Regulation 106089-18 (163(j))

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

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–106089–18]
RIN 1545–BO73

Limitation on Deduction for Business
Interest Expense
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking;
notification of public hearing; and
withdrawal of notice of proposed
rulemaking.
AGENCY:

This notice of proposed
rulemaking provides rules regarding the
limitation on the deduction for business
interest expense after the enactment of
recent tax legislation. Specifically, these
regulations provide general rules and
definitions. The regulations also provide
rules for calculating the limitation in
consolidated group, partnership, and
international contexts. The regulations
affect taxpayers that have deductible
business interest expense, other than
certain small businesses, electing real
property trades or businesses, electing
farming businesses, and certain utility
businesses. This document also
withdraws a notice of proposed
rulemaking relating to the disallowance
of a deduction for certain interest paid
or accrued by a corporation. This
document also provides notice of a
public hearing on the proposed
regulations.
DATES: Written or electronic comments
must be received by February 26, 2019.
Outlines of topics to be discussed at the
public hearing scheduled for February
27, 2019, at 10 a.m. must be received by
February 26, 2019. If there is not
sufficient time to discuss all of the
topics on February 27, 2019, the hearing
will continue the following day at 10
a.m. in the same location.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–106089–18), Room
5203, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20044.
Submissions may be hand-delivered
Monday through Friday between the
hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG–106089–18),
Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW,
Washington, DC 20224, or sent
electronically, via the Federal
Rulemaking Portal at http://
www.regulations.gov (indicate IRS and
REG–106089–18). The public hearing
will be held in the Main IRS
Auditorium beginning at 10 a.m. in the

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SUMMARY:

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Internal Revenue Building, 1111
Constitution Avenue NW, Washington,
DC 20224.
FOR FURTHER INFORMATION CONTACT:
Concerning § 1.163(j)–1, § 1.163(j)–2,
§ 1.163(j)–3, § 1.163(j)–9, or § 1.263A–9,
Zachary King, (202) 317–4875, Charles
Gorham, (202) 317–5091, Susie Bird,
(202) 317–4860, Jaime Park, (202) 317–
4877, or Sophia Wang, (202) 317–4890;
concerning § 1.163(j)–4, § 1.163(j)–5,
§ 1.163(j)–10, § 1.163(j)–11,
§ 1.381(c)(20)–1, § 1.382–1, § 1.382–2,
§ 1.382–5, § 1.382–6, § 1.383–0, § 1.383–
1, § 1.1502–13, § 1.1502–21, § 1.1502–
36, § 1.1502–79, § 1.1502–91, § 1.1502–
95, § 1.1502–98, § 1.1502–99, or
§ 1.1504–4, Kevin M. Jacobs, (202) 317–
5332, Russell Jones, (202) 317–5357, or
John Lovelace, (202) 317–5363;
concerning § 1.163(j)–6 or § 1.469–
9(b)(2), Meghan Howard, (202) 317–
5055, William Kostak, (202) 317–6852,
Anthony McQuillen, (202) 317–5027,
Adrienne Mikolashek, (202) 317–5050,
or James Quinn (202) 317–5054;
concerning § 1.163(j)–7, § 1.163(j)–8, or
§ 1.882–5, Angela Holland, (202) 317–
5474, Steve Jensen, (202) 317–6938, or
Charles Rioux, (202) 317–6842;
concerning § 1.446–3, RICs, REITs,
REMICs, and the definition of the term
‘‘interest’’, Michael Chin, (202) 317–
5846; concerning submissions of
comments and outlines of topics for the
public hearing, Regina Johnson (202)
317–6901 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed
amendments to the Income Tax
Regulations (26 CFR part 1) under
section 163(j) of the Internal Revenue
Code (Code). Section 163(j) was
amended as part of ‘‘An Act to provide
for reconciliation pursuant to titles II
and V of the concurrent resolution on
the budget for fiscal year 2018,’’ Public
Law 115–97 (2017) (TCJA). Section
13301(a) of the TCJA amended section
163(j) by removing prior section
163(j)(1) through (9) and adding section
163(j)(1) through (10). The provisions of
section 163(j) as amended by section
13301 of the TCJA are effective for tax
years beginning after December 31,
2017. Unless otherwise indicated, all
references to section 163(j) in this
document are references to section
163(j) as amended by the TCJA.
Section 163(j), prior to the
amendment by the TCJA (old section
163(j)), disallowed a deduction for
‘‘disqualified interest’’ paid or accrued
by a corporation in a taxable year if two
threshold tests were satisfied. The first
threshold test under old section 163(j)

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was satisfied if the payor’s debt-toequity ratio exceeded 1.5 to 1.0 (safe
harbor ratio). The second threshold test
under old section 163(j) was satisfied if
the payor’s net interest expense
exceeded 50 percent of its adjusted
taxable income, generally, taxable
income computed without regard to
deductions for net interest expense, net
operating losses, domestic production
activities under section 199,
depreciation, amortization, and
depletion. Disqualified interest for
purposes of old section 163(j) included
interest paid or accrued to (1) related
parties when no Federal income tax was
imposed with respect to such interest;
(2) unrelated parties in certain instances
in which a related party guaranteed the
debt; or (3) a real estate investment trust
(REIT) by a taxable REIT subsidiary of
that REIT. Interest amounts disallowed
for any taxable year under old section
163(j) were treated as interest paid or
accrued in the succeeding taxable year
and could be carried forward
indefinitely. In addition, any excess
limitation, namely, the excess of 50
percent of the adjusted taxable income
of the payor over the payor’s net interest
expense, could be carried forward three
years under old section 163(j)(2)(B). On
June 18, 1991, the Department of the
Treasury (Treasury Department) and the
IRS published in the Federal Register
(56 FR 27907) a notice of proposed
rulemaking (1991–2 C.B. 1040) (Prior
Proposed Regulations) to implement the
rules under old section 163(j).
In contrast to old section 163(j), for
tax years beginning after December 31,
2017, section 163(j) generally limits the
amount of business interest expense that
can be deducted in the current taxable
year (also referred to in this Explanation
of Provisions as the current year). Under
section 163(j)(1), the amount allowed as
a deduction for business interest
expense is limited to the sum of (1) the
taxpayer’s business interest income for
the taxable year; (2) 30 percent of the
taxpayer’s adjusted taxable income
(ATI) for the taxable year; and (3) the
taxpayer’s floor plan financing interest
expense for the taxable year. The
limitation under section 163(j)(1)
applies to all taxpayers, except for
certain small businesses that meet the
gross receipts test in section 448(c) and
certain trades or businesses listed in
section 163(j)(7).
Section 163(j)(2) provides that the
amount of any business interest not
allowed as a deduction for any taxable
year as a result of the limitation under
section 163(j)(1) is carried forward and
treated as business interest paid or
accrued in the next taxable year. In
contrast to old section 163(j), section

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
163(j) does not provide for the
carryforward of any excess limitation.
Section 163(j)(3) provides that the
limitation under section 163(j)(1) does
not apply to a taxpayer, other than a tax
shelter as defined in section 448(a)(3),
with average annual gross receipts of
$25 million or less, determined under
section 448(c) (including any
adjustment for inflation under section
448(c)(4)). For taxpayers other than
corporations or partnerships, section
163(j)(3) provides that the gross receipts
test is determined for purposes of
section 163(j) as if the taxpayer were a
corporation or partnership.
Section 163(j)(4) provides special
rules for applying section 163(j) in the
case of partnerships and S corporations.
Section 163(j)(4)(A) requires that the
limitation on the deduction for business
interest expense be applied at the
partnership level, and that a partner’s
ATI be increased by the partner’s share
of excess taxable income, as defined in
section 163(j)(4)(C), but not by the
partner’s distributive share of income,
gain, deduction, or loss. Section
163(j)(4)(B) provides that the amount of
partnership business interest expense
limited by section 163(j)(1) is carried
forward at the partner-level. Section
163(j)(4)(B)(ii) provides that excess
business interest expense allocated to a
partner and carried forward is available
to be deducted in a subsequent year
only if the partnership allocates excess
taxable income to the partner. Section
163(j)(4)(B)(iii) provides rules for the
adjusted basis in a partnership of a
partner that is allocated excess business
interest expense. Section 163(j)(4)(D)
provides that rules similar to the rules
of section 163(j)(4)(A) and (C) apply to
S corporations and S corporation
shareholders.
Section 163(j)(5) and (6) defines
‘‘business interest’’ and ‘‘business
interest income,’’ respectively, for
purposes of section 163(j). Generally,
these terms include interest expense
and interest includible in gross income
that is properly allocable to a trade or
business (as defined in section
163(j)(7)). The legislative history states
that ‘‘a corporation has neither
investment interest nor investment
income within the meaning of section
163(d). Thus, interest income and
interest expense of a corporation is
properly allocable to a trade or business,
unless such trade or business is
otherwise explicitly excluded from the
application of the provision.’’ H. Rept.
115–466, at 386, fn. 688 (2017).
Under section 163(j)(7), the limitation
on the deduction for business interest
expense in section 163(j)(1) does not
apply to certain trades or businesses.

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The excepted trades or businesses are
the trade or business of providing
services as an employee, electing real
property businesses, electing farming
businesses, and certain regulated utility
businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without
regard to the following: Items not
properly allocable to a trade or business;
business interest and business interest
income; net operating loss deductions;
and deductions for qualified business
income under section 199A. ATI also
generally excludes deductions for
depreciation, amortization, and
depletion with respect to taxable years
beginning before January 1, 2022 and
includes other adjustments provided by
the Secretary of the Treasury.
Section 163(j)(9) defines ‘‘floor plan
financing interest’’ as interest paid or
accrued on ‘‘floor plan financing
indebtedness.’’ These provisions allow
taxpayers incurring interest expense for
the purpose of securing an inventory of
motor vehicles held for sale or lease to
deduct the full expense without regard
to the limitation under section 163(j)(1).
Section 163(j)(10) provides cross
references to provisions requiring that
electing farming businesses and electing
real property businesses excepted from
the limitation under section 163(j)(1)
use the alternative depreciation system
(ADS), rather than the general
depreciation system for certain types of
property. The required use of ADS
results in the inability of these electing
trades or businesses to use the
additional first-year depreciation
deduction under section 168(k) for those
types of property.
The Conference Report states that
‘‘[i]n the case of a group of affiliated
corporations that file a consolidated
return, the limitation applies at the
consolidated tax return filing level.’’ H.
Rept. 115–466, at 386 (2017). Old
section 163(j) treated an affiliated group
as one taxpayer, and authorized superaffiliation rules for treating certain other
groups as one taxpayer. Both of these
provisions were removed by the TCJA,
and no equivalent provisions are
included in section 163(j).
On April 16, 2018, the Treasury
Department and the IRS published
Notice 2018–28 (2018–16 I.R.B. 492) to
announce an intent to issue proposed
regulations that will provide guidance
to assist taxpayers in complying with
section 163(j). Notice 2018–28 further
describes certain rules that those
proposed regulations will include to
provide taxpayers with interim
guidance as more comprehensive
guidance is developed. In addition,
Notice 2018–28 requested comments

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from taxpayers about the application of
section 163(j). Where relevant to the
provisions of these proposed
regulations, comments are addressed in
the Explanation of Provisions section.
Notice 2018–28 also stated the intent
of the Treasury Department and the IRS
to withdraw the Prior Proposed
Regulations issued under old section
163(j).
Explanation of Provisions
These proposed regulations would
withdraw the Prior Proposed
Regulations and provide guidance
regarding the new limitation on the
deduction for business interest expense
under section 163(j). These proposed
regulations also would add or amend
regulations under certain other
provisions of the Code where necessary
to provide conformity across the Income
Tax Regulations. A significant number
of the terms used throughout these
proposed regulations are defined in
proposed § 1.163(j)–1. Some of these
terms are discussed in this Explanation
of Provisions section as they relate to
specific provisions of these proposed
regulations.
Consistent with section 163(j)(1),
these proposed regulations would limit
a taxpayer’s deduction for business
interest expense to the sum of the
taxpayer’s current-year business interest
income, 30 percent of the taxpayer’s
ATI, and certain floor plan financing
interest expense. These proposed
regulations would provide that any
amount of business interest expense that
cannot be deducted because of the
limitation under section 163(j)(1)
(section 163(j) limitation) can be carried
forward and treated as business interest
expense in future years. These proposed
regulations also would provide special
rules related to the business interest
expense carried forward (‘‘disallowed
business interest expense
carryforwards’’) by passthrough entities,
C corporations, and consolidated
groups. Amounts carried forward under
old section 163(j) as disallowed
disqualified interest are included as
disallowed business interest expense
carryforwards of a taxpayer to the extent
that the amounts otherwise qualify as
business interest expense of the
taxpayer under these proposed
regulations.
These proposed regulations are
organized into eleven sections,
proposed §§ 1.163(j)–1 through 1.163(j)–
11. Proposed § 1.163(j)–1 would provide
common definitions used throughout
the proposed regulations. Proposed
§ 1.163(j)–2 would provide general rules
relating to the computation of a
taxpayer’s section 163(j) limitation and

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proposed § 1.163(j)–3 would provide
ordering and other rules regarding the
relationship of the section 163(j)
limitation and other provisions of the
Code affecting interest. Proposed
§ 1.163(j)–4 would provide rules
applicable to C corporations (including
REITs, RICs, and consolidated group
members) and tax-exempt corporations,
whereas proposed § 1.163(j)–5 would
provide rules governing the disallowed
business interest expense carryforwards
of C corporations. Proposed § 1.163(j)–6
would provide special rules for
applying the section 163(j) limitation to
partnerships and S corporations.
Proposed § 1.163(j)–7 would provide
rules regarding the application of
section 163(j) to foreign corporations
and their shareholders, whereas
proposed § 1.163(j)–8 would provide
rules regarding the application of
section 163(j) to foreign persons with
effectively connected income. Proposed
§ 1.163(j)–9 would provide rules
regarding elections for excepted trades
or businesses as well as a safe harbor for
certain REITs. Proposed § 1.163(j)–10
would provide rules to allocate expense
and income between non-excepted and
excepted trades or businesses. Finally,
proposed § 1.163(j)–11 would provide
certain transition rules relating to the
application of the section 163(j)
limitation. The remainder of this
Explanation of Provisions section
discusses these eleven sections, as well
as related conforming and coordinating
provisions set forth in these proposed
regulations.
1. Proposed § 1.163(j)–1: Definitions
Proposed § 1.163(j)–1 would provide
definitions of terms used in these
proposed regulations. This part 1 of the
Explanation of Provisions section briefly
discusses the most significant
definitions contained in proposed
§ 1.163(j)–1.

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A. Adjusted Taxable Income
i. Background
The Prior Proposed Regulations under
old section 163(j) defined adjusted
taxable income to include a number of
adjustments in addition to those set
forth in the statutory text of old section
163(j). Some of the additional
adjustments resulted in an adjusted
taxable income value that approximated
cash flow. Two commenters to Notice
2018–28 asked if ATI for purposes of
section 163(j) would also attempt to
approximate cash flow. Comments on
the Prior Proposed Regulations raised a
number of administrative concerns with
the additions and subtractions to ATI
that approximated cash flow in those

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proposed regulations. The Prior
Proposed Regulations were not finalized
and therefore did not incorporate the
suggestions of these comments to
abandon this approach. In addition,
because the Prior Proposed Regulations
were never finalized, the approach of
the Prior Proposed Regulations was
never formally required or adopted.
Finally, nothing in the Conference
Report or the text of section 163(j)
requires or suggests that adjustments
should be made to ATI in order to
approximate cash flow. Such a
requirement could have been written
into the statutory language or the
discussion of section 163(j) contained in
the Conference Report if Congress
intended ATI to be adjusted in such a
manner.
As a result, these proposed
regulations would not adopt a cash flow
approach to ATI. Instead, proposed
§ 1.163(j)–1(b)(1) would follow the
statutory framework of section 163(j)(8)
and define ATI to include the
adjustments specified in section
163(j)(8)(A), as well as additional
adjustments under the authority granted
in section 163(j)(8)(B) to prevent double
counting and other distortions of items
such as floor plan financing interest
expense and certain deductions for
depreciation, amortization, or depletion
upon the sale or disposition of property.
ii. General Application of the Definition
of ATI
To compute ATI, taxpayers would
first compute taxable income, as defined
in proposed § 1.163(j)–1(b)(37), in
accordance with section 63. In
computing taxable income for this
purpose, taxpayers would treat all
business interest expense as deductible
without regard to the section 163(j)
limitation. Second, taxpayers would add
or subtract, as appropriate, the items
specified in these proposed regulations
as adjustments to taxable income.
iii. Adjustments to ATI Specifically
Referenced in Section 163(j)(8)(A)
Proposed § 1.163(j)–1(b)(1) includes
as adjustments to taxable income items
specifically referenced in section
163(j)(8)(A): Any item of income, gain,
deduction, or loss which is not properly
allocable to a trade or business; business
interest and business interest income;
net operating loss deductions under
section 172; deductions for qualified
business income under section 199A;
and, deductions for depreciation,
amortization, and depletion, but only
with respect to taxable years beginning
before January 1, 2022. Net operating
losses under section 172 are added to
taxable income in determining ATI,

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including net operating losses arising in
taxable years prior to the effective date
of these proposed regulations and
carried forward. For purposes of
computing ATI, it is intended that
deductions for depreciation include
special allowances under section 168(k).
Additionally, to clarify an issue raised
by a commenter in response to Notice
2018–28, the Treasury Department and
the IRS note that an amount incurred as
depreciation, amortization, or depletion,
but capitalized to inventory under
section 263A and included in cost of
goods sold, is not a deduction for
depreciation, amortization, or depletion
for purposes of section 163(j).
iv. Other Adjustments to ATI Under
Section 163(j)(8)(B)
These proposed regulations would
include a number of adjustments under
the authority granted in section
163(j)(8)(B). For example, these
proposed regulations would include
special rules that apply in defining the
taxable income of: A regulated
investment company (RIC) or REIT in
proposed § 1.163(j)–4(b)(4)(ii); a
consolidated group in proposed
§ 1.163(j)–4(d)(2)(iv); a partnership in
proposed § 1.163(j)–6(d)(1); an S
corporation in proposed § 1.163(j)–
6(l)(3); and certain controlled foreign
corporations in proposed § 1.163(j)–
7(c)(1).
Under the authority granted in section
163(j)(8)(B), proposed § 1.163(j)–1(b)(1)
also includes additional adjustments to
prevent double counting. Thus, in
addition to a subtraction for any floor
plan financing interest expense, these
proposed regulations include
adjustments for sales or dispositions of
certain property for taxable years
beginning before January 1, 2022.
Proposed § 1.163(j)–1(b)(1)(i)(D), (E),
and (F) would provide that in
determining the amount of a taxpayer’s
ATI for a taxable year, deductions for
depreciation under section 167 or 168,
the amortization of intangibles and
other amortized expenditures, and
depletion under section 611 are added
back to a taxpayer’s taxable income. As
a result, the taxpayer would have
increased their taxable income by these
amounts for section 163(j) purposes.
However, the Treasury Department and
the IRS note that a taxpayer could
receive a double benefit associated with
the depreciation, amortization, and
depletion, for ATI calculation purposes
if the taxpayer’s ATI is increased in
respect of a deduction associated with
depreciation, amortization, or depletion
and then the taxpayer sells or otherwise
disposes of the property that was
depreciated, amortized, or depleted.

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This double benefit would result
because the amount of the gain that
would otherwise be reflected in the ATI
in respect of the sale or other
disposition would reflect the decreased
basis in such assets as a result of the
depreciation, amortization, or depletion.
Additionally, similar concerns are
present if the property was held by
either a partnership or a member of a
consolidated group and the partnership
interest or the stock of the member is
sold or otherwise disposed of, because
the adjusted basis in the partnership
interest or member stock would have
been reduced to reflect the depreciation,
amortization, or depletion. As a result,
these proposed regulations would
eliminate the double benefit associated
with these sales or other dispositions of
property. See proposed § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E).
v. Other Rules for Adjusting ATI
Taxpayers can take each adjustment
into account only once for purposes of
computing ATI; for instance, a
deduction for the depreciation of
nonbusiness property under section 167
cannot be taken into account as an
adjustment to taxable income as both a
deduction for depreciation and an item
of deduction that is not properly
allocable to a trade or business. For
purposes of computing ATI, only the
adjustments to taxable income that are
specified in these proposed regulations
may be made. For instance, a deduction
under section 243 for dividends
received by a C corporation that is
neither a RIC nor a REIT reduces the
taxable income of the C corporation, and
the C corporation cannot add back the
amount of such deduction in computing
ATI. Proposed § 1.163(j)–4(c)(2) would
provide special rules that affect
deductions under section 243 for RICs
and REITs.
If for a taxable year a taxpayer is
allowed a deduction under section
250(a)(1), the taxpayer should take into
account the deduction when computing
taxable income that is used to calculate
ATI, but these proposed regulations
would provide that the taxable income
limitation in section 250(a)(2) does not
apply for this purpose. Taxpayers,
however, may be required to make
adjustments adding back the section
250(a)(1) deduction to the extent that
some or all of the deduction is
attributable to an inclusion under
section 951A. See proposed § 1.163(j)–
7(d).
A separate set of proposed regulations
under development will provide general
guidance regarding section 250,
including the computation of the
section 250 deduction and the

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application of the taxable income
limitation in section 250(a)(2).
vi. Comment Request Related To
Ordering of Code Provisions
The Treasury Department and the IRS
are also aware that various Code
provisions in addition to sections 163(j)
and 250 (for example, see section
246(b)), affect the amount of taxable
income of a taxpayer and are based on,
or are limited in some fashion based
upon, the taxable income of the
taxpayer. As a result, ordering rules are
necessary to coordinate application of
all of these provisions of the Code with
one another. The Treasury Department
and the IRS request comments on this
matter, which presents broader issues
than the ordering of these provisions
relative to the application of section
163(j) and may therefore be addressed in
guidance unrelated to these proposed
regulations.
vii. Comment Request Related to the
Computation of ATI
The Treasury Department and the IRS
request comments regarding the
methodology for computing ATI for
purposes of these proposed section
163(j) regulations, including any items
that should be included as additional
adjustments to taxable income.
B. Interest
There are no generally applicable
regulations or statutory provisions
addressing when financial instruments
are treated as debt for Federal income
tax purposes or when a payment is
interest. As a result, the proposed
regulations draw upon past guidance
and case law that address the meaning
of interest in the context of Federal tax
law. As a general matter, the factors that
distinguish debt from equity are
described in Notice 94–47, 1994–1 C.B.
357, and interest is defined as
compensation for the use or forbearance
of money. Deputy v. Dupont, 308 U.S.
488 (1940). Using these well-established
principles regarding the meaning of
interest, these proposed regulations
would define interest to include any
amount paid or accrued as
compensation for the use or forbearance
of money under the terms of an
instrument or contractual arrangement,
including a series of transactions, that is
treated as a debt instrument for
purposes of section 1275(a) and
§ 1.1275–1(d) (similar to the definition
of interest described in Deputy v.
Dupont). Thus, these proposed
regulations would apply to interest
associated with conventional debt
instruments, as well as transactions that
are indebtedness in substance although

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not in form. See Schering-Plough Corp.
v. U.S., 651 F.Supp. 2d 219 (N.J. Dist.
Ct. 2009), aff’d sub nom. Merck & Co.,
Inc. v. U.S., 652 F.3d 475 (3d Cir. 2011);
Mapco Inc. v. U.S., 556 F.2d 1107 (Ct.
Cl. 1977). The interest definition in
these proposed regulations also would
include any amount treated as interest
under other provisions of the Code or
the regulations thereunder, such as
original issue discount, accrued market
discount, and amounts with respect to
an integrated transaction under
§ 1.1275–6.
For purposes of section 163(j), these
proposed regulations also would treat as
interest certain amounts that are closely
related to interest and that affect the
economic yield or cost of funds of a
transaction involving interest, but that
may not be compensation for the use or
forbearance of money on a stand-alone
basis. Income, deduction, gain, or loss
from a transaction used to hedge an
interest bearing asset or liability, a
substitute interest payment made on a
debt instrument under the terms of a
securities lending or a sale-repurchase
transaction, certain commitment fees,
and certain debt issuance costs are
examples of amounts that would be
treated as interest under these proposed
regulations. In addition, in order to
prevent transactions that are essentially
financing transactions from avoiding the
application of section 163(j), these
proposed regulations contain an antiavoidance rule that treats as interest
expense for purposes of section 163(j)
an expense or loss predominantly
incurred in consideration of the time
value of money in a transaction or series
of integrated or related transactions in
which a taxpayer secures the use of
funds for a period of time.
Treating amounts that are closely
related to interest as interest income or
expense when appropriate to achieve a
statutory purpose is not new; most of
the rules treating such payments as
interest in these proposed regulations
were developed in §§ 1.861–9T and
1.954–2. As a consequence of these
rules, however, in some cases certain
items could be tested under section
163(j) that are not treated as interest
under other provisions that interpret the
definition of interest more narrowly.
Thus, for example, in certain cases, an
amount that was previously deductible
under section 162 without limitation
could now be tested as business interest
expense under section 163(j).
As previously noted, these proposed
regulations address the treatment of a
commitment fee paid in connection
with a lending transaction. This
treatment is based on a rule in § 1.954–
2(h). The Treasury Department and the

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IRS request comments on whether other
types of fees paid in connection with a
lending transaction that are not
otherwise treated as interest for Federal
income tax purposes should be treated
as interest for purposes of section 163(j).
As also previously noted, these
proposed regulations would treat as
interest certain amounts that are closely
related to interest and that affect the
economic yield or cost of funds of
transactions involving interest. The
Treasury Department and the IRS
request comments on whether
additional guidance is needed regarding
amounts that are covered or not covered
by this rule, specific types of amounts
that should or should not be covered,
how such amounts are linked to related
transactions involving interest, and how
such amounts are treated for financial
reporting or other nontax purposes.
More generally, the Treasury
Department and the IRS request
comments on whether other types of
income and expense should be treated
as interest income or interest expense
for purposes of section 163(j). For
example, should income earned by a
taxpayer in a transaction in which the
taxpayer provides the use of funds be
treated as interest income of the
taxpayer if such income is earned
predominantly in consideration of the
time value of money?
Finally, these proposed regulations
generally would treat a swap with
significant nonperiodic payments as two
separate transactions consisting of an
on-market, level payment swap and a
loan. The loan would be accounted for
by the parties to the contract
independently of the swap. The time
value component associated with the
loan, determined in accordance with
§ 1.446–3(f)(2)(iii)(A), would be
recognized as interest expense to the
payor and interest income to the
recipient. This provision in these
proposed regulations would apply in
the same manner as § 1.446–3(g)(4)
before it was amended on May 8, 2015,
by T.D. 9719 (80 FR 26437, as corrected
by 80 FR 61308 (October 13, 2015)),
except that this provision would not
apply to a collateralized swap that is
cleared by a derivatives clearing
organization or by a clearing agency.
The treatment of such collateralized
cleared swaps is reserved, and these
proposed regulations would not require
testing the assets used for
collateralization or condition the
exception for collateralized cleared
swaps on the extent of collateralization.
The Treasury Department and the IRS
request comments on the proper
treatment of swaps that are cleared by

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a derivatives clearing organization or by
a clearing agency, and any requirements
with respect to collateralization that
would be necessary or appropriate to
identify swaps that could be used to
effectively advance funds through the
use of nonperiodic payments.
The Treasury Department and the IRS
considered three options with respect to
the definition of interest. The first
option considered was to not provide a
definition of interest, and thus rely on
general tax principles and case law for
purposes of defining interest for
purposes of section 163(j). While
adopting this option might reduce the
compliance burden for some taxpayers,
not providing an explicit definition of
interest would create its own
uncertainty as neither taxpayers nor the
IRS might have a clear sense of what
types of payments are treated as interest
income and interest expense for
purposes of section 163(j). Such
uncertainty could increase burdens to
the IRS and taxpayers including with
respect to disputes and litigation about
whether particular payments are interest
for section 163(j) purposes. Importantly,
this option could be distortive as it
could result in inappropriate outcomes
for taxpayers that earn income that is
economically similar to interest income
but that has not historically been so
treated under general tax principles. For
example, in the case of the acquisition
of a customer receivable at a discount,
existing income tax principles may treat
the difference between the acquisition
price and the amount ultimately paid on
the receivable as ordinary income that is
not interest income. In addition, such an
approach to the definition of interest
would incentivize taxpayers to engage
in transactions that provide leverage
while generating deductions
economically similar to interest but
make arguments that such deductions
fail to be described by existing
principles defining interest expense. If
successful, such strategies may greatly
limit the application of section 163(j),
contrary to the Congressional intent of
limiting the deductibility of interest of
businesses with the greatest levels of
leverage. See House Report, H.R. 115–
409 at 248. In addition, such an
approach may ignore the statutory
language of section 163(j)(1) ‘‘[t]he
amount allowed as a deduction under
this chapter for any taxable year for
business interest . . .’’ (emphasis
added), which is, on its face, broader
than merely deductions under section
163.
The second option considered would
have been to adopt a definition of
interest but limit the scope of the
definition to cover only amounts

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associated with conventional debt
instruments and amounts that are
generally treated as interest under the
Code or regulations for all purposes
prior to the passage of the TCJA. For
example, this is similar to the definition
of interest proposed in § 1.163(j)–
1(b)(20)(i). While this would bring
clarity to many transactions regarding
what would be deemed interest for the
section 163(j) limitation, the Treasury
Department and the IRS believe that this
approach would potentially distort
future financing transactions. Some
taxpayers would choose to use financial
instruments and transactions that
provide a similar economic result to
using a conventional debt instrument,
but would avoid the label of interest
expense under such a definition,
potentially enabling these taxpayers to
avoid the section 163(j) limitation
without a substantive change in capital
structure. As a result, the transactions
discussed in the prior paragraph would
continue to be possible and incentivized
under this approach.
In addition, there are certain
transactions where under a specific
provision of the Code and regulations,
amounts could be characterized as
ordinary income when in substance the
amounts are interest income. For
example, in the case of the acquisition
of a customer receivable at a discount,
existing income tax principles may treat
the difference between the acquisition
price and the amount ultimately paid on
the receivable as ordinary income that is
not interest income; however, such
income would count as interest income
under economic principles. As another
example, the receipt of substitute
interest paid on a securities loan
arrangement may, under existing
income tax principles, also be treated as
ordinary income rather than interest
income despite the fact that such
income would also be treated as interest
income under economic principles.
Prior to the enactment of the section
163(j) interest limitation in TCJA,
whether such amounts were labeled as
ordinary income or interest income was
not often material to the overall tax
liability of most taxpayers, but now this
distinction may have a significant
impact on a large number of taxpayers.
The final option considered and the
one ultimately adopted in these
proposed regulations is to provide a
complete definition of interest that
addresses all transactions that are
commonly understood to produce
interest income and expense, including
transactions that may otherwise have
been entered into to avoid the
application of section 163(j). This
approach has the advantage of also

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providing rules that clearly treat
amounts as interest in appropriate cases.
Although a comprehensive definition of
interest requires an unavoidable degree
of detail, the benefits of a detailed
definition should decidedly outweigh
any complexity that results. The
proposed regulations also reduce
taxpayer burden by adopting definitions
of interest that have already been
developed and administered in
§§ 1.861–9T and 1.954–2, and add
several definitions of interest income
that were suggested by commenters
(such as the rules regarding amounts on
contingent payment debt instruments in
§ 1.163(j)–1(b)(20)(iii)(B)).
The Treasury Department and the IRS
invite comments on the definition of
interest for purposes of section 163(j)
contained in these proposed regulations,
whether another definition of interest
would be more appropriate in the
context of section 163(j), and, generally,
what definition of interest would be the
most appropriate definition for purposes
of section 163(j).
C. Trades or Businesses and Excepted
Trades or Businesses
While section 163(j) and the
legislative history to section 163(j)
provide that certain activities are not
treated as trades or businesses, neither
section 163(j) nor its legislative history
provide a definition of what activities
generally constitute a trade or business.
The most established and developed
definition of trade or business is found
under section 162(a), which permits a
deduction for ordinary and necessary
expenses paid or incurred in carrying on
a trade or business. The rules under
section 162 for determining the
existence of a trade or business are wellestablished, and there is a large body of
case law and administrative guidance
interpreting the meaning in section 162
of a trade or business. Therefore, these
proposed regulations would define a
trade or business as a trade or business
within the meaning of section 162, and
such definition should aid taxpayers in
the proper allocation of interest
expense, interest income, and other tax
items to a trade or business and an
excepted trade or business.
These proposed regulations would
also define excepted trades or
businesses that are not subject to the
limitation of interest expense deduction
under section 163(j). These excepted
trades or businesses are defined in
163(j)(7)(A), and include (1) the trade or
business of providing services as an
employee; (2) certain real property
businesses that elect to be excepted; (3)
certain farming businesses that elect to
be excepted; and (4) certain regulated

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utility businesses. These proposed
regulations would provide additional
guidance with respect to regulated
utility businesses and the allocation of
interest expense to such businesses. See
proposed §§ 1.163(j)–1(b)(13) and
1.163(j)–10. Proposed regulations under
section 469 would provide additional
detail with respect to the definition of
a real property trade or business. See
proposed § 1.469–9(b).
The Treasury Department and the IRS
invite comments on whether another
definition of trade or business would be
preferable or appropriate in the context
of section 163(j).
D. Electing Real Property Trade or
Business
These proposed regulations would
provide that taxpayers can make an
election to treat certain trades or
businesses as an excepted trade or
business if it is a real property trade or
business under section 469(c)(7)(C), or
certain trades or businesses that are
conducted by REITs. Definitions and
special rules for REITs would be
provided in proposed § 1.163(j)–9.
E. Electing Farming Business
These proposed regulations would
provide that taxpayers can make an
election to treat a trade or business that
is a farming business as defined in
section 263A(e)(4) or that is a farming
business under § 1.263A–4(a)(4) for
capitalization purposes as an excepted
farming business for purposes of section
163(j). These proposed regulations
would also provide that a trade or
business that is a specified agricultural
or horticultural cooperative under
section 199A(g)(4) and regulations
thereunder can elect to be an excepted
farming business for purposes of section
163(j). The Treasury Department and the
IRS note that section 163(j)(7)(B) cites
section 199A(g)(2) for the definition of
a specified agricultural or horticultural
cooperative. However, after Public Law
115–141 amended section 199A, the
correct citation is section 199A(g)(4).
Additionally, the Treasury Department
and the IRS are developing separate
proposed regulations to provide
additional guidance under section
199A(g).
F. Regulated Utility Trade or Business
Consistent with section
163(j)(7)(A)(iv), these proposed
regulations would provide that an
excepted trade or business includes a
regulated utility trade or business that
furnishes or sells certain regulated items
to the extent the rates for such
furnishing or sale have been established
or approved by a State or political

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

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

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

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vehicle’’ as set forth in section
163(j)(9)(C).
2. Proposed § 1.163(j)–2: Deduction for
Business Interest Expense Limited
A. General Rules
Consistent with section 163(j)(1),
these proposed regulations would
provide that the deduction for business
interest expense for any taxpayer, other
than businesses qualifying for the small
business exemption, cannot exceed the
sum of current-year business interest
income, 30 percent of ATI, and currentyear floor plan financing interest
expense. See proposed § 1.163(j)–2(b).
To the extent that a taxpayer has
business interest expense for the taxable
year in excess of the section 163(j)
limitation, these proposed regulations
would allow the taxpayer a disallowed
business interest expense carryforward
to the next taxable year. See proposed
§ 1.163(j)–2(c). The limitation under
section 163(j)(1) applies to the total
amount of business interest expense of
the taxpayer in a taxable year (including
disallowed business interest expense
carryforwards from prior taxable years)
and does not directly trace to interest
expense in respect of any particular debt
obligation of the taxpayer. Similarly, the
disallowed business interest expense
carryforward allowed in a taxable year
represents the total amount of
disallowed business interest expense
that is carried forward to the taxable
year and does not directly trace to a
particular debt obligation of a taxpayer.
B. Exemption for Certain Small
Taxpayers; Aggregation; Inherently
Personal Items
Consistent with section 163(j)(3),
these proposed regulations would
provide that taxpayers that meet the
gross receipts test of section 448(c) are
not subject to the section 163(j)
limitation. Eligible taxpayers are those,
other than tax shelters under section
448(a)(3), with average annual gross
receipts of $25 million or less, tested for
the three taxable years immediately
preceding the current taxable year. Such
a taxpayer is not permitted to make an
election under either section 163(j)(7)(B)
or (C) because the taxpayer is already
not subject to the section 163(j)
limitation.
The gross receipts test of section
448(c) is an annual determination based
on the prior three taxable years. Thus,
a taxpayer’s status as an exempt small
business under section 163(j) may
change from year to year. Because the
exemption applies to the taxpayer, any
interest paid or accrued in the taxable
year in which the taxpayer meets the

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gross receipts test under section 448(c)
is not subject to the section 163(j)
limitation. Accordingly, and consistent
with section 163(j)(2), these proposed
regulations would provide that if a
taxpayer who is subject to the limitation
under section 163(j)(1) carries
disallowed business interest expense
forward to a taxable year in which the
taxpayer qualifies for the small business
exemption, the amount of the
carryforward is not subject to the
section 163(j) limitation in that taxable
year and would be deductible in that
taxable year unless disallowed,
deferred, or capitalized under another
provision of the Code.
Consistent with the regulations under
section 448(c), for organizations that are
exempt from tax under section 501(a),
these proposed regulations would
provide that only gross receipts from the
activities of such organization that
constitute unrelated trades or businesses
are taken into account in determining
whether the gross receipts test is
satisfied. The Treasury Department and
the IRS request comments on whether
additional guidance is needed in the
case of any other exempt organizations
with respect to the application of the
gross receipts test for purposes of
section 163(j).
These proposed regulations would
also provide that each partner in a
partnership includes a share of
partnership gross receipts in proportion
to such partner’s distributive share of
items of gross income that were taken
into account by the partnership under
section 703. With respect to
shareholders in S corporations, these
regulations would provide that such
shareholders include a pro rata share of
the S corporation’s gross receipts. The
Treasury Department and the IRS
request comments on this approach, and
also whether other approaches to
determining the gross receipts of
partners and S corporation shareholders
for purposes of section 163(j) would
more accurately measure the gross
receipts of such partners and
shareholders.
These proposed regulations would
provide that a taxpayer who is not
subject to section 448 is treated as
though it were a partnership or
corporation when applying the section
448(c) gross receipts test for purposes of
the section 163(j) small business
exemption. The aggregation rules of
sections 52 and 414 would apply to
determine whether entities should be
aggregated for purposes of the gross
receipts test. For an individual taxpayer,
it is intended that gross receipts include
all items that a business entity could
receive, including, but not limited to,

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

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3. Proposed § 1.163(j)–3: Relationship of
Business Interest Deduction Limitation
to Other Provisions Affecting Interest
These proposed regulations would
provide ordering and operating rules to
control the interaction of the section
163(j) limitation with other provisions
of the Code. The legislative history to
the TCJA shows an intent for section
163(j) to apply after other provisions
that defer, capitalize, or disallow
interest expense. See H. Rept. 115–466,
at 387 (2017). Therefore, these proposed
regulations generally would apply to
interest expense that could be deducted
without regard to the section 163(j)
limitation; interest expense that has
been disallowed, deferred, or
capitalized in the current taxable year,
or which has not yet been accrued,
would not be taken into account for
purposes of section 163(j). However, it
is intended that, under these proposed
regulations, section 163(j) would apply
before the operation of the loss
limitation rules in sections 465 and 469
and before the application of section
461(l), consistent with how taxpayers
apply old section 163(j)(7). In addition,
the Treasury Department and the IRS
request comments regarding the
interaction between section 163(j) and
the rules addressing income from
discharge of indebtedness under section
108.
The Treasury Department and the IRS
have received comments on the
interaction of sections 163(j) and 59A,
relating to the tax on the base erosion
minimum tax amount. These proposed
regulations reserve on the interaction of
these provisions. The comments
previously received, as well as any
additional comments received, will be
further considered in conjunction with
separate guidance under section 59A.

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4. Proposed § 1.163(j)–4: General Rules
Applicable to C Corporations
(Including REITs, RICs, and Members
of Consolidated Groups) and TaxExempt Corporations
Proposed § 1.163(j)–4 would provide
certain rules regarding the computation
of items of income and expense under
section 163(j) for taxpayers that are C
corporations (including members of a
consolidated group, REITs, and RICs)
and tax-exempt corporations. Proposed
§ 1.163(j)–4(b) would provide rules
regarding the characterization of items
of income, gain, deduction, or loss.
Proposed § 1.163(j)–4(c) would provide
rules regarding adjustments to earnings
and profits. Proposed § 1.163(j)–4(d)
would provide special rules applicable
to members of a consolidated group.
A. Proposed § 1.163(j)–4(b):
Characterization of Items of Income,
Gain, Deduction, or Loss
Like other taxpayers, corporations are
subject to the limitations on the
deductibility of business interest
expense in section 163(j). However,
unlike other taxpayers, corporations are
not subject to the limitations on the
deductibility of investment interest
expense in section 163(d). In enacting
section 163(j), which excludes from the
definition of business interest in section
163(j)(5), investment interest within the
meaning of section 163(d), and excludes
from the definition of business interest
income, investment income within the
meaning of section 163(d), Congress
commented on the interaction between
section 163(d) and (j) and the
implications thereof for the application
of section 163(j) to corporations. More
specifically, the legislative history states
that—
[s]ection 163(d) applies in the case of a
taxpayer other than a corporation. Thus, a
corporation has neither investment interest
nor investment income within the meaning
of section 163(d). Thus, interest income and
interest expense of a corporation is properly
allocable to a trade or business, unless such
trade or business is otherwise explicitly
excluded from the application of the
provision.

H. Rept. 115–466, at 386, fn. 688 (2017).
Although the foregoing language
could be read to apply to both C
corporations and S corporations, it is
clear that an S corporation can have
investment income and investment
expenses within the meaning of section
163(d). These items are separately stated
on an S corporation’s Schedule K–1,
‘‘Partner’s Share of Income, Deductions,
Credits, etc.,’’ and they are passed
through to an S corporation’s
shareholders. Thus, Congress appears to

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have made the foregoing statement with
C corporations in mind.
Consistent with congressional intent,
proposed § 1.163(j)–4(b) would provide
that, solely for purposes of section
163(j), and except as otherwise provided
in proposed § 1.163(j)–10 (concerning
allocations between excepted and nonexcepted trades or businesses), all
interest paid or accrued by a taxpayer
that is a C corporation is treated as
business interest expense, and all
interest received or accrued by a
taxpayer that is a C corporation and that
is includible in the taxpayer’s gross
income is treated as business interest
income. Thus, all of a C corporation’s
interest expense would be subject to
limitation under section 163(j), and all
of a C corporation’s interest income
would increase the C corporation’s
section 163(j) limitation, except to the
extent such interest expense or interest
income is allocable to an excepted trade
or business under proposed § 1.163(j)–
10.
To reflect congressional intent, and to
achieve consistency with the treatment
of interest income and interest expense,
proposed § 1.163(j)–4(b) would further
provide that, solely for purposes of
section 163(j), and except as otherwise
provided in proposed § 1.163(j)–10, all
other items of income, gain, deduction,
or loss of a taxpayer that is a C
corporation are properly allocable to a
trade or business. As a result, such tax
items would be factored into a C
corporation’s calculation of its ATI
(except to the extent such items are
allocable to an excepted trade or
business).
Although a C corporation cannot have
investment interest, investment
expenses, or investment income, within
the meaning of section 163(d), for
purposes of section 163(j), a partnership
in which a C corporation is a partner
may have such tax items. The
partnership will allocate such tax items
to its partners, including its C
corporation partners, as separately
stated items. Thus, the question arises
how to treat investment interest,
investment expenses, and investment
income that is allocated by a
partnership to a C corporation partner.
To address this situation, proposed
§ 1.163(j)–4(b) would recharacterize
investment interest expense that a
partnership allocates to a C corporation
partner as interest expense properly
allocable to a trade or business of the C
corporation. Similarly, proposed
§ 1.163(j)–4(b) would treat investment
income and investment expenses that a
partnership allocates to a C corporation
partner as properly allocable to a trade
or business of the C corporation. See the

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

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B. Proposed § 1.163(j)–4(c): Effect on
Earnings and Profits
Distributions by a C corporation to its
shareholders out of earnings and profits
(E&P) are treated as dividends under
section 316(a). Although the Code does
not define the term ‘‘earnings and
profits,’’ the computation of E&P
generally is based upon accounting
concepts that take into account the
economic realities of corporate
transactions, in particular, their impact
on the corporation’s economic ability to
pay dividends to its shareholders, and
the applicable tax laws.
Proposed § 1.163(j)–4(c) generally
would provide that the disallowance
and carryforward of a deduction for a C
corporation’s business interest expense
under proposed § 1.163(j)–2 will not
affect whether or when such business
interest expense reduces the taxpayer’s
E&P. In other words, C corporations
generally should not wait to reduce
their E&P for business interest expense
until the taxable year in which a
deduction for such expense is allowed
under section 163(j). This approach,
which is the same approach used in the
Prior Proposed Regulations under old
section 163(j) (see § 1.163(j)–1(e), 56 FR
27907 (June 18, 1991)), reflects the fact
that the payment or accrual of business
interest expense generally reduces the C
corporation’s dividend-paying capacity
in the year the expense is paid or
accrued, without regard to the
application of section 163(j).
Additionally, disallowed business
interest expense carryforwards are
somewhat analogous to net operating
loss (NOL) carryovers, and taxpayers
reduce their E&P in the year the losses
that give rise to an NOL are incurred
rather than in a subsequent year in
which an NOL carryover is absorbed.
However, the section 163(j)
regulations would contain several
modifications to or clarifications of the
general rule regarding E&P. First, if a
taxpayer is a RIC or a REIT for the
taxable year in which a deduction is
disallowed under section 163(j), or in
which the RIC or REIT is allocated
excess business interest expense from a
partnership under section 163(j)(4)(B)(i)
and proposed § 1.163(j)–6, then the
taxpayer’s E&P would not be reduced in
the year the expense is paid or accrued
without regard to the application of
section 163(j). Rather, the taxpayer’s
E&P would be reduced in the taxable
year(s) in which the business interest
expense is deductible or, if earlier, in
the first taxable year for which the
taxpayer no longer is a RIC or a REIT.
See proposed § 1.163(j)–4(c)(2) and the
discussion of RICs and REITs later in

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part 4(C) of this Explanation of
Provisions section.
Second, a taxpayer would not reduce
its E&P in a taxable year beginning after
December 31, 2017, to reflect any
carryforwards of disallowed disqualified
interest (within the meaning of old
section 163(j)) to the extent the taxpayer
previously reduced its E&P to reflect
those interest payments in a prior
taxable year. See proposed § 1.163(j)–
11(b).
Third, C corporations other than
REITs and RICs would make special
E&P adjustments with respect to excess
business interest expense allocated from
a partnership. In general, a C
corporation partner must reduce its E&P
to reflect expense allocations from the
partnership, including allocations of
excess business interest expense.
However, with respect to excess
business interest expense in particular,
the C corporation partner also must
increase its E&P upon the disposition of
the partnership interest to reflect the
amount of excess business interest
expense that the partner did not take
into account while it held the
partnership interest.
C. RICs and REITs
RICs and REITs are C corporations
and are generally subject to the rules
that apply to other C corporations,
unless a provision in subchapter M of
chapter 1 of the Code makes the rules
inapplicable. There are no rules in
subchapter M or section 163(j) that
make section 163(j) inapplicable to
REITs or RICs. Therefore, under these
proposed regulations, RICs and REITs
would be subject to section 163(j). Some
REITs may not have any business
interest expense subject to limitation
under section 163(j) because they have
only electing real property trades or
businesses described in section
163(j)(7)(B). Other REITs, however, will
have trades or businesses for which the
REIT cannot or will not make the
election under section 163(j)(7)(B). For
example, a mortgage REIT cannot make
such an election because real property
financing is not an activity described in
section 469(c)(7)(C).
RICs and REITs often derive a
significant amount (if not all) of their
income from property held for
investment. However, under these
proposed regulations, RICs and REITs
would apply the same rules as other C
corporations in determining which
items are properly allocable to a trade or
business. Thus, solely for purposes of
163(j), all of the interest expense and
interest income of a RIC or REIT would
be treated as business interest expense
and business interest income, and all

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

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taxable income, because the deductions
do not reduce the tax liability of RICs
and REITs (or the amounts that RICs or
REITs must distribute to eliminate
entity-level tax).
RICs and REITs must meet
distribution requirements each year in
order to be allowed the deduction for
dividends paid. If interest expense paid
or accrued by a RIC or REIT is
disallowed or deferred under section
163(j), or if a RIC or REIT is allocated
any excess business interest expense
from a partnership, such expense will
not reduce the entity’s taxable income,
the entity’s ICTI or REITTI as the case
may be, or the amount of dividends that
the entity must pay from its earnings
and profits. Therefore, the earnings and
profits of the RIC or REIT also should
not be reduced. Accordingly, these
proposed regulations would contain a
special rule for RICs and REITs under
which their earnings and profits
generally would not be reduced by a
disallowed business interest expense
deduction in the year it is disallowed,
or by any excess business interest
expense allocated from a partnership.
D. Proposed § 1.163(j)–4(d): Special
Rules for Consolidated Groups
Section 1502 provides broad authority
for the Secretary of the Treasury to
prescribe such regulations as are
necessary in order that the tax liability
of any affiliated group of corporations
filing a consolidated return may be
returned, determined, computed,
assessed, collected, and adjusted, in
order to clearly reflect the income tax
liability of the consolidated group and
to prevent the avoidance of such tax
liability. The legislative history of
section 163(j) states that, ‘‘[i]n the case
of a group of affiliated corporations that
file a consolidated return, the limitation
applies at the consolidated tax return
filing level.’’ H. Rept. 115–466, at 386
(2017). Consistent with legislative
intent, proposed § 1.163(j)–4(d)
generally would provide that a
consolidated group (as defined in
§ 1.1502–1(h)) has a single section 163(j)
limitation. In contrast, members of an
affiliated group that does not file a
consolidated return would not be
aggregated for purposes of applying the
section 163(j) limitation. Additionally,
partnerships that are wholly owned by
members of a consolidated group would
not be aggregated with the consolidated
group for purposes of applying the
section 163(j) limitation. The Treasury
Department and the IRS have
determined that non-consolidated
entities should not be aggregated for
purposes of applying the section 163(j)
limitation because, whereas old section

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67499

163(j)(6)(C) expressly provided that
‘‘[a]ll members of the same affiliated
group (within the meaning of section
1504(a)) shall be treated as 1 taxpayer,’’
section 163(j) no longer contains such
language, and nothing in the legislative
history of section 163(j) suggests that
Congress intended non-consolidated
entities to be treated as a single taxpayer
for purposes of section 163(j).
Proposed § 1.163(j)–4(d) would
provide specific rules regarding the
calculation of the section 163(j)
limitation for a consolidated group. In
particular, proposed § 1.163(j)–4(d)
would provide that the relevant taxable
income in computing the group’s ATI is
the group’s consolidated taxable income
determined under § 1.1502–11 without
regard to any carryforwards or
disallowances under section 163(j).
Additionally, if for a taxable year a
member of a consolidated group is
allowed a deduction under section
250(a)(1) that is properly allocable to a
non-excepted trade or business, then,
for purposes of calculating ATI,
consolidated taxable income for the
taxable year is determined as if the
deduction were not subject to the
limitation in section 250(a)(2) and the
regulations thereunder. For this
purpose, the amount of the deduction
allowed under section 250(a)(1) is
determined without regard to the
application of section 163(j) and the
section 163(j) regulations. Moreover, for
purposes of calculating the group’s
section 163(j) limitation, the group’s
current-year business interest expense
and business interest income,
respectively, would be the sum of the
current-year business interest expense
and business interest income of all
members of the group. For purposes of
this Explanation of Provisions and the
proposed section 163(j) regulations, the
term ‘‘current-year business interest
expense’’ means business interest
expense that would be deductible in the
current taxable year without regard to
section 163(j) and that is not a
disallowed business interest expense
carryforward from a prior taxable year
(see proposed § 1.163(j)–5(a)(2)(i)).
Additionally, intercompany obligations
(as defined in § 1.1502–13(g)(2)(ii))
would be disregarded for purposes of
determining a member’s current-year
business interest expense and business
interest income and for purposes of
calculating the consolidated group’s
ATI, and intercompany items and
corresponding items (within the
meaning of § 1.1502–13(b)(2)(i) and
(b)(3)(i), respectively) would be
disregarded for purposes of calculating

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the group’s ATI to the extent those items
offset in amount.
Proposed § 1.163(j)–4(d) also crossreferences the rules in § 1.1502–32(b),
which govern investment adjustments
within a consolidated group. Under
those rules, if a member has currentyear business interest expense for which
a deduction is disallowed in the current
taxable year under section 163(j), basis
in the member’s stock would be
adjusted in a later taxable year when the
expense is absorbed by the group.
Proposed § 1.163(j)–4(d) would
further clarify that the transfer of a
partnership interest in an intercompany
transaction that does not result in the
termination of the partnership is treated
as a disposition for purposes of the basis
adjustment rule in section
163(j)(4)(B)(iii)(II), regardless of whether
the transfer is one in which gain or loss
is recognized. Several examples would
be added to § 1.1502–13(c)(7)(ii) to
illustrate the application of these rules.
The Treasury Department and the IRS
have determined that intercompany
transfers of partnership interests should
be treated as dispositions for purposes
of section 163(j)(4) because dispositions
are broadly defined in section
163(j)(4)(B)(iii)(II), and because ignoring
intercompany transfers of partnership
interests for purposes of section
163(j)(4) would be inconsistent with the
view that an entity whose owners are all
members of the same consolidated
group can be a partnership. In contrast,
a change in status of a member,
becoming or ceasing to be a member of
a consolidated group, would not be
treated as a disposition for these
purposes.
The Treasury Department and the IRS
request comments as to whether the
intercompany transfer of a partnership
interest in a nonrecognition transaction
should constitute a disposition for
purposes of section 163(j)(4)(B)(iii)(II)
and, if so, how § 1.1502–13(c) should
apply to such a transfer if there is excess
taxable income in a succeeding taxable
year. The Treasury Department and the
IRS also request comments as to the
treatment of the transfer of a partnership
interest in an intercompany transaction
that results in the termination of the
partnership.
Additionally, proposed § 1.163(j)–4(d)
would provide that a member’s
allocation of excess business interest
expense from a partnership and the
resulting decrease in basis in the
partnership interest under section
163(j)(4)(B) is not a noncapital,
nondeductible expense for purposes of
§ 1.1502–32(b)(3)(iii). Similarly, an
increase in a member’s basis in a
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163(j)(4)(B)(iii)(II) to reflect excess
business interest expense not deducted
by the consolidated group is not taxexempt income for purposes of
§ 1.1502–32(b)(3)(ii). These special rules
are intended to ensure that the
allocations and basis adjustments under
proposed § 1.163(j)–6 do not result in
investment adjustments within the
consolidated group. This result is
appropriate because the application of
the proposed § 1.163(j)–6 rules does not
result in a net reduction in the tax
attributes of the member partner; rather,
there is an exchange of one type of
attribute for another (excess business
interest expense allocated from the
partnership vs. basis in the partnership
interest). The Treasury Department and
the IRS request comments as to whether
additional rules are needed to prevent
loss duplication upon the disposition of
stock of a member holding partnership
interests.
5. Proposed § 1.163(j)–5: General Rules
Governing Disallowed Business Interest
Expense Carryforwards for C
Corporations
Proposed § 1.163(j)–5 would provide
certain rules regarding disallowed
business interest expense carryforwards
for taxpayers that are C corporations,
including members of a consolidated
group. Proposed § 1.163(j)–5(b) would
provide rules regarding the treatment of
disallowed business interest expense
carryforwards. Proposed § 1.163(j)–5(c)
would provide cross-references to rules
regarding disallowed business interest
expense carryforwards in transactions to
which section 381(a) applies. Proposed
§ 1.163(j)–5(d) would provide rules
regarding limitations on disallowed
business interest expense carryforwards
from separate return limitation years
(SRLYs). Proposed § 1.163(j)–5(e) would
provide cross-references to rules
regarding the application of section 382.
Proposed § 1.163(j)–5(f) would provide
rules regarding the overlap of the SRLY
limitation with section 382.
A. Proposed § 1.163(j)–5(b): Treatment
of Disallowed Business Interest Expense
Carryforwards
Proposed § 1.163(j)–2 limits the
amount of business interest expense for
which a deduction is allowed in the
taxable year. Proposed § 1.163(j)–2
further provides that the amount of any
business interest expense not allowed as
a deduction for any taxable year as a
result of the section 163(j) limitation is
carried forward to the succeeding
taxable year as a disallowed business
interest expense carryforward.
Proposed § 1.163(j)–5(b)(2) generally
would provide that, for a C corporation

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

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

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

If a corporation ceases to be a member
during a consolidated return year, the
amount of its business interest expense,
including carryforwards from prior
taxable years, that is neither deducted
by the consolidated group in that year
nor reduced under § 1.1502–36(d)

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would be carried forward to the
corporation’s first separate return year.
The foregoing rules are intended to
roughly mirror the rules in § 1.1502–21
governing the absorption of a
consolidated net operating loss (CNOL).
However, the Treasury Department and
the IRS considered various other
approaches to allocating disallowed
business interest expense carryforwards
among members of a consolidated
group. For example, one alternative
approach under consideration was a
regime whereby disallowed business
interest expense carryforwards would be
allocated based upon the actual use of
externally borrowed funds by each
member. Under such an approach,
intercompany obligations would be
taken into account in allocating
disallowed business interest expense
carryforwards.
The Treasury Department and the IRS
do not propose to adopt such an
approach, for several reasons. First,
requiring taxpayers to trace externally
borrowed funds to the member that
ultimately uses such funds would create
an administrative burden for taxpayers.
Second, because money is fungible, a
tracing regime would place undue
importance on the location of
intercompany obligations. Thus, this
approach would permit significant
manipulation through the creation of
intercompany obligations for the
purpose of shifting disallowed business
interest expense carryforwards among
members. Third, this approach could
result in the non-economic allocation of
disallowed business interest expense
carryforwards to members with no
business interest expense to creditors
outside the consolidated group. This
approach would result in value transfers
among consolidated group members and
require complex rules to account for
those transfers. These proposed
regulations implement the statute
consistent with legislative intent while
avoiding these complications.
The Treasury Department and the IRS
request comments on the rules in
proposed § 1.163(j)–5(b)(3), including
comments on whether these rules
should be revised to incorporate
additional language or principles from
the CNOL allocation rules in § 1.1502–
21.
B. Proposed § 1.163(j)–5(c): Disallowed
Business Interest Expense Carryforwards
in Transactions To Which Section
381(a) Applies
In the case of certain asset
acquisitions, section 381(a) generally
requires the acquiring corporation to
succeed to and take into account the tax
items described in section 381(c) of the

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distributor or transferor corporation. In
the TCJA, Congress added disallowed
business interest expense carryforwards
to the list of items to which the
acquiring corporation succeeds in a
transaction to which section 381(a)
applies (see section 381(c)(20)).
Sections 1.381(c)(1)–1 and
1.381(c)(1)–2 provide rules that, in part,
limit the acquiring corporation’s ability
to use NOL carryforwards in the
acquiring corporation’s first taxable year
ending after the acquisition date. The
Treasury Department and the IRS have
determined that similar rules should
apply to disallowed business interest
expense carryforwards. See proposed
§§ 1.163(j)–5(c) and 1.381(c)(20)–1.
The Treasury Department and the IRS
request comments as to whether section
381(c)(20) and proposed §§ 1.163(j)–5(c)
and 1.381(c)(20)–1 should apply to
excess business interest expense
allocated to a corporate partner.
C. Proposed § 1.163(j)–5(d): Limitations
on Disallowed Business Interest Expense
Carryforwards From Separate Return
Limitation Years
In general, the taxable income of a
consolidated group is determined by
aggregating the income and losses of
each member. Thus, a consolidated
group may offset the income earned by
profitable members against the losses
incurred by other members. However,
an exception to this general rule applies
to losses incurred by a member in a
taxable year in which the member did
not join in filing a consolidated return
with the current group. The SRLY
limitation in § 1.1502–21(c) generally
limits the amount of a member’s losses
arising in a SRLY that may be included
in the consolidated group’s CNOL to the
amount of net income generated by that
member. Similar rules in §§ 1.1502–15
and 1.1502–22(c) apply to built-in losses
and net capital losses, respectively.
Absent a SRLY limitation and other
limitations, notably section 382, the
consolidated group could reduce its
consolidated taxable income simply by
acquiring new members with built-in
losses, NOLs, net capital losses, or
disallowed business interest expense
carryforwards.
The Treasury Department and the IRS
have determined that rules similar to
those in § 1.1502–21(c) should apply to
disallowed business interest expense
carryforwards. See proposed § 1.163(j)–
5(d). However, the calculation of the
SRLY limitation for disallowed business
interest expense carryforwards would
differ from the calculation of the SRLY
limitation for NOL carryovers. The
SRLY limitation for NOL carryovers is
cumulative—in other words, it is based

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upon a member’s aggregate contribution
to consolidated taxable income,
determined by reference to only the
member’s tax items, for all consolidated
return years of the consolidated group
in which the member was included in
the group. As a result, a member may
carry forward its unused SRLY
limitation from one year to the next. In
contrast, the SRLY limitation for
disallowed business interest expense
carryforwards would be calculated
annually based upon a member’s section
163(j) limitation, determined by
reference to only the member’s tax
items, for any given taxable year. As a
result, a member may not carry forward
its unused section 163(j) SRLY
limitation from one year to the next. The
Treasury Department and the IRS have
determined that this result is
appropriate because Congress did not
retain the excess limitation carryforward
provisions from old section 163(j). Thus,
allowing members to carry forward their
unused section 163(j) SRLY limitation
would be inconsistent with
congressional intent.
Proposed § 1.163(j)–5(d) would
provide several additional limitations
on a member’s ability to use its
disallowed business interest expense
carryforwards arising in a SRLY. First,
such items only may be taken into
account by the consolidated group in a
taxable year to the extent the group has
any remaining section 163(j) limitation
for that year after applying the rules in
proposed § 1.163(j)–5(b). Second, such
items only may be taken into account to
the extent the SRLY member’s section
163(j) limitation for that year exceeds
the amount of the member’s business
interest expense already taken into
account by the group in that year under
the rules in proposed § 1.163(j)–5(b).
Third, SRLY-limited disallowed
business interest expense carryforwards
would be deducted on a pro rata basis
with non-SRLY limited disallowed
business interest expense carryforwards
from taxable years ending on the same
date.
The Treasury Department and the IRS
request comments on the SRLY rules in
proposed § 1.163(j)–5(d), including
whether a member’s SRLY-limited
disallowed business interest expense
carryforwards should cease to be subject
to a SRLY limitation (to the extent of the
member’s stand-alone section 163(j)
limitation) in taxable years in which the
member’s stand-alone section 163(j)
limitation exceeds the consolidated
group’s section 163(j) limitation.

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D. Proposed § 1.163(j)–5(e): Application
of Section 382
Like the SRLY limitation, the section
382 limitation limits a taxpayer’s ability
to reduce its taxable income simply by
acquiring a loss corporation. In general,
if a loss corporation experiences an
ownership change, section 382 limits
the amount of the new loss
corporation’s taxable income that can be
offset by pre-change losses to the
product of the old loss corporation’s
value at the time of the ownership
change times the long-term tax-exempt
rate. For a discussion of the regulations
under sections 163(j), 382, and 383 that
govern the applicability of section 382
to business interest expense, see parts
11 and 14 through 16 of this
Explanation of Provisions section.
E. Proposed § 1.163(j)–5(f): Overlap of
SRLY Limitation With Section 382
As noted in parts 5(C) and 5(D) of this
Explanation of Provisions section, both
the SRLY limitation and the section 382
limitation are intended to prevent
taxpayers from trafficking in loss
corporations. Moreover, both of these
limitations could apply to the same
corporation as a result of the same
transaction (for example, if a
consolidated group acquires a loss
corporation in a transaction that is an
ownership change for purposes of
section 382) or as a result of several
transactions that occur within a short
period of time.
Section 1.1502–21(g) provides an
overlap rule to prevent both the section
382 limitation and the SRLY limitation
from applying to NOL carryovers under
certain circumstances. The Treasury
Department and the IRS have
determined that a similar overlap rule
should apply with respect to disallowed
business interest expense carryforwards.
Thus, proposed § 1.163(j)–5(f) would
apply the principles of § 1.1502–21(g) to
disallowed business interest expense
carryforwards when the application of
the SRLY limitation would result in an
overlap with the application of section
382.
6. Proposed § 1.163(j)–6: Application of
the Business Interest Expense
Deduction Limitations to Partnerships
and Subchapter S Corporations
A. In General
Proposed § 1.163(j)–6 would provide
guidance regarding partnership and S
corporation deductions and
carryforwards under section 163(j). To
the extent a partnership is subject to the
limitations imposed by section 163(j),
the section 163(j) limitation shall be
applied at the partnership level and any

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deduction for business interest expense
not disallowed under section 163(j) is
taken into account in determining the
nonseparately stated taxable income or
loss of the partnership. Similar rules
shall apply to an S corporation. See part
6(H) of this Explanation of Provisions
section for a discussion of rules specific
to S corporations.
The phrase ‘‘nonseparately stated
taxable income or loss of the
partnership’’ has not previously been
defined by statute. However, section
1366(a)(2) provides a definition of
‘‘nonseparately computed income or
loss’’ as applied to S corporations. The
legislative history of section 163(j)
references ‘‘ordinary business income or
loss’’ as reflected on Form 1065, ‘‘U.S.
Return of Partnership Income,’’ and the
partner’s distributive share as reflected
in Box 1 of Schedule K–1. H. Rept. 115–
466, at 387, fn. 690 (2017).
One commenter noted that, in general,
an item of income or deduction that is
included in nonseparately stated
income of a partnership, as determined
under section 702(a)(8), loses its tax
character in the hands of the partner to
whom the item is allocated. The
Treasury Department and the IRS agree
that for purposes of proposed § 1.163(j)–
6(a), to the extent a partnership’s
business interest expense is less than or
equal to the partnership’s section 163(j)
limitation, such business interest
expense loses its character as business
interest expense at the partner’s level for
purposes of the partner’s section 163(j)
calculation (that is, the business interest
expense is not subject to further
limitations under section 163(j)). See
proposed § 1.163(j)–6(c).
For purposes of the Code other than
section 163(j), proposed § 1.163(j)–6(c)
would provide that business interest
expense and, in the case of a
partnership, excess business interest
expense, retains its character as
business interest expense at the partner
and S corporation shareholder-level. For
purposes of section 469, such interest
retains its characterization as either
passive or non-passive when allocated
to the partner or shareholder.
Additionally, for purposes of section
469, business interest expense from a
partnership or S corporation and, in the
case of a partnership, excess business
interest expense, remains interest
derived from a trade or business in the
hands of a partner or shareholder, even
if the partner or shareholder does not
materially participate in the partnership
or S corporation’s trade or business
activity. See proposed § 1.163(j)–3 for
additional rules regarding the
interaction among sections 461(l), 465,
469, and 163(j).

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The Treasury Department and the IRS
intend to adopt rules for the proper
treatment of business interest income
and business interest expense with
respect to lending transactions between
a passthrough entity and an owner of
the entity (self-charged lending
transactions). Although reserved in
these proposed regulations, the Treasury
Department and the IRS intend to adopt
certain rules to re-characterize, for both
the lender and the borrower, the
business interest expense and
corresponding business interest income
arising from a self-charged lending
transaction that may be allocable to the
owner, to prevent such business interest
income and expense from entering or
affecting the section 163(j) limitation
calculations for both the lender and the
borrower in such situations. One
possible approach is to adopt rules
similar in scope as those contained in
§ 1.469–7, dealing with the treatment of
self-charged lending transactions for
purposes of section 469. The Treasury
Department and the IRS request
comments with respect to any potential
rules that may be considered to achieve
this result, as well as comments
regarding the potential adverse effects
that such rules may have with respect
to other Code provisions, such as
section 163(d), and any methods for
mitigating or eliminating those effects.
Guidance on the treatment of excess
business interest expense in tiered
partnerships has been reserved in these
proposed regulations. Section 163(j)(4)
requires the section 163(j) limitation to
be taken into account at the entity-level
and for business interest expense
carryforwards to be allocated to
partners. The Treasury Department and
the IRS request comments regarding
whether, in a tiered partnership
arrangement, carryforwards should be
allocated through upper-tier
partnerships. Additionally, comments
are requested regarding how and when
an upper-tier partner’s basis should be
adjusted when a lower-tier partnership
is subject to a section 163(j) limitation.
Guidance regarding the application of
section 163(j) to a partnership merger or
division has been also reserved in these
proposed regulations. The Treasury
Department and the IRS request
comments on the effect of partnership
mergers and divisions on excess
business interest expense, excess
taxable income, and excepted trade or
business elections in the context of
section 163(j).

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

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in the double counting of the income in
ATI for section 163(j) purposes, first by
the transferor partner on the sale of the
partnership interest and again by the
partnership on a sale of partnership
property.
Under a second approach considered,
the partnership would increase or
decrease its ATI by the amount of the
partner-level adjustments allocated to
each partner. Essentially, the
partnership would be required to
aggregate all partner-level adjustments
and take them into account at the
partnership level for purposes of section
163(j). The Treasury Department and the
IRS viewed taking partner-level
adjustments into account at the
partnership level as being contrary to
the intent of section 743(b), section
704(c)(1)(C), and remedial allocations,
and have therefore not adopted this
approach.
Under a third approach, (i) partnerlevel adjustments are not taken into
account when computing ATI for
purposes of the partnership’s section
163(j) limitation; and (ii) each partner’s
partner-level adjustments are taken into
account as items derived directly by the
partner in determining its own section
163(j) limitation. This approach takes
partner-level adjustments into account
at the partner, rather than partnership,
level when determining the partner’s
ATI.
This third approach was
recommended by a commenter with
respect to section 743(b) adjustments.
The commenter argued that if a rule was
adopted requiring that a partner’s
section 743(b) adjustment be included
in the computation of a partnership’s
ATI for purposes of applying section
163(j) at the partnership level, then a
particular partner’s section 743(b)
adjustment could impact the
deductibility of partnership interest by
other partners, which would be
inconsistent with the basic approach
taken in the section 743(b) regulations.
The Treasury Department and the IRS
agree that this approach strikes the best
balance between the entity-level
calculation under section 163(j) and the
aggregate nature of section 743(b)
adjustments, as well as other partnerlevel adjustments. Accordingly, partnerlevel adjustments are not taken into
account when the partnership
determines its section 163(j) limitation
under proposed § 1.163(j)–6(f). Instead,
partner-level adjustments are taken into
account by the partner in determining
the partner’s ATI pursuant to proposed
§ 1.163(j)–6(e). However, in keeping
with the entity approach taken under
section 163(j)(4), a partnership shall
take adjustments made to the basis of its

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property pursuant to section 734(b) into
account for purposes of calculating its
ATI pursuant to proposed § 1.163(j)–
6(d).
The commenter acknowledged that
this approach would create disparities
between the situation where a
partnership purchases assets in which,
until 2022, depreciation will enter into
the partnership’s ATI; and a transaction
structured as a purchase of partnership
interests, where depreciation generated
by a section 743(b) basis adjustment or
section 704(c) remedial allocation will
not enter into a partnership’s ATI. The
Treasury Department and the IRS are
aware of these concerns and request
additional comments on the impact of
partner-level adjustments on a
partnership’s ATI calculation under
section 163(j), particularly as it relates
to publicly traded partnerships.
C. ATI and Business Interest Income of
Partners
i. In General
Proposed § 1.163(j)–6(e) would
provide that the ATI of a partner shall
generally be determined in accordance
with proposed § 1.163(j)–1(b)(1) without
regard to such partner’s distributive
share of any items of income, gain,
deduction or loss of such partnership,
and shall be increased by such partner’s
share of excess taxable income, as
defined in proposed § 1.163(j)–1(b)(13)
and determined pursuant to proposed
§ 1.163(j)–6(f). This provision prohibits
the double counting of items in ATI by
a partner in its own section 163(j)
calculation when a partnership has
already taken those items into account
under section 163(j). To the extent a
partnership has excess taxable income,
a partner may include its share of the
partnership’s excess taxable income, as
determined in proposed § 1.163(j)–6(f),
in the partner’s own ATI for purposes of
determining the partner’s section 163(j)
limitation. For guidance regarding the
partner’s inclusion of partner-level
adjustments, see proposed § 1.163(j)–
6(e). For guidance regarding the
recharacterization of a partnership’s
investment interest, investment income,
and investment expenses at the C
corporation partner-level, see proposed
§ 1.163(j)–4(b)(3).
ii. Sale of Partnership Interests
Proposed § 1.163(j)–6(e)(3) would
provide guidance on the inclusion of the
proceeds from the sale of a partnership
interest in the selling partner’s ATI. In
the event a partner sells a partnership
interest and the partnership in which
the interest is being sold owns only nonexcepted trade or business assets, as

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such term is defined in proposed
§ 1.163(j)–6(b)(6), the gain or loss on the
sale of the partnership interest is
included in the partner’s ATI. If a
partner sells a partnership interest and
the partnership in which the interest is
being sold owns both excepted assets, as
such term is defined in proposed
§ 1.163(j)–6(b)(7), and non-excepted
assets, the partner shall generally use
the method set forth in proposed
§ 1.163(j)–10(c) in order to determine
the amount properly allocable to a nonexcepted trade or business, and
therefore, properly includible in the
partner’s ATI. Proposed § 1.163(j)–
6(e)(4) would also apply to tiered
partnerships.
The Treasury Department and the IRS
also considered adopting a reasonable
method standard by which a
partnership could determine the amount
properly allocable to a non-excepted
trade or business, and therefore,
properly includible in the partner’s ATI.
Such provisions would have adopted
tracing rules similar to those set forth in
§ 1.163–8T, as modified by Notice 88–
20, 1988–9 I.R.B. 5 (Feb. 9, 1988), Notice
88–37, 1988–15 I.R.B. 8 (Mar. 16, 1988),
and Notice 89–35, 1989–13 I.R.B. 4
(Mar. 9, 1989). The Treasury
Department and the IRS request
comments on what reasonable methods
other than the method set forth in
proposed § 1.163(j)–10(c), possibly
including a tracing method similar to
§ 1.163–8T, would be appropriate in
order to determine the amount properly
allocable to a non-excepted trade or
business and under what circumstances
such methods would be appropriate.
iii. Double Counting of Business Interest
Income Prohibited
Notice 2018–28 stated that for
purposes of calculating a partner’s
annual deduction limitation under
section 163(j) for business interest
expense paid or accrued by the partner,
the partner shall only include business
interest income from a partnership in its
section 163(j)(1)(A) amount to the extent
that business interest income exceeds
business interest expense determined at
the partnership level under section
163(j). Additionally, a partner shall not
include its share of the partnership’s
floor plan financing for purposes of
determining the partner’s annual
deduction limitation for business
interest expense under section
163(j)(1)(C). Proposed § 1.163(j)–6(e)(2)
would incorporate these limitations into
these proposed regulations.

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D. Section 163(j) Partnership
Calculation
i. Allocation of Deductible Business
Interest Expense and Section 163(j)
Excess Items—Made in the Same
Manner as the Nonseparately Stated
Taxable Income or Loss of the
Partnership
Section 163(j)(4)(A)(ii)(II) states that a
partner’s excess taxable income is
determined in the same manner as the
nonseparately stated taxable income or
loss of the partnership. Section
163(j)(4)(B)(i)(II) states that excess
business interest expense is allocated to
each partner in the same manner as the
nonseparately stated taxable income or
loss of the partnership. Similarly, excess
business interest income is allocated to
each partner in the same manner as the
nonseparately stated taxable income or
loss of the partnership. The phrase
‘‘nonseparately stated taxable income or
loss of the partnership’’ is not defined
in section 163(j), and as mentioned in
part 6(A) of this Explanation of
Provisions section, has not previously
been defined by statute or regulations.
The phrase ‘‘in the same manner as’’ is
also undefined.
Under the proposed regulations, the
manner for allocating excess taxable
income, excess business interest
income, and excess business interest
expense (hereinafter ‘‘section 163(j)
excess items’’) must be consistent with
the Treasury Department and the IRS’s
resolution of the following three
descriptive (1 through 3) and two
normative (4 through 5) issues: (1)
Section 163(j) is applied at the
partnership level; (2) a partnership
cannot have both excess taxable income
(or excess business interest income) and
excess business interest expense in the
same taxable year; (3) parity must be
preserved between a partnership’s
deductible business interest expense
and section 163(j) excess items and the
aggregate of each partner’s share of
deductible business interest expense
and section 163(j) excess items from
such partnership; (4) if in a given year
a partnership has both deductible
business interest expense and excess
business interest expense, a partnership
should not allocate excess business
interest expense to a partner to the
extent such partner was allocated the
items comprising ATI (or business
interest income) that supported the
partnership’s deductible business
interest expense; and (5) if in a given
year a partnership has excess taxable
income (or excess business interest
income), only partners allocated more
items comprising ATI (or business
interest income) than necessary to

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support their allocation of business
interest expense should be allocated a
share of excess taxable income (or
excess business interest income).
One commenter proposed a manner
for allocating section 163(j) excess items
that would require a partnership to
allocate each section 163(j) excess item
(for example, excess business interest
expense) in the same proportion as its
underlying section 163(j) item (business
interest expense). For example, if
partnership AB had $30 of business
interest income, which it allocated
solely to A, and $40 of business interest
expense, which it allocated $20 each to
A and B, then A and B would each have
$15 of deductible business interest
expense and $5 of excess business
interest expense. In situations where the
partnership does not allocate all of its
section 163(j) items pro rata, such as
this example, this method could require
a partnership to allocate its section
163(j) excess items in a manner
inconsistent with the Treasury
Department and the IRS’s resolution of
issues four and five. Because this
approach could require a partnership to
arguably allocate inappropriate amounts
of section 163(j) excess items to its
partners, it is not adopted in these
proposed regulations.
The calculation adopted in proposed
§ 1.163(j)–6(f)(2) preserves the entitylevel calculation requirement set forth
in section 163(j)(4), while also
preserving the economics of the
partnership and respecting any special
allocations made by the partnership in
accordance with section 704 and the
regulations thereunder. Applying the
method in these proposed regulations to
the previous example, A would have
$20 of deductible business interest
expense, and B would have $10 of
deductible business interest expense
and $10 of excess business interest
expense. This result is consistent with
the Treasury Department and the IRS’s
interpretation of section 163(j) as
previously discussed.
ii. Allocation of Deductible Business
Interest Expense and Section 163(j)
Excess Items—General Calculation
Proposed § 1.163(j)–6(f)(2) provides
that partnerships must allocate any
section 163(j) excess items and any
deductible business interest expense in
the manner described in paragraphs
(f)(2)(i) through (xi). In general, each
paragraph (i) through (xi) is a step in a
set of instructions that, when
completed, provide the partnership with
the proper allocation of each of its
section 163(j) excess items to each of its
partners. This resulting array of
allocations is consistent with the

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Treasury Department and the IRS’s
resolution of the five key issues
described in part 6(D)(i) of this
Explanation of Provisions section.
Stated otherwise, such prescribed
allocations recognize the aggregate
nature of partnerships under subchapter
K of the Code to the greatest extent
possible while remaining consistent
with section 163(j) applying at the
partnership level.
No rule set forth in proposed
§ 1.163(j)–6(f)(2) of this section prohibits
a partnership from making an allocation
to a partner of any section 163(j) item
that is otherwise permitted under
section 704 and the regulations
thereunder. Accordingly, any
calculations in proposed § 1.163(j)–
6(f)(2)(i) through (xi) are solely for the
purpose of determining each partner’s
deductible business interest expense
and section 163(j) excess items, and do
not otherwise affect any other provision
under the Code, such as section 704(b).
Proposed § 1.163(j)–6(f)(2) creates
numerous defined terms. These defined
terms are solely for the purpose of
proposed § 1.163(j)–6(f)(2) and are
meant to aid the partnership in its
application of proposed § 1.163(j)–
6(f)(2) by allowing the calculation to be
broken into discrete steps.
Proposed § 1.163(j)–6(f)(2)(i) requires
the partnership to calculate its section
163(j) deduction pursuant to proposed
§ 1.163(j)–2(b). This step is the entitylevel calculation required by section
163(j)(4)(A), and it provides the
partnership with its total amount of
deductible business interest expense,
excess business interest income, excess
taxable income, and excess business
interest expense under section 163(j) for
a taxable year. The remaining steps in
proposed § 1.163(j)–6(f)(2)(ii) through
(xi) determine the allocations a
partnership must make of its deductible
business interest expense and each
section 163(j) excess item to its partners.
At the conclusion of the eleven steps set
forth in proposed § 1.163(j)–6(f)(2), the
total amount of deductible business
interest expense and section 163(j)
excess items allocated to each partner
will equal the partnership’s total
amount of deductible business interest
expense and section 163(j) excess items.
Proposed § 1.163(j)–6(f)(2)(ii) begins
the partner-level calculations. It should
be noted that the calculations under
proposed § 1.163(j)–6(f)(2) do not
determine a partner’s allocation of
business interest expense, business
interest income or items comprising
ATI, as these allocations are determined
under section 704(b) and (c) and the
regulations thereunder. Rather, the
proposed § 1.163(j)–6(f)(2) partner-level

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calculations determine each partner’s
amount of deductible business interest
expense and amount of any section
163(j) excess items. This determination
provides the starting point for the
remainder of the steps in proposed
§ 1.163(j)–6(f)(2). Only items that were
taken into account in the partnership’s
section 163(j) calculation are taken into
account for the proposed § 1.163(j)–
6(f)(2) partner-level calculation. Section
743(b) adjustments, built-in loss
amounts with respect to partnership
property under section 704(c)(1)(C),
section 704(c) remedial allocations,
allocations of investment income and
expense, and amounts determined for
the partner under § 1.882–5 are
therefore not taken into account for
purposes of the proposed § 1.163(j)–
6(f)(2) partner-level calculation. To
clarify that only section 163(j) items of
the partnership are relevant for the
calculations under proposed § 1.163(j)–
6(f)(2), paragraph (f)(2)(ii) defines
‘‘allocable ATI’’ as a partner’s allocable
share of the partnership’s ATI,
‘‘allocable business interest income’’ as
a partner’s allocable share of the
partnership’s business interest income,
and ‘‘allocable business interest
expense’’ as a partner’s allocable share
of the partnership’s business interest
expense that is not floor plan financing
interest expense.
As noted previously, the primary goal
of proposed § 1.163(j)–6(f)(2) is to
provide the partnership with an array of
allocations that recognizes the aggregate
nature of partnerships under subchapter
K of the Code to the greatest extent
possible while still remaining consistent
with section 163(j) applying at the
partnership level. Proposed § 1.163(j)–
6(f)(2)(iii) through (v) contain the
adjustment mechanism necessary to
achieve this goal. Section 163(j) permits
taxpayers with a sufficient amount of
appropriate income (ATI and business
interest income) to deduct their
business interest expense. However,
section 163(j) applies at the entity level
with respect to partnerships under
section 163(j)(4). Proposed § 1.163(j)–
6(f)(2)(iii) recognizes this normative
principle of the statute, and then
proposed § 1.163(j)–6(f)(2)(iv) and (v)
reconcile the proposed § 1.163(j)–
6(f)(2)(iii) partner-level calculation with
the proposed § 1.163(j)–6(f)(2)(i)
partnership-level result.
To illustrate the mechanism at work
in proposed § 1.163(j)–6(f)(2)(iii)
through (v), consider the example used
above. Partnership AB has $30 of
business interest income, which it
allocates solely to A, and $40 of
business interest expense, which it
allocates $20 each to A and B. Upon

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applying proposed § 1.163(j)–6(f)(2)(iii),
AB determines that A has been allocated
more allocable business interest income
than necessary to deduct its allocable
business interest expense ($10 of
allocable business interest income
excess), and B has not been allocated
enough allocable business interest
income to deduct its allocable business
interest expense ($20 of allocable
business interest income deficit).
Because AB cannot have both excess
business interest income and excess
business interest expense in the same
year, proposed § 1.163(j)–6(f)(2)(iv) and
(v) reconcile the proposed § 1.163(j)–
6(f)(2)(iii) partner-level calculation with
the proposed § 1.163(j)–6(f)(2)(i)
partnership-level result. This process of
reallocating allocable business interest
income excess to partners with allocable
business interest income deficits is
broken into two steps; proposed
§ 1.163(j)–6(f)(2)(iv) first proportionately
reduces each partner’s excess amount,
and then proposed § 1.163(j)–6(f)(2)(v)
proportionately reduces each partner’s
deficit amount to reflect the reallocation
of the benefit of the excess amounts.
Proposed § 1.163(j)–6(f)(2)(vii), (ix),
and (x) contain the same adjustment
mechanism as proposed § 1.163(j)–
6(f)(2)(iii) through (v), except for ATI
instead of business interest income. To
illustrate, if in the previous example AB
had $100 of ATI which it allocated
solely to A instead of $30 of business
interest income, AB would perform the
calculations in proposed § 1.163(j)–
6(f)(2)(vii), (ix), and (x)—which parallel
the calculations in proposed § 1.163(j)–
6(f)(2)(iii) through (v)—and arrive at the
same result. The partnership must make
the adjustments regarding business
interest income (proposed § 1.163(j)–
6(f)(2)(iii) through (v)) before the
adjustments regarding ATI (proposed
§ 1.163(j)–6(f)(2)(vii), (ix), and (x)) due
to section 163(j)(4)(C), which requires
partnerships to first fully offset business
interest expense using business interest
income before turning to ATI.
Finally, proposed § 1.163(j)–6(f)(2)(xi)
allocates section 163(j) excess items and
deductible business interest expense to
the partners. Excess business interest
income as determined in proposed
§ 1.163(j)–6(f)(2)(i) is allocated dollar for
dollar to the partners with final
allocable excess business interest
income determined pursuant to
proposed § 1.163(j)–6(f)(2)(iv). After
grossing up each partner’s final ATI
capacity excess amount by ten-thirds
(10/3) (the multiplicative inverse of the
30 percent ATI limitation), excess
taxable income, as determined in
proposed § 1.163(j)–6(f)(2)(i), is
allocated dollar for dollar to partners

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with final ATI capacity excess amounts
determined pursuant to proposed
§ 1.163(j)–6(f)(2)(ix). It is necessary to
gross up the ATI capacity excess
amount by ten thirds in order to account
for the reduction to ATI capacity that
occurred in proposed § 1.163(j)–
6(f)(2)(vii). Excess business interest
expense is allocated dollar for dollar to
partners with final ATI capacity deficit
amounts determined pursuant to
proposed § 1.163(j)–6(f)(2)(x). A
partner’s allocable business interest
expense is deductible business interest
expense to the extent it exceeds such
partner’s share of excess business
interest expense.
iii. Allocation of Deductible Business
Interest Expense and Section 163(j)
Excess Items—Steps 6 and 8
In a given year, if a partnership does
not have any partners with a negative
allocable ATI under proposed
§ 1.163(j)–6(f)(2)(vi) (that is, an allocable
ATI under proposed § 1.163(j)–6(f)(2)(ii)
that is comprised of more items of
deduction and loss than income and
gain), then the partnership would not
have any adjustments under proposed
§ 1.163(j)–6(f)(2)(vi) and (viii). Thus, the
only adjustments and reallocations the
partnership would have to perform as
part of its proposed § 1.163(j)–6(f)(2)
calculation are described in part 6(D)(ii)
of this Explanation of Provisions
section. However, if a partnership does
have a total negative allocable ATI that
is greater than zero, then the partnership
would have adjustments under
proposed § 1.163(j)–6(f)(2)(vi), and may
have adjustments under proposed
§ 1.163(j)–6(f)(2)(viii) as well. Proposed
§ 1.163(j)–6(f)(2)(vi) and (viii) are
closely related. In general, proposed
§ 1.163(j)–6(f)(2)(viii) corrects
distortions that would otherwise occur
following certain proposed § 1.163(j)–
6(f)(2)(vi) adjustments.
The purpose of proposed § 1.163(j)–
6(f)(2)(vi) is to address the situation in
which a partner’s allocable ATI under
proposed § 1.163(j)–6(f)(2)(ii) is
comprised of more items of deduction
and loss than income and gain—that is,
negative allocable ATI. For purposes of
the section 163(j) calculation, a
partnership that has ATI of less than
zero will not be able to deduct business
interest expense with respect to ATI
under section 163(j)(1). Accordingly, for
purposes of the proposed § 1.163(j)–
6(f)(2) calculation, the partnership must
ensure that each partner has a ‘‘final
allocable ATI’’ of at least zero before
performing the ATI adjustment
calculation described in proposed
§ 1.163(j)–6(f)(2)(vii), (ix), and (x). This
is accomplished by proportionately

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reallocating positive allocable ATI from
partners with positive allocable ATI to
partners with negative allocable ATI in
order to gross such partners up to zero.
Upon completion of the calculation in
proposed § 1.163(j)–6(f)(2)(vi), the
aggregate of the partners’ final allocable
ATI amounts will equal the
partnership’s ATI amount used in
calculating its section 163(j) limitation
under proposed § 1.163(j)–6(f)(2)(i), and
no partner will have a final allocable
ATI amount less than zero.
A partnership must always apply
proposed § 1.163(j)–6(f)(2)(vi), even if
the partnership does not have any
numerical adjustment resulting from it.
For example, if a partnership has a total
negative allocable ATI of $0 in proposed
§ 1.163(j)–6(f)(2)(vi), then even though
the partnership will not reallocate any
positive allocable ATI in proposed
§ 1.163(j)–6(f)(2)(vi), the partnership
must still apply proposed § 1.163(j)–
6(f)(2)(vi) to convert each partner’s
positive allocable ATI to final allocable
ATI, which is used in subsequent
paragraphs as the successor term of
allocable ATI.
The purpose of proposed § 1.163(j)–
6(f)(2)(viii) is to ensure that any
adjustments the partnership was
required to make under proposed
§ 1.163(j)–6(f)(2)(vi) do not result in
proposed § 1.163(j)–6(f)(2) requiring the
partnership to allocate deductible
business interest expense and section
163(j) excess items in an inequitable
manner. To illustrate, consider the
following example. Partnership ABC has
$100 of ATI, comprised of $200 of items
of income and gain and $100 of
deduction and loss, and $40 of business
interest expense. ABC allocates the
income and gain $100 each to A and C,
and all $100 of the deduction and loss
to B. ABC has $40 of business interest
expense, which it allocates $20 each to
A and B. Upon applying proposed
§ 1.163(j)–6(f)(2)(i), ABC has $30 of
deductible business interest expense
and $10 of excess business interest
expense.
Given these facts and the Treasury
Department and the IRS’s interpretation
of section 163(j), A is clearly entitled to
treat all $20 of its allocable business
interest expense as deductible business
interest expense in the current year, and
B should be allocated the $10 of excess
business interest expense. However, in
the absence of proposed § 1.163(j)–
6(f)(2)(viii), proposed § 1.163(j)–6(f)(2)
would require ABC to make different,
less equitable, allocations. The issue
stems from proposed § 1.163(j)–
6(f)(2)(vi). Following the application of
proposed § 1.163(j)–6(f)(2)(vi) and (vii),
A has an ATI capacity deficit of $5, B

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has an ATI capacity deficit of $20, and
C has an ATI capacity excess of $15.
The calculations in proposed § 1.163(j)–
6(f)(2)(ix) and (x) reallocate ATI
capacity excess to partners with ATI
capacity deficits solely based on each
partners ATI capacity deficit relative to
the total ATI capacity deficit. Because
proposed § 1.163(j)–6(f)(2)(ix) and (x)
only takes each partner’s proportionate
share of ATI capacity deficit into
account when reallocating ATI capacity
excess, proposed § 1.163(j)–6(f)(2)(ix)
and (x) always treat all of partners as
though they are on equal footing
regardless of any adjustments that may
have happened in proposed § 1.163(j)–
6(f)(2)(vi). As a result, in the absence of
proposed § 1.163(j)–6(f)(2)(viii), A
would be allocated deductible business
interest expense of only $18 (instead of
$20), and B would be allocated excess
business interest expense of only $8
(instead of $10).
The proposed § 1.163(j)–6(f)(2)(viii)
adjustment begins by filtering out
partnerships that do not need to make
the adjustment using the criteria listed
in proposed § 1.163(j)–6(f)(2)(viii)(A).
This treatment is possible due to the
predictability and limited universe of
situations that require a proposed
§ 1.163(j)–6(f)(2)(viii) adjustment.
Specifically, a proposed § 1.163(j)–
6(f)(2)(viii) adjustment is always
triggered when a positive allocable ATI
partner that helped gross up a negative
allocable ATI partner in proposed
§ 1.163(j)–6(f)(2)(vi) is subsequently
forced to compete with such partner for
a limited amount of ATI capacity
excess.
Next, under proposed § 1.163(j)–
6(f)(2)(viii)(B), a partnership must
determine each partner’s priority
amount. This priority amount represents
what a partner’s ATI capacity would
have been if such partner had not been
required under proposed § 1.163(j)–
6(f)(2)(vi) to offset another partner’s
negative allocable ATI. For purposes of
determining whether to apply proposed
§ 1.163(j)–6(f)(2)(viii)(C) or (D) and
performing the calculations under the
applicable paragraph, each partner’s
usable priority amount must be
determined. A partner’s usable priority
amount is the lesser of its priority
amount and ATI capacity deficit.
A partnership must use the amounts
it determined under proposed
§ 1.163(j)–6(f)(2)(viii)(B) to determine
whether it must perform the
calculations in proposed § 1.163(j)–
6(f)(2)(viii)(C) or (D). If the total ATI
capacity excess amount, as determined
under proposed § 1.163(j)–6(f)(2)(vii), is
greater than or equal to the total usable
priority amount, then the adjustments in

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proposed § 1.163(j)–6(f)(2)(viii)(C) must
occur. If the total usable priority amount
is greater than the total ATI capacity
excess amount, as determined under
proposed § 1.163(j)–6(f)(2)(vii), then the
adjustments in proposed § 1.163(j)–
6(f)(2)(viii)(D) must occur. The
application of proposed § 1.163(j)–
6(f)(2)(viii)(C) or (D) may result in
adjustments to the partner’s ATI
capacity excess (and deficit) amounts
used in proposed § 1.163(j)–6(f)(2)(ix)
and (x).
The purpose of these adjustments is to
ensure that the partners who had a
negative allocable ATI do not
improperly benefit under proposed
§ 1.163(j)–6(f)(2)(ix) through (xi) to the
detriment of the partners who had a
positive allocable ATI. In general,
proposed § 1.163(j)–6(f)(2)(viii)(C) and
(D) correct any artificial distortion of the
economics between the partners that
may have occurred under proposed
§ 1.163(j)–6(f)(2)(vi) by modifying the
outputs of proposed § 1.163(j)–
6(f)(2)(vii) to restore the partners’ true
economic arrangement before such
outputs are used in proposed § 1.163(j)–
6(f)(2)(ix) and (x). Stated otherwise,
proposed § 1.163(j)–6(f)(2)(viii)(C) and
(D) compensate for the assumption
made by proposed § 1.163(j)–6(f)(2)(ix)
and (x) that all partners are always on
equal footing by modifying the outputs
of proposed § 1.163(j)–6(f)(2)(vii) to put
all partners on equal footing before
allowing such outputs to reach
proposed § 1.163(j)–6(f)(2)(ix) and (x).
Turning back to the foregoing
example, in accordance with proposed
§ 1.163(j)–6(f)(2)(viii), ABC would first
determine whether it has all three
attributes in proposed § 1.163(j)–
6(f)(2)(viii)(A)(1) through (3). Because
ABC (1) has excess business interest
expense under proposed § 1.163(j)–
6(f)(2)(i); (2) has total negative allocable
ATI greater than $0 under proposed
§ 1.163(j)–6(f)(2)(vi); and (3) has a total
ATI capacity excess amount greater than
$0 under proposed § 1.163(j)–6(f)(2)(vii),
ABC must perform the calculations and
make the necessary adjustments
described under proposed § 1.163(j)–
6(f)(2)(viii)(B) and (C) or (D). Given
ABC’s facts, proposed § 1.163(j)–
6(f)(2)(viii)(B) would require ABC to
perform the calculations in proposed
§ 1.163(j)–6(f)(2)(viii)(C). As a result, A
would be allocated deductible business
interest expense of $20, and B would be
allocated excess business interest
expense of $10 and deductible business
interest expense of $10. This result is
consistent with the Treasury
Department and the IRS’s resolution of
the five key issues described in part

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

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E. Business Interest Expense
Carryforwards
i. In General
Proposed § 1.163(j)–6(g) would
provide that to the extent a partnership
has business interest expense in excess
of its section 163(j) limitation, such
excess business interest expense shall
not be carried forward by the
partnership. Instead, such excess
business interest expense would be
allocated to the partners in accordance
with proposed § 1.163(j)–6(f).
A commenter requested guidance
regarding whether a partner will be
permitted to use its share of the
partnership’s excess business interest
income in the current taxable year to
absorb the partner’s excess business
interest expense allocated from such
partnership in prior years. The Treasury
Department and the IRS believe that it
is consistent with section 163(j) to allow
excess business interest income
allocated to a partner from a partnership
to absorb the partner’s excess business
interest expenses allocated from that
same partnership in an earlier taxable
year to the extent of the excess business
interest income allocated to the partner.
This allowance places partners in a
similar position to other taxpayers with
carryforwards.
Regarding a partner’s allocation of
excess taxable income, the Treasury
Department and the IRS considered
three options when drafting guidance on
the deductibility of a partner’s excess
business interest expense carryforward
as it relates to a partner’s share of excess
taxable income. Section
163(j)(4)(B)(ii)(I) provides that the
carryforward ‘‘shall be treated as
business interest expense paid or
accrued by the partner in the next
succeeding taxable year in which the
partner is allocated excess taxable

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income from such partnership, but only
to the extent of such excess taxable
income.’’ The first option would apply
a plain reading of the statutory language
to treat as paid or accrued by the partner
the amount of excess business interest
expense carryforward from the
partnership equal to the excess taxable
income the partner is allocated from the
partnership, but it would limit the
deductibility of the excess business
interest expense by a partner to the
partner’s business interest income and
30 percent of the partner’s ATI for the
taxable year. Given this interpretation is
the most consistent with the plain
meaning of the statute, proposed
§ 1.163(j)–6(g) would provide that to the
extent a partner receives an allocation of
excess taxable income from a
partnership in a taxable year, such
partner’s excess business interest
expense is treated as paid or accrued in
that year in an amount equal to the
partner’s share of the excess taxable
income. To the extent the partner’s
excess business interest expense
exceeds its share of the partnership’s
excess taxable income in a taxable year,
it remains excess business interest
expense and is carried over to the
following taxable year. When the excess
business interest expense is treated as
paid or accrued, it becomes business
interest paid or accrued by the partner
and may be deducted by the partner,
subject to any partner-level section
163(j) limitation and any other
applicable limitations.
The second option considered would
entitle a partner to deduct excess
business interest expense only to the
extent the partner can deduct that
excess business interest expense against
the excess taxable income received from
the partnership (for example, 30 percent
of excess taxable income which
increases the partner’s ATI under
section 163(j)(4)(A)(ii)(II)), regardless of
any ATI or business interest income that
the partner has from sources other than
the partnership. This option would
produce the same result as if the
partnership had paid or accrued all the
relevant income and expense in a single
year. The legislative history can be read
to suggest this result: ‘‘The partner may
deduct its share of the partnership’s
excess business interest in any future
year, but only against excess taxable
income attributed to the partner by the
partnership the activities of which gave
rise to the excess business interest
carryforward.’’ H. Rept. 115–466, at 391
(2017). However, this interpretation
does not appear to be consistent with
the plain language of the statute, which
states that excess business interest

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expense is treated as paid or accrued to
the extent of the partner’s excess taxable
income.
The third option considered would
entitle a partner to fully deduct excess
business interest expense to the extent
it receives an allocation of excess
taxable income from the same
partnership (for example, for every
dollar of excess taxable income a
partner is allocated, the partner is able
to deduct one dollar of excess business
interest expense). This interpretation
would treat all excess business interest
expense, to the extent of excess taxable
income, as interest deductible under
section 163(a). However, this
interpretation ignores the possibility
that the partner may be subject to its
own section 163(j) limitation and
ignores the 30 percent limitation on ATI
that a partnership would be subject to
had the business interest expense been
paid or accrued in the current year.
Accordingly, this option is not adopted
in the proposed regulations.
ii. Ordering Rule
The ordering rule in proposed
§ 1.163(j)–6(f)(2)(iii) would clarify that
to the extent a partner is allocated
excess taxable income or excess
business interest income from a
partnership in the current taxable year
and, in a prior year, that partner was
allocated excess business interest
expense from that same partnership that
has not been previously treated as paid
or accrued by the partner, the partner
must treat that current-year excess
taxable income and excess business
interest income as causing the excess
business interest expense carried
forward from the partnership to be
treated as paid or accrued in such year
to the extent of the excess taxable
income and excess business interest
income. In the event a partner receives
excess taxable income or excess
business interest income from a
partnership, it cannot choose to keep
excess business interest expense as not
paid or accrued in the current taxable
year.
F. Basis Adjustments
i. Basis and Capital Account
Adjustments for Excess Business
Interest Expense Allocations
Generally, a partner’s adjusted basis
in its partnership interest shall be
reduced by allocated items of
partnership loss or deduction, but not
below zero, pursuant to § 1.704–1(d)(2).
Deductible business interest expense
and excess business interest expense are
subject to section 704(d). If a partner is
subject to a limitation on loss under

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
section 704(d) and a partner is allocated
losses from a partnership in a taxable
year, § 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,
§ 1.704–1(d)(2) requires the partner to
apportion the limitation on losses under
section 704(d) to each section 704(d)
loss class proportionately. For purposes
of applying this proportionate rule, any
deductible business interest expense
(whether allocated to the partner in the
current taxable year or suspended under
section 704(d) in a prior taxable year),
any excess business interest expense
allocated to the partner in the current
taxable year, and any excess business
interest expense from a prior taxable
year that was suspended under section
704(d) (‘‘negative section 163(j)
expense’’) shall comprise the same
section 704(d) loss class. Once the
partner determines the amount of
limitation on losses apportioned to this
section 704(d) loss class, any deductible
business interest expense is taken into
account before any excess business
interest expense or negative section
163(j) expense.
The adjusted basis of a partner in a
partnership interest is reduced, but not
below zero, by the amount of excess
business interest expense allocated to
the partner pursuant to proposed
§ 1.163(j)–6(f)(2). Negative section 163(j)
expense is not treated as excess business
interest expense in any subsequent year
until such negative section 163(j)
expense is no longer suspended under
section 704(d). Consequently, an
allocation of excess taxable income or
excess business interest income does
not result in the negative section 163(j)
expense being treated as business
interest expense paid or accrued by the
partner. Further, unlike excess business
interest expense preventing a partner
from including excess taxable income in
its ATI as described in section
163(j)(4)(B)(ii) flush language, negative
section 163(j) expense does not affect,
and is not affected by, any allocation of
excess taxable income to the partner.
Accordingly, any excess taxable income
allocated to a partner from a partnership
while the partner still has a negative
section 163(j) expense will be included
in the partner’s ATI. However, once the
negative section 163(j) expense is no
longer suspended under section 704(d),
it becomes excess business interest
expense, which is subject to the general
rules in proposed § 1.163(j)–6(g).

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Section 163(j) has no effect on the
maintenance of capital accounts (for
example, a partner’s capital account is
reduced in the year such partner is
allocated excess business interest
expense). See § 1.704–1(b)(2)(iv)(b).
The guidance provided in proposed
§ 1.163(j)–6(h)(2) is intended to address
situations in which a partner is subject
to a limitation under section 704(d) and
is also allocated excess taxable income.
Pursuant to proposed § 1.163(j)–6(g),
excess business interest expense would
otherwise be treated as paid or accrued
by the partner in an amount equal to the
excess taxable income, but the partner’s
basis in the partnership does not
increase in an amount equal to the
allocated excess taxable income and,
therefore, remains subject to the loss
limitation in section 704(d). The
approach taken in proposed § 1.163(j)–
6(h)(2) attempts to reconcile the
competing deduction limitations
imposed by sections 704(d) and 163(j)
along with section 163(j) treating excess
business interest expense as paid or
accrued by the partner when the partner
is allocated excess taxable income. The
Treasury Department and the IRS
request comments on this issue.
ii. Basis Adjustments Upon Disposition
of Partnership Interests Pursuant to
Section 163(j)(4)(B)(iii)(II)
Proposed § 1.163(j)–6(h)(3) would
provide that if a partner disposes of all
or substantially all of its partnership
interest, the adjusted basis of the partner
in the partnership interest shall be
increased immediately before the
disposition by the amount of excess, if
any, of the amount of the basis
reduction under proposed § 1.163(j)–
6(h)(1) over the portion of any excess
business interest expense allocated to
the partner under proposed § 1.163(j)–
6(f)(2) which has not been previously
treated under proposed § 1.163(j)–6(g) as
business interest expense paid or
accrued by the partner, regardless of
whether the disposition was as a result
of a taxable or non-taxable transaction.
No deduction under section 163(j) shall
be allowed to the transferor or transferee
under chapter 1 of the Code for any
excess business interest expense
resulting in a basis increase under
section 163(j) and these proposed
regulations or for any negative section
163(j) expense.
In the event a partner disposes of less
than substantially all of its interest in a
partnership, proposed § 1.163(j)–6(h)(2)
would provide that a partner shall not
increase its basis in its partnership by
the amount of any excess business
interest expense that has not yet been
treated as paid or accrued by the partner

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67509

in accordance with proposed § 1.163(j)–
6(g). Any such excess business interest
expense would remain excess business
interest expense in the hands of the
transferor partner until such time as the
transferor partner is allocated an
appropriate amount of excess taxable
income or excess business interest
income from the partnership or added to
the basis of its partnership interest
when the partner fully disposes of the
partnership interest. Additionally, any
negative section 163(j) expense shall
remain negative section 163(j) expense
of the transferor partner until such
negative section 163(j) expense is no
longer suspended under section 704(d).
These rules are similar to the rules
found under section 469 and the
regulations thereunder relating to
suspended passive activity loss
deductions.
The Treasury Department and the IRS
considered alternate approaches when
analyzing the effect of partial
dispositions on a partner’s basis. One
alternate approach would add excess
business interest expense to the
partner’s basis in the partnership
interest to the extent the partner’s
capital account is reduced by the
transfer or redemption. A second
approach would increase the partner’s
remaining basis in the partnership
interest by the amount of excess
business interest expense that is
proportionate to the amount of the
partner’s adjusted basis in the
partnership interest that was transferred
or redeemed. This method would
require a partner to track its basis in the
partnership interest in a manner similar
to that set forth in Rev. Rul. 84–53,
1984–15 I.R.B. 17, 1984–1 C.B. 159
(Apr. 9, 1984). The Treasury Department
and the IRS request comments on this
issue.
G. Investment Items
Proposed § 1.163(j)–6(j) would
provide guidance on the treatment of
investment income and expense items
under section 163(d) allocated by a
partnership to its partners. Notice 2018–
28 stated that the Treasury Department
and the IRS intend to issue regulations
clarifying that, solely for purposes of
section 163(j), in the case of a taxpayer
that is a C corporation, all interest paid
or accrued by the C corporation on
indebtedness of such C corporation will
be business interest expense within the
meaning of section 163(j)(5), and all
interest on indebtedness held by the C
corporation that is includible in gross
income of such C corporation will be
business interest income within the
meaning of section 163(j)(6).
Additionally, comments were received

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requesting guidance on the treatment of
investment interest expense and
investment interest income, as defined
in section 163(d), allocated to a C
corporation (corporate partner) by a
partnership.
The Treasury Department and the IRS
considered two approaches to address
this issue. Under the first approach, the
investment interest expense would be
allocated directly from the partnership
to the corporate partner without being
subject to the section 163(j) limitations
of the partnership. This option is most
consistent with a plain reading of the
statute. The definition of business
interest expense under section 163(j)(5)
specifically excludes investment
interest. Section 163(j)(4) requires the
business interest expense deduction to
be calculated with respect to the
partnership’s specific items of income
and expense, and the statute does not
require any partner-specific
considerations to be taken into account
when performing the calculation at the
partnership level.
The legislative history of section
163(j) indicates that a corporation can
never have investment income and
expenses, and instead, those items shall
be treated as business interest income
and expenses: ‘‘Section 163(d) applies
in the case of a taxpayer other than a
corporation. Thus, a corporation has
neither investment interest nor
investment income within the meaning
of section 163(d). Therefore, interest
income and interest expense of a
corporation is properly allocable to a
trade or business, unless such trade or
business is otherwise explicitly
excluded from the application of the
provision.’’ H. Rept. 115–466, at 386, fn.
688 (2017).
This language suggests a legislative
intent to transform any interest that
would otherwise be classified as
investment interest in the hands of the
corporate partner into business interest
expense, thereby subjecting that interest
to the corporate partner’s limitations
under section 163(j).
The second approach considered
would require a partnership to perform
a notional calculation under section
163(j) with respect to the investment
interest that is allocated to its corporate
partners. Based on the text and
legislative history, this provision could
arguably be interpreted to mean that
investment interest expenses should be
classified as business interest expenses
at the time they are allocated to a
corporate partner, and accordingly, the
partnership should perform a section
163(j) calculation with respect to those
items because section 163(j) requires a
partnership to take the business interest

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expense deduction into account.
Because this calculation would be done
at the partnership level, any partnership
with both corporate and non-corporate
partners would need to make two
section 163(j) calculations: One for any
corporate partners and one for noncorporate partners.
Proposed § 1.163(j)–6(j) would adopt
the first approach. Section 163(j)(4) does
not require the partnership to look
beyond its own tax attributes to that of
its partners when making a
determination as to whether a section
163(j) calculation is necessary.
Accordingly, a plain reading of the
statute does not support the partnership
treating investment interest as business
interest expense prior to allocating the
interest to its partners. Instead, the
statute appears to require the corporate
partner to calculate its section 163(j)
limitation while including this
investment interest as it would with all
other business and investment interest it
receives from all sources.
It should be noted that, with respect
to passthrough entities, including S
corporations, engaged in trades or
businesses that are not passive activities
and with respect to which certain
owners of the passthrough entities do
not materially participate for purposes
of section 469, as described in section
163(d)(5)(A)(ii) and as illustrated in Rev.
Rul. 2008–12, the rules of section
163(j)(4) will apply to business interest
expense allocable to such trades or
businesses of those passthrough entities
if those entities are otherwise subject to
section 163(j). To the extent business
interest expense of a passthrough entity
is not limited under section 163(j), such
business interest expense may still be
limited by section 163(d) at the
passthrough entity owner level in these
situations. With respect to partnerships,
to the extent that such business interest
expense is limited under section
163(j)(4) and becomes a carryover item
of partners who do not materially
participate with respect to such trades
or businesses, those items will be
treated as items of investment interest
expense in the hands of those owners
for purposes of section 163(d) once
those carryover items are treated as paid
or accrued in a succeeding taxable year.
The Treasury Department and the IRS
have concluded that this is the result of
the statutory rules contained in section
163(d)(4)(B) and (d)(5)(A)(ii) and,
therefore, no additional rules are needed
in regulations to reach this result.

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

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excepted assets, (2) investment assets, or
(3) both, the shareholder would
determine the proportionate share of the
amount properly allocable to a nonexcepted trade or business, in
accordance with the allocation rules set
forth in proposed § 1.163(j)–
10(c)(5)(ii)(B)(3), and would include
such proportionate share of gain or loss
in the shareholder’s ATI. Proposed
§ 1.163(j)–10(b)(4)(ii) would also apply
to tiered passthrough entities, as defined
in proposed § 1.163(j)–7(f)(13), by
looking through each passthrough entity
tier (for example, an S corporation that
is the partner of the highest-tier
partnership would look through each
lower-tier partnership), subject to
proposed § 1.163(j)–10(c)(5)(ii)(D).

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iii Double Counting of Business Interest
Income Prohibited
Proposed § 1.163(j)–6(l)(4)(iii) would
incorporate the limitations set forth in
Notice 2018–28, which the Treasury
Department and the IRS issued ‘‘to
prevent the double counting of business
interest income and floor plan financing
interest expense for purposes of the
deduction afforded by section 163(j).’’
Notice 2018–28, section 7. Consistent
with the Notice’s statement regarding
the application of such limitations to S
corporations and their shareholders,
proposed § 1.163(j)–6(l)(4)(iii) would
provide that, for purposes of calculating
an S corporation shareholder’s section
163(j) limitation, the shareholder would
not include business interest income
from an S corporation that is subject to
section 163(j) except to the extent it is
allocated excess business interest
income from that S corporation
pursuant to proposed § 1.163(j)–6(l)(1).
In addition, proposed § 1.163(j)–
6(l)(4)(iii) would provide that an S
corporation shareholder could not
include its share of the S corporation’s
floor plan financing interest expense for
purposes of calculating a shareholder’s
section 163(j) limitation because such
floor plan financing interest expense
would have already have been taken
into account by the S corporation in
determining its nonseparately stated
taxable income or loss for purposes of
section 163(j).
iv. Business Interest Expense
Carryforwards
Section 163(j)(4) does not indicate the
manner by which disallowed business
interest expense carryforwards should
be treated by an S corporation and its
shareholders. However, by virtue of the
fact that section 163(j)(4)(D) references
both sections 163(j)(4)(A) and (C), but
not (B), an inference could be made that
Congress intended that disallowed

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business interest expense carryforwards
that arise from an S corporation should
be treated differently than excess
business interest expense incurred by a
partnership. The legislative history
appears to support such inference by
indicating that the ‘‘special rule for
carryforward of disallowed partnership
interest’’ in section 163(j)(4)(B) ‘‘does
not apply to S corporations and their
shareholders.’’ H. Rept. 115–466, at 391
(2017).
In light of the statutory language and
the legislative history, proposed
§ 1.163(j)–6(l)(5) provides that the rules
set forth in proposed § 1.163(j)–2(c)
govern the treatment of S corporation
business interest expense carryforwards.
Consequently, if an S corporation has a
disallowed business interest expense
carryforward in the year the S
corporation terminates, such item will
be carried forward to the succeeding C
corporation taxable year. The Treasury
Department and the IRS request
comments regarding the treatment of
disallowed business interest expense
carryforwards as an attribute of the S
corporation, subject to section 382
limitations, as opposed to the
shareholders, and the timing for any
adjustments to shareholder basis and
the S corporation’s accumulated
adjustment account. By deferring
adjustments to shareholder basis and
the S corporation’s accumulated
adjustments account until any
carryforwards are deductible at the
corporate level, these proposed
regulations generally would match the
economics of these adjustments to the
shareholders holding stock at the time
the S corporation’s carryforwards would
become deductible.
The Treasury Department and the IRS,
however, have considered an alternative
option to the rules set forth in proposed
§ 1.163(j)–6(l)(5). This alternative option
would allocate carryforwards from an S
corporation to its shareholders in a
manner similar to proposed § 1.163(j)–
6(g) for partnerships and their partners.
This option would require shareholders
to receive excess taxable income or
excess business interest income from
the S corporation in order to treat the
disallowed business interest
carryforwards as paid or accrued by the
shareholder. The shareholder’s basis
and the S corporation’s accumulated
adjustment account would be reduced
upon an allocation of excess business
interest expense to the shareholders.
This alternative option would set
forth a framework that would be
consistent with the flow-through nature
of S corporations. For example, S
corporations, similar to partnerships,
allocate items of deduction and expense

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67511

in the year that they occur, even if such
items might be suspended at the
shareholder-level under section 1366(d).
In addition, S corporation shareholders
calculate their respective bases in a
manner similar to partners, except that
S corporation shareholders do not take
into account entity-level debt. Thus,
corporate attributes generally are
suspended at the shareholder-level
under the existing subchapter S
framework. The Treasury Department
and the IRS request comments on this
alternative approach and the
authoritative support for adopting it.
v. Applicability of Section 382 to S
Corporations Regarding Disallowed
Business Interest Expense
Carryforwards
Although the Treasury Department
and the IRS have determined that
sections 381(c)(20) and 382(d)(3) and
(k)(1) apply to S corporations with
respect to disallowed business interest
expense carryforwards, the Treasury
Department and the IRS continue to
consider the extent to which section 382
should apply to S corporations for
purposes other than section 163(j). The
application of section 382 to S
corporations for purposes of section
163(j) should not be construed as
creating any inference regarding the
application of section 382 to S
corporations for other purposes. The
Treasury Department and the IRS seek
comments regarding the proper
integration of these two Code sections
and subchapter S of the Code (for
example, comments regarding the
interaction between sections 382 and
1362(e)(6)(D)).
I. Partnership or S Corporation Not
Subject to Section 163(j)
Proposed § 1.163(j)–6(m) would
provide guidance regarding partnerships
and S corporations not subject to section
163(j). If a partnership or S corporation
is not subject to section 163(j) by reason
of proposed § 1.163(j)–2(d) (exempt
entity), the exempt entity would not be
required to perform the business interest
expense limitation calculations under
proposed §§ 1.163(j)–2(b) and 1.163(j)–
6. To the extent a partner or shareholder
receives business interest expense from
an exempt entity, however, that
business interest expense will be subject
to the partner or shareholder’s own
section 163(j) deduction. In the event a
partner or shareholder is subject to
section 163(j) and the S corporation or
partnership is not, the partnership or S
corporation shall provide the partner or
shareholder with the information
necessary to inform the partner or
shareholder of the partner or

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shareholder’s share of the partnership or
S corporation’s business interest
expense, business interest income, and
items of ATI.
To the extent a partnership or S
corporation is not subject to section
163(j) by reason of proposed § 1.163(j)–
1(b)(38)(ii) because it has an excepted
trade or business (excepted entity), the
excepted entity would not have to
perform the business interest expense
limitation calculations under proposed
§§ 1.163(j)–2(b) and 1.163(j)–6 with
respect to the business interest expense
that is allocated to such electing trade
or business. To the extent a partner or
shareholder is allocated any section
163(j) item that is allocated to the
partnership’s excepted trade or business
(excepted 163(j) items), such excepted
163(j) items would be excluded from the
partner or shareholder’s section 163(j)
deduction calculation.
In the event a partnership allocates
excess business interest expense to one
or more of its partners, and in a later
taxable year becomes exempt from the
requirements of section 163(j)(4),
proposed § 1.163(j)–6(l) would provide
that the excess business interest expense
from the prior taxable years is treated as
paid or accrued by the partner in such
later taxable year.
7. Proposed § 1.163(j)–7: Application of
Section 163(j) to Foreign Corporations
and Their Shareholders

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A. Overview
The Treasury Department and the IRS
received comments requesting
clarification on whether section 163(j)
applies to a controlled foreign
corporation (as defined in section 957)
(CFC) and, if so, the manner in which
it applies.
These proposed regulations would
provide the general rule that section
163(j) and the section 163(j) regulations
apply to determine the deductibility of
a CFC’s business interest expense in the
same manner as those provisions apply
to determine the deductibility of a
domestic C corporation’s business
interest expense. See proposed
§ 1.163(j)–7(b)(2). Thus, a CFC with
business interest expense would apply
section 163(j) to determine the extent to
which that expense is deductible for
purposes of computing subpart F
income as defined under section 952,
tested income as defined under section
951A(c)(2)(A), and income which is
effectively connected with the conduct
of a U.S. trade or business (ECI), as
applicable. Additional guidance for a
CFC (and other foreign persons) with
ECI is provided in proposed § 1.163(j)–

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8 and discussed in part 8 of this
Explanation of Provisions section.
Notwithstanding the general
applicability of section 163(j) to CFCs
under these proposed regulations, the
Treasury Department and the IRS have
determined that it is appropriate in
certain cases to modify its application.
As discussed in part 7(B) and part 7(C)
of this Explanation of Provisions
section, these proposed regulations
would, in certain cases, limit the
amount of a CFC’s business interest
expense subject to the section 163(j)
limitation and modify the computation
of a CFC’s ATI, respectively.
The Treasury Department and the IRS
continue to study whether it would be
appropriate to provide additional
modifications to the application of
section 163(j) to CFCs and whether there
are particular circumstances in which it
may be appropriate to exempt a CFC
from the application of section 163(j).
The Treasury Department and the IRS
request comments on this matter.
B. Computation of Amount of Business
Interest Expense Subject to Section
163(j)
The Treasury Department and the IRS
are aware that if business interest
expense is paid by one CFC to a related
CFC, the application of section 163(j)
could result in an inappropriate
mismatch of a deduction and payee
income item. Such mismatch could
inappropriately impact the calculation
of the tax liability of a United States
shareholder, as defined in section
951(b), under section 951A or the GILTI
provision. Consider an example where a
United States person (USP) wholly
owns two CFCs (CFC1 and CFC2), and
CFC1 has made a loan to CFC2 with
respect to which CFC1 annually accrues
$100x of business interest income that
is included in CFC1’s tested income,
and CFC2 pays or accrues $100x of
business interest expense, which absent
section 163(j), would be fully deductible
in computing CFC2’s tested income or
tested loss, as applicable. Thus, the
intercompany business interest income
and business interest expense would
fully offset one another for purposes of
computing USP’s inclusion under
section 951A(a). To the extent section
163(j) were to disallow a deduction for
business interest expense to CFC2 while
the business interest income would be
included in CFC1’s tested income, the
amounts would not fully offset, and
USP’s inclusion under section 951A(a)
may be increased solely due to the use
of intercompany debt between CFC1
and CFC2.
The Treasury Department and the IRS
considered the possibility of completely

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disregarding all business interest
income and business interest expense
with respect to intercompany debt
between related CFCs for purposes of
computing the section 163(j) limitation
of the lender CFC and borrower CFC
(the disregard approach). However, the
disregard approach was rejected because
it could cause inappropriate results
where, for example, one CFC (CFC
finco) borrows from a third party and
on-lends the debt proceeds to one or
more other CFCs within a group (funded
CFCs). Assume for purposes of
simplicity that a CFC finco charges
interest on loans to the funded CFCs at
the same rate that it is charged by the
third party. If intercompany business
interest income received by CFC finco
and business interest expense paid or
accrued by the funded CFCs were
disregarded in determining each CFC’s
section 163(j) limitation, then CFC finco
would have no business interest
income, and all of CFC finco’s business
interest expense paid to the third party
would be subject to the section 163(j)
limitation. Furthermore, all of the
funded CFCs would have no business
interest expense subject to the section
163(j) limitation. This would be the
case, even though the funded CFCs have
borrowed from CFC finco and have the
use of the funds originally borrowed
from the third party.
The Treasury Department and the IRS
have determined that an approach that
better reflects the reality of borrowings
by related CFCs is one that takes into
account the principle that money is
fungible within a group of highly related
CFCs (such a group, a ‘‘CFC group’’ and
a CFC that is a member of the group, a
‘‘CFC group member’’). Accordingly,
these proposed regulations would
provide for an election to apply an
alternative method that would limit the
amount of business interest expense of
a CFC group member subject to the
section 163(j) limitation to the amount
of the CFC group member’s allocable
share of the CFC group’s applicable net
business interest expense. See proposed
§ 1.163(j)–7(b)(3). The applicable net
business interest expense of a CFC
group is the excess, if any, of the sum
of the amounts of business interest
expense of each CFC group member
over the sum of the amounts of business
interest income of each CFC group
member. See proposed § 1.163(j)–7(f)(3).
A CFC group member’s allocable share
is computed by multiplying the
applicable net business interest expense
of the CFC group by a fraction, the
numerator of which is the CFC group
member’s net business interest expense
(computed on a separate company

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basis), and the denominator of which is
the sum of the amounts of the net
business interest expense of each CFC
group member with net business
interest expense (computed on a
separate company basis). See proposed
§ 1.163(j)–7(f)(1).
Thus, if an election is made to apply
the alternative method and if a CFC
group has only intercompany debt
within the CFC group, then the amount
of the CFC group’s applicable net
business interest expense is zero, and no
business interest expense of any CFC
group member would be subject to the
section 163(j) limitation. As a result, for
example, there would be no increase in
an inclusion under section 951A(a)
solely by reason of the use of
intercompany debt within a CFC group.
On the other hand, if a CFC group has
applicable net business interest
expense, then, consistent with the
principle that money is fungible, each
CFC group member that has net
business interest expense, computed on
a separate company basis, will
determine its allocable share of the
applicable net business interest
expense, and such allocable share is the
amount of business interest expense of
the CFC group member that is subject to
the section 163(j) limitation. Using its
allocable share of the CFC group’s
applicable net business interest
expense, a CFC group member computes
its section 163(j) limitation on a separate
company basis. However, as discussed
in part 7(C) of this Explanation of
Provisions section, under these
proposed regulations, for purposes of
computing a CFC’s ATI, an upper-tier
CFC group member takes into account a
proportionate share of the ‘‘excess’’ ATI
of a lower-tier CFC group member.
In general, for purposes of these
proposed regulations, a CFC group
means two or more CFCs, if at least 80
percent of the stock by value of each
CFC is owned, within the meaning of
section 958(a), by a single U.S.
shareholder or, in aggregate, by related
U.S. shareholders that own stock of each
member in the same proportion. See
proposed § 1.163(j)–7(f)(6). For purposes
of identifying a CFC group, members of
a consolidated group are treated as a
single person, as are individuals filing a
joint return, and stock owned by certain
passthrough entities is treated as owned
by the owners or beneficiaries of the
passthrough entity. The Treasury
Department and the IRS determined that
the alternative method is appropriately
limited to situations in which a payor
CFC and payee CFC have substantially
identical ownership by United States
shareholders because the alternative is
based on the principle that money is

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fungible. The alternative is based on the
principle that money is fungible, but
fungibility should only apply in cases of
close relationship where borrowings
essentially support the entire group.
Furthermore, the mismatch of a
deduction and a payee income item is
most significant when the payee and
payor CFC have substantially identical
ownership by United States
shareholders. These proposed
regulations narrow the scope of foreign
corporations that are CFCs for this
purpose to those foreign corporations in
which at a least one United States
shareholder owns stock, within the
meaning of section 958. These proposed
regulations refer to such a CFC as an
‘‘applicable CFC.’’ See proposed
§ 1.163(j)–7(f)(2).
If one or more CFC group members
conduct a financial services business,
the alternative method is applied by
treating those entities as comprising a
separate subgroup (such a subgroup, a
‘‘financial services subgroup’’ and such
a member, a ‘‘financial services
subgroup member’’). For this purpose,
an entity conducts a financial services
business if it is an eligible controlled
foreign corporation, as defined in
section 954(h)(2)(A), is a qualified
insurance company, as defined in
section 953(e)(3), or is eligible for the
dealer exception in computing foreign
personal holding company income as
described in section 954(c)(2)(C). The
Treasury Department and the IRS
determined that it is appropriate to
apply the alternative method separately
for entities that conduct financial
services businesses, because those
businesses are typically highly
leveraged with significant amounts of
business interest income and business
interest expense and could reasonably
be expected to cause distortion if
included in the alternative method with
other, non-financial services business
CFC group members.
These proposed regulations generally
treat a controlled partnership (in
general, a partnership in which CFC
group members own, in aggregate, at
least 80 percent of the interests) as a
CFC group member and the interest in
the controlled partnership is treated as
stock. Thus, for example, if a U.S.
person wholly owns two applicable
CFCs, which each own a 50–percent
interest in a partnership, then, if an
election is made to apply the alternative
method, the partnership will also apply
the alternative method. The Treasury
Department and the IRS determined that
it is appropriate to extend the relief to
partnerships that are substantially
owned by CFC group members because
the principle that money is fungible is

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not limited to corporate entities.
Furthermore, absent such a rule, a
partnership could be used to
inappropriately exclude an applicable
CFC from the CFC group by having the
partnership own the applicable CFC.
These proposed regulations exclude
from the definition of a CFC group
member an applicable CFC that has ECI.
Thus, an applicable CFC with ECI may
not compute its section 163(j) limitation
under the alternative method, and
furthermore, the CFC group, and any
financial services subgroup, must
exclude such CFC from all group-level
computations (for example, in
determining the amount of the CFC
group’s applicable net business interest
expense). The Treasury Department and
the IRS determined that it is appropriate
to exclude an applicable CFC with ECI
from application of the alternative
method so that section 163(j) applies to
a CFC with ECI in the same manner as
it does to a domestic C corporation.
However, although an applicable CFC
with ECI cannot use the alternative
method, an applicable CFC with ECI is
treated as a CFC group member solely
for purposes of determining a CFC
group. Thus, for example, if an
applicable CFC with ECI is wholly
owned by an upper-tier CFC and the
applicable CFC with ECI wholly owns a
lower-tier CFC, the lower-tier CFC may
still qualify as a CFC group member.
If not all CFC group members have the
same taxable year, then, if the election
is made, these proposed regulations
require that all group-level
computations be made with respect to a
majority U.S. shareholder taxable year.
See proposed § 1.163(j)–7(f)(11). Thus,
if, for example, USP, a domestic
corporation with a calendar taxable
year, wholly owns two applicable CFCs,
one with a calendar year and one with
a November 30 fiscal year, then, with
respect to USP’s 2019 calendar year, the
group-level computations must be
determined using amounts for the
taxable year ending November 30, 2019,
for the one applicable CFC, and
amounts for the taxable year ending
December 31, 2019, for the other
applicable CFC.
Finally, these proposed regulations
provide rules concerning the election
(referred to as a ‘‘CFC group election’’),
including the requirements for making
the CFC group election, the manner for
making the CFC group election, and the
duration of the CFC group election. See
proposed § 1.163(j)–7(b)(5). The
Treasury Department and the IRS
determined that the alternative method
should be elective, rather than required,
because for certain situations, the

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general application of section 163(j) may
be preferable to taxpayers.
C. Rules for Computing the ATI of an
Applicable CFC
Proposed § 1.163(j)–7(c) would
provide rules for computing the ATI of
an applicable CFC. The principles of
§ 1.952–2 for determining the CFC’s
income and deductions or, for CFCs
with ECI, the rules of section 882, apply
for purposes of computing the CFC’s
taxable income. See proposed § 1.163(j)–
7(c)(1). The Treasury Department and
the IRS request comments on the
application of the rules under § 1.952–
2 for purposes of determining a CFC’s
taxable income for purposes of section
163(j). In particular, comments are
requested as to whether these rules
should allow a CFC a deduction, or
require a CFC to take into account
income, that is expressly limited to
domestic corporations under the Code.
For example, questions have arisen as to
whether a CFC should be allowed a
dividends-received deduction under
section 245A, even though section 245A
by its terms applies only to dividends
received by a domestic corporation.
To mitigate potential double-counting
of income in ATI, any dividend received
by an applicable CFC from a related
person is subtracted from the
distributee’s taxable income for
purposes of computing ATI as the
dividend represents income that could
be part of the distributing corporation’s
ATI. See proposed § 1.163(j)–7(c)(2).
If a CFC group election is in effect
with respect to a CFC group, then an
upper-tier CFC group member takes into
account a proportionate share of the
‘‘excess’’ ATI (referred to in these
proposed regulations as ‘‘CFC excess
taxable income’’) of each lower-tier
member in which it directly owns stock
for purposes of computing the uppertier member’s ATI. See proposed
§ 1.163(j)–7(c)(3). The meaning of the
term CFC excess taxable income is
analogous to the meaning of the term
‘‘excess taxable income’’ in the context
of a partnership and S corporation, and,
in general, means the amount of a CFC
group member’s ATI in excess of the
amount needed before there would be
disallowed business interest expense.
See proposed § 1.163(j)–7(f)(5). A CFC
group member that is a partnership does
not have CFC excess taxable income
because under the statute and proposed
§ 1.163(j)–6, the partnership has excess
taxable income and such excess taxable
income is allocated to the partners of
the partnership. For a discussion of the
computation of a partnership’s excess
taxable income and the treatment of a
partner’s distributive share of any such

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excess taxable income, see the
discussion in part 6 of this Explanation
of Provisions section.
The process of computing and
‘‘rolling up’’ CFC excess taxable income
among CFC group members for purposes
of computing ATI of each of the CFC
group members begins with a lowest-tier
member and continues through the
chain of ownership to a highest-tier
member of the CFC group (referred to in
these proposed regulations as a
‘‘specified highest-tier member’’). Thus,
a lowest-tier member computes its
section 163(j) limitation, and if the
lowest-tier member has CFC excess
taxable income, the CFC excess taxable
income is taken into account
proportionately by one or more highertier members that directly own stock of
the lower-tier member for purposes of
computing ATI; and, if such a highertier member has CFC excess taxable
income, such CFC excess taxable
income is taken into account by a next
higher-tier member, and so forth.
A higher-tier member that is a
partnership may take into account a pro
rata share of the CFC excess taxable
income of a lower-tier member, other
than a partnership, which does not have
CFC excess taxable income, for purposes
of computing the higher-tier member
partnership’s ATI and determining if the
higher-tier member partnership has
excess taxable income that may be
allocated to CFC group members that are
partners.
D. Rules for Computing ATI of a United
States Shareholder
i. General Rules
In general, a United States
shareholder that owns, within the
meaning of section 958(a), stock of a
CFC is required to include in its gross
income each year its pro rata share of
the CFC’s subpart F income, and
investments in U.S. property, as defined
in section 956. In addition, a United
States shareholder that owns stock of a
CFC is required to include in its gross
income for each year its GILTI. Thus,
these income inclusions are included in
the United States shareholder’s taxable
income, and absent an exercise of
regulatory authority, would be included
in ATI.
To avoid double counting of the
taxable income of a CFC already taken
into account to determine the CFC’s
section 163(j) limitation, proposed
§ 1.163(j)–7(d)(1)(i) would provide the
general rule (the double counting rule)
that the ATI of a United States
shareholder is computed without regard
to any amounts included in gross
income under sections 78, 951(a), and

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

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States shareholder may add to its
taxable income an amount equal to its
proportionate share of the ‘‘eligible’’
CFC excess taxable income of the
specified highest-tier member and any
other highest-tier members (the addback
rule). See proposed § 1.163(j)–7(d)(2).
However, the addition to taxable income
under the addback rule is limited to the
portion of the specified deemed
inclusions, all of which are subtracted
from taxable income of any United
States shareholder under the doublecounting rule, that is with respect to
CFC group members, reduced by the
portion of any specified section 250
deduction that is allowable by reason of
such specified deemed inclusions.
These proposed regulations refer to the
portion described in the preceding
sentence as ‘‘CFC group inclusions’’ (see
proposed § 1.163(j)–7(d)(2)(iii)).
Furthermore, the limitation is computed
without regard to amounts included in
gross income by reason of section 78
with respect to CFC group members.
This result is appropriate because
section 78 requires a deemed inclusion
only in order to carry out the purposes
of the foreign tax credit provisions.
To determine the amount of ‘‘eligible’’
CFC excess taxable income (ETI) of a
specified highest-tier member (defined
under proposed § 1.163(j)–7(d)(2)(ii) as
‘‘eligible CFC group ETI’’), the CFC
excess taxable income is multiplied by
the specified ETI ratio. The specified
ETI ratio is a fraction (expressed as a
percentage) that compares the amounts
of taxable income of each specified
highest-tier member and each specified
lower-tier member of the specified
highest-tier member to the portions of
such taxable income that gave rise to
inclusions under section 951(a) or
951A(a). The specified ETI ratio
includes in the numerator and the
denominator of the fraction only taxable
income amounts with respect to CFC
group members that have CFC excess
taxable income without regard to the
‘‘roll up’’ of CFC excess taxable income
from a lower-tier member. See proposed
§ 1.163(j)–7(f)(14). The purpose of the
specified ETI ratio is to address the fact
that within the CFC group, income of a
lower-tier member CFC that is neither
subpart F income nor tested income to
the extent of GILTI is included in CFC
excess taxable income and may be used
by an upper-tier CFC group member. It
would be distortive for a United States
shareholder to obtain an increase in ATI
in respect of such income because this
income is not taxed in the United States.
The specified ETI ratio is intended to
provide an estimate of the portion of
CFC excess taxable income attributable

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to this income. The Treasury
Department and the IRS determined that
this formulaic approach is superior to a
tracing approach, because a tracing
approach would increase complexity
and therefore also generally increase
administrative and compliance burdens.
If a United States shareholder of a
CFC group member with a CFC group
election in effect is a domestic
partnership (a U.S. shareholder
partnership), the addback rule does not
apply to determine the ATI of the U.S.
shareholder partnership. See proposed
§ 1.163(j)–7(d)(3). This is because the
Treasury Department and the IRS are of
the view that if a U.S. shareholder
partnership includes amounts in gross
income under section 951(a) or 951A(a)
with respect to stock of a CFC group
member, then such amounts will, in
virtually all fact patterns, be treated as
investment income with respect to the
partnership, and therefore interest
expense of the partnership that is
allocable to stock of a CFC group
member will be treated as investment
interest expense that is not subject to
section 163(j) at the partnership-level. In
this case, however, if a U.S. shareholder
partnership has a domestic C
corporation partner (a U.S. corporate
partner), the addback rule is applied,
with certain modifications, to the U.S.
corporate partner for purposes of
computing the U.S. corporate partner’s
ATI. In particular, for purposes of
computing the amount of the addition to
taxable income of the U.S. corporate
partner allowed under the addback rule,
the addback rule is modified to provide
that the U.S. corporate partner takes into
account not only its own specified
deemed inclusions with respect to stock
of a CFC group member, but for this
purpose also its distributive share, if
any, of amounts included in gross
income under section 951(a) or 951A(a)
of the U.S. shareholder partnership with
respect to stock of a CFC group member.
In addition, the addback rule is
modified to provide that for purposes of
determining a U.S. corporate partner’s
pro rata share of eligible CFC excess
taxable income of a specified highesttier member, the U.S. shareholder
partnership is treated as if it were a
foreign partnership.
E. Effect on Earnings and Profits
Under proposed § 1.163(j)–7(e), and
consistent with the rules in proposed
§ 1.163(j)–4(c), the disallowance and
carryforward of a deduction for a foreign
corporation’s business interest expense
does not affect whether and when such
business interest expense reduces the
corporation’s earnings and profits. For
example, in the case of a passive foreign

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investment company (PFIC), the
disallowance and carryforward of a
deduction will not impact the amount of
inclusions of earnings under section
1293 if the PFIC is treated as a qualified
electing fund. Similarly, the
disallowance and carryforward of a
deduction for an applicable CFC’s
business interest expense will not affect
the limitation of subpart F income to
earnings and profits under section
952(c).
8. Proposed § 1.163(j)–8: Application of
Section 163(j) to Foreign Persons With
Effectively Connected Income
In general, unlike U.S. citizens or
residents that are subject to U.S. tax on
their worldwide income, a nonresident
alien individual or foreign corporation
is subject to net basis income taxation
only with respect to its income that is
or is treated as effectively connected
with a trade or business (ECI) conducted
in the United States as provided under
section 872 or 882. Deductions are
allowed only to the extent that they are
connected with such income. In certain
circumstances, the tax liability may be
reduced or eliminated by the provisions
of an income tax treaty entered into by
the United States with a foreign country.
While a nonresident alien individual or
foreign corporation that is not an
applicable CFC (hereafter a non-CFC FC)
that has ECI is still subject to section
163(j) and the section 163(j) regulations,
the rules need to be modified since
these foreign persons are only taxed on
their ECI. Accordingly, the definitions
for ATI, business interest expense,
business interest income, and floor plan
financing interest expense in § 1.163(j)–
1 are modified to limit such amounts to
income which is effectively connected
income and expenses properly allocable
to effectively connected income. See
proposed § 1.163(j)–8(b).
As discussed in part 6 of this
Explanation of Provisions section,
section 163(j)(4) provides that in the
case of a partnership, section 163(j) is
applied at the partnership level. The
partner’s ATI is increased by the
partnership’s excess taxable income,
and the partnership’s excess business
interest expense is allocated to the
partner as disallowed business interest
expense carryforward that can be
deducted when the partners are
allocated excess taxable income from
the partnership, but only to the extent
of such excess. Pursuant to section
163(j)(8)(B), which permits adjustments
to the computation of ATI, a
nonresident alien individual or nonCFC FC that is a partner in a partnership
that is engaged in a U.S. trade or
business modifies the application of the

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general allocation rules in § 1.163(j)–6
with respect to excess taxable income,
excess business interest expense, and
excess business interest income of the
partnership to take into account the
limitation of such foreign person’s
liability for U.S. tax to its ECI. The
excess amounts of the partnership,
therefore, can be used by the
nonresident alien individual or nonCFC FC only to the extent of the
partnership’s income that would be
effectively connected income with
respect to the foreign partner. The
amount of excess taxable income and
excess business interest expense that
can be used by such partner is
determined by multiplying the amount
of the excess taxable income or the
excess business interest allocated under
§ 1.163(j)–6 by a ratio equal to the ATI
of the partnership, with the adjustments
described previously to limit such
amount to only effectively connected
income or expense items, over the ATI
of the partnership determined under
§ 1.163(j)–6(d). The amount of excess
business interest income that can be
used by such partner is limited to ECI
business interest income over allocable
ECI business interest expense. See
proposed § 1.163(j)–8(c).
Proposed § 1.163(j)–8(e) would also
include rules coordinating section 163(j)
and § 1.882–5. Section 1.882–5 provides
rules for determining the amount of a
foreign corporation’s interest expense
that is allocable under section 882(c) to
ECI. These proposed regulations require
that a foreign corporation that has ECI
must first determine its business interest
expense allocable to ECI under § 1.882–
5 before applying section 163(j). The
foreign corporation then applies section
163(j) to its business interest expense to
determine if any of that business
interest expense is disallowed business
interest expense. If the foreign
corporation is also a partner in a
partnership that has ECI, the foreign
corporation must back out that portion
of the business interest expense
determined under § 1.882–5 which is
deemed to have come from the
partnership as such business interest
expense has already been subject to
section 163(j) at the partnership level
and the foreign corporation is then left
with only the non-partnership business
interest expense. If the partnership also
had disallowed business interest
expense, a portion of the partnershiplevel interest expense that was backed
out of the amount determined under
§ 1.882–5 will also be disallowed
business interest expense. Disallowed
business interest expense determined at
either the partner-level or partnership

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level, as appropriate, will not be taken
into account for the purpose of
determining interest expense under
§ 1.882–5 in subsequent tax years, but
rather will be subject to the limitations
of section 163(j).
As provided in proposed § 1.163(j)–
8(d), an applicable CFC (as defined in
proposed § 1.163(j)–8(g)(1)) that has ECI
must first apply the general rules of
section 163(j) and the section 163(j)
regulations, pursuant to § 1.163(j)–
7(b)(2), to determine how section 163(j)
applies to the applicable CFC. If, after
applying section 163(j) and the section
163(j) regulations, the applicable CFC
has disallowed business interest
expense, the applicable CFC then must
apportion a part of its disallowed
business interest expense to interest
expense allocable to effectively
connected income as determined under
§ 1.882–5.
These proposed regulations also
provide that disallowed business
interest expense and disallowed
business interest expense carryforwards
will not affect the determination of
effectively connected earnings and
profits or U.S. net equity for purposes of
the branch profits tax under section 884.
These rules are consistent with the
general principles of these proposed
regulations with respect to earnings and
profits. See proposed §§ 1.163(j)–4(c)
and 1.163(j)–8(f).
9. Proposed § 1.163(j)–9: Elections for
Excepted Trades or Businesses; Safe
Harbor for Certain REITs
A. Election Procedure
Proposed § 1.163(j)–9 would provide
guidance relating to the election to be
treated as an excepted trade or business
for real property or farming trades or
businesses. These proposed regulations
clarify that an election is made for a
particular trade or business, not
necessarily for a particular entity, and
would apply for the taxable year that the
election is made and all subsequent
years.
Proposed § 1.163(j)–9 would provide
the time and manner in which to make
the election. Taxpayers making the
election should attach an election
statement to their timely filed original
Federal income tax return, including
extensions. The statement should
include basic information of the
taxpayer and the electing trade or
business. Where a taxpayer has multiple
trades or businesses that may be eligible
for the election, an election must be
made for each trade or business, and the
election statement must specify or
describe the different electing trades or
businesses. The election statement is

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necessary in order for taxpayers and for
the IRS to identify each electing trade or
business. The Treasury Department and
the IRS request comments on whether
the information required to be included
in the statement is sufficient, or whether
additional information should be
included to reduce any potential audit
controversy.
Because the election applies to the
particular trade or business, the election
generally terminates automatically if the
taxpayer ceases to exist, or ceases the
operation of the electing trade or
business. However, these proposed
regulations would also provide that
where a taxpayer transfers all of the
assets of an electing trade or business to
a related party, the election does not
terminate for that trade or business, and
transfers to the related party. The
purpose of this rule is to disregard a
transaction that purports to be a
termination or cessation of a trade or
business, but is merely a change in the
form of conducting the trade or business
where the taxpayer (through a related
party) retains a relationship to such
trade or business. For this purpose, a
related party means any person who
bears a relationship to the taxpayer
which is described in section 267(b) or
707(b)(1). Additional guidance may be
provided detailing transactions in
which an election might terminate.
Additionally, these proposed
regulations would contain an anti-abuse
rule to prevent a situation where the
taxpayer attempts to terminate the
election through a transfer of the assets
in the trade or business, but with the
intent of resuming a trade or business of
a similar nature. These proposed
regulations would provide that if a
taxpayer re-acquires substantially all of
the assets used in the trade or business,
or substantially similar assets, and
resumes conducting such prior trade or
business within 60 months of ceasing
the trade or business, the election will
be revived with the resumed trade or
business.
The Treasury Department and the IRS
request comments on the method by
which certain taxpayers can make the
election under section 163(j)(7)(B) or
(C), and the types of transactions in
which the election should terminate.
B. Safe Harbor for Certain REITs
Proposed § 1.163(j)–9(g) provides a
special safe harbor for REITs. For REITs
that take advantage of this safe harbor,
the rules applicable to REITs are
substantially similar to the general rules
provided for other taxpayers. However,
these proposed regulations provide
certain modifications to take into

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account the existing rules governing
REIT taxation.
If a REIT holds real property, interests
in partnerships holding real property, or
shares in other REITs holding real
property, the safe harbor provides that
the REIT is eligible to make an election
to be an electing real property trade or
business for all or part of its assets. For
this purpose, the term ‘‘real property’’ is
defined consistently with the definition
of real property under section 856,
rather than the more restrictive
definition set forth under the proposed
section 469 regulations.
The term ‘‘real property trade or
business’’ in section 469(c)(7)(C) does
not include real property financing and,
for purposes of the section 163(j)
regulations, any assets used in a real
property financing trade or business are
generally allocated to a non-excepted
trade or business. Under proposed
§ 1.163(j)–9(g), REIT real property
financing assets include mortgages,
guaranteed mortgage pass-thru
certificates, real estate mortgage
investment conduit (REMIC) regular
interests, and debt instruments issued
by publicly offered REITs.
If a REIT makes an election to be an
electing real property trade or business,
and the value of the REIT’s real property
financing assets is 10 percent or less of
the value of the REIT’s total assets, then,
under the safe harbor, all of the REIT’s
assets are treated as assets of an
excepted trade or business. This
determination is based on the same
values used for the REIT asset test under
section 856(c)(4) as of the close of the
REIT’s taxable year. If a REIT makes an
election to be an electing real property
trade or business, and the value of a
REIT’s real property financing assets is
more than 10 percent of the value of the
REIT’s total assets, then, under the safe
harbor, the REIT’s business interest
income, business interest expense, and
other items of expense and gross income
are allocated between excepted and
non-excepted trades or businesses under
the rules set forth in proposed
§ 1.163(j)–10, as modified by proposed
§ 1.163(j)–9(g)(4).
For purposes of valuing a REIT’s
assets, REIT real property financing
assets also include partnership assets
that a REIT is deemed to hold under
§ 1.856–3(g) and the portion of a REIT’s
interest in another REIT attributable to
that other REIT’s real property financing
assets. The Treasury Department and
the IRS request comments on whether
the list of real property financing assets
in these proposed regulations includes
all direct and indirect investments that
REITs make to finance real property.

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Under the safe harbor, the definition
of real property under § 1.856–10
applies to determine whether the assets
of a REIT are properly allocable to an
excepted trade or business. If a REIT
holds an interest in a partnership, in
applying the partnership look-through
rule described in proposed § 1.163(j)–
10(c)(5)(ii)(A)(2), the REIT also applies
this definition of real property to
determine whether the partnership’s
assets are allocable to an excepted trade
or business.
Under section 856(c)(5)(B), shares in
other REITs qualify as real estate assets
without regard to the portion of the
REIT owned. Under the safe harbor, if
a REIT (shareholder REIT) owns shares
in another REIT and all of the other
REIT’s assets are treated as assets of an
excepted trade or business, then all of
shareholder REIT’s adjusted basis in the
shares of the other REIT is properly
allocable to an excepted trade or
business of shareholder REIT. If this is
not the case, the safe harbor provides
that shareholder REIT applies the
partnership look-through rule described
in proposed § 1.163(j)–10(c)(5)(ii)(A)(2)
(as if the other REIT were a partnership)
in determining the extent to which
shareholder REIT’s adjusted basis in the
shares of the other REIT is properly
allocable to an excepted trade or
business of shareholder REIT. If
shareholder REIT does not receive the
information from the other REIT that is
necessary to apply the look-through
rule, then shareholder REIT’s shares of
the other REIT are properly allocable to
a non-excepted trade or business of
shareholder REIT.
C. Anti-Abuse Rule for Certain Real
Property Trades or Businesses
The Treasury Department and the IRS
have determined that it would be
inappropriate to allow an election to be
an excepted real property trade or
business for a trade or business that
leases substantially all of its real
property to the owner of the real
property trade or business, or to a
related party of the owner. To permit
such an election would encourage a
taxpayer to enter into non-economic
structures where the real estate
components of non-real estate
businesses are separated from the rest of
such businesses in order to artificially
reduce the application of section 163(j)
by leasing the real property to the
taxpayer or a related party of the
taxpayer and electing for this
‘‘business’’ to be an excepted real
property trade or business. As a result,
these proposed regulations would also
contain an anti-abuse rule. If at least 80
percent of the business’s real property,

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determined by fair market value, is
leased to a trade or business under
common control with the real property
trade or business, the trade or business
will not be eligible for the election.
Common control in this case means that
50 percent of the direct and indirect
ownership interests in both businesses
are held by related parties within the
meaning of sections 267(b) and 707(b).
REITs that lease qualified lodging
facilities, as defined in section
856(d)(9)(D), and qualified healthcare
properties, as defined in section
856(e)(6)(D), are generally permitted
pursuant to section 856(d)(8)(B) to lease
these properties to a taxable REIT
subsidiary; thus, this anti-abuse rule
does not apply to these types of REITs.
The Treasury Department and the IRS
request comments on whether other
exceptions to the anti-abuse rule (such
as, for example, an exception for certain
fact patterns where real property that is
leased from a related party is ultimately
sub-leased to a third party) would be
appropriate.
10. Proposed § 1.163(j)–10: Allocation of
Expense and Income to an Excepted
Trade or Business
As provided in section 163(j)(7) and
proposed § 1.163(j)–2, certain trades or
businesses are excepted from the
application of section 163(j), including
electing real property trades or
businesses, electing farming businesses,
regulated utility trades or businesses,
and the trade or business of performing
services as an employee. Section
1.163(j)–10 would provide rules for
determining the amount of a taxpayer’s
interest expense, interest income, and
other tax items that is properly allocable
to excepted and non-excepted trades or
businesses for purposes of section
163(j). It is not necessary for a taxpayer
to undertake any allocations under
proposed § 1.163(j)–10 if all of the
taxpayer’s items are properly allocable
to non-excepted trades or businesses, or
if all of the taxpayer’s items are properly
allocable to excepted trades or
businesses.
Proposed § 1.163(j)–10(a) would
provide an overview of the section and
certain general rules, including rules
regarding the application of the
allocation rules to members of a
consolidated group. Proposed § 1.163(j)–
10(b) would provide rules regarding the
allocation of tax items other than
interest expense and interest income
between excepted and non-excepted
trades or businesses. Proposed
§ 1.163(j)–10(c) would provide the
general method of allocating interest
expense and interest income between
excepted and non-excepted trades or

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businesses using asset basis, as well as
various special rules that would apply
under this general method. Proposed
§ 1.163(j)–10(d) would describe several
limited situations in which tracing
rather than asset-based allocation is
required.
Organizations subject to tax under
section 511 are required to compute
their unrelated business taxable income
separately with respect to each trade or
business, resulting in a more granular
allocation than is required for purposes
of the section 163(j) regulations.
Accordingly, proposed § 1.163(j)–
10(a)(5) would provide that such
organizations would apply the
allocation rules under section 512 and
the regulations thereunder in
determining whether items of income or
expense are allocable to an excepted
trade or business. The Treasury
Department and the IRS request
comments as to whether additional
guidance is needed regarding the
allocation of income and expenses of an
organization subject to tax under section
511 to an excepted trade or business for
purposes of section 163(j).
A. Proposed § 1.163(j)–10(a): Overview
Before applying the allocation rules in
proposed § 1.163(j)–10, a taxpayer first
must determine whether any interest
paid or accrued is properly allocable to
a trade or business. If so, and if the
taxpayer does not qualify for the small
business exemption under section
163(j)(3) and proposed § 1.163(j)–2, the
taxpayer must apply the allocation rules
of proposed § 1.163(j)–10 if the taxpayer
has tax items from both excepted and
non-excepted trades or businesses. The
taxpayer must do so in order to
determine the amount of interest
expense that is business interest
expense subject to limitation under
section 163(j) and to determine which
items are included or excluded in
computing its section 163(j) limitation.
For purposes of the allocation rules in
proposed § 1.163(j)–10, a taxpayer’s
activities are not treated as a trade or
business if those activities do not
involve the provision of services or
products to a person other than the
taxpayer. For example, if a taxpayer
engaged in a manufacturing trade or
business has in-house legal personnel
that provide legal services solely to the
taxpayer, the taxpayer is not treated as
also engaged in the trade or business of
providing legal services.
Additionally, for purposes of the
allocation rules in proposed § 1.163(j)–
10, a consolidated group would be
treated as a single corporation. Thus,
stock of a member that is owned by
another member of the same group

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would not be treated as an asset for
purposes of proposed § 1.163(j)–10, and
the transfer of member stock to a nonmember would be treated by the group
as the transfer of the member’s assets.
Additionally, the group, rather than a
particular member, would be treated as
engaged in excepted or non-excepted
trades or businesses. Intercompany
obligations issued by a member
borrower would not be considered an
asset of the creditor member for
purposes of allocating asset basis
between excepted and non-excepted
trades or businesses. Moreover,
intercompany transactions would be
disregarded for purposes of proposed
§ 1.163(j)–10, along with the resulting
offsetting items.
The Treasury Department and the IRS
have determined that this approach to
consolidated groups is necessary for
purposes of proposed § 1.163(j)–10
because a particular trade or business
may be conducted by multiple group
members that also are engaged in other
trades or businesses. Under these
proposed regulations, the distinction
between excepted and non-excepted
trades or businesses applies at the level
of the trade or business, not at the level
of the group member; thus, the
allocation rules in this section apply
without regard to which member
conducts a trade or business or
possesses assets used in a trade or
business.
The Treasury Department and the IRS
considered an approach to the
allocation rules in proposed § 1.163(j)–
10 that would have taken into account
intercompany transactions between
consolidated group members engaged in
excepted trades or businesses and
members engaged in non-excepted
trades or businesses. However, this
approach would have resulted in
different treatment for consolidated
groups in which each member conducts
a single trade or business and
consolidated groups in which a single
member engages in multiple trades or
businesses. Moreover, if intercompany
transactions were taken into account for
purposes of proposed § 1.163(j)–10, then
taxpayers potentially could increase the
amount of interest allocable to an
excepted trade or business or increase
their section 163(j) limitation by
engaging in intercompany transactions.
Thus, the Treasury Department and the
IRS have determined that intercompany
transactions should be disregarded for
purposes of proposed § 1.163(j)–10.
After a consolidated group has
determined the percentage of the
group’s interest expense that is allocable
to an excepted trade or business and
thus is not subject to limitation under

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section 163(j), this exempt percentage
would be applied proportionally to each
member that has paid or accrued
interest to a person other than a group
member during the taxable year. Thus,
in general, each member with interest
paid or accrued to a lender that is not
a group member will have the same
percentage of interest allocable to
excepted trades or businesses,
regardless of whether any particular
member actually engaged in an excepted
trade or business. For rules regarding
the deduction of interest expense paid
or accrued by group members, see the
discussion of proposed § 1.163(j)–5(b) in
part 5 of this Explanation of Provisions
section.
B. Proposed § 1.163(j)–10(b): Allocating
Tax Items Other Than Interest Income
and Interest Expense
In general, gross income other than
dividends and interest income would be
allocated to the trade or business that
generated such gross income. The
Treasury Department and the IRS
request comments regarding this
method of allocating items of income
other than dividends and interest,
including comments as to how this rule
should be expanded or clarified.
With regard to dividend income, the
Treasury Department and the IRS have
determined that, if a taxpayer’s
ownership interest in a corporation
equals or exceeds a certain threshold,
the taxpayer generally should look
through to the business activities of the
corporation that paid the dividend.
More specifically, if a taxpayer owns at
least 80 percent of the stock of a
domestic C corporation or a CFC (by
vote and value; see section 1504(a)(2))
that is not eligible for the small business
exemption under section 163(j)(3) and
proposed § 1.163(j)–2(d)(1), then the
taxpayer’s dividend income would be
treated as allocable to excepted or nonexcepted trades or businesses based
upon the relative amounts of the payor
corporation’s adjusted basis in the assets
used in such trades or businesses.
Additionally, if at least 90 percent of the
payor corporation’s adjusted basis in its
assets is allocable to either excepted
trades or businesses or non-excepted
trades or businesses, then all of the
taxpayer’s dividend income from such
corporation for the taxable year would
be treated as allocable to either excepted
or non-excepted trades or businesses,
respectively.
If a shareholder in an S corporation
looks through to the S corporation’s
basis in its assets for purposes of the
basis allocation rules in proposed
§ 1.163(j)–10(c), the shareholder also
would be required to look through to the

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S corporation’s basis in its assets for
purposes of characterizing any
dividends received from the S
corporation.
If a taxpayer receives a dividend that
is not investment income, and if the
dividend look-through rule is
inapplicable to the taxpayer, then the
taxpayer would treat the dividend
income as allocable to a non-excepted
trade or business. The Treasury
Department and the IRS request
comments on this proposed rule,
including whether taxpayers that are C
corporations or tax-exempt corporations
should treat dividend income as
allocable to a non-excepted trade or
business if they fail to meet the
minimum ownership threshold for
dividends from domestic C corporations
and CFCs.
With regard to dispositions of stock in
a corporation or interests in a
partnership, if a taxpayer recognizes
gain or loss upon the disposition of
stock in a non-consolidated C
corporation that is not property held for
investment, within the meaning of
section 163(d)(5), and if the taxpayer
looks through to the corporation’s basis
in its assets for purposes of the basis
allocation rules in proposed § 1.163(j)–
10(c), then the taxpayer would allocate
the gain or loss to excepted or nonexcepted trades or businesses based
upon the relative amounts of the
corporation’s adjusted basis in the assets
used in its trades or businesses,
determined pursuant to proposed
§ 1.163(j)–10(c). If the taxpayer does not
look through to the corporation’s basis
in its assets, the taxpayer would treat
the gain or loss as allocable to a nonexcepted trade or business. If a taxpayer
recognizes gain or loss upon the
disposition of interests in a partnership
or stock in an S corporation that owns
(1) non-excepted assets and excepted
assets, (2) investment assets, or (3) both,
the taxpayer would determine the
proportionate share of the amount of
basis properly allocable to a nonexcepted trade or business in
accordance with the allocation rules set
forth in proposed § 1.163(j)–
10(c)(5)(ii)(A) or proposed § 1.163(j)–
10(c)(5)(ii)(B)(3), as appropriate, and
include such proportionate amount of
gain or loss in the taxpayer’s ATI.
With regard to expenses, losses, and
deductions other than interest, any such
items that are definitely related to a
trade or business, within the meaning of
§ 1.861–8(b), would be allocable to that
trade or business. All other expenses
would be ratably apportioned to gross
income. The Treasury Department and
the IRS request comments on this
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other than interest expense, including
whether this proposed rule should
incorporate any of the special allocation
rules in § 1.861–8(e).
C. Proposed § 1.163(j)–10(c): Allocating
Interest Expense and Interest Income
Proposed § 1.163(j)–10(c) would set
forth the general rule for allocating
interest expense and interest income
between excepted and non-excepted
trades or businesses. Under this general
rule, interest expense and interest
income would be allocated between
excepted and non-excepted trades or
businesses based upon the relative
amounts of the taxpayer’s adjusted basis
in the assets used in its excepted and
non-excepted trades or businesses. This
general method of allocation reflects the
fact that money is fungible and the view
that interest expense is attributable to
all activities and property, regardless of
any specific purpose for incurring an
obligation on which interest is paid.
Under proposed § 1.163(j)–10(c), a
taxpayer would determine the adjusted
basis in its assets on a quarterly basis
(each such quarterly period, a
‘‘determination period’’) and average
those amounts to determine the relative
amounts of asset basis for its excepted
and non-excepted trades or businesses
for a taxable year. The Treasury
Department and the IRS request
comments on the frequency of asset
basis determinations required under
proposed § 1.163(j)–10(c).
Proposed § 1.163(j)–10(c)(1) contains
a general de minimis rule. Under this
rule, if at least 90 percent of a taxpayer’s
basis in its assets for the taxable year is
allocable to either excepted or nonexcepted trades or businesses,
determined under proposed § 1.163(j)–
10(c), then all of the taxpayer’s interest
expense and interest income for that
year that is properly allocable to a trade
or business would be treated as
allocable to excepted or non-excepted
trades or businesses, respectively. The
Treasury Department and the IRS
request comments as to whether the
application of this de minimis rule
should be elective.
If an asset is used in more than one
trade or business during a determination
period, the taxpayer’s basis in such asset
would be allocated to each trade or
business using the permissible
methodology (see the following
paragraph) that most reasonably reflects
the use of the asset in each trade or
business during the determination
period. An allocation methodology most
reasonably reflects the use of the asset
in each trade or business if the
methodology most properly reflects the
proportionate benefit derived from the

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use of the asset in each trade or
business.
Proposed § 1.163(j)–10(c) would
provide several permissible
methodologies for allocating basis in an
asset used in more than one trade or
business during a determination period,
including the following: The relative
amounts of gross income that an asset
generates, has generated, or may
reasonably be expected to generate with
respect to the trades or businesses; the
relative amounts of physical space used
by each trade or business if the asset is
land or an inherently permanent
structure; and the relative amounts of
output of each trade or business if each
trade or business generates the same
unit of output. The choice of method
would be subject to de minimis
exceptions, and taxpayers generally
would not be permitted to vary their
allocation methodology across
determination periods within a taxable
year or from one year to the next.
Additionally, if none of the permissible
methodologies reasonably reflects the
use of an asset in each trade or business,
the taxpayer’s basis in the asset would
not be taken into account for purposes
of proposed § 1.163(j)–10(c). The
Treasury Department and the IRS
request comments on these proposed
methods of allocating basis in an asset
used in more than one trade or business.
Proposed § 1.163(j)–10(c)(3)(iii) would
provide that for utility trades or
businesses, the only permissible method
for allocating asset basis between
excepted and non-excepted utility
activities is the relative amounts of
output of the trades or businesses. For
example, if an asset is used to furnish
or sell electric energy, and a portion of
the energy is sold to wholesale
customers where rates are not set on a
cost of service and rate of return basis
while the remaining portion is sold at a
rate established by a ratemaking body
described in proposed § 1.163(j)–
1(b)(13), the taxpayer must allocate the
basis in the asset between the taxpayer’s
excepted and non-excepted trades or
businesses. The Treasury Department
and the IRS believe that other methods
listed in proposed § 1.163(j)–10(c) that
do not take into account the relative
amounts of regulated and unregulated
utility activities do not properly reflect
the proportionate benefit derived from
the use of the asset in each trade or
business. The Treasury Department and
the IRS request comments on this
allocation methodology, including
whether another methodology would
more accurately reflect the extent to
which a trade or business is an excepted
utility business for this purpose.

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These proposed regulations also
would provide a de minimis rule for
utility trades or businesses. Under the
proposed de minimis rule, if more than
90 percent of the output of a trade or
business is sold at rates described in the
exception for regulated utility trades or
businesses, the taxpayer would treat the
entire trade or business as an excepted
trade or business. The Treasury
Department and the IRS request
comments with respect to the de
minimis rule for assets used in a utility
trade or business, including whether
another percentage threshold with
respect to the de minimis rule would be
more appropriate.
The allocation of asset basis between
excepted and non-excepted trades or
businesses under proposed § 1.163(j)–
10(c) would be subject to numerous
additional special rules. First, a
taxpayer’s adjusted basis in tangible
depreciable property other than
inherently permanent structures for
which a deduction is allowable under
section 167 would be determined using
the alternative depreciation system
under section 168(g). Additional first
year depreciation, for example under
section 168(k), would not be taken into
account for purposes of the basis
allocation rule in proposed § 1.163(j)–
10(c) due to the distortive effects that
such depreciation would have upon the
relative adjusted basis of assets. Further,
a taxpayer’s adjusted basis in tangible
depreciable property other than
inherently permanent structures for
which a deduction is allowable under
section 168 of the 1954 Code (former
section 168) would be determined using
the taxpayer’s method of computing
depreciation for the property under
former section 168. Additionally, a
taxpayer’s adjusted basis in any
intangible asset with respect to which a
deduction is allowable under section
167 or section 197 would be determined
in accordance with section 167 or
section 197, as applicable. Self-created
intangibles would not be taken into
account for purposes of the allocation
rules in proposed § 1.163(j)–10(c). The
Treasury Department and the IRS
request comments on these proposed
rules regarding asset basis in
depreciable property, including whether
taxpayers should be permitted to use
other methods of depreciation, such as
the general depreciation system under
section 168(a), for purposes of proposed
§ 1.163(j)–10(c).
Second, the adjusted basis of any
asset that is land, including
nondepreciable improvements to land,
or an inherently permanent structure
used in a trade or business generally
would be its unadjusted basis rather

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than its adjusted basis. This special rule,
which would not apply to land or
inherently permanent structures that fall
within the special rule described in the
following paragraph, is intended to
provide taxpayers with a readily
ascertainable figure that better reflects
the relative underlying value of this
limited class of assets—which, in some
cases, are held for many years—than
adjusted basis. The Treasury
Department and the IRS request
comments regarding this approach to
allocating basis to land and inherently
permanent structures, including
whether this rule should be elective,
and whether taxpayers should be able to
use fair market value rather than
acquisition basis for land or inherently
permanent structures used in a trade or
business.
Third, assets that have been acquired
or that are under development but that
are not yet used in a trade or business
would not be taken into account for
purposes of proposed § 1.163(j)–10(c).
Such assets would include (but would
not be limited to) construction works in
progress, such as buildings, airplanes, or
ships, prior to their completion, and
land that was acquired by a taxpayer for
construction of a building by the
taxpayer to be used in a trade or
business if the building is not yet placed
in service. This rule would not apply to
stock in a corporation or interests in a
partnership. The Treasury Department
and the IRS request comments on this
special rule, including whether and to
what extent exceptions are needed (for
example, with respect to start-up
businesses).
Fourth, trusts required by law to fund
specific liabilities (for example, pension
trusts and plant decommissioning
trusts) would not be taken into account
for purposes of proposed § 1.163(j)–
10(c).
Fifth, taxpayers generally would be
permitted to look through their interests
in partnerships or S corporations, and
taxpayers that satisfy a minimum
ownership threshold in nonconsolidated domestic C corporations
and CFCs would be required to look
through their interests in such
corporations, in determining the extent
to which their basis in a partnership
interest or corporate stock is allocable to
excepted or non-excepted trades or
businesses. For domestic C corporations
and CFCs, the minimum ownership
threshold would be 80 percent by vote
and value (see section 1504(a)(2)).
Partners that own 80 percent or more of
the capital or profits interests in a
partnership, and shareholders that own
80 percent or more of S corporation
stock by vote and value, generally

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would be required, rather than merely
permitted, to look through their
interests in the partnership or S
corporation for this purpose.
These look-through rules would not
apply to a taxpayer with an interest in
a partnership or non-consolidated
subsidiary that is eligible for the small
business exemption under section
163(j)(3) and proposed § 1.163(j)–
2(d)(1). The Treasury Department and
the IRS have determined that the lookthrough rules should not be available in
these cases because of the
administrative burden that would be
imposed on small businesses from
collecting and providing information to
their shareholders or partners regarding
inside asset basis when those small
businesses are themselves exempt from
the application of section 163(j). The
Treasury Department and the IRS also
have determined that small businesses
that are exempt under section 163(j)(3)
and proposed § 1.163(j)–2(d)(1) may not
make an election under proposed
§ 1.163(j)–9.
If a taxpayer does not look through a
C corporation for purposes of the
allocation rules in § 1.163(j)–10(c), and
if the taxpayer is not a C corporation or
tax-exempt corporation, the taxpayer
generally would treat its basis in the
stock as an asset held for investment; if
the taxpayer is a C corporation or taxexempt corporation, the taxpayer would
treat its entire basis in the C corporation
stock as allocable to a non-excepted
trade or business. If a taxpayer does not
look through a partnership or S
corporation, and if the taxpayer is not a
C corporation or tax-exempt
corporation, the taxpayer would
generally treat its basis in a partnership
interest or S corporation stock as either
an investment asset or a non-excepted
trade or business asset. If the taxpayer
does not look through a partnership or
S corporation, and if the taxpayer is a
C corporation or a tax-exempt
corporation, the taxpayer would treat its
entire basis in the partnership interest
or S corporation stock as allocable to a
non-excepted trade or business.
The Treasury Department and the IRS
request comments on these proposed
look-through rules, including whether
any further adjustments should be made
to the taxpayer’s basis in its partnership
interest or corporate stock (for example,
under § 1.861–12(c)(2)) and whether the
minimum ownership threshold for
nonconsolidated domestic C
corporations and CFCs should be
modified.
Sixth, a taxpayer’s basis in its
customer receivables and cash and cash
equivalents would be disregarded for
purposes of proposed § 1.163(j)–10(c).

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This rule is intended to discourage
taxpayers from moving cash to excepted
trades or businesses to increase the
amount of asset basis therein. For these
purposes, the term ‘‘cash and cash
equivalents’’ would include cash,
foreign currency, commercial paper,
interests in certain investment
companies, government obligations,
derivatives that are substantially
secured by an obligation of a
government, and similar assets. The
Treasury Department and the IRS
request comments on this special rule,
including the list of assets to which it
would apply, and whether any
exceptions should apply, such as for
working capital.
Seventh, solely for purposes of
determining the amount of basis
allocable to excepted and non-excepted
trades or businesses under proposed
§ 1.163(j)–10(c), an election under
section 336, 338, or 754, as applicable,
would be deemed to have been made for
any acquisition of corporate stock or
partnership interests with respect to
which the taxpayer demonstrates to the
satisfaction of the Commissioner of the
Internal Revenue Service (the
Commissioner) that the taxpayer was
eligible to make such an election but
was actually or effectively precluded
from doing so by a regulatory agency
with respect to a regulated utility trade
or business. The Treasury Department
and the IRS have determined that such
a rule is necessary to place taxpayers
that are actually or effectively precluded
from making an election under section
336, 338, or 754 on the same footing for
purposes of the basis allocation rules in
proposed § 1.163(j)–10(c) as taxpayers
that are not subject to such limitations.
The Treasury Department and the IRS
request comments on this special rule.
Eighth, taxpayers would be required
to comply with certain reporting
requirements regarding their asset basis
allocation under proposed § 1.163(j)–
10(c). Additionally, taxpayers would be
required to keep books of account and
other records and data as necessary to
substantiate the taxpayer’s use of an
asset in an excepted trade or business
(see § 1.6001–1). If the taxpayer fails to
provide the required information,
proposed § 1.163(j)–10(c) would permit
the Commissioner to treat all of the
taxpayer’s interest expense as properly
allocable to a non-excepted trade or
business, unless the taxpayer shows that
there was reasonable cause for failing to
comply with, and the taxpayer acted in
good faith with respect to, these
reporting requirements. The Treasury
Department and the IRS request
comments on these proposed reporting

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requirements and the consequences of
failing to satisfy these requirements.
Finally, proposed § 1.163(j)–10(c)
would provide that a taxpayer’s
adjusted basis in an asset will not be
taken into account for purposes of this
section if one of the principal purposes
for the acquisition, disposition, or
change in use of that asset is to increase
artificially the amount of basis allocable
to excepted or non-excepted trades or
businesses.
The foregoing basis allocation rules
would not apply to disallowed business
interest expense carryforwards, with the
exception of disallowed disqualified
interest. Disallowed business interest
expense carryforwards other than
disallowed disqualified interest would
have been allocated during the year in
which they were first disallowed under
section 163(j). On becoming
carryforwards, these disallowed
expenses would retain their allocation
from prior taxable years and would not
be reallocated in a subsequent taxable
year. The Treasury Department and the
IRS request comments as to how the
allocation rules in proposed § 1.163(j)–
10 should apply to disallowed
disqualified interest.
These basis allocation rules also
would not apply to floor plan financing
interest expense. As provided in section
163(j)(1)(C) and proposed § 1.163(j)–2,
taxpayers are entitled to deduct their
business interest expense to the full
extent of their floor plan financing
interest expense.
The Treasury Department and the IRS
considered various alternatives to asset
basis in determining how interest
expense should be allocated between
excepted and non-excepted trades or
businesses. One such alternative was a
tracing regime whereby taxpayers would
be required to trace disbursements of
debt proceeds to specific expenditures.
However, tracing would impose a
significant administrative burden upon
taxpayers. Further, it is not clear how
taxpayers would retroactively apply a
tracing regime to existing debt. In
particular, because C corporations
would have had no reason to trace the
proceeds of any existing indebtedness,
imposing a tracing regime on existing
indebtedness would require
corporations to reconstruct the use of
funds within their treasury operations at
the time such indebtedness was issued,
even if the issuance occurred many
years ago, and even if the funds were
used for a myriad of purposes across a
large number of entities. Such an
approach would involve a great deal of
administrative cost and may be
impractical or even impossible for
indebtedness issued years ago.

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Moreover, because money is fungible,
the Treasury Department and the IRS
have determined that a tracing regime
would be distortive and subject to
manipulation, and thus would not be
appropriate. Although taxpayers are
impacted from both a commercial and
tax perspective by the amount of capital
raised through the issuance of equity
and indebtedness, any trade or business
conducted by a taxpayer is generally
indifferent to the source of funds. As a
result, if taxpayers were allowed to use
a tracing regime to allocate indebtedness
to excepted trades or businesses, there
would be an incentive to treat excepted
trades or businesses as funded largely
from indebtedness, and to treat nonexcepted trades or businesses as funded
largely from other types of funding,
such as equity funding, despite the fact
that, as an economic matter, all of a
taxpayer’s trades or businesses are
funded based on the taxpayer’s overall
capital structure.
The assumption that a trade or
business is indifferent to its source of
funds may not be appropriate in cases
in which certain indebtedness is
secured by the assets of the trade or
business and cash flow from those
assets is expected to support the
payments required on the indebtedness.
These proposed regulations would
provide for a limited tracing rule in
those cases. See the discussion of
qualified non-recourse indebtedness in
proposed § 1.163(j)–10(d) in part 10(D)
of this Explanation of Provisions
section.
The Treasury Department and the IRS
also considered allocating interest
expense based upon the relative fair
market value of the assets used in
excepted and non-excepted trades or
businesses. However, determinations of
fair market value frequently are
burdensome for taxpayers, which may
have numerous assets without a readily
established market price, and for the
IRS. For this reason, disputes between
taxpayers and the IRS over the fair
market value of an asset are a common
and costly occurrence. In the TCJA,
Congress repealed the use of fair market
value in the apportionment of interest
expense under section 864 of the Code
(see section 14502(a) of the TCJA). Thus,
the Treasury Department and the IRS
have determined that allocating interest
expense based upon the relative fair
market value of assets is a less viable
approach than a regime based upon
relative amounts of asset basis.
The Treasury Department and the IRS
also considered allocating interest
expense to excepted and non-excepted
trades or businesses based on the
relative amounts of gross income

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generated by such trades or businesses.
However, gross income is more variable
and volatile than asset basis, in part
because it is based on an annual
measurement. Methods could be
developed to look at multiple years of
gross income through an averaging or
other smoothing methodology, but any
such approach would necessarily create
a number of difficult technical questions
because the income of different trades or
businesses may be subject to differing
business cycles and the timing of
income items may be within taxpayers’
control. In the TCJA, Congress also
repealed the use of gross income in the
apportionment of interest expense
under section 864 of the Code (see
section 14502(a) of the TCJA).
Thus, although allocating interest
expense between excepted and nonexcepted trades or businesses using
asset basis is not without its
shortcomings, the Treasury Department
and the IRS have determined that this
approach represents the most viable
option. The Treasury Department and
the IRS also note that various
commenters recommended using this
approach to allocate interest expense
between excepted and non-excepted
trades or businesses.
The Treasury Department and the IRS
have determined that the same approach
should be used to allocate interest
income, for several reasons. Such an
approach is simpler to administer than
applying a separate regime to interest
income. Additionally, using the same
regime for both interest expense and
interest income reduces the likelihood
that the IRS or taxpayers will be
whipsawed. Under this rule, the greater
the amount of basis in assets used in
excepted trades or businesses, the
greater the amount of both interest
expense that is not subject to the section
163(j) limitation and interest income
that is not properly allocable to a trade
or business and that, as a result, is not
factored into the taxpayer’s calculation
of ATI, which reduces the amount of
interest expense that may be deducted.
The Treasury Department and the IRS
request comments on the use of asset
basis to allocate interest expense and
interest income between excepted and
non-excepted trades or businesses,
including whether other measures, such
as gross income, should be used in
addition to, or instead of, asset basis.
The Treasury Department and the IRS
also request comments on the special
rules contained in proposed § 1.163(j)–
10(c), including whether additional
special rules are needed (for example,
for financial instruments that are
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section 475, or additional rules
contained in § 1.861–12T).
D. Proposed § 1.163(j)–10(d): Direct
Allocations
The basis allocation rules in proposed
§ 1.163(j)–10(c) would not apply to
interest expense and interest income in
several circumstances. First, a taxpayer
with qualified nonrecourse
indebtedness would be required to
directly allocate interest expense from
such indebtedness to the taxpayer’s
assets, as provided in § 1.861–10T(b).
Second, a taxpayer that is engaged in
the trade or business of banking,
insurance, financing, or a similar
business would be required to directly
allocate interest expense and interest
income from such business to the
taxpayer’s assets used in that business.
The special rule for cash and cash
equivalents under proposed § 1.163(j)–
10(c) would not apply to such
taxpayers.
A taxpayer to which both proposed
§ 1.163(j)–10(c) and (d) apply would be
required to reduce its asset basis for
purposes of proposed § 1.163(j)–10(c) to
reflect assets to which interest expense
is directly allocated under proposed
§ 1.163(j)–10(d).
The Treasury Department and the IRS
request comments as to whether direct
allocation should be required in any
other circumstances, including but not
limited to circumstances in which a
taxpayer with both excepted and nonexcepted trades or businesses is subject
to significant limitations on transferring
borrowed funds outside the excepted
trade or business. The Treasury
Department and the IRS also request
comments on whether a taxpayer should
be permitted to elect to treat all of its
interest expense and interest income as
properly allocable to non-excepted
trades or businesses for purposes of
section 163(j), in lieu of applying the
allocation rules in proposed § 1.163(j)–
10(c) and (d).
11. Proposed § 1.163(j)–11: Transition
Rules
Proposed § 1.163(j)–11 would provide
certain transition rules. Proposed
§ 1.163(j)–11(a) would provide rules that
apply if a corporation (S) that is subject
to the section 163(j) limitation joins a
consolidated group whose taxable year
began before January 1, 2018, and thus
is not currently subject to the section
163(j) limitation. For example, assume
that S is a calendar-year, stand-alone C
corporation, and that S is acquired by
Acquiring Group (with a November 30
fiscal year) on May 31, 2018. Acquiring
Group is not subject to the section 163(j)
limitation during its taxable year

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

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rules based upon the rules in § 1.163(j)–
5(c)(2) of the Prior Proposed Regulations
for allocating disallowed disqualified
interest carryforwards among members
of an affiliated group that was treated as
a single taxpayer under old section
163(j).
Proposed § 1.163(j)–11(b) also would
clarify the application of section 382 to
disallowed disqualified interest
carryforwards. For example, disallowed
disqualified interest would not be
treated as a pre-change loss subject to a
section 382 limitation under section
382(d)(3) with regard to an ownership
change on a change date occurring
before the date the Treasury decision
adopting these regulations as final
regulations is published in the Federal
Register, unless the disallowed
disqualified interest is carried forward
under section 163(j)(2). But see section
382(h)(6)(B) regarding built-in
deduction items.
Similarly, for purposes of section
382(k)(1), regarding determination of
status as a loss corporation, disallowed
disqualified interest would not be
treated as a carryforward of disallowed
interest described in section 381(c)(20)
with regard to an ownership change on
a change date occurring before the date
the Treasury decision adopting these
regulations as final regulations is
published in the Federal Register,
unless the disallowed disqualified
interest is carried forward under section
163(j)(2). But see section 382(h)(6)
regarding built-in deductions. For a
description of changes to regulations
under section 382, see the discussion of
proposed §§ 1.382–2 and 1.382–6 in
parts 14 and 15 of this Explanation of
Provisions section.
Finally, whereas old section
163(j)(2)(B)(ii) permitted taxpayers with
excess limitation, within the meaning of
old section 163(j)(2)(B)(iii), to carry such
limitation forward, section 163(j)
contains no such language. Thus, the
Treasury Department and the IRS have
determined that no amount of excess
limitation under old section 163(j)(2)(B)
may be carried forward to taxable years
beginning after December 31, 2017.
12. Proposed § 1.263A–9
Because of the amendments to section
163(j), a conforming amendment to
§ 1.263A–9(g) is required. Proposed
§ 1.263A–9 would update references to
section 163(j) to reflect current law.
13. Proposed § 1.381(c)(20)–1
As noted in part 5 of this Explanation
of Provisions section, Congress added
disallowed business interest expense
carryforwards to the list of items to
which the acquiring corporation

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succeeds in a transaction to which
section 381(a) applies. See section
381(c)(20). Sections 1.381(c)(1)–1 and
1.381(c)(1)–2 provide rules that, in part,
limit the acquiring corporation’s ability
to use NOL carryforwards in the
acquiring corporation’s first taxable year
ending after the acquisition date. The
Treasury Department and the IRS have
determined that similar rules should
apply to disallowed business interest
expense carryforwards.
Proposed § 1.381(c)(20)–1 also would
provide that, for purposes of section
381(c)(20), the term ‘‘carryover of
disallowed business interest described
in section 163(j)(2)’’ includes
disallowed disqualified interest.
14. Proposed § 1.382–2
In the TCJA, Congress added section
382(d)(3) and a new sentence to section
382(k)(1) for taxable years beginning
after December 31, 2017. Section 1.382–
2 contains certain definitions for
purposes of sections 382 and 383 and
the regulations thereunder, including
definitions of the terms ‘‘pre-change
loss’’ and ‘‘loss corporation.’’
Section 382(d)(3) provides that, for
purposes of section 382, the term ‘‘prechange loss’’ includes carryovers of
disallowed interest described in section
163(j)(2) ‘‘under rules similar to the
rules’’ in section 382(d)(1). Section
163(j)(2) provides that interest expense
paid or accrued in a taxable year that is
not allowed as a deduction pursuant to
section 163(j)(1) is carried forward to
the succeeding taxable year. Section
382(d)(1) treats as a ‘‘pre-change loss’’
both (i) net operating loss carryforwards
to the taxable year in which the change
date occurs (change year), and (ii) the
net operating loss carryforward for the
change year, to the extent such loss is
allocable to the pre-change period.
Proposed § 1.382–2 would clarify the
equivalent treatment of items under
section 382(d)(1) and (3) by providing
that a ‘‘pre-change loss’’ includes the
portion of any disallowed business
interest expense of the old loss
corporation paid or accrued in the
taxable year of the testing date that is
attributable to the pre-change period.
For purposes of determining the
portion of disallowed business interest
expense that is attributable to the prechange period, proposed § 1.382–2
would require that disallowed business
interest expense be ratably allocated to
each day in the year, regardless of
whether the loss corporation makes a
closing-of-the-books election under
§ 1.382–6(b)(2) with regard to allocating
its other taxable items to the pre-change
period and the post-change period
within the change year. This ratable

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allocation of disallowed business
interest expense is consistent with the
allocation of the loss corporation’s
deduction for business interest expense
in the taxable year of the ownership
change (see proposed § 1.382–6).
Ratable allocation also is consistent
with the general application of the
section 163(j) regulations, which apply
without regard to any particular debt
instrument or particular date of
payment or accrual of interest. See the
discussion in part 2(A) of this
Explanation of Provisions section.
The TCJA also modified section
382(k)(1) to provide that the term ‘‘loss
corporation’’ includes a corporation
entitled to use a disallowed business
interest expense carryforward. These
proposed regulations would revise
§ 1.382–2 to reflect the changes to the
definitions of the terms ‘‘pre-change
loss’’ and ‘‘loss corporation.’’ These
provisions would be applicable with
regard to ownership changes occurring
on or after the date on which the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register.
15. Proposed § 1.382–6
When a loss corporation experiences
an ownership change, § 1.382–6(a)
provides that, in general, the loss
corporation must allocate its NOL or
taxable income and its net capital loss
or modified capital gain net income for
the change year between the pre-change
period and the post-change period by
ratably allocating an equal portion to
each day in the year. However, instead
of using ratable allocation, a loss
corporation may elect to use the closingof-the-books method in § 1.382–6(b). A
closing-of-the-books election applies
only for purposes of certain allocations,
such as NOL or taxable income
allocations, and does not terminate the
loss corporation’s taxable year as of the
change date.
Proposed § 1.382–6 would clarify that,
for purposes of section 163(j), a loss
corporation’s current-year business
interest expense may not be allocated
under the closing-of-the-books method.
Thus, even if a taxpayer generally has a
closing-of-the-books election in effect
for the change year, the taxpayer would
be required to ratably allocate its
current-year business interest expense
for which a deduction is allowable
under section 163(j) in that year
between the pre-change period and the
post-change period. For example, if X, a
calendar-year loss corporation,
experiences an ownership change on
May 26, 2019, and if X has $100x of
current-year business interest expense
for which a deduction is allowable

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under section 163(j) for that year, $40x
of X’s business interest expense
deduction would be allocated to the prechange period, and $60x of X’s business
interest expense deduction would be
allocated to the post-change period,
regardless of which of the two general
allocation methods—ratable allocation
or closing-of-the-books—X uses. Under
this approach, taxpayers would not
need to compute ATI separately for the
pre-change and post-change periods.
The Treasury Department and the IRS
are considering publishing a separate
notice of proposed rulemaking to
address, among other issues, the
treatment of a corporate partner’s excess
business interest expense (including
negative section 163(j) expense) under
section 382.
16. Proposed § 1.383–1
Section 1.383–1(d) provides ordering
rules for the utilization of pre-change
losses and pre-change credits and for
the absorption of the section 382
limitation and the section 383 credit
limitation. Generally, pre-change capital
losses are absorbed first for these
purposes, followed by NOLs and
recognized built-in losses, other prechange losses and, finally, pre-change
credits.
The Treasury Department and the IRS
have determined that disallowed
business interest expense carryforwards
should be absorbed after pre-change
capital losses and all recognized builtin losses, but before NOLs. Disallowed
business interest expense carryforwards
should be absorbed before NOLs
because taxpayers must calculate their
current-year income or loss in order to
determine whether and to what extent
they can use an NOL in that year, and
deductions for business interest
expense, including carryforwards from
prior taxable years, factor into the
calculation of current-year income or
loss.
Proposed § 1.383–1 would reflect the
addition of disallowed business interest
expense to the ordering rules, would
make conforming changes to other
provisions, and would update other
provisions to reflect additional changes
effectuated by the TCJA. The ordering
rules in proposed § 1.383–1 include
alternative rules that reflect the fact that
certain regulations pertaining to the
interaction between sections 163(j) and
382 may not be applicable to all
ownership changes.
17. Proposed § 1.469–9(b)
These proposed regulations would
also propose amendments to § 1.469–
9(b) to provide rules relating to the
definition of real property trade or

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business under section 469(c)(7)(C).
Specifically, these proposed regulations
would provide guidance on the meaning
of real property and on the types of
trades or businesses that qualify as ‘‘real
property trades or businesses’’ for
purposes of section 469(c)(7).
Section 469(a) of the Code disallows
passive activity losses or credits. In
general, a passive activity loss is the
excess of the aggregate losses over the
aggregate income from all passive
activities in a taxable year. A passive
activity is defined as any trade or
business activity in which the taxpayer
does not materially participate, and any
rental activity subject to the exception
for rental real estate under section
469(c)(7). Generally, under section
469(c)(2), a rental activity is treated as
a per se passive activity regardless of
whether the taxpayer materially
participates in the activity.
The Omnibus Budget Reconciliation
Act of 1993, Public Law 103–66, sec.
13143(a), added section 469(c)(7) to the
Code effective for tax years beginning
after December 31, 1993. In doing so,
Congress expressed the belief that
applying the ‘‘per se’’ passive rule to all
rental real estate activities
disadvantaged taxpayers who were
otherwise actively engaged in real estate
businesses and who also owned rental
real estate. According to H. Rept. 103–
111, 103rd Cong., 1st sess. (May 25,
1993), ‘‘[t]he committee considers it
unfair that a person who performs
personal services in a real estate trade
or business in which he materially
participates may not offset losses from
rental real estate activities against
income from nonrental real estate
activities or against other types of
income such as portfolio investment
income.’’ Section 469(c)(7) was added to
alleviate this unfair treatment.
Section 469(c)(7) provides that the
rental real estate activities of qualifying
taxpayers who are actively engaged in
real property trades or businesses are
not subject to the ‘‘per se’’ passive rule
in section 469(c)(2). Instead, under
section 469(c)(7), a rental real estate
activity of a qualifying taxpayer will not
be a passive activity if the taxpayer
materially participates in the rental real
estate activity.
In section 469(c)(7)(C), Congress
defined ‘‘real property trade or
business’’ as ‘‘any real property
development, redevelopment,
construction, reconstruction,
acquisition, conversion, rental,
operation, management, leasing, or
brokerage trade or business.’’ However,
neither section 469 nor the legislative
history defines any of the terms
contained in section 469(c)(7)(C).

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These proposed regulations would
amend the regulations under section
469 to provide a definition of the term
‘‘real property’’ along with certain other
terms contained in section 469(c)(7)(C).
Consistent with ordinary usage, these
proposed regulations would define ‘‘real
property’’ to include land, buildings,
and other inherently permanent
structures that are permanently affixed
to land, and exclude from the definition
certain other items, such as machines
and equipment that serve an active
function, which may be permanently
affixed to real property.
Given Congress’s focus in enacting
section 469(c)(7) to provide relief to
entrepreneurs in real property trades or
businesses with some nexus to or
involvement with rental real estate,
these proposed regulations would not
include trades or businesses that
generally do not play a significant or
substantial role in the creation,
acquisition, or management of rental
real estate in the definition of real
property trade or business under section
469(c)(7)(C). Therefore, taxpayers
engaged in trades or businesses that are
not directly or substantially involved in
the creation, acquisition, or
management of rental real estate, or that
provide personal services which are
merely ancillary to a real property trade
or business, will generally not be treated
as engaged in real property trades or
businesses for this purpose. In addition,
machinery, equipment, and other assets
or items that are not generally viewed as
items of real property until after their
installation or permanent affixation to
real property (for example, HVAC
systems, elevators, escalators, solar
panels, glass fixtures, doors, windows,
tiling, etc.) will not be treated as real
property for these purposes and,
accordingly, taxpayers engaged in trades
or businesses of manufacturing,
installing, operating, maintaining, or
repairing such items generally will not
be treated as engaged in real property
trades or businesses within the meaning
of section 469(c)(7)(C).
As the Treasury Department and the
IRS have previously recognized (see
Notice of Proposed Rulemaking,
‘‘Definition of Real Estate Investment
Trust Real Property,’’ published in the
Federal Register (79 FR 27508, 27510)
on May 14, 2014), the term ‘‘real
property’’ appears in numerous Code
provisions, which could ordinarily
imply that, absent specific statutory
modifications, the term ‘‘real property’’
should have the same meaning
throughout the Code. However, the
context and legislative purpose
underlying a specific Code provision
may necessitate a broader or narrower

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

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

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19. Proposed § 1.1502–36
Section 1.1502–36 contains the
unified loss rule, which limits the
ability of a consolidated group to
recognize non-economic or duplicated
losses on subsidiary stock. The rule
applies when a consolidated group
member transfers subsidiary (S) stock
that has a loss. If § 1.1502–36(d) applies
to the transfer of a loss share, the
attributes of S and its lower-tier
subsidiaries are reduced as needed to
prevent the duplication of any loss
recognized on the transferred stock.
Such attributes include capital loss
carryovers, NOL carryovers, deferred
deductions, and basis of assets other
than cash and general deposit accounts.
See § 1.1502–36(d)(4).
The Treasury Department and the IRS
have determined that, for purposes of
§ 1.1502–36(d), disallowed business
interest expenses should be treated as
deferred deductions. Section 1.1502–36
would be modified accordingly.
20. Proposed §§ 1.1502–91 Through
1.1502–99
As discussed in parts 11 and 14
through 16 of this Explanation of
Provisions section, the section 163(j)
regulations and §§ 1.382–2, 1.382–6,
and 1.383–1 of these proposed
regulations would address the
application of section 382 to business
interest expense, including disallowed
business interest expense carryforwards.
Sections 1.1502–90 through 1.1502–99
contain rules applying section 382 to a
consolidated group. These proposed
regulations would add a new
coordination rule in § 1.1502–98(b)
pursuant to which the rules in
§§ 1.1502–91 through 1.1502–96 would
apply to business interest expense,
including disallowed business interest
expense carryforwards, of members of a
consolidated group (or corporations that
join or leave a consolidated group), with
appropriate adjustments.
The Treasury Department and the IRS
request comments on the new
coordination rule in § 1.1502–98(b),
including whether additional examples
should be added to clarify the
application of this rule.
21. Areas Where the Proposed
Regulations Have Reserved on Issues
The proposed regulations reserve on a
number of issues, either where the
reserved issue is expected to be
addressed in other guidance, where
comments would be helpful in
determining the best manner of
addressing an issue, or where the
Treasury Department and the IRS are
unsure whether additional guidance
would be helpful.

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A. Reservations Made Because Other
Guidance May Address the Reserved
Issue
The proposed regulations reserve on
the interaction of sections 163(j) and
59A because separate guidance under
section 59A is expected to address these
issues.
The proposed regulations under
sections 382 and 383 also reserve on a
number of paragraphs related to the
treatment of a corporate partner’s excess
business interest expense (including
negative section 163(j) expense) under
section 382. The Treasury Department
and the IRS are considering publishing
a separate notice of proposed
rulemaking to address these and other
issues related to section 382.
B. Reservations Made Where Comments
Would Be Helpful in Determining the
Best Manner of Addressing an Issue
The proposed regulations reserve on
the treatment of collateralized cleared
swaps and the types of fees that should
be treated as interest for purposes of the
interest definition because comments
would be helpful in determining the
best manner of addressing these issues.
The proposed regulations also reserve
on the coordination with certain other
statutory provisions based on or limited
by the income of taxpayers because
determining the best approach for
ordering such provisions would benefit
from comments.
For similar reasons, the proposed
regulations also reserve on the proper
treatment of business interest income
and business interest expense with
respect to lending transactions between
a passthrough entity and an owner of
the entity (self-charged lending
transactions), the treatment of excess
business interest expense in tiered
partnerships has been reserved in these
proposed regulations, and the
application of section 163(j) to a
partnership merger or division.
C. Reservations Made Where the
Treasury Department and the IRS Are
Unsure Whether Additional Guidance
Would Be Helpful
The proposed regulations reserve on
nine of the eleven terms listed in section
469(c)(7)(C). Comments are requested as
to whether further definitions are
needed. However, in the absence of
comments requesting additional
guidance with respect to these terms, it
is unclear whether such additional
guidance would be helpful.
Finally, the proposed regulations also
reserve on additional guidance in the
case of certain exempt organizations
with respect to the application of the

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

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Statement of Availability of IRS
Documents
The IRS Notices and Revenue
Procedures cited in this document are
published in the Internal Revenue
Bulletin (or Cumulative Bulletin) and
are available from the Superintendent of
Documents, U.S. Government Printing
Office, Washington, DC 20402, or by
visiting the IRS website at http://
www.irs.gov.
Proposed Applicability/Effective Dates
Except as otherwise provided in this
section, the regulations are proposed to
be effective for taxable years ending
after the date the Treasury decision
adopting these regulations as final is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of these regulations to a taxable
year beginning after December 31, 2017,
so long as the taxpayers and their
related parties consistently apply the
rules of §§ 1.163(j)–1, 1.163(j)–2,
1.163(j)–3, 1.163(j)–4, 1.163(j)–5,
1.163(j)–6, 1.163(j)–7, 1.163(j)–8,
1.163(j)–9, 1.163(j)–10, and 1.163(j)–11,
and if applicable, §§ 1.263A–9,
1.381(c)(20)–1, 1.382–6, 1.383–1, 1.469–
9, 1.882–5, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–6 and
1.383–1), and 1.1504–4 to those taxable
years.
With respect to proposed §§ 1.382–2,
1.382–5, and 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–2 and 1.382–5), if
applicable, the regulations are proposed
to be effective for ownership changes
occurring on or after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of §§ 1.382–2 and 1.382–5, and
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2 and 1.382–5), if applicable,
to an ownership change that occurs in
a taxable year beginning after December
31, 2017, so long as the taxpayers and
their related parties consistently apply
the rules of §§ 1.163(j)–1, 1.163(j)–2,
1.163(j)–3, 1.163(j)–4, 1.163(j)–5,
1.163(j)–6, 1.163(j)–7, 1.163(j)–8,
1.163(j)–9, 1.163(j)–10, and 1.163(j)–11,
and if applicable, §§ 1.263A–9,

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1.381(c)(20)–1, 1.382–6, 1.383–1, 1.469–
9, 1.882–5, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, and 1.1504–4 to
taxable years beginning after Decembers
31, 2017.
Special Analyses
I. Regulatory Planning and Review—
Economic Analysis
Executive Orders 13771, 13563 and
12866 direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits, of
reducing costs, of harmonizing rules,
and of promoting flexibility.
These proposed regulations have been
designated by the Office of Information
and Regulatory Affairs (OIRA) as
Economically Significant under section
1(c) of the Memorandum of Agreement
(April 11, 2018) between the Treasury
Department and the Office of
Management and Budget (OMB)
regarding review of tax regulations and
thereby subject to review under
Executive Order 12866. Accordingly,
these proposed regulations have been
reviewed by OIRA. In addition, the
Treasury Department and the IRS expect
the proposed regulations, when final, to
be an Executive Order 13771 regulatory
action and request comment on this
designation. For more detail on the
economic analysis, please refer to the
following analysis.
A. Background and Overview
The TCJA substantially modified the
statutory rules of section 163(j) to limit
the amount of net business interest
expense that can be deducted in the
current taxable year of any taxpayer
with only limited exceptions. As
previously described in this preamble,
section 163(j) prior to TCJA generally
applied to domestic corporations with
interest paid or accrued to related
persons that were not subject to Federal
income tax. As described in the
Explanation of Provisions section, the
amount allowed under section 163(j)(1)
as a deduction for business interest
expense is limited to the sum of (1) the
taxpayer’s business interest income for
the taxable year; (2) 30 percent of the
taxpayer’s ATI for the taxable year; and
(3) the taxpayer’s floor plan financing
interest expense for the taxable year.
The section 163(j) limitation applies to
all taxpayers, except for certain small

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businesses with average annual gross
receipts of $25 million or less and
certain trades or businesses. Any
amount of business interest not allowed
as a deduction for any taxable year as
a result of the limitation under section
163(j)(1) is carried forward and treated
as business interest paid or accrued in
the next taxable year under section
163(j)(2).
Congress modified section 163(j)
under TCJA, in part, out of concern that
prior law treated debt-financed
investment more favorably than equityfinanced investment. This debt bias
generally encouraged taxpayers to
utilize more leverage than would occur
in the absence of the Code. Limiting the
deduction of business interest is meant
to reduce the relative favorability of
debt and hence encourage a more
efficient capital structure for firms.
Congress also believed it necessary to
apply the limit broadly across different
types of taxpayers so as not to distort
the choice of entity (see H. Rept. 115–
409, at 247 (2017)).
B. Need for the Proposed Regulations
Because the section 163(j) limitation
has been substantially modified, a large
number of the relevant terms and
necessary calculations that taxpayers are
currently required to apply under the
statute can benefit from greater
specificity. Among other benefits, the
clarity provided by the proposed
regulations generally helps ensure that
all taxpayers calculate the business
interest expense limitation in a similar
manner.
For example, there is no universal
definition for the term ‘‘interest’’ under
the Code. In general, because section
163(j) applies to limit certain
deductions for interest under chapter A
of the Code, the proposed regulations’
definition of the term ‘‘interest’’ is
relatively broad to create a balanced
application of section 163(j). This
definition limits tax-avoidance
incentives for taxpayers to, in form,
label payments as something other than
interest that, in substance, are
economically interest. At the same time,
this definition allows taxpayers to treat
certain amounts of income as business
interest income for purposes of
calculating the section 163(j) limitation
that they may be required to, for nontax reasons, label as something other
than interest, so that taxpayers with
such income are not unduly impacted
by the section 163(j) limitation.
Pursuant to section 163(j)(8)(B), the
proposed regulations prescribe
adjustments to the calculation of ATI to
prevent double counting of deductions
and to provide relief for particular types

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
of taxpayers or taxpayers in particular
circumstances to ensure that such
taxpayers are treated similarly to other
taxpayers when calculating ATI.
The statute applies broadly to
different types of entities, including
passthrough entities such as
partnerships and S corporations. The
statute specifies that the section 163(j)
limitation applies at the entity level for
a partnership but that items such as
excess business interest expense and
excess taxable income must be allocated
to partners for a variety of reasons
including to compute their own 163(j)
limitation. The statute further specifies
that the items should be allocated in the
same manner as ‘‘nonseparately stated
taxable income or loss of the
partnership’’; however, this concept has
not previously been defined by statute
or regulations. Without the specified
method of allocating these excess items
provided by the proposed regulations,
partnerships would likely have both
significant flexibility but also
uncertainty in determining which
partners receive excess items. This
flexibility could potentially lead
partnerships to specially allocate items
of income or expense such that they are
separately stated to change the partner’s
allocation of excess interest expense or
excess taxable income.
There are a number of potential
uncertainties in how taxpayers should
apply the section 163(j) limitation to
CFCs in a manner consistent with other
provisions of the Code. For example,
interest deductions of individual CFCs
may be limited by section 163(j) but
might not be if the interest deductions
of CFCs were computed on a group
basis. The proposed regulations provide
an election for treating related CFCs
similarly to a consolidated group for the
purpose of calculating the amount of
business interest expense for purposes
of the section 163(j) limitation. This
election also provides clarity that in
performing a CFC group calculation,
finance and non-finance businesses are
largely treated as separate groups
(because of the dual role of interest
payments as a cost of goods or services
sold as well as a payment for debt
finance and because of possible
distortions in the case of conglomerate
companies with financial and nonfinancial businesses in their CFCs, due
to financial businesses’ outsize amounts
of interest expense and income). The
proposed regulations also provide
clarity by permitting the bottom-up
transfer within chains of CFCs of excess
taxable income for electing groups of
CFCs.
Other areas where clarity is provided
under the proposed regulations for CFCs

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include adjustments for partnerships
held by CFCs, the treatment of CFCs
with effectively connected income (ECI),
the treatment of intergroup dividends
(to avoid double counting of ATI), the
effect of deemed inclusions (from
branch income, Subpart F income, and
GILTI) (also to avoid double counting of
ATI), and the effect foreign derived
intangible income (FDII) on ATI.
For purposes of section 163(j), the
statute states in section 163(j)(7) that the
term ‘‘trade or business’’ does not
include certain regulated utilities, or an
electing real property trade or business
or an electing farming business. While
the statute does reference other places
in the Code where a farming business
and a real property trade or business are
described or defined, regulations have
not previously been issued under
section 469(c)(7)(C), the rule that section
163(j) refers to in order to define a real
property trade or business. The
proposed regulations provide such a
definition, which clarifies whether a
trade or business could elect as a real
property trade or business to be
excepted from section 163(j). In
addition, the proposed regulations
describe procedures for allocating
income and business interest income
and expense between excepted and nonexcepted trades or businesses of the
taxpayer. The proposed regulations
provide a uniform method for allocating
income and business interest income
and expense which should lower
administrative and compliance costs
relative to no guidance being provided.
C. Economic Analysis
1. Baseline
The analysis in this section compares
the proposed regulations to a no-action
baseline reflecting anticipated Federal
income tax-related and other economic
behavior in the absence of these
proposed regulations.
2. Anticipated Benefits
a. In General
The Treasury Department and the IRS
expect that the definitions and guidance
provided in the proposed regulations
will enhance U.S. economic
performance relative to the baseline. An
economically efficient tax system
generally aims to treat income and
expense derived from similar economic
decisions similarly in order to reduce
incentives to make choices based on tax
rather than market incentives. In this
context, an important benefit of this part
of the proposed regulations is to reduce
taxpayer uncertainty regarding the
calculation of the section 163(j)
limitation relative to an alternative

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scenario in which no such regulations
were issued and thus to help ensure that
all taxpayers interpret the statutory
rules of section 163(j) in a similar
manner, a tenet of economic efficiency.
b. Proposed §§ 1.163(j)–1 Through
1.163(j)–5
The proposed regulations make
several adjustments to the calculation of
ATI. One of these adjustments prevents
the double counting of depreciation
deductions when a depreciable asset is
sold (only relevant for taxable years
beginning before January 1, 2022). Other
adjustments apply to particular types of
taxpayers, such as RICs, REITs, or
consolidated groups. These adjustments
ensure that the section 163(j) limitation
is applied evenly across different types
of taxpayers in a manner consistent with
the Code. Without such adjustments,
certain taxpayers may be disadvantaged
relative to otherwise similar taxpayers.
For example, if RICs and REITs
included the dividends paid deduction
when calculating ATI, then these
taxpayers would almost always have
ATI of zero or close to zero, which
would limit the ability of such taxpayers
to ever deduct business interest expense
for Federal income tax purposes.
In addition, the proposed regulations
define the term ‘‘interest.’’ There are
several places in the Code and
regulations where interest expense or
interest income is defined, such as in
the regulations that allocate and
apportion interest expense (§ 1.861–9T)
and in the subpart F regulations
(§ 1.954–2). However, these rules only
apply to particular taxpayers in
particular situations. As described in
the Explanation of Provisions section,
there are no generally applicable
statutory provisions or regulations
addressing when financial instruments
are treated as debt for Federal income
tax purposes or when a payment is
interest. The approach taken to defining
interest for the section 163(j) limitation
in these proposed regulations is to (1)
include amounts associated with
conventional debt instruments and
amounts already treated as interest for
all purposes under existing statutory
provisions or regulations; (2) add some
additional amounts that are functionally
similar to interest, such as the rules
regarding amounts on contingent
payment debt instruments in § 1.163(j)–
1(b)(20)(iii)(B), which was drafted in
response to comments, or amounts
treated as interest for certain purposes,
such as amounts described in §§ 1.861–
9T and 1.954–2; and (3) provide an antiavoidance rule based on the economic
principle that any expense or loss
predominantly incurred in

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consideration of the time value of
money is treated as an interest expense
for section 163(j). Thus, the proposed
regulations would apply to interest
associated with conventional debt
instruments, as well as transactions that
are indebtedness in substance even if
not in form.
Other options for defining interest
were considered by the Treasury
Department and the IRS but were
determined to be less beneficial and not
chosen. The first option considered
would be to not provide a definition of
interest in the proposed regulations, and
thus rely on general tax principles and
case law for purposes of defining
interest for purposes of section 163(j).
While adopting this option might
reduce the compliance burden for some
taxpayers, not providing an explicit
definition of interest would create its
own uncertainty (as neither taxpayers
nor the IRS might have a clear sense of
what types of payments are treated as
interest income and interest expense for
purposes of section 163(j)). Such
uncertainty could increase burdens to
the IRS and taxpayers including with
respect to disputes and litigation about
whether particular payments are interest
for section 163(j) purposes.
In addition, such an approach to the
definition of interest could encourage
taxpayers to engage in transactions that
provide financing while generating
deductions economically similar to
interest but make arguments that such
deductions fail to be described by
existing principles defining interest
expense. There are several reasons why
curbing such taxpayer behavior would
be beneficial. First, taxpayer use of such
transactions is likely to be uneven and
dependent in part on the subjective
understanding of taxpayers regarding
whether such transactions would be
allowable under the statute. Second, the
ability of taxpayers to engage in such
transactions would likely be correlated
with size of the trade or business, with
large businesses more likely to benefit
from such avoidance strategies than
small businesses. Third, when the
deciding factor for using such
transactions is the tax benefit of
avoiding a section 163(j) limitation, then
such transactions would impose more
cost or risk on the taxpayer than using
a traditional debt instrument. Engaging
in such transactions is an inefficient use
of resources. Fourth, such avoidance
strategies may also discourage taxpayers
from shifting to a less leveraged capital
structure, and thus would counteract
the intention of the statute to reduce the
prevalence of highly-leveraged firms
and the probability of systemic financial
distress. Fifth, greater use of financing

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outside of conventional debt
instruments may make it more difficult
for financial institutions to determine
the overall level of leverage and credit
risk of firms seeking financing, which
may distort the allocation of capital
across businesses away from firms and
investments with less credit risk.
The second option considered would
have been to adopt a definition of
interest but limit it to amounts
associated with conventional debt
instruments and amounts that were
already treated as interest under the
Code or regulations for all purposes
prior to the passage of the TCJA. For
example, this is similar to the definition
of interest proposed in § 1.163(j)–
1(b)(20)(i). While this would bring
clarity to many transactions regarding
what would be deemed interest for the
section 163(j) limitation, it would
potentially distort future financing
transactions. Some taxpayers would
choose to use financial instruments and
transactions that provide a similar
economic result of using a conventional
debt instrument, but would avoid the
label of business interest expense,
potentially enabling these taxpayers to
avoid the section 163(j) limitation
without a substantive change in capital
structure. The arguments discussed
above regarding the costs of this
situation would continue to apply.
In addition, there are certain
transactions where under a specific
provision of the Code and regulations,
amounts could be deemed ordinary
income when in substance the amounts
are interest income. For example, the
receipt of substitute interest paid on a
securities loan arrangement may, under
existing income tax principles, be
treated as ordinary income rather than
interest income despite the fact that
such income is economically equivalent
to interest income. Prior to the
enactment of the 163(j) interest
limitation, whether the amount was
labeled as ordinary income or interest
was not material to the overall tax
liability of the taxpayer, but now this
distinction matters.
Because of the tax-motivated
financing distortions that would arise
from a less comprehensive definition of
interest, the Treasury Department and
the IRS consider the best approach to
the definition of interest is to expand
the definition beyond § 1.163(j)–
1(b)(20)(i). Under § 1.163(j)–1(b)(20)(ii)
and (iii), the Treasury Department and
the IRS identified existing financial
transactions that have the economic
substance of debt and interest, but
under the existing Code and regulations
may have been deemed ordinary income
or gain or may have been treated as

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interest for limited purposes, and
clarifies that such amounts would be
considered interest income or expense
for the purpose of the new section 163(j)
limitation.
In addition, it is difficult for the
Treasury Department and the IRS to
specifically identify every type of
transaction already in practice or to
anticipate future innovations in
financial transactions, therefore,
proposed § 1.163(j)–1(b)(20)(iv) provides
an anti-avoidance rule that any expense
or loss predominately incurred in
consideration of the time value of
money is treated as an interest expense
for purposes of section 163(j). This
should help limit the ability of
taxpayers to structure transactions in
such a way that would allow deductible
expenses that are economically similar
to interest and frustrate the application
of the statute.
In summary, the definition of interest
in these proposed regulations provides
clarity to taxpayers and the IRS
regarding which specific transactions
and types of transactions generate
interest subject to the section 163(j)
limitation, which should lower
compliance and administrative costs
relative to providing no definition or a
more limited definition of interest. Also,
the proposed definition should
encourage a more efficient allocation of
capital and use of financing across
taxpayers.
c. Proposed § 1.163(j)–6
The proposed regulations § 1.163(j)–6
provide guidance on how to allocate
partnership excess business interest
expense, excess business interest
income, and excess taxable income to
partners. The statute specifies that the
limitation applies at the partnership
level but that these items must be
allocated to partners for their own 163(j)
limitation and because carryforwards of
these items occurs at the partner level.
Without a specified method of
allocating these excess items,
partnerships would likely have
significant freedom to determine which
partners receive excess items. While the
statute specifies that the items should be
allocated in the same manner as
‘‘nonseparately stated taxable income or
loss of the partnership’’, this concept
has not previously been defined by
statute or regulations. Partnerships have
significant control over what items are
separately and nonseparately stated for
each partner and could potentially
reclassify income to be separately stated
to favorably change the partner’s
allocation of excess interest expense or
excess taxable income.

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The allocation method detailed in the
proposed regulations follows a number
of principles. First, it ensures that the
sum of the excess items at the partner
level is equal to the partnership level.
Second, it ensures that the partnership
does not allocate excess business
interest expense to a partner that was
allocated items comprising ATI and
business interest income that supported
the partnership’s deductible business
interest expense (unless the partner was
allocated more interest expense than its
share of deductible business interest
expense). Finally, it ensures that the
partnership allocates any excess taxable
income or excess business interest
income to partners that are allocated
more items comprising ATI or business
interest income than necessary to
support their allocation of business
interest expense. The proposed
regulations provide a method to ensure
that all partnerships allocate these items
consistently and in a way that matches
income and interest expense, thus
promoting economically efficient
investment decisions. Equivalently, they
address tax motivated allocations of
excess items to avoid the section 163(j)
limitation.
The proposed regulations also ensure
that, for owners of partnerships and S
corporations, business interest income
is used only once, at the entity level, in
offsetting business interest expenses.
This eliminates the incentive to create
tiered partnerships purely to doublecount interest income in order to avoid
the Section 163(j) limitation. It also
avoids exacerbating the incentive to
seek out interest income relative to
other forms of income in order to avoid
the Section 163(j) limitation. By
avoiding these incentives, the proposed
regulations would reduce economically
inefficient uses of resources.
d. Proposed §§ 1.163(j)–7 Through
1.163(j)–8
The Treasury Department and the IRS
expect that proposed §§ 1.163(j)–7
through 1.163(j)–8 will implement the
section 163(j) limitation consistent with
preserving the integrity of the
international tax system reflected in the
Code after TCJA. As described in the
Explanation of Provisions section,
business interest deductions of
individual CFCs may be limited by
section 163(j) even when, if calculated
on a group basis, business interest
deductions would not be limited. The
application of section 163(j) to CFCs on
an individual basis can result in
inappropriate results in certain cases. In
particular, to the extent section 163(j)
were to disallow a deduction for
business interest expense to a CFC that

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has borrowed from a related CFC, the
interest paid to the lender CFC would be
included in the income of the lender
CFC, the amounts would not fully offset,
and the United States shareholder’s
inclusion under subpart F and GILTI
may be increased solely due to the use
of intercompany debt between these
CFCs. Taxpayers could restructure or
‘‘self-help’’ to reduce this problem, but
that option involves economically
wasteful restructuring costs to the
taxpayer. Another option is to ignore
within-group interest payments (the
‘‘disregard approach’’), but that could
lead to inappropriate results, for
example, a CFC group member
borrowing from a third party and using
the loan proceeds to lend to related
CFCs (borrowing CFCs) would not be
able to have interest income from the
loans to the borrowing CFCs offset the
interest expense to the third party
lender for purposes of the section 163(j)
limitation while the borrowing CFCs
would not have any interest expense
subject to the section 163(j) limitation,
even though they are benefiting from the
capital provided by the third party loan.
The Treasury Department and the IRS
consider a preferable option within the
authority of the Treasury Department
and the IRS to be to allow an election
to treat related CFCs and their U.S.
shareholders as a group for purposes of
calculating the amount of business
interest expense subject to the section
163(j) limitation (the ‘‘alternative
method’’).
e. Proposed §§ 1.163(j)–9 Through
1.163(j)–11
Proposed § 1.163(j)–9 provides (1)
guidance in applying the rules for
farming and real property trade or
business elections and (2) guidance in
use of a safe harbor for REITs. For
electing real property trade or business
and electing farming business, the statue
specifies that ‘‘any such election shall
be made at such time and in such
manner as the Secretary shall prescribe,
and once made, shall be irrevocable.’’
Therefore proposed § 1.163(j)–9
provides taxpayers with the time and
manner for electing real property trades
or businesses and electing farming
businesses. In addition, proposed
§ 1.163(j)–9 defines the conditions
under which an election terminates.
Without these conditions specified,
taxpayers may engage in behavior which
counteracts the intention of the statute
and would not otherwise be taken
except to game the irrevocable nature of
the election the statute specified. The
conditions specified increase the
likelihood that all similarly situated
taxpayers interpret the ‘irrevocable’

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designation similarly and will not
engage in tax-motivated behavior to
appear to cease operations in an effort
to change an irrevocable designation.
Proposed § 1.163(j)–9(g) provides a
safe harbor for certain REITs to elect to
be electing real property trades or
businesses. In addition, a special rule
applies to REITs for which 10 percent or
less of the value of the REIT’s assets are
real property financing assets. Under
this rule, all of the assets of the REIT are
treated as real property trade or business
assets. The benefit of the safe harbor is
to provide REITs the same tax treatment
and apply the same general rules as
apply to other taxpayers, an
economically efficient approach. The
special rule threshold of 10 percent for
real property financing assets has the
benefit of maintaining consistency with
section 856(c)(4), which uses the same
values for the REIT asset test at the close
of the REIT’s taxable year. Taxpayers
will benefit in reduced time and cost
applying new rules if they are familiar
and consistent with other rules that they
must comply with under the Code.
Proposed § 1.163(j)–9 provides a rule
that stipulates that if at least 80 percent
of a trade or business’s real property (by
fair market value) is leased to a trade or
business under common control with
the real property trade or business, the
trade or business cannot make an
election to be an electing real trade or
business. In the absence of such a rule,
taxpayers could restructure their
business such that real estate
components of non-real estate
businesses are separated from the rest of
their business to artificially reduce the
application of section 163(j) by leasing
the real property to the taxpayer and
electing this ‘‘business’’ to be an
excepted real property trade or business.
Therefore, the prime benefit of this rule
is to preserve the intent of the statute of
allowing elections in the real property
sector without incentivizing other
sectors of the economy to restructure
their business for the sole intent of
avoiding the section 163(j) limitation.
This guidance ensures that taxpayers
face more uniform incentives when
making economic decisions, a tenet of
economic efficiency. Rules that
maintain consistent structuring activity
across taxpayers also increases IRS’s
ability to consistently enforce the tax
rules, thus decreasing opportunities for
tax evasion.
Proposed § 1.163(j)–10 provides rules
for allocations of ATI and interest
expense and interest income between
excepted and non-excepted trades or
businesses. The proposed regulations
allocate interest expense and interest
income between the related excepted

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and non-excepted trades or businesses
based upon the relative amounts of the
taxpayer’s adjusted tax basis in the
assets used in its excepted and nonexcepted trades or businesses. As
discussed in the Explanation of
Provisions section, this general method
of allocation reflects the fact that money
is fungible and the view that interest
expense is attributable to all activities
and property, regardless of any specific
purpose for incurring an obligation on
which interest is paid. Since any
allocation method will require an
increase in compliance costs for
taxpayers, an allocation is only required
when the share of the asset tax basis in
the excepted or non-excepted business
exceeds 10 percent. Finally, this asset
basis approach provides consistency
with the regulations under section 861.
By providing taxpayer guidance that is
already familiar to them and consistent
with other parts of the Code, taxpayers
benefit in reduced time and cost spent
learning and applying new rules.
The Treasury Department and the IRS
considered several alternatives to this
asset basis approach for allocating
interest income and expense. First, a
tracing approach was considered
whereby taxpayers would be required to
trace disbursements of debt proceeds to
specific expenditures. However, tracing
would impose a significant
administrative burden upon taxpayers
due to the complexity of matching
interest income and expense among
related companies. Further, it is not
clear how taxpayers would retroactively
apply a tracing regime to existing debt.
In particular, because C corporations
would have had no reason to trace the
proceeds of any existing indebtedness,
imposing a tracing regime on existing
indebtedness would require
corporations to reconstruct the use of
funds within their treasury operations at
the time such indebtedness was issued,
even if the issuance occurred many
years ago, and even if the funds were
used for a myriad of purposes across a
large number of entities. Such an
approach would involve a great deal of
administrative cost and may be
impractical or even impossible for
indebtedness issued years ago.
Moreover, because money is fungible,
a tracing regime would be distortive and
subject to manipulation. Although
taxpayers are impacted from both a
commercial and tax perspective by the
amount of capital raised through the
issuance of equity and indebtedness,
any trade or business conducted by a
taxpayer is generally indifferent to the
source of funds. As a result, if taxpayers
were allowed to use a tracing regime to
allocate indebtedness to excepted trades

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or businesses, there would be an
incentive to treat excepted trades or
businesses as funded largely from
indebtedness, and to treat non-excepted
trades or businesses as funded largely
from other types of funding, such as
equity funding, despite the fact that, as
an economic matter, all of a taxpayer’s
trades or businesses are funded based
on the taxpayer’s overall capital
structure.
The Treasury Department and the IRS
rejected a tracing approach because the
complexity of such an approach could
be more difficult for taxpayers and the
IRS to administer and would create too
great an incentive to structure financing
with the sole purpose of avoiding the
application of the statute. The
assumption that a trade or business is
indifferent to its source of funds may
not be appropriate in cases in which
certain indebtedness is secured by the
assets of the trade or business and cash
flow from those assets is expected to
support the payments required on the
indebtedness. These proposed
regulations would provide for a limited
tracing rule in those cases. See the
discussion of qualified non-recourse
indebtedness in proposed § 1.163(j)–
10(d) in part 10(D) of the Explanation of
Provisions section.
Second, the Treasury Department and
the IRS also considered allocating
interest expense based upon the relative
fair market value of the assets used in
excepted and non-excepted trades or
businesses. However, determinations of
fair market value frequently are
burdensome for taxpayers, which may
have numerous assets without a readily
established market price, and for the
IRS. For this reason, disputes between
taxpayers and the IRS over the fair
market value of an asset are a common
and costly occurrence. In the TCJA,
Congress repealed the use of fair market
value in the apportionment of interest
expense under section 864 of the Code
(see section 14502(a) of the TCJA). Thus,
the Treasury Department and the IRS
have determined that allocating interest
expense based upon the relative fair
market value of assets is a less viable
approach than a regime based upon
relative amounts of asset basis.
Third, the Treasury Department and
the IRS also considered allocating
interest expense to excepted and nonexcepted 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

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other smoothing methodology, but any
such approach would necessarily create
a number of difficult technical questions
because the income of different trades or
businesses may be subject to differing
business cycles and the timing of
income items may be within taxpayers’
control. In the TCJA, Congress also
repealed the use of gross income in the
apportionment of interest expense
under section 864 of the Code (see
section 14502(a) of the TCJA). The
Treasury Department and the IRS
request comment on the approaches and
decisions discussed in this section.
3. Anticipated Impacts on
Administrative and Compliance Costs
The proposed regulations include
requirements about how excess interest
income, interest expense, and taxable
income should be allocated to partners.
This allocation method will require
some partnerships to do a number of
calculations to figure out the
appropriate allocations.
The proposed regulations as applied
to CFCs involve additional tax
calculations, such as aggregating CFC
income, separating finance from nonfinance businesses, and eliminating
intra-group dividends, but these
calculations are relatively simple and
involve data that are already collected.
Hence, the increase in compliance costs
should not be substantial. Furthermore,
because the alternative method is
elective, the associated compliance
costs would be avoided if the election
is not made.
As the compliance costs in both of
these cases would be part of the cost of
filing tax Form 8990, ‘‘Limitation on
Business Interest Expense,’’ the estimate
of the cost of these calculations will be
included as part of the overall reporting
burden of Form 8990, as is further
discussed in the next section.
D. Paperwork Reduction Act
The collection of information
contained in this notice of proposed
rulemaking has been submitted to the
Office of Management and Budget for
review in accordance with the
Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). An agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a valid
control number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and return information are

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confidential, as required by section
6103.
1. Collections of Information
The collection of information in these
proposed regulations is in §§ 1.163(j)–9
and 1.163(j)–10. The collection of
information in proposed § 1.163(j)–9 is
required for taxpayers to make a onetime election to treat their real property
or farming trade or business as an
electing real property trade or business
or an electing farming trade or business
under section 163(j)(7)(B) and (C). The
collection of information in proposed
§ 1.163(j)–10 is required for taxpayers to
demonstrate how they allocated their
interest expense, interest income, and
other items of income and deduction
between excepted and non-excepted
trades or businesses. It is necessary to
report this information to the IRS to
ensure that taxpayers properly report
the amount of interest that is potentially
subject to the limitation.

The collection of information is
necessary to ensure tax compliance but
is not expected to be available as a
finalized IRS form by the end of the
calendar year. When available, draft
revised versions of the affected IRS
forms will be posted for comment at
https://apps.irs.gov/app/picklist/list/
draftTaxForms.html. All of the
information collections mentioned in
§§ 1.163(j)–9 and 1.163(j)–10 may
eventually be reported on a form. The
specific forms that are expected to
change as a result of these proposed
regulations are described in more detail
in the next section.
2. Future Expected Modifications To
Forms To Collect Information
In order to collect necessary
information, we are modifying four
forms (Forms 1120, 1120S, 1065, and
1120–REIT) and creating one new form
(Form 8990). We are modifying Forms
1120, 1120S, 1065, and 1120–REIT to

Draft form
Form 1120 ......................
Form 1120S ...................
Form 1065 ......................
Form 1120–REIT ...........
Form 8990 ......................

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ask filers about the applicability of
section 163(j) and the need to file the
new Form 8990, as well as the related
one-time election statement. When the
changes to the IRS forms are finalized,
every taxpayer who deducts business
interest beginning in tax year 2018
generally will be required to file a new
tax Form 8990, ‘‘Limitation on Business
Interest Expense IRC 163(j),’’ except for
taxpayers with average annual gross
receipts of $25 million or less for the
three prior tax years (as determined
under section 448(c) principles, and as
adjusted for inflation starting in 2019).
For purposes of the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)), the reporting burden of tax
form 8990 is associated with OMB
control number 1545–0123. Tax form
8990 is estimated to be required by
fewer than 92,500 taxpayers in 2018.
The draft forms are available on the
IRS website at:

IRS website link
https://www.irs.gov/pub/irs-dft/f1120-dft.pdf
(Draft instructions: https://www.irs.gov/pub/irs-dft/i1120-dft.pdf)
https://www.irs.gov/pub/irs-dft/f1120s-dft.pdf
(Draft instructions: https://www.irs.gov/pub/irs-dft/i1120s-dft.pdf)
https://www.irs.gov/pub/irs-dft/f1065-dft.pdf
(Draft instructions: https://www.irs.gov/pub/irs-dft/i1065-dft.pdf)
https://www.irs.gov/pub/irs-dft/f1120rei-dft.pdf
(Draft instructions: https://www.irs.gov/pub/irs-dft/i1120rei-dft.pdf)
https://www.irs.gov/pub/irs-dft/f8990-dft.pdf

A draft of the Form 8990 instructions
is not available at the time of the
proposed rule-making. When available,
a draft of the IRS Form 8990
instructions will be posted for comment
at https://www.irs.gov/pub/irs-dft/f8990dft.pdf.
3. Burden Estimates
The following estimates are based on
the information that is available to the
IRS. The most recently available 2015
Statistics of Income (SOI) tax data
indicates that 80,702 firms would have
contemplated a one-time election to opt
out of the section 163(j) limitation as an
electing real property trade or business
or as an electing farming business were
the statute then in effect. The Treasury
Department and the IRS anticipate that
these proposed regulations will apply to
a similar proportion of taxpayers going
forward. This estimate is based on a
count of filers of Forms 1120, 1120S,
1065, and 1120–REIT in the real estate
and farming industries that had over
$25 million in gross receipts in taxable
year 2015. Each of these forms for
taxable years after 2017 will ask filers

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about the applicability of 163(j) and the
need to file Form 8890 as well as the
related one-time election. Similarly,
using the 2015 SOI tax data, we estimate
that 82,755 firms would have allocated
interest income and expenses among
multiple trades or businesses, some of
which are excepted from the section
163(j) limitation and some that are not.
This estimate is a count of all tax Forms
1120, 1120S, and 1065 in real estate,
farming, and public utilities industries
that had over $25 million in gross
receipts. While the number of affected
taxpayers will increase with growth in
the economy, the Treasury Department
and the IRS expect that the portion of
affected taxpayers will remain
approximately the same over the
foreseeable future.
The time and dollar compliance
burden are derived from the Business
Taxpayers Burden model provided by
the IRS’s Office of Research, Applied
Analytics, and Statistics (RAAS). This
model relates the time and out-of-pocket
costs of business tax preparation,
derived from survey data, to assets and
receipts of affected taxpayers along with

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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.

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Likely respondents

§ 1.163(j)–9
(one-time
statement).

§ 1.163(j)–10
statement).

(annual

election

allocation

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§ 1.163(j)–10 ....................................
(one-time start-up cost to develop
procedures for filing an annual allocation statement).
Three year monetized burden estimate.

Individuals, corporations, and partnerships with real property or
farming trades or businesses
with gross receipts exceeding
the statutory threshold of $25
million.
Individuals, corporations, and partnerships (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.
Same as above ..............................

........................................................

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

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Estimated number
of respondents
(2015 levels)

Estimated average
annual burden hours
per respondent

Estimated
frequency of
responses

20,176

$1.9

One-time.

82,755 business respondents (including Forms 1120,
1120–S, and 1065
filers).

15 minutes to 2
hours.
(estimated average:
1 hour).

82,755

7.9

Annually.

82,755 .....................

4 hours ....................
(start-up burden) .....

331,020

31.4

One-time.

..................................

..................................

....................

19.0

Three year
annual average.

II. Regulatory Flexibility Act
It is hereby certified that these
proposed regulations, if adopted as
final, will not have a significant
economic impact on a substantial
number of small entities. Although the
Treasury Department and the IRS
believe that the proposed regulations
may impact small entities, the number
of small entities impacted is low.
Section 163(j) provides exceptions for
which many small entities will qualify.
First, under section 163(j)(3), the
limitation does not apply to any
taxpayer, other than a tax shelter under
section 448(a)(3), which meets the gross
receipts test under section 448(c) for any
taxable year. A taxpayer meets the gross
receipts test under section 448(c) if the
taxpayer has average annual gross
receipts for the 3–taxable year period
ending with the taxable year that
precedes the current taxable year that do
not exceed $25,000,000. Second, section
163(j) provides that certain trades or
businesses are not subject to the
limitation, including the trade or
business of performing services as an
employee, electing real property trades

Frm 00044

Estimated
monetized
burden @
$95/hour
($2017
millions)

80,702 business re0 to 30 minutes (esspondents (includtimated avering Forms 1120,
age:15 minutes).
1120–REIT, 1120–
S, and 1065 filers).

How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with
the proposed collection of information
may be minimized, including through
the application of automated collection
techniques or other forms of information
technology; and
Estimates of capital or start-up costs
and costs of operation, maintenance,
and purchase of services to provide
information.

PO 00000

Estimated
total annual
reporting
burden
(hours)
(2015
levels)

Fmt 4701

Sfmt 4702

or businesses, electing farming
businesses, and certain utilities as
defined in section 163(j)(7)(A)(iv).
Lastly, certain REITs, as described in
proposed § 1.163(j)–9(g), are eligible to
make the election out of the limitation
as a real property trades or businesses.
Any economic impact on any small
entities as a result of the requirements
in this notice of proposed rulemaking
are not expected to be significant. The
small entities potentially subject to the
provision in proposed § 1.163(j)–9 are
individuals, corporations, including S
corporations, and partnerships that (1)
have average annual gross receipts for
the 3–taxable year period ending with
the taxable year that precedes the
current taxable year exceeding
$25,000,000, and (2) want to make the
election out of the limitation as an
electing real property trade or business
under section 163(j)(7)(B) or electing
farming business under section
163(j)(7)(C). Proposed § 1.163(j)–9
requires such taxpayers to attach a onetime statement to their return providing
the taxpayer’s name, address, social
security number (SSN) or employer
identification number (EIN), a
description of the taxpayer’s electing
trade or business, including the
principal business activity code, a
statement that the taxpayer
acknowledges the election is
irrevocable, and a statement that the
taxpayer is making an election under
section 163(j)(7)(B) or (C), as applicable.
The small entities potentially subject
to the requirements in proposed
§ 1.163(j)–10 are individuals,
corporations (including S corporations),
and partnerships that (1) have average

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annual gross receipts for the 3–taxable
year period ending with the taxable year
that precedes the current taxable year
exceeding $25,000,000, and (2) have
multiple trades or businesses, some of
which are excepted from the limitation
and some of which are not excepted
from the limitation, for which the
taxpayer must properly allocate
business interest expense. Proposed
§ 1.163(j)–10 requires such taxpayers to
attach an annual statement to their
return demonstrating the following: (1)
The taxpayer’s adjusted basis in the
aggregated assets used in its excepted
and non-excepted businesses, (2) the
determination dates on which asset
basis was measured during the taxable
year, (3) the names and TINs of all
entities for which basis information is
being provided, (4) asset basis
information for corporations or
partnerships if the taxpayer looks
through to the corporation’s or
partnership’s basis in the corporation’s
or partnership’s assets under proposed
§ 1.163(j)–10(c)(5)(ii), and (5) a summary
of the method or methods used to
determine asset basis in property used
in both excepted and non-excepted
businesses.
As discussed elsewhere in this
preamble, the reporting burden for the
one-time election statement is estimated
at 0 to 30 minutes, depending on
individual circumstances, with an
estimated average of 15 minutes for all
affected entities, regardless of size. The
reporting burden for the annual
allocation statement is estimated at 15
minutes to 2 hours, depending on
individual circumstances, with an
estimated average of 1 hour. The
estimated monetized burden for
compliance is $95 per hour.
For these reasons, the Treasury
Department and the IRS have
determined that the collections of
information in this notice of proposed
rulemaking will not have a significant
economic impact. Accordingly, a
regulatory flexibility analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required.
Notwithstanding this certification, the
Treasury Department and the IRS invite
comments from interested members of
the public on both the number of
entities affected and the economic
impact on small entities.
It is hereby certified that proposed
§§ 1.163(j)–4, 1.163(j)–5, and 1.163(j)–6
will not have a significant economic
impact on a substantial number of small
entities. Although the Treasury
Department and the IRS believe that the
proposed regulations may affect small
entities, the economic impact on small
entities as a result of the notice of

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proposed rulemaking is not expected to
be significant. In particular, only firms
with more than $25 million in gross
receipts are required to file a tax Form
8990. Accordingly, a regulatory
flexibility analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is
not required. Notwithstanding this
certification, the Treasury Department
and the IRS invite comments from
interested members of the public on
both the number of entities affected and
the economic impact on small entities.
Pursuant to section 7805(f) of the
Code, this notice of proposed
rulemaking has been submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations,
consideration will be given to any
comments that are submitted timely to
the IRS in the preamble under the
ADDRESSES section. The Treasury
Department and the IRS request
comments on all aspects of the proposed
rules.
All comments submitted will be made
available at http://www.regulations.gov
for public inspection and copying. A
public hearing has been scheduled for
February 27, 2019, beginning at 10 a.m.
in the Auditorium of the Internal
Revenue Building, 1111 Constitution
Avenue NW, Washington, DC 20224. If
there is not sufficient time to discuss all
of the topics on February 27, 2019, the
hearing will continue the following day
at 10 a.m. in the same location. Due to
building security procedures, visitors
must enter at the Constitution Avenue
entrance. In addition, all visitors must
present photo identification to enter the
building. Because of access restrictions,
visitors will not be admitted beyond the
immediate entrance area more than 30
minutes before the hearing starts. For
more information about having your
name placed on the building access list
to attend the hearing, see the FOR
FURTHER INFORMATION CONTACT section of
this preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish
to present oral comments at the hearing
must submit an outline of the topics to
be discussed and the time to be devoted
to each topic by February 26, 2019.
Submit a signed paper or electronic
copy of the outline as prescribed in this
preamble under the ADDRESSES heading.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.

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67533

Drafting Information
The principal authors of these
regulations are Susie Bird, Charles
Gorham, Zachary King, Jaime Park,
Kathy Reed, and Sophia Wang, Office of
the Associate Chief Counsel (Income
Tax and Accounting); Kevin M. Jacobs,
Russell Jones, and John Lovelace, Office
of the Associate Chief Counsel
(Corporate); Meghan Howard, William
Kostak, Anthony McQuillen, Adrienne
Mikolashek, and James Quinn, Office of
the Associate Chief Counsel
(Passthroughs and Special Industries);
Angela Holland, Steve Jensen, and
Charles Rioux, Office of the Associate
Chief Counsel (International); William
E. Blanchard, Michael Chin, Steven
Harrison, Andrea Hoffenson, and Diana
Imholtz, Office of the Associate Chief
Counsel (Financial Institutions and
Products). Other personnel from the
Treasury Department and the IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Withdrawal of Proposed Regulations
Under the authority of 26 U.S.C. 7805,
the notice of proposed rulemaking that
was published in the Federal Register
on Tuesday, June 18, 1991, (56 FR
27907, as corrected by 56 FR 40285
(August 14, 1991)) is withdrawn.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by:
■ 1. Adding entries in numerical order
for §§ 1.163(j)–1 through 1.163(j)–11;
■ 2. Revising the entry for §§ 1.263A–8
through 1.263A–15;
■ 3. Adding entries in numerical order
for §§ 1.382–1 and 1.383–0;
■ 4. Revising the entry for § 1.383–1;
and
■ 5. Adding entries in numerical order
for §§ 1.860C–2 and 1.1502–90.
The additions and revisions read, in
part, as follows:
■

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

*

*

*

*

*

Section 1.163(j)–1 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–2 also issued under 26
U.S.C. 1502.
Section 1.163(j)–3 also issued under 26
U.S.C. 1502.
Section 1.163(j)–4 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–5 also issued under 26
U.S.C. 1502.

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Section 1.163(j)–6 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–7 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–8 also issued under 26
U.S.C. 163(j)(8)(B).
Section 1.163(j)–9 also issued under 26
U.S.C. 163(j)(7)(B) and (C) and 26 U.S.C.
1502.
Section 1.163(j)–10 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–11 also issued under 26
U.S.C. 1502.

*

*

*

*

*

Sections 1.263A–8 through 1.263A–15 also
issued under 26 U.S.C. 263A(j).

*

*

*

*

*

Section 1.382–1 also issued under 26
U.S.C. 382(m).

*

*

*

*

*

Section 1.383–0 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.
Section 1.383–1 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.

*

*

*

*

*

Section 1.860C–2 also issued under 26
U.S.C. 860C(b)(1).

*

*

*

*

*

Section 1.1502–90 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 1502.

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

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*

§ 1.163(j)–0 Table of contents.
This section lists the table of contents for
§§ 1.163(j)–1 through 1.163(j)–11.
§ 1.163(j)–1 Definitions.
(a) In general.
(b) Definitions.
(1) Adjusted taxable income.
(i) Additions.
(ii) Subtractions.
(iii) Depreciation, amortization, or
depletion expenses capitalized to inventory
under section 263A.
(iv) Other adjustments.
(v) Additional rules relating to adjusted
taxable income in other sections.
(2) Business interest expense.
(i) In general.
(ii) Special rules.
(3) Business interest income.
(i) In general.
(ii) Special rules.
(4) C corporation.
(5) Cleared swap.
(6) Consolidated group.
(7) Consolidated return year.
(8) Disallowed business interest expense.
(9) Disallowed business interest expense
carryforward.
(10) Disallowed disqualified interest.
(11) Electing farming business.
(12) Electing real property trade or
business.
(13) Excepted regulated utility trade or
business.
(i) In general.
(ii) Excepted and non-excepted utility
trades or businesses.
(14) Excess business interest expense.
(15) Excess taxable income.

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(16) Floor plan financing indebtedness.
(17) Floor plan financing interest expense.
(18) Group.
(19) Intercompany transaction.
(20) Interest.
(i) In general.
(ii) Swaps with significant nonperiodic
payments.
(A) Non-cleared swaps.
(B) [Reserved]
(iii) Other amounts treated as interest.
(A) Treatment of premium.
(1) Issuer.
(2) Holder.
(B) Treatment of ordinary income or loss
on certain debt instruments.
(C) Substitute interest payments.
(D) Section 1258 gain.
(E) Amounts affecting a taxpayer’s effective
cost of borrowing.
(F) Yield adjustments.
(G) Certain amounts labeled as fees.
(1) Commitment fees.
(2) [Reserved]
(H) Debt issuance costs.
(I) Guaranteed payments.
(J) Factoring income.
(iv) Anti-avoidance rule for amounts
predominantly associated with the time
value of money.
(v) Examples.
(21) Interest expense.
(22) Interest income.
(23) Inventory.
(24) Member.
(25) Motor vehicle.
(26) Old section 163(j).
(27) Real estate investment trust.
(28) Real property.
(29) Regulated investment company.
(30) S corporation.
(31) Section 163(j) limitation.
(32) Section 163(j) regulations.
(33) Separate return limitation year.
(34) Separate return year.
(35) Separate taxable income.
(36) Tax-exempt corporation.
(37) Taxable income.
(i) In general.
(ii) General rules to coordinate the
application of sections 163(j) and 250.
(iii) [Reserved]
(iv) Special rules for defining taxable
income.
(38) Trade or business.
(i) In general.
(ii) Excepted trade or business.
(iii) Non-excepted trade or business.
(39) Unadjusted basis.
(c) Applicability date.
§ 1.163(j)–2 Deduction for business interest
expense limited.
(a) Overview.
(b) General rule.
(c) Disallowed business interest expense
carryforward.
(1) In general.
(2) Coordination with small business
exemption.
(3) Cross-references.
(d) Small business exemption.
(1) Exemption.
(2) Application of the gross receipts test.
(i) In general.
(ii) Gross receipts of individuals.
(iii) Partners and S corporation
shareholders.

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(iv) Tax-exempt organizations.
(e) REMICs.
(f) Calculation of ATI with respect to
certain beneficiaries.
(g) Examples.
(h) Anti-avoidance rule.
(i) Applicability date.
§ 1.163(j)–3 Relationship of business
interest deduction limitation to other
provisions affecting interest.
(a) Overview.
(b) Coordination of section 163(j) with
certain other provisions.
(1) In general.
(2) Disallowed interest provisions.
(3) Deferred interest provisions.
(4) At risk rules, passive activity loss
provisions, and limitation on excess business
losses of noncorporate taxpayers.
(5) Capitalized interest expenses under
sections 263A and 263(g).
(6) Reductions under section 246A.
(7) Section 381.
(8) Section 382.
(9) Other types of interest provisions.
(10) [Reserved]
(c) Examples.
(d) Applicability date.
§ 1.163(j)–4 General rules applicable to C
corporations (including REITs, RICs, and
members of consolidated groups) and
tax-exempt corporations.
(a) Scope.
(b) Characterization of items of income,
gain, deduction, or loss.
(1) Interest expense and interest income.
(2) Adjusted taxable income.
(3) Investment interest, investment income,
and investment expenses of a partnership
with a C corporation partner.
(i) Characterization as expense or income
properly allocable to a trade or business.
(ii) Impact of characterization on
partnership.
(iii) Investment interest expense and
investment interest income of a partnership
not treated as excess business interest
expense or excess taxable income of a C
corporation partner.
(4) Application to RICs and REITs.
(i) In general.
(ii) Taxable income for purposes of
calculating the adjusted taxable income of
RICs and REITs.
(iii) Other adjustments to adjusted taxable
income for RICs and REITs.
(5) Application to tax-exempt corporations.
(6) Examples.
(c) Effect on earnings and profits.
(1) In general.
(2) Special rule for RICs and REITs.
(3) Special rule for partners that are C
corporations.
(4) Examples.
(d) Special rules for consolidated groups.
(1) Scope.
(2) Calculation of the section 163(j)
limitation for members of a consolidated
group.
(i) In general.
(ii) Interest.
(iii) Calculation of business interest
expense and business interest income for a
consolidated group.
(iv) Calculation of adjusted taxable income.

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(v) Treatment of intercompany obligations.
(3) Investment adjustments.
(4) Ownership of partnership interests by
members of a consolidated group.
(i) Dispositions of partnership interests.
(ii) Basis adjustments under § 1.1502–32.
(iii) [Reserved]
(5) Examples.
(e) Cross-references.
(f) Applicability date.
§ 1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
(a) Scope and definitions.
(1) Scope.
(2) Definitions.
(i) Current-year business interest expense.
(ii) Allocable share of the consolidated
group’s remaining section 163(j) limitation.
(iii) Consolidated group’s remaining
section 163(j) limitation.
(iv) Remaining current-year interest ratio.
(b) Treatment of disallowed business
interest expense carryforwards.
(1) In general.
(2) Deduction of business interest expense.
(3) Consolidated groups.
(i) In general.
(ii) Deduction of business interest expense.
(A) General rule.
(B) Section 163(j) limitation is equal to or
exceeds the current-year business interest
expense and disallowed business interest
expense carryforwards from prior taxable
years.
(C) Current-year business interest expense
and disallowed business interest expense
carryforwards exceed section 163(j)
limitation.
(iii) Departure from group.
(iv) Example.
(c) Disallowed business interest expense
carryforwards in transactions to which
section 381(a) applies.
(d) Limitations on disallowed business
interest expense carryforwards from separate
return limitation years.
(1) General rule.
(2) Deduction of disallowed business
interest expense carryforwards arising in a
SRLY.
(3) Examples.
(e) Application of section 382.
(1) Pre-change loss.
(2) Loss corporation.
(3) Ordering rules for utilization of prechange losses and for absorption of the
section 382 limitation.
(4) Disallowed business interest expense
from the pre-change period in the year of a
testing date.
(f) Overlap of SRLY limitation with section
382.
(g) Additional limitations.
(h) Applicability date.
§ 1.163(j)–6 Application of the business
interest deduction limitation to
partnerships and subchapter S
corporations.
(a) Overview.
(b) Definitions.
(1) Section 163(j) items.
(2) Partner basis items.
(3) Remedial items.
(4) Excess business interest income.

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(5) Deductible business interest expense.
(6) Section 163(j) excess items.
(7) Non-excepted assets.
(8) Excepted assets.
(c) Character of business interest expense.
(d) Adjusted taxable income of the
partnership.
(1) Modification of adjusted taxable income
for partnerships.
(2) Section 734(b), partner basis items, and
remedial items.
(e) Adjusted taxable income and business
interest income of partners.
(1) Modification of adjusted taxable income
for partners.
(2) Partner basis items and remedial items.
(3) Disposition of partnership interests.
(4) Double counting of business interest
income and floor plan financing interest
expense prohibited.
(f) Allocation and determination of section
163(j) excess items made in the same manner
as nonseparately stated taxable income or
loss of the partnership.
(1) Overview.
(i) In general.
(ii) Relevance solely for purposes of section
163(j).
(2) Steps for allocating deductible business
interest expense and section 163(j) excess
items.
(i) Partnership-level calculation required
by section 163(j)(4)(A).
(ii) Determination of each partner’s
relevant section 163(j) items.
(iii) Partner-level comparison of business
interest income and business interest
expense.
(iv) Matching partnership and aggregate
partner excess business interest income.
(v) Remaining business interest expense
determination.
(vi) Determination of final allocable ATI.
(A) Positive allocable ATI.
(B) Negative allocable ATI.
(C) Final allocable ATI.
(vii) Partner-level comparison of thirty
percent of adjusted taxable income and
remaining business interest expense.
(viii) Partner priority right to ATI capacity
excess determination.
(ix) Matching partnership and aggregate
partner excess taxable income.
(x) Matching partnership and aggregate
partner excess business interest expense.
(xi) Final section 163(j) excess item and
deductible business interest expense
allocation.
(g) Carryforwards.
(1) In general.
(2) Treatment of excess of business interest
expense allocated to partners.
(3) Excess taxable income and excess
business interest income ordering rule.
(h) Basis adjustments.
(1) Section 704(d) ordering.
(2) Excess business interest expense basis
adjustments.
(3) Basis adjustments upon disposition of
partnership interest.
(i) Complete disposition of partnership
interest.
(ii) Partial disposition of partnership
interest.
(i) [Reserved]
(j) Investment items.

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(k) [Reserved]
(l) S corporations.
(1) In general.
(2) Character of deductible business
interest expense.
(3) Adjusted taxable income of an S
corporation.
(4) Adjusted taxable income and business
interest income of S corporation
shareholders.
(i) Adjusted taxable income of S
corporation shareholders.
(ii) Disposition of S corporation stock.
(iii) Double counting of business interest
income and floor plan financing interest
expense prohibited.
(5) Carryforwards.
(6) Basis adjustments and disallowed
business interest expense carryforwards.
(7) Accumulated adjustment accounts.
(8) Termination of qualified subchapter S
subsidiary election.
(9) Investment items.
(m) Partnerships and S corporations not
subject to section 163(j).
(1) Partnerships and S corporations not
subject to section 163(j) by reason of the
small business exemption.
(2) Partnerships and S corporations not
subject to section 163(j) by reason of an
excepted trade or business.
(3) Partnerships that allocated excess
business interest expense prior to becoming
not subject to section 163(j).
(4) S corporations with disallowed
business interest expense carryforwards prior
to becoming not subject to section 163(j).
(n) [Reserved]
(o) Examples.
(p) Applicability date.
§ 1.163(j)–7 Application of the business
interest deduction limitation to foreign
corporations and United States
shareholders.
(a) Overview.
(b) Application of section 163(j) to an
applicable CFC and certain partnerships.
(1) Scope.
(2) General application of section 163(j) to
an applicable CFC and a partnership with at
least one partner that is an applicable CFC.
(3) Alternative approach for computing the
deduction for business interest expense.
(4) Treatment of certain partnerships as a
CFC group member.
(i) General rule.
(ii) Exception for certain partnerships
engaged in a United States trade or business.
(5) CFC group election.
(i) Manner of making a CFC group election.
(ii) Consistency requirement.
(iii) Duration of a CFC group election.
(c) Rules concerning the computation of
adjusted taxable income of an applicable CFC
and certain CFC group members.
(1) Computation of taxable income.
(2) Treatment of certain dividends.
(3) Treatment of CFC excess taxable
income.
(i) In general.
(ii) Ordering rules.
(d) Rules concerning the computation of
adjusted taxable income of a United States
shareholder.
(1) In general.

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(i) Treatment of gross income inclusions
that are properly allocable to a non-excepted
trade or business.
(ii) Treatment of deemed inclusions of a
domestic partnership that are not allocable to
any trade or business.
(2) Additional rule after application of
paragraph (d)(1) of this section for a United
States shareholder of a CFC group member
with a CFC group election in effect.
(i) In general.
(ii) Eligible CFC group ETI.
(iii) CFC group inclusions.
(3) Special rules if a domestic partnership
is a United States shareholder of a CFC group
member with a CFC group election in effect.
(4) Inclusions under section 951A(a).
(e) Effect on earnings and profits.
(f) Definitions.
(1) Allocable share.
(i) General rule.
(ii) Special rule if there is a financial
services subgroup.
(2) Applicable CFC.
(3) Applicable net business interest
expense.
(4) Applicable subgroup net business
interest expense.
(5) CFC excess taxable income.
(i) In general.
(ii) CFC group member is a partnership.
(6) CFC group.
(i) In general.
(ii) Aggregation rules.
(7) CFC group election.
(8) CFC group member.
(9) Financial services subgroup.
(10) Financial services subgroup member.
(11) Majority U.S. shareholder taxable year.
(12) Net business interest expense.
(13) Passthrough entity.
(14) Specified ETI ratio.
(i) In general.
(ii) Includable CFC group members.
(iii) Numerator.
(iv) Denominator.
(15) Specified highest-tier member.
(16) Specified lower-tier member.
(17) Specified taxable year.
(18) United States shareholder.
(g) Examples.
(h) Applicability date.
§ 1.163(j)–8 Application of the business
interest deduction limitation to foreign
persons with effectively connected
income.
(a) Overview.
(b) Application of section 163(j) and the
section 163(j) regulations to specified foreign
persons with effectively connected taxable
income.
(1) In general.
(2) Modification of adjusted taxable
income.
(3) Modification of business interest
expense.
(i) General rule.
(ii) Exclusion of certain business interest
expense of a specified foreign partner.
(4) Modification of business interest
income.
(5) Modification of floor plan financing
interest expense.
(6) Modification of allocation of interest
expense and interest income that is properly
allocable to trade or business.

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(c) Partner-level modifications to
§ 1.163(j)–6 for partnerships engaged in a
U.S. trade or business.
(1) Modification related to a partnership’s
excess taxable income.
(2) Modification related to a partnership’s
excess business interest expense.
(3) Modification related to a partnership’s
excess business interest income.
(d) An applicable CFC with effectively
connected taxable income.
(e) Coordination of section 163(j) and
§ 1.882–5.
(1) General rules.
(i) Ordering rule.
(ii) Treatment of disallowed business
interest expense carryforward.
(iii) Treatment of allocable excess business
interest expense.
(iv) Scaling ratio.
(2) Amount of interest determined under
§ 1.882–5 that is disallowed business interest
expense.
(i) Foreign corporation is not a specified
foreign partner.
(ii) Foreign corporation is a specified
foreign partner.
(f) Coordination with branch profits tax.
(1) Effect on effectively connected earnings
and profits.
(2) Effect on U.S. net equity.
(g) Definitions.
(1) Applicable CFC.
(2) ECI excess business interest income.
(3) Effectively connected taxable income.
(4) Specified excess business interest
expense.
(5) Specified excess taxable income.
(6) Specified foreign partner.
(7) Specified foreign person.
(8) Specified ratio.
(h) Examples.
(i) Applicability date.
§ 1.163(j)–9 Elections for excepted trades or
businesses; safe harbor for certain REITs.
(a) Overview.
(b) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(c) Time and manner of making election.
(1) In general.
(2) Election statement contents.
(3) Consolidated group’s trade or business.
(4) Partnership’s trade or business.
(d) Termination of election.
(1) In general.
(2) Taxable asset transfer defined.
(3) Related party defined.
(4) Anti-abuse rule.
(e) Additional guidance.
(f) Examples.
(g) Safe harbor for REITs.
(1) In general.
(2) REITs that do not significantly invest in
real property financing assets.
(3) REITs that significantly invest in real
property financing assets.
(4) REIT real property assets, interests in
partnerships, and shares in other REITs.
(i) Real property assets.
(ii) Partnership interests.
(iii) Shares in other REITs.
(5) Value of shares in other REITs.
(6) Real property financing assets.
(h) Special anti-abuse rule for certain real
property trades or businesses.

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(1) In general.
(2) Exception for certain REITs.
(i) Applicability date.
§ 1.163(j)–10 Allocation of interest expense,
interest income, and other items of
expense and gross income to an excepted
trade or business.
(a) Overview.
(1) In general.
(i) Purposes.
(ii) Application of section.
(2) Coordination with other rules.
(i) In general.
(ii) Treatment of investment interest,
investment income, and investment expenses
of a partnership with a C corporation or taxexempt corporation as a partner.
(3) Application of allocation rules to
foreign corporations and foreign
partnerships.
(4) Application of allocation rules to
members of a consolidated group.
(i) In general.
(ii) Application of excepted business
percentage to members of a consolidated
group.
(iii) Basis in assets transferred in an
intercompany transaction.
(5) Tax-exempt organizations.
(6) [Reserved]
(7) Examples.
(b) Allocation of tax items other than
interest expense and interest income.
(1) In general.
(2) Gross income other than dividends and
interest income.
(3) Dividends.
(i) Look-through rule.
(ii) Inapplicability of the look-through rule.
(4) Gain or loss from the disposition of
non-consolidated C corporation stock,
partnership interests, or S corporation stock.
(i) Non-consolidated C corporations.
(ii) Partnerships and S corporations.
(5) Expenses, losses, and other deductions.
(i) Expenses, losses, and other deductions
that are definitely related to a trade or
business.
(ii) Other deductions.
(6) Treatment of certain investment items
of a partnership with a C corporation partner.
(7) Example—Allocation of income and
expense.
(c) Allocating interest expense and interest
income that is properly allocable to a trade
or business.
(1) General rule.
(i) In general.
(ii) De minimis exception.
(2) Example.
(3) Asset used in more than one trade or
business.
(i) General rule.
(ii) Permissible methodologies for
allocating asset basis between or among two
or more trades or businesses.
(iii) Special rules.
(A) Consistent allocation methodologies.
(1) In general.
(2) Consent to change allocation
methodology.
(B) De minimis exceptions.
(1) De minimis amount of gross income
from trades or businesses.
(2) De minimis amount of asset basis
allocable to a trade or business.

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

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(ii) Partnerships.
(iii) Inapplicability of look-through rule.
(8) Anti-abuse rule.
(d) Direct allocations.
(1) In general.
(2) Financial services entities.
(3) Assets used in more than one trade or
business.
(4) Adjustments to basis of assets to
account for direct allocations.
(5) Example.
(e) Examples.
(f) Applicability date.
§ 1.163(j)–11 Transition rules.
(a) Application of section 163(j) limitation
if a corporation joins a consolidated group
with a taxable year beginning before January
1, 2018.
(1) In general.
(2) Example.
(b) Treatment of disallowed disqualified
interest.
(1) In general.
(2) Earnings and profits.
(3) Disallowed disqualified interest of
members of an affiliated group.
(i) Scope.
(ii) Allocation of disallowed disqualified
interest to members of the affiliated group.
(A) In general.
(B) Definitions.
(1) Allocable share of the affiliated group’s
disallowed disqualified interest.
(2) Disallowed disqualified interest ratio.
(3) Exempt related person interest expense.
(iii) Treatment of carryforwards.
(4) Application of section 382.
(i) Ownership change occurring before the
date the Treasury decision adopting these
regulations as final regulations is published
in the Federal Register.
(A) Pre-change loss.
(B) Loss corporation.
(ii) Ownership change occurring on or after
the date the Treasury decision adopting these
regulations as final regulations is published
in the Federal Register.
(A) Pre-change loss.
(B) Loss corporation.
(iii) Definitions.
(5) [Reserved]
(6) Treatment of excess limitation from
taxable years beginning before January 1,
2018.
(7) Example.
(c) Applicability date.

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

■

Sec.

*

*

*

*

*

1.163(j)–1 Definitions.
1.163(j)–2 Deduction for business interest
expense limited.
1.163(j)–3 Relationship of business interest
deduction limitation to other provisions
affecting interest.
1.163(j)–4 General rules applicable to C
corporations (including REITs, RICs, and
members of consolidated groups) and
tax-exempt corporations.
1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
1.163(j)–6 Application of the business
interest deduction limitation to

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partnerships and subchapter S
corporations.
1.163(j)–7 Application of the business
interest deduction limitation to foreign
corporations and United States
shareholders.
1.163(j)–8 Application of the business
interest deduction limitation to foreign
persons with effectively connected
income.
1.163(j)–9 Elections for excepted trades or
businesses; safe harbor for certain REITs.
1.163(j)–10 Allocation of interest expense,
interest income, and other items of
expense and gross income to an excepted
trade or business.
1.163(j)–11 Transition rules.

*

*

§ 1.163(j)–1

*

*

*

Definitions.

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

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(C) With respect to the sale or other
disposition of property, the lesser of:
(1) Any gain recognized on the sale or
other disposition of such property; and
(2) Any depreciation, amortization, or
depletion deductions for the taxable
years beginning after December 31,
2017, and before January 1, 2022, with
respect to such property;
(D) With respect to the sale or other
disposition of stock of a member of a
consolidated group that includes the
selling member, the investment
adjustments, as defined under § 1.1502–
32, with respect to such stock that are
attributable to deductions described in
paragraph (b)(1)(ii)(C) of this section;
(E) With respect to the sale or other
disposition of an interest in a
partnership, the taxpayer’s distributive
share of deductions described in
paragraph (b)(1)(ii)(C) of this section
with respect to property held by the
partnership at the time of such sale or
other disposition to the extent such
deductions were allowable under
section 704(d); and
(F) Any income or gain that is not
properly allocable to a non-excepted
trade or business (for rules governing
the allocation of items to an excepted
trade or business, see §§ 1.163(j)–
1(b)(38) and 1.163(j)–10)).
(iii) Depreciation, amortization, or
depletion expenses capitalized to
inventory under section 263A.
Depreciation, amortization, or depletion
expense that is capitalized to inventory
under section 263A is not a
depreciation, amortization, or depletion
deduction for purposes of this
paragraph (b)(1).
(iv) Other adjustments. ATI is
computed with the other adjustments
provided in §§ 1.163(j)–2 through
1.163(j)–11.
(v) Additional rules relating to
adjusted taxable income in other
sections. (A) For rules governing the
ATI of C corporations, see §§ 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 § 1.163(j)–4(b)(4).
(C) For rules governing the ATI of taxexempt corporations, see § 1.163(j)–
4(b)(5).
(D) For rules governing the ATI of
consolidated groups, see § 1.163(j)–
4(d)(2)(iv) and (v).
(E) For rules governing the ATI of
partnerships, see § 1.163(j)–6(d).
(F) For rules governing the ATI of
partners, see § 1.163(j)–6(e).
(G) For rules governing partnership
basis adjustments impacting ATI, see
§ 1.163(j)–6(h)(2).
(H) For rules governing the ATI of S
corporations, see § 1.163(j)–6(l)(3).

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(I) For rules governing the ATI of S
corporation shareholders, see § 1.163(j)–
6(l)(4).
(J) For rules governing the ATI of
applicable CFCs and certain CFC group
members, as defined in § 1.163(j)–7(f),
see § 1.163(j)–7(c).
(K) For rules governing the ATI of
United States shareholders of applicable
CFCs, including the treatment of
inclusions under sections 78, 951(a),
and 951A(a), see § 1.163(j)–7(d).
(L) For rules governing the ATI of
specified foreign persons, as defined in
§ 1.163(j)–8(g)(7), with effectively
connected income, see § 1.163(j)–8(b)(2).
(M) For rules governing the ATI of
specified foreign partners, as defined in
§ 1.163(j)–8(g)(6), other than applicable
CFCs, as defined in § 1.163(j)–8(g)(1),
see § 1.163(j)–8(c)(1).
(N) For rules governing the ATI of
certain beneficiaries of trusts and
estates, see § 1.163(j)–2(f).
(2) Business interest expense—(i) In
general. The term business interest
expense means interest expense that is
properly allocable to a non-excepted
trade or business or that is floor plan
financing interest expense. Business
interest expense also includes
disallowed business interest expense
carryforwards (as defined in paragraph
(b)(9) of this section). For the treatment
of investment interest, see section
163(d); and for the treatment of personal
interest, see section 163(h).
(ii) Special rules. For special rules for
defining business interest expense in
certain circumstances, see §§ 1.163(j)–
3(b)(2) (regarding disallowed interest
expense), 1.163(j)–4(b) (regarding C
corporations) and (d)(2)(iii) (regarding
consolidated groups), and 1.163(j)–
8(b)(3) (regarding foreign persons
engaged in a U.S. trade or business).
(3) Business interest income—(i) In
general. The term business interest
income means interest income which is
properly allocable to a non-excepted
trade or business. For the treatment of
investment income, see section 163(d).
(ii) Special rules. For special rules
defining business interest income in
certain circumstances, see §§ 1.163(j)–
4(b) (regarding C corporations) and
(d)(2)(iii) (regarding consolidated
groups) and 1.163(j)–8(b)(4) (regarding
foreign persons engaged in a U.S. trade
or business).
(4) C corporation. The term C
corporation has the meaning provided
in section 1361(a)(2).
(5) Cleared swap. The term cleared
swap means a swap that is cleared by a
derivatives clearing organization, as
such term is defined in section 1a of the
Commodity Exchange Act (7 U.S.C. 1a),
or by a clearing agency, as such term is

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defined in section 3 of the Securities
Exchange Act of 1934 (15 U.S.C. 78c),
that is registered as a derivatives
clearing organization under the
Commodity Exchange Act or as a
clearing agency under the Securities
Exchange Act of 1934, respectively, if
the derivatives clearing organization or
clearing agency requires the parties to
the swap to post and collect margin or
collateral.
(6) Consolidated group. The term
consolidated group has the meaning
provided in § 1.1502–1(h).
(7) Consolidated return year. The term
consolidated return year has the
meaning provided in § 1.1502–1(d).
(8) Disallowed business interest
expense. The term disallowed business
interest expense means the amount of
business interest expense for a taxable
year in excess of the amount allowed as
a deduction for the taxable year under
section 163(j)(1) and § 1.163(j)–2(b).
(9) Disallowed business interest
expense carryforward. The term
disallowed business interest expense
carryforward means any business
interest expense described in § 1.163(j)–
2(c).
(10) Disallowed disqualified interest.
The term disallowed disqualified
interest means interest expense,
including carryforwards, for which a
deduction was disallowed under old
section 163(j) (as defined in paragraph
(b)(26) of this section) in the taxpayer’s
last taxable year beginning before
January 1, 2018, and that was carried
forward pursuant to old section 163(j).
(11) Electing farming business. The
term electing farming business means a
trade or business that makes an election
as provided in § 1.163(j)–9 or other
published guidance and that is—
(i) A farming business, as defined in
section 263A(e)(4) or § 1.263A–4(a)(4);
or
(ii) Any trade or business of a
specified agricultural or horticultural
cooperative, as defined in section
199A(g)(4).
(12) Electing real property trade or
business. The term electing real
property trade or business means a trade
or business that makes an election as
provided in § 1.163(j)–9 or other
published guidance and that is
described in—
(i) Section 469(c)(7)(C) and § 1.469–
9(b)(2); or
(ii) Section 1.163(j)–9(g).
(13) Excepted regulated utility trade
or business—(i) In general. The term
excepted regulated utility trade or
business means a trade or business—
(A) That furnishes or sells:
(1) Electrical energy, water, or sewage
disposal services;

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(2) Gas or steam through a local
distribution system; or
(3) Transportation of gas or steam by
pipeline; and
(B) To the extent that the rates for the
furnishing or sale of the items in
paragraph (b)(13)(i)(A) of this section—
(1) Have been established or approved
by a State or political subdivision
thereof, by any agency or
instrumentality of the United States, or
by a public service or public utility
commission or other similar body of any
State or political subdivision thereof
and are determined on a cost of service
and rate of return basis; or
(2) Have been established or approved
by the governing or ratemaking body of
an electric cooperative.
(ii) Excepted and non-excepted utility
trades or businesses. If a taxpayer is
engaged in both an excepted trade or
business and a non-excepted trade or
business described in this paragraph
(b)(13), the taxpayer must allocate items
between the trades or businesses. See
§§ 1.163(j)–1(b)(38) and 1.163(j)–
10(c)(3)(iii)(C). Some trades or
businesses with de minimis furnishing
or sales of items described in paragraph
(b)(13)(i)(A) of this section that are not
sold pursuant to rates determined on a
cost of service and rate of return basis
as required in paragraph (b)(13)(i)(B)(1)
of this section, or by the governing or
ratemaking body of an electric
cooperative as required in paragraph
(b)(13)(i)(B)(2) of this section are treated
as excepted trades or businesses. See
§ 1.163(j)–10(c)(3)(iii)(C)(3).
(14) Excess business interest expense.
The term excess business interest
expense means, with respect to a
partnership, the amount of disallowed
business interest expense of the
partnership for a taxable year under
section § 1.163(j)–2(b), except as
provided in § 1.163(j)–6(h)(2).
(15) Excess taxable income. With
respect to any partnership or S
corporation, the term excess taxable
income means the amount which bears
the same ratio to the partnership’s ATI
as—
(i) The excess (if any) of—
(A) The amount determined for the
partnership or S corporation under
section 163(j)(1)(B); over
(B) The amount (if any) by which the
business interest expense of the
partnership, reduced by the floor plan
financing interest expense, exceeds the
business interest income of the
partnership or S corporation; bears to
(ii) The amount determined for the
partnership or S corporation under
section 163(j)(1)(B).
(16) Floor plan financing
indebtedness. The term floor plan

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financing indebtedness means
indebtedness—
(i) Used to finance the acquisition of
motor vehicles held for sale or lease;
and
(ii) Secured by the inventory so
acquired.
(17) Floor plan financing interest
expense. The term floor plan financing
interest expense means interest paid or
accrued on floor plan financing
indebtedness. For purposes of the
section 163(j) regulations, all floor plan
financing interest expense is treated as
business interest expense. See
paragraph (b)(2) of this section.
(18) Group. The term group has the
meaning provided in § 1.1502–1(a).
(19) Intercompany transaction. The
term intercompany transaction has the
meaning provided in § 1.1502–
13(b)(1)(i).
(20) Interest. The term interest means
any amount described in paragraph
(b)(20)(i), (ii), (iii), or (iv) of this section.
(i) In general. Interest is an amount
paid, received, or accrued as
compensation for the use or forbearance
of money under the terms of an
instrument or contractual arrangement,
including a series of transactions, that is
treated as a debt instrument for
purposes of section 1275(a) and
§ 1.1275–1(d), and not treated as stock
under § 1.385–3, or an amount that is
treated as interest under other
provisions of the Internal Revenue Code
(Code) or the regulations thereunder.
Thus, for example, interest includes—
(A) Original issue discount (OID), as
adjusted by the holder for any
acquisition premium or amortizable
bond premium;
(B) Qualified stated interest, as
adjusted by the holder for any
amortizable bond premium or by the
issuer for any bond issuance premium;
(C) Acquisition discount;
(D) Amounts treated as taxable OID
under section 1286 (relating to stripped
bonds and stripped coupons);
(E) Accrued market discount on a
market discount bond to the extent
includible in income by the holder
under either section 1276(a) or 1278(b);
(F) OID includible in income by a
holder that has made an election under
§ 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 § 1.1275–6;
(H) Repurchase premium to the extent
deductible by the issuer under § 1.163–
7(c);
(I) Deferred payments treated as
interest under section 483;
(J) Amounts treated as interest under
a section 467 rental agreement;

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(K) Amounts treated as interest under
section 988;
(L) Forgone interest under section
7872;
(M) De minimis OID taken into
account by the issuer;
(N) Amounts paid or received in
connection with a sale-repurchase
agreement treated as indebtedness
under Federal tax principles; in the case
of a sale-repurchase agreement relating
to tax-exempt bonds, however, the
amount is not tax-exempt interest;
(O) Redeemable ground rent treated as
interest under section 163(c); and
(P) Amounts treated as interest under
section 636.
(ii) Swaps with significant
nonperiodic payments—(A) Noncleared swaps. A swap other than a
cleared swap with significant
nonperiodic payments is treated as two
separate transactions consisting of an
on-market, level payment swap and a
loan. The loan must be accounted for by
the parties to the contract
independently of the swap. The time
value component associated with the
loan, determined in accordance with
§ 1.446–3(f)(2)(iii)(A), is recognized as
interest expense to the payor and
interest income to the recipient.
(B) [Reserved]
(iii) Other amounts treated as
interest—(A) Treatment of premium—
(1) Issuer. If a debt instrument is issued
at a premium within the meaning of
§ 1.163–13, any ordinary income under
§ 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 § 1.171–1 and the
holder elects to amortize the premium,
any amount otherwise deductible under
section 171(a)(1) as a bond premium
deduction under § 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 § 1.1275–4(b), a
nonfunctional currency contingent
payment debt instrument subject to
§ 1.988–6, or an inflation-indexed debt
instrument subject to § 1.1275–7
recognizes ordinary income on the debt
instrument in accordance with the rules
in § 1.1275–4(b), § 1.988–6(b)(2), or
§ 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 § 1.1275–4(b), a
nonfunctional currency contingent
payment debt instrument subject to
§ 1.988–6, or an inflation-indexed debt
instrument subject to § 1.1275–7

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recognizes an ordinary loss on the debt
instrument in accordance with the rules
in § 1.1275–4(b), § 1.988–6(b)(2), or
§ 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
§ 1.861–2(a)(7) is treated as interest
expense to the payor or interest income
to the recipient; in the case of a salerepurchase agreement or a securities
lending transaction relating to taxexempt bonds, however, the recipient of
a substitute payment does not receive
tax-exempt interest income.
(D) Section 1258 gain. Any gain
treated as ordinary gain under section
1258 is treated as interest income.
(E) Amounts affecting a taxpayer’s
effective cost of borrowing. Income,
deduction, gain, or loss from a
derivative, as defined in section
59A(h)(4)(A), that alters a taxpayer’s
effective cost of borrowing with respect
to a liability of the taxpayer is treated
as an adjustment to interest expense of
the taxpayer. For example, a taxpayer
that is obligated to pay interest at a
floating rate on a note and enters into an
interest rate swap that entitles the
taxpayer to receive an amount that is
equal to or that closely approximates the
interest rate on the note in exchange for
a fixed amount is, in effect, paying
interest expense at a fixed rate by
entering into the interest rate swap.
Income, deduction, gain, or loss from
the swap is treated as an adjustment to
interest expense. Similarly, any gain or
loss resulting from a termination or
other disposition of the swap is an
adjustment to interest expense, with the
timing of gain or loss subject to the rules
of § 1.446–4.
(F) Yield adjustments. Income,
deduction, gain, or loss from a
derivative, as defined in section
59A(h)(4)(A), that alters a taxpayer’s
effective yield with respect to a debt
instrument held by the taxpayer is
treated as an adjustment to interest
income by the taxpayer.
(G) Certain amounts labeled as fees—
(1) Commitment fees. Any fees in
respect of a lender commitment to
provide financing are treated as interest
if any portion of such financing is
actually provided.
(2) [Reserved]
(H) Debt issuance costs. Any debt
issuance costs subject to § 1.446–5 are
treated as interest expense of the issuer.
(I) Guaranteed payments. Any
guaranteed payments for the use of
capital under section 707(c) are treated
as interest.
(J) Factoring income. The excess of
the amount that a taxpayer collects on

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a factored receivable (or realizes upon
the sale or other disposition of the
factored receivable) over the amount
paid for the factored receivable by the
taxpayer is treated as interest income.
For purposes of this paragraph
(b)(20)(iii)(J), the term factored
receivable includes any account
receivable or other evidence of
indebtedness, whether or not issued at
a discount and whether or not bearing
stated interest, arising out of the
disposition of property or the
performance of services by any person,
if such account receivable or evidence
of indebtedness is acquired by a person
other than the person who disposed of
the property or provided the services
that gave rise to the account receivable
or evidence of indebtedness.
(iv) Anti-avoidance rule for amounts
predominantly associated with the time
value of money. Any expense or loss, to
the extent deductible, incurred by a
taxpayer in a transaction or series of
integrated or related transactions in
which the taxpayer secures the use of
funds for a period of time is treated as
interest expense of the taxpayer if such
expense or loss is predominantly
incurred in consideration of the time
value of money.
(v) Examples. The examples in this
paragraph (b)(20)(v) illustrate the
application of paragraphs (b)(20)(i)
through (iv) of this section. Unless
otherwise indicated, assume the
following: A, B, C, D, and Bank are
domestic C corporations that are
publicly traded; the exemption for
certain small businesses in § 1.163(j)–
2(d) does not apply; A is not engaged in
an excepted trade or business; and all
amounts of interest expense are
deductible except for the potential
application of section 163(j).
(A) Example 1—(1) Facts. (i) A is a
calendar year taxpayer that is engaged in a
manufacturing business. In January 2019, A,
which has an investment-grade credit rating,
enters into the following transactions (the
transactions): Bank transfers a portfolio of
U.S. Treasury bonds (the Treasury portfolio)
to A; A agrees to pay Bank an amount
equivalent to any interest paid on the
Treasury portfolio during the transactions
and a fee for lending the Treasury portfolio
to A; A agrees to return to Bank securities
that are substantially identical to the
Treasury portfolio upon request, regardless of
any value increases or decreases in the
market value of the Treasury portfolio; A
rehypothecates the Treasury portfolio in
exchange for cash, which A uses to purchase
a portfolio of corporate bonds (the debt
portfolio); and the transactions remain in
place for the duration of the 2019 calendar
year until Bank delivers a notice to A
recalling the Treasury portfolio 5 business
days before December 31, 2019.

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

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

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(22) Interest income. The term interest
income means interest that is included
in gross income for the taxable year.
(23) Inventory. The term inventory
means property held for sale or for
lease, or both, by a taxpayer in the
ordinary course of its trade or business.
(24) Member. The term member has
the meaning provided in § 1.1502–1(b).
(25) Motor vehicle. The term motor
vehicle means a motor vehicle as
defined in section 163(j)(9)(C).
(26) Old section 163(j). The term old
section 163(j) means section 163(j)
immediately prior to its amendment by
Public Law 115–97, 131 Stat. 2054
(2017).
(27) Real estate investment trust. The
term real estate investment trust (REIT)
has the meaning provided in section
856.
(28) Real property. The term real
property includes—
(i) Real property as defined in
§ 1.469–9(b)(2); and
(ii) Any direct or indirect right,
including a license or other contractual
right, to share in the appreciation in
value of, or the gross or net proceeds or
profits generated by, an interest in real
property, including net proceeds or
profits associated with tolls, rents or
other similar fees.
(29) Regulated investment company.
The term regulated investment company
(RIC) has the meaning provided in
section 851.
(30) S corporation. The term S
corporation has the meaning provided
in section 1361(a)(1).
(31) Section 163(j) limitation. The
term section 163(j) limitation means the
limit on the amount of business interest
expense that a taxpayer may deduct in
a taxable year under section 163(j) and
§ 1.163(j)–2(b).
(32) Section 163(j) regulations. The
term section 163(j) regulations means
this section and §§ 1.163(j)–2 through
1.163(j)–11.
(33) Separate return limitation year.
The term separate return limitation year
(SRLY) has the meaning provided in
§ 1.1502–1(f).
(34) Separate return year. The term
separate return year has the meaning
provided in § 1.1502–1(e).
(35) Separate taxable income. The
term separate taxable income has the
meaning provided in § 1.1502–12.
(36) Tax-exempt corporation. The
term tax-exempt corporation means any
corporation subject to tax under section
511.
(37) Taxable income—(i) In general.
The term taxable income, with respect
to a taxpayer and a taxable year, has the
meaning provided in section 63, but for
this purpose computed without regard

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to the application of section 163(j) and
the section 163(j) regulations.
(ii) General rules to coordinate the
application of sections 163(j) and 250.
If for a taxable year a taxpayer is
allowed a deduction under section
250(a)(1) that is properly allocable to a
non-excepted trade or business, then
taxable income for the taxable year is
determined without regard to the
limitation in section 250(a)(2). For this
purpose, the amount of the deduction
allowed under section 250(a)(1),
without regard to the limitation in
section 250(a)(2), is determined without
regard to the application of section
163(j) and the section 163(j) regulations.
(iii) [Reserved]
(iv) Special rules for defining taxable
income. (A) For special rules defining
the taxable income of a RIC or REIT, see
§ 1.163(j)–4(b)(4)(ii).
(B) For special rules defining the
taxable income of consolidated groups,
see § 1.163(j)–4(d)(2)(iv).
(C) For special rules defining the
taxable income of a partnership, see
§ 1.163(j)–6(d)(1).
(D) For special rules defining the
taxable income of an S corporation, see
§ 1.163(j)–6(l)(3).
(E) For special rules defining the
taxable income of certain controlled
foreign corporations, see § 1.163(j)–
7(c)(1).
(38) Trade or business—(i) In general.
The term trade or business means a
trade or business within the meaning of
section 162.
(ii) Excepted trade or business. The
term excepted trade or business means
a trade or business that is described in
paragraphs (b)(38)(ii)(A) through (D) of
this section. For additional rules related
to excepted trades or businesses,
including elections made under section
163(j)(7)(B) and (C), see § 1.163(j)–9.
(A) The trade or business of
performing services as an employee.
(B) Any electing real property trade or
business.
(C) Any electing farming business.
(D) Any excepted regulated utility
trade or business.
(iii) Non-excepted trade or business.
The term non-excepted trade or
business means any trade or business
that is not an excepted trade or
business.
(39) Unadjusted basis. The term
unadjusted basis means the basis as
determined under section 1012 or other
applicable sections of chapter 1 of
subtitle A of the Code, including
subchapters O (relating to gain or loss
on dispositions of property), C (relating
to corporate distributions and
adjustments), K (relating to partners and
partnerships), and P (relating to capital

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67541

gains and losses) of the Code.
Unadjusted basis is determined without
regard to any adjustments described in
section 1016(a)(2) or (3), to any
adjustments for tax credits claimed by
the taxpayer (for example, under section
50(c)), or to any adjustments for any
portion of the basis for which the
taxpayer has elected to treat as an
expense (for example, under section
179, 179B, or 179C).
(c) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99, (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–2 Deduction for business
interest expense limited.

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

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Under section 163(j)(2), any business
interest expense disallowed under
paragraph (b) of this section, or any
disallowed disqualified interest that is
properly allocable to a non-excepted
trade or business under § 1.163(j)–10, is
carried forward to the succeeding
taxable year as business interest expense
that is subject to paragraph (b) of this
section in such succeeding taxable year
(a disallowed business interest expense
carryforward).
(2) Coordination with small business
exemption. If disallowed business
interest expense is carried forward
under the rules of paragraph (c)(1) of
this section to a taxable year in which
the small business exemption in
paragraph (d) of this section applies to
the taxpayer, then the general rule in
paragraph (b) of this section does not
apply to limit the deduction of the
disallowed business interest expense
carryforward in that taxable year.
(3) Cross-references—(i) For special
rules regarding disallowed business
interest expense carryforwards for
taxpayers that are C corporations,
including members of a consolidated
group, see § 1.163(j)–5.
(ii) For special rules regarding
disallowed business interest expense
carryforwards of S corporations, see
§§ 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
§ 1.163(j)–6.
(iv) For special rules regarding
disallowed business interest expense
carryforwards from partnerships
engaged in a U.S. trade or business, see
§ 1.163(j)–8(c)(2).
(d) Small business exemption—(1)
Exemption. The general rule in
paragraph (b) of this section does not
apply to any taxpayer, other than a tax
shelter as defined in section 448(d)(3),
in any taxable year if the taxpayer meets
the gross receipts test of section 448(c)
and the regulations thereunder for the
taxable year.
(2) Application of the gross receipts
test—(i) In general. In the case of any
taxpayer that is not a corporation or a
partnership, and except as provided in
paragraphs (d)(2)(ii), (iii), and (iv) of this
section, the gross receipts test and
aggregation rules of section 448(c) and
the regulations thereunder are applied
in the same manner as if such taxpayer
were a corporation or partnership.
(ii) Gross receipts of individuals.
Except as provided in paragraph
(d)(2)(iii) of this section regarding
partnership and S corporation interests
and when the aggregation rules of
section 448(c) apply, an individual
taxpayer’s gross receipts include all

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items specified as gross receipts in
regulations under section 448(c),
whether or not derived in the ordinary
course of the taxpayer’s trade or
business. For purposes of section 163(j),
an individual taxpayer’s gross receipts
do not include inherently personal
amounts, including, but not limited to,
personal injury awards or settlements
with respect to an injury of the
individual taxpayer, disability benefits,
Social Security benefits received by the
taxpayer during the taxable year, and
wages received as an employee that are
reported on Form W–2.
(iii) Partners and S corporation
shareholders. Except when the
aggregation rules of section 448(c)
apply, each partner in a partnership
includes a share of partnership gross
receipts in proportion to such partner’s
distributive share (as determined under
section 704) of items of gross income
that were taken into account by the
partnership under section 703.
Additionally, each shareholder in an S
corporation includes a pro rata share of
S corporation gross receipts.
(iv) Tax-exempt organizations. For
purposes of section 163(j), the gross
receipts of an organization subject to tax
under section 511 includes only gross
receipts taken into account in
determining its unrelated business
taxable income.
(e) REMICs. For the treatment of
interest expense by a REMIC as defined
in section 860D, see § 1.860C–2(b)(2)(ii).
(f) Calculation of ATI with respect to
certain beneficiaries. The ATI of a trust
or estate beneficiary is reduced by any
income (including any distributable net
income) received from the trust or estate
by the beneficiary to the extent such
income supported a deduction for
business interest expense under section
163(j)(1)(B) or § 1.163(j)–2(b)(2) in
computing the trust or estate’s taxable
income.
(g) Examples. The examples of this
paragraph (g) illustrate the application
of section 163(j) and the provisions of
this section. Unless otherwise indicated,
assume the following: X and Y are
domestic C corporations; C and D are
U.S. resident individuals not subject to
any foreign income tax; PRS is a
domestic partnership with partners who
are all individuals; all taxpayers use a
calendar taxable year; the exemption for
certain small businesses in section
163(j)(3) and paragraph (d) of this
section does not apply; and the interest
expense would be deductible but for
section 163(j).
(1) Example 1: Limitation on business
interest expense deduction—(i) Facts. During
its taxable year ending December 31, 2019, X
has ATI of $100x. X has business interest

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

TABLE 1 TO PARAGRAPH (g)(3)(II)(A)

Taxable income: ...............................
Less:
Floor plan financing interest ......
Business interest income ..........

$30x
10x
20x
0x

(B) Plus:

TABLE 1 TO PARAGRAPH (g)(3)(II)(B)

Business interest expense ........
Net operating loss deduction ....
Depreciation deduction ..............

$50x
25x
15x

ATI .............................................

90x

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

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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 § 1.163(j)–10 the
interest paid on the loan to purchase the
convertibles is properly allocable to C’s
dealership trade or business, and because
floor plan financing interest expense is also
business interest expense, C has $50x of
business interest expense for the 2019 taxable
year.
(5) Example 5: Interest not properly
allocable to non-excepted trade or business—
(i) Facts. The facts are the same as in
Example 4 in paragraph (g)(4)(i) of this
section, except that the $20x of interest C
pays is on acquisition indebtedness obtained
to purchase C’s personal residence and not to
purchase convertibles for C’s dealership trade
or business.
(ii) Analysis. Because the $20x of interest
expense is not properly allocable to a nonexcepted trade or business, and therefore is
not business interest expense as defined in
§ 1.163(j)–1(b)(2), C’s only business interest
expense is the $30x that C pays on the loan
used to purchase sedans for sale in C’s
dealership trade or business. C deducts the
$20x of interest related to his residence
under the rules of section 163(h), without
regard to section 163(j).
(6) Example 6: Small business exemption—
(i) Facts. During the 2019 taxable year, D, the
sole proprietor of a trade or business reported
on Schedule C, has interest expense properly
allocable to that trade or business. D also
earns gross income from providing services
as an employee that is reported on a Form
W–2. Under section 448(c) and the
regulations thereunder, D has average annual
gross receipts of $21 million, including $1
million of wages in each of the three prior
taxable years and $2 million of income from
investments not related to a trade or business
in each of the three prior taxable years. Also,
in each of the three prior taxable years, D
received $5 million in periodic payments of
compensatory damages awarded in a
personal injury lawsuit.
(ii) Analysis. Section 163(j) does not apply
to D for the taxable year, because D qualifies
for the small business exemption under
§ 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
§ 1.163(j)–2(d)(2)(ii). D may deduct all of its
business interest expense for the 2019 taxable
year without regard to section 163(j).
(7) Example 7: Aggregation of gross
receipts—(i) Facts. X and Y are domestic C
corporations under common control, within
the meaning of section 52(a) and § 1.52–1(b).
X’s only trade or business is a farming
business described in § 1.263A–4(a)(4).

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During the taxable year ending December 31,
2019, X has average annual gross receipts
under section 448(c) of $6 million. During
the same taxable year, Y has average annual
gross receipts under section 448(c) of $21
million.
(ii) Analysis. Because X and Y are under
common control, they must aggregate gross
receipts for purposes of section 448(c) and
the small business exemption in § 1.163(j)–
2(d). See section 448(c)(2). Therefore, X and
Y are both considered to have $27 million in
average annual gross receipts for 2019. X and
Y must separately apply section 163(j) to
determine any limitation on the deduction
for business interest expense. Assuming X
otherwise meets the requirements in
§ 1.163(j)–9 in 2019, X may elect for its
farming business to be an excepted trade or
business.

(h) Anti-avoidance rule.
Arrangements entered into with a
principal purpose of avoiding the rules
of section 163(j) or the section 163(j)
regulations, including the use of
multiple entities to avoid the gross
receipts test of section 448(c), may be
disregarded or recharacterized by the
Commissioner of the IRS to the extent
necessary to carry out the purposes of
section 163(j).
(i) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99, (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–3 Relationship of business
interest deduction limitation to other
provisions affecting interest.

(a) Overview. This section contains
rules regarding the relationship between
section 163(j) and certain other
provisions of the Code. Paragraph (b) of
this section provides the general rules
concerning the relationship between
section 163(j) and certain other
provisions of the Code. Paragraph (c) of
this section provides examples
illustrating the application of this
section. For rules regarding the
relationship between sections 163(j) and
704(d), see § 1.163(j)–6(h)(1) and (2).
(b) Coordination of section 163(j) with
certain other provisions—(1) In general.
Section 163(j) and the section 163(j)

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

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§§ 1.163(j)–5(e) and 1.163(j)–11(b), the
regulations under sections 382 and 383,
and §§ 1.1502–91 through 1.1502–99.
(9) Other types of interest provisions.
Except as otherwise provided in the
section 163(j) regulations, provisions
that characterize interest expense as
something other than business interest
expense under section 163(j), such as
section 163(d), govern the treatment of
that interest expense, and such interest
expense will not be treated as business
interest expense for any purpose under
section 163(j).
(10) [Reserved]
(c) Examples. The examples of this
paragraph (c) illustrate the application
of section 163(j) and the provisions of
this section. Unless otherwise indicated,
assume the following: X and Y are
domestic C corporations with a calendar
taxable year; D is a U.S. resident
individual not subject to any foreign
income tax; none of the taxpayers have
floor plan financing interest expense;
and the exemption for small businesses
in § 1.163(j)–2(d) does not apply.
(1) Example 1: Disallowed interest
expense—(i) Facts. In 2019, X has $30x of
interest expense. Of X’s interest expense,
$10x is permanently disallowed under
section 265. X’s business interest income is
$3x and X’s ATI is $90x.
(ii) Analysis. Under paragraph (b)(2) of this
section, the $10x interest expense that is
permanently disallowed under section 265
cannot be taken into consideration for
purposes of section 163(j) in the 2019 taxable
year. X’s section 163(j) limitation, or the
amount of business interest expense that X
may deduct is limited to $30x under
§ 1.163(j)–2(b), determined by adding X’s
business interest income ($3x) and 30
percent of X’s 2018 ATI ($27x). Therefore, in
the 2019 taxable year, none of the $20x of X’s
deduction for its business interest expense is
disallowed under section 163(j).
(2) Example 2: Deferred interest expense—
(i) Facts. In 2019, Y has no business interest
income, $120x of ATI, and $70x of interest
expense. Of Y’s interest expense, $30x is not
currently deductible under section 267(a)(2).
Assume that the $30x expense will be
allowed as a deduction under section
267(a)(2) in 2020.
(ii) Analysis. Under paragraph (b)(3) of this
section, section 267(a)(2) is applied before
section 163(j). Accordingly, $30x of Y’s
interest expense cannot be taken into
consideration for purposes of section 163(j)
in 2019 because it is not currently deductible
under section 267(a)(2). Accordingly, in
2019, if the interest expense is properly
allocable to a non-excepted trade or business,
Y will have $4x of disallowed business
interest expense because the $40x of business
interest expense in 2019 ($70x¥$30x)
exceeds 30 percent of its ATI for the taxable
year ($36x). The $30x of interest expense not
allowed as a deduction in the 2019 taxable
year under section 267(a)(2) will be taken
into account in determining the business
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163(j) in 2020, the taxable year in which it
is allowed as a deduction under section
267(a)(2), if it is allocable to a trade or
business. Additionally, the $4x of disallowed
business interest expense in 2019 will be
carried forward to 2020 as a disallowed
business interest expense carryforward. See
§ 1.163(j)–2(c).
(3) Example 3: Passive activity loss—(i)
Facts. D is engaged in a rental activity treated
as a passive activity within the meaning of
section 469. For tax year 2019, D receives
$200x of rental income and incurs $300x of
expenses all properly allocable to the rental
activity, consisting of $150x of interest
expense, $60x of maintenance expenses, and
$90x of depreciation expense. D’s ATI is
$400x.
(ii) Analysis. Under paragraph (b)(4) of this
section, section 163(j) is applied before the
section 469 passive loss rules apply. D’s
section 163(j) limitation is $120x, determined
by adding to D’s business interest income
($0), floor plan financing ($0), and 30 percent
of D’s ATI ($120x). See § 1.163(j)–2(b).
Because D’s business interest expense of
$150x exceeds D’s section 163(j) limitation
for 2019, $30x of D’s business interest
expense is disallowed under section 163(j)
and will be carried forward as a disallowed
business interest expense carryforward. See
§ 1.163(j)–2(c). Because the section 163(j)
limitation is applied before the limitation
under section 469, only $120x of the business
interest expense allowable under section
163(j) is included in determining D’s passive
activity loss limitation for the 2019 tax year
under section 469. The $30x of disallowed
business interest expense is not an allowable
deduction under section 163(j) and,
therefore, is not a deduction under section
469 in the current taxable year. See § 1.469–
2(d)(8).
(4) Example 4: Passive activity loss by
taxpayer that also participates in a nonpassive activity—(i) Facts. For 2019, D has no
business interest income and ATI of $1,000x,
entirely attributable to a passive activity
within the meaning of section 469. D has
business interest expense of $1,000x, $900x
of which is properly allocable to a passive
activity and $100x of which is properly
allocable to a non-passive activity in which
D materially participates. D has other
business deductions that are not subject to
section 469 of $600x, and a section 469
passive loss from the previous year of $250x.
(ii) Analysis. Under paragraph (b)(4) of this
section, section 163(j) is applied before the
section 469 passive loss rules apply. D’s
section 163(j) limitation is $300x, determined
by adding D’s business interest income ($0),
floor plan financing ($0), and 30 percent of
D’s ATI ($300x)). Next, applying the
limitation under section 469 to the $300x
business interest expense deduction
allowable under sections 163(a) and (j),
$270x (a proportionate amount of the $300x
(0.90 x $300x)) is business interest expense
included in determining D’s passive activity
loss limitation under section 469, and $30x
(a proportionate amount of the $300x (0.10 x
$300)) is business interest expense not
included in determining D’s passive activity
loss limitation under section 469. Because
D’s interest expense of $1,000x exceeds 30

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percent of its ATI for 2019, $700x of D’s
interest expense is disallowed under section
163(j) and will be carried forward as a
disallowed business interest expense
carryforward. Section 469 does not apply to
any portion of the $700x disallowed business
interest expense because that business
interest expense is not an allowable
deduction under section 163(j) and,
therefore, is not an allowable deduction
under section 469 in the current taxable year.
See § 1.469–2(d)(8).

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

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

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between excepted and non-excepted
trades or businesses, see § 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 § 1.163(j)–10.
(3) Investment interest, investment
income, and investment expenses of a
partnership with a C corporation
partner—(i) Characterization as expense
or income properly allocable to a trade
or business. For purposes of section
163(j), any investment interest, within
the meaning of section 163(d), that a
partnership pays or accrues and that is
allocated to a C corporation partner is
treated by the C corporation as interest
expense that is properly allocable to a
trade or business of that partner.
Similarly, for purposes of section 163(j),
except as provided in § 1.163(j)–
7(d)(1)(ii), any investment income or
investment expenses, within the
meaning of section 163(d), that a
partnership receives, pays, or accrues
and that is allocated to a C corporation
partner is treated by the C corporation
as properly allocable to a trade or
business of that partner.
(ii) Impact of characterization on
partnership. The characterization of a
partner’s investment interest,
investment income, or investment
expenses pursuant to paragraph (b)(3)(i)
of this section will not affect the
characterization of these items as
investment interest, investment income,
or investment expenses at the
partnership level.
(iii) Investment interest expense and
investment interest income of a
partnership not treated as excess
business interest expense or excess
taxable income of a C corporation
partner. Investment interest expense of
a partnership that is treated as business
interest expense by a C corporation
partner is not treated as excess business
interest expense. Investment interest
income of a partnership that is treated
as business interest income by a C
corporation partner is not treated as
excess taxable income. For rules
governing excess business interest
expense and excess taxable income, see
§ 1.163(j)–6.
(4) Application to RICs and REITs—(i)
In general. Except as otherwise
provided in paragraphs (b)(4)(ii) and
(iii) of this section, the rules in this
paragraph (b) apply to RICs and REITs.
(ii) Taxable income for purposes of
calculating the adjusted taxable income
of RICs and REITs. The taxable income

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of a RIC or REIT for purposes of
calculating adjusted taxable income
(ATI) is the taxable income of the
corporation, without any adjustment
that would be made under section
852(b)(2) or 857(b)(2) to compute
investment company taxable income or
real estate investment trust taxable
income, respectively. For example, the
taxable income of a RIC or REIT is not
reduced by the deduction for dividends
paid, but is reduced by the dividends
received deduction (DRD) and the other
deductions described in sections
852(b)(2)(C) and 857(b)(2)(A), taking
into account § 1.163(j)–1(b)(37)(ii). See
paragraph (b)(4)(iii) of this section for an
adjustment to adjusted taxable income
in respect of these items.
(iii) Other adjustments to adjusted
taxable income for RICs and REITs. In
the case of a taxpayer that, for a taxable
year, is a RIC to which section 852(b)
applies or a REIT to which section
857(b) applies, the taxpayer’s ATI for
the taxable year is increased by the
amounts of any deductions described in
section 852(b)(2)(C) or 857(b)(2)(A),
taking into account § 1.163(j)–
1(b)(37)(ii).
(5) Application to tax-exempt
corporations. The rules in this
paragraph (b) apply to a corporation that
is subject to the unrelated business
income tax under section 511 only with
respect to that corporation’s items of
income, gain, deduction, or loss that are
taken into account in computing the
corporation’s unrelated business taxable
income, as defined in section 512.
(6) Examples. The principles of this
paragraph (b) are illustrated by the
following examples. For purposes of the
examples in this paragraph (b)(6), T is
a taxable domestic C corporation whose
taxable year ends on December 31; T is
neither a consolidated group member
nor a RIC or a REIT; neither T nor PS1,
a domestic partnership, owns at least 80
percent of the stock of any corporation;
neither T nor PS1 qualifies for the small
business exemption in § 1.163(j)–2(d) or
is engaged in an excepted trade or
business; T has no floor plan financing
expense; all interest expense is
deductible except for the potential
application of section 163(j); and the
facts set forth the only corporate or
partnership activity.
(i) Example 1: C corporation items
properly allocable to a trade or business—(A)
Facts. In taxable year 2019, T’s taxable
income (without regard to the application of
section 163(j)) is $320x. This amount is
comprised of the following tax items: $1,000x
of revenue from inventory sales; $500x of
ordinary and necessary business expenses
(excluding interest and depreciation); $200x
of interest expense; $50x of interest income;

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$50x of depreciation deductions under
section 168; and a $20x gain on the sale of
stock.
(B) Analysis. For purposes of section 163(j),
each of T’s tax items is treated as properly
allocable to a trade or business. Thus, T’s ATI
for the 2019 taxable year is $520x ($320x of
taxable income + $200x business interest
expense¥$50x business interest income +
$50x depreciation deductions = $520x), and
its section 163(j) limitation for the 2019
taxable year is $206x ($50x of business
interest income + 30 percent of its ATI (30
percent × $520x) = $206x). As a result, all
$200x of T’s interest expense is deductible in
the 2019 taxable year under section 163(j).
(C) Taxable year beginning in 2022. The
facts are the same as in Example 1 in
paragraph (b)(6)(i)(A) of this section, except
that the taxable year is 2022 and therefore
depreciation deductions are not added back
to ATI under § 1.163(j)–1(b)(1)(i)(E). As a
result, T’s ATI for 2022 is $470x ($320x of
taxable income + $200x business interest
expense¥$50x business interest income =
$470x), and its section 163(j) limitation for
the 2022 taxable year is $191x ($50x of
business interest income + 30 percent of its
ATI (30 percent × $470x) = $191x). As a
result, T may only deduct $191x of its
business interest expense for the taxable year,
and the remaining $9x will be carried
forward to the 2023 taxable year as a
disallowed business interest expense
carryforward. See § 1.163(j)–2(c).
(ii) Example 2: C corporation partner—(A)
Facts. T and individual A each own a 50
percent interest in PS1, a general partnership.
PS1 borrows funds from a third party (Loan
1) and uses those funds to buy stock in
publicly-traded corporation X. PS1’s only
activities are holding X stock (and receiving
dividends) and making payments on Loan 1.
In the 2019 taxable year, PS1 receives $150x
in dividends and pays $100x in interest on
Loan 1.
(B) Analysis. For purposes of section
163(d) and (j), PS1 has investment interest
expense of $100x and investment income of
$150x, and PS1 has no interest expense or
interest income that is properly allocable to
a trade or business. PS1 allocates its
investment interest expense and investment
income to its two partners pursuant to
§ 1.163(j)–6(j). Pursuant to paragraph (b)(3) of
this section, T’s allocable share of PS1’s
investment interest expense is treated as a
business interest expense of T, and T’s
allocable share of PS1’s investment income is
treated as properly allocable to a trade or
business of T. This business interest expense
is not treated as excess business interest
expense, and this income is not treated as
excess taxable income. See paragraph
(b)(3)(iii) of this section. T’s treatment of its
allocable share of PS1’s investment interest
expense and investment income as business
interest expense and income properly
allocable to a trade or business, respectively,
does not affect the character of these items
at the PS1 level and does not affect the
character of A’s allocable share of PS1’s
investment interest and investment income.
(C) Partnership engaged in a trade or
business. The facts are the same as in
Example 2 in paragraph (b)(6)(ii)(A) of this

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

(c) Effect on earnings and profits—(1)
In general. In the case of a taxpayer that
is a C corporation, except as otherwise
provided in paragraph (c)(2) of this
section, the disallowance and
carryforward of a deduction for the
taxpayer‘s business interest expense
under § 1.163(j)–2 will not affect
whether or when the business interest
expense reduces the taxpayer’s earnings
and profits.
(2) Special rule for RICs and REITs. In
the case of a taxpayer that is a RIC or
a REIT for the taxable year in which a
deduction for the taxpayer’s business
interest expense is disallowed under
§ 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
§ 1.163(j)–6, the taxpayer’s earnings and
profits are adjusted in the taxable year
or years in which the business interest
expense is deductible or, if earlier, in
the first taxable year for which the
taxpayer no longer is a RIC or a REIT.
(3) Special rule for partners that are
C corporations. If a taxpayer that is a C
corporation is allocated any excess
business interest expense from a
partnership under section 163(j)(4)(B)(i)
and § 1.163(j)–6, and if any amount of
the excess business interest expense has
not yet been treated as business interest
expense by the taxpayer at the time of

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the taxpayer’s disposition of all or
substantially all of its interest in the
partnership, then the taxpayer must
increase its earnings and profits by that
amount immediately prior to its
disposition of the partnership interest.
(4) Examples. The principles of this
paragraph (c) are illustrated by the
following examples. For purposes of the
examples in this paragraph (c)(4), except
as otherwise provided in the examples,
X is a taxable domestic C corporation
whose taxable year ends on December
31; X is not a member of a consolidated
group; X does not qualify for the small
business exemption under § 1.163(j)–
2(d); X is not engaged in an excepted
trade or business; X has no floor plan
financing indebtedness; all interest
expense is deductible except for the
potential application of section 163(j); X
has no accumulated earnings and profits
at the beginning of the 2019 taxable
year; and the facts set forth the only
corporate activity.
(i) Example 1: Earnings and profits of a
taxable domestic C corporation other than a
RIC or a REIT—(A) Facts. X is a corporation
that does not intend to qualify as a RIC or a
REIT for its 2019 taxable year. In that year,
X has taxable income (without regard to the
application of section 163(j)) of $0, which
includes $100x of gross income and $100x of
interest expense on a loan from an unrelated
third party. X also makes a $100x
distribution to its shareholders that year.
(B) Analysis. The $100x of interest expense
is business interest expense for purposes of
section 163(j) (see paragraph (b)(1) of this
section). X’s ATI in the 2019 taxable year is
$100x ($0 of taxable income computed
without regard to $100x of business interest
expense). Thus, X may deduct $30x of its
$100x of business interest expense in the
2019 taxable year under § 1.163(j)–2(b) (30
percent × $100x), and X may carry forward
the remainder ($70x) to X’s 2020 taxable year
as a disallowed business interest expense
carryforward under § 1.163(j)–2(c). Although
X may not currently deduct all $100x of its
business interest expense in the 2019 taxable
year, X must reduce its earnings and profits
in that taxable year by the full amount of its
business interest expense ($100x) in that
taxable year. As a result, no portion of X’s
distribution of $100x to its shareholders in
the 2019 taxable year is a dividend within
the meaning of section 316(a).
(ii) Example 2: RIC adjusted taxable
income and earnings and profits—(A) Facts.
X is a corporation that intends to qualify as
a RIC for its 2019 taxable year. In that taxable
year, X’s only items are $100x of interest
income, $50x of dividend income from C
corporations that only issue common stock
and in which X has less than a twenty
percent interest (by vote and value), $10x of
net capital gain, and $125x of interest
expense. None of the dividends are received
on debt financed portfolio stock under
section 246A. The DRD determined under
section 243(a) with respect to X’s $50x of
dividend income is $25x. X pays $42x in

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dividends to its shareholders, meeting the
requirements of section 562 during X’s 2019
taxable year, including $10x that X reports as
capital gain dividends in written statements
furnished to X’s shareholders.
(B) Analysis. (1) Under paragraph (b) of
this section, all of X’s interest expense is
considered business interest expense, all of
X’s interest income is considered business
interest income, and all of X’s other income
is considered to be properly allocable to a
trade or business. Under paragraph (b)(4)(ii)
of this section, prior to the application of
section 163(j), X’s taxable income is $10x
($100x business interest income + $50x
dividend income + $10x net capital
gain¥$125x business interest expense¥$25x
DRD = $10x). Under paragraph (b)(4)(iii) of
this section, X’s ATI is increased by the DRD.
As such, X’s ATI for the 2019 taxable year
is $60x ($10x taxable income + $125x
business interest expense¥$100x business
interest income + $25x DRD = $60x).
(2) X may deduct $118x of its $125x of
business interest expense in the 2019 taxable
year under section 163(j)(1) ($100x business
interest income + (30 percent × $60x of ATI)
= $118x), and X may carry forward the
remainder ($7x) to X’s taxable year ending
December 31, 2020. See § 1.163(j)–2(b) and
(c).
(3) After the application of section 163(j),
X has taxable income of $17x ($100x interest
income + $50x dividend income + $10x
capital gain¥$25x DRD¥$118x allowable
interest expense = $17x) for the 2019 taxable
year. X will have investment company
taxable income (ICTI) in the amount of $0
($17x taxable income¥$10x capital gain +
$25x DRD¥$32x dividends paid deduction
for ordinary dividends = 0). The excess of X’s
net capital gain ($10x) over X’s dividends
paid deduction determined with reference to
capital gain dividends ($10x) is also $0.
(4) Under paragraph (c)(2) of this section,
X will not reduce its earnings and profits by
the amount of interest expense disallowed as
a deduction in the 2019 taxable year under
section 163(j). Thus, X has current earnings
and profits in the amount of $42x ($100x
interest income + $50x dividend income +
$10x capital gain¥$118x allowable business
interest expense = $42x) before giving effect
to dividends paid during the 2019 taxable
year.
(iii) Example 3: Carryforward of disallowed
interest expense—(A) Facts. The facts are the
same as the facts in Example 2 in paragraph
(c)(4)(ii)(A) of this section for the 2019
taxable year. In addition, X has $50x of
interest income and $20x of interest expense
for the 2020 taxable year.
(B) Analysis. Under paragraph (b) of this
section, all of X’s interest expense is
considered business interest expense, all of
X’s interest income is considered business
interest income, and all of X’s other income
is considered to be properly allocable to a
trade or business. Because X’s $50x of
business interest income exceeds the $20x of
business interest expense from the 2020
taxable year and the $7x of disallowed
business interest expense carryforward from
the 2019 taxable year, X may deduct $27x of
business interest expense in the 2020 taxable
year. Under paragraph (c)(2) of this section,

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X must reduce its current earnings and
profits for the 2020 taxable year by the full
amount of the deductible business interest
expense ($27x).
(iv) Example 4: REIT adjusted taxable
income and earnings and profits—(A) Facts.
X is a corporation that intends to qualify as
a REIT for its 2019 taxable year. X is not
engaged in an excepted trade or business and
is not engaged in a trade or business that is
eligible to make any election under section
163(j)(7). In that year, X’s only items are
$100x of mortgage interest income, $30x of
dividend income from C corporations that
only issue common stock and in which X has
less than a ten percent interest (by vote and
value) in each C corporation, $10x of net
capital gain from the sale of mortgages on
real property that is not property described
in section 1221(a)(1), and $125x of interest
expense. None of the dividends are received
on debt financed portfolio stock under
section 246A. The DRD determined under
section 243(a) with respect to X’s $30x of
dividend income is $15x. X pays $28x in
dividends meeting the requirements of
section 562 during X’s 2019 taxable year,
including $10x that X properly designates as
capital gain dividends under section
857(b)(3)(B).
(B) Analysis. (1) Under paragraph (b) of
this section, all of X’s interest expense is
considered business interest expense, all of
X’s interest income is considered business
interest income, and all of X’s other income
is considered to be properly allocable to a
trade or business. Under paragraph (b)(4)(ii)
of this section, prior to the application of
section 163(j), X’s taxable income is $0
($100x business interest income + $30x
dividend income + $10x net capital
gain¥$125x business interest expense¥$15x
DRD = $0). Under paragraph (b)(4)(iii) of this
section, X’s ATI is increased by the DRD. As
such, X’s ATI for the 2019 taxable year is
$40x ($0 taxable income + $125x business
interest expense¥$100x business interest
income + $15x DRD = $40x).
(2) X may deduct $112x of its $125x of
business interest expense in the 2019 taxable
year under section 163(j)(1) ($100x business
interest income + (30 percent × $40x of ATI)
= $112x), and X may carry forward the
remainder of its business interest expense
($13x) to X’s 2020 taxable year.
(3) After the application of section 163(j),
X has taxable income of $13x ($100x
business interest income + $30x dividend
income + $10x capital gain¥$15x
DRD¥$112x allowable business interest
expense = $13x) for the 2019 taxable year. X
will have real estate investment trust taxable
income (REITTI) in the amount of $0 ($13x
taxable income + $15x of DRD¥$28x
dividends paid deduction = $0).
(4) Under paragraph (c)(2) of this section,
X will not reduce earnings and profits by the
amount of business interest expense
disallowed as a deduction in the 2019 taxable
year. Thus, X has current earnings and profits
in the amount of $28x ($100x business
interest income + $30x dividend income +
$10x capital gain¥$112x allowable business
interest expense = $28x) before giving effect
to dividends paid during X’s 2019 taxable
year.

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(v) Example 5: Carryforward of disallowed
interest expense—(A) Facts. The facts are the
same as in Example 4 in paragraph
(c)(4)(iv)(A) of this section for the 2019
taxable year. In addition, X has $50x of
mortgage interest income and $20x of interest
expense for the 2020 taxable year. X has no
other tax items for the 2020 taxable year.
(B) Analysis. Because X’s $50x of business
interest income exceeds the $20x of business
interest expense from the 2020 taxable year
and the $13x of disallowed business interest
expense carryforwards from the 2019 taxable
year, X may deduct $33x of business interest
expense in 2020. Under paragraph (c)(2) of
this section, X must reduce its current
earnings and profits for 2020 by the full
amount of the deductible interest expense
($33x).

(d) Special rules for consolidated
groups—(1) Scope. This paragraph (d)
provides certain rules applicable to
members of a consolidated group. For
all members of a consolidated group for
a consolidated return year, the
computations required by section 163(j)
and the section 163(j) regulations are
made in accordance with the rules of
this paragraph (d) unless otherwise
provided elsewhere in the section 163(j)
regulations. For rules governing the
carryforward of disallowed business
interest expense, including rules
governing the treatment of disallowed
business interest expense carryforwards
when members enter or leave a group,
see § 1.163(j)–5.
(2) Calculation of the section 163(j)
limitation for members of a
consolidated group—(i) In general. A
consolidated group has a single section
163(j) limitation, the absorption of
which is governed by § 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
§ 1.1502–13(g)(2)(ii), intercompany
items, as defined in § 1.1502–13(b)(2), or
corresponding items, as defined in
§ 1.1502–13(b)(3), are treated as interest
within the meaning of § 1.163(j)–
1(b)(20), all members of a consolidated
group are treated as a single taxpayer.
(iii) Calculation of business interest
expense and business interest income
for a consolidated group. For purposes
of calculating the section 163(j)
limitation for a consolidated group, the
consolidated group’s current-year
business interest expense (as defined in
§ 1.163(j)–5(a)(2)(i)) and business
interest income, respectively, are the
sum of each member’s current-year
business interest expense and business
interest income, including amounts
treated as business interest expense and
business interest income under
paragraph (b)(3) of this section.

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67547

(iv) Calculation of adjusted taxable
income. For purposes of calculating the
ATI for a consolidated group, the
relevant taxable income is the
consolidated group’s consolidated
taxable income, determined under
§ 1.1502–11 without regard to any
carryforwards or disallowances under
section 163(j). Additionally, if for a
taxable year a member of a consolidated
group is allowed a deduction under
section 250(a)(1) that is properly
allocable to a non-excepted trade or
business, then, for purposes of
calculating ATI, consolidated taxable
income for the taxable year is
determined as if the deduction were not
subject to the limitation in section
250(a)(2). For this purpose, the amount
of the deduction allowed under section
250(a)(1) is determined without regard
to the application of section 163(j) and
the section 163(j) regulations. Further,
for purposes of calculating the ATI of
the group, intercompany items and
corresponding items are disregarded to
the extent that they offset in amount.
Thus, for example, certain portions of
the intercompany items and
corresponding items of a group member
engaged in a non-excepted trade or
business will not be included in ATI to
the extent that the counterparties to the
relevant intercompany transactions are
engaged in one or more excepted trades
or businesses.
(v) Treatment of intercompany
obligations. For purposes of determining
a member’s business interest expense
and business interest income, and for
purposes of calculating the consolidated
group’s ATI, all intercompany
obligations, as defined in § 1.1502–
13(g)(2)(ii), are disregarded. Therefore,
interest expense and interest income
from intercompany obligations are not
treated as business interest expense and
business interest income.
(3) Investment adjustments. For rules
governing investment adjustments
within a consolidated group, see
§ 1.1502–32(b).
(4) Ownership of partnership interests
by members of a consolidated group—
(i) Dispositions of partnership interests.
The transfer of a partnership interest in
an intercompany transaction that does
not result in the termination of the
partnership is treated as a disposition
for purposes of the basis adjustment rule
in section 163(j)(4)(B)(iii)(II), regardless
of whether the transfer is one in which
gain or loss is recognized. See § 1.1502–
13 for rules applicable to the
redetermination of attributes of group
members. A change in status of a
member (becoming or ceasing to be a
member) is not treated as a disposition

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for purposes of section
163(j)(4)(B)(iii)(II).
(ii) Basis adjustments under § 1.1502–
32. A member’s allocation of excess
business interest expense from a
partnership and the resulting decrease
in basis in the partnership interest
under section 163(j)(4)(B) is not a
noncapital, nondeductible expense for
purposes of § 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
§ 1.1502–32(b)(3)(ii). Investment
adjustments are made under § 1.1502–
32(b)(3)(i) when the excess business
interest expense from the partnership is
absorbed by the consolidated group. See
§ 1.1502–32(b).
(iii) [Reserved]
(5) Examples. The principles of this
paragraph (d) are illustrated by the
following examples (see also § 1.1502–
13(c)(7)(ii)(R) and (S)). For purposes of
the examples in this paragraph (d)(5), S
is a member of the calendar-year
consolidated group of which P is the
common parent; the P group does not
qualify for the small business exemption
in § 1.163(j)–2(d); no member of the P
group is engaged in an excepted trade or
business; all interest expense is
deductible except for the potential
application of section 163(j); and the
facts set forth the only corporate
activity.
(i) Example 1: Calculation of the section
163(j) limitation—(A) Facts. In the 2019
taxable year, P has $50x of separate taxable
income after taking into account $65x of
interest paid on a loan from a third party
(without regard to any disallowance under
section 163(j)) and $35x of depreciation
deductions under section 168. In turn, S has
$40x of separate taxable income in the 2019
taxable year after taking into account $10x of
depreciation deductions under section 168. S
has no interest expense in the 2019 taxable
year. The P group’s consolidated taxable
income for the 2019 taxable year is $90x,
determined under § 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 × $150x = $45x), and a deduction for
$20x of its $65x of business interest expense
would be disallowed in the 2019 taxable year
under section 163(j). However, as provided in
paragraph (d)(2) of this section, the P group
computes a single section 163(j) limitation,
and that computation begins with the P
group’s consolidated taxable income (as

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determined prior to the application of section
163(j)), or $90x. The P group’s ATI is $200x
($50x + $40x + $65x + $35x + $10x = $200x).
Thus, the P group’s section 163(j) limitation
for the 2019 taxable year is $60x (30 percent
× $200x = $60x). As a result, all but $5x of
the P group’s business interest expense is
deductible in the 2019 taxable year. P carries
over the $5x of disallowed business interest
expense to the succeeding taxable year.
(ii) Example 2: Intercompany obligations—
(A) Facts. On January 1, 2019, G, a
corporation unrelated to P and S, lends P
$100x in exchange for a note that accrues
interest at a 10 percent annual rate. A month
later, P lends $100x to S in exchange for a
note that accrues interest at a 12 percent
annual rate. In 2019, P accrues and pays $10x
of interest to G on P’s note, and S accrues and
pays $12x of interest to P on S’s note. For
that year, the P group’s only other items of
income, gain, deduction, and loss are $40x of
income earned by S from the sale of
inventory, and a $30x deductible expense
arising from P’s payment of tort liability
claims.
(B) Analysis. As provided in paragraph
(d)(2)(v) of this section, the intercompany
obligation between P and S is disregarded in
determining P and S’s business interest
expense and business interest income and in
determining the P group’s ATI. For purposes
of section 163(j), P has $10x of business
interest expense and a $30x deduction for the
payment of tort liability claims, and S has
$40x of income. The P group’s ATI is $10x
($40x¥$30x = $10x), and its section 163(j)
limitation is $3x (30 percent x $10x = $3x).
The P group may deduct $3x of its business
interest expense in the 2019 taxable year. A
deduction for P’s remaining $7x of business
interest expense is disallowed in the 2019
taxable year, and this amount is carried
forward to the 2020 taxable year.

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

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rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.

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

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remaining current-year business interest
expense of the member after applying
the rule in paragraph (b)(3)(ii)(C)(2) of
this section, to the sum of the amounts
of remaining current-year business
interest expense for all members of the
consolidated group after applying the
rule in paragraph (b)(3)(ii)(C)(2) of this
section.
(b) Treatment of disallowed business
interest expense carryforwards—(1) In
general. The amount of any business
interest expense of a C corporation not
allowed as a deduction for any taxable
year as a result of the limitation under
section 163(j)(1) and § 1.163(j)–2(b) is
carried forward to the succeeding
taxable year as a disallowed business
interest expense carryforward under
section 163(j)(2) and § 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 currentyear business interest expense of
members of a consolidated group is
deducted in the current year before any
disallowed business interest expense
carryforwards from prior taxable years
are deducted in the current year.
Disallowed business interest expense
carryforwards from prior taxable years
are deducted in the order of the taxable
years in which they arose, beginning
with the earliest taxable year, subject to
the limitations described in this section.
(B) Section 163(j) limitation is equal
to or exceeds the current-year business
interest expense and disallowed
business interest expense carryforwards
from prior taxable years. If a
consolidated group’s section 163(j)
limitation for the current year is equal

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to or exceeds the aggregate amount of its
members’ current-year business interest
expense and disallowed business
interest expense carryforwards from
prior taxable years that are available for
deduction, then none of the current-year
business interest expense or disallowed
business interest expense carryforwards
will be subject to disallowance in the
current year under section 163(j).
However, a deduction for the members’
business interest expense may be
subject to limitation under other
provisions of the Code or the regulations
promulgated thereunder (see, for
example, paragraphs (c), (d), (e), and (f)
of this section).
(C) Current-year business interest
expense and disallowed business
interest expense carryforwards exceed
section 163(j) limitation. If the aggregate
amount of members’ current-year
business interest expense and
disallowed business interest expense
carryforwards from prior taxable years
exceeds the consolidated group’s
section 163(j) limitation for the current
year, then the following rules apply in
the order provided.
(1) The group first determines
whether its section 163(j) limitation for
the current year equals or exceeds the
aggregate amount of the members’
current-year business interest expense.
(i) If the group’s section 163(j)
limitation for the current year equals or
exceeds the aggregate amount of the
members’ current-year business interest
expense, then no amount of the group’s
current-year business interest expense
will be subject to disallowance in the
current year under section 163(j). Once
the group has taken into account its
members’ current-year business interest
expense, the group applies the rules of
paragraph (b)(3)(ii)(C)(4) of this section.
(ii) If the aggregate amount of
members’ current-year business interest
expense exceeds the group’s section
163(j) limitation for the current year,
then the group applies the rule in
paragraph (b)(3)(ii)(C)(2) of this section.
(2) If this paragraph (b)(3)(ii)(C)(2)
applies (see paragraph (b)(3)(ii)(C)(1)(ii)
of this section), then each member with
current-year business interest expense
and with current-year business interest
income or floor plan financing interest
deducts current-year business interest
expense in an amount that does not
exceed the sum of the member’s
business interest income and floor plan
financing interest expense for the
current year.
(3) After applying the rule in
paragraph (b)(3)(ii)(C)(2) of this section,
if the group has any section 163(j)
limitation remaining for the current
year, then each member with remaining

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67549

current-year business interest expense
deducts a portion of its expense based
on its allocable share of the
consolidated group’s remaining section
163(j) limitation.
(4) If this paragraph (b)(3)(ii)(C)(4)
applies (see paragraph (b)(3)(ii)(C)(1)(i)
of this section), and if the group has any
section 163(j) limitation remaining for
the current year after applying the rules
in paragraph (b)(3)(ii)(C)(1) of this
section, then disallowed business
interest expense carryforwards
permitted to be deducted in the current
year will be deducted in the order of the
taxable years in which they arose,
beginning with the earliest taxable year.
Disallowed business interest expense
carryforwards from taxable years ending
on the same date that are available to
offset consolidated taxable income for
the current year generally will be
deducted on a pro rata basis, under the
principles of paragraph (b)(3)(ii)(C)(3) of
this section. For example, assume that P
and S are the only members of a
consolidated group with a section 163(j)
limitation for the current year (Year 2)
of $200x; the amount of current-year
business interest expense deducted in
Year 2 is $100x; and P and S,
respectively, have $140x and $60x of
disallowed business interest expense
carryforwards from Year 1 that are not
subject to limitation under paragraph
(c), (d), or (e) of this section. Under
these facts, P would be allowed to
deduct $70x of its carryforwards from
Year 1 ($100x × ($140x/($60x + $140x))
= $70x), and S would be allowed to
deduct $30x of its carryforwards from
Year 1 ($100x × ($60x/($60x + $140x))
= $30x). But see § 1.383–1(d)(1)(ii),
providing that, if losses subject to and
not subject to the section 382 limitation
are carried from the same taxable year,
losses subject to the limitation are
deducted before losses not subject to the
limitation.
(5) Each member with remaining
business interest expense after applying
the rules of this paragraph (b)(3)(ii),
taking into account the limitations in
paragraphs (c), (d), (e), and (f) of this
section, will carry the expense forward
to the succeeding taxable year as a
disallowed business interest expense
carryforward under section 163(j)(2) and
§ 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

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offset consolidated taxable income in
the consolidated return year, are first
made available for deduction during
that consolidated return year. See
§ 1.1502–76(b)(1)(i); see also § 1.1502–
36(d) (regarding reductions of deferred
deductions on the transfer of loss shares
of subsidiary stock). Only the amount

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:

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,

TABLE 1 TO PARAGRAPH (b)(3)(iv)(A)(1)
P’s business interest
expense

Year
1 ...................................................................................................
2 ...................................................................................................
3 ...................................................................................................

(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 § 1.163(j)–2(d) nor
engaged in an excepted trade or business
within the meaning of § 1.163(j)–1(b)(38)(ii).
(B) Analysis—(1) Year 1. In Year 1, the
aggregate amount of the P group members’
current-year business interest expense ($150x
+ $50x) exceeds the P group’s section 163(j)
limitation ($100x). As a result, the rules of
paragraph (b)(3)(ii)(C) of this section apply.
Because the P group members’ current-year
business interest expense exceeds the group’s
section 163(j) limitation for Year 1, P and A
must apply the rule in paragraph
(b)(3)(ii)(C)(2) of this section. Pursuant to
paragraph (b)(3)(ii)(C)(2) of this section, each
of P and A must deduct its current-year
business interest expense to the extent of its
business interest income and floor plan
financing interest expense. Neither P nor A
has business interest income or floor plan
financing interest expense in Year 1. Next,
pursuant to paragraph (b)(3)(ii)(C)(3) of this
section, each of P and A must deduct a
portion of its current-year business interest
expense based on its allocable share of the
consolidated group’s remaining section 163(j)

A’s business interest
expense

$150x
60x
25x

$50x
90x
50x

limitation ($100x). P’s allocable share is $75x
($100x × ($150x/$200x) = $75x), and A’s
allocable share is $25x ($100x × ($50x/$200x)
= $25x). Accordingly, in Year 1, P deducts
$75x of its current-year business interest
expense, and A deducts $25x of its currentyear 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 group’s section 163(j)
limitation
$100x
120x
185x

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 × ($60x/$150x)) = $48x), and A’s
allocable share is $72x (($120x × ($90x/
$150x)) = $72x). Accordingly, in Year 2, P
deducts $48x of current-year business
interest expense, and A deducts $72x of
current-year business interest expense. P has
a disallowed business interest expense
carryforward from Year 2 of $12x
($60x¥$48x = $12x), and A has a disallowed
business interest expense carryforward from
Year 2 of $18x ($90x¥$72x = $18x).
Additionally, because the P group has no
section 163(j) limitation remaining after
deducting current-year business interest
expense in Year 2, the full amount of P and
A’s disallowed business interest expense
carryforwards from Year 1 ($75x and $25x,
respectively) also are carried forward to Year
3. As a result, at the beginning of Year 3, P
and A’s respective disallowed business
interest expense carryforwards are as follows:

TABLE 1 TO PARAGRAPH (b)(3)(iv)(B)(2)

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Year 1 disallowed
business interest
expense carryforwards

Year 2 disallowed
business interest
expense carryforwards

Total disallowed
business interest
expense carryforwards

P ...................................................................................................
A ...................................................................................................

$75x
25x

$12x
18x

$87x
43x

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

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expense will be subject to disallowance
under section 163(j) (see paragraph
(b)(3)(ii)(C)(1) of this section). After each of
P and A deducts its current-year business
interest expense, the P group has $110x of
section 163(j) limitation remaining for Year 3
($185x¥$25x¥$50x = $110x). Next,
pursuant to paragraph (b)(3)(ii)(C)(4) of this
section, $110x of disallowed business
interest expense carryforwards are deducted
on a pro rata basis, beginning with
carryforwards from Year 1. Because the total

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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

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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.

deducted by the group in that year
under paragraph (b)(3)(ii) of this section.
SRLY-limited disallowed business
interest expense carryforwards are
deducted on a pro rata basis (under the
principles of paragraph (b)(3)(ii)(C)(3) of
this section) with non-SRLY limited
disallowed business interest expense
carryforwards from taxable years ending
on the same date.
(3) Examples. The principles of this
paragraph (d) are illustrated by the
(c) Disallowed business interest
expense carryforwards in transactions to following examples. For purposes of the
examples in this paragraph (d)(3),
which section 381(a) applies. For rules
unless otherwise stated, P, R, S, and T
governing the application of section
are taxable domestic C corporations that
381(c)(20) to disallowed business
are not regulated investment companies
interest expense carryforwards,
(RICs) or real estate investment trusts
including limitations on an acquiring
(REITs) and that file their tax returns on
corporation’s use of the disallowed
business interest expense carryforwards a calendar-year basis; none of P, R, S, or
T qualifies for the small business
of the transferor or distributor
exemption under section 163(j)(3) or is
corporation in the acquiring
engaged in an excepted trade or
corporation’s first taxable year ending
business; all interest expense is
after the date of distribution or transfer,
deductible except for the potential
see § 1.381(c)(20)–1.
(d) Limitations on disallowed business application of section 163(j); and the
facts set forth the only corporate
interest expense carryforwards from
activity.
separate return limitation years—(1)
General rule. Except as provided in
(i) Example 1: Determination of SRLY
limitation—(A) Facts. Individual A owns P.
paragraph (f) of this section (relating to
In 2019, A forms T, which pays or accrues
an overlap with section 382), the
a $100x business interest expense for which
disallowed business interest expense
a deduction is disallowed under section
carryforwards of a member arising in a
163(j) and that is carried forward to 2020. P
separate return limitation year (or SRLY does not pay or accrue business interest
(see § 1.1502–1(f))) that are included in
expense in 2019, and P has no disallowed
the consolidated group’s business
business interest expense carryforwards from
prior taxable years. At the close of 2019, P
interest expense deduction for any
acquires all of the stock of T, which joins
taxable year under paragraph (b) of this
with P in filing a consolidated return
section may not exceed the group’s
beginning in 2020. Neither P nor T pays or
section 163(j) limitation for that year,
accrues business interest expense in 2020,
determined by reference only to the
and the P group has a section 163(j)
member’s items of income, gain,
limitation of $300x in that year. This
deduction, and loss for that year
limitation would be $70x if determined by
reference solely to T’s items for 2020.
(section 163(j) SRLY limitation). For
(B) Analysis. T’s $100x of disallowed
purposes of this paragraph (d), the SRLY
subgroup principles of § 1.1502–21(c)(2) business interest expense carryforwards from
2019 arose in a SRLY. P’s acquisition of T
apply with appropriate adjustments.
was not an ownership change as defined by
(2) Deduction of disallowed business
section 382(g); thus, T’s disallowed business
interest expense carryforwards arising
interest expense carryforwards are subject to
in a SRLY. Notwithstanding paragraph
the SRLY limitation in paragraph (d)(1) of
(d)(1) of this section, disallowed
this section. The section 163(j) SRLY
business interest expense carryforwards limitation for 2020 is the P group’s section
163(j) limitation, determined by reference
of a member arising in a SRLY are
solely to T’s items for 2020 ($70x). See
available for deduction by the
paragraph (d)(1) of this section. Thus, $70x
consolidated group in the current year
of T’s disallowed business interest expense
only to the extent the group has any
carryforwards are available to be deducted by
remaining section 163(j) limitation for
the P group in 2020, and the remaining $30x
the current year after the deduction of
of T’s disallowed business interest expense
current-year business interest expense
carryforwards are carried forward to 2021.
(C) Section 163(j) limitation of $0. The facts
and disallowed business interest
are the same as in paragraph (A) of this
expense carryforwards from earlier
Example 1, except that the section 163(j)
taxable years that are permitted to be
SRLY limitation for 2020 (computed by
deducted in the current year (see
reference solely to T’s items for that year) is
paragraph (b)(3)(ii)(A) of this section),
$0. Because the amount of T’s disallowed
and only to the extent the section 163(j) business interest expense carryforwards that
SRLY limitation for the current year
may be deducted by the P group in 2020 may
exceeds the amount of the member’s
not exceed the section 163(j) SRLY limitation
for that year, none of T’s carryforwards from
business interest expense already

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2019 may be deducted by the P group in
2020.
(ii) Example 2: Deduction of disallowed
business interest expense carryforwards
arising in a SRLY—(A) Facts. P and S are the
only members of a consolidated group. P has
neither current-year business interest
expense nor disallowed business interest
expense carryforwards. S has $100x of
disallowed business interest expense
carryforwards that arose in a SRLY and
$150x of current-year business interest. The
section 163(j) SRLY limitation for the current
year (computed by reference solely to S’s
items for that year) is $200x. Assume that the
P group’s section 163(j) limitation for the
current year would permit all of S’s currentyear business interest expense and
disallowed business interest expense
carryforwards to be deducted in the current
year but for the rules of this paragraph (d).
(B) Analysis. Under paragraph (d)(1) of this
section, the section 163(j) SRLY limitation for
the current year of $200x (computed by
reference solely to S’s items for that year)
exceeds the amount of S’s business interest
expense taken into account by the P group in
the current year under paragraph (b)(3)(ii) of
this section ($150x) by $50x. Thus, $50x of
S’s disallowed business interest expense
carryforwards that arose in a SRLY may be
taken into account by the P group in the
current year.

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

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

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

(a) Overview. If a deduction for
business interest expense of a
partnership or S corporation is subject
to limitation under section 163(j),
section 163(j)(4) provides that the
section 163(j) limitation applies at the
partnership or S corporation level and
any deduction for business interest
expense within the meaning of section
163(j) is taken into account in
determining the nonseparately stated
taxable income or loss of the
partnership or S corporation. Once a
partnership or S corporation determines
its business interest expense, business
interest income, ATI, and floor plan
financing interest expense, the
partnership or S corporation calculates
its section 163(j) limitation by applying
the rules of § 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.

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Paragraph (e) of this section provides
rules regarding a partner’s ATI and
business interest income. Paragraph (f)
of this section provides an eleven-step
computation necessary for properly
allocating a partnership’s deductible
business interest expense and section
163(j) excess items to its partners.
Paragraph (g) of this section applies
carryforward rules at the partner level if
a partnership has excess business
interest expense, as defined in
§ 1.163(j)–1(b)(14). Paragraph (h) of this
section provides basis adjustment rules
and paragraph (j) of this section
provides rules regarding investment
items of a partnership. Paragraph (l) of
this section provides rules regarding S
corporations. Paragraph (m) of this
section provides rules for partnerships
and S corporations not subject to section
163(j). Paragraph (o) of this section
provides examples illustrating the rules
of this section. Paragraph (p) provides
the applicability date of the rules in this
section.
(b) Definitions. In addition to the
definitions contained in § 1.163(j)–1, the
following definitions apply for purposes
of this section.
(1) Section 163(j) items. The term
section 163(j) items means the
partnership or S corporation’s business
interest expense, business interest
income, and items comprising ATI, as
defined in § 1.163(j)–1(b)(1).
(2) Partner basis items. The term
partner basis items means any items of
income, gain, loss, or deduction
resulting from either an adjustment to
the basis of partnership property used in
a non-excepted trade or business made
pursuant to section 743(b) or the
operation of section 704(c)(1)(C)(i) with
respect to such property. Partner basis
items also include section 743(b) basis
adjustments used to increase or decrease
a partner’s share of partnership gain or
loss on the sale of partnership property
used in a non-excepted trade or
business (as described in § 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 § 1.704–3(d).
(4) Excess business interest income.
The term excess business interest
income means the amount by which a
partnership’s or S corporation’s
business interest income exceeds its
business interest expense in a taxable
year.

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(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 § 1.163(j)–2(b).
(6) Section 163(j) excess items. The
term section 163(j) excess items means
the partnership’s excess business
interest expense, excess taxable income,
and excess business interest income.
(7) Non-excepted assets. The term
non-excepted assets means assets from
a trade or business other than assets
from an excepted regulated utility trade
or business, electing farming business,
or electing real property trade or
business, as such terms are defined in
§ 1.163(j)–1.
(8) Excepted assets. The term
excepted assets means assets from an
excepted regulated utility trade or
business, electing farming business, or
electing real property trade or business,
as such terms are defined in § 1.163(j)–
1.
(c) Character of business interest
expense. If a partnership has deductible
business interest expense, such
deductible business interest expense is
not subject to any additional application
of section 163(j) at the partner-level
because it is taken into account in
determining the nonseparately stated
taxable income or loss of the
partnership. For all other purposes of
the Code, however, deductible business
interest expense and excess business
interest expense retain their character as
business interest expense at the partnerlevel. 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
§ 1.163(j)–3.
(d) Adjusted taxable income of the
partnership—(1) Modification of
adjusted taxable income for
partnerships. The ATI of the
partnership generally is determined in
accordance with § 1.163(j)–1(b)(1). For
purposes of computing the partnership’s
ATI, the taxable income of the
partnership is determined under section
703(a) and includes any items described

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in section 703(a)(1) to the extent such
items are otherwise included under
§ 1.163(j)–1(b)(1).
(2) Section 734(b), partner basis items,
and remedial items. A partnership takes
into account items resulting from
adjustments made to the basis of its
property pursuant to section 734(b) for
purposes of calculating its ATI pursuant
to § 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 § 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 § 1.163(j)–1(b)(1). See
Example 8 in paragraph (o)(8) of this
section.
(e) Adjusted taxable income and
business interest income of partners—
(1) Modification of adjusted taxable
income for partners. The ATI of a
partner in a partnership generally is
determined in accordance with
§ 1.163(j)–1(b)(1) without regard to such
partner’s distributive share of any items
of income, gain, deduction, or loss of
such partnership, and is increased by
such partner’s distributive share of such
partnership’s excess taxable income
determined under paragraph (f) of this
section. For rules regarding corporate
partners, see § 1.163(j)–4(b)(3).
(2) Partner basis items and remedial
items. Partner basis items and remedial
items are taken into account as items
derived directly by the partner in
determining the partner’s ATI for
purposes of the partner’s section 163(j)
limitation. If a partner is allocated
remedial items, such partner’s ATI is
increased or decreased by the amount of
such items. Additionally, to the extent
a partner is allocated partner basis
items, such partner’s ATI is increased or
decreased by the amount of such item.
See Example 8 in paragraph (o)(8) of
this section.
(3) Disposition of partnership
interests. If a partner recognizes gain or
loss upon the disposition of interests in
a partnership, and the partnership in
which the interest is being disposed
owns only non-excepted trade or
business assets, the gain or loss on the
disposition of the partnership interest is
included in the partner’s ATI. For
dispositions of interests in partnerships
that own:
(i) Non-excepted assets and excepted
assets; or
(ii) Investment assets; or
(iii) Both. See § 1.163(j)–10(b)(4)(ii).
(4) Double counting of business
interest income and floor plan financing
interest expense prohibited. For
purposes of calculating a partner’s

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section 163(j) limitation, the partner
does not include—
(i) Business interest income from a
partnership that is subject to section
163(j) except to the extent it is allocated
excess business interest income from
that partnership pursuant to paragraph
(f)(2) of this section; and
(ii) The partner’s allocable share of
the partnership’s floor plan financing
interest expense because such floor plan
financing interest expense has already
been taken into account by the
partnership in determining its
nonseparately stated taxable income or
loss for purposes of section 163(j).
(f) Allocation and determination of
section 163(j) excess items made in the
same manner as nonseparately stated
taxable income or loss of the
partnership—(1) Overview—(i) In
general. The purpose of this section is
to provide guidance regarding how a
partnership must allocate its deductible
business interest expense and section
163(j) excess items, if any, among its
partners. For purposes of section
163(j)(4) and this section, allocations
and determinations of deductible
business interest expense and section
163(j) excess items are considered made
in the same manner as the
nonseparately stated taxable income or
loss of the partnership if, and only if,
such allocations and determinations are
made in accordance with the elevenstep computation set forth in paragraphs
(f)(2)(i) through (xi) of this section. A
partnership first determines its section
163(j) limitation, total amount of
deductible business interest expense,
and section 163(j) excess items under
paragraph (f)(2)(i) of this section. The
partnership then applies paragraphs
(f)(2)(ii) through (xi) of this section, in
that order, to determine how those items
of the partnership are allocated among
its partners. At the conclusion of the
eleven-step computation set forth in
paragraphs (f)(2)(i) through (xi) of this
section, the total amount of deductible
business interest expense and section
163(j) excess items allocated to each
partner will equal the partnership’s total
amount of deductible business interest
expense and section 163(j) excess items.
(ii) Relevance solely for purposes of
section 163(j). No rule set forth in
paragraph (f)(2) of this section prohibits
a partnership from making an allocation
to a partner of any item of partnership
income, gain, loss, or deduction that is
otherwise permitted under section 704
and the regulations thereunder.
Accordingly, any calculations in
paragraphs (f)(2)(i) through (xi) of this
section are solely for the purpose of
determining each partner’s deductible
business interest expense and section

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67553

163(j) excess items, and do not
otherwise affect any other provision
under the Code, such as section 704(b).
Additionally, floor plan financing
interest expense is not allocated in
accordance with paragraph (f)(2) of this
section. Instead, floor plan financing
interest expense of a partnership is
allocated to its partners under section
704(b) and is taken into account as a
nonseparately stated item of loss for
purposes of section 163(j).
(2) Steps for allocating deductible
business interest expense and section
163(j) excess items—(i) Partnershiplevel calculation required by section
163(j)(4)(A). First, a partnership must
determine its section 163(j) limitation
pursuant to § 1.163(j)–2(b). This
calculation determines a partnership’s
total amounts of excess business interest
income, excess taxable income, excess
business interest expense (that is, the
partnership’s section 163(j) excess
items), and deductible business interest
expense under section 163(j) for a
taxable year.
(ii) Determination of each partner’s
relevant section 163(j) items. Second, a
partnership must determine each
partner’s allocable share of each section
163(j) item under section 704(b) and the
regulations thereunder including any
allocations under section 704(c), other
than remedial items as defined in
paragraph (b)(3) of this section. Only
section 163(j) items that were actually
taken into account in the partnership’s
section 163(j) calculation under
paragraph (f)(2)(i) of this section are
taken into account for purposes of this
paragraph (f)(2)(ii). Partner basis items,
allocations of investment income and
expense, remedial items, and amounts
determined for the partner under
§ 1.163(j)–8T are not taken into account
for purposes of this paragraph (f)(2)(ii).
For purposes of paragraphs (f)(2)(ii)
through (xi) of this section, the term
allocable ATI means a partner’s
distributive share of the partnership’s
ATI (i.e., a partner’s distributive share of
gross income and gain items comprising
ATI less such partner’s distributive
share of gross loss and deduction items
comprising ATI), the term allocable
business interest income means a
partner’s distributive share of the
partnership’s business interest income,
and the term allocable business interest
expense means a partner’s distributive
share of the partnership’s business
interest expense that is not floor plan
financing interest expense.
(iii) Partner-level comparison of
business interest income and business
interest expense. Third, a partnership
must compare each partner’s allocable
business interest income to such

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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

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interest expense is calculated by
reducing, but not below zero, such
partner’s allocable business interest
income deficit (if any) by such partner’s
step five adjustment amount. A
partner’s step five adjustment amount is
the product of the total allocable
business interest income excess and the
ratio of such partner’s allocable business
interest income deficit to the total
allocable business interest income
deficit. Generally, a partner’s remaining
business interest expense is a partner’s
allocable business interest income
deficit adjusted to reflect a reallocation
of allocable business interest income
excess from other partners. Determining
a partner’s remaining business interest
expense is necessary to perform an ATI
calculation that begins in paragraph
(f)(2)(vii) of this section.
(vi) Determination of final allocable
ATI. Sixth, a partnership must
determine each partner’s final allocable
ATI. Paragraphs (f)(2)(vi) through (x) of
this section determine how a
partnership must allocate its excess
taxable income and excess business
interest expense among its partners.
(A) Positive allocable ATI. To the
extent a partner’s income and gain items
comprising its allocable ATI exceed its
deduction and loss items comprising its
allocable ATI, the partner has positive
allocable ATI. The aggregate of all the
partners’ positive allocable ATI amounts
is the total positive allocable ATI.
(B) Negative allocable ATI. To the
extent a partner’s deduction and loss
items comprising its allocable ATI
exceed its income and gain items
comprising its allocable ATI, the partner
has negative allocable ATI. The
aggregate of all the partners’ negative
allocable ATI amounts is the total
negative allocable ATI.
(C) Final allocable ATI. Any partner
with a negative allocable ATI, or an
allocable ATI of $0, has a positive
allocable ATI of $0. Any partner with a
positive allocable ATI of $0 has a final
allocable ATI of $0. The final allocable
ATI of any partner with a positive
allocable ATI greater than $0 is such
partner’s positive allocable ATI
reduced, but not below zero, by the
partner’s step six adjustment amount. A
partner’s step six adjustment amount is
the product of the total negative
allocable ATI and the ratio of such
partner’s positive allocable ATI to the
total positive allocable ATI. The total of
the partners’ final allocable ATI
amounts must equal the partnership’s
ATI amount used to compute its section
163(j) limitation pursuant to § 1.163(j)–
2(b).
(vii) Partner-level comparison of thirty
percent of adjusted taxable income and

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remaining business interest expense.
Seventh, a partnership must compare
each partner’s ATI capacity to such
partner’s remaining business interest
expense as determined under paragraph
(f)(2)(v) of this section. A partner’s ATI
capacity is the amount that is thirty
percent of such partner’s final allocable
ATI as determined under paragraph
(f)(2)(vi) of this section. A partner’s final
allocable ATI is grossed down to thirty
percent prior to being compared to its
remaining business interest expense in
this calculation to parallel the
partnership’s adjustment to its ATI
under section 163(j)(1)(B). To the extent
a partner’s ATI capacity exceeds its
remaining business interest expense, the
partner has an ATI capacity excess. The
aggregate of all the partners’ ATI
capacity excess amounts is the total ATI
capacity excess. To the extent a
partner’s remaining business interest
expense exceeds its ATI capacity, the
partner has an ATI capacity deficit. The
aggregate of all the partners’ ATI
capacity deficit amounts is the total ATI
capacity deficit. These amounts (which
may be subject to adjustment under
paragraph (f)(2)(viii) of this section) are
required to perform calculations in
paragraphs (f)(2)(ix) and (x) of this
section, which appropriately reallocate
ATI capacity excess to partners with
ATI capacity deficits in order to
reconcile the partner-level calculation
under paragraph (f)(2)(vii) of this
section with the partnership-level result
under paragraph (f)(2)(i) of this section.
(viii) Partner priority right to ATI
capacity excess determination—(A)
Eighth, the partnership must determine
whether it is required to make any
adjustments described in this paragraph
(f)(2)(viii) and, if it is, make such
adjustments. The rules of this paragraph
(f)(2)(viii) are necessary to account for
adjustments made to a partner’s
allocable ATI in paragraph (f)(2)(vi) of
this section to ensure that the partners
who had a negative allocable ATI do not
inappropriately benefit under the rules
of paragraphs (f)(2)(ix) through (xi) of
this section to the detriment of the
partners who had positive allocable
ATI. The partnership must perform the
calculations and make the necessary
adjustments described under paragraphs
(f)(2)(viii)(B) and (C) or paragraph
(f)(2)(viii)(D) of this section if, and only
if, there is—
(1) An excess business interest
expense amount greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
amount greater than $0 under paragraph
(f)(2)(vi) of this section; and

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(3) A total ATI capacity excess
amount greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) A partnership must determine
each partner’s priority amount and
usable priority amount. A partner’s
priority amount is thirty percent of the
amount by which a partner’s positive
allocable ATI under paragraph
(f)(2)(vi)(A) of this section exceeds such
partner’s final allocable ATI under
paragraph (f)(2)(vi)(C) of this section.
However, only partners with an ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section can
have a priority amount greater than $0.
The aggregate of all the partners’
priority amounts is the total priority
amount. A partner’s usable priority
amount is the lesser of such partner’s
priority amount and such partner’s ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section. The
aggregate of all the partners’ usable
priority amounts is the total usable
priority amount. If the total ATI
capacity excess amount, as determined
under paragraph (f)(2)(vii) of this
section, is greater than or equal to the
total usable priority amount, then the
partnership must perform the
adjustments described in paragraph
(f)(2)(viii)(C) of this section. If the total
usable priority amount is greater than
the total ATI capacity excess amount, as
determined under paragraph (f)(2)(vii)
of this section, then the partnership
must perform the adjustments described
in paragraph (f)(2)(viii)(D) of this
section.
(C) For purposes of paragraph
(f)(2)(ix) of this section, each partner’s
final ATI capacity excess amount is $0.
For purposes of paragraph (f)(2)(x) of
this section, the following terms have
the following meanings for each partner:
(1) Each partner’s ATI capacity deficit
is such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section reduced by such partner’s
usable priority amount.
(2) The total ATI capacity deficit is
the total ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section reduced by the total
usable priority amount.
(3) The total ATI capacity excess is
the total ATI capacity excess as
determined under paragraph (f)(2)(vii)
of this section reduced by the total
usable priority amount.
(D) Any partner with a priority
amount greater than $0 is a priority
partner. Any partner that is not a
priority partner is a non-priority
partner. For purposes of paragraph
(f)(2)(ix) of this section, each partner’s
final ATI capacity excess amount is $0.
For purposes of paragraph (f)(2)(x) of

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this section, each non-priority partner’s
final ATI capacity deficit amount is
such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section. For purposes of
paragraph (f)(2)(x) of this section, the
following terms have the following
meanings for priority partners.
(1) Each priority partner must
determine its step eight excess share. A
partner’s step eight excess share is the
product of the total ATI capacity excess
as determined under paragraph
(f)(2)(vii) of this section and the ratio of
the partner’s priority amount to the total
priority amount.
(2) To the extent a priority partner’s
step eight excess share exceeds its ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section, such
excess amount is the priority partner’s
ATI capacity excess for purposes of
paragraph (f)(2)(x) of this section. The
total ATI capacity excess is the
aggregate of the priority partners’ ATI
capacity excess amounts as determined
under this paragraph (f)(2)(viii)(D)(2).
(3) To the extent a priority partner’s
ATI capacity deficit as determined
under paragraph (f)(2)(vii) of this
section exceeds its step eight excess
share, such excess amount is the
priority partner’s ATI capacity deficit
for purposes of paragraph (f)(2)(x) of this
section. The total ATI capacity deficit is
the aggregate of the priority partners’
ATI capacity deficit amounts as
determined under this paragraph
(f)(2)(viii)(D)(3).
(ix) Matching partnership and
aggregate partner excess taxable
income. Ninth, a partnership must
determine each partner’s final ATI
capacity excess. A partner’s final ATI
capacity excess amount is determined
by reducing, but not below zero, such
partner’s ATI capacity excess (if any) by
the partner’s step nine adjustment
amount. A partner’s step nine
adjustment amount is the product of the
total ATI capacity deficit and the ratio
of such partner’s ATI capacity excess to
the total ATI capacity excess. The rules
of this paragraph (f)(2)(ix) ensure that,
following the application of paragraph
(f)(2)(xi) of this section, the aggregate of
all the partners’ allocations of excess
taxable income equals the total amount
of the partnership’s excess taxable
income as determined in paragraph
(f)(2)(i) of this section.
(x) Matching partnership and
aggregate partner excess business
interest expense. Tenth, a partnership
must determine each partner’s final ATI
capacity deficit. A partner’s final ATI
capacity deficit amount is determined
by reducing, but not below zero, such
partner’s ATI capacity deficit (if any) by

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67555

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 tenthirds, excess taxable income calculated
under paragraph (f)(2)(i) of this section,
if any, is allocated dollar for dollar to
partners with final ATI capacity excess
amounts. A partner’s allocable business
interest expense is deductible business
interest expense to the extent it exceeds
such partner’s share of excess business
interest expense. See paragraphs (o)(11)
through (15) of this section.
(g) Carryforwards—(1) In general. The
amount of any business interest expense
not allowed as a deduction to a
partnership by reason of § 1.163(j)–2(b)
and paragraph (f)(2) of this section for
any taxable year is—
(i) Not treated as business interest
expense of the partnership in the
succeeding taxable year; and
(ii) Subject to paragraph (g)(2) of this
section, treated as excess business
interest expense which is allocated to
each partner pursuant to paragraph (f)(2)
of this section.
(2) Treatment of excess business
interest expense allocated to partners. If
a partner is allocated excess business
interest expense from a partnership
under paragraph (f)(2) of this section for
any taxable year—
(i) Solely for purposes of section
163(j), such excess business interest
expense is treated as business interest

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expense paid or accrued by the partner
in the next succeeding taxable year in
which the partner is allocated excess
taxable income or excess business
interest income from such partnership,
but only to the extent of such excess
taxable income or excess business
interest income; and
(ii) Any portion of such excess
business interest expense remaining
after the application of paragraph
(g)(2)(i) of this section is excess business
interest expense that is subject to the
limitations of paragraph (g)(2)(i) of this
section in succeeding years, unless
paragraph (m)(3) of this section applies.
See paragraphs (o)(1) through (10) of
this section.
(3) Excess taxable income and excess
business interest income ordering rule.
In the event a partner has excess
business interest expense from a prior
taxable year and is allocated excess
taxable income or excess business
interest income from the same
partnership in a succeeding taxable
year, the partner must treat, for
purposes of section 163(j), the excess
business interest expense as business
interest expense paid or accrued by the
partner in an amount equal to the
partner’s share of the partnership’s
excess taxable income or excess
business interest income in such
succeeding taxable year. See paragraphs
(o)(2) through (10) of this section.
(h) Basis adjustments—(1) Section
704(d) ordering. Deductible business
interest expense and excess business
interest expense are subject to section
704(d). If a partner is subject to a
limitation on loss under section 704(d)
and a partner is allocated losses from a
partnership in a taxable year, § 1.704–
1(d)(2) requires that the limitation on
losses under section 704(d) be
apportioned amongst these losses based
on the character of each loss (each
grouping of loses based on character
being a ‘‘section 704(d) loss class’’). If
there are multiple section 704(d) loss
classes in a given year, § 1.704–1(d)(2)
requires the partner to apportion the
limitation on losses under section
704(d) to each section 704(d) loss class
proportionately. For purposes of
applying this proportionate rule, any
deductible business interest expense
(whether allocated to the partner in the
current taxable year or suspended under
section 704(d) in a prior taxable year),
any excess business interest expense
allocated to the partner in the current
taxable year, and any excess business
interest expense from a prior taxable
year that was suspended under section
704(d) (‘‘negative section 163(j)
expense’’) shall comprise the same
section 704(d) loss class. Once the

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partner determines the amount of
limitation on losses apportioned to this
section 704(d) loss class, any deductible
business interest expense is taken into
account before any excess business
interest expense or negative section
163(j) expense. See paragraph (o)(9) of
this section.
(2) Excess business interest expense
basis adjustments. The adjusted basis of
a partner in a partnership interest is
reduced, but not below zero, by the
amount of excess business interest
expense allocated to the partner
pursuant to paragraph (f)(2) of this
section. Negative section 163(j) expense
is not treated as excess business interest
expense in any subsequent year until
such negative section 163(j) expense is
no longer suspended under section
704(d). Therefore, negative section
163(j) expense does not affect, and is not
affected by, any allocation of excess
taxable income to the partner.
Accordingly, any excess taxable income
allocated to a partner from a partnership
while the partner still has negative
section 163(j) expense will be included
in the partner’s ATI. However, once the
negative section 163(j) expense is no
longer suspended under section 704(d),
it becomes excess business interest
expense, which is subject to the general
rules in paragraph (g) of this section.
See paragraph (o)(10) of this section.
(3) Basis adjustments upon
disposition of partnership interest—(i)
Complete disposition of partnership
interest. If a partner disposes of all or
substantially all of a partnership interest
(whether by sale, exchange, or
redemption), the adjusted basis of the
partnership interest is increased
immediately before the disposition by
the amount of the excess (if any) of the
amount of the basis reduction under
paragraph (h)(2) of this section over the
portion of any excess business interest
expense allocated to the partner under
paragraph (f)(2) of this section which
has previously been treated under
paragraph (g) of this section as business
interest expense pair or accrued by the
partner, regardless of whether the
disposition was a result of a taxable or
non-taxable transaction. Therefore, the
adjusted basis of a partner in a
partnership interest is not increased by
any negative section 163(j) expense
upon the disposition of a partnership
interest. No deduction under section
163(j) is allowed to the transferor or
transferee under chapter 1 of subtitle A
of the Code for any excess business
interest expense resulting in a basis
increase under this section or any
negative section 163(j) expense.
(ii) Partial disposition of partnership
interest. If a partner disposes of less

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than substantially all of its interest in a
partnership (whether by sale, exchange,
or redemption), a partner shall not
increase its basis in its partnership
interest by the amount of any excess
business interest expense that has not
yet been treated as business interest
expense paid or accrued by the partner
in accordance with paragraph (g) of this
section. Any such excess business
interest expense shall remain excess
business interest expense of the
transferor partner until such time as the
transferor partner is allocated an
appropriate amount of excess taxable
income or excess business interest
income from the partnership or the
partner disposes of its partnership
interest in accordance with paragraph
(h)(2)(i) of this section. Additionally,
any negative section 163(j) expense
shall remain negative section 163(j)
expense of the transferor partner until
such negative section 163(j) expense is
no longer suspended under section
704(d).
(i) [Reserved]
(j) Investment items. Any item of a
partnership’s income, gain, deduction,
or loss that is investment interest
income or expense pursuant to § 1.163–
8T is allocated to each partner in
accordance with section 704(b) and the
regulations thereunder and the effect of
such allocation for purposes of section
163 is determined at the partner-level.
See § 1.163(j)–4(b)(3), section 163(d),
and § 1.163–8T.
(k) [Reserved]
(l) S corporations—(1) In general. In
the case of any S corporation, the
section 163(j) limitation is applied at the
S corporation level, and any deduction
allowed for business interest expense is
taken into account in determining the
nonseparately stated taxable income or
loss of the S corporation. An S
corporation determines its section 163(j)
limitation in the same manner as set
forth in § 1.163(j)–2(b). Allocations of
excess taxable income and excess
business interest income are made in
accordance with the shareholders’
respective pro rata interests in the S
corporation pursuant to section
1366(a)(1) after determining the S
corporation’s section 163(j) limitation
pursuant to § 1.163(j)–2(b).
(2) Character of deductible business
interest expense. If an S corporation has
deductible business interest expense,
such deductible business interest
expense is not subject to any additional
application of section 163(j) at the
shareholder-level because such
deductible business interest expense is
taken into account in determining the
nonseparately stated taxable income or
loss of the S corporation. For all other

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purposes of the Code, however,
deductible business interest expense
retains its character as business interest
expense at the shareholder-level. For
example, for purposes of section 469,
such deductible business interest
expense retains its character as either
passive or non-passive in the hands of
the shareholder. Additionally, for
purposes of section 469, deductible
business interest expense from an S
corporation remains interest derived
from a trade or business in the hands of
a shareholder even if the shareholder
does not materially participate in the S
corporation’s trade or business activity.
For additional rules regarding the
interaction between sections 465, 469,
and 163(j), see § 1.163(j)–3.
(3) Adjusted taxable income of an S
corporation. The ATI of an S
corporation generally is determined in
accordance with § 1.163(j)–1(b)(1). For
purposes of computing the S
corporation’s ATI, the taxable income of
the S corporation is determined under
section 1363(b) and includes—
(i) Any item described in section
1363(b)(1); and
(ii) Any item described in § 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 § 1.163(j)–1(b)(1)
without regard to such shareholder’s
distributive share of any items of
income, gain, deduction, or loss of such
S corporation, and is increased by such
shareholder’s distributive share of such
S corporation’s excess taxable income,
as defined in § 1.163(j)–1(b)(15).
(ii) Disposition of S corporation stock.
If a shareholder of an S corporation
recognizes gain or loss upon the
disposition of stock of the S corporation,
and the corporation in which the stock
is being disposed only owns nonexcepted trade or business assets, the
gain or loss on the disposition of the
stock is included in the shareholder’s
ATI. For dispositions of stock of S
corporations that own:
(A) Non-excepted assets and excepted
assets; or
(B) Investment assets; or
(C) Both. See § 1.163(j)–10(b)(4)(ii).
(iii) Double counting of business
interest income and floor plan financing
interest expense prohibited. For
purposes of calculating an S corporation
shareholder’s section 163(j) limitation,
the shareholder does not include—

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(A) Business interest income from an
S corporation that is subject to section
163(j) except to the extent it is allocated
excess business interest income from
that S corporation pursuant to
paragraph (l)(1) of this section; and
(B) The shareholder’s share of the S
corporation’s floor plan financing
interest expense because such floor plan
financing interest expense has already
been taken into account by the S
corporation in determining its
nonseparately stated taxable income or
loss for purposes of section 163(j).
(5) Carryforwards. The amount of any
business interest expense not allowed as
a deduction for any taxable year by
reason of the limitation contained in
§ 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 § 1.163(j)–
2(c) (whether to an S corporation or C
corporation taxable year). S corporations
are subject to:
(i) The same ordering rules as a C
corporation that is not a member of a
consolidated group; and
(ii) The limitation under section 382.
See § 1.163(j)–5(b)(2) and (e).
(6) Basis adjustments and disallowed
business interest expense carryforwards.
An S corporation shareholder’s adjusted
basis in its S corporation stock is
reduced, but not below zero, when a
disallowed business interest expense
carryforward becomes deductible under
section 163(j).
(7) Accumulated adjustment
accounts. The accumulated adjustment
account of an S corporation is adjusted
to take into account business interest
expense in the year in which the S
corporation treats such business interest
expense as deductible under the section
163(j) limitation. See section 1368(e)(1).
(8) Termination of qualified
subchapter S subsidiary election. If a
corporation’s qualified subchapter S
subsidiary election terminates and any
disallowed business interest expense
carryforward is attributable to the
activities of the qualified subchapter S
subsidiary at the time of termination,
such disallowed business interest
expense carryforward remains with the
parent S corporation and no portion of
these items is allocable to the former
qualified subchapter S subsidiary.
(9) Investment items. Any item of an
S corporation’s income, gain, deduction,
or loss that is investment interest
income or expense pursuant to § 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), § 1.163–8T.

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67557

(m) Partnerships and S corporations
not subject to section 163(j)—(1)
Partnerships and S corporations not
subject to section 163(j) by reason of the
small business exemption. If a
partnership or S corporation is not
subject to section 163(j) by reason of
§ 1.163(j)–2(d) (exempt entity), the
exempt entity does not calculate the
section 163(j) limitation under
§ 1.163(j)–2 and these regulations.
Because an exempt entity is not subject
to section 163(j)(4), it does not take its
deduction for business interest expense
into account in determining its nonseparately stated taxable income or loss
within the meaning of section
163(j)(4)(A)(i) and retains its character
as business interest expense. See
§ 1.163(j)–6(c). Thus, if a partner or S
corporation shareholder is allocated
business interest expense from an
exempt entity, that allocated business
interest expense will be subject to the
partner’s or S corporation shareholder’s
section 163(j) limitations. Additionally,
contrary to the general rule in § 1.163(j)–
6(e)(1), a partner or S corporation
shareholder includes items of income,
gain, loss, or deduction of such exempt
entity when calculating its ATI. Finally,
business interest income of such exempt
entity is included in the partner’s or S
corporation shareholder’s section 163(j)
limitation regardless of the exempt
entity’s business interest expense
amount.
(2) Partnerships and S corporations
not subject to section 163(j) by reason of
an excepted trade or business. To the
extent a partnership or S corporation is
not subject to section 163(j) because it
has an excepted trade or business as
defined in § 1.163(j)–1(b)(38)(ii)
(excepted entity), the entity does not
apply its section 163(j) limitation under
§ 1.163(j)–2 and this section with
respect to the business interest expense
that is allocable to such excepted trade
or business. If a partner or S corporation
shareholder is allocated any section
163(j) item that is allocable to the
partnership’s or S corporation’s
excepted trade or business (excepted
163(j) items), such excepted 163(j) items
are excluded from the partner or
shareholder’s section 163(j) deduction
calculation. See § 1.163(j)–10(c)
(regarding the allocation of items
between excepted and non-excepted
trades or businesses).
(3) Partnerships that allocated excess
business interest expense prior to
becoming not subject to section 163(j). If
a partnership allocates excess business
interest expense to one or more of its
partners, and in a succeeding taxable
year becomes not subject to the
requirements of section 163(j), the

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excess business interest expense from
the prior taxable years is treated as paid
or accrued by the partner in such
succeeding taxable year. See paragraphs
(o)(6) and (7) of this section.
(4) S corporations with disallowed
business interest expense carryforwards
prior to becoming not subject to section
163(j). If an S corporation has a
disallowed business interest expense
carryforward for a taxable year, and in
the succeeding taxable year becomes not
subject to the requirements of section
163(j), then such disallowed business
interest expense carryforward—
(i) Continues to be carried forward at
the S corporation level;
(ii) Is no longer subject to the section
163(j) limitation; and
(iii) Is taken into account in
determining the nonseparately stated
taxable income or loss of the S
corporation.
(n) [Reserved]
(o) Examples. The examples in this
paragraph illustrate the provisions of
section 163(j) as applied to partnerships
and subchapter S corporations. For
purposes of these examples, each
partnership is subject to the provisions
of section 163(j), was created or
organized in the United States, and is a
calendar year taxpayer. Unless stated
otherwise, all partners are subject to the
provisions of section 163(j), are not
subject to a limitation under section
704(d) or 1366(d), have no tax items
other than those listed in the example,
are U.S. citizens, and are calendar year
taxpayers. The phrase ‘‘section 163(j)
limit’’ shall equal the maximum
potential deduction allowed under
section 163(j)(1). Unless stated
otherwise, business interest expense
means business interest expense that is
not floor plan financing interest
expense. With respect to partnerships,
all allocations are in accordance with
section 704(b) and the regulations
thereunder.
(1) Example 1—(i) Facts. X and Y are equal
partners in partnership PRS. In Year 1, PRS
has $100 of ATI and $40 of business interest
expense. PRS allocates the items comprising
its $100 of ATI $50 to X and $50 to Y. PRS
allocates its $40 of business interest expense
$20 to X and $20 to Y. X has $100 of ATI
and $20 of business interest expense from its
sole proprietorship. Y has $0 of ATI and $20
of business interest expense from its sole
proprietorship.
(ii) Partnership-level. In Year 1, PRS’s
section 163(j) limit is 30 percent of its ATI,
or $30 ($100 x 30 percent). Thus, PRS has
$30 of deductible business interest expense
and $10 of excess business interest expense.
Such $30 of deductible business interest
expense is includable in PRS’s nonseparately stated income or loss, and is not
subject to further limitation under section
163(j) at the partners’ level.

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(iii) Partner-level allocations. Pursuant to
§ 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 § 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 × 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 × 30 percent).
Thus, Y’s $20 of business interest expense is
not allowed as a deduction and is treated as
business interest expense paid or accrued by
Y in Year 2.
(2) Example 2—(i) Facts. The facts are the
same as in Example 1 in paragraph (o)(1)(i)
of this section. In Year 2, PRS has $200 of
ATI, $0 of business interest income, and $30
of business interest expense. PRS allocates
the items comprising its $200 of ATI $100 to
X and $100 to Y. PRS allocates its $30 of
business interest expense $15 to X and $15
to Y. X has $100 of ATI and $20 of business
interest expense from its sole proprietorship.
Y has $0 of ATI and $20 of business interest
expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its ATI
plus its business interest income, or $60
($200 x 30 percent). Thus, PRS has $100 of
excess taxable income, $30 of deductible
business interest expense, and $0 of excess
business interest expense. Such $30 of
deductible business interest expense is
includable in PRS’s non-separately stated
income or loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations. Pursuant to
§ 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

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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 × 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 × 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
× 30 percent) + $60). Thus, PRS has $20 of
excess business interest income, $0 of excess
taxable income, $40 of deductible business
interest expense, and $0 of excess business
interest expense. Such $40 of deductible
business interest expense is includable in
PRS’s non-separately stated income or loss,
and is not subject to further limitation under
section 163(j) at the partners’ level.
(iii) Partner-level allocations. Pursuant to
§ 1.163(j)–6(f)(2), X and Y are each allocated
$10 of excess business interest income, and
$20 of deductible business interest expense.
As a result, X and Y each increase their
business interest income by $10. Because X
and Y are each allocated $10 of excess
business interest income from PRS, and
excess business interest expense from a
partnership is treated as paid or accrued by
a partner to the extent excess taxable income
and excess business interest income are
allocated from such partnership to a partner,
X and Y each treat $5 of excess business
interest expense (the carryforward from Year
1) as paid or accrued in Year 2. X and Y each
increase their outside basis in PRS by $10
($30¥$20).
(iv) Partner-level computations. X, in
computing its limit under section 163(j), has
$100 of ATI (from its sole proprietorship),
$10 of business interest income (from the

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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
× 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 × 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 × 30 percent)) + $60). Thus, PRS has
$20 of excess business interest income, $100
of excess taxable income, $40 of deductible
business interest expense, and $0 of excess
business interest expense. Such $40 of
deductible business interest expense is
includable in PRS’s non-separately stated
income or loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations. Pursuant to
§ 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).

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(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
× 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 × 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 × 30 percent) + $11.20). Thus, PRS has
$0 of excess business interest income, $4 of
excess taxable income, and $40 of deductible
business interest expense. Such $40 of
deductible business interest expense is
includable in PRS’s non-separately stated
income or loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations. Pursuant to
§ 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)

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67559

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 × 30
percent). Thus, X’s $22 of business interest
expense is deductible business interest
expense. At the end of Year 2, X has $3 of
excess business interest expense from PRS
($5 from Year 1, less $2 treated as paid or
accrued in Year 2). Y, in computing its limit
under section 163(j), has $2 of ATI ($0 from
its sole proprietorship, plus $2 excess taxable
income), $0 of business interest income, and
$42 of business interest expense ($20 from its
sole proprietorship, plus $20 disallowed
business interest expense from Year 1, plus
$2 excess business interest expense treated as
paid or accrued in Year 2). Y’s section 163(j)
limit is $0.60 ($2 × 30 percent). Thus, $0.60
of Y’s business interest expense is deductible
business interest expense. Y’s $41.40 of
business interest expense not allowed as a
deduction ($42 business interest expense,
less $0.60 section 163(j) limit) is treated as
business interest expense paid or accrued by
Y in Year 3. At the end of Year 2, Y has $3
of excess business interest expense from PRS
($5 from Year 1, less $2 treated as paid or
accrued in Year 2).
(6) Example 6—(i) Facts. The facts are the
same as in Example 5 in paragraph (o)(5)(i)
of this section, except in Year 2 Y becomes
not subject to section 163(j) under section
163(j)(3).
(ii) Partnership-level. Same analysis as
Example 5 in paragraph (o)(5)(ii) of this
section.
(iii) Partner-level allocations. Same
analysis as Example 5 in paragraph (o)(5)(iii)
of this section.
(iv) Partner-level computations. For X,
same analysis as Example 5 in paragraph
(o)(5)(iv) of this section. Y is not subject to
section 163(j) under section 163(j)(3). Thus,
all $42 of business interest expense ($20 from
its sole proprietorship, plus $20 disallowed
business interest expense from Year 1, plus
$2 excess business interest expense treated as
paid or accrued in Year 2) is not subject to
limitation under § 1.163(j)–2(d). At the end of
Year 2, Y has $3 of excess business interest
expense from PRS ($5 from Year 1, less $2
treated as paid or accrued in Year 2).
(7) Example 7—(i) Facts. The facts are the
same as in Example 5 in paragraph (o)(5)(i)
of this section, except in Year 2 PRS and Y
become not subject to section 163(j) under
section 163(j)(3).
(ii) Partnership-level. In Year 2, PRS
becomes not subject to section 163(j)(4) by
reason of section 163(j)(3). As a result, none
of PRS’s $30 of business interest expense is
subject to limitation at the partnership level.
(iii) Partner-level allocations. Because
section 163(j) does not apply, PRS’s $30 of
business interest expense is not taken into
account in determining its non-separately
stated taxable income or loss. Thus, PRS’s

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$30 of business interest expense retains its
character as business interest expense for
purposes of section 163(j), and is potentially
subject to limitation at the partners’ level. As
a result, X and Y each increase their business
interest expense by $15. Further, because
PRS is not subject to section 163(j)(4) by
reason of section 163(j)(3), the provision
requiring each partner of the partnership to
determine their ATI without regard to such
partner’s distributive share of any items of
income, gain, deduction, or loss of such
partnership (section 163(j)(4)(ii)(I)) is no
longer applicable under § 1.163(j)–6(m)(1).
As a result, X and Y each increase their ATI
by $100. Further, because PRS is not subject
to section 163(j)(4) by reason of section
163(j)(3), the excess business interest expense
from Year 1 is treated as paid or accrued by
the partners pursuant to § 1.163(j)–6(m)(3).
As a result, X and Y each treat their $5 of
excess business interest expense from Year 1
as paid or accrued in Year 2, and increase
their business interest expense by $5.
(iv) Partner-level computations. X, in
computing its limit under section 163(j), has
$200 of ATI ($100 from its sole
proprietorship, plus $100 ATI from PRS) and
$40 of business interest expense ($20 from its
sole proprietorship, plus $15 from PRS, plus
$5 of excess business interest expense treated
as paid or accrued in Year 2). X’s section
163(j) limit is $60 ($200 × 30 percent). Thus,
$40 of X’s business interest expense is
deductible business interest expense. Y is not
subject to section 163(j) under section
163(j)(3). As a result, Y’s business interest
expense is not subject to limitation under
section 163(j). Thus, all $60 of Y’s business
interest expense ($20 from its sole
proprietorship, plus $20 disallowed from
year 1, plus $15 from PRS from year 2, plus
$5 of excess business interest expense treated
as paid or accrued in Year 2) is not subject
to limitation under section 163(j).
(8) Example 8—(i) Facts. In Year 1, X, Y,
and Z formed partnership PRS. Upon
formation, X and Y each contributed $100,
and Z contributed non-excepted and nondepreciable 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 § 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,

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or $30 ($100 × 30 percent). Thus, PRS has
$15 of deductible business interest expense
and $50 of excess taxable income. Such $15
of deductible business interest expense is
includable in PRS’s non-separately stated
income or loss, and is not subject to further
limitation under section 163(j) at X’s level.
(iii) Partner-level allocations. Pursuant to
§ 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 § 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 ×
30 percent). Thus, all $25 of A’s business
interest expense is not allowed as a
deduction and is treated as business interest
expense paid or accrued by A in Year 3.
(9) Example 9—(i) Facts. X and Y are equal
partners in partnership PRS. At the beginning
of Year 1, X and Y each have an outside basis
in PRS of $5. In Year 1, PRS has $0 of ATI,
$20 of business interest income, and $40 of
business interest expense. PRS allocates its
$20 of business interest income $10 to X and
$10 to Y. PRS allocates $40 of business
interest expense $20 to X and $20 to Y. X has
$100 of ATI and $20 of business interest
expense from its sole proprietorship. Y has
$0 of ATI and $20 of business interest
expense from its sole proprietorship.
(ii) Partnership-level. In Year 1, PRS’s
section 163(j) limit is 30 percent of its ATI
plus its business interest income, or $20 (($0
× 30 percent) + $20). Thus, PRS has $0 of
excess business interest income, $0 of excess
taxable income, $20 of deductible business
interest expense, and $20 of excess business
interest expense. Such $20 of deductible
business interest expense is includable in
non-separately stated income or loss of PRS,
and not subject to further limitation under
section 163(j) by the partners.
(iii) Partner-level allocations. Pursuant to
§ 1.163(j)–6(f)(2), X and Y are each allocated
$10 of deductible business interest expense
and $10 of excess business interest expense.
After adjusting each partners respective basis
for business interest income under section
705(a)(1)(A), pursuant to § 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

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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 § 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 × 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 × 30 percent). Thus, $20 of Y’s business
interest expense is not allowed as a
deduction in Year 1, and is treated as
business interest expense paid or accrued by
Y in Year 2.
(10) Example 10—(i) Facts. The facts are
the same as in Example 9 in paragraph
(o)(9)(i) of this section. In Year 2, PRS has
$20 of gross income that is taken into account
in determining PRS’s ATI (i.e., properly
allocable to a trade or business), $30 of gross
deductions from an investment activity, and
$0 of business interest expense. PRS allocates
the items comprising its $20 of ATI $10 to
X and $10 to Y. PRS allocates the items
comprising its $30 of gross deductions $15 to
X and $15 to Y. X has $100 of ATI and $20
of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of
business interest expense from its sole
proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its ATI
plus its business interest income, or $6 ($20
× 30 percent). Because PRS has no business
interest expense, all $20 of its ATI is excess
taxable income.
(iii) Partner-level allocations. Pursuant to
§ 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 § 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 × ($15 of
total gross deductions from Year 2/$20 of
total losses disallowed)), and $2.50 of excess

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business interest expense that was carried
over as negative section 163(j) expense from
Year 1 ($10 × ($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 × 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 × 30 percent). Thus, $3 of Y’s
business interest expense is deductible
business interest expense. The $44.50 of Y’s
business interest expense not allowed as a
deduction ($47.50 business interest expense,
less $3 section 163(j) limit) is treated as
business interest expense paid or accrued by
Y in Year 3. At the end of Year 2, Y has $0
of excess business interest expense from PRS
($5 from Year 1, plus $2.50 treated as excess
business interest expense in Year 2, less
$7.50 treated as paid or accrued in Year 2),
and $2.50 of negative section 163(j) expense
from PRS.
(11) Example 11: Facts. A (an individual)
and B (a corporation) own all of the interests
in partnership PRS. In Year 1, PRS has $100
of ATI, $10 of investment interest income,
$20 of business interest income (BII), $60 of
business interest expense (BIE), and $10 of
floor plan financing interest expense. PRS’s
ATI consists of $100 of gross income and $0
of gross deductions. PRS allocates its items
comprising ATI $100 to A and $0 to B. PRS

allocates its business interest income $10 to
A and $10 to B. PRS allocates its business
interest expense $30 to A and $30 to B. PRS
allocates all $10 of its investment interest
income and all $10 of its floor plan financing
interest expense to B. A has ATI from a sole
proprietorship, unrelated to PRS, in the
amount of $300.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section 163(j)
limit is 30 percent of its ATI plus its business
interest income, or $50 (($100 × 30 percent)
+ $20). Thus, PRS has $0 of excess business
interest income (EBII), $0 of excess taxable
income, $50 of deductible business interest
expense, and $10 of excess business interest
expense. PRS takes its $10 of floor plan
financing into account in determining its
nonseparately stated taxable income or loss.
(ii) Second, PRS determines each partner’s
allocable share of section 163(j) items used in
its own section 163(j) calculation. B’s $10 of
investment interest income is not included in
B’s allocable business interest income
amount because the $10 of investment
interest income was not taken into account
in PRS’s section 163(j) calculation. B’s $10 of
floor plan financing interest expense is not
included in B’s allocable business interest
expense. The $300 of ATI from A’s sole
proprietorship is not included in A’s
allocable ATI amount because the $300 was
not taken into account in PRS’s section 163(j)
calculation.

TABLE 1 TO PARAGRAPH (o)(11)(ii)
A
Allocable ATI ................................................................................................................................
Allocable BII .................................................................................................................................
Allocable BIE ...............................................................................................................................

(iii) Third, PRS compares each partner’s
allocable business interest income to such
partner’s allocable business interest expense.
Because each partner’s allocable business
interest expense exceeds its allocable

business interest income by $20 ($30¥$10),
each partner has an allocable business
interest income deficit of $20. Thus, the total
allocable business interest income deficit is
$40 ($20 + $20). No partner has allocable

B
$100
10
30

Total
$0
10
30

$100
20
60

business interest income excess because no
partner has allocable business interest
income in excess of its allocable business
interest expense. Thus, the total allocable
business interest income excess is $0.

TABLE 1 TO PARAGRAPH (o)(11)(iii)
A

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Allocable BII .................................................................................................................................
Allocable BIE ...............................................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess .....................
If allocable BIE exceeds allocable BII, then 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. PRS
determines A’s remaining business interest
expense by reducing, but not below $0, A’s
allocable business interest income deficit

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($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 × 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

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B
$10
30
0
20

Total
$10
30
0
20

N/A
N/A
$0
40

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 × 50 percent). As a result, B’s
remaining business interest expense is $20.

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TABLE 1 TO PARAGRAPH (o)(11)(v)
A

B

Total

Allocable BII deficit ......................................................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII deficit) .................

$20
0

$20
0

$40
N/A

= 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 × 100 percent). As a
result, A’s final allocable ATI is $100.
Because B has a positive allocable ATI of $0,
B’s final allocable ATI is $0.

TABLE 1 TO PARAGRAPH (o)(11)(vi)
A
Allocable ATI ................................................................................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ............................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items
comprising allocable ATI, then such amount = Positive allocable ATI ...................................

B

Total

$100

$0

$100

0

0

0

100

0

100

TABLE 2 TO PARAGRAPH (o)(11)(vi)
A

B

Total

Positive allocable ATI ..................................................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive allocable ATI) ......

$100
0

$0
0

$100
N/A

= 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 × 30 percent) and
B’s ATIC amount is $0 ($0 × 30 percent).

Because A’s ATIC amount exceeds its
remaining business interest expense by $10
($30¥$20), A has an ATIC excess of $10. B
does not have any ATIC excess. Thus, the
total ATIC excess is $10 ($10 + $0). A does

not have any ATIC deficit. Because B’s
remaining business interest expense exceeds
its ATIC amount by $20 ($20¥$0), B has an
ATIC deficit of $20. Thus, the total ATIC
deficit is $20 ($0 + $20).

TABLE 1 TO PARAGRAPH (o)(11)(vii)
A

amozie on DSK3GDR082PROD with PROPOSALS2

ATIC (Final allocable ATI × 30 percent) ......................................................................................
Remaining BIE .............................................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ............................................
If remaining BIE exceeds ATIC, 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.
(B) Because PRS does not meet all three
requirements in paragraph (o)(11)(viii)(A) of

B
$30
20
10
0

Total
$0
20
0
20

N/A
N/A
10
20

this section, PRS does not perform the
calculations or adjustments described in
paragraph (f)(2)(viii) of this section. In sum,
the correct amounts to be used in paragraphs
(o)(11)(ix) and (x) of this section are as
follows.

TABLE 1 TO PARAGRAPH (o)(11)(viii)(B)
A
ATIC excess ................................................................................................................................
ATIC deficit ..................................................................................................................................

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B
$10
0

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$0
20

$10
20

67563

Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
(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 × 100 percent)).

TABLE 1 TO PARAGRAPH (o)(11)(ix)(B)
A

B

Total

ATIC excess ................................................................................................................................
Less: (Total ATIC deficit) × (ATIC excess/Total ATIC excess) ...................................................

$10
20

$0
0

N/A
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 × 100 percent)).

TABLE 1 TO PARAGRAPH (o)(11)(x)
A

B

Total

ATIC deficit ..................................................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .....................................................

$0
0

$20
10

N/A
N/A

= Final ATIC deficit ...............................................................................................................

0

10

10

(xi) Eleventh, PRS allocates deductible
business interest expense and section 163(j)
excess items to the partners. Pursuant to
paragraph (f)(2)(i) of this section, PRS has
$10 of excess business interest expense. PRS
allocates the excess business interest expense

dollar for dollar to the partners with final
ATIC deficits amounts. Thus, PRS allocates
all $10 of its excess business interest expense
to B. A partner’s allocable business interest
expense is deductible business interest
expense to the extent it exceeds such

partner’s share of excess business interest
expense. Therefore, A has deductible
business interest expense of $30 ($30 ¥ $0)
and B has deductible business interest
expense of $20 ($30¥$10).

TABLE 1 TO PARAGRAPH (o)(11)(xi)
A
Deductible BIE .............................................................................................................................
EBIE allocated .............................................................................................................................
ETI allocated ................................................................................................................................
EBII allocated ...............................................................................................................................

(12) Example 12: Facts. A, B, and C own
all of the interests in partnership PRS. In
Year 1, PRS has $150 of ATI, $10 of business
interest income, and $40 of business interest
expense. PRS’s ATI consists of $200 of gross
income and $50 of gross deductions. PRS
allocates its items comprising ATI ($50) to A,
$200 to B, and $0 to C. PRS allocates its

business interest income $0 to A, $0 to B, and
$10 to C. PRS allocates its business interest
expense $30 to A, $10 to B, and $0 to C.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section 163(j)
limit is 30 percent of its ATI plus its business
interest income, or $55 (($150 × 30 percent)
+ $10). Thus, PRS has $0 of excess business

B
$30
0
0
0

Total
$20
10
0
0

$50
10
0
0

interest income, $50 of excess taxable
income, $40 of deductible business interest
expense, and $0 of excess business interest
expense.
(ii) Second, PRS determines each partner’s
allocable share of section 163(j) items used in
its own section 163(j) calculation.

TABLE 1 TO PARAGRAPH (o)(12)(ii)
A

amozie on DSK3GDR082PROD with PROPOSALS2

Allocable ATI ....................................................................................................
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................

(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

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B
($50)
0
30

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

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C
$200
0
10

Total
$0
10
0

$150
10
40

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).

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 1 TO PARAGRAPH (o)(12)(iii)
A

Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess ..............................................................................................................
If allocable BIE exceeds allocable BII, then 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

B

C

Total

$0
30

$0
10

$10
0

N/A
N/A

0

0

10

$10

30

10

0

40

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 × 100 percent).
As a result, C’s allocable business interest
income excess is $0.

TABLE 1 TO PARAGRAPH (o)(12)(iv)
A

B

C

Total

Allocable BII excess ........................................................................................
Less: (Total allocable BII deficit) × (Allocable BII excess/Total allocable BII
excess) .........................................................................................................

$0

$0

$10

N/A

0

0

40

N/A

= Final Allocable BII Excess .....................................................................

0

0

0

$10

(v) Fifth, PRS determines each partner’s
remaining business interest expense. PRS
determines A’s remaining business interest
expense by reducing, but not below $0, A’s
allocable business interest income deficit
($30) by the product of the total allocable
business interest income excess ($10) and the
ratio of A’s allocable business interest
income deficit to the total business interest
income deficit ($30/$40). Therefore, A’s

allocable business interest income deficit of
$30 is reduced by $7.50 ($10 × 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 × 25 percent). As a result, B’s
remaining business interest expense is $7.50.
Because C does not have any allocable
business interest income deficit, C’s
remaining business interest expense is $0.

TABLE 1 TO PARAGRAPH (o)(12)(v)
A

B

C

Total

Allocable BII deficit ..........................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII
deficit) ...........................................................................................................

$30

$10

$0

$40

7.50

2.50

0

N/A

= 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 × 100 percent). As a
result, B’s final allocable ATI is $150.

TABLE 1 TO PARAGRAPH (o)(12)(vi)

amozie on DSK3GDR082PROD with PROPOSALS2

A
Allocable ATI ....................................................................................................
If deduction and loss items comprising allocable ATI exceed income and
gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ..........................................................................................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ..........................................................................................

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B

C

Total

($50)

$200

$0

$150

50

0

0

50

0

200

0

200

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67565

Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 2 TO PARAGRAPH (o)(12)(vi)
A

B

C

Total

Positive allocable ATI ......................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive
allocable ATI) ...............................................................................................

$0

$200

$0

$200

0

50

0

N/A

= 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 × 30 percent), B’s
ATIC amount is $45 ($150 × 30 percent), and
C’s ATIC amount is $0 ($0 × 30 percent). A

does not have any ATIC excess. Because B’s
ATIC amount exceeds its remaining business
interest expense by $37.50 ($45¥$7.50), B
has an ATIC excess amount of $37.50. C does
not have any ATIC excess. Thus, the total
ATIC excess amount is $37.50 ($0 + $37.50

+ $0). Because A’s remaining business
interest expense exceeds its ATIC amount by
$22.50 ($22.50¥$0), A has an ATIC deficit of
$22.50. B and C do not have any ATIC
deficit. Thus, the total ATIC deficit is $22.50
($22.50 + $0 + $0).

TABLE 1 TO PARAGRAPH (o)(12)(vii)
A
ATIC (Final allocable ATI × 30 percent) ..........................................................
Remaining BIE .................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ................
If remaining BIE exceeds ATIC, 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;

B
$0
22.50
0
22.50

(2) A total negative allocable ATI greater
than $0 under paragraph (f)(2)(vi) of this
section; and
(3) A total ATIC excess amount greater
than $0 under paragraph (f)(2)(vii) of this
section.
(B) Because PRS does not meet all three
requirements in paragraph (o)(12)(viii)(A) of

C
$45
7.50
37.50
0

Total
$0
0
0
0

N/A
N/A
37.50
22.50

this section, PRS does not perform the
calculations or adjustments described in
paragraph (f)(2)(viii) of this section. In sum,
the correct amounts to be used in paragraphs
(o)(12)(ix) and (x) of this section are as
follows.

TABLE 1 TO PARAGRAPH (o)(12)(viii)(B)
A
ATIC excess ....................................................................................................
ATIC deficit ......................................................................................................

(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

B
$0
22.50

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/

C

$37.50
0

Total
$0
0

$37.50
22.50

$37.50). Therefore, B has $15 of final ATIC
excess ($37.50¥($22.50 × 100 percent)).

TABLE 1 TO PARAGRAPH (o)(12)(ix)
A

C

Total

ATIC excess ....................................................................................................
Less: (Total ATIC deficit) × (ATIC excess/Total ATIC excess) .......................

$0
0

$37.50
22.50

$0
0

N/A
N/A

= 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
amozie on DSK3GDR082PROD with PROPOSALS2

B

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 × 100 percent)).

TABLE 1 TO PARAGRAPH (o)(12)(x)
A

B

C

Total

ATIC deficit ......................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .........................

$22.50
37.50

$0
0

$0
0

N/A
N/A

= Final ATIC deficit ...................................................................................

0

0

0

$0

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

(xi) Eleventh, PRS allocates deductible
business interest expense and section 163(j)
excess items to the partners. Pursuant to
paragraph (f)(2)(i) of this section, PRS has
$50 of excess taxable income and $40 of
deductible business interest expense. After
grossing up each partner’s final ATIC excess

amounts by ten-thirds, excess taxable income
is allocated dollar for dollar to partners with
final ATIC excess amounts. Thus, PRS
allocates its excess taxable income (ETI) $50
to B. A partner’s allocable business interest
expense is deductible business interest
expense to the extent it exceeds such

partner’s share of excess business interest
expense (EBIE). Therefore, A has deductible
business interest expense of $30 ($30¥$0), B
has deductible business interest expense of
$10 ($10¥$0), and C has deductible business
interest expense of $0 ($0¥$0).

TABLE 1 TO PARAGRAPH (o)(12)(xi)
A
Deductible BIE .................................................................................................
EBIE allocated .................................................................................................
ETI allocated ....................................................................................................
EBII allocated ...................................................................................................

(13) Example 13: Facts. A, B, and C own
all of the interests in partnership PRS. In
Year 1, PRS has $100 of ATI, $0 of business
interest income, and $50 of business interest
expense. PRS’s ATI consists of $200 of gross
income and $100 of gross deductions. PRS
allocates its items comprising ATI $100 to A,

B
$30
0
0
0

$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 § 1.163(j)–2. PRS’s section 163(j)
limit is 30 percent of its ATI plus its business
interest income, or $30 ($100 × 30 percent).

C
$10
0
50
0

Total
$0
0
0
0

$40
0
50
0

Thus, PRS has $30 of deductible business
interest expense and $20 of excess business
interest expense.
(ii) Second, PRS determines each partner’s
allocable share of section 163(j) items used in
its own section 163(j) calculation.

TABLE 1 TO PARAGRAPH (o)(13)(ii)
A
Allocable ATI ....................................................................................................
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................

(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

B
$100
0
0

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

C
$100
0
25

Total
($100)
0
25

$100
0
50

income excess because no partner has
allocable business interest income in excess
of its allocable business interest expense.
Thus, the total allocable business interest
income excess is $0.

TABLE 1 TO PARAGRAPH (o)(13)(iii)
A
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess ..............................................................................................................
If allocable BIE exceeds allocable BII, then 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.

B

C

Total

$0
0

$0
25

$0
25

N/A
N/A

0

0

0

$0

0

25

25

50

(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.

amozie on DSK3GDR082PROD with PROPOSALS2

TABLE 1 TO PARAGRAPH (o)(13)(v)
A

B

C

Total

Allocable BII deficit ..........................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII
deficit) ...........................................................................................................

$0

$25

$25

$50

0

0

0

N/A

= Remaining BIE ......................................................................................

0

25

25

N/A

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67567

Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
(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 × 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 × 50 percent). As a result, B’s final
allocable ATI is $50. Because C has a positive
allocable ATI of $0, C’s final allocable ATI
is $0.

TABLE 1 TO PARAGRAPH (o)(13)(vi)
A
Allocable ATI ....................................................................................................
If deduction and loss items comprising allocable ATI exceed income and
gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ..........................................................................................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ..........................................................................................

B

C

Total

$100

$100

($100)

$100

0

0

100

100

100

100

0

200

TABLE 2 TO PARAGRAPH (o)(13)(vi)
A

B

C

Total

Positive allocable ATI ......................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive
allocable ATI) ...............................................................................................

$100

$100

$0

$200

50

50

0

N/A

= 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 × 30 percent), B’s
ATIC amount is $15 ($50 × 30 percent), and
C’s ATIC amount is $0 ($0 × 30 percent).
Because A’s ATIC amount exceeds its

remaining business interest expense by $15
($15¥$0), A has an ATIC excess of $15. B
and C do not have any ATIC excess. Thus,
the total ATIC excess is $15 ($15 + $0 + $0).
A does not have any ATIC deficit. Because
B’s remaining business interest expense
exceeds its ATIC amount by $10 ($25¥$15),

B has an ATIC deficit of $10. Because C’s
remaining business interest expense exceeds
its ATIC amount by $25 ($25¥$0), C has an
ATIC deficit of $25. Thus, the total ATIC
deficit is $35 ($0 + $10 + $25).

TABLE 1 TO PARAGRAPH (o)(13)(vii)
A

amozie on DSK3GDR082PROD with PROPOSALS2

ATIC (Final allocable ATI × 30 percent) ..........................................................
Remaining BIE .................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ................
If remaining BIE exceeds ATIC, 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 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

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B
$15
0
15
0

adjustments described under paragraph
(f)(2)(viii)(B) and (C) or (D) of this section.
(B) PRS must determine each partner’s
priority amount and usable priority amount.
Only partners with an ATIC deficit under
paragraph (f)(2)(vii) of this section can have
a priority amount greater than $0. Thus, only
partners B and C can have a priority amount
greater than $0. PRS determines a partner’s
priority amount as thirty percent of the
amount by which such partner’s allocable
positive ATI exceeds its final allocable ATI.
Therefore, A’s priority amount is $0, B’s
priority amount is $15 (($100¥$50) × 30
percent), and C’s priority amount is $0
(($0¥$0) × 30 percent). Thus, the total

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C
$15
25
0
10

Total
$0
25
0
25

N/A
N/A
15
35

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.

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 1 TO PARAGRAPH (o)(13)(viii)(B)
A

B

C

Total

(Positive allocable ATI—Final allocable ATI) ..................................................
Multiplied by 30 percent ..................................................................................

$0
30 percent

$50
30 percent

$0
30 percent

N/A
N/A

=Priority amount .......................................................................................

0

15

0

15

TABLE 2 TO PARAGRAPH (o)(13)(viii)(B)
A
Priority amount .................................................................................................
ATIC deficit ......................................................................................................
Lesser of priority amount or ATIC deficit = Usable priority amount ................

(C) For purposes of paragraph (f)(2)(ix) of
this section, each partner’s final ATIC excess
is $0. For purposes of paragraph (f)(2)(x) of
this section, the following terms shall have
the following meanings. Each partner’s ATIC
deficit is such partner’s ATIC deficit as
determined pursuant to paragraph (f)(2)(vii)

B
$0
0
0

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

C
$15
10
10

Total
$0
25
0

N/A
N/A
10

total usable priority amount ($10). Thus, the
total ATIC deficit is $25 ($35¥$10). The total
ATIC excess is the total ATIC excess
determined pursuant to paragraph (f)(2)(vii)
of this section ($15) reduced by the total
usable priority amount ($10). Thus, the total
ATIC excess is $5 ($15¥$5).

TABLE 1 TO PARAGRAPH (o)(13)(viii)(C)
A

B

C

Total

ATIC deficit ......................................................................................................
Less: Usable priority amount ...........................................................................

$0
0

$10
10

$25
0

N/A
N/A

= ATIC deficit for purposes of paragraph (f)(2)(x) of this section ............

0

0

25

25

(D) In light of the fact that the total ATIC
excess was greater than the total usable
priority amount under paragraph

(f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(D) of this section does not apply.
In sum, the correct amounts to be used in

paragraph (f)(2)(x) of this section are as
follows.

TABLE 1 TO PARAGRAPH (o)(13)(viii)(C)
A
ATIC excess ....................................................................................................
ATIC deficit ......................................................................................................

(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.

B
$5
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,

C
$0
0

Total
$0
25

$5
25

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 × 100 percent)).

TABLE 1 TO PARAGRAPH (o)(13)(x)

amozie on DSK3GDR082PROD with PROPOSALS2

A

B

C

Total

ATIC deficit ......................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .........................

$0
0

$0
0

$25
5

N/A
N/A

= 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

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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

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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).

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TABLE 1 TO PARAGRAPH (o)(13)(xi)
A
Deductible BIE .................................................................................................
EBIE allocated .................................................................................................
ETI allocated ....................................................................................................
EBII allocated ...................................................................................................

(14) Example 14: Facts. A, B, C, and D own
all of the interests in partnership PRS. In
Year 1, PRS has $200 of ATI, $0 of business
interest income, and $140 of business interest
expense. PRS’s ATI consists of $600 of gross
income and $400 of gross deductions. PRS
allocates its items comprising ATI $100 to A,

B
$0
0
0
0

$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 § 1.163(j)–2. PRS’s section 163(j)
limit is 30 percent of its ATI plus its business
interest income, or $60 ($200 ¥ 30 percent).

C
$25
0
0
0

Total
$5
20
0
0

$30
20
0
0

Thus, PRS has $60 of deductible business
interest expense and $80 of excess business
interest expense.
(ii) Second, PRS determines each partner’s
allocable share of section 163(j) items used in
its own section 163(j) calculation.

TABLE 1 TO PARAGRAPH (o)(14)(ii)
A
Allocable ATI ........................................................................
Allocable BII .........................................................................
Allocable BIE ........................................................................

(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

B
$100
0
0

C
$100
0
40

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

D
$400
0
60

Total
($400)
0
40

$200
0
140

+ $40 + $60 + $40). No partner has allocable
business interest income excess because no
partner has allocable business interest
income in excess of its allocable business
interest expense. Thus, the total allocable
business interest income excess is $0.

TABLE 1 TO PARAGRAPH (o)(14)(iii)
A
Allocable BII .........................................................................
Allocable BIE ........................................................................
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess .........................................................
If allocable BIE exceeds 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.

B

C

D

Total

$0
0

$0
40

$0
60

$0
40

N/A
N/A

0

0

0

0

0

0

40

60

40

140

(v) Fifth, PRS determines each partner’s
remaining business interest expense. Because
no partner has any allocable business interest
income excess, each partner’s remaining
business interest expense equals its allocable
business interest income deficit. Thus, A’s

remaining business interest expense is $0, B’s
remaining business interest expense is $40,
C’s remaining business interest expense is
$60, and D’s remaining business interest
expense is $40.

TABLE 1 TO PARAGRAPH (o)(14)(v)

amozie on DSK3GDR082PROD with PROPOSALS2

A

B

C

D

Total

Allocable BII deficit ..............................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/
Total allocable BII deficit) .................................................

$0

$40

$60

$40

$140

0

0

0

0

N/A

= 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

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ATI, or an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, D has a
positive allocable ATI of $0. PRS determines
A’s final allocable ATI by reducing, but not
below $0, A’s positive allocable ATI ($100)
by the product of total negative allocable ATI
($400) and the ratio of A’s positive allocable
ATI to the total positive allocable ATI ($100/

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$600). Therefore, A’s positive allocable ATI
is reduced by $66.67 ($400 × 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

E:\FR\FM\28DEP2.SGM

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

allocable ATI ($100/$600). Therefore, B’s
positive allocable ATI is reduced by $66.67
($400 × 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 × 66.67 percent).
As a result, C’s final allocable ATI is $133.33.
Because D has a positive allocable ATI of $0,
D’s final allocable ATI is $0.

TABLE 1 TO PARAGRAPH (o)(14)(vi)
A
Allocable ATI ........................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI,
then such excess amount = Negative allocable ATI .......
If income and gain items comprising allocable ATI equal
or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ....

B

C

D

Total

$100

$100

$400

($400)

$200

0

0

0

400

400

100

100

400

0

600

TABLE 2 TO PARAGRAPH (o)(14)(vi)
A

B

C

D

Total

Positive allocable ATI ..........................................................
Less: (Total negative allocable ATI) x (Positive allocable
ATI/Total positive allocable ATI) ......................................

$100

$100

$400

$0

$600

66.67

66.67

266.67

0

N/A

= 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 × 30 percent),
B’s ATIC amount is $10 ($33.33 × 30
percent), C’s ATIC amount is $40 ($133.33 ×
30 percent), and D’s ATIC amount is $0 ($0
× 30 percent). Because A’s ATIC amount

exceeds its remaining business interest
expense by $10 ($10¥$0), A has an ATIC
excess of $10. B, C, and D do not have any
ATIC excess. Thus, the total ATIC excess is
$10 ($10 + $0 + $0 + $0). A does not have
any ATIC deficit. Because B’s remaining
business interest expense exceeds its ATIC
amount by $30 ($40¥$10), B has an ATIC

deficit of $30. Because C’s remaining
business interest expense exceeds its ATIC
amount by $20 ($60¥$40), C has an ATIC
deficit of $20. Because D’s remaining
business interest expense exceeds its ATIC
amount by $40 ($40¥$0), D has an ATIC
deficit of $40. Thus, the total ATIC deficit is
$90 ($0 + $30 + $20 + $40).

TABLE 1 TO PARAGRAPH (o)(14)(vii)
A

amozie on DSK3GDR082PROD with PROPOSALS2

ATIC (Final allocable ATI x 30 percent) ..............................
Remaining BIE .....................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC
excess ..............................................................................
If remaining BIE exceeds ATIC, 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

C

D

Total

$10
0

$10
40

$40
60

$0
40

N/A
N/A

10

0

0

0

10

0

30

20

40

90

(B) PRS must determine each partner’s
priority amount and usable priority amount.
Only partners with an ATIC deficit under
paragraph (f)(2)(vii) of this section can have
a priority amount greater than $0. Thus, only
partners B, C, and D can have a priority
amount greater than $0. PRS determines a
partner’s priority amount as thirty percent of
the amount by which such partner’s allocable
positive ATI exceeds its final allocable ATI.
Therefore, B’s priority amount is $20
(($100¥$33.33) × 30 percent), C’s priority
amount is $80 (($400¥$133.33) × 30
percent), and D’s priority amount is $0
(($0¥$0) × 30 percent). Thus, the total
priority amount is $100 ($0 + $20 + $80 +

$0). Next, PRS must determine each partner’s
usable priority amount. Each partner’s usable
priority amount is the lesser of such partner’s
priority amount or ATIC deficit. Thus, A has
a usable priority amount of $0, B has a usable
priority amount of $20, C has a usable
priority amount of $20, and D has a usable
priority amount of $0. As a result, the total
usable priority amount is $40 ($0 + $20 + $20
+ $0). Because the total usable priority
amount ($40) is greater than the total ATIC
excess under paragraph (f)(2)(vii) ($10), PRS
must perform the adjustments described in
paragraph (f)(2)(viii)(D) of this section.

TABLE 1 TO PARAGRAPH (o)(14)(viii)(B)
A
(Positive allocable ATI¥Final allocable ATI) ......................
Multiplied by 30 percent .......................................................

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B

$0
30 percent

Fmt 4701

Sfmt 4702

$66.67
30 percent

C

D

$266.67
30 percent

E:\FR\FM\28DEP2.SGM

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$0
30 percent

Total
N/A
N/A

67571

Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 1 TO PARAGRAPH (o)(14)(viii)(B)—Continued
A
= Priority amount ..........................................................

B
0

C
20

D
80

Total
0

100

TABLE 2 TO PARAGRAPH (o)(14)(viii)(B)
A
Priority amount .....................................................................
ATIC deficit ..........................................................................
Lesser of priority amount or 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

B

C

D

Total

$0
0

$20
30

$80
20

$0
40

N/A
N/A

0

20

20

0

40

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 × ($20/
$100)) and C’s step eight excess share is $8
($10 × ($80/$100)). To the extent a priority
partner’s step eight excess share exceeds its
ATIC deficit, the excess shall be the partner’s
ATIC excess for purposes of paragraph
(f)(2)(x) of this section. Thus, B and C each
have an ATIC excess of $0, resulting in a total

ATIC excess is $0. To the extent a priority
partner’s ATIC deficit exceeds its step eight
excess share, the excess shall be the partner’s
ATIC deficit for purposes of paragraph
(f)(2)(x) of this section. Because B’s ATIC
deficit ($30) exceeds its step eight excess
share ($2), B’s ATIC deficit for purposes of
paragraph (f)(2)(x) of this section is $28
($30¥$2). Because C’s ATIC deficit ($20)
exceeds its step eight excess share ($8), C’s
ATIC deficit for purposes of paragraph
(f)(2)(x) of this section is $12 ($20¥$8).
Thus, the total ATIC deficit is $40 ($28 +
$12).

TABLE 1 TO PARAGRAPH (o)(14)(viii)(D)(1)
A
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) =
Final ATIC deficit for purposes of paragraph (f)(2)(x) of
this section .......................................................................

B

$0

C

N/A

D

N/A

Total

$40

N/A

TABLE 2 TO PARAGRAPH (o)(14)(viii)(D)(1)
A
Priority partners step eight excess share = (Total ATIC excess) × (Priority/Total priority) ..........................................
ATIC deficit ..........................................................................
If step eight excess share exceeds ATIC deficit, then such
excess = ATIC excess for purposes of paragraph
(f)(2)(x) of this section ......................................................
If ATIC deficit exceeds step eight excess share, then such
excess = ATIC deficit for purposes of paragraph (f)(2)(x)
of this section ...................................................................

B

C

D

Total

N/A
N/A

$2
30

$8
20

N/A
N/A

N/A
N/A

N/A

0

0

N/A

0

N/A

28

12

N/A

40

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

TABLE 1 TO PARAGRAPH (o)(14)(viii)(D)(2)
amozie on DSK3GDR082PROD with PROPOSALS2

A
ATIC excess .........................................................................
ATIC deficit ..........................................................................
Non-priority partner final ATIC deficit ..................................

(ix) Ninth, PRS determines each partner’s
final ATIC excess amount. Pursuant to
paragraph (f)(2)(viii)(D) of this section, each

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20:55 Dec 27, 2018

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B
$0
0
0

C
$0
28
0

priority and non-priority partner’s final ATIC
excess amount is $0.

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D
$0
12
0

Total
$0
0
40

$0
40
N/A

(x) Tenth, PRS determines each partner’s
final ATIC deficit amount. Because B has an
ATIC deficit, PRS must determine B’s final

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

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 × 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 × 30 percent)). Pursuant to
paragraph (f)(2)(viii)(D) of this section, D’s
final ATIC deficit amount is $40.

TABLE 2 TO PARAGRAPH (o)(14)(x)
A

B

C

D

Total

ATIC deficit ..........................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) ....................................................................................

N/A

$28

$12

N/A

N/A

N/A

0

0

N/A

N/A

= Final ATIC deficit .......................................................

0

28

12

40

80

(xi) Eleventh, PRS allocates deductible
business interest expense and section 163(j)
excess items to the partners. Pursuant to
paragraph (f)(2)(i) of this section, PRS has
$80 of excess business interest expense. PRS
allocates the excess business interest expense
dollar for dollar to the partners with final

ATIC deficits. Thus, PRS allocates its excess
business interest expense $28 to B, $12 to C,
and $40 to D. A partner’s allocable business
interest expense is deductible business
interest expense to the extent it exceeds such
partner’s share of excess business interest
expense. Therefore, A has deductible

business interest expense of $0 ($0¥$0), B
has deductible business interest expense of
$12 ($40¥$28), C has deductible business
interest expense of $48 ($60¥$12), and D has
deductible business interest expense of $0
($40¥$40).

TABLE 1 TO PARAGRAPH (o)(14)(xi)
A
Deductible BIE .....................................................................
EBIE allocated .....................................................................
ETI allocated ........................................................................
EBII allocated .......................................................................

(15) Example 15: Facts. A, B, C, and D own
all of the interests in partnership PRS. In
Year 1, PRS has $200 of ATI, $0 of business
interest income, and $150 of business interest
expense. PRS’s ATI consists of $500 of gross
income and $300 of gross deductions. PRS
allocates its items comprising ATI $50 to A,

B
$0
0
0
0

C
$12
28
0
0

$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 § 1.163(j)–2. PRS’s section 163(j)
limit is 30 percent of its ATI plus its business
interest income, or $60 ($200 × 30 percent).

D
$48
12
0
0

Total
$0
40
0
0

$60
80
0
0

Thus, PRS has $60 of deductible business
interest expense, and $90 of excess business
interest expense.
(ii) Second, PRS determines each partner’s
allocable share of section 163(j) items used in
its own section 163(j) calculation.

TABLE 1 TO PARAGRAPH (o)(15)(ii)
A
Allocable ATI ........................................................................
Allocable BII .........................................................................
Allocable BIE ........................................................................

(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

B
$50
0
0

C
$50
0
50

interest expense. Thus, A’s allocable business
interest income deficit is $0, B’s allocable
business interest income deficit is $50, C’s
allocable business interest income deficit is
$50, and D’s allocable business interest
income deficit is $50. The total allocable
business interest income deficit is $150 ($0

D
$400
0
50

Total
($300)
0
50

$200
0
150

+ $50 + $50 + $50). No partner has allocable
business interest income excess because no
partner has allocable business interest
income in excess of its allocable business
interest expense. Thus, the total allocable
business interest income excess is $0.

TABLE 1 TO PARAGRAPH (o)(15)(iii)

amozie on DSK3GDR082PROD with PROPOSALS2

A
Allocable BII .........................................................................
Allocable BIE ........................................................................
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess .........................................................
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit ...........................................................

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B

C

D

Total

$0
0

$0
50

$0
50

$0
50

N/A
N/A

0

0

0

0

0

0

50

50

50

150

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
(iv) Fourth, PRS determines each partner’s
final allocable business interest income
excess. Because no partner has any allocable
business interest income excess, each partner
has final allocable business interest income
excess of $0.

(v) Fifth, PRS determines each partner’s
remaining business interest expense. Because
no partner has any allocable business interest
income excess, each partner’s remaining
business interest expense equals its allocable
business interest income deficit. Thus, A’s

remaining business interest expense is $0, B’s
remaining business interest expense is $50,
C’s remaining business interest expense is
$50, and D’s remaining business interest
expense is $50.

TABLE 1 TO PARAGRAPH (o)(15)(v)
A

B

C

D

Total

Allocable BII deficit ..............................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/
Total allocable BII deficit) .................................................

$0

$50

$50

$50

$150

0

0

0

0

N/A

= 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 × 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 × 80 percent). As a
result, C’s final allocable ATI is $160.
Because D has a positive allocable ATI of $0,
D’s final allocable ATI is $0.

TABLE 1 TO PARAGRAPH (o)(15)(vi)
A
Allocable ATI ........................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI,
then such excess amount = Negative allocable ATI .......
If income and gain items comprising allocable ATI equal
or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ....

B

C

D

Total

$50

$50

$400

($300)

$200

0

0

0

300

300

50

50

400

0

500

TABLE 2 TO PARAGRAPH (o)(15)(vi)
A

C

D

Total

Positive allocable ATI ..........................................................
Less: (Total negative allocable ATI) × (Positive allocable
ATI/Total positive allocable ATI) ......................................

$50

$50

$400

$0

$500

30

30

240

0

N/A

= 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 × 30 percent), B’s
ATIC amount is $6 ($20 × 30 percent), C’s
ATIC amount is $48 ($160 × 30 percent), and
D’s ATIC amount is $0 ($0 × 30 percent).
Because A’s ATIC amount exceeds its
amozie on DSK3GDR082PROD with PROPOSALS2

B

remaining business interest expense by $6
($6 ¥ $0), A has an ATIC excess of $6. B,
C, and D do not have any ATIC excess. Thus,
the total ATIC excess amount is $6 ($6 + $0
+ $0 + $0). A does not have any ATIC deficit.
Because B’s remaining business interest
expense exceeds its ATIC amount by $44
($50 ¥ $6), B has an ATIC deficit of $44.

Because C’s remaining business interest
expense exceeds its ATIC amount by $2 ($50
¥ $48), C has an ATIC deficit of $2. Because
D’s remaining business interest expense
exceeds its ATIC amount by $50 ($50 ¥ $0),
D has an ATIC deficit of $50. Thus, the total
ATIC deficit is $96 ($0 + $44 + $2 + $50).

TABLE 1 TO PARAGRAPH (o)(15)(vii)
A
ATIC (Final allocable ATI × 30 percent) ..............................
Remaining BIE .....................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC
excess ..............................................................................

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B

C

D

Total

$6
0

$6
50

$48
50

$0
50

N/A
N/A

6

0

0

0

$6

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 1 TO PARAGRAPH (o)(15)(vii)—Continued
A

If remaining BIE exceeds ATIC, 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

B
0

C
44

adjustments described under paragraph
(f)(2)(viii) of this section.
(B) PRS must determine each partner’s
priority amount and usable priority amount.
Only partners with an ATIC deficit under
paragraph (f)(2)(vii) of this section of this
section can have a priority amount greater
than $0. Thus, only partners B, C, and D can
have a priority amount greater than $0. PRS
determines a partner’s priority amount as
thirty percent of the amount by which such
partner’s allocable positive ATI exceeds its
final allocable ATI. Therefore, B’s priority
amount is $9 (($50 ¥ $20) × 30 percent), C’s
priority amount is $72 (($400 ¥ $160) × 30
percent), and D’s priority amount is $0 (($0

D
2

Total
50

96

¥ $0) × 30 percent). Thus, the total priority
amount is $81 ($0 + $9 + $72 + $0). Next,
PRS must determine each partner’s usable
priority amount. Each partner’s usable
priority amount is the lesser of such partner’s
priority amount or ATIC deficit. Thus, B has
a usable priority amount of $9, C has a usable
priority amount of $2, and D has a usable
priority amount of $0. As a result, the total
usable priority amount is $11 ($0 + $9 + $2
+ $0). Because the total usable priority
amount ($11) is greater than the total ATIC
excess ($6) under paragraph (f)(2)(vii) of this
section, PRS must perform the adjustments
described in paragraph (f)(2)(viii)(D) of this
section.

TABLE 1 TO PARAGRAPH (o)(15)(viii)(B)
A

B

C

D

Total

(Positive allocable ATI¥Final allocable ATI) ......................
Multiplied by 30 percent .......................................................

$0
30 percent

$30
30 percent

$240
30 percent

$0
30 percent

N/A
N/A

= Priority amount ..........................................................

0

9

72

0

81

TABLE 2 TO PARAGRAPH (o)(15)(viii)(B)
A
Priority amount .....................................................................
ATIC deficit ..........................................................................
Lesser of priority amount or 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

B

C

D

Total

$0
0

$9
44

$72
2

$0
50

N/A
N/A

0

9

2

0

$11

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 × ($9/
$81)) and C’s step eight excess share is $5.33
($6 × ($72/$81)). To the extent a priority
partner’s step eight excess share exceeds its
ATIC deficit, the excess shall be the partner’s
ATIC excess for purposes of paragraph
(f)(2)(x) of this section. B’s step eight excess
share does not exceed its ATIC deficit.
Because C’s step eight excess share ($5.33)
exceeds its ATIC deficit ($2), C’s ATIC excess

for purposes of paragraph (f)(2)(x) of this
section is $3.33 ($5.33¥$2). Thus, the total
ATIC excess for purposes of paragraph
(f)(2)(x) of this section is $3.33 ($0 + $3.33).
To the extent a priority partner’s ATIC deficit
exceeds its step eight excess share, the excess
shall be the partner’s ATIC deficit for
purposes of paragraph (f)(2)(x) of this section.
Because B’s ATIC deficit ($44) exceeds its
step eight excess share ($0.67), B’s ATIC
deficit for purposes of paragraph (f)(2)(x) of
this section is $43.33 ($44¥$0.67). C’s ATIC
deficit does not exceed its step eight excess
share. Thus, the total ATIC deficit for
purposes of paragraph (f)(2)(x) of this section
is $43.33 ($43.33 + $0).

amozie on DSK3GDR082PROD with PROPOSALS2

TABLE 1 TO PARAGRAPH (o)(15)(viii)(D)(1)
A
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) =
Final ATIC deficit for purposes of paragraph (f)(2)(x) of
this section .......................................................................

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$0

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C

N/A

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D

N/A

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$50

N/A

67575

Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
TABLE 2 TO PARAGRAPH (o)(15)(viii)(D)(1)
A
Priority partners step eight excess share = (Total ATIC excess) × (Priority/Total priority) ..........................................
ATIC deficit ..........................................................................
If step eight excess share exceeds ATIC deficit, then such
excess = ATIC excess for purposes of paragraph
(f)(2)(x) of this section ......................................................
If ATIC deficit exceeds step eight excess share, then such
excess = ATIC deficit for purposes of paragraph (f)(2)(x)
of this section ...................................................................

B

C

D

Total

N/A
N/A

$0.67
44

$5.33
2

N/A
N/A

N/A
N/A

N/A

0

3.33

N/A

$3.33

N/A

43.33

0

N/A

43.33

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

TABLE 1 TO PARAGRAPH (o)(15)(viii)(D)(2)
A
ATIC excess .........................................................................
ATIC deficit ..........................................................................
Non-priority partner final ATIC 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.

B
$0
0
0

C
$0
43.33
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

D
$3.33
0
0

Total
$0
0
50

$3.33
43.33
N/A

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 × 100 percent)).
Pursuant to paragraph (f)(2)(viii)(D) of this
section, D’s final ATIC deficit amount is $40.

TABLE 1 TO PARAGRAPH (o)(15)(x)
A

B

C

D

Total

ATIC deficit ..........................................................................
Less: (Total ATIC excess) x (ATIC deficit/Total ATIC deficit) ....................................................................................

$0

$43.33

$0

N/A

N/A

0

3.33

0

N/A

N/A

= Final ATIC deficit .......................................................

0

40

0

$50

$90

(xi) Eleventh, PRS allocates deductible
business interest expense and section 163(j)
excess items to the partners. Pursuant to
paragraph (f)(2)(i) of this section, PRS has
$90 of excess business interest expense. PRS
allocates the excess business interest expense
dollar for dollar to the partners with final

ATIC deficits. Thus, PRS allocates its excess
business interest expense $40 to B and $50
to D. A partner’s allocable business interest
expense is deductible business interest
expense to the extent it exceeds such
partner’s share of excess business interest
expense. Therefore, A has deductible

business interest expense of $0 ($0¥$0), B
has deductible business interest expense of
$10 ($50¥$40), C has deductible business
interest expense of $50 ($50¥$0), and D has
deductible business interest expense of $0
($50¥$50).

TABLE 1 TO PARAGRAPH (o)(15)(xi)
A

amozie on DSK3GDR082PROD with PROPOSALS2

Deductible BIE .....................................................................
EBIE allocated .....................................................................
ETI allocated ........................................................................
EBII allocated .......................................................................

(16) Example 16—(i) Facts. A and B are
equal shareholders in X, a subchapter S
corporation. In Year 1, X has $100 of ATI and
$40 of business interest expense. A has $100
of ATI and $20 of business interest expense
from its sole proprietorship. B has $0 of ATI
and $20 of business interest expense from its
sole proprietorship.

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B
$0
0
0
0

C
$10
40
0
0

(ii) S corporation-level. In Year 1, X’s
section 163(j) limit is 30 percent of its ATI,
or $30 ($100 × 30 percent). Thus, X has $30
of deductible business interest expense and
$10 of disallowed business interest expense.
Such $30 of deductible business interest
expense is includable in X’s non-separately
stated income or loss, and is not subject to
further limitation under section 163(j). X

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D
$50
0
0
0

Total
$0
50
0
0

$60
90
0
0

carries forward the $10 of disallowed
business interest expense to Year 2 as a
disallowed business interest expense
carryforward under § 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 § 1.163(j)–6(l)(7).

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

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

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($40 business interest expense, less $15
section 163(j) limit) is treated as business
interest expense paid or accrued by B in Year
3.

(p) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–7 Application of the business
interest deduction limitation to foreign
corporations and United States
shareholders.

(a) Overview. This section provides
rules for the application of section 163(j)
to foreign corporations with
shareholders that are United States
persons. Paragraph (b) of this section
provides rules regarding the application
of section 163(j) to certain controlled
foreign corporations. Paragraph (c) of
this section provides rules concerning
the computation of adjusted taxable
income (ATI) of certain controlled
foreign corporations. Paragraph (d) of
this section provides rules concerning
the computation of ATI of a United
States shareholder of certain controlled
foreign corporations (CFC). Paragraph
(e) of this section provides a rule
regarding the effect of section 163(j) on
the earnings and profits of foreign
corporations. Paragraph (f) of this
section provides definitions that apply
for purposes of this section. Paragraph
(g) of this section provides examples
illustrating the application of this
section. Paragraph (h) of this section
provides dates of applicability.
(b) Application of section 163(j) to an
applicable CFC and certain
partnerships—(1) Scope. This paragraph
(b) provides rules regarding the
application of section 163(j) to an
applicable CFC and certain
partnerships. Paragraph (b)(2) of this
section describes the general application
of section 163(j) to an applicable CFC
and certain partnerships in which an
applicable CFC is a partner. Paragraph
(b)(3) of this section provides an
election to use an alternative method for
computing the deduction for business

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interest expense of a member of a CFC
group. Paragraph (b)(4) of this section
treats certain partnerships as members
of a CFC group for purposes of this
paragraph (b). Paragraph (b)(5) of this
section provides the rules regarding an
election to apply paragraph (b)(3) of this
section.
(2) General application of section
163(j) to an applicable CFC and a
partnership with at least one partner
that is an applicable CFC. Except as
otherwise provided in this paragraph (b)
or in the section 163(j) regulations,
section 163(j) and the section 163(j)
regulations apply to determine the
deductibility of an applicable CFC’s
business interest expense for purposes
of computing its taxable income in the
same manner as those provisions apply
to determine the deductibility of a
domestic C corporation’s business
interest expense for purposes of
computing its taxable income.
Furthermore, if an applicable CFC is a
partner in a partnership, except as
otherwise provided in this paragraph (b)
or in the section 163(j) regulations,
section 163(j) and the section 163(j)
regulations apply to the partnership in
the same manner as those provisions
would apply if the applicable CFC were
a domestic C corporation. If an
applicable CFC has income that is, or is
treated as, effectively connected with
the conduct of a trade or business in the
United States or if a partnership is
engaged in a trade or business
conducted in the United States, see also
§§ 1.163(j)–8(d) and 1.882–5 for
additional rules concerning the
deduction for interest.
(3) Alternative approach for
computing the deduction for business
interest expense. If a CFC group election
is properly made and in effect with
respect to a specified taxable year of a
CFC group member of a CFC group,
then—
(i) The portion of the CFC group
member’s business interest expense that
is subject to the general rule under
§ 1.163(j)–2(b) is the amount equal to
the CFC group member’s allocable share
of the CFC group’s applicable net
business interest expense, or, in the case
in which the CFC group member is also
a member of a financial services
subgroup, the allocable share of the
applicable subgroup net business
interest expense; and
(ii) The limitation provided in
§ 1.163(j)–2(b) is applied without regard
to § 1.163(j)–2(b)(1) and (3).
(4) Treatment of certain partnerships
as a CFC group member—(i) General
rule. If one or more CFC group members
of the same CFC group, in the aggregate,
own more than 80 percent of the

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interests in the capital or profits in a
partnership, then, except as provided in
paragraph (b)(4)(ii) of this section, the
partnership is treated as a CFC group
member. If there is a financial services
subgroup with respect to the CFC group,
this paragraph (b)(4) will apply only if
all of the CFC group members described
in the preceding sentence are financial
services subgroup members or none of
them are financial services subgroup
members. If a partnership is treated as
a CFC group member, then an interest
in the partnership is treated as stock for
purposes of applying this section.
(ii) Exception for certain partnerships
engaged in a United States trade or
business. Notwithstanding paragraph
(b)(4)(i) of this section, a partnership is
not treated as a CFC group member if
the partnership is engaged in a trade or
business in the United States, directly or
indirectly through another passthrough
entity, and one or more partners has
income that is effectively connected
with the conduct of a trade or business
in the United States, including any
income that is treated as effectively
connected income under an applicable
provision of the Code or regulations,
and at least one of the partners is not
exempt from U.S. tax by reason of a U.S.
income tax treaty. Notwithstanding the
preceding sentence, a partnership that,
without regard to this paragraph
(b)(4)(ii), would be treated as a CFC
group member under paragraph (b)(4)(i)
of this section, is treated as a CFC group
member solely for purposes of
determining if another entity is a CFC
group member with respect to the CFC
group.
(5) CFC group election—(i) Manner of
making a CFC group election. Subject to
paragraph (b)(5)(ii) of this section, a CFC
group election is made by applying
paragraph (b)(3) of this section for
purposes of computing the amount of a
CFC group member’s deduction for
business interest expense. Except as
otherwise provided in publications,
forms, instructions, or other guidance, a
separate statement or form evidencing
the election need not be filed.
(ii) Consistency requirement. An
election under paragraph (b)(5)(i) of this
section is not effective unless all CFC
group members of the CFC group make
the election. If an entity becomes a CFC
group member of a CFC group for which
a CFC group election is in effect, the
entity must make the CFC group
election.
(iii) Duration of a CFC group election.
A CFC group election is irrevocable. If
an entity ceases to be a CFC group
member of a CFC group for which a CFC
group election is in effect, the election
terminates solely with respect to such

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entity. If a CFC group ceases to exist, a
CFC group election terminates with
respect to all CFC group members of the
CFC group.
(c) Rules concerning the computation
of adjusted taxable income of an
applicable CFC and certain CFC group
members—(1) Computation of taxable
income. For purposes of computing
taxable income of an applicable CFC for
a taxable year, the applicable CFC’s
gross income and allowable deductions
are determined under the principles of
§ 1.952–2 or the rules of section 882 for
determining taxable income that is
effectively connected with the conduct
of a trade or business in the United
States, as applicable.
(2) Treatment of certain dividends.
For purposes of computing the ATI of
an applicable CFC for a taxable year,
any dividend included in gross income
that is received from a related person,
within the meaning of section 954(d)(3),
with respect to the distributee is
subtracted from taxable income.
(3) Treatment of CFC excess taxable
income—(i) In general. If a CFC group
election is in effect for a specified
taxable year of a CFC group member and
if the CFC group member (upper-tier
member) directly owns stock in one or
more other CFC group members (lowertier member), then, for purposes of
computing ATI of the upper-tier
member for the specified taxable year,
there is added to taxable income the
sum of the products of the following
amounts with respect to each lower-tier
member—
(A) The CFC excess taxable income (if
any) of the lower-tier member for the
lower-tier member’s specified taxable
year; and
(B) The percentage (by value) of the
stock of the lower-tier member that is
directly owned by the upper-tier
member on the last day of the lower-tier
member’s specified taxable year.
(ii) Ordering rules. For purposes of
applying paragraph (c)(3)(i) of this
section, if a CFC group member is an
upper-tier member with respect to a
CFC group member and a lower-tier
member with respect to another CFC
group member, paragraph (c)(3)(i) of this
section is applied starting with the
lowest-tier CFC group member in the
chain of ownership. If an upper-tier
member is a partner in a lower-tier
member that is a partnership, which is
an entity that does not have CFC excess
taxable income but that may have excess
taxable income (as defined in § 1.163(j)–
1(b)(15)), see § 1.163(j)–6(f) for
determining the upper-tier member’s
share of the lower-tier member’s excess
taxable income (if any).

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(d) Rules concerning the computation
of adjusted taxable income of a United
States shareholder—(1) In general—(i)
Treatment of gross income inclusions
that are properly allocable to a nonexcepted trade or business. If for a
taxable year a United States shareholder
with respect to one or more applicable
CFCs includes amounts in gross income
under section 78, 951(a), or 951A(a) that
are properly allocable to a non-excepted
trade or business (each amount, a
specified deemed inclusion and such
amounts, collectively specified deemed
inclusions), then, for purposes of
computing ATI of the United States
shareholder, there is subtracted from
taxable income an amount equal to the
specified deemed inclusions, reduced
by the portion of the deduction allowed
under section 250(a)(1), without regard
to the taxable income limitation of
section 250(a)(2), by reason of the
specified deemed inclusions (such a
deduction, a specified section 250
deduction). For rules concerning
inclusions under sections 78, 951(a),
and 951A(a) and deductions allowable
under section 250 that are not properly
allocable to a non-excepted trade or
business, see § 1.163(j)–1(b)(1)(ii)(F) and
(b)(1)(i)(H), respectively.
(ii) Treatment of deemed inclusions of
a domestic partnership that are not
allocable to any trade or business. If a
United States shareholder that is a
domestic partnership includes amounts
in gross income under section 951(a) or
951A(a) that are not properly allocable
to trade or business of the domestic
partnership, then, notwithstanding
§ 1.163(j)–4(b)(3), to the extent a C
corporation partner, including an
indirect partner in the case of tiered
partnerships, takes such amounts into
account as a distributive share in
accordance with section 702 and
§ 1.702–1(a)(8)(ii), the C corporation
partner may not treat such amounts as
properly allocable to a trade or business
of the C corporation partner.
(2) Additional rule after application of
paragraph (d)(1) of this section for a
United States shareholder of a CFC
group member with a CFC group
election in effect—(i) In general. Subject
to paragraph (d)(3) of this section, if for
a taxable year, a United States
shareholder owns directly, or indirectly
through one or more foreign passthrough entities, stock of one or more
CFC group members of a CFC group for
which a CFC group election is in effect
for the specified taxable year of each
CFC group member that ends with or
within the taxable year of the United
States shareholder, then, for purposes of
computing ATI of the United States
shareholder, in addition to the

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subtraction described in paragraph
(d)(1) of this section, there is added to
taxable income the amount equal to the
sum of the amounts of eligible CFC
group ETI, as defined in paragraph
(d)(2)(ii) of this section, with respect to
each specified highest-tier member of
the United States shareholder, but not in
excess of the amount of the CFC group
inclusions, as defined in paragraph
(d)(2)(iii) of this section, of the United
States shareholder for the taxable year.
For purposes of this paragraph (d)(2)(i),
members of a consolidated group are
treated as a single United States
shareholder.
(ii) Eligible CFC group ETI. The term
eligible CFC group ETI means, with
respect to a specified highest-tier
member and a specified taxable year,
the amount equal to the product of the
following three amounts—
(A) The specified highest-tier
member’s CFC excess taxable income for
the specified taxable year, taking into
account the application of paragraph
(c)(3) of this section;
(B) The specified highest-tier
member’s specified ETI ratio for the
specified taxable year; and
(C) The percentage, by value, of the
stock of the specified highest-tier
member that is owned directly, or
indirectly through one or more foreign
passthrough entities, by the United
States shareholder on the last day of the
specified taxable year.
(iii) CFC group inclusions. The term
CFC group inclusions means, with
respect to a United States shareholder
and a taxable year, the amounts of the
specified deemed inclusions subtracted
from taxable income under paragraph
(d)(1)(i) of this section that are with
respect to CFC group members, other
than amounts included in gross income
by reason of section 78, reduced by the
portion of any specified section 250
deduction described in paragraph
(d)(1)(i) of this section that is allowable
by reason of such specified deemed
inclusions.
(3) Special rules if a domestic
partnership is a United States
shareholder of a CFC group member
with a CFC group election in effect.
Paragraph (d)(2) of this section does not
apply with respect to a United States
shareholder described in paragraph
(d)(2) of this section that is a domestic
partnership (such a partnership, a U.S.
shareholder partnership). If a U.S.
shareholder partnership has a domestic
C corporation partner, including an
indirect partner in the case of tiered
partnerships, (such a partner, a U.S.
corporate partner), then, for purposes of
computing ATI of the U.S. corporate
partner, paragraph (d)(2) of this section

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is applied by treating the U.S.
shareholder partnership, and in case of
tiered partnerships, any tiered
partnership that is a domestic
partnership, as if it were a foreign
partnership and by making the
following modifications—
(i) The term ‘‘U.S. corporate partner’’
is substituted for the term ‘‘United
States shareholder’’ each place it
appears in paragraph (d)(2) of this
section; and
(ii) If a U.S. shareholder partnership
includes an amount in gross income
under section 951(a) or 951(A) with
respect to a CFC group member, then to
the extent the amount is taken into
account by a U.S. corporate partner as
a distributive share in accordance with
section 702 and § 1.702–1(a)(8)(ii), such
amount is treated as a specified deemed
inclusion of the U.S. corporate partner
with respect to the CFC group member
for purposes of applying paragraph
(d)(2)(iii) of this section.
(4) Inclusions under section 951A(a).
For purposes of applying paragraph (d)
of this section, the portion of a United
States shareholder’s inclusion under
section 951A(a) treated as being with
respect to a CFC group member is
determined under section 951A(f)(2)
and § 1.951A–6(b)(2).
(e) Effect on earnings and profits. In
the case of a foreign corporation, the
disallowance and carryforward of a
deduction for the corporation’s business
interest expense under § 1.163(j)–2 will
not affect whether and when such
business interest expense reduces the
corporation’s earnings and profits. Thus,
for example, if a United States person
has elected under section 1295 to treat
a passive foreign investment company
(as defined in section 1297) (PFIC) as a
qualified electing fund, then the
disallowance and carryforward of a
deduction for the PFIC’s business
interest expense under § 1.163(j)–2 will
not affect whether or when such
business interest expense reduces the
PFIC’s earnings and profits. Similarly,
the disallowance and carryforward of a
deduction for an applicable CFC’s
business interest expense will not affect
the earnings and profits limitation for
subpart F income under section 952(c).
See also § 1.163(j)–4(c).
(f) Definitions. The following
definitions apply for purposes of this
section.
(1) Allocable share—(i) General rule.
The term allocable share means, with
respect to a CFC group member of a CFC
group and a specified taxable year, the
amount equal to the product of the CFC
group’s applicable net business interest
expense (multiplicand), if any, and a
fraction, the numerator of which is

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equal to the amount of the CFC group
member’s net business interest expense,
and the denominator of which is equal
to the sum of the amounts of the net
business interest expense of each CFC
group member.
(ii) Special rule if there is a financial
services subgroup. If there is a financial
services subgroup with respect to a CFC
group, then paragraph (f)(1)(i) of this
section is applied with the following
modifications—
(A) With respect to a CFC group
member that is also a financial services
subgroup member—
(1) The multiplicand is equal to the
amount of the applicable subgroup net
business interest expense; and
(2) The denominator of the fraction is
determined by replacing the term ‘‘CFC
group member’’ with the term ‘‘financial
services subgroup member.’’
(B) With respect to a CFC group
member this is not a financial services
subgroup member—
(1) The multiplicand is reduced by
the amount of the applicable subgroup
net business interest expense; and
(2) The denominator of the fraction is
reduced by the sum of the amounts of
the net business interest expense of each
financial services subgroup member.
(2) Applicable CFC. The term
applicable CFC means a controlled
foreign corporation described in section
957, but only if the foreign corporation
has at least one United States
shareholder that owns, within the
meaning of section 958(a), stock of the
foreign corporation.
(3) Applicable net business interest
expense. The term applicable net
business interest expense means, with
respect to a CFC group and a majority
U.S. shareholder taxable year, the
excess, if any, of the sum of the amounts
of the business interest expense of each
CFC group member for the specified
taxable year, over the sum of the
amounts of the business interest income
of each CFC group member for the
specified taxable year.
(4) Applicable subgroup net business
interest expense. The term applicable
subgroup net business interest expense
means, with respect to a financial
services subgroup of a CFC group and a
majority U.S. shareholder taxable year,
the excess, if any, of the sum of the
amounts of the business interest
expense of each financial services
subgroup member for the specified
taxable year, over the sum of the
amounts of the business interest income
of each financial services subgroup
member for the specified taxable year.
(5) CFC excess taxable income—(i) In
general. The term CFC excess taxable
income means, with respect to a CFC

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group member, other than a partnership
described in paragraph (b)(4)(i) of this
section, and a specified taxable year, the
amount which bears the same ratio to
the CFC group member’s ATI, as—
(A) The excess (if any) of—
(1) The amount determined for the
CFC group member under § 1.163(j)–
2(b)(2); over
(2) The CFC group member’s allocable
share of either the applicable net
business interest expense or the
applicable subgroup net business
interest expense, as applicable; bears to
(B) The amount determined for the
CFC group member under § 1.163(j)–
2(b)(2).
(ii) CFC group member is a
partnership. If a CFC group member is
a partnership, see § 1.163(j)–1(b)(15) for
determining the extent to which the
partnership has excess taxable income.
For rules concerning a partner’s share of
a partnership’s excess taxable income,
see § 1.163(j)–6(f).
(6) CFC group—(i) In general. The
term CFC group means two or more
applicable CFCs if 80 percent or more of
the total value of shares of all classes of
stock of each applicable CFC is owned,
within the meaning of section 958(a),
either by a single United States
shareholder or by multiple U.S.
shareholders that are related persons,
within the meaning of section 267(b) or
707(b)(1), (each a related United States
shareholder and collectively related
United States shareholders), provided
the stock of each applicable CFC is
owned in the same proportion by each
related United States shareholder.
(ii) Aggregation rules. The following
rules apply for the purpose of applying
paragraph (f)(6)(i) of this section—
(A) Members of a consolidated group
and individuals described in section
318(a)(1)(A)(i) who file a joint tax return
are treated as a single person; and
(B) If a single United States person, as
defined in section 957(c), taking into
account the application of paragraph
(f)(6)(ii)(A) of this section, owns,
directly or indirectly through one or
more passthrough entities, more than 80
percent of the interests in a passthrough entity that is a United States
shareholder that owns, within the
meaning of section 958(a), stock in an
applicable CFC, then that United States
person is treated as owning the stock of
the applicable CFC that is owned by the
passthrough entity. For purposes of
applying the 80–percent threshold
described in the preceding sentence, if
the pass-through entity is a partnership,
then the 80–percent threshold is
satisfied if the United States person
owns at least 80 percent of the interests
in the capital or the profits of the

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partnership, and if the passthrough
entity is not a partnership, then the 80–
percent threshold is satisfied if the
United States person owns at least 80
percent of the value of all interests of
the passthrough entity.
(7) CFC group election. The term CFC
group election means an election to
apply paragraph (b)(3) of this section.
(8) CFC group member. The term CFC
group member means, with respect to a
CFC group, an entity included in the
CFC group. An entity that has, including
through ownership of an interest in a
passthrough entity, income which is
effectively connected with a trade or
business conducted in the United
States, including any income that is
treated as effectively connected income
under an applicable provision of the
Code or regulations, and not exempt
from U.S. tax by reason of a U.S. income
tax treaty is not treated as a member of
a CFC group, other than solely for
purposes of determining if another
entity is a CFC group member with
respect to the CFC group.
(9) Financial services subgroup. The
term financial services subgroup means,
with respect to a CFC group, a group
comprised of each CFC group member
of the CFC group that is an eligible
controlled foreign corporation (as
defined in section 954(h)(2)(A)), a
qualified insurance company (as
defined in section 953(e)(3)), or eligible
for the dealer exception in computing
foreign personal holding company
income (as described in section
954(c)(2)(C)).
(10) Financial services subgroup
member. The term financial services
subgroup member means, with respect
to a financial services subgroup of a CFC
group, a CFC group member that is also
a member of the financial services
subgroup.
(11) Majority U.S. shareholder taxable
year. The term majority U.S.
shareholder taxable year means, with
respect to a CFC group, one of the
following taxable years, applied
sequentially—
(i) If there is a single United States
shareholder of the CFC group for
purposes of paragraph (f)(6)(i) of this
section, then the taxable year of the
United States shareholder;
(ii) If paragraph (f)(11)(i) of this
section does not apply and a related
United States shareholder owns, within
the meaning of section 958(a), more
stock of the members of the CFC group,
by value, than is owned, within the
meaning of section 958(a), by any other
related United States shareholder, then
the taxable year of the first-mentioned
related United States shareholder;

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(iii) If paragraphs (f)(11)(i) and (ii) of
this section do not apply and if one or
more related United States shareholders
with the same taxable year, in aggregate,
own, within the meaning of section
958(a), more stock of the members of the
CFC group (by value) than is, in
aggregate, owned, within the meaning of
section 958(a), by other related United
States shareholders with the same
taxable year, then the taxable year of the
first-mentioned related United States
shareholders; and
(iv) If paragraphs (f)(11)(i), (ii), and
(iii) of this section do not apply, then
the calendar year.
(12) Net business interest expense.
The term net business interest expense
means, with respect to a CFC group
member of a CFC group and a specified
taxable year, the excess, if any, of the
amount of the CFC group member’s
business interest expense over the
amount of the CFC group member’s
business interest income, in each case
determined without regard to section
163(j) and the section 163(j) regulations.
(13) Passthrough entity. The term
passthrough entity means a partnership,
S corporation, or any other entity
(domestic or foreign) that is not a
corporation if all items of income and
deduction of the entity are included in
the income of its owners or
beneficiaries. An interest in a
passthrough entity means an interest in
the capital or profits of the entity or
stock of an S corporation, as applicable.
(14) Specified ETI ratio—(i) In
general. The term specified ETI ratio
means, with respect to a specified
highest-tier member of a CFC group and
a specified taxable year, the ratio
computed as a fraction (expressed as a
percentage), the numerator of which is
the sum of the amounts described in
paragraph (f)(14)(iii) of this section with
respect to each CFC group member
described in paragraph (f)(14)(ii) of this
section, and the denominator of which
is the sum of the amounts described in
paragraph (f)(14)(iv) of this section with
respect to each CFC group member
described in paragraph (f)(14)(ii) of this
section that has amounts included in
the numerator. The specified ETI ratio
may not exceed 100 percent. If the
numerator and the denominator of the
fraction are not both greater than zero,
the specified ETI ratio is treated as being
equal to zero.
(ii) Includable CFC group members.
For purposes of applying paragraph
(f)(14)(i) of this section, a CFC group
member is described in this paragraph
(f)(14)(ii) if—
(A) The CFC group member is the
specified highest-tier member or a
specified lower-tier member with

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

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or is an entity described in paragraph
(f)(9) of this section (regarding entities
that provide certain types of financial
services).
(1) Example 1: Computation of section
163(j) limitation of CFC group members—(i)
Facts. USP, a domestic C corporation, wholly
owns US1 and US2, each of which is a
domestic C corporation. USP, US1, and US2
are members of a consolidated group of
which USP is the common parent (USP
group). US1 wholly owns CFC1, a foreign
corporation, and US2 wholly owns CFC2 and
CFC3, each of which is a foreign corporation.
The USP group has a calendar year taxable
year. For U.S. tax purposes, CFC1, CFC2, and
CFC3 each have a fiscal taxable year ending
on November 30. CFC1 has an outstanding
loan of $1,000x from a third-party (CFC1
note). CFC1 has a receivable of $500x from
each of CFC2 and CFC3 (CFC2 note and CFC3
note, respectively). Interest on all debt is paid
and accrued annually on November 30.
During the taxable year ending November 30,
2019, CFC1 has business interest expense of
$90x attributable to CFC1 note and business
interest income of $100x attributable to CFC2
note and CFC3 note, and CFC2 and CFC3
each have $50x of business interest expense
attributable to CFC2 note and CFC3 note,
respectively. Assume that each of CFC1,
CFC2, and CFC3 has ATI of $100x computed
on a separate company basis for the taxable
year ending November 30, 2019. The USP
group has no business interest expense.
(ii) Analysis—(A) Determination of CFC
group. US1 owns (within the meaning of
section 958(a)) all of the stock of CFC1, and
US2 owns (within the meaning of section
958(a)) all of the stock of each of CFC2 and
CFC3. Under paragraph (f)(2) of this section,
each of CFC1, CFC2, and CFC3 is an
applicable CFC. Under paragraph (f)(6)(ii)(A)
of this section, because US1 and US2 are
members of a consolidated group, US1 and
US2 are treated as a single person for
purposes determining a CFC group under
paragraph (f)(6)(i) of this section. Therefore,
because 80 percent or more of the stock of
each of CFC1, CFC2, and CFC3 is owned
(within the meaning of section 958(a)) by a
single United States shareholder, under
paragraph (f)(6)(i) of this section, CFC1,
CFC2, and CFC3 are members of a CFC group
(USP CFC group).
(B) CFC group election is made. Assume a
CFC group election is properly made. Under
paragraph (f)(11)(i) of this section, because
there is a single United States shareholder of
the USP CFC group with a calendar taxable
year, the majority U.S. shareholder taxable
year with respect to the USP CFC group ends
on December 31, 2019. Under paragraph
(f)(17) of this section, the specified taxable
year of each of CFC1, CFC2, and CFC3 is
November 30, 2019, which is the taxable year
that ends with or within the majority U.S.
shareholder taxable year ending on December
31, 2019. Under paragraph (f)(3) of this
section, the applicable net business interest
expense of the USP CFC group is $90x. The
$90x is the excess of $190x, which is the sum
of the amounts of the business interest
expense of each of CFC1, CFC2, and CFC3
($90x, $50x, and $50x, respectively), over

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$100x, which is the sum of the amounts of
the business interest income of each of CFC1,
CFC2, and CFC3 ($100x, $0, and $0,
respectively). Under paragraph (f)(12) of this
section, CFC1 has $0 of net business interest
expense ($90x business interest expense does
not exceed $100x of business interest
income), and CFC2 and CFC3 each have $50x
of net business interest expense (each has
$50x business interest expense and $0
business interest income). Because CFC2 and
CFC3 each has net business interest expense,
under paragraph (f)(1) of this section, each
has an allocable share of the applicable net
business interest expense of the USP CFC
group. The allocable share of each of CFC2
and CFC3 is $45x, computed as $90x (the
applicable net business interest expense)
multiplied by the fraction equal to $50x/
$100x (the net business interest expense of
the member and the sum of the amounts of
net business interest expense of all members,
respectively). Under paragraph (b)(3)(i) of
this section, none of CFC1’s $90x of business
interest expense and $45x of each of CFC2’s
and CFC3’s $50x of business interest expense
is subject to the general rule under § 1.163(j)–
2(b) (and $5x of each of CFC2’s and CFC3’s
business interest expense is not subject to
limitation under § 1.163(j)–2(b)), and, under
paragraph (b)(3)(ii) of this section, the general
rule under § 1.163(j)–2(b), as applied to CFC2
and CFC3, is computed without regard to
§ 1.163(j)–2(b)(1) and (3). Thus, under
§ 1.163(j)–2(b), CFC2’s limitation is $30x
($100x ATI computed on a separate company
basis x 30 percent). The amount of CFC2’s
business interest expense subject to
limitation under paragraph (b)(3) of this
section, $45x, exceeds CFC2’s limitation
under § 1.163(j)–2(b), $30x. Accordingly,
$35x ($5x not subject to limitation + $30x)
of CFC2’s business interest expense is
deductible, and under § 1.163(j)–2(c), the
remaining $15x of business interest expense
is not deductible and will be carried forward
as a disallowed business interest expense
carryforward. The analysis for CFC3 is the
same as for CFC2. Because the USP group has
no business interest expense, the application
of paragraph (d) of this section is not
relevant.
(C) CFC group election is not made.
Instead, assume a CFC group election is not
made. In this case, each of CFC1, CFC2, and
CFC3 must compute its interest deduction
limitation under § 1.163(j)–2(b), without
regard to paragraph (b)(3) of this section.
CFC1’s business interest expense of $90x is
deductible because it has business interest
income of $100x. CFC2’s business interest
expense limitation is $30x ($100x ATI
computed on a separate company basis x 30
percent). Accordingly, $30x of CFC2’s
business interest expense is deductible, and
under § 1.163(j)–2(c), the remaining $20x of
business interest expense is disallowed
business interest expense and will be carried
forward as a disallowed business interest
expense carryforward. The analysis for CFC3
is the same as for CFC2.
(2) Example 2: Computation and allocation
of CFC excess taxable income—(i) Facts.
USP, a domestic C corporation, wholly owns
CFC1, a foreign corporation. CFC1 wholly
owns CFC2, a foreign corporation, and CFC2

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wholly owns each of CFC3 and CFC4, both
of which are foreign corporations (CFC1,
CFC2, CFC3, and CFC4, collectively, the USP
CFC group). All entities have a calendar year
for U.S. tax purposes. For Year 1, assume the
following additional facts: Prior to the
application of section 163(j), CFC1 has no
items of income, gain, deduction, or loss;
CFC2 has a taxable loss of $5x (including $5x
of business interest expense); CFC3 has
taxable income of $85x (including $15x of
business interest expense); CFC4 has $60x of
taxable income (including $40x of business
interest expense); a CFC group election is in
effect for the CFC group; there is no
intercompany debt between any CFC group
member; 50 percent of CFC3’s items of
income and gain are subpart F income (as
defined in section 952), and 50 percent of
CFC3’s items of deduction and loss are
properly allocable to subpart F income, and
with respect to the remaining portion of
CFC3’s items of income, gain, deduction, and
loss, no portion is taken into account in
computing tested income (as defined in
section 951A(c)(2)(A)) or tested loss (as
defined in section 951A(c)(2)(B)) of CFC3;
CFC4’s items of income and gain are all
tested income, and CFC4’s items of
deduction are all properly allocable to such
income; no portion of CFC2’s items of
income, gain, deduction, or loss is taken into
account in computing tested income or tested
loss; no CFC group member has qualified
business asset investment (as defined in
section 951A(d)); for purposes of computing
ATI, there are no subtractions or additions to
taxable income described in § 1.163(j)–1(b)(1)
with respect to any CFC group member of the
USP CFC group other than for business
interest expense; for simplicity, no foreign
income taxes are paid by any CFC group
member of the USP CFC group; in addition
to the inclusions in gross income under
sections 951(a)(1) and 951A(a) with respect
to the CFC group members of the USP CFC
group, USP has business interest expense of
$20x.
(ii) Analysis—(A) Application of section
163(j) to CFC group members of the USP CFC
group; computation of USP CFC group’s
applicable net business interest expense.
Under paragraph (f)(3) of this section, the
USP CFC group’s applicable net business
interest expense is $60x ($0 + $5x + $15x +
$40x with respect to CFC1, CFC2, CFC3, and
CFC4, respectively). Because there is no debt
between the CFC group members of the USP
CFC group, under paragraph (b)(3) of this
section, each of the CFC group members
allocable share of the $60x is equal to its
separate company business interest expense.
In particular, CFC1’s allocable share of the
USP CFC group’s applicable net interest
expense is zero, CFC2’s allocable share is
$5x, CFC3’s allocable share is $15x, and
CFC4’s allocable share is $40x.
(B) Application of section 163(j) to CFC4.
Under § 1.163(j)–1(b)(1), CFC4’s ATI is $100x
($60x taxable income + $40x business
interest expense). Under § 1.163(j)–2(b),
CFC4’s limitation is $30x ($100x ATI
computed on a separate company basis × 30
percent). The amount of CFC4’s business
interest expense subject to limitation, $40x,
exceeds CFC4’s limitation, $30x.

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Accordingly, under § 1.163(j)–2(c), $10x of
business interest expense is not deductible
and will be carried forward as a disallowed
business interest expense carryforward.
Because $10x of business interest expense is
not currently deductible, CFC4’s tested
income is $70x ($60x taxable income prior to
application of section 163(j), increased by
$10x of disallowed business interest
expense).
(C) Application of section 163(j) to CFC3.
Under § 1.163(j)–1(b)(1), CFC3’s ATI is $100x
($85x taxable income + 15x business interest
expense). Under § 1.163(j)–2(b), CFC3’s
limitation is $30x ($100x ATI computed on
a separate company basis × 30 percent).
Because the amount of CFC3’s business
interest expense subject to limitation, $15x,
does not exceed CFC3’s limitation, $30x, all
of CFC3’s business interest expense is
currently deductible. Accordingly, CFC3’s
subpart F income is $42.50x ($85x taxable
income x 50 percent). Furthermore, CFC3 has
CFC excess taxable income of $50x ($100x ×
($15x/$30x)).
(D) Application of section 163(j) to CFC2.
Under § 1.163(j)–1(b)(1), taking into account
the application of paragraph (c)(3) of this
section, CFC2’s ATI is $50x (($5x) taxable
loss + $5x business interest expense + $50x
(100 percent × $50x of CFC3’s excess taxable
income)). Under § 1.163(j)–2(b), CFC2’s
limitation is $15x ($50x ATI x 30 percent).
Because the amount of CFC2’s business
interest expense subject to limitation, $5x,
does not exceed CFC2’s limitation, $15x, all
of CFC2’s business interest expense is
currently deductible. Furthermore, CFC2 has
CFC excess taxable income of $33.33x ($50x
× ($10x/$15x)).
(E) Application of section 163(j) to CFC1.
Under § 1.163(j)–1(b)(1), taking into account
the application of paragraph (c)(3) of this
section, CFC1’s ATI is $33.33x ($0 taxable
income + $33.33x (100 percent × $33.33x of
CFC2’s excess taxable income)). CFC1 has no
business interest expense subject to
limitation and therefore CFC1 has CFC excess
taxable income of $33.33x.
(F) Application of section 163(j) to USP.
Under section 951(a)(1), USP includes
$42.50x in gross income with respect to
CFC3. Under section 951A(a), USP includes
$70x in gross income, all of which is
allocable to CFC4 under section 951A(f)(2),
and under section 250(a)(1)(B), USP is
allowed a deduction of $35x. Thus, the
amount of USP’s CFC group inclusions is
$77.50x ($42.50 + $70x ¥$35x), and USP’s
taxable income prior to the application of
section 163(j) is $57.50x ($77.50x ¥ $20x
business interest expense). Under § 1.163(j)–
1(b)(1), taking into account the application of
paragraph (d)(2) of this section, USP’s ATI is
$16.67x. USP’s ATI, $16.67x, is equal to
$57.50x of taxable income + $20x of business
interest expense ¥ $77.50x of CFC group
inclusions + $16.67x of eligible CFC group
ETI. The eligible CFC group ETI, $16.67x, is
determined as $33.33x (CFC1’s excess taxable
income) × 50 percent (CFC1’s specified ETI
ratio) × 100 percent (percentage of stock of
CFC1 owned directly by USP)). Under
paragraph (f)(14) of this section, the specified
ETI ratio of CFC1 is 50 percent ($42.50x/
$85x). The numerator of the fraction,

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67581

$42.50x, is equal to the amount of USP’s
gross income inclusion under section 951(a)
with respect to CFC3. The denominator of the
fraction, $85x, is equal to the amount of the
taxable income of CFC3. The numerator and
the denominator of the fraction do not
include amounts with respect to CFC1, CFC2,
and CFC4, because none of them has CFC
excess taxable income without regard to the
application of paragraph (c)(3) of this section.
Furthermore, USP includes no amounts in
gross income under section 951(a) or 951A(a)
with respect to CFC1 or CFC2. Under
§ 1.163(j)–2(b), USP’s section 163(j)
limitation is $5x ($16.67x ATI × 30 percent).
The amount of USP’s business interest
expense, $20x, exceeds USP’s section 163(j)
limitation, $5x. Accordingly, under
§ 1.163(j)–2(c), $15x of business interest
expense is not deductible and is carried
forward as a disallowed business interest
expense carryforward.

(h) Applicability date. This section
applies to a taxable year of a foreign
corporation ending after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register and to
a taxable year of a shareholder of the
foreign corporation ending with or
within the taxable year of the foreign
corporation. However, a foreign
corporation and its shareholders and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
apply this section to a taxable year of
the foreign corporation beginning after
December 31, 2017, and to a taxable
year of a shareholder of the foreign
corporation ending with or within the
taxable year of the foreign corporation,
if the foreign corporation and its
shareholders and their related parties
consistently apply all of the section
163(j) regulations, and if applicable,
§§ 1.263A–9, 1.381(c)(20)–1, 1.382–6,
1.383–1, 1.469–9, 1.882–5, 1.1502–13,
1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–6 and 1.383–1), and 1.1504–4
to those taxable years.
§ 1.163(j)–8 Application of the business
interest deduction limitation to foreign
persons with effectively connected income.

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

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with effectively connected taxable
income. Paragraph (e) of this section
coordinates the application of section
163(j) and § 1.882–5. Paragraph (f) of
this section provides a coordination rule
for determining effectively connected
earnings and profits for purposes of the
branch profits tax under section 884.
Paragraph (g) of this section provides
definitions that apply for purposes of
this section. Paragraph (h) of this
section provides examples that illustrate
the application of this section.
Paragraph (i) of this section provides
dates of applicability.
(b) Application of section 163(j) and
the section 163(j) regulations to
specified foreign persons with effectively
connected taxable income—(1) In
general. If a taxpayer is a specified
foreign person, then the modifications
described in this paragraph (b) are made
to the application of section 163(j) and
the section 163(j) regulations. If a
specified foreign person is also a
specified foreign partner, then the
modifications described in this
paragraph (b) are subject to the partnerlevel modifications described in
paragraph (c) of this section.
(2) Modification of adjusted taxable
income. ATI for a specified foreign
person for a taxable year means the
specified foreign person’s effectively
connected taxable income for the
taxable year, adjusted for the items
described in § 1.163(j)–1(b)(1)(i) through
(iv) that are taken into account in
determining effectively connected
taxable income.
(3) Modification of business interest
expense—(i) General rule. Business
interest expense for a specified foreign
person means interest described in
§ 1.163(j)–1(b)(2) that is determined
under § 1.882–5, in the case of a foreign
corporation, or under § 1.861–9T(d)(2),
in the case of a non-resident alien
individual, and allocable to income
which is effectively connected taxable
income.
(ii) Exclusion of certain business
interest expense of a specified foreign
partner. If a foreign corporation is a
specified foreign partner in a
partnership engaged in a trade or
business in the United States, then, for
purposes of paragraph (b)(3)(i) of this
section, business interest expense
excludes the portion of interest expense
determined under § 1.882–5 that is
attributable to interest on U.S. booked
liabilities of the partnership determined
under § 1.882–5(d)(2)(vii).
(4) Modification of business interest
income. The business interest income of
a specified foreign person means
interest described in § 1.163(j)–1(b)(3)

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that is effectively connected taxable
income.
(5) Modification of floor plan
financing interest expense. The floor
plan financing interest expense of a
specified foreign person means interest
described § 1.163(j)–1(b)(17) that is
allocable to income which is effectively
connected taxable income.
(6) Modification of allocation of
interest expense and interest income
that is properly allocable to a trade or
business. For purposes of § 1.163(j)–
10(c), a specified foreign person’s
interest expense and interest income
that is properly allocable to a trade or
business is only allocated to the
specified foreign person’s excepted or
non-excepted trades or business that
have effectively connected taxable
income. If the specified foreign person
is also a specified foreign partner, this
rule only applies to the trades or
business not in the partnership.
(c) Partner-level modifications to
§ 1.163(j)–6 for partnerships engaged in
a U.S. trade or business—(1)
Modification related to a partnership’s
excess taxable income. If for a taxable
year a specified foreign partner, other
than an applicable CFC, has allocable
excess taxable income with respect to a
partnership, then, for purposes of
computing the specified foreign
partner’s ATI for the taxable year, the
excess, if any, of the amount of the
allocable excess taxable income over the
amount of the specified excess taxable
income is subtracted from ATI.
(2) Modification related to a
partnership’s excess business interest
expense. If for a taxable year a specified
foreign partner, other than an applicable
CFC, has allocable excess business
interest expense with respect to a
partnership, then, for purposes of
determining the specified foreign
partner’s business interest expense for a
succeeding taxable year, the amount of
the allocable excess business interest
expense treated as disallowed business
interest expense carryforward under
§ 1.163(j)–6(f) is determined by taking
into account only the portion of
allocable excess business interest
expense that is specified excess
business interest expense and such
excess business interest expense is
limited to the portion of allocable excess
taxable income for the succeeding
taxable year that is specified excess
taxable income.
(3) Modification related to a
partnership’s excess business interest
income. If for a taxable year a specified
foreign partner, other than an applicable
CFC, has allocable excess business
interest income (as defined in § 1.163(j)–
6(b)(4)) with respect to a partnership,

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then, for purposes of determining the
specified foreign partner’s section 163(j)
limitation, the amount of allocable
excess business interest income that can
be used by the specified foreign partner
cannot exceed the amount of ECI excess
business interest income.
(d) An applicable CFC with effectively
connected taxable income. If an
applicable CFC has effectively
connected taxable income for a taxable
year in which the applicable CFC has
disallowed business interest expense,
then a portion of the disallowed
business interest expense is treated as
being with respect to the applicable
CFC’s interest expense determined
under § 1.882–5. That portion is equal to
the amount of the applicable CFC’s
disallowed business interest expense
multiplied by a fraction, the numerator
of which is the applicable CFC’s
effectively connected taxable income for
the taxable year, adjusted for the items
described in § 1.163(j)–1(b)(1)(i) through
(iv) that are taken into account in
determining effectively connected
taxable income, and the denominator of
which is the applicable CFC’s ATI for
the taxable year. However, in no case
will such portion exceed the amount of
interest expense determined under
§ 1.882–5. See also § 1.163(j)–7(b)(2)
(concerning the general application of
section 163(j) to an applicable CFC).
(e) Coordination of section 163(j) and
§ 1.882–5—(1) General rules—(i)
Ordering rule. A foreign corporation
first determines its interest expense
under § 1.882–5 and then determines
the amount of disallowed business
interest expense.
(ii) Treatment of disallowed business
interest expense carryforward. If a
foreign corporation has a disallowed
business interest expense carryforward
from a taxable year, then such
carryforward is not taken into account
for purposes of determining interest
expense under § 1.882–5 in the
succeeding taxable year.
(iii) Treatment of allocable excess
business interest expense. If a foreign
corporation has allocable excess
business interest expense from a taxable
year that is treated under § 1.163(j)–
6(g)(2) as disallowed business interest
expense carryforward, such interest is
not taken into account for purposes of
determining interest expense under
§ 1.882–5 in the succeeding taxable
year.
(iv) Scaling ratio. If a foreign
corporation determines its interest
expense under the method described in
§ 1.882–5(b) through (d) and has U.S.
booked liabilities in excess of U.S.
connected liabilities, the foreign
corporation must apply the scaling ratio

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(as defined in § 1.882–5(d)(4)(ii)) pro
rata to all interest expense paid or
accrued by the foreign corporation
consistent with § 1.882–5(d)(4)(i),
including for purposes of paragraph
(b)(3)(ii) of this section.
(2) Amount of interest determined
under § 1.882–5 that is disallowed
business interest expense—(i) Foreign
corporation is not a specified foreign
partner. If a foreign corporation is not a
specified foreign partner for a taxable
year, then the amount of the foreign
corporation’s interest expense
determined under § 1.882–5 for which a
deduction is disallowed for the taxable
year is either—
(A) The amount of disallowed
business interest expense computed
under § 1.163(j)–2(b) with respect to
business interest expense described in
paragraph (b)(3)(i) of this section, in the
case of a foreign corporation that is not
an applicable CFC; or
(B) The amount of disallowed
business interest expense determined
under paragraph (d) of this section, in
the case of an applicable CFC.
(ii) Foreign corporation is a specified
foreign partner. If a foreign corporation
is a specified foreign partner with
respect to one or more partnerships
engaged in a trade or business in the
United States for a taxable year, then the
portion of the foreign corporation’s
business interest expense determined
under § 1.882–5 for which a deduction
is disallowed for the taxable year is
equal to the sum of the following
amounts—
(A) Either—
(1) The amount described in
paragraph (e)(2)(i)(A) of this section, in
the case of a foreign corporation that is
not an applicable CFC; or
(2) The amount described in
paragraph (e)(2)(i)(B) of this section, in
the case of an applicable CFC; and
(B) With respect to each partnership
that has excess business interest
expense for the taxable year that ends
with or within the foreign corporation’s
taxable year, the amount of the foreign
corporation’s specified excess business
interest expense.
(f) Coordination with branch profits
tax—(1) Effect on effectively connected
earnings and profits. The disallowance
and carryforward of business interest
expense under § 1.163(j)–2(b) and (c)
will not affect when such business
interest expense reduces the effectively
connected earnings and profits of a
foreign corporation, as defined in
§ 1.884–1(f).
(2) Effect on U.S. net equity. The
disallowance and carryforward of
business interest expense under
§ 1.163(j)–2(b) and (c) will not affect the

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computation of the U.S. net equity of a
foreign corporation, as defined in
§ 1.884–1(c).
(g) Definitions. The following
definitions apply for purposes of this
section.
(1) Applicable CFC. The term
applicable CFC means a foreign
corporation described in section 957,
but only if the foreign corporation has
at least one United States shareholder
that owns, within the meaning of
section 958(a), stock of the foreign
corporation.
(2) ECI excess business interest
income. The term ECI excess business
interest income means, with respect to
a specified foreign partner and a
partnership, the excess, if any, of the
specified foreign partner’s allocable
business interest income (as defined in
§ 1.163(j)–6(f)(2)(ii)) over its allocable
business interest expense (as defined in
§ 1.163(j)–6(f)(2)(ii)), but, for purposes of
determining a specified foreign partner’s
allocable business interest income and
allocable business interest expense,
taking into account only the portion of
the partnership’s business interest
income determined under paragraph
(b)(4) of this section as if the partnership
were a specified foreign person, over the
business interest expense on the U.S.
booked liabilities of the partnership as
determined under § 1.882–5(d)(2)(vii).
(3) Effectively connected taxable
income. The term effectively connected
taxable income means taxable income of
a person that is, or is treated as.
effectively connected with the conduct
of a trade business in the United States
under an applicable provision of the
Code or regulations or, if an income tax
treaty applies, business profits
attributable to a U.S. permanent
establishment of a tax treaty resident
eligible for benefits under an income tax
treaty between the United States and the
treaty country.
(4) Specified excess business interest
expense. The term specified excess
business interest expense means, with
respect to a specified foreign partner
and a partnership, the amount
determined by multiplying the specified
foreign partner’s allocable excess
business interest expense (as
determined under § 1.163(j)–6(f)) by the
partnership’s specified ratio for the
taxable year.
(5) Specified excess taxable income.
The term specified excess taxable
income means, with respect to a
specified foreign partner and a
partnership, the amount determined by
multiplying the amount of the specified
foreign partner’s allocable excess
taxable income (as determined under
§ 1.163(j)–6(f)) by the amount of the

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partnership’s specified ratio for the
taxable year.
(6) Specified foreign partner. The term
specified foreign partner means, with
respect to a partnership that is engaged
in a U.S. trade or business, a partner
that is a specified foreign person or an
applicable CFC.
(7) Specified foreign person. The term
specified foreign person means a
nonresident alien individual, as defined
in section 7701(b) and the regulations
thereunder, or a foreign corporation
other than an applicable CFC.
(8) Specified ratio. The term specified
ratio means, with respect to a
partnership, a fraction (expressed as a
percentage), the numerator of which is
the ATI for the partnership determined
under paragraph (b)(2) of this section as
if the partnership were a specified
foreign person, and the denominator of
which is the ATI for the partnership
determined under § 1.163(j)–6(d).
(h) Examples. The following examples
illustrate the application of this section.
For all examples, assume that all
referenced interest expense is
deductible but for the application of
section 163(j), the small business
exemption under § 1.163(j)–2(d) is not
available, no party is engaged in an
excepted trade or business, and no
business interest expense is floor plan
financing interest expense.
(1) Example 1: Limitation on business
interest deduction of a foreign corporation—
(i) Facts. FC, a foreign corporation that is not
an applicable CFC, has $100x of gross income
that is effectively connected income. FC has
$60x of other income which is not effectively
connected income. FC has total expenses of
$100x. Assume that under § 1.882–5, FC has
$30x of interest expense allocable to income
which is effectively connected income.
Under section 882(c) and the regulations
thereunder, FC has $40x of other expenses
properly allocated and apportioned to
income which is effectively connected
taxable income. FC does not have any
business interest income.
(ii) Analysis. FC is a specified foreign
person under paragraph (g)(7) of this section.
Under paragraph (e)(2) of this section, the
amount of FC’s interest expense determined
under § 1.882–5 that is disallowed is the
disallowed business interest expense
computed under § 1.163(j)–2(b) with respect
to interest expense described in paragraph
(b)(3) of this section. Under § 1.163(j)–4(b)(1),
all interest paid or accrued by FC is properly
allocable to a trade or business and therefore
under paragraph (b)(3) of this section, FC has
business interest expense of $30x. FC has
$30x of effectively connected taxable income
described in paragraph (g)(3) of this section
($100x ¥ $30x ¥ $40x). Under paragraph
(b)(2) of this section, FC has ATI of $60x,
determined as $30x of effectively connected
taxable income, increased by $30x of
business interest expense. Accordingly, FC’s
section 163(j) limitation is $18x ($60x × 30

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percent). Because FC’s business interest
expense ($30x) exceeds the section 163(j)
limitation ($18x), FC may only deduct $18x
of business interest expense. Under
§ 1.163(j)–2(c), the remaining $12x is
disallowed business interest expense
carryforward and under paragraph (e)(1)(ii) of
this section, the $12x is not taken into
account for purposes of applying § 1.882–5 in
the succeeding taxable year.
(2) Example 2: Use of a disallowed
business interest expense carryforward—(i)
Facts. The facts are the same as in Example
1 in paragraph (h)(1)(i) of this section except
that FC has $300x of gross income which is
all effectively connected income.
Furthermore assume that FC has a disallowed
business interest expense carryforward of
$25x from the prior taxable year.
(ii) Analysis. Under paragraph (e)(1)(ii) of
this section, FC’s $25x of disallowed
business interest expense carryforward is not
taken into account for purposes of
determining FC’s interest under § 1.882–5.
Therefore, FC has $30x of business interest
expense determined under § 1.882–5. Under
paragraph (g)(3) of this section, FC has
effectively connected taxable income of
$205x ($300x gross income ¥ $55x interest
expense ($30x + $25x) ¥ $40x other
expenses). Under paragraph (b)(2) of this
section, FC has ATI of $260x, determined as
$205x of effectively connected taxable
income, increased by $55x of business
interest expense. Accordingly, FC’s section
163(j) limitation is $78x ($260x × 30 percent).
Under paragraph (b)(3) of this section, FC has
business interest expense of $55x ($30x +
$25x disallowed interest carryforward) for
the taxable year. Because FC’s business
interest expense ($55x) does not exceed the
section 163(j) limitation ($78x), FC may
deduct all $55x of business interest expense.
(3) Example 3: Foreign corporation is
engaged in a U.S. trade or business and a
specified foreign partner in a partnership
engaged in a U.S. trade or business—(i)
Facts. FC, a foreign corporation that is not an
applicable CFC, owns a 50–percent interest
in ABC, a foreign partnership that is engaged
in a trade or business in the United States.
ABC has two lines of businesses, Business A
and Business B. Business A produces $120x
of taxable income (including interest
expense) and Business B produces $80x of
taxable income. FC is allocated 50 percent of
all items of income and expense of Business
A and Business B. Business A has business
interest expense of $20x on $400x of
liabilities but has no business interest
income. Business B does not have any
business interest expense or business interest
income. With respect to FC, only Business A
produces effectively connected income. FC
has an outside basis of $500x in the ABC
partnership for purposes of § 1.882–5(b), step
1. All of the liabilities of Business A are U.S.
booked liabilities for purposes of § 1.882–
5(d). In addition to owning a 50–percent
interest in ABC, FC conducts a separate
business that is engaged in a trade or
business in the United States (Business X).
Business X has effectively connected taxable
income of $50x, U.S. assets with an adjusted
basis of $300x, U.S. booked liabilities of
$160x, and interest on U.S. booked liabilities

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of $15x. FC computes its interest expense
under the three-step method described in
§ 1.882–5(b) through (d) and uses the fixed
ratio of 50 percent for purposes of § 1.882–
5(c), step 2. Assume the interest rate on
excess U.S. connected liabilities is 5 percent.
For the taxable year, FC has total interest
expense of 500x for purposes of § 1.882–
5(a)(3).
(ii) Analysis—(A) Application of section
163(j) to ABC. Under § 1.163(j)–6(a), ABC
computes a section 163(j) limitation at the
partnership level. Under § 1.163(j)–6(d), ABC
has ATI of $220x, determined as $200x of
taxable income ($120x from Business A +
$80x from Business B), increased by $20x of
business interest expense of Business A.
Under § 1.163(j)–2(b), ABC’s section 163(j)
limitation is $66x ($220x × 30 percent).
Because ABC’s business interest expense
($20x) does not exceed the section 163(j)
limitation ($66x), ABC can deduct all of its
business interest expense for the taxable year.
Under § 1.163(j)–1(b)(15), ABC has excess
taxable income of $153.33x ($220x × ($46x/
$66x)). Under § 1.163(j)–6(f), FC is allocated
50 percent of the $153.33x of ABC’s excess
taxable income, or $76.67x of allocable
excess taxable income, but, under paragraph
(c)(1) of this section, the amount by which
the allocable excess taxable income exceeds
FC’s specified excess taxable income (as
defined in paragraph (g)(5) of this section) is
a subtraction from FC’s ATI. Under
paragraph (g)(5) of this section, FC’s specified
excess taxable income is $48.79x, which is
equal to the product of $76.67x and ABC’s
specified ratio of 63.64 percent. Under
paragraph (g)(8) of this section, ABC’s
specified ratio of 63.64 percent is determined
as $140x/$220x (where the numerator of
$140x is the ATI of ABC determined under
paragraph (b)(2) of this section as if ABC
were a specified foreign person ($120x
taxable income of Business A, increased by
$20x of business interest expense), and the
denominator of $220x is the ATI of ABC
under § 1.163(j)–6(d)). FC’s allocable excess
taxable income ($76.67x) exceeds its
specified excess taxable income ($48.79x) by
$27.88x.
(B) Application of § 1.882–5 to FC. FC is a
specified foreign partner under paragraph
(g)(6) of this section. Under paragraph (e)(1)
of this section, FC first determines its interest
expense under § 1.882–5 and then
determines its disallowed business interest
expense. Under § 1.882–5(b), step 1, FC has
U.S. assets of $800x ($500x (FC’s basis in its
interest in ABC) + $300x (FC’s basis in
Business X assets). Under § 1.882–5(c), step
2, applying the 50–percent safe harbor in
§ 1.882–5 for a non-banking business, FC has
U.S. connected liabilities of $400x ($800x ×
50 percent). Under § 1.882–5(d), step 3, FC
has U.S. booked liabilities of $360x ($200x
(50–percent share of Business A liabilities of
ABC of $400x) + $160x (Business X
liabilities) and interest on U.S. booked
liabilities of $25x ($10x (50–percent share of
$20x interest expense of Business A) + $15x
(interest expense of Business X)). FC has
excess U.S. connected liabilities of $40x
($400x ¥ $360x) and interest on such excess
liabilities of $2x ($40x x 5 percent). FC’s
interest expense determined under § 1.882–5
is $27x ($25x + $2x).

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(C) Application of section 163(j) to FC.
Under paragraph (e)(2)(ii) of this section, the
amount of business interest expense that is
disallowed for FC is equal to only the amount
of interest described in paragraph (b)(3) of
this section that is disallowed because there
is no specified excess business interest
expense with respect to ABC. Under
paragraph (b)(3) of this section, FC’s business
interest expense (at the corporate level) is
$17x, the amount determined under § 1.882–
5 ($27x) less the amount of interest on U.S.
booked liabilities from ABC determined
under § 1.882–5(d)(2)(vii) ($10x), which was
subject to the section 163(j) limitation at the
ABC partnership level. Under § 1.163(j)–
6(e)(1), FC’s ATI is determined under
§ 1.163(j)–1(b)(1) without regard to FC’s
distributive share of any items of income,
gain, deduction, or loss of ABC. Under
paragraph (b)(2) of this section, taking into
account the application of paragraph (c)(1) of
this section, FC’s ATI is $115.77x ($50x
effectively connected taxable income with
respect to Business X, + $17x (business
interest expense under § 1.882–5 of 27x less
the amount of interest on U.S. booked
liabilities from ABC determined under
§ 1.882–5(d)(2)(vii) of $10x) + $76.65x
(excess taxable income from ABC) ¥ $27.88x
(amount excess taxable income exceeds
specified excess taxable income)). FC’s
section 163(j) limitation is $34.73x ($115.77x
× 30 percent). Because FC’s business interest
expense ($17x) is less than FC’s section 163(j)
limitation ($34.73x) and all of its share of
ABC’s interest is deductible, FC may deduct
all $27x of interest determined under
§ 1.882–5.
(4) Example 4: Scaleback of interest
expense under § 1.882–5—(i) Facts. Assume
the same facts in Example 3 in paragraph
(h)(3)(i) of this section except that Business
X has U.S. booked liabilities of $300x and
interest on U.S. booked liabilities of $20x.
(ii) Analysis—(A) Application of section
163(j) to ABC. The analysis is the same as
Example 3 in paragraph (h)(3)(ii)(A) of this
section.
(B) Application of § 1.882–5 to FC. Under
§ 1.882–5(b), step 1, FC has U.S. assets of
$800x ($500x (FC’s basis in its interest in
ABC) + $300x (FC’s basis in Business X
assets)). Under § 1.882–5(c), step 2, applying
the 50–percent safe harbor in § 1.882–5 for a
non-banking business, FC has U.S. connected
liabilities of $400x ($800x x 50 percent).
Under § 1.882–5(d), step 3, FC has U.S.
booked liabilities of $500x ($200x (50–
percent share of Business A liabilities of ABC
of $400x) + $300x (Business X liabilities) and
interest on U.S. booked liabilities of $30x
($10x (50–percent share of $20x interest
expense of Business A) + $20x (interest
expense of Business X)). FC has excess U.S.
booked liabilities of $100x ($500x ¥ $400x)
and the interest expense on U.S. booked
liabilities must be reduced by the scaling
ratio as provided in § 1.882–5(d)(4). FC’s
interest expense determined under § 1.882–5
is $24x ($30x x (400/500 scaling ratio)).
(C) Application of section 163(j) to FC.
Under paragraph (b)(3) of this section, FC’s
business interest expense is $16x, the amount
determined under § 1.882–5 ($24x) less the
amount of interest on U.S. booked liabilities

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

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2, applying the 50-percent fixed ratio in
§ 1.882–5 for a non-banking business, FC has
U.S. connected liabilities of $250x ($500x ×
50 percent). Under § 1.882–5(d), step 3, FC
has U.S. booked liabilities of $250x ($500x ×
50–percent share of Business S liabilities of
XYZ) and interest on U.S. booked liabilities
of $15x (50 percent share of $30x interest
expense of Business S). Because FC has U.S.
connected liabilities equal to its U.S. booked
liabilities, its interest expense under § 1.882–
5 is $15x (the amount of interest expense on
its U.S. booked liabilities).
(C) Application of section 163(j) to FC.
Under paragraph (e)(2)(ii) of this section, the
amount of business interest expense that is
disallowed for FC is equal to the sum of the
amount of interest described in paragraph
(b)(3) of this section that is disallowed plus
the amount of FC’s specified excess business
interest expense. FC’s business interest
expense (at the corporate level) under
paragraph (b)(3) of this section is $0, the
amount determined under § 1.882–5 ($15x)
less the amount of interest on U.S. booked
liabilities from XYZ determined under
§ 1.882–5(d)(2)(vii) ($15x), which was subject
to the section 163(j) limitation at the XYZ
partnership level. Because FC (at the
corporate level) has no business interest
expense, there is no business interest
expense subject to the section 163(j)
limitation. However, because FC has excess
business interest expense with respect to
XYZ, a deduction for a portion of the $15x
of interest on U.S. booked liabilities from
XYZ determined under § 1.882–5(d)(2)(vii)
will be disallowed for the taxable year. The
amount of such interest that is limited is
equal to the amount of the FC’s specified
excess business interest expense determined
under paragraph (g)(4) of this section. The
specified excess business interest expense is
$6.82x, determined by multiplying FC’s
distributive share of excess business interest
expense ($14.5x) by XYZ’s specified ratio of
47.06 percent, determined under paragraph
(g)(8) of this section. The specified ratio of
47.06 percent is determined by dividing $80x
ATI determined under paragraph (b)(2) of the
section as if XYZ were a specified foreign
person (determined as $50x taxable income
from Business S + $30x business interest
expense from Business S) by $170x of XYZ
ATI. FC may only deduct $8.18x ($15x ¥
$6.82x) of business interest expense. Under
§ 1.163(j)–2(c), the remaining $6.82x is
disallowed business interest expense
carryforward and under paragraph (e)(1)(ii) of
this section, the $6.82x is not taken into
account for purposes of applying § 1.882–5 in
the succeeding taxable year.
(iii) Facts—Year 2. During Year 2, Business
S produces $170x of taxable income
(including interest expense) and Business T
produces $150x (including interest expense)
of taxable income. Business S has business
interest expense of $30x on $500x of
liabilities but has no business interest
income. Business T has business interest
expense of $50x on $500x of liabilities but no
business interest income. With respect to FC,
only Business S produces effectively
connected taxable income. FC has an
adjusted basis of $600x in XYZ for purposes
of § 1.882–5(b), step 1. All of the liabilities

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of Business S are U.S. booked liabilities for
purposes of § 1.882–5(d). FC computes its
interest expense under the three-step method
described in § 1.882–5(b) through (d) and
uses the fixed ratio of 50 percent for purposes
of § 1.882–5(c), step 2. The interest rate on
excess U.S. connected liabilities is 5 percent.
For the taxable year, FC has total interest
expense of $1,000x for purposes of § 1.882–
5(a)(3).
(iv) Analysis with respect to Year 2—(A)
Application of section 163(j) to XYZ. Under
§ 1.163(j)–6(a), XYZ computes a section
163(j) limitation at the partnership-level.
Under § 1.163(j)–6(d), XYZ has ATI of $400x,
determined as $320x of taxable income
($170x from Business S + $150x from
Business T), increased by $80x of business
interest expense ($30x from Business S +
$50x from Business T). Under § 1.163(j)–2(b),
XYZ’s section 163(j) limitation is $120x
($400x × 30 percent). Because XYZ’s business
interest expense ($80x) does not exceed the
section 163(j) limitation ($120x), XYZ can
deduct all of its business interest expense for
the taxable year. Under § 1.163(j)–1(b)(15),
XYZ has excess taxable income of $133.30x
($400x × ($40x/$120x)). Under § 1.163(j)–6(f),
FC is allocated 50 percent of the $133.33x of
XYZ’s excess taxable income, or $66.66x of
allocable excess taxable income, but, under
paragraph (c)(1) of this section, the amount
by which the allocable excess taxable income
exceeds FC’s specified excess taxable income
(as defined in paragraph (g)(5) of this section)
is a subtraction from FC’s ATI. Under
paragraph (g)(5) of this section, FC’s specified
excess taxable income is $33.33x, which is
equal to the product of FC’s allocable excess
taxable income of $66.66x and XYZ’s
specified ratio of 50 percent. Under
paragraph (g)(8) of this section, XYZ’s
specified ratio of 50 percent is determined as
$200x/$400x (where the numerator of $200x
is the ATI of XYZ determined under
paragraph (b)(2) of this section as if XYZ
were a specified foreign person ($170x
taxable income of Business S, increased by
$30x of business interest expense), and the
denominator of $400x is the ATI of XYZ
under § 1.163(j)–6(d)). FC’s allocable excess
taxable income ($66.66x) exceeds its
specified excess taxable income ($33.33x) by
$33.33x.
(B) Treatment of excess business interest
expense from Year 1. In Year 1, XYZ had
disallowed business interest expense of $29x
and under § 1.163(j)–6(f), FC’s allocable
excess business interest expense was
$14.50x. Under paragraph (c)(2) of this
section, FC may use its allocable excess
business interest expense in a succeeding
taxable year only to the extent of its specified
excess business interest expense, which, in
this case, was determined to be $6.82x, and,
with respect to Year 2, the amount of
specified excess business interest expense
treated as paid or accrued by FC is limited
to FC’s specified excess taxable income
($33.33x). Thus, FC can treat the entire
$6.82x as business interest expense paid or
accrued in Year 2.
(C) Application of § 1.882–5 to FC. Under
§ 1.882–5(b), step 1, FC has U.S. assets of
$600x (FC’s adjusted basis in its interest in
XYZ). Under § 1.882–5(c), step 2, applying

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the 50 percent fixed ratio in § 1.882–5 for a
non-banking business, FC has U.S. connected
liabilities of $300x ($600x × 50 percent).
Under § 1.882–5(d), step 3, FC has U.S.
booked liabilities of $250x ($500x × 50percent share of Business S liabilities of
XYZ) and interest on U.S. booked liabilities
of $15x (50 percent share of $30x interest
expense of Business S). FC has excess U.S.
connected liabilities of $50x ($300x ¥
$250x) and interest on such excess liabilities
of $2.5x ($50x × 5 percent). FC’s interest
expense determined under § 1.882–5 is
$17.5x ($15x + $2.5x).
(D) Application of section 163(j) to FC.
Under paragraph (e)(2)(ii) of this section, the
amount of business interest expense that is
disallowed for FC is equal to only the amount
of interest described in paragraph (b)(3) of
this section that is disallowed because there
is no excess business interest expense with
respect to XYZ. FC’s business interest
expense (at the corporate level) under
paragraphs (b)(3) and (e)(1) of this section is
$9.32x, determined as the sum of $2.50x (the
amount determined under § 1.882–5
($17.50x) less the amount of interest on U.S.
booked liabilities from XYZ determined
under § 1.882–5(d)(2)(vii) ($15x) that is
excluded under paragraph (b)(3)(ii) of this
section) + $6.82x (allocable business interest
expense from Year 1 treated as paid or
accrued in Year 2). Under § 1.163(j)–6(e)(1),
FC’s ATI is determined under § 1.163(j)–
1(b)(1) without regard to FC’s distributive
share of any items of income, gain,
deduction, or loss of XYZ. Under paragraph
(b)(2) of this section, taking into account the
application of paragraph (c)(1) of this section,
FC’s ATI is $33.33x, determined as $66.66x
(excess taxable income from XYZ) ¥ $33.33x
(amount excess taxable income exceeds
specified excess taxable income). FC’s
section 163(j) limitation is $10x ($33.33x x 30
percent). Because FC’s business interest
expense (at the corporate level) of $9.32x is
less than FC’s section 163(j) limitation of
$10x, FC may deduct all $9.32x of business
interest expense ($2.50x from Year 2 and
$6.82x from Year 1). Because all of XYZ’s
business interest expense is deductible, FC
may also deduct the $15x of business interest
expense on U.S. booked liabilities of XYZ for
Year 2.
(7) Example 7: Coordination of section
163(j) and branch profits tax—(i) Facts. FC,
a foreign corporation that is not an applicable
CFC, uses cash that is treated as a U.S. asset
under § 1.884–1(d) in order to pay interest
described in paragraph (b)(3) of this section
for which a deduction for such interest is
disallowed under § 1.163(j)–2(b).
(ii) Analysis. Assuming that FC’s U.S.
assets otherwise remain constant during the
year, the U.S. assets of FC will have
decreased by the amount of cash used to pay
the interest expense, and the U.S. net equity
of FC will be computed accordingly.

(i) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections

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267(b) and 707(b)(1), may apply this
section to a taxable year beginning after
December 31, 2017, if the taxpayers and
their related parties consistently apply
all of the section 163(j) regulations, and
if applicable, §§ 1.263A–9, 1.381(c)(20)–
1, 1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–9 Elections for excepted trades
or businesses; safe harbor for certain
REITs.

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

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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
§ 1.1502–77, must be provided on the
election statement.
(4) Partnership’s trade or business. An
election for a partnership must be made
on the partnership’s return with respect
to any trade or business that the
partnership conducts. An election by a
partnership does not apply to a trade or
business conducted by a partner outside
the partnership.
(d) Termination of election—(1) In
general. An election under this section
automatically terminates if a taxpayer
ceases to engage in the electing trade or
business. A taxpayer is considered to
cease to engage in an electing trade or
business if the taxpayer sells or transfers
substantially all of the assets of the
electing trade or business to an acquirer
that is not a related party in a taxable
asset transfer. A taxpayer is also
considered to cease to engage in an
electing trade or business if the taxpayer
terminates its existence for Federal
income tax purposes or ceases operation
of the electing trade or business, except
to the extent that such termination or
cessation results in the sale or transfer
of substantially all of the assets of the
electing trade or business to an acquirer
that is a related party, or in a transaction
that is not a taxable asset transfer.
(2) Taxable asset transfer defined. For
purposes of this paragraph (d), the term
taxable asset transfer means a transfer in
which the acquirer’s basis or adjusted
basis in the assets is not determined,
directly or indirectly, in whole or in
part, by reference to the transferor’s
basis in the assets.
(3) Related party defined. For
purposes of this paragraph (d), the term
related party means any person who
bears a relationship to the taxpayer
which is described section 267(b) or
707(b)(1).
(4) Anti-abuse rule. If, within 60
months of a sale or transfer of assets
described in paragraph (d)(1) of this
section, the taxpayer or a related party
reacquires substantially all of the assets
that were used in the taxpayer’s prior
electing trade or business, or
substantially similar assets, and resumes
conducting such prior electing trade or
business, the taxpayer’s previously
terminated election under this section is
reinstated and is effective on the date
the prior electing trade or business is
reacquired.
(e) Additional guidance. The rules
and procedures regarding the time and
manner of making an election under this
section and the election statement
contents in paragraph (c) of this section

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may be modified through other
guidance (see §§ 601.601(d) and 601.602
of this chapter). Additional situations in
which an election may terminate under
paragraph (d) of this section may be
provided through guidance published in
the Federal Register or in the Internal
Revenue Bulletin (see § 601.601(d) of
this chapter).
(f) Examples. The examples of this
paragraph (f) illustrate the application of
this section. Unless otherwise indicated,
assume the following: X and Y are
domestic C corporations; D and E are
U.S. resident individuals not subject to
any foreign income tax; and the
exemption for certain small businesses
in § 1.163(j)–2(d) does not apply.
(1) Example 1: Scope of election—(i) Facts.
During her taxable year ending December 31,
2019, D, a sole proprietor, owned and
operated a dairy farm and a tree farm as
separate farming businesses described in
section 263A(e)(4). D filed its original Federal
income tax return for the 2019 taxable year
on August 1, 2020, and included with the
return an election statement meeting the
requirements of paragraph (c)(2) of this
section. The election statement identified D’s
dairy farm business as an electing trade or
business under this section. On March 1,
2021, D sold some but not all or substantially
all of the assets from her dairy farm business
to her neighbor, E, who is unrelated to D.
After the sale, D continued to operate the
dairy farm trade or business.
(ii) Analysis. D’s election under this
section was properly made and is effective
for the 2019 taxable year and subsequent
years. D’s dairy farm business is an excepted
trade or business because D made the
election with her timely filed Federal income
tax return. D’s tree farm business is a nonexcepted trade or business. The sale of some
but not all or substantially all of the assets
from D’s dairy farm business has no impact
on D’s election under this section.
(2) Example 2: Cessation of entire trade or
business—(i) Facts. X has a real property
trade or business for which X made an
election under this section by attaching an
election statement to A’s 2019 Federal
income tax return. On March 1, 2020, X sold
all of the assets used in its real property trade
or business to Y, an unrelated party, and
ceased to engage in the electing trade or
business. On June 1, 2027, X started a new
real property trade or business that was
substantially similar to X’s prior electing
trade or business.
(ii) Analysis. X’s election under this
section terminated on March 1, 2020, under
paragraph (d)(1) of this section. X may
choose whether to make an election under
this section for X’s new real property trade
or business that A started in 2027.
(3) Example 3: Anti-abuse rule—(i) Facts.
The same facts are the same as in Example
2 in paragraph (f)(2)(i) of this section, except
that X re-started her previous real property
trade or business on February 1, 2021, when
X reacquired substantially all of the assets
that X had sold on March 1, 2020.

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67587

(ii) Analysis. X’s election under this
section terminated on March, 1, 2020, under
paragraph (d)(1) of this section. On February
1, 2021, X’s election was reinstated under
paragraph (d)(4) of this section. X’s new real
property trade or business is treated as a
resumption of X’s prior electing trade or
business and is therefore treated as an
electing real property trade or business.

(4) Example 4: Trade or business
continuing after acquisition—(i) Facts.
X has a farming business for which X
made an election under this section by
attaching an election statement to X’s
timely filed 2019 Federal income tax
return. Y, unrelated to X, also has a
farming business, but Y has not made an
election under this section. On July 1,
2020, X transferred all of its assets to Y
in a transaction described in section
368(a)(1)(D) (a ‘‘D reorganization’’).
After the transfer, Y continues to
operate the farming trade or business
acquired from X.
(ii) Analysis. Under paragraph (d)(1)
of this section, Y is subject to X’s
election under this section for the trade
or business that uses X’s assets because
the sale or transfer was not in a taxable
transaction. Y cannot revoke X’s
election, but X’s election has no effect
on Y’s existing farming business for
which Y has not made an election under
this section.
(5) Example 5: Trade or business
merged after acquisition—(i) Facts. The
facts are the same as in Example 4 in
paragraph (f)(4)(i) of this section, except
that Y uses the assets acquired from X
in a trade or business that is neither a
farming business (as defined in section
263A(e)(4) or § 1.263A–4(a)(4)) nor a
trade or business of a specified
agricultural or horticultural cooperative
(as defined in section 199A(g)(4)).
(ii) Analysis. Y is not subject to X’s
election for Y’s farming business
because the farming trade or business
ceased to exist after the acquisition.
(g) Safe harbor for REITs—(1) In
general. If a REIT holds real property, as
defined in § 1.856–10, interests in
partnerships holding real property, as
defined in § 1.856–10, or shares in other
REITs holding real property, as defined
in § 1.856–10, the REIT is eligible to
make the election described in
paragraph (b)(1) of this section to be an
electing real property trade or business
for purposes of sections 163(j)(7)(B) and
168(g)(1)(F) for all or part of its assets.
The portion of the REIT’s assets eligible
for this election is determined under
paragraph (g)(2) or (3) of this section.
(2) REITs that do not significantly
invest in real property financing assets.
If a REIT makes an election described in
paragraph (g)(1) of this section and the
value of the REIT’s real property

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financing assets, as defined in
paragraphs (g)(5) and (6) of this section,
at the close of the taxable year is 10
percent or less of the value of the REIT’s
total assets at the close of the taxable
year, as determined under section
856(c)(4)(A), then all of the REIT’s assets
are treated as assets of an excepted trade
or business.
(3) REITs that significantly invest in
real property financing assets. If a REIT
makes an election described in
paragraph (g)(1) of this section and the
value of the REIT’s real property
financing assets, as defined in
paragraphs (g)(5) and (6) of this section,
at the close of the taxable year is more
than 10 percent of the value of the
REIT’s total assets at the close of the
taxable year, as determined under
section 856(c)(4)(A), then for allocation
of interest expense, interest income, and
other items of expense and gross income
to excepted and non-excepted trades or
businesses, the REIT must apply the
rules set forth in § 1.163(j)–10 as
modified by paragraph (g)(4) of this
section.
(4) REIT real property assets, interests
in partnerships, and shares in other
REITs—(i) Real property assets. Assets
held by a REIT described in paragraph
(g)(3) of this section that meet the
definition of real property under
§ 1.856–10 are treated as assets of an
excepted trade or business.
(ii) Partnership interests. If a REIT
described in paragraph (g)(3) of this
section holds an interest in a
partnership, in applying the partnership
look-through rule described in
§ 1.163(j)–10(c)(5)(ii)(A)(2), the REIT
treats assets of the partnership that meet
the definition of real property under
§ 1.856–10 as assets of an excepted trade
or business. This application of the
definition of real property under
§ 1.856–10 does not affect the
characterization of the partnership’s
assets at the partnership level or for any
non-REIT partner.
(iii) Shares in other REITs. If a REIT
(shareholder REIT) described in
paragraph (g)(3) of this section holds an
interest in another REIT, then for
purposes of applying the allocation
rules in § 1.163(j)–10, the partnership
look-through rule described in
§ 1.163(j)–10(c)(5)(ii)(A)(2) applies to
the assets of the other REIT (as if the
other REIT were a partnership) in
determining the extent to which
shareholder REIT’s adjusted basis in the
shares of the other REIT is allocable to
an excepted or non-excepted trade or
business of shareholder REIT. However,
no portion of the adjusted basis of
shareholder REIT’s shares in the other
REIT is allocated to a non-excepted

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trade or business if all of the other
REIT’s assets are treated as assets of an
excepted trade or business under
paragraph (g)(2) of this section. If
shareholder REIT does not receive from
the other REIT the information
necessary to determine whether and the
extent that the assets of the other REIT
are investments in real property
financing assets, then shareholder
REIT’s shares in the other REIT are
treated as assets of a non-excepted trade
or business under § 1.163(j)–10(c).
(5) Value of shares in other REITs. If
a REIT (shareholder REIT) holds shares
in another REIT, then for purposes of
applying the value tests under
paragraphs (g)(2) and (3) of this section,
the value of shareholder REIT’s real
property financing assets includes the
portion of the value of shareholder
REIT’s shares in the other REIT that is
attributable to the other REIT’s
investments in real property financing
assets. However, no portion of the value
of shareholder REIT’s shares in the other
REIT is included in the value of
shareholder REIT’s real property
financing assets if all of the other REIT’s
assets are treated as assets of an
excepted trade or business under
paragraph (g)(2) of this section. If
shareholder REIT does not receive from
the other REIT the information
necessary to determine whether and the
extent that the assets of the other REIT
are investments in real property
financing assets, then shareholder
REIT’s shares in the other REIT are
treated as real property financing assets
for purposes of paragraphs (g)(2) and (3)
of this section.
(6) Real property financing assets. For
purposes of this paragraph (g), real
property financing assets include
interests, including participation
interests, in the following: Mortgages,
deeds of trust, and installment land
contracts; mortgage pass-thru
certificates guaranteed by Government
National Mortgage Association (GNMA),
Federal National Mortgage Association
(FNMA), Federal Home Loan Mortgage
Corporation (FHLMC), or Canada
Mortgage and Housing Corporation
(CMHC); REMIC regular interests; other
interests in investment trusts classified
as trusts under § 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

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properties under state law; and debt
instruments issued by publicly offered
REITs.
(h) Special anti-abuse rule for certain
real property trades or businesses—(1)
In general. Except as provided in
paragraph (h)(2) of this section, a real
property trade or business does not
constitute a trade or business eligible for
an election described in paragraph (b)(1)
of this section to be an electing real
property trade or business if at least 80
percent, determined by fair market
value, of the business’s real property is
leased, whether or not the arrangement
is pursuant to a written lease or
pursuant to a service contract or another
agreement that is not denominated as a
lease, to a trade or business under
common control with the real property
trade or business. For purposes of this
paragraph (h), two trades or businesses
are under common control if 50 percent
of the direct and indirect ownership of
both businesses are held by related
parties within the meaning of sections
267(b) and 707(b).
(2) Exception for certain REITs. The
special anti-abuse rule in paragraph
(h)(1) does not apply to REITs that lease
qualified lodging facilities, as defined in
section 856(d)(9)(D), and qualified
health care properties, as defined in
section 856(e)(6)(D).
(i) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–10 Allocation of interest
expense, interest income, and other items
of expense and gross income to an
excepted trade or business.

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

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businesses is not subject to limitation
under section 163(j). The amount of a
taxpayer’s other items of income, gain,
deduction, or loss, including interest
income, that is properly allocable to
excepted trades or businesses is
excluded from the calculation of the
taxpayer’s section 163(j) limitation. See
section 163(j)(6) and (j)(8)(A)(i); see also
§ 1.163(j)–1(b)(1)(i)(H), (b)(1)(ii)(F), and
(b)(3). The general method of allocation
set forth in paragraph (c) of this section
is based on the approach that money is
fungible and that interest expense is
attributable to all activities and
property, regardless of any specific
purpose for incurring an obligation on
which interest is paid. In no event may
the amount of interest expense allocated
under this section exceed the amount of
interest paid or accrued, or treated as
paid or accrued, by the taxpayer within
the taxable year.
(ii) Application of section. The
amount of a taxpayer’s tax items
properly allocable to a trade or business,
other than interest expense and interest
income, that is properly allocable to
excepted trades or businesses for
purposes of section 163(j) is determined
as set forth in paragraph (b) of this
section. The amount of a taxpayer’s
interest expense and interest income
that is properly allocable to excepted
trades or businesses for purposes of
section 163(j) generally is determined as
set forth in paragraph (c) of this section,
except as otherwise provided in
paragraph (d) of this section. For
purposes of this section, a taxpayer’s
activities are not treated as a trade or
business if those activities do not
involve the provision of services or
products to a person other than the
taxpayer. For example, if a taxpayer
engaged in a manufacturing trade or
business has in-house legal personnel
that provide legal services solely to the
taxpayer, the taxpayer is not treated as
also engaged in the trade or business of
providing legal services.
(2) Coordination with other rules—(i)
In general. The rules of this section
apply after a taxpayer has determined
whether any interest expense or interest
income paid, received, or accrued is
properly allocable to a trade or business.
Similarly, the rules of this section apply
to other tax items after a taxpayer has
determined whether those items are
properly allocable to a trade or business.
For instance, a taxpayer must apply
§ 1.163–8T to determine which items of
interest expense are investment interest
under section 163(d) before applying the
rules in paragraph (c) of this section to
allocate interest expense between
excepted and non-excepted trades or
businesses. After determining whether

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its tax items are properly allocable to a
trade or business, a taxpayer that is
engaged in both excepted and nonexcepted trades or businesses must
apply the rules of this section to
determine the amount of interest
expense that is business interest
expense subject to limitation under
section 163(j) and to determine which
items are included or excluded in
computing its section 163(j) limitation.
(ii) Treatment of investment interest,
investment income, and investment
expenses of a partnership with a C
corporation or tax-exempt corporation
as a partner. For rules governing the
treatment of investment interest,
investment income, and investment
expenses of a partnership with a C
corporation or tax-exempt corporation
as a partner, see §§ 1.163(j)–4(b)(3) and
1.163(j)–6(j).
(3) Application of allocation rules to
foreign corporations and foreign
partnerships. The rules of this section
apply to foreign corporations and
foreign partnerships. See §§ 1.163(j)–7
and 1.163(j)–8.
(4) Application of allocation rules to
members of a consolidated group—(i) In
general. As provided in § 1.163(j)–4(d),
the computations required by section
163(j) and the section 163(j) regulations
generally are made for a consolidated
group on a consolidated basis. In this
regard, for purposes of applying the
allocation rules of this section, all
members of a consolidated group are
treated as one corporation. Therefore,
the rules of this section apply to the
activities conducted by the group as if
those activities were conducted by a
single corporation. For example, the
group (rather than a particular member)
is treated as engaged in excepted or nonexcepted trades or businesses. In the
case of intercompany obligations,
within the meaning of § 1.1502–
13(g)(2)(ii), for purposes of allocating
asset basis between excepted and nonexcepted 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
§ 1.1502–13(b)(1)(i), are disregarded for
purposes of this section, as are the
resulting offsetting items, and property
is not treated as used in a trade or
business to the extent the use of such
property in that trade or business
derives from an intercompany
transaction. Further, stock of a group
member that is owned by another
member of the same group is not treated
as an asset for purposes of this section,
and the transfer of any amount of
member stock to a non-member is
treated by the group as a transfer of the

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member’s assets proportionate to the
amount of member stock transferred.
Additionally, stock of a corporation that
is not a group member is treated as
owned by the group.
(ii) Application of excepted business
percentage to members of a
consolidated group. After a consolidated
group has determined the percentage of
the group’s interest expense allocable to
excepted trades or businesses for the
taxable year (and thus not subject to
limitation under section 163(j)), this
exempt percentage is applied to the
interest paid or accrued by each member
during the taxable year to any lender
that is not a group member. Therefore,
except to the extent paragraph (d) of this
section (providing rules for certain
qualified nonrecourse indebtedness)
applies, an identical percentage of the
interest paid or accrued by each member
of the group to any lender that is not a
group member will be treated as
allocable to excepted trades or
businesses, regardless of whether any
particular member actually engaged in
an excepted trade or business.
(iii) Basis in assets transferred in an
intercompany transaction. For purposes
of allocating interest expense and
interest income under paragraph (c) of
this section, the basis of property does
not include any gain or loss realized
with respect to the property by another
member in an intercompany transaction,
as defined in § 1.1502–13(b), whether or
not the gain or loss is deferred.
(5) Tax-exempt organizations. For
organizations subject to tax under
section 511, section 512 and the
regulations thereunder determine the
rules for allocating all income and
expenses among multiple trades or
businesses.
(6) [Reserved]
(7) Examples. The following examples
illustrate the principles of this
paragraph (a).
(i) Example 1: Items properly allocable to
a trade or business—(A) Facts. Individual T
operates Business X, a non-excepted trade or
business, as a sole proprietor. In Year 1, T
pays or accrues $40x of interest expense and
receives $100x of gross income with respect
to Business X that is not eligible for a section
199A deduction. T borrows money to buy a
car for personal use, and T pays or accrues
$20x of interest expense with respect to the
car loan. T also invests in corporate bonds,
and, in Year 1, T receives $50x of interest
income on those bonds.
(B) Analysis. Under paragraphs (a)(1) and
(2) of this section, T must determine which
items of income and expense, including
items of interest income and interest
expense, are properly allocable to a trade or
business. T’s $100x of gross income and T’s
$40x of interest expense with respect to
Business X are properly allocable to a trade

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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 nonexcepted trade or business (Business Y). P
leases Building V (which P owns) to S for use
in Business Y.
(B) Analysis. Under paragraph (a)(4)(i) of
this section, a consolidated group is treated
as a single corporation for purposes of
applying the allocation rules of this section,
and the consolidated group (rather than a
particular member of the group) is treated as
engaged in excepted and non-excepted trades
or businesses. Thus, intercompany
transactions are disregarded for purposes of
this section. As a result, the lease of Building
V by P to S is disregarded. Moreover, because
Building V is used in Business Y, basis in
this asset is allocated to Business Y rather
than Business X for purposes of these
allocation rules, regardless of which member
(P or S) owns the building.

(b) Allocation of tax items other than
interest expense and interest income—
(1) In general. For purposes of
calculating ATI, tax items other than
interest expense and interest income are
allocated to a particular trade or
business in the manner described in this
paragraph (b). It is not necessary to
allocate items under this paragraph (b)
for purposes of calculating ATI if all of
the taxpayer’s items subject to allocation
under this paragraph (b) are allocable to
excepted trades or businesses, or if all
of those items are allocable to nonexcepted trades or businesses.
(2) Gross income other than dividends
and interest income. A taxpayer’s gross
income other than dividends and
interest income is allocated to the trade
or business that generated the gross
income.
(3) Dividends—(i) Look-through rule.
If a taxpayer receives a dividend, within
the meaning of section 316, that is not
investment income, within the meaning
of section 163(d), and if the taxpayer
looks through to the assets of the payor
corporation under paragraph (c)(5)(ii) of
this section for the taxable year, then,
solely for purposes of allocating
amounts received as a dividend during
the taxable year to excepted or nonexcepted trades or businesses under this
paragraph (b), the dividend income is
treated as allocable to excepted or nonexcepted trades or businesses based
upon the relative amounts of the payor
corporation’s adjusted basis in the assets
used in its trades or businesses,

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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 nonexcepted trades or businesses, all of the
taxpayer’s dividend income from the
payor corporation for the taxable year is
treated as allocable to either excepted or
non-excepted trades or businesses,
respectively.
(ii) Inapplicability of the look-through
rule. If a taxpayer receives a dividend
that is not investment income, within
the meaning of section 163(d), and if the
taxpayer does not look through to the
assets of the payor corporation under
paragraph (c)(5)(ii) of this section for the
taxable year, then the taxpayer must
treat the dividend as allocable to a nonexcepted trade or business.
(4) Gain or loss from the disposition
of non-consolidated C corporation
stock, partnership interests, or S
corporation stock—(i) Non-consolidated
C corporations. If a taxpayer recognizes
gain or loss upon the disposition of
stock in a non-consolidated C
corporation that is not property held for
investment, within the meaning of
section 163(d)(5), and if the taxpayer
looks through to the assets of the C
corporation under paragraph (c)(5)(ii) of
this section for the taxable year, then the
taxpayer must allocate gain or loss from
the disposition of stock to excepted or
non-excepted trades or businesses based
upon the relative amounts of the
corporation’s adjusted basis in the assets
used in its trades or businesses,
determined pursuant to paragraph (c) of
this section. However, if a taxpayer
recognizes gain or loss upon the
disposition of stock in a nonconsolidated C corporation that is not
property held for investment, within the
meaning of section 163(d)(5), and if the
taxpayer does not look through to the
assets of the C corporation under
paragraph (c)(5)(ii) of this section for the
taxable year, then the taxpayer must
treat the gain or loss from the
disposition of stock as allocable to a
non-excepted trade or business. For
rules governing the transfer of stock of
a member of a consolidated group, see
paragraph (a)(4)(i) of this section.
(ii) Partnerships and S corporations.
(A) If a taxpayer recognizes gain or loss
upon the disposition of interests in a
partnership or stock in an S corporation
that owns:
(1) Non-excepted assets and excepted
assets;
(2) Investment assets; or
(3) Both;

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(B) The taxpayer determines a
proportionate share of the amount
properly allocable to a non-excepted
trade or business in accordance with the
allocation rules set forth in paragraph
(c)(5)(ii)(A) or (c)(5)(ii)(B)(3) of this
section, as appropriate, and includes
such proportionate share of gain or loss
in the taxpayer’s ATI. This rule also
applies to tiered passthrough entities, as
defined in § 1.163(j)–7(f)(13), by looking
through each passthrough entity tier (for
example, an S corporation that is the
partner of the highest-tier partnership
would look through each lower-tier
partnership), subject to paragraph
(c)(5)(ii)(D) of this section. With respect
to a partner that is a C corporation or
tax-exempt corporation, a partnership’s
investment assets are taken into account
and treated as non-excepted trade or
business assets.
(5) Expenses, losses, and other
deductions—(i) Expenses, losses, and
other deductions that are definitely
related to a trade or business. Expenses
(other than interest expense), losses, and
other deductions (collectively,
deductions for purposes of this
paragraph (b)(5)) that are definitely
related to a trade or business are
allocable to the trade or business to
which they relate. A deduction is
considered definitely related to a trade
or business if the item giving rise to the
deduction is incurred as a result of, or
incident to, an activity of the trade or
business or in connection with property
used in the trade or business (see
§ 1.861–8(b)(2)). If a deduction is
definitely related to one or more
excepted trades or businesses and one
or more non-excepted trades or
businesses, the deduction is
apportioned between the excepted and
non-excepted trades or businesses based
upon the relative amounts of the
taxpayer’s adjusted basis in the assets
used in those trades or businesses, as
determined under paragraph (c) of this
section.
(ii) Other deductions. Deductions that
are not described in paragraph (b)(5)(i)
of this section are ratably apportioned to
all gross income.
(6) Treatment of certain investment
items of a partnership with a C
corporation partner. Any investment
income or investment expenses that a
partnership receives, pays, or accrues
and that is treated as properly allocable
to a trade or business of a C corporation
partner under § 1.163(j)–4(b)(3)(i) is
treated as properly allocable to a nonexcepted trade or business of the C
corporation partner.
(7) Example: Allocation of income and
expense. The following example illustrates
the principles of this paragraph (b):

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

(c) Allocating interest expense and
interest income that is properly
allocable to a trade or business—(1)
General rule—(i) In general. Except as
otherwise provided in this section, the
amount of a taxpayer’s interest expense
and interest income that is properly
allocable to a trade or business is
allocated to the taxpayer’s excepted or
non-excepted trades or businesses for
purposes of section 163(j) based upon
the relative amounts of the taxpayer’s
adjusted basis in the assets, as
determined under paragraph (c)(5) of
this section, used in its excepted or nonexcepted 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 nonexcepted 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

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excepted trades or businesses (in which
case the taxpayer is not subject to the
section 163(j) limitation) or if all of the
taxpayer’s interest income and expense
is allocable to non-excepted trades or
businesses.
(ii) De minimis exception. If 90
percent or more of the taxpayer’s basis
in its assets for the taxable year is
allocable to either excepted or nonexcepted 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 nonexcepted trades or businesses,
respectively.
(2) Example. The following example
illustrates the principles of paragraph
(c)(1) of this section: T is a calendar-year
C corporation engaged in an electing
real property trade or business, the
business of selling wine, and the
business of selling hand-carved wooden
furniture. In Year 1, T has $100x of
interest expense that is deductible
except for the potential application of
section 163(j). Based upon
determinations made on the
determination dates of March 31, June
30, September 30, and December 31, T’s
average adjusted basis in the assets used
in the electing real property trade or
business (an excepted trade or business)
in Year 1 is $800x, and T’s total average
adjusted basis in the assets used in the
other two businesses in Year 1 is $200x.
Thus, $80x (($800x/($800x + $200x)) ×
$100x) of T’s interest expense for Year
1 is allocable to T’s electing real
property trade or business and is not
business interest expense subject to
limitation under section 163(j). The
remaining $20x of T’s interest expense
is business interest expense for Year 1
that is subject to limitation under
section 163(j).
(3) Asset used in more than one trade
or business—(i) General rule. If an asset
is used in more than one trade or
business during a determination period,
as defined in paragraph (c)(6) of this
section, the taxpayer’s adjusted basis in
the asset is allocated to each trade or
business using the permissible
methodology under this paragraph (c)(3)
that most reasonably reflects the use of
the asset in each trade or business
during that determination period. An
allocation methodology most reasonably
reflects the use of the asset in each trade
or business if it most properly reflects
the proportionate benefit derived from
the use of the asset in each trade or
business. If none of the permissible
methodologies set forth in paragraph
(c)(3)(ii) of this section reasonably
reflects the use of the asset in each trade

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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 § 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 kilowatthours generated by each trade or
business).
(iii) Special rules—(A) Consistent
allocation methodologies—(1) In
general. Except as otherwise provided
in paragraph (c)(3)(iii)(A)(2) of this
section, a taxpayer may not vary its
allocation methodology from one
determination period to the next within
a taxable year or from one taxable year
to the next.
(2) Consent to change allocation
methodology. If a taxpayer determines
that a different allocation methodology
properly reflects the proportionate
benefit derived from the use of assets in
its trades or businesses, the taxpayer
may change its method of allocation
under paragraphs (c)(3)(i) and (ii) of this
section with the consent of the
Commissioner. To obtain consent, a
taxpayer must submit a request for a
letter ruling under the applicable
administrative procedures, and consent
only will be granted in extraordinary
circumstances.
(B) De minimis exceptions—(1) De
minimis amount of gross income from
trades or businesses. If at least 90
percent of gross income that an asset
generates, has generated, or may
reasonably be expected to generate,
within the meaning of § 1.861–9T(g)(3),
during a determination period is with
respect to either excepted trades or

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businesses or non-excepted trades or
businesses, the taxpayer’s entire basis in
the asset for the determination period
must be allocated to either excepted or
non-excepted trades or businesses,
respectively.
(2) De minimis amount of asset basis
allocable to a trade or business. If 90
percent or more of the taxpayer’s basis
in an asset would be allocated to either
excepted trades or businesses or nonexcepted trades or businesses during a
determination period pursuant to this
paragraph (c)(3), the taxpayer’s entire
basis in the asset for the determination
period must be allocated to either
excepted or non-excepted trades or
businesses, respectively.
(C) Allocations of excepted regulated
utility trades or businesses—(1) In
general. Except as provided in the de
minimis rule in paragraph
(c)(3)(iii)(C)(3) of this section, if a
taxpayer is engaged in the trade or
business of the furnishing or sale of
items described in § 1.163(j)–
1(b)(13)(i)(A), the taxpayer is engaged in
an excepted regulated utility trade or
business only to the extent the rates for
the items furnished and sold are
described in § 1.163(j)–1(b)(13)(i)(B).
Thus, for example, electricity sold at
market rates rather than on a cost of
service and rate of return basis must be
treated as electricity sold by a nonexcepted 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 nonexcepted trades or businesses.
(2) Permissible method for allocating
asset basis for utility trades or
businesses. In the case of a utility trade
or business described in paragraph
(c)(3)(iii)(C)(1) of this section, and
except as provided in the de minimis
rule in paragraph (c)(3)(iii)(C)(3) of this
section, the method described in
paragraph (c)(3)(ii)(C) of this section is
the only permissible method for
allocating the taxpayer’s basis in assets
used in the trade or business between
the taxpayer’s excepted and nonexcepted trades or businesses of selling
or furnishing the items described in
§ 1.163(j)–1(b)(13)(i)(A).
(3) De minimis rule for excepted
utility trades or businesses. If a taxpayer
is engaged in a utility trade or business
described in paragraph (c)(3)(iii)(C)(1) of
this section, and if more than 90 percent
of the items described in § 1.163(j)–
1(b)(13)(i)(A) are furnished or sold at
rates determined in the manner
described in § 1.163(j)–1(b)(13)(i)(B), the
taxpayer’s entire trade or business is an
excepted regulated utility trade or

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

(4) Disallowed business interest
expense carryforwards; floor plan
financing interest expense. Disallowed
business interest expense carryforwards
(which were treated as allocable to a
non-excepted trade or business in a
prior taxable year) are not re-allocated
between non-excepted and excepted
trades or businesses in a succeeding
taxable year. Instead, the carryforwards
continue to be treated as allocable to a
non-excepted trade or business. Floor
plan financing interest expense also is
not subject to allocation between
excepted and non-excepted trades or
businesses (see § 1.163(j)–1(b)(17)) and
is always treated as allocable to nonexcepted trades or businesses.
(5) Additional rules relating to basis—
(i) Calculation of adjusted basis—(A)
Non-depreciable property other than
land. Except as otherwise provided in
paragraph (c)(5)(i)(E) of this section, for
purposes of this section, the adjusted
basis of an asset other than land with
respect to which no deduction is
allowable under section 167, section
168 of the Internal Revenue Code of
1954 (former section 168), or section
197, as applicable, is the adjusted basis
of the asset for determining gain or loss
from the sale or other disposition of that
asset as provided in § 1.1011–1. Selfcreated 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

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basis of any tangible asset with respect
to which a deduction is allowable under
section 167, other than inherently
permanent structures, is determined by
using the alternative depreciation
system under section 168(g) before any
application of the additional first-year
depreciation deduction (for example,
under section 168(k) or (m)), and the
adjusted basis of any tangible asset with
respect to which a deduction is
allowable under former section 168,
other than inherently permanent
structures, is determined by using the
taxpayer’s method of computing
depreciation for the asset under former
section 168. The depreciation deduction
with respect to the property described
in this paragraph (c)(5)(i)(B) is allocated
ratably to each day during the period in
the taxable year to which the
depreciation relates.
(C) Special rule for land and
inherently permanent structures. Except
as otherwise provided in paragraph
(c)(5)(i)(E) of this section, for purposes
of this section, the adjusted basis of any
asset that is land, including
nondepreciable improvements to land,
or an inherently permanent structure is
its unadjusted basis.
(D) Depreciable or amortizable
intangible property and depreciable
income forecast method property. For
purposes of this section, the adjusted
basis of any intangible asset with
respect to which a deduction is
allowable under section 167 or 197, as
applicable, is determined in accordance
with section 167 or 197, as applicable,
and the adjusted basis of any asset
described in section 167(g)(6) for which
the deduction allowable under section
167 is determined by the taxpayer under
section 167(g), is determined in
accordance with section 167(g). The
depreciation or amortization deduction
with respect to the property described
in this paragraph (c)(5)(i)(D) is allocated
ratably to each day during the period in
the taxable year to which the
depreciation or amortization relates.
(E) Assets not yet used in a trade or
business. Assets that have been acquired
or that are under development but that
are not yet used in a trade or business
are not taken into account for purposes
of this paragraph (c). For example,
construction works in progress (such as
buildings, airplanes, or ships) are not
taken into account for purposes of this
paragraph (c). Similarly, land acquired
by a taxpayer for construction of a
building by the taxpayer to be used in
a trade or business is not taken into
account for purposes of this paragraph
(c) until the building is placed in
service. This rule does not apply to

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interests in a partnership or stock in a
corporation.
(F) Trusts established to fund specific
liabilities. Trusts required by law to
fund specific liabilities (for example,
pension trusts and plant
decommissioning trusts) are not taken
into account for purposes of this
paragraph (c).
(G) Inherently permanent structure.
For purposes of this section, the term
inherently permanent structure has the
meaning provided in § 1.856–10(d)(2).
(ii) Partnership interests; stock in nonconsolidated domestic corporations—
(A) Partnership interests—(1)
Calculation of asset basis. For purposes
of this section, a partner’s interest in a
partnership is treated as an asset of the
partner. For these purposes, the
partner’s adjusted basis in a partnership
interest is reduced, but not below zero,
by the partner’s share of partnership
liabilities, as determined under section
752, and is further reduced as provided
in paragraph (c)(5)(ii)(A)(2)(iii) of this
section.
(2) Allocation of asset basis—(i) In
general. For purposes of determining
the extent to which a partner’s adjusted
basis in its partnership interest is
allocable to an excepted or nonexcepted trade or business, the partner
may look through to such partner’s
share of the partnership’s basis in the
partnership’s assets, taking into account
any adjustments under sections 734(b)
and 743(b), and adjusted to the extent
required under paragraph (d)(4) of this
section, except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
For purposes of the preceding sentence,
such partner’s share of partnership
assets is determined using a reasonable
method taking into account special
allocations under section 704(b).
Notwithstanding paragraph (c)(7) of this
section, if a partner’s direct and indirect
interest in a partnership is greater than
or equal to 80 percent of the
partnership’s capital or profits, the
partner must apply the rules in this
paragraph (c)(5)(ii)(A) to look through to
the partnership’s basis in the
partnership’s assets.
(ii) De minimis rule. If, after applying
paragraph (c)(5)(ii)(A)(2)(iii) of this
section, at least 90 percent of a partner’s
share of a partnership’s basis in its
assets (including adjustments under
sections 734(b) and 743(b)) is allocable
to either excepted trades or businesses
or non-excepted trades or businesses,
without regard to assets not properly
allocable to a trade or business, the
partner’s entire basis in its partnership
interest is treated as allocable to either
excepted or non-excepted trades or
businesses, respectively. For purposes

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of the preceding sentence, such
partner’s share of partnership assets is
determined using a reasonable method
taking into account special allocations
under section 704(b).
(iii) Partnership assets not properly
allocable to a trade or business. For
purposes of applying paragraphs
(c)(5)(ii)(A)(2)(i) and (ii) of this section
with respect to a partner that is a C
corporation or tax-exempt corporation,
such partner’s share of a partnership’s
assets that are not properly allocable to
a trade or business is treated as properly
allocable to an excepted or nonexcepted trade or business with respect
to such partner in the same manner that
such assets would be treated if held
directly by such partner. With respect to
a partner other than a C corporation or
tax-exempt corporation, a partnership’s
assets that are not properly allocable to
a trade or business are treated as neither
excepted nor non-excepted trade or
business assets, and such partner’s
adjusted basis in its partnership interest
is reduced by that partner’s share of the
partnership’s asset basis with respect to
those assets. For purposes of this
paragraph (c)(5)(ii)(A)(2)(iii), such
partner’s share of a partnership’s assets
is determined under a reasonable
method taking into account special
allocations under section 704(b).
(iv) Inapplicability of partnership
look-through rule. If a partner, other
than a C corporation or a tax-exempt
corporation, chooses not to look through
to the partnership’s basis in the
partnership’s assets under paragraph
(c)(5)(ii)(A)(2)(i) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such
partnership look-through rule, the
partner generally will treat its basis in
the partnership interest as either an
asset held for investment or a nonexcepted trade or business asset as
determined under section 163(d). If a
partner that is a C corporation or a taxexempt corporation chooses not to look
through to the partnership’s basis in the
partnership’s assets under paragraph
(c)(5)(ii)(A)(2)(i) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such
partnership look-through rule, the
taxpayer must treat its entire basis in the
partnership interest as allocable to a
non-excepted trade or business.
(B) Stock in non-consolidated
domestic corporations—(1) In general.
For purposes of this section, if a
taxpayer owns stock in a domestic C
corporation that is not a member of the
taxpayer’s consolidated group, or if the
taxpayer owns stock in an S
corporation, the stock is treated as an
asset of the taxpayer.

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(2) Domestic non-consolidated C
corporations—(i) Allocation of asset
basis. If a shareholder satisfies the
minimum ownership threshold in
paragraph (c)(7) of this section, then, for
purposes of determining the extent to
which the shareholder’s basis in its
stock in the domestic non-consolidated
C corporation is allocable to an excepted
or non-excepted trade or business, the
shareholder must look through to the
corporation’s basis in the corporation’s
assets, adjusted to the extent required
under paragraph (d)(4) of this section,
except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
(ii) De minimis rule. If at least 90
percent of the domestic nonconsolidated C corporation’s basis in the
corporation’s assets is allocable to either
excepted trades or businesses or nonexcepted trades or businesses, the
shareholder’s entire interest in the
corporation’s stock is treated as
allocable to either excepted or nonexcepted trades or businesses,
respectively.
(iii) Inapplicability of corporate lookthrough rule. If a shareholder other than
a C corporation or a tax-exempt
corporation does not satisfy the
minimum ownership threshold in
paragraph (c)(7) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying the
corporation look-through rule of
paragraph (c)(5)(ii)(B)(2)(i) of this
section, the shareholder generally will
treat its entire basis in the corporation’s
stock as an asset held for investment. If
a shareholder that is a C corporation or
a tax-exempt corporation does not
satisfy the minimum ownership
threshold in paragraph (c)(7) of this
section or is precluded by paragraph
(c)(5)(ii)(D) of this section from applying
the corporation look-through rule of
paragraph (c)(5)(ii)(B)(2)(i) of this
section, the shareholder must treat its
entire basis in the corporation’s stock as
allocable to a non-excepted trade or
business.
(3) S corporations—(i) Calculation of
asset basis. For purposes of this section,
a shareholder’s share of stock in an S
corporation is treated as an asset of the
shareholder. Additionally, for these
purposes, the shareholder’s adjusted
basis in a share of S corporation stock
is adjusted to take into account the
modifications in paragraph (c)(5)(i)(A)
of this section with respect to the assets
of the S corporation (for example, a
shareholder’s adjusted basis in its S
corporation stock is increased by the
shareholder’s share of depreciation with
respect to an inherently permanent
structure owned by the S corporation).

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(ii) Allocation of asset basis. For
purposes of determining the extent to
which a shareholder’s basis in its stock
of an S corporation is allocable to an
excepted or non-excepted trade or
business, the shareholder may look
through to such shareholder’s share of
the S corporation’s basis in the S
corporation’s assets, allocated on a pro
rata basis, adjusted to the extent
required under paragraph (d)(4) of this
section, except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
Notwithstanding paragraph (c)(7) of this
section, if a shareholder’s direct and
indirect interest in an S corporation is
greater than or equal to 80 percent of the
S corporation’s stock by vote and value,
the shareholder must apply the rules in
this paragraph (c)(5)(ii)(B)(3) to look
through to the S corporation’s basis in
the S corporation’s assets.
(iii) De minimis rule. If at least 90
percent of a shareholder’s share of an S
corporation’s basis in its assets is
allocable to either excepted trades or
businesses or non-excepted trades or
businesses, the shareholder’s entire
basis in its S corporation stock is treated
as allocable to either excepted or nonexcepted trades or businesses,
respectively.
(iv) Inapplicability of S corporation
look-through rule. If a shareholder
chooses not to look through to the S
corporation’s basis in the S
corporation’s assets under paragraph
(c)(5)(ii)(B)(3)(ii) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such S
corporation look-through rule, the
shareholder generally will treat its basis
in the S corporation stock as either an
asset held for investment or a nonexcepted trade or business asset as
determined under section 163(d).
(C) Stock in CFCs. The rules
applicable to domestic non-consolidated
C corporations in paragraph (c)(5)(ii)(B)
of this section also apply to CFCs.
(D) Inapplicability of look-through
rule to partnerships or non-consolidated
corporations to which the small
business exemption applies. A taxpayer
may not apply the look-through rules in
paragraphs (b)(3) and (c)(5)(ii)(A), (B),
and (C) of this section to a partnership,
S corporation, or non-consolidated
corporation that is eligible for the small
business exemption under section
163(j)(3) and § 1.163(j)–2(d)(1).
(E) Tiered entities. If a taxpayer
applies the look-through rules of this
paragraph (c)(5)(ii), the taxpayer must
do so for all lower-tier entities with
respect to which the taxpayer satisfies,
directly or indirectly, the minimum
ownership threshold in paragraph (c)(7)
of this section, subject to the limitation

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in paragraph (c)(5)(ii)(D) of this section,
beginning with the lowest-tier entity.
(iii) Cash and cash equivalents and
customer receivables. Except as
otherwise provided in paragraph (d)(2)
of this section, a taxpayer’s basis in its
cash and cash equivalents and customer
receivables is not taken into account for
purposes of this paragraph (c). This rule
also applies to a lower-tier entity if a
taxpayer looks through to the assets of
that entity under paragraph (c)(5)(ii) of
this section. For purposes of this
paragraph (c)(5)(iii), the term cash and
cash equivalents includes cash, foreign
currency, commercial paper, any
interest in an investment company
registered under the Investment
Company Act of 1940 (1940 Act) and
regulated as a money market fund under
17 CFR 270.2a–7 (Rule 2a–7 under the
1940 Act), any obligation of a
government, and any derivative that is
substantially secured by an obligation of
a government, or any similar asset. For
purposes of this paragraph (c)(5)(iii), a
derivative is a derivative described in
section 59A(h)(4)(A), without regard to
section 59A(h)(4)(C). For purposes of
this paragraph (c)(5)(iii), the term
government means the United States or
any agency or instrumentality of the
United States; a State or any political
subdivision thereof, including the
District of Columbia and any possession
or territory of the United States, within
the meaning of section 103 and § 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
§ 1.1471–6(b).
(iv) Deemed asset sale. Solely for
purposes of determining the amount of
basis allocable to excepted and nonexcepted trades or businesses under this
section, an election under section 336,
338, or 754, as applicable, is deemed to
have been made for any acquisition of
corporate stock or partnership interests
with respect to which the taxpayer
demonstrates to the satisfaction of the
Commissioner, in the information
statement required by paragraph
(c)(6)(iii)(B) of this section, that the
taxpayer was eligible to make an
election but was actually or effectively
precluded from doing so by a regulatory
agency with respect to an excepted
regulated utility trade or business. Any
additional basis taken into account
under this rule is reduced ratably over
a 15-year period beginning with the
month of the acquisition and is not
subject to the anti-abuse rule in
paragraph (c)(8) of this section.
(v) Other adjustments. The
Commissioner may make appropriate

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adjustments to prevent a taxpayer from
intentionally and artificially increasing
its basis in assets attributable to an
excepted trade or business.
(6) Determination dates;
determination periods; reporting
requirements—(i) Definitions. For
purposes of this section, the term
determination date means the last day
of each quarter of the taxpayer’s taxable
year (and the last day of the taxpayer’s
taxable year, if the taxpayer has a short
taxable year), and the term
determination period means the period
beginning the day after one
determination date and ending on the
next determination date.
(ii) Application of look-through rules.
If a taxpayer that applies the lookthrough rules of paragraph (c)(5)(ii) of
this section has a different taxable year
than the partnership or nonconsolidated corporation to which the
taxpayer is applying those rules, then,
for purposes of this paragraph (c)(6), the
taxpayer must use the most recent
quarterly figures from the partnership or
non-consolidated corporation. For
example, assume that PS1 is a
partnership with a May 31 taxable year,
and that C (a calendar-year C
corporation) is a partner whose
ownership interest satisfies the
ownership threshold in paragraph (c)(7)
of this section. PS1’s determination
dates are February 28, May 31, August
31, and November 30. In turn, C’s
determination dates are March 31, June
30, September 30, and December 31. If
C looks through to PS1’s basis in its
assets under paragraph (c)(5)(ii) of this
section, then, for purposes of
determining the amount of C’s asset
basis that is attributable to its excepted
and non-excepted businesses on March
31, C must use PS1’s asset basis
calculations for February 28.
(iii) Reporting requirements—(A)
Books and records. A taxpayer must
maintain books of account and other
records and data as necessary to
substantiate the taxpayer’s use of an
asset in an excepted trade or business
and to substantiate the adjustments to
asset basis for purposes of applying
paragraph (c) of this section. One
indication demonstrating that a
particular asset is used in a particular
trade or business is if the taxpayer
maintains separate books and records
for all of its excepted and non-excepted
trades or businesses, and can show the
asset in the books and records of a
particular excepted or non-excepted
trade or business. For rules governing
record retention, see § 1.6001–1.
(B) Information statement. Except as
otherwise provided in publications,
forms, instructions, or other guidance,

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each taxpayer that is making an
allocation under this paragraph (c) must
prepare a statement containing the
information described in this paragraph
(c)(6)(iii) and must attach the statement
to its timely filed Federal income tax
return for the taxable year. The
statement, which must be titled
‘‘Section 163(j) Asset Basis
Calculations,’’ must include the
following information:
(1) The taxpayer’s adjusted basis in
the assets used in its excepted and nonexcepted businesses, determined on a
quarterly basis as set forth in this
section, including detailed information
for the different groups of assets
identified in paragraphs (c)(5)(i),
(c)(5)(ii), and (d) of this section;
(2) The determination dates on which
asset basis was measured during the
taxable year;
(3) The names and taxpayer
identification numbers (TINs) of all
entities for which basis information is
being provided, including partnerships
and corporations if the taxpayer that
owns an interest in a partnership or
corporation looks through to the
partnership’s or corporation’s basis in
the partnership’s or corporation’s assets
under paragraph (c)(5)(ii) of this section.
If the taxpayer is a member of a
consolidated group, the name and TIN
of the agent for the group, as defined in
§ 1.1502–77, must be provided, but the
taxpayer need not provide the names
and TINs of all other consolidated group
members;
(4) Asset basis information for
corporations or partnerships if the
taxpayer looks through to the
corporation’s or partnership’s basis in
the corporation’s or partnership’s assets
under paragraph (c)(5)(ii) of this section;
and
(5) A summary of the method or
methods used to determine asset basis
in property used in both excepted and
non-excepted businesses, as well as
information regarding any deemed sale
under paragraph (c)(5)(iv) of this
section.
(iv) Failure to file statement. If a
taxpayer fails to file the statement
described in paragraph (c)(6)(iii) of this
section or files a statement that does not
comply with the requirements of
paragraph (c)(6)(iii) of this section, the
Commissioner may treat the taxpayer as
if all of its interest expense is properly
allocable to a non-excepted trade or
business, unless the taxpayer shows that
there was reasonable cause for failing to
comply with, and the taxpayer acted in
good faith with respect to, the
requirements of paragraph (c)(6)(iii) of
this section, taking into account all
pertinent facts and circumstances.

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(7) Ownership threshold for lookthrough rules—(i) Corporations—(A)
Asset basis. A shareholder must look
through to the assets of a nonconsolidated domestic C corporation or
a CFC under paragraph (c)(5)(ii) of this
section for purposes of allocating the
shareholder’s basis in its stock in the
corporation between excepted and nonexcepted trades or businesses if the
shareholder’s direct and indirect
interest in the corporation satisfies the
ownership requirements of section
1504(a)(2). A shareholder may look
through to the assets of an S corporation
under paragraph (c)(5)(ii) of this section
for purposes of allocating the
shareholder’s basis in its stock in the S
corporation between excepted and nonexcepted 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 nonconsolidated domestic C corporation or
a CFC under paragraph (b)(3) of this
section if the shareholder’s direct and
indirect interest in the corporation
satisfies the ownership requirements of
section 1504(a)(2). A shareholder may
look through to the activities of an S
corporation under paragraph (b)(3) of
this section regardless of the
shareholder’s direct and indirect
interest in the S corporation.
(ii) Partnerships. A partner may look
through to the assets of a partnership
under paragraph (c)(5)(ii) of this section
for purposes of allocating the partner’s
basis in its partnership interest between
excepted and non-excepted trades or
businesses regardless of the partner’s
direct and indirect interest in the
partnership.
(iii) Inapplicability of look-through
rule. For circumstances in which a
taxpayer that satisfies the ownership
threshold in this paragraph (c)(7) may
not apply the look-through rules in
paragraphs (b)(3) and (c)(5)(ii) of this
section, see paragraph (c)(5)(ii)(D) of
this section.
(8) Anti-abuse rule. If a principal
purpose for the acquisition, disposition,
or change in use of an asset was to
artificially shift the amount of basis
allocable to excepted or non-excepted
trades or businesses on a determination
date, the additional basis or change in
use will not be taken into account for
purposes of this section. For example, if
an asset is used in a non-excepted trade
or business for most of the taxable year,
and if the taxpayer begins using the
asset in an excepted trade or business
towards the end of the year with a
principal purpose of shifting the amount
of basis in the asset that is allocable to
the excepted trade or business, the

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change in use is disregarded for
purposes of this section. A purpose may
be a principal purpose even though it is
outweighed by other purposes (taken
together or separately). In determining
whether a taxpayer has a principal
purpose described in this paragraph
(c)(8), factors to be considered include,
for example, the following: the business
purpose for the acquisition, disposition,
or change in use; the length of time the
asset was used in a trade or business;
whether the asset was acquired from a
related person; and whether the
taxpayer’s aggregate basis in its assets
increased or decreased temporarily on
or around a determination date. A
principal purpose is presumed to be
present in any case in which the
acquisition, disposition, or change in
use lacks a substantial business purpose
and increases the taxpayer’s basis in
assets used in its excepted trades or
businesses by more than 10 percent
during the taxable year.
(d) Direct allocations—(1) In general.
For purposes of this section, a taxpayer
with qualified nonrecourse
indebtedness, within the meaning of
§ 1.861–10T(b), must directly allocate
interest expense from the indebtedness
to the taxpayer’s assets in the manner
and to the extent provided in § 1.861–
10T(b).
(2) Financial services entities. For
purposes of this section, a taxpayer that
is engaged in the trade or business of
banking, within the meaning of section
581, insurance, financing, or a similar
business that derives active financing
income as described in § 1.904–4(e)(2)
(an active financing business) must
directly allocate interest expense and
interest income from that business to
the taxpayer’s assets used in that
business. The special rule for cash and
cash equivalents in paragraph (c)(5)(iii)
of this section does not apply to an
entity that qualifies as a financial
services entity as described in § 1.904–
4(e)(3).
(3) Assets used in more than one trade
or business. If an asset is used in more
than one trade or business, the taxpayer
must apply the rules in paragraph (c)(3)
of this section to determine the extent
to which interest that is directly
allocated under this paragraph (d) is
allocable to excepted or non-excepted
trades or businesses.
(4) Adjustments to basis of assets to
account for direct allocations. In
determining the amount of a taxpayer’s
basis in the assets used in its excepted
and non-excepted trades or businesses
for purposes of paragraph (c) of this
section, adjustments must be made to
reflect direct allocations under this
paragraph (d). These adjustments

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

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(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 nonexcepted 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 § 1.861–10T(b)) secured by
Building B. T then uses those funds to
acquire Building B for $1,200x, and T uses
Building B in Business X. During Year 1, T
pays $500x of interest, of which $100x is
interest payments on Note A. For Year 1, T’s
basis in its assets used in Business X (as
determined under paragraph (c) of this
section) is $3,600x (excluding cash and cash
equivalents), and T’s basis in its assets used
in Business Y (as determined under
paragraph (c) of this section) is $800x
(excluding cash and cash equivalents). Each
of Business X and Business Y also has $100x
of cash and cash equivalents.
(ii) Analysis. Because Note A is qualified
nonrecourse indebtedness that is secured by
Building B, in allocating interest expense
between Businesses X and Y, T first must
directly allocate the $100x of interest
expense it paid with respect to Note A to
Business X in accordance with paragraph
(d)(1) of this section. Thereafter, T must
allocate the remaining $400x of interest
expense between Businesses X and Y under
paragraph (c) of this section. After excluding
T’s $1,200× cost basis in Building B (see
paragraph (d)(4) of this section), and without
regard to T’s $200x of cash and cash
equivalents (see paragraph (c)(5)(iv) of this
section), T’s basis in assets used in
Businesses X and Y is $2,400x and $800x (75
percent and 25 percent), respectively. Thus,
$300x of the remaining $400x of interest
expense would be allocated to Business X,
and $100x would be allocated to Business Y.

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

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(without regard to section 163(j)) $35x of
interest expense and receives $10x of interest
income, and S pays or accrues (without
regard to section 163(j)) $115x of interest
expense and receives $5x of interest income
(for a total of $150x of interest expense and
$15x of interest income). For purposes of this
example, assume that, pursuant to paragraph
(c) of this section, $30x of the P group’s
interest expense and $3x of the P group’s
interest income is allocable to Business X,
and the remaining $120x of interest expense
and $12x of interest income is allocable to
Business Y.
(ii) Analysis. Under paragraph (a)(4) of this
section, 20 percent of the P group’s Year 1
interest expense ($30x/$150x) and interest
income ($3x/$15x) is allocable to an excepted
trade or business. Thus, $7x ($35x × 20
percent) of P’s interest expense and $2x
($10x × 20 percent) of P’s interest income is
allocable to an excepted trade or business.
The remaining $28x of P’s interest expense
is business interest expense subject to
limitation under section 163(j), and the
remaining $8x of P’s interest income is
business interest income that increases the
group’s section 163(j) limitation. In turn,
$23x ($115x × 20 percent) of S’s interest
expense and $1x ($5x × 20 percent) of S’s
interest income is allocable to an excepted
trade or business. The remaining $92x of S’s
interest expense is business interest expense
subject to limitation under section 163(j), and
the remaining $4x of S’s interest income is
business interest income that increases the
group’s section 163(j) limitation.
(2) Example 2: Interest allocation within a
consolidated group with assets used in more
than one trade or business—(i) Facts. S is a
member of a consolidated group of which P
is the common parent. P conducts an electing
real property trade or business (Business X),
and S conducts a non-excepted trade or
business (Business Y). In Year 1, P pays or
accrues (without regard to section 163(j))
$50x of interest expense, and S pays or
accrues $100x of interest expense (without
regard to section 163(j)). P leases 40 percent
of space in Building V (which P owns) to S
for use in Business Y, and P leases the
remaining 60 percent of space in Building V
to third parties. For purposes of allocating
interest expense under paragraph (c) of this
section, the P group’s basis in its assets
(excluding Building V) used in Businesses X
and Y is $180x and $620x, respectively. The
P group’s basis in Building V for purposes of
allocating interest expense under paragraph
(c) of this section is $200x.
(ii) Analysis. Under paragraph (c)(3)(ii) of
this section, the P group’s basis in Building
V ($200x) is allocated to excepted and nonexcepted 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 × $200x), and $80x
is allocated to non-excepted trades or
businesses (40 percent × $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

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section, 30 percent ($300x/$1000x) of the P
group’s Year 1 interest expense is properly
allocable to an excepted trade or business.
Thus, $15x ($50x × 30 percent) of P’s interest
expense is properly allocable to an excepted
trade or business, and the remaining $35x of
P’s interest expense is business interest
expense subject to limitation under section
163(j). In turn, $30x ($100x × 30 percent) of
S’s interest expense is properly allocable to
an excepted trade or business, and the
remaining $70x of S’s interest expense is
business interest expense subject to
limitation under section 163(j).
(3) Example 3: Application of look-through
rules—(i) Facts. (A) A and B are unrelated
individual taxpayers. A owns 100 percent of
the stock of Corp 1, a calendar-year domestic
C corporation. The basis of A’s stock in Corp
1 is $500x. Corp 1 owns 10 percent of the
interests in PS1 (a domestic partnership), and
B owns the remaining 90 percent. Corp 1’s
basis in its PS1 interests is $25x, and B’s
basis in its PS1 interests is $225x. PS1 owns
100 percent of the stock of Corp 2, a
calendar-year domestic C corporation. PS1
has a basis of $1000x in its Corp 2 stock.
(B) In 2020, Corp 1 was engaged solely in
a non-excepted trade or business. That same
year, PS1’s only activity was holding Corp 2
stock. In turn, Corp 2 was engaged in both
an electing farming business and a nonexcepted trade or business. Under the
allocation rules in paragraph (c) of this
section, 50 percent of Corp 2’s asset basis in
2020 was allocable to the electing farming
business. The remaining 50 percent was
allocable to the non-excepted trade or
business.
(C) Individuals A and B each paid or
accrued (without regard to section 163(j))
$150x of interest expense allocable to a trade
or business under § 1.163–8T (along with
personal interest and investment interest).
A’s trade or business was an excepted trade
or business, and B’s trade or business was a
non-excepted trade or business. A’s basis in
the assets used in its trade or business was
$100x, and B’s basis in the assets used in its
trade or business was $112.5x.
(ii) Analysis. (A) As provided in paragraph
(c)(5)(ii)(E) of this section, if a taxpayer
applies the look-through rules of paragraph
(c)(5)(ii) of this section, the taxpayer must
begin with the lowest-tier entity to which it
is eligible to apply the look-through rules. A
directly owns 100 percent of the stock of
Corp 1; thus, A satisfies the 80 percent
minimum ownership threshold with respect
to Corp 1. A also owns 10 percent of the
interests in PS1. There is no minimum
ownership threshold for partnerships; thus,
A may apply the look-through rules to PS1.
However, A does not directly or indirectly
own at least 80 percent of the stock of Corp
2; thus, A may not look through its indirect
interest in Corp 2. In turn, B directly owns
90 percent of the interests in PS1, and B
indirectly owns at least 80 percent of the
stock of Corp 2. Thus, B may apply the lookthrough rules to both PS1 and Corp 2.
(B) From A’s perspective, PS1 is not
engaged in a trade or business for purposes
of section 163(j); instead, PS1 is merely
holding its Corp 2 stock as an investment.
Under paragraph (c)(5)(ii)(A)(2) of this

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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 nonexcepted trade or business. Thus, for
purposes of A’s application of the lookthrough rules, Corp 1’s entire basis in its PS1
interest ($25x) is allocable to a non-excepted
trade or business. Corp 1’s basis in its other
assets also is allocable to a non-excepted
trade or business (the only trade or business
in which Corp 1 is engaged). Thus, under
paragraph (c) of this section, A’s $500x basis
in its Corp 1 stock is allocable entirely to a
non-excepted trade or business. A’s $100x
basis in its other business assets is allocable
to an excepted trade or business. Thus, 5⁄6 (or
$125x) of A’s $150x of interest expense is
properly allocable to a non-excepted trade or
business and is business interest expense
subject to limitation under section 163(j), and
the remaining $25x of A’s $150x of interest
expense is allocable to an excepted trade or
business and is not subject to limitation
under section 163(j).
(C) From B’s perspective, PS1 must look
through its stock in Corp 2 to determine the
extent to which PS1’s basis in the stock is
allocable to an excepted or non-excepted
trade or business. Half of Corp 2’s basis in
its assets is allocable to an excepted trade or
business, and the other half is allocable to a
non-excepted trade or business. Thus, from
B’s perspective, $500x of PS1’s basis in its
Corp 2 stock (PS1’s only asset) is allocable to
an excepted trade or business, and the other
half is allocable to a non-excepted trade or
business. B’s basis in its PS1 interests is
$225x. Applying the look-through rules to B’s
PS1 interests, $112.5x of B’s basis in its PS1
interests is allocable to an excepted trade or
business, and $112.5x of B’s basis in its PS1
interests is allocable to a non-excepted trade
or business. Since B’s basis in the assets used
in its non-excepted trade or business also
was $112.5x, two-thirds of B’s interest
expense ($100x) is properly allocable to a
non-excepted trade or business and is
business interest expense subject to
limitation under section 163(j), and one-third
of B’s interest expense ($50x) is allocable to
an excepted trade or business and is not
subject to limitation under section 163(j).
(4) Example 4: Excepted and non-excepted
trades or businesses in a consolidated
group—(i) Facts. P is the common parent of
a consolidated group of which A and B are
the only other members. A conducts an
electing real property trade or business
(Business X), and B conducts a non-excepted
trade or business (Business Y). In Year 1, A
pays or accrues (without regard to section
163(j)) $50x of interest expense and earns
$70x of gross income in the conduct of
Business X, and B pays or accrues (without
regard to section 163(j)) $100x of interest
expense and earns $150x of gross income in
the conduct of Business Y. B owns Building
V, which it uses in Business Y. For purposes
of allocating the P group’s Year 1 business
interest expense between excepted and nonexcepted 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

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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 nonexcepted 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 × $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

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67597

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 nonexcepted trade or business of the P group
(Business Y) prior to its sale.
(5) Example 5: Captive activities—(i) Facts.
S and T are members of a consolidated group
of which P is the common parent. P conducts
an electing real property trade or business
(Business X), S conducts a non-excepted
trade or business (Business Y), and T
provides transportation services to
Businesses X and Y but does not have any
customers outside of the P group. For Year
1, T provides transportation services using a
single bus with a basis of $120x.
(ii) Analysis. Under paragraph (a)(4) of this
section, activities conducted by a
consolidated group are treated as though
those activities were conducted by a single
corporation. Because the activities of T are
limited to providing intercompany
transportation services, T does not conduct a
trade or business for purposes of section
163(j). Under paragraph (c)(3) of this section,
business interest expense is allocated to
excepted and non-excepted trades or
businesses based on the relative basis of the
assets used in those businesses. The basis in
T’s only asset, a bus, is therefore allocated
between Business X and Business Y
according to the use of T’s bus by these
businesses. Business X uses one-third of T’s
services, and Business Y uses two-thirds of
T’s services. Thus, $40x of the basis of T’s
bus is allocated to Business X, and $80x of
the basis of T’s bus is allocated to Business
Y.

(f) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
§ 1.163(j)–11

Transition rules.

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

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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, § 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 standalone calendar-year C corporation. On
May 31, 2018, Acquiring Group acquires
Target in a transaction that is not an
ownership change for purposes of
section 382. Acquiring Group is not
subject to the section 163(j) limitation
during its taxable year beginning
December 1, 2017. As a result of the
acquisition, Target has a short taxable
year beginning January 1, 2018 and
ending May 31, 2018. Target is subject
to the section 163(j) limitation during
this short taxable year. However, Target
(as a member of Acquiring Group) is not
subject to the section 163(j) limitation
during Acquiring Group’s taxable year
ending November 30, 2018. Any
disallowed business interest expense
carryforwards from Target’s taxable year
ending May 31, 2018, will not be
available for use in Acquiring Group’s
taxable year ending November 30, 2018.
However, that disallowed business
interest expense is carried forward to
Acquiring Group’s taxable year
beginning December 1, 2018, and can be
deducted by the group, subject to the
separate return limitation year (SRLY)
limitation. See § 1.163(j)–5(d).
(b) Treatment of disallowed
disqualified interest—(1) In general.
Disallowed disqualified interest is
carried forward to the taxpayer’s first
taxable year beginning after December
31, 2017, and is subject to disallowance
as a disallowed business interest
expense carryforward under section
163(j) and § 1.163(j)–2, except to the
extent the interest is properly allocable
to an excepted trade or business under
§ 1.163(j)–10. See § 1.163(j)–10(a)(6).
(2) Earnings and profits. A taxpayer
may not reduce its earnings and profits
in a taxable year beginning after
December 31, 2017, to reflect any
disallowed disqualified interest
carryforwards to the extent the payment
or accrual of the disallowed disqualified
interest reduced the earnings and profits
of the taxpayer in a prior taxable year.

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(3) Disallowed disqualified interest of
members of an affiliated group—(i)
Scope. This paragraph (b)(3)(i) applies
to corporations that were treated as a
single taxpayer under old section
163(j)(6)(C) and that had disallowed
disqualified interest.
(ii) Allocation of disallowed
disqualified interest to members of the
affiliated group—(A) In general. Each
member of the affiliated group is
allocated its allocable share of the
affiliated group’s disallowed
disqualified interest as provided in
paragraph (b)(3)(ii)(B) of this section.
(B) Definitions. The following
definitions apply for purposes of
paragraph (b)(3)(ii) of this section.
(1) Allocable share of the affiliated
group’s disallowed disqualified interest.
The term allocable share of the
affiliated group’s disallowed
disqualified interest means, with respect
to any member of an affiliated group for
the member’s last taxable year beginning
before January 1, 2018, the product of
the total amount of the disallowed
disqualified interest of all members of
the affiliated group under old section
163(j)(6)(C) and the member’s
disallowed disqualified interest ratio.
(2) Disallowed disqualified interest
ratio. The term disallowed disqualified
interest ratio means, with respect to any
member of an affiliated group for the
member’s last taxable year beginning
before January 1, 2018, the ratio of the
exempt related person interest expense
of the member for the last taxable year
beginning before January 1, 2018, to the
sum of the amounts of exempt related
person interest expense for all members
of the affiliated group.
(3) Exempt related person interest
expense. The term exempt related
person interest expense means interest
expense that is, or is treated as, paid or
accrued by a domestic C corporation, or
by a foreign corporation with income,
gain, or loss that is effectively
connected, or treated as effectively
connected, with the conduct of a trade
or business in the United States, to—
(i) Any person related to the taxpayer,
within the meaning of sections 267(b) or
707(b)(1), applying the constructive
ownership and attribution rules of
section 267(c), if no U.S. tax is imposed
with respect to the interest under
subtitle A of the Internal Revenue Code,
determined without regard to net
operating losses or net operating loss
carryovers, and taking into account any
applicable treaty obligation of the
United States. For this purpose, interest
that is subject to a reduced rate of tax
under any treaty obligation of the
United States applicable to the recipient
is treated as in part subject to the

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statutory tax rate under sections 871 or
881 and in part not subject to tax, based
on the proportion that the rate of tax
under the treaty bears to the statutory
tax rate. Thus, for purposes of section
163(j), if the statutory tax rate is 30
percent, and pursuant to a treaty U.S.
tax is instead limited to a rate of 10
percent, two-thirds of the interest is
considered interest not subject to U.S.
tax under subtitle A of the Internal
Revenue Code;
(ii) A person that is not related to the
taxpayer, within the meaning of sections
267(b) or 707(b)(1), applying the
constructive ownership and attribution
rules of section 267(c), with respect to
indebtedness on which there is a
disqualified guarantee, within the
meaning of paragraph (6)(D) of old
section 163(j), of such indebtedness, and
no gross basis U.S. tax is imposed with
respect to the interest. For purposes of
this paragraph (b)(3)(ii)(B)(3)(ii), a gross
basis U.S. tax means any tax imposed by
this subtitle A of the Internal Revenue
Code that is determined by reference to
the gross amount of any item of income
without any reduction for any
deduction allowed by subtitle A of the
Internal Revenue Code. Interest that is
subject to a gross basis U.S. tax that is
eligible for a reduced rate of tax under
any treaty obligation of the United
States applicable to the recipient is
treated as, in part, subject to the
statutory tax rate under sections 871 or
881 and, in part, not subject to a gross
basis U.S. tax, based on the proportion
that the rate of tax under the treaty bears
to the statutory tax rate. Thus, for
purposes of section 163(j), if the
statutory tax rate is 30 percent, and
pursuant to a treaty U.S. tax is instead
limited to a rate of 10 percent, twothirds of the interest is considered
interest not subject to a gross basis U.S.
tax under subtitle A of the Internal
Revenue Code; or
(iii) A REIT, directly or indirectly, to
the extent that the domestic C
corporation, or a foreign corporation
with income, gain, or loss that is
effectively connected, or treated as
effectively connected, with the conduct
of a trade or business in the United
States, is a taxable REIT subsidiary, as
defined in section 856(l), with respect to
the REIT.
(iii) Treatment of carryforwards. The
amount of disallowed disqualified
interest allocated to a taxpayer pursuant
to paragraph (b)(3)(ii) of this section is
treated in the same manner as described
in paragraph (b)(1) of this section.
(4) Application of section 382—(i)
Ownership change occurring before the
date the Treasury decision adopting
these regulations as final regulations is

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published in the Federal Register—(A)
Pre-change loss. For purposes of section
382(d)(3), unless the rules of § 1.382–
2(a)(7) apply, disallowed disqualified
interest is not a pre-change loss under
§ 1.382–2(a) subject to a section 382
limitation with regard to an ownership
change on a change date occurring
before the date the Treasury decision
adopting these regulations as final
regulations is published in the Federal
Register. But see section 382(h)(6)(B)
(regarding built-in deduction items).
(B) Loss corporation. For purposes of
section 382(k)(1), unless the rules of
§ 1.382–2(a)(7) apply, disallowed
disqualified interest is not a
carryforward of disallowed interest
described in section 381(c)(20) with
regard to an ownership change on a
change date occurring before the date
the Treasury decision adopting these
regulations as final regulations is
published in the Federal Register. But
see section 382(h)(6) (regarding built-in
deductions).
(ii) Ownership change occurring on or
after the date the Treasury decision
adopting these regulations as final
regulations is published in the Federal
Register—(A) Pre-change loss. For rules
governing the treatment of disallowed
disqualified interest as a pre-change loss
for purposes of section 382 with regard
to an ownership change on a change
date occurring on or after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register, see
§§ 1.382–2(a)(2) and 1.382–6(c)(3).
(B) Loss corporation. For rules
governing when disallowed disqualified
interest causes a corporation to be a loss
corporation with regard to an ownership
change occurring on or after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register, see
§ 1.382–2(a)(1)(i)(A).
(iii) Definitions. For purposes of this
paragraph (b)(4), the terms ownership
change and change date have the
meanings provided in section 382 and
the regulations thereunder.
(5) [Reserved]
(6) Treatment of excess limitation
from taxable years beginning before
January 1, 2018. No amount of excess
limitation under old section 163(j)(2)(B)
may be carried forward to taxable years
beginning after December 31, 2017.
(7) Example: Members of an affiliated
group—(i) Facts. A, B, and C are
calendar-year domestic C corporations
that are members of an affiliated group
(within the meaning of section 1504(a))
that was treated as a single taxpayer
under old section 163(j)(6)(C) and the
proposed regulations thereunder (see

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formerly proposed § 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) × $200x), and
disallowed disqualified interest of $40x
is allocated to C (($150x/$750x) ×
$200x). Thus, B and C have $160x and
$40x, respectively, of disallowed
disqualified interest that is carried
forward to the first taxable year
beginning after December 31, 2017. No
excess limitation that was allocated to
A, B, or C under old section 163(j) will
carry forward to the first taxable year
beginning after December 31, 2017.
(iii) Carryforward of disallowed
disqualified interest to 2018 taxable
year. The facts are the same as in the
Example in paragraph (b)(7)(i) of this
section, except that, for the taxable year
ending December 31, 2018, A, B, and C
are members of a consolidated group
that has a section 163(j) limitation of
$140x, current-year business interest
expense (as defined in § 1.163(j)–
5(a)(2)(i)) of $80x, and no excepted trade
or business. Under paragraph (b)(1) of
this section, disallowed disqualified
interest is carried to the taxpayer’s first
taxable year beginning after December
31, 2017, and is subject to disallowance
under section 163(j) and § 1.163(j)–2.
Under § 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 currentyear business interest expense deducts
each member’s disallowed disqualified
interest carryforwards from prior taxable
years, starting with the earliest taxable
year, on a pro rata basis (subject to
certain limitations). In accordance with
paragraph (b)(1) of this section, the rule
in § 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

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interest carryforwards. Under paragraph
(b)(3) of this section, B has $160x of
disallowed disqualified interest
carryforwards, and C has $40x of
disallowed disqualified interest
carryforwards. Thus, $48x (($160x/
$200x) × $60x) of B’s disallowed
disqualified interest carryforwards, and
$12x (($40x/$200x) × $60x) of C’s
disallowed disqualified interest
carryforwards, are deducted by the
consolidated group in the 2018 taxable
year.
(c) Applicability date. This section
applies to taxable years ending after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.382–6, 1.383–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–6 and 1.383–1), and
1.1504–4 to those taxable years.
■ Par. 4. Section 1.263A–9 is amended
by revising the first and third sentences
of paragraph (g)(1)(i) to read as follows:
§ 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.
* * *
*
*
*
*
*
■ Par. 5. Section 1.381(c)(20)–1 is added
to read as follows:

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§ 1.381(c)(20)–1 Carryforward of
disallowed business interest.

(a) Carryover requirement. Section
381(c)(20) provides that the acquiring
corporation in a transaction described in
section 381(a) will succeed to and take
into account the carryover of disallowed
business interest described in section
163(j)(2) to taxable years ending after
the date of distribution or transfer.
(b) Carryover of disallowed business
interest described in section 163(j)(2).
For purposes of section 381(c)(20) and
this section, the term carryover of
disallowed business interest described
in section 163(j)(2) means the
disallowed business interest expense
carryforward (within the meaning of
§ 1.163(j)–1(b)(9)), including any
disallowed disqualified interest (within
the meaning of § 1.163(j)–1(b)(10)), and
including the distributor or transferor
corporation’s disallowed business
interest expense from the taxable year
that ends on the date of distribution or
transfer. For the application of section
382 to disallowed business interest
expense described in section 163(j)(2),
see the regulations under section 382,
including but not limited to § 1.382–2.
(c) Limitation on use of disallowed
business interest expense carryforwards
in the acquiring corporation’s first
taxable year ending after the date of
distribution or transfer—(1) In general.
In determining the extent to which the
acquiring corporation may use
disallowed business interest expense
carryforwards in its first taxable year
ending after the date of distribution or
transfer, the principles of §§ 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.

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(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
§ 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
§ 1.163(j)–1(b)(31)) (or, if the acquiring
corporation is a member of a
consolidated group, the consolidated
group’s section 163(j) limitation) for the
first taxable year ending after the date of
distribution or transfer (taking into
account items to which the acquiring
corporation succeeds under section 381,
other than disallowed business interest
expense carryforwards) as the number of
days in that year after the date of
distribution or transfer bears to the total
number of days in that year.
(5) Examples. For purposes of this
paragraph (c)(5), unless otherwise
stated, X, Y, and Z are taxable domestic
C corporations that were incorporated
on January 1, 2018 and that file their tax
returns on a calendar-year basis; none of
X, Y, or Z is a member of a consolidated
group; the small business exemption in
§ 1.163(j)–2(d) does not apply; interest
expense is deductible except to the
extent of the potential application of
section 163(j); and the facts set forth the
only corporate activity. The principles
of this paragraph (c) are illustrated by
the following examples.
(i) Example 1: Transfer before last day of
acquiring corporation’s taxable year—(A)
Facts. On October 31, 2019, X transferred all
of its assets to Y in a statutory merger to
which section 361 applies. For the 2018
taxable year, X had $400x of disallowed
business interest expense, and Y had $0 of
disallowed business interest expense. For the
taxable year ending October 31, 2019, X had
an additional $350x of disallowed business
interest expense (X did not deduct any of its
2018 carryforwards in its 2019 taxable year).
For the taxable year ending December 31,
2019, Y had business interest expense of
$100x, business interest income of $200x,
and adjusted taxable income (ATI) of
$1,000x. Y’s section 163(j) limitation for the
2019 taxable year was $500x ($200x + (30
percent × $1,000x) = $500x).

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

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

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

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*

*

Table of contents.

*

*

*

§ 1.382–2 General rules for ownership
change.
(a) * * *
(7) Section 382 disallowed business
interest carryforward.
(8) Testing period.
(b) * * *
(3) Rules provided in paragraphs
(a)(1)(i)(A), (a)(1)(ii), (iv), and (v),
(a)(2)(iv) through (vi), (a)(3)(i), and (a)(4)
through (8) of this section.
*
*
*
*
*
§ 1.382–6 Allocation of income and
loss to periods before and after the
change date for purposes of section 382.
*

*

*

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*

*

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

General rules for ownership

(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

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67601

loss carryforwards, excess foreign taxes,
or other items described in section
381(c) are succeeded to and taken into
account by an acquiring corporation in
a transaction described in section
381(a), such loss corporation shall be
treated as continuing in existence
until—
(A) Any pre-change losses (excluding
pre-change credits described in § 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 § 1.163(j)–1(b)(9),
including disallowed disqualified
interest, within the meaning of
§ 1.163(j)–1(b)(10), as of the ownership
change.
(ii) The carryforward of the loss
corporation’s disallowed business
interest expense (within the meaning of
§ 1.163(j)–1(b)(8)) paid or accrued
(without regard to section 163(j)) in the
pre-change period (within the meaning
of § 1.382–6(g)(2)) in the year of the
testing date, determined by allocating an
equal portion of the disallowed business
interest expense paid or accrued
(without regard to section 163(j)) in the
year of the testing date to each day in
that year, regardless of whether the loss
corporation has made a closing-of-thebooks election under § 1.382–6(b)(2).
(8) Testing period. Notwithstanding
the temporal limitations provided in
§ 1.382–2T(d)(3)(i), the testing period for
a loss corporation can begin as early as
the first day of the first taxable year
from which there is a section 382
disallowed business interest
carryforward to the first taxable year
ending after the testing date.
(b) * * *
(3) Rules provided in paragraphs
(a)(1)(i)(A), (a)(1)(ii), (iv), and (v),
(a)(2)(iv) through (vi), (a)(3)(i), and (a)(4)
through (8) of this section. The rules
provided in paragraphs (a)(1)(i)(A),
(a)(1)(ii), (iv), and (v), (a)(2)(iv) through
(vi), (a)(3)(i), and (a)(4) through (8) of
this section apply to testing dates
occurring on or after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register. For

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

Section 382 limitation.

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*

*
*
*
*
(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 § 1.382–2(a)(7)) attributable
to the period preceding the earlier
ownership change are treated as prechange 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 prechange losses. * * *
*
*
*
*
*
(f) * * * Paragraph (d)(1) of this
section applies with respect to an
ownership change occurring on or after
the date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register. For
loss corporations that have undergone
an ownership change before or after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register, see
§ 1.382–5 as contained in 26 CFR part 1,
revised April 1, 2018. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may apply the rules of
this section to testing dates occurring
during a taxable year beginning after
December 31, 2017, so long as the
taxpayers and their related parties

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consistently apply the rules of this
section, the section 163(j) regulations
(within the meaning of § 1.163(j)–
1(b)(32)), §§ 1.382–2, 1.382–6, and
1.383–1, and if applicable, §§ 1.263A–9,
1.381(c)(20)–1, 1.469–9, 1.882–5,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–2, 1.382–5, 1.382–6,
and 1.383–1), and 1.1504–4 to taxable
years beginning after December 31,
2017.
■ Par. 9. Section 1.382–6 is amended
by:
■ 1. Removing ‘‘Subject to paragraphs
(b)(3)(ii) and (d)’’ in the first sentence of
paragraph (b)(1) and adding ‘‘Subject to
paragraphs (b)(3)(ii), (b)(4), and (d)’’ in
its place;
■ 2. Adding paragraph (b)(4); and
■ 3. Revising paragraph (h).
The addition and revision read as
follows:
§ 1.382–6 Allocation of income and loss to
periods before and after the change date for
purposes of section 382.

*

*
*
*
*
(b) * * *
(4) Allocation of business interest
expense—(i) In general. Regardless of
whether a loss corporation has made a
closing-of-the-books election pursuant
to paragraph (b) of this section, for
purposes of calculating the taxable
income of a loss corporation attributable
to the pre-change period, the amount of
the loss corporation’s deduction for
current-year business interest expense,
within the meaning of § 1.163(j)–
5(a)(2)(i), is calculated based on a single
tax year and is allocated between the
pre-change period and the post-change
period by ratably allocating an equal
portion to each day in the year.
(ii) Example—(A) Facts. X is a
calendar-year C corporation that is not
a member of a consolidated group. On
May 26, 2019, X is acquired by Z (an
unrelated third-party) in a transaction
that qualifies as an ownership change
under section 382(g). For calendar year
2019, X has paid or accrued $100x of
current-year business interest expense
(within the meaning of § 1.163(j)–
5(a)(2)(i)) and has an $81x section 163(j)
limitation (within the meaning of
§ 1.163(j)–1(b)(31)).
(B) Analysis. Pursuant to paragraph
(b)(4)(i) of this section, regardless of
whether X has made a closing-of-thebooks election pursuant to paragraph (b)
of this section, X’s business interest
expense deduction is ratably allocated
between the pre-change and post-change
periods. For calendar year 2019, X may
deduct $81x of business interest
expense (see § 1.163(j)–2(b)), of which

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$32.4x ($81x × (146 days/365 days) =
$32.4x) is allocable to the pre-change
period. The remaining $19x of interest
that was paid or accrued in calendar
year 2019 is disallowed business
interest expense, of which $7.6x ($19x
× (146 days/365 days) = $7.6x) is
allocable to the pre-change period. The
$7.6x of disallowed business interest
expense is treated as a section 382
disallowed business interest
carryforward (see § 1.382–2(a)(7)), and
thus is a pre-change loss within the
meaning of § 1.382–2(a)(2).
*
*
*
*
*
(h) Applicability date—(1) In general.
This section applies to ownership
changes occurring on or after June 22,
1994.
(2) Paragraphs (b)(1) and (4) of this
section. Paragraphs (b)(1) and (4) of this
section apply with respect to an
ownership change occurring during a
taxable year ending after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register. For
ownership changes occurring during a
taxable year ending before the date the
Treasury decision adopting these
regulations is published in the Federal
Register, see § 1.382–6 as contained in
26 CFR part 1, revised April 1, 2018.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may apply the
rules of this section to testing dates
occurring during a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
this section, and the section 163(j)
regulations (within the meaning of
§ 1.163(j)–1(b)(32)) and § 1.383–1, and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.469–9, 1.882–5, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–6 and
1.383–1), and 1.1504–4 to taxable years
beginning after December 31, 2017.
■ Par. 10. Section 1.383–0 is amended
by revising paragraph (a) to read as
follows:
§ 1.383–0

Effective date.

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

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

§ 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.

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(2) Interaction with section 163(j).
*
*
*
*
(c) * * *
(6) * * *
(ii) Example. L, a new loss
corporation, is a calendar-year taxpayer.
L has an ownership change on
December 31, 2019. For 2020, L has
taxable income (prior to the use of any
pre-change losses) of $100,000. In
addition, L has a section 382 limitation
of $25,000, a pre-change net operating
loss carryover of $12,000, a pre-change
general business credit carryforward
under section 39 of $50,000, and no
items described in § 1.383–1(d)(2)(i)
through (iv). L’s section 383 credit
limitation for 2020 is the excess of its
regular tax liability computed after
allowing a $12,000 net operating loss
deduction (taxable income of $88,000;
regular tax liability of $18,480), over its
regular tax liability computed after
allowing an additional deduction in the
amount of L’s section 382 limitation
remaining after the application of
paragraphs (d)(2)(i) through (v) of this
section, or $13,000 (taxable income of
$75,000; regular tax liability of $15,750).
L’s section 383 credit limitation is
therefore $2,730 ($18,480 minus
$15,750).
(d) * * *
(1) In general—(i) In general. The
amount of taxable income of a new loss
corporation for any post-change year
that may be offset by pre-change losses
shall not exceed the amount of the
section 382 limitation for the postchange year. The amount of the regular
tax liability of a new loss corporation for
any post-change year that may be offset
by pre-change credits shall not exceed
the amount of the section 383 credit
limitation for the post-change year.
(ii) Ordering rule for losses or credits
from same taxable year. A loss
corporation’s taxable income is offset
first by losses subject to a section 382
limitation, to the extent the section 382
limitation for that taxable year has not
yet been absorbed, before being offset by
losses of the same type from the same
taxable year that are not subject to a
section 382 limitation. For example,
assume that Corporation X has an
ownership change in Year 1 and carries
over disallowed business interest
expense within the meaning of
§ 1.163(j)–1(b)(8), some of which
constitutes a section 382 disallowed
business interest carryforward, from
Year 1 to Year 2. To the extent of its
section 163(j) limitation, within the
meaning of § 1.163(j)–1(b)(31), and its
remaining section 382 limitation,
Corporation X offsets its Year 2 income
with the section 382 disallowed

*

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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 § 1.382–2(a)(2)(iii), other
than losses that are pre-change capital
losses, that are recognized and are
subject to the section 382 limitation in
such post-change year;
(iv)(A) With respect to an ownership
change date occurring prior to the date
the Treasury decision adopting these
regulations as final regulations is
published in the Federal Register, but
during the taxable year which includes
the date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register, the
pre-change loss described in section
382(d)(3);
(B) With respect to an ownership
change date occurring on or after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register,
section 382 disallowed business interest
carryforwards (within the meaning of
§ 1.382–2(a)(7));
(v) Pre-change losses not described in
paragraphs (d)(2)(i) through (iv) of this
section;
*
*
*
*
*
(3) * * *
(ii) Example. L, a calendar-year
taxpayer, has an ownership change on
December 31, 2019. For 2020, L has
taxable income of $300,000 and a
regular tax liability of $63,000. L has no
pre-change losses, but it has a business
credit carryforward from 2018 of
$25,000. L has a section 382 limitation
for 2020 of $50,000. L’s section 383
credit limitation is $10,500, an amount
equal to the excess of L’s regular tax
liability ($63,000) over its regular tax
liability calculated by allowing an
additional deduction of $50,000
($52,500). Pursuant to the limitation
contained in section 38(c), however, L is
entitled to use only $9,500 (($63,000 ¥
$25,000) × 25 percent) of its business
credit carryforward in 2020. The
unabsorbed portion of L’s section 382
limitation (computed pursuant to
paragraph (e) of this section) is carried
forward under section 382(b)(2). The
unused portion of L’s business credit
carryforward, $1,000, is carried forward
to the extent provided in section 39.
*
*
*
*
*
(f) * * *
(2) Example 2—(i) Facts. L, a calendar-year
taxpayer, has an ownership change on
December 31, 2019. For 2020, L has $750,000

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

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

$750,000
500,000
1,500,000

500,000
250,000
1,000,000
200,000
52,500

0
52,500

52,500

147,500
250,000

750,000

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

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25,000

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

1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
16,800
5, 1.382–6, and 1.383–1), and 1.1504–4,
to those ownership changes.
11,550 ■ Par. 12. Section 1.446–3 is amended
by revising paragraphs (g)(4) and (j)(2) to
5,250 read as follows:
10,000

§ 1.446–3

Notional principal contracts.

*
*
*
*
(g) * * *
(4) Swaps with significant
nonperiodic payments. For swaps with
significant nonperiodic payments, see
4,750
§ 1.163(j)–1(b)(20)(ii).
*
*
*
*
11,550 *
(j) * * *
(2) The rules provided in paragraph
25,000
(g)(4) of this section apply to notional
principal contracts entered into on or
after the date of publication of a
0 Treasury decision adopting these rules
as final regulations in the Federal
*
*
*
*
*
Register. Taxpayers may apply the rules
(j) Applicability date—(1) In general.
provided in paragraph (g)(4) of this
* * *
section to notional principal contracts
(2) Interaction with section 163(j).
entered into before the date of
Paragraphs (c)(6)(i)(B) and (c)(6)(ii),
publication of a Treasury decision
(d)(1), (d)(2)(iii) through (viii), (d)(3)(ii),
adopting these rules as final regulations
(e)(1) through (3), (f), and (g) of this
in the Federal Register.
section apply with respect to ownership
■ Par. 13. Section 1.469–9 is amended
changes occurring during a taxable year
by revising paragraph (b)(2) to read as
ending after the Treasury decision
follows:
adopting these regulations as final
regulations is published in the Federal
§ 1.469–9 Rules for certain rental real
Register. For loss corporations that have estate activities.
undergone an ownership change during *
*
*
*
*
a taxable year ending before the date the
(b) * * *
Treasury decision adopting these
(2) Real property trade or business.
regulations as final regulations is
The following terms have the following
published in the Federal Register, see
meanings in determining whether a
§ 1.383–1 as contained in 26 CFR part 1, trade or business is a real property trade
revised April 1, 2018. However,
or business for purposes of section
taxpayers and their related parties,
469(c)(7)(C) and this section.
within the meaning of sections 267(b)
(i) Real property—(A) In general. The
and 707(b)(1), may apply the rules of
term real property includes land,
this section to an ownership change
buildings, and other inherently
occurring during a taxable year
permanent structures that are
beginning after December 31, 2017, so
permanently affixed to land. Any
long as the taxpayers and their related
interest in real property, including fee
parties consistently apply either the
ownership, co-ownership, a leasehold,
rules of this section, except paragraph
an option, or a similar interest is real
(d)(2)(iv)(B) of this section, the section
property under this section. Tenant
163(j) regulations, within the meaning
improvements to land, buildings, or
of § 1.163(j)–1(b)(32), and § 1.382–6, and other structures that are inherently
if applicable, §§ 1.263A–9, 1.381(c)(20)– permanent or otherwise classified as
1, 1.469–9, 1.882–5, 1.1502–13, 1.1502– real property within the meaning of this
21, 1.1502–36, 1.1502–79, 1.1502–91
section are real property for purposes of
through 1.1502–99 (to the extent they
section 469(c)(7)(C). However, property
effectuate the rules of §§ 1.382–6 and
produced for sale that is not real
1.383–1), and 1.1504–4; or the rules of
property in the hands of the producing
this section (except paragraph
taxpayer or a related person, but that
(d)(2)(iv)(A) of this section), the section
may be incorporated into real property
163(j) regulations, within the meaning
by an unrelated person, is not treated as
of § 1.163(j)–1(b)(32), and §§ 1.382–2,
real property of the producing taxpayer
1.382–5, 1.382–6, and 1.383–1, and if
for purposes of section 469(c)(7)(C) and
applicable, §§ 1.263A–9, 1.381(c)(20)–1, this section (for example, bricks, nails,
1.469–9, 1.882–5, 1.1502–13, 1.1502–21, paint, and windowpanes).

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(B) Land. The term land includes
water and air space superjacent to land
and natural products and deposits that
are unsevered from the land. Natural
products and deposits, such as plants,
crops, trees, water, ores, and minerals,
cease to be real property when they are
harvested, severed, extracted, or
removed from the land. Accordingly,
any trade or business that involves the
cultivation and harvesting of plants,
crops, or trees, or severing, extracting, or
removing natural products or deposits
from land is not a real property trade or
business for purposes of section
469(c)(7)(C) and this section. The
storage or maintenance of severed or
extracted natural products or deposits,
such as plants, crops, trees, water, ores,
and minerals, in or upon real property
does not cause the stored property to be
recharacterized as real property, and
any trade or business relating to or
involving such storage or maintenance
of severed or extracted natural products
or deposits is not a real property trade
or business, even though such storage or
maintenance otherwise may occur upon
or within real property.
(C) Inherently permanent structure.
The term inherently permanent
structure means any permanently
affixed building or other permanently
affixed structure. If the affixation is
reasonably expected to last indefinitely,
based on all the facts and
circumstances, the affixation is
considered permanent. However, an
asset that serves an active function, such
as an item of machinery or equipment
(for example, HVAC system, elevator or
escalator), is not a building or other
inherently permanent structure, and
therefore is not real property for
purposes of section 469(c)(7)(C) and this
section, even if such item of machinery
or equipment is permanently affixed to
or becomes incorporated within a
building or other inherently permanent
structure. Accordingly, a trade or
business that involves the manufacture,
installation, operation, maintenance, or
repair of any asset that serves an active
function will not be a real property
trade or business, or a unit or
component of another real property
trade or business, for purposes of
section 469(c)(7)(C) and this section.
(D) Building—(1) In general. A
building encloses a space within its
walls and is generally covered by a roof
or other external upper covering that
protects the walls and inner space from
the elements.
(2) Types of buildings. Buildings
include the following assets if
permanently affixed to land: Houses;
townhouses; apartments;
condominiums; hotels; motels;

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stadiums; arenas; shopping malls;
factory and office buildings;
warehouses; barns; enclosed garages;
enclosed transportation stations and
terminals; and stores.
(E) Other inherently permanent
structures—(1) In general. Other
inherently permanent structures include
the following assets if permanently
affixed to land: Parking facilities;
bridges; tunnels; roadbeds; railroad
tracks; pipelines; storage structures such
as silos and oil and gas storage tanks;
and stationary wharves and docks.
(2) Facts and circumstances
determination. The determination of
whether an asset is an inherently
permanent structure is based on all the
facts and circumstances. In particular,
the following factors must be taken into
account:
(i) The manner in which the asset is
affixed to land and whether such
manner of affixation allows the asset to
be easily removed from the land;
(ii) Whether the asset is designed to be
removed or to remain in place
indefinitely on the land;
(iii) The damage that removal of the
asset would cause to the asset itself or
to the land to which it is affixed;
(iv) Any circumstances that suggest
the expected period of affixation is not
indefinite (for example, a lease that
requires or permits removal of the asset
from the land upon the expiration of the
lease); and
(v) The time and expense required to
move the asset from the land.
(ii) Other definitions—(A) through (G)
[Reserved]
(H) Real property operation. The term
real property operation means handling,
by a direct or indirect owner of the real
property, the day-to-day operations of a
trade or business, within the meaning of
paragraph (b)(1) of this section, relating
to the maintenance and occupancy of
the real property that affect the
availability and functionality of that real
property used, or held out for use, by
customers where payments received
from customers are principally for the
customers’ use of the real property. The
principal purpose of such business
operations must be the provision of the
use of the real property, or physical
space accorded by or within the real
property, to one or more customers, and
not the provision of other significant or
extraordinary personal services, within
the meaning of § 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

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operations must be to provide the
customer with exclusive use of the real
property or physical space in
furtherance of the customer’s trade or
business, and not to provide other
significant or extraordinary personal
services to the customer in addition to
or in conjunction with the use of the
real property or physical space,
regardless of whether the customer pays
for the services separately. However,
other incidental personal services may
be provided to the customer in
conjunction with the use of real
property or physical space, as long as
such services are insubstantial in
relation to the customer’s use of the real
property or physical space and the
receipt of such services is not a
significant factor in the customer’s
decision to use the real property or
physical space.
(I) Real property management. The
term real property management means
handling, by a professional manager, the
day-to-day operations of a trade or
business, within the meaning of
paragraph (b)(1) of this section, relating
to the maintenance and occupancy of
real property that affect the availability
and functionality of that property used,
or held out for use, by customers where
payments received from customers are
principally for the customers’ use of the
real property. The principal purpose of
such business operations must be the
provision of the use of the real property,
or physical space accorded by or within
the real property, to one or more
customers, and not the provision of
other significant or extraordinary
personal services, within the meaning of
§ 1.469–1T(e)(3)(iv) and (v), to
customers in conjunction with the
customers’ incidental use of the real
property or physical space. If the real
property or physical space is provided
to a customer to be used to carry on the
customer’s trade or business, the
principal purpose of the business
operations must be to provide the
customer with exclusive use of the real
property or physical space in
furtherance of the customer’s trade or
business, and not to provide other
significant or extraordinary personal
services to the customer in addition to
or in conjunction with the use of the
real property or physical space,
regardless of whether the customer pays
for the services separately. However,
other incidental personal services may
be provided to the customer in
conjunction with the use of real
property or physical space, as long as
such services are insubstantial in
relation to the customer’s use of the real
property or physical space and the

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receipt of such services is not a
significant factor in the customer’s
decision to use the real property or
physical space. A professional manager
is a person responsible, on a full-time
basis, for the overall management and
oversight of the real property or
properties and who is not a direct or
indirect owner of the real property or
properties.
(J) and (K) [Reserved]
(iii) Examples. The following
examples illustrate the operation of this
paragraph (b)(2):
(A) Example 1. A owns farmland and uses
the land in A’s farming business to grow and
harvest crops of various kinds. As part of this
farming business, A utilizes a greenhouse
that is an inherently permanent structure to
grow certain crops during the winter months.
Under the rules of this section, any trade or
business that involves the cultivation and
harvesting of plants, crops, or trees is not a
real property trade or business for purposes
of section 469(c)(7)(C) and this section, even
though the cultivation and harvesting of
crops occurs upon or within real property.
Accordingly, under these facts, A is not
engaged in a real property trade or business
for purposes of section 469(c)(7)(C) and this
section.
(B) Example 2. B is a retired farmer and
owns farmland that B rents exclusively to C
to operate a farm. The arrangement between
B and C is a trade or business (within the
meaning of paragraph (b)(1) of this section)
where payments by C are principally for C’s
use of B’s real property. B also provides
certain farm equipment for C’s use. However,
C is solely responsible for the maintenance
and repair of the farm equipment along with
any costs associated with operating the
equipment. B also occasionally provides oral
advice to C regarding various aspects of the
farm operation, based on B’s prior experience
as a farmer. Other than the provision of this
occasional advice, B does not provide any
significant or extraordinary personal services
to C in connection with the rental of the
farmland to C. Under these facts, B is
engaged in a real property trade or business
(which does not include the use or deemed
rental of any farm equipment) for purposes
of section 469(c)(7)(C) and this section, and
B’s oral advice is an incidental personal
service that B provides in conjunction with
C’s use of the real property. Nevertheless,
under these facts, C is not engaged in a real
property trade or business for purposes of
section 469(c)(7)(C) and this section because
C is engaged in the business of farming.
(C) Example 3. D owns a building in which
D operates a restaurant and bar. Even though
D provides customers with use of the
physical space inside the building, D is not
engaged in a trade or business where
payments by customers are principally for
the use of real property or physical space.
Instead, the payments by D’s customers are
principally for the receipt of significant or
extraordinary personal services (within the
meaning of § 1.469–1T(e)(3)(iv) and (v)),
mainly food and beverage preparation and
presentation services, and the use of the

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physical space by customers is incidental to
the receipt of these personal services. Under
the rules of this section, any trade or business
that involves the provision of significant or
extraordinary personal services to customers
in conjunction with the customers’ incidental
use of real property or physical space is not
a real property trade or business, even though
the business operations occur upon or within
real property. Accordingly, under these facts,
D is not engaged in a real property trade or
business for purposes of section 469(c)(7)(C)
and this section.
(D) Example 4. E owns a majority interest
in an S corporation, X, that is engaged in the
trade or business of manufacturing industrial
cooling systems for installation in
commercial buildings and for other uses. E
also owns a majority interest in an S
corporation, Y, that purchases the industrial
cooling systems from X and that installs,
maintains, and repairs those systems in both
existing commercial buildings and
commercial buildings under construction.
Under the rules of this section, any trade or
business that involves the manufacture,
installation, operation, maintenance, or
repair of any machinery or equipment that
serves an active function will not be a real
property trade or business (or a unit or
component of another real property trade or
business) for purposes of section 469(c)(7)(C)
and this section, even though the machinery
or equipment will be permanently affixed to
real property once it is installed. In this case,
the industrial cooling systems are machinery
or equipment that serves an active function.
Accordingly, under these facts, E, X and Y
will not be treated as engaged in one or more
real property trades or businesses for
purposes of section 469(c)(7)(C) and this
section.
(E) Example 5. (1) F owns an interest in P,
a limited partnership. P owns and operates
a luxury hotel. In addition to providing
rooms and suites for use by customers, the
hotel offers many additional amenities such
as in-room food and beverage service, maid
and linen service, parking valet service,
concierge service, front desk and bellhop
service, dry cleaning and laundry service,
and in-room barber and hairdresser service.
P contracted with M to provide maid and
janitorial services to P’s hotel. M is an S
corporation principally engaged in the trade
or business of providing maid and janitorial
services to various types of businesses,
including hotels. G is a professional manager
employed by M who handles the day-to-day
business operations relating to M’s provision
of maid and janitorial services to M’s various
customers, including P.
(2) Even though the personal services that
P provides to the customers of its hotel are
significant personal services within the
meaning of § 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

PO 00000

Frm 00118

Fmt 4701

Sfmt 4702

and P are treated as engaged in a real
property trade or business for purposes of
section 469(c)(7)(C) and this section.
(3) With respect to the maid and janitorial
services provided by M, M’s operations affect
the availability and functionality of real
property used, or held out for use, by
customers in a trade or business where
payments by customers are principally for
the use of real property (in this case, P’s
hotel). However, M does not operate or
manage real property. Instead, M is engaged
in a trade or business of providing maid and
janitorial services to customers, such as P,
that are engaged in real property trades or
businesses. Thus, M’s business operations are
merely ancillary to real property trades or
businesses. Therefore, M is not engaged in
real property operations or management as
defined in this section. Accordingly, under
these facts, M is not engaged in a real
property trade or business within the
meaning of section 469(c)(7)(C) and this
section.
(4) With respect to the day-to-day business
operations that G handles as a professional
manager of M, the business operations that G
manages is not the provision of use of P’s
hotel rooms and suites to customers. G does
not operate or manage real property. Instead,
G manages the provision of maid and
janitorial services to customers, including P’s
hotel. Therefore, G is not engaged in real
property management as defined in this
section. Accordingly, under these facts, G is
not engaged in a real property trade or
business within the meaning of section
469(c)(7)(C) and this section.

*

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

§ 1.469–11
rules.

Effective date and transition

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

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
ownership change during a taxable year
ending after the date of the Treasury
decision adopting these regulations as
final regulations is published in the
Federal Register. However, taxpayers
and their related parties, within the
meaning of sections 267(b) and
707(b)(1), may rely on the rules of this
section if applied consistently by the
taxpayers and their related parties, until
the date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register;
*
*
*
*
*
■ Par. 15. Section 1.860C–2 is amended
by revising paragraph (b)(2) to read as
follows:
§ 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.
*
*
*
*
*
■ Par. 16. Section 1.882–5 is amended
by adding a sentence to the end of
paragraph (a)(5) to read as follows:

(a) * * *
(5) * * * For rules regarding the
coordination of this section and section
163(j), see § 1.163(j)–8(e).
*
*
*
*
*
■ Par. 17. Section 1.1502–13 is
amended by—
■ 1. In paragraph (a)(6)(ii)—
■ a. Under the heading ‘‘Matching rule.
(§ 1.1502–13(c)(7)(ii))’’:
■ i. Designating Examples 1 through 17
as entries (A) through (Q).
■ ii. Adding entries (R) and (S).
■ b. Under the heading ‘‘Anti-avoidance
rules. (§ 1.1502–13(h)(2))’’:
■ i. Designating Examples 1 through 5
as entries (i) through (v).
■ ii. Adding an entry (vi).
■ 2. In paragraph (c)(7)(ii):
■ a. Designating Examples 1 through 17
as paragraphs (c)(7)(ii)(A) through (Q),
respectively.
■ b. In newly designated paragraphs
(c)(7)(ii)(A) through (Q):
■ i. Redesignating paragraphs
(c)(7)(ii)(A)(a) through (i) as paragraphs
(c)(7)(ii)(A)(1) through (9).
■ ii. Redesignating paragraphs
(c)(7)(ii)(B)(a) and (b) as paragraphs
(c)(7)(ii)(B)(1) and (2).
■ iii. Redesignating paragraphs
(c)(7)(ii)(C)(a) through (d) as paragraphs
(c)(7)(ii)(C)(1) through (4).
■ iv. Redesignating paragraphs
(c)(7)(ii)(D)(a) through (e) as paragraphs
(c)(7)(ii)(D)(1) through (5).

Paragraph

Remove

(c)(7)(ii)(A)(5) ......................
(c)(7)(ii)(A)(5) ......................

paragraph (a) of this Example 1 .......
paragraphs (c) and (d) of this Example 1.
paragraph (a) of this Example 1 .......
paragraph (a) of this Example 1 .......
paragraph (a) of this Example 1 .......
paragraph (a) of this Example 1 .......
paragraph (a) of this Example 3 .......
paragraph (c) of this Example 3 ........
paragraph (b) of this Example 3 .......
paragraph (a) of this Example 4 .......
paragraphs (c) and (d) of this Example 4.
paragraph (a) of this Example 5 .......
paragraph (a) of this Example 5 .......
paragraph (a) of this Example 5 .......
paragraph (a) of this Example 5 .......
paragraph (a) of this Example 6 .......
paragraph (a) of this Example 6 .......
paragraph (a) of this Example 7 .......
paragraph (c) of this Example 7 ........
paragraph (a) of this Example 9 .......
paragraph (a) of this Example 9 .......
paragraph (d) of this Example 9 .......
paragraph (a) of this Example 10 .....
paragraph (a) of this Example 10 .....
paragraph (a) of this Example 11 .....
paragraph (a) of this Example 14 .....
paragraph (a) of this Example 15 .....
Example 16 ........................................

(c)(7)(ii)(A)(6)
(c)(7)(ii)(A)(7)
(c)(7)(ii)(A)(8)
(c)(7)(ii)(A)(9)
(c)(7)(ii)(C)(3)
(c)(7)(ii)(C)(4)
(c)(7)(ii)(C)(4)
(c)(7)(ii)(D)(5)
(c)(7)(ii)(D)(5)

amozie on DSK3GDR082PROD with PROPOSALS2

§ 1.882–5 Determination of interest
deduction.

......................
......................
......................
......................
......................
......................
......................
......................
......................

(c)(7)(ii)(E)(3) ......................
(c)(7)(ii)(E)(4) ......................
(c)(7)(ii)(E)(5) ......................
(c)(7)(ii)(E)(6) ......................
(c)(7)(ii)(F)(3) .......................
(c)(7)(ii)(F)(4) .......................
(c)(7)(ii)(G)(4) ......................
(c)(7)(ii)(G)(4) ......................
(c)(7)(ii)(I)(3) ........................
(c)(7)(ii)(I)(4) ........................
(c)(7)(ii)(I)(5) ........................
(c)(7)(ii)(J)(3) .......................
(c)(7)(ii)(J)(4) .......................
(c)(7)(ii)(K)(4) ......................
(c)(7)(ii)(N)(2) ......................
(c)(7)(ii)(O)(4) ......................
(c)(7)(ii)(Q)(1) ......................

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PO 00000

v. Redesignating paragraphs
(c)(7)(ii)(E)(a) through (f) as paragraphs
(c)(7)(ii)(E)(1) through (6).
■ vi. Redesignating paragraphs
(c)(7)(ii)(F)(a) through (d) as paragraphs
(c)(7)(ii)(F)(1) through (4).
■ v. Redesignating paragraphs
(c)(7)(ii)(G)(a) through (d) as paragraphs
(c)(7)(ii)(G)(1) through (4).
■ vi. Redesignating paragraphs
(c)(7)(ii)(I)(a) through (e) as paragraphs
(c)(7)(ii)(I)(1) through (5).
■ vii. Redesignating paragraphs
(c)(7)(ii)(J)(a) through (d) as paragraphs
(c)(7)(ii)(J)(1) through (4).
■ viii. Redesignating paragraphs
(c)(7)(ii)(K)(a) through (d) as paragraphs
(c)(7)(ii)(K)(1) through (4).
■ ix. Redesignating paragraphs
(c)(7)(ii)(L)(a) and (b) as paragraphs
(c)(7)(ii)(L)(1) and (2).
■ x. Redesignating paragraphs
(c)(7)(ii)(N)(a) through (c) as paragraphs
(c)(7)(ii)(N)(1) through (3).
■ xi. Redesignating paragraphs
(c)(7)(ii)(O)(a) through (d) as paragraphs
(c)(7)(ii)(O)(1) through (4).
■ xii. Redesignating paragraphs
(c)(7)(ii)(P)(a) and (b) as paragraphs
(c)(7)(ii)(P)(1) and (2).
■ xiii. Redesignating paragraphs
(c)(7)(ii)(Q)(a) through (c) as paragraphs
(c)(7)(Q)(1) through (3).
c. In the table below, for each newly
redesignated paragraph listed in the
‘‘Paragraph’’ column, remove the text
indicated in the ‘‘Remove’’ column and
add in its place the text indicated in the
‘‘Add’’ column:
■

Add

Frm 00119

Example 1 in paragraph (c)(7)(ii)(A)(1) of this section.
Example 1 in paragraphs (c)(7)(ii)(A)(3) and (4) of this section.
Example
Example
Example
Example
Example
Example
Example
Example
Example

1
1
1
1
3
3
3
4
4

Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example
Example

5 in paragraph (c)(7)(ii)(E)(1) of this section.
5 in paragraph (c)(7)(ii)(E)(1) of this section.
5 in paragraph (c)(7)(ii)(E)(1) of this section.
5 in paragraph (c)(7)(ii)(E)(1) of this section.
6 in paragraph (c)(7)(ii)(F)(1) of this section.
6 in paragraph (c)(7)(ii)(F)(1) of this section.
7 in paragraph (c)(7)(ii)(G)(1) of this section.
7 in paragraph (c)(7)(ii)(G)(3) of this section.
9 in paragraph (c)(7)(ii)(I)(1) of this section.
9 in paragraph (c)(7)(ii)(I)(1) of this section.
9 in paragraph (c)(7)(ii)(I)(4) of this section.
10 in paragraph (c)(7)(ii)(J)(1) of this section.
10 in paragraph (c)(7)(ii)(J)(1) of this section.
11 in paragraph (c)(7)(ii)(K)(1) of this section.
14 in paragraph (c)(7)(ii)(N)(1) of this section.
15 in paragraph (c)(7)(ii)(O)(1) of this section.
16 in paragraph (c)(7)(ii)(P) of this section.

Fmt 4701

in
in
in
in
in
in
in
in
in

Sfmt 4702

67607

paragraph (c)(7)(ii)(A)(1) of this section.
paragraph (c)(7)(ii)(A)(1) of this section.
paragraph (c)(7)(ii)(A)(1) of this section.
paragraph (c)(7)(ii)(A)(1) of this section.
paragraph (c)(7)(ii)(C)(1) of this section.
paragraph (c)(7)(ii)(C)(3) of this section.
paragraph (c)(7)(ii)(C)(2) of this section.
paragraph (c)(7)(ii)(D)(1) of this section.
paragraphs (c)(7)(ii)(D)(3) and (4) of this section.

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67608

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

Remove

(c)(7)(ii)(Q)(2) ......................

paragraph (f)(7), Example 2 of this
section.
Paragraphs (c)(6)(ii)(C), (c)(6)(ii)(D),
and (c)(7)(ii), Examples 16 and 17
of this section.

(c)(7)(iii)(A) ..........................

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

§ 1.1502–13

Intercompany transactions.

amozie on DSK3GDR082PROD with PROPOSALS2

(a) * * *
(6) * * *
(ii) * * *
Matching rule. (§ 1.1502–13(c)(7)(ii))
*
*
*
*
*
(R) Example 18. Transfer of
partnership interests in an
intercompany sale.
(S) Example 19. Intercompany transfer
of partnership interests in a nonrecognition transaction.
*
*
*
*
*
Anti-avoidance rules. (§ 1.1502–
13(h)(2))
*
*
*
*
*
(vi) Example 6. Section 163 interest
limitation.
*
*
*
*
*
(c) * * *
(7) * * *
(ii) * * *
(R) Example 18: Transfer of partnership
interests in an intercompany sale—(1) Facts.
P wholly owns S and B, both of which are
members of the consolidated group of which
P is the common parent. S and A (an
unrelated third party) are equal partners in
PS1, which was formed in Year 1. At the end
of Year 1, the fair market value of PS1 is
$200x, and S’s adjusted basis in its
partnership interest is $100x. During Year 2,
PS1 borrows money, pays $100x of business
interest expense, and repays the debt. PS1’s

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

section 163(j) limitation is $0; thus, the
$100x of Year 2 business interest expense is
disallowed as a deduction to PS1, is
characterized as excess business interest
expense, and is allocated proportionally to
PS1’s partners. S reduces its basis in its PS1
interest under § 1.163(j)–6(h) to reflect the
$50x of excess business interest expense
allocated to S, but the reduction is not treated
as a noncapital, nondeductible expense (see
§ 1.163(j)–4(d)(4)(ii)). On the last day of Year
2, S sells its PS1 partnership interest to B for
$50x. S has not used any of the excess
business interest expense allocated from PS1;
thus, immediately before the sale, S’s basis in
its PS1 interest is increased by $50x (to
$100x) under § 1.163(j)–6(h). This basis
increase is not treated as tax-exempt income
(see § 1.163(j)–4(d)(4)(ii)). During Year 3, PS1
earns $50x of income, all of which is
reported to the partners as excess taxable
income, and $25x of which is allocated to B.
B’s basis in its PS1 interest is increased
accordingly. Additionally, during Year 3, B
earns $25x of business interest income and
has no business interest expense other than
its allocation of business interest expense
from PS1. At the close of business on the last
day of Year 4, B sells its PS1 partnership
interest to Z (an unrelated third party) for
$85x. At the time of the sale, B’s basis in its
PS1 interest is $75x.
(2) Definitions. Under paragraph (b)(1) of
this section, S’s sale of its PS1 interest to B
in Year 2 is an intercompany transaction,
with S as the selling member and B as the
buying member. S’s $50x capital loss on the
sale is an intercompany item within the
meaning of paragraph (b)(2)(i) of this section.
B’s $25 of ordinary income in Year 3 and its
$10x gain on the sale of the PS1 interest to
Z in Year 4 are both corresponding items
within the meaning of paragraph (b)(3)(i) of
this section.
(3) Timing and attributes. S takes its $50x
loss into account to reflect the difference in
each consolidated return year between B’s
corresponding items taken into account for
the year and the recomputed corresponding
item for the year. If S and B were divisions
of a single corporation and the intercompany
sale were a transfer between divisions, the
single entity would have had zero income
inclusion in Year 3, as the $25x of excess
taxable income attributable to the single
entity’s interest in PS1 would have allowed
the single entity to use $25x of the excess
business interest expense allocation from PS1
in Year 2. However, on a separate entity
basis, B’s corresponding item for Year 3 is
$25x of ordinary income (the excess taxable
income from PS1). As a result, under
§ 1.1502–13(c)(ii), S takes into account $25x
of its loss in Year 3, the difference between
the recomputed corresponding item and B’s
corresponding item in Year 3 ($0—$25x =

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Frm 00120

Fmt 4701

Sfmt 4702

¥$25x). Under paragraphs (c)(1)(i) and
(c)(4)(i)(A) of this section, the $25x is
redetermined to be ordinary. The remaining
$25x of S’s loss continues to be deferred. The
recomputed corresponding item in Year 4 is
a $15x capital loss ($85x of sales proceeds
minus $100x basis (the original $100x basis,
minus a $50 reduction in basis under
§ 1.163(j)–6(h), plus a $25x increase for its
allocable share of PS1’s income, plus a $25x
increase under § 1.163(j)–6(h)). B’s
corresponding item is a $10x capital gain
($85x sales proceeds minus $75x basis).
Accordingly, the remaining $25x of S’s $50x
Year 2 capital loss is taken into account in
Year 4.
(S) Example 19: Intercompany transfer of
partnership interests in a non-recognition
transaction—(1) Facts. P wholly owns B,
which is a member of the consolidated group
of which P is the common parent. P and A
(an unrelated third party) are equal partners
in PS1, which was formed in Year 1. At the
end of Year 1, the fair market value of PS1
is $200x, and P’s adjusted basis in its
partnership interest is $100x. At the
beginning of Year 2, PS1 borrows money and
purchases inventory. During Year 2, PS1 pays
$100x of business interest expense, sells
inventory for $100x (net of cost of goods
sold), and repays the debt in full. PS1’s
section 163(j) limitation for Year 2 is $30x
(30 percent × $100x). Thus, $70x of PS1’s
Year 2 business interest expense is
disallowed as a deduction to PS1, is
characterized as excess business interest, and
is allocated proportionally to PS1’s partners.
P reduces its basis in its PS1 interest under
§ 1.163(j)–6(h) to reflect the $35x of excess
business interest allocated to P. P’s basis in
its PS1 interest also is increased to reflect the
$35x of income allocated to P, leaving P with
a basis in its PS1 interest of $100x at the end
of Year 2. On the first day of Year 3, P
contributes its PS1 partnership interest to B
in exchange for B stock in a non-recognition
exchange under section 351. At the time, P
had not used any of the excess business
interest expense allocated from PS1. During
Year 4, B sells its PS1 partnership interest to
Z (an unrelated third party) for $200x.
(2) Analysis. P’s transfer of its interest in
PS1 to B is an intercompany transaction. The
transfer also is a disposition for purposes of
§ 1.163(j)–6(h). Therefore, immediately before
the transfer, P increases its $100x basis in its
PS1 interest by $35x (the amount of P’s
unused excess business interest expense).
Under section 362, B receives a carryover
basis of $135x in the PS1 interest. P has no
intercompany item, but B’s $65x of capital
gain from its sale of the PS1 interest to Z is
a corresponding item because the PS1
interest was acquired in an intercompany

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Federal Register / Vol. 83, No. 248 / Friday, December 28, 2018 / Proposed Rules
transaction. B takes the $65x of capital gain
into account in Year 4.

*

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

*

*

(vi) Example 6: Section163(j) interest
limitation—(A) Facts. S1 and S2 are members
of a consolidated group of which P is the
common parent. S1 is engaged in an excepted
trade or business, and S2 is engaged in a nonexcepted trade or business. If S1 were to lend
funds directly to S2 in an intercompany
transaction, under § 1.163(j)–10(a)(4)(i), the
intercompany obligation of S2 would not be
considered an asset of S1 for purposes of
§ 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 § 1.163(j)–
10, to the extent of the loan from X to S2.

*

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

Net operating losses.

amozie on DSK3GDR082PROD with PROPOSALS2

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

Unified loss rule.

*

*
*
*
*
(f) * * *
(2) * * * Such provisions include, for
example, sections 163(j), 267(f), and
469, and § 1.1502–13. * * *
*
*
*
*
*

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

(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 § 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 § 1.163(j)–2(b). The
disallowed business interest expense is
carried over to Year 2 under section 163(j)(2)
and § 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 § 1.1502–98(b)
(providing that §§ 1.1502–91 through 1.1502–
96 apply section 382 to business interest
expense, with appropriate adjustments).

§ 1.1502–79

*

Separate return years.

*

*

67609

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

*

*

Table of contents.

*

*

*

§ 1.1502–98 Coordination with
sections 383 and 163(j).
§ 1.1502–99

Effective dates.

*

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

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

§ 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 § 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 § 1.1502–98(b) (providing that §§ 1.1502–
91 through 1.1502–96 apply section 382 to

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

business interest expense, with appropriate
adjustments).

*

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

amozie on DSK3GDR082PROD with PROPOSALS2

§ 1.1502–98 Coordination with sections
383 and 163(j).

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

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Par. 25. Section 1.1502–99 is
amended by adding paragraph (d) to
read as follows:

■

§ 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 §§ 1.1502–91 through
1.1502–99 effectuate the rules of
§§ 1.382–2 and 1.382–5, the provisions
apply with respect to ownership
changes occurring on or after the date
the Treasury decision adopting these
regulations as final regulations is
published in the Federal Register. For
loss corporations that have ownership
changes occurring before the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register, see
§§ 1.1502–91 through 1.1502–99 as
contained in 26 CFR part 1, revised
April 1, 2018. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
apply the rules of §§ 1.1502–91 through
1.1502–99 to the extent they apply the
rules of §§ 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 §§ 1.1502–91
through 1.1502–99 to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1, the section
163(j) regulations (within the meaning
of § 1.163(j)–1(b)(32)), and if applicable,
§§ 1.263A–9, 1.381(c)(20)–1, 1.469–9,
1.882–5, 1.1502–13, 1.1502–21, 1.1502–
36, 1.1502–79, and 1.1504–4 to taxable
years beginning after December 31,
2017.
(2) Sections 1.382–6 and 1.383–1. To
the extent the rules of §§ 1.1502–91
through 1.1502–98 effectuate the rules
of §§ 1.382–6 and 1.383–1, the
provisions apply with respect to
ownership changes occurring during a
taxable year ending after the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register. For
the application of these rules to an
ownership change with respect to an
ownership change occurring during a
taxable year ending before the date the
Treasury decision adopting these
regulations as final regulations is
published in the Federal Register, see
§§ 1.1502–91 through 1.1502–99 as
contained in 26 CFR part 1, revised

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April 1, 2018. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
apply the rules of §§ 1.1502–91 through
1.1502–99 (to the extent that those rules
effectuate the rules of §§ 1.382–6 and
1.383–1), to ownership changes
occurring during a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations (within the
meaning of § 1.163(j)–1(b)(32)), and if
applicable, §§ 1.263A–9, 1.381(c)(20)–1,
1.469–9, 1.882–5, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, and 1.1504–4 to
taxable years beginning after December
31, 2017.
■ Par. 26. Section 1.1504–4 is amended
by:
■ 1. Removing ‘‘163(j), 864(e),’’ from
paragraph the first sentence of
paragraph (a)(2) and adding ‘‘864(e)’’ in
its place; and
■ 2. Adding two sentences at the end of
paragraph (i).
The addition reads as follows:
§ 1.1504–4 Treatment of warrants, options,
convertible obligations, and other similar
interests.

*

*
*
*
*
(i) * * * Paragraph (a)(2) of this
section applies with respect to taxable
years ending after the date the Treasury
decision adopting these regulations as
final regulations is published in the
Federal Register. However, taxpayers
and their related parties, within the
meaning of sections 267(b) and
707(b)(1), may apply the rules of this
section to a taxable year beginning after
December 31, 2017, so long as the
taxpayers and their related parties
consistently apply the rules of this
section, the section 163(j) regulations
(within the meaning of § 1.163(j)–
1(b)(32)), and if applicable, §§ 1.263A–
9, 1.381(c)(20)–1, 1.382–6, 1.383–1,
1.469–9, 1.882–5, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, and 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–6, and
1.383–1), to those taxable years.
Dated: October 4, 2018.
Douglas W. O’Donnell,
Acting Deputy Commissioner for Services and
Enforcement.
[FR Doc. 2018–26257 Filed 12–20–18; 4:15 pm]
BILLING CODE 4830–01–P

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