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

(a) Overview.

(1) In general.

(i) Purposes. Except as provided in §1.163(j)-6(m) or §1.163(j)-9(h), this section provides the exclusive rules for allocating tax items that are properly allocable to a trade or business between excepted trades or businesses and non-excepted trades or businesses for purposes of section 163(j). The amount of a taxpayer’s interest expense that is properly allocable to excepted trades or businesses is not subject to the section 163(j) limitation. The amount of a taxpayer’s other items of income, gain, deduction, or loss, including interest income, that is properly allocable to excepted trades or businesses is excluded from the calculation of the taxpayer’s section 163(j) limitation. See section 163(j)(6) and (j)(8)(A)(i); see also §1.163(j)-1(b)(1)(i)(H), (b)(1)(ii)(F), and (b)(3). The general method of allocation set forth in paragraph (c) of this section is based on the approach that money is fungible and that interest expense is attributable to all activities and property, regardless of any specific purpose for incurring an obligation on which interest is paid. In no event may the amount of interest expense allocated under this section exceed the amount of interest paid or accrued, or treated as paid or accrued, by the taxpayer within the taxable year.

(ii) Application of section. The amount of a taxpayer’s tax items properly allocable to a trade or business, other than interest expense and interest income, that is properly allocable to excepted trades or businesses for purposes of section 163(j) is determined as set forth in paragraph (b) of this section. The amount of a taxpayer’s interest expense and interest income that is properly allocable to excepted trades or businesses for purposes of section 163(j) generally is determined as set forth in paragraph (c) of this section, except as otherwise provided in paragraph (d) of this section. For purposes of this section, a taxpayer’s activities are not treated as a separate trade or business to the extent those activities involve the provision of real property, goods, or services to a trade or business of the taxpayer (or, if the taxpayer is a member of a consolidated group, the consolidated group). For example, if a taxpayer engaged in a manufacturing trade or business has in-house legal personnel that provide legal services solely with respect to the taxpayer’s manufacturing business, the taxpayer is not treated as also engaged in the trade or business of providing legal services. Similarly, if the taxpayer described in the previous sentence constructs or acquires real property solely for use by the taxpayer’s manufacturing business, the taxpayer is not treated as also engaged in a real property trade or business.

(2) Coordination with other rules.

(i) In general. The rules of this section apply after a taxpayer has determined whether any interest expense or interest income paid, received, or accrued is properly allocable to a trade or business. Similarly, the rules of this section apply to other tax items after a taxpayer has determined whether those items are properly allocable to a trade or business. For instance, a taxpayer must apply §1.163-8T, if applicable, to determine which items of interest expense are investment interest under section 163(d) before applying the rules in paragraph (c) of this section to allocate interest expense between excepted and non-excepted trades or businesses. After determining whether its tax items are properly allocable to a trade or business, a taxpayer that is engaged in both excepted and non-excepted trades or businesses must apply the rules of this section to determine the amount of interest expense that is business interest expense subject to the section 163(j) limitation and to determine which items are included or excluded in computing its section 163(j) limitation.

(ii) Treatment of investment interest, investment income, investment expenses, and certain other tax items of a partnership with a C corporation or tax-exempt corporation as a partner. For rules governing the treatment of investment interest, investment income, investment expenses, and certain other separately stated tax items of a partnership with a C corporation or tax-exempt corporation as a partner, see §§1.163(j)-4(b)(3) and 1.163(j)-6(k).

(3) Application of allocation rules to foreign corporations and foreign partnerships. The rules of this section apply to foreign corporations and foreign partnerships.

(4) Application of allocation rules to members of a consolidated group.

(i) In general. As provided in §1.163(j)-4(d), the computations required by section 163(j) and the regulations in this part under section 163(j) of the Code generally are made for a consolidated group on a consolidated basis. In this regard, for purposes of applying the allocation rules of this section, all members of a consolidated group are treated as one corporation. Therefore, the rules of this section apply to the activities conducted by the group as if those activities were conducted by a single corporation. For example, the group (rather than a particular member) is treated as engaged in excepted or non-excepted trades or businesses. In the case of intercompany obligations, within the meaning of §1.1502-13(g)(2)(ii), for purposes of allocating asset basis between excepted and non-excepted trades or businesses, the obligation of the member borrower is not considered an asset of the creditor member. Similarly, intercompany transactions, within the meaning of §1.1502-13(b)(1)(i), are disregarded for purposes of this section, as are the resulting offsetting items, and property is allocated to a trade or business based on the activities of the group as if the members of the group were divisions of a single corporation. Further, stock of a group member that is owned by another member of the same group is not treated as an asset for purposes of this section, and the transfer of any amount of member stock to a non-member is treated by the group as a transfer of the member’s assets proportionate to the amount of member stock transferred. Additionally, stock of a corporation that is not a group member is treated as owned by the group.

(ii) Application of excepted business percentage to members of a consolidated group. After a consolidated group has determined the percentage of the group’s interest expense allocable to excepted trades or businesses for the taxable year (and thus not subject to the section 163(j) limitation), this exempt percentage is applied to the interest paid or accrued by each member during the taxable year to any lender that is not a group member. Therefore, except to the extent paragraph (d) of this section (providing rules for certain qualified nonrecourse indebtedness) applies, an identical percentage of the interest paid or accrued by each member of the group to any lender that is not a group member is treated as allocable to excepted trades or businesses, regardless of whether any particular member actually engaged in an excepted trade or business.

(iii) Basis in assets transferred in an intercompany transaction. For purposes of allocating interest expense and interest income under paragraph (c) of this section, the basis of property does not include any gain or loss realized with respect to the property by another member in an intercompany transaction, as defined in §1.1502-13(b), whether or not the gain or loss is deferred.

(5) Tax-exempt organizations. For tax-exempt organizations, section 512 and the regulations in this part under section 512 of the Code determine the rules for allocating all income and expenses among multiple trades or businesses.

(6) Application of allocation rules to disallowed disqualified interest. A taxpayer may apply the allocation rules of this section to disallowed disqualified interest by either:

(i) Applying the allocation rules of this section to all of the taxpayer’s disallowed disqualified interest in the taxable year(s) in which the disallowed disqualified interest was paid or accrued (the historical approach); or

(ii) Treating all of the taxpayer’s disallowed disqualified interest as if it were paid or accrued in the taxpayer’s first taxable year beginning after December 31, 2017 (the effective date approach).

(7) Examples. The following examples illustrate the principles of this paragraph (a).

(i) Example 1: Items properly allocable to a trade or business.

(A) Facts. Individual T operates Business X, a non-excepted trade or business, as a sole proprietor. In Year 1, T pays or accrues $40x of interest expense and receives $100x of gross income with respect to Business X that is not eligible for a section 199A deduction. T borrows money to buy a car for personal use, and T pays or accrues $20x of interest expense with respect to the car loan. T also invests in corporate bonds, and, in Year 1, T receives $50x of interest income on those bonds.

(B) Analysis. Under paragraphs (a)(1) and (2) of this section, T must determine which items of income and expense, including items of interest income and interest expense, are properly allocable to a trade or business. T’s $100x of gross income and T’s $40x of interest expense with respect to Business X are properly allocable to a trade or business. However, the interest expense on T’s car loan is personal interest within the meaning of section 163(h)(2) rather than interest properly allocable to a trade or business. Similarly, T’s interest income from corporate bonds is not properly allocable to a trade or business because it is interest from investment activity. See section 163(d)(4)(B).

(ii) Example 2: Intercompany transaction.

(A) Facts. S is a member of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), and S conducts a non-excepted trade or business (Business Y). P leases Building V (which P owns) to S for use in Business Y.

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

(iii) Example 3: Intercompany sale of natural gas.

(A) Facts. S is a member of a consolidated group of which P is the common parent. S drills for natural gas and is not an excepted regulated utility trade or business. S sells most of its natural gas production to P, which produces electricity at its natural gas-fired power plants, and S sells the rest of its natural gas production to third parties at market rates. P is an excepted regulated utility trade or business to the extent that it is engaged in a trade or business described in §1.163(j)-1(b)(15)(i).

(B) Analysis. Intercompany transactions are disregarded for purposes of this section. As a result, the intercompany sales of natural gas by S to P are disregarded. Moreover, the assets of S and P are allocated between the excepted and non-excepted trades or businesses of the P group based on the assets used in each trade or business. Assets of S may be allocated to the P group’s excepted trade or business to the extent those assets are used in the trade or business of the furnishing or sale of electrical energy. Likewise, assets of P may be allocated to the P group’s non-excepted trade or business to the extent those assets are used in the trade or business of natural gas production.

(iv) Example 4: Disallowed disqualified interest.

(A) Facts. S is a member of a consolidated group of which P is the common parent. P and S are the only members of an affiliated group under old section 163(j)(6)(C). S operates a farm equipment leasing business (Business X) that is not an excepted trade or business. P is engaged in an electing farming business (Business Y). Entering its first taxable year beginning after December 31, 2017, the P group has disallowed disqualified interest of $120x, all of which the P group paid or accrued in earlier taxable years in which it only operated Business X. The P group also incurs $100x of interest expense during its 2018 taxable year, of which $25x (25 percent of $100x) is business interest expense properly allocable to Business X and $75x (75 percent of $100x) is properly allocable to Business Y under paragraph (c) of this section.

(B) Analysis. Under paragraph (a)(6) of this section, the P group may allocate disallowed disqualified interest to Business X and Business Y by either applying the allocation rules of this section in the taxable years in which the disallowed disqualified interest was paid or accrued (the historical approach) or by treating such interest as though it were paid or accrued in the P group’s first taxable year beginning after December 31, 2017 (the effective date approach). Accordingly, if the P group chooses to rely on the historical approach, it allocates all $120x of disallowed disqualified interest to Business X (a non-excepted trade or business), and all $120x of disallowed disqualified interest is subject to the section 163(j) limitation. If, instead, the P group chooses to rely on the effective date approach, it allocates its $120x of disallowed disqualified interest in the same proportion as its $100x of business interest expense that was paid or accrued in its 2018 taxable year. Of the $120x of disallowed disqualified interest, $30x (25 percent of $120x) is allocated to Business X and $90x (75 percent of $120x) is allocated to Business Y. The $90x of disallowed disqualified interest that is properly allocable to Business Y (an excepted trade or business) is not subject to the section 163(j) limitation.

(b) Allocation of tax items other than interest expense and interest income.

(1) In general. Except as otherwise provided in §1.163(j)-6(m) or §1.163(j)-9(h), for purposes of calculating ATI, tax items other than interest expense and interest income are allocated to a particular trade or business in the manner described in this paragraph (b). It is not necessary to allocate items under this paragraph (b) for purposes of calculating ATI if all of the taxpayer’s items subject to allocation under this paragraph (b) are allocable to excepted trades or businesses, or if all of those items are allocable to non-excepted trades or businesses.

(2) Gross income other than dividends and interest income. A taxpayer’s gross income other than dividends and interest income is allocated to the trade or business that generated the gross income.

(3) Dividends.

(i) Look-through rule. If a taxpayer receives a dividend, within the meaning of section 316, that is not investment income, within the meaning of section 163(d), and if the taxpayer satisfies the minimum ownership threshold in paragraph (c)(7) of this section, then, solely for purposes of allocating amounts received as a dividend during the taxable year to excepted or non-excepted trades or businesses under this paragraph (b), the dividend income is treated as allocable to excepted or non-excepted trades or businesses based upon the relative amounts of the payor corporation’s adjusted basis in the assets used in its trades or businesses, determined pursuant to paragraph (c) of this section. If at least 90 percent of the payor corporation’s adjusted basis in its assets during the taxable year, determined pursuant to paragraph (c) of this section, is allocable to either excepted trades or businesses or to non-excepted trades or businesses, all of the taxpayer’s dividend income from the payor corporation for the taxable year is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(ii) Inapplicability of the look-through rule. If a taxpayer receives a dividend that is not investment income, within the meaning of section 163(d), and if the taxpayer does not satisfy the minimum ownership threshold in paragraph (c)(7) of this section, then the taxpayer must treat the dividend as allocable to a non-excepted trade or business.

(4) Gain or loss from the disposition of non-consolidated C corporation stock, partnership interests, or S corporation stock.

(i) Non-consolidated C corporations.

(A) If a taxpayer recognizes gain or loss upon the disposition of stock in a non-consolidated C corporation that is not property held for investment, within the meaning of section 163(d)(5), and if the taxpayer looks through to the assets of the C corporation under paragraph (c)(5)(ii) of this section for the taxable year, then the taxpayer must allocate gain or loss from the disposition of stock to excepted or non-excepted trades or businesses based upon the relative amounts of the C corporation’s adjusted basis in the assets used in its trades or businesses, determined pursuant to paragraph (c) of this section. If at least 90 percent of the C corporation’s adjusted basis in its assets during the taxable year, determined pursuant to paragraph (c) of this section, is allocable to either excepted trades or businesses or to non-excepted trades or businesses, all of the taxpayer’s gain or loss from the disposition is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(B) If a taxpayer recognizes gain or loss upon the disposition of stock in a non-consolidated C corporation that is not property held for investment, within the meaning of section 163(d)(5), and if the taxpayer does not look through to the assets of the C corporation under paragraph (c)(5)(ii) of this section for the taxable year, then the taxpayer must treat the gain or loss from the disposition of stock as allocable to a non-excepted trade or business.

(C) For rules governing the transfer of stock of a member of a consolidated group, see paragraph (a)(4)(i) of this section.

(ii) Partnerships and S corporations.

(A) If a taxpayer recognizes gain or loss upon the disposition of interests in a partnership or stock in an S corporation that owns--

(1) Non-excepted assets and excepted assets;

(2) Investment assets; or

(3) Both;

(B) The taxpayer determines a proportionate share of the amount properly allocable to a non-excepted trade or business in accordance with the allocation rules set forth in paragraph (c)(5)(ii)(A) or (c)(5)(ii)(B)(3) of this section, as appropriate, and includes such proportionate share of gain or loss in the taxpayer’s ATI. However, if at least 90 percent of the partnership’s or S corporation’s adjusted basis in its assets during the taxable year, determined pursuant to paragraph (c) of this section, is allocable to either excepted trades or businesses or to non-excepted trades or businesses, all of the taxpayer’s gain or loss from the disposition is treated as allocable to either excepted or non-excepted trades or businesses, respectively. This rule also applies to tiered passthrough entities by looking through each passthrough entity tier (for example, an S corporation that is the partner of the highest-tier partnership would look through each lower-tier partnership), subject to paragraph (c)(5)(ii)(D) of this section. With respect to a partner that is a C corporation or tax-exempt corporation, a partnership’s investment assets are taken into account and treated as non-excepted trade or business assets. For purposes of this paragraph, a passthrough entity means a partnership, S corporation, or any other entity (domestic or foreign) that is not a corporation if all items of income and deduction of the entity are included in the income of its owners or beneficiaries.

(5) Expenses, losses, and other deductions.

(i) Expenses, losses, and other deductions that are definitely related to a trade or business. Expenses (other than interest expense), losses, and other deductions (collectively, deductions for purposes of this paragraph (b)(5)) that are definitely related to a trade or business are allocable to the trade or business to which they relate. A deduction is considered definitely related to a trade or business if the item giving rise to the deduction is incurred as a result of, or incident to, an activity of the trade or business or in connection with property used in the trade or business (see §1.861-8(b)(2)). If a deduction is definitely related to one or more excepted trades or businesses and one or more non-excepted trades or businesses, the deduction is apportioned between the excepted and non-excepted trades or businesses based upon the relative amounts of the taxpayer’s adjusted basis in the assets used in those trades or businesses, as determined under paragraph (c) of this section.

(ii) Other deductions. Deductions that are not described in paragraph (b)(5)(i) of this section are ratably apportioned based on the gross income of each trade or business.

(6) Treatment of investment items and certain other items of a partnership with a C corporation partner. Any investment income, investment expense, or other item that a partnership receives, pays, or accrues and that is treated as properly allocable to a trade or business of a C corporation partner under §1.163(j)-4(b)(3)(i) is treated as properly allocable to a non-excepted trade or business of the C corporation partner, except that any item with respect to property or activities for which an election has been made by the partnership under §1.163(j)-9(b) is treated as properly allocable to an excepted trade or business. See, for example, an election for activities described in §1.163(j)-9(b)(2)(ii) or an election under §1.163(j)-9(h).

(7) Examples: Allocation of income and expense. The following examples illustrate the principles of this paragraph (b):

(i) Example 1: Allocation of income and expense between excepted and non-excepted trades or businesses.

(A) Facts. T conducts an electing real property trade or business (Business Y), which is an excepted trade or business. T also operates a lumber yard (Business Z), which is a non-excepted trade or business. In Year 1, T receives $100x of gross rental income from real property leasing activities. T also pays or accrues $60x of expenses in connection with its real property leasing activities and $20x of legal services performed on behalf of both Business Y and Business Z. T receives $60x of gross income from lumber yard customers and pays or accrues $50x of expenses related to the lumber yard business. For purposes of expense allocations under paragraphs (b) and (c) of this section, T has $240x of adjusted basis in its Business Y assets and $80x of adjusted basis in its Business Z assets.

(B) Analysis. Under paragraph (b)(2) of this section, for Year 1, $100x of rental income is allocated to Business Y, and $60x of income from lumber yard customers is allocated to Business Z. Under paragraph (b)(5)(i) of this section, $60x of expenses paid or accrued in connection with real property leasing activities are allocated to Business Y, and $50x of expenses related to the lumber yard are allocated to Business Z. The $20x of remaining expenses for legal services performed on behalf of both Business Y and Business Z are allocated according to the relative amounts of T’s basis in the assets used in each business. The total amount of T’s basis in the assets used in Businesses Y and Z is $320x, of which 75 percent ($240x / $320x) is used in Business Y and 25 percent ($80x / $320x) is used in Business Z. Accordingly, $15x of the expenses for legal services are allocated to Business Y and $5x are allocated to Business Z.

(ii) Example 2: Allocation of partnership items from investment activity.

(A) Facts. U, a domestic C corporation, directly conducts an electing real property trade or business. U also has an interest in PRS, a partnership that holds real property for investment. PRS’s investment in real property is not a trade or business under section 162 or a real property trade or business under section 469. During the taxable year, PRS sells some of its real property to third parties and allocates $80x of income to U from these sales. In addition, PRS incurs deductible expenses related to its investment in real property and allocates $9x of these deductible expenses to U.

(B) Analysis. Under paragraph (b)(6) of this section, any investment income or investment expense that a partnership receives, pays, or accrues and that is treated as properly allocable to a trade or business of a C corporation partner is treated as properly allocable to a non-excepted trade or business of the C corporation partner. Because PRS generates its income and expense from investment activity that is not a trade or business under section 162 or a real property trade or business under section 469, U’s allocation of $80x of income and $9x of deductible expense from PRS is treated as properly allocable to a non-excepted trade or business.

(c) Allocating interest expense and interest income that is properly allocable to a trade or business.

(1) General rule.

(i) In general. Except as otherwise provided in this section, §1.163(j)-6(m), or §1.163(j)-9(h), the amount of a taxpayer’s interest expense and interest income that is properly allocable to a trade or business is allocated to the taxpayer’s excepted or non-excepted trades or businesses for purposes of section 163(j) based upon the relative amounts of the taxpayer’s adjusted basis in the assets, as determined under paragraph (c)(5) of this section, used in its excepted or non-excepted trades or businesses. The taxpayer must determine the adjusted basis in its assets as of the close of each determination date, as defined in paragraph (c)(6) of this section, in the taxable year and average those amounts to determine the relative amounts of asset basis for its excepted and non-excepted trades or businesses for that year. It is not necessary to allocate interest expense or interest income under this paragraph (c) for purposes of determining a taxpayer’s business interest expense and business interest income if all of the taxpayer’s interest income and expense is allocable to excepted trades or businesses (in which case the taxpayer is not subject to the section 163(j) limitation) or if all of the taxpayer’s interest income and expense is allocable to non-excepted trades or businesses.

(ii) De minimis exception. If at least 90 percent of the taxpayer’s basis in its assets for the taxable year is allocable to either excepted or non-excepted trades or businesses pursuant to this paragraph (c), then all of the taxpayer’s interest expense and interest income for that year that is properly allocable to a trade or business is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(2) Example. The following example illustrates the principles of paragraph (c)(1) of this section:

(i) Facts. T is a calendar-year C corporation engaged in an electing real property trade or business, the business of selling wine, and the business of selling hand-carved wooden furniture. In Year 1, T has $100x of interest expense that is deductible except for the potential application of section 163(j). Based upon determinations made on the determination dates in Year 1, T’s average adjusted basis in the assets used in the electing real property trade or business (an excepted trade or business) in Year 1 is $800x, and T’s total average adjusted basis in the assets used in the other two businesses (which are non-excepted trades or businesses) in Year 1 is $200x.

(ii) Analysis. $80x (($800x / ($800x + $200x)) x $100x) of T’s interest expense for Year 1 is allocable to T’s electing real property trade or business and is not business interest expense subject to the section 163(j) limitation. The remaining $20x of T’s interest expense is business interest expense for Year 1 that is subject to the section 163(j) limitation.

(3) Asset used in more than one trade or business.

(i) General rule. If an asset is used in more than one trade or business during a determination period, as defined in paragraph (c)(6) of this section, the taxpayer’s adjusted basis in the asset is allocated to each trade or business using the permissible methodology under this paragraph (c)(3) that most reasonably reflects the use of the asset in each trade or business during that determination period. An allocation methodology most reasonably reflects the use of the asset in each trade or business if it most properly reflects the proportionate benefit derived from the use of the asset in each trade or business. A taxpayer is not required to use the same allocation methodology for each type of asset used in a trade a business. Instead, a taxpayer may use different allocation methodologies for different types of assets used in a trade or business. If none of the permissible methodologies set forth in paragraph (c)(3)(ii) of this section reasonably reflects the use of the asset in each trade or business, the taxpayer’s basis in the asset is not taken into account for purposes of this paragraph (c).

(ii) Permissible methodologies for allocating asset basis between or among two or more trades or businesses. Subject to the special rules in paragraphs (c)(3)(iii) and (c)(5) of this section, a taxpayer’s basis in an asset used in two or more trades or businesses during a determination period may be allocated to those trades or businesses based upon--

(A) The relative amounts of gross income that an asset generates, has generated, or may reasonably be expected to generate, within the meaning of §1.861-9T(g)(3), with respect to the trades or businesses;

(B) If the asset is land or an inherently permanent structure, the relative amounts of physical space used by the trades or businesses; or

(C) If the trades or businesses generate the same unit of output, the relative amounts of output of those trades or businesses (for example, if an asset is used in two trades or businesses, one of which is an excepted regulated utility trade or business, and the other of which is a non-excepted regulated utility trade or business, the taxpayer may allocate basis in the asset based upon the relative amounts of kilowatt-hours generated by each trade or business).

(iii) Special rules.

(A) Consistent allocation methodologies.

(1) In general. Except as otherwise provided in paragraph (c)(3)(iii)(A)(2) of this section, a taxpayer must maintain the same allocation methodology for a period of at least five taxable years.

(2) Consent to change allocation methodology. If a taxpayer has used the same allocation methodology for at least five taxable years, the taxpayers may change its method of allocation under paragraphs (c)(3)(i) and (ii) of this section without the consent of the Commissioner. If a taxpayer has used the same allocation methodology for less than five taxable years, and if the taxpayer determines that a different allocation methodology properly reflects the proportionate benefit derived from the use of assets in its trades or businesses, the taxpayer may change its method of allocation under paragraphs (c)(3)(i) and (ii) of this section only with the consent of the Commissioner. To obtain consent, a taxpayer must submit a request for a letter ruling under the applicable administrative procedures, and consent will be granted only in extraordinary circumstances.

(B) De minimis exception. If at least 90 percent of the taxpayer’s basis in an asset would be allocated to either excepted trades or businesses or non-excepted trades or businesses during a determination period pursuant to this paragraph (c)(3), the taxpayer’s entire basis in the asset for the determination period must be allocated to either excepted or non-excepted trades or businesses, respectively. This rule applies before the application of paragraph (c)(1)(ii) of this section.

(C) Allocations of excepted regulated utility trades or businesses.

(1) In general. Except as provided in the de minimis rule in paragraph (c)(3)(iii)(C)(3) of this section, a taxpayer is engaged in an excepted regulated utility trade or business only to the extent that the taxpayer is engaged in an excepted regulated utility trade or business described in §1.163(j)-1(b)(15)(i)(A), (B) or (C), and any remaining utility trade or business is a non-excepted trade or business. Thus, for example, electricity sold by a utility trade or business at rates not established or approved by an entity described in §1.163(j)-1(b)(15)(i)(A)(2) and not subject to an election under §1.163(j)-1(b)(15)(iii) must be treated as electricity sold by a non-excepted regulated utility trade or business. The taxpayer must allocate under this paragraph (c) the basis of assets used in the utility trade or business between its excepted and non-excepted trades or businesses.

(2) Permissible method for allocating asset basis for utility trades or businesses. In the case of a utility trade or business described in paragraph (c)(3)(iii)(C)(1) of this section, and except as provided in the de minimis rule in paragraph (c)(3)(iii)(C)(3) of this section, the method described in paragraph (c)(3)(ii)(C) of this section is the only permissible method under this paragraph (c)(3) for allocating the taxpayer’s basis in assets used in both the excepted and non-excepted trades or businesses of selling or furnishing the items described in §1.163(j)-1(b)(15)(i)(A)(1).

(3) De minimis rule for excepted utility trades or businesses. If a taxpayer is engaged in a utility trade or business described in paragraph (c)(3)(iii)(C)(1) of this section, and if at least 90 percent of the items described in §1.163(j)-1(b)(15)(i)(A)(1) are furnished or sold by trades or businesses described in §1.163(j)-1(b)(15)(i)(A), (B) or (C), the taxpayer’s entire trade or business is an excepted regulated utility trade or business, and paragraph (c)(3)(iii)(C)(2) of this section does not apply. This rule applies before the application of paragraph (c)(3)(iii)(B) of this section.

(4) Example. The following example illustrates the principles of this paragraph (c)(3)(iii)(C):

(i) Facts. X, a C corporation, is engaged in the trade or business of generating electrical energy. During each determination period in the taxable year, 80 percent of the megawatt-hours generated in the electricity generation trade or business is sold at rates negotiated with the purchaser, and with respect to which X filed a schedule of rates with a public utility commission. The public utility commission has the authority to take action on the filed schedule of rates, but if no action is taken, the rules governing the public utility commission explicitly state that the public utility commission is deemed to have approved the rates. The public utility has taken no action with respect to the negotiated rate. The remaining 20 percent of the megawatt-hours is sold on the wholesale market at rates not established or subject to approval by a regulator described in §1.163(j)-1(b)(15)(i)(A)(2). X has not made an election under §1.163(j)-1(b)(15)(iii) None of the assets used in X’s utility generation trade or business are used in any other trade or business.

(ii) Analysis. For purposes of section 163(j), under paragraph (c)(3)(iii)(C)(1) of this section, 80 percent of X’s electricity generation business is an excepted regulated utility trade or business, because the rate for the sale of the electricity was subject to approval by a regulator described in §1.163(j)-1(b)(15)(i)(A)(2). The remaining 20 percent of X’s business is a non-excepted utility trade or business. Under paragraph (c)(3)(iii)(C)(2) of this section, X must allocate 80 percent of the basis of the assets used in its utility business to excepted trades or business and the remaining 20 percent of the basis in the assets to non-excepted trades or businesses.

(D) Special allocation rule for real property trades or businesses subject to special anti-abuse rule.

(1) In general. In the case of a trade or business that leases real property subject to an arrangement described in §1.163(j)-9(j)(1), including trades or businesses to which the look-through exception in §1.163(j)-9(j)(2)(ii) applies, the taxpayer must allocate under this paragraph (c)(3) the basis of property used in both the excepted and non-excepted portions of its trade or business, as determined under §1.163(j)-9(j)(3).

(2) Allocation methodology for real property. For purposes of this paragraph (c)(3)(iii)(D), a taxpayer must allocate the basis of real property leased under an arrangement described in §1.163(j)-9(j)(1) or (j)(2)(i) between the excepted and non-excepted portions of the real property trade or business based on the relative fair market rental value of the real property that is attributable to the excepted and non-excepted portions of the trade or business, respectively.

(3) Example. The following example illustrates the principles of this paragraph (c)(3)(iii)(D):

(i) Facts. X and Y are domestic C corporations under common control within the meaning of section 267(b), but neither X nor Y are members of a consolidated group. The small business exemption in §1.163(j)-2(d) does not apply to X or Y. X owns an office building and leases the entire building to Y. Y subleases 80 percent of the office building, measured by fair market rental value, to a related party. Y subleases the remaining 20 percent of the building to unrelated third parties. X also owns depreciable scaffolding equipment, which it uses to clean all of the building’s windows as part of its leasing arrangement with Y.

(ii) Analysis. Under §1.163(j)-9(j)(2)(ii), X is eligible to make an election for 20 percent of its business of leasing the office building to be an electing real property trade or business. Assuming X makes such an election, X must allocate the basis of assets used in both the excepted and non-excepted portions of its leasing trade or business under this paragraph (c). Under paragraph (c)(3)(iii)(D)(2) of this section, X must allocate the basis of the office building based on the relative fair market value attributable to the excepted and non-excepted portions of its leasing business. Therefore, X must allocate 20 percent of the basis of the building to the excepted portion of its leasing business, and it must allocate the remaining 80 percent of the building to the non-excepted portion of its leasing business. Under paragraph (c)(3)(iii)(D)(2) of this section, X may use one of the allocation methods described in paragraph (c)(3)(ii) of this section to allocate the basis of its scaffolding equipment between the excepted and non-excepted portions of its leasing trade or business.

(4) Disallowed business interest expense carryforwards; floor plan financing interest expense. Disallowed business interest expense carryforwards (which were treated as allocable to a non-excepted trade or business in a prior taxable year) are not re-allocated between non-excepted and excepted trades or businesses in a succeeding taxable year. Instead, the carryforwards continue to be treated as allocable to a non-excepted trade or business. Floor plan financing interest expense also is not subject to allocation between excepted and non-excepted trades or businesses (see §1.163(j)-1(b)(19)) and is always treated as allocable to non-excepted trades or businesses.

(5) Additional rules relating to basis.

(i) Calculation of adjusted basis.

(A) Non-depreciable property other than land. Except as otherwise provided in paragraph (c)(5)(i)(E) of this section, for purposes of this section, the adjusted basis of an asset other than land with respect to which no deduction is allowable under section 167, former section 168, or section 197, as applicable, is the adjusted basis of the asset for determining gain or loss from the sale or other disposition of that asset as provided in §1.1011-1. Self-created intangible assets are not taken into account for purposes of this paragraph (c).

(B) Depreciable property other than inherently permanent structures. For purposes of this section, the adjusted basis of any tangible asset with respect to which a deduction is allowable under section 167, other than inherently permanent structures, is determined by using the alternative depreciation system under section 168(g) before any application of the additional first-year depreciation deduction (for example, under section 168(k) or (m)), and the adjusted basis of any tangible asset with respect to which a deduction is allowable under former section 168, other than inherently permanent structures, is determined by using the taxpayer’s method of computing depreciation for the asset under former section 168. The depreciation deduction with respect to the property described in this paragraph (c)(5)(i)(B) is allocated ratably to each day during the period in the taxable year to which the depreciation relates. A change to the alternative depreciation system should be determined in a manner similar to that in §1.168(i)-4(d)(4) or (d)(5)(ii)(B), as applicable.

(C) Special rule for land and inherently permanent structures. Except as otherwise provided in paragraph (c)(5)(i)(E) of this section, for purposes of this section, the adjusted basis of any asset that is land, including nondepreciable improvements to land, or an inherently permanent structure is its unadjusted basis.

(D) Depreciable or amortizable intangible property and depreciable income forecast method property. For purposes of this section, the adjusted basis of any intangible asset with respect to which a deduction is allowable under section 167 or 197, as applicable, is determined in accordance with section 167 or 197, as applicable, and the adjusted basis of any asset described in section 167(g)(6) for which a deduction is allowable under section 167 is determined in accordance with section 167(g). The adjusted basis of any intangible asset under this paragraph (c)(5)(i)(D) is determined before any application of the additional first-year depreciation deduction. The depreciation or amortization deduction with respect to the property described in this paragraph (c)(5)(i)(D) is allocated ratably to each day during the period in the taxable year to which the depreciation or amortization relates.

(E) Assets not yet used in a trade or business. Assets that have been acquired or that are under development but that are not yet used in a trade or business are not taken into account for purposes of this paragraph (c). For example, construction works in progress (such as buildings, airplanes, or ships) are not taken into account for purposes of this paragraph (c). Similarly, land acquired by a taxpayer for construction of a building by the taxpayer to be used in a trade or business is not taken into account for purposes of under this paragraph (c) until the building is placed in service. This rule does not apply to interests in a partnership or stock in a corporation.

(F) Trusts established to fund specific liabilities. Trusts required to fund specific liabilities (for example, pension trusts, and nuclear decommissioning funds (including, but not limited to, those funds for which an election is made under section 468A)) are not taken into account for purposes of this paragraph (c).

(G) Inherently permanent structure. For purposes of this section, the term inherently permanent structure has the meaning provided in §1.856-10(d)(2).

(ii) Partnership interests; stock in non-consolidated C corporations.

(A) Partnership interests.

(1) Calculation of asset basis. For purposes of this section, a partner’s interest in a partnership is treated as an asset of the partner. For these purposes, the partner’s adjusted basis in a partnership interest is reduced, but not below zero, by the partner’s share of partnership liabilities, as determined under section 752, and is further reduced as provided in paragraph (c)(5)(ii)(A)(2)(iii) of this section. If a partner elects or is required to apply the rules in this paragraph (c)(5)(ii)(A) to look through to a partnership’s basis in the partnership’s assets, the partner's basis in the partnership interest is adjusted to the extent of the partner's share of any adjustments to the basis of the partnership's assets required pursuant to the rules in paragraph (c)(5)(i) of this section.

(2) Allocation of asset basis.

(i) In general. For purposes of determining the extent to which a partner’s adjusted basis in its partnership interest is allocable to an excepted or non-excepted trade or business, the partner may look through to such partner’s share of the partnership’s basis in the partnership’s assets, taking into account any adjustments under sections 734(b) and 743(b), and adjusted to the extent required under paragraph (d)(4) of this section, except as otherwise provided in paragraph (c)(5)(ii)(D) of this section. For purposes of the preceding sentence, such partner’s share of partnership assets is determined using a reasonable method taking into account special allocations under section 704(b). Notwithstanding paragraph (c)(7) of this section, if a partner’s direct and indirect interest in a partnership is greater than or equal to 80 percent of the partnership’s capital or profits, the partner must apply the rules in this paragraph (c)(5)(ii)(A)(2) to look through to the partnership’s basis in the partnership’s assets. If a partner elects or is required to apply the rules in this paragraph (c)(5)(ii)(A)(2) to look through to a partnership’s basis in the partnership’s assets, the partner allocates the basis of its partnership interest between excepted and non-excepted trades or businesses based on the ratio in which the partner's share of the partnership's adjusted tax basis in its trade or business assets is allocated between excepted and non-excepted trade or business assets.

(ii) De minimis rule. If, after applying paragraph (c)(5)(ii)(A)(2)(iii) of this section, at least 90 percent of a partner’s share of a partnership’s basis in its assets (including adjustments under sections 734(b) and 743(b)) is allocable to either excepted trades or businesses or non-excepted trades or businesses, without regard to assets not properly allocable to a trade or business, the partner’s entire basis in its partnership interest is treated as allocable to either excepted or non-excepted trades or businesses, respectively. For purposes of the preceding sentence, such partner’s share of partnership assets is determined using a reasonable method taking into account special allocations under section 704(b).

(iii) Partnership assets not properly allocable to a trade or business. For purposes of applying paragraphs (c)(5)(ii)(A)(2)(i) and (ii) of this section to a partner that is a C corporation or tax-exempt corporation, such partner’s share of a partnership’s assets that are not properly allocable to a trade or business is treated as properly allocable to a non-excepted trade or business of such partner. However, if the partnership made an election under §1.163(j)-9(b) or §1.163(j)-9(h) with respect to an asset or activity, the assets (or assets related to such activities) are treated as properly allocable to an excepted trade or business of such partner. See, for example, an election under §1.163(j)-9(h) for an asset or an election under §1.163(j)-9(b) with respect to activities described in §1.163(j)-9(b)(2)(ii). For a partner other than a C corporation or tax-exempt corporation, a partnership’s assets that are not properly allocable to a trade or business are treated as neither excepted nor non-excepted trade or business assets; instead, such partner’s adjusted basis in its partnership interest is decreased by that partner’s share of the excess of the partnership’s basis in those assets over the partnership’s debt that is traced to such assets in accordance with §1.163-8T, and it is increased by that partner’s share of the excess of the partnership’s debt that is traced to such assets in accordance with §1.163-8T over the partnership’s basis in those assets. For purposes of the preceding sentence, the partnership's asset basis in property not allocable to a trade or business is adjusted pursuant to the rules in paragraph (c)(5)(i) of this section. For purposes of this paragraph (c)(5)(ii)(A)(2)(iii), such partner’s share of a partnership’s assets is determined under a reasonable method taking into account special allocations under section 704(b).

(iv) Inapplicability of partnership look-through rule. If a partner, other than a C corporation or a tax-exempt corporation, chooses not to look through to the partnership’s basis in the partnership’s assets under paragraph (c)(5)(ii)(A)(2)(i) of this section or is precluded by paragraph (c)(5)(ii)(D) of this section from applying such partnership look-through rule, the partner generally will treat its basis in the partnership interest as either an asset held for investment or a non-excepted trade or business asset as determined under section 163(d). If a partner that is a C corporation or a tax-exempt corporation chooses not to look through to the partnership’s basis in the partnership’s assets under paragraph (c)(5)(ii)(A)(2)(i) of this section or is precluded by paragraph (c)(5)(ii)(D) of this section from applying such partnership look-through rule, the taxpayer must treat its entire basis in the partnership interest as allocable to a non-excepted trade or business.

(B) Stock in domestic non-consolidated corporations.

(1) In general. For purposes of this section, if a taxpayer owns stock in a domestic C corporation that is not a member of the taxpayer’s consolidated group, or if the taxpayer owns stock in an S corporation, the stock is treated as an asset of the taxpayer.

(2) Domestic non-consolidated C corporations.

(i) Allocation of asset basis. If a shareholder satisfies the minimum ownership threshold in paragraph (c)(7) of this section for stock in a domestic non-consolidated C corporation, and if dividends paid on such stock would not be included in the shareholder’s investment income under section 163(d)(4)(B), then, for purposes of determining the extent to which the shareholder’s basis in the stock is allocable to an excepted or non-excepted trade or business, the shareholder must look through to the corporation’s basis in the corporation’s assets, adjusted to the extent required under paragraph (d)(4) of this section, except as otherwise provided in paragraph (c)(5)(ii)(D) of this section. If a shareholder does not satisfy the minimum ownership threshold in paragraph (c)(7) of this section for stock in a domestic non-consolidated C corporation, but the shareholder’s direct and indirect interest in such corporation is greater than or equal to 80 percent by value, and if dividends paid on such stock would not be included in the shareholder’s investment income under section 163(d)(4)(B), then, for purposes of determining the extent to which the shareholder’s basis in the stock is allocable to an excepted or non-excepted trade or business, the shareholder may look through to the corporation’s basis in the corporation’s assets, adjusted to the extent required under paragraph (d)(4) of this section, except as otherwise provided in paragraph (c)(5)(ii)(D) of this section. For purposes of the preceding sentence, indirect stock ownership is determined by applying the constructive ownership rules of section 318(a).

(ii) De minimis rule. If at least 90 percent of the domestic non-consolidated C corporation’s basis in the corporation’s assets is allocable to either excepted trades or businesses or non-excepted trades or businesses, the shareholder’s entire interest in the corporation’s stock is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(iii) Inapplicability of corporate look-through rule. If a shareholder other than a C corporation or a tax-exempt corporation is ineligible to look through or chooses not to look through to a corporation’s basis in its assets under paragraph (c)(5)(ii)(B)(2)(i) of this section, the shareholder generally will treat its entire basis in the corporation’s stock as an asset held for investment. If a shareholder that is a C corporation or a tax-exempt corporation is ineligible to look through or chooses not to look through to a corporation’s basis in its assets under paragraph (c)(5)(ii)(B)(2)(i) of this section, the shareholder must treat its entire basis in the corporation’s stock as allocable to a non-excepted trade or business.

(iv) Use of inside basis for purposes of C corporation look-through rule. This paragraph (c)(5)(ii)(B)(2)(iv) applies if a shareholder meets the requirements to look through the stock of a domestic non-consolidated C corporation under paragraph (c)(5)(ii)(B)(2)(i) of this section, determined without applying the constructive ownership rules of section 318(a). If this paragraph (c)(5)(ii)(B)(2)(iv) applies, then solely for purposes of allocating asset basis under paragraph (c)(5)(ii)(B)(2)(i) of this section, and except as otherwise provided in paragraph (c)(5)(ii)(D) of this section, the shareholder may look through to such shareholder’s pro rata share of the C corporation’s basis in its assets, taking into account the modifications in paragraph (c)(5)(i) of this section with respect to the C corporation’s assets, and adjusted to the extent required under paragraph (d)(4) of this section (asset basis look-through approach). If a shareholder applies the asset basis look-through approach, it must do so for all domestic non-consolidated C corporations for which the shareholder is eligible to use this approach, and it must report its use of this approach on the information statement described in paragraph (c)(6)(iii) of this section. The shareholder also must continue to use the asset basis look-through approach in all future taxable years in which the shareholder is eligible to use this approach.

(3) S corporations.

(i) Calculation of asset basis. For purposes of this section, a shareholder’s share of stock in an S corporation is treated as an asset of the shareholder. Additionally, for these purposes, the shareholder’s adjusted basis in a share of S corporation stock is adjusted to take into account the modifications in paragraph (c)(5)(i) of this section with respect to the assets of the S corporation (for example, a shareholder’s adjusted basis in its S corporation stock is increased by the shareholder’s share of depreciation with respect to an inherently permanent structure owned by the S corporation).

(ii) Allocation of asset basis. For purposes of determining the extent to which a shareholder’s basis in its stock of an S corporation is allocable to an excepted or non-excepted trade or business, the shareholder may look through to such shareholder’s share of the S corporation’s basis in the S corporation’s assets, allocated on a pro rata basis, adjusted to the extent required under paragraph (d)(4) of this section, except as otherwise provided in paragraph (c)(5)(ii)(D) of this section. Notwithstanding paragraph (c)(7) of this section, if a shareholder’s direct and indirect interest in an S corporation is greater than or equal to 80 percent of the S corporation’s stock by vote and value, the shareholder must apply the rules in this paragraph (c)(5)(ii)(B)(3) to look through to the S corporation’s basis in the S corporation’s assets. For these purposes, indirect stock ownership is determined by applying the constructive ownership rules of section 318(a).

(iii) De minimis rule. If at least 90 percent of a shareholder’s share of an S corporation’s basis in its assets is allocable to either excepted trades or businesses or non-excepted trades or businesses, the shareholder’s entire basis in its S corporation stock is treated as allocable to either excepted or non-excepted trades or businesses, respectively.

(iv) Inapplicability of S corporation look-through rule. If a shareholder chooses not to look through to the S corporation’s basis in the S corporation’s assets under paragraph (c)(5)(ii)(B)(3)(ii) of this section or is precluded by paragraph (c)(5)(ii)(D) of this section from applying such S corporation look-through rule, the shareholder will treat its basis in the S corporation stock as either an asset held for investment or a non-excepted trade or business asset as determined under section 163(d).

(C) Stock in relevant foreign corporations.

(1) In general. The rules applicable to domestic non-consolidated C corporations in paragraph (c)(5)(ii)(B) of this section also apply to relevant foreign corporations (as defined in §1.163(j)-1(b)(33)).

(2) Special rule for CFC utilities. Solely for purposes of applying the rules in paragraph (c)(5)(ii)(B) of this section, a utility trade or business conducted by an applicable CFC is treated as an excepted regulated utility trade or business, but only to the extent that the applicable CFC sells or furnishes the items described in §1.163(j)-1(b)(15)(i)(A)(1) pursuant to rates established or approved by an entity described in §1.163(j)-1(b)(15)(i)(A)(2), a foreign government, a public service or public utility commission or other similar body of any foreign government, or the governing or ratemaking body of a foreign electric cooperative. For purposes of this paragraph (c)(5)(ii)(C)(2), the term foreign government means any foreign government, any political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one of the foregoing within the meaning of §1.1471-6(b).

(D) Limitations on application of look-through rules.

(1) Inapplicability of look-through rule to partnerships or non-consolidated C corporations to which the small business exemption applies. A taxpayer may not apply the look-through rules in paragraphs (b)(3) and (c)(5)(ii)(A), (B), and (C) of this section to a partnership, S corporation, or non-consolidated C corporation that is eligible for the small business exemption under section 163(j)(3) and §1.163(j)-2(d)(1), unless the partnership, S corporation, or non-consolidated C corporation elects under §1.163(j)-9 for a trade or business to be an electing real property trade or business or an electing farming business.

(2) Limitation on application of look-through rule to C corporations. Except as provided in §1.163(j)-9(h)(4)(iii) and (iv) (for a REIT or a partnership making the election under §1.163(j)-9(h)(1) or (7), respectively), for purposes of applying the look-through rules in paragraph (c)(5)(ii)(B) and (C) of this section to a non-consolidated C corporation (upper-tier entity), that upper-tier entity may not apply these look-through rules to a lower-tier non-consolidated C corporation if a principal purpose for borrowing funds at the upper-tier entity level or adding an upper-tier or lower-tier entity to the ownership structure is increasing the amount of the taxpayer’s basis allocable to excepted trades or businesses. For example, P wholly and directly owns S1 (the upper-tier entity), which wholly and directly owns S2. Each of S1 and S2 is a non-consolidated C corporation to which the small business exemption does not apply, and S2 is engaged in an excepted trade or business. With a principal purpose of increasing the amount of basis allocable to its excepted trades or businesses, P has S1 (rather than S2) borrow funds from a third party. S1 may not look through the stock of S2 (and may not apply the asset basis look-through rule described in paragraph (c)(5)(ii)(B)(2)(iv) of this section) for purposes of P’s allocation of its basis in its S1 stock between excepted and non-excepted trades or businesses; instead, S1 must treat its stock in S2 as an asset used in a non-excepted trade or business for that purpose. However, S1 may look through the stock of S2 for purposes of S1’s allocation of its basis in its S2 stock between excepted and non-excepted trades or businesses.

(E) Tiered entities. If a taxpayer applies the look-through rules of this paragraph (c)(5)(ii), the taxpayer must do so for all lower-tier entities with respect to which the taxpayer satisfies, directly or indirectly, the minimum ownership threshold in paragraph (c)(7) of this section, subject to the limitation in paragraph (c)(5)(ii)(D) of this section, beginning with the lowest-tier entity.

(iii) Cash and cash equivalents and customer receivables. Except as otherwise provided in the last sentence of this paragraph (c)(5)(iii), a taxpayer’s basis in its cash and cash equivalents and customer receivables is not taken into account for purposes of this paragraph (c). This rule also applies to a lower-tier entity if a taxpayer looks through to the assets of that entity under paragraph (c)(5)(ii) of this section. For purposes of this paragraph (c)(5)(iii), the term cash and cash equivalents includes cash, foreign currency, commercial paper, any interest in an investment company registered under the Investment Company Act of 1940 (1940 Act) and regulated as a money market fund under 17 CFR 270.2a-7 (Rule 2a-7 under the 1940 Act), any obligation of a government, and any derivative that is substantially secured by an obligation of a government, or any similar asset. For purposes of this paragraph (c)(5)(iii), a derivative is a derivative described in section 59A(h)(4)(A), without regard to section 59A(h)(4)(C). For purposes of this paragraph (c)(5)(iii), the term government means the United States or any agency or instrumentality of the United States; a State, a territory, a possession of the United States, the District of Columbia, or any political subdivision thereof within the meaning of section 103 and §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). This paragraph (c)(5)(iii) does not apply to an entity that qualifies as a financial services entity as described in §1.904-4(e)(3).

(iv) Deemed asset sale. Solely for purposes of determining the amount of basis allocable to excepted and non-excepted trades or businesses under this section, an election under section 336, 338, or 754, as applicable, is deemed to have been made for any acquisition of corporate stock or partnership interests with respect to which the taxpayer demonstrates, in the information statement required by paragraph (c)(6)(iii)(B) of this section, that the acquisition qualified for such an election and that, immediately before the acquisition, the acquired entity had a regulatory liability for deferred taxes recorded on its books with respect to property predominantly used in an excepted regulated utility trade or business. Any additional basis taken into account under this rule is reduced ratably over a 15-year period beginning with the month of the acquisition and is not subject to the anti-abuse rule in paragraph (c)(8) of this section.

(v) Other adjustments. The Commissioner may make appropriate adjustments to prevent a taxpayer from intentionally and artificially increasing its basis in assets attributable to an excepted trade or business.

(6) Determination dates; determination periods; reporting requirements.

(i) Determination dates and determination periods.

(A) Quarterly determination periods. For purposes of this section, and except as otherwise provided in paragraph (c)(6)(i)(B) of this section, the term determination date means the last day of each quarter of the taxpayer’s taxable year (and the last day of the taxpayer’s taxable year, if the taxpayer has a short taxable year), and the term determination period means the period beginning the day after one determination date and ending on the next determination date.

(B) Annual determination periods. If a taxpayer satisfies the requirements of the last sentence of this paragraph (c)(6)(i)(B), the taxpayer may allocate asset basis for a taxable year based on the average of adjusted asset basis at the beginning of the year and the end of the year (annual determination method). For these purposes, the term determination date means the last day of the taxpayer’s taxable year, and the term determination period has the same meaning as provided in paragraph (c)(6)(i)(A) of this section. A taxpayer may use the annual determination method for a taxable year only if the taxpayer demonstrates that its total adjusted basis (as determined under paragraph (c)(5) of this section) at the end of the year in its assets used in its excepted trades or businesses, as a percentage of the taxpayer’s total adjusted basis at the end of such year in all of its assets used in a trade or business, does not differ by more than 20 percent from such percentage at the beginning of the year.

(ii) Application of look-through rules. If a taxpayer that applies the look-through rules of paragraph (c)(5)(ii) of this section has a different taxable year than the partnership or non-consolidated C corporation to which the taxpayer is applying those rules, then, for purposes of this paragraph (c)(6), the taxpayer must use the most recent asset basis figures from the partnership or non-consolidated C corporation. For example, assume that PS1 is a partnership with a May 31 taxable year, and that C (a calendar-year C corporation that is ineligible to use the annual determination method for the taxable year) is a partner in PS1. PS1’s determination dates are February 28, May 31, August 31, and November 30. In turn, C’s determination dates are March 31, June 30, September 30, and December 31. If C looks through to PS1’s basis in its assets under paragraph (c)(5)(ii) of this section, then, for purposes of determining the amount of C’s asset basis that is attributable to its excepted and non-excepted businesses on March 31, C must use PS1’s asset basis calculations for February 28.

(iii) Reporting requirements.

(A) Books and records. A taxpayer must maintain books of account and other records and data as necessary to substantiate the taxpayer’s use of an asset in an excepted trade or business and to substantiate any adjustments to asset basis for purposes of applying this paragraph (c). One indication that a particular asset is used in a particular trade or business is if the taxpayer maintains separate books and records for all of its excepted and non-excepted trades or businesses and can show the asset in the books and records of a particular excepted or non-excepted trade or business. For rules governing record retention, see §1.6001-1.

(B) Information statement. Except as otherwise provided in publications, forms, instructions, or other guidance, each taxpayer that is making an allocation under this paragraph (c), including any taxpayer that satisfies the de minimis rule in paragraph (c)(1)(ii) of this section, must prepare a statement titled “Section 163(j) Asset Basis Calculations” containing the information described in paragraphs (c)(6)(iii)(B)(1) through (7) of this section and must attach the statement to its timely filed Federal income tax return for the taxable year:

(1) The taxpayer’s adjusted basis in the assets used in its excepted and non-excepted businesses, determined as set forth in this section, including detailed information for the different groups of assets identified in paragraphs (c)(5)(i) and (ii) and (d) of this section;

(2) The determination dates on which asset basis was measured during the taxable year;

(3) The names and taxpayer identification numbers (TINs) of all entities for which basis information is being provided, including partnerships and corporations if the taxpayer that owns an interest in a partnership or corporation looks through to the partnership’s or corporation’s basis in the partnership’s or corporation’s assets under paragraph (c)(5)(ii) of this section. If the taxpayer is a member of a consolidated group, the name and TIN of the agent for the group, as defined in §1.1502-77, must be provided, but the taxpayer need not provide the names and TINs of all other consolidated group members;

(4) Asset basis information for corporations or partnerships if the taxpayer looks through to the corporation’s or partnership’s basis in the corporation’s or partnership’s assets under paragraph (c)(5)(ii) of this section;

(5) A summary of the method or methods used to determine asset basis in property used in both excepted and non-excepted businesses, as well as information regarding any deemed sale under paragraph (c)(5)(iv) of this section;

(6) Whether the taxpayer used the historical approach or the effective date approach for all of its disallowed disqualified interest; and

(7) If the taxpayer changed its methodology for allocating asset basis between or among two or more trades or businesses under paragraph (c)(3)(ii) of this section, a statement that the taxpayer has changed the allocation methodology and a description of the new methodology or, if the taxpayer is required to request consent for the allocation methodology change under paragraph (c)(3)(iii)(A)(2) of this section, a statement that the request has been or will be filed and a description of the methodology change.

(iv) Failure to file statement. If a taxpayer fails to file the statement described in paragraph (c)(6)(iii) of this section or files a statement that does not comply with the requirements of paragraph (c)(6)(iii) of this section, the Commissioner may treat the taxpayer as if all of its interest expense is properly allocable to a non-excepted trade or business, unless the taxpayer shows that there was reasonable cause for failing to comply with, and the taxpayer acted in good faith with respect to, the requirements of paragraph (c)(6)(iii) of this section, taking into account all pertinent facts and circumstances.

(7) Ownership threshold for look-through rules.

(i) Corporations.

(A) Asset basis. For purposes of this section, a shareholder must look through to the assets of a domestic non-consolidated C corporation or a relevant foreign corporation under paragraph (c)(5)(ii) of this section if the shareholder’s direct and indirect interest in the corporation satisfies the ownership requirements of section 1504(a)(2). For purposes of this paragraph (c)(7)(i)(A), indirect stock ownership is determined by applying the constructive ownership rules of section 318(a). A shareholder may look through to the assets of an S corporation under paragraph (c)(5)(ii) of this section for purposes of allocating the shareholder’s basis in its stock in the S corporation between excepted and non-excepted trades or businesses regardless of the shareholder’s direct and indirect interest in the S corporation.

(B) Dividends. A shareholder must look through to the activities of a domestic non-consolidated C corporation or a relevant foreign corporation under paragraph (b)(3) of this section if the shareholder’s direct interest in the corporation satisfies the ownership requirements of section 1504(a)(2). A shareholder may look through to the activities of a domestic non-consolidated C corporation or an applicable CFC under paragraph (b)(3) of this section if the shareholder’s direct interest in the corporation is greater than or equal to 80 percent by value. A shareholder may look through to the activities of an S corporation under paragraph (b)(3) of this section regardless of the shareholder’s direct interest in the S corporation.

(ii) Partnerships. A partner may look through to the assets of a partnership under paragraph (c)(5)(ii) of this section for purposes of allocating the partner’s basis in its partnership interest between excepted and non-excepted trades or businesses regardless of the partner’s direct and indirect interest in the partnership.

(iii) Inapplicability of look-through rule. For circumstances in which a taxpayer that satisfies the ownership threshold in this paragraph (c)(7) may not apply the look-through rules in paragraphs (b)(3) and (c)(5)(ii) of this section, see paragraph (c)(5)(ii)(D) of this section.

(8) Anti-abuse rule. If a principal purpose for the acquisition, disposition, or change in use of an asset was to artificially shift the amount of basis allocable to excepted or non-excepted trades or businesses on a determination date, the additional basis or change in use will not be taken into account for purposes of this section. For example, if an asset is used in a non-excepted trade or business for most of the taxable year, and if the taxpayer begins using the asset in an excepted trade or business towards the end of the year with a principal purpose of shifting the amount of basis in the asset that is allocable to the excepted trade or business, the change in use is disregarded for purposes of this section. A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately). In determining whether a taxpayer has a principal purpose described in this paragraph (c)(8), factors to be considered include, for example, the following: the business purpose for the acquisition, disposition, or change in use; the length of time the asset was used in a trade or business; whether the asset was acquired from a related person; and whether the taxpayer’s aggregate basis in its assets increased or decreased temporarily on or around a determination date. A principal purpose is presumed to be present in any case in which the acquisition, disposition, or change in use lacks a substantial business purpose and increases the taxpayer’s basis in assets used in its excepted trades or businesses by more than 10 percent during the taxable year.

(d) Direct allocations.

(1) In general. It is not necessary to allocate interest expense under this paragraph (d) if all of the taxpayer’s interest expense is allocable to excepted trades or businesses or if all of the taxpayer’s interest expense is allocable to non-excepted trades or businesses.

(2) Qualified nonrecourse indebtedness. For purposes of this section, a taxpayer with qualified nonrecourse indebtedness must directly allocate interest expense from the indebtedness to the taxpayer’s assets in the manner and to the extent provided in §1.861-10T(b). For purposes of this paragraph (d)(2), the term qualified nonrecourse indebtedness has the meaning provided in §1.861-10T(b), except that the term cash flow from the property (within the meaning of §1.861-10T(b)(3)(i)) includes revenue derived from the sale or lease of inventory or similar property with respect to an excepted regulated utility trade or business or a non-excepted regulated utility trade or business.

(3) Assets used in more than one trade or business. If an asset is used in more than one trade or business, the taxpayer must apply the rules in paragraph (c)(3) of this section to determine the extent to which interest that is directly allocated under this paragraph (d) is allocable to excepted or non-excepted trades or businesses.

(4) Adjustments to basis of assets to account for direct allocations. In determining the amount of a taxpayer’s basis in the assets used in its excepted and non-excepted trades or businesses for purposes of paragraph (c) of this section, adjustments must be made to reflect direct allocations under this paragraph (d). These adjustments consist of reductions in the taxpayer’s basis in its assets for purposes of paragraph (c) of this section to reflect assets to which interest expense is directly allocated under this paragraph (d). The amount of the taxpayer’s basis in these assets must be reduced, but not below zero, by the amount of qualified nonrecourse indebtedness secured by these assets. These adjustments must be made before the taxpayer averages the adjusted basis in its assets as determined on each determination date during the taxable year.

(5) Example: Direct allocation of interest expense.

(i) Facts. T conducts an electing real property trade or business (Business X) and operates a retail store that is a non-excepted trade or business (Business Y). In Year 1, T issues Note A to a third party in exchange for $1,000x for the purpose of acquiring Building B. Note A is qualified nonrecourse indebtedness (within the meaning of §1.861-10T(b)) secured by Building B. T then uses those funds to acquire Building B for $1,200x, and T uses Building B in Business X. During Year 1, T pays $500x of interest, of which $100x is interest payments on Note A. For Year 1, T’s basis in its assets used in Business X (as determined under paragraph (c) of this section) is $3,600x (excluding cash and cash equivalents), and T’s basis in its assets used in Business Y (as determined under paragraph (c) of this section) is $800x (excluding cash and cash equivalents). Each of Business X and Business Y also has $100x of cash and cash equivalents.

(ii) Analysis. Because Note A is qualified nonrecourse indebtedness that is secured by Building B, in allocating interest expense between Businesses X and Y, T first must directly allocate the $100x of interest expense it paid with respect to Note A to Business X in accordance with paragraph (d)(2) of this section. Thereafter, T must allocate the remaining $400x of interest expense between Businesses X and Y under paragraph (c) of this section. After excluding $1,000x of T’s basis in Building B to reflect the amount of Note A (see paragraph (d)(4) of this section), and without regard to T’s $200x of cash and cash equivalents (see paragraph (c)(5)(iii) of this section), T’s basis in its assets used in Businesses X and Y is $2,600x and $800x (76.5 percent and 23.5 percent), respectively. Thus, $306x of the remaining $400x of interest expense would be allocated to Business X, and $94x would be allocated to Business Y.

(e) Examples. The examples in this paragraph (e) illustrate the principles of this section. For purposes of these examples, no taxpayer is eligible for the small business exemption under section 163(j)(3) and §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 (without regard to section 163(j)) $35x of interest expense and receives $10x of interest income, and S pays or accrues (without regard to section 163(j)) $115x of interest expense and receives $5x of interest income (for a total of $150x of interest expense and $15x of interest income). For purposes of this example, assume that, pursuant to paragraph (c) of this section, $30x of the P group’s interest expense and $3x of the P group’s interest income is allocable to Business X, and the remaining $120x of interest expense and $12x of interest income is allocable to Business Y.

(ii) Analysis. Under paragraph (a)(4) of this section, 20 percent of the P group’s Year 1 interest expense ($30x / $150x) and interest income ($3x / $15x) is allocable to an excepted trade or business. Thus, $7x ($35x x 20 percent) of P’s interest expense and $2x ($10x x 20 percent) of P’s interest income is allocable to an excepted trade or business. The remaining $28x of P’s interest expense is business interest expense subject to the section 163(j) limitation, and the remaining $8x of P’s interest income is business interest income that increases the group’s section 163(j) limitation. In turn, $23x ($115x x 20 percent) of S’s interest expense and $1x ($5x x 20 percent) of S’s interest income is allocable to an excepted trade or business. The remaining $92x of S’s interest expense is business interest expense subject to the section 163(j) limitation, and the remaining $4x of S’s interest income is business interest income that increases the group’s section 163(j) limitation.

(2) Example 2: Interest allocation within a consolidated group with assets used in more than one trade or business.

(i) Facts. S is a member of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), and S conducts a non-excepted trade or business (Business Y). In Year 1, P pays or accrues (without regard to section 163(j)) $50x of interest expense, and S pays or accrues $100x of interest expense (without regard to section 163(j)). P leases 40 percent of space in Building V (which P owns) to S for use in Business Y, and P leases the remaining 60 percent of space in Building V to third parties. For purposes of allocating interest expense under paragraph (c) of this section, the P group’s basis in its assets (excluding Building V) used in Businesses X and Y is $180x and $620x, respectively. The P group’s basis in Building V for purposes of allocating interest expense under paragraph (c) of this section is $200x.

(ii) Analysis. Under paragraph (c)(3)(ii) of this section, the P group’s basis in Building V ($200x) is allocated to excepted and non-excepted trades or businesses in accordance with the use of space by Business Y (40 percent) and Business X (the remainder, or 60 percent). Accordingly, $120x of the basis in Building V is allocated to excepted trades or businesses (60 percent x $200x), and $80x is allocated to non-excepted trades or businesses (40 percent x $200x). After allocating the basis in Building V, the P group’s total basis in the assets used in excepted and non-excepted trades or businesses is $300x and $700x, respectively. Under paragraphs (a)(4) and (c) of this section, 30 percent ($300x / $1,000x) of the P group’s Year 1 interest expense is properly allocable to an excepted trade or business. Thus, $15x ($50x x 30 percent) of P’s interest expense is properly allocable to an excepted trade or business, and the remaining $35x of P’s interest expense is business interest expense subject to the section 163(j) limitation. In turn, $30x ($100x x 30 percent) of S’s interest expense is properly allocable to an excepted trade or business, and the remaining $70x of S’s interest expense is business interest expense subject to the section 163(j) limitation.

(3) Example 3: Application of look-through rules.

(i) Facts.

(A) Each of Corp A, Corp B, Corp C, and Corp D is a domestic calendar-year corporation that is not a member of a consolidated group. Corp A owns 100 percent of the stock of Corp C; the basis of Corp A’s stock in Corp C is $500x. Corp C owns 10 percent of the interests in PS1 (a domestic partnership), and Corp B owns the remaining 90 percent. Corp C’s basis in its PS1 interests is $25x; Corp B’s basis in its PS1 interests is $225x. PS1 owns 100 percent of the stock of Corp D; the basis of PS1’s stock in Corp D is $1,000x. Corp A and Corp B are owned by unrelated, non-overlapping shareholders.

(B) In 2021, Corp C was engaged solely in a non-excepted trade or business. That same year, PS1’s only activity was holding Corp D stock. In turn, Corp D was engaged in both an electing farming business and a non-excepted trade or business. Under the allocation rules in paragraph (c) of this section, 50 percent of Corp D’s asset basis in 2021 was allocable to the electing farming business, and the remaining 50 percent was allocable to the non-excepted trade or business.

(C) Corp A and Corp B each paid or accrued (without regard to section 163(j)) $150x of interest expense allocable to a trade or business. Corp A’s trade or business was an excepted trade or business, and Corp B’s trade or business was a non-excepted trade or business. Corp A’s basis in the assets used in its trade or business was $100x, and Corp B’s basis in the assets used in its trade or business was $112.5x.

(ii) Analysis.

(A) As provided in paragraph (c)(5)(ii)(E) of this section, if a taxpayer applies the look-through rules of paragraph (c)(5)(ii) of this section, the taxpayer must begin with the lowest-tier entity to which it is eligible to apply the look-through rules. Corp A directly owns 100 percent of the stock of Corp C; thus, Corp A satisfies the 80 percent minimum ownership threshold with respect to Corp C. Corp A also owns 10 percent of the interests in PS1. There is no minimum ownership threshold for partnerships; thus, Corp A may apply the look-through rules to PS1. However, Corp A does not directly or indirectly own at least 80 percent of the stock of Corp D; thus, Corp A cannot look through its indirect interest in Corp D. In turn, Corp B directly owns 90 percent of the interests in PS1, and Corp B indirectly owns at least 80 percent of the stock of Corp D. Thus, Corp B must apply the look-through rules to PS1 and Corp D.

(B) From Corp A’s perspective, PS1 is not engaged in a trade or business for purposes of section 163(j); instead, PS1 is merely holding its Corp D stock as an investment. Under paragraph (c)(5)(ii)(A)(2) of this section, if a partnership is not engaged in a trade or business, then its C corporation partner must treat its entire basis in the partnership interest as allocable to a non-excepted trade or business. Thus, for purposes of Corp A’s application of the look-through rules, Corp C’s entire basis in its PS1 interest ($25x) is allocable to a non-excepted trade or business. Corp C’s basis in its other assets also is allocable to a non-excepted trade or business (the only trade or business in which Corp C is engaged). Thus, under paragraph (c) of this section, Corp A’s $500x basis in its Corp C stock is allocable entirely to a non-excepted trade or business. Corp A’s $100x basis in its other business assets is allocable to an excepted trade or business. Thus, 5/6 (or $125x) of Corp A’s $150x of interest expense is properly allocable to a non-excepted trade or business and is business interest expense subject to the section 163(j) limitation, and the remaining $25x of Corp A’s $150x of interest expense is allocable to an excepted trade or business and is not subject to the section 163(j) limitation.

(C) From Corp B’s perspective, PS1 must look through its stock in Corp D to determine the extent to which PS1’s basis in the stock is allocable to an excepted or non-excepted trade or business. Half of Corp D’s basis in its assets is allocable to an excepted trade or business, and the other half is allocable to a non-excepted trade or business. Thus, from Corp B’s perspective, $500x of PS1’s basis in its Corp D stock (PS1’s only asset) is allocable to an excepted trade or business, and the other half is allocable to a non-excepted trade or business. Corp B’s basis in its PS1 interests is $225x. Applying the look-through rules to Corp B’s PS1 interests, $112.5x of Corp B’s basis in its PS1 interests is allocable to an excepted trade or business, and $112.5x of Corp B’s basis in its PS1 interests is allocable to a non-excepted trade or business. Since Corp B’s basis in the assets used in its non-excepted trade or business also was $112.5x, two-thirds of Corp B’s interest expense ($100x) is properly allocable to a non-excepted trade or business and is business interest expense subject to the section 163(j) limitation, and one-third of Corp B’s interest expense ($50x) is allocable to an excepted trade or business and is not subject to the section 163(j) limitation.

(4) Example 4: Excepted and non-excepted trades or businesses in a consolidated group.

(i) Facts. P is the common parent of a consolidated group of which A and B are the only other members. A conducts an electing real property trade or business (Business X), and B conducts a non-excepted trade or business (Business Y). In Year 1, A pays or accrues (without regard to section 163(j)) $50x of interest expense and earns $70x of gross income in the conduct of Business X, and B pays or accrues (without regard to section 163(j)) $100x of interest expense and earns $150x of gross income in the conduct of Business Y. B owns Building V, which it uses in Business Y. For purposes of allocating the P group’s Year 1 business interest expense between excepted and non-excepted trades or businesses under paragraph (c) of this section, the P group’s basis in its assets (other than Building V) used in Businesses X and Y is $180x and $620x, respectively, and the P group’s basis in Building V is $200x. At the end of Year 1, B sells Building V to a third party and realizes a gain of $60x in addition to the $150x of gross income B earned that year from the conduct of Business Y.

(ii) Analysis.

(A) Under paragraphs (a)(4) and (c) of this section, the P group’s basis in its assets used in its trades or businesses is allocated between the P group’s excepted trade or business (Business X) and its non-excepted trade or business (Business Y) as though these trades or businesses were conducted by a single corporation. Under paragraph (c) of this section, the P group’s basis in its assets used in Businesses X and Y is $180x and $820x, respectively. Accordingly, 18 percent ($180x / $1,000x) of the P group’s total interest expense ($150x) is properly allocable to an excepted trade or business ($27x), and the remaining 82 percent of the P group’s total interest expense is business interest expense properly allocable to a non-excepted trade or business ($123x).

(B) To determine the P group’s section 163(j) limitation, paragraph (a) of this section requires that certain items of income and deduction be allocated to the excepted and non-excepted trades or businesses of the P group as though these trades or businesses were conducted by a single corporation. In Year 1, the P group’s excepted trade or business (Business X) has gross income of $70x, and the P group’s non-excepted trade or business (Business Y) has gross income of $150x. Because Building V was used exclusively in Business Y, the $60x of gain from the sale of Building V in Year 1 is attributed to Business Y under paragraph (b)(2) of this section. The P group’s section 163(j) limitation is $63x (30 percent x $210x), which allows the P group to deduct $63x of its $123x of business interest expense allocated to the P group’s non-excepted trades or businesses. The group’s $27x of interest expense that is allocable to excepted trades or businesses may be deducted without limitation under section 163(j).

(iii) Intercompany transaction. The facts are the same as in Example 4 in paragraph (e)(4)(i) of this section, except that A owns Building V and leases it to B in Year 1 for $20x for use in Business Y, and A sells Building V to a third party for a $60 gain at the end of Year 1. Under paragraphs (a)(4) and (c) of this section, all members of the P group are treated as a single corporation. As a result, the P group’s basis in its assets used in its trades or businesses is allocated between the P group’s excepted trade or business (Business X) and its non-excepted trade or business (Business Y) as though these trades or businesses were conducted by a single corporation. A lease between two divisions of a single corporation would produce no rental income or expense. Thus, the $20x of rent paid by B to A does not affect the P group’s ATI. Moreover, under paragraph (c) of this section, Building V is an asset used in the P group’s non-excepted trade or business (Business Y). Accordingly, although A owns Building V, the basis in Building V is added to the P group’s basis in assets used in Business Y for purposes of allocating interest expense under paragraph (c) of this section. In the same vein, when A sells Building V to a third party at a gain of $60x, the gain is included in the P group’s ATI because Building V was used in a non-excepted trade or business of the P group (Business Y) prior to its sale.

(5) Example 5: Captive activities.

(i) Facts. S and T are members of a consolidated group of which P is the common parent. P conducts an electing real property trade or business (Business X), S conducts a non-excepted trade or business (Business Y), and T provides transportation services to Businesses X and Y but does not have any customers outside of the P group. For Year 1, T provides transportation services using a single bus with a basis of $120x.

(ii) Analysis. Under paragraph (a)(4) of this section, activities conducted by a consolidated group are treated as though those activities were conducted by a single corporation. Because the activities of T are limited to providing intercompany transportation services, T does not conduct a trade or business for purposes of section 163(j). Under paragraph (c)(3) of this section, business interest expense is allocated to excepted and non-excepted trades or businesses based on the relative basis of the assets used in those businesses. The basis in T’s only asset, a bus, is therefore allocated between Business X and Business Y according to the use of T’s bus by these businesses. Business X uses one-third of T’s services, and Business Y uses two-thirds of T’s services. Thus, $40x of the basis of T’s bus is allocated to Business X, and $80x of the basis of T’s bus is allocated to Business Y.

(6) Example 6: Constructive ownership.

(i) Facts. P, S, T, and U are domestic C corporations that are not members of a consolidated group. P directly owns 80 percent of the stock of each of S and T as measured by total voting power and value; an unrelated third party, X, owns the remaining 20 percent. In turn, S and T directly own 15 percent and 80 percent, respectively, of the stock of U as measured by total voting power and value; P directly owns the remaining 5 percent. P conducts both excepted and non-excepted trades or businesses. S and T conduct only non-excepted trades or businesses, and U conducts both excepted and non-excepted trades or businesses.

(ii) Analysis. Under paragraph (c)(7)(i)(A) of this section, a shareholder must look through to the assets of a domestic non-consolidated C corporation for purposes of allocating the shareholder’s basis in its stock in the corporation between excepted and non-excepted trades or businesses if the shareholder’s direct and indirect interest in the corporation satisfies the ownership requirements of section 1504(a)(2). For purposes of paragraph (c)(7)(i)(A) of this section, a shareholder’s stock ownership is determined by applying the constructive ownership rules of section 318(a). P directly owns 80 percent of each of S and T as measured by total voting power and value; thus, P must look through to the assets of S and T when allocating the basis in its stock of S and T. P directly owns 5 percent of the stock of U as measured by total voting power and value, and P constructively owns the other 95 percent; thus, P also must look through to U’s assets when allocating the basis in its U stock. S directly owns 15 percent of the stock of U, and S constructively owns only 5 percent through P; thus, S cannot look through to U’s assets when allocating the basis in its U stock. T directly owns 80 percent of the stock of U, and T constructively owns an additional 5 percent; thus, T must look through to U’s assets when allocating the basis in its U stock.

(iii) Dividend. The facts are the same as in paragraph (e)(6)(i) of this section, except that U distributes a $160x dividend pro rata to its shareholders. Thus, P receives $8x (5 percent of $160x) of the U dividend, S receives $24x (15 percent of $160x), and T receives $128x (80 percent of $160x). Under paragraph (c)(7)(i)(B) of this section, if a shareholder’s direct interest in a corporation satisfies the ownership requirements of section 1504(a)(2), the shareholder must look through to the activities of a domestic non-consolidated C corporation in determining whether dividend income is from an excepted or non-excepted trade or business. The constructive ownership rules do not apply in allocating dividends under paragraph (c)(7)(i)(B) of this section. P directly owns 5 percent of the stock of U as measured by vote and value, and S directly owns 15 percent of the stock of U as measured by vote and value; thus, neither P nor S is required to apply the look-through rules in allocating its dividend income from U, and all such income is allocable to non-excepted trades or businesses. T directly owns 80 percent of the stock of U as measured by vote and value; thus, T must allocate its U dividend in accordance with the activities of U’s excepted and non-excepted trades or businesses.

(7) Example 7: Dispositions with a principal purpose of shifting basis.

(i) Facts. U and V are members of a consolidated group of which P is the common parent. U conducts an electing farming business (Business F), and V conducts a farm equipment leasing business (Business L) that is a non-excepted trade or business. After the end of a farming season, the P group, with a principal purpose of shifting basis from Business L to Business F, has V sell to U all off-lease farming equipment that previously was leased out as part of Business L. Immediately before the start of the next season, U sells the farming equipment back to V for use in Business L.

(ii) Analysis. Under paragraph (c)(8) of this section, in the case of a disposition of assets undertaken with a principal purpose of artificially shifting the amount of basis allocable to excepted or non-excepted trades or businesses on a determination date, the additional basis or change in use will not be taken into account. Because V’s sale of farming equipment to U for storage in Business F’s facilities is undertaken with a principal purpose of shifting basis from Business L to Business F, the additional basis Business F receives from these transactions will not be taken into account for purposes of this section. Instead, the basis of the farming equipment will be allocated as though the farming equipment continued to be used in Business L.

(f) Applicability dates.

(1) In general. This section applies to taxable years beginning on or after November 13, 2020. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of this section to a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of the section 163(j) regulations, and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year. Accordingly, for purposes of §1.163(j)-10(c)(5), taxpayers make any change to the alternative depreciation system as of November 13, 2020, or if relying on the provisions of §1.163(j)-10 in regulation project REG-106089-18 (83 FR 67490), as of December 28, 2018.

(2) Paragraph (c)(5)(ii)(D)(2). The rules contained in paragraph (c)(5)(ii)(D)(2) of this section apply for taxable years beginning on or after March 22, 2021. However, taxpayers may choose to apply the rules in paragraph (c)(5)(ii)(D)(2) of this section to a taxable year beginning after December 31, 2017, and before March 22, 2021, provided that those taxpayers and their related parties consistently apply all of the rules in the section 163(j) regulations as contained in T.D. 9905 (§§ 1.163(j)-0 through 1.163(j)-11, effective November 13, 2020) as modified by T.D. 9943 (effective January 13, 2021), and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-0, 1.383-1, 1.469-9, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4 contained in T.D. 9905 as modified by T.D. 9943, to that taxable year and each subsequent taxable year.

[Added by T.D. 9905, 85 FR 56686-56845, Sept. 14, 2020; amended by T.D. 9943, 86 FR 5496-5541, Jan. 19, 2021.]

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