Rev. Rul. 76-299

Advice has been requested concerning the earnings and profits of the taxable year available for the payment of dividends of a regulated investment company and the taxable status of the company's distribution under the circumstances described below.

In 1970 and prior years M, a domestic corporation, qualified as a regulated investment company under subchapter M, chapter 1 of the Internal Revenue Code of 1954.

On January 1, 1969, M had zero accumulated earnings and profits available for the payment of dividends. In the taxable year 1969, M sustained a net capital loss of 800x dollars and had no other income, expenses, or losses. Thus, on January 1, 1970, M had a deficit in accumulated earnings and profits of 800x dollars and an unused net capital loss of 800x dollars from 1969 that was a carryover to 1970. In the taxable year 1970, M had 1,000x dollars of net long-term capital gain, no short-term capital gains or losses, ordinary income of 10,000x dollars, and no other income, expenses, or losses. In 1970, M distributed 11,000x dollars pro rata to its shareholders, and designated 1,000x dollars of this distribution as a capital gain dividend. In determining the amount designated as a capital gain dividend, M did not take into account as a short-term capital loss of 1970, the capital loss carryover from 1969.

Section 852(b)(3)(C) of the Code provides that the aggregate amount of dividends that may be capital gain dividends of a regulated investment company with respect to a taxable year is limited to the excess of the net long-term capital gain over the net short-term capital loss of the taxable year.

Section 1212(a) of the Code provides, in part, that if for any taxable year a corporation has a net capital loss, the amount thereof shall be a short-term capital loss in each of the 5 succeeding taxable years to the extent such amount exceeds the total of any net capital gains of any taxable years intervening between the taxable year in which the net capital loss arose and such succeeding taxable year.

Rev. Rul. 60-217, 1960-1 C.B. 301, holds that a regulated investment company, as defined in section 851 of the Code, carries over a net capital loss to succeeding taxable years under the provisions of section 1212 in the same manner as other corporations.

Pursuant to section 1212 of the Code and Rev. Rul. 60-217, a capital loss carryover of a regulated investment company is a short-term capital loss in the succeeding taxable years to which it is carried. Thus, the net short-term capital loss of a taxable year includes a capital loss carryover.

A capital loss carryover does not affect the earnings and profits of the taxable year in which it is used because the loss giving rise to the carryover is reflected in the accumulated earnings and profits at the beginning of the taxable year of the carryover. See section 1.312-6(d) of the Income Tax Regulations.

Section 316 of the Code provides, in part, that the term "dividend" means a distribution to shareholders out of the earnings and profits of the taxable year.

Accordingly, in the instant case, since the capital loss carryover of M that was a short-term capital loss of 1969 did not reduce the earnings and profits of 1970 available for the payment of dividends because it was reflected in the deficit in the accumulated earnings and profits of 800x dollars on January 1, 1970, M's earnings and profits of the taxable year 1970 available for the payment of dividends were 11,000x dollars, attributable to the 1,000x dollars of net long-term capital gain and the 10,000x dollars of other net income. Thus, the entire distribution of 11,000x dollars was paid from the earnings and profits of the taxable year 1970 and was a dividend within the meaning of section 316 of the Code. In addition, the capital loss carryover of 800x dollars became a short-term capital loss of the taxable year 1970 and must be used to reduce the amount of a dividend designated as a capital gain dividend. Thus, for the taxable year 1970 the excess of the net long-term capital gain of 1,000x dollars over the net short-term capital loss of 800x dollars was 200x dollars. The portion of the dividend designated a capital gain dividend by the company that actually was a capital gain dividend was 200x dollars and is treated by the shareholders as the gain from the sale or exchange of a capital asset held for more than 6 months as provided by section 852(b)(3)(B). The balance of the dividend, 10,800x dollars, is includible in the gross income of the shareholders as provided by section 1.852-4(a) of the regulations. Further, M had a deficit in accumulated earnings and profits at January 1, 1971, of 800x dollars. Notwithstanding the designation of 1,000x dollars as capital gain by M, the capital loss carryover of 800x dollars will not be a carryover to a subsequent year.

The conclusions set forth in this Revenue Ruling are also applicable as provided by section 857 of the Code to a similar situation in which the organization is a real estate investment trust that qualifies under subchapter M, chapter 1 of the Code.