(j) limit, then X would deduct its remaining $20 of post-change BIE 
pursuant to paragraph (b)(4)(ii)(D) of this section.)
    (iv) Example 2--Potential deduction of disallowed business interest 
expense carryforwards. The facts are the same as in paragraph 
(b)(4)(iii)(A) of this section, except that, as of January 1, 2021, X 
has $90 of disallowed business interest expense carryforwards and $150 
(rather than $250) of pre-change BIE. X's pre-change section 163(j) 
limit and post-change section 163(j) limit are the same as in paragraph 
(b)(4)(iii)(B)(3) of this section. Pursuant to paragraph (b)(4)(ii)(C) 
of this section, X deducts all $150 of its pre-change BIE and all $100 
of its post-change BIE. X has no remaining pre-change BIE or post-
change BIE to deduct under paragraph (b)(4)(ii)(D) of this section. 
Paragraph (b)(4)(ii)(E) of this section applies because X has $80 of 
excess pre-change section 163(j) limit ($230-$150) and $40 of excess 
post-change section 163(j) limit ($140-$100). Under paragraph 
(b)(4)(ii)(E) of this section, X allocates $60 of its disallowed 
business interest expense carryforwards to the pre-change period ($90 x 
($80/($80 + $40))) and $30 of its disallowed business interest expense 
carryforwards to the post-change period ($90 x ($40/($80 + $40))). As 
provided in paragraph (b)(4)(ii)(F) of this section, X deducts all $60 
of its disallowed business interest expense carryforwards that are 
allocated to the pre-change period; subject to the application of 
section 382, X deducts all $30 of its disallowed business interest 
expense carryforwards that are allocated to the post-change period.
* * * * *
    (h) Applicability date--(1) In general. This section applies to 
ownership changes occurring on or after June 22, 1994.
    (2) Ownership changes. Paragraphs (a) and (b)(1) and (4) of this 
section apply with respect to an ownership change occurring during a 
taxable year beginning on or after November 13, 2020. For ownership 
changes occurring during a taxable year beginning before November 13, 
2020, see Sec.  1.382-6 as contained in 26 CFR part 1, revised April 1, 
2019. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may choose to 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 (as defined in Sec.  1.163(j)-1(b)(37)), Sec. Sec.  
1.382-1, 1.382-2, 1.382-5, 1.383-0, and 1.383-1, and, if applicable, 
Sec. Sec.  1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 
1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 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, 1.382-7, 
and 1.383-1), and 1.1504-4, to taxable years beginning after December 
31, 2017.

0
Par. 11. Section 1.382-7 is amended by adding paragraphs (c), (d), (e), 
(f), and (g) to read as follows:


Sec.  1.382-7   Built-in gains and losses.

* * * * *
    (c) [Reserved]
    (d) Special rules. This paragraph (d) contains special rules 
regarding the identification of recognized built-in losses.
    (1)-(4) [Reserved]
    (5) Section 382 disallowed business interest carryforwards. Section 
382 disallowed business interest carryforwards are not treated as 
recognized built-in losses.
    (e)-(f) [Reserved]
    (g) Applicability dates.
    (1)-(3) [Reserved]
    (4) Paragraph (d)(5) of this section. Paragraph (d)(5) of this 
section applies with respect to an ownership change occurring on or 
after November 13, 2020. For loss corporations that have undergone an 
ownership change before or after November 13, 2020, see Sec.  1.382-7 
as contained in 26 CFR part 1, revised April 1, 2019. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to apply the rules of paragraph (d)(5) 
of this section to testing dates occurring during a taxable year 
beginning after December 31, 2017.

0
Par. 12. Section 1.383-0 is amended by revising paragraph (a) to read 
as follows:


Sec.  1.383-0   Effective date.

    (a) The regulations in this part under section 383 of the Code 
(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 Public Law 115-97 
(2017). See Sec.  1.383-1(j) for effective date rules.
* * * * *

0
Par. 13. Section 1.383-1 is amended by:
0
1. In paragraph (a):
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), (ii), and (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 subject 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:

[[Page 56838]]

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, 2021. For 2022, 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 2022 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) General rule. 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 as defined in Sec.  1.163(j)-1(b)(10), 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, 
as defined in Sec.  1.163(j)-1(b)(36), 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 
November 13, 2020, but during the taxable year which includes November 
13, 2020, the pre-change loss described in section 382(d)(3);
    (B) With respect to an ownership change date occurring on or after 
November 13, 2020, 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, 2021. For 2022, 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 2020 of $25,000. L has a 
section 382 limitation for 2022 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 2022. The unabsorbed portion of L's section 382 
limitation, $1,000 (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, $14,500, 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, 2021. For 2022, L has $750,000 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-
2021 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 
2022.
    (ii) Analysis. The following computation illustrates the 
application of this section for 2022:

                     Table 1 to Paragraph (f)(2)(ii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
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 4)..    1,000,000
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 2022         52,500
 (lesser of line 7 or line 10).............................
12. Amount of pre-change credits to be carried over to 2023      147,500
 under section 904(c) (line 7 minus line 11)...............

[[Page 56839]]

 
13. Section 383 credit reduction amount: $52,500/0.21......      250,000
14. Section 382 limitation to be carried to 2023 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, 2021. L has $80,000 of ordinary 
taxable income (before the application of carryovers) and a section 382 
limitation of $25,000 for 2022, a post-change year. L's only carryover 
is from a pre-2021 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 2022.
    (ii) Analysis. The following computation illustrates the 
application of this section:

                     Table 2 to paragraph (f)(3)(ii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
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 section        11,550
 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 of        5,250
 line 3 or line 6).........................................
8. Amount of pre-change credits to be carried over to 2023         4,750
 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 2023 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 beginning on or after 
November 13, 2020. For loss corporations that have undergone an 
ownership change during a taxable year beginning before November 13, 
2020, see Sec.  1.383-1 as contained in 26 CFR part 1, revised April 1, 
2019. However, taxpayers and their related parties, within the meaning 
of sections 267(b) and 707(b)(1), may choose to 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 (as defined in Sec.  1.163(j)-1(b)(37)), Sec. Sec.  1.382-
1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-0, and, if applicable, 
Sec. Sec.  1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 
1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 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, Sec.  1.382-5, 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 (as 
defined in Sec.  1.163(j)-1(b)(37)) and Sec. Sec.  1.382-1, 1.382-2, 
1.382-5, 1.382-6, and 1.383-0, and, if applicable, Sec. Sec.  1.263A-9, 
1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-
3, 1.1368-1, 1.1377-1, 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, 1.382-7, and 1.383-1), and 
1.1504-4, to those ownership changes.

0
Par. 14. 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--(i) General rule. 
Except as provided in paragraph (g)(4)(ii) of this section, a 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 paragraph (f)(2)(iii)(A) of this 
section, is recognized as interest expense to the payor and interest 
income to the recipient.
    (ii) Exception for cleared swaps and non-cleared swaps subject to 
margin or collateral requirements. Paragraph (g)(4)(i) of this section 
does not apply to a swap if the contract is described in paragraph 
(g)(4)(ii)(A) or (B) of this section.
    (A) The swap 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, and the derivatives clearing organization or 
clearing agency requires the parties to the swap to post and collect 
margin or collateral.
    (B) The swap is a non-cleared swap that requires the parties to 
meet the margin or collateral requirements of a federal regulator or 
that provides for margin or collateral requirements that are 
substantially similar to a cleared swap or a non-cleared swap subject 
to the margin or collateral requirements of a federal regulator. For 
purposes of this paragraph (g)(4)(ii)(B), the term federal regulator 
means the Securities and Exchange Commission (SEC), the Commodity 
Futures Trading Commission (CFTC), or a prudential regulator, as 
defined in section 1a(39) of the Commodity Exchange Act (7 U.S.C. 1a), 
as amended by section 721 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act of 2010, Public Law 111-203, 124 Stat. 1376, 
Title VII.

[[Page 56840]]

    (iii) Coordination with section 163(j). For the treatment of swaps 
with significant nonperiodic payments under section 163(j), see Sec.  
1.163(j)-1(b)(22)(ii).
* * * * *
    (j) * * *
    (2) The rules provided in paragraph (g)(4) of this section apply to 
notional principal contracts entered into on or after September 14, 
2021. Taxpayers may choose to apply the rules provided in paragraph 
(g)(4) of this section to notional principal contracts entered into 
before September 14, 2021.

0
Par. 15. 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 under this section are real 
property for purposes of section 469(c)(7)(C). However, property 
manufactured or produced for sale that is not real property in the 
hands of the manufacturer or producer, but that may be incorporated 
into real property through installation or any similar process or 
technique by any person after the manufacture or production of such 
property (for example, bricks, nails, paint, and windowpanes), is not 
treated as real property in the hands of any person (including any 
person involved in the manufacture, production, sale, incorporation or 
installation of such property) prior to the completed incorporation or 
installation of such property into the real property for purposes of 
section 469(c)(7)(C) and this section.
    (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 certain types of trees in a farming operation as 
defined in section 464(e), 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, under 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, under 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

[[Page 56841]]

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, for purposes of and 
with respect to the preceding sentence, 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.
    (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, under 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, under 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, for purposes of and with respect to the preceding sentence, 
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. 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.
    (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 (under 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 (under 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

[[Page 56842]]

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 under 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 is treated 
as owning an interest in a real property trade or business conducted by 
or through P and P is 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 under 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 under section 
469(c)(7)(C) and this section.
* * * * *

0
Par. 16. Section 1.469-11 is amended by:
0
1. Revising the section heading;
0
2. Removing the period at the end of paragraph (a)(1) and adding a 
semicolon in its place;
0
3. Revising paragraph (a)(3);
0
4. Redesignating paragraphs (a)(4) and (5) as paragraphs (a)(5) and 
(6), respectively; and
0
5. Adding a new paragraph (a)(4).
    The revision and addition read as follows:


Sec.  1.469-11   Applicability date and transition rules.

    (a) * * *
    (3) The rules contained in Sec.  1.469-9, other than paragraph 
(b)(2), 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;
    (4) The rules contained in Sec.  1.469-9(b)(2) apply to taxable 
years beginning on or after November 13, 2020. However, taxpayers and 
their related parties, under sections 267(b) and 707(b)(1), may choose 
to apply the rules of Sec.  1.469-9(b)(2) for a taxable year beginning 
after December 31, 2017, so long as they consistently apply the rules 
of Sec.  1.469-9(b)(2), the section 163(j) regulations (as defined in 
Sec.  1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.  1.263A-9, 
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 
1.383-0, 1.383-1, 1.469-9, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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.  1.382-2, 1.382-
5, 1.382-6, 1.382-7, and 1.383-1), and 1.1504-4 to that taxable year;
* * * * *

0
Par. 17. Section 1.704-1 is amended by adding paragraph (b)(4)(xi) to 
read as follows:


Sec.  1.704-1   Partner's distributive share.

* * * * *
    (b) * * *
    (4) * * *
    (xi) Section 163(j) excess items. Allocations of section 163(j) 
excess items as defined in Sec.  1.163(j)-6(b)(6) do not have 
substantial economic effect under paragraph (b)(2) of this section and, 
accordingly, such expenditures must be allocated in accordance with the 
partners' interests in the partnership. See paragraph (b)(3)(iv) of 
this section. Allocations of section 163(j) excess items will be deemed 
to be in accordance with the partners' interests in the partnership if 
such allocations are made in accordance with Sec.  1.163(j)-6(f).
* * * * *

0
Par. 18. 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. 19. Section 1.1362-3 is amended by:
0
1. Redesignating the text in paragraph (c)(3) as paragraph (c)(3)(i), 
adding a subject heading to newly redesignated paragraph (c)(3)(i), and 
adding paragraph (c)(3)(ii); and
0
2. Designating Examples 1 through 4 of paragraph (d) as paragraphs 
(d)(1) through (d)(4), respectively.
    The additions read as follows:


Sec.  1.1362-3   Treatment of S termination year.

* * * * *
    (c) * * *
    (3) * * *
    (i) In general. * * *
    (ii) Application of section 163(j). For purposes of section 163(j), 
a separate limitation (as defined in Sec.  1.163(j)-1(b)(36)) applies 
to each S short year and each C short year. Any items necessary to 
determine the amount of business interest expense (as defined in Sec.  
1.163(j)-1(b)(3)) that are deducted in each S short year or C short 
year must be allocated between the S short year and C short year in 
accordance with an allocation methodology provided in section 1362(e).
* * * * *

0
Par. 20. Section 1.1368-1 is amended by adding a sentence to the end of 
paragraph (g)(2)(ii) to read as follows:


Sec.  1.1368-1   Distributions by S corporations.

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * * In the case of a taxable year for which an election is 
made under paragraph (g)(2)(i), for purposes of section 163(j), a 
separate section 163(j) limitation (as defined in Sec.  1.163(j)-
1(b)(36)) applies to each separate taxable year. Any items necessary to 
determine

[[Page 56843]]

the amount of business interest expense (as defined in Sec.  1.163(j)-
1(b)(3)) that are deducted in each separate taxable year must be 
allocated between the two separate taxable years in accordance with an 
allocation methodology provided in this paragraph (g).
* * * * *

0
Par. 21. Section 1.1377-1 is amended by:
0
1. Redesignating paragraphs (b)(3)(ii) through (iv) as paragraphs 
(b)(3)(iii) through (v), respectively; and
0
2. Adding a new paragraph (b)(3)(ii).
    The addition reads as follows:


Sec.  1.1377-1   Pro rata share.

* * * * *
    (b) * * *
    (3) * * *
    (ii) Section 163(j). If a terminating election is made to treat the 
S corporation's taxable year as consisting of separate taxable years, 
for purposes of section 163(j), a separate limitation (as defined in 
Sec.  1.163(j)-1(b)(36)) will apply to each separate taxable year. Any 
items necessary to determine the amount of business interest expense 
(as defined in Sec.  1.163(j)-1(b)(3)) that are deducted in each 
separate taxable year must be allocated between the separate taxable 
years in accordance with an allocation methodology provided in this 
section.
* * * * *

0
Par. 22. Section 1.1502-13 is amended:
0
1. In paragraph (a)(6)(ii), under the heading ``Anti-avoidance rules. 
(Sec.  1.1502-13(h)(2))'', by:
0
i. Designating Examples 1 through 5 as entries (i) through (v); and
0
ii. Adding an entry (vi);
0
2. In paragraph (h)(2) by:
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. Redesignating paragraphs (h)(2)(v)(a) and (b) as paragraphs 
(h)(2)(iv)(A) and (B); and
0
c. Adding paragraph (h)(2)(vi).
    The additions read as follows:


Sec.  1.1502-13  Intercompany transactions.

    (a) * * *
    (6) * * *
    (ii) * * *
    Anti-avoidance rules. (Sec.  1.1502-13(h)(2))
* * * * *
    (vi) Example 6. Section 163(j) interest limitation.
* * * * *
    (h) * * *
    (2) * * *
    (vi) Example 6: Section 163(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. 23. Section 1.1502-21 is amended by adding new paragraph (c)(3) to 
read as follows:


Sec.  1.1502-21   Net operating losses.

* * * * *
    (c) * * *
    (3) 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. 24. 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 beginning on or after 
November 13, 2020. For taxable years beginning before November 13, 
2020, see Sec.  1.1502-36 as contained in 26 CFR part 1, revised April 
1, 2019. However, taxpayers and their related parties, within the 
meaning of sections 267(b) and 707(b)(1), may choose to apply the rules 
of this section to a taxable year beginning after December 31, 2017, 
and before November 13, 2020, so long as the taxpayers and their 
related parties consistently apply the rules of this section, the 
section 163(j) regulations (as defined in Sec.  1.163(j)-1(b)(37)), 
and, if applicable, Sec. Sec.  1.263A-9, 1.263A-15, 1.381(c)(20)-1, 
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 
1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 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.  1.382-2, 1.382-5, 1.382-6, 1.382-7, 
and 1.383-1), and 1.1504-4, to that taxable year.

0
Par. 25. 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 (as 
defined in Sec.  1.163(j)-1(b)(11)) of a member arising in a separate 
return limitation year, see Sec.  1.163(j)-5(d) and (f).

0
Par. 26. 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).

[[Page 56844]]

Sec.  1.1502-99 Effective dates.
* * * * *
    (d) Application to section 163(j).

0
Par. 27. 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. 28. 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 business interest expense, with appropriate 
adjustments).
* * * * *

0
Par. 29. 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 
subject 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 
in this part under sections 163(j), 382, and 383 of the Code contain 
rules governing the application of section 382 to interest expense 
governed by section 163(j) and the regulations in this part under 
section 163(j) of the Code. See, for example, Sec. Sec.  1.163(j)-
11(c), 1.382-2, 1.382-6, 1.382-7, 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, as defined in Sec.  1.163(j)-
1(b)(11), 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 (as defined in Sec.  1.163(j)-1(b)(9)), disallowed 
business interest expense carryforwards, and section 382 disallowed 
business interest carryforwards, appropriate adjustments are required.

0
Par. 30. 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 November 
13, 2020. For loss corporations that have ownership changes occurring 
before November 13, 2020, see Sec. Sec.  1.1502-91 through 1.1502-99 as 
contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers 
and their related parties, within the meaning of sections 267(b) and 
707(b)(1), may choose to 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.  1.382-6 and 1.383-
1), the section 163(j) regulations (as defined in Sec.  1.163(j)-
1(b)(37)), and, if applicable, Sec. Sec.  1.263A-9, 1.263A-15, 
1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 
1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, and 1.1504-4, to 
that taxable year.
    (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 beginning on or after 
November 13, 2020. For the application of these rules to an ownership 
change with respect to an ownership change

[[Page 56845]]

occurring during a taxable year beginning before November 13, 2020, see 
Sec. Sec.  1.1502-91 through 1.1502-99 as contained in 26 CFR part 1, 
revised April 1, 2019. However, taxpayers and their related parties, 
within the meaning of sections 267(b) and 707(b)(1), may choose to 
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 1.1502-91 through 
1.1502-99 (to the extent that those rules effectuate the rules of 
Sec. Sec.  1.382-2 and 1.382-5), the section 163(j) regulations (as 
defined in Sec.  1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.  
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, and 1.1504-4, to a taxable year beginning after December 
31, 2017.

0
Par. 31. Section 1.1504-4 is amended by:
0
1. Removing ``163(j), 864(e),'' from 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 additions read 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 beginning on or after November 13, 2020. However, 
taxpayers and their related parties, within the meaning of sections 
267(b) and 707(b)(1), may choose to 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 (as defined in Sec.  
1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.  1.263A-9, 1.263A-15, 
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 
1.1377-1, 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, 1.382-7, and 1.383-1), to that taxable year.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.

    Approved: July 14, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-16531 Filed 9-3-20; 4:15 pm]
BILLING CODE 4830-01-P