Td 8645

66496

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

Dated: December 14. 1995.
Robert C. Livingston,
Director, Office of New Animal Drug
Evaluation, Center for Veterinary Medicine.
[FR Doc. 95–31199 Filed 12–21–95; 8:45 am]
BILLING CODE 4160–01–F

21 CFR Part 558
New Animal Drugs; Change of Sponsor
AGENCY:

Dated: December 14, 1995.
Robert C. Livingston,
Director, Office of New Animal Drug
Evaluation, Center for Veterinary Medicine.
[FR Doc. 95–31198 Filed 12–21–95; 8:45 am]
BILLING CODE 4160–01–F

Internal Revenue Service
Final rule.

The Food and Drug
Administration (FDA) is amending the
animal drug regulations to reflect a
change of sponsor for two new animal
drug applications (NADA’s) from
Farmland Industries, Inc., to A. L.
Pharma, Inc.
EFFECTIVE DATE: December 22, 1995.
FOR FURTHER INFORMATION CONTACT:
Thomas J. McKay, Center for Veterinary
Medicine (HFV–102), Food and Drug
Administration, 7500 Standish Pl.,
Rockville, MD 20855, 301–827–0213.
SUPPLEMENTARY INFORMATION: Farmland
Industries, Inc., Kansas City, MS 64116,
has informed FDA that it has transferred
the ownership of, and all rights and
interests in, approved NADA’s 46–415
(Tylosin Premixes) and 91–749
(Tylosin-Sulfa Premixes) to A. L.
Pharma, Inc., One Executive Dr., Fort
Lee, NJ 07024. Accordingly, the agency
is amending the regulations in 21 CFR
558.625 and 558.630.
SUMMARY:

List of Subject in 21 CFR Part 558
Animal drugs, Animal feeds.
Therefore, under the Federal Food,
Drug, and Cosmetic Act and under
authority delegated to the Commissioner
of Food and Drugs and redelegated to
the Center for Veterinary Medicine, 21
CFR part 558 is amended as follows:
PART 558—NEW ANIMAL DRUGS FOR
USE IN ANIMAL FEEDS
1. The authority citation for 21 CFR
part 558 continues to read as follows:
Authority: Secs. 512, 701 of the Federal
Food, Drug, and Cosmetic Act (21 U.S.C.
360b, 371).
§ 558.625

[Amended]

2. Section 558.625 Tylosin is
amended in paragraph (b)(83) by
removing ‘‘021676’’ and adding in its
place ‘‘046573’’.
§ 558.630

[Amended]

3. Section 558.630 Tylosin and
sulfamethazine is amended in
paragraph (b)(10) by removing ‘‘021676’’

reducing this burden should be sent to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, PC:FP,
Washington, DC 20224, and to the
Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503.
Background

DEPARTMENT OF THE TREASURY

Food and Drug Administration,

HHS.
ACTION:

and by adding ‘‘046573’’ in numerical
order.

26 CFR Part 1
[TD 8645]
RIN 1545–AS38

Rules for Certain Rental Real Estate
Activities
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

This document contains final
regulations providing rules for rental
real estate activities of taxpayers
engaged in certain real property trades
or businesses. The regulations reflect
changes to the law made by the
Omnibus Budget Reconciliation Act of
1993, and affect taxpayers subject to the
limitations on passive activity losses
and passive activity credits.
DATES: These regulations are effective
on January 1, 1995. See § 1.469–11 for
applicability.
ADDRESSES: Send submissions to:
CC:DOM:CORP:T:R (TD 8645), room
5228, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. In the alternative,
submissions may be hand delivered
between the hours of 8:00 a.m. and 5:00
p.m. to: CC:DOM:CORP:T:R (TD 8645),
Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW,
Washington, DC.
FOR FURTHER INFORMATION CONTACT:
William M. Kostak at (202) 622–3080
(not a toll-free number).
SUMMARY:

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collection of information
contained in these final regulations has
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork
Reduction Act (44 U.S.C. 3504(h)) under
control number 1545–AS38. The
estimated annual burden per respondent
varies from 0.10 hours to 0.25 hours,
depending on individual circumstances,
with an estimated average of 0.15 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for

This document amends 26 CFR part 1
to provide rules relating to the treatment
of rental real estate activities of certain
taxpayers under the passive activity loss
and credit limitations of section 469.
Section 469 disallows losses from
passive activities to the extent they
exceed income from passive activities
and similarly disallows credits from
passive activities to the extent they
exceed tax liability allocable to passive
activities. In general, passive activities
are activities in which the taxpayer does
not materially participate. In addition,
until the enactment of the Omnibus
Budget Reconciliation Act of 1993
(OBRA 1993), all rental activities
(including those in which a taxpayer
materially participated) were passive.
OBRA 1993 added section 469(c)(7),
which provides that rental real estate
activities of qualifying taxpayers are not
subject to the rule that treats all rental
activities as passive. Thus, a rental real
estate activity of a qualifying taxpayer is
not passive if the taxpayer materially
participates in the activity. Further,
section 469(c)(7) provides that each of a
qualifying taxpayer’s interests in rental
real estate is treated as a separate
activity unless the taxpayer elects to
treat all interests in rental real estate as
a single activity.
On January 10, 1995, the IRS
published in the Federal Register a
notice of proposed rulemaking (60 FR
2557) to provide guidance regarding
section 469(c)(7). A number of public
comments were received concerning the
proposed regulations, and a public
hearing was held on May 11, 1995. After
consideration of the comments received,
the proposed regulations are adopted as
revised by this Treasury decision.
Explanation of Provisions
I. General Background
The proposed regulations provide
rules for determining whether a
taxpayer qualifies for treatment under
section 469(c)(7). The proposed
regulations also provide rules for
determining the rental real estate
activities of qualifying taxpayers for
purposes of section 469. Except for
modifications in response to comments
received on the proposed regulations,

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations
the final regulations generally adopt the
rules contained in the proposed
regulations.
II. Public Comments
Several comments requested that the
Service reconsider the rule in the
proposed regulations prohibiting
qualifying taxpayers from grouping
rental real estate activities with other
activities in determining whether the
taxpayers materially participate in the
rental real estate activities. After careful
consideration, the final regulations
adopt the rule in the proposed
regulations because that position is
consistent with the statutory language
and the legislative history.
Several comments suggested that the
rule in the proposed regulations
prohibiting the grouping of rental real
estate activities with other activities be
modified to allow qualifying taxpayers
to group the activities of development or
construction of rental real estate with
rental real estate activities. The final
regulations do not adopt this
modification because in most cases
development and construction activities
are separate and distinct from rental
activities. In addition, this modification
would introduce significant
administrative difficulties in
determining which development
activities or construction activities
qualify. However, the IRS and Treasury
Department invite comments
concerning whether the material
participation tests in § 1.469–5T(a)
should be amended to include a lookback material participation test for
taxpayers significantly involved in the
development or construction of their
rental real estate interests.
Several comments requested
clarification regarding whether a
qualifying taxpayer’s participation in a
management activity may count towards
material participation in a rental real
estate activity if the management
activity includes the management of
rental real estate owned by the taxpayer.
The final regulations clarify that a
qualifying taxpayer may participate in a
rental real estate activity through
participation in a management activity.
In determining whether the taxpayer
materially participates in the rental real
estate activity, however, work the
taxpayer performs in the management
activity is taken into account only to the
extent it is performed in managing the
taxpayer’s own rental real estate. The
final regulations also clarify that a
qualifying taxpayer who owns rental
real estate through an entity, including
a C corporation that is subject to section
469, may count work performed by the
taxpayer in managing the rental real

estate of the entity in establishing
material participation in the taxpayer’s
rental real estate activities. Thus, if a
qualifying taxpayer owns some interests
in rental real estate through a closely
held C corporation and makes the
election to treat all interests in rental
real estate as a single activity, the
aggregate rental real estate activity will
include those interests held through the
closely held C corporation for purposes
of material participation.
One comment requested that the
regulations modify the definition of
trade or business to clarify that a
taxpayer’s real property trades or
businesses are determined without
regard to the taxpayer’s grouping of
activities under § 1.469–4. The final
regulations clarify that a taxpayer’s
grouping of activities under § 1.469–4
does not control the determination of
the taxpayer’s real property trades or
businesses for purposes of this section.
Several comments requested that the
regulations provide a detailed definition
of real property trades or businesses
beyond the cross-reference to section
469(c)(7)(C). However, to avoid complex
and mechanical rules, the final
regulations do not adopt a detailed
definition of real property trades or
businesses. Instead, the regulations
provide that taxpayers may use any
reasonable method for determining their
real property trades or businesses.
Several comments requested that the
final regulations modify the rule in the
proposed regulations providing that
only employees who are five-percent
owners of their employer at all times
during the taxable year may treat
personal services performed as an
employee as services performed in a real
property trade or business. The
comments suggested that the regulations
should take into account personal
services performed by employees that
are five-percent owners for a significant
portion of a taxable year. In response to
these comments, the final regulations
are modified to provide that an
employee may count services performed
in a real property trade or business
during the portion of the taxable year
that the employee is a five-percent
owner in the employer.
Several comments requested
clarification concerning whether a
qualifying taxpayer that makes an
election to treat all interests in rental
real estate as a single activity will be
treated as having a single rental real
estate activity for purposes of the former
passive activity rule under section 469
(f). In addition, comments requested
that the regulations be modified to
provide that qualifying taxpayers that
make the aggregation election will be

66497

treated as having separate activities for
purposes of the disposition rules under
section 469(g) and § 1.469–4(g). In
response to these comments, the final
regulations clarify that a qualifying
taxpayer that makes the election to treat
all interests in rental real estate as a
single rental real estate activity will be
treated as having a single activity for all
purposes of section 469, including
sections 469(f) and (g). The statutory
language and the legislative history do
not support a rule allowing a qualifying
taxpayer to treat all interests in rental
real estate as a single activity for
purposes of material participation and
section 469(f), but as separate activities
for purposes of section 469(g).
In addition, in response to comments,
the final regulations provide an example
illustrating the operation of the former
passive activity rule for qualifying
taxpayers that make the election to treat
all interests in rental real estate as a
single activity. This example illustrates
that qualifying taxpayers that make the
aggregation election may use current net
income from the aggregate rental real
estate activity to offset the prior-year
disallowed passive losses of the
aggregate rental real estate activity,
regardless of which rental real estate
interests within that activity produced
the income or prior-year losses.
Some comments requested that the
regulations permit qualifying taxpayers
to make or revoke the aggregation
election on an amended income tax
return. After careful consideration of
this issue, the final regulations adopt
the rule in the proposed regulations that
aggregation elections must be made or
revoked on an original return. The final
regulations provide, however, that the
election may be revoked in any year in
which the facts are materially changed
from those in the taxable year for which
the election was made.
In addition, one comment requested
clarification as to what constitutes a
material change in the facts and
circumstances that would allow a
taxpayer to revoke an aggregation
election. However, the final regulations
do not provide an example or bright-line
rule for determining when a material
change in the facts and circumstances
has occurred, because this
determination is intended to be a broad
factual inquiry. Providing an example or
bright-line rule may inappropriately
restrict the scope of that inquiry.
One comment requested the
modification of the rule in the proposed
regulations that the aggregation election
has no effect in years the taxpayer is not
a qualifying taxpayer. Instead, the
comment suggested that, for ease of
administration and compliance, the

66498

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

aggregation election should be binding
and irrevocable for all future years,
including years in which the taxpayer is
not a qualifying taxpayer. However, the
final regulations adopt the rule in the
proposed regulations because the
position advocated by the comment
would be unfavorable to many taxpayers
and would not significantly improve
administration.
Several comments requested that the
regulations modify the rule in the
proposed regulations treating each
rental real estate interest of a
passthrough entity as a separate interest
of a person owning a fifty-percent or
greater interest in the capital, gain, loss,
income, deduction, or credit of the
entity at any time during a taxable year.
A commentator stated that this rule is
burdensome on many passthrough
entities and should be eliminated or
modified. The final regulations modify
this rule so that it applies only when a
qualifying taxpayer owns a fifty-percent
or greater interest in the capital, profits,
or losses of a passthrough entity for a
taxable year. Accordingly, this rule will
not apply if a qualifying taxpayer owns
a fifty-percent or greater interest in a
single item of income or deduction but
does not own a fifty-percent or greater
interest in the overall capital, profits, or
losses of the passthrough entity.
In response to one comment, the final
regulations also clarify the application
of the fifty-percent ownership rule to
tiered passthrough entities. The final
regulations provide that if a passthrough
entity owns a fifty-percent or greater
interest in the capital, profits, or losses
of another passthrough entity for a
taxable year, each interest in rental real
estate of the lower-tier entity will be a
separate interest in rental real estate of
the upper-tier entity.
In response to another comment, the
final regulations clarify that section
469(i) applies after the rules of section
469(c)(7) are applied. Accordingly, the
$25,000 offset will be applied only
against passive losses from rental real
estate activities, and not against losses
that are allowable as a result of section
469(c)(7). In addition, the final
regulations clarify that adjusted gross
income for purposes of section 469(i) is
not reduced by any losses from rental
real estate that are allowable as a result
of section 469(c)(7).
Several comments requested a
modification to the effective date
provision, to provide that aggregation
elections made for taxable years
beginning before January 1, 1995, are
not binding for future years. Because
taxpayers had sufficient notice of the
rules of section 469(c)(7) and these
regulations, this modification is

unnecessary and would add
administrative complexity. Accordingly,
the final regulations adopt the effective
date provision of the proposed
regulations.
Finally, in response to a comment, the
activity regrouping rule of § 1.469–
4(e)(2) is clarified to provide that a
taxpayer may not regroup activities
unless the taxpayer’s original grouping
was clearly inappropriate or there has
been a material change in the facts and
circumstances that makes the original
grouping clearly inappropriate.
III. Effective Dates
In general, section 469(c)(7) applies
for taxable years beginning after
December 31, 1993. These regulations
are effective for taxable years beginning
on or after January 1, 1995. These
regulations are also effective for
elections under section 469(c)(7)(A) and
paragraph (g) of these regulations that
are made with returns filed on or after
January 1, 1995.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory
assessment is not required. It also has
been determined that section 553(b) of
the Administrative Procedure Act (5
U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and,
therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was
submitted to the Small Business
Administration for comment on its
impact on small business.
Drafting Information
The principal author of these
regulations is William M. Kostak, Office
of Assistant Chief Counsel
(Passthroughs and Special Industries),
IRS. However, other personnel from the
IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an entry
in numerical order to read as follows:

Authority: 26 U.S.C. 7805. * * *
Section 1.469–9 also issued under 26
U.S.C. 469(c)(6), (h)(2), and (l)(1).

Par. 2. Section 1.469–0 is amended
by:
1. Revising the entry for § 1.469–4(h).
2. Revising the heading for § 1.469–9
and adding entries for paragraphs (a)
through (j) of § 1.469–9.
3. Revising the entry for § 1.469–
11(b)(2) and removing the entries for
§ 1.469–11(b)(2)(i) and (ii).
4. Revising the entry for § 1.469–
11(b)(3).
5. Adding an entry for § 1.469–
11(b)(4).
6. The revisions and additions read as
follows:
§ 1.469–0 Table of contents.

*

*

*

*

*

§ 1.469–4 Definition of Activity.

*

*

*

*

*

(h) Rules for grouping rental real estate
activities for taxpayers qualifying under
section 469(c)(7).

*

*

*

*

*

§ 1.469–9 Rules for certain rental real estate
activities.
(a) Scope and purpose.
(b) Definitions.
(1) Trade or business.
(2) Real property trade or business.
(3) Rental real estate.
(4) Personal services.
(5) Material participation.
(6) Qualifying taxpayer.
(c) Requirements for qualifying taxpayers.
(1) In general.
(2) Closely held C corporations.
(3) Requirement of material participation
in the real property trades or businesses.
(4) Treatment of spouses.
(5) Employees in real property trades or
businesses.
(d) General rule for determining real
property trades or businesses.
(1) Facts and circumstances.
(2) Consistency requirement.
(e) Treatment of rental real estate activities
of a qualifying taxpayer.
(1) In general.
(2) Treatment as a former passive activity.
(3) Grouping rental real estate activities
with other activities.
(i) In general.
(ii) Special rule for certain management
activities.
(4) Example.
(f) Limited partnership interests in rental
real estate activities.
(1) In general.
(2) De minimis exception.
(g) Election to treat all interests in rental
real estate as a single rental real estate
activity.
(1) In general.
(2) Certain changes not material.
(3) Filing a statement to make or revoke the
election.
(h) Interests in rental real estate held by
certain passthrough entities.

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations
(1) General rule.
(2) Special rule if a qualifying taxpayer
holds a fifty-percent or greater interest in a
passthrough entity.
(3) Special rule for interests held in tiered
passthrough entities.
(i) [Reserved].
(j) $25,000 offset for rental real estate
activities of qualifying taxpayers.
(1) In general.
(2) Example.

*

*

*

*

*

§ 1.469–11 Effective date and transition rules.

*

*

*

*

*

(b) * * *
(2) Additional transition rule for 1992
amendments.
(3) Fresh starts under consistency rules.
(i) Regrouping when tax liability is first
determined under Project PS–1–89.
(ii) Regrouping when tax liability is first
determined under § 1.469–4.
(iii) Regrouping when taxpayer is first
subject to section 469(c)(7).
(4) Certain investment credit property.

*

*
*
*
*
Par. 3. Section 1.469–4 is amended by
revising paragraphs (e) (1) and (2) and
(h). The revisions read as follows:
§ 1.469–4

Definition of Activity.

*

*
*
*
*
(e) * * *
(1) Original groupings. Except as
provided in paragraph (e)(2) of this
section and § 1.469–11, once a taxpayer
has grouped activities under this
section, the taxpayer may not regroup
those activities in subsequent taxable
years. Taxpayers must comply with
disclosure requirements that the
Commissioner may prescribe with
respect to both their original groupings
and the addition and disposition of
specific activities within those chosen
groupings in subsequent taxable years.
(2) Regroupings. If it is determined
that a taxpayer’s original grouping was
clearly inappropriate or a material
change in the facts and circumstances
has occurred that makes the original
grouping clearly inappropriate, the
taxpayer must regroup the activities and
must comply with disclosure
requirements that the Commissioner
may prescribe.
*
*
*
*
*
(h) Rules for grouping rental real
estate activities for taxpayers qualifying
under section 469(c)(7). See § 1.469–9
for rules for certain rental real estate
activities.
Par. 4. Section 1.469–9 is revised to
read as follows:
§ 1.469–9 Rules for certain rental real
estate activities.

(a) Scope and purpose. This section
provides guidance to taxpayers engaged
in certain real property trades or

businesses on applying section 469(c)(7)
to their rental real estate activities.
(b) Definitions. The following
definitions apply for purposes of this
section:
(1) Trade or business. A trade or
business is any trade or business
determined by treating the types of
activities in § 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.
(2) Real property trade or business.
Real property trade or business is
defined in section 469(c)(7)(C).
(3) Rental real estate. Rental real
estate is any real property used by
customers or held for use by customers
in a rental activity within the meaning
of § 1.469–1T(e)(3). However, any rental
real estate that the taxpayer grouped
with a trade or business activity under
§ 1.469–4(d)(1)(i)(A) or (C) is not an
interest in rental real estate for purposes
of this section.
(4) Personal services. Personal
services means any work performed by
an individual in connection with a trade
or business. However, personal services
do not include any work performed by
an individual in the individual’s
capacity as an investor as described in
§ 1.469–5T(f)(2)(ii).
(5) Material participation. Material
participation has the same meaning as
under § 1.469–5T. Paragraph (f) of this
section contains rules applicable to
limited partnership interests in rental
real estate that a qualifying taxpayer
elects to aggregate with other interests
in rental real estate of that taxpayer.
(6) Qualifying taxpayer. A qualifying
taxpayer is a taxpayer that owns at least
one interest in rental real estate and
meets the requirements of paragraph (c)
of this section.
(c) Requirements for qualifying
taxpayers—(1) In general. A qualifying
taxpayer must meet the requirements of
section 469(c)(7)(B).
(2) Closely held C corporations. A
closely held C corporation meets the
requirements of paragraph (c)(1) of this
section by satisfying the requirements of
section 469(c)(7)(D)(i). For purposes of
section 469(c)(7)(D)(i), gross receipts do
not include items of portfolio income
within the meaning of § 1.469–2T(c)(3).
(3) Requirement of material
participation in the real property trades
or businesses. A taxpayer must
materially participate in a real property
trade or business in order for the
personal services provided by the
taxpayer in that real property trade or
business to count towards meeting the

66499

requirements of paragraph (c)(1) of this
section.
(4) Treatment of spouses. Spouses
filing a joint return are qualifying
taxpayers only if one spouse separately
satisfies both requirements of section
469(c)(7)(B). In determining the real
property trades or businesses in which
a married taxpayer materially
participates (but not for any other
purpose under this paragraph (c)), work
performed by the taxpayer’s spouse in a
trade or business is treated as work
performed by the taxpayer under
§ 1.469–5T(f)(3), regardless of whether
the spouses file a joint return for the
year.
(5) Employees in real property trades
or businesses. For purposes of
paragraph (c)(1) of this section, personal
services performed during a taxable year
as an employee generally will be treated
as performed in a trade or business but
will not be treated as performed in a real
property trade or business, unless the
taxpayer is a five-percent owner (within
the meaning of section 416(i)(1)(B)) in
the employer. If an employee is not a
five-percent owner in the employer at
all times during the taxable year, only
the personal services performed by the
employee during the period the
employee is a five-percent owner in the
employer will be treated as performed
in a real property trade or business.
(d) General rule for determining real
property trades or businesses—(1) Facts
and circumstances. The determination
of a taxpayer’s real property trades or
businesses for purposes of paragraph (c)
of this section is based on all of the
relevant facts and circumstances. A
taxpayer may use any reasonable
method of applying the facts and
circumstances in determining the real
property trades or businesses in which
the taxpayer provides personal services.
Depending on the facts and
circumstances, a real property trade or
business consists either of one or more
than one trade or business specifically
described in section 469(c)(7)(C). A
taxpayer’s grouping of activities under
§ 1.469–4 does not control the
determination of the taxpayer’s real
property trades or businesses under this
paragraph (d).
(2) Consistency requirement. Once a
taxpayer determines the real property
trades or businesses in which personal
services are provided for purposes of
paragraph (c) of this section, the
taxpayer may not redetermine those real
property trades or businesses in
subsequent taxable years unless the
original determination was clearly
inappropriate or there has been a
material change in the facts and

66500

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

circumstances that makes the original
determination clearly inappropriate.
(e) Treatment of rental real estate
activities of a qualifying taxpayer—(1)
In general. Section 469(c)(2) does not
apply to any rental real estate activity of
a taxpayer for a taxable year in which
the taxpayer is a qualifying taxpayer
under paragraph (c) of this section.
Instead, a rental real estate activity of a
qualifying taxpayer is a passive activity
under section 469 for the taxable year
unless the taxpayer materially
participates in the activity. Each interest
in rental real estate of a qualifying
taxpayer will be treated as a separate
rental real estate activity, unless the
taxpayer makes an election under
paragraph (g) of this section to treat all
interests in rental real estate as a single
rental real estate activity. Each separate
rental real estate activity, or the single
combined rental real estate activity if
the taxpayer makes an election under
paragraph (g), will be an activity of the
taxpayer for all purposes of section 469,
including the former passive activity
rules under section 469(f) and the
disposition rules under section 469(g).
However, section 469 will continue to
be applied separately with respect to
each publicly traded partnership, as
required under section 469(k),
notwithstanding the rules of this
section.
(2) Treatment as a former passive
activity. For any taxable year in which
a qualifying taxpayer materially
participates in a rental real estate
activity, that rental real estate activity
will be treated as a former passive
activity under section 469(f) if
disallowed deductions or credits are
allocated to the activity under § 1.469–
1(f)(4).
(3) Grouping rental real estate
activities with other activities—(i) In
general. For purposes of this section, a
qualifying taxpayer may not group a
rental real estate activity with any other
activity of the taxpayer. For example, if
a qualifying taxpayer develops real
property, constructs buildings, and
owns an interest in rental real estate, the
taxpayer’s interest in rental real estate
may not be grouped with the taxpayer’s
development activity or construction
activity. Thus, only the participation of
the taxpayer with respect to the rental
real estate may be used to determine if
the taxpayer materially participates in
the rental real estate activity under
§ 1.469–5T.
(ii) Special rule for certain
management activities. A qualifying
taxpayer may participate in a rental real
estate activity through participation,
within the meaning of §§ 1.469–5(f) and
5T(f), in an activity involving the

management of rental real estate (even
if this management activity is conducted
through a separate entity). In
determining whether the taxpayer
materially participates in the rental real
estate activity, however, work the
taxpayer performs in the management
activity is taken into account only to the
extent it is performed in managing the
taxpayer’s own rental real estate
interests.
(4) Example. The following example
illustrates the application of this
paragraph (e).
Example. (i) Taxpayer B owns interests in
three rental buildings, U, V and W. In 1995,
B has $30,000 of disallowed passive losses
allocable to Building U and $10,000 of
disallowed passive losses allocable to
Building V under § 1.469–1(f)(4). In 1996, B
has $5,000 of net income from Building U,
$5,000 of net losses from Building V, and
$10,000 of net income from Building W. Also
in 1996, B is a qualifying taxpayer within the
meaning of paragraph (c) of this section. Each
building is treated as a separate activity of B
under paragraph (e)(1) of this section, unless
B makes the election under paragraph (g) to
treat the three buildings as a single rental real
estate activity. If the buildings are treated as
separate activities, material participation is
determined separately with respect to each
building. If B makes the election under
paragraph (g) to treat the buildings as a single
activity, all participation relating to the
buildings is aggregated in determining
whether B materially participates in the
combined activity.
(ii) Effective beginning in 1996, B makes
the election under paragraph (g) to treat the
three buildings as a single rental real estate
activity. B works full-time managing the
three buildings and thus materially
participates in the combined activity in 1996
(even if B conducts this management
function through a separate entity, including
a closely held C corporation). Accordingly,
the combined activity is not a passive activity
of B in 1996. Moreover, as a result of the
election under paragraph (g), disallowed
passive losses of $40,000 ($30,000+$10,000)
are allocated to the combined activity. B’s net
income from the activity for 1996 is $10,000
($5,000¥$5,000+$10,000). This net income
is nonpassive income for purposes of section
469. However, under section 469(f), the net
income from a former passive activity may be
offset with the disallowed passive losses
from the same activity. Because Buildings U,
V and W are treated as one activity for all
purposes of section 469 due to the election
under paragraph (g), and this activity is a
former passive activity under section 469(f),
B may offset the $10,000 of net income from
the buildings with an equal amount of
disallowed passive losses allocable to the
buildings, regardless of which buildings
produced the income or losses. As a result,
B has $30,000 ($40,000¥$10,000) of
disallowed passive losses remaining from the
buildings after 1996.

(f) Limited partnership interests in
rental real estate activities—(1) In
general. If a taxpayer elects under

paragraph (g) of this section to treat all
interests in rental real estate as a single
rental real estate activity, and at least
one interest in rental real estate is held
by the taxpayer as a limited partnership
interest (within the meaning of § 1.469–
5T(e)(3)), the combined rental real estate
activity will be treated as a limited
partnership interest of the taxpayer for
purposes of determining material
participation. Accordingly, the taxpayer
will not be treated under this section as
materially participating in the combined
rental real estate activity unless the
taxpayer materially participates in the
activity under the tests listed in § 1.469–
5T(e)(2) (dealing with the tests for
determining the material participation
of a limited partner).
(2) De minimis exception. If a
qualifying taxpayer elects under
paragraph (g) of this section to treat all
interests in rental real estate as a single
rental real estate activity, and the
taxpayer’s share of gross rental income
from all of the taxpayer’s limited
partnership interests in rental real estate
is less than ten percent of the taxpayer’s
share of gross rental income from all of
the taxpayer’s interests in rental real
estate for the taxable year, paragraph
(f)(1) of this section does not apply.
Thus the taxpayer may determine
material participation under any of the
tests listed in § 1.469–5T(a) that apply to
rental real estate activities.
(g) Election to treat all interests in
rental real estate as a single rental real
estate activity—(1) In general. A
qualifying taxpayer may make an
election to treat all of the taxpayer’s
interests in rental real estate as a single
rental real estate activity. This election
is binding for the taxable year in which
it is made and for all future years in
which the taxpayer is a qualifying
taxpayer under paragraph (c) of this
section, even if there are intervening
years in which the taxpayer is not a
qualifying taxpayer. The election may
be made in any year in which the
taxpayer is a qualifying taxpayer, and
the failure to make the election in one
year does not preclude the taxpayer
from making the election in a
subsequent year. In years in which the
taxpayer is not a qualifying taxpayer,
the election will not have effect and the
taxpayer’s activities will be those
determined under § 1.469–4. If there is
a material change in the taxpayer’s facts
and circumstances, the taxpayer may
revoke the election using the procedure
described in paragraph (g)(3) of this
section.
(2) Certain changes not material. The
fact that an election is less advantageous
to the taxpayer in a particular taxable
year is not, of itself, a material change

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations
in the taxpayer’s facts and
circumstances. Similarly, a break in the
taxpayer’s status as a qualifying
taxpayer is not, of itself, a material
change in the taxpayer’s facts and
circumstances.
(3) Filing a statement to make or
revoke the election. A qualifying
taxpayer makes the election to treat all
interests in rental real estate as a single
rental real estate activity by filing a
statement with the taxpayer’s original
income tax return for the taxable year.
This statement must contain a
declaration that the taxpayer is a
qualifying taxpayer for the taxable year
and is making the election pursuant to
section 469(c)(7)(A). The taxpayer may
make this election for any taxable year
in which section 469(c)(7) is applicable.
A taxpayer may revoke the election only
in the taxable year in which a material
change in the taxpayer’s facts and
circumstances occurs or in a subsequent
year in which the facts and
circumstances remain materially
changed from those in the taxable year
for which the election was made. To
revoke the election, the taxpayer must
file a statement with the taxpayer’s
original income tax return for the year
of revocation. This statement must
contain a declaration that the taxpayer
is revoking the election under section
469(c)(7)(A) and an explanation of the
nature of the material change.
(h) Interests in rental real estate held
by certain passthrough entities—(1)
General rule. Except as provided in
paragraph (h)(2) of this section, a
qualifying taxpayer’s interest in rental
real estate held by a partnership or an
S corporation (passthrough entity) is
treated as a single interest in rental real
estate if the passthrough entity grouped
its rental real estate as one rental
activity under § 1.469–4(d)(5). If the
passthrough entity grouped its rental
real estate into separate rental activities
under § 1.469–4(d)(5), each rental real
estate activity of the passthrough entity
will be treated as a separate interest in
rental real estate of the qualifying
taxpayer. However, the qualifying
taxpayer may elect under paragraph (g)
of this section to treat all interests in
rental real estate, including the rental
real estate interests held through
passthrough entities, as a single rental
real estate activity.
(2) Special rule if a qualifying
taxpayer holds a fifty-percent or greater
interest in a passthrough entity. If a
qualifying taxpayer owns, directly or
indirectly, a fifty-percent or greater
interest in the capital, profits, or losses
of a passthrough entity for a taxable
year, each interest in rental real estate
held by the passthrough entity will be

treated as a separate interest in rental
real estate of the qualifying taxpayer,
regardless of the passthrough entity’s
grouping of activities under § 1.469–
4(d)(5). However, the qualifying
taxpayer may elect under paragraph (g)
of this section to treat all interests in
rental real estate, including the rental
real estate interests held through
passthrough entities, as a single rental
real estate activity.
(3) Special rule for interests held in
tiered passthrough entities. If a
passthrough entity owns a fifty-percent
or greater interest in the capital, profits,
or losses of another passthrough entity
for a taxable year, each interest in rental
real estate held by the lower-tier entity
will be treated as a separate interest in
rental real estate of the upper-tier entity,
regardless of the lower-tier entity’s
grouping of activities under § 1.469–
4(d)(5).
(i) [Reserved].
(j) $25,000 offset for rental real estate
activities of qualifying taxpayers—(1) In
general. A qualifying taxpayer’s passive
losses and credits from rental real estate
activities (including prior-year
disallowed passive activity losses and
credits from rental real estate activities
in which the taxpayer materially
participates) are allowed to the extent
permitted under section 469(i). The
amount of losses or credits allowable
under section 469(i) is determined after
the rules of this section are applied.
However, losses allowable by reason of
this section are not taken into account
in determining adjusted gross income
for purposes of section 469(i)(3).
(2) Example. The following example
illustrates the application of this
paragraph (j).
Example. (i) Taxpayer A owns building X
and building Y, both interests in rental real
estate. In 1995, A is a qualifying taxpayer
within the meaning of paragraph (c) of this
section. A does not elect to treat X and Y as
one activity under section 469(c)(7)(A) and
paragraph (g) of this section. As a result, X
and Y are treated as separate activities
pursuant to section 469(c)(7)(A)(ii). A
materially participates in X which has
$100,000 of passive losses disallowed from
prior years and produces $20,000 of losses in
1995. A does not materially participate in Y
which produces $40,000 of income in 1995.
A also has $50,000 of income from other
nonpassive sources in 1995. A otherwise
meets the requirements of section 469(i).
(ii) Because X is not a passive activity in
1995, the $20,000 of losses produced by X in
1995 are nonpassive losses that may be used
by A to offset part of the $50,000 of
nonpassive income. Accordingly, A is left
with $30,000 ($50,000–$20,000) of
nonpassive income. In addition, A may use
the prior year disallowed passive losses of X
to offset any income from X and passive
income from other sources. Therefore, A may

66501

offset the $40,000 of passive income from Y
with $40,000 of passive losses from X.
(iii) Because A has $60,000 ($100,000–
$40,000) of passive losses remaining from X
and meets all of the requirements of section
469(i), A may offset up to $25,000 of
nonpassive income with passive losses from
X pursuant to section 469(i). As a result, A
has $5,000 ($30,000–$25,000) of nonpassive
income remaining and disallowed passive
losses from X of $35,000 ($60,000–$25,000)
in 1995.

Par. 5. Section 1.469–11 is amended
as follows:
1. Paragraph (a)(2) is amended by
removing ‘‘; and’’ and adding ‘‘;’’ in its
place.
2. Paragraph (a)(3) is redesignated as
paragraph (a)(4) and a new paragraph
(a)(3) is added.
3. Paragraph (b)(1) is revised.
4. The heading for paragraph (b)(2) is
revised; the headings for paragraphs
(b)(2)(i) and (b)(2)(ii) are removed;
paragraph (b)(2)(ii) is removed, and
paragraph (b)(2)(i) is redesignated as
paragraph (b)(2).
5. Paragraph (b)(3) is redesignated as
paragraph (b)(4).
6. A new paragraph (b)(3) is added.
The added and revised provisions
read as follows:
§ 1.469–11
rules.

Effective date and transition

(a) * * *
(3) The rules contained in § 1.469–9
apply for taxable years beginning on or
after January 1, 1995, and to elections
made under § 1.469–9(g) with returns
filed on or after January 1, 1995; and
*
*
*
*
*
(b) * * * (1) Application of 1992
amendments for taxable years beginning
before October 4, 1994. Except as
provided in paragraph (b)(2) of this
section, for taxable years that end after
May 10, 1992, and begin before October
4, 1994, a taxpayer may determine tax
liability in accordance with Project PS–
1–89 published at 1992–1 C.B. 1219 (see
§ 601.601(d)(2)(ii)(b) of this chapter).
(2) Additional transition rule for 1992
amendments. * * *
(3) Fresh starts under consistency
rules—(i) Regrouping when tax liability
is first determined under Project PS–1–
89. For the first taxable year in which
a taxpayer determines its tax liability
under Project PS–1–89, the taxpayer
may regroup its activities without regard
to the manner in which the activities
were grouped in the preceding taxable
year and must regroup its activities if
the grouping in the preceding taxable
year is inconsistent with the rules of
Project PS–1–89.
(ii) Regrouping when tax liability is
first determined under § 1.469–4. For
the first taxable year in which a

66502

Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

taxpayer determines its tax liability
under § 1.469–4, rather than under the
rules of Project PS–1–89, the taxpayer
may regroup its activities without regard
to the manner in which the activities
were grouped in the preceding taxable
year and must regroup its activities if
the grouping in the preceding taxable
year is inconsistent with the rules of
§ 1.469–4.
(iii) Regrouping when taxpayer is first
subject to section 469(c)(7). For the first
taxable year beginning after December
31, 1993, a taxpayer may regroup its
activities to the extent necessary or
appropriate to avail itself of the
provisions of section 469(c)(7) and
without regard to the manner in which
the activities were grouped in the
preceding taxable year.
*
*
*
*
*
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: December 12, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 95–30872 Filed 12–21–95; 8:45 am]
BILLING CODE 4830–01-U

26 CFR Part 1
[TD 8646]
RIN 1545–AT49

Allocation and Apportionment of
Research and Experimental
Expenditures
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

SUMMARY: This document provides
guidance concerning the allocation and
apportionment of research and
experimental expenditures for purposes
of determining taxable income from
sources within and without the United
States. This document affects taxpayers
that have income from United States
and foreign sources and that have made
expenditures for research and
experimentation that the taxpayer
deducts under section 174 of the
Internal Revenue Code of 1986.
EFFECTIVE DATE: January 1, 1996.
FOR FURTHER INFORMATION CONTACT: Carl
Cooper at (202) 622–3840 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:

Background and Explanation of
Provisions
On May 24, 1995, the IRS published
a notice of proposed rulemaking and
notice of public hearing in the Federal

Register (60 FR 27453) proposing
amendments to the Income Tax
Regulations (26 CFR part 1) under
section 861 of the Internal Revenue
Code of 1986. Section 1.861–8(e)(3) of
the Income Tax Regulations provides
rules regarding the allocation and
apportionment of research and
experimental expenditures for purposes
of determining taxable income from
sources inside and outside the United
States.
The notice of proposed rulemaking
proposed three principal changes to the
existing regulations. First, allocation of
research and experimental expenditures
to three-digit SIC code product
categories of gross income would be
permitted. Second, the percentage of
research and experimental expenditures
that may be exclusively apportioned to
United States source income under the
sales method of apportionment under
§ 1.861–8(e)(3)(ii) would be increased
from 30 percent to 50 percent. Third,
use of the optional gross income
methods of apportionment would
constitute a binding election to use such
methods in subsequent years. The
election would not be revocable without
the prior consent of the Commissioner.
The three changes were proposed in
part on the basis of an economic study
performed by the Treasury Department
pursuant to Rev. Proc. 92–56 (1992–2
C.B. 409), ‘‘The Relationship Between
U.S. Research and Development and
Foreign Income,’’ which was published
by the Treasury Department
simultaneously with the proposed
regulations.
Written comments responding to the
notice were received, and a public
hearing was held on September 8, 1995.
Regarding the determination of
product categories under § 1.861–
8(e)(3)(i)(B) of the proposed regulations,
commenters suggested that the rule
requiring a taxpayer to determine
relevant product categories by reference
to the three-digit classification of the
Standard Industrial Classification
Manual should be modified to allow
determinations by reference to the fivedigit classifications of the Manual. This
suggestion was not adopted, because
such a rule would too narrowly restrict
the necessarily broad scope of the
deduction. The IRS continues to believe
that research and experimentation is an
inherently speculative activity, that
findings may contribute unexpected
benefits, and that gross income derived
from successful research and
experimentation must bear the cost of
unsuccessful research and
experimentation.
Commenters suggested that the
regulations permit taxpayers to

determine product categories by
reference to two- or three-digit
categories at the annual election of the
taxpayer. This suggestion was not
adopted. The regulations provide that a
taxpayer may determine product
categories by reference to two- or threedigit categories. A taxpayer may
aggregate, disaggregate or change a
previously selected SIC code category if
the taxpayer establishes to the
satisfaction of the Commissioner that,
due to changes in the relevant facts, a
change in product category is
appropriate. This rule provides a simple
and workable format for balancing the
need for consistency with the desire for
flexibility.
Referring to current § 1.861–8(g)
Example 6 (which has been
redesignated § 1.861–17(h) Example 4),
commenters suggested that the
regulations allow the use of the
Wholesale Trade SIC code category with
respect to sales from any other category.
The current § 1.861–8(g) Example 6 was
not correct on this point and does not
override the rule stated parenthetically
in the list of two digit SIC code
categories in present § 1.861–
8(e)(3)(i)(A) that wholesale trade may
not be combined with other product
categories. The final regulations include
this rule along with Example 6
corrected to conform to the rule.
Regarding the exclusive place of
performance apportionment rule under
§ 1.861–8(e)(3)(ii)(A) of the proposed
regulations, commenters suggested
adding a rule providing that if the ratio
of foreign research and experimental
expenditures in a three digit SIC code
category of all foreign affiliates of a
United States consolidated group over
foreign affiliate sales in that SIC code
category exceed fifty percent of the ratio
of United States consolidated group
research and experimental expenditures
in that SIC code category over United
States consolidated group sales in that
SIC code category, then the United
States consolidated group research and
experimental expenditures should be
exclusively apportioned to United
States source gross income. This
suggestion has not been adopted.
Although a foreign affiliate may incur
substantial research and experimental
expenditures in a given product
category, the foreign affiliate may still
benefit from the research and
experimental expenditures of the United
States consolidated group. See PerkinElmer Corporation v. Commissioner,
103 T.C. 464 (1994).
Regarding the optional gross income
methods of apportionment under
§ 1.861–8(e)(3)(iii) of the proposed
regulations, commenters suggested that