Internal Revenue Bulletin 2020-40 (PDF rendition): IRS Announcements

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Bulletin No. 2020–40
September 28, 2020
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
ADMINISTRATIVE
Notice 2020-66, page 785.
This notice provides interim guidance addressing whether
certain Medicaid coverage of COVID-19 testing and diagnos-
tic services is minimum essential coverage for purposes of
the premium tax credit under section 36B of the Internal Rev-
enue Code. This notice also announces that the Department
of the Treasury and the Internal Revenue Service intend to
amend § 1.5000A-2 of the Income Tax Regulations to add
Medicaid coverage of COVID-19 testing and diagnostic ser-
vices to the list of health care coverage that is not minimum
essential coverage under a government-sponsored program.
ADMINISTRATIVE, EMPLOYEE PLANS
Announcement 2020-17, page 794.
Announcement 2020-17 postpones, until January 15, 2021,
the due dates for reporting and paying the excise taxes un-
der §§ 4971(a)(1) and 4971(f)(1) of the Internal Revenue
Code with respect to certain delayed minimum required con-
tributions to a single employer defined benefit plan. This
postponement applies with respect to a required contribution
to which the extended due date under § 3608(a) of the Coro-
navirus Aid, Relief, and Economic Security Act, Pub. L. No.
116-136 (134 Stat. 281) (CARES Act), applies.
EMPLOYEE PLANS
Notice 2020-72, page 789.
This notice sets forth updates on the corporate bond month-
ly yield curve, the corresponding spot segment rates for
September 2020 used under § 417(e)(3)(D), the 24-month
average segment rates applicable for September 2020, and
the 30-year Treasury rates, as reflected by the application of
§ 430(h)(2)(C)(iv).
INCOME TAX
Notice 2020-59, page 782.
This notice contains a proposed revenue procedure with a
safe harbor for a trade or business that manages or oper-
ates a qualified residential living facility to be treated as a real
property trade or business solely for purposes of qualifying
as an electing real property trade or business under section
163(j)(7)(B) of the Internal Revenue Code.
Notice 2020-71, page 786.
Optional special per diem rates. This notice provides the
2020-2021 special per diem rates for taxpayers to use in
substantiating the amount of ordinary and necessary busi-
ness expenses incurred while traveling away from home.
The notice includes (1) the special transportation industry
rate, (2) the rate for the incidental expenses only deduction,
and (3) the rates and list of high-cost localities for the high-
low substantiation method.
REG-107911-18, page 795.
This notice of proposed rulemaking supplements TD 9905
and provides rules concerning the limitation on the deduction
for business interest expense. Specifically, these proposed
regulations address application of the limitation in contexts
involving passthrough entities, regulated investment compa-
nies (RICs), United States shareholders of controlled foreign
corporations, and foreign persons with effectively connected
income in the United States. These proposed regulations also
provide guidance regarding the definitions of real property de-
velopment, real property redevelopment, and a syndicate.
Rev. Proc. 2020-41, page 793.
Revenue Procedure 2020-41 provides domestic asset/liabil-
ity percentages and domestic investment yields needed by
foreign life insurance companies and foreign property and
liability insurance companies to compute their minimum ef-
Finding Lists begin on page ii.

fectively connected net investment income under section
842(b) of the Internal Revenue Code for taxable years begin-
ning after December 31, 2018.
Rev. Rul. 2020-19, page 611.
This revenue ruling provides guidance on what constitutes a
change in basis of computing life insurance reserves under
§ 807(f) of the Internal Revenue Code, as amended by the
Tax Cuts and Jobs Act. This revenue ruling provides specific
holdings in a number of different situations, with each hold-
ing indicating whether the described situation is a change in
basis under § 807(f).
T.D. 9905, page 614.
This document contains final regulations providing
guidance about the limitation on the deduction for
business interest expense. The regulations provide
guidance to taxpayers on how to calculate the limita-
tion, what constitutes interest for purposes of the lim-
itation, which taxpayers and trades or businesses are
subject to the limitation, and how the limitation applies
in consolidated group, partnership, international, and
other contexts.

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing of-
ficial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
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It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
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modify, or amend any of those previously published in the
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wise indicated. Procedures relating solely to matters of inter-
nal management are not published; however, statements of
internal practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service
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comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
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procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative
Rulings. Bank Secrecy Act Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
September 28, 2020 Bulletin No. 2020–40

Part I
Section 807.—Rules for
certain reserves
Rev. Rul. 2020-19
ISSUE
In the situations described below, is
there a change in basis of computing life
insurance reserves under § 807(f) of the
Internal Revenue Code, as amended by
section 13513 of Public Law No. 115-97,
commonly referred to as the Tax Cuts and
Jobs Act (TCJA), 131 Stat. 2054, 2143
(2017)?
FACTS
IC, a calendar year life insurance com-
pany within the meaning of § 816(a), is-
sues life insurance and annuity contracts
directly and also reinsures the risks on
such contracts issued by other compa-
nies. IC is required to determine life in-
surance reserves under § 807(d) with
respect to both directly written and rein-
sured contracts and to take net increases
or decreases in the reserves into account
in computing life insurance company tax-
able income. IC computes the amount of
the life insurance reserve for a contract in
accordance with the net surrender value
(NSV) floor of § 807(d)(1)(A) and (B) and
the statutory cap of § 807(d)(1)(C).
Situation 1. Beginning in Year 1, IC
issues variable annuity contracts within
the meaning of § 817(d). On its Federal
income tax returns for Years 1 and 2, IC
computed the amount of the reserve with
regard to each of those contracts under the
Commissioners’ Annuities Reserve Valua-
tion Method (CARVM) prescribed by the
National Association of Insurance Com-
missioners (NAIC) but incorrectly applied
the 92.81% factor of § 807(d)(1)(B) to
that entire amount, rather than only to the
excess of that amount over the greater of
each contract’s NSV or the portion of the
reserve separately accounted for under
§ 817.
Situation 2. In Year 4, the NAIC makes
a change to the NAIC Valuation Manual
21 (VM-21) that imposes a new compu-
tational requirement as a component of
CARVM on issuers of variable annuities
with guaranteed minimum benefits. The
requirement applies to the determination
of statutory reserves as of December 31,
Year 4, with regard to contracts issued af-
ter December 31, Year 1. On its Federal
income tax returns for Years 2 and 3, IC
determined its reserves for variable an-
nuity contracts under the requirements of
VM-21. As a result of the change in VM-
21, IC’s statutory reserves for these con-
tracts as of December 31, Year 4, will be
lower than they would have been had the
change not been made.
Situation 3. The facts are the same as
in Situation 2, except that the change to
VM-21 applies to the determination of
statutory reserves as of December 31,
Year 4, with regard to contracts issued af-
ter December 31, Year 3.
Situation 4. The NAIC issues a new
Actuarial Guideline that imposes a new
computational requirement for the Com-
missioners’ Reserve Valuation Method
(CRVM) for universal life contracts issued
before Year 1. The requirement applies to
the determination of statutory reserves for
these contracts as of December 31, Year 3.
IC’s statutory reserves for these contracts
as of December 31, Year 3, will be lower
than they would have been had the NAIC
not issued the new Actuarial Guideline.
Situation 5. IC computes its reserves
for a group of life insurance contracts un-
der NAIC Valuation Manual 20 (VM-20).
The group of contracts passes both the
stochastic exclusion test and the deter-
ministic exclusion test of VM-20, and the
company elects to exclude the group from
both the stochastic reserve calculation
and the deterministic reserve calculation.
Accordingly, the statutory reserve for the
group is equal to the sum of the policy net
premium reserves.
VM-20 prescribes the mortality standard
to be used to compute the net premium re-
serves for the contracts. The NAIC changes
the Valuation Manual to require the use of
the Year 1 Commissioners’ Standard Or-
dinary (CSO) mortality tables to compute
the net premium reserves for all contracts
subject to VM-20. The requirement applies
to the determination of statutory reserves
for these contracts as of December 31,
Year 3. IC’s statutory reserves for each of
the contracts in the group of contracts as of
December 31, Year 3, will be lower than
they would have been had the NAIC not
changed the Valuation Manual to prescribe
the use of the Year 1 CSO mortality tables.
Situation 6. IC computes its reserves
for certain life insurance contracts under
VM-20. Under VM-20, the minimum stat-
utory reserve for the contracts is equal to
the sum of the policy minimum net pre-
mium reserves for the contracts, plus the
excess, if any, of the greater of the deter-
ministic reserve for the contracts and the
stochastic reserve for the contracts. For the
taxable years ended December 31, Year 1,
and December 31, Year 2, the determin-
istic reserve exceeded both the stochastic
reserve and the sum of the policy net pre-
mium reserves for the contracts and thus
was the statutory reserve reported on the
NAIC annual statement. The excess of the
deterministic reserve over the sum of the
policy net premium reserves was allocated
to individual contracts in the manner pre-
scribed by VM-20. IC’s statutory reserves
at December 31, Year 3, were equal to the
sum of the policy net premium reserves
for the contracts because this amount ex-
ceeded the deterministic reserve and sto-
chastic reserve as of that date. There was
no change in the method of computing
the deterministic reserve, the stochastic
reserve, or the sum of the policy net pre-
mium reserves for the contracts in Year 3.
Situation 7. IC computes its reserves
for certain life insurance contracts under
VM-20. Under VM-20, the minimum stat-
utory reserve for the contracts is equal to
the sum of the policy minimum net pre-
mium reserves for the contracts, plus the
excess, if any, of the greater of the deter-
ministic reserve for the contracts and the
stochastic reserve for the contracts. For the
taxable years ended December 31, Year 1,
and December 31, Year 2, the determin-
istic reserve exceeded both the stochastic
reserve and the sum of the policy net pre-
mium reserves for the contracts, and thus
was the statutory reserve reported on the
NAIC annual statement. Pursuant to the
requirements of VM-20, this excess was
allocated to individual contracts. For pur-
poses of computing the deterministic re-
serve, section 9.c.2 of VM-20 requires that
Bulletin No. 2020–40 611 September 28, 2020

company experience mortality rates be de-
termined for each mortality segment and
that the company experience data used to
determine those rates be updated at least
every three years. Because of the VM-20
mandated update, the mortality rates used
for certain segments to compute the deter-
ministic reserve as of December 31, Year
2, differed from those used for purposes of
computing the deterministic reserve as of
December 31, Year 1.
Situation 8. On its Federal income tax
return for the taxable year ended Decem-
ber 31, Year 1, IC reported tax reserves
for certain fixed annuity contracts equal
to 92.81% of the CARVM reserves for
the contracts, because that amount for
each contract exceeded the NSV for each
contract. For the taxable year ended De-
cember 31, Year 2, IC instead reported tax
reserves equal to the NSV of those same
contracts because that amount for each
contract was greater than 92.81% of the
CARVM reserve for each contract. There
was no change in the CARVM or in the
method of computing the NSV for any
contract in Year 2.
Situation 9. For purposes of computing
its life insurance reserves under § 807(d),
IC organizes its life insurance contracts
into policy groupings or cells, each con-
sisting of policies that are identical as to
plan of insurance, year of issue or contract
duration, age of issue, and other factors.
In Year 2, after filing its Federal income
tax return for the Year 1 taxable year, IC
discovered that due to a computer pro-
gramming error the policy cells for cer-
tain contracts issued during Year 1 had
been omitted from the computation of
IC’s closing Year 1 tax reserves. Had the
omitted policy cells been included in IC’s
closing Year 1 reserves, IC’s life insurance
reserves under § 807(d) at December 31,
Year 1, would have been greater than the
amounts originally claimed. The comput-
er programming error took place in Year 1
and affected no other taxable year.
Situation 10. In Year 2, IC announced
to certain of its policyholders that their
policies would, at no increase in premium,
henceforth carry an additional indemnity
benefit should death result from a non-oc-
cupational vehicular accident. At the end
of Year 2, IC included in its reserves for the
relevant contracts an additional amount
for the present value of this additional fu-
ture unaccrued obligation. The additional
amount would be a life insurance reserve
under § 816(b) and was determined under
a tax reserve method within the meaning
of § 807(d)(2).
LAW AND ANALYSIS
Section 811(a) provides that a life in-
surance company is required to compute
its taxable income using an accrual meth-
od of accounting or, to the extent permit-
ted under regulations prescribed by the
Secretary of the Treasury or his delegate
(Secretary), using a combination of an ac-
crual method of accounting with another
permissible method (other than the cash
receipts and disbursements method). To
the extent not inconsistent with the re-
quirement in the preceding sentence or
other Federal income tax rules applica-
ble to life insurance companies, all such
computations, however, are to be made
in a manner consistent with the manner
required for purposes of the annual state-
ment approved by the NAIC.
Section 803(a)(2) requires income to
be taken into account for any net decrease
in reserves described in § 807(c). Similar-
ly, § 805(a)(2) authorizes a deduction for
any net increase in reserves described in
§ 807(c). Under § 807(c)(1), the reserves
to which this treatment applies include
“life insurance reserves (as defined in
§ 816(b)).”
Section 807(d)(1) provides rules for
determining the amount of life insurance
reserves other than for purposes of § 816
(relating to qualification as a life insur-
ance company). In general, the amount of
the life insurance reserve with respect to
any contract is the greater of the NSV of
the contract or 92.81% of the reserve de-
termined under § 807(d)(2). For a variable
contract, the reserve is the sum of (1) the
greater of the NSV of the contract and the
portion of the reserve separately account-
ed for under § 817 plus (2) 92.81% of the
excess of the total reserve determined un-
der § 807(d)(2) over the NSV or § 817 re-
serve, as applicable.
Section 807(d)(2) provides that the re-
serve for any contract must be determined
using the tax reserve method applicable to
the contract. Section 807(d)(3) provides
that the applicable tax reserve method is
(1) in the case of a contract covered by
the CRVM, the CRVM prescribed by the
NAIC that is applicable to the contract and
in effect as of the date the reserve is de-
termined and (2) in the case of a contract
covered by the CARVM, the CARVM
prescribed by the NAIC that is applicable
to the contract and in effect as of the date
the reserve is determined.
Section 807(f) provides that if the ba-
sis for determining any item referred to
in § 807(c), which includes life insurance
reserves, as of the close of any taxable
year differs from the basis for determining
that item as of the close of the preceding
taxable year, then so much of the differ-
ence between (1) the amount of the item
at the close of the taxable year, computed
on the new basis, and (2) the amount of
the item at the close of the taxable year,
computed on the old basis, as is attribut-
able to contracts issued before the taxable
year, is taken into account under § 481(a)
as an adjustment attributable to a change
in method of accounting initiated by the
taxpayer and made with the consent of the
Secretary.
Section 1.807-4(a) of the Income Tax
Regulations provides that a change in
basis of computing an item referred to in
§ 807(c) is a change in method of account-
ing for purposes of § 1.446-1(e), unless
§ 1.446-1(e) provides otherwise. Accord-
ingly, a change in basis under § 807(f) is
a change in method of accounting subject
to § 446(e) and the regulations thereunder.
In accordance with § 446(e) and § 1.446-
1(e), before computing an item described
in § 807(c) under a new basis, a life insur-
ance company must obtain the consent of
the Commissioner of the Internal Revenue
or his delegate (Commissioner) pursuant
to administrative procedures prescribed
by the Commissioner. See section 26.04
of Rev. Proc. 2019-43, 2019-48 I.R.B.
1107 (or successor) (generally providing
the Commissioner’s automatic consent
for a life insurance company to change
its basis of computing an item referred to
in § 807(c)). Section 1.807-4(b) provides
rules relating to the required adjustments
under § 481(a). Section 1.807-4(c) de-
scribes how opening and closing balances
of § 807(c) items are determined under
§ 807(a) and (b) when there is a change in
basis under § 807(f).
As with the general rules for methods
of accounting, a company adopts a basis of
September 28, 2020 612 Bulletin No. 2020–40

Bulletin No. 2020–40 613 September 28, 2020
computing an item referred to in § 807(c)
when it uses a permissible basis of com-
puting the item on the first Federal income
tax return that reflects the item. If a com-
pany uses an impermissible basis of com-
puting an item on the tax return for one
taxable year, such computation does not
constitute the adoption of a basis of com-
puting the item. However, the consistent
use of an impermissible basis of comput-
ing an item on two or more consecutively
filed tax returns establishes the basis of
computing the item. If a company has ad-
opted a basis of computing an item, it may
not change the basis by amending its prior
tax returns. See Rev. Rul. 90-38, 1990-1
C.B. 57; Rev. Rul. 2003-127, 2003-2 C.B.
1245; Thrasys, Inc. v. Commissioner, T.C.
Memo 2018-199. Additionally, a change
in an item referred to in § 807(c) resulting
from a change in underlying facts or from
the correction of mathematical or posting
errors is not a change in basis of comput-
ing the item under § 807(f). See § 1.446-
1(e)(2)(ii)(b).
In Situation 1, IC applied the 92.81%
factor of § 807(d) impermissibly on two
consecutively filed Federal income tax
returns – those for Year 1 and Year 2. IC
therefore adopted an impermissible basis
of computing reserves (old basis). Ap-
plying the 92.81% factor to the correct
portion of the reserve determined under
§ 807(d)(2) (new basis) for Year 3 (year
of change) is a change in basis under
§ 807(f). For the year of change, IC must
obtain the consent of the Commissioner to
make this change following the applicable
administrative guidance under § 446(e)
and § 1.446-1(e) and account for the dif-
ference between the tax reserve computed
on the new basis as of December 31, Year
3, and the tax reserve computed on the old
basis as of December 31, Year 3, attribut-
able to contracts issued before Year 3, as
an adjustment under § 481(a).
In Situation 2, a change to VM-21 im-
poses a new computational requirement
as a component of CARVM on issuers
of variable annuities with guaranteed
minimum benefits (new basis). The re-
quirement applies to the determination of
reserves as of December 31, Year 4 (year
of change), and revises the prior VM-21
requirements (old basis) with regard to
contracts issued after December 31, Year
1. Because for Federal income tax purpos-
es § 807(d)(3)(B)(ii) requires the use of
the CARVM “which is applicable to the
contract and in effect as of the date the re-
serve is determined,” the change to VM-
21 is required to be taken into account for
purposes of applying § 807(d). The new
requirement represents a change in the
methodology for satisfying the CARVM
as prescribed by the NAIC. The change is
therefore a change in basis under § 807(f).
IC must obtain the consent of the Com-
missioner to make this change and must
account for the difference between the tax
reserve computed on the new basis as of
December 31, Year 4, and the tax reserve
computed on the old basis as of December
31, Year 4, attributable to contracts issued
after Year 1 and before Year 4 as an adjust-
ment under § 481(a).
In Situation 3, as in Situation 2, the new
requirement (new basis) is a change in
the methodology for satisfying CARVM
and is therefore a change in basis under
§ 807(f). IC must obtain the consent of the
Commissioner to make this change. Be-
cause the change only applies to contracts
issued after Year 3, the change is made on
a cut-off basis and no adjustment is re-
quired under § 481(a). See section 2.07 of
Rev. Proc. 2015-13.
In Situation 4, a newly-issued Actuari-
al Guideline imposes a new computational
requirement for the CRVM for universal
life contracts (new basis). The requirement
applies to the determination of reserves as
of December 31, Year 3 (year of change),
and revises the prior CRVM requirements
(old basis) with regard to contracts issued
before Year 1. Because for Federal income
tax purposes § 807(d)(3)(B)(i) requires
the use of the CRVM “which is applica-
ble to the contract and in effect as of the
date the reserve is determined,” the new
Actuarial Guideline is required to be tak-
en into account for purposes of applying
§ 807(d). The new requirement represents
a change in the methodology for satisfy-
ing the CRVM prescribed by the NAIC.
The change is therefore a change in basis
under § 807(f). IC must obtain the consent
of the Commissioner to make this change
and account for the difference between the
tax reserve computed on the new basis as
of December 31, Year 3, and the tax re-
serve computed on the old basis as of De-
cember 31, Year 3, as an adjustment under
§ 481(a).
In Situation 5, a group of contracts that
is subject to VM-20 passes both the sto-
chastic and deterministic exclusion tests
of VM-20, and IC elects to exclude the
group from both the stochastic and deter-
ministic reserve calculations. As a result,
the statutory reserve with regard to each
contract is equal to the policy net premium
reserve, and the tax reserve is the greater
of 92.81% of this amount or the contract’s
NSV (old basis). The NAIC changes the
Valuation Manual to require the use of the
Year 1 CSO mortality tables to compute
the net premium reserves for all contracts
subject to VM-20 (new basis), effective
for the determination of statutory reserves
(and, as a result, tax reserves) as of De-
cember 31, Year 3 (year of change). IC’s
statutory reserves for each of the contracts
in the group of contracts will be lower
than they would have been had there not
been a change in tables. The new require-
ment represents a change in the methodol-
ogy for satisfying the CRVM prescribed
by the NAIC. The change is therefore a
change in basis under § 807(f). IC must
obtain the consent of the Commissioner to
make this change and account for the dif-
ference between the tax reserve computed
on the new basis as of December 31, Year
3, and the tax reserve computed on the old
basis as of December 31, Year 3, as an ad-
justment under § 481(a).
In Situation 6, the comparison of the
sum of the policy net premium reserves
to the stochastic reserve and deterministic
reserve is required under VM-20, which is
the CRVM and the tax reserve method re-
quired to be used under § 807(d)(3). As a
result, a change from using the determin-
istic reserve to using the sum of the policy
net premium reserves is not a change in
basis but rather a function of the year-
over-year change in those amounts. The
result would be the same if there had been
a statutory deterministic reserve in Years
1, 2, and 3, and under the terms of VM-
20 some contracts were not allocated any
deterministic reserve in Years 1 and 2 but
were allocated a portion of the determinis-
tic reserve in Year 3.
In Situation 7, the statutory reserve for
the relevant contracts was equal to the de-
terministic reserve, and the mortality rates
that IC used for purposes of computing
the deterministic reserve as of December
31, Year 2, differed from those used for

September 28, 2020 614 Bulletin No. 2020–40
purposes of computing the deterministic
reserve as of December 31, Year 1. The
rates were different, however, by reason
of a requirement of VM-20 that the com-
pany experience rates be determined for
each mortality segment and that experi-
ence data used to determine those rates
be updated at least every three years. The
update in mortality rates, therefore, was
by operation of the reserve methodology
of VM-20, which IC used consistently in
both Year 1 and Year 2. The change there-
fore is not a change in basis of computing
reserves.
In Situation 8, IC reported tax re-
serves as of December 31, Year 1, equal
to 92.81% of the CARVM reserve deter-
mined under § 807(d)(2) for certain of
its fixed annuity contracts because that
amount for each contract exceeded the
NSV for each of those contracts. It re-
ported tax reserves as of December 31,
Year 2, equal to the NSV of the contracts
because this amount for each contract ex-
ceeded 92.81% of the CARVM reserve
determined under § 807(d)(2) for each
contract. Just as in Situation 6, where the
reserve methodology entailed a compar-
ison of the deterministic reserve and the
sum of the policy net premium reserves,
here the reserve methodology entails
a comparison of two amounts, in this
case prescribed by § 807(d) itself. The
fact that year-over-year changes in these
amounts results in different calculated
amounts being taken into account does
not change the principle that the compar-
ison is inherent in the reserve methodolo-
gy itself, and applying that methodology
consistently is not a change in basis of
computing reserves.
In Situation 9, the understatement
of IC’s reserves at December 31, Year
1, caused by the omission of the policy
cells for certain contracts issued during
Year 1 is the result of a mathematical or
posting error. Correction of IC’s omission
of reserves for certain contracts is not a
change in basis of computing reserves.
See § 1.446-1(e)(2)(ii)(b). Because this
mathematical or posting error occurred
only on its Federal income tax return for
Year 1, IC should file an amended return
for that taxable year, restating the closing
reserves at December 31, Year 1, to reflect
the correct reserve amounts and taking
these recomputed reserves into account in
redetermining its life insurance company
taxable income for that year.
In Situation 10, there was no reserve
attributable to the new life insurance ben-
efit at the close of Year 1 because the new
life insurance benefit did not exist before
the company became contractually lia-
ble for it in Year 2. The addition of the
new benefit in Year 2 is a change in fact.
An increase in reserve resulting from a
change in fact is not a change in basis of
computing reserves. See § 1.446-1(e)(2)
(ii)(b). Accordingly, the increase in re-
serves solely to provide for the additional
contractual obligation of IC pursuant to
the additional benefits provided during
Year 2 under existing policies is not at-
tributable to a change in basis of comput-
ing reserves.
HOLDINGS
(1) In Situation 1, a change in the con-
sistent, impermissible application of the
92.81% factor prescribed by § 807(d) is a
change in basis.
(2) In Situation 2, an NAIC Valuation
Manual change in the methodology for
computing reserves on previously-issued
contracts is a change in basis.
(3) In Situation 3, an NAIC Valuation
Manual change in the methodology for
computing reserves on contracts issued in
the year of the change is a change in basis.
(4) In Situation 4, a change in Actuarial
Guideline that results in a change in the
methodology for computing reserves is a
change in basis.
(5) In Situation 5, a change in the NA-
IC-prescribed mortality tables is a change
in basis.
(6) In Situation 6, a change under VM-
20 from the deterministic reserve to the
sum of the policy net premium reserves
due solely to the fact that the sum of the
policy net premium reserves is greater is
not a change in basis.
(7) In Situation 7, an experience-based
update in mortality rates as required by
VM-20 to determine the deterministic re-
serve is not a change in basis.
(8) In Situation 8, a change from tax re-
serves based on 92.81% of the reserve de-
termined under § 807(d)(2) to tax reserves
based on the contract NSV resulting solely
from a year-over-year change in which is
greater is not a change in basis.
(9) In Situation 9, an inclusion of poli-
cy cells that were previously omitted on a
single return is a mathematical or posting
error that is not a change in basis.
(10) In Situation 10, the increase in re-
serves to provide solely for new benefits
on existing contracts is not a change in
basis.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Ian Follansbee of the Office of
the Associate Chief Counsel (Financial
Institutions and Products). For further in-
formation regarding this revenue ruling
contact Ian Follansbee at 202-317-4453
(not a toll-free number).
26 CFR 1.163(j)-1 through -11, etc.
T.D. 9905
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1
Limitation on Deduction for
Business Interest Expense
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations providing guidance about
the limitation on the deduction for busi-
ness interest expense after amendment of
the Internal Revenue Code (Code) by the
provisions commonly known as the Tax
Cuts and Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus
Aid, Relief, and Economic Security Act,
which was enacted on March 27, 2020.
The regulations provide guidance to tax-
payers on how to calculate the limitation,
what constitutes interest for purposes of
the limitation, which taxpayers and trades
or businesses are subject to the limitation,
and how the limitation applies in consol-
idated group, partnership, international,
and other contexts.

Bulletin No. 2020–40 615 September 28, 2020
DATES: Effective date: The regulations
are effective on November 13, 2020. Sec-
tions 1.163(j)-1 through 1.163(j)-11 are
generally applicable to taxable years be-
ginning on or after November 13, 2020.
Applicability dates: For dates of appli-
cability, see §§1.163(j)-1(c), 1.163(j)-2(k),
1.163(j)-3(d), 1.163(j)-4(g), 1.163(j)-5(h),
1.163(j)-6(p), 1.163(j)-9(k), 1.163(j)-
10(f), 1.163(j)-11(d), 1.263A-15(a),
1.381(c)(20)-1(d), 1.382-2(b)(3), 1.382-
5(f), 1.382-6(h), 1.383-1(j), 1.446-3(j)(2),
1.469-11(a)(3) and (4), 1.1502-36(h)(2),
1.1502-99(d), and 1.1504-4(i).
Pursuant to section 7805(b)(7), tax-
payers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may apply the rules set forth in §§1.163(j)-
1 through 1.163(j)-11, in their entirety, to
a taxable year beginning after December
31, 2017, and before November 13, 2020,
so long as the taxpayers and their related
parties consistently apply these rules, and,
if applicable, §§1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5,
1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-
9, 1,469-11, 1.704-1, 1.882-5, 1.1362-3,
1.1368-1, 1.1377-1, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-90,
1.1502-91 through 1.1502-99 (to the ex-
tent 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. However,
see §1.163(j)-1(c) for the applicability
date rules relating to notional principal
contracts and the interest anti-avoidance
rule; see also part II(E)(2) (relating to no-
tional principal contracts) and part II(E)
(4) (relating to the interest anti-avoidance
rule) of the Summary of Comments and
Revisions section of this preamble.
Alternatively, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may rely on
proposed §§1.163(j)-1 through 1.163(j)-
11, which were issued in a notice of pro-
posed rulemaking (REG-106089-18) and
published on December 28, 2018, in the
Federal Register (83 FR 67490), in their
entirety, for a taxable year beginning after
December 31, 2017, and before Novem-
ber 13, 2020, so long as the taxpayers
and their related parties consistently ap-
ply proposed §§1.163(j)-1 through -11,
and, if applicable, proposed §§1.263A-9,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-
5, 1.382-6, 1.382-7, 1.383-0, 1.383-1,
1.469-9, 1.469-11, 1.882-5, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-
5, 1.382-6, and 1.383-1), and 1.1504-4,
to that taxable year. Notwithstanding the
preceding sentence, taxpayers applying
the provisions in the notice of proposed
rulemaking may apply §1.163(j)-1(b)(1)
(iii) in these final regulations for taxable
years beginning after December 31, 2017.
With respect to §1.382-2 and, if ap-
plicable, §§1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§1.382-2), and with respect to §1.382-5
and, if applicable, §§1.1502-91 through
1.1502-99 (to the extent they effectuate
the rules of §1.382-5), the regulations ap-
ply to testing dates and ownership chang-
es, respectively, occurring on or after No-
vember 13, 2020.
Taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b)(1), may choose to apply the rules
of §1.382-2 and, if applicable, §§1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §1.382-2), and
§1.382-5 and, if applicable, §§1.1502-91
through 1.1502-99 (to the extent they ef-
fectuate the rules of §1.382-5), to a testing
date or an ownership change, respective-
ly, that occurs in a taxable year beginning
after December 31, 2017, and before No-
vember 13, 2020, so long as the taxpayers
and their related parties consistently ap-
ply the rules of §§1.163(j)-1 through -11,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-
7, 1.383-0, and 1.383-1, and, if applica-
ble, §§1.263A-9, 1.263A-15, 1.381(c)
(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-
13, 1.1502-21, 1.1502-36, 1.1502-79,
1.1502-90, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§§1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4, to that taxable year.
Alternatively, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may rely on
the rules of proposed §1.382-2 and, if
applicable, §§1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §1.382-2), and §1.382-5 and, if appli-
cable, §§1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§1.382-5), which were issued in a notice
of proposed rulemaking (REG-106089-
18) and published on December 28, 2018,
in the Federal Register (83 FR 67490),
with respect to a testing date or an own-
ership change, respectively, that occurs in
a taxable year beginning after December
31, 2017, and before November 13, 2020,
so long as the taxpayers and their related
parties consistently apply the rules of pro-
posed §§1.163(j)-1 through -11, 1.382-1,
1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-
0, and 1.383-1, and, if applicable, proposed
§§1.263A-9, 1.381(c)(20)-1, 1.469-9,
1.469-11, 1.882-5, 1.1502-13, 1.1502-21,
1.1502-36, 1.1502-79, 1.1502-90, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-
5, 1.382-6, and 1.383-1), and 1.1504-4,
to that taxable year. As noted previously,
taxpayers relying on the provisions in the
notice of proposed rulemaking may apply
§1.163(j)-1(b)(1)(iii) in these final regu-
lations for taxable years ending after De-
cember 31, 2017.
FOR FURTHER INFORMATION
CONTACT: Concerning §1.163(j)-1,
§1.163(j)-2, §1.163(j)-3, §1.163(j)-9,
§1.263A-9, or §1.263A-15, Sophia Wang,
(202) 317-4890 or Justin Grill, (202) 317-
4850; concerning §1.163(j)-4, §1.163(j)-
5, §1.163(j)-10, §1.163(j)-11, §1.381(c)
(20)-1, §1.382-1, §1.382-2, §1.382-5,
§1.382-6, §1.382-7, §1.383-0, §1.383-
1, §1.1502-13, §1.1502-21, §1.1502-36,
§1.1502-79, §1.1502-90, §1.1502-91,
§1.1502-95, §1.1502-98, §1.1502-99, or
§1.1504-4, Russell Jones, (202) 317-5357,
John Lovelace, (202) 317-5363, Aglaia
Ovtchinnikova, (202) 317-6975, or Ma-
rie C. Milnes-Vasquez, (202) 317-3181;
concerning §1.163(j)-6, §1.469-9(b)(2),
§1.469-11, §1.704-1, §1.1362-3, §1.1368-
1, or §1.1377-1, William Kostak, (202)
317-6852, Anthony McQuillen, (202) 317-
5027, or Adrienne Mikolashek, (202) 317-
5050; concerning §1.163(j)-7, §1.163(j)-
8, or §1.882-5, Azeka Abramoff, (202)
317-3800, Angela Holland, (202) 317-
5474, or Steve Jensen, (202) 317-6938;
concerning §1.446-3, §1.860C-2, RICs,
REITs, REMICs, and the definition of the
term “interest”, Michael Chin, (202) 317-
5846 (not toll-free numbers).
ADDRESSES: Submit electronic submis-
sions to the Federal eRulemaking Portal
at http://www.regulations.gov (indicate

September 28, 2020 616 Bulletin No. 2020–40
IRS and REG-106089-18) by following
the online instructions for submitting
comments. Once submitted to the Feder-
al eRulemaking Portal, comments cannot
be edited or withdrawn. The Department
of the Treasury (Treasury Department)
and the Internal Revenue Service (IRS)
will publish for public availability any
comment received to its public docket,
whether submitted electronically or in
hard copy. Send hard copy submissions
to CC:PA:LPD:PR (REG-106089-18),
Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
SUPPLEMENTARY INFORMATION:
Background
Table of Contents
I. Overview
II. Comments on and Changes to Pro-
posed §1.163(j)-1: Definitions
A. Definition and Calculation of Adjust-
ed Taxable Income (ATI) – Proposed
§1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable
Income
2. Adjustments to ATI for Amounts In-
curred as Depreciation, Amortization, and
Depletion
3. ATI and Floor Plan Financing Interest
4. Adjustments to Taxable Income in
Computing ATI Under Section 163(j)(8)
(A)
5. Certain Adjustments to Tentative Tax-
able Income in Computing ATI Under
Section 163(j)(8)(B)
6. Adjustments to Adjusted Taxable In-
come in Respect of United States Share-
holders of CFCs
B. Definition of Business Interest Expense
– Proposed §1.163(j)-1(b)(2)
C. Definition of Excepted Regulated Utili-
ty Trade or Business – Proposed §1.163(j)-
1(b)(13)
D. Definition of Floor Plan Financing In-
terest Expense – Proposed §1.163(j)-1(b)
(17)
E. Definition of Interest – Proposed
§1.163(j)-1(b)(20)
1. In General
2. Swaps with Significant Nonperiodic
Payments
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary
Income or Loss on Certain Debt Instru-
ments, Section 1258 Gain, and Factoring
Income
ii. Substitute Interest Payments
iii. Commitment Fees
iv. Debt Issuance Costs
v. Guaranteed Payments
vi. Hedging Transactions
vii. Other Items
a. Dividends from Regulated Investment
Company (RIC) Shares
b. MMF Income
c. Negative Interest
d. Leases
4. Anti-Avoidance Rule for Amounts Pre-
dominantly Associated with the Time
Value of Money
5. Authority Comments
F. Definition of Motor Vehicle – Proposed
§1.163(j)-1(b)(25)
G. Definition of Taxable Income – Pro-
posed §1.163(j)-1(b)(37)
1. Calculation of Taxable Income
2. Interaction with Section 250
3. When Disallowed Business Interest Ex-
pense is “Paid or Accrued”
4. Interaction with Sections 461(l), 465,
and 469 – Proposed §1.163(j)-1(b)(37)
H. Definition of Trade or Business – Pro-
posed §1.163(j)-1(b)(38)
1. In General
2. Multiple Trades or Businesses Within
an Entity
3. Rental Real Estate Activities as a Trade
or Business
4. Separate Entities
I. Applicability Dates
III. Comments on and Changes to Pro-
posed §1.163(j)-2: Deduction for Busi-
ness Interest Expense Limited
A. Whether the Section 163(j) Limitation
is a Method of Accounting
B. General Gross Receipts Test and Ag-
gregation
C. Small Business Exemption and Single
Employer Aggregation Rules – Proposed
§§1.163(j)-2(d) and 1.52-1(d)(1)(i)
D. Small Business Exemption and Tax
Shelters - Proposed §1.163(j)-2(d)(1)
E. Gross Receipts for Partners in Partner-
ships and Shareholders of S Corporation
Stock – Proposed §1.163(j)-2(d)(2)(iii)
IV. Comments on and Changes to Section
Proposed §1.163(j)-3: Relationship of
Section 163(j) Limitation to Other Provi-
sions Affecting Interest
A. Capitalized Interest
B. Provisions that Characterize Interest
Expense as Something Other Than Busi-
ness Interest Expense
C. Section 108
D. Sections 461(l), 465, and 469
V. Comments on and Changes to Proposed
§1.163(j)-4: General Rules Applicable to
C Corporations (Including Real Estate In-
vestment Trusts (REITs), RICs, and Mem-
bers of Consolidated Groups) and Tax-Ex-
empt Corporations
A. Aggregating Affiliated but Non-Con-
solidated Entities
B. Intercompany Transactions and Inter-
company Obligations
C. Repurchase Premium on Obligations
that are Deemed Satisfied and Reissued
D. Intercompany Transfers of Partnership
Interests
1. Overview of Proposed §1.163(j)-4(d)
(4)
2. Intercompany Transfers of Partner-
ship Interests Treated as Dispositions;
Single-Entity Treatment; Application of
§1.1502-13
3. Possible Approach to Intercompany
Partnership Interest Transfers
4. Offsetting Excess Business Interest Ex-
pense and Adjusted Taxable Income With-
in the Consolidated Group
5. Intercompany Nonrecognition Transac-
tions
6. Basis Adjustments Under §1.1502-32
7. Partnership Terminations
E. Application of §1.1502-36 to Excess
Business Interest Expense
F. Calculating ATI for Cooperatives
G. Calculating ATI for a Consolidated
Group
H. Application of Section 163(j) to
Life-Nonlife Groups
I. Application of Section 163(j) to Tax-Ex-
empt Entities
J. Partnership Investment Income and
Corporate Partners
K. Earnings and Profits of a Corporate
Partner
VI. Comments on and Changes to Pro-
posed §1.163(j)-5: General Rules Govern-
ing Disallowed Business Interest Expense
Carryforwards for C Corporations
A. Absorption of Disallowed Business In-
terest Expense Carryforwards Before Use
of NOLs in Life-Nonlife Groups
B. Carryforwards from Separate Return
Limitation Years

Bulletin No. 2020–40 617 September 28, 2020
C. Offsetting Business Interest Expense
with Business Interest Income and Floor
Plan Financing Interest Expense at the
Member Level
VII. Comments on and Changes to Sec-
tion 1.163(j)-6: Application of the Busi-
ness Interest Expense Deduction Limita-
tions to Partnerships and Subchapter S
Corporations
A. Partnership-Level Calculation and Al-
location of Section 163(j) Excess Items
1. Nonseparately Stated Taxable Income
or Loss of the Partnership
2. Requested Clarifications and Modifica-
tions
3. Recommended Alternative Methods
4. Publicly Traded Partnerships
5. Pro Rata Exception
B. Basis Adjustments
1. Basis and Capital Account Adjustments
for Excess Business Interest Expense Al-
locations
2. Basis Adjustments Upon Disposition of
Partnership Interests Pursuant to Section
163(j)(4)(B)(iii)(II)
3. Intercompany Transfer of a Partnership
Interest
C. Debt-Financed Distributions
D. Trading Partnerships
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
F. Partnership Mergers and Divisions
G. Applicability of Section 382 to S Cor-
porations Regarding Disallowed Business
Interest Expense Carryforwards
H. Separate Application of Section 163(j)
Limitation to Short Taxable Years of S
Corporation
I. Partnership or S Corporation Not Sub-
ject to Section 163(j)
J. Trusts
K. Qualified Expenditures
L. CARES Act Partnership Rules
VIII. Comments on and Changes to Pro-
posed §1.163(j)-7: Application of the Sec-
tion 163(j) Limitation to Foreign Corpora-
tions and United States Shareholders
IX. Comments on and Changes to Sec-
tion 1.163(j)-8: Application of the Sec-
tion 163(j) Limitation to Foreign Persons
with Effectively Connected Taxable In-
come.
X. Comments on and Changes to Pro-
posed §1.163(j)-9: Elections for Except-
ed Trades or Businesses; Safe Harbor for
Certain REITs
A. Protective Elections
B. One-Time Late Election or Withdrawal
of Election Procedures
C. The Anti-Abuse Rule Under Proposed
§1.163(j)-9(h)
D. Residential Living Facilities and No-
tice with Proposed Revenue Procedure
E. Safe Harbor for Certain REITs
F. Real Property Trade or Business
XI. Comments on and Changes to Pro-
posed §1.163(j)-10: Allocation of Inter-
est Expense, Interest Income, and Other
Items of Expense and Gross Income to an
Excepted Trade or Business.
A. General Method of Allocation: Asset
Basis
B. Allocation Between Trades or Busi-
nesses and Non-Trades or Businesses
C. Consolidated Groups
1. Overview
2. Intercompany Transactions
3. Use of Property Derives from an Inter-
company Transaction
4. Purchase of Member Stock from a Non-
member
5. Inclusion of Income from Excepted
Trades or Businesses in Consolidated ATI
6. Engaging in Excepted or Non-Excepted
Trades or Businesses as a “Special Status”
D. Quarterly Asset Testing
E. De Minimis Rules
1. Overview
2. Order in Which the De Minimis Rules
Apply
3. Mandatory Application of De Minimis
Rules
4. De Minimis Threshold for Electric Co-
operatives
5. Standardization of 90 Percent De Mi-
nimis Tests
6. Overlapping De Minimis Tests
F. Assets Used in More than One Trade or
Business
1. Overview
2. Consistency Requirement
3. Changing a Taxpayer’s Allocation
Methodology
4. Mandatory Use of Relative Output for
Utility Trades or Businesses
G. Exclusions from Basis Calculations
H. Look-Through Rules
1. Ownership Thresholds; Direct and Indi-
rect Ownership Interests
2. Application of Look-Through Rules to
Partnerships
i. In General
ii. Coordination of Look-Through Rule
and Basis Determination Rules
iii. Applying the Look-Through Rule and
Determining Share of Partnership Basis
iv. Investment Asset Basis Reduction Rule
v. Coordination of Section 752 Basis Re-
duction Rule and Investment Asset Basis
Reduction Rule
vi. Allocating Basis in a Partnership Inter-
est Between Excepted and Non-Excepted
Trades or Businesses
3. Additional Limitation on Application of
Look-Through Rules to C Corporations
4. Dispositions of Stock in Non-Consoli-
dated C Corporations
5. Application of Look-through Rules to
Small Businesses
6. Application of the Look-Through Rules
to Foreign Utilities
I. Deemed Asset Sale
J. Carryforwards of Disallowed Disquali-
fied Interest
K. Anti-Abuse Rule
L. Direct Allocation
1. Overview
2. Expansion of the Direct Allocation Rule
3. Basis Reduction Requirement for Qual-
ified Nonrecourse Indebtedness
4. Direct Allocation Rule for Financial
Services Businesses
XII. Comments on Proposed Changes to
§1.382-2: General Rules for Ownership
Change
XIII. Comments on Proposed Changes to
§1.382-6: Allocation of Income and Loss
to Periods Before and After the Change
Date for Purposes of Section 382
XIV. Comments on and Changes to Pro-
posed §1.383-1: Special Limitations on
Certain Capital Losses and Excess Credits
XV. Other Comments about Section 382
A. Application of Section 382(l)(5)
B. Application of Section 382(e)(3)
C. Application of Section 382(h)(6)
XVI. Definition of Real Property Trade or
Business
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 163(j) of the Code.
The final regulations reflect amendments
to section 163(j) made by Public Law 115-
97, 131 Stat. 2054 (December 22, 2017),
commonly referred to as the Tax Cuts and
Jobs Act (the TCJA) and the Coronavi-
rus Aid, Relief, and Economic Security
Act, Public Law No. 116-136 (2020) (the
CARES Act). Section 13301(a) of the
TCJA amended section 163(j) by remov-

September 28, 2020 618 Bulletin No. 2020–40
ing prior section 163(j)(1) through (9) and
adding section 163(j)(1) through (10) and
significantly changed the limitation for
deducting interest on certain indebted-
ness. The provisions of section 163(j) as
amended by section 13301 of the TCJA
are effective for tax years beginning after
December 31, 2017. The CARES Act fur-
ther amended section 163(j) by redesig-
nating section 163(j)(10), as amended by
the TCJA, as new section 163(j)(11), and
adding a new section 163(j)(10) providing
special rules for applying section 163(j) to
taxable years beginning in 2019 or 2020.
All references to “old section 163(j)” in
this document are references to section
163(j) prior to amendment by the TCJA
and the CARES Act, and all references to
“section 163(j)” are references to section
163(j) as amended by the TCJA and the
CARES Act.
Old section 163(j) generally disal-
lowed a deduction for “disqualified inter-
est” paid or accrued by a corporation in
a taxable year if the payor’s debt-to-eq-
uity ratio exceeded 1.5 to 1.0, and if the
payor’s net interest expense exceeded 50
percent of its adjusted taxable income.
Disqualified interest included interest
paid or accrued to (1) related parties
when no Federal income tax was imposed
with respect to such interest; (2) unrelat-
ed parties in certain instances in which
a related party guaranteed the debt; or
(3) certain real estate investment trusts
(REIT). Interest amounts disallowed for
any taxable year under old section 163(j)
were treated as interest paid or accrued in
the succeeding taxable year and could be
carried forward indefinitely. In addition,
any excess limitation, the excess of the
taxpayer’s net interest expense over 50
percent of its adjusted taxable income,
could be carried forward three years.
The interest limitation under old section
163(j) was designed to prevent a taxpay-
er from deducting interest from its U.S.
taxable income without a corresponding
inclusion in U.S. taxable income by the
recipient, or to prevent the stripping of
earnings from the U.S. tax system.
In contrast, section 163(j) now applies
broadly to all business interest expense re-
gardless of whether the related indebted-
ness is between related parties or incurred
by a corporation, and regardless of the
taxpayer’s debt-to-equity ratio. Section
163(j) provides an entirely new limitation
on the deduction for “business interest
expense” of all taxpayers, including, for
example, individuals, corporations, part-
nerships, S corporations, unless a specif-
ic exclusion applies under section 163(j).
Although certain terms are used in both
old section 163(j) and section 163(j), such
as “adjusted taxable income,” such terms
have been updated in the final regulations
to reflect the new limitation under section
163(j).
Section 163(j) generally limits the
amount of business interest expense that
can be deducted in the current taxable
year (also referred to in this preamble as
the current year). Under section 163(j)
(1), the amount allowed as a deduction
for business interest expense is limited
to the sum of (1) the taxpayer’s business
interest income for the taxable year; (2)
30 percent of the taxpayer’s adjusted tax-
able income (ATI) for the taxable year
(30 percent ATI limitation); and (3) the
taxpayer’s floor plan financing interest
expense for the taxable year. As further
described later in this Background sec-
tion, section 163(j)(10), as amended by
the CARES Act, provides special rules
relating to the 30 percent ATI limitation
for taxable years beginning in 2019 or
2020. The section 163(j) limitation ap-
plies to all taxpayers, except for certain
small businesses that meet the gross re-
ceipts test in section 448(c) and certain
trades or businesses listed in section
163(j)(7).
Section 163(j)(2) provides that the
amount of any business interest not al-
lowed as a deduction for any taxable year
as a result of the section 163(j) limitation
is carried forward and treated as business
interest paid or accrued in the next tax-
able year. In contrast to old section 163(j),
section 163(j) does not allow the carryfor-
ward of any excess limitation.
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to a taxpayer, other than a tax shelter as
described in section 448(a)(3), with aver-
age annual gross receipts of $25 million
or less, determined under section 448(c)
(including any adjustment for inflation un-
der section 448(c)(4)). For taxpayers other
than corporations or partnerships, section
163(j)(3) provides that the gross receipts
test is determined for purposes of section
163(j) as if the taxpayer were a corpora-
tion or partnership.
Section 163(j)(4) provides special
rules for applying section 163(j) in the
case of partnerships and S corporations.
Section 163(j)(4)(A) requires that the
limitation on the deduction for business
interest expense be applied at the part-
nership level, and that a partner’s ATI be
increased by the partner’s share of the
partnership’s excess taxable income, as
defined in section 163(j)(4)(C), but not
by the partner’s distributive share of the
partnership’s income, gain, deduction,
or loss. Section 163(j)(4)(B)(i) provides
that the amount of partnership business
interest expense limited by section 163(j)
(1) is carried forward at the partner level.
Section 163(j)(4)(B)(ii) provides that ex-
cess business interest expense allocated
to a partner and carried forward is avail-
able to be deducted in a subsequent year
only if, and to the extent, the partnership
allocates excess taxable income to the
partner. As further described later in this
Background section, section 163(j)(10)
(A)(ii)(II), as amended by the CARES
Act, provides a special rule for excess
business interest expense allocated to
a partner in a taxable year beginning in
2019. Section 163(j)(4)(B)(iii) provides
basis adjustment rules for a partner that
is allocated excess business interest ex-
pense. Section 163(j)(4)(D) provides that
rules similar to the rules of section 163(j)
(4)(A) and (C) apply to S corporations
and S corporation shareholders.
Section 163(j)(5) and (6) defines “busi-
ness interest” and “business interest in-
come,” respectively, for purposes of sec-
tion 163(j). Generally, these terms include
interest expense and interest includible in
gross income that is properly allocable to
a trade or business (as defined in section
163(j)(7)) and do not include investment
income or investment expense within the
meaning of section 163(d). The legisla-
tive history states that “a corporation has
neither investment interest nor investment
income within the meaning of section
163(d). Thus, interest income and interest
expense of a corporation is properly allo-
cable to a trade or business, unless such
trade or business is otherwise explicitly
excluded from the application of the pro-
vision.” H. Rept. 115-466, at 386, fn. 688
(2017).

Bulletin No. 2020–40 619 September 28, 2020
Under section 163(j)(7), the limitation
on the deduction for business interest ex-
pense in section 163(j)(1) does not apply
to certain trades or businesses (excepted
trades or businesses). The excepted trades
or businesses are the trade or business of
providing services as an employee, elect-
ing real property businesses, electing
farming businesses, and certain regulated
utility businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without
regard to the following: items not prop-
erly allocable to a trade or business;
business interest and business interest
income; net operating loss (NOL) deduc-
tions; and deductions for qualified busi-
ness income under section 199A. ATI
also generally excludes deductions for
depreciation, amortization, and depletion
with respect to taxable years beginning
before January 1, 2022, and it includes
other adjustments provided by the Secre-
tary of the Treasury.
Section 163(j)(9) defines “floor plan
financing interest” as interest paid or ac-
crued on “floor plan financing indebted-
ness.” These provisions allow taxpayers
incurring interest expense for the purpose
of securing an inventory of motor vehicles
held for sale or lease to deduct the full ex-
pense without regard to the section 163(j)
limitation.
Under section 163(j)(10)(A)(i), the
amount of business interest that is de-
ductible under section 163(j)(1) for tax-
able years beginning in 2019 or 2020 is
computed using 50 percent, rather than
30 percent, of the taxpayer’s ATI for the
taxable year (50 percent ATI limitation).
A taxpayer may elect not to apply the 50
percent ATI limitation to any taxable year
beginning in 2019 or 2020, and instead
apply the 30 percent ATI limitation. The
election must be made separately for each
taxable year. Once the taxpayer makes the
election, the election may not be revoked
without the consent of the Secretary of
the Treasury or his delegate. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)
(10)(A)(iii) provide that, in the case of a
partnership, the 50 percent ATI limitation
does not apply to partnerships for taxable
years beginning in 2019, and the election
to not apply the 50 percent ATI limitation
may be made only for taxable years begin-
ning in 2020. This election may be made
only by the partnership and may not be
revoked without the consent of the Secre-
tary of the Treasury or his delegate. Under
section 163(j)(10)(A)(ii)(II), however, a
partner treats 50 percent of its allocable
share of a partnership’s excess business
interest expense for 2019 as a business in-
terest expense in the partner’s first taxable
year beginning in 2020 that is not subject
to the section 163(j) limitation (50 percent
EBIE rule). The remaining 50 percent of
the partner’s allocable share of the part-
nership’s excess business interest expense
remains subject to the section 163(j) lim-
itation applicable to excess business inter-
est expense carried forward at the partner
level. A partner may elect out of the 50
percent EBIE rule.
Section 163(j)(10)(B)(i) allows a tax-
payer to elect to use its ATI for the last
taxable year beginning in 2019 for the tax-
payer’s ATI in determining the taxpayer’s
section 163(j) limitation for any taxable
year beginning in 2020.
Section 163(j)(11) provides cross-ref-
erences to provisions requiring that elect-
ing farming businesses and electing real
property businesses excepted from the
section 163(j) limitation use the alterna-
tive depreciation system (ADS), rather
than the general depreciation system for
certain types of property. The required
use of ADS results in the inability of these
electing trades or businesses to use the ad-
ditional first-year depreciation deduction
under section 168(k) for those types of
property.
On December 28, 2018, the Treasury
Department and the IRS (1) published
proposed regulations under section 163(j)
in a notice of proposed rulemaking (REG-
106089-18) (proposed regulations) in the
Federal Register (83 FR 67490), and (2)
withdrew the notice of proposed rulemak-
ing (1991-2 C.B. 1040) published in the
Federal Register on June 18, 1991 (56
FR 27907) (as corrected by 56 FR 40285
(August 14, 1991)) to implement rules
under old section 163(j) (1991 Proposed
Regulations). The proposed regulations
were issued following guidance announc-
ing and describing regulations intended to
be issued under section 163(j). See Notice
2018-28, 2018-16 I.R.B. 492.
A public hearing was held on Febru-
ary 27, 2019. The Treasury Department
and the IRS received written comments
responding to the notice of proposed
rulemaking. Comments received before
the final regulations were substantially
developed, including all comments re-
ceived on or before the deadline for com-
ments on February 26, 2019, were care-
fully considered in developing the final
regulations.
Copies of the comments received are
available for public inspection at http://
www.regulations.gov or upon request.
After consideration of the comments re-
ceived and the testimony at the public
hearing, this Treasury decision adopts
the proposed regulations as revised in re-
sponse to such comments and testimony
as described in the Summary of Com-
ments and Explanation of Revisions sec-
tion. The revisions are discussed in this
preamble. Concurrently with the publica-
tion of the final regulations, the Treasury
Department and the IRS are publishing
in the Proposed Rule section of this edi-
tion of the Federal Register (RIN 1545-
BO76) a notice of proposed rulemaking
providing additional proposed regula-
tions under section 163(j) (REG-107911-
18) (Concurrent NPRM). The Concurrent
NPRM includes proposed regulations re-
lating to changes made to section 163(j)
under the CARES Act.
On September 10, 2019, the Treasury
Department and the IRS published pro-
posed regulations under section 382(h)
(REG-125710-18) in the Federal Regis-
ter (84 FR 47455) (the September 2019
section 382 proposed regulations). The
September 2019 section 382 proposed
regulations included a rule to clarify that
section 382 disallowed business interest
carryforwards are not treated as recog-
nized built-in losses (RBILs). No formal
comments were received on this rule
during the comment period for the Sep-
tember 2019 section 382 proposed regu-
lations.
On April 10, 2020, the Treasury De-
partment and the IRS released Revenue
Procedure 2020-22, 2020-18 I.R.B. 745,
to provide the time and manner of making
a late election, or withdrawing an elec-
tion under section 163(j)(7)(B) to be an
electing real property trade or business, or
under section 163(j)(7)(C) to be an elect-
ing farming business, for taxable years
beginning in 2018, 2019, or 2020. Reve-

September 28, 2020 620 Bulletin No. 2020–40
nue Procedure 2020-22 also provides the
time and manner of making or revoking
elections provided by the CARES Act
under section 163(j)(10) for taxable years
beginning in 2019 or 2020. As described
earlier in this Background section, these
elections are: (1) to not apply the 50 per-
cent ATI limitation under section 163(j)
(10)(A)(iii); (2) to use the taxpayer’s ATI
for the last taxable year beginning in 2019
to calculate the taxpayer’s section 163(j)
limitation in 2020 under section 163(j)
(10)(B); and (3) for a partner to elect out
of the 50 percent EBIE rule under section
163(j)(10)(A)(ii)(II).
Summary of Comments and
Explanation of Revisions
I. Overview
The Treasury Department and the
IRS received approximately 120 written
comments in response to the notice of
proposed rulemaking. Most of the com-
ments addressing the proposed regula-
tions are summarized in this Summary
of Comments and Explanation of Revi-
sions section. However, comments merely
summarizing or interpreting the proposed
regulations or recommending statutory re-
visions generally are not discussed in this
preamble. Additionally, comments outside
the scope of this rulemaking are generally
not addressed in this Summary of Com-
ments and Explanation of Revisions sec-
tion.
The Treasury Department and the IRS
continue to study comments on certain
issues related to section 163(j), including
issues that are beyond the scope of the fi-
nal regulations (or the Concurrent NPRM
in the Proposed Rules section of this issue
of the Federal Register), and may discuss
those comments if future guidance on
those issues is published.
The final regulations retain the same
basic structure as the proposed regula-
tions, with certain revisions.
II. Comments on and Changes to
Proposed §1.163(j)-1: Definitions
Section 1.163(j)-1 provides definitions
of the terms used in the final regulations.
The following discussion addresses com-
ments relating to proposed §1.163(j)-1.
A. Definition and Calculation of Adjusted
Taxable Income (ATI) – Proposed
§1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable
Income
Consistent with section 163(j)(8), pro-
posed §1.163(j)-1(b)(1) defines ATI as the
“taxable income” of the taxpayer for the
taxable year, with certain specified ad-
justments. Thus, in calculating ATI, the
proposed regulations begin with taxable
income as the amount to which adjust-
ments are made when calculating ATI.
Proposed §1.163(j)-1(b)(37)(i) generally
provides that the term “taxable income”
has the meaning provided in section 63,
but for purposes of section 163(j), is com-
puted without regard to the application
of section 163(j) and the section 163(j)
regulations. However, in some instances
in the section 163(j) regulations the term
“taxable income” is used to indicate the
amount calculated under section 63 for
purposes other than calculating ATI.
To prevent confusion from using the
term “taxable income” in different con-
texts (in determining ATI, and for purpos-
es other than determining ATI), the final
regulations use a new term, “tentative
taxable income,” to refer to the amount to
which adjustments are made in calculat-
ing ATI. See §1.163(j)-1(b)(43). Tentative
taxable income is generally determined in
the same manner as taxable income under
section 63, but is computed without regard
to the application of the section 163(j)
limitation, and without regard to any dis-
allowed business interest expense carry-
forwards. This definitional change avoids
confusion with section 63 taxable income,
avoids creating an iterative loop that takes
into account the section 163(j) limitation,
and ensures that disallowed business in-
terest expense carryforwards are taken
into account only once in testing business
interest expense against the limitation.
Therefore, “tentative taxable income”
is used in the final regulations and, where
appropriate, in this Summary of Com-
ments and Explanation of Provisions sec-
tion, to describe the starting point for the
calculation of ATI in the final regulations.
See part II(G)(1) of this Summary of
Comments and Explanation of Revisions
section.
2. Adjustments to ATI for Amounts
Incurred as Depreciation, Amortization,
and Depletion
Section 163(j)(8)(A)(v) defines ATI as
the taxable income of the taxpayer com-
puted without regard to certain items,
including any deduction allowable for de-
preciation, amortization, or depletion for
taxable years beginning before January
1, 2022. Consistent with section 163(j)
(8)(A)(v), proposed §1.163(j)-1(b)(1)(i)
requires an addback to taxable income of
deductions for depreciation, amortization,
and depletion for taxable years beginning
before January 1, 2022. In general, section
263A requires certain taxpayers that man-
ufacture or produce inventory to capitalize
all direct costs and certain indirect costs
into the basis of the property produced or
acquired for resale. Depreciation, amor-
tization or depletion that is capitalized
into inventory under section 263A is re-
covered through cost of goods sold as an
offset to gross receipts in computing gross
income; cost of goods sold reduces the
amount realized upon the sale of goods
that is used to calculate gross income and
is technically not a deduction that is ap-
plied against gross income in determin-
ing taxable income. See §§1.61-3(a) and
1.263A-1(e)(3)(ii)(I) and (J). Thus, pro-
posed §1.163(j)-1(b)(1)(iii) provides that
depreciation, amortization, or depletion
expense capitalized into inventory under
section 263A is not a depreciation, amor-
tization, or depletion deduction, that may
be added back to taxable income in com-
puting ATI. The preamble to the proposed
regulations further noted that an amount
that is incurred as depreciation, amortiza-
tion, or depletion, but that is capitalized
to inventory under section 263A and in-
cluded in costs of goods sold, is not a de-
duction for depreciation, amortization, or
depletion for purposes of section 163(j).
Many commenters raised questions and
concerns regarding proposed §1.163(j)-
1(b)(1)(iii) and requested that the addback
of deductions for depreciation, amortiza-
tion, and depletion include any amount
that is required to be capitalized into in-
ventory under section 263A. First, com-
menters stated that the provision does not
reflect congressional intent, which was
to determine ATI using earnings before
interest, tax, depreciation, and amortiza-

Bulletin No. 2020–40 621 September 28, 2020
tion (EBITDA) through taxable year 2021
and using earnings before interest and tax
(EBIT) thereafter. Commenters noted that
the proposed rule would eliminate this
distinction for certain manufacturers or
producers of property for sale. Comment-
ers pointed out that capital-intensive busi-
nesses that manufacture or produce inven-
tory are at a disadvantage in comparison
to other types of businesses because the
manufacturers or producers would have
to compute ATI without an addback for a
substantial amount of their depreciation,
and that neither section 163(j) nor its leg-
islative history indicates an intent by Con-
gress to treat manufacturers or producers
of inventory differently from other trades
or businesses. Commenters also contrast-
ed the language in section 163(j)(8)(A)
(iv), which allows an addback of “the
amount of any deduction allowed under
section 199A,” with section 163(j)(8)(A)
(v), which allows an addback of “any de-
duction allowable for depreciation, amor-
tization, or depletion” (emphasis added).
The phrase “allowed or allowable” is
used in other Code provisions. Section
1016(a)(2) provides that, in calculating
tax basis, adjustments are required for de-
preciation to the extent such amounts are
allowed as deductions in computing tax-
able income but not less than the amounts
allowable. Some commenters noted that
depreciation allowable as a deduction for
purposes of section 1016(a)(2) should be
read consistently with depreciation allow-
able as a deduction for purposes of section
163(j), and that section 1016(a)(2) treats
depreciation capitalized into inventory un-
der section 263A as deductions allowable.
As provided in section 263A(a)(2) and
§1.263A-1(c)(2), an amount is not subject
to capitalization under section 263A un-
less such cost may be taken into account
in computing taxable income.
The Treasury Department and the IRS
have reconsidered proposed §1.163(j)-
1(b)(1)(iii). Accordingly, under the final
regulations, the amount of any deprecia-
tion, amortization, or depletion that is cap-
italized into inventory under section 263A
during taxable years beginning before
January 1, 2022, is added back to tentative
taxable income as a deduction for depreci-
ation, amortization, or depletion when cal-
culating ATI for that taxable year, regard-
less of the period in which the capitalized
amount is recovered through cost of goods
sold. For example, if a taxpayer capital-
ized an amount of depreciation to invento-
ry under section 263A in the 2020 taxable
year, but the inventory is not sold until the
2021 taxable year, the entire capitalized
amount of depreciation is added back to
tentative taxable income in the 2020 tax-
able year, and such capitalized amount of
depreciation is not added back to tentative
taxable income when the inventory is sold
and recovered through cost of goods sold
in the 2021 taxable year. Under such facts,
the entire capitalized amount is deemed to
be included in the calculation of the tax-
payer’s tentative taxable income for the
2020 taxable year, regardless of the period
in which the capitalized amount is actu-
ally recovered. See §§1.163(j)-1(b)(1)(iii)
and 1.163(j)-2(h)(3).
Further, in order to treat similarly sit-
uated taxpayers similarly, the final regu-
lations allow taxpayers, and their related
parties within the meaning of sections
267(b) and 707(b)(1), otherwise relying
on the proposed regulations in their en-
tirety under §1.163(j)-1(c) to alternative-
ly choose to follow §1.163(j)-1(b)(1)(iii)
rather than proposed §1.163(j)-1(b)(1)
(iii). See §1.163(j)-1(c).
The Treasury Department and the IRS
note that neither proposed §1.163(j)-1(b)
(1) nor §1.163(j)-1(b)(1) determines the
amount of allowed or allowable deprecia-
tion, amortization, or depletion for purpos-
es of any other Code section (for example,
sections 167(c), 1016(a)(2), 1245, and
1250). Accordingly, no inference should
be drawn regarding the determination of
the amount of allowed or allowable depre-
ciation, amortization, or depletion under
any other Code section based on proposed
§1.163(j)-1(b)(1) or §1.163(j)-1(b)(1).
In addition to comments about whether
depreciation, amortization, and depletion
include amounts recovered through cost
of goods sold, a commenter requested
clarification that section 179 deductions
are depreciation deductions for purposes
of section 163(j)(8)(A)(v) and proposed
§1.163(j)-1(b)(1)(i)(D). Section 179 de-
ductions are allowed to be added back as
amortization under proposed §1.163(j)-
1(b)(1)(i)(E), which allows an addback of
any deduction for the amortization of in-
tangibles (for example, under section 167
or 197) and other amortized expenditures
(for example, under section 195(b)(1)(B),
248, or 1245(a)(2)(C)), for taxable years
beginning before January 1, 2022. Section
1245(a)(2)(C) provides “any deduction al-
lowable under sections 179, 179B, 179C,
179D, 179E, 181, 190, 193, or 194 shall
be treated as if it were a deduction allow-
able for amortization.” Because section
179 deductions are included as amortiza-
tion under proposed §1.163(j)-1(b)(1)(i)
(E), rather than as depreciation under pro-
posed §1.163(j)-1(b)(1)(i)(D), no clarifi-
cation is necessary in the final regulations.
See §1.163(j)-1(b)(1)(i)(E).
3. ATI and Floor Plan Financing Interest
Consistent with section 163(j)(8)(A)
(ii), the proposed regulations provide that
any business interest expense or business
interest income is added back to (in the
case of business interest expense) or sub-
tracted from (in the case of business inter-
est income) taxable income in computing
ATI. Because business interest expense
includes floor plan financing interest ex-
pense, ATI is further adjusted by subtract-
ing from it any floor plan financing inter-
est expense under proposed §1.163(j)-1(b)
(1)(ii)(B). Floor plan financing interest
expense is also separately included in the
section 163(j) limitation as provided in
section 163(j)(1)(C).
One commenter suggested that floor
plan financing interest expense should
not be subtracted from ATI because such
adjustment is inconsistent with the stat-
ute and the ordering implied by section
168(k)(9)(B). The addition of floor plan
financing interest expense as business
interest in the calculation of ATI is con-
sistent with section 163(j)(8)(A)(ii). The
purpose of subtracting floor plan financ-
ing interest expense from tentative tax-
able income to compute ATI is to avoid
the double benefit that would result upon
separately including floor plan financing
interest expense in the computation of
the section 163(j) limitation. If floor plan
financing interest expense were included
in ATI without a corresponding subtrac-
tion, thus resulting in an increased ATI,
taxpayers with such expense would be
able to increase their section 163(j) lim-
itation not only by the separately stated
floor plan financing interest under section
163(j)(1)(C), but also by the inclusion of

September 28, 2020 622 Bulletin No. 2020–40
such amount in ATI, which would permit
a deduction of $1.30 (or $1.50, if the 50
percent ATI limitation is applicable) of
business interest expense for each $1 of
floor plan financing interest expense. Al-
though it is clear that Congress did not in-
tend to limit the deduction for floor plan
financing interest expense under section
163(j), there is no indication that Con-
gress also intended to provide the addi-
tional benefit of an increased ATI related
to floor plan financing interest expense.
Therefore, under the authority granted in
section 163(j)(8)(B), the final regulations
adopt the proposed rule without change
to include a subtraction of floor plan fi-
nancing interest expense from tentative
taxable income in computing ATI.
Several commenters also requested
clarification and submitted recommenda-
tions on the interaction between section
168(k)(9) and section 163(j). Section
168(k)(9)(B) provides that the additional
first-year depreciation deduction is not al-
lowed for any property used in a trade or
business that has had floor plan financing
indebtedness (as defined in section 163(j)
(9)), if the floor plan financing interest re-
lated to such indebtedness was taken into
account under section 163(j)(1)(C).
First, commenters requested that floor
plan financing indebtedness not be treated
as taken into account if the sum of busi-
ness interest income and 30 percent of
ATI (the sum of section 163(j)(1)(A) and
section 163(j)(1)(B)) is greater than the
business interest expense paid or accrued
in the taxable year. Second, if the sum of
business interest income and 30 percent of
ATI is less than the business interest ex-
pense paid or accrued in the taxable year,
commenters requested that taxpayers be
given the option to either include floor
plan financing interest to increase the sec-
tion 163(j) limitation, or to forgo the use
of floor plan financing interest to increase
the section 163(j) limitation (any forgone
floor plan financing interest would be in-
cluded in the disallowed business interest
expense carryforward under proposed
§1.163(j)-2(c)) in order to utilize the ad-
ditional first-year depreciation deduction
under section 168(k).
Section 163(j) does not provide any
guidance on the availability of section
168(k) for taxpayers that have had floor
plan financing interest expense. As these
comments relate to the operation of sec-
tion 168(k)(9), taxpayers should look to
Treasury Department or IRS guidance
provided under section 168(k) for clarifi-
cation. On September 24, 2019, the Trea-
sury Department and the IRS published
in the Federal Register final regulations
(TD 9874, 84 FR 50108) and proposed
regulations (REG-106808-19, 84 FR
50152) under section 168(k). The rules
regarding when floor plan financing in-
terest expense is “taken into account” for
purposes of 168(k) are in the proposed
regulations under §1.168(k)-2(b)(2)(ii)
(G). Accordingly, these final regulations
do not address the interaction between
section 163(j) and section 168(k)(9) re-
garding floor plan financing interest ex-
pense.
4. Adjustments to Taxable Income in
Computing ATI Under Section 163(j)(8)
(A)
Section 163(j)(8)(A) provides that ATI
means taxable income “computed with-
out regard to” the specified adjustments.
The purpose of the adjustments listed in
section 163(j)(8)(A) is to keep certain
items, such as deductions for depreci-
ation, amortization, depletion, or NOL
carryforward amounts, from directly in-
creasing or decreasing the amount of the
deduction for business interest expense.
Therefore, the Treasury Department and
the IRS have determined that the ad-
justments listed in section 163(j)(8)(A)
should adjust tentative taxable income
for purposes of calculating ATI under
§1.163(j)-1(b)(1) only to the extent that
they have been reflected (or deemed re-
flected, as in the case of certain amounts
capitalized into inventory under section
263A as discussed in part II(A)(2) of this
Summary of Comments and Explanation
of Revisions section) in tentative taxable
income under §1.163(j)-1(b)(43).
A commenter requested that the defini-
tion of ATI not include some of the adjust-
ments listed in section 163(j)(8)(A), such
as the adjustments for NOL deductions
and deductions under section 199A. The
Treasury Department and the IRS do not
have authority to ignore these clear and
unambiguous statutory adjustments. Thus,
the final regulations do not incorporate the
commenter’s suggestion.
5. Certain Adjustments to Tentative
Taxable Income in Computing ATI Under
Section 163(j)(8)(B)
Under the authority granted in section
163(j)(8)(B), the proposed regulations
include several adjustments to taxable in-
come in computing ATI to address certain
sales or other dispositions of depreciable
property, stock of a consolidated group
member, or interests in a partnership. Pro-
posed §1.163(j)-1(b)(1)(ii)(C) provides
that, if property is sold or otherwise dis-
posed of, the lesser of the amount of gain
on the disposition or the amount of depre-
ciation, amortization, or depletion deduc-
tions (collectively, depreciation deduc-
tions) with respect to the property for the
taxable years beginning after December
31, 2017 and before January 1, 2022 (such
years, the EBITDA period) is subtracted
from taxable income to determine ATI.
Proposed §1.163(j)-1(b)(1)(ii)(D) pro-
vides that, with respect to the sale or other
disposition of stock of a member of a con-
solidated group that includes the selling
member, the investment adjustments (see
§1.1502-32) with respect to such stock that
are attributable to deductions described
in proposed §1.163(j)-1(b)(1)(ii)(C) are
subtracted from taxable income. In turn,
proposed §1.163(j)-1(b)(1)(ii)(E) pro-
vides that, with respect to the sale or other
disposition of an interest in a partnership,
the taxpayer’s distributive share of deduc-
tions described in proposed §1.163(j)-1(b)
(1)(ii)(C) with respect to property held by
the partnership at the time of such disposi-
tion is subtracted from taxable income to
the extent such deductions were allowable
under section 704(d).
In general, when a taxpayer takes de-
preciation deductions with respect to an
asset, the taxpayer must reduce its ad-
justed basis in the asset accordingly. As a
result, the taxpayer will realize additional
gain (or less loss) upon the subsequent
disposition of the asset than the taxpayer
would have realized absent depreciation
deductions. Thus, except with regard to
timing (and, in some cases, character), de-
preciation deductions should have no net
effect on a taxpayer’s taxable income.
In order to mitigate the effects of the
section 163(j) limitation during the EBIT-
DA period, Congress provided an adjust-
ment to taxable income for depreciation

Bulletin No. 2020–40 623 September 28, 2020
deductions. More specifically, as dis-
cussed in part II(A)(2) of this Summary of
Comments and Explanation of Revisions
section, depreciation deductions are added
back to taxable income during the EBIT-
DA period, thereby increasing a taxpay-
er’s ATI and its section 163(j) limitation.
Congress intended this adjustment to be a
timing provision that delays the inclusion
of depreciation deductions in calculating a
taxpayer’s section 163(j) limitation. Stat-
ed differently, Congress intended to allow
taxpayers to accelerate the recognition of
gain attributable to depreciation deduc-
tions when computing ATI.
However, if a taxpayer were to sell
its depreciable property after making the
foregoing adjustment to ATI, the taxpay-
er would realize additional gain (or less
loss) on the disposition as a result of its
depreciation deductions, and the taxpay-
er’s ATI would be increased yet again.
Similarly, if the depreciable property were
held by a member of a consolidated group
(S), and if another member of the group
were to sell S’s stock after making neg-
ative adjustments to its basis in S’s stock
under §1.1502-32 to reflect S’s deprecia-
tion deductions, the consolidated group’s
ATI would be increased yet again. A simi-
lar double benefit would arise with respect
to interests in a partnership if, after the
partner’s basis in its partnership interest is
reduced by depreciation deductions asso-
ciated with the depreciable property, ATI
were to reflect that reduced basis upon a
subsequent sale of the partnership interest.
Proposed §1.163(j)-1(b)(1)(ii)(C), (D),
and (E) were intended to address these sit-
uations and ensure that the positive adjust-
ment for depreciation deductions during
the EBITDA period merely defers (rather
than permanently excludes) depreciation
deductions from a taxpayer’s calculation
of the section 163(j) limitation.
Commenters submitted various ques-
tions and comments about these pro-
visions. First, a commenter questioned
whether these proposed subtractions from
taxable income are an advisable exercise
of the authority granted in section 163(j)
(8)(B) in light of congressional silence on
the issue. However, the 1991 Proposed
Regulations contained similar subtrac-
tions from taxable income in computing
ATI. The 1991 Proposed Regulations had
been outstanding for more than 25 years
when Congress enacted the TCJA. Thus,
Congress likely was well aware of these
adjustments when it granted the Secre-
tary of the Treasury the authority to make
adjustments in new section 163(j)(8)(B).
Moreover, there is no indication that Con-
gress intended to preclude the Secretary
from making adjustments similar to those
in the 1991 Proposed Regulations.
Second, commenters asked why the
subtraction from taxable income in pro-
posed §1.163(j)-1(b)(1)(ii)(D) does not
include a “lesser of” calculation similar
to proposed §1.163(j)-1(b)(1)(ii)(C), and
they questioned whether the “lesser of”
calculation in proposed §1.163(j)-1(b)(1)
(ii)(C) captures the correct amount. For
example, if a taxpayer purchased proper-
ty for $100x, fully depreciated the prop-
erty, and then sold the property for $60x,
should the amount that is backed out under
proposed §1.163(j)-1(b)(1)(ii)(C) be $60x
or $100x? Commenters also stated that
the presence of a “lesser of” limitation in
proposed §1.163(j)-1(b)(1)(ii)(C) and the
absence of such a limitation in proposed
§1.163(j)-1(b)(1)(ii)(D) can yield discon-
tinuities. For example, if S (a member
of P’s consolidated group) uses $50x to
purchase an asset that it fully depreciates
under section 168(k) (resulting in a $50x
reduction in P’s basis in its S stock under
§1.1502-32), and if S sells the depreciat-
ed asset for $25x the following year, the
P group would have to subtract $25x from
taxable income under proposed §1.163(j)-
1(b)(1)(ii)(C), whereas the group would
have had to reduce its taxable income by
$50x under proposed §1.163(j)-1(b)(1)(ii)
(D) if P had sold its S stock instead. Com-
menters recommended several solutions
to address this discontinuity, including
eliminating the “lesser of” test.
Proposed §1.163(j)-1(b)(1)(ii)(D) does
not include a “lesser of” calculation be-
cause such a calculation would require
consolidated groups to value their assets
each time there is a sale of member stock.
However, the Treasury Department and
the IRS recognize the discrepancy in tax-
able income adjustments between asset
dispositions and member stock disposi-
tions under the proposed regulations. To
eliminate this discrepancy, the final reg-
ulations revise proposed §1.163(j)-1(b)
(1)(ii)(C) by eliminating the “lesser of”
standard and requiring taxpayers to back
out depreciation deductions that were al-
lowed or allowable during the EBITDA
period with respect to sales or disposi-
tions of property. This revised approach
is consistent with the adjustment for asset
sales in the 1991 Proposed Regulations, is
simpler for taxpayers to administer than
the “lesser of” approach in the proposed
regulations, and renders moot questions
as to whether that “lesser of” calculation
captures the correct amount. However,
the Treasury Department and the IRS also
recognize that, in certain cases, a “lesser
of” computation would not be difficult to
administer. Thus, the Concurrent NPRM
provides taxpayers the option to apply the
“lesser of” standard, so long as they do so
consistently. See proposed §1.163(j)-1(b)
(1)(iv)(E) of the Concurrent NPRM.
Third, commenters asked whether the
application of proposed §1.163(j)-1(b)(1)
(ii)(C) and (D) to the same consolidated
group member would result in an inap-
propriate double inclusion if the asset
sale precedes the stock sale, and whether
proposed §1.163(j)-1(b)(1)(ii)(C) should
continue to apply to a group member if
the sale of member stock precedes the
asset sale. For example, S (a member of
P’s consolidated group) takes a $50x de-
preciation deduction in 2020 with respect
to asset X, P’s basis in its S stock is re-
duced accordingly under §1.1502-32, and
$50x is added back to the P group’s tenta-
tive taxable income in computing its 2020
ATI. In 2021, S realizes a $50x gain upon
the sale of asset X, P’s basis in its S stock
is increased accordingly by $50x under
§1.1502-32, and the P group subtracts
$50x from its tentative taxable income
under proposed §1.163(j)-1(b)(1)(ii)(C)
in computing its 2021 ATI. Then, in 2022,
P sells the S stock to an unrelated buyer.
Must P subtract another $50x from its
tentative taxable income under proposed
§1.163(j)-1(b)(1)(ii)(D)? What if the or-
der of sales were reversed (with P selling
its S stock to a member of another con-
solidated group in 2021 and S selling as-
set X in 2022)—would both consolidated
groups be required to subtract $50x from
tentative taxable income in computing
ATI? To prevent duplicative adjustments
under proposed §1.163(j)-1(b)(1)(ii)(C)
and (D), commenters recommended that
these rules “turn off” further subtractions
once a subtraction already has been made

September 28, 2020 624 Bulletin No. 2020–40
under either provision, and that the appli-
cation of proposed §1.163(j)-1(b)(1)(ii)
(C) be limited to the group in which the
depreciation deductions accrued.
The Treasury Department and the IRS
agree that the application of §1.163(j)-
1(b)(1)(ii)(C) and (D) to the same con-
solidated group member would result in
an inappropriate double inclusion, and
that proposed §1.163(j)-1(b)(1)(ii)(C)
should not apply to a former group mem-
ber with respect to depreciation deduc-
tions claimed by the member in a former
group. Thus, §1.163(j)-1(b)(1)(iv)(D)
provides anti-duplication rules to ensure
that neither §1.163(j)-1(b)(1)(ii)(C) nor
§1.163(j)-1(b)(1)(ii)(D) applies if a sub-
traction for the same economic amount
already has been required under either
provision.
For example, assume that P wholly
owns S1, which wholly owns S2, which
owns depreciable asset Q, and that S1
and S2 are members of P’s consolidated
group. Further assume that S2’s depreci-
ation deductions with respect to asset Q
have resulted in investment adjustments
in S1’s stock in S2 and in P’s stock in
S1. If S1 were to sell its S2 stock to a
third party, adjustments to the P group’s
tentative taxable income would be re-
quired under proposed §1.163(j)-1(b)(1)
(ii)(D). If P later were to sell its S1 stock
to a third party, an additional adjustment
under proposed §1.163(j)-1(b)(1)(ii)(D)
would not be required with respect to
investment adjustments attributable to
asset Q.
Fourth, commenters observed that
these proposed subtractions from taxable
income in computing ATI are required
even if the disposition of the depreciable
property, member stock, or partnership
interest occurs many years after the EBIT-
DA period. Commenters expressed con-
cern that tracking depreciation deductions
for purposes of these adjustments could
become burdensome, and a commenter
questioned the appropriateness in pro-
posed §1.163(j)-1(b)(1)(ii)(C) of treating
all gain upon the disposition of property
after the EBITDA period as attributable to
depreciation deductions during the EBIT-
DA period.
Commenters are correct in observing
that these proposed adjustments to tax-
able income in computing ATI must be
made even if the relevant depreciable as-
set, member stock, or partnership interest
is disposed of after the EBITDA period.
However, the Treasury Department and
the IRS note that members of consoli-
dated groups already must track depre-
ciation deductions to calculate separate
taxable income (see §1.1502-12) and to
preserve the location of tax items (see
§1.1502-13). Additionally, all taxpayers
must track depreciation deductions on
an asset-by-asset basis for purposes of
section 1245. Thus, the Treasury Depart-
ment and the IRS have determined that
the adjustments proposed in §1.163(j)-
1(b)(1)(ii)(C), (D), and (E) should not
impose a significant administrative bur-
den in many situations. The Treasury
Department and the IRS further note that
eliminating the “lesser of” standard in
proposed §1.163(j)-1(b)(1)(ii)(C) (see
the response to the second comment in
this part of the Summary of Comments
and Explanation of Revisions section)
will render moot the commenter’s con-
cern about the calculation of gain.
Fifth, a commenter asked whether the
term “sale or other disposition” in pro-
posed §1.163(j)-1(b)(1)(ii)(C), (D), and
(E) is intended to apply to the transfer of
stock of a consolidated group member in
an intercompany transaction (within the
meaning of §1.1502-13(b)(1)(i)) or to
the transfer of assets in a nonrecognition
transaction to which section 381 applies (a
section 381 transaction).
As provided in proposed §1.163(j)-
4(d)(2), a consolidated group has a single
section 163(j) limitation, and intercom-
pany items and corresponding items are
disregarded for purposes of calculating
the group’s ATI to the extent they offset in
amount. The Treasury Department and the
IRS have determined that regarding inter-
company items and corresponding items
for purposes of §1.163(j)-1(b)(1)(ii)(C)
and (D) would be inconsistent with this
general approach. Thus, §1.163(j)-1(b)(1)
(iv)(A)(2) provides that an intercompa-
ny transaction should not be treated as a
“sale or other disposition” for purposes of
§1.163(j)-1(b)(1)(ii)(C) and (D).
In turn, the transfer of depreciable as-
sets in a section 381 transaction generally
should not be treated as a “sale or other
disposition” because the transfer does not
affect ATI and because the transferee cor-
poration is the successor to the transferor
corporation. Thus, the final regulations
generally provide that a transfer of an as-
set to an acquiring corporation in a trans-
action to which section 381(a) applies
is not treated as a “sale or other disposi-
tion” for purposes of §1.163(j)-1(b)(1)(ii)
(C), (D), and (E). However, if a member
leaves a consolidated group, that transac-
tion generally is treated as a sale or other
disposition under the final regulations for
purposes of §1.163(j)-1(b)(1)(ii)(C) and
(D), regardless of whether the transaction
is a section 381 transaction, because the
adjustment to ATI under these provisions
should be reflected on the tax return of the
group that received the benefit of the ear-
lier increase in ATI.
Sixth, a commenter asked for clarifi-
cation as to when the adjustment in pro-
posed §1.163(j)-1(b)(1)(ii)(D) is required
and which investment adjustments under
§1.1502-32 are treated as “attributable to”
depreciation deductions for purposes of
this provision. For example, P wholly and
directly owns both S and S1 (members of
P’s consolidated group). In 2021, S pur-
chases asset X for $100x and fully depre-
ciates asset X under section 168(k), and P
reduces its basis in its S stock by $100x
under §1.1502-32. In 2022, P contributes
the stock of S to S1 in an intercompany
transaction (which, as noted previously,
is not treated as a “sale or other disposi-
tion” for purposes of proposed §1.163(j)-
1(b)(1)(ii)(C) and (D)). If P later sells the
S1 stock, is the adjustment in proposed
§1.163(j)-1(b)(1)(ii)(D) required even
though no adjustment to P’s basis in the
S1 stock under §1.1502-32 is “attributable
to” the $100x of depreciation deductions
taken with respect to asset X?
The Treasury Department and the
IRS have determined that the adjustment
to tentative taxable income in proposed
§1.163(j)-1(b)(1)(ii)(D) should apply in
the foregoing situation. The final regula-
tions have been revised to provide that,
for these purposes, P’s stock in S1 would
be treated as a successor asset (within the
meaning of §1.1502-13(j)(1)) to P’s stock
in S.
Seventh, commenters stated that there
should be no adjustments to taxable in-
come under proposed §1.163(j)-1(b)(1)
(ii)(C), (D), and (E) if and to the extent
that adding back depreciation deductions

Bulletin No. 2020–40 625 September 28, 2020
pursuant to section 163(j)(8)(A)(v) and
proposed §1.163(j)-1(b)(1)(i) did not in-
crease the amount of business interest
expense the taxpayer could have deducted
in the year the deductions were incurred.
For example, in 2021, corporation C has
$500x of ATI (computed by adding back
$50x of depreciation deductions with re-
spect to asset X) and $100x of business
interest expense. Without adding back the
depreciation deductions, C’s ATI would
have been $450x, C’s section 163(j) lim-
itation would have been $135x ($450x
x 30 percent), and C still could have de-
ducted all $100x of its business interest
expense in that year. In 2022, C has $90x
of business interest expense and $300x of
ATI. C sells asset X for a $50x gain in that
year. If C were required to reduce its ATI
by $50x (from $300x to $250x) in 2022
under proposed §1.163(j)-1(b)(1)(ii)(C),
its section 163(j) limitation would be re-
duced to $75x ($250x x 30 percent), and
C would not be able to deduct all $90x of
its business interest expense in 2022 even
though C derived no benefit from adding
back its depreciation deductions to taxable
income in 2021.
The Treasury Department and the IRS
have determined that predicating the
application of proposed §1.163(j)-1(b)
(1)(ii)(C), (D), and (E) upon whether a
taxpayer derived a benefit under section
163(j) from adding back its depreciation
deductions to taxable income would in-
volve significant additional complexity.
In addition, this approach would have an
effect similar to allowing a carryforward
of these amounts to the taxable year in
which gain on the related items is rec-
ognized on a sale or other disposition.
Such a carryforward is inconsistent with
the general approach of section 163(j),
which does not permit a carryforward
of excess ATI to later taxable years. As
noted earlier in this part II(A)(5) of this
Summary of Comments and Explanation
of Revisions section, depreciation de-
ductions should have no net effect on the
amount of a taxpayer’s taxable income
(except with respect to timing and, per-
haps, character). Thus, if a taxpayer sells
an asset with respect to which the tax-
payer has taken depreciation deductions,
the increase in gain (or decrease in loss)
upon the sale should be reversed under
proposed §1.163(j)-1(b)(1)(ii)(C).
6. Adjustments to Adjusted Taxable
Income in Respect of United States
Shareholders of CFCs
Some commenters argued that United
States shareholders, as defined in section
951(b) (U.S. shareholders), of controlled
foreign corporations, as defined in section
957(a) (CFCs), should be allowed to in-
clude in their ATI the amounts included in
gross income under section 951(a) (sub-
part F inclusions), section 951A(a) glob-
al intangible low-taxed income (GILTI)
inclusions, and section 78 “gross-up” in-
clusions (collectively, CFC income inclu-
sions) attributable to non-excepted trades
or businesses. Because section 163(j) ap-
plies to CFCs, the Treasury Department
and the IRS have determined that allow-
ing a U.S. shareholder to include its CFC
income inclusions in its ATI would not be
appropriate. The income of the CFC that
gives rise to such income is taken into ac-
count in computing the ATI of the CFC for
purposes of determining its section 163(j)
limitation, and allowing the same income
to also be taken into account in comput-
ing the ATI of a U.S. shareholder would
result in an inappropriate double-counting
of income.
Furthermore, the Treasury Department
and the IRS question the premise of sev-
eral comments that, if the business interest
expense of a CFC were excluded from the
application of section 163(j), including the
income of a CFC in a U.S. shareholder’s
ATI would be appropriate. Even if section
163(j) did not apply to CFCs, CFCs are
entities that also may be leveraged. Thus,
permitting the income of the CFC that
gives rise to CFC income inclusions at-
tributable to non-excepted trades or busi-
nesses of CFCs to be included in the ATI
of U.S. shareholders would be inconsis-
tent with the principles of section 163(j).
In particular, consider a case in which a
CFC has interest expense of $100x, trade
or business gross income of $300x treat-
ed as subpart F income, and no foreign
tax liability. In such a case, a U.S. share-
holder that wholly owns the CFC would
have a subpart F inclusion of $200x (if
section 163(j) did not apply to CFCs). If
the $200x subpart F inclusion were in-
cluded in the ATI of the U.S. shareholder,
the U.S. shareholder could deduct an ad-
ditional $60x of business interest expense
($200x x 30 percent). As a result, $300x
of gross income could support $160x of
interest expense deductions rather than the
$90x permitted under section 163(j)(1).
Finally, under the final regulations (and
consistent with proposed §1.163(j)-7(d)
(1)(ii)), if a domestic partnership includes
amounts in gross income under sections
951(a) and 951A(a) with respect to an
applicable CFC and such amounts are in-
vestment income to the partnership, then,
a domestic C corporation partner’s distrib-
utive share of such amounts that are prop-
erly allocable to a non-excepted trade or
business of the domestic C corporation by
reason of §§1.163(j)-4(b)(3) and 1.163(j)-
10(c) are excluded from the domestic C
corporation partner’s ATI.
B. Definition of Business Interest
Expense – Proposed §1.163(j)-1(b)(2)
The proposed regulations provide that
business interest expense includes interest
expense allocable to a non-excepted trade
or business, floor plan financing interest
expense, and disallowed business interest
expense carryforwards. The Treasury De-
partment and the IRS received informal
questions about the interaction between
section 163(j) and sections 465 and 469,
which may operate to disallow a deduc-
tion for business interest expense even
if such expense was allowable after the
application of section 163(j). More spe-
cifically, questions have arisen regarding
how to treat amounts of business interest
expense that are disallowed under section
465 or 469, including which amounts car-
ry forward to subsequent taxable years but
keep their character as interest expense,
and which amounts, if any, are business
interest expense in such subsequent tax-
able years.
If amounts of business interest ex-
pense that are disallowed under section
465 or 469 are treated as business inter-
est expense in subsequent taxable years,
the section 163(j) limitation could oper-
ate to disallow a deduction even though
such amounts were allowable in the prior
taxable year after application of the sec-
tion 163(j) limitation. The Treasury De-
partment and the IRS do not intend such
a result. Therefore, the final regulations
clarify that amounts allowable as a deduc-
tion after application of the section 163(j)

September 28, 2020 626 Bulletin No. 2020–40
limitation but disallowed by section 465
or 469 are not business interest expense
subject to the section 163(j) limitation in
subsequent taxable years.
C. Definition of Excepted Regulated
Utility Trade or Business – Proposed
§1.163(j)-1(b)(13)
Numerous comments were submitted
concerning the definition of an “excepted
regulated utility trade or business” under
proposed §1.163(j)-1(b)(13). Proposed
§1.163(j)-1(b)(13), which implements
the exception in section 163(j)(7)(A)(iv)
to the definition of a “trade or business,”
generally provides that an excepted regu-
lated utility trade or business is a trade or
business that sells or furnishes the items
listed in section 163(j)(7)(A)(iv) at rates
that are established or approved by certain
regulatory bodies described in proposed
§1.163(j)-1(b)(13)(i)(B)(1) and (2).
The proposed regulations provide that
utilities that sell or furnish the regulated
items at rates that are established or ap-
proved by a regulatory body described in
proposed §1.163(j)-1(b)(13)(i)(B)(1), oth-
er than an electric cooperative, are consid-
ered to be excepted only to the extent that
such rates are determined on a “cost of
service and rate of return” basis. The “cost
of service and rate of return” requirement
was intended to provide certainty to tax-
payers because many utilities are familiar
with the definition of “cost of service and
rate of return,” which is used to determine
whether a public utility company must use
a normalization method of accounting un-
der section 168 for certain properties.
However, several commenters ques-
tioned whether a “cost of service and rate
of return” requirement would be satisfied
in specific fact patterns. Commenters
questioned whether certain negotiated
rates are established or approved on a
“cost of service and rate of return” basis
if (1) the applicable regulatory body has
the authority to impose a cost-based rate
instead of the negotiated rate, (2) the rates
are computed with reference to cost but
discounted from the recourse (or maxi-
mum) rate allowed by the regulatory body,
or (3) the rates are computed with refer-
ence to cost and a set rate of return but
are subject to a market-based cap. Com-
menters also asked whether the inclusion
of certain amounts in determining “cost
of service,” specifically the costs of af-
filiates and some revenues attributable to
market-rate sales, would affect the deter-
mination of whether rates are established
or approved on a “cost of service and rate
of return” basis.
One commenter noted that the normal-
ization rules operate logically only in the
“cost of service and rate of return” con-
text. The commenter stated that, because
section 163(j)(7)(A)(iv) does not refer-
ence the normalization rules, there is no
need to include the “cost of service and
rate of return” requirement in the section
163(j) regulations.
The Treasury Department and the IRS
note that, in private letter rulings and in-
formal guidance related to section 168(i)
(9) and (10), the IRS has stated that, for
purposes of applying the normalization
rules, the definition of “public utility prop-
erty” must contain the requirement that
the regulated rates be established or ap-
proved on a “rate of return” basis. In this
guidance, the IRS explained that the nor-
malization method, which must be used
for public utility property to be eligible
for the depreciation allowance available
under section 168, is defined in terms of
the method the taxpayer uses in comput-
ing its tax expense in establishing its “cost
of service” for ratemaking purposes and
reflecting operating results in its regulated
books of account. Furthermore, the IRS
has issued numerous private letter rulings
regarding whether under the specific facts
of the taxpayer, the cost of service and
rate of return requirement has been met
for purposes of section 168(i). Thus, it is
clear that, in the context of section 168,
the “cost of service and rate of return” re-
quirement is necessary.
Neither the text of section 163(j) nor
the legislative history specifically refer-
ences the normalization rules or the “cost
of service and rate of return” requirement
under section 168(i)(10). With the omis-
sion of such references, the exception in
section 163(j) for regulated utility trade or
business could be applied broadly with-
out reference to specific requirements
applicable in the normalization rules.
However, the Treasury Department and
the IRS note that under section 168(k)
(9), the additional first-year depreciation
deduction is not available to any proper-
ty that is primarily used in an excepted
regulated utility trade or business. There-
fore, to ease the administrative burden of
determining whether businesses qualify
as excepted regulated utility trades or
businesses, and to allow taxpayers the
option of claiming the additional first-
year depreciation deduction under sec-
tion 168(k) in lieu of being treated as an
excepted regulated utility trade or busi-
ness, the final regulations retain the “cost
of service and rate of return” requirement
from the proposed regulations, and also
allow taxpayers to make an election to
be an excepted regulated utility trade or
business to the extent that the rates for the
furnishing or sale of the items described
in §1.163(j)-1(b)(15)(i)(A)(1) have been
established or approved by a regulatory
body described in §1.163(j)-1(b)(15)(i)
(A)(2), if the rates are not determined on
a “cost of service and rate of return” ba-
sis. See §1.163(j)-1(b)(15)(i) and (iii).
For purposes of the election, the focus
of section 163(j)(7)(A)(iv) is the phrase
“established or approved” in section
163(j)(7)(A)(iv), which describes the au-
thority of the regulatory body described
in §1.163(j)-1(b)(15)(i)(A)(2). Ratemak-
ing programs similar to those described
by commenters and discussed previous-
ly in this part II(C) of this Summary of
Comments and Explanation of Revisions
section, including discounted rates, nego-
tiated rates, and regulatory rate caps, are
established or approved by a regulatory
body if the taxpayer files a schedule of
such rates with a regulatory body that has
the power to approve, disapprove, alter
the rates, or substitute a rate determined in
an alternate manner.
Similar to elections for electing real
property trades or businesses and electing
farming businesses, the election to be an
excepted regulated utility trade or busi-
ness is irrevocable. Taxpayers making
the election to be an excepted regulated
utility trade or business are not required
to allocate items between regulated utility
trades or businesses that are described in
§1.163(j)-1(b)(15)(i) and trades or busi-
nesses that are described in §1.163(j)-
1(b)(15)(iii)(A) as to which the taxpayer
makes an election because they are treated
as operating an entirely excepted regulat-
ed utility trade or business. Electing tax-
payers cannot claim the additional first-

Bulletin No. 2020–40 627 September 28, 2020
year depreciation deduction under section
168(k).
The rules set forth in the final regula-
tions are limited solely to the determina-
tion of an “excepted regulated utility trade
or business” for purposes of section 163(j)
(7)(A)(iv). As a result of this limited ap-
plication, the rules in the final regulations
are not applicable to the determination of
“public utility property” or the applica-
tion of the normalization rules within the
meaning of section 46(f), as in effect on
the day before the date of the enactment of
the Revenue Reconciliation Act of 1990,
section 168(i)(9) and (10) and the regula-
tions thereunder, or to the determination
of any depreciation allowance available
under sections 167 and 168.
Comments also were received on the
application of the rules for excepted reg-
ulated utility trades or businesses to elec-
tric cooperatives. The definition of an
“excepted regulated utility trade or busi-
ness” under proposed §1.163(j)-1(b)(13)
includes trades or businesses that sell or
furnish the items listed in section 163(j)
(7)(A)(iv) at rates established or approved
by an electric cooperative. Unlike utility
businesses regulated by public authori-
ties, utilities that sell items at rates regu-
lated by a cooperative are not described
in section 168(i)(10). However, there is a
long-standing body of law regulating the
taxation of electric cooperatives. Electric
cooperatives described in section 501(c)
(12) are generally exempt from income
tax but are subject to taxation under sec-
tion 511. The application of section 163(j)
and the section 163(j) regulations with
respect to exempt electric cooperatives is
governed by proposed §1.163(j)-4(b)(5).
Other electric cooperatives are subject
to taxation under sections 1381 through
1388 in subchapter T of chapter 1 of sub-
title A of the Code (subchapter T), except
for certain rural electric cooperatives spe-
cifically excluded from subchapter T by
section 1381(a)(2)(C).
Generally, the exception in section
163(j)(7)(A)(iv) for the trade or business
of selling or furnishing items at rates es-
tablished or approved by the governing
or ratemaking body of an electric coop-
erative applies both to sales and furnish-
ing by an electric cooperative and to sales
and furnishing to an electric cooperative
by another utility provider, as long as the
rates for the sale or furnishing have been
established or approved in the manner re-
quired by section 163(j). Thus, an electric
cooperative exempt from Federal income
tax under section 501(c)(12) may not be
subject to section 163(j) for the sale or fur-
nishing of electricity due to the operation
of proposed §1.163(j)-4(b)(5), and anoth-
er utility provider may be in an excepted
regulated utility trade or business to the
extent that it sells electricity to the section
501(c)(12) cooperative at rates established
or approved by the governing or ratemak-
ing body of the cooperative.
A commenter asked whether proposed
§1.163(j)-1(b)(13) requires that, for sales
involving electric cooperatives to qualify
as an excepted regulated utility trade or
business, the rates for the sales be estab-
lished or approved by the governing or
ratemaking body of an electric coopera-
tive on a “cost of service and rate of re-
turn” basis, or if all sales made subject to
a contract or tariff approved by an electric
cooperative’s governing or ratemaking
body would qualify. Under the proposed
regulations, the specific requirement that
rates for the sale or furnishing of items
listed in proposed §1.163(j)-1(b)(13)
(i)(A) be established or approved on a
“cost of service and rate of return” ba-
sis did not extend to rates established or
approved by the governing or ratemaking
body of an electric cooperative. These
regulations adopt the proposed rule, and
do not impose a requirement that rates
for the sale or furnishing of items listed
in §1.163(j)-1(b)(15)(i)(A) by an electric
cooperative be established or approved
on a “cost of service and rate of return”
basis.
Comments also were submitted regard-
ing the allocation of tax items between ex-
cepted regulated utility trades or business-
es and non-excepted trades or businesses.
These comments are discussed with other
comments on proposed §1.163(j)-10 in
part XI of this Summary of Comments and
Explanation of Revisions section.
D. Definition of Floor Plan Financing
Interest Expense – Proposed §1.163(j)-
1(b)(17)
Commenters recommended that inter-
est paid on commercial financing liabili-
ties or trade financing (in which a taxpayer
borrows to fund the purchase or transport
of commodities and then sells the invento-
ry to pay off the debt) should not be sub-
ject to section 163(j). Commenters noted
that trade financing is different from nor-
mal financing because it is short-term and
backed by inventory that is monetizable
(rather than plant and equipment). Thus,
commenters suggested that section 163(j)
should not apply to trade financing be-
cause there is no depreciation trade-off for
inventory purchased with trade financing.
Commenters compared trade financing
to floor plan financing (because both are
used to finance the purchase of invento-
ry), and they noted that the 1991 Proposed
Regulations under old section 163(j) ex-
cluded commercial financing liabilities
from debt taken into account for purposes
of applying the debt-equity ratio under old
section 163(j). See 1991 Proposed Regu-
lations §1.163(j)-3(b)(2)(ii).
The Treasury Department and the IRS
decline to exclude commercial financing
liabilities from the section 163(j) limita-
tion. Section 163(j) does not contain a
provision analogous to the debt-equity ra-
tio safe harbor that was present in old sec-
tion 163(j) and for which rules were pro-
posed in the 1991 Proposed Regulations.
In addition, because Congress specifically
excluded interest paid on floor plan fi-
nancing from the section 163(j) limita-
tion, but not all commercial financing lia-
bilities and trade financing, Congress does
not appear to have intended to exclude all
commercial financing liabilities from the
section 163(j) limitation.
E. Definition of Interest – Proposed
§1.163(j)-1(b)(20)
1. In General
Commenters submitted numerous
comments on the definition of “interest”
in the proposed regulations. Proposed
§1.163(j)-1(b)(20) contains a relatively
broad definition of the term “interest” for
purposes of section 163(j). This definition
was proposed to provide a complete defi-
nition of interest that addresses all trans-
actions that are commonly understood to
produce interest income and expense, in-
cluding transactions that otherwise may
have been entered into to avoid the appli-
cation of section 163(j).

September 28, 2020 628 Bulletin No. 2020–40
Under the proposed regulations, the
term “interest” means any amount de-
scribed in one of four categories. First,
proposed §1.163(j)-1(b)(20)(i) generally
provides that interest is an amount paid,
received, or accrued as compensation for
the use or forbearance of money under the
terms of an instrument or contractual ar-
rangement, including a series of transac-
tions, that is treated as a debt instrument,
or an amount that is treated as interest un-
der other provisions of the Code or the In-
come Tax Regulations. For example, this
category includes qualified stated interest,
original issue discount (OID), and accrued
market discount. Commenters agree that
this definition of interest has long been
accepted, is consistent with longstanding
precedent, and reduces the risk of incon-
sistency within the Code and regulations.
No commenters requested any changes
to this category, and the final regulations
adopt this category in the definition of the
term “interest” without any substantive
changes.
Second, proposed §1.163(j)-1(b)(20)
(ii) treats a swap (other than a cleared
swap) with significant nonperiodic pay-
ments as two separate transactions con-
sisting of an on-market, level payment
swap and a loan. Under the proposed reg-
ulations, the time value component of the
loan is recognized as interest expense to
the payor and as interest income to the re-
cipient. Several comments were received
on this category in the definition and are
described in part II(E)(2) of this Summary
of Comments and Explanation of Revi-
sions section.
Third, proposed §1.163(j)-1(b)(20)(iii)
treats as interest certain amounts that are
closely related to interest and that affect
the economic yield or cost of funds of a
transaction involving interest, but that
may not be compensation for the use or
forbearance of money on a stand-alone
basis. For example, this category includes
substitute interest payments, debt issu-
ance costs, commitment fees, and hedging
gains and losses that affect the yield of
a debt instrument. Numerous comments
were received on this category and are de-
scribed in part II(E)(3) of this Summary of
Comments and Explanation of Revisions
section.
Fourth, proposed §1.163(j)-1(b)(20)
(iv) provides an anti-avoidance rule.
Under this rule, an expense or loss pre-
dominantly incurred in consideration of
the time value of money in a transaction
or series of integrated or related transac-
tions in which a taxpayer secures the use
of funds for a period of time is treated as
interest expense for purposes of section
163(j). Numerous comments were re-
ceived on this category and are described
in part II(E)(4) of this Summary of Com-
ments and Explanation of Revisions sec-
tion.
2. Swaps with Significant Nonperiodic
Payments
The proposed regulations treat a non-
cleared swap with significant nonperiod-
ic payments as two separate transactions
consisting of an on-market, level payment
swap and a loan (the embedded loan rule).
The embedded loan rule did not apply to
a collateralized swap that was cleared by
a derivatives clearing organization or by
a clearing agency (a cleared swap) be-
cause the treatment of cleared swaps was
reserved. In the preamble to the proposed
regulations, the Treasury Department and
the IRS requested comments on the prop-
er treatment of collateralized swaps under
the embedded loan rule.
One commenter recommended that the
final regulations provide an exception to
the embedded loan rule for cleared swaps
and for non-cleared swaps that are sub-
stantially collateralized. This commenter
further suggested that the final regulations
not include any specific rules regarding
the type of collateral that is required to be
posted to qualify for the exception. The
commenter also recommended that the
final regulations provide objective rules
for determining if a nonperiodic payment
is “significant” and if a financial instru-
ment is treated as a “swap” for purposes
of these rules.
Another commenter agreed with the
embedded loan rule, including use of
the “significant” standard, and also rec-
ommended exceptions to the embedded
loan rule for both cleared swaps and non-
cleared swaps that are required to be ful-
ly collateralized by the terms of the swap
contract or by a federal regulator. Howev-
er, this commenter interpreted the embed-
ded loan rule in the proposed regulations
to apply solely for purposes of section
163(j) and recommended that the embed-
ded loan rule, as well as timing and char-
acter rules for nonperiodic payments on
swaps, be issued under section 446. Until
that guidance is issued, the commenter
requested that the application of the em-
bedded loan rule for purposes of section
163(j) be delayed. The proposed regula-
tions provide that the time value compo-
nent of the embedded loan is determined
in accordance with §1.446-3(f)(2)(iii)(A).
This commenter questioned the reference
to §1.446-3(f)(2)(iii)(A) because, under
that rule, the time value component is not
treated as interest; rather, the time value
component is only used to compute the
amortization of the nonperiodic payment.
As a result of the cross-reference in
proposed §1.446-3(g)(4) to proposed
§1.163(j)-1(b)(20)(ii), the embedded
loan rule set forth in the proposed regu-
lations applies for purposes of both sec-
tions 163(j) and 446. In addition, and as
noted in the preamble to the proposed
regulations, the embedded loan rule set
forth in the proposed regulations applies
in the same manner that former §1.446-
3(g)(4) applied before it was amended by
the now expired temporary regulations in
T.D. 9719 (80 FR 26437) (May 8, 2015)
(as corrected by 80 FR 61308 (October
13, 2015)). The Treasury Department and
the IRS do not adopt commenters’ sug-
gestions to delay finalizing the embed-
ded loan rule or to provide guidance on
determining if a nonperiodic payment is
“significant” because the same embedded
loan rule applied in the context of section
446 for over 20 years from 1993 to 2015.
See T.D. 8491 (58 FR 53125) (October
14, 1993). Instead, subject to the excep-
tions discussed in this part II(E)(2) of this
Summary of Comments and Explanation
of Revisions section, the final regulations
adopt the embedded loan rule without
change. The final regulations retain the
reference to §1.446-3(f)(2)(iii)(A), which
provides a known method for computing
the time value component associated with
the loan component that is treated as in-
terest under §§1.163(j)-1(b)(22)(ii) and
1.446-3(g)(4).
Further, to eliminate the possibility of
confusion regarding the application of the
embedded loan rule for purposes of sec-
tions 163(j) and 446, the final regulations
add the substantive text of the embedded

Bulletin No. 2020–40 629 September 28, 2020
loan rule and the exceptions to that rule
to both §§1.446-3(g)(4) and 1.163(j)-
1(b)(22)(ii) instead of merely including
a cross-reference in §1.446-3(g)(4) to
§1.163(j)-1(b)(22)(ii).
In response to comments, the final reg-
ulations add two exceptions to the embed-
ded loan rule. Specifically, the final regu-
lations add exceptions for cleared swaps
and for non-cleared swaps that require
the parties to meet the margin or collat-
eral requirements of a federal regulator
or that provide for margin or collateral
requirements that are substantially similar
to a cleared swap or a non-cleared swap
subject to the margin or collateral require-
ments of a federal regulator. For purposes
of this exception, the term “federal regu-
lator” means the Securities and Exchange
Commission (SEC), the Commodity Fu-
tures Trading Commission (CFTC), or a
prudential regulator, as defined in section
1a(39) of the Commodity Exchange Act (7
U.S.C. 1a), as amended by section 721 of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, Public
Law No. 111-203, 124 Stat. 1376, Title
VII (the Dodd-Frank Act). Because fed-
eral regulators have adopted final require-
ments for non-cleared swaps that permit
netting of swap exposures and specify the
types of collateral required to be posted,
the final regulations do not address netting
or require that the margin or collateral be
paid or received in cash.
In addition, §1.163(j)-1(c)(3)(i) delays
the applicability date of the embedded
loan rule for purposes of section 163(j)
to allow taxpayers additional time to de-
velop systems to implement these rules
(the delayed applicability date), though
taxpayers may choose to apply the rules
to swaps entered into before the delayed
applicability date. See also §1.446-3(j)
(2), which provides applicability date
rules similar to those in §1.163(j)-1(c)
(3)(i). However, the delayed applicabil-
ity date does not apply for purposes of
the anti-avoidance rules in §1.163(j)-1(b)
(22)(iv) (described in part II(E)(4) of this
Summary of Comments and Explanation
of Revisions section). Instead, the applica-
bility date in §1.163(j)-1(c)(3)(ii) applies.
As a result, the anti-avoidance rules in
§1.163(j)-1(b)(22)(iv) apply to a notional
principal contract entered into on or after
September 14, 2020. However, for a no-
tional principal contract entered into be-
fore September 14, 2021, the anti-avoid-
ance rules in §1.163(j)-1(b)(22)(iv) apply
without regard to the references in those
rules to §1.163(j)-1(b)(22)(ii). For exam-
ple, if a taxpayer enters into a swap with a
significant nonperiodic payment that does
not meet the exceptions in §1.163(j)-1(b)
(22)(ii)(B) or (C) before the delayed ap-
plicability date, and a principal purpose of
the taxpayer is to reduce the amount that
otherwise would be interest expense, the
anti-avoidance rules apply and the taxpay-
er must treat the time value component
associated with the loan component of the
swap as interest expense.
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary
Income or Loss on Certain Debt
Instruments, Section 1258 Gain, and
Factoring Income
Proposed §1.163(j)-1(b)(20)(iii)(A)
treats any bond issuance premium treated
as ordinary income under §1.163-13(d)
(4) as interest income of the issuer and
any amount deductible as a bond premi-
um deduction under §1.171-2(a)(4)(i)(A)
or (C) as interest expense of the holder.
Proposed §1.163(j)-1(b)(20)(iii)(B) treats
any ordinary income recognized by an is-
suer of a debt instrument, and any ordi-
nary loss recognized by a holder of a debt
instrument, under the rules for a contin-
gent payment debt instrument, a nonfunc-
tional currency contingent payment debt
instrument, or an inflation-indexed debt
instrument, as interest income of the issu-
er and as interest expense of the holder,
respectively. Proposed §1.163(j)-1(b)(20)
(iii)(D) treats any ordinary gain under sec-
tion 1258 as interest income. Commenters
supported treating the amounts in pro-
posed §1.163(j)-1(b)(20)(iii)(A), (B), and
(D) as interest income or interest expense
for purposes of section 163(j). According-
ly, the final regulations adopt the rules in
the proposed regulations for these three
items without any substantive changes.
Proposed §1.163(j)-1(b)(20)(iii)(J)
treats factoring income as interest income.
Several commenters supported treat-
ing factoring income as interest income.
However, one commenter questioned the
differences between the provisions related
to the inclusion of factoring income and
§1.954-2(h)(4). The inclusion of factoring
income in the definition of interest is gen-
erally supported by the commenters, is a
taxpayer-favorable rule, is generally con-
sistent with the rules in §1.954-2(h)(4),
and is consistent with the treatment of oth-
er types of discount, such as acquisition
discount and market discount. Accord-
ingly, the final regulations adopt the rules
in the proposed regulations for factoring
income without any substantive changes.
In the case of a factoring transaction with
a principal purpose of artificially increas-
ing a taxpayer’s business interest income,
the anti-avoidance rules in §1.163(j)-1(b)
(22)(iv) (described in part II(E)(4) of this
Summary of Comments and Explanation
of Revisions section) would not permit the
taxpayer to treat factoring income as inter-
est income for purposes of section 163(j).
ii. Substitute Interest Payments
Proposed §1.163(j)-1(b)(20)(iii)(C)
generally provides that a substitute inter-
est payment described in §1.861-2(a)(7)
and made in connection with a sale-re-
purchase or securities lending transaction
is treated as interest expense to the pay-
or and interest income to the recipient.
In general, substitute interest payments
are economically equivalent to interest.
A few commenters questioned the inclu-
sion of substitute interest payments in the
definition of interest in the proposed reg-
ulations. Commenters stated that treating
these amounts as interest would be con-
trary to longstanding tax law, including
the holding in Deputy v. Du Pont, 308
U.S. 488, 498 (1940). However, com-
menters recommended that, if the Trea-
sury Department and the IRS decide to
include substitute interest payments in the
definition of interest in the final regula-
tions, the inclusion be limited to the extent
the substitute interest payments relate to
transactions that are economically similar
to a borrowing. Commenters recommend-
ed that the following factors be taken into
consideration in making this determina-
tion: (a) Whether the taxpayer posted (or
has received) collateral consisting of cash
or liquid assets; (b) whether the borrowed
security is due to mature shortly after the
scheduled termination date of the secu-
rities borrowing; (c) the type of security

September 28, 2020 630 Bulletin No. 2020–40
being lent (for example, Treasury bonds as
compared to riskier corporate bonds); and
(d) whether the securities borrowing was
entered into in the ordinary course of the
taxpayer’s trade or business.
The final regulations retain substitute
interest payments in the definition of in-
terest because the payments generally are
economically equivalent to interest and
should be treated as such for purposes of
section 163(j). However, in response to
comments, the final regulations provide
that a substitute interest payment is treat-
ed as interest expense to the payor only if
the payment relates to a sale-repurchase
or securities lending transaction that is
not entered into by the payor in the pay-
or’s ordinary course of business, and that
a substitute interest payment is treated as
interest income to the recipient only if the
payment relates to a sale-repurchase or se-
curities lending transaction that is not en-
tered into by the recipient in the recipient’s
ordinary course of business. The final reg-
ulations do not adopt the other suggested
factors because the Treasury Department
and the IRS have determined that the or-
dinary course rule in the final regulations
provides an appropriate and effective limit
on the scope of the definition. Specifical-
ly, the Treasury Department and the IRS
have determined that these transactions
are rarely entered into outside the payor’s
ordinary course of business, and that any
such non-ordinary course transactions
likely would involve an intention to avoid
section 163(j).
iii. Commitment Fees
Proposed §1.163(j)-1(b)(20)(iii)(G)
(1) treats any fees in respect of a lend-
er commitment to provide financing as
interest if any portion of such financing
is actually provided. Commenters rec-
ommended that commitment fees and
other debt-related fees not be included
in the definition of interest until gener-
al substantive guidance is provided on
the treatment of the fees in the separate
fee-related project on the Office of Tax
Policy and IRS 2019-2020 Priority Guid-
ance Plan (REG-132517-17). According
to the commenters, uncertainty exists as
to whether to characterize these fees for
Federal income tax purposes as fees for
services or property or for compensation
for the use or forbearance of money. In
addition, under existing guidance, com-
mitment fees are treated differently by
the borrower (similar to an option pre-
mium) and the lender (service income).
See Rev. Rul. 81-160, 1981-1 C.B. 312,
and Rev. Rul. 70-540, 1970-2 C.B. 101,
Situation (3). Some taxpayers, however,
argue that a commitment fee should be
treated as creating or increasing discount
on a debt instrument and that the fee
should be treated consistently by both the
borrower and the lender. If commitment
fees are included in the definition of in-
terest in the final regulations, comment-
ers recommended that only the portion of
the commitment fee that is proportionate
to the amount drawn be treated as inter-
est.
In response to comments, the final reg-
ulations do not include commitment fees
in the definition of interest. The treatment
of commitment fees and other fees paid in
connection with lending transactions will
be addressed in future guidance that ap-
plies for all purposes of the Code.
iv. Debt Issuance Costs
Proposed §1.163(j)-1(b)(20)(iii)(H)
treats debt issuance costs as interest ex-
pense of the issuer. Commenters argued
that debt issuance costs should not be
treated as interest expense because these
costs are paid to third parties in connec-
tion with the issuance of debt and are not
paid or incurred for the use or forbearance
of money under a debt instrument. For tax
purposes, these costs are capitalized by
the issuer and are treated as deductible un-
der section 162 over the term of the debt
instrument as if the costs adjust the instru-
ment’s yield by reducing the instrument’s
issue price by the amount of the costs. See
§1.446-5.
In response to comments, the final reg-
ulations exclude debt issuance costs from
the definition of interest.
v. Guaranteed Payments
Proposed §1.163(j)-1(b)(20)(iii)(I)
provides that any guaranteed payments for
the use of capital under section 707(c) are
treated as interest. Some commenters stat-
ed that a guaranteed payment for the use
of capital should not be treated as interest
for purposes of section 163(j) unless the
guaranteed payment was structured with
a principal purpose of circumventing sec-
tion 163(j). Other commenters stated that
section 163(j) never should apply to guar-
anteed payments for the use of capital.
In response to comments, the final
regulations do not explicitly include
guaranteed payments for the use of capi-
tal under section 707(c) in the definition
of interest. However, consistent with the
recommendations of some commenters,
the anti-avoidance rules in §1.163(j)-1(b)
(22)(iv) (described in part II(E)(4) of this
Summary of Comments and Explanation
of Revisions section) include an example
of a situation in which a guaranteed pay-
ment for the use of capital is treated as
interest expense and interest income for
purposes of section 163(j). See §1.163(j)-
1(b)(22)(v)(E), Example 5.
vi. Hedging Transactions
Proposed §1.163(j)-1(b)(20)(iii)(E)
generally treats income, deduction, gain,
or loss from a derivative that alters a tax-
payer’s effective cost of borrowing with
respect to a liability of the taxpayer as an
adjustment to the taxpayer’s interest ex-
pense. Proposed §1.163(j)-1(b)(20)(iii)
(F) generally treats income, deduction,
gain, or loss from a derivative that alters
a taxpayer’s effective yield with respect to
a debt instrument held by the taxpayer as
an adjustment to the taxpayer’s interest in-
come. The rules in the two provisions are
referred to as the “hedging rules” in this
preamble.
Numerous comments were received on
the hedging rules. The commenters ques-
tioned the administrability of the broad
hedging rules, especially if the taxpayer
hedges on a macro (that is, on an aggre-
gate) basis. Also, the commenters noted
that it is not clear how to apply the rules in
certain situations, including a situation in
which the hedge relates to non-debt items
(for example, if the taxpayer hedges the
mismatch or “gap” between its assets and
liabilities), the debt instrument is not sub-
ject to section 163(j), or the debt instru-
ment is subject to other interest deferral
provisions for Federal tax purposes. In
addition, the commenters noted that the
proposed regulations effectively would
require integration, even if the hedge oth-

Bulletin No. 2020–40 631 September 28, 2020
erwise would not be integrated with the
debt instrument for Federal tax purpos-
es and the income, deduction, gain, and
loss from the hedge ordinarily would be
accounted for separately, which the com-
menters suggested would require taxpay-
ers to maintain two sets of books. More-
over, the commenters stated that, under
the proposed regulations, any gain or loss
on the underlying debt instrument (for
example, due to changes in interest rates)
would not be treated as an adjustment to
interest income or expense, whereas the
corresponding loss or gain on the hedge
would be treated as an adjustment to inter-
est expense or income. Some commenters
stated that the yield on third-party borrow-
ings reflects the true cost of the borrow-
ing, and that hedges are not relevant to the
cost of the borrowing.
Commenters recommended that, if the
hedging rules are retained in the final reg-
ulations as a separate item, the final regu-
lations precisely define (a) what standard
is used to include a derivative in section
163(j) (for example, a primary purpose
or principal motivation standard), and
(b) the standard for determining whether
the effect of a derivative on the cost of
borrowing or effective yield is sufficient-
ly significant for the income, deduction,
gain, or loss from the derivative to be in-
cluded in the computation. Commenters
noted that one approach would be to ap-
ply the hedging rules only to derivatives
that qualify for integration under §1.988-
5 or §1.1275-6. Another approach would
be to apply the hedging rules to deriva-
tives that have a sufficiently close con-
nection with the liability to qualify as
hedging transactions under §§1.446-4
and 1.1221-2. Some commenters indi-
cated that the hedging rules could apply
if the derivative is treated as a hedge of
a borrowing or liability for financial re-
porting purposes, and that the hedging
rules should not apply to broker-dealers,
active traders in derivatives, and finan-
cial institutions acting in the ordinary
course of business.
One commenter recommended that
section 163(j) not alter the timing of tax-
able items from hedging transactions that
are subject to §1.446-4, regardless of
whether interest expense on the hedged
item is deferred under section 163(j). Oth-
er commenters noted that the proposed
regulations do not provide guidance on
the interaction between the hedging rules
and the straddle rules.
With respect to foreign currency hedg-
ing transactions, a commenter noted that
foreign currency gain or loss is due to the
time value of money only to a limited ex-
tent; thus, the commenter recommended
that section 163(j) not apply to a taxpay-
er’s foreign currency hedging transactions
(other than an integrable transaction under
§1.988-5).
In response to comments, the final reg-
ulations do not include the hedging rules
in the definition of interest. However, in
certain circumstances, the anti-avoidance
rules in §1.163(j)-1(b)(22)(iv) (described
in part II(E)(4) of this Summary of Com-
ments and Explanation of Revisions
section) may apply to require income,
deduction, gain, or loss from a hedging
transaction to be taken into account for
purposes of section 163(j).
vii. Other Items
Commenters recommended other items
to be included in, or excluded from, the
definition of interest as follows:
a. Dividends from Regulated Investment
Company (RIC) Shares
Some commenters recommended that
dividend income from a RIC be treated
as interest income for a shareholder in a
RIC, to the extent that the dividend is at-
tributable to interest income earned by the
RIC. To address this comment, in the Con-
current NPRM, the Treasury Department
and the IRS have proposed rules under
which a RIC that earns business interest
income may pay section 163(j) interest
dividends that certain shareholders may
treat as interest income for purposes of
section 163(j). See paragraphs (b)(22)(iii)
(F) and (b)(35) in proposed §1.163(j)-1 in
the Concurrent NPRM.
b. MMF Income
A few commenters recommended that
the final regulations allow look-through
treatment for earnings from certain for-
eign entities, such as foreign money
market funds (MMFs), so that dividends
from foreign MMFs would be treated as
interest income to the extent the under-
lying income derived by a foreign MMF
was interest income. According to the
commenters, this treatment would allevi-
ate issues for a CFC that borrows money
from related parties and invests in for-
eign MMFs. In general, the commenters
stated that any interest limitation under
section 163(j) could lead to unexpected
results in this situation, such as section
952(c) recapture accounts solely generat-
ed by the section 163(j) interest expense
limitation.
The final regulations do not adopt this
recommendation because it is beyond the
scope of the final regulations and because
there are significant differences between
the rules governing income inclusions
in respect of passive foreign investment
companies (PFICs), such as foreign
MMFs, and RICs. These differences make
it difficult to adopt a rule that would pro-
vide for look-through treatment in the
context of dividends or inclusions from
a PFIC. In particular, the regime for tax-
ing income from a PFIC that shareholders
have elected to treat as a qualified electing
fund (QEF) under section 1295 generally
focuses only on inclusions related to or-
dinary income or net capital gain income
and does not separately report amounts
of interest income for Federal income tax
purposes. In the case of a PFIC for which
a QEF election has not been made, there
would be no information about the un-
derlying taxable income of the PFIC and
no reason or ability to treat an interest in
the PFIC differently from the treatment of
stock held in other C corporations.
c. Negative Interest
One commenter requested clarification
on the treatment of negative interest (an
amount that a depositor may owe a bank
in a negative interest rate environment)
and inquired whether such payments are
more similar to payments for custodial or
service fees rather than for interest. The
final regulations do not address this issue
because it is beyond the scope of the final
regulations. However, in certain cases (for
example, a Treasury bill acquired with a
negative yield), a payment may be treated
as bond premium subject to the rules in
section 171, including the rules in §1.171-
2(a)(4)(i)(C).

September 28, 2020 632 Bulletin No. 2020–40
d. Leases
A commenter recommended that the
Treasury Department and the IRS adopt
rules that clearly describe the circumstances
in which fleet leases are treated as generating
interest for purposes of section 163(j). The
commenter noted that there is a time-value-
of-money portion of a fleet lease payment
similar to the time-value-of-money portion
of other items treated as interest under the
proposed regulations, such as guaranteed
payments, commitment fees, debt issuance
costs, and items of income or loss from a
derivative instrument that alters a taxpayer’s
effective yield or effective cost of borrow-
ing. In addition, to the extent that the an-
ti-avoidance rule in the proposed regulations
is retained, the commenter asked that the
final regulations clearly define the circum-
stances (if any) in which the anti-avoidance
rule would operate to recharacterize any
portion of a fleet lease payment as interest
expense, and modify the anti-avoidance rule
to apply to both interest expense of the fleet
lessee and interest income of the fleet lessor.
The Treasury Department and the IRS
do not adopt the commenter’s suggestions
in the final regulations because the sugges-
tions generally are no longer relevant after
the revisions made to the definition of inter-
est in the final regulations. For example, as
explained in this part II(E)(3) of this Sum-
mary of Comments and Explanation of Re-
visions section, no portion of the items gen-
erally cited by the commenter is explicitly
treated as interest in the final regulations.
Moreover, there are explicit provisions in
the Code that determine whether a portion
of a lease payment is treated as interest for
Federal income tax purposes depending on
the terms of a lease, such as sections 467
and 483. In addition, as explained in part
II(E)(4) of this Summary of Comments and
Explanation of Revisions section, the an-
ti-avoidance rule in the final regulations is
revised to include a principal purpose test
and to generally align the treatment of in-
come and expense, which should address
the commenter’s concerns.
4. Anti-Avoidance Rule for Amounts
Predominantly Associated with the Time
Value of Money
Proposed §1.163(j)-1(b)(20)(iv) pro-
vides that any expense or loss, to the ex-
tent deductible, incurred by a taxpayer
in a transaction or series of integrated or
related transactions in which the taxpay-
er secures the use of funds for a period of
time is treated as interest expense of the
taxpayer if such expense or loss is pre-
dominantly incurred in consideration of
the time value of money. Numerous com-
ments were received on this anti-avoid-
ance rule in the proposed regulations.
Most commenters recommended that any
anti-avoidance rule in the final regulations
contain a requirement that the taxpayer
have a principal purpose to avoid section
163(j). Several commenters asserted that
the anti-avoidance rule should cover only
transactions that are economically equiv-
alent to interest and should set forth ex-
amples of transactions that are and are not
covered. Most commenters recommended
that the anti-avoidance rule be symmetrical
and apply to income or gain, as well as to
expense or loss. One commenter suggest-
ed that, based on section 1258 concepts,
the anti-avoidance rule should apply only
if, at the time of the relevant transaction or
series of transactions that secure the use of
funds for a period of time for the taxpay-
er, substantially all of the expense or loss
was expected to be attributable to the time
value of money. In addition, commenters
noted that it should be clear when a tax-
payer should test whether a transaction
falls within the anti-avoidance rule. Other
commenters requested specific rules coor-
dinating this anti-avoidance rule with the
general anti-avoidance rule in proposed
§1.163(j)-2(h).
Some commenters stated that an in-
terest anti-avoidance rule should not be
included in the final regulations because,
for example, the rule would impose sub-
stantial compliance costs, the Treasury
Department and the IRS have other tools
to combat any abuse, and there already is
a general anti-avoidance rule in proposed
§1.163(j)-2(h). Commenters also noted
that the interest anti-avoidance rule in the
proposed regulations has the potential to
capture ordinary market transactions that
possess a time value component but that
are not generally treated as financings
with disguised interest for tax purposes.
In response to comments, the Treasury
Department and the IRS have modified
the anti-avoidance rule in the final regu-
lations. Under §1.163(j)-1(b)(22)(iv)(A)
(1), any expense or loss economically
equivalent to interest is treated as interest
expense for purposes of section 163(j) if a
principal purpose of structuring the trans-
action(s) is to reduce an amount incurred
by the taxpayer that otherwise would have
been interest expense or treated as inter-
est expense under §1.163(j)-1(b)(22)(i)
through (iii). For this purpose, the fact that
the taxpayer has a business purpose for
obtaining the use of funds does not affect
the determination of whether the manner
in which the taxpayer structures the trans-
action(s) is with a principal purpose of re-
ducing the taxpayer’s interest expense. In
addition, the fact that the taxpayer has ob-
tained funds at a lower pre-tax cost based
on the structure of the transaction(s) does
not affect the determination of whether the
manner in which the taxpayer structures
the transaction(s) is with a principal pur-
pose of reducing the taxpayer’s interest
expense.
For purposes of §1.163(j)-1(b)(22)(iv)
(A)(1), any expense or loss is economical-
ly equivalent to interest to the extent that
the expense or loss is (1) deductible by the
taxpayer; (2) incurred by the taxpayer in a
transaction or series of integrated or relat-
ed transactions in which the taxpayer se-
cures the use of funds for a period of time;
(3) substantially incurred in consideration
of the time value of money; and (4) not
described in §1.163(j)-1(b)(22)(i), (ii), or
(iii).
Under §1.163(j)-1(b)(22)(iv)(A)(2), if
a taxpayer knows that an expense or loss
is treated by the payor as interest expense
under §1.163(j)-1(b)(22)(iv)(A)(1), the
taxpayer provides the use of funds for a
period of time in the transaction(s) subject
to §1.163(j)-1(b)(22)(iv)(A)(1), the tax-
payer earns income or gain with respect
to the transaction(s), and such income or
gain is substantially earned in consider-
ation of the time value of money provided
by the taxpayer, such income or gain is
treated as interest income for purposes of
section 163(j) to the extent of the expense
or loss treated by the payor as interest ex-
pense under §1.163(j)-1(b)(22)(iv)(A)(1).
Under §1.163(j)-1(b)(22)(iv)(B),
notwithstanding §1.163(j)-1(b)(22)(i)
through (iii), any income realized by a
taxpayer in a transaction or series of inte-
grated or related transactions is not treated
as interest income of the taxpayer for pur-

Bulletin No. 2020–40 633 September 28, 2020
poses of section 163(j) if and to the extent
that a principal purpose for structuring the
transaction(s) is to artificially increase the
taxpayer’s business interest income. For
this purpose, the fact that the taxpayer
has a business purpose for holding inter-
est-generating assets does not affect the
determination of whether the manner in
which the taxpayer structures the transac-
tion(s) is with a principal purpose of arti-
ficially increasing the taxpayer’s business
interest income.
For purposes of the foregoing an-
ti-avoidance rules, §1.163(j)-1(b)(22)(iv)
(C) provides that whether a transaction or a
series of integrated or related transactions
is entered into with a principal purpose de-
pends on all the facts and circumstances
related to the transaction(s), except that the
fact that the taxpayer has obtained funds at
a lower pre-tax cost based on the structure
of the transaction(s) or the fact that the
taxpayer has a business purpose related
to the item is ignored for this purpose. A
purpose may be a principal purpose even
though it is outweighed by other purposes
taken together or separately. Factors to be
taken into account in determining wheth-
er one of the taxpayer’s principal pur-
poses for entering into the transaction(s)
include the taxpayer’s normal borrowing
rate in the taxpayer’s functional currency,
whether the taxpayer would enter into the
transaction(s) in the ordinary course of
the taxpayer’s trade or business, whether
the parties to the transaction(s) are relat-
ed persons (within the meaning of section
267(b) or section 707(b)), whether there is
a significant and bona fide business pur-
pose for the structure of the transaction(s),
whether the transactions are transitory, for
example, due to a circular flow of cash or
other property, and the substance of the
transaction(s).
In response to comments, §1.163(j)-
1(b)(22)(iv)(D) provides that the an-
ti-avoidance rules in §1.163(j)-1(b)(22)
(iv), rather than the general anti-avoidance
rules in §1.163(j)-2(j), apply to determine
whether an item is treated as interest ex-
pense or interest income.
Section 1.163(j)-1(b)(22)(v) contains
examples illustrating the application of the
interest anti-avoidance rules in a number
of situations, including examples relating
to a hedging transaction involving a for-
eign currency swap transaction, a forward
contract involving gold, a loan guaranteed
by a related party in which the related par-
ty receives guarantee fees, and guaranteed
payments for the use of capital. However,
these examples are not intended to repre-
sent the only situations in which the an-
ti-avoidance rules might apply.
The anti-avoidance rules in §1.163(j)-
1(b)(22)(iv) apply to transactions entered
into on or after September 14, 2020. See
§1.163(j)-1(c)(2).
5. Authority Comments
Most of the commenters on the defini-
tion of interest in the proposed regulations
questioned whether the Treasury Depart-
ment and the IRS have the authority to
expand the definition of interest for pur-
poses of section 163(j) to include “interest
equivalents” (the items listed in proposed
§1.163(j)-1(b)(20)(iii) and the expenses
or losses subject to the anti-avoidance rule
in proposed §1.163(j)-1(b)(20)(iv)). The
commenters asserted that the term “busi-
ness interest” in section 163(j)(5) means
any interest paid or accrued on indebted-
ness properly allocable to a trade or busi-
ness, and that expanding the definition to
include interest equivalents would capture
amounts that do not fall within the scope
of the general rule in section 163(a) that
“[t]here shall be allowed as a deduction
all interest paid or accrued within the tax-
able year on indebtedness.” Even though
section 163(j)(1) refers to an “amount al-
lowed as a deduction under this chapter
for business interest” when describing
the amounts limited by section 163(j),
the commenters argued that the deduction
otherwise allowed must be with respect
to “business interest” (which is defined in
section 163(j)(5)) and that the phrase “de-
duction under this chapter” does not and
should not modify the definition of “busi-
ness interest” in section 163(j)(5).
The commenters noted that section
163(j), as amended by the TCJA, does not
contain a specific delegation of regulatory
authority to expand the definition of inter-
est. The commenters further asserted that
the Treasury Department and the IRS may
issue only “interpretive regulations” under
section 7805, and that any such regulations
may not go beyond the stated meaning of
the statutory language. The commenters
noted that old section 163(j)(9) provided
broad regulatory authority to prescribe
regulations, including regulations appro-
priate to prevent the avoidance of old sec-
tion 163(j). In addition, the commenters
noted that the legislative history for old
section 163(j) indicated that the Treasury
Department could issue guidance treating
“items not denominated as interest but
appropriately characterized as equivalent
to interest” as interest income or interest
expense. The commenters stated that there
is no similar regulatory authority or legis-
lative history relating to section 163(j) as
amended by the TCJA.
Commenters also noted that, when
Congress has chosen to expand the defini-
tion of interest in other parts of the Code,
Congress has done so explicitly. For ex-
ample, section 263(g) provides that, “[for
purposes of section 263(g)(2)(A)], the
term ‘interest’ includes any amount paid
or incurred in connection with personal
property used in a short sale.” As noted in
the preamble to the proposed regulations,
most of the rules treating interest equiva-
lent items as interest income or expense
in proposed §1.163(j)-1(b)(20)(iii) were
developed in §§1.861-9T and 1.954-2.
However, commenters argued that the use
of the interest equivalent provisions in
§§1.861-9T and 1.954-2 by analogy to de-
fine interest for purposes of section 163(j)
is inappropriate because different policy
considerations underlie those sections,
there is statutory or regulatory authority
to address interest equivalents under those
sections (unlike section 163(j)), and those
sections apply only for limited purposes
(for example, for sourcing purposes).
In addition, because the broad defini-
tion of interest in the proposed regulations
applies only for purposes of section 163(j),
commenters asserted that there will be
additional compliance burdens and costs
for taxpayers to separately track amounts
treated as interest for purposes of section
163(j) and for other purposes. Comment-
ers asserted that the broad definition of
interest for purposes of section 163(j) in
the proposed regulations may create un-
certainty and confusion for taxpayers with
respect to other sections of the Code.
Contrary to the assertions made by
many of the commenters, the Treasury
Department and the IRS have the author-
ity to prescribe rules relating to interest
equivalents and an anti-avoidance rule.

September 28, 2020 634 Bulletin No. 2020–40
As noted in the preamble to the proposed
regulations, there are no generally appli-
cable regulations or statutory provisions
addressing when financial instruments are
treated as indebtedness for Federal income
tax purposes or when a payment is “inter-
est.” Therefore, a regulatory definition of
interest is needed in order to implement
the statutory language of section 163(j).
In addition, it would be inconsistent
with the purpose of section 163(j) to allow
transactions that are essentially financ-
ing transactions to avoid the application
of section 163(j). Thus, an anti-avoid-
ance rule is needed to address situations
in which a taxpayer’s principal purpose
in structuring a transaction or series of
transactions is to artificially reduce the
taxpayer’s business interest expense or to
increase the taxpayer’s business interest
income. Moreover, at least one comment-
er suggested the inclusion of the type of
anti-avoidance rule that is included in the
final regulations and that the Treasury De-
partment and the IRS have the authority to
include such a rule.
Section 7805(a) provides the Treasury
Department and the IRS with the authority
to prescribe all rules and regulations need-
ed for enforcement of the Code, including
all rules and regulations as may be nec-
essary by reason of any alteration of law
in relation to internal revenue. Providing a
regulatory definition of interest for purpos-
es of section 163(j) and the anti-avoidance
rule falls within this authority. The statu-
tory language of section 163(j)(1) (‘‘The
amount allowed as a deduction under this
chapter for any taxable year for business
interest . . .’’) (emphasis added) also sup-
ports the application of section 163(j) to
more items than merely items traditionally
deducted under section 163(a).
Although the Treasury Department and
the IRS have the authority to prescribe
regulations addressing interest equivalents
and anti-avoidance transactions, as not-
ed earlier in parts II(E)(3) and (4) of this
Summary of Comments and Explanation
of Revisions section, in response to com-
ments, the final regulations nevertheless
limit the interest equivalent items to those
items commenters agreed should be treat-
ed as interest expense or interest income,
substitute interest payments made in con-
nection with a sale-repurchase agreement
or securities lending transaction that is not
entered into by the taxpayer in the tax-
payer’s ordinary course of business, and
certain amounts relating to transaction(s)
entered into by a taxpayer with a princi-
pal purpose of artificially reducing interest
expense or increasing interest income.
F. Definition of Motor Vehicle – Proposed
§1.163(j)-1(b)(25)
Proposed §1.163(j)-1(b)(25) provides
that the term “motor vehicle” means a mo-
tor vehicle as defined in section 163(j)(9)
(C). Under section 163(j)(9)(C), a motor
vehicle means any self-propelled vehicle
designed for transporting persons or prop-
erty on a public street, highway, or road; a
boat; and farm machinery or equipment.
A few commenters questioned whether
towed recreational vehicles and trailers
are included in the definition of “motor
vehicle.” One commenter requested that
the final regulations define motor vehicle
to include any trailer or camper that is de-
signed to provide temporary living quar-
ters for recreational, camping, travel, or
seasonal use and is designed to be towed
by, or affixed to, a motor vehicle. Another
commenter recommended allowing mo-
tor vehicle dealers to deduct floor plan
financing interest on both motor vehicles
and trailers that are offered for sale in in-
tegrated or related businesses.
Because section 163(j)(9)(C) specifi-
cally defines motor vehicles as self-pro-
pelled vehicles, the Treasury Department
and the IRS do not have the authority to
expand the definition of motor vehicles
in the final regulations to include vehi-
cles that are not self-propelled, such as
towed recreational vehicles and trailers.
For this reason, the Treasury Department
and the IRS decline to adopt these com-
ments in the final regulations. Therefore,
the definition of motor vehicles in the fi-
nal regulations continues to incorporate
the definition in section 163(j)(9)(C) by
cross-reference.
G. Definition of Taxable Income –
Proposed §1.163(j)-1(b)(37)
1. Calculation of Taxable Income
Proposed §1.163(j)-1(b)(1)(i)(A) pro-
vides that business interest expense is
added to taxable income to determine
ATI. Some commenters noted that this
provision could be construed as distorting
ATI if a taxpayer has a disallowed busi-
ness interest expense carryforward from
a prior taxable year. Under such facts,
the proposed regulations would not have
reduced taxable income by the amount
of the carryforward, because proposed
§1.163(j)-1(b)(37) disregards the carry-
forward as part of section 163(j) and the
section 163(j) regulations. However, in
calculating ATI, taxpayers might argue
that taxable income should be increased
by the amount of the disallowed business
interest expense carryforward because the
term “business interest expense” in the
proposed regulations includes disallowed
business interest expense carryforwards.
The Treasury Department and the IRS
did not intend to create a net positive ad-
justment to ATI for disallowed business
interest expense carryforwards. To address
this potential distortion, the final regula-
tions clarify that tentative taxable income
is computed without regard to the section
163(j) limitation, and that disallowed
business interest expense carryforwards
are not added to tentative taxable income
in computing ATI under §1.163(j)-1(b)(1).
2. Interaction with Section 250
Proposed §1.163(j)-1(b)(37)(ii) pro-
vides a rule to coordinate the application
of sections 163(j) and 250. Section 250(a)
(1) generally provides a deduction based
on the amount of a domestic corpora-
tion’s foreign-derived intangible income
and GILTI. Section 250(a)(2) limits the
amount of this deduction based on the tax-
payer’s taxable income—the greater the
amount of a taxpayer’s taxable income for
purposes of section 250(a)(2), the greater
the amount of the taxpayer’s allowable de-
duction under section 250(a)(1).
In particular, proposed §1.163(j)-1(b)
(37)(ii) provides that, if a taxpayer is al-
lowed a deduction for a taxable year under
section 250(a)(1) that is properly allocable
to a non-excepted trade or business, then
the taxpayer’s taxable income for that year
is determined without regard to the limita-
tion in section 250(a)(2). Some comment-
ers observed that this proposed rule results
in a lower ATI and section 163(j) limita-
tion for the taxpayer than if the limita-
tion in section 250(a)(2) were taken into

Bulletin No. 2020–40 635 September 28, 2020
account. Commenters also stated that the
rationale for this approach (which does
not reflect the taxpayer’s actual taxable in-
come) is unclear, and they recommended
that this provision be withdrawn or made
elective for taxpayers.
The Treasury Department and the
IRS have determined that further study
is required to determine the appropriate
rule for coordinating sections 250(a)(2),
163(j), and other Code provisions (such
as sections 170(b)(2) and 172(a)(2)) that
limit the availability of deductions based,
directly or indirectly, upon a taxpayer’s
taxable income (taxable income-based
provisions). Therefore, the final regula-
tions do not contain the rule in proposed
§1.163(j)-1(b)(37)(ii). Until such addi-
tional guidance is effective, taxpayers
may choose any reasonable approach
(which could include an ordering rule or
the use of simultaneous equations) for
coordinating taxable income-based provi-
sions as long as such approach is applied
consistently for all relevant taxable years.
For this purpose, the ordering rule con-
tained in proposed §§1.163(j)-1(b)(37)
(ii) (83 FR 67490 (Dec. 28, 2018)) and
1.250(a)-1(c)(4) (contained in 84 FR 8188
(March 6, 2019)) is treated as a reasonable
approach for coordinating sections 163(j)
and 250. Comments are welcome on what
rules should be provided, and whether an
option to use simultaneous equations in
lieu of an ordering rule would be appro-
priate in order to coordinate taxable in-
come-based provisions.
3. When Disallowed Business Interest
Expense is “Paid or Accrued”
As noted in the Background section of
this preamble, section 163(j)(2) provides
that the amount of any business interest
not allowed as a deduction for any tax-
able year under section 163(j)(1) is treated
as business interest “paid or accrued” in
the succeeding taxable year. Commenters
asked for clarification as to whether disal-
lowed business interest expense should be
treated as “paid or accrued” in the taxable
year in which such expense is taken into
account for Federal income tax purpos-
es (without regard to section 163(j)), or
whether such expense instead should be
treated as paid or accrued in the succeed-
ing taxable year in which the expense can
be deducted by the taxpayer under section
163(j).
For purposes of section 163(j) and the
section 163(j) regulations, the term “paid
or accrued” in section 163(j)(2) must
be construed in such a way as to further
congressional intent. Although the use of
this term in section 163(j)(2) provides a
mechanism for disallowed business inter-
est expense to be carried forward to and
deducted in a subsequent taxable year, it
does not mean that a disallowed business
interest expense carryforward is treated as
paid or accrued in a subsequent year for
all purposes. In certain contexts, a dis-
allowed business interest expense must
be treated as paid or accrued in the year
the expense was paid or accrued without
regard to section 163(j) to give effect to
congressional intent. For example, if a
disallowed business interest expense were
treated as paid or accrued only in a future
taxable year in which such expense could
be deducted after the application of sec-
tion 163(j), then section 382 never would
apply to such expense (because disal-
lowed business interest expense carryfor-
wards never would be pre-change losses).
This outcome is clearly contrary to con-
gressional intent (see section 382(d)(3)).
Similarly, if a disallowed business interest
expense were treated as paid or accrued in
a future taxable year for purposes of sec-
tion 163(j)(8)(A)(ii), then such expense
would be added back to tentative taxable
income in determining ATI for that tax-
able year (and for all future taxable years
to which such expense is carried forward
under section 163(j)(2)), thereby artifi-
cially increasing the taxpayer’s section
163(j) limitation. (See part II(A) of this
Summary of Comments and Explanation
of Revisions section.) This outcome also
is inconsistent with congressional intent.
However, in other contexts, a disallowed
business interest expense must be treated
as paid or accrued in a succeeding taxable
year to allow for the deduction of the car-
ryforward in that year.
The definition of “disallowed business
interest expense” has been revised in the
final regulations to reflect that, solely for
purposes of section 163(j) and the section
163(j) regulations, disallowed business
interest expense is treated as “paid or ac-
crued” in the taxable year in which the
expense is taken into account for Federal
income tax purposes (without regard to
section 163(j)), or in a succeeding taxable
year in which the expense can be deduct-
ed by the taxpayer under section 163(j), as
the context may require.
4. Interaction with Sections 461(l), 465,
and 469 – Proposed §1.163(j)-1(b)(37)
The Treasury Department and the IRS
received questions asking for clarifica-
tion of the interaction between proposed
§1.163(j)-1(b)(37) and the limitations in
sections 461(l), 465, and 469. The final
regulations clarify that sections 461(l),
465, and 469 are taken into account when
determining tentative taxable income.
Then, as provided in proposed §1.163(j)-
3(b)(4), sections 461(l), 465, and 469 are
applied after the application of the section
163(j) limitation. See part II(B) of this
Summary of Comments and Explanation
of Revisions section.
H. Definition of Trade or Business –
Proposed §1.163(j)-1(b)(38)
1. In General
The section 163(j) limitation applies
to taxpayers with “business interest,”
which is defined in section 163(j)(5) as
any interest properly allocable to a trade
or business. Neither section 163(j) nor the
legislative history defines the term “trade
or business.” However, section 163(j)(7)
provides that the term “trade or business”
does not include the trade or business of
performing services as an employee, as
well as electing real property, electing
farming, and certain utility trades or busi-
nesses.
As described in the preamble to the
proposed regulations, the proposed reg-
ulations define the term “trade or busi-
ness” by reference to section 162. Section
162(a) permits a deduction for all the or-
dinary and necessary expenses paid or in-
curred in carrying on a trade or business.
Commenters requested additional guid-
ance in determining whether an activity
constitutes a section 162 trade or business.
The rules under section 162 for deter-
mining the existence of a trade or busi-
ness are well-established and illustrat-
ed through a large body of case law and
administrative guidance. Additionally,

September 28, 2020 636 Bulletin No. 2020–40
whether an activity is a section 162 trade
or business is inherently a factual ques-
tion. Higgins v. Commissioner, 312 U.S.
212, 217 (1941) (determining “whether
the activities of a taxpayer are ‘carrying
on a business’ requires an examination of
the facts in each case”).
The courts have developed two defi-
nitional requirements. One, in relation
to profit motive, requires the taxpayer to
enter into and carry on the activity with
a good-faith intention to make a profit or
with the belief that a profit can be made
from the activity. The second, in relation
to the scope of the activities, requires con-
siderable, regular, and continuous activity.
See generally Commissioner v. Groetzing-
er, 480 U.S. 23 (1987). In the seminal case
of Groetzinger, the Supreme Court stated
that, “[w]e do not overrule or cut back on
the Court’s holding in Higgins when we
conclude that if one’s gambling activity is
pursued full time, in good faith, and with
regularity, to the production of income for
a livelihood, and is not a mere hobby, it is
a trade or business within the meaning of
the statutes with which we are here con-
cerned.” Id. at 35.
2. Multiple Trades or Businesses Within
an Entity
Commenters also suggested there
should be factors to determine how to
delineate separate section 162 trades or
businesses within an entity and when an
entity’s combined activities should be
considered a single section 162 trade or
business for purposes of section 163(j).
One commenter suggested adopting the
rules for separate trades or businesses pro-
vided in section 446 and the regulations
thereunder.
The Treasury Department and the IRS
decline to adopt these recommendations
because specific guidance under section
162 is beyond the scope of the final reg-
ulations. Further, §1.446-1(d) does not
provide guidance on when trades or busi-
nesses will be considered separate and
distinct. Instead, it provides that a taxpay-
er may use different methods of account-
ing for separate and distinct trades or busi-
nesses, and it specifies two circumstances
in which trades or businesses will not be
considered separate and distinct. For ex-
ample, §1.446-1(d)(2) provides that no
trade or business will be considered sep-
arate and distinct unless a complete and
separable set of books and records is kept
for such trade or business.
The Treasury Department and the IRS
recognize that an entity can conduct more
than one trade or business under section
162. This position is inherent in the alloca-
tion rules detailed in proposed §1.163(j)-
10(c)(3), which require a taxpayer with an
asset used in more than one trade or busi-
ness to allocate its adjusted basis in the as-
set to each trade or business using the per-
missible methodology described therein.
In this context, the final regulations pro-
vide, consistent with the proposed regula-
tions, that maintaining separate books and
records for all excepted and non-excepted
trades or businesses is one indication that
a particular asset is used in a particular
trade or business.
Whether an entity has multiple trades
or businesses is a factual determination,
and numerous court decisions that define
the meaning of “trade or business” also
provide taxpayers guidance in determin-
ing whether more than one trade or busi-
ness exists. See Groetzinger, 480 U.S. at
35. For example, some court decisions
discuss whether the activities have sep-
arate books and records, facilities, loca-
tions, employees, management, and cap-
ital structures, and whether the activities
are housed in separate legal entities.
Accordingly, the final regulations de-
fine “trade or business” as a trade or busi-
ness within the meaning of section 162,
which should aid taxpayers in the proper
allocation of interest expense, interest
income, and other tax items to a trade or
business and to an excepted or non-ex-
cepted trade or business.
3. Rental Real Estate Activities as a Trade
or Business
See the discussion of elections for real
property trades or businesses that may not
qualify as section 162 trades or businesses
in part X of this Summary of Comments
and Explanation of Revisions section.
4. Separate Entities
One commenter requested clarifica-
tion that the determination of whether an
entity generates interest attributable to
a trade or business within the meaning
of section 162 is made at the entity level
without regard to the classification of the
entity’s owners. Except in the context of
a consolidated group, or if §1.163(j)-10
provides otherwise, the determination of
whether an entity generates interest and
whether such interest is properly allocable
to a trade or business is determined at the
entity level, without regard to the classi-
fication of the entity’s owners. See also
the discussion of trading partnerships and
CFC groups in the Concurrent NPRM.
I. Applicability Dates
The proposed regulations provide gen-
erally that the final regulations would ap-
ply to taxable years ending after the date
that this Treasury Decision is published in
the Federal Register. The proposed ap-
plicability date has been changed in the
final regulations to avoid the application
of the changes reflected in the final regula-
tions to a taxpayer at the end of the taxable
year, which may result in unexpected ef-
fects on the taxpayer under section 163(j).
Accordingly, the final regulations general-
ly apply to taxable years beginning on or
after the date that is 60 days after the date
that this Treasury Decision is published in
the Federal Register.
III. Comments on and Changes to
Proposed §1.163(j)-2: Deduction for
Business Interest Expense Limited
Proposed §1.163(j)-2 provides general
rules regarding the section 163(j) limita-
tion, including rules on how to calculate
the limitation, how to treat disallowed
business interest expense carryforwards,
and how the small business exemption
and the aggregation rules apply with the
limitation. The following discussion ad-
dresses comments relating to proposed
§1.163(j)-2.
A. Whether the Section 163(j) Limita-
tion is a Method of Accounting
A few commenters requested clarifica-
tion that the section 163(j) limitation is not
a method of accounting under section 446
and the regulations thereunder. The com-
menters requested clarification on whether
the application of the section 163(j) lim-
itation is a method of accounting because
the rules under section 163(j) appear to

Bulletin No. 2020–40 637 September 28, 2020
defer, rather than permanently disallow, a
deduction for disallowed business interest
expense and disallowed disqualified inter-
est (as defined in proposed §1.163(j)-1(b)
(10)). Specifically, section 163(j)(2) and
proposed §1.163(j)-2(c) allow the carry-
forward of disallowed business interest
expense, and proposed §1.163(j)-2(c) al-
lows the carryforward of disallowed dis-
qualified interest, to succeeding taxable
years.
Section 1.446-1(a)(1) defines the term
“method of accounting” to include not
only the overall method of accounting
of a taxpayer, but also the accounting
treatment of any item of gross income or
deduction. Under §1.446-1(e)(2)(ii)(a),
an accounting method change includes
a change in the overall plan of account-
ing for gross income or deductions or a
change in the treatment of any material
item used in such overall plan of account-
ing. Moreover, §1.446-1(e)(2)(ii)(a) pro-
vides that a “material item” is any item
that involves the proper time for the in-
clusion of the item in income or the tak-
ing of a deduction. The key characteristic
of a material item “is that it determines
the timing of income or deductions.”
Knight-Ridder Newspapers, Inc. v. Unit-
ed States, 743 F.2d 781, 798 (11th Cir.
1984). Once a taxpayer has established
a method of accounting for an item of
income or expense, the taxpayer must
obtain the consent of the Commissioner
under section 446(e) before changing to
a different method of accounting for that
item.
For purposes of §1.446-1(e)(2)(ii)(a),
if there is a change in the application of
the section 163(j) limitation, the item in-
volved is the taxpayer’s deduction for
business interest expense. The taxpayer
is not changing its treatment of this item;
instead, the taxpayer is changing the lim-
itation placed upon that specific item. The
effect of removing the section 163(j) lim-
itation is that the taxpayer would be able
to recognize the full amount of the interest
expense that is otherwise deductible un-
der its accounting method in a given tax-
able year before it was limited by section
163(j).
The Treasury Department and the IRS
do not view the section 163(j) limitation
as a method of accounting under section
446(e) and the regulations thereunder.
The determination of whether a taxpay-
er is subject to the section 163(j) limita-
tion is determined for each taxable year.
The carryover rules in section 163(j)(2)
and proposed §1.163(j)-2(c) provide that
disallowed business interest expense and
disallowed disqualified interest may be
carried forward to a future taxable year.
However, section 163(j) does not provide
a mechanism to ensure that, in every situ-
ation, a taxpayer will be able to deduct the
business interest expense that the taxpayer
was not permitted to deduct in one taxable
year and was required to carry forward to
succeeding taxable years. Thus, the sec-
tion 163(j) limitation is not a method of
accounting under §1.446-1(e)(2)(ii)(a)
because the change in practice may result
in a permanent change in the taxpayer’s
lifetime taxable income. Further, the sec-
tion 163(j) limitation does not involve an
“item” as it is not a recurring element of
income or expense.
B. General Gross Receipts Test and
Aggregation
As noted in the preamble to the pro-
posed regulations, section 163(j)(3) ex-
empts certain small businesses from the
section 163(j) limitation. See proposed
§1.163(j)-2(d). Under section 163(j), a
small business taxpayer is one that meets
the gross receipts test in section 448(c) and
is not a tax shelter under section 448(a)(3).
The gross receipts test is met if a taxpayer
has average annual gross receipts for the
three taxable years prior to the current
taxable year of $25 million or less. For
taxable years beginning after December
31, 2018, the gross receipts threshold re-
flects an annual adjustment for inflation as
provided for in section 448(c)(4); thus, the
gross receipts threshold for taxable years
beginning in 2020 is $26 million. See sec-
tion 3.31 of Rev. Proc. 2019-44, 2019-47
I.R.B.1093. Section 448(c)(2) aggregates
the gross receipts of multiple taxpayers
that are treated as a single employer un-
der sections 52(a) and (b) and 414(m) and
(o). The gross receipts test under section
448(c) normally applies only to corpora-
tions and to partnerships with C corpora-
tion partners. However, section 163(j)(3)
and proposed §1.163(j)-2(d)(2)(i) provide
that, for a taxpayer that is not a corpora-
tion or a partnership, the gross receipts
test of section 448(c) applies as if the tax-
payer were a corporation or a partnership.
Some commenters noted that the ag-
gregation rules in sections 52(a) and (b)
and sections 414(m) and (o) could be dif-
ficult to apply in certain instances due to
their complexity. Other commenters asked
that the final regulations clarify the appli-
cation of the aggregation rules to the gross
receipts test under section 448(c). Ad-
dressing the application of the aggregation
rules to the gross receipts test is beyond
the scope of the final regulations. The sec-
tion 52(a) and (b) aggregation rules were
enacted as part of the work opportunity
tax credit, but have also been applied to
numerous Code provisions, including
sections 45A, 45S, 264, 280C and 448.
The affiliated service group rules under
section 414(m) were enacted to address
certain abuses related to qualified retire-
ment plans, but also have been applied to
several other Code provisions, including
sections 45R, 162(m), 414(t), 4980H, and
4980I.
However, the Treasury Department
and the IRS are aware that the aggrega-
tion rules set forth in sections 52(a) and
(b) and sections 414(m) and (o) are com-
plex. Therefore, Frequently Asked Ques-
tions that explain the basic operation of
these rules are provided on http://irs.gov/
newsroom. See FAQs Regarding the Ag-
gregation Rules Under Section 448(c)(2)
that Apply to the Section 163(j) Small
Business Exemption. The Treasury De-
partment and the IRS continue to study
the application of the aggregation rules to
the gross receipts test, and request com-
ments on issues relating to such applica-
tion, taking into account the application
of the aggregation rules beyond the gross
receipts test.
The Treasury Department and the IRS
continue to review and consider issues
relating to the affiliated service group
rules under section 414(m), and a guid-
ance project regarding the aggregation
rules under section 414(m) is listed on the
2019-2020 Priority Guidance Plan (RIN
1545–BO34). As guidance is published
relating to the affiliated service group
rules, the FAQs will be updated, taking
into account the various Code provisions
to which these aggregation rules apply.
In addition, the Treasury Department
and the IRS recognize that proposed

September 28, 2020 638 Bulletin No. 2020–40
§1.163(j)-2(d)(2)(i) may generate confu-
sion with respect to the aggregation rules.
Although section 448(c) applies only to
corporations and to partnerships with a C
corporation partner, sections 52(a), 52(b),
414(m), and 414(o) apply to a broader ar-
ray of entities. These statutes contain dif-
ferent ownership thresholds for different
types of entities that apply in determining
whether multiple entities are treated as a
single employer. To resolve potential con-
fusion, the final regulations remove the
reference to the aggregation rules from
proposed §1.163(j)-2(d)(2)(i). Taxpayers
that are not a corporation or a partnership
with a C corporation partner must apply
section 448(c) as if they were a corpora-
tion or a partnership in accordance with
section 163(j)(3) and proposed §1.163(j)-
2(d)(2)(i). However, taxpayers should
treat themselves as the type of entity that
they actually are in applying sections
52(a), 52(b), 414(m), and 414(o).
C. Small Business Exemption and Single
Employer Aggregation Rules – Proposed
§§1.163(j)-2(d) and 1.52-1(d)(1)(i)
Section 52(b) treats trades or busi-
nesses under common control as a single
employer. Section 1.52-1(b) through (d)
defines “trades or businesses under com-
mon control” to include parent-subsidiary
groups and brother-sister groups. Com-
menters noted that the version of §1.52-
1(d)(1)(i) in effect at the time of the pro-
posed regulations defined “brother-sister
groups” to include entities a controlling
interest in which is owned by the same 5
or fewer people who are individuals, es-
tates, or trusts (directly and with the appli-
cation of §1.414(c)-4(b)(1)) .
Section 1.414(c)-4(b)(1) provides that,
if a person has an option to purchase an
interest in an organization, the person is
deemed to own an interest in that organi-
zation. Other provisions under §1.414(c)-
4 apply attribution on a broader scale,
such as through familial relationships and
for closely held partnerships and S corpo-
rations.
Commenters questioned whether the
cross-reference in §1.52-1(d)(1)(i) was
correct, and whether the cross-reference
should have been to §1.414(c)-4 instead
of §1.414(c)-4(b)(1). The Treasury De-
partment and the IRS agree that there is
no discernible reason why §1.52-1(d)(1)
(i) aggregation should be limited solely to
options holders. Taxpayers need to know
how to aggregate gross receipts properly
in order to know if they are subject to sec-
tion 163(j).
On July 11, 2019, a correcting amend-
ment to T.D. 8179 was published in
the Federal Register to clarify that the
cross-reference in §1.52-1(d)(1)(i) should
be to §1.414(c)-4. See 84 FR 33002. This
correcting amendment should eliminate
uncertainty for taxpayers that need to de-
termine how to aggregate gross receipts in
the context of a brother-sister group under
common control.
D. Small Business Exemption and Tax
Shelters - Proposed §1.163(j)-2(d)(1)
Consistent with section 163(j)(3), pro-
posed §1.163(j)-2(d)(1) provides that the
exemption for certain small businesses
that meet the gross receipts test of section
448(c) does not apply to a tax shelter as
defined in section 448(d)(3). Several com-
menters requested clarification on the ap-
plication of the small business exemption
under section 163(j)(3) to a tax shelter.
Section 448(d)(3) defines a tax shelter
by cross-reference to section 461(i)(3),
which defines a tax shelter, in relevant
part, as a syndicate within the meaning
of section 1256(e)(3)(B). Section 1.448-
1T(b)(3) provides, in part, that a syndicate
is a partnership or other entity (other than
a C corporation) if more than 35 percent
of its losses during the taxable year are
allocated to limited partners or limited
entrepreneurs, whereas section 1256(e)
(3)(B) refers to losses that are allocable to
limited partners or limited entrepreneurs.
As a result, the scope of the small business
exemption in section 163(j)(3) is unclear.
Commenters requested that an entity be a
syndicate in a taxable year only if it has
net losses in that year and more than 35
percent of those net losses are actually
allocated to limited partners or limited
entrepreneurs. To provide a consistent
definition of the term “syndicate” for pur-
poses of sections 163(j), 448, and 1256,
the Treasury Department and the IRS pro-
pose to define the term “syndicate” using
the actual allocation rule from the defini-
tion in §1.448-1T(b)(3). This definition is
also consistent with the definition used in
a number of private letter rulings under
section 1256. See proposed §1.1256(e)-
2(a) in the Concurrent NPRM.
Commenters also requested specific re-
lief for small business taxpayers from the
definition of a syndicate based on the “ac-
tive management” exception under sec-
tion 1256(e)(3)(C). Section 1256(e)(3)(C)
lists several examples of interests in an en-
tity that “shall not be treated as held by a
limited partner or a limited entrepreneur,”
thus excluding the entity from the defini-
tion of a syndicate. In particular, section
1256(e)(3)(C)(v) allows the Secretary to
determine (by regulations or otherwise)
“that such interest should be treated as
held by an individual who actively partic-
ipates in the management of such entity,
and that such entity and such interest are
not used (or to be used) for tax-avoidance
purposes.”
The commenters requested that the
Treasury Department use its authority un-
der section 1256(e)(3)(C)(v) to provide
relief from the definition of a syndicate
to small business entities that (1) qualify
under the gross receipts test of section
448(c), (2) meet the definition of a syn-
dicate, and (3) do not qualify to make
an election as an electing real property
business or electing farming business. If
a small business satisfies these three con-
ditions, the commenters requested that the
Treasury Department and the IRS provide
a rule that all interests in the entity are
treated as held by partners or owners who
actively participate in the management of
such entity.
The Treasury Department and the IRS
have determined that the request deeming
limited partners in small partnerships to
be active participants even if those owners
would not be treated as active participants
under section 1256(e)(3)(C) is contrary
to the statutory language and legislative
history in section 163(j)(3). Therefore, the
Treasury Department and the IRS decline
to adopt the comments.
Another commenter asked for clarifi-
cation on how to compute the amount of
loss to be tested under §1.448-1T(b)(3)
and section 1256(e)(3)(B). The comment-
er provided a particular fact pattern in
which a small business would be caught in
an iterative loop of (a) of having net loss-
es due to a business interest deduction, (b)
which would trigger disallowance of the

Bulletin No. 2020–40 639 September 28, 2020
exemption for small businesses in section
163(j)(3) if more than 35 percent of the
losses were allocated to a limited partner,
(c) which would trigger the application of
the section 163(j)(1) limitation to reduce
the amount of the interest deduction, (d)
which would then lead to the taxpayer
having no net losses and therefore being
eligible for the application of the exemp-
tion for small businesses under section
163(j)(3). To address this fact pattern,
in the Concurrent NPRM, the Treasury
Department and the IRS have added an
ordering rule providing that, for purpos-
es of section 1256(e)(3)(B) and §1.448-
1T(b)(3), losses are determined without
regard to section 163(j). See proposed
§1.1256(e)-2(b) and the example pro-
vided in proposed §1.1256(e)-2(c) in the
Concurrent NPRM.
E. Gross Receipts for Partners in
Partnerships and Shareholders of S
Corporation Stock – Proposed §1.163(j)-
2(d)(2)(iii)
Proposed §1.163(j)-2(d)(iii) provides
that, in determining whether a taxpayer
meets the gross receipts test of section
448(c), each partner in a partnership in-
cludes a share of partnership gross receipts
in proportion to such partner’s distributive
share of items of gross income that were
taken into account by the partnership un-
der section 703. Similarly, shareholders
of S corporations include a pro rata share
of the S corporation’s gross receipts. See
Rev. Rul. 71-455, 1971-2 C.B. 318 (hold-
ing that a partner’s distributive share of
the partnership’s gross receipts is used in
applying the passive investment income
test under section 1372(e)(5)).
This approach would be applicable
only in situations in which the partner and
the partnership (or a shareholder and the S
corporation) are not treated as one person
under the aggregation rules of sections
52(a) and (b) and 414(m) and (o). The
Treasury Department and the IRS request-
ed comments in the preamble to the pro-
posed regulations on this approach and on
whether other approaches to determining
the gross receipts of partners and S corpo-
ration shareholders for purposes of section
163(j) would measure the gross receipts of
such partners and shareholders more ac-
curately.
In response, several commenters sug-
gested different approaches for determin-
ing the gross receipts of partners and S
corporation shareholders. One comment-
er recommended that a taxpayer should
include gross receipts only from entities
eligible for the small business exemp-
tion (exempt entities). In other words,
the commenter recommended that a tax-
payer’s gross receipts should not include
gross receipts from (1) any electing real
property trade or business or electing
farming business; (2) any entities utilizing
the floor plan financing interest exception
under section 163(j)(1)(C); and (3) any
other entities subject to section 163(j).
The commenter noted that this modifica-
tion would simplify the computation of
gross receipts and prevent the same gross
receipts from being double-counted both
at the entity level and the partner or S cor-
poration shareholder level. However, the
determination of gross receipts generally
is not affected by whether any other entity
is subject to section 163(j).
One commenter noted that passthrough
entities generally do not provide informa-
tion regarding gross receipts to their part-
ners. As it is difficult for partners to deter-
mine the partnership’s gross receipts, the
commenter suggested various approaches,
such as a de minimis rule whereby a less-
than-10 percent owner of a passthrough
entity may use the taxable income from
such entity rather than gross receipts; use
the current-year gross receipts as a reason-
able estimate of the past three years; or not
exclude the gross receipts of the exempt
entity in certain situations.
Another commenter recommended
that, in situations in which a partner and
a partnership are not subject to the ag-
gregation rules of section 448(c), a part-
ner should not be required to include any
share of partnership gross receipts when
determining its partner-level eligibility for
the small business exemption. The com-
menter noted that section 163(j) is applied
at the partnership level. The commenter
stated it is inconsistent to take an aggre-
gate view of partnerships for purposes of
the small business exemption without a
specific rule under section 163(j) requir-
ing such attribution or aggregation. The
commenter also stated that requiring a
partner to include a share of partnership
gross receipts would discourage taxpayers
who operate small businesses from invest-
ing in partnerships.
The Treasury Department and the IRS
understand that passthrough entities might
not have reported gross receipts to their
partners or shareholders in the past. How-
ever, the statute is clear that a taxpayer
must meet the gross receipts test of section
448(c), and that, if the taxpayer is not sub-
ject to section 448(c), the section 448(c)
rules must be applied in the same manner
as if such taxpayer were a corporation or
partnership. The alternatives presented ei-
ther do not have universal application or
do not adequately reflect a passthrough
entity’s gross receipts.
Additionally, there is no authority
under section 448 and the regulations
thereunder to substitute taxable income
for gross receipts or to estimate gross re-
ceipts. Accordingly, the Treasury Depart-
ment and the IRS do not adopt the sug-
gested approaches, and the proposed rules
are finalized without any change.
IV. Comments on and Changes to Section
Proposed §1.163(j)-3: Relationship
of Section 163(j) Limitation to Other
Provisions Affecting Interest
Proposed §1.163(j)-3 provides order-
ing and operating rules that control the
interaction of the section 163(j) limitation
with other provisions of the Code that de-
fer, capitalize or disallow interest expense.
The ordering and operating rules provide
that section 163(j) applies before the oper-
ation of the loss limitation rules in section
465 and 469, and before the application of
section 461(l), and after other provisions
of the Code that defer, capitalize, or dis-
allow interest expense. The ordering and
operating rules in proposed §1.163(j)-3
apply only in determining the amount of
interest expense that could be deducted
without regard to the section 163(j) lim-
itation, and not for other purposes, such
as the calculation of ATI. The following
discussion addresses comments relating to
proposed §1.163(j)-3.
A. Capitalized Interest
Proposed §1.163(j)-3(b)(5) provides
that provisions that require interest to
be capitalized, such as sections 263A
and 263(g), apply before section 163(j).

September 28, 2020 640 Bulletin No. 2020–40
Commenters suggested that this section
is too restrictive by referring solely to
sections 263(A) and 263(g), and that
other provisions could require interest
to be capitalized. The Treasury Depart-
ment and the IRS agree with this com-
ment, and an appropriate revision has
been made in the final regulations to
account for any possible additional pro-
visions that could require interest to be
capitalized.
B. Provisions that Characterize Interest
Expense as Something Other Than
Business Interest Expense
Proposed §1.163(j)-3(b)(9) generally
provides that provisions requiring inter-
est expense to be treated as something
other than business interest expense, such
as section 163(d) governing investment
interest expense, govern the treatment
of the interest expense. Commenters
expressed confusion with the provision,
suggesting that, by virtue of the statute
and the proposed regulations, if interest
expense is treated as something other
than business interest expense, there is
no need to consult proposed §1.163(j)-
3. The Treasury Department and the IRS
generally agree with the comment and
have removed this section from the final
regulations.
C. Section 108
In the preamble to the proposed regu-
lations, the Treasury Department and the
IRS requested comments on the interac-
tion between section 163(j) and the rules
addressing income from the discharge of
indebtedness under section 108. In re-
sponse, commenters noted, for example,
that it is unclear whether cancellation of
indebtedness income under section 61(a)
(11) arises when the taxpayer only re-
ceives a benefit in the form of a disallowed
business interest expense carryforward, or
whether any exclusions, such as sections
108(e)(2) or 111, or any tax benefit prin-
ciples, should apply. In light of the com-
plex and novel issues raised in these com-
ments, the Treasury Department and the
IRS have determined that the interaction
between section 163(j) and section 108
requires further consideration and may be
the subject of future guidance.
D. Sections 461(l), 465, and 469
The proposed regulations provide that
sections 461(l), 465, and 469 apply af-
ter the application of section 163(j). The
Treasury Department and the IRS re-
ceived informal questions about the effect
of these sections on the calculation of ATI.
Therefore, the final regulations clarify
whether and how sections 461(l), 465, and
469 are applied when determining tenta-
tive taxable income. The final regulations
also include examples to demonstrate the
calculation of ATI if a loss tentatively is
suspended in the calculation of tentative
taxable income, and if a loss is carried
forward from a prior taxable year under
section 469.
V. Comments on and Changes to
Proposed §1.163(j)-4: General Rules
Applicable to C Corporations (Including
Real Estate Investment Trusts (REITs),
RICs, and Members of Consolidated
Groups) and Tax-Exempt Corporations
Section 1.163(j)-4 provides rules re-
garding the computation of items of in-
come and expense under section 163(j)
for taxpayers that are C corporations
(including members of a consolidated
group, REITs, and RICs) and tax-exempt
corporations. The following discussion
addresses comments relating to proposed
§1.163(j)-4.
A. Aggregating Affiliated but Non-
Consolidated Entities
Under the proposed regulations, mem-
bers of a consolidated group are aggregat-
ed for purposes of section 163(j), and the
consolidated group has a single section
163(j) limitation. In contrast, partnerships
that are wholly owned by members of a
consolidated group are not aggregated
with the group for purposes of section
163(j), and members of an affiliated group
that do not file a consolidated return are
not aggregated with each other for purpos-
es of section 163(j).
Several commenters recommended
that aggregation rules be applied to related
taxpayers other than consolidated group
members. For example, one comment-
er recommended that aggregation rules
similar to those provided under section
199A be applied for purposes of the sec-
tion 163(j) limitation to obviate the need
for related entities to shift debt or business
assets around to avoid this limitation. Sev-
eral other commenters noted that the 1991
Proposed Regulations applied section
163(j) to an affiliated group of corpora-
tions (including all domestic corporations
controlled by the same parent, whether
consolidated or not) and recommended
that this “super-affiliation rule” be re-
tained so that affiliated but non-consoli-
dated groups are not disadvantaged under
the section 163(j) regulations. In contrast,
another commenter agreed with the ap-
proach taken in the proposed regulations
with respect to affiliated but non-consol-
idated groups, in part because the alloca-
tion of the section 163(j) limitation among
non-consolidated affiliates can become
quite complex.
Commenters also recommended that
a partnership owned by members of an
affiliated group (controlled partnership)
be treated as an aggregate rather than an
entity so that the section 163(j) limita-
tion would not apply separately at the
partnership level. Instead, each partner
would include its allocable share of the
controlled partnership’s tax items in de-
termining its own section 163(j) limita-
tion, and transactions between the con-
trolled partnership and its controlling
partners would be disregarded. Some
commenters would apply this approach
to partnerships wholly owned by mem-
bers of a controlled group of corpora-
tions (as defined in section 1563). Others
would apply this approach to partner-
ships wholly owned (or at least 80 per-
cent-owned) by members of a consolidat-
ed group in order to reduce compliance
complexity, to ensure that similarly sit-
uated taxpayers (namely, consolidated
groups that conduct business activities
directly and those that conduct such ac-
tivities through a controlled partnership)
are treated similarly, and to discourage
consolidated groups from creating a
controlled partnership to obtain a better
result under section 163(j). Commenters
observed that the proposed regulations
apply an aggregate approach to certain
controlled partnerships that own CFCs
(see proposed §1.163(j)-7(f)(6)(ii)(B)),
and they recommended applying this
principle more broadly.

Bulletin No. 2020–40 641 September 28, 2020
As explained in the preamble to the
proposed regulations, the Treasury De-
partment and the IRS have determined that
non-consolidated entities generally should
not be aggregated for purposes of apply-
ing the section 163(j) limitation. Whereas
old section 163(j)(6)(C) expressly provid-
ed that “[a]ll members of the same affili-
ated group (within the meaning of section
1504(a)) shall be treated as 1 taxpayer,”
section 163(j) no longer contains such lan-
guage, and nothing in the legislative histo-
ry of section 163(j) suggests that Congress
intended non-consolidated entities to be
treated as a single taxpayer for purposes of
section 163(j). See the Concurrent NPRM
for a discussion of a proposed exception to
this general rule for CFCs. Moreover, the
Treasury Department and the IRS have de-
termined that controlled partnerships gen-
erally should not be treated as aggregates
because section 163(j) clearly applies at
the partnership level. See section 163(j)
(4). In other words, Congress decided that
partnerships should be treated as entities
rather than aggregates for purposes of sec-
tion 163(j). Additionally, revising the reg-
ulations to treat controlled partnerships as
aggregates would not necessarily achieve
the objectives sought by commenters be-
cause the controlling partners effectively
could “elect” entity or aggregate treatment
for the partnership simply by selling or ac-
quiring interests therein (thereby causing
the partnership to satisfy or fail the owner-
ship requirement for aggregate treatment).
However, the Treasury Department and
the IRS are concerned that the application
of section 163(j) on an entity-by-entity ba-
sis outside the consolidated group context
could create the potential for abuse in cer-
tain situations by facilitating the separa-
tion of excepted and non-excepted trades
or businesses. For example, a consolidated
group that is engaged in both excepted and
non-excepted trades or businesses could
transfer its excepted trades or businesses
to a controlled partnership, which in turn
could borrow funds from a third party and
distribute those funds to the consolidat-
ed group tax-free under section 731 (un-
less the debt is recharacterized as debt of
the consolidated group in substance; see
Plantation Patterns, Inc. v. Commission-
er, 462 F.2d 712 (5th Cir. 1972)). Similar-
ly, an individual taxpayer that is engaged
in both excepted and non-excepted trades
or businesses could transfer its excepted
trades or businesses to a controlled corpo-
ration, which in turn could borrow funds
from a third party and distribute those
funds to the individual tax-free under sec-
tion 301(c)(2) (assuming the corporation
has no earnings and profits). Additionally,
a partnership with two trades or business-
es—one that generates ATI, and anoth-
er that generates losses—could separate
the two trades or businesses into a tiered
partnership structure solely for the pur-
pose of borrowing through the partnership
that generates ATI and avoiding a section
163(j) limitation.
The anti-avoidance rule in proposed
§1.163(j)-2(h) and the anti-abuse rule in
proposed §1.163(j)-10(c)(8) would pre-
clude taxpayers from undertaking the
foregoing transfers in certain circum-
stances. The final regulations add an ex-
ample illustrating the application of the
anti-avoidance rule in proposed §1.163(j)-
2(h) to the use of a controlled corporation
to avoid the section 163(j) limitation, as
well as an example illustrating the appli-
cation of this anti-avoidance rule to the
use of a lower-tier partnership to avoid
the section 163(j) limitation in a similar
manner.
Commenters further requested that the
Treasury Department and the IRS simplify
the rules applicable to controlled partner-
ships if the final regulations do not treat
such partnerships as aggregates rather
than entities. For example, comment-
ers recommended (i) eliminating steps 3
through 10 in proposed §1.163(j)-6(f)(2)
for such partnerships, (ii) applying the
principles of the §1.469-7 self-charged in-
terest rules to partnership interest expense
and income owed to or from consolidated
group members by treating all members
of the group as a single taxpayer, or (iii)
allowing excess taxable income (ETI) that
is allocated by a partnership to one con-
solidated group member to offset excess
business interest expense allocated by that
partnership to another group member.
The final regulations do not adopt these
recommendations. For a discussion of
steps 3 through 10 in proposed §1.163(j)-
6(f)(2), see part VII(A)(3) of this Sum-
mary of Comments and Explanation of
Revisions section. For a discussion of the
self-charged interest rules, see the Con-
current NPRM. For a discussion of the
proposal to allow ETI allocated by a part-
nership to one member of a consolidated
group to offset excess business interest
expense allocated by that partnership to
another group member, see part V(D)(4)
of this Summary of Comments and Expla-
nation of Revisions section.
B. Intercompany Transactions and
Intercompany Obligations
Proposed §1.163(j)-4(d)(2) contains
rules governing the calculation of the sec-
tion 163(j) limitation for members of a
consolidated group. These rules provide,
in part, that: (i) a consolidated group has
a single section 163(j) limitation; (ii) for
purposes of calculating the group’s ATI,
the relevant taxable income is the con-
solidated group’s consolidated taxable
income, and intercompany items and cor-
responding items are disregarded to the
extent they offset in amount; and (iii) for
purposes of calculating the group’s ATI
and determining the business interest ex-
pense and business interest income of
each member, all intercompany obliga-
tions (as defined in §1.1502-13(g)(2)(ii))
are disregarded (thus, interest expense and
interest income from intercompany obli-
gations are not treated as business interest
expense and business interest income for
purposes of section 163(j)).
In turn, proposed §1.163(j)-5(b)(3)
contains rules governing the treatment of
disallowed business interest expense car-
ryforwards for consolidated groups. These
rules provide, in part, that if the aggregate
amount of members’ business interest ex-
pense (including disallowed business in-
terest expense carryforwards) exceeds the
group’s section 163(j) limitation, then: (i)
each member with current-year business
interest expense and either current-year
business interest income or floor plan
financing interest expense deducts cur-
rent-year business interest expense to the
extent of its current-year business interest
income and floor plan financing interest
expense; (ii) if the group has any remain-
ing section 163(j) limitation, each mem-
ber with remaining current-year business
interest expense deducts a pro rata portion
of its expense; (iii) if the group has any
remaining section 163(j) limitation, dis-
allowed business interest expense carry-
forwards are deducted on a pro rata basis

September 28, 2020 642 Bulletin No. 2020–40
in the order of the taxable years in which
they arose; and (iv) each member whose
business interest expense is not fully ab-
sorbed by the group in the current taxable
year carries the expense forward to the
succeeding taxable year as a disallowed
business interest expense carryforward.
Commenters posed several questions
and comments with regard to these pro-
posed rules. One commenter expressed
concern that these provisions would
create noneconomic and distortive allo-
cations of disallowed business interest
expense within consolidated groups. For
example, assume P (the parent of a con-
solidated group) acts as a group’s sole
external borrower, and P on-lends the
loan proceeds to S (a member of P’s con-
solidated group) for use in S’s business
operations. Under the proposed regula-
tions, any disallowed business interest
expense would be allocated to P even
though S is the economic user of the
borrowed funds and may generate the
income that supports the external debt.
The commenter also expressed concern
that, under the proposed regulations,
consolidated groups effectively may de-
cide which member will carry forward
disallowed business interest expense by
having that member borrow funds from
third parties, regardless of whether that
member actually uses the funds. The
commenter raised similar concerns about
business interest income, noting that a
group may choose which member will
loan funds outside the group and thereby
affect which member’s business interest
expense is absorbed within the group.
To address the foregoing concerns,
the commenter suggested that the final
regulations (i) take intercompany inter-
est income and expense into account for
purposes of section 163(j), (ii) allocate
current-year disallowed business interest
expense to members without regard to
whether the interest expense results from
intercompany obligations or external bor-
rowings, and (iii) de-link disallowed busi-
ness interest expenses from intercompany
interest income for purposes of the rules
under §1.1502-13. However, the com-
menter acknowledged that this approach
could introduce unwarranted complexity.
Alternatively, the commenter suggested
that taxpayers be permitted to apply any
reasonable approach (apart from tracing)
consistent with the economics, subject to a
narrowly tailored anti-avoidance rule.
In the proposed regulations, the Trea-
sury Department and the IRS determined
that intercompany obligations should be
disregarded for purposes of section 163(j)
for several reasons. First, section 163(j) is
concerned with interest expense paid to
external lenders, not internal borrowing
between divisions of a single corporation
(or between members of a consolidated
group). In this regard, the Treasury De-
partment and the IRS note that treating a
member with intercompany debt but no
external debt as having business interest
expense could lead to strange results.
Second, the approach taken in the pro-
posed regulations results in application of
the section 163(j) limitation at the con-
solidated group level, consistent with the
expressed intent of Congress (see H. Rept.
115-466, at 386 (2017)).
Third, such an approach is simpler for
taxpayers to administer than an approach
that would require consolidated groups to
track disallowed business interest expense
with regard to intercompany obligations
across taxable years, as further discussed
in the following paragraph. Allowing tax-
payers to apply any reasonable approach
(and to ignore or take into account inter-
est expense on intercompany obligations
as they determine to be appropriate) also
would further complicate rather than sim-
plify tax administration, particularly with
regard to the application of section 163(j)
to consolidated groups.
Fourth, as the commenter acknowl-
edged, taking intercompany obligations
into account for purposes of section 163(j)
would complicate the application of
§1.1502-13. Section 1.1502-13 achieves
single-entity treatment for a consolidat-
ed group by preventing intercompany
transactions from creating, accelerat-
ing, avoiding, or deferring consolidated
taxable income or liability. To this end,
§1.1502-13(c) “matches” the tax items
of the members that are parties to an in-
tercompany transaction. In the case of
intercompany interest, income and deduc-
tions do not affect consolidated taxable
income or liability because each side of
the transaction “nets out” the other in each
taxable year. If section 163(j) applied to
intercompany payments of business inter-
est expense, and if a consolidated group’s
section 163(j) limitation did not permit the
deduction of all of the group’s intercom-
pany business interest expense, the inter-
est income and expense would not net out
each other. Thus, the group would need
to separately track both the intercompany
borrower’s non-deductible expense and
the intercompany lender’s non-includible
income through future taxable years.
The Treasury Department and the IRS
acknowledge that disregarding intercom-
pany obligations may lead to results in
some circumstances that are less econom-
ically accurate than a regime that takes
such obligations into account, but the
Treasury Department and the IRS consid-
ered administrability as well as economic
accuracy when promulgating the proposed
regulations. Moreover, although disre-
garding intercompany obligations may
grant consolidated groups the latitude to
decide which member will incur business
interest expense, consolidated groups also
would have significant flexibility to al-
locate business interest expense within a
group using intercompany obligations if
such obligations were regarded for pur-
poses of section 163(j).
Although the proposed rules in the
Concurrent NPRM concerning CFC group
elections do regard inter-CFC group net
interest expense in allocating CFC group
disallowed business interest expense, the
CFC group setting is materially different
from that of a consolidated group. First,
in the context of a CFC group, neither
§1.1502-13 nor similar rules apply. Sec-
ond, the location of disallowed business
interest expense may have more effect
on tax liability. In particular, disallowed
business interest expense may affect the
calculation of foreign tax credits and the
amount of qualified business asset in-
vestment within the meaning of section
951A(d)(1) (QBAI) taken into account in
determining a U.S. shareholder’s tax lia-
bility under section 951A. This effect de-
pends entirely on the particular CFC group
member affected by disallowed business
interest expense. Although the location
of disallowed business interest expense
has an effect on consolidated groups, this
effect often will be less than in the CFC
group context.
For the foregoing reasons, the final
regulations do not apply section 163(j) to
business interest expense or business in-

Bulletin No. 2020–40 643 September 28, 2020
terest income incurred on intercompany
obligations, with one limited exception
related to repurchase premium on obli-
gations that are deemed satisfied and re-
issued, which is described in part V(C) of
this Summary of Comments and Explana-
tion of Revisions section.
Commenters also expressed concern
that consolidated groups may have diffi-
culty determining which member is the
borrower on external debt if other group
members are co-obligors or guarantors on
the debt, and that, as a result, each mem-
ber may have difficulty calculating its
business interest expense for each taxable
year. Commenters voiced similar concerns
about the lack of parameters for determin-
ing the appropriate location of business
interest income and floor plan financing
interest expense within the group.
The Treasury Department and the IRS
do not find this comment persuasive. Con-
solidated groups (and other related parties)
are required to determine which member
is entitled to a deduction for interest ex-
pense. Specifically, a consolidated group
must use this information for purposes of
computing consolidated taxable income
under §§1.1502-11 and 1.1502-12 and
making stock basis adjustments in mem-
bers under §1.1502-32. Moreover, consol-
idated groups must determine which mem-
ber has incurred business interest expense
for purposes of applying section 382 and
the separate return limitation year (SRLY)
rules. Consolidated groups must look to
existing law to determine which member
should be treated as incurring business in-
terest expense or business interest income
for purposes of section 163(j).
C. Repurchase Premium on Obligations
that are Deemed Satisfied and Reissued
As discussed in part V(B) of this Sum-
mary of Comments and Explanation of
Revisions section, interest expense on
intercompany obligations generally is dis-
regarded for purposes of section 163(j).
Thus, commenters asked whether repur-
chase premium that is treated as interest
with respect to intercompany obligations
should be subject to the section 163(j)
limitation. In general, if debt that is not an
intercompany obligation becomes an in-
tercompany obligation (for example, if a
member of a consolidated group acquires
another member’s debt from a non-mem-
ber), the debt is treated for all Federal in-
come tax purposes, immediately after it
becomes an intercompany obligation, as
having been satisfied by the issuer for cash
in an amount equal to the holder’s basis in
the note and as having been reissued as a
new intercompany obligation for the same
amount of cash. See §1.1502-13(g)(5)(ii)
(A). Additionally, if a debt instrument is
repurchased by the issuer for a price in ex-
cess of its adjusted issue price (as defined
in §1.1275-1(b)), the excess (repurchase
premium) generally is deductible as inter-
est for the taxable year in which the repur-
chase occurs. See §1.163-7(c).
For example, S is a member of P’s
consolidated group, and S has borrowed
$100x from unrelated X. At a time when
S’s note has increased in value to $130x
due to a decline in prevailing interest rates,
P purchases the note from X for $130x.
Under §1.1502-13(g)(5)(ii), S’s note is
treated as satisfied for $130x immediately
after it becomes an intercompany obliga-
tion. As a result of the deemed satisfaction
of the note, P has no gain or loss, and S
has $30x of repurchase premium that is
deductible as interest. See §1.1502-13(g)
(7)(ii), Example 10. Similarly, if S were
to repurchase its note from X for $130x, S
would have $30x of repurchase premium
that is deductible as interest.
If S were to repurchase its note from
X at a premium, the interest (in the form
of repurchase premium) paid on that note
would be subject to the section 163(j)
limitation. See §1.163(j)-1(b)(22)(i)(H)
(treating repurchase premium that is de-
ductible under §1.163-7(c) as interest for
purposes of section 163(j)). If section
163(j) does not apply to repurchase pre-
mium paid by S to P after P purchases S’s
note from X, the P group would obtain a
different (and better) result than if S were
to repurchase its own note. The Treasury
Department and the IRS have determined
that achieving different results under sec-
tion 163(j) depending on which member
repurchases external debt would be incon-
sistent with treating a consolidated group
as a single entity for purposes of section
163(j) and would undermine the purpose
of §1.1502-13. Thus, the final regula-
tions provide that, for purposes of section
163(j), if any member of a consolidated
group purchases a member’s note from a
third party at a premium, the repurchase
premium that is deductible under §1.163-
7(c) is treated as interest expense for
purposes of section 163(j), regardless of
whether the repurchase premium is treated
as paid on intercompany indebtedness.
D. Intercompany Transfers of Partnership
Interests
1. Overview of Proposed §1.163(j)-4(d)
(4)
Proposed §1.163(j)-4(d)(4) provides
that the transfer of a partnership interest
in an intercompany transaction that does
not result in the termination of the part-
nership is treated as a disposition for
purposes of section 163(j)(4)(B)(iii)(II),
regardless of whether the transfer is one
in which gain or loss is recognized. Thus,
the transferor member’s excess business
interest expense is eliminated rather than
transferred to the transferee member. Pro-
posed §1.163(j)-4(d)(4) further provides
that neither the allocation of excess busi-
ness interest expense to a member from a
partnership (and the resulting decrease in
basis in the partnership interest) nor the
elimination of excess business interest ex-
pense of a member upon a disposition of
the partnership interest (and the resulting
increase in basis in the partnership inter-
est) affects basis in the member’s stock for
purposes of §1.1502-32(b)(3)(ii). Instead,
investment adjustments are made under
§1.1502-32(b)(3)(i) when the excess busi-
ness interest expense from the partnership
is absorbed by the consolidated group. See
§1.1502-32(b).
2. Intercompany Transfers of Partnership
Interests Treated as Dispositions;
Single-Entity Treatment; Application of
§1.1502-13
Commenters posed various questions
and comments about the treatment of in-
tercompany transfers of partnership inter-
ests as dispositions for purposes of section
163(j). For example, commenters asked
why, in applying section 163(j) to consol-
idated groups, the proposed regulations
treat such transfers as dispositions, rather
than simply disregard the transfers, given
that the proposed regulations generally
treat consolidated groups as a single entity

September 28, 2020 644 Bulletin No. 2020–40
and disregard intercompany transactions
for purposes of section 163(j).
The proposed regulations provide that
intercompany transfers of partnership
interests are treated as dispositions for
purposes of section 163(j) because each
member’s separate ownership of interests
in a partnership generally is respected
(otherwise, a partnership whose inter-
ests are wholly owned by members of a
consolidated group would be treated as a
disregarded entity), and because the term
“disposition” in section 163(j)(4)(B)(iii)
(II) has broad application (for example,
it applies to nonrecognition transactions).
Moreover, if an intercompany transfer of
partnership interests were not treated as a
disposition (and if, as a result, basis were
not restored to the transferor member), the
amount of the transferor member’s gain or
loss on the intercompany transfer would
be incorrect. Special rules also would be
needed to account for the transfer of ex-
cess business interest expense from one
member to another in a manner consistent
with the purposes of §1.1502-13 and to
comply with the directive of section 1502
to clearly reflect the income of each mem-
ber of the group.
Several commenters also noted prob-
lems with the approach in proposed
§§1.163(j)-4(d)(4) and 1.1502-13(c)(7)
(ii)(R), Example 18. These commenters
pointed out that the approach in the pro-
posed regulations does not achieve sin-
gle-entity treatment because one mem-
ber’s transfer of its partnership interest to
another member causes the transferor’s
excess business interest expense to be
eliminated; thus, an intercompany trans-
action may alter the amount of business
interest expense that is absorbed by the
group. One commenter suggested a dif-
ferent approach under which the trans-
feree could claim deductions for excess
business interest expense to the extent the
transferee is allocated excess taxable in-
come from the same partnership. Howev-
er, the commenter acknowledged that this
approach would require additional rules
under §1.1502-13.
Another commenter suggested that in-
tercompany transfers in which the trans-
feree is the successor to the transferor (for
example, in transactions to which section
381(a) applies, or in which the transferee’s
basis in the partnership interest is deter-
mined by reference to the transferor’s ba-
sis) should not be treated as dispositions
for purposes of section 163(j)(4)(B)(iii)
(II). However, this approach would not re-
sult in an increase in the transferor mem-
ber’s (S’s) basis in its partnership interest
immediately before the transfer; thus,
this approach would be inconsistent with
§1.1502-13, which requires the clear re-
flection of income at the level of the con-
solidated group member. This approach
also would be inconsistent with section
163(j)(4)(B)(iii)(II), which clearly treats
“a transaction in which gain is not recog-
nized in whole or in part” as a disposition
for purposes of that section.
Still another commenter observed that
the analysis in proposed §1.1502-13(c)
(7)(ii)(R), Example 18, does not work in
certain other fact patterns. In proposed
§1.1502-13(c)(7)(ii)(R), Example 18, P
wholly owns S and B, both of which are
members of P’s consolidated group. S
and A (an unrelated third party) are equal
partners in PS1, which allocates $50x of
excess business interest expense to each
partner in Year 2. At the end of Year 2, S
sells its PS1 interest to B at a $50x loss
(S’s excess business interest expense is
eliminated, and S’s basis in its PS1 in-
terest is increased by $50x immediately
before the sale). In Year 3, PS1 allocates
$25x of excess taxable income to B. At the
end of Year 4, B sells its PS1 interest to Z
(an unrelated third party) for a $10x gain.
The example concludes that S takes into
account $25x of its loss in Year 3 as an or-
dinary loss, which matches B’s inclusion
of $25x of ordinary income in Year 3. The
remaining $25x of S’s $50x capital loss
is taken into account in Year 4. The com-
menter noted that, although the analysis in
proposed §1.1502-13(c)(7)(ii)(R), Exam-
ple 18, works under the facts presented,
it would not work if, for example, S were
to sell the PS1 interest to B at a gain (be-
cause S’s gain and B’s income could not
be offset).
The Treasury Department and the IRS
acknowledge the concerns raised by these
commenters. The Treasury Department
and the IRS are continuing to study the
proper treatment of intercompany trans-
fers of partnership interests that do not
result in the termination of the partnership
(intercompany partnership interest trans-
fers), including whether such transfers
should be treated as dispositions for pur-
poses of section 163(j)(4)(B)(iii)(II). The
final regulations reserve on issues relating
to intercompany partnership interest trans-
fers, and the Treasury Department and the
IRS welcome further comments on such
issues.
3. Possible Approach to Intercompany
Partnership Interest Transfers
The Treasury Department and the
IRS are considering various possible
approaches to intercompany partnership
interest transfers. Under one possible ap-
proach, such a transfer would be treated
as a disposition by S; thus, S’s excess
business interest expense would be elim-
inated (and its basis in its partnership
interest would be increased according-
ly immediately before the transfer), as
would S’s negative section 163(j) ex-
pense (within the meaning of §1.163(j)-
6(h)(1)). However, unlike the approach
in proposed §1.163(j)-4(d)(4), B would
be treated as if B had been allocated ex-
cess business interest expense or nega-
tive section 163(j) interest expense from
the partnership in an amount equal to the
amount of S’s excess business interest
expense or negative section 163(j) ex-
pense, respectively, immediately before
the transfer. B’s basis in its partnership
interest would be adjusted under section
163(j)(4)(B)(iii)(I) and §1.163(j)-6(h)
to reflect the deemed allocation of ex-
cess business interest expense from the
partnership. Similar rules would apply
to intercompany transfers of partnership
interests in nonrecognition transactions.
The foregoing approach would attempt
to approximate single-entity treatment
while treating the intercompany transfer of
a partnership interest as a disposition for
purposes of section 163(j)(4)(B)(iii)(II).
To ensure that B has the same amount of
excess business interest expense, negative
section 163(j) expense, and disallowed
business interest expense carryforwards
as if S and B were divisions of a single
corporation, this approach also would in-
clude special basis rules. For example, if
S transfers its partnership interest to B at a
gain, the excess of B’s basis in the partner-
ship interest at any time after the transfer
over S’s basis in the partnership interest
immediately before the transfer would not

Bulletin No. 2020–40 645 September 28, 2020
be available to convert negative section
163(j) expense into excess business inter-
est expense in the hands of B or to prevent
excess business interest expense from
converting into negative section 163(j)
expense in the hands of B. Additionally, if
adjustments to B’s basis in its partnership
interest under section 163(j)(4)(B)(iii)
(I) and §1.163(j)-6(h) (upon the deemed
allocation of excess business interest ex-
pense from the partnership) would exceed
B’s basis, B would be treated as having a
suspended negative basis adjustment in
the partnership interest (similar to an ex-
cess loss account within the meaning of
§1.1502-19(a)(2)(i)).
The Treasury Department and the IRS
request comments on possible approach-
es to intercompany partnership interest
transfers, including the approach outlined
in this part V(D)(3) of this Summary of
Comments and Explanation of Revisions
section.
4. Offsetting Excess Business Interest
Expense and Adjusted Taxable Income
Within the Consolidated Group
A commenter also recommended
that, if the section 163(j) regulations do
not treat partnerships wholly owned by
members of the same consolidated group
as aggregates rather than as entities (see
part V(A) of this Summary of Comments
and Explanation of Revisions section),
the rules applicable to such partnerships
should be simplified. For example, the
excess taxable income allocated to one
member partner could be made available
to offset excess business interest expense
allocated to another member partner.
The commenter’s recommendation
presents several issues. For example, the
commenter’s recommendation would en-
tail disregarding the location of excess
business interest expense and excess tax-
able income within a consolidated group.
Such an approach would not fully respect
each member’s separate interest in a part-
nership and would not clearly reflect the
taxable income of the members of the
group. See section 1502; see also part
V(D)(2) of this Summary of Comments
and Explanation of Revisions section. Fur-
ther, to the extent the ownership structure
of the group is altered by an intercompany
transfer of the partnership interest, sub-
stantial additional rules under §1.1502-13
would be required.
5. Intercompany Nonrecognition
Transactions
In proposed §§1.163(j)-4(d)(4) and
1.1502-13(c)(7)(ii)(S), Example 19, the
intercompany transfer of a partnership
interest in a nonrecognition transaction
is treated as a disposition for purposes of
section 163(j)(4)(B)(iii)(II). In the pream-
ble to the proposed regulations, the Trea-
sury Department and the IRS requested
comments as to whether such transfers
should constitute dispositions for pur-
poses of section 163(j)(4)(B)(iii)(II) and,
if so, how §1.1502-13(c) should apply if
there is excess taxable income in a suc-
ceeding taxable year. In such a case, S
would have no intercompany item from
the intercompany transfer, and B would
take a carryover basis in the partnership
interest (this amount would include any
basis increase to reflect S’s unused excess
business interest expense under section
163(j)(4)(B)(iii)(II)).
One commenter agreed that, based on
the plain language of section 163(j)(4)
(B)(iii)(II), intercompany transfers that
are nonrecognition transactions should
be treated as dispositions. Another com-
menter stated that such transfers generally
should not be treated as dispositions (if
the transferee is the successor to the trans-
feror, as previously discussed), but that, if
such transfers are treated as dispositions,
no redeterminations should be made under
§1.1502-13(c) with respect to S unless S
recognizes gain in the intercompany trans-
fer.
The Treasury Department and the IRS
continue to study the proper treatment of
intercompany partnership interest trans-
fers and welcome further comments on
this issue.
6. Basis Adjustments Under §1.1502-32
A commenter stated that the approach
to basis adjustments under §1.1502-32 in
the proposed regulations may lead to tem-
porary inside/outside basis disparities. Al-
though the commenter generally described
this approach as reasonable and consistent
with the application of both section 163(j)
and §1.1502-32, the commenter suggest-
ed that it may lead to anomalous results
in certain cases. The commenter request-
ed an example to illustrate the application
of the matching and acceleration rules in
the case of an intercompany transfer of an
interest in a partnership with disallowed
business interest expense.
When S (a member of a consolidated
group that is not the common parent) is
allocated excess business interest expense
from a partnership, S’s basis in the part-
nership is reduced under section 163(j)(4)
(B)(iii)(I). Although S’s basis in the part-
nership is reduced, S has excess business
interest expense in the same amount, and
S’s overall inside attribute amount is un-
changed. Because there is no net change
to S’s inside attribute amount, §1.1502-32
does not apply to reduce other members’
basis in S’s stock, and there is no inside/
outside disparity. Moreover, nothing in the
final regulations affects the operation of
§1.1502-32(a), which generally requires
adjustments to a member’s basis in its S
stock to reflect S’s distributions and S’s
items of income, gain, deduction, and loss
that are taken into account by the group
while S is a member. Thus, the final reg-
ulations make no changes in response to
this comment.
7. Partnership Terminations
In the preamble to the proposed regu-
lations, the Treasury Department and the
IRS requested comments on the treatment
of the transfer of a partnership interest
in an intercompany transaction that re-
sults in the termination of the partnership.
Some commenters recommended that
the transfer be treated as a disposition
for purposes of section 163(j)(4)(B)(iii)
(II) and proposed §1.163(j)-6(h)(3). Oth-
er commenters recommended that, under
Revenue Ruling 99-6, 1999-1 C.B. 432,
if the transferee member (B) also were a
partner in the partnership before the inter-
company transfer, B should be viewed as
(i) receiving a distribution of assets from
the terminating partnership with respect to
its partnership interest, and (ii) purchasing
the partnership’s assets deemed distribut-
ed to the transferor member (S).
The Treasury Department and the IRS
are continuing to study the proper treat-
ment of intercompany transfers of partner-
ship interests that result in the termination

September 28, 2020 646 Bulletin No. 2020–40
of the partnership. But see §1.163(j)-6(h)
(3) with respect to partnership termina-
tions generally.
E. Application of §1.1502-36 to Excess
Business Interest Expense
Under proposed §1.163(j)-4(d)(4), a
partner’s change in status as a member
of a consolidated group is not treated as a
disposition for purposes of section 163(j)
(4)(B)(iii)(II) and proposed §1.163(j)-
6(h)(3). In other words, if a corporation
becomes or ceases to be a member of a
consolidated group, and if that corpora-
tion is a partner in a partnership, that cor-
poration’s entry into or departure from a
consolidated group does not trigger basis
adjustments under section 163(j)(4)(B)
(iii)(II). However, in the preamble to the
proposed regulations, the Treasury De-
partment and the IRS requested comments
as to whether additional rules are needed
to prevent loss duplication upon the dispo-
sition of stock of a subsidiary member (S)
holding partnership interests.
Section 1.1502-36 contains the uni-
fied loss rule, which limits the ability of a
consolidated group to recognize non-eco-
nomic or duplicated losses on the transfer
of S stock. The rule applies when a group
member transfers a loss share of S stock.
If §1.1502-36(d) applies to the transfer of
a loss share, the attributes of S and its low-
er-tier subsidiaries generally are reduced
as needed to prevent the duplication of
any loss recognized on the transferred
stock. Such attributes include capital loss
carryovers, NOL carryovers, deferred de-
ductions, and basis in assets other than
cash and general deposit accounts. See
§1.1502-36(d)(4).
As noted in the preamble to the pro-
posed regulations, the Treasury Depart-
ment and the IRS have determined that
disallowed business interest expenses
should be treated as deferred deductions
for purposes of §1.1502-36 (see pro-
posed §1.1502-36(f)(2)). A commenter
recommended that excess business inter-
est expense also be treated as a deferred
deduction in determining the net inside
attribute amount for purposes of §1.1502-
36(c) and (d). Additionally, the comment-
er recommended that a consolidated group
be permitted to elect to reattribute excess
business interest expense from S to the
common parent under §1.1502-36(d)(6) if
the common parent also is a partner in the
partnership that allocated excess business
interest expense to S.
The Treasury Department and the IRS
agree that excess business interest ex-
pense should be treated as an attribute that
is taken into account in determining the
net inside attribute amount for purposes
of §1.1502-36(c) and (d). However, the
Treasury Department and the IRS have
determined that excess business interest
expense is more akin to basis (a Category
D attribute) than to deferred deductions (a
Category C attribute) (see §1.1502-36(d)
(4)(i)). Section 1.163(j)-4(e)(4) reflects
this conclusion.
The Treasury Department and the IRS
also have determined that excess business
interest expense should not be eligible
for reattribution under §1.1502-36(d)(6)
because the election is not available with
respect to Category D attributes. Thus, the
final regulations do not adopt this recom-
mendation.
F. Calculating ATI for Cooperatives
Proposed §1.163(j)-1(b)(1) defines
ATI as the taxable income of the taxpayer
for the taxable year, with certain adjust-
ments. Proposed §1.163(j)-4(b)(4) pro-
vides a special rule for calculating the
ATI of a RIC or REIT, allowing the RIC
or REIT not to reduce its taxable income
by the amount of any deduction for divi-
dends paid. The preamble to the proposed
regulations also requested comments on
whether additional special rules are need-
ed for specific types of taxpayers, includ-
ing cooperatives.
A commenter asked that the final reg-
ulations include a special rule for calcu-
lating the ATI of cooperatives subject to
taxation under subchapter T of the Code.
Under this special rule, taxable income
would not be reduced by amounts deduct-
ed under section 1382(b)(1) (patronage
dividends), section 1382(b)(2) (amounts
paid in redemption of nonqualified writ-
ten notices of allocation distributed as
patronage dividends), or section 1382(c)
(certain amounts incurred by farm co-
operatives described in sections 521 and
1381(a)(1)). The commenter reasoned that
such amounts are earnings passed on to
members and are therefore analogous to
dividends paid by a RIC or REIT to its
investor.
The Treasury Department and the IRS
agree that, for purposes of section 163(j),
amounts deducted by cooperatives un-
der sections 1382(b)(1), (b)(2), and (c)
are similar to amounts deducted by RICs
and REITs for dividends paid to their in-
vestors. The final regulations adopt a rule
providing that, for purposes of calculating
ATI, the tentative taxable income of a co-
operative subject to taxation under sec-
tions 1381 through 1388 is not reduced by
such amounts. In order to provide similar
treatment to similarly situated taxpayers,
the final regulations also provide that,
for purposes of calculating ATI, the ten-
tative taxable income of cooperatives not
subject to taxation under subchapter T of
the Code is not reduced by the amount
of deductions equivalent to the amounts
deducted by cooperatives under sections
1382(b)(1), (b)(2), and (c).
G. Calculating ATI for a Consolidated
Group
Proposed §1.163(j)-1(b)(1) defines ATI
as the taxable income of the taxpayer for
the taxable year, with certain adjustments.
For example, ATI is computed without
regard to the amount of any NOL de-
duction under section 172. See proposed
§1.163(j)-1(b)(1)(i)(B).
As noted in part V(B) of this Summary
of Comments and Explanation of Revi-
sions section, for purposes of calculating
the ATI of a consolidated group, the rele-
vant taxable income is the group’s consol-
idated taxable income, determined under
§1.1502-11 without regard to any carry-
forwards or disallowances under section
163(j). See proposed §1.163(j)-4(d)(2)
(iv). Commenters asked for clarification
that a consolidated group’s ATI does not
take into account any NOL deductions
available under section 172 and §1.1502-
11(a)(2) that result from either the carry-
back or carryforward of NOLs.
Proposed §1.163(j)-4(d)(2)(iv) does
not expressly mention the adjustments
made to ATI in proposed §1.163(j)-1(b)
(1) because those adjustments are general-
ly applicable (for example, the adjustment
for NOLs applies to all taxpayers to whom
section 172 applies, regardless of whether
such taxpayers file a consolidated return).

Bulletin No. 2020–40 647 September 28, 2020
Moreover, there is no exception in pro-
posed §1.163(j)-4(d)(2)(iv) to the adjust-
ment for NOLs in proposed §1.163(j)-1(b)
(1)(i)(B). Thus, under these provisions, a
consolidated group’s ATI would not take
into account any NOL deductions result-
ing from the carryback or carryforward of
NOLs. The Treasury Department and the
IRS have determined that no change to
proposed §1.163(j)-4(d)(2)(iv) is needed
to effectuate this result.
H. Application of Section 163(j) to Life-
Nonlife Groups
Proposed §1.163(j)-4(d)(2) provides
that a consolidated group has a single
section 163(j) limitation and that, for pur-
poses of calculating the group’s ATI, the
relevant taxable income is the group’s
consolidated taxable income. However,
§1.1502-47 requires consolidated groups
whose members include life insurance
companies and other companies (life-non-
life groups) to adopt a subgroup method
to determine consolidated taxable in-
come. (One subgroup is the group’s non-
life companies; the other subgroup is the
group’s life insurance companies.) Un-
der the subgroup method, each subgroup
initially computes its own consolidated
taxable income, and there are limitations
on a life-nonlife group’s ability to offset
one subgroup’s income with the other sub-
group’s loss.
In light of the apparent tension between
proposed §1.163(j)-4(d)(2) and the sub-
group method in §1.1502-47, one com-
menter asked for clarification that there
are not separate section 163(j) limitations
for each subgroup in a life-nonlife group.
The subject matter of this comment is
beyond the scope of the final regulations.
The Treasury Department and the IRS ex-
pect to issue future guidance regarding the
interaction of section 163(j) and §1.1502-
47 and welcome further comments on this
topic.
I. Application of Section 163(j) to Tax-
Exempt Entities
Proposed §1.163(j)-1(b)(36) defines
a tax-exempt corporation but does not
define other types of tax-exempt orga-
nizations. Thus, a commenter asked for
clarification as to whether section 163(j)
applies solely to tax-exempt corporations
or whether it also applies to other entities
subject to tax under section 511. The final
regulations clarify that section 163(j) ap-
plies to all entities that are subject to tax
under section 511.
The commenter also suggested that
section 163(j) should not apply to state
colleges and universities described in sec-
tion 511(a)(2)(B). The Treasury Depart-
ment and the IRS have found nothing in
the statute or legislative history to suggest
that Congress intended special treatment
for state colleges and universities to the
extent such organizations are subject to
tax under section 511. Therefore, the final
regulations do not adopt this recommen-
dation.
J. Partnership Investment Income and
Corporate Partners
Under the proposed regulations, a
partnership’s investment interest income
and investment expense are allocated to
each partner in accordance with section
704(b), and the effect of the allocation is
determined at the partner level. In gen-
eral, any investment interest, investment
income, and investment expense allocated
by a partnership to a C corporation part-
ner is treated by the partner as allocable
to a non-excepted trade or business of the
partner for purposes of section 163(j).
See proposed §§1.163(j)-4(b)(3)(i) and
1.163(j)-10(b)(6).
In light of the statutory restriction
against including investment income in
a partner’s ATI (see section 163(j)(8)(A)
(i)), a commenter requested confirmation
that a partnership’s investment income is
treated as properly allocable to a trade or
business of (and thus is included in the
ATI of) a corporate partner, perhaps by
adding an example to illustrate the appli-
cation of this rule.
Proposed §1.163(j)-10(b)(6) provides
that any investment income or investment
expenses that a partnership receives, pays,
or accrues and that is treated as prop-
erly allocable to a trade or business of a
C corporation partner under proposed
§1.163(j)-4(b)(3)(i) is treated as properly
allocable to a non-excepted trade or busi-
ness of the C corporation partner. Thus, if
a partnership incurs investment interest
expense, any portion of that expense that
is allocable to a C corporation partner is
treated as a business interest expense of
that partner that is subject to the section
163(j) limitation. However, if the partner-
ship also has investment interest income,
any portion thereof that is allocable to a C
corporation partner is treated as business
interest income of the partner, and any
other investment income of the partner-
ship that is allocable to the C corporation
partner increases the partner’s ATI. See
§1.163(j)-4(b)(7)(ii), Example 2.
To the extent that an investment item
or other item of a partnership is with re-
spect to property for which an election has
been made by the partnership to treat as
an electing real property trade or business
or electing farming business, such item is
treated as properly allocable to an except-
ed trade or business. This rule is necessary
because the final regulations permit elec-
tions for some assets and activities to be
an excepted trade or business even when
such assets and activities are not trades or
businesses for section 162 purposes. See
part X(A) of this Summary of Comments
and Explanation of Revisions section.
The final regulations also expand pro-
posed §1.163(j)-4(b)(3)(i) to cover not
only a partnership’s items of investment
interest, investment income, and invest-
ment expense, but also a partnership’s
other separately stated tax items that are
subject to neither section 163(j) nor sec-
tion 163(d). Such items might include tax
items allocable to rental activities that do
not rise to the level of a section 162 trade
or business that otherwise give rise to al-
lowable deductions (such as under section
212 as it existed under prior law) that are
subject to section 469. Thus, such items
are treated as properly allocable to a trade
or business of a C corporation partner as
well.
K. Earnings and Profits of a Corporate
Partner
Proposed §1.163(j)-4(c)(1) generally
provides that the disallowance and carry-
forward of a deduction for a C corpora-
tion’s business interest expense under pro-
posed §1.163(j)-2 does not affect whether
or when the business interest expense re-
duces the corporation’s earnings and prof-
its. Some commenters suggested that, if
the business interest expense in question

September 28, 2020 648 Bulletin No. 2020–40
is incurred by a partnership rather than
by the C corporation partner, the partner
should reduce its earnings and profits
twice with respect to that expense—once
when the expense is allocated from the
partnership to the partner, and again when
the partner claims a deduction with respect
to that expense (after the excess business
interest expense allocated to that partner
is treated as business interest expense and
deducted by that partner).
The Treasury Department and the IRS
have determined that the proposed reg-
ulations do not permit a C corporation
partner to reduce its earnings and prof-
its twice with respect to business interest
expense incurred by a partnership. The
final regulations are modified to clarify
this point.
Proposed §1.163(j)-4(c)(3) also pro-
vides a special earnings and profits rule
for C corporations (other than REITs or
RICs) with respect to excess business in-
terest expense allocated from a partner-
ship. Under this rule, the C corporation
partner must increase its earnings and
profits upon the disposition of the part-
nership interest to reflect the amount of
excess business interest expense that the
partner did not take into account while it
held the partnership interest. The Trea-
sury Department and the IRS have de-
termined that the same rule should apply
with respect to negative section 163(j)
expense, and the final regulations have
been modified accordingly.
VI. Comments on and Changes to
Proposed §1.163(j)-5: General Rules
Governing Disallowed Business
Interest Expense Carryforwards for C
Corporations
Section 1.163(j)-5 provides rules re-
garding disallowed business interest ex-
pense carryforwards for taxpayers that are
C corporations, including members of a
consolidated group. The following discus-
sion addresses comments relating to pro-
posed §1.163(j)-5.
A. Absorption of Disallowed Business
Interest Expense Carryforwards Before
Use of NOLs in Life-Nonlife Groups
Proposed §1.163(j)-5(b)(3) provides
rules regarding the treatment of disal-
lowed business interest expense carry-
forwards of a consolidated group. Com-
menters asked for confirmation that, in the
context of a life-nonlife group, such carry-
forwards are factored into taxable income
at the subgroup level before NOLs are
carried forward and limited under section
1503(c)(1).
In general, a consolidated group must
determine the amount of business interest
expense (whether current-year or carry-
forwards) that can be absorbed in a par-
ticular taxable year before determining
whether NOLs can be carried forward or
back to that taxable year. However, the
specific subject matter of this comment is
beyond the scope of the final regulations.
The Treasury Department and the IRS ex-
pect to issue future guidance regarding the
interaction of section 163(j) and §1.1502-
47 and welcome further comments in this
regard.
B. Carryforwards from Separate Return
Limitation Years
Proposed §1.163(j)-5(d) contains rules
for consolidated groups regarding disal-
lowed business interest expense carryfor-
wards from a separate return limitation
year (a SRLY; see §1.1502-1(f)). Under
these rules, the disallowed business inter-
est expense carryforwards of a member
arising in a SRLY that are included in a
group’s business interest expense deduc-
tion for any taxable year may not exceed
the group’s section 163(j) limitation for
that year, determined by reference only
to the member’s tax items for that year
(the section 163(j) SRLY limitation). See
proposed §1.163(j)-5(d)(1). Additionally,
disallowed business interest expense car-
ryforwards of a member arising in a SRLY
would be available for deduction by the
consolidated group in the current year
only to the extent the group had remain-
ing section 163(j) limitation after deduct-
ing current-year business interest expense
and disallowed business interest expense
carryforwards from earlier taxable years,
and only to the extent the section 163(j)
SRLY limitation for the current year ex-
ceeded the amount of the member’s busi-
ness interest expense already deducted by
the group in that year. In addition, SR-
LY-limited disallowed business interest
expense carryforwards must be deducted
on a pro rata basis with non-SRLY limit-
ed disallowed business interest expense
carryforwards from taxable years ending
on the same date. See proposed §1.163(j)-
5(d)(2).
Commenters asked several ques-
tions about the SRLY rules in proposed
§1.163(j)-5(d). In particular, commenters
asked why the section 163(j) SRLY lim-
itation is calculated annually rather than
on an aggregate or cumulative basis, as is
the case for NOLs. (Section 1.1502-21(c)
(1)(i) generally limits the amount of a
member’s NOL carryforwards and carry-
backs from a SRLY that may be included
in the group’s consolidated net operating
loss deduction to the member’s aggregate
contribution to the group’s consolidat-
ed taxable income for the entire period
the member has been a group member,
not just for the taxable year in question).
More specifically, a commenter noted that
the SRLY rules in §1.1502-21(c) were
designed to produce a result that roughly
approximates the absorption that would
have occurred if the SRLY member had
not joined a consolidated group. In con-
trast, the annual section 163(j) limitation
in proposed §1.163(j)-5(d) could put the
SRLY member in a worse position than if
such member had not joined a consolidat-
ed group.
For example, if S were a standalone
corporation with $100x of disallowed
business interest expense carryforwards at
the start of Year 2, and if S’s section 163(j)
limitation were $30 in Year 2, S could de-
duct $30x of its carryforwards. In compar-
ison, if S joined a consolidated group at
the start of Year 2, and if the group’s sec-
tion 163(j) limitation were $0 in Year 2, S
could not deduct any of its $100x of carry-
forwards in Year 2 even if S’s standalone
section 163(j) limitation were $30x in that
year. This result is correct for the P group
for Year 2 given Congress’s intent that
the section 163(j) limitation apply at the
consolidated group level. However, under
the annual measurement approach in the
proposed regulations, S also could not de-
duct any of its carryforwards in Year 3 if
S had a standalone section 163(j) limita-
tion of $0 in that year, even if the group’s
section 163(j) limitation were positive in
that year. Thus, S would be in a worse
position (with respect to the deduction of
its disallowed business interest expense

Bulletin No. 2020–40 649 September 28, 2020
carryforwards) than if S had not joined a
consolidated group.
To put S in roughly the same position
as if S were a standalone corporation,
commenters recommended the creation
of a cumulative section 163(j) register
under which the amount of a member’s
SRLY carryforwards that may be ab-
sorbed by the consolidated group in a
taxable year may not exceed (i) the mem-
ber’s contributions (positive and nega-
tive) to the group’s section 163(j) lim-
itation in all consolidated return years,
less (ii) the member’s business interest
expense (including carryforwards) ab-
sorbed by the group in all consolidated
return years. For these purposes, and un-
like the general rule in section 163(j)(1)
and proposed §1.163(j)-2(b)(2), the ad-
justment to a member’s cumulative sec-
tion 163(j) SRLY register for any taxable
year or its total register for any taxable
year could be less than zero.
In the preamble to the proposed regu-
lations, the Treasury Department and the
IRS stated that applying an aggregate or
cumulative approach to the section 163(j)
SRLY limitation would be inconsistent
with congressional intent because Con-
gress did not retain the excess limitation
carryforward provisions from old section
163(j). One commenter expressed agree-
ment with this conclusion. However,
other commenters noted that applying a
cumulative section 163(j) SRLY register
would not effectuate the carryforward
of excess limitation at the level of the
consolidated group. In other words, al-
though the SRLY member would be able
to deduct its SRLY disallowed business
interest expense carryforwards in a tax-
able year to the extent of that member’s
cumulative (rather than annual) contri-
bution to the group’s section 163(j) lim-
itation, the SRLY member’s ability to
deduct such carryforwards still would
be subject to the group’s annual section
163(j) limitation.
After considering the comments re-
ceived, the Treasury Department and the
IRS have determined that a cumulative
section 163(j) SRLY register would bet-
ter approximate the results under sec-
tion 163(j) if the SRLY member had not
joined a consolidated group, and that this
approach is not inconsistent with congres-
sional intent. Therefore, the final regula-
tions adopt a cumulative section 163(j)
SRLY register.
The cumulative section 163(j) SRLY
register operates in a manner similar to,
but is separate and distinct from, the cu-
mulative register for NOLs described in
§1.1502-21(c). In computing a member’s
section 163(j) SRLY register, the inter-
company transaction rules of §1.1502-13
generally continue to apply; thus, for ex-
ample, intercompany income items and
intercompany deductions and losses (to
the extent absorbed by the group) gener-
ally are taken into account in computing
the section 163(j) SRLY register. Howev-
er, interest income and expense from in-
tercompany obligations are not taken into
account in computing the section 163(j)
SRLY register. This approach approxi-
mates the SRLY member’s capacity to uti-
lize carryforwards on a standalone basis
while harmonizing with the single-entity
application of section 163(j) to consol-
idated groups. Under this approach, in-
tercompany interest income and expense
items will neither increase nor decrease
the SRLY register.
In the preamble to the proposed reg-
ulations, the Treasury Department and
the IRS requested comments on anoth-
er alternative to both an annual register
and a cumulative register—removing the
SRLY limitation from a member’s SR-
LY-limited disallowed business interest
expense carryforwards, to the extent of
the member’s standalone section 163(j)
limitation, in taxable years in which the
member’s standalone section 163(j) lim-
itation exceeds the consolidated group’s
section 163(j) limitation. A commenter
endorsed this approach. However, other
commenters expressed concern that this
approach would be more distortive than
a cumulative register approach. The Trea-
sury Department and the IRS agree that a
cumulative register more closely approx-
imates the results on a standalone basis
than this alternative approach. Thus, the
final regulations adopt a cumulative reg-
ister approach rather than this alternative
approach.
Commenters also expressed concern
that proposed §1.163(j)-5(d)(2) would
treat SRLY carryforwards as available
for deduction only to the extent the
amount of the SRLY member’s business
interest expense already deducted by the
group in the current year does not ex-
ceed the member’s annual section 163(j)
SRLY limitation. The adoption of the cu-
mulative section 163(j) SRLY limitation
mechanism, with the associated reduction
to reflect all business interest expense
of that member that is absorbed by the
group, obviates the issues highlighted in
the comment. The final regulations retain
the other SRLY limitations in proposed
§1.163(j)-5(d)(2).
C. Offsetting Business Interest Expense
with Business Interest Income and Floor
Plan Financing Interest Expense at the
Member Level
As described in part V(B) of this Sum-
mary of Comments and Explanation of
Revisions section, proposed §1.163(j)-
5(b)(3) provides, in part, that if the ag-
gregate amount of members’ business in-
terest expense (including carryforwards)
exceeds the consolidated group’s section
163(j) limitation for the current year, then
each member with current-year business
interest expense and current-year busi-
ness interest income or floor plan financ-
ing interest expense deducts current-year
business interest expense to the extent of
its current-year business interest income
and floor plan financing interest expense.
Thereafter, if the group has any remaining
section 163(j) limitation, each member
with remaining current-year business in-
terest expense deducts a pro rata portion
thereof.
A commenter stated that offsetting
business interest expense with business
interest income or floor plan financing in-
terest expense at the member level seems
inconsistent with the single-entity princi-
ples adopted by the proposed regulations.
Moreover, the commenter expressed
concern that a consolidated group could
choose where to incur business interest
income within a group and thereby affect
which member has disallowed business in-
terest expense carryforwards. In addition,
the commenter asserted that a group may
have difficulty determining which mem-
ber has incurred business interest income
and floor plan financing interest expense
(see the discussion in part V(B) of this
Summary of Comments and Explanation
of Revisions section). Thus, the comment-
er recommended an alternative approach

September 28, 2020 650 Bulletin No. 2020–40
that does not require such offsetting at the
member level.
The Treasury Department and the IRS
acknowledge that netting business inter-
est income and floor plan financing inter-
est expense against business interest ex-
pense at the member level deviates from
a “pure” single-entity approach. This ap-
proach was adopted in the proposed reg-
ulations to give effect to section 163(j)
(1) (which allows taxpayers to deduct
business interest expense to the full ex-
tent of business interest income and floor
plan financing interest expense) and to
ensure that income tax liability is clearly
reflected at the member level in accor-
dance with section 1502 and §1.1502-
13. Further, because consolidated groups
are under common control by definition
(see section 1504), a consolidated group
largely has control over the location of
interest expense, even before the appli-
cation of section 163(j). With regard to
the comment regarding the difficulty of
determining which member actually has
incurred an interest expense, section 61
provides that interest income is inclu-
dible in gross income, and section 163
provides rules by which interest expense
is deductible in computing the taxable
income. Section 1.1502-12 also requires
consolidated group members to report in-
terest income and expense at the member
level for purposes of computing separate
taxable income. Thus, the final regula-
tions do not adopt the commenter’s rec-
ommendation.
VII. Comments on and Changes to
Section 1.163(j)-6: Application of the
Business Interest Expense Deduction
Limitations to Partnerships and
Subchapter S Corporations
As discussed in the preamble to the
proposed regulations, §1.163(j)-6 pro-
vides general rules regarding the applica-
tion of section 163(j)(4) to partnerships, S
corporations, and their owners, including
rules on how to calculate the limitation
and how to treat disallowed business in-
terest expense carryforwards. The follow-
ing discussion addresses comments relat-
ing to proposed §1.163(j)-6.
A. Partnership-Level Calculation and
Allocation of Section 163(j) Excess Items
1. Nonseparately Stated Taxable Income
or Loss of the Partnership
Section 163(j)(4)(A)(ii)(II) states that
a partner’s excess taxable income is de-
termined in the same manner as the non-
separately stated taxable income or loss
of the partnership. Section 163(j)(4)(B)
(i)(II) states that excess business interest
expense is allocated to each partner in the
same manner as the non-separately stated
taxable income or loss of the partnership.
Similarly, excess business interest income
is allocated to each partner in the same
manner as the nonseparately stated tax-
able income or loss of the partnership.
As highlighted in the proposed regu-
lations, the phrase “nonseparately stated
taxable income or loss of the partnership”
is not defined in section 163(j), and it has
not previously been defined by statute
or regulations.
1
The phrase “in the same
manner as” is also undefined. The pro-
posed regulations interpreted the phrase
“nonseparately stated taxable income or
loss,” as it is used in sections 163(j)(4)(A)
(ii)(II) and 163(j)(4)(B)(i)(II), as meaning
the items comprising adjusted taxable in-
come, business interest income, and busi-
ness interest expense of the partnership.
The legislative history and structure of the
statute suggest the purpose of the phrase
“nonseparately stated taxable income or
loss of the partnership” is to help coordi-
nate the section 163(j) limit imposed at the
partnership and partner levels.
Section 163(j)(4)(A)(i) uses this phrase
when describing business interest expense
that already has been tested at the partner-
ship level. In general, an item included in
nonseparately stated taxable income or
loss of a partnership under section 702(a)
(8) loses its tax character in the hands of
the partner to whom it is allocated. By
providing that such business interest ex-
pense is treated as a nonseparately stat-
ed item, section 163(j)(4)(A)(i) causes
such business interest expense to lose its
character as business interest expense,
thus preventing it from being subject to
retesting at the partner level under sec-
tion 163(j). Although it does not use the
same phrase, section 163(j)(4)(A)(ii)(I),
in conjunction with section 163(j)(4)(C),
similarly provides that, to the extent the
partnership’s adjusted taxable income was
used in its section 163(j) calculation, such
adjusted taxable income is not included
in a partner’s section 163(j) calculation.
Consistent with this principle, proposed
§1.163(j)-6(e)(4) provided similar rules
to prevent the double counting of business
interest income. Therefore, interpreting
the phrase “nonseparately stated taxable
income or loss of the partnership,” as it is
used in section 163(j)(4) as meaning the
items comprising adjusted taxable income,
business interest income, and business in-
terest expense of the partnership (herein-
after, “section 163(j) items”) is support-
ed by the statute, which requires each of
these items to be taken into account at the
partnership level and prohibits the double
counting of such items in the partner’s
section 163(j) calculation.
To allocate excess taxable income,
excess business interest income, and ex-
cess business interest expense (herein-
after, “section 163(j) excess items”) “in
the same manner” as the “nonseparately
stated taxable income or loss of the part-
nership” (that is, the section 163(j) items),
proposed §1.163(j)-6(f)(2) provided an
11-step calculation that, when completed
by the partnership, provides the partner-
ship with an allocation of each of its sec-
tion 163(j) excess items to each of its part-
ners. This resulting array of allocations is
consistent with the Treasury Department
and the IRS’s resolution of the three de-
scriptive (1 through 3) and two normative
(4 through 5) issues outlined in part 6(D)
(1) of the Explanation of Provisions sec-
tion in the proposed regulations: (1) sec-
tion 163(j) is applied at the partnership
level; (2) a partnership cannot have both
excess taxable income (or excess business
interest income) and excess business in-
terest expense in the same taxable year;
(3) parity must be preserved between a
partnership’s deductible business interest
expense and section 163(j) excess items
and the aggregate of each partner’s share
of deductible business interest expense
and section 163(j) excess items from
1
Sections 163(j)(4)(A)(i) and (B)(i)(II) use the word “nonseparately” (no hyphen), but section 163(j)(4)(A)(ii)(II) uses the word “non-separately” (hyphen). For purposes of consistency, these
final regulations use “nonseparately” when discussing the phrase at issue.

Bulletin No. 2020–40 651 September 28, 2020
such partnership; (4) if, in a given year,
a partnership has both deductible business
interest expense and excess business in-
terest expense, a partnership should not
allocate excess business interest expense
to a partner to the extent such partner was
allocated the items comprising ATI (or
business interest income) that supported
the partnership’s deductible business in-
terest expense; and (5) if, in a given year,
a partnership has excess taxable income
(or excess business interest income), only
partners allocated more items comprising
ATI (or business interest income) than
necessary to support their allocation of
business interest expense should be allo-
cated a share of excess taxable income (or
excess business interest income).
In general, the 11-step calculation pre-
serves the entity-level calculation required
in section 163(j)(4) while also preserving
the economics of the partnership, includ-
ing respecting any special allocations
made in accordance with section 704 and
the regulations under section 704 of the
Code. Stated otherwise, the allocations of
section 163(j) excess items prescribed by
the 11-step calculation attempt to reflect
the aggregate nature of partnerships under
subchapter K of the Code while remaining
consistent with the application of section
163(j) at the partnership level.
The Treasury Department and the IRS
requested comments on the 11-step cal-
culation in the preamble to the proposed
regulations. Specifically, the Treasury
Department and the IRS requested com-
ments regarding alternative methods for
allocating deductible business interest ex-
pense and section 163(j) excess items in a
manner that permits partners that bear the
taxable income supporting the deductible
business interest expense to be allocated a
disproportionate share of deductible busi-
ness interest expense and excess taxable
income.
2. Requested Clarifications and
Modifications
Commenters requested several clarifi-
cations of and modifications to the 11-step
calculation. First, commenters requested
confirmation that a partnership’s alloca-
tions of section 163(j) excess items pursu-
ant to the 11-step calculation will be con-
sidered to meet the requirements of section
704(b). The final regulations confirm that
allocations pursuant to the 11-step calcu-
lation meet the requirements of section
704(b). Nothing in the 11-step calculation
prohibits a partnership from making an al-
location to a partner of any section 163(j)
item that is otherwise permitted under
section 704 and the regulations thereun-
der. Accordingly, any calculations in the
11-step calculation are solely for the pur-
pose of determining each partner’s section
163(j) excess items, and do not otherwise
affect any other provision under the Code,
such as section 704(b). Further, the state-
ment in the proposed regulations that the
11-step calculation is solely for section
163(j) purposes and does not apply for any
other purposes of the Code does not mean
that section 163(j) excess items have no
effect on either outside basis or capital ac-
counts. To illustrate this point, §1.163(j)-
6(o)(17), Example 17 has been revised to
show the beginning and ending outside
basis and capital accounts after applying
the 11-step calculation.
To further clarify that the allocation of
section 163(j) excess items pursuant to
the 11-step calculation will be sustained
under section 704, a special rule has been
added to §1.704-1(b)(4). The allocation
of deductible and nondeductible business
interest expense does not have economic
effect because classifying a portion of the
interest expense as nondeductible merely
changes the tax character of the item. Ac-
cordingly, §1.704-1(b)(4)(xi) is added to
clarify that, if §1.163(j)-6(f) is satisfied,
the allocation of section 163(j) excess
items will be deemed to be in accordance
with the partners’ interests in the partner-
ship.
Second, commenters recommended
the 11-step calculation take remedial al-
locations into account. Commenters noted
that the exclusion of remedial allocations
from the partnership-level computation
could frustrate the ability of the 11-step
calculation to reach the most equitable
result given its purpose. The Treasury De-
partment and the IRS acknowledge that
taking remedial allocations into account
in the 11-step calculation after 2021 might
produce an equitable result. However, be-
cause remedial income would not always
be offset by remedial losses prior to 2022
for purposes of computing ATI, the Trea-
sury Department and that IRS have de-
termined that taking remedial allocations
into account in the 11-step calculation
would not achieve appropriate results in
all circumstances. Therefore, the Treasury
Department and the IRS decline to accept
the recommendation.
Third, a commenter recommended that
the final regulations allow partnerships to
make remedial allocations of excess tax-
able income. Under this recommended
modification to the 11-step calculation, if
a partner receives an allocation of taxable
income in excess of such partner’s alloca-
tion of excess taxable income, the partner-
ship could elect to create positive reme-
dial excess taxable income in the amount
of the excess and allocate such positive
remedial excess taxable income to the af-
fected partner. The partnership also would
create an offsetting negative remedial
excess taxable income item in an equal
amount that would be allocated to the oth-
er partners. The Treasury Department and
the IRS do not adopt this recommenda-
tion in the final regulations in light of the
fact that the definition of “excess taxable
income” is statutory and the statute does
not appear to contemplate negative excess
taxable income.
3. Recommended Alternative Methods
Commenters recommended the final
regulations retain the 11-step calculation.
Additionally, commenters recommended
that the final regulations provide alterna-
tive methods for allocating section 163(j)
excess items in addition to the 11-step cal-
culation. The commenters seeking an al-
ternative method expressed concern about
the complexity of the 11-step calculation
– specifically, that the required compu-
tations and recordkeeping are excessive
for many taxpayers. Commenters argued
that the attempted precision of the 11-step
calculation should be weighed against its
complexity and compared to the reduced
precision that could be achieved through
simpler methods.
As an alternative to the 11-step calcula-
tion, commenters recommended the final
regulations allow taxpayers to adopt any
reasonable method for allocating section
163(j) excess items, provided the method
does not produce results inconsistent with
the Treasury Department and the IRS’s
resolution of the five issues articulated in

September 28, 2020 652 Bulletin No. 2020–40
the preamble to the proposed regulations.
See part VII(A)(1) of this Summary of
Comments and Explanation of Revisions
section. Commenters provided multiple
examples of reasonable methods, and they
recommended that the final regulations
treat section 163(j) excess item allocations
as reasonable if the allocations are: (1)
reasonably consistent with the allocations
of the corresponding items under section
704(b); (2) in proportion to the allocation
of the underlying section 163(j) item; (3)
in proportion to the manner in which the
partners bear liability for the debt or, in
the case of non-recourse debt, in propor-
tion to the manner in which profits will
be allocated in order to repay the debt; or
(4) the result of arms-length bargaining
among partners with adverse tax interests.
The Treasury Department and the IRS
do not adopt any of these alternatives in
the final regulations. Each of the alter-
natives recommended by commenters
requires an application of section 163(j)
at the partnership level, a determination
of each partner’s share of the partner-
ship’s section 163(j) items, and a final
determination of each partner’s section
163(j) excess items that takes into ac-
count each partner’s share of the partner-
ship’s section 163(j) items. These three
determinations mirror steps 1, 2, and 11
(respectively) of the 11-step calculation.
The Treasury Department and the IRS
recognize the complexity of the compu-
tations and recordkeeping imposed by the
statute on partnerships, but the Treasury
Department and the IRS have concluded
that the computations and recordkeeping
associated with steps 1, 2, and 11 of the
11-step calculation are unavoidable under
any approach. As such, the commenters’
recommendation is, in effect, that the final
regulations allow alternatives to steps 3
through 10 of the 11-step calculation.
With respect to steps 3 through 10, the
Treasury Department and the IRS agree
that these computations add to the com-
plexity already required by the statute;
thus, a worksheet and multiple examples
have been provided to aid in the com-
pletion of these computations. Howev-
er, the Treasury Department and the IRS
have concluded that these computations
are not overly burdensome given that the
partnerships required to perform these
calculations already are experienced with
handling the complexities associated with
special allocations or section 704(c) allo-
cations. In terms of recordkeeping, tax-
payers are not required to keep records
of steps 3 through 10 because compliance
with the 11-step calculation can be deter-
mined solely based on the records asso-
ciated with steps 1, 2, and 11. Moreover,
in terms of accuracy, the alternatives fall
short of achieving the purpose of steps 3
through 10, which is to align deductible
business interest expense with the ATI and
business interest income that supported
such deduction at the partnership level.
For example, consider the recom-
mended alternative of allocating section
163(j) excess items in proportion to the
allocation of the underlying section 163(j)
item. If partnership AB’s sole items of in-
come, gain, loss, and deduction were $30
of business interest income, which it al-
located solely to A, and $40 of business
interest expense, which it allocated $20
to each of A and B, then A and B each
would have $15 of deductible business in-
terest expense and $5 of excess business
interest expense. In situations where, as
in this case, the partnership does not allo-
cate all of its section 163(j) items pro rata
this method could require a partnership to
allocate its section 163(j) excess items in
a manner inconsistent with the Treasury
Department and the IRS’s resolution of
issues four and five. See part VII(A)(1) of
this Summary of Comments and Explana-
tion of Revisions section.
Applying the 11-step calculation to
the previous example, A would have $20
of deductible business interest expense,
and B would have $10 of deductible busi-
ness interest expense and $10 of excess
business interest expense. This result is
consistent with the Treasury Department
and the IRS’s resolution of the five issues
described in part VII(A)(1) of this Sum-
mary of Comments and Explanation of
Revisions section. Because the alternative
of allocating section 163(j) excess items
in proportion to the allocation of the un-
derlying section 163(j) item could require
a partnership to allocate section 163(j)
excess items to its partners in a manner
that does not attempt to align deductible
business interest expense with the ATI and
business interest income that supported
it at the partnership level (which is in-
consistent with the resolution of the five
issues described in part VII(A)(1) of this
Summary of Comments and Explanation
of Revisions section), this alternative is
not adopted in the final regulations. Oth-
er commenters’ similar alternatives were
considered and were rejected on the same
grounds based on the foregoing analysis.
One commenter recommended another
alternative method that, in a more general
way than the 11-step calculation, attempts
to align deductible business interest ex-
pense with the ATI and business interest
income that supported such deduction
at the partnership level. The commenter
stated that this objective could be accom-
plished as follows. For each partner that
is allocated business interest expense, de-
termine the portion of the business inter-
est expense allocated to such partner that
would be considered deductible business
interest expense, taking into account only
the business interest income and ATI al-
located to such partner. If the aggregate
amount determined for all partners is
equal to, or less than, the amount of the
partnership’s deductible business inter-
est expense, then each partner would be
allocated deductible business interest ex-
pense in the amount determined in the first
step. If the first step produced deductible
business interest expense in excess of the
limitation determined at the partnership
level, each partner’s allocation of deduct-
ible business interest expense would equal
the proportion of the partnership’s total
deductible business interest expense that
the deductible amount determined in the
first step for such partner constitutes of the
deductible amount determined for all part-
ners. Also, any deductible business inter-
est expense as determined at the partner-
ship level that is not allocated through the
first step then would be allocated among
the partners that have been allocated busi-
ness interest deductions in proportion to
the amount of business interest expense of
each partner remaining after the first step.
The Treasury Department and the IRS
do not adopt this alternative method in
the final regulations. The commenter’s
approach provides a method for allo-
cating excess business interest expense,
but it does not provide any guidance on
allocating excess taxable income or ex-
cess business interest income. Further, it
is not possible to infer a manner for al-
locating excess taxable income and ex-

Bulletin No. 2020–40 653 September 28, 2020
cess business interest income from this
approach because it fails to distinguish
each partner’s ATI from its business in-
terest income. By comingling ATI and
business interest income in its first step,
this method fails to account for the order-
ing of ATI and business interest income
in the partnership context as required by
the statute. Section 163(j)(4)(C) provides
that partnership ATI does not begin off-
setting partnership business interest ex-
pense until partnership business interest
income has been fully utilized. Because
this method is only capable of address-
ing fact patterns in which there is excess
business interest expense, it is not adopt-
ed in the final regulations.
Moreover, the Treasury Department
and the IRS have concluded that this
method for allocating excess business in-
terest expense does not sufficiently reduce
taxpayer burden given the trade-off in pre-
cision and administrability. To illustrate,
the commenter applied its recommend-
ed method to the facts of Example 14 of
§1.163(j)-6(o) of the proposed regulations.
In that example, partnership PRS has $140
of business interest expense, $200 of ATI,
and no business interest income. Accord-
ingly, PRS has $60 of deductible business
interest expense. PRS allocates its items
of ATI such that A, B, and C have income
of $100, $100, and $400 respectively,
while D has a loss of $400. PRS allocates
its business interest expense $40 to B, $60
to C, and $40 to D.
Under the suggested method, PRS first
would determine for each of B, C, and D
the amount of the business interest ex-
pense allocated to each partner that would
be deductible under section 163(j) taking
into account solely the ATI and business
interest income allocated to such partner.
In this case, the entire $60 of business in-
terest expense allocated to C would have
been deductible, $30 of the business in-
terest expense allocated to B would have
been deductible, and no amount of busi-
ness interest expense allocable to D would
have been deductible. The total amount
of business interest expense determined
in the first step (or $90) exceeds the total
amount deductible under section 163(j)
applied at the partnership level (or $60).
PRS then would determine the proportion
of the business interest expense allocated
to each partner that is determined to be de-
ductible in the first step and allocate the to-
tal deduction in those proportions. Thus, C
would be entitled to two-thirds ($60 / $90)
of the $60 deduction ($40 of deductible
business interest expense) and B would be
entitled to one-third ($30 / $90) of the $60
deduction ($20 of deductible business in-
terest expense). D would not be entitled to
any business interest expense deduction.
Accordingly, B would have $20 of excess
business interest expense, C would have
$20 of excess business interest expense,
and D would have $40 of excess business
interest expense.
In contrast, applying the 11-step calcu-
lation to the same example results in an
allocation of more deductible business in-
terest expense to C ($48) than to B ($12)
because C was allocated more ATI ($400)
from PRS than B ($100). Unlike the com-
menter’s method, the 11-step calculation
increases a partner’s amount of deductible
business interest expense in response to an
increased allocation of ATI and business
interest income. The commenter’s method
allocates deductible business interest ex-
pense based on a ratio that does not take
into account the fact that C was allocat-
ed significantly more ATI from PRS than
B. To illustrate this point, consider what
would happen in the previous example if
the facts were changed so that C was allo-
cated $1,100 of ATI and D was allocated
($1,100) of ATI. Applying the 11-step cal-
culation, C would have $55 of deductible
business interest expense. Applying the
commenter’s method, C’s increased allo-
cation of ATI from PRS would have no
effect on C’s deductible business interest
expense—C still would have $40 of de-
ductible business interest expense and $20
of excess business interest expense.
The Treasury Department and the IRS
have determined that the 11-step calcula-
tion produces the result that is most con-
sistent with the normative principle in the
statute that the amount of business interest
expense a taxpayer is capable of deduct-
ing should increase as its ATI and busi-
ness interest income increase. Further, the
Treasury Department and the IRS view
methods that do not increase a partner’s
amount of deductible business interest
expense in response to an increased allo-
cation of ATI from the partnership as less
intuitive, and therefore more burdensome
in application. Therefore, the final regula-
tions do not adopt commenters’ suggested
alternative methods.
4. Publicly Traded Partnerships
The Treasury Department and the IRS
received comments raising concerns about
the continued fungibility of publicly trad-
ed partnership (PTP) units if PTPs are
required to allocate section 163(j) excess
items pursuant to the 11-step calculation.
The effect of section 163(j) on the fungi-
bility of PTP units is being addressed in
the Concurrent NPRM. Therefore, these
issues are not addressed in the final reg-
ulations.
5. Pro Rata Exception
Multiple commenters recommended
that partnerships that allocate all items
of income and expense on a pro rata ba-
sis (similar to S corporations) be exempt
from the 11-step calculation. Commenters
stated that these partnerships by nature
do not make the kinds of allocations the
11-step calculation is designed to address.
Commenters asserted that simplifying the
11-step calculation for these pro-rata part-
nerships would reduce complexity and re-
duce their administrative burden.
The Treasury Department and the IRS
agree with these comments. Accordingly,
the final regulations provide an exception
(pro rata exception) from steps 3 through
11 of the 11-step calculation for partner-
ships that allocate all section 163(j) items
in step 2 proportionately. This pro rata
exception will not result in allocations of
section 163(j) excess items that vary from
the array of allocations of section 163(j)
excess items that would have resulted
had steps 3 through 11 been performed.
See §1.163(j)-6(f)(2)(ii) and Example 1
through Example 16 of §1.163(j)-6(o).
B. Basis Adjustments
1. Basis and Capital Account Adjustments
for Excess Business Interest Expense
Allocations
Pursuant to proposed §1.163(j)-6(f)
(2), the adjusted basis of a partner’s in-
terest in a partnership is reduced, but
not below zero, by the amount of excess
business interest expense allocated to the

September 28, 2020 654 Bulletin No. 2020–40
partner. If a partner is subject to a loss
limitation under section 704(d) and the
partner is allocated losses from a part-
nership in a taxable year, the limited
losses are grouped based on the charac-
ter of each loss (each grouping of loss-
es based on character, a “section 704(d)
loss class”). If there are multiple section
704(d) loss classes in a given year, the
partner apportions the limitation to each
section 704(d) loss class proportionately.
For purposes of applying this proportion-
ate rule, any deductible business interest
expense and business interest expense
of an exempt entity (whether allocated
to the partner in the current taxable year
or suspended under section 704(d) in a
prior taxable year), any excess business
interest expense allocated to the part-
ner in the current taxable year, and any
excess business interest expense from
a prior taxable year that was suspend-
ed under section 704(d) (negative sec-
tion 163(j) expense) makes up the same
section 704(d) loss class (section 163(j)
loss class). Moreover, once the partner
determines the amount of limitation on
losses apportioned to the section 163(j)
loss class, any deductible business inter-
est expense is taken into account before
any excess business interest expense or
negative section 163(j) expense.
Proposed §1.163(j)-6(h)(2) provides
that negative section 163(j) expense is
not treated as excess business interest ex-
pense in any subsequent year until such
negative section 163(j) expense is no
longer suspended under section 704(d).
Consequently, an allocation of excess
taxable income or excess business inter-
est income does not result in the nega-
tive section 163(j) expense being treat-
ed as business interest expense paid or
accrued by the partner. Further, unlike
excess business interest expense, which
prevents a partner from including excess
taxable income in its ATI as described in
section 163(j)(4)(B)(ii) (flush language),
negative section 163(j) expense does not
affect, and is not affected by, any allo-
cation of excess taxable income to the
partner. Accordingly, any excess tax-
able income allocated to a partner from
a partnership while the partner still has
a negative section 163(j) expense will be
included in the partner’s ATI. However,
once the negative section 163(j) expense
is no longer suspended under section
704(d), it becomes excess business inter-
est expense, which is subject to the gen-
eral rules in proposed §1.163(j)-6(g).
Commenters noted that the rule in
proposed §1.163(j)-6(h)(2) is helpful
and should be retained in the final reg-
ulations. However, commenters further
noted that partners with no business in-
terest expense from other sources gener-
ally would prefer to treat their negative
section 163(j) expense as deductible
business interest expense suspended un-
der section 704(d) and utilize excess tax-
able income in the current year for that
purpose, even though the resulting de-
ductible business interest expense would
continue to be non-deductible because of
a section 704(d) limit. Thus, comment-
ers recommended allowing a partner to
use excess taxable income to treat nega-
tive section 163(j) expense as deductible
business interest expense suspended un-
der section 704(d) instead of using it to
increase partner ATI.
The final regulations do not adopt this
recommendation. No precedent exists for
allowing items suspended under section
704(d) to preemptively clear limitations
that apply after section 704(d) while re-
maining suspended under section 704(d).
For example, in the section 469 context,
a non-materially participating partner al-
located passive income cannot use such
passive income to recharacterize pas-
sive losses allocated in a previous year
as non-passive while those losses remain
suspended under section 704(d).
One commenter also recommended
adopting a silo approach under section
704(d). Under this approach, if a partner
had a section 704(d) limitation, it could
bifurcate its items between non-excepted
and excepted partnership business items.
If the non-excepted portion was net pos-
itive, none of the excess business interest
expense allocated from the partnership
would be negative section 163(j) expense.
However, this approach would be a
significant departure from the current rule
under section 704(d), which generally re-
quires the limitation on losses under sec-
tion 704(d) to be allocated to a partner’s
distributive share of each loss proportion-
ately, regardless of whether such loss is
from an excepted or non-excepted trade
or business under section 163(j). More-
over, nothing in section 163(j) indicates
Congress intended to give excess business
interest expense suspended under section
704(d) a better result than any other part-
nership losses suspended under section
704(d). For that reason, the final regula-
tions do not adopt this recommendation.
2. Basis Adjustments Upon Disposition
of Partnership Interests Pursuant to
Section 163(j)(4)(B)(iii)(II)
Under the proposed regulations, if a
partner disposes of all or substantially all
of its partnership interest, the adjusted ba-
sis of the partnership interest is increased
immediately before the disposition by the
entire amount of the remaining excess
business interest expense. Following such
a disposition, no deduction is permitted to
either the transferor or the transferee with
respect to the excess business interest ex-
pense resulting in the basis increase. If a
partner disposes of less than substantially
all of its interest in a partnership, the part-
ner cannot increase its basis by any por-
tion of the remaining excess business in-
terest expense. The Treasury Department
and the IRS requested comments on this
approach in the preamble to the proposed
regulations.
Commenters cited multiple concerns
with the approach adopted in the proposed
regulations. First, commenters claimed
that the absence of an excess business
interest expense basis addback for a par-
tial disposition of a partnership interest
could result in tax gain in excess of eco-
nomic gain in connection with the sale
of a partial interest, while the addition of
the entire adjustment to outside basis in
connection with a complete disposition
could result in economic gain in excess
of tax gain. Commenters suggested this
timing difference between economic gain
and tax gain inappropriately disconnects
taxable income from economic income.
Second, commenters expressed concern
that, because a partial disposition would
result in a partner holding a smaller inter-
est in a partnership than it held prior to
the partial disposition, the partner would
receive smaller allocations of excess tax-
able income (and excess business interest
income) in subsequent years. If none of
the excess business interest expense of
the partner is affected by the partial dis-

Bulletin No. 2020–40 655 September 28, 2020
position, this could extend the amount of
time needed for a partner to convert its
excess business interest expense to busi-
ness interest expense treated as paid or
accrued. Third, commenters noted that,
in the event of a partial disposition of a
partnership interest, the proposed regula-
tions may cause a discrepancy between
the capital accounts of the transferor and
the transferee and the excess business in-
terest expense associated with each part-
ner’s interest.
Commenters stated that neither the
statute nor its policy of limiting business
interest expense deductions calls for the
potentially harsh results that could be
imposed by the approach provided in the
proposed regulations. The main purpose
of the excess business interest expense
carryover rule is to limit the partner’s abil-
ity to claim a business interest expense de-
duction that exceeds the statutory thresh-
old under section 163(j)(1). Commenters
stated that this statutory purpose can be
accomplished by denying the business in-
terest expense deduction and eliminating
the carryforward upon a partial disposi-
tion of the partnership interest. In other
words, to the extent that a partner foregoes
its business interest expense deduction,
the purpose of the statute is fulfilled. Thus,
a proportionate approach would fulfill the
purpose of the statute while not subjecting
taxpayers to outcomes that are not plainly
contemplated by the statue.
As a solution, commenters recom-
mended that a partial disposition of a
partnership interest trigger a proportion-
ate excess business interest expense ba-
sis addback and corresponding decrease
in such partner’s excess business inter-
est expense carryover (proportionate
approach). Under the proportionate ap-
proach, the partner would be required to
track its basis in its partnership interest
in a manner similar to that set forth in
Revenue Ruling 84-53, 1984-1 C.B. 159
(April 9, 1984). Commenters advocating
for a proportionate addback rule varied in
their recommendations regarding where
the addback should occur. In general,
commenters suggested three options:
(1) increase the basis of the partnership
interest retained; (2) apportion the basis
increase proportionally between the part-
nership interest retained and the partner-
ship interest being disposed of; and (3)
increase the basis of the partnership in-
terest being disposed of.
As described in the preamble to the pro-
posed regulations, the Treasury Depart-
ment and the IRS originally considered
and rejected the proportionate approach.
One reason the Treasury Department and
the IRS adopted the all or substantially all
approach in the proposed regulations over
the proportionate approach was because
the former appeared more taxpayer-fa-
vorable in certain circumstances. Under
the all or substantially all approach in the
proposed regulations, the excess business
interest expense basis addback is delayed
for the maximum amount of time (until
a partner disposes of all or substantially
all of its interest), giving taxpayers more
time to receive excess taxable income
(and excess business interest income) and
thus potentially take an ordinary deduc-
tion. However, as commenters pointed
out, a smaller partnership interest likely
will result in a correspondingly smaller
allocation of excess taxable income (and
excess business interest income) from the
partnership. For this reason, commenters
did not perceive the proposed approach as
taxpayer-favorable for preserving the pos-
sibility of a future ordinary deduction, but
rather as taxpayer-unfavorable for delay-
ing what likely will be a capital loss.
Accordingly, the Treasury Department
and the IRS adopt the recommended pro-
portionate approach in the final regula-
tions. In the preamble to the proposed
regulations, the Treasury Department and
the IRS indicated that, if final regulations
were to adopt a proportionate approach,
such approach would increase the basis
of the partnership interest being retained
by the amount of the excess business in-
terest expense basis addback. However,
upon further consideration, the Treasury
Department and the IRS agree with com-
menters that the basis addback should
instead increase the basis of the partner-
ship interest being disposed of. Thus, the
final regulations adopt a proportionate ap-
proach that increases the basis of the part-
nership interest being disposed of.
For purposes of §1.163(j)-6(h)(3), a
disposition includes a distribution of mon-
ey or other property by the partnership to
a partner in complete liquidation of its in-
terest in the partnership. The Treasury De-
partment and the IRS request comments
on whether a current distribution of mon-
ey or other property by the partnership to a
continuing partner as consideration for an
interest in the partnership should also trig-
ger an addback and, if so, how to deter-
mine the appropriate amount of the add-
back. Additionally, the final regulations
clarify that each partner is considered to
have disposed of its partnership interest
within the meaning of §1.163(j)-6(h)(3)
if the partnership terminates under section
708(b)(1).
The proportionate rule adopted in
the final regulations applies the equita-
ble apportionment principles of §1.61-6
(referenced in Revenue Ruling 84-53)
to determine the amount of excess busi-
ness interest expense attributable to the
partner’s interest sold. In Example 1 of
§1.61-6, basis is apportioned among prop-
erties based on the fair market value of the
property and is treated as equitably appor-
tioned. Similarly, in Situations 1 and 3 of
Revenue Ruling 84-53, the IRS ruled that
a selling partner’s basis in the transferred
portion of the interest generally equals an
amount that bears the same relation to the
partner’s basis in the partner’s entire in-
terest as the fair market value of the trans-
ferred portion of the interest bears to the
fair market value of the entire interest (the
pro rata approach to equitable apportion-
ment). However, if a partnership has lia-
bilities, special adjustments must be made
to take into account the effect of the liabil-
ities on the basis of the partner’s interest.
Accordingly, the final regulations adopt
the pro rata approach to equitable appor-
tionment and generally provide that the
adjusted basis of the partnership interest
being disposed of is increased immediate-
ly before the disposition by the amount of
the excess business interest expense that is
proportionate to the interest disposed of in
the transaction.
The Treasury Department and the IRS
also received comments recommending
the final regulations treat a sale of all or
substantially all of a partnership’s assets
as a deemed disposition of each part-
ner’s interest in the partnership within the
meaning of section 163(j)(4)(B)(iii)(II).
Because the statute requires a disposition
of a partnership interest to trigger the ba-
sis adjustment described in section 163(j)
(4)(B)(iii)(II), the final regulations do not
adopt this recommendation.

September 28, 2020 656 Bulletin No. 2020–40
3. Intercompany Transfer of a Partnership
Interest
For a discussion of comments received
on intercompany transfers of partnership
interests, see part V(D) of this Summary
of Comments and Explanation of Revi-
sions section.
C. Debt-Financed Distributions
The treatment of interest expense asso-
ciated with debt incurred by a partnership
or S corporation to finance distributions
to owners (debt-financed distributions) is
being addressed in the Concurrent NPRM.
Therefore, these issues are not addressed
in the final regulations.
D. Trading Partnerships
The preamble to the proposed regula-
tions stated that the business interest ex-
pense of certain passthrough entities, in-
cluding S corporations, that are engaged
in trades or businesses that are per se
non-passive activities and in which one
or more owners of the entities do not ma-
terially participate within the meaning of
section 469, as described in section 163(d)
(5)(A)(ii) and as illustrated in Revenue
Ruling 2008-12, 2008-1 C.B. 520 (March
10, 2008), will be subject to section 163(j)
at the entity level (even if the interest ex-
pense is also subject to limitation under
section 163(d) at the individual partner
level). With respect to partnerships, to the
extent that such business interest expense
is limited under section 163(j)(4) and be-
comes a carryover item of partners who do
not materially participate with respect to
such trades or businesses, those items will
be treated as items of investment interest
expense in the hands of those owners for
purposes of section 163(d) once those car-
ryover items are treated as paid or accrued
in a succeeding taxable year. This rule
does not apply to corporate partners.
The Treasury Department and the IRS
received multiple comments questioning
this interpretation of section 163(j)(5) and
its interaction with section 163(d)(5)(A)
(ii). The interaction of section 163(j)(5)
with section 163(d)(5)(A)(ii) is being ad-
dressed in the Concurrent NPRM. There-
fore, this issue is not addressed in the final
regulations.
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
The preamble to the proposed regula-
tions requested comments regarding the
application of section 163(j) to tiered part-
nership structures, and the proposed regu-
lations reserved on this topic. Specifical-
ly, the preamble requested comments on
whether excess business interest expense
should be allocated through upper-tier
partnerships and how or when an upper-ti-
er partner’s basis should be adjusted when
a lower-tier partnership is subject to a
section 163(j) limitation. This issue is be-
ing addressed in the Concurrent NPRM.
Therefore, this issue is not addressed in
the final regulations.
F. Partnership Mergers and Divisions
The proposed regulations reserve on
guidance regarding the application of
section 163(j) to partnership mergers and
divisions, and the Treasury Department
and the IRS requested comments in the
preamble to the proposed regulations on
the effect of partnership mergers and divi-
sions on excess business interest expense,
excess taxable income, and excepted trade
or business elections in the context of sec-
tion 163(j).
In response to this request, one com-
menter recommended that: (i) the carry-
forward rule in proposed §1.163(j)-6(g)
apply to partners of a partnership treated
as a continuing partnership in a partner-
ship merger or division; (ii) the dispo-
sition rule of proposed §1.163(j)-6(h)
(3)(i) apply to partnership interests that
are treated as liquidated in a partnership
merger or division; and (iii) the final reg-
ulations confirm, perhaps through exam-
ples, the application of the excepted trade
or business election and termination rules
in proposed §1.163(j)-9 in the context of a
partnership merger or division.
The partnership merger and division
rules under section 708 may treat a part-
nership as terminating or continuing, and
the regulations under §1.708-1(c) and (d)
provide a construct for analyzing the tax
effects of a partnership merger or division.
The Treasury Department and the IRS
have determined that, in most situations,
a partnership merger or division can be
analyzed appropriately under the rules of
§1.708-1(c) and (d). As a result, the Trea-
sury Department and the IRS are not pro-
viding special rules in the final regulations
to analyze the consequences of a partner-
ship merger or division in the context of
section 163(j) at this time. However, the
Treasury Department and the IRS contin-
ue to study these issues.
G. Applicability of Section 382 to S
Corporations Regarding Disallowed
Business Interest Expense Carryforwards
The proposed regulations provide
that sections 381(c)(20) and 382(d)(3)
and (k)(1) apply to S corporations with
respect to disallowed business expense
carryforwards. Proposed §1.163(j)-6(l)
(5) provides that the amount of any busi-
ness interest expense not allowed as a
deduction for any taxable year by reason
of the section 163(j) limitation is carried
forward in the succeeding taxable year
as a disallowed business interest expense
carryforward. Proposed §1.163(j)-6(l)
(1) provides that any disallowed business
interest expense is not allocated to the
S corporation’s shareholders until such
business interest expense is allowed as a
deduction under section 163(j). Similarly,
under proposed §1.163(j)-6(l)(6) and (7),
an S corporation shareholder’s stock ba-
sis is reduced, but not below zero, and an
S corporation’s accumulated adjustments
account (AAA) balance is adjusted, when
a disallowed business interest expense be-
comes deductible under section 163(j).
The preamble to the proposed regula-
tions requested comments regarding the
proper integration of section 163(j) and
section 382 and subchapter S of the Code
(subchapter S). In addition, the pream-
ble to the proposed regulations requested
comments regarding the treatment of dis-
allowed business interest expense carry-
forwards as an attribute of the S corpora-
tion subject to the section 382 limitation,
as opposed to an attribute of the share-
holders, and regarding the timing for any
adjustments to shareholder basis and the
corporation’s AAA.
In response, one commenter recom-
mended that the final regulations retain
the approach as set forth in the proposed
regulations. In particular, the commenter
recommended that section 382 (and the
comparable provisions of section 383) be

Bulletin No. 2020–40 657 September 28, 2020
applied only to those attributes that are
carried forward and taken into account
at the corporate level. The comment-
er contended that it would be appropri-
ate to treat disallowed business interest
expense of an S corporation as a “pre-
change loss” such that the corporation
would be a loss corporation pursuant to
section 382(k)(1).
The Treasury Department and the IRS
agree with the commenter. Because disal-
lowed business interest expense is treated
as an attribute of the S corporation, the S
corporation’s disallowed business interest
expense carryforwards will be treated as
pre-change losses subject to a section 382
limitation under section 382(d)(3) follow-
ing an S corporation’s ownership change
(within the meaning of section 382(g)).
Accordingly, consistent with the treatment
of C corporations under section 382, the
final regulations provide that a disallowed
business interest expense carryforward of
an S corporation is treated as pre-change
loss and will be subject to a section 382
limitation only if an S corporation un-
dergoes an ownership change within the
meaning of section 382(g). For example,
under the final regulations, a “qualifying
disposition” by a shareholder that results
in a 20-percent ownership change of the
S corporation, on its own, will not cause
section 382 to apply to an S corporation
upon such qualifying disposition. See
§1.1368-1(g)(2)(i)(A). See also §1.1368-
1(g)(2) (defining the term “qualifying dis-
position”).
A commenter also recommended that
section 382 not be applied to any item
of deduction, loss, or credit that is allo-
cated to shareholders on a current basis
and taken into account at the sharehold-
er level. As expressed in the preamble to
the proposed regulations, the Treasury
Department and the IRS continue to
consider the extent to which section 382
should apply to S corporations for pur-
poses other than section 163(j). The ap-
plication of section 382 to S corporations
for purposes of section 163(j) should not
be construed as creating any inference
regarding the application of section 382
to S corporations for other purposes. The
Treasury Department and the IRS contin-
ue to seek comments regarding the prop-
er integration of these two Code sections
and subchapter S.
H. Separate Application of Section 163(j)
Limitation to Short Taxable Years of S
Corporation
An S corporation’s items of income
and loss generally are allocated on a pro
rata, per-day basis to all shareholders that
hold the corporation’s stock during the
corporation’s taxable year. See section
1377(a)(1). However, subchapter S pro-
vides limited exceptions to that general
allocation rule. For example, in the event
that a shareholder completely terminates
its interest, the S corporation and affect-
ed shareholders can elect to treat its tax-
able year “as if the taxable year consisted
of 2 taxable years the first of which ends
on the date of the termination” (each, a
hypothetical short taxable year). Section
1377(a)(2)(A). In addition, an S corpora-
tion may make such an election if a share-
holder has made a qualifying disposition.
See §1.1368-1(g)(2). With regard to each
of these instances, the S corporation may
elect to “close the books” even though the
corporation will file one Federal income
tax return for the taxable year covering
both separate taxable periods.
Subchapter S also specifies instances in
which an S corporation may elect, or is re-
quired, to file a Federal income tax return
for a short taxable year (actual short tax-
able year). For example, an S corporation
may elect to determine taxable income
or loss based on a closing-of-the-books
method with respect to an S termination
year. See section 1362(e)(3) (providing
an election to have items assigned to each
short taxable year under normal Federal
income tax accounting rules). However, if
a sale or exchange of at least 50 percent
of the S corporation’s stock occurs during
that S termination year, the S corpora-
tion must utilize the closing-of-the-books
method. See section 1362(e)(6)(D). See
also section 1362(e)(6)(C) (requiring the
use of the closing-of-the-books method
with respect to any item resulting from the
application of section 338).
Based on a request from a commenter,
the Treasury Department and the IRS have
considered whether the section 163(j) lim-
itation should apply separately with re-
spect to each hypothetical or actual short
taxable year. Specifically, the commenter
recommended that, if an S corporation (1)
has an actual short taxable year, or (2) de-
termines its taxable income or loss as if its
taxable year consisted of separate taxable
years (that is, hypothetical short taxable
years), the final regulations should clari-
fy that a separate section 163(j) limitation
should be calculated for, and applied to,
each actual or hypothetical short taxable
year. To support that recommendation,
the commenter emphasized “sound policy
reasons” for ensuring that owners of the
corporation during the first short taxable
period are not affected by the fortunes of
the corporation during the second short
period, and vice versa.
The Treasury Department and the IRS
agree that a separate section 163(j) lim-
itation should be calculated for, and ap-
plied to, each actual or hypothetical short
taxable year. Section 163(j)(1) limits the
amount of business interest expense al-
lowed as a deduction “for any taxable
year.” Accordingly, the Treasury Depart-
ment and the IRS have determined that a
separate section 163(j) limitation should
apply to each actual short taxable year.
See §1.1362-3(c)(3) (setting forth the gen-
eral rule that “the S and C short years are
treated as two separate years for purposes
of all provisions of the Internal Revenue
Code”). In addition, subchapter S and the
regulations in this part under subchapter
S explicitly treat hypothetical short tax-
able years as separate taxable years. See
section 1377(a)(2)(A) (providing that an S
corporation can treat its taxable year “as
if the taxable year consisted of 2 taxable
years”) and §1.1368-1(g)(1) (providing
that the “section applies as if the taxable
year consisted of separate taxable years”).
As a result, the Treasury Department and
the IRS also have determined that a sepa-
rate section 163(j) limitation should apply
to each hypothetical short taxable year
and sections 1.1362-3(c), 1.1368-1(g)(2),
and 1.1377-1(b)(3) have been amended
accordingly.
I. Partnership or S Corporation Not
Subject to Section 163(j)
Under proposed §1.163(j)-6(m)(1), if
a partner or S corporation shareholder is
allocated business interest expense from
an exempt entity, that allocated business
interest expense will be subject to the part-
ner’s or S corporation shareholder’s sec-
tion 163(j) limitations. Commenters rec-

September 28, 2020 658 Bulletin No. 2020–40
ommended that proposed § 1.163(j)-6(m)
(1) be modified so that business interest
expense incurred by a partnership that is
an exempt entity is not subject to section
163(j) at the partner level. Commenters
argued that proposed §1.163(j)-6(m)(1)
was inconsistent with section 163(j)(4)
(A), which requires the testing of part-
nership-level business interest expense
at the partnership level, not the partner
level. The Treasury Department and the
IRS agree, and have determined that the
same argument naturally should apply to
S corporations and their shareholders. See
section 163(j)(4)(D) (in relevant part, pro-
viding that rules similar to section 163(j)
(4)(A) shall apply with respect to any S
corporation and its shareholders). Accord-
ingly, the final regulations provide that
business interest expense of an exempt
partnership, or exempt S corporation, pur-
suant to section 163(j)(3) does not retain
its character as business interest expense
and, as a result, is not subject to the sec-
tion 163(j) limitation at the partner or S
corporation shareholder level.
One commenter requested clarification
as to whether proposed §1.163(j)-6(m)
(3) applies only to exempt entities or also
could apply to trades or businesses that
become not subject to the requirements
of section 163(j) by reason of engaging
in excepted trades or businesses. The fi-
nal regulations clarify that §1.163(j)-6(m)
(3) does not apply when a partnership
engages in excepted trades or business-
es. Accordingly, if a partner is allocated
excess business interest expense from a
partnership and, in a succeeding taxable
year, such partnership engages in except-
ed trades or businesses, then the partner
shall not treat any of its excess business
interest expense that was previously allo-
cated from such partnership as business
interest expense paid or accrued by the
partner in such succeeding taxable year by
reason of the partnership engaging in ex-
cepted trades or businesses. Rather, such
excess business interest expense shall re-
main as excess business interest expense
until such time as it is treated as business
interest expense paid or accrued by the
partner pursuant to §1.163(j)-6(g)(2) or by
reason of the partnership becoming an ex-
empt entity. The final regulations provide
a similar clarification for S corporations in
§1.163(j)-6(m)(4).
J. Trusts
For purposes of determining ATI for
trusts, one commenter noted that the defi-
nition of ATI does not contain an addback
for deductible trust distributions. Trusts
and decedents’ estates taxable under sec-
tion 641 are permitted to deduct under
sections 651 and 661 certain distributions
made to beneficiaries. The commenter
suggested that section 163(j) should apply
before a trust takes a deduction for distri-
butions to beneficiaries, and that, if a de-
ductible trust or estate distribution is add-
ed back to the trust’s ATI and thus is taken
into account in determining the amount
of interest expense allowable to the trust
under section 163(j), such trust or estate
distribution should be excluded from the
recipient beneficiaries’ calculation of ATI.
Thus, under the commenter’s approach, a
beneficiary of a trust or a decedent’s estate
would not be able to utilize a trust distri-
bution to deduct additional business inter-
est expense at the beneficiary level.
The Treasury Department and the IRS
agree with this comment. Proposed Regu-
lation §1.163(j)-2(f) is consistent with this
result. However, in order to clarify that
trusts and decedents’ estates taxable under
section 641 compute ATI without regard
to deductions under sections 651 and 661,
the final regulations explicitly provide for
this positive ATI adjustment. Additionally,
the Treasury Department and the IRS have
determined that a similar rule should ap-
ply for charitable deductions of a trust or
a decedent’s estate under section 642(c).
K. Qualified Expenditures
The ATI of a partnership is generally
determined in accordance with proposed
§1.163(j)-1(b)(1). Partnership ATI is
therefore reduced by deductions claimed
under sections 173 (relating to circulation
expenditures), 174(a) (relating to research
and experimental expenditures), 263(c)
(relating to intangible drilling and devel-
opment expenditures), 616(a) (relating
to mine development expenditures), and
617(a) (relating to mining exploration
expenditures) (collectively, “qualified
expenditures”). As a result, deductions
for qualified expenditures will reduce a
partnership’s section 163(j) limitation
pursuant to proposed §1.163(j)-2(b). De-
ductions for those items also will reduce
the amount of excess taxable income that
may be allocated to the partners and thus
reduce the amount by which partner-lev-
el ATI may be increased under proposed
§1.163(j)-6(e)(1).
A partner may elect to capitalize its dis-
tributive share of any qualified expendi-
tures of a partnership under section 59(e)
(4)(C) or may be required to capitalize
a portion of its distributive share of cer-
tain qualified expenditures of a partner-
ship under section 291(b). As a result, the
taxable income reported by a partner in a
taxable year attributable to the ownership
of a partnership interest may exceed the
amount of taxable income reported to the
partner on a Schedule K-1.
Commenters recommended that a dis-
tributive share of partnership deductions
capitalized by a partner under section
59(e) or section 291(b) increase the ATI of
the partner because qualified expenditures
reduce both partnership ATI and excess
taxable income but may not reduce the
taxable income of a partner. Commenters
suggested two different approaches for
achieving this result: (1) adjust the excess
taxable income of the partnership, result-
ing in an increase to partner ATI; and (2)
increase the ATI of the partner directly,
without making any adjustments to part-
nership excess taxable income. The in-
teraction of qualified expenditures with
section 163(j)(4) is being addressed in the
Concurrent NPRM. Therefore, this issue
is not addressed in the final regulations.
L. CARES Act Partnership Rules
As discussed in the Background sec-
tion to this preamble, section 163(j)(10),
as amended by the CARES Act, provides
a special rule for excess business interest
expense allocated to a partner in a tax-
able year beginning in 2019 (50 percent
EBIE Rule). See section 163(j)(10)(a)(ii).
The 50 percent EBIE rule is addressed in
proposed §1.163(j)-6(g)(4) of the Concur-
rent NPRM. The application of the 2019
ATI rule, as provided in section 163(j)(10)
(B), in the partnership context is also ad-
dressed in proposed §1.163(j)-6(g)(4) of
the Concurrent NPRM. Therefore, the 50
percent EBIE rule and the application of
the 2019 ATI rule to partnerships are not
addressed in the final regulations.

Bulletin No. 2020–40 659 September 28, 2020
VIII. Comments on and Changes to
Proposed §1.163(j)-7: Application
of the Section 163(j) Limitation to
Foreign Corporations and United States
Shareholders
Section 1.163(j)-7 provides gener-
al rules regarding the application of the
section 163(j) limitation to foreign cor-
porations and U.S. shareholders. The fol-
lowing discussion addresses comments
relating to proposed §1.163(j)-7.
The proposed regulations general-
ly apply section 163(j) and the section
163(j) regulations to determine the de-
ductibility of an applicable CFC’s busi-
ness interest expense in the same manner
as these provisions apply to determine
the deductibility of a domestic C cor-
poration’s business interest expense.
See proposed §1.163(j)-7(b)(2). The
proposed regulations define an applica-
ble CFC as a CFC in which at least one
U.S. shareholder owns stock, within the
meaning of section 958(a). However, in
certain cases, the proposed regulations
limit the amount of an applicable CFC’s
business interest expense subject to the
section 163(j) limitation and modify the
computation of an applicable CFC’s ATI,
respectively. Thus, under the proposed
regulations, an applicable CFC with
business interest expense applies section
163(j) to determine the extent to which
that expense is deductible for purposes of
computing subpart F income as defined
under section 952, tested income as de-
fined under section 951A(c)(2)(A), and
income that is effectively connected with
the conduct of a U.S. trade or business
(ECI), as applicable. The proposed reg-
ulations provide additional guidance for
an applicable CFC (and other foreign
persons) with ECI in proposed §1.163(j)-
8, as discussed in part IX of this Sum-
mary of Comments and Explanation of
Revisions section.
The Treasury Department and the IRS
requested comments in the preamble to
the proposed regulations regarding wheth-
er it would be appropriate to provide ad-
ditional modifications to the application
of section 163(j) to applicable CFCs and
whether there are particular circumstances
in which it may be appropriate to exempt
an applicable CFC from the application of
section 163(j).
Some commenters recommended that
section 163(j) generally should not apply
to applicable CFCs. Other commenters
suggested that section 163(j) should apply
to applicable CFCs only to the extent that
they have ECI or, if an income tax treaty
applies, business profits attributable to a
United States permanent establishment, or
to the extent that debt was introduced to
an applicable CFC with a principal pur-
pose of avoiding U.S. income taxes. Some
commenters argued that the Treasury De-
partment and the IRS lack the authority to
apply section 163(j) to applicable CFCs
because section 163(j) applies to taxpay-
ers and, they argue, applicable CFCs are
not taxpayers. Furthermore, some com-
menters argued that old section 163(j)
did not apply to applicable CFCs and that
Congress expressed no intent to change
that. Some commenters also argued that
applying section 163(j) to applicable
CFCs creates significant complexity and
an administrative burden. Furthermore,
some commenters suggested that apply-
ing section 163(j) to applicable CFCs may
have a limited effect on tax revenue or
that applying section 163(j) to applicable
CFCs could, in some cases, result in a net
tax benefit to U.S. shareholders.
The Treasury Department and the IRS
have determined that, under current law,
section 163(j) applies to applicable CFCs
and other foreign corporations whose in-
come is relevant for U.S. tax purposes.
As a general matter, application of U.S.
tax principles to a foreign corporation for
purposes of determining its income for
U.S. tax purposes is within the authority
of the Treasury Department and the IRS.
For example, a U.S. shareholder of an
applicable CFC takes into account its pro
rata share of the subpart F income and net
tested income of an applicable CFC. Ac-
cordingly, in order to determine the U.S.
shareholder’s pro rata share, the income of
the applicable CFC must be determined.
Section 1.952-2(a)(1) provides that, “[e]
xcept as provided in subparagraph (2) of
this paragraph [relating to insurance gross
income], the gross income of a foreign
corporation for any taxable year shall,
subject to the special rules of paragraph
(c) of this section, be determined by treat-
ing such foreign corporation as a domestic
corporation taxable under section 11 and
by applying the principles of section 61
and the regulations thereunder.” Neither
§1.952-2(a)(2) nor (c) implicates section
163(j). Accordingly, pursuant to §1.952-2,
a foreign corporation is treated as a do-
mestic corporation for U.S. tax purposes
when calculating its taxable income, in-
cluding by application of section 163(j).
The exclusion of CFCs from the appli-
cation of old section 163(j) under the 1991
Proposed Regulations is not determinative
as to whether applicable CFCs and other
foreign corporations should be excluded
from the application of section 163(j).
Although both old section 163(j) and sec-
tion 163(j) limit deductions for business
interest expense, the policies of each pro-
vision are significantly different. Old sec-
tion 163(j) was a narrower provision that
limited a corporation’s ability to use inter-
est expense deductions to move earnings
out of the United States tax base. Section
163(j) focuses on limiting the potential
tax benefit of overleveraged businesses.
Because Congress wholly repealed and
replaced old section 163(j), the provisions
of old section 163(j) and the 1991 Pro-
posed Regulations are not determinative
as to the application of section 163(j).
Furthermore, nothing in the Code or
legislative history indicates that Congress
intended to exclude applicable CFCs or
other foreign corporations from the ap-
plication of section 163(j). Congress ex-
pressly provided that section 163(j) should
not apply to certain small businesses or
to certain excepted trades or businesses.
Congress did not exempt applicable CFCs
or other foreign corporations from the ap-
plication of section 163(j).
Accordingly, the final regulations clar-
ify that section 163(j) applies to foreign
corporations whose income is relevant for
U.S. tax purposes, other than by reason
of section 881 or 882 (relevant foreign
corporations). Section 1.163(j)-7(b). Fur-
thermore, no comments were received on
the application of §1.952-2 or section 882
for purposes of determining the income,
including ECI, of an applicable CFC or
on the reduction of an applicable CFC’s
taxable income by the amount of any div-
idend received from a related person for
purposes of determining ATI. In addition
to clarifying that these rules apply to all
relevant foreign corporations, the final
regulations otherwise adopt these rules
unchanged. §1.163(j)-7(g)(1).

September 28, 2020 660 Bulletin No. 2020–40
The Treasury Department and the IRS
acknowledge that the application of sec-
tion 163(j) to applicable CFCs and other
relevant foreign corporations, like many
other tax provisions, will increase the
complexity of determining the taxable
income of a relevant foreign corporation.
Similarly, section 163(j) may have a sig-
nificant effect on the amount of taxable
income of some relevant foreign corpora-
tions and have limited or no effect on the
amount of taxable income of others. The
Treasury Department and the IRS do not
view the complexity of a provision of the
Code or its net effect on tax revenue as
determinative as to whether the provision
applies to CFCs. Nonetheless, the Trea-
sury Department and the IRS have deter-
mined that it is appropriate to reduce the
compliance and administrative burdens of
applying section 163(j) to certain applica-
ble CFCs.
Accordingly, the Treasury Department
and the IRS have developed new rules,
taking into account comments received,
that substantially modify the rules con-
tained in proposed §1.163(j)-7. The Trea-
sury Department and the IRS anticipate
that, in many cases, these modifications
will significantly reduce the compliance
and administrative burdens of applying
section 163(j) to applicable CFCs. How-
ever, because the operation of these new
rules is sufficiently different from the op-
eration of the rules in proposed §1.163(j)-
7, the Treasury Department and the IRS
have determined that these rules should be
proposed in order to provide taxpayers the
opportunity to comment before their final-
ization. These rules and a discussion of
their operation are contained in the Con-
current NPRM.
IX. Comments on and Changes to Section
1.163(j)-8: Application of the Section
163(j) Limitation to Foreign Persons with
Effectively Connected Taxable Income.
Proposed §1.163(j)-8 provides rules
for applying section 163(j) to a nonresi-
dent alien individual or foreign corpora-
tion with ECI. Although no comments
were received on proposed §1.163(j)-8,
the Treasury Department and the IRS
continue to study methods of determining
the amount of deductible business interest
expense and disallowed business interest
expense carryforwards that are allocable
to ECI. Accordingly, the final regulations
reserve on the application of the business
interest expense deduction limitation to
foreign persons with ECI.
In the Concurrent NPRM, the Trea-
sury Department and the IRS are propos-
ing rules for determining the amount of
deductible business interest expense and
disallowed business interest expense car-
ryforward of a nonresident alien, foreign
corporation, or partnership that is proper-
ly allocable to ECI. The Treasury Depart-
ment and the IRS request comments on
appropriate methods of making this deter-
mination. These comments should consid-
er the appropriate method for determining
the extent to which business interest ex-
pense determined under §1.882-5 should
be treated as attributable to a partnership
and subject to the section 163(j) limitation
at the partnership level.
X. Comments on and Changes to
Proposed §1.163(j)-9: Elections for
Excepted Trades or Businesses; Safe
Harbor for Certain REITs
Section 1.163(j)-9 provides general
rules and procedures for making an elec-
tion for a trade or business to be an elect-
ing real property trade or business under
section 163(j)(7)(B) and an election for a
trade or business to be an electing farming
business under section 163(j)(7)(C). The
following discussion addresses some of
the provisions in §1.163(j)-9 and the com-
ments received.
A. Protective Elections
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to taxpayers that meet the gross receipts
test of section 448(c). The small business
exemption applies automatically if the
requirements are met; thus, no election
is necessary to ensure that the section
163(j) limitation does not apply. Howev-
er, for real property trades or businesses
under section 163(j)(7)(B), and for farm-
ing businesses under section 163(j)(7)(C),
the section 163(j) limitation does not ap-
ply only if the taxpayer is eligible for and
makes an election.
The preamble to the proposed regula-
tions provides that a taxpayer that qual-
ifies for the small business exemption is
not eligible to make an election for a trade
or business to be an electing real property
trade or business or an electing farming
business, in part because the taxpayer is
already not subject to the section 163(j)
limitation, and in part because an electing
real property trade or business or an elect-
ing farming business is required to use
ADS for certain types of property under
section 163(j)(10) and cannot claim the
additional first-year depreciation deduc-
tion under section 168(k) for those types
of property. The Treasury Department
and the IRS were concerned that certain
small business taxpayers might make the
election without realizing that the election
could have adverse effects on their deduc-
tion for depreciation expense and their
method of accounting for depreciation.
Commenters suggested that, in some
situations, making an annual gross re-
ceipts determination, to determine wheth-
er a taxpayer should make an election or is
already exempt from the limitation, could
be burdensome. For example, a taxpay-
er that has to request the average annual
gross receipts of numerous unrelated enti-
ties under section 448 aggregation princi-
ples in order to make the gross receipts de-
termination may choose to forgo making
that determination if the taxpayer knows
that its trade or business qualifies to be
an electing real property trade or business
or an electing farming business. These
commenters requested that taxpayers be
allowed to make such an election without
regard to whether the gross receipts test of
section 448(c) has been tested or is met,
notwithstanding the potentially adverse
depreciation expense implications.
The Treasury Department and the IRS
agree with the commenters. Accordingly,
the final regulations provide that taxpayers
may make an election for a trade or busi-
ness to be an electing real property trade
or business or an electing farming busi-
ness, provided that they qualify to make
such elections, even if the gross receipts
test under section 448(c) may be satisfied
by the electing trades or businesses in the
taxable year in which the election is made.
As is the case for all other electing real
property trades or businesses and electing
farming businesses, the elections are irre-
vocable and affect depreciation as provid-
ed in section 163(j)(11). However, this rule

Bulletin No. 2020–40 661 September 28, 2020
also benefits taxpayers subject to section
163(j) that are owners of small businesses
because treating these small businesses as
engaged in an excepted trade or business
may result in the allocation of more own-
er interest expense to excepted trades or
businesses under §1.163(j)-10(c).
Commenters also requested a protec-
tive election for taxpayers engaged in
rental real estate activities if it is unclear
whether the activities rise to the level of
a trade or business under section 162. The
protective election is necessary, according
to some commenters, because the defini-
tion of an “electing real property trade or
business” in section 163(j)(7)(B) and pro-
posed §1.163(j)-1(b)(14) allows a trade
or business described in section 469(c)(7)
(C) to make the election, and a real prop-
erty trade or business as defined in section
469(c)(7)(C) can include rental real estate
that does not rise to the level of a section
162 trade or business.
Generally, interest expense associated
with an activity that does not rise to the
level of a section 162 trade or business is
not subject to the section 163(j) limitation.
The section 163(j) limitation applies to
taxpayers with business interest, which is
defined under section 163(j)(5) as any in-
terest properly allocable to a trade or busi-
ness. Proposed §1.163(j)-1(b)(38) defines
a “trade or business” as a trade or business
under section 162. In contrast, an electing
real property trade or business must be
described in section 469(c)(7)(C). Section
1.469-9(b)(1) provides that, for purposes
of section 469(c)(7), the term “trade or
business” is defined as “any trade or busi-
ness determined by treating the types of
activities in §1.469-4(b)(1) as if they in-
volved the conduct of a trade or business;
and any interest in rental real estate, in-
cluding any interest in rental real estate
that gives rise to deductions under section
212.”
Thus, section 469(c)(7)(C) includes all
rental real estate (as defined in §1.469-
9(b)(3)) and adopts a broader definition
of a “trade or business” than section 162.
Under this broader definition, taxpayers
with rental real estate may be able to qual-
ify as “real estate professionals” through
work performed in their rental real estate,
even if the rental real estate activities oth-
erwise do not rise to the level of a section
162 trade or business.
For example, for purposes of section
469(c)(7)(C), a taxpayer who owns real
property and rents to tenants under a triple
net lease arrangement will be treated as en-
gaged in a real property trade or business
even though the renting under the terms
of a triple net lease arrangement may not
rise to the level of a section 162 trade or
business. The triple net lease arrangement
is included in the broader definition of a
trade or business under §1.469-9(b)(1) be-
cause the arrangement represents an inter-
est in rental real estate. Accordingly, rent-
ing real property under a triple net lease
arrangement generally will fall within the
definition of a “rental real property trade
or business” in section 469(c)(7)(C) and
proposed §1.469-9(b)(2). As a result, the
taxpayer with such a rental arrangement
should be able to make an election to treat
this activity as an electing real property
trade or business, if the taxpayer so choos-
es, even though the renting of real prop-
erty under a triple net lease arrangement
might not be a section 162 trade or busi-
ness. This result is simply a consequence
of Congress cross-referencing the broader
section 469 definition of a “real property
trade or business” for purposes of section
163(j).
Thus, the commenters stated that, al-
though taxpayers who are certain they are
not engaged in a section 162 trade or busi-
ness do not need to make an election out
of the section 163(j) limitation because
they are not subject to this limitation,
taxpayers engaged in rental real estate ac-
tivities who are not certain whether their
rental real estate activities rise to the level
of a section 162 trade or business should
be given the ability to obtain certainty by
making a protective election to treat their
rental real estate activities as an electing
real property trade or business.
The Treasury Department and the IRS
agree with the recommendation for a pro-
tective election under these circumstances.
Thus, the final regulations provide that an
election to treat rental real estate activities
as an electing real property trade or busi-
ness is available regardless of whether the
taxpayer making the election is engaged in
a trade or business within the meaning of
section 162. Under the protective election,
a taxpayer engaged in activities described
in section 469(c)(7)(C) and §1.469-9(b)
(2), as required in proposed §1.163(j)-1(b)
(14)(i), but unsure whether its activities
rise to the level of a section 162 trade or
business, may make an election for a trade
or business to be an electing real property
trade or business.
As with all other electing real property
trades or businesses, once the election is
made, all other consequences of the elec-
tion outlined in §1.163(j)-9 apply, such as
the irrevocability of the election and the
required use of the alternative deprecia-
tion system for certain assets.
B. One-Time Late Election or Withdrawal
of Election Procedures
Commenters requested a one-time au-
tomatic extension of time for certain tax-
payers to file an election under section
163(j)(7)(B) or section 163(j)(7)(C) due
to uncertainty about the effect of a deci-
sion to make or not make such an election
and about which taxpayers are eligible to
make such an election prior to the publica-
tion of the final regulations. Additionally,
commenters requested a one-time oppor-
tunity to withdraw an election made un-
der section 163(j)(7)(B) or section 163(j)
(7)(C) prior to the publication of the final
regulations. The Treasury Department
and the IRS agree with the commenters’
concerns. Thus, in order to address the
commenters’ concerns, and to provide
immediate transition guidance under sec-
tion 163(j) for taxpayers affected by the
various amendments to the Code made by
the CARES Act (including, for example,
the technical corrections to section 168(e)
of the Code relating to the classification
of qualified improvement property), Rev-
enue Procedure 2020-22 was issued to
provide an automatic extension of time
to make, or an opportunity to withdraw,
an election for taxable years beginning in
2018, 2019, or 2020. The revenue proce-
dure also provides the time and manner
of making or revoking the three elections
provided by the CARES Act under section
163(j)(10) for taxable years beginning in
2019 or 2020.
C. The Anti-Abuse Rule Under Proposed
§1.163(j)-9(h)
Numerous comments were received
concerning the anti-abuse rule in pro-
posed §1.163(j)-9(h)(1) (proposed -9(h)

September 28, 2020 662 Bulletin No. 2020–40
anti-abuse rule). The proposed -9(h) an-
ti-abuse rule prohibits an otherwise qual-
ifying real property trade or business
from making an election under section
163(j)(7)(B) if at least 80 percent of the
business’s real property, determined by
fair market value, is leased to a trade or
business under common control (that is,
50 percent of the direct and indirect own-
ership of both businesses is held by relat-
ed parties within the meaning of sections
267(b) and 707(b)) with the real property
trade or business. Proposed §1.163(j)-9(h)
(2) provides an exception to the proposed
-9(h) anti-abuse rule for REITs that lease
qualified lodging facilities (defined in sec-
tion 856(d)(9)(D)) and qualified health
care properties (defined in section 856(e)
(6)(D)) (REIT exception).
The preamble to the proposed regula-
tions explains that it would be inappro-
priate to allow an election under section
163(j)(7)(B) to be an excepted real prop-
erty trade or business for a trade or busi-
ness that leases substantially all of its real
property to the owner of the real property
trade or business, or to a related party of
the owner: “To permit such an election
would encourage a taxpayer to enter into
non-economic structures where the real
estate components of non-real estate busi-
nesses are separated from the rest of such
businesses in order to artificially reduce
the application of section 163(j) by leas-
ing the real property to the taxpayer or a
related party of the taxpayer and electing
for this “business” to be an excepted real
property trade or business. As a result,
these proposed regulations would also
contain an anti-abuse rule.” The pream-
ble further explains the reasoning for the
REIT exception by stating that, because
REITs that lease qualified lodging facili-
ties and qualified healthcare properties are
generally permitted (pursuant to section
856(d)(8)(B)) to lease these properties to
a taxable REIT subsidiary (TRS), this an-
ti-abuse rule does not apply to these types
of REITs. The Treasury Department and
the IRS requested comments in the pream-
ble to the proposed regulations on wheth-
er other exceptions to the anti-abuse rule
(such as, for example, an exception for
certain fact patterns where real property
that is leased from a related party is ulti-
mately sub-leased to a third party) would
be appropriate.
Commenters suggested eliminating
or modifying the proposed -9(h) an-
ti-abuse rule because of the concern that,
as currently written, this rule applies to
non-abusive lease arrangements between
commonly controlled trades or busi-
nesses. Specifically, commenters raised
concerns about the applicability of the
proposed -9(h) anti-abuse rule to specific
types of business structures where the real
property is owned by one legal entity (re-
ferred to as property company, or PropCo)
and leased to a separate but commonly
controlled legal entity that operates and
manages a business (referred to as oper-
ating company, or OpCo). According to
commenters, this PropCo/OpCo structure
has valid business protection, lending, and
regulatory purposes in certain industries.
Commenters also claimed that this struc-
ture was in existence for many years prior
to the enactment of the section 163(j) lim-
itation and was not created in an attempt
to circumvent application of the section
163(j) limitation.
For example, the PropCo/OpCo struc-
ture is used by some hotels in the follow-
ing manner: PropCo generally owns the
real property subject to significant debt,
services such debt, and leases the real
property to OpCo, which operates a real
property trade or business by licensing the
property to unrelated third parties (guests).
This structure is used to limit legal liabil-
ity, manage state and local tax burdens,
plan for family wealth transfers, and for
other business objectives. One comment-
er recommended a “look-through” ex-
ception to the proposed -9(h) anti-abuse
rule where the real property is ultimately
leased (or licensed) to unrelated third par-
ties in a PropCo/OpCo structure. This ex-
ception would allow a real property trade
or business owning real property, or Prop-
Co, to make an election to be an electing
real property trade or business if it leases
real property to a commonly controlled
real property trade or business, or OpCo,
if OpCo subleases (or licenses) the real
property to unrelated third parties.
Similarly, commenters noted that the
property ownership, mortgage, and result-
ing interest expense for trades or business-
es described as nursing homes, continuing
care retirement communities, independent
living facilities, assisted living facilities,
memory care facilities, and skilled nurs-
ing facilities (collectively, “residential
living facilities”) is often contained in one
legal entity, or PropCo, and the operation
and management of the residential living
facility is contained in another, common-
ly controlled legal entity, or OpCo. Com-
menters explained that the Department of
Housing and Urban Development, which
is a major lender in the residential living
industry, and many other lenders often
require the use of single-asset or separate
legal entities for lending purposes.
To prevent the application of the pro-
posed -9(h) anti-abuse rule to a PropCo
that leases real property to a residential
living facility, some commenters suggest-
ed that the anti-abuse rule should not ap-
ply to a trade or business that leases real
property to a residential living facility (1)
regardless of whether the lessor and les-
see are under common control, or (2) if
both the lessor trade or business and the
commonly controlled lessee independent-
ly qualify as electing real property trades
or businesses. Commenters noted that
the proposed -9(h) anti-abuse rule should
not apply to situations where the entities,
if combined or aggregated and without
taking the lease into account, would each
qualify as real property trades or busi-
nesses. Without modification to the pro-
posed -9(h) anti-abuse rule, the PropCo
in a PropCo/OpCo structure would be
prohibited from making a real property
trade or business election even though all
of its lease income is derived from a real
property trade or business. Commenters
suggested that proposed §1.163(j)-9(h)
(2), which provides an exception for RE-
ITs, should apply to similarly situated tax-
payers that are privately owned but use a
commonly controlled entity in a PropCo/
OpCo structure rather than a REIT.
Other suggestions made by comment-
ers include (1) eliminating the proposed
-9(h) anti-abuse rule and instead relying
on the more general proposed §1.163(j)-
2(h) anti-avoidance rule to disregard or
recharacterize the types of non-economic
structures targeted by the proposed -9(h)
anti-abuse rule, (2) clarifying that the pro-
posed -9(h) anti-abuse rule would apply
only if there is a “principal purpose of
tax avoidance,” (3) providing exceptions
to the proposed -9(h) anti-abuse rule if
the taxpayer demonstrates a substantial
economic purpose for the PropCo/OpCo

Bulletin No. 2020–40 663 September 28, 2020
structures unrelated to avoiding section
163(j), or if the PropCo/OpCo structure
was in place prior to enactment of the
TCJA, and (4) expanding the REIT excep-
tion to include all real property trades or
businesses that lease to residential living
facilities.
The operation of two separate, but
commonly controlled, legal entities is
also common in the cattle and beef indus-
try—one entity owns all of the land and
the buildings used by the operating entity,
whereas the operating entity owns inven-
tory (cattle or crops) and equipment and
operates the farm, ranch, or feed yard.
Commenters recommended providing an
exception from the proposed -9(h) an-
ti-abuse rule for farming businesses or,
alternatively, clarifying that the allocation
rules under proposed §1.163(j)-10 do not
apply to separate out the real property to
real property businesses included under
the proposed -9(h) anti-abuse rule.
The Treasury Department and the IRS
agree with commenters that certain ex-
ceptions should be added to the proposed
-9(h) anti-abuse rule. The final regulations
provide two additional exceptions to the
anti-abuse rule. Under the first exception,
if at least 90 percent of a lessor’s real
property, determined by fair market rental
value, is leased to a related party that oper-
ates an excepted trade or business and/or
to unrelated parties, the lessor is eligible
to make an election to be an electing real
property trade or business for its entire
trade or business (de minimis exception).
The de minimis exception accommodates
taxpayers that, by law or for valid busi-
ness reasons, divide their real property
holding and leasing activities from their
operating trade or business that qualifies
as an excepted trade or business, while
still maintaining an anti-abuse rule to pre-
vent non-economic business structures
designed to circumvent the section 163(j)
limitation. See §1.163(j)-9(j).
The second exception is a look-through
rule that modifies the proposed -9(h) an-
ti-abuse rule by allowing taxpayers to
make an election for a certain portion
of their real property trade or business
(look-through exception). Under the look-
through exception, if a lessor trade or busi-
ness leases to a trade or business under
common control (lessee), the lessor is eli-
gible to make an election to be an electing
real property trade or business to the extent
that the lessor leases to an unrelated party
or to an electing trade or business under
common control with the lessor or lessee,
and to the extent that the lessee trade or
business under common control subleas-
es (or licenses) to unrelated third parties
and/or related parties that operate an ex-
cepted trade or business. Accordingly, the
lessor can make an election for the portion
of its trade or business that is equivalent
to the portion of the real property that is
ultimately leased to unrelated parties and/
or related parties that operate an excepted
trade or business. A lessor that makes an
election under the look-through exception
must allocate the basis of assets used in its
trades or businesses under the rules pro-
vided in §1.163(j)-10(c)(3)(iii)(D).
D. Residential Living Facilities and
Notice with Proposed Revenue Procedure
The PropCo/OpCo structure, discussed
previously in part X(C) of this Summary of
Comments and Explanation of Revisions
section, is used extensively by certain res-
idential living facilities that provide resi-
dential housing along with supplemental
assistive, nursing, and other routine med-
ical services. The commonly controlled
lessees in the PropCo/OpCo structure
expressed concern about whether the resi-
dential living facility trades or businesses
qualify as real property trades or busi-
nesses under section 469 and §1.469-9(b)
(2), and are thus eligible to make an elec-
tion under section 163(j)(7)(B), because
of the supplemental services that they
provide. Accordingly, Notice 2020-59,
2020-[INSERT CB/IRB GUIDANCE
NUMBERS], released concurrently with
these final regulations, provides notice of
a proposed revenue procedure detailing a
proposed safe harbor under which a tax-
payer engaged in a trade or business that
manages or operates a residential living
facility and that also provides supplemen-
tal assistive, nursing, and other routine
medical services may elect to treat such
trade or business as a real property trade
or business within the meaning of section
469(c)(7)(C), solely for purposes of qual-
ifying as an electing real property trade or
business under section 163(j)(7)(B). Thus,
if a lessor leases real property to a com-
monly controlled lessee that operates a
residential living facility, which qualifies
as and makes an election to be an excepted
trade or business under the proposed safe
harbor in Notice 2020-59, the lessor may
qualify to use the de minimis exception or
the look-through exception.
The Treasury Department and the IRS
request comments in Notice 2020-59 on
the proposed revenue procedure. Interest-
ed parties are invited to submit comments
on the proposed revenue procedure by
September 29, 2020.
The proposed revenue procedure is
proposed to apply to taxpayers with tax-
able years ending after December 31,
2017. Until such time that the proposed
revenue procedure is published in final
form, taxpayers may use the safe harbor
described in the proposed revenue proce-
dure for purposes of determining whether
a residential living facility, as defined in
the proposed revenue procedure, may be
treated as a real property trade or business
solely for purposes of section 163(j).
Future guidance might be needed to
determine whether a particular trade or
business can make an election. Accord-
ingly, the definitions of electing real prop-
erty trade or business in §1.163(j)-1(b)
(14) and electing farming business in
§1.163(j)-1(b)(13) include a new provi-
sion noting that the Secretary may issue
guidance on whether a trade or business
can be an electing real property trade or
business or electing farming business.
E. Safe Harbor for Certain REITs
Proposed §1.163(j)-9(g) provides a
special safe harbor for REITs. The safe
harbor provides that, if a REIT holds real
property, interests in partnerships holding
real property, or shares in other REITs
holding real property, the REIT is eligible
to make an election to be an electing real
property trade or business for all or part
of its assets. If a REIT makes an election
to be an electing real property trade or
business, and if the value of the REIT’s
real property financing assets (as defined
in proposed §1.163(j)-9(g)(5) and (6)) at
the close of the taxable year is 10 percent
or less of the value of the REIT’s total as-
sets at the close of the taxable year, then,
under the safe harbor in the proposed
regulations, all of the REIT’s assets are
treated as assets of an excepted trade or

September 28, 2020 664 Bulletin No. 2020–40
business. If a REIT makes an election to
be an electing real property trade or busi-
ness, and if the value of the REIT’s real
property financing assets at the close of
the taxable year is more than 10 percent of
the value of the REIT’s total assets, then,
under the safe harbor in the proposed reg-
ulations, the REIT’s business interest in-
come, business interest expense, and other
items of expense and gross income are
allocated between excepted and non-ex-
cepted trades or businesses under the
rules set forth in proposed §1.163(j)-10,
as modified by proposed §1.163(j)-9(g)
(4). The safe harbor also allows REITs to
use §1.856-10 for the definition of “real
property” in determining which assets are
assets of an excepted trade or business.
The final regulations generally adopt the
safe harbor for REITs in the proposed reg-
ulations, with modifications in response to
comments discussed in this part X(E) of
the Summary of Comments and Explana-
tion of Revisions section.
One commenter recommended that the
Treasury Department and the IRS revise
proposed §1.163(j)-9(g)(1) to clarify that
a REIT may make the safe harbor election
if the REIT owns an interest in one or more
partnerships holding real property or stock
in one or more REITs holding real proper-
ty. The commenter indicated that the use
of the plural “interests in partnerships”
and “shares in other REITs” could imply
that a REIT cannot make the safe harbor
election if the REIT owns an interest in
a single partnership or shares in a single
REIT. The Treasury Department and the
IRS agree that the regulations should not
preclude a REIT that owns an interest in
a single partnership or shares in a single
REIT from applying the safe harbor.
This commenter also recommended
that the final regulations clarify that the
safe harbor election may be made if the
electing REIT owns a direct interest in a
partnership or lower-tier REIT that does
not directly hold real property, but that
holds an interest in another partnership
or lower-tier REIT that directly holds real
property.
The determination of whether a REIT
is eligible to make the safe harbor elec-
tion under the proposed regulations was
intended to mirror the determination of
whether the REIT holds real property (as
defined under §1.856-10) when testing
the value of the REIT’s real estate assets
under section 856(c)(4)(A). If a REIT is
a partner in a partnership that holds real
property (as defined under §1.856-10), the
REIT is deemed to own its proportionate
share of the partnership’s real property for
purposes of section 856(c)(4). The Trea-
sury Department and the IRS also recog-
nize that, for purposes of section 856(c)
(4), a REIT is deemed to own a share of
real property from any partnership interest
held through an upper-tier partnership.
Moreover, under section 856(c)(5)(B),
shares in other REITs qualify as real es-
tate assets. Although a REIT (shareholder
REIT) that holds shares in another REIT
would not need to determine whether the
other REIT holds real property for purpos-
es of testing the value of the shareholder
REIT’s real estate assets under section
856(c)(4), the proposed regulations al-
lowed the shareholder REIT to make the
safe harbor election as long as it deter-
mines that the other REIT holds real prop-
erty. The Treasury Department and the
IRS recognize that the other REIT in this
situation may not necessarily hold real
property but instead may hold shares in a
lower-tier REIT (which is a real estate as-
set in the hands of the other REIT).
Because the shareholder REIT can hold
shares in another REIT that holds shares in
a lower-tier REIT that holds real property,
the Treasury Department and the IRS have
concluded that a shareholder REIT may
make the safe harbor election if it deter-
mines that it holds an indirect interest in a
REIT that holds real property. According-
ly, the final regulations clarify that a REIT
may elect to be an electing real property
trade or business if the REIT holds real
property, interests in one or more partner-
ships holding real property either direct-
ly or indirectly through interests in other
partnerships or shares in other REITs, or
shares in one or more other REITs holding
real property either directly or indirectly
through interests in partnerships or shares
in other REITs.
Several commenters also requested
that certain partnerships with a REIT as
a partner be allowed to apply the REIT
safe harbor election at the partnership lev-
el. Commenters noted that many REITs
own interests in partnerships that directly
or indirectly hold real property, and these
partnerships incur the debt that is secured
by the real property and claim the interest
expense deductions. Commenters recom-
mended that the REIT safe harbor election
be made available to partnerships if: (1)
At least one partner is a REIT that owns,
directly or indirectly, at least 50 percent
of the partnership’s capital or profits; (2)
the partnership meets the requirements
of section 856(c)(2), (3), and (4) as if the
partnership were a REIT; and (3) the part-
nership satisfies the requirements of pro-
posed §1.163(j)-9(g)(1) as if the partner-
ship were a REIT.
The Treasury Department and the IRS
agree that a partnership that is controlled
by a REIT or REITs and that would meet
the REIT gross income and asset tests in
section 856(c)(2), (3), and (4) (as if the
partnership were a REIT) is sufficiently
similar to a REIT for this purpose. Accord-
ingly, the final regulations provide that a
partnership may apply the REIT safe har-
bor election at the partnership level if one
or more REITs own, directly or indirect-
ly, at least 50 percent of the partnership’s
capital and profits, the partnership meets
the requirements of section 856(c)(2), (3),
and (4) as if the partnership were a REIT,
and the partnership satisfies the require-
ments described in §1.163(j)-9(h)(1) as if
the partnership were a REIT.
A commenter also recommended
that the REIT exception to the proposed
§1.163(j)-9(h) anti-abuse rule be clarified
to apply to any partnership in which a
REIT owns a 50 percent or greater direct
or indirect capital or profits interest, if the
partnership leases a qualified lodging fa-
cility or qualified health care property to
a TRS or a partnership in which a TRS is
a 50 percent or greater direct or indirect
partner. The REIT exception was intended
to allow REITs that lease qualified lodging
facilities and qualified healthcare proper-
ties pursuant to the related party rental
exception in section 856(d)(8)(B) to make
a real property trade or business election
because these leases are explicitly autho-
rized by the Code. In response to com-
ments, the final regulations clarify that the
REIT exception also applies to partner-
ships making the REIT safe harbor elec-
tion that lease qualified lodging facilities
and qualified healthcare properties. How-
ever, the final regulations do not specify
the related party to which the REIT must
lease the qualified lodging facility or qual-

Bulletin No. 2020–40 665 September 28, 2020
ified healthcare property in order to qual-
ify for the REIT exception and, therefore,
Treasury and the IRS did not include a
provision for partnerships in which a TRS
is a partner.
A commenter requested clarification
regarding the application of the real prop-
erty trade or business election to a rental
real estate partnership and its REIT part-
ners if the partnership holds real property
and is not engaged in a trade or business
within the meaning of section 162. Part
XVI of this Summary of Comments and
Explanation of Revision section clarifies
that taxpayers engaged in rental real estate
activities that do not necessarily rise to the
level of a section 162 trade or business
nevertheless are treated as engaged in real
property trades or businesses within the
meaning of section 469(c)(7)(C) (and for
purposes of section 163(j) by reference).
As such, a partnership engaged in a rental
real estate activity (regardless of whether
that activity rises to the level of a section
162 trade or business) will be permitted
to make the election under section 163(j)
(7)(B) with respect to the rental real es-
tate activity to be an electing real property
trade or business for purposes of section
163(j), and any interest expense that is
allocable to that rental real estate activi-
ty and that is allocable to a REIT partner
will not be investment interest (within the
meaning of section 163(d)) that is treated
as interest expense allocable to a trade or
business of a C corporation partner under
§1.163(j)-4(b)(3).
For purposes of valuing a REIT’s as-
sets, the proposed regulations provide that
REIT real property financing assets also
include the portion of a shareholder RE-
IT’s interest in another REIT attributable
to that other REIT’s real property financ-
ing assets. The final regulations clarify
that this rule also applies in the context of
tiered-REIT structures.
The proposed regulations provide that
no portion of the value of a shareholder
REIT’s shares in another REIT is included
in the value of the shareholder REIT’s real
property financing assets if all of the other
REIT’s assets are treated as assets of an
excepted trade or business under proposed
§1.163-9(g)(2). The proposed regulations
provide that if a shareholder REIT does
not receive from the other REIT the in-
formation necessary to determine whether
and the extent that the assets of the other
REIT are investments in real property fi-
nancing assets, then the shareholder RE-
IT’s shares in the other REIT are treated
as real property financing assets.
A commenter requested that the fi-
nal regulations clarify how a shareholder
REIT determines whether the value of
the other REIT’s real property financing
assets is 10 percent or less of the other
REIT’s total asset value for purposes of
determining whether the electing share-
holder REIT must allocate interest ex-
pense between excepted and non-excepted
businesses. The commenter recommended
that the final regulations provide an exam-
ple to clarify this point or specify that the
shareholder REIT may make this determi-
nation based on all of the facts available
to the shareholder REIT. The commenter
proposed that a shareholder REIT that
makes an incorrect determination in good
faith that the other REIT qualifies under
proposed §1.163-9(g)(2) nevertheless be
permitted to treat all of the value of the
lower REIT’s shares as assets other than
real property financing assets.
In response to this comment, the final
regulations allow a shareholder REIT
to use an applicable financial statement
(within the meaning of section 451(b)) of
the other REIT to determine whether and
the extent that the assets of the other REIT
are investments in real property financ-
ing assets (rather than having to receive
the information directly from the other
REIT). However, the final regulations do
not permit a shareholder REIT to treat the
shares in the other REIT as assets other
than real property financing assets when
the shareholder REIT’s determination is
based on information other than an appli-
cable financial statement or information
received directly from the other REIT.
In the event that a REIT is required to
allocate its interest expense between ex-
cepted and non-excepted trades or busi-
nesses under §1.163(j)-10, a commenter
requested clarification regarding the appli-
cation of the look-through rules to tiered
entities. Under the proposed regulations, if
a REIT holds an interest in a partnership,
in applying the partnership look-through
rule in proposed §1.163(j)-10(c)(5)(ii)(A)
(2), the REIT also applies the definition
of real property under §1.856-10 to deter-
mine whether the partnership’s assets are
allocable to an excepted trade or business.
In addition, under the proposed regula-
tions, if a shareholder REIT holds shares
in another REIT and all of the other RE-
IT’s assets are not treated as assets of an
excepted trade or business, the proposed
regulations provide that the shareholder
REIT applies the same partnership look-
through rule (as if the other REIT were a
partnership) in determining the extent to
which the shareholder REIT’s adjusted
basis in the shares of the other REIT is
properly allocable to an excepted trade or
business of the shareholder REIT.
In response to comments, the final reg-
ulations provide that, when applying the
partnership look-through rule in the case
of tiered entities, a REIT applies the defi-
nition of real property in §1.856-10 to
each partnership in the chain to determine
whether the partnership’s assets are alloca-
ble to an excepted trade or business. Fur-
thermore, because shares in other REITs
qualify as real estate assets under section
856(c)(5)(B), the final regulations provide
that, when applying the look-through rule
to REITs within a tiered-entity structure, a
shareholder REIT may apply the partner-
ship look-through rule in §1.163(j)-10(c)
(5)(ii)(A)(2) to all REITs in the chain.
In response to an informal inquiry, the
final regulations also clarify that a REIT
or a partnership that is eligible but chooses
not to apply the REIT safe harbor election
may still elect, under §1.163(j)-9(b)(1),
for one or more of its trades or business-
es to be an electing real property trade or
business, provided that such trade or busi-
ness is otherwise eligible to elect under
§1.163(j)-9(b)(1). A REIT or partnership
that makes the election under §1.163(j)-
9(b)(1) without utilizing the REIT safe
harbor provisions may not rely on any
portion of §1.163(j)-9(h)(1) through (7).
F. Real Property Trade or Business
Proposed §1.163(j)-10(a)(1)(i) provides
that the amount of a taxpayer’s interest ex-
pense that is properly allocable to excepted
trades or businesses is not subject to the
section 163(j) limitation, and the amount
of a taxpayer’s other items of income, gain,
deduction, or loss, including interest in-
come, that is properly allocable to excepted
trades or businesses is excluded from the
calculation of the taxpayer’s section 163(j)

September 28, 2020 666 Bulletin No. 2020–40
limitation. Commenters suggested that, for
purposes of allocating interest between a
non-excepted trade or business and an ex-
cepted trade or business, a corporate part-
ner in a partnership that conducts a real
property trade or business should be al-
lowed to treat its share of the partnership’s
real property trade or business as an elect-
ing real property trade or business even if
the partnership does not make the election.
The Treasury Department and the IRS
have rejected this comment because an
election under section 163(j)(7)(B) has
certain consequences—for example, the
use of ADS rather than the general depre-
ciation system for certain types of proper-
ty, which results in the inability of electing
real property trades or businesses to claim
the additional first-year depreciation de-
duction under section 168(k) for those
types of property. Therefore, the Treasury
Department and the IRS have determined
that a corporate partner in a partnership
that conducts a real property trade or busi-
ness should be allowed to treat its share
of the partnership’s real property trade or
business as an electing real property trade
or business only if the partnership makes
the election. However, see part X(A) of this
Summary of Comments and Explanation of
Revisions section regarding taxpayers that
are eligible to make an election to be an
electing real property trade or business but
are not certain whether they are engaged in
a trade or business under section 162.
XI. Comments on and Changes to
Proposed §1.163(j)-10: Allocation of
Interest Expense, Interest Income, and
Other Items of Expense and Gross
Income to an Excepted Trade or
Business.
Section 1.163(j)-10 provides rules for
allocating tax items that are properly al-
locable to a trade or business between
excepted trades or businesses and non-ex-
cepted trades or businesses for purposes
of section 163(j). The following discus-
sion addresses comments relating to pro-
posed §1.163(j)-10.
A. General Method of Allocation: Asset
Basis
Proposed §1.163(j)-10(c) sets forth the
general rule for allocating interest expense
and interest income between excepted
and non-excepted trades or businesses.
Under this general rule, interest expense
and interest income is allocated between
excepted and non-excepted trades or busi-
nesses based upon the relative amounts of
the taxpayer’s adjusted basis in the assets
used in its trades or businesses. As noted
in the preamble to the proposed regula-
tions, this general method of allocation
reflects the fact that money is fungible and
the view that interest expense is attribut-
able to all activities and property, regard-
less of any specific purpose for incurring
an obligation on which interest is paid.
Many commenters expressed support for
this proposed allocation method.
However, some commenters argued
that taxpayers should be permitted to allo-
cate interest expense and income between
excepted and non-excepted trades or
businesses based on the earnings or gross
income of each business, for various rea-
sons. For example, some commenters pos-
ited that asset basis may bear little connec-
tion to a corporation’s borrowing capacity,
whereas earnings or revenue are useful
indicators of a taxpayer’s ability to meet
its debt obligations, and earnings are a key
factor in determining the amount of debt
the taxpayer may borrow and the interest
rate the taxpayer will be charged. These
commenters also noted that an asset-basis
allocation method could yield inconsistent
results across industries (for example, in-
dustries whose asset mix is heavily skewed
towards self-created intangibles will have
low asset basis) or within similarly situ-
ated industries (if assets are purchased at
different times). One commenter also sug-
gested that an earnings-based approach
would be easier for the IRS and taxpayers
to administer because ATI already must be
calculated by each taxpayer that is subject
to a section 163(j) limitation.
Although the foregoing arguments
have merit, adopting an earnings-based
approach would raise many additional
considerations, such as taxpayers’ ability
to time income recognition to affect al-
location and create other distortions (as
in the case of a trade or business that re-
quires capital investment for a period of
years before earning significant gross in-
come). Thus, after further consideration,
the Treasury Department and the IRS
have decided to retain the asset-basis al-
location approach contained in proposed
§1.163(j)-10(c). However, the Treasury
Department and the IRS continue to study
these comments and may provide future
guidance on this issue.
B. Allocation Between Trades or
Businesses and Non-Trades or Businesses
Proposed §1.163(j)-10(a)(2)(i) coordi-
nates the rules under proposed §1.163(j)-
10 with other Federal income tax rules.
For example, proposed §1.163(j)-10(a)(2)
(i) provides that, before a taxpayer may
determine the amount of interest expense,
interest income, or other tax items that is
properly allocable to excepted or non-ex-
cepted trades or businesses, the taxpayer
first must apply §1.163-8T to determine
which tax items are allocable to non-
trades or businesses rather than to trades
or businesses. Some commenters recom-
mended that non-corporate partners be
permitted to allocate tax items between a
trade or business and a non-trade or busi-
ness based on an approach that looks to
the earnings of the trade or business and
non-trade or business. The commenters
argued that an earnings-based approach to
determining when debt is properly alloca-
ble between a trade or business and a non-
trade or business is consistent with deter-
mining whether the earnings of a taxpayer
can support the level of debt incurred.
After further consideration, the Trea-
sury Department and the IRS have decided
to retain the §1.163-8T tracing approach
contained in proposed §1.163(j)-10(a)(2)
(i). However, the Treasury Department
and the IRS continue to study these com-
ments and may provide future guidance
on this issue. Additionally, the Treasury
Department and the IRS are considering
issuing additional guidance related to the
allocation of interest expense by partner-
ships or S corporations. See proposed
§1.163-14 in the Concurrent NPRM.
Commenters also recommended that
no allocation between business and non-
business interest expense be required
when a partnership is wholly owned by
corporate partners because a corporation
can have only business interest income
and expense and cannot have investment
interest income and expense (see pro-
posed §1.163(j)-4(b)(3)(i)). The Treasury
Department and the IRS have rejected this

Bulletin No. 2020–40 667 September 28, 2020
comment because the recommended ap-
proach is inconsistent with the entity ap-
proach taken with respect to partnerships
in section 163(j)(4). Moreover, a sepa-
rate rule for partnerships that are wholly
owned by corporate partners is subject
to manipulation because the partnership
could alter the rules to which it is subject
simply by admitting a non-corporate part-
ner with a small economic interest in the
partnership.
C. Consolidated Groups
1. Overview
As provided in proposed §1.163(j)-
10(a)(4)(i), the computations required by
section 163(j) and the section 163(j) reg-
ulations generally are made for a consoli-
dated group on a consolidated basis. Thus,
for purposes of applying the allocation
rules of proposed §1.163(j)-10, all mem-
bers of a consolidated group are treated
as a single corporation. For example, the
group (rather than a particular member) is
treated as engaged in excepted or non-ex-
cepted trades or businesses. Moreover,
intercompany transactions (as defined in
§1.1502-13(b)(1)(i)) are disregarded for
purposes of these allocation rules, and
property is not treated as used in a trade
or business to the extent the use of such
property in that trade or business derives
from an intercompany transaction. Addi-
tionally, stock of a member that is owned
by another member of the same consoli-
dated group is not treated as an asset for
purposes of §1.163(j)-10, and the trans-
fer of any amount of member stock to a
non-member is treated by the group as a
transfer of the member’s assets propor-
tionate to the amount of member stock
transferred.
After a consolidated group has deter-
mined the percentage of the group’s inter-
est expense allocable to excepted trades
or businesses for the taxable year, this ex-
empt percentage is applied to the interest
paid or accrued by each member during
the taxable year to any lender that is not
a group member. Thus, except to the ex-
tent proposed §1.163(j)-10(d) (providing
rules for direct allocation in certain lim-
ited circumstances) applies, the same per-
centage of interest paid or accrued by each
member to a lender that is not a member
is treated as allocable to excepted trades
or businesses, regardless of whether any
particular member actually engaged in an
excepted trade or business.
2. Intercompany Transactions
Commenters observed that ignoring
all intercompany transactions and inter-
company obligations for purposes of pro-
posed §1.163(j)-10 is theoretically simple
and generally furthers the single-entity
approach adopted elsewhere in the pro-
posed regulations. However, a commenter
recommended that taxpayers be permitted
to take into account basis from certain in-
tercompany transactions, so long as ade-
quate safeguards are put in place against
abuse (for example, to prevent taxpayers
from using intercompany transactions to
increase the consolidated group’s ATI or
to shift asset basis to excepted trades or
businesses), in order to reduce the admin-
istrative burden of tracking asset basis
separately for purposes of section 163(j).
The commenter also recommended that
the Treasury Department and the IRS re-
consider whether, in certain circumstanc-
es, items from intercompany transactions
(other than business interest expense and
business interest income) should affect the
amount of the consolidated group’s ATI.
The Treasury Department and the IRS
acknowledge that the approach in pro-
posed §1.163(j)-10(a)(4)(i) creates an ad-
ministrative burden for members of con-
solidated groups. However, this approach
is consistent with §1.1502-13, the stated
purpose of which is to prevent intercom-
pany transactions from creating, acceler-
ating, avoiding, or deferring consolidated
taxable income or consolidated tax liabil-
ity (see §1.1502-13(a)(1)). Allowing tax
items from intercompany transactions to
affect the calculation of a consolidated
group’s tentative taxable income and ATI
would be inconsistent with the single-enti-
ty principles of §1.1502-13(a). Moreover,
taxpayers already must track asset basis
information for purposes of §1.1502-13.
Additionally, giving effect to intercom-
pany transactions for purposes of section
163(j) would create other administrative
burdens for consolidated group members.
See the discussion in part V(B) of this
Summary of Comments and Explanation
of Revisions section. Thus, the final regu-
lations continue to disregard intercompa-
ny transactions for purposes of the alloca-
tion rules in proposed §1.163(j)-10.
3. Use of Property Derives from an
Intercompany Transaction
A commenter observed that the mean-
ing of the phrase “property is not treated
as used in a trade or business to the extent
the use of such property derives from an
intercompany transaction” is unclear. For
example, one member of a consolidated
group (S) leases property to another mem-
ber of the group (B), which uses the prop-
erty in its trade or business. B’s lease with
S entitles B to use the property. Should B’s
use of the property in its trade or business
be disregarded for purposes of proposed
§1.163(j)-10 because such use “derives
from an intercompany transaction”?
The Treasury Department and the IRS
did not intend for B’s use of the property
in the foregoing scenario to be disregard-
ed for purposes of the allocation rules in
proposed §1.163(j)-10. If S and B were
treated as disregarded entities owned by
the same corporation, the lease would be
ignored, and the leased property would
be treated as an asset used in B’s trade
or business. The final regulations clarify
proposed §1.163(j)-10(a)(4)(i) to better
reflect this intended result.
The commenter also requested confir-
mation that the same allocation principle
applies to third-party costs incurred by
members of the group (in other words,
that such costs are allocated based on the
use of assets in excepted or non-excepted
trades or businesses). However, proposed
§1.163(j)-10(b)(5) already provides spe-
cial rules for the allocation of expenses
other than interest expenses. Thus, the
final regulations do not adopt this recom-
mendation.
4. Purchase of Member Stock from a
Nonmember
A commenter recommended that a pur-
chase by one consolidated group member
(S) of stock of another member (or of an
entity that becomes a member as a result
of the purchase) (in either case, T) from a
non-member (X) be treated as a purchase
of a proportionate amount of T’s assets
for purposes of proposed §1.163(j)-10.

September 28, 2020 668 Bulletin No. 2020–40
Although the proposed regulations treat
the transfer of the stock of a member to
a non-member as a transfer of a propor-
tionate amount of the member’s assets,
the proposed regulations do not expressly
address the acquisition of the stock of a
member (or of a corporation that becomes
a member as a result of the acquisition).
The commenter noted that, if such acqui-
sitions are not treated as asset purchases,
the amount of adjusted basis allocated to
an excepted or non-excepted trade or busi-
ness may differ significantly depending on
whether S and T file a consolidated return.
For example, T (which is engaged sole-
ly in an excepted trade or business) has
assets with a fair market value of $100x
and $0 adjusted basis, and $0 liabilities. S
(which is engaged solely in a non-except-
ed trade or business) has $100x adjusted
basis in its assets. S purchases 100 percent
of T’s stock from X for $100x, and S and
T do not file a consolidated tax return. As
a result, S’s stock in T is treated as an as-
set (under proposed §1.163(j)-10(c)(5)(ii)
(B)) with a basis of $100x. In contrast, if
S and T were to file a consolidated return,
S’s stock in T would not be treated as an
asset under proposed §1.163(j)-10(a)(4).
Moreover, it is unclear how much adjusted
basis the group could take into account for
purposes of the allocation rules. Would the
group’s adjusted basis in T’s assets equal
T’s basis in its assets immediately before
the acquisition (here, $0)? Or would all or
some portion of the amount paid by S to
acquire T’s stock be taken into account?
The commenter argued that S should have
the same amount of adjusted basis in T’s
assets regardless of whether S and T file
a consolidated return, and that there is no
legislative history revealing congressional
intent to treat members of a consolidated
group and non-consolidated corporations
differently in this regard. Thus, accord-
ing to the commenter, S should be able to
take into account the amount paid for its T
stock for purposes of the allocation rules
in proposed §1.163(j)-10.
Although Congress did not express-
ly address this issue, Congress did make
clear that the section 163(j) limitation
applies at the consolidated group level
(see H. Rept. 115-466, at 386 (2017)).
Moreover, section 1502 provides broad
authority for the Secretary of the Treasury
to prescribe regulations to determine the
tax liability of a consolidated group in a
manner that clearly reflects the income tax
liability of the group and that prevents the
avoidance of tax liability. Consistent with
legislative intent regarding section 163(j)
and with the broad grant of authority un-
der section 1502, the proposed regulations
treat a consolidated group as a single cor-
poration for purposes of the allocation
rules of §1.163(j)-10, and they disregard
the stock of members for purposes of this
section.
Additionally, the Treasury Department
and the IRS have questions and concerns
about treating the acquisition of stock of
a member (or of an entity that becomes a
member) as an asset sale. How would the
purchase price be added to the group’s ba-
sis in the member’s assets, and how would
the additional basis added to these assets
be depreciated? Would this approach deem
the transaction to be an asset acquisition
for all Federal income tax purposes or just
for purposes of section 163(j), and what
complications would arise from treating
the transaction as an asset purchase for
purposes of section 163(j) but as a stock
purchase for other purposes?
Due to concerns about these and other
issues, the final regulations do not adopt
the commenter’s recommendation. How-
ever, the Treasury Department and the IRS
continue to study the issue raised by the
commenter and may address the issue in
future guidance.
5. Inclusion of Income from Excepted
Trades or Businesses in Consolidated ATI
A commenter noted that, because every
member of a consolidated group is treat-
ed as engaged in every trade or business
of the group for purposes of proposed
§1.163(j)-10, a member engaged solely in
an excepted regulated utility trade or busi-
ness that incurs interest expense related
to its business activities will be subject to
the section 163(j) limitation if other group
members are engaged in non-excepted
trades or businesses. The commenter sug-
gested that this outcome is contrary to
the policy rationale for the exception for
regulated utility trades or businesses. The
commenter further noted that the gross
income of the excepted trade or business
is not included in the group’s ATI calcula-
tion, and that this outcome could produce
anomalous results. The commenter thus
recommended that a proportionate share
of the gross income of the excepted trade
or business be included as an adjustment
to consolidated ATI.
The Treasury Department and the IRS
do not agree that the results under proposed
§1.163(j)-10(a)(4) are inconsistent with
congressional intent or lead to anomalous
results. As noted in part XI(C)(4) of this
Summary of Comments and Explanation
of Revisions section, Congress expressly
stated that the section 163(j) limitation ap-
plies at the consolidated group level. Thus,
the treatment of a consolidated group as a
single corporation, and the treatment of
every member as engaged in every trade
or business of the group, is consistent with
congressional intent. Moreover, if the sec-
tion 163(j) limitation were inapplicable
to group members engaged in excepted
trades or businesses, consolidated groups
could readily avoid the section 163(j)
limitation by concentrating their external
borrowing in such members. Furthermore,
although a portion of the interest expense
of a member engaged solely in an except-
ed trade or business will be subject to the
section 163(j) limitation if the group is
otherwise engaged in non-excepted trades
or businesses, a portion of the interest ex-
pense of a member engaged solely in a
non-excepted trade or business will not
be subject to the section 163(j) limitation
if the group is otherwise engaged in ex-
cepted trades or businesses—and all of
that member’s income will factor into the
group’s ATI calculation. Finally, as the
commenter acknowledged, section 163(j)
(8)(A)(i) specifically excludes from the
determination of ATI any item of income,
gain, deduction, or loss that is allocable to
an excepted trade or business.
For the foregoing reasons, the Treasury
Department and the IRS have determined
that no changes to the final regulations are
needed with respect to this comment.
6. Engaging in Excepted or Non-
Excepted Trades or Businesses as a
“Special Status”
One commenter suggested that the
Treasury Department and the IRS consid-
er whether engaging in an excepted trade
or business should be treated as a “special
status” under §1.1502-13(c)(5) for pur-

Bulletin No. 2020–40 669 September 28, 2020
poses of applying the intercompany trans-
action rules of §1.1502-13.
The intercompany transaction rules
apply for purposes of redetermining and
allocating attributes under §1.1502-13(c)
(1)(i) in order to reach a “single enti-
ty” answer under the matching rule of
§1.1502-13(c). For example, one member
of a consolidated group is a dealer in secu-
rities under section 475 (dealer) and sells
a security to a second member that is not a
dealer; that second member then sells the
security to a nonmember in a later year.
The matching rule can apply to ensure that
the taxable items of the two members har-
monize with regard to timing and charac-
ter in order to reach the same overall tax
treatment that would be given to a single
corporation whose two operating divi-
sions engaged in those transactions. See
§1.1502-13(c)(7)(i), Example 11.
However, if one member has “spe-
cial status” under §1.1502-13(c)(5) but
the other does not, then attributes of the
item would not be redetermined under the
matching rule. For example, if S (a bank
to which section 582(c) applies) and B (a
nonbank) are members of a consolidated
group, and if S sells debt securities at a
gain to B, the character of S’s intercom-
pany gain is ordinary (as required under
section 582(c)), but the character of B’s
corresponding item is determined under
§1.1502-13(c)(1)(i) without the applica-
tion of section 582(c). See §1.1502-13(c)
(5).
The “special status” rules of §1.1502-
13(c)(5) are applicable to entities, such
as banks or insurance companies, that are
subject to a separate set of Federal income
tax rules. Although there are special tax
rules for farming, real estate, and utili-
ties, an entity engaged in such trades or
businesses also may be engaged in other
trades or businesses to which such special
tax rules would not apply. Further, the en-
tity’s farming, real estate, or utility trade
or business need not be its primary trade
or business. Moreover, the treatment of
excepted trades or businesses as a special
status effectively would result in addition-
al tracing of specific items for purposes
of §1.1502-13. As noted in the preamble
to the proposed regulations, the Treasury
Department and the IRS have decided not
to apply a tracing regime to allocate inter-
est expense and income between excepted
and non-excepted trades or businesses.
Thus, the final regulations do not treat en-
gaging in an excepted trade or business as
a special status.
D. Quarterly Asset Testing
Under proposed §1.163(j)-10(c)(6), a
taxpayer must determine the adjusted ba-
sis in its assets on a quarterly basis and
average those amounts to determine the
relative amounts of asset basis for its ex-
cepted and non-excepted trades or busi-
nesses for a taxable year. In the preamble
to the proposed regulations, the Treasury
Department and the IRS requested com-
ments on the frequency of asset basis
determinations required under proposed
§1.163(j)-10(c).
In response, commenters stated that
this quarterly determination requirement
is administratively burdensome, and that
such a burden is unwarranted because, in
many circumstances, measuring asset ba-
sis less frequently would produce similar
results. Thus, commenters recommended
that taxpayers be permitted to allocate as-
set basis for a taxable year based on the
average of adjusted asset basis at the be-
ginning and end of the year. As a result,
the “determination date” would be the last
day of the taxpayer’s taxable year, and the
“determination period” would begin on
the first day of the taxpayer’s taxable year
and end on the last day of the year.
Several commenters recommended
that this approach be modeled on the inter-
est valuation provisions in §1.861-9T(g)
(2)(i). Under these rules, taxpayers gen-
erally must compute the value of assets
based on an average of asset values at the
beginning and end of the year. However,
if a “substantial distortion” of asset val-
ues would result from this approach (for
example, if there is a major acquisition or
disposition), the taxpayer must use a dif-
ferent method of asset valuation that more
clearly reflects the average value of assets.
Other commenters suggested that their
proposed approach could be limited to
cases in which there is no more than a de
minimis change in asset basis between the
beginning and end of the taxable year. For
example, this approach could be available
for a taxable year only if the taxpayer
demonstrates that its total adjusted basis
(as measured in accordance with the rules
in proposed §1.163(j)-10(c)(5)) at the end
of the year in its assets used in its excepted
trades or businesses, as a percentage of the
taxpayer’s total adjusted basis at the end
of such year in all of its assets used in a
trade or business, does not differ by more
than 10 percent from such percentage at
the beginning of the year.
The Treasury Department and the
IRS acknowledge that determining asset
basis on a quarterly basis would impose
an administrative burden. The Treasury
Department and the IRS also agree with
commenters that a safeguard is needed
to account for episodic events, such as
acquisitions, dispositions, or changes in
business, that could affect average values.
Thus, the final regulations permit a tax-
payer to compute asset basis in its except-
ed and non-excepted trades or businesses
by averaging asset basis at the beginning
and end of the year, so long as the tax-
payer falls under a 20 percent de minimis
threshold.
E. De Minimis Rules
1. Overview
The proposed regulations provide a
number of de minimis rules to simplify
the application of §1.163(j)-10. For exam-
ple, proposed §1.163(j)-10(c)(3)(iii)(C)
(3) provides that a utility trade or business
is treated entirely as an excepted regulat-
ed utility trade or business if more than 90
percent of the items described in proposed
§1.163(j)-1(b)(15) are furnished or sold
at rates qualifying for the excepted regu-
lated utility trade or business exception.
Proposed §1.163(j)-10(c)(3)(iii)(B)(2)
provides that, if 90 percent or more of the
basis in an asset would be allocated un-
der proposed §1.163(j)-10(c)(3) to either
excepted or non-excepted trades or busi-
nesses, then the entire basis in the asset
is allocated to either excepted or non-ex-
cepted trades or businesses, respectively.
In turn, proposed §1.163(j)-10(c)(1)(ii)
provides that, if 90 percent or more of a
taxpayer’s basis in its assets is allocated
under proposed §1.163(j)-10(c) to either
excepted or non-excepted trades or busi-
nesses, then all of the taxpayer’s interest
expense and interest income are allocated
to either excepted or non-excepted trades
or businesses, respectively.

September 28, 2020 670 Bulletin No. 2020–40
2. Order in Which the De Minimis Rules
Apply
A commenter recommended that these
de minimis rules be applied in the order
in which they are listed in the foregoing
paragraph. In other words, a taxpayer first
should determine the extent to which its
utility businesses are excepted regulat-
ed utility trades or businesses. The tax-
payer then should determine the extent
to which the basis of any assets used in
both excepted and non-excepted trades or
businesses should be wholly allocated to
either excepted or non-excepted trades or
businesses. Only then should the taxpayer
determine whether all of its interest ex-
pense and interest income should be whol-
ly allocated to either excepted or non-ex-
cepted trades or businesses. The Treasury
Department and the IRS agree that the
order recommended by the commenter is
the most reasonable application of these
de minimis rules, and the final regulations
adopt language confirming this ordering.
3. Mandatory Application of De Minimis
Rules
Commenters also requested that the
final regulations continue to mandate the
application of the foregoing de minimis
rules rather than make such de minimis
rules elective. The commenters expressed
concern that creating an election to use the
de minimis rules in §1.163(j)-10(c)(1) and
(3) would create uncertainty for taxpayers,
and they argued that mandatory applica-
tion of the de minimis rules would sim-
plify the rules for taxpayers. The Treasury
Department and the IRS agree that man-
datory application of the de minimis rules
simplifies the application of §1.163(j)-10
and eases the burdens of compliance and
administration. Therefore, the final regu-
lations continue to mandate the applica-
tion of the de minimis rules in §1.163(j)-
10(c)(1) and (3).
4. De Minimis Threshold for Electric
Cooperatives
A commenter requested that the de mi-
nimis threshold for utilities in proposed
§1.163(j)-10(c)(3)(iii)(C)(3) be lowered
from 90 percent to 85 percent for elec-
tric cooperatives. The commenter argued
that a different threshold is appropriate
for electric cooperatives because, under
section 501(c)(12), 85 percent or more
of an electric cooperative’s income (with
adjustments) must consist of amounts col-
lected from members for the sole purpose
of meeting losses and expenses in order
for the cooperative to be exempt from
Federal income tax.
The Treasury Department and the IRS
have determined that the final regula-
tions should provide the same de minimis
threshold for electric cooperatives as for
other utility trades or businesses. The 85
percent threshold under section 501(c)
(12) measures a cooperative’s income,
with adjustments that are specific to sec-
tion 501. Moreover, an electric coopera-
tive is not required to qualify for tax ex-
emption under section 501(c)(12) to be
engaged in an excepted regulated utility
trade or business. Therefore, the Treasury
Department and the IRS have determined
that the nexus between section 501(c)(12)
and proposed §1.163(j)-10 is insufficient
to justify lowering the utility de minimis
threshold to 85 percent for electric coop-
eratives, and the final regulations do not
incorporate the commenter’s suggestion.
5. Standardization of 90 Percent De
Minimis Tests
The terminology used in the 90 percent
de minimis tests in proposed §1.163(j)-10
is not consistent. For example, proposed
§1.163(j)-10(c)(3)(iii)(C)(3) uses a “more
than 90 percent” standard, whereas pro-
posed §1.163(j)-10(c)(3)(iii)(B)(2) uses
a “90 percent or more” standard. For the
sake of consistency, and in order to mini-
mize confusion, the final regulations stan-
dardize the language used in these tests.
6. Overlapping De Minimis Tests
In addition to the de minimis tests pre-
viously described in this part XI(E) of the
Summary of Comments and Explanation
of Revisions section, proposed §1.163(j)-
10(c)(3)(iii)(B)(1) also contains another
de minimis rule. Under this rule, if at least
90 percent of gross income generated by
an asset during a determination period is
with respect to either excepted or non-ex-
cepted trades or businesses, then the entire
basis in the asset is allocated to either ex-
cepted or non-excepted trades or business-
es, respectively.
The Treasury Department and the IRS
have determined that this rule not only
overlaps with, but also may yield results
inconsistent with, the de minimis rule in
§1.163(j)-10(c)(3)(iii)(B)(2). Thus, the fi-
nal regulations eliminate the de minimis
rule in proposed §1.163(j)-10(c)(3)(iii)(B)
(1).
F. Assets Used in More than One Trade or
Business
1. Overview
Proposed §1.163(j)-10(c)(3) contains
special rules for allocating basis in assets
used in more than one trade or business.
In general, if an asset is used in more than
one trade or business during a determina-
tion period, the taxpayer’s adjusted basis
in the asset must be allocated to each trade
or business using one of three permissi-
ble methodologies, depending on which
methodology most reasonably reflects the
use of the asset in each trade or business
during that determination period. These
three methodologies are: (i) The relative
amounts of gross income that an asset gen-
erates, has generated, or may reasonably
be expected to generate, within the mean-
ing of §1.861-9T(g)(3), with respect to the
trades or businesses; (ii) if the asset is land
or an inherently permanent structure, the
relative amounts of physical space used
by the trades or businesses; and (iii) if the
trades or businesses generate the same
unit of output, the relative amounts of out-
put of those trades or businesses. Howev-
er, taxpayers must use the relative output
methodology to allocate the basis of assets
used in both excepted and non-excepted
utility trades or businesses.
As described in part XI(E)(1) of this
Summary of Comments and Explanation
of Revisions section, a taxpayer’s alloca-
tion of basis in assets used in more than
one trade or business is subject to several
de minimis rules (see proposed §1.163(j)-
10(c)(3)(iii)).
2. Consistency Requirement
A commenter requested clarification
that the consistency requirement in pro-
posed §1.163(j)-10(c)(3)(iii)(A) does not

Bulletin No. 2020–40 671 September 28, 2020
require a taxpayer to use a single meth-
odology for different categories of assets,
because a methodology that is reasonable
for one type of asset (for example, office
buildings) may not be reasonable for an-
other (for example, intangibles). The
Treasury Department and the IRS agree
with this comment, and the final regula-
tions have been clarified accordingly.
3. Changing a Taxpayer’s Allocation
Methodology
The Treasury Department and the IRS
have determined that requiring taxpayers
to obtain consent from the Commissioner
to change their allocation methodology
would impose an undue burden. Thus,
the final regulations permit a taxpayer to
change its allocation methodology after a
period of five taxable years without ob-
taining consent from the Commissioner.
A taxpayer that seeks to change its al-
location methodology more frequently
must obtain consent from the Commis-
sioner.
The Treasury Department and the IRS
also have determined that an allocation
methodology is not a method of account-
ing because there is no guarantee that a
taxpayer will be able to deduct a disal-
lowed business interest expense carryfor-
ward in future taxable years (as a result,
there could be a permanent disallowance).
See the discussion in part III(A) of this
Summary of Comments and Explanation
of Revisions section.
4. Mandatory Use of Relative Output for
Utility Trades or Businesses
A commenter requested that the final
regulations allow electric cooperatives
to use methodologies other than relative
output to allocate the basis of assets used
in both excepted and non-excepted utility
trades or businesses. The commenter not-
ed that alternative methods, such as allo-
cations based on dollars of sales (or sales
less the cost of sales), have been allowed
by the IRS in the context of allocating
expenses between patronage and non-pa-
tronage sales. The commenter also stat-
ed that economic realities facing electric
cooperatives operating on a not-for-profit
basis would not be accurately reflected by
a relative output methodology.
The Treasury Department and the IRS
have concluded that relative output most
reasonably reflects the use of assets in
excepted and non-excepted utility trades
or businesses because §1.163(j)-1(b)(15)
(i)(A) divides utility businesses into ex-
cepted regulated utility trades or busi-
nesses and non-excepted utility busi-
nesses on the same basis. To the extent
that items described in §1.163(j)-1(b)
(15)(i)(A) are sold at rates described in
§1.163(j)-1(b)(15)(i)(B), and to the ex-
tent that the trade or business is an elect-
ing regulated utility trade or business
under §1.163(j)-1(b)(15)(iii), a utility
trade or business is an excepted trade or
business. The Treasury Department and
the IRS do not agree that the final reg-
ulations should apply one methodology
for differentiating excepted and non-ex-
cepted utility trades or businesses under
§1.163(j)-1 and a different methodology
to determine the allocation of an asset’s
basis between such businesses. There-
fore, the final regulations do not incor-
porate the commenter’s suggestion.
Another commenter recommended that
the rule mandating the use of relative out-
put for the allocation of asset basis under
proposed §1.163(j)-10(c)(3)(iii)(C)(2)
not be used either to allocate assets used
exclusively in excepted or non-excepted
utility trades or businesses or to apply the
de minimis test of proposed §1.163(j)-
10(c)(1)(ii).
The special rule in proposed §1.163(j)-
10(c)(3)(iii)(C)(2) mandates the use of
relative output only for the purpose of
allocating the basis of assets used in both
excepted and non-excepted utility trades
or businesses. Therefore, the rule does not
mandate the use of relative output to allo-
cate the basis of an asset that is used sole-
ly in either an excepted regulated utility
trade or business or a non-excepted utility
trade or business, except to the extent the
de minimis rule in proposed §1.163(j)-
10(c)(3)(iii)(C)(3) treats a taxpayer’s en-
tire trade or business as either an excepted
trade or business or a non-excepted trade
or business. The language proposed by the
commenter still subjects assets to the de
minimis rule in proposed §1.163(j)-10(c)
(3)(iii)(C)(3). Because the proposed regu-
lations achieve the result requested by the
commenter, the final regulations do not
adopt the recommended change.
The de minimis rule in proposed
§1.163(j)-10(c)(1)(ii) applies only after
the basis of assets has been allocated be-
tween excepted and non-excepted trades
or businesses. This de minimis rule treats
all of a taxpayer’s trades or businesses as
either excepted or non-excepted trades or
businesses based on such allocation. Be-
cause the rule of proposed §1.163(j)-10(c)
(1)(ii) does not apply the methodologies
listed in proposed §1.163(j)-10(c)(3), in-
cluding the relative output methodology,
no change to the proposed regulations is
necessary to achieve the result requested
by the commenter with respect to pro-
posed §1.163(j)-10(c)(1)(ii).
G. Exclusions from Basis Calculations
For purposes of allocating interest
expense and interest income under the
asset-basis allocation method in pro-
posed §1.163(j)-10(c), a taxpayer’s basis
in certain types of assets generally is not
taken into account. These assets include
cash and cash equivalents (see proposed
§1.163(j)-10(c)(5)(iii)). As noted in the
preamble to the proposed regulations, this
rule is intended to discourage taxpayers
from moving cash to excepted trades or
businesses to increase the amount of as-
set basis therein. In the preamble to the
proposed regulations, the Treasury De-
partment and the IRS requested comments
on this special rule, including whether
any exceptions should apply (such as for
working capital).
In response, commenters recommend-
ed that working capital be included in the
basis allocation determination, along with
collateral that secures derivatives that
hedge business assets and liabilities with-
in the meaning of §1.1221-2.
The Treasury Department and the IRS
have concluded that the inclusion of work-
ing capital in the basis allocation deter-
mination could lead to frequent disputes
between taxpayers and the IRS over the
amount of cash that comprises “working
capital” and the allocation of such amount
between and among a taxpayer’s except-
ed and non-excepted trades or businesses.
Thus, the final regulations do not adopt
this recommendation.
The Treasury Department and the IRS
also have concluded that the inclusion
of collateral that secures derivatives that

September 28, 2020 672 Bulletin No. 2020–40
hedge business assets and liabilities with-
in the meaning of §1.1221-2 could lead
to frequent disputes between taxpayers
and the IRS for reasons similar to those
for working capital. For example, it is not
always clear which business asset or lia-
bility is being hedged, especially in the
case of an aggregate hedging transaction.
In addition, taxpayers could use this rule
as a planning opportunity for purposes of
allocating the collateral to excepted trades
or businesses. Thus, the final regulations
also do not adopt this recommendation.
H. Look-Through Rules
1. Ownership Thresholds; Direct and
Indirect Ownership Interests
Proposed §1.163(j)-10(c)(5)(ii) pro-
vides, in part, that if a taxpayer owns
an interest in a partnership or stock in a
corporation that is not a member of the
taxpayer’s consolidated group, the part-
nership interest or stock is treated as an
asset of the taxpayer for purposes of the
allocation rules of proposed §1.163(j)-10.
For purposes of allocating a partner’s
basis in its partnership interest between
excepted and non-excepted trades or
businesses under proposed §1.163(j)-10,
the partner generally may look through
to its share of the partnership’s basis in
the partnership’s assets (with certain
modifications and limitations) regardless
of the extent of the partner’s ownership
interest in the partnership. However, the
partner must apply this look-through
rule if its direct and indirect interest in
the partnership is greater than or equal to
80 percent. Similar rules apply to share-
holders of S corporations. See proposed
§1.163(j)-10(c)(5)(ii)(A)(2)(i) and (c)(5)
(ii)(B)(3)(ii).
For purposes of allocating a share-
holder’s stock basis between excepted
and non-excepted trades or businesses, a
shareholder of a domestic non-consolidat-
ed C corporation or a CFC also must look
through to the assets of the corporation if
the shareholder’s direct and indirect inter-
est therein satisfies the ownership require-
ments of section 1504(a)(2). Shareholders
of domestic non-consolidated C corpora-
tions and CFCs may not look through their
stock in such corporations if they do not
satisfy this ownership threshold. See pro-
posed §1.163(j)-10(c)(5)(ii)(B)(2)(i) and
(c)(7)(i)(A).
If a shareholder receives a dividend
that is not investment income, and if the
shareholder looks through to the assets
of the payor corporation under proposed
§1.163(j)-10(c)(5)(ii) for the taxable year,
the shareholder also must look through to
the activities of the payor corporation to
allocate the dividend between the share-
holder’s excepted and non-excepted trades
or businesses. See proposed §1.163(j)-
10(b)(3) and (c)(7)(i)(B).
Commenters recommended that tax-
payers be afforded greater flexibility
to look through their stock in domestic
non-consolidated C corporations and
CFCs. For example, one commenter
suggested that the look-through thresh-
old for CFCs be lowered to 50 percent
(analogous to the look-through threshold
for related CFCs in section 954(c)(6)).
Another commenter recommended that a
taxpayer be allowed to look through its
stock in a domestic non-consolidated C
corporation if the taxpayer owns at least
80 percent of such stock by value, regard-
less of whether the taxpayer also owns
80 percent of such stock by vote. Yet
another commenter recommended that a
taxpayer be allowed to look through its
stock in a domestic non-consolidated C
corporation (or be allowed to allocate its
entire basis in such stock to an except-
ed trade or business) if (i) the taxpayer
and the C corporation are engaged in the
same excepted trade or business, and (ii)
the taxpayer either (A) owns at least 50
percent of the stock of the C corporation,
or (B) owns at least 20 percent of the
stock of the C corporation and exercises
a significant degree of control over the
corporation’s trade or business. Another
commenter recommended that the own-
ership threshold for looking through do-
mestic non-consolidated C corporations
and CFCs be eliminated entirely so that
interest expense paid or accrued on debt
incurred to finance the acquisition of a
real estate business is exempt from the
section 163(j) limitation (if the business
qualifies for and makes an election un-
der proposed §1.163(j)-9), regardless of
whether that business is held directly or
through a subsidiary.
The Treasury Department and the IRS
have determined that a de minimis own-
ership threshold is appropriate for domes-
tic non-consolidated C corporations and
CFCs because, unlike a partnership, a cor-
poration generally is respected as an entity
separate from its owner(s) for tax purpos-
es. See, for example, Moline Properties v.
Commissioner, 319 U.S. 436 (1943). The
look-through rule for non-consolidated C
corporations provides a limited exception
to this general rule. Moreover, unlike S
corporations, domestic C corporations are
not taxed as flow-through entities. Thus,
the final regulations retain an 80 percent
ownership threshold for looking through a
domestic non-consolidated C corporation
or a CFC.
However, the final regulations permit
a taxpayer to look through its stock in a
domestic non-consolidated C corporation
or a CFC if the taxpayer owns at least 80
percent of such stock by value, regardless
of whether the taxpayer also owns at least
80 percent of such stock by vote. Corre-
sponding changes have been made to the
look-through rule for dividends.
Additionally, the final regulations per-
mit a shareholder that meets the owner-
ship requirements for looking through the
stock of a domestic non-consolidated C
corporation (determined without applying
the constructive ownership rules of sec-
tion 318(a)) to look through to such share-
holder’s pro rata share of the C corpora-
tion’s basis in its assets for purposes of
§1.163(j)-10(c) (asset basis look-through
approach). If a shareholder applies the as-
set basis look-through approach, it must
do so for all domestic non-consolidated
C corporations for which the sharehold-
er is eligible to use this approach, and it
must continue to use the asset basis look-
through approach in all future taxable
years in which the shareholder is eligible
to use this approach.
Commenters also asked for clarifica-
tion as to the meaning of an “indirect” in-
terest for purposes of these look-through
rules. For example, commenters asked
what the term “indirect” means in the
context of the look-through rule for divi-
dends. Commenters further noted that, be-
cause section 1504(a)(2) does not contain
constructive ownership rules, there is un-
certainty as to when a shareholder’s indi-
rect ownership in a corporation is counted
for purposes of the ownership requirement
in the look-through rule. Commenters also

Bulletin No. 2020–40 673 September 28, 2020
requested specific constructive ownership
rules, as well as examples to illustrate
the application of the “direct or indirect”
ownership threshold.
The Treasury Department and the
IRS have determined that, for purposes
of applying the ownership thresholds in
§1.163(j)-10(c)(5)(ii)(B)(2)(i), (c)(5)
(ii)(B)(3)(ii), and (c)(7)(i)(A) to share-
holders of domestic non-consolidated C
corporations, CFCs, and S corporations,
as applicable, the constructive owner-
ship rules of section 318(a) should ap-
ply. For example, assume A, B, and C
are all non-consolidated C corporations;
A wholly and directly owns B; A and B
each directly own 50 percent of C; A and
B both conduct a non-excepted trade or
business; and C conducts an excepted
trade or business. Under section 318(a)
(2)(C), A is considered to own the stock
owned by B. As a result, A is considered
to own 100 percent of the stock of C,
and the look-through rule of proposed
§1.163(j)-10(c)(5)(ii)(B)(2)(i) and (c)(7)
(i)(A) applies to A’ s stock in C. Thus, al-
though the Treasury Department and the
IRS have determined that the ownership
threshold for non-consolidated C corpo-
rations should remain at 80 percent, the
constructive ownership rules of section
318 will broaden the availability of the
look-through rules to shareholders of
such corporations.
In contrast, the Treasury Department
and the IRS have determined that the con-
structive ownership rules of section 318(a)
should not apply for purposes of apply-
ing the ownership threshold in proposed
§1.163(j)-10(b)(3) and (c)(7)(i)(B) to the
receipt of dividends from domestic C cor-
porations and CFCs because dividends are
not paid to indirect shareholders. To avoid
confusion in this regard, the final regu-
lations remove the word “indirect” from
the ownership threshold for the dividend
look-through rule.
2. Application of Look-Through Rules to
Partnerships
i. In General
For purposes of proposed §1.163(j)-
10(c), a partnership interest is treated as
an asset of the partner. Pursuant to pro-
posed §1.163(j)-10(c)(5)(ii)(A)(1), the
partner’s adjusted basis in its partnership
interest is reduced, but not below zero, by
the partner’s share of partnership liabili-
ties as determined under section 752 (sec-
tion 752 basis reduction rule). Pursuant
to proposed §1.163(j)-10(c)(5)(ii)(A)(2)
(iii), a partner other than a C corporation
or tax-exempt corporation must further
reduce its adjusted basis in its partnership
interest by its share of the tax basis of part-
nership assets that is not properly alloca-
ble to a trade or business (investment asset
basis reduction rule).
As noted in part XI(H)(1) of this Sum-
mary of Comments and Explanation of
Revisions section, a partner may deter-
mine what portion of its adjusted tax ba-
sis in a partnership interest is attributable
to an excepted or non-excepted trade or
business by reference to its share of the
partnership’s basis in the partnership’s
assets (look-through rule). Under pro-
posed §1.163(j)-10(c)(5)(ii)(A)(2)(i), a
partner generally may choose whether
to apply the look-through rule without
regard to its ownership percentage, with
two exceptions. First, if a partner’s di-
rect or indirect interest in a partnership
is greater than or equal to 80 percent of
the partnership’s capital or profits, the
partner must apply the look-through rule.
Second, if the partnership is eligible for
the small business exemption under sec-
tion 163(j)(3) and proposed §1.163(j)-
2(d)(1), a partner may not apply the look-
through rule.
Proposed §1.163(j)-10(c)(5)(ii)(A)
(2)(ii) provides that if, after applying the
investment asset basis reduction rule, at
least 90 percent of a partner’s share of a
partnership’s basis in its assets (includ-
ing adjustments under sections 734(b)
and 743(b)) is allocable to either except-
ed or non-excepted trades or businesses,
the partner’s entire basis in its partnership
interest is treated as allocable to such ex-
cepted or non-excepted trades or business-
es.
Pursuant to proposed §1.163(j)-10(c)
(5)(ii)(A)(2)(iv), if a partner, other than
a C corporation or a tax-exempt corpora-
tion, does not apply the look-through rule,
the partner generally will treat its basis in
the partnership interest as either an asset
held for investment or a non-excepted
trade or business asset as determined un-
der section 163(d).
ii. Coordination of Look-Through Rule
and Basis Determination Rules
Outside of the partnership context, pro-
posed §1.163(j)-10(c)(5)(i) provides rules
regarding the computation of adjusted
basis for purposes of allocating business
interest expense between excepted and
non-excepted trades or businesses (col-
lectively, the “basis determination rules”).
For example, proposed §1.163(j)-10(c)(5)
(i)(A) generally provides that the adjusted
basis of non-depreciable property other
than land is the adjusted basis of the as-
set used for determining gain or loss from
the sale or other disposition of that asset
as provided in §1.1011-1, and proposed
§1.163(j)-10(c)(5)(i)(C) generally pro-
vides that the adjusted basis of land and
inherently permanent structures is its un-
adjusted basis. For purposes of applying
the look-through rule, the Treasury De-
partment and the IRS intended the basis
determination rules to require adjustments
to the partnership’s basis in its assets and
the partner’s basis in its partnership inter-
est to the extent of the partner’s share of
any adjustments to the basis of the part-
nership’s assets. Accordingly, the final
regulations explicitly provide that such is
the case.
Multiple commenters noted that the
proposed regulations do not specify
whether a partner that does not apply the
look-through rule should use the adjust-
ed tax basis in its partnership interest or
should adjust its tax basis to reflect what
its basis would be if the partnership ap-
plied the basis determination rules to its
assets. Because all partnerships are not
subject to section 163(j) and cannot pro-
vide all partners with the information
necessary to adjust the tax basis of their
partnership interests consistent with the
basis determination rules, the Treasury
Department and the IRS have determined
that the basis determination rules should
not apply to the basis of a partnership in-
terest if a partner does not apply the look-
through rule.
iii. Applying the Look-Through Rule and
Determining Share of Partnership Basis
Proposed §1.163(j)-10(c)(5)(ii)(A)
(2)(i) provides that, for purposes of the
look-through rule, a partner’s share of a

September 28, 2020 674 Bulletin No. 2020–40
partnership’s assets is determined using
a reasonable method, taking into account
special allocations under section 704(b),
adjustments under sections 734(b) and
743(b), and direct adjustments relating
to assets subject to qualified nonrecourse
indebtedness under proposed §1.163(j)-
10(d)(4). Commenters argued that this
language does not provide adequate
guidance regarding how a partner should
determine its share of the tax basis of a
specific partnership asset when applying
the look-through rule. The commenters
stated that, by indicating that sections
743(b) and 704(b) should be taken into
account, the proposed regulations imply
that a partner’s share of the partnership’s
basis in an asset is determined by refer-
ence to the future depreciation deduc-
tions that a partner would be allocated
with regard to such asset or the amount
of basis to be taken into account by that
partner in determining its allocable share
of gain or loss on the partnership’s dispo-
sition of the asset. The commenters also
requested that final regulations address
whether and how allocations under sec-
tion 704(c) affect a partner’s share of the
partnership’s basis in its assets. After fur-
ther consideration, the Treasury Depart-
ment and the IRS have decided to retain
the rule in proposed §1.163(j)-10(c)(5)
(ii)(A)(2)(i).
iv. Investment Asset Basis Reduction
Rule
Under proposed §1.163(j)-10(c)(5)(ii)
(A)(2)(iii), for purposes of applying the
investment asset basis reduction rule, a
partner’s share of a partnership’s assets
is determined under a reasonable method,
taking into account special allocations un-
der section 704(b). A commenter recom-
mended clarifying whether the investment
asset basis reduction should be made in
accordance with a partner’s share of the
partnership’s actual adjusted basis in an
asset or in accordance with the partner’s
share of the partnership’s basis in an asset
as determined pursuant to the basis deter-
mination rules. The commenter further
recommended that the approach adopted
on this issue should be consistent with
the approach adopted for purposes of de-
termining a partner’s adjusted basis in its
partnership interest.
The Treasury Department and the IRS
agree that these two rules should be ap-
plied consistently. After further consid-
eration, the Treasury Department and the
IRS have decided to retain the rule that
allows a partner’s share of a partnership’s
investment assets to be determined using
a reasonable method, taking into account
special allocations under section 704(b).
However, if a partner elects to apply the
look-through rule, then the partner also
must apply the basis determination rules.
If a partner elects not to apply, or is pre-
cluded from applying, the look-through
rule, then the approach the partner uses
for purposes of the investment asset basis
reduction rule must be consistent with the
approach the partner uses to determine the
partner’s adjusted basis in its partnership
interest.
v. Coordination of Section 752 Basis
Reduction Rule and Investment Asset
Basis Reduction Rule
Multiple commenters noted that the
combined effect of the section 752 basis
reduction rule and the investment asset ba-
sis reduction rule could require a partner,
other than a C corporation or a tax-exempt
corporation, in a partnership that holds
investment assets funded by partnership
liabilities to reduce the adjusted tax basis
of its partnership interest twice—once for
the partnership’s basis in its investment
assets, and a second time for the liabilities
that funded their purchase. The Treasury
Department and the IRS have determined
that this result would be inappropriate.
Accordingly, the final regulations amend
the investment asset basis reduction rule
by providing that, with respect to a partner
other than a C corporation or tax-exempt
corporation, the partner’s adjusted basis
in its partnership interest is decreased by
the partner’s share of the excess of (a) the
partnership’s asset basis with respect to
those assets over (b) the partnership’s debt
that is traced to such assets in accordance
with §1.163-8T. In order to neutralize the
effect of any cost recovery deductions as-
sociated with a partnership’s investment
assets funded by partnership liabilities
(for example, non-trade or business prop-
erty held for the production of income),
the final regulations also amend the in-
vestment asset basis reduction rule by
providing that, with respect to a partner
other than a C corporation or tax-exempt
corporation, the partner’s adjusted basis
in its partnership interest is increased by
the partner’s share of the excess of (a) the
partnership’s debt that is traced to such
assets in accordance with §1.163-8T over
(b) the partnership’s asset basis with re-
spect to those assets.
vi. Allocating Basis in a Partnership
Interest Between Excepted and Non-
Excepted Trades or Businesses
A commenter requested explicit con-
firmation that, under the look-through
rule, a partner allocates the basis of its
partnership interest between excepted and
non-excepted trades or businesses in the
same proportion as the partner’s share of
the partnership’s adjusted tax basis in its
trade or business assets is allocated be-
tween excepted and non-excepted trades
or businesses. The final regulations ex-
plicitly state that this is the rule.
Commenters also stated that the pro-
posed regulations do not address how a
partner should allocate business interest
expense and business interest income
under proposed §1.163(j)-10(c) to the
extent the partner (i) has zero basis in all
partnership interests for purposes of sec-
tion 163(j), and (ii) owns no other trade
or business assets. The Treasury Depart-
ment and the IRS have determined that
these facts would be rare, particularly
given the adjustments to partnership basis
provided for in §1.163(j)-10. Therefore,
the final regulations do not include a rule
addressing this fact pattern. However, the
Treasury Department and the IRS request
comments on how frequently this fact pat-
tern would occur and how best to address
such a situation.
3. Additional Limitation on Application
of Look-Through Rules to C
Corporations
A commenter noted that the look-
through rules may be distortive if an in-
dividual (A) that is directly engaged in a
trade or business also owns stock in a C
corporation (with its own trade or busi-
ness) that satisfies the section 1504(a)(2)
ownership requirements. A’s interest ex-
pense that is attributable to A’s investment

Bulletin No. 2020–40 675 September 28, 2020
in the C corporation under §1.163-8T re-
tains its character as investment interest
expense. Moreover, if A also has business
interest expense, the allocation of that ex-
pense between excepted and non-excepted
trades or businesses would appear to take
into account A’s investment in the C cor-
poration on a look-through basis as well.
Thus, A’s shares in the C corporation may
be double-counted insofar as they affect
the character of both the directly attribut-
able investment interest expense and the
unrelated business interest expense.
To address the possible distortive ef-
fects of the look-through rules when ap-
plied to stock of a non-consolidated C
corporation that is held as an investment,
the final regulations provide that the look-
through rule in §1.163(j)-10(c)(5)(ii)(B)
(2)(i) is available only if dividends paid on
the stock would not be included in the tax-
payer’s investment income under section
163(d)(4)(B). Because corporations can-
not have investment income under section
163(d)(4)(B), this additional requirement
does not otherwise affect their ability to
look-through the stock of a non-consoli-
dated C corporation.
4. Dispositions of Stock in Non-
Consolidated C Corporations
Under proposed §1.163(j)-10(b)(4)
(i), if a shareholder recognizes gain or
loss upon the disposition of its stock in a
non-consolidated C corporation, if such
stock is not property held for investment,
and if the taxpayer looks through to the as-
sets of the C corporation under proposed
§1.163(j)-10(c)(5)(ii)(B), then the tax-
payer must allocate gain or loss from the
stock disposition to excepted or non-ex-
cepted trades or businesses based upon the
relative amounts of the corporation’s ad-
justed basis in the assets used in its trades
or businesses. This rule is analogous to
the look-through rule for dividends in pro-
posed §1.163(j)-10(b)(3).
However, the dividend look-through
rule also provides that, if at least 90 per-
cent of the payor corporation’s adjusted
basis in its assets during the taxable year
is allocable to either excepted or non-ex-
cepted trades or businesses, then all of
the taxpayer’s dividend income from the
payor corporation for the taxable year is
treated as allocable to excepted or non-ex-
cepted trades or businesses, respectively.
Commenters asked why the rule regarding
the disposition of non-consolidated C cor-
poration stock is not subject to a 90 per-
cent de minimis rule analogous to the rule
for dividends.
The Treasury Department and the IRS
have determined that the rule regarding the
disposition of stock in a non-consolidated
C corporation (including a CFC) should
be subject to a 90 percent de minimis rule.
The final regulations have modified pro-
posed §1.163(j)-10(b)(4)(i) accordingly.
5. Application of Look-through Rules to
Small Businesses
Under proposed §1.163(j)-10(c)(5)(ii)
(D), a taxpayer may not apply the look-
through rules in proposed §1.163(j)-10(b)
(3) and (c)(5)(ii)(A), (B), and (C) to an en-
tity that is eligible for the small business
exemption. As described in the preamble
to the proposed regulations, the Treasury
Department and the IRS determined that
these look-through rules should not be
available in these cases because of the
administrative burden that would be im-
posed on small businesses from collect-
ing and providing information to their
shareholders or partners regarding inside
asset basis when those small businesses
are themselves exempt from the applica-
tion of section 163(j). The preamble to the
proposed regulations also provides that a
taxpayer that is eligible for the small busi-
ness exemption may not make an election
under proposed §1.163(j)-9.
Commenters requested that entities
that qualify for the small business exemp-
tion be allowed to make an election under
proposed §1.163(j)-9, and that such an
electing entity’s shareholders or partners
be permitted to apply the look-through
rules. Absent such a rule, shareholders
and partners of a small business entity that
conducts an excepted trade or business
could be worse off than shareholders and
partners of a larger entity (ineligible for
the small business exemption) that con-
ducts an excepted trade or business.
As noted in part X(A) of this Summa-
ry of Comments and Explanation of Re-
visions section, the Treasury Department
and the IRS have determined that entities
eligible for the small business exemption
should be permitted to make a protective
election under proposed §1.163(j)-9. Ac-
cordingly, the final regulations also allow
taxpayers to apply the look-through rules
to entities that qualify for the small busi-
ness exemption and that make a protective
election under proposed §1.163(j)-9.
6. Application of the Look-Through
Rules to Foreign Utilities
Section 163(j)(7)(A)(iv) does not treat
utilities that are exclusively regulated by
foreign regulators (and not by a State gov-
ernment, a political subdivision of a State
government, an agency or instrumentality
of the United States, or the governing or
ratemaking body of a domestic electric
cooperative) (foreign-regulated utility)
as excepted trades or businesses. As a
result, under the interest allocation rules
of proposed §1.163(j)-10(c), a U.S. cor-
poration that looks through to the assets
of a CFC that operates a foreign-regulat-
ed utility must allocate its entire basis in
its CFC stock to a non-excepted trade or
business, even if all of the CFC’s operat-
ing assets are used in a foreign-regulated
utility business. Moreover, if the U.S. cor-
poration has significant basis in its CFC
stock, a significant portion of the U.S. cor-
poration’s business interest expense will
be subject to the section 163(j) limitation,
even if the U.S. corporation is solely or
primarily engaged in an excepted utility
trade or business.
A commenter noted that, if the U.S.
corporation does not have sufficient in-
come from non-excepted trades or busi-
nesses, the corporation might never be
able to deduct its disallowed business in-
terest expense. The commenter thus rec-
ommended that stock in a CFC engaged
in a foreign-regulated utility trade or busi-
ness be treated as having zero basis for
purposes of the interest allocation rules in
proposed §1.163(j)-10(c).
The final regulations do not adopt the
commenter’s recommendation. However,
the Treasury Department and the IRS have
determined that, if a taxpayer applies the
look-through rule to a CFC, the taxpayer
may allocate its basis in its CFC stock to
an excepted trade or business to the extent
the CFC is engaged in either (i) an except-
ed trade or business, or (ii) a foreign-reg-
ulated utility trade or business that would
be treated as an excepted trade or business

September 28, 2020 676 Bulletin No. 2020–40
if the utility meets certain requirements
related to regulation by a foreign gov-
ernment. The final regulations have been
modified accordingly. See §1.163(j)-10(c)
(5)(ii)(C)(2).
I. Deemed Asset Sale
Proposed §1.163(j)-10(c)(5)(iv) pro-
vides that, solely for purposes of deter-
mining the amount of basis allocable to
excepted and non-excepted trades or busi-
nesses under proposed §1.163(j)-10(c), an
election under section 336, 338, or 754, as
applicable, is deemed to have been made
for any acquisition of corporate stock or
partnership interests with respect to which
the taxpayer demonstrates to the satisfac-
tion of the Commissioner that the taxpay-
er was eligible to make an election but
was actually or effectively precluded from
doing so by a regulatory agency with re-
spect to an excepted regulated utility trade
or business. As explained in the preamble
to the proposed regulations, this deemed
asset sale rule is intended to place taxpay-
ers that are actually or effectively preclud-
ed from making an election under section
336, section 338, or section 754 on the
same footing for purposes of the basis al-
location rules in proposed §1.163(j)-10(c)
as taxpayers that are not subject to such
limitations.
Commenters pointed out that, as a prac-
tical matter, a basis step-up election gener-
ally cannot be made if the acquired entity
has a regulatory liability for deferred taxes
on its books because, in that case, the elec-
tion may cause customer bills to increase.
In other words, deferred tax liabilities typ-
ically lower a utility’s rate base (which is
used to compute the rates charged to cus-
tomers). An election under section 336,
section 338, or section 754 would elim-
inate this deferred tax liability, thereby
increasing the rate base and potentially
increasing the rates charged to customers.
As a result, regulatory agencies frequent-
ly do not approve a basis step-up election
made in connection with the sale or pur-
chase of a regulated utility. Commenters
argued that even broaching the possibility
of such a basis step-up could create con-
cerns for the regulatory agency regarding
a proposed acquisition. Commenters also
queried how taxpayers that do not raise
this issue with the regulatory agency can
“demonstrate” that they were “effectively
precluded” by the agency from making
the election. In short, commenters claimed
that the “demonstration” requirement in
proposed §1.163(j)-10(c)(5)(iv) would be
impractical, result in unnecessary requests
to regulatory agencies, lead to controver-
sy, create uncertainty, and limit the effec-
tiveness of this provision.
To address the foregoing concerns, the
final regulations provide that a taxpayer
that acquired or acquires an interest in a
regulated entity should be deemed to have
made an election to step up the tax basis of
the assets of the acquired entity if the tax-
payer can demonstrate that (a) the acqui-
sition qualified for an election under sec-
tion 336, 338, or 754, and (b) immediately
before the acquisition, the acquired entity
had a regulatory liability for deferred tax-
es on its books with respect to property
predominantly used in an excepted regu-
lated utility trade or business.
J. Carryforwards of Disallowed
Disqualified Interest
Proposed §1.163(j)-1(b)(10) defines
the term “disallowed disqualified inter-
est” to mean interest expense, including
carryforwards, for which a deduction was
disallowed under old section 163(j) in the
taxpayer’s last taxable year beginning be-
fore January 1, 2018, and that was carried
forward under old section 163(j). Under
the proposed regulations, disallowed dis-
qualified interest that is properly alloca-
ble to a non-excepted trade or business is
subject to the section 163(j) limitation as a
disallowed business interest expense car-
ryforward. See proposed §§1.163(j)-2(c)
(1) and 1.163(j)-11(b)(1). In the preamble
to the proposed regulations, the Treasury
Department and the IRS requested com-
ments as to how the allocation rules in
proposed §1.163(j)-10 should apply to
disallowed disqualified interest.
Commenters recommended several
possible approaches to allocating disal-
lowed disqualified interest between ex-
cepted and non-excepted trades or busi-
nesses. Under one approach (historical
approach), a taxpayer would apply the al-
location rules of proposed §1.163(j)-10 to
disallowed disqualified interest in the tax-
able year in which such interest expense
was incurred. Although this approach
would be consistent with the allocation
rules for other business interest expense, it
likely would be administratively burden-
some for many taxpayers because such
interest expense may have been incurred
years (if not decades) ago.
Under another approach (effective date
approach), a taxpayer would apply the
allocation rules of proposed §1.163(j)-
10 to disallowed disqualified interest in
the taxpayer’s first taxable year begin-
ning after December 31, 2017, as if the
disallowed disqualified interest expense
were incurred in that year. Although this
approach would be less administratively
burdensome than the historical approach,
it might not accurately represent the tax-
payer’s circumstances in the year(s) in
which the disallowed disqualified interest
actually was incurred.
Under a third approach, taxpayers
would be permitted to use any reasonable
method to allocate disallowed disqualified
interest between excepted and non-ex-
cepted trades or businesses, provided the
method is applied consistently to disal-
lowed disqualified interest that arose in
the same taxable year. This approach also
might include the effective date approach
as a safe harbor. However, this approach
could prove to be administratively bur-
densome for the IRS.
To reduce the administrative burden for
both taxpayers and the IRS, the final reg-
ulations permit taxpayers to use either the
historical approach or the effective date
approach.
A commenter also pointed out that
proposed §1.163(j)-11(b)(1) could be
construed as permitting only disallowed
disqualified interest that is properly allo-
cable to a non-excepted trade or business
to be carried forward to the taxpayer’s
first taxable year beginning after Decem-
ber 31, 2017. The commenter requested
confirmation that disallowed disqualified
interest that is properly allocable to an
excepted trade or business also is carried
forward. The final regulations confirm this
point. See §1.163(j)-11(c)(1).
K. Anti-Abuse Rule
Proposed §1.163(j)-10(c)(8) provides
an anti-abuse rule to discourage taxpay-
ers from manipulating the allocation of
business interest expense and business in-

Bulletin No. 2020–40 677 September 28, 2020
terest income between non-excepted and
excepted trades or businesses. Pursuant to
this provision, if a principal purpose for
the acquisition, disposition, or change in
use of an asset was to artificially shift the
amount of basis allocable to excepted or
non-excepted trades or businesses on a
determination date, the additional basis or
change in use is not taken into account for
purposes of §1.163(j)-10.
A commenter expressed support for
this rule but suggested that the final reg-
ulations eliminate the “principal purpose”
standard and rely instead on a rule based
on asset acquisitions, dispositions, or
changes in use that do not have “a sub-
stantial business purpose.”
The Treasury Department and the IRS
have determined that using “a substantial
business purpose” as the threshold for
applying the anti-abuse rule would limit
the effectiveness of this rule because tax-
payers generally would be able to provide
an ostensible business purpose for the
acquisition, disposition, or transfer of an
asset. Thus, the anti-abuse rule in the final
regulations retains the “principal purpose”
standard.
L. Direct Allocation
1. Overview
As previously noted, proposed
§1.163(j)-10(c) generally requires interest
expense and interest income to be allocat-
ed between excepted and non-excepted
trades or businesses according to the rel-
ative amounts of basis in the assets used
in such trades or businesses. However,
proposed §1.163(j)-10(d) contains several
exceptions to this general rule.
First, a taxpayer with qualified non-
recourse indebtedness is required to di-
rectly allocate interest expense from such
indebtedness to the taxpayer’s assets in
the manner and to the extent provided in
§1.861-10T(b) (see proposed §1.163(j)-
10(d)(1)). Section 1.861-10T(b) defines
the term “qualified nonrecourse indebted-
ness” to mean any borrowing (other than
borrowings excluded by §1.861-10T(b)
(4)) that satisfies certain requirements, in-
cluding the requirements that (i) the cred-
itor can look only to the identified proper-
ty (or any lease or other interest therein)
as security for payment of the principal
and interest on the loan, and (ii) the cash
flow from the property is reasonably ex-
pected to be sufficient to fulfill the terms
and conditions of the loan agreement. For
these purposes, the term “cash flow from
the property” does not include revenue if a
significant portion thereof is derived from
activities such as sales or the use of other
property. Thus, revenue derived from the
sale or lease of inventory or similar prop-
erty, including plant or equipment used in
the manufacture and sale or lease, or pur-
chase and sale or lease, of such inventory
or similar property, does not constitute
cash flow from the property. See §1.861-
10T(b)(3)(i).
Second, a taxpayer that is engaged in
the trade or business of banking, insur-
ance, financing, or a similar business is re-
quired to directly allocate interest expense
and interest income from such business to
the taxpayer’s assets used in that business
(see proposed §1.163(j)-10(d)(2)).
Additionally, for purposes of the gen-
eral allocation rule in proposed §1.163(j)-
10(c), taxpayers are required to reduce
their asset basis by the entire amount of
the basis in the assets to which interest
expense is directly allocated pursuant to
proposed §1.163(j)-10(d)(1) or (2). See
proposed §1.163(j)-10(d)(4).
2. Expansion of the Direct Allocation
Rule
Some commenters recommended that
the direct allocation rule in proposed
§1.163(j)-10(d) be applied in circum-
stances other than those set forth in pro-
posed §1.163(j)-10(d)(1) and (2). For
example, a commenter queried whether a
borrowing could be considered qualified
nonrecourse indebtedness for purposes of
proposed §1.163(j)-10(d) even if the loan
document doesn’t require the creditor to
look exclusively to an asset as security for
payment of principal and interest on a loan
(as required by §1.861-10T(b)(2)(iii)).
Other commenters asked that direct allo-
cation be applied to debt directly incurred
by an excepted regulated utility trade or
business. These commenters argued that,
because such debt must be approved by
a regulatory agency and relates directly
to the underlying needs of that trade or
business, such debt should be viewed as
“properly allocable” to that trade or busi-
ness. Moreover, they claimed that the defi-
nition of “qualified nonrecourse indebted-
ness” in §1.861-10T(b) is too narrow to
include either debt directly incurred by an
excepted regulated utility trade or busi-
ness or debt incurred to purchase stock of
a corporation or interests in a partnership
primarily engaged in an excepted regulat-
ed utility trade or business.
In contrast, other commenters support-
ed the decision to limit the availability of
tracing to the limited circumstances in
proposed §1.163(j)-10(d).
As noted in part XI(L)(1) of this Sum-
mary of Comments and Explanation of
Revisions section, a borrowing is not
considered qualified nonrecourse indebt-
edness under §1.861-10T(b) unless the
creditor can look only to the identified
property (or any interest therein) as secu-
rity for the loan. By definition, the credi-
tor on a non-recourse loan may not seek
to recover the borrower’s other assets; in
other words, the creditor has no further
recourse. The Treasury Department and
the IRS decline to expand the exception
in proposed §1.163(j)-10(d)(1) to include
unsecured debt because, by definition,
such debt is supported by all of the assets
of the borrower.
The Treasury Department and the IRS
also have determined that the definition
of qualified nonrecourse indebtedness
should not be expanded to encompass in-
debtedness incurred to acquire stock or
partnership interests in an entity primari-
ly engaged in an excepted trade or busi-
ness because such an approach is akin to
tracing. As noted in the preamble to the
proposed regulations, money is fungible,
and the Treasury Department and the IRS
have determined that a tracing regime
would be inappropriate, with limited ex-
ceptions. The Treasury Department and
the IRS have determined that the defini-
tion of qualified nonrecourse indebtedness
should not be expanded to encompass all
indebtedness directly incurred by regulat-
ed utility trades or businesses, for similar
reasons.
However, the Treasury Department
and the IRS appreciate that it is difficult
for utility trades or businesses to avail
themselves of the direct allocation rule
in proposed §1.163(j)-10(d)(1) given the
definition of qualified nonrecourse debt
in §1.861-10T(b). In particular, the Trea-

September 28, 2020 678 Bulletin No. 2020–40
sury Department and the IRS understand
that the exclusion of inventory revenue
from the calculation of “cash flow from
the property” effectively precludes many
utilities from using direct allocation under
proposed §1.163(j)-10(d)(1). Thus, sole-
ly for purposes of the allocation rules in
proposed §1.163(j)-10, the final regula-
tions create an exception to the definition
of qualified nonrecourse indebtedness in
§1.861-10T(b) to allow for the inclusion
of revenue from the sale or lease of inven-
tory for utility trades or businesses.
Another commenter recommended
that, for taxpayers engaged in excepted
regulated utility trades or businesses, the
basis in certain grants and contributions
in aid of construction should be directly
allocated to non-excepted trades or busi-
nesses if the costs have not been taken
into account by a regulatory body in de-
termining the cost of the utility’s service
for ratemaking purposes. As discussed
in part II of this Summary of Comments
and Explanation of Revisions section, the
final regulations do not require the rates
for the sale or furnishing of utility items
to be established or approved on a cost
of service and rate of return basis in or-
der for a utility trade or business to qual-
ify as an excepted regulated utility trade
or business. Without such a requirement,
the Treasury Department and the IRS do
not find a significant nexus between a reg-
ulatory body’s determination of a utility
trade or business’s cost of service and the
allocation of the basis in grants and contri-
butions in aid of construction. Therefore,
the final regulations do not adopt the com-
menter’s recommendation.
3. Basis Reduction Requirement for
Qualified Nonrecourse Indebtedness
Commenters noted that, as drafted, the
basis reduction requirement in proposed
§1.163(j)-10(d)(4) would lead to inappro-
priate results for assets that are acquired
using both equity financing and qualified
nonrecourse indebtedness (or using both
recourse and nonrecourse indebtedness)
because this requirement would remove
asset basis that was not financed by quali-
fied nonrecourse indebtedness.
Commenters also observed that this re-
quirement could lead to significant distor-
tions because a small amount of qualified
nonrecourse indebtedness would cause
an entire property to be removed from a
taxpayer’s basis allocation computation.
For example, assume a taxpayer has (i)
$500,000 of unsecured debt, (ii) property
used in an excepted trade or business with
a basis of $10 million and $100,000 of
qualified nonrecourse indebtedness (As-
set A), and (iii) a non-excepted trade or
business whose assets have a basis of $1
million. Under proposed §1.163(j)-10(d)
(4), Asset A would be entirely excluded
from the basis allocation computation in
proposed §1.163(j)-10(c). As a result, all
interest expense on the $500,000 of unse-
cured debt would be subject to the section
163(j) limitation.
Commenters further noted that taxpay-
ers could take advantage of this basis ad-
justment rule to minimize the application
of section 163(j). In other words, taxpay-
ers could incur a relatively small amount
of nonrecourse debt to acquire assets used
in non-excepted trades or businesses,
thereby reducing the amount of asset basis
allocated to such trades or businesses for
purposes of the general allocation rule in
proposed §1.163(j)-10(c).
To eliminate these distortions and in-
appropriate results, commenters recom-
mended that basis in the assets securing
qualified nonrecourse indebtedness be re-
duced (but not below zero) for purposes
of the general allocation rule solely by the
amount of such qualified nonrecourse in-
debtedness. The Treasury Department and
the IRS agree with this recommendation,
and the final regulations have been modi-
fied accordingly.
4. Direct Allocation Rule for Financial
Services Businesses
Commenters asked for clarification
of the direct allocation rule for financial
services entities in proposed §1.163(j)-
10(d)(2). For example, commenters noted
that, because the definition in §1.904-4(e)
(2) includes income from certain services
(including investment advisory services),
this rule may apply to taxpayers that are
not doing much actual financing, and com-
menters queried whether the direct alloca-
tion rule should apply to such taxpayers.
Commenters also asked whether proposed
§1.163(j)-10(d)(2) is intended to cover all
of a bank’s activities or only part of them
and, if the answer is the latter, whether a
bank must bifurcate its activities for pur-
poses of proposed §1.163(j)-10.
Commenters also questioned the basis
reduction rule in proposed §1.163(j)-10(d)
(4) for financial services businesses. Com-
menters noted that, unlike the case of qual-
ified nonrecourse indebtedness, it may not
be possible to trace all interest expense
related to a financial services business
to specific assets. Moreover, requiring a
taxpayer to fully eliminate its basis in the
assets of a financial services business un-
der proposed §1.163(j)-10(d)(4) could be
distortive because the taxpayer’s general
debt obligations likely support at least
some portion of the taxpayer’s financial
services business assets.
Given the uncertainty surrounding the
proper scope of the direct allocation rule
for financial services businesses in pro-
posed §1.163(j)-10(d)(2) and the proper
application of the basis reduction rule to
such businesses in proposed §1.163(j)-
10(d)(4), the Treasury Department and
the IRS have decided to remove proposed
§1.163(j)-10(d)(2). To ensure that finan-
cial services entities are not unduly af-
fected by the rule (in proposed §1.163(j)-
10(c)(5)(iii)) that excludes cash and cash
equivalents from the general asset basis
allocation rule in proposed §1.163(j)-
10(c), the final regulations have retained
the exception in proposed §1.163(j)-10(c)
(5)(iii) for financial services entities.
XII. Comments on Proposed Changes to
§1.382-2: General Rules for Ownership
Change
As described in the preamble to the
proposed regulations, section 382(k)(1)
provides that, for purposes of section 382,
the term “loss corporation” includes a cor-
poration entitled to use a carryforward of
disallowed interest described in section
381(c)(20), which refers to carryovers of
disallowed business interest described in
section 163(j)(2). Section 163(j)(2) per-
mits business interest expense for which
a deduction is disallowed under section
163(j)(1) to be carried forward to the suc-
ceeding taxable year.
In turn, section 382(d)(3) provides that
the term “pre-change loss” includes disal-
lowed business interest expense carryfor-
wards “under rules similar to the rules” in

Bulletin No. 2020–40 679 September 28, 2020
section 382(d)(1). Section 382(d)(1) treats
as a “pre-change loss” both (i) net operat-
ing loss carryforwards to the taxable year
in which the change date occurs (change
year), and (ii) the net operating loss carry-
forward for the change year to the extent
such loss is allocable to the pre-change
period.
Proposed changes to §1.382-2 clarified
that a “pre-change loss” includes the por-
tion of any disallowed business interest
expense of the old loss corporation paid or
accrued in the taxable year of the testing
date that is attributable to the pre-change
period, and that a “loss corporation” in-
cludes a corporation that is entitled to use
a carryforward of such a disallowed busi-
ness interest expense.
Commenters noted that, viewed in iso-
lation, section 382(k)(1) would not appear
to apply to a corporation that has only a
current-year disallowed business interest
expense. Some commenters also claimed
that the inclusion of current-year disal-
lowed business interest expense in the
definition of a “loss corporation” is incon-
sistent with the statutory language of sec-
tion 382(k)(1).
The Treasury Department and the IRS
have determined that section 382 should
apply to current-year disallowed busi-
ness interest expense (to the extent such
expense is allocable to the pre-change
period) because this approach is consis-
tent with the statutory treatment of NOLs.
See section 382(k)(1) (providing, in part,
that the term “loss corporation” means a
corporation “having a net operating loss
for the taxable year in which the own-
ership change occurs”). Moreover, as a
policy matter, current-year attributes that
relate to the period before an ownership
change should be subject to section 382.
The exclusion of these items would permit
trafficking in losses, which is contrary to
the stated policy underlying section 382
of preventing “exploit[ation] by persons
other than those who incurred the loss.”
H. Rept. 83-1337, at 42 (1954). Thus, no
changes to the final regulations have been
made in response to these comments.
However, the final regulations revise the
definition of a “section 382 disallowed
business interest carryforward” (which
includes both disallowed business interest
expense carryforwards and current-year
disallowed business interest expense allo-
cable to the pre-change period) in §1.382-
2(a)(7) to reflect changes to the allocation
rules discussed in part XIII of this Sum-
mary of Comments and Explanation of
Revisions section.
XIII. Comments on Proposed Changes to
§1.382-6: Allocation of Income and Loss
to Periods Before and After the Change
Date for Purposes of Section 382
Section 1.382-6 provides rules for the
allocation of income and loss to periods
before and after the change date for pur-
poses of section 382. Section 1.382-6(a)
generally provides that a loss corporation
must allocate its net operating loss or tax-
able income, and its net capital loss or
modified capital gain net income, for the
change year between the pre-change and
post-change periods by ratably allocating
an equal portion to each day in the year.
Section 1.382-6(b), which contains an ex-
ception to this general rule, permits a loss
corporation to elect to allocate the forego-
ing items for the change year between the
pre-change and post-change periods as if
the loss corporation’s books were closed
on the change date. Such an election does
not terminate the loss corporation’s tax-
able year as of the change date (in other
words, the change year is still treated as
a single tax year for Federal income tax
purposes).
The proposed regulations revise
§1.382-6 to address the treatment of busi-
ness interest expense. More specifically,
the proposed regulations provide that,
regardless of whether a loss corporation
has made a closing-of-the-books election
under §1.382-6(b), the amount of the cor-
poration’s deduction for current-year busi-
ness interest expense is calculated based
on ratable allocation for purposes of cal-
culating the corporation’s taxable income
attributable to the pre-change period.
Commenters objected to the mandatory
use of ratable allocation for business in-
terest expense in §1.382-6. For example,
commenters argued that this approach is
distortive (and taxpayer-unfavorable) in
situations in which the loss corporation
incurs minimal interest expense in the pre-
change period but makes highly leveraged
acquisitions in the post-change period.
Another commenter noted that this ap-
proach is distortive (and taxpayer-favor-
able) in situations in which the loss corpo-
ration incurs significant business interest
expense in the pre-change period and allo-
cates a portion of that expense to the post-
change period. To avoid these distortions
and complications, commenters recom-
mended that a closing-of-the-books elec-
tion also be allowed for business interest
expense.
The Treasury Department and the IRS
acknowledge that a ratable allocation
approach may lead to distortions and ad-
ministrative burdens in certain situations.
Thus, the final regulations permit a loss
corporation to allocate current-year busi-
ness interest expense between the pre-
change and post-change periods using
the closing-of-the-books method set forth
in §1.382-6(b)(4) if the loss corporation
makes a closing-of-the-books election
under §1.382-6(b). Section 1.382-6(b)(4)
also provides correlative rules for the al-
location of disallowed business interest
expense carryforwards to the pre-change
and post-change periods when a closing-
of-the-books election is made. In turn,
section 1.382-6(a)(2) clarifies the amount
of business interest expense, disallowed
business interest expense, and disallowed
business interest expense carryforwards
that are allocable to the pre-change and
post-change periods if no closing-of-the-
books election is made.
XIV. Comments on and Changes to
Proposed §1.383-1: Special Limitations
on Certain Capital Losses and Excess
Credits
Section 1.383-1(d) provides ordering
rules for the utilization of pre-change
losses and pre-change credits and for the
absorption of the section 382 limitation
and the section 383 credit limitation. Un-
der proposed changes to §1.383-1(d), a
taxpayer’s section 382 limitation would
be absorbed by disallowed business in-
terest expense carryforwards before being
absorbed by NOLs. As described in the
preamble to the proposed regulations, the
Treasury Department and the IRS prior-
itized the use of disallowed business in-
terest expense carryforwards over NOLs
because “taxpayers must calculate their
current-year income or loss in order to de-
termine whether and to what extent they
can use an NOL in that year, and deduc-

September 28, 2020 680 Bulletin No. 2020–40
tions for business interest expense, in-
cluding carryforwards from prior taxable
years, factor into the calculation of cur-
rent-year income or loss.”
Although commenters described the
foregoing ordering rule as understandable
and fairly simple to administer, they not-
ed that pre-2018 NOLs (unlike disallowed
business interest expense carryforwards)
have a limited carryforward period, and
that such NOLs may expire without use as
a result of this ordering rule. Commenters
thus recommended allowing taxpayers to
elect an alternative ordering rule with re-
spect to pre-2018 NOLs.
The Treasury Department and the IRS
have decided not to adopt this recom-
mended approach, for several reasons.
First, as commenters also noted, such an
approach would add complexity. Second,
as stated in the preamble to the proposed
regulations, deductions for business in-
terest expense (including disallowed
business interest expense carryforwards)
factor into the determination whether and
to what extent a taxpayer can use an NOL
in a taxable year. Thus, no changes have
been made to proposed §1.383-1(d) in the
final regulations.
XV. Other Comments about Section 382
A. Application of Section 382(l)(5)
Section 382(l)(5) provides an excep-
tion to the general loss limitation rule un-
der section 382(a) for an old loss corpora-
tion in Title 11 proceedings or in similar
cases if the historic shareholders and
creditors of such corporation own at least
50 percent of the stock of the new loss
corporation as a result of being share-
holders or creditors immediately before
the ownership change. If this exception
applies, the corporation’s pre-change
losses and excess credits that may be
carried over to a post-change year must
be “computed as if no deduction was al-
lowable under this chapter for the inter-
est paid or accrued” on debt converted
into stock under Title 11 (or in a similar
case) during the 3-year period preceding
the year of the ownership change (change
year) or during the pre-change period in
the change year. Section 382(l)(5)(B). In
other words, because the old loss corpo-
ration gets the benefit of treating certain
creditors as shareholders for purposes of
determining whether the corporation has
undergone an ownership change within
the meaning of section 382(g), the cor-
poration must treat the debt held by such
creditors as equity for Federal income
tax purposes. As a result, the corpora-
tion must treat the interest payments as
non-deductible distributions on equity.
As provided in proposed §1.382-2,
section 382 disallowed business interest
carryforwards are pre-change losses. Be-
cause a deduction for such carryforwards
is “allowable” in a future year, comment-
ers asked whether such carryforwards
must be recomputed under section 382(l)
(5)(B).
The Treasury Department and the
IRS have determined that no clarifica-
tion of the rule is necessary. Because
section 382 disallowed business interest
carryforwards are pre-change losses, if
a corporation has such a carryforward
from any taxable year ending during
the 3-year period preceding the change
year (or during the pre-change period in
the change year), and if section 382(l)
(5) applies to an ownership change, the
corporation must recompute the amount
of such carryforwards as if the business
interest expense that generated such car-
ryforwards were not interest.
B. Application of Section 382(e)(3)
A commenter also recommended that
the final regulations address the applica-
tion of section 382(e)(3) to foreign cor-
porations with section 382 disallowed
business interest carryforwards. Section
382(e)(3) provides that, except as other-
wise provided in regulations, only items
treated as connected with the conduct of
a U.S. trade or business are taken into
account in determining the value of an
old loss corporation that is a foreign cor-
poration if an ownership change occurs.
Thus, if a foreign corporation is not en-
gaged in a U.S. trade or business, that
corporation’s section 382 limitation is
zero. As a result, if a foreign corporation
with no U.S. trade or business undergoes
a section 382 ownership change, section
382(e)(3) appears to limit the corpora-
tion’s section 382 disallowed business
interest carryforwards to $0. The com-
menter described this result as onerous
and unintended and recommended that,
for purposes of applying section 382 to
such carryforwards, a foreign corpora-
tion’s value be treated as the total value
of its stock.
The Treasury Department and the IRS
are aware of this issue and other issues
relating to the application of section 382
to CFCs. The Treasury Department and
the IRS continue to study the application
of section 382 to CFCs and may address
this issue in future guidance. The Treasury
Department and the IRS welcome further
comments on the application of section
382 to CFCs.
C. Application of Section 382(h)(6)
As noted in the Background section,
the September 2019 section 382 pro-
posed regulations included a rule ex-
pressly providing that section 382 disal-
lowed business interest carryforwards are
not treated as RBILs, thus precluding a
double detriment under section 382 with
respect to such carryforwards. This con-
clusion might have been reached by ap-
plication of the general anti-duplication
principles reflected in the current regula-
tions under section 382. See, for exam-
ple, §1.382-8(d) (regarding duplicative
reductions in value of loss corporations).
However, because of the complexity of
this area, the Treasury Department and
the IRS included the clarification to pre-
vent possible confusion and to provide
certainty to taxpayers that there is no
double detriment with respect to section
382 disallowed business interest carry-
forwards. Although no formal comments
were received on this rule during the
comment period for the September 2019
section 382 proposed regulations, infor-
mal comments from practitioners active
in the field have been uniformly positive
and have confirmed that this rule is a wel-
come, taxpayer-beneficial addition to the
regulations under section 382.
Due to the uncontroversial nature of
this rule, the Treasury Department and the
IRS have determined that finalization of
this portion of the September 2019 sec-
tion 382 proposed regulations is warrant-
ed at this time. The Treasury Department
and the IRS continue to actively study the
remainder of the rules in the September
2019 section 382 proposed regulations.

Bulletin No. 2020–40 681 September 28, 2020
XVI. Definition of Real Property Trade
or Business
Commenters suggested that the defini-
tion of a “real property trade or business”
should be clarified to include all rental real
estate, even if the rental real estate does
not rise to the level of a section 162 trade
or business. The Treasury Department and
the IRS have determined that modifica-
tions to the rules in the proposed regula-
tions are not necessary to make this point
clear. Section 1.469-9(b)(1) provides that
the definition of a “trade or business” (for
purposes of section 469(c)(7)(C)) includes
interests in rental real estate even if the
rental real estate gives rise to deductions
under section 212. The definition of real
property trade or business in §1.469-9(b)
(2) (for purposes of section 469(c)(7)(C))
necessarily would encompass or include
the definition of a trade or business as
provided in §1.469-9(b)(1). Accordingly,
taxpayers engaged in rental real estate ac-
tivities that do not necessarily rise to the
level of a section 162 trade or business
nevertheless will be treated as engaged in
real property trades or businesses for pur-
poses of section 469(c)(7)(C) (and section
163(j) by reference), and such taxpayers
will be permitted to make the election for
a trade or business to be an electing real
property trade or business for purposes of
section 163(j).
Commenters also requested clarifica-
tion that a trade or business should not
be required to have a direct nexus or re-
lationship to rental real estate in order to
qualify as a real property trade or business
under section 469(c)(7)(C). The Trea-
sury Department and the IRS agree that
businesses involving real property con-
struction, reconstruction, development,
redevelopment, conversion, acquisition,
or brokerage should not necessarily be
required to have a direct nexus or rela-
tionship to rental real estate to be treated
as a real property trade or business under
section 469(c)(7)(C). The proposed reg-
ulations provide definitions for the terms
“real property management” and “real
property operations” while reserving the
remaining nine terms in section 469(c)(7)
(C) as undefined. The statement in the pre-
amble to the proposed regulations regard-
ing a nexus or relationship to rental real
estate was intended as the rationale for the
decision to limit the definition of the two
terms to the management and operation of
rental real estate. Without these limiting
definitions, the Treasury Department and
the IRS were concerned that these two
terms could be read so broadly as to allow
virtually any type of business to qualify
as a real property trade or business. The
other nine terms in section 469(c)(7)(C)
currently remain undefined, although the
Treasury Department and the IRS intend
to issue additional guidance in the future
to provide definitions for these terms.
The Treasury Department and the IRS
generally agree with the observation that
real property construction, reconstruction,
development, redevelopment, conver-
sion, acquisition, or brokerage businesses
should not necessarily be required to have
a direct nexus or relationship to rental real
estate in order to be treated as real prop-
erty trades or businesses. However, the
expectation nevertheless remains that the
end products or final objectives of such
businesses should at least have the poten-
tial to be used as rental real estate or as
integral components in rental real estate
activities.
Several commenters requested clarifi-
cation regarding whether timberlands will
qualify as real property trades or busi-
nesses. The Treasury Department and the
IRS have concluded that unharvested or
unsevered timber clearly fall within the
definition of “real property” as provided
in the proposed regulations. The ques-
tion is whether the activity of holding of
timberlands falls within the definition of
a “real property trade or business.” The
Treasury Department and the IRS have
concluded that the maintenance and man-
agement of timberlands generally does not
meet the intended meaning of any of the
eleven terms in section 469(c)(7)(C), and
that the owners of timberlands were not
intended recipients for relief from the per
se passive rule for rental real estate when
section 469(c)(7) originally was enacted.
However, as set forth in the Concurrent
NPRM, such activities might constitute
the development of real estate within the
meaning of section 469(c)(7)(C). See pro-
posed §1.469-9(b)(2)(ii)(A) and (B) con-
tained in the Concurrent NPRM.
One commenter requested an example
illustrating that the management or opera-
tion of a pipeline or transmission line will
meet the definition of a real property trade
or business. In addition, another com-
menter requested an example illustrating
that the operation of a bridge, tunnel, toll
road, or airport qualifies as a real property
trade or business.
Although the Treasury Department and
the IRS generally agree that the operation
of a pipeline, bridge, tunnel, toll road, or
airport may meet the definition of a real
property trade or business under certain
and specific facts and circumstances, the
answers to these questions will remain de-
pendent on the facts and circumstances of
each case. The Treasury Department and
the IRS expect that such examples gener-
ally will provide very limited guidance to
most taxpayers because any such exam-
ples likely will be viewed as inapplicable
for taxpayers with any differing facts and
circumstances.
Additionally, one commenter recom-
mended removing the reference to the
term “customers” from the definitions of
the terms “real property management”
and “real property operation” because, in
certain situations, the party paying for the
use of the property or for other services
may be a governmental agency providing
services to the general public or for the
public good. The Treasury Department
and the IRS have determined that this
modification is unnecessary because the
term “customer” for this purpose is broad
enough to include governmental entities.
One commenter also requested that
the definition of a real property trade or
business be revised to include broadband,
street lighting, telephone poles, parking
meters, and rolling stock. The Treasury
Department and the IRS decline to re-
vise the definition of real property trade
or business in section 469(c)(7)(C) in
this manner because the maintenance
and management of these types of assets
generally do not meet the intended mean-
ing of any of the eleven terms in section
469(c)(7)(C), and the owners of such as-
sets were not intended recipients for relief
from the per se passive rule for rental real
estate when section 469(c)(7) originally
was enacted.
One commenter requested that the fi-
nal regulations remove the last sentence
in the definition of each of the terms “real
property management” and “real proper-
ty operation.” The commenter stated that

September 28, 2020 682 Bulletin No. 2020–40
these sentences create confusion regard-
ing whether incidental services provided
along with rental real estate will cause the
business to fail to qualify as a real prop-
erty trade or business. In response to this
comment, the Treasury Department and
the IRS have revised these sentences to
clarify that incidental services, even if sig-
nificant, do not disqualify a business as a
real property trade or business.
Statement of Availability of IRS
Documents
The IRS Notices, Revenue Rulings,
and Revenue Procedures cited in this doc-
ument are published in the Internal Reve-
nue Bulletin (or Cumulative Bulletin) and
are available from the Superintendent of
Documents, U.S. Government Publish-
ing Office, Washington, DC 20402, or by
visiting the IRS website at http://www.irs.
gov.
Special Analyses
I. Regulatory Planning and Review –
Economic Analysis
Executive Orders 13771, 13563 and
12866 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to
select regulatory approaches that max-
imize net benefits (including potential
economic, environmental, public health
and safety effects, distributive impacts,
and equity). Executive Order 13563 em-
phasizes the importance of quantifying
both costs and benefits, of reducing costs,
of harmonizing rules, and of promoting
flexibility.
The final regulations have been des-
ignated as subject to review under Ex-
ecutive Order 12866 pursuant to the
Memorandum of Agreement (April 11,
2018) between the Treasury Department
and the Office of Management and Bud-
get (OMB) regarding review of tax reg-
ulations. OMB has designated this final
regulation as economically significant
under section 1(c) of the Memorandum
of Agreement. Accordingly, the final reg-
ulations have been reviewed by OMB’s
Office of Information and Regulatory
Affairs. For purposes of E.O. 13771 this
rule is regulatory.
A. Need for the Final Regulations
The Tax Cuts and Jobs Act (TCJA)
substantially modified the statutory rules
of section 163(j) to limit the amount of
net business interest expense that can be
deducted in the current taxable year. As a
result of those changes, a number of the
relevant terms and necessary calculations
that taxpayers are required to apply under
the statute can benefit from greater spec-
ificity. The Treasury Department and the
IRS issued proposed regulations related
to section 163(j) on December 28, 2018
(proposed regulations). The comments
to the proposed regulations demonstrate
a variety of opinions on how to define
terms and on how section 163(j) interacts
with other sections of the Code and corre-
sponding regulations.
Based on these considerations, the final
regulations are needed to bring clarity to
instances where the meaning of the statute
was unclear and to respond to comments
received on the proposed regulations.
Among other benefits, the clarity provid-
ed by the final regulations generally helps
ensure that all taxpayers calculate the
business interest expense limitation in a
similar manner.
B. Background and Overview
The TCJA substantially modified the
statutory rules of section 163(j) to limit the
amount of net business interest expense
that can be deducted in the current taxable
year of any taxpayer, with limited excep-
tions. As described in the preamble to
the proposed regulations (83 FR 67490),
section 163(j) prior to TCJA generally ap-
plied to domestic corporations with inter-
est paid or accrued to related persons that
were not subject to Federal income tax.
With the enactment of TCJA, the amount
allowed under section 163(j)(1) as a de-
duction for business interest expense is
limited to the sum of (1) the taxpayer’s
business interest income for the taxable
year; (2) 30 percent of the taxpayer’s ad-
justed taxable income (ATI) for the tax-
able year; and (3) the taxpayer’s floor plan
financing interest expense for the taxable
year. As described in the Background sec-
tion earlier, the Coronavirus Aid, Relief,
and Economic Security Act (CARES Act)
amended section 163(j) to provide special
rules relating to the ATI limitation for tax-
able years beginning in 2019 or 2020. The
section 163(j) limitation applies to all tax-
payers, except for certain small businesses
with average annual gross receipts of $25
million or less (adjusted for inflation) and
certain trades or businesses. The excepted
trades or businesses are the trade or busi-
ness of providing services as an employee,
electing real property businesses, electing
farming businesses, and certain regulated
utility businesses. Any amount of business
interest not allowed as a deduction for any
taxable year as a result of the limitation
under section 163(j)(1) is carried forward
and treated as business interest paid or ac-
crued in the next taxable year under sec-
tion 163(j)(2).
Congress modified section 163(j) un-
der the TCJA, in part, out of concern that
prior law treated debt-financed investment
more favorably than equity-financed in-
vestment. According to Congress, this
debt bias generally encouraged taxpayers
to utilize more leverage than they would
in the absence of the Code. Limiting the
deduction of business interest is meant to
reduce the relative favorability of debt and
hence encourage a more efficient capital
structure for firms. Congress also believed
it necessary to apply the limit broadly
across different types of taxpayers so as
not to distort the choice of entity (see H.R.
Rep. No. 115-409, at 247 (2017)).
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS
have assessed the economic effects of the
final regulations relative to a no-action
baseline reflecting anticipated Federal in-
come tax-related behavior in the absence
of these final regulations.
2. Summary of Economic Effects
The final regulations provide certainty
and clarity to taxpayers regarding terms
and calculations that are contained in
section 163(j), which was substantially
modified by TCJA. In the absence of this
clarity, the likelihood that different tax-
payers would interpret the rules regard-
ing the deductibility of business interest
expense differently would be exacerbat-

Bulletin No. 2020–40 683 September 28, 2020
ed. In general, overall economic perfor-
mance is enhanced when businesses face
more uniform signals about tax treatment.
Certainty and clarity over tax treatment
also reduce compliance costs for taxpay-
ers. For those situations where taxpayers
would generally adopt similar interpre-
tations of the statute even in the absence
of guidance, the final regulations provide
value by helping to ensure that those in-
terpretations are consistent with the intent
and purpose of the statute. For example,
the final regulations may specify a tax
treatment that few or no taxpayers would
adopt in the absence of specific guidance
but that nonetheless advances Congressio-
nal intent.
The Treasury Department and the IRS
project that the final regulations will have
an annual economic effect greater than
$100 million ($2020). This determination
is based on the substantial volume of busi-
ness interest payments in the economy
2

and the general responsiveness of busi-
ness investment to effective tax rates,
3
one
component of which is the deductibility
of interest expense. Based on these two
magnitudes, even modest changes in the
deductibility of interest payments (and
in the certainty of that deductibility) pro-
vided by the final regulations, relative to
the no-action baseline, can be expected
to have annual effects greater than $100
million. This claim is particularly likely to
hold for the first set of general 163(j) guid-
ance that is promulgated following major
legislation, such as TCJA.
The Treasury Department and the IRS
have not undertaken more precise esti-
mates of the economic effects of changes
in business activity stemming from these
final regulations. The Treasury Depart-
ment and the IRS do not have readily
available data or models that predict with
reasonable precision the decisions that
taxpayers would make under the final reg-
ulations versus alternative regulatory ap-
proaches, including the no-action baseline.
Nor do they have readily available data or
models that would measure with reason-
able precision the loss or gain in economic
surplus resulting from those business de-
cisions relative to the decisions that would
be made under an alternative regulatory
approach. Such estimates would be nec-
essary to quantify the economic effects
of the final regulations versus alternative
approaches.
In the absence of such quantitative es-
timates, the Treasury Department and the
IRS have undertaken a qualitative analysis
of the economic effects of the final reg-
ulations relative to the no-action baseline
and relative to alternative regulatory ap-
proaches. This analysis is presented in the
next two sections of this Special Analyses.
3. Economic Effects of Provisions
Substantially Revised from the Proposed
Regulations
a. Calculation of ATI
Similar to the proposed regulations,
the final regulations prescribe various
adjustments to the calculation of ATI to
prevent double counting of deductions
and to provide relief for particular types
of taxpayers or taxpayers in particular
circumstances to ensure that all taxpay-
ers are treated equitably when calculating
ATI. One of these adjustments prevents
the double counting of depreciation de-
ductions when a depreciable asset is sold
(only relevant for depreciation deduc-
tions in taxable years beginning after De-
cember 31, 2017, and before January 1,
2022). Other adjustments apply to partic-
ular types of taxpayers, such as regulated
investment companies (RICs), real estate
investment trusts (REITs), or consolidat-
ed groups.
As an alternative, the Treasury De-
partment and the IRS considered not pro-
viding such adjustments. Without such
adjustments, however, certain taxpayers
may be disadvantaged relative to other-
wise similar taxpayers. For example, if
RICs and REITs included the dividends
paid deduction when calculating ATI, then
these entities would almost always have
ATI of zero or close to zero. This outcome
would limit the ability of such taxpayers
to ever deduct business interest expense
for Federal income tax purposes even
when their financing profile was similar to
other entities that could deduct similar net
business interest expense.
Based on calculations using the IRS’s
Statistics of Income (SOI) sample of cor-
porate taxpayers for 2017, the Treasury
Department and the IRS estimate that ap-
proximately $13.5 billion of net business
interest expense is potentially affected by
the dividends paid deduction adjustment
to ATI provided to RICs and REITs in the
final regulations. This net business interest
expense is the amount of interest expense
that is greater than interest income for
RICs and REITs with gross receipts great-
er than $25 million.
The final regulations make one notable
change compared to the proposed regu-
lations regarding the ATI calculation for
taxpayers that manufacture or produce in-
ventory. Under the proposed regulations,
the amount of any depreciation, amortiza-
tion, or depletion that is capitalized into
inventory under section 263A during a
taxable year beginning before January 1,
2022 was not added back to taxable in-
come when calculating ATI for that tax-
able year. Under the final regulations,
such amounts are added back to tentative
taxable income, regardless of the period in
which the capitalized amount is recovered
through cost of goods sold.
Without the final regulations, a tax-
payer with depreciation, amortization, or
depletion expense that is subject to capi-
talization would have lower ATI (and po-
tentially a higher tax liability due to small-
er net interest deductions) than a similarly
situated taxpayer with depreciation, amor-
tization, or depletion expense that is not
subject to capitalization. Thus, the effect
of the final regulations for the calculation
of ATI is to prevent economic distortions
by having the net interest limitation apply
more stringently for certain types of tax-
payers than others. The final regulations
achieve this outcome more effectively
that alternative regulatory approaches, in-
cluding the proposed regulations and the
no-action baseline.
Number of Affected Taxpayers. The
Treasury Department and the IRS estimate
that roughly 61,000 entities are both (i)
subject to calculating their section 163(j)
net interest limitation and (ii) required
by the Code to capitalize any expenses,
including depreciation, amortization, or
2
Interest deductions in tax year 2013 for corporations, partnerships, and sole proprietorships were approximately $800 billion.
3
See E. Zwick and J. Mahon, “Tax Policy and Heterogeneous Investment Behavior,” at American Economic Review 2017, 107(1): 217-48 and articles cited therein.

September 28, 2020 684 Bulletin No. 2020–40
depletion expenses. This estimate is an
upper bound estimate of the number of
taxpayers potentially affected by the defi-
nition of ATI prescribed under the regu-
lations because capitalized depreciation,
amortization, or depletion expenses are
not separately reported and this tax return
item includes other types of capitalized
expenses.
b. Definition of interest
The statute limits the amount of deduct-
ible interest expense for a taxpayer but, as
described in the Explanation of Provisions
section of the proposed regulations, there
are no generally applicable statutory pro-
visions or regulations addressing when
financial instruments are treated as debt
for Federal income tax purposes or when
a payment is counted as interest. While
there are several places in the Code and
regulations where interest expense or in-
terest income is defined, such as in the
regulations that allocate and apportion
interest expense (§1.861-9T) and in the
Subpart F regulations (§1.954-2), these
rules only apply to particular taxpayers in
particular situations.
The proposed regulations defined
interest for the purpose of the section
163(j) limitation as (1) amounts associ-
ated with conventional debt instruments
and amounts already treated as interest
for all purposes under existing statutory
provisions or regulations; (2) additional
amounts that are functionally similar to
interest but not currently labeled as in-
terest under the Code, or amounts treat-
ed as interest for certain purposes, such
as amounts described in §§1.861-9T and
1.954-2; and (3) any deductible expense
or loss predominantly incurred in con-
sideration of the time value of money as
part of an anti-avoidance rule. Thus, the
proposed regulations applied to interest
associated with conventional debt instru-
ments as well as generally to transactions
that are indebtedness in substance even if
not in form.
The Treasury Department and the IRS
proposed this definition of interest, rather
than leaving the term interest undefined
for purposes of section 163(j). In the ab-
sence of this clarity, the likelihood that
different taxpayers would reach different
conclusions over whether a particular
business expense was deductible business
interest expense would be exacerbated. In
general, overall economic performance is
enhanced when businesses face more uni-
form signals about tax treatment. Another
concern about not defining the term at all
is that taxpayer uncertainty over whether
certain transactions are considered interest
could increase burdens to the IRS and tax-
payers including with respect to disputes
and litigation about whether particular
payments are interest for section 163(j)
purposes.
A further concern, over providing a
narrower definition of interest, is that it
could encourage taxpayers to engage in
transactions that provide financing while
generating deductions economically simi-
lar to interest but that were not defined as
interest for the purposes of section 163(j).
There are several reasons why curbing
such taxpayer behavior would be ben-
eficial. First, the ability of taxpayers to
engage in such transactions is correlated
with the size of the trade or business, with
large businesses more likely to benefit
from such avoidance strategies than small
businesses. Second, when the deciding
factor for using such transactions is the
tax benefit of avoiding a section 163(j)
limitation, then such transactions would
impose more cost or risk on the taxpayer
than using a traditional debt instrument.
Engaging in such transactions is an ineffi-
cient use of resources. Third, such avoid-
ance strategies may discourage taxpayers
from shifting to a less leveraged capital
structure, and thus would counteract the
intention of the statute to reduce the prev-
alence of highly-leveraged firms and the
probability of systemic financial distress.
Fourth, greater use of financing outside of
conventional debt instruments may make
it more difficult for financial institutions
to determine the overall level of leverage
and credit risk of firms seeking financing,
which may distort the allocation of capital
across businesses away from firms and in-
vestments with less credit risk
The final regulations prescribe a defini-
tion of interest that is similar to the defini-
tion of interest in the proposed regulations
although with changes made in response
to comments.
4
There are three general
types of changes: (1) Changes are made
to the proposed regulations that modify,
and generally limit, to what extent certain
amounts are included under the defini-
tion of interest for the purposes of section
163(j). (2) Several items deemed to be
interest for the purpose of section 163(j)
under proposed §1.163(j)-1(b)(20)(iii)
are not included in the final regulations.
(3) The anti-avoidance rule in proposed
§1.163-1(b)(20)(iv) is modified to include
a principal purpose test and now also ap-
plies to situations where a taxpayer seeks
to artificially increase the amount of inter-
est income.
To the extent that these changes narrow
the definition of interest that is subject to
the section 163(j) limitation relative to the
proposed regulations, they are expected to
(i) reduce the cost of financing for taxpay-
ers, an effect that is expected to increase
investment by these taxpayers, and (ii)
increase the proportion of that financing
that might generally be considered debt-fi-
nanced. The first effect occurs because
taxpayers can deduct without limitation
costs from a larger set of financial instru-
ments under the final regulations, relative
to the proposed regulations. They will
choose these instruments only if the cost
of obtaining funds through those instru-
ments is lower than what would have been
available under the proposed regulations.
By extension, this change lowers the over-
all cost of financing for taxpayers. A lower
cost of financing is associated with greater
investment by taxpayers, all other things
equal. The second effect occurs because
the larger set of financial instruments for
which taxpayers can deduct expense with-
out limitation (under the final regulations,
relative to the proposed regulations) gen-
erally consists of instruments that have a
greater share of debt characteristics, rather
than equity characteristics. To the extent
that taxpayers use these instruments to
a greater degree under the final regula-
tions relative to the proposed regulations,
the share of debt-financing will increase.
Congress has generally expressed the
view that excessive debt-financing may be
a less efficient capital structure for firms.
See Senate Budget Explanation of the Bill
at 165.
4
The proposed regulations represent the regulatory alternative to which the final regulations are compared in the following analysis.

Bulletin No. 2020–40 685 September 28, 2020
Because the final regulations define in-
terest based on the intent and purpose of
the statute and generally treat similar tax-
payers similarly and similar economic ac-
tivity similarly, the Treasury Department
and the IRS have determined that the net
result under these final regulations is a
more efficient allocation of capital across
taxpayers relative to regulatory alterna-
tives, within the context of the intent and
purpose of the statute.
The Treasury Department and the IRS
have not undertaken quantitative esti-
mates of the change in the level or nature
of economic activity arising from the fi-
nal regulations relative to the proposed
regulations due to limitations on avail-
able data, but to the extent possible has
provided further below an estimate of the
quantity of potentially affected taxpayers
and volume of transactions. Consider,
for example, the treatment of guaranteed
payments for the use of capital provided
by a partner to a partnership, a financial
arrangement that has both equity and debt
characteristics. The proposed regulations
included guaranteed payments to capital
in the definition of interest while the final
regulations do not, except to the extent
that they are covered by other provisions
of the final regulations. The Treasury De-
partment and the IRS have not undertaken
quantitative estimates of this regulatory
decision because we do not have readily
available data or models to measure with
sufficient precision: (i) the volume and na-
ture of guaranteed payments to capital and
other financial instruments that taxpayers
might use if the final regulations were in
effect; (ii) the volume and nature of guar-
anteed payments and other financial in-
struments that taxpayers might have used
if the proposed regulations were in effect;
and (iii) the types of economic activities
that partnerships might undertake under
these two financial portfolios. Regarding
item (iii), the Treasury Department and
the IRS do not have readily available data
or models to predict how economic activi-
ty might differ under debt-financed versus
equity-financed investment for the sets of
instruments affected by these final regu-
lations.
Compliance costs are also expected to
be lower for those transactions that are
not subject to the section 163(j) limita-
tion under the final regulations and that
would be subject to the limitation under
the proposed regulations. Generally, this
is because taxpayers would be less like-
ly to need to calculate the section 163(j)
limitation and less likely to need to track
unused interest deductions that are carried
forward to future tax years. For most tax-
payers, this impact on compliance costs is
expected to be relatively small. However,
for certain taxpayers using hedging trans-
actions, calculating the amount of interest
associated with the transactions would be
burdensome and not including such trans-
actions in the definition of interest lowers
compliance costs to a greater degree. The
Treasury Department and the IRS have
not estimated the reduction in compliance
costs for these taxpayers (under the final
regulations, relative to the proposed reg-
ulations) because we do not have data or
models that are suitable for this estima-
tion.
The specific changes made with regard
to items (1), (2), and (3) are discussed in
further detail here.
(1) The final regulations change (rel-
ative to the proposed regulations) how
amounts from certain transactions will
be considered interest for the purposes of
section 163(j). There are two main forms
of transactions that are affected:
Treatment of swaps. The proposed reg-
ulations treated a non-cleared swap with
significant non-periodic payments as two
separate transactions consisting of an
on-market, level payment swap and a loan
(the embedded loan rule).
5
The time value
component associated with the embedded
loan is recognized as interest expense to
the payor and interest income to the recip-
ient. The treatment of cleared swaps was
not specified in the proposed regulations.
The final regulations add two exceptions
to the embedded loan rule. Specifically,
the final regulations add exceptions for
cleared swaps and for those non-cleared
swaps that require the parties to meet the
margin or collateral requirements of a fed-
eral regulator (or requirements that are
substantially similar to a federal regula-
tor). Relative to the proposed regulations
this treatment will discourage taxpayers
from using swaps that are unregulated and
dissimilar to regulated swaps, because un-
der the final regulations only such swaps
will require the time value component
associated with the embedded loan to be
treated as interest. One reason for except-
ing both regulated and non-regulated col-
lateralized swaps from the definition of
interest is that the repayment risk of us-
ing such transactions is small, while the
non-collateralized swaps are more risky as
individual transactions and would be like-
ly to contribute to the overall riskiness of
the financial system.
Substitute interest payments. The pro-
posed regulations provided that certain
substitute interest payments will be treat-
ed as interest for the purposes of section
163(j).
6
The final regulations modify the
treatment of substitute interest payments
by only including such transactions as
interest when the transaction is not part
of the ordinary course of business of the
taxpayer. The Treasury Department and
the IRS have determined that the ordinary
course rule in the final regulations pro-
vides an appropriate and effective limit
on the treatment of substitute interest as
interest for section 163(j) purposes. This
change has the effect of reducing the
amount of substitute interest payments
that will be deemed interest for the pur-
pose of section 163(j) relative to the pro-
posed regulations.
For taxpayers that use substitute in-
terest payments in the ordinary course of
business, the final regulations may low-
er the after-tax cost of such transactions
and such taxpayers are more likely to use
transactions with substitute interest pay-
ments relative to the proposed regulations.
The Treasury Department and the IRS do
not have readily available data or models
to estimate either (i) the change in financ-
ing arrangements, including both substi-
tute interest payments and other financial
instruments, that will be used by taxpayers
under this provision of the final regula-
tions relative to the proposed regulations,
or (ii) the change in the volume or nature
5
A cleared swap is a collateralized swap that was cleared by a derivatives clearing organization or by a clearing agency. A non-cleared swap is a swap that has not been so cleared.
6
A substitute interest payment is a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to an interest pay-
ment which the owner of the transferred security is entitled to receive during the term of the transaction. This provision applies to substitute interest payments as described in §1.861-2(a)(7).

September 28, 2020 686 Bulletin No. 2020–40
of economic activity by these taxpayers
given these financing arrangements.
(2) The items removed by the final reg-
ulations from the definition of interest in
the proposed regulations include debt is-
suance costs, guaranteed payments for the
use of capital provided by a partner to a
partnership, and hedging transactions.
7

Under the final regulations, these items
can still be considered interest under the
anti-avoidance rule. These items share
some characteristics with interest, but
comments received on the proposed reg-
ulations indicate there is not a consensus
that such items should always be defined
as interest. Removing these items from the
definition of interest lowers compliance
costs for taxpayers in some cases relative
to the proposed regulations. However, not
including these items in the definition of
interest increases uncertainty regarding
whether amounts from certain transac-
tions will be treated as interest under the
anti-avoidance rule, and more disputes are
likely to arise between taxpayers and the
IRS.
The final regulations do not include
debt issuance costs, such as legal fees for
document preparation, in the definition of
interest. Debt issuance costs are usually
small relative to total interest payments
in a lending transaction and often the pay-
ments are made to a third-party who is not
the lender. Hence, there is limited ability
for taxpayers to be able to disguise interest
payments as debt issuance costs. The pri-
mary effect of not including debt issuance
costs in the definition of interest is to de-
crease the after-tax cost of debt financing.
The final regulations do not include
hedging transactions in the definition of
interest. Taxpayers could have multiple
reasons for engaging in hedging transac-
tions other than just to lower the amount
of interest expense, such as a reduction
in risk. Not including hedging transac-
tions in the definition of interest should
decrease administration and compliance
costs compared to the treatment in the
proposed regulations since it can be diffi-
cult to separate the time value component
from the insurance aspects of a hedging
transaction. Under the final regulations,
taxpayers are more likely to use hedging
relative to the proposed regulations due to
the decline in compliance costs and due to
the reduced after-tax cost of using hedges.
The final regulations do not include
guaranteed payments in the definition of
interest. Guaranteed payments for the use
of capital provided by a partner to a part-
nership have both equity and debt char-
acteristics. The partner who provided the
capital is an owner of the business, but
also receives payments that are similar to
interest. Removing guaranteed payments
from the definition of interest lowers the
after-tax cost of such financing for some
taxpayers and may lead these taxpayers to
increase the fraction of financing through
capital with guaranteed payments relative
to other financial instruments. The Trea-
sury Department and the IRS do not have
readily available data or models to proj-
ect the change in the volume or nature of
businesses’ economic activities that would
arise as a consequence of this change in
the tax treatment of guaranteed payments
to capital, relative to the proposed regu-
lations.
(3) The final regulations also modi-
fy the anti-avoidance rule found in pro-
posed §1.163-1(b)(20)(iv) relative to the
proposed rule. One change is that the
anti-avoidance rule not only applies to
financing transactions used to avoid the
classification of financing expense as in-
terest expense, but also excludes transac-
tions that artificially increase the taxpay-
er’s interest income from being included
as interest income. The final regulations
also add a principal purpose condition to
the anti-avoidance rule. That is, the an-
ti-avoidance rule in the final regulations
only applies to amounts where a principal
purpose of the taxpayer for engaging in
a transaction is to artificially reduce the
amount of net business interest expense,
whether this stems from a decrease in the
amounts reported as interest expense or
an increase in the amounts reported as in-
terest income. This symmetric anti-avoid-
ance rule adopted under the final regula-
tions, applying to both interest income and
interest expense, increases the number of
transactions to which the rule could po-
tentially apply compared to the proposed
regulations. However, including a princi-
pal purpose test in the anti-avoidance rule
will decrease how often the rule would po-
tentially apply to transactions relative to
the proposed rule.
The anti-avoidance rule is an import-
ant component of the definition of inter-
est because it is difficult for the Treasury
Department and the IRS to specifically
categorize every type of transaction al-
ready in practice or to anticipate future
innovations in financial transactions.
Relative to regulatory alternatives, the
anti-avoidance rule will help limit the
ability of taxpayers to structure transac-
tions in such a way that would allow de-
ductible expenses that are economically
similar to interest and frustrate the appli-
cation of the statute. In summary, the defi-
nition of interest in the final regulations
provides clarity to taxpayers and the IRS
regarding which specific transactions and
types of transactions generate interest
subject to the section 163(j) limitation,
which should lower compliance and ad-
ministrative costs relative to providing
no definition or a narrower definition of
interest. The Treasury Department and
the IRS further have determined that the
definition of interest specified under the
final regulations will encourage a more
efficient allocation of capital and use of
financing across taxpayers relative to the
no-action baseline, within the context of
the intent and purpose of the statute.
Number of Affected Taxpayers. The
Treasury Department and the IRS estimate
that the number of partnerships potential-
ly affected by the change in treatment to
guaranteed payments for the use of capi-
tal provided by a partner to a partnership
is 6,000. This is the number of partner-
ships in tax year 2017 with more than $25
million in gross receipts that also report
paying deductible guaranteed payments.
The amount of total guaranteed payments
reported by these partnerships is approx-
imately $30 billion. However, it is not
known to what extent these guaranteed
payments are made to capital or labor, as
the tax form for that tax year did not distin-
guish between the two types of guaranteed
7
Commitment fees are also not included in the definition of interest in the final regulations, but may be addressed as part of another guidance project on the treatment of fees relating to debt
instruments and other securities in the future.

Bulletin No. 2020–40 687 September 28, 2020
payments. Beginning in 2019, Form 1065
will separately report those two types of
guaranteed payments.
It is not possible to provide a meaning-
ful estimate of the number of taxpayers
potentially affected by the final regula-
tions that have deductible debt issuance
costs, substitute interest payments, or
amounts from swaps or hedging transac-
tions, because those amounts are not re-
ported separately on a tax return.
4. Economic Effects of Provisions not
Substantially Revised from the Proposed
Regulations
a. Calculation of excess business
interest expense, excess business interest
income, and excess taxable income for
partnerships and S corporations
The statute applies broadly to different
types of entities, including passthrough
entities, such as partnerships and S corpo-
rations. The statute specifies that the sec-
tion 163(j) limitation applies at the entity
level for a partnership but that items such
as excess business interest expense and
excess taxable income must be allocated
to partners for a variety of reasons in-
cluding to compute their own 163(j) lim-
itation. The statute further specifies that
the items should be allocated in the same
manner as “nonseparately stated tax-
able income or loss of the partnership”;
however, this concept had not previous-
ly been defined by statute or regulations
prior to the proposed regulations. In the
absence of guidance, partnerships would
have significant uncertainty in determin-
ing which partners receive excess items.
This uncertainty could lead one partner-
ship to undertake an activity that another
partnership might decline to take based
solely on different expectations about tax
treatment of interest income rather than
underlying productivity differences or
economic signals.
The final regulations provide guidance
on how to allocate partnership excess
business interest expense, excess business
interest income, and excess taxable in-
come to partners. The allocation method
detailed in the final regulations follows a
number of principles. First, it ensures that
the sum of the excess items at the partner
level is equal to the total at the partner-
ship level. Second, it ensures that the part-
nership does not allocate excess business
interest expense to a partner that was al-
located items that include ATI and busi-
ness interest income that supported the
partnership’s deductible business interest
expense (unless the partner was allocat-
ed more interest expense than its share of
deductible business interest expense). Fi-
nally, it ensures that the partnership allo-
cates any excess taxable income or excess
business interest income to partners that
are allocated more items comprising ATI
or business interest income than necessary
to support their allocation of business in-
terest expense.
The final regulations thus provide a
method to ensure that all partnerships allo-
cate these items consistently and in a way
that matches income and interest expense,
thus promoting economically efficient in-
vestment decisions across taxpayers and
across financing options, relative to the
no-action baseline.
b. Interest income inclusion for owners of
partnerships and S corporations
The final regulations ensure that, for
owners of partnerships and S corpora-
tions, business interest income is used
only once, at the entity level, in offset-
ting business interest expenses. It there-
by avoids exacerbating the incentive to
seek out interest income relative to oth-
er forms of less economically produc-
tive income in order to avoid the section
163(j) limitation, relative to the no-action
baseline.
c. Rules related to excepted businesses
For purposes of section 163(j), the
statute states in section 163(j)(7) that the
term “trade or business” does not include
certain regulated utilities, or an elect-
ing real property trade or business or an
electing farming business. The final reg-
ulations clarify whether a trade or busi-
ness could elect as a farming business or
a real property trade or business and thus
be excepted from section 163(j). Specif-
ically, §1.163(j)-9 provides guidance in
applying the rules for farming and real
property trade or business elections. For
an electing real property trade or business
and electing farming business, the statue
specifies that “any such election shall be
made at such time and in such manner as
the Secretary shall prescribe, and once
made, shall be irrevocable.” Therefore
§1.163(j)-9 provides taxpayers with the
time and manner for electing real property
trades or businesses and electing farming
businesses. In addition, the final regula-
tions define the conditions under which an
election terminates.
In the absence of specific guidance,
taxpayers may engage in behavior that
counteracts the intent and purpose of the
statute and would not otherwise be taken
except to avoid the irrevocable nature of
the election the statute specified. The fi-
nal regulations increase the likelihood
that taxpayers interpret the ‘irrevocable’
designation similarly and do not engage
in tax-motivated behavior by appearing to
cease operations in an effort to change an
irrevocable designation.
In addition, §1.163(j)-9(h) provides a
safe harbor for certain REITs to elect to
be electing real property trades or busi-
nesses. A special rule applies to REITs
for which 10 percent or less of the value
of the REIT’s assets are real property fi-
nancing assets. Under this rule, all of the
assets of the REIT are treated as real prop-
erty trade or business assets. The benefit
of the safe harbor is to provide REITs the
same tax treatment and apply the same
general rules as apply to other taxpay-
ers, an economically efficient approach.
The special rule threshold of 10 percent
for real property financing assets has the
benefit of maintaining consistency with
section 856(c)(4), which uses the same
values for the REIT asset test at the close
of the REIT’s taxable year. Taxpayers will
benefit in reduced compliance time and
cost in applying new rules if the rules are
consistent with other rules that they must
comply with under the Code. An estimate
of the compliance cost savings that would
be due to this cross-code consistency, rel-
ative to regulatory alternatives, is beyond
the capabilities of the IRS’s compliance
model.
In addition, the final regulations pro-
vide a rule that stipulates that if at least 80
percent of a trade or business’s real prop-
erty (by fair market value) is leased to a
trade or business under common control
with the real property trade or business,
the trade or business cannot make an elec-

September 28, 2020 688 Bulletin No. 2020–40
tion to be an electing real trade or busi-
ness. In the absence of such a rule, taxpay-
ers could restructure their business such
that real estate components of non-real
estate businesses are separated from the
rest of their business to artificially reduce
the application of section 163(j) by leas-
ing the real property to the taxpayer and
electing this “business” to be an excepted
real property trade or business. Therefore,
the prime benefit of this rule is to preserve
the intent of the statute of allowing elec-
tions in the real property sector without
incentivizing other sectors of the econ-
omy to restructure their business for the
sole intent of avoiding the section 163(j)
limitation.
The Treasury Department and the IRS
received no comments requesting that the
percentage amounts be changed.
Number of Affected Taxpayers. The
Treasury Department and the IRS project
that nearly 3,500 REITs are potentially
affected by the provision in the final reg-
ulations that allows REITs for which 10
percent or less of the value of the REIT’s
assets are real property financing assets
to elect to treat all of its assets as allo-
cable to an excepted real property trade
or business. This estimate is based the
number of REITs in the SOI sample of
corporate taxpayers for 2017 that identi-
fy as an Equity REIT. An Equity REIT is
identified by a check-box on form 1120-
REIT where the choice is Equity REIT or
Mortgage REIT. The Mortgage REIT cat-
egory should be chosen by the taxpayer
if the primary source of gross receipts is
derived from mortgage interest and fees.
These Equity REITs reported $1.7 trillion
in total assets.
The Treasury Department and the IRS
project that roughly 2.8 million filers are
potentially affected by provisions of the
final regulations that affect electing real
property trades or businesses or electing
farm businesses. This estimate is based
on a count of all filers with NAICS codes
starting with 111 or 112 (farming), and
531 (real property) with at least $10 mil-
lion in gross receipts in taxable year 2017.
d. Allocation rules between excepted and
non-excepted trades or businesses
The statute is silent over how ATI,
interest income, and expense should be
allocated between excepted and non-ex-
cepted trades or businesses. Thus, the
Treasury Department and the IRS decid-
ed to provide taxpayers with an allocation
method. Because allocation, by whatever
method, is costly for taxpayers, the final
regulations further provide that allocation
is only required when the share of the as-
set tax basis in both the excepted and the
non-excepted trades or businesses exceeds
10 percent. In other words, if the share for
either excepted or non-excepted trades or
businesses is 10 percent or less, allocation
is not required. The Treasury Department
and the IRS received no comments that
addressed the 10 percent threshold pro-
vided in this provision.
In terms of the allocation method, the
Treasury Department and the IRS decided
in the final regulations to require taxpay-
ers to allocate interest expense and inter-
est income between related excepted and
non-excepted trades or businesses based
on the relative amounts of the taxpayer’s
adjusted tax basis in the assets used in
its excepted and non-excepted trades or
businesses. As discussed in the Explana-
tion of Provisions section of the proposed
regulations, this general method of alloca-
tion reflects the fact that money is fungi-
ble and the view that interest expense is
attributable to all activities and property,
regardless of any specific purpose for in-
curring an obligation on which interest
is paid. This asset basis approach is con-
sistent with the regulations under section
861. Because this approach is familiar to
taxpayers and consistent with other parts
of the Code, taxpayers benefit in reduced
time and cost spent learning and applying
the rules, relative to alternative regulatory
approaches. An estimate of the compli-
ance cost savings that would be due to this
familiarity and cross-code consistency,
relative to regulatory alternatives, is be-
yond the capabilities of the IRS’s compli-
ance model.
The Treasury Department and the IRS
considered several alternatives to this as-
set basis approach for allocating interest
income and expense. First, a tracing ap-
proach was considered whereby taxpayers
would be required to trace disbursements
of debt proceeds to specific expenditures.
However, tracing would impose a signifi-
cant compliance burden on taxpayers due
to the complexity of matching interest in-
come and expense among related compa-
nies. Further, it is not clear how taxpayers
would retroactively apply a tracing regime
to existing debt. In particular, because C
corporations would have had no reason
to trace the proceeds of any existing in-
debtedness, imposing a tracing regime on
existing indebtedness would require cor-
porations to reconstruct the use of funds
within their treasury operations at the time
such indebtedness was issued, even if the
issuance occurred many years ago, and
even if the funds were used for a myriad of
purposes across a large number of entities.
Such an approach would impose substan-
tial compliance costs and may be imprac-
tical or even impossible for indebtedness
issued years ago.
Moreover, because money is fungible,
a tracing regime would be distortive and
subject to manipulation. Although taxpay-
ers are impacted from both a commercial
and tax perspective by the amount of cap-
ital raised through the issuance of equity
and indebtedness, any trade or business
conducted by a taxpayer is generally in-
different to the source of funds. As a re-
sult, if taxpayers were allowed to use a
tracing regime to allocate indebtedness to
excepted trades or businesses, there would
be an incentive to treat excepted trades or
businesses as funded largely from indebt-
edness, and to treat non-excepted trades or
businesses as funded largely from other
types of funding, such as equity funding,
despite the fact that, as an economic mat-
ter, all of a taxpayer’s trades or businesses
are funded based on the taxpayer’s overall
capital structure.
The Treasury Department and the IRS
rejected a tracing approach because the
complexity of such an approach could be
more difficult for taxpayers and the IRS
to administer and would create too great
an incentive to structure financing with
the sole purpose of avoiding the appli-
cation of the statute, relative to the final
regulations. The assumption that a trade
or business is indifferent to its source of
funds may not be appropriate in cases in
which certain indebtedness is secured by
the assets of the trade or business and
cash flow from those assets is expected
to support the payments required on the
indebtedness. The final regulations pro-
vide for a limited tracing rule in those
cases.

Bulletin No. 2020–40 689 September 28, 2020
The Treasury Department and the IRS
also considered allocating interest ex-
pense based on the relative fair market
value of the assets used in excepted and
non-excepted trades or businesses. How-
ever, determinations of fair market value
frequently are burdensome for taxpayers,
which may have numerous assets with-
out a readily established market price.
For this reason, disputes between tax-
payers and the IRS over the fair market
value of an asset are a common and cost-
ly occurrence. In the TCJA, Congress
repealed the use of fair market value in
the apportionment of interest expense
under section 864 of the Code (see sec-
tion 14502(a) of the TCJA) and claimed
that the ability to elect to allocate interest
expense under section 864 on the basis
of fair market value of assets has led to
inappropriate results and needless com-
plexity. See Senate Budget Explanation
of the Bill at 400. Thus, the Treasury De-
partment and the IRS have determined
that allocating interest expense based on
relative amounts of asset basis is more
appropriate than a regime based on the
relative fair market value of assets.
The Treasury Department and the
IRS also considered allocating interest
expense to excepted and non-excepted
trades or businesses based on the relative
amounts of gross income generated by
such trades or businesses. However, gross
income is more variable and volatile than
asset basis, in part because it is based on
an annual measurement. Methods could
be developed to look at multiple years
of gross income through an averaging or
other smoothing methodology, but any
such approach would necessarily create
a number of difficult technical questions
because the income of different trades or
businesses may be subject to differing
business cycles and the taxpayers may
exert control over the timing of income
items, which may lead taxpayers to make
tax-driven business decisions with no ac-
companying general economic benefit. In
the TCJA, Congress also repealed the use
of gross income in the apportionment of
interest expense under section 864 of the
Code (see section 14502(a) of the TCJA).
Thus, the Treasury Department and the
IRS have determined that allocating in-
terest expense based on relative amounts
of asset basis is more appropriate than a
regime based on the relative amounts of
gross income.
Number of Affected Taxpayers. The
Treasury Department and the IRS esti-
mate that roughly 83,000 firms had allo-
cated interest income and expenses among
multiple trades or businesses in tax year
2015 and thus are potentially affected by
provisions of the final regulations that af-
fect the annual allocation statement. This
estimate is based on a count of all Forms
1120, 1120S, and 1065 in tax year 2015 in
real estate, farming, and public utilities in-
dustries that had over $25 million in gross
receipts.
II. Paperwork Reduction Act
The collections of information con-
tained in the final regulations have been
submitted to the Office of Management
and Budget for review in accordance with
the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). An agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of in-
formation unless it displays a valid control
number assigned by the Office of Man-
agement and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
return information are confidential, as re-
quired by section 6103.
A. Collections of Information Imposed
by the Regulations
The collections of information imposed
directly by these regulations are contained
in §§1.163(j)-1(b)(15)(iii), 1.163(j)-2(b)
(2)(ii), 1.163(j)-2(b)(3), 1.163(j)-9 and
1.163(j)-10.
The collection of information in
§§1.163(j)-1(b)(15)(iii) and 1.163(j)-9,
the election statement, is required for tax-
payers to make a one-time election to treat
their regulated utility trade or business,
real property trade or business or farming
trade or business as an electing excepted
regulated utility trade or business, elect-
ing real property trade or business under
section 163(j)(7)(B) or an electing farm-
ing business under section 163(j)(7)(C).
The election to be an excepted regulated
utility trade or business was not in the pro-
posed regulations. The scope of taxpayers
eligible to make an election to be an ex-
cepted real property or farming trade or
business has changed from the proposed
regulations. As discussed in part X of the
Summary of Comments and Explanation
of Revisions section, under the proposed
regulations, taxpayers that met the small
business exemption test under section
448(c) were not able to make an election
for their trade or business to be an electing
real property trade or business or an elect-
ing farming business because they were
already not subject to the limitation. Un-
der the final regulations, those taxpayers
are eligible to make a protective election.
Additionally, under the proposed regula-
tions, it was unclear whether taxpayers
that were unsure of whether their activity
constitutes a trade or business under sec-
tion 162 could make an election. The final
regulations clarify that a taxpayer that is
unsure whether its activity constitutes a
trade or business under section 162 is eli-
gible to make an election.
The collections of information in
§§1.163(j)-2(b)(2)(ii) and 1.163(j)-2(b)(3)
are required to make two elections relat-
ing to changes made to section 163(j)(10)
by the CARES Act. The election under
§1.163(j)-2(b)(2)(ii) is for a taxpayer to
use the 30 percent ATI limitation instead
of the 50 percent ATI limitation when cal-
culating the taxpayer’s section 163(j) lim-
itation for a 2019 or 2020 taxable year, as
provided in section 163(j)(10)(A)(i) and
(iii). The election under §1.163(j)-2(b)
(2) is for a taxpayer to use the taxpayer’s
ATI for the last taxable beginning in 2019
as its ATI for any taxable year beginning
in 2020, as provided in section 163(j)
(10)(B). Revenue Procedure 2020-22 de-
scribes the time and manner for making
these elections. See also §1.163(j)-2(b)
(4).
Taxpayers make the elections by time-
ly filing a Federal income tax return or
Form 1065, including extensions, an
amended Federal income tax return,
amended Form 1065, or administrative
adjustment request, as applicable. More
specifically, taxpayers complete the
Form 8990, Limitation on Business In-
terest Expense under Section 163(j), us-
ing the 30 percent ATI limitation and/ or
using the taxpayer’s 2019 ATI, as appli-

September 28, 2020 690 Bulletin No. 2020–40
cable. No formal statements are required
to make these elections. Accordingly,
for Paperwork Reduction Act purposes,
the reporting burden associated with the
collections of information in §§1.163(j)-
2(b)(2)(ii) and 1.163(j)-2(b)(3) will be
reflected in the IRS Form 8990 Paper-
work Reduction Act Submissions (OMB
control number 1545-0123).
The collection of information in
§1.163(j)-10, the allocation statement, is
required for taxpayers to demonstrate how
they allocated their interest expense, inter-
est income, and other items of income and
deduction between excepted and non-ex-
cepted trades or businesses. The mechan-
ics of the allocation statement, and the
scope of taxpayers required to file the al-
location statement, have not changed from
the proposed regulations.
Section 1.163(j)-10 in the final reg-
ulations contains another collection of
information, an allocation methodology
change request, requiring taxpayers to re-
quest the Commissioner’s permission to
change a methodology for allocating the
basis in an asset that is used in multiple
trades or businesses if the request is be-
ing made within five years of any prior
change. This requirement does not cre-
ate a new burden because the allocation
methodology change request is made by
following the procedures for requesting
a letter ruling in section 7.01 of Revenue
Procedure 2020-1, 2020-1 IRB 1. Reve-
nue Procedure 2020-1 was approved by
the Office of Management and Budget in
accordance with the Paperwork Reduc-
tion Act (44 U.S.C. § 3507) under control
number 1545-0123.
In 2018, the Treasury Department and the
IRS considered developing a form election
and allocation statement under §§1.163(j)-9
and 1.163(j)-10 for taxpayers to make the
one-time election and to demonstrate their
interest allocation. To minimize taxpayer
burden, the Treasury Department and the
IRS decided that, for now, taxpayers should
be allowed to use their own election form
and allocation statement. In the future, if the
Treasury Department and the IRS develop
election or allocation form, the draft ver-
sions of the forms will be posted for com-
ment at https://apps.irs.gov/app/picklist/
list/draftTaxForms.html.
Certain forms have been modified with
simple questions to signal whether the
taxpayer is subject to section 163(j). The
Treasury Department and the IRS are con-
sidering modifying certain forms with a
checkbox to note that a taxpayer has made
an election for a trade or business to be an
electing real property trade or business or
electing farming business.
For the allocation methodology
change request in §1.163(j)-10, the Trea-
sury Department and the IRS initially
determined that taxpayers should file a
change request any time there is a change
in methodology. However, a change in
allocation methodology presents a bur-
den for taxpayers. The disadvantages
of changing an allocation methodology
regularly, including the administrative
and accounting costs associated with any
such change, outweigh the advantages of
changing an allocation methodology reg-
ularly. Accordingly, the Treasury Depart-
ment and the IRS do not anticipate tax-
payers using the allocation methodology
change request regularly. The final reg-
ulations require the request to be made
only if a change has not been made in the
past 5 years. To minimize any compli-
ance burden, the procedures in Revenue
Procedure 2020-1, which are familiar to
taxpayers, apply for the allocation meth-
odology change request.
B. Burden Estimates
The following burden estimates are
based on the information that is avail-
able to the IRS, and have been updated
from the proposed regulations to take
into account the new election for certain
regulated utility trades or businesses, the
increased scope of potential filers for the
election statement and to use 2017 Statis-
tics of Income (SOI) tax data where avail-
able.
The most recently available 2017
SOI tax data indicates that approximate-
ly 8,208 filers are possible for the one-
time election to opt out of the section
163(j) limitation as an electing excepted
regulated utility trade or business. This
estimate was based on a count of Form
1065, 1065B, 1120 and 1120-S filers with
NAICS codes starting with 2211 (elec-
tric power generation, transmission and
distribution), 2212 (natural gas distribu-
tion), and 2213 (water, sewage and other
systems).
The 2017 SOI tax data indicates that
approximately 2,838,981 filers are pos-
sible for the one-time election to opt
out of the section 163(j) limitation as an
electing real property trade or business
or as an electing farming business were
the statute then in effect. This estimate is
based on a count of all filers with NAICS
codes starting with 111 or 112 (farming),
and 531 (real property) with at least $10
million in gross receipts in taxable year
2017. The increase in potential filers
from the number provided in the pro-
posed regulations is due exclusively to
the fact that the final regulations pro-
vide that taxpayers that satisfy the small
business exemption are eligible to file an
election.
For the election to use the 30 percent
ATI limitation for a 2019 or 2020 tax-
able year under §1.163(j)-2(b)(ii), while
any taxpayer subject to the section 163(j)
limitation is eligible to make the election,
the Treasury Department and the IRS es-
timate that only taxpayers that actively
want to reduce their deductions will make
this election. The application of the base
erosion minimum tax under section 59A
depends, in part, on the amount of a tax-
payer’s deductions. Accordingly, the Trea-
sury Department and the IRS estimate that
taxpayers that are subject to both the base
erosion minimum tax under section 59A
and section 163(j) are the potential filers
of this election. Using the 2017 SOI tax
data, the Treasury Department estimate
that 3,376 firms will make the election.
This estimate was determined by examin-
ing the number of C corporations with at
least $500,000,000 in gross receipts, that
do not have an NAICS code associated
with a trade or business that is generally
not subject to the section 163(j) limitation
(2211 (electric power generation, trans-
mission and distribution), 2212 (natural
gas distribution), 2213 (water, sewage and
other systems), 111 or 112 (farming), 531
(real property)).
For the election to use the taxpayer’s
2019 ATI in 2020 under §1.163(j)-2(b)
(3), the Treasury Department and the IRS

Bulletin No. 2020–40 691 September 28, 2020
estimate that 72,608 firms will make the
election. This figure was determined,
using 2017 SOI tax data, by examining
Form 1040, Form 1120, Form 1120S, and
Form 1065 filers with more than $26M in
gross receipts, that have reported inter-
est expense, and do not have an NAICS
code associated with any trade or business
that is generally not subject to the section
163(j) limitation.
The Treasury Department and the IRS
continue to estimate the same number of
filers, 82,755, for the annual allocation
statement as was projected in the proposed
regulations. Using the 2015 SOI tax data,
the Treasury Department and the IRS esti-
mate that 82,755 firms will have allocated
interest income and expenses among mul-
tiple trades or businesses, some of which
are excepted from the section 163(j) limita-
tion and some that are not. This estimate is
a count of all tax Forms 1120, 1120S, and
1065 in real estate, farming, and public util-
ities industries that had over $25 million in
gross receipts. While the number of affect-
ed taxpayers will increase with growth in
the economy, the Treasury Department and
the IRS expect that the portion of affected
taxpayers will remain approximately the
same over the foreseeable future.
The time and dollar compliance bur-
den are derived from the Business Tax-
payers Burden model provided by the
IRS’s Office of Research, Applied Ana-
lytics, and Statistics (RAAS). This model
relates the time and out-of-pocket costs
of business tax preparation, derived from
survey data, to assets and receipts of af-
fected taxpayers along with other relevant
variables. See “Tax Compliance Burden”
(John Guyton et al, July 2018) at https://
www.irs.gov/pub/irs-soi/d13315.pdf. A
respondent may require more or less time
than the estimated burden, depending on
the circumstances.
The burden estimates listed in the be-
low table attempt to capture only those
discretionary changes made in these pro-
posed regulations, and may not include
burden estimates for forms associated
with the statute. Changes made by the Act
or through new information collections
are captured separately in forthcoming
published “Supporting Statements” for
each of these forms and will be aggre-
gated with the estimates provided below
to summarize the total burden estimates
for each information collection listed be-
low. Those total burden estimates will be
available for review and public comment
at https://www.reginfo.gov/public/For-
ward?SearchTarget=PRA&textfield. The
Treasury Department and the IRS request
comment on these estimates.
Likely RespondentsEstimated
number of
respondents
Estimated
average
annual
burden
hours per
respondent
Estimated
total annual
reporting
burden
(hours)
Estimated
monetized
burden @
$95/hour
($millions)
Estimated
frequency
of responses
Section 1.163(j)-
1(b)(15)(iii)
(one-time election
statement (2017
Levels)
Corporations and partnerships
with regulated utility trades or
businesses
8,028 business
respondents (in-
cluding Forms
1120, 1120-S,
and 1065 filers)
0 to 30
minutes
(estimated
average: 15
minutes)
2,007$190,665One-time
Section 1.163(j)-
2(b)(ii) (election to
apply the 30 percent
ATI percentage)
C corporations with more than
$500M in gross receipts
3,376 business
respondents
(Form 1120
filers)
See Form
8990
See Form
8990
See Form
8990
See Form
8990
Section 1.163(j)-
2(b)(3)
(election to use
2019 ATI as 2020
ATI)
Individuals, corporations, and
partnerships with more than
$26M in gross receipts and not
part of an excepted trade or
business
72,608 business
respondents
(including
Form 1120,
Form 1120-S,
and Form 1065
filers)
See Form
8990
See Form
8990
See Form
8990
See Form
8990
Section 1.163(j)-9
(one-time election
statement)
(2017 Levels)
Individuals, corporations, and
partnerships with real property
or farming trades or business-
es with gross receipts exceed-
ing $10 million
2,838,981 busi-
ness respon-
dents (all filers)
0 to 30
minutes
(estimated
average:15
minutes)
70,746$67.4One-time

September 28, 2020 692 Bulletin No. 2020–40
Likely RespondentsEstimated
number of
respondents
Estimated
average
annual
burden
hours per
respondent
Estimated
total annual
reporting
burden
(hours)
Estimated
monetized
burden @
$95/hour
($millions)
Estimated
frequency
of responses
Section 1.163(j)-10
(annual allocation
statement)
(2015 Levels)
Individuals, corporations, and
partnerships (1) with more
than one trade or business (at
least one of which is a real
property or farming trade
or business), and (2) public
utilities, with gross receipts
exceeding the statutory thresh-
old of $25 million
82,755 business
respondents (in-
cluding Forms
1120, 1120-S,
and 1065 filers)
15 minutes
to 2 hours
(estimated
average: 1
hour)
82,755$7.9Annually
Section
1.163(j)-10
(change in alloca-
tion methodology
request)
Individuals, corporations,
and partnerships that want to
change their methodology for
allocating basis among two
or more trades or businesses,
and (1) with more than one
trade or business (at least one
of which is a real property or
farming trade or business), and
(2) public utilities, with gross
receipts exceeding the statuto-
ry threshold of $25 million
See Rev. Proc.
2020-1
See Rev.
Proc. 2020-
1
See Rev.
Proc. 2020-1
See Rev.
Proc.
2020-1
On occasion
Section 1.163(j)-10
(one-time start-up
cost to develop
procedures for filing
an annual allocation
statement)
(2017 Levels)
Same as above82,7554 hours
(start-up
burden)
331,020$31.4One-time
Three year mon-
etized burden
estimate
$40.8Three year
annual aver-
age
The three-year annual average of the
monetized burden for the information col-
lection and resulting from discretionary
requirements contained in this rulemaking
is estimated to be 40.9 million ($2017)
([($190, 665) + ($67.4 million + $31.4 mil-
lion) + ($7.9 million x 3)]/3). To ensure
more accuracy and consistency across its
information collections, the IRS is currently
in the process of revising the methodology
it uses to estimate burden and costs. Once
this methodology is complete, the IRS will
provide this information to reflect a more
precise estimate of burdens and costs.
C. Forms
The IRS has developed Form 8990,
“Limitation on Business Interest Expense
Under Section 163(j),” to facilitate report-
ing of the limitation. The form is posted
at https://www.irs.gov/pub/irs-access/
f8990_accessible.pdf. The Form 8990
instructions are posted at https://www.
irs.gov/pub/irs-pdf/i8990.pdf. The Form
1120 series and the Form 1065 have been
revised to include a question to alert tax-
payers of the need to file a Form 8990.
The instructions to those and other forms
have been revised to include information
about the Form 8990.
As described previously, the reporting
burdens associated with the information
collections in the proposed regulations
are included in the aggregated burden
estimates for OMB control number 1545-
0123 (in the case of filers of Form 1120,
Form 1065 and Form 8990), 1545-0074
(in the case of individual filers), and 1545-
0123 (in the case of filers under Revenue
Procedure 2020-1).
The Treasury Department and the IRS
request comment on all aspects of informa-

Bulletin No. 2020–40 693 September 28, 2020
tion collection burdens related to these reg-
ulations, including estimates for how much
time it would take to comply with the pa-
perwork burdens described previously for
each relevant form and ways for the IRS
to minimize the paperwork burden. In ad-
dition, when available, drafts of IRS forms
are posted for comment at https://apps.irs.
gov/app/picklist/list/draftTaxForms.htm.
Form/
Revenue
Procedure
Type of
Filer
OMB
Number(s)
Status
Business
(NEW Model)
1545-0123
Published in the Federal Register on 10/8/18. Public comment period closed on
12/10/18.
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-
for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd
Individual
(NEW Model)
1545-0074
Limited scope submission (1040 only) on 10/11/18 at OIRA for review. Full ICR
submission for all forms in 2019.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031
Revenue
Procedure
20201
IRS Research
estimates
1545-0123Published in the Internal Revenue Bulletin on January 2, 2020.
Link: https://www.irs.gov/irb/2020-01_IRB
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that the final regulations will not
have a significant economic impact on a
substantial number of small entities within
the meaning of section 601(6) of the Reg-
ulatory Flexibility Act (small entities).
This certification can be made because the
Treasury Department and the IRS have
determined that the regulations may affect
a substantial number of small entities but
have also concluded that the economic ef-
fect on small entities as a result of these
regulations is not expected to be signifi-
cant.
When enacted, the section 163(j) lim-
itation generally applied to taxpayers with
average annual gross receipts exceeding
$25 million. The gross receipts threshold
for general applicability of the section
163(j) limitation increased to $26 million
in 2020. The threshold will be adjusted an-
nually for inflation. However, under the fi-
nal regulations, small taxpayers operating
regulated utility trades or businesses, real
property trades or businesses and farming
trades or businesses are now eligible to
protectively elect out of the election. Ac-
cordingly, the regulations in §§1.163(j)-1
and -9 may apply to small business filers
that operate regulated utility trades or
businesses, real property trades or busi-
nesses or farming trades or businesses.
Those taxpayers may choose to make a
protective election, such that they are not
subject to the limitation if their average
annual gross receipts for the three prior
tax years eventually exceeds $26 million
(for 2020). Although the exact number
of small entities that will make an elec-
tion is unknown, an upper bound on the
number of potentially affected entities is
10.5 million. This number was determined
by looking at, for the 2017 taxable year,
the number of Form 1120, 1120-S, 1120-
REIT, 1065, and individual business filers
with more than $10M in gross receipts that
have NAICS codes commonly associated
with real property trades or businesses or
farming businesses.
If a taxpayer chooses to make the
election for its trades or businesses, the
taxpayer must attach to its tax return a
statement identifying and describing the
trade or business for which the election is
being made, and must provide other infor-
mation as the Commissioner may require
in forms, instructions, or other published
guidance. The election is not required.
The election is potentially beneficial to
businesses with business interest, but is
detrimental to businesses that have assets
for which bonus depreciation is desired.
The reporting burden is estimated at
0-30 minutes, depending on individual
circumstances, with an estimated average
of 0.25 hours for all affected entities, re-
gardless of size. The burden on small en-
tities is expected to be the same as other
entities because the requirements to make
the election apply equally to all taxpayers.
Using the IRS’s taxpayer compliance cost
estimates, the monetization rate is $95 per
hour. Thus, the average annual burden is
$23.75 per business.
For the section 163(j)(10) elections un-
der §§1.163(j)-2(b)(ii) or 1.163(j)-2(b)(3),
most small business taxpayers do not need
the elections because, as discussed earlier,
they are not subject to the section 163(j)
limitation. For small taxpayers that are
subject to the limitation, the cost to imple-
ment the elections is low. Pursuant to Rev-
enue Procedure 2020-22, these taxpayers
simply complete the Form 8990 as if the
election has been made. Accordingly, the
burden of complying with the elections, if
needed, is no different than for taxpayers
that do not make the elections.
Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
preceding this regulation was submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its effect on small business, and
no comments were received.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 (UMRA) requires
that agencies assess anticipated costs and
benefits and take certain actions before is-

September 28, 2020 694 Bulletin No. 2020–40
suing a final rule that includes any Federal
mandate that may result in expenditures
in any one year by a state, local, or trib-
al government, in the aggregate, or by the
private section, of $100 million in 1995
dollars, update annually for inflation. This
rule does not include any Federal mandate
that may result in expenditures by state,
local, or tribal governments, or by the pri-
vate section in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive Order. This final rule does
not have federalism implications and does
not impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive Order.
VI. Congressional Review Act
The Administrator of the Office of In-
formation and Regulatory Affairs of the
Office of Management and Budget has de-
termined that this is a major rule for pur-
poses of the Congressional Review Act (5
U.S.C. 801 et seq.) (CRA). Under section
801(3) of the CRA, a major rule takes
effect 60 days after the rule is published
in the Federal Register. Notwithstanding
this requirement, section 808(2) of the
CRA allows agencies to dispense with
the requirements of 801 when the agency
for good cause finds that such procedure
would be impracticable, unnecessary, or
contrary to the public interest and the rule
shall take effect at such time as the agency
promulgating the rule determines.
The Treasury Department and the IRS
have determined that the rules in this Trea-
sury decision shall take effect for taxable
years beginning on or after November 13,
2020. Pursuant to section 808(2) of the
CRA, however, the Treasury Department
and the IRS find, for good cause, that a 60-
day delay in the effective and the appli-
cability date for the anti-avoidance rules
in §1.163(j)-1(b)(22)(iv) is unnecessary
and contrary to the public interest. Sec-
tion 1.163(j)-1(b)(22)(iv) serves an an-
ti-abuse function and, because §1.163(j)-
1(b)(22)(iv) provides a clear scope of
abusive transactions that could otherwise
be executed prior to the effective date
of the section, immediate application of
§1.163(j)-1(b)(22)(iv) is necessary as of
the publication of this final regulation.
Drafting Information
The principal authors of these regu-
lations are Susie Bird, Charles Gorham,
Justin Grill, Zachary King, Jaime Park,
Kathy Reed, Joanna Trebat and Sophia
Wang, Office of the Associate Chief
Counsel (Income Tax and Accounting);
Kevin M. Jacobs, Russell Jones, John
Lovelace, Marie Milnes-Vasquez, Aglaia
Ovtchinnikova, and Julie Wang, Office of
the Associate Chief Counsel (Corporate);
William Kostak, Anthony McQuillen, and
Adrienne Mikolashek, Office of the As-
sociate Chief Counsel (Passthroughs and
Special Industries); Azeka Abramoff, An-
gela Holland, and Steve Jensen, Office of
the Associate Chief Counsel (Internation-
al); William E. Blanchard, Michael Chin,
Steven Harrison, Andrea Hoffenson, and
Diana Imholtz, Office of the Associate
Chief Counsel (Financial Institutions and
Products). Other personnel from the Trea-
sury Department and the IRS participated
in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by:
1. Adding entries in numerical order for
§§1.163(j)-1 through 1.163(j)-11;
2. Revising the entries for §§1.263A-8
through 1.263A-15;
3. Adding entries in numerical order for
§§1.382-1 and 1.383-0;
4. Revising the entry for §1.383-1; and
5. Adding entries in numerical order for
§§1.860C-2 and 1.1502-90.
The additions and revisions read as fol-
lows:
Authority: 26 U.S.C. 7805, unless
otherwise noted.
*****
Section 1.163(j)-1 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)-2 also issued under 26
U.S.C. 1502.
Section 1.163(j)-3 also issued under 26
U.S.C. 1502.
Section 1.163(j)-4 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)-5 also issued under 26
U.S.C. 1502.
Section 1.163(j)-6 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)-7 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)-8 also issued under 26
U.S.C. 163(j)(8)(B).
Section 1.163(j)-9 also issued under 26
U.S.C. 163(j)(7)(B) and (C) and 26 U.S.C.
1502.
Section 1.163(j)-10 also issued under
26 U.S.C. 163(j)(8)(B) and 26 U.S.C.
1502.
Section 1.163(j)-11 also issued under
26 U.S.C. 1502.
*****
Sections 1.263A-8 through 1.263A-15
also issued under 26 U.S.C. 263A(j).
*****
Section 1.382-1 also issued under 26
U.S.C. 382(m).
*****
Section 1.383-0 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.
Section 1.383-1 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.
*****
Section 1.860C-2 also issued under 26
U.S.C. 860C(b)(1) and 860G(e).
*****
Section 1.1502-90 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 1502.
*****
Par. 2. Section 1.163(j)-0 is added to
read as follows:
§1.163(j)-0 Table of contents.
This section lists the table of contents
for §§1.163(j)-1 through 1.163(j)-11.

Bulletin No. 2020–40 695 September 28, 2020
§1.163(j)-1 Definitions.
(a) In general.
(b) Definitions.
(1) Adjusted taxable income.
(i) Additions.
(ii) Subtractions.
(iii) Depreciation, amortization, or de-
pletion capitalized under section 263A.
(iv) Application of §1.163(j)-1(b)(1)
(ii)(C), (D), and (E).
(A) Sale or other disposition.
(1) In general.
(2) Intercompany transactions.
(3) Deconsolidations.
(B) Deductions by members of a con-
solidated group.
(C) Successor assets.
(D) Anti-duplication rule.
(1) In general.
(2) Adjustments following deconsoli-
dation.
(v) Other adjustments.
(vi) Additional rules relating to adjust-
ed taxable income in other sections.
(vii) ATI cannot be less than zero.
(viii) Examples.
(2) Applicable CFC.
(3) Business interest expense.
(i) In general.
(ii) Special rules.
(4) Business interest income.
(i) In general.
(ii) Special rules.
(5) C corporation.
(6) Cleared swap.
(7) Consolidated group.
(8) Consolidated return year.
(9) Current-year business interest ex-
pense.
(10) Disallowed business interest ex-
pense.
(11) Disallowed business interest ex-
pense carryforward.
(12) Disallowed disqualified interest.
(13) Electing farming business.
(14) Electing real property trade or
business.
(15) Excepted regulated utility trade or
business.
(i) In general.
(A) Automatically excepted regulated
utility trades or businesses.
(B) Electing regulated utility trades or
businesses.
(C) Designated excepted regulated util-
ity trades or businesses.
(ii) Depreciation and excepted and
non-excepted utility trades or businesses.
(A) Depreciation.
(B) Allocation of items.
(iii) Election to be an excepted regulat-
ed utility trade or business.
(A) In general.
(B) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(C) Time and manner of making elec-
tion.
(1) In general.
(2) Election statement contents.
(3) Consolidated group’s or partner-
ship’s trade or business.
(4) Termination of election.
(5) Additional guidance.
(16) Excess business interest expense.
(17) Excess taxable income.
(18) Floor plan financing indebtedness.
(19) Floor plan financing interest ex-
pense.
(20) Group.
(21) Intercompany transaction.
(22) Interest.
(i) In general.
(ii) Swaps with significant nonperiodic
payments.
(A) In general.
(B) Exception for cleared swaps.
(C) Exception for non-cleared swaps
subject to margin or collateral require-
ments.
(iii) Other amounts treated as interest.
(A) Treatment of premium.
(1) Issuer.
(2) Holder.
(B) Treatment of ordinary income or
loss on certain debt instruments.
(C) Substitute interest payments.
(D) Section 1258 gain.
(E) Factoring income.
(F) [Reserved]
(iv) Anti-avoidance rules.
(A) Principal purpose to reduce interest
expense.
(1) Treatment as interest expense.
(2) Corresponding treatment of
amounts as interest income.
(B) Interest income artificially in-
creased.
(C) Principal purpose.
(D) Coordination with anti-avoidance
rule in §1.163(j)-2(j).
(v) Examples.
(23) Interest expense.
(24) Interest income.
(25) Member.
(26) Motor vehicle.
(27) Old section 163(j).
(28) Ownership change.
(29) Ownership date.
(30) Real estate investment trust.
(31) Real property.
(32) Regulated investment company.
(33) Relevant foreign corporation.
(34) S corporation.
(35) [Reserved]
(36) Section 163(j) limitation.
(37) Section 163(j) regulations.
(38) Separate return limitation year.
(39) Separate return year.
(40) Separate tentative taxable income.
(41) Tax-exempt corporation.
(42) Tax-exempt organization.
(43) Tentative taxable income.
(i) In general.
(ii) [Reserved]
(iii) Special rules for defining tentative
taxable income.
(44) Trade or business.
(i) In general.
(ii) Excepted trade or business.
(iii) Non-excepted trade or business.
(45) Unadjusted basis.
(46) United States shareholder.
(c) Applicability date.
(1) In general.
(2) Anti-avoidance rules.
(3) Swaps with significant nonperiodic
payments.
(i) In general.
(ii) Anti-avoidance rule.
§1.163(j)-2 Deduction for business
interest expense limited.
(a) Overview.
(b) General rule.
(1) In general.
(2) 50 percent ATI limitation for tax-
able years beginning in 2019 or 2020.
(3) Election to use 2019 ATI in 2020.
(4) Time and manner of making or re-
voking the elections.
(c) Disallowed business interest ex-
pense carryforward.
(1) In general.
(2) Coordination with small business
exemption.
(3) Cross-references.
(d) Small business exemption.
(1) Exemption.

September 28, 2020 696 Bulletin No. 2020–40
(2) Application of the gross receipts test.
(i) In general.
(ii) Gross receipts of individuals.
(iii) Partners and S corporation share-
holders.
(iv) Tax-exempt organizations.
(e) REMICs.
(f) Trusts.
(i) Calculation of ATI with respect to
certain trusts and estates.
(ii) Calculation of ATI with respect to
certain beneficiaries.
(g) Tax-exempt organizations.
(h) Examples.
(i) [Reserved]
(j) Anti-avoidance rule.
(1) In general.
(2) Examples.
(k) Applicability date.
§1.163(j)-3 Relationship of the section
163(j) limitation to other provisions
affecting interest.
(a) Overview.
(b) Coordination of section 163(j) with
certain other provisions.
(1) In general.
(2) Disallowed interest provisions.
(3) Deferred interest provisions.
(4) At risk rules, passive activity loss
provisions, and limitation on excess busi-
ness losses of noncorporate taxpayers.
(5) Capitalized interest expenses.
(6) Reductions under section 246A.
(7) Section 381.
(8) Section 382.
(c) Examples.
(d) Applicability date.
§1.163(j)-4 General rules applicable to
C corporations (including REITs, RICs,
and members of consolidated groups)
and tax-exempt corporations.
(a) Scope.
(b) Characterization of items of in-
come, gain, deduction, or loss.
(1) Interest expense and interest income.
(2) Adjusted taxable income.
(3) Investment interest, investment in-
come, investment expenses, and certain
other tax items of a partnership with a
C corporation partner.
(i) Characterization as expense or in-
come properly allocable to a trade or busi-
ness.
(ii) Effect of characterization on part-
nership.
(iii) Separately stated interest expense
and interest income of a partnership not
treated as excess business interest expense
or excess taxable income of a C corpora-
tion partner.
(iv) Treatment of deemed inclusions of
a domestic partnership that are not alloca-
ble to any trade or business.
(4) Application to RICs and REITs.
(i) In general.
(ii) Tentative taxable income of RICs
and REITs.
(iii) Other adjustments to adjusted tax-
able income for RICs and REITs.
(5) Application to tax-exempt corpora-
tions.
(6) Adjusted taxable income of coop-
eratives.
(7) Examples.
(c) Effect on earnings and profits.
(1) In general.
(2) Special rule for RICs and REITs.
(3) Special rule for partners that are
C corporations.
(4) Examples.
(d) Special rules for consolidated groups.
(1) Scope.
(2) Calculation of the section 163(j)
limitation for members of a consolidated
group.
(i) In general.
(ii) Interest.
(iii) Calculation of business interest ex-
pense and business interest income for a
consolidated group.
(iv) Calculation of adjusted taxable in-
come.
(v) Treatment of intercompany obliga-
tions.
(A) In general.
(B) Repurchase premium.
(3) Investment adjustments.
(4) Examples.
(e) Ownership of partnership interests
by members of a consolidated group.
(1) [Reserved]
(2) Change in status of a member.
(3) Basis adjustments under §1.1502-
32.
(4) Excess business interest expense
and §1.1502-36.
(f) Cross-references.
(g) Applicability date.
(1) In general.
(2) [Reserved]
§1.163(j)-5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
(a) Scope and definitions.
(1) Scope.
(2) Definitions.
(i) Allocable share of the consolidated
group’s remaining section 163(j) limita-
tion.
(ii) Consolidated group’s remaining
section 163(j) limitation.
(iii) Remaining current-year interest
ratio.
(b) Treatment of disallowed business
interest expense carryforwards.
(1) In general.
(2) Deduction of business interest ex-
pense.
(3) Consolidated groups.
(i) In general.
(ii) Deduction of business interest ex-
pense.
(A) General rule.
(B) Section 163(j) limitation equals or
exceeds the current-year business interest
expense and disallowed business interest
expense carryforwards from prior taxable
years.
(C) Current-year business interest ex-
pense and disallowed business interest ex-
pense carryforwards exceed section 163(j)
limitation.
(iii) Departure from group.
(iv) Example: Deduction of interest ex-
pense.
(c) Disallowed business interest ex-
pense carryforwards in transactions to
which section 381(a) applies.
(d) Limitations on disallowed business
interest expense carryforwards from sepa-
rate return limitation years.
(1) General rule.
(A) Cumulative section 163(j) SRLY
limitation.
(B) Subgrouping.
(2) Deduction of disallowed business
interest expense carryforwards arising in
a SRLY.
(3) Examples.
(e) Application of section 382.
(1) Pre-change loss.
(2) Loss corporation.
(3) Ordering rules for utilization of pre-
change losses and for absorption of the
section 382 limitation.

Bulletin No. 2020–40 697 September 28, 2020
(4) Disallowed business interest ex-
pense from the pre-change period in the
year of a testing date.
(5) Recognized built-in loss.
(f) Overlap of SRLY limitation with
section 382.
(g) Additional limitations.
(h) Applicability date.
§1.163(j)-6 Application of the section
163(j) limitation to partnerships and
subchapter S corporations.
(a) Overview.
(b) Definitions.
(1) Section 163(j) items.
(2) Partner basis items.
(3) Remedial items.
(4) Excess business interest income.
(5) Deductible business interest ex-
pense.
(6) Section 163(j) excess items.
(7) Non-excepted assets.
(8) Excepted assets.
(c) Business interest income and busi-
ness interest expense of the partnership.
(1)-(2) [Reserved]
(3) Character of business interest ex-
pense.
(d) Adjusted taxable income of a part-
nership.
(1) Tentative taxable income of a part-
nership.
(2) Section 734(b), partner basis items,
and remedial items.
(e) Adjusted taxable income and busi-
ness interest income of partners.
(1) Modification of adjusted taxable in-
come for partners.
(2) Partner basis items and remedial
items.
(3) Disposition of partnership interests.
(4) Double counting of business inter-
est income and floor plan financing inter-
est expense prohibited.
(f) Allocation and determination of
section 163(j) excess items made in the
same manner as nonseparately stated tax-
able income or loss of the partnership.
(1) Overview.
(i) In general.
(ii) Relevance solely for purposes of
section 163(j).
(2) Steps for allocating deductible busi-
ness interest expense and section 163(j)
excess items.
(i) Partnership-level calculation re-
quired by section 163(j)(4)(A).
(ii) Determination of each partner’s rel-
evant section 163(j) items.
(iii) Partner-level comparison of busi-
ness interest income and business interest
expense.
(iv) Matching partnership and aggre-
gate partner excess business interest in-
come.
(v) Remaining business interest ex-
pense determination.
(vi) Determination of final allocable
ATI.
(A) Positive allocable ATI.
(B) Negative allocable ATI.
(C) Final allocable ATI.
(vii) Partner-level comparison of 30
percent of adjusted taxable income and re-
maining business interest expense.
(viii) Partner priority right to ATI ca-
pacity excess determination.
(ix) Matching partnership and aggre-
gate partner excess taxable income.
(x) Matching partnership and aggregate
partner excess business interest expense.
(xi) Final section 163(j) excess item
and deductible business interest expense
allocation.
(g) Carryforwards.
(1) In general.
(2) Treatment of excess business inter-
est expense allocated to partners.
(3) Excess taxable income and excess
business interest income ordering rule.
(h) Basis adjustments.
(1) Section 704(d) ordering.
(2) Excess business interest expense
basis adjustments.
(3) Partner basis adjustment upon dis-
position of partnership interest.
(4)-(5) [Reserved]
(i)-(j) [Reserved]
(k) Investment items and certain other
items.
(l) S corporations.
(1) In general.
(i) Corporate level limitation.
(ii) Short taxable periods.
(2) Character of deductible business in-
terest expense.
(3) Adjusted taxable income of an
S corporation.
(4) Adjusted taxable income and busi-
ness interest income of S corporation
shareholders.
(i) Adjusted taxable income of S corpo-
ration shareholders.
(ii) Disposition of S corporation stock.
(iii) Double counting of business inter-
est income and floor plan financing inter-
est expense prohibited.
(5) Carryforwards.
(6) Basis adjustments and disallowed
business interest expense carryforwards.
(7) Accumulated adjustment accounts.
(8) Termination of qualified subchapter
S subsidiary election.
(9) Investment items.
(10) Application of section 382.
(m) Partnerships and S corporations
not subject to section 163(j).
(1) Exempt partnerships and S corpo-
rations.
(2) Partnerships and S corporations en-
gaged in excepted trades or businesses.
(3) Treatment of excess business inter-
est expense from partnerships that are ex-
empt entities in a succeeding taxable year.
(4) S corporations with disallowed
business interest expense carryforwards
prior to becoming exempt entities.
(n) [Reserved]
(o) Examples.
(p) Applicability date.
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
(a) Overview.
(b) General rule regarding the applica-
tion of section 163(j) to relevant foreign
corporations.
(c)-(f) [Reserved]
(g) Rules concerning the computation
of adjusted taxable income of a relevant
foreign corporation.
(1) Tentative taxable income.
(2) Treatment of certain dividends.
(h)-(l) [Reserved]
(m) Applicability date.
§1.163(j)-8 [Reserved]
§1.163(j)-9 Elections for excepted trades
or businesses; safe harbor for certain
REITs.
(a) Overview.
(b) Availability of election.
(1) In general.
(2) Special rules.

September 28, 2020 698 Bulletin No. 2020–40
(i) Exempt small businesses.
(ii) Section 162 trade or business not
required for electing real property trade or
business.
(c) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(3) Depreciation.
(d) Time and manner of making elec-
tion.
(1) In general.
(2) Election statement contents.
(3) Consolidated group’s trade or busi-
ness.
(4) Partnership’s trade or business.
(e) Termination of election.
(1) In general.
(2) Taxable asset transfer defined.
(3) Related party defined.
(4) Anti-abuse rule.
(f) Additional guidance.
(g) Examples.
(h) Safe harbor for REITs.
(1) In general.
(2) REITs that do not significantly in-
vest in real property financing assets.
(3) REITs that significantly invest in
real property financing assets.
(4) REIT real property assets, interests
in partnerships, and shares in other REITs.
(i) Real property assets.
(ii) Partnership interests.
(iii) Shares in other REITs.
(A) In general.
(B) Information necessary.
(iv) Tiered entities.
(5) Value of shares in other REITs.
(i) In general.
(ii) Information necessary.
(iii) Tiered REITs.
(6) Real property financing assets.
(7) Application of safe harbor for part-
nerships controlled by REITS.
(8) REITs or partnerships controlled by
REITs that do not apply the safe harbor.
(i) [Reserved]
(j) Special anti-abuse rule for certain
real property trades or businesses.
(1) In general.
(2) Exceptions.
(i) De minimis exception.
(ii) Look-through exception.
(iii) Inapplicability of exceptions to
consolidated groups.
(iv) Exception for certain REITs.
(3) Allocations.
(4) Examples.
(k) Applicability date.
§1.163(j)-10 Allocation of interest
expense, interest income, and other
items of expense and gross income to an
excepted trade or business.
(a) Overview.
(1) In general.
(i) Purposes.
(ii) Application of section.
(2) Coordination with other rules.
(i) In general.
(ii) Treatment of investment interest,
investment income, investment expenses,
and certain other tax items of a partnership
with a C corporation or tax-exempt corpo-
ration as a partner.
(3) Application of allocation rules to
foreign corporations and foreign partner-
ships.
(4) Application of allocation rules to
members of a consolidated group.
(i) In general.
(ii) Application of excepted business
percentage to members of a consolidated
group.
(iii) Basis in assets transferred in an in-
tercompany transaction.
(5) Tax-exempt organizations.
(6) Application of allocation rules to
disallowed disqualified interest.
(7) Examples.
(b) Allocation of tax items other than
interest expense and interest income.
(1) In general.
(2) Gross income other than dividends
and interest income.
(3) Dividends.
(i) Look-through rule.
(ii) Inapplicability of the look-through
rule.
(4) Gain or loss from the disposition
of non-consolidated C corporation stock,
partnership interests, or S corporation
stock.
(i) Non-consolidated C corporations.
(ii) Partnerships and S corporations.
(5) Expenses, losses, and other deduc-
tions.
(i) Expenses, losses, and other deduc-
tions that are definitely related to a trade
or business.
(ii) Other deductions.
(6) Treatment of investment items and
certain other items of a partnership with a
C corporation partner.
(7) Examples: Allocation of income
and expense.
(c) Allocating interest expense and in-
terest income that is properly allocable to
a trade or business.
(1) General rule.
(i) In general.
(ii) De minimis exception.
(2) Example.
(3) Asset used in more than one trade
or business.
(i) General rule.
(ii) Permissible methodologies for allo-
cating asset basis between or among two
or more trades or businesses.
(iii) Special rules.
(A) Consistent allocation methodolo-
gies.
(1) In general.
(2) Consent to change allocation meth-
odology.
(B) De minimis exception.
(C) Allocations of excepted regulated
utility trades or businesses.
(1) In general.
(2) Permissible method for allocating
asset basis for utility trades or businesses.
(3) De minimis rule for excepted utility
trades or businesses.
(4) Example.
(D) Special allocation rule for real
property trades or business subject to spe-
cial anti-abuse rule.
(1) In general.
(2) Allocation methodology for real
property.
(3) Example.
(4) Disallowed business interest ex-
pense carryforwards; floor plan financing
interest expense.
(5) Additional rules relating to basis.
(i) Calculation of adjusted basis.
(A) Non-depreciable property other
than land.
(B) Depreciable property other than in-
herently permanent structures.
(C) Special rule for land and inherently
permanent structures.
(D) Depreciable or amortizable intan-
gible property and depreciable income
forecast method property.
(E) Assets not yet used in a trade or
business.
(F) Trusts established to fund specific
liabilities.
(G) Inherently permanent structure.

Bulletin No. 2020–40 699 September 28, 2020
(ii) Partnership interests; stock in
non-consolidated C corporations.
(A) Partnership interests.
(1) Calculation of asset basis.
(2) Allocation of asset basis.
(i) In general.
(ii) De minimis rule.
(iii) Partnership assets not properly al-
locable to a trade or business.
(iv) Inapplicability of partnership look-
through rule.
(B) Stock in domestic non-consolidat-
ed corporations.
(1) In general.
(2) Domestic non-consolidated C cor-
porations.
(i) Allocation of asset basis.
(ii) De minimis rule.
(iii) Inapplicability of corporate look-
through rule.
(iv) Use of inside basis for purposes of
C corporation look-through rule.
(3) S corporations.
(i) Calculation of asset basis.
(ii) Allocation of asset basis.
(iii) De minimis rule.
(iv) Inapplicability of S corporation
look-through rule.
(C) Stock in relevant foreign corpora-
tions.
(1) In general.
(2) Special rule for CFC utilities.
(D) Inapplicability of look-through
rule to partnerships or non-consolidated C
corporations to which the small business
exemption applies.
(E) Tiered entities.
(iii) Cash and cash equivalents and cus-
tomer receivables.
(iv) Deemed asset sale.
(v) Other adjustments.
(6) Determination dates; determination
periods; reporting requirements.
(i) Determination dates and determina-
tion periods.
(A) Quarterly determination periods.
(B) Annual determination periods.
(ii) Application of look-through rules.
(iii) Reporting requirements.
(A) Books and records.
(B) Information statement.
(iv) Failure to file statement.
(7) Ownership threshold for look-
through rules.
(i) Corporations.
(A) Asset basis.
(B) Dividends.
(ii) Partnerships.
(iii) Inapplicability of look-through
rule.
(8) Anti-abuse rule.
(d) Direct allocations.
(1) In general.
(2) Qualified nonrecourse indebted-
ness.
(3) Assets used in more than one trade
or business.
(4) Adjustments to basis of assets to ac-
count for direct allocations.
(5) Example: Direct allocation of inter-
est expense.
(e) Examples.
(f) Applicability date.
§1.163(j)-11 Transition rules.
(a) Overview.
(b) Application of section 163(j) lim-
itation if a corporation joins a consoli-
dated group during a taxable year of the
group beginning before January 1, 2018.
(1) In general.
(2) Example
(c) Treatment of disallowed disquali-
fied interest.
(1) In general.
(2) Earnings and profits.
(3) Disallowed disqualified interest of
members of an affiliated group.
(i) Scope.
(ii) Allocation of disallowed disquali-
fied interest to members of the affiliated
group.
(A) In general.
(B) Definitions.
(1) Allocable share of the affiliated
group’s disallowed disqualified interest.
(2) Disallowed disqualified interest ra-
tio.
(3) Exempt related person interest ex-
pense.
(iii) Treatment of carryforwards.
(4) Application of section 382.
(i) Ownership change occurring before
November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(ii) Ownership change occurring on or
after November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(5) Treatment of excess limitation from
taxable years beginning before January 1,
2018.
(6) Example: Members of an affiliated
group.
(d) Applicability date.
Par. 3. Sections 1.163(j)-1 through
1.163(j)-11 are added to read as follows:
Sec.
* * * * *
1.163(j)-1 Definitions.
1.163(j)-2 Deduction for business in-
terest expense limited.
1.163(j)-3 Relationship of the section
163(j) limitation to other provisions af-
fecting interest.
1.163(j)-4 General rules applicable to
C corporations (including REITs, RICs,
and members of consolidated groups) and
tax-exempt corporations.
1.163(j)-5 General rules governing dis-
allowed business interest expense carry-
forwards for C corporations.
1.163(j)-6 Application of the section
163(j) limitation to partnerships and sub-
chapter S corporations.
1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
1.163(j)-8 [Reserved]
1.163(j)-9 Elections for excepted
trades or businesses; safe harbor for cer-
tain REITs.
1.163(j)-10 Allocation of interest ex-
pense, interest income, and other items of
expense and gross income to an excepted
trade or business.
1.163(j)-11 Transition rules.
* * * * *
§1.163(j)-1 Definitions.
(a) In general. The definitions provided
in this section apply for purposes of the
section 163(j) regulations. For purposes of
the rules set forth in §§1.163(j)-2 through
1.163(j)-11, additional definitions for cer-
tain terms are provided in those sections.
(b) Definitions—(1) Adjusted taxable
income. The term adjusted taxable income
(ATI) means the tentative taxable income
of the taxpayer for the taxable year, with
the adjustments in this paragraph (b)(1).
(i) Additions. The amounts of the fol-
lowing items that were included in the
computation of the taxpayer’s tentative
taxable income (if any) are added to ten-
tative taxable income to determine ATI—

September 28, 2020 700 Bulletin No. 2020–40
(A) Any business interest expense, oth-
er than disallowed business interest ex-
pense carryforwards;
(B) Any net operating loss deduction
under section 172;
(C) Any deduction under section 199A;
(D) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any depreciation
under section 167, section 168, or section
168 of the Internal Revenue Code (Code)
of 1954 (former section 168);
(E) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any amortization
of intangibles (for example, under section
167 or 197) and other amortized expendi-
tures (for example, under section 174(b),
195(b)(1)(B), 248, or 1245(a)(2)(C));
(F) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any depletion un-
der section 611;
(G) Any deduction for a capital loss
carryback or carryover; and
(H) Any deduction or loss that is not
properly allocable to a non-excepted
trade or business (for rules governing the
allocation of items to an excepted trade
or business, see §§1.163(j)-1(b)(44) and
1.163(j)-10).
(ii) Subtractions. The amounts of the
following items (if any) are subtracted
from the taxpayer’s tentative taxable in-
come to determine ATI —
(A) Any business interest income that
was included in the computation of the
taxpayer’s tentative taxable income;
(B) Any floor plan financing interest
expense for the taxable year that was in-
cluded in the computation of the taxpay-
er’s tentative taxable income;
(C) With respect to the sale or other
disposition of property, the greater of the
allowed or allowable depreciation, amor-
tization, or depletion of the property, as
provided under section 1016(a)(2), for the
taxpayer (or, if the taxpayer is a member
of a consolidated group, the consolidated
group) for the taxable years beginning af-
ter December 31, 2017, and before Janu-
ary 1, 2022, with respect to such property;
(D) With respect to the sale or other
disposition of stock of a member of a con-
solidated group by another member, the
investment adjustments under §1.1502-32
with respect to such stock that are attribut-
able to deductions described in paragraph
(b)(1)(ii)(C) of this section;
(E) With respect to the sale or other
disposition of an interest in a partnership,
the taxpayer’s distributive share of deduc-
tions described in paragraph (b)(1)(ii)(C)
of this section with respect to property
held by the partnership at the time of such
sale or other disposition to the extent such
deductions were allowable under section
704(d);
(F) Any income or gain that is not
properly allocable to a non-excepted
trade or business (for rules governing the
allocation of items to an excepted trade
or business, see §§1.163(j)-1(b)(44) and
1.163(j)-10)) and that was included in the
computation of the taxpayer’s tentative
taxable income; and
(G) An amount equal to the sum of any
specified deemed inclusions that were in-
cluded in the computation of the taxpay-
er’s tentative taxable income, reduced
by the portion of the deduction allowed
under section 250(a) by reason of the
specified deemed inclusions. For this pur-
pose, a specified deemed inclusion is the
inclusion of an amount by a United States
shareholder (as defined in section 951(b))
in gross income under section 78, 951(a),
or 951A(a) with respect to an applicable
CFC (as defined in §1.163(j)-1(b)(2)) that
is properly allocable to a non-excepted
trade or business. Furthermore, a specified
deemed inclusion includes any amounts
included in a domestic partnership’s gross
income under section 951(a) or 951A(a)
with respect to an applicable CFC to the
extent such amounts are attributable to
investment income of the partnership and
are allocated to a domestic C corporation
that is a direct (or indirect partner) and
treated as properly allocable to a non-ex-
cepted trade or business of the domestic C
corporation under §§1.163(j)-4(b)(3) and
1.163(j)-10. To determine the amount of
a specified deemed inclusion described
in this paragraph (b)(1)(ii)(G), the por-
tion of a United States shareholder’s in-
clusion under section 951A(a) treated as
being with respect to an applicable CFC is
determined under section 951A(f)(2) and
§1.951A-6(b)(2).
(iii) Depreciation, amortization, or de-
pletion capitalized under section 263A.
For purposes of paragraph (b)(1)(i) of this
section, amounts of depreciation, amor-
tization, or depletion that are capitalized
under section 263A during the taxable
year are deemed to be included in the
computation of the taxpayer’s tentative
taxable income for such taxable year, re-
gardless of the period in which the capi-
talized amount is recovered. See Example
3 in §1.163(j)-2(h)(3).
(iv) Application of §1.163(j)-1(b)(1)(ii)
(C), (D), and (E)—(A) Sale or other dis-
position—(1) In general. For purposes of
paragraphs (b)(1)(ii)(C), (D), and (E) of
this section, except as otherwise provided
in this paragraph (b)(1)(iv)(A), the term
sale or other disposition does not include
a transfer of an asset to an acquiring cor-
poration in a transaction to which section
381(a) applies.
(2) Intercompany transactions. For
purposes of paragraphs (b)(1)(ii)(C) and
(D) of this section, the term sale or oth-
er disposition excludes all intercompa-
ny transactions, within the meaning of
§1.1502-13(b)(1)(i).
(3) Deconsolidations. Notwithstanding
any other rule in this paragraph (b)(1)(iv)
(A), any transaction in which a member
leaves a consolidated group is treated as
a sale or other disposition for purposes of
paragraphs (b)(1)(ii)(C) and (D) of this
section unless the transaction is described
in §1.1502-13(j)(5)(i)(A).
(B) Deductions by members of a con-
solidated group. If paragraph (b)(1)(ii)
(C), (D), or (E) of this section applies to
adjust the tentative taxable income of a
taxpayer, the amount of the adjustment
under paragraph (b)(1)(ii)(C) of this sec-
tion equals the greater of the allowed or
allowable depreciation, amortization, or
depletion of the property, as provided un-
der section 1016(a)(2), for any member
of the consolidated group for the taxable
years beginning after December 31, 2017,
and before January 1, 2022, with respect
to such property.
(C) Successor assets. This paragraph
(b)(1)(iv)(C) applies if deductions de-
scribed in paragraph (b)(1)(ii)(C) of this
section are allowed or allowable to a con-
solidated group member (S) and either the
depreciable property or S’s stock is sub-
sequently transferred to another member
(S1) in an intercompany transaction in
which the transferor receives S1 stock. If
this paragraph (b)(1)(iv)(C) applies, and
if the transferor’s basis in the S1 stock

Bulletin No. 2020–40 701 September 28, 2020
received in the intercompany transaction
is determined, in whole or in part, by ref-
erence to its basis in the S stock, the S1
stock received in the intercompany trans-
action is treated as a successor asset to S’s
stock for purposes of paragraph (b)(1)(ii)
(D) of this section. Thus, except as other-
wise provided in paragraph (b)(1)(iv)(D)
of this section, the subsequent disposition
of either the S1 stock or the S stock gives
rise to an adjustment under paragraph (b)
(1)(ii)(D) of this section.
(D) Anti-duplication rule—(1) In gen-
eral. The aggregate of the subtractions
from tentative taxable income of a con-
solidated group under paragraphs (b)(1)
(ii)(C) and (D) of this section with respect
to an item of property (including with re-
gard to dispositions of successor assets
described in paragraph (b)(1)(iv)(C) of
this section) cannot exceed the aggregate
amount of the consolidated group mem-
bers’ deductions described in paragraph
(b)(1)(ii)(C) of this section with respect to
such item of property. For example, if an
adjustment to the tentative taxable income
of a consolidated group is made under
paragraph (b)(1)(ii)(C) of this section with
respect to the sale or other disposition of
property by a consolidated group member
(S) to an unrelated person, and if a mem-
ber of the group subsequently sells or oth-
erwise disposes of S’s stock, no further
adjustment to the group’s tentative taxable
income is made under paragraph (b)(1)(ii)
(D) of this section in relation to the same
property with respect to that stock dispo-
sition.
(2) Adjustments following deconsol-
idation. Depreciation, amortization, or
depletion deductions allowed or allow-
able for a corporation for a consolidated
return year of a group are disregarded in
applying this paragraph (b)(1)(iv)(D) to
any year that constitutes a separate return
year (as defined in §1.1502-1(e)) of that
corporation. For example, assume that S
deconsolidates from a group (Group 1)
after holding property for which deprecia-
tion, amortization, or depletion deductions
were allowed or allowable in Group 1. On
the deconsolidation, S and Group 1 would
adjust tentative taxable income with re-
gard to that property under paragraphs
(b)(1)(ii)(D) and (b)(1)(iv)(A)(3) of this
section. If, following the deconsolidation,
S sells the property referred to in the pre-
vious sentence, no subtraction from tenta-
tive taxable income is made under para-
graph (b)(1)(ii)(C) of this section during
S’s separate return year with regard to the
amounts included in Group 1 under para-
graphs (b)(1)(ii)(C) and (b)(1)(iv)(A)(3)
of this section.
(v) Other adjustments. ATI is comput-
ed with the other adjustments provided in
§§1.163(j)-2 through 1.163(j)-11.
(vi) Additional rules relating to adjust-
ed taxable income in other sections. (A)
For rules governing the ATI of C corpora-
tions, see §§1.163(j)-4(b)(2) and (3) and
1.163(j)-10(a)(2)(ii).
(B) For rules governing the ATI of
RICs and REITs, see §1.163(j)-4(b)(4).
(C) For rules governing the ATI of
tax-exempt corporations, see §1.163(j)-
4(b)(5).
(D) For rules governing the ATI of con-
solidated groups, see §1.163(j)-4(d)(2)(iv)
and (v).
(E) For rules governing the ATI of part-
nerships, see §1.163(j)-6(d).
(F) For rules governing the ATI of
partners, see §§1.163(j)-6(e) and 1.163(j)-
6(m)(1) and (2).
(G) For rules governing partnership
basis adjustments affecting ATI, see
§1.163(j)-6(h)(2).
(H) For rules governing the ATI of
S corporations, see §1.163(j)-6(l)(3).
(I) For rules governing the ATI of
S corporation shareholders, see §1.163(j)-
6(l)(4).
(J) For rules governing the ATI of cer-
tain beneficiaries of trusts and estates, see
§1.163(j)-2(f).
(vii) ATI cannot be less than zero. If the
ATI of a taxpayer would be less than zero,
the ATI of the taxpayer is zero.
(viii) Examples. The examples in this
paragraph (b)(1)(viii) illustrate the appli-
cation of paragraphs (b)(1)(ii), (iii), and
(iv) of this section. Unless otherwise indi-
cated, A, B, P, S, and T are calendar-year
domestic C corporations; P is the parent of
a consolidated group of which S and T are
members; the exemption for certain small
businesses in §1.163(j)-2(d) does not ap-
ply; no entity is engaged in an excepted
trade or business; no entity has business
interest income or floor plan financing in-
terest expense; and all amounts of interest
expense are deductible except for the po-
tential application of section 163(j).
(A) Example 1—(1) Facts. In 2021, A purchases
a depreciable asset (Asset X) for $100x and fully de-
preciates Asset X under section 168(k). For the 2021
taxable year, A’s ATI (after adding back A’s depreci-
ation deductions with respect to Asset X under para-
graph (b)(1)(i)(D) of this section) is $150x. A incurs
$45x of business interest expense in 2021. In 2024, A
sells Asset X to an unrelated third party.
(2) Analysis. A’s section 163(j) limitation for
2021 is $45x ($150x x 30 percent). Thus, all $45x of
A’s business interest expense incurred in 2021 is de-
ductible in that year. However, under paragraph (b)
(1)(ii)(C) of this section, A must subtract $100x from
its tentative taxable income in computing its ATI for
its 2024 taxable year. A would be required to subtract
$100x from its tentative taxable income in comput-
ing its ATI for its 2024 taxable year even if A’s ATI in
2021 was $150x before adding back A’s depreciation
deductions with respect to Asset X.
(3) Transfer of assets in a nonrecognition trans-
action to which section 381 applies. The facts are
the same as in paragraph (b)(1)(viii)(A)(1) of this
section, except that, rather than sell Asset X to an
unrelated third party in 2024, A merges with and into
an unrelated third party in 2024 in a transaction de-
scribed in section 368(a)(1)(A) in which no gain is
recognized. As provided in paragraph (b)(1)(iv)(A)
of this section, the merger transaction is not treated
as a “sale or other disposition” for purposes of para-
graph (b)(1)(ii)(C) of this section. Thus, no adjust-
ment to tentative taxable income is required in 2024
under paragraph (b)(1)(ii)(C) of this section.
(4) Transfer of assets in a nonrecognition trans-
action to which section 351 applies. The facts are
the same as in paragraph (b)(1)(viii)(A)(1) of this
section, except that, rather than sell Asset X to an
unrelated third party in 2024, A transfers Asset X to
B (A’s wholly owned subsidiary) in 2024 in a trans-
action to which section 351 applies. The section 351
transaction is treated as a “sale or other disposition”
for purposes of paragraph (b)(1)(ii)(C) of this sec-
tion. Thus, A must subtract $100x from its tentative
taxable income in computing its ATI for its 2024 tax-
able year.
(B) Example 2—(1) Facts. In 2021, S purchas-
es a depreciable asset (Asset Y) for $100x and fully
depreciates Asset Y under section 168(k). P reduces
its basis in its S stock by $100x under §1.1502-32
to reflect S’s depreciation deductions. For the 2021
taxable year, the P group’s ATI (after adding back S’s
depreciation deductions with respect to Asset Y un-
der paragraph (b)(1)(i)(D) of this section) is $150x.
The P group incurs $45x of business interest expense
in 2021. In 2024, P sells all of its S stock to an unre-
lated third party.
(2) Analysis. The P group’s section 163(j) lim-
itation for 2021 is $45x ($150x x 30 percent). Thus,
all $45x of the P group’s business interest expense
incurred in 2021 is deductible in that year. However,
under paragraph (b)(1)(ii)(D) of this section, the P
group must subtract $100x from its tentative taxable
income in computing its ATI for its 2024 taxable
year. The answer would be the same if the P group’s
ATI in 2021 were $150x before adding back S’s de-
preciation deductions with respect to Asset Y.
(3) Disposition of less than all member stock.
The facts are the same as in paragraph (b)(1)(viii)
(B)(1) of this section, except that, in 2024, P sells

September 28, 2020 702 Bulletin No. 2020–40
half of its S stock to an unrelated third party. Pur-
suant to paragraph (b)(1)(ii)(D) of this section,
the P group must subtract $100x from its tentative
taxable income in computing its ATI for its 2024
taxable year.
(4) Transfer in an intercompany transaction.
The facts are the same as in paragraph (b)(1)(viii)
(B)(1) of this section, except that, rather than sell
S’s stock to an unrelated third party in 2024, P trans-
fers S’s stock to another member of the P group in
an intercompany transaction (as defined in §1.1502-
13(b)(1)(i)) in 2024. As provided in paragraph (b)
(1)(iv)(A) of this section, the intercompany transac-
tion is not treated as a “sale or other disposition” for
purposes of paragraph (b)(1)(ii)(D) of this section.
Thus, no adjustment to tentative taxable income is
required in 2024 under paragraph (b)(1)(ii)(D) of
this section.
(5) Disposition of successor assets. The facts are
the same as in paragraph (b)(1)(viii)(B)(1) of this
section, except that, rather than sell S’s stock to an
unrelated third party in 2024, P transfers S’s stock
to T in 2024 in a transaction to which section 351
applies and, in 2025, P sells all of its T stock to an
unrelated third party. Pursuant to paragraph (b)(1)
(iv)(A) of this section, P’s intercompany transfer of
S’s stock to T is not a “sale or other disposition” for
purposes of paragraph (b)(1)(ii)(D) of this section.
However, pursuant to paragraph (b)(1)(iv)(C) of this
section, P’s stock in T is treated as a successor asset
for purposes of paragraph (b)(1)(ii)(D) of this sec-
tion. Thus, the P group must subtract $100x from its
tentative taxable income in computing its ATI for its
2025 taxable year.
(C) Example 3—(1) Facts. In 2021, S purchas-
es a depreciable asset (Asset Z) for $100x and fully
depreciates Asset Z under section 168(k). P reduces
its basis in its S stock by $100x under §1.1502-32
to reflect S’s depreciation deductions. For the 2021
taxable year, the P group’s ATI (after adding back S’s
depreciation deductions with respect to Asset Z un-
der paragraph (b)(1)(i)(D) of this section) is $150x.
The P group incurs $45x of business interest expense
in 2021. In 2024, S sells Asset Z to an unrelated third
party. In 2025, P sells all of its S stock to a member
of another consolidated group.
(2) Analysis. Under paragraph (b)(1)(ii)(C) of
this section, the P group must subtract $100x from
its tentative taxable income in computing its ATI for
its 2024 taxable year. The answer would be the same
if the P group’s ATI in 2021 were $150x before add-
ing back S’s depreciation deductions with respect to
Asset Z. P’s sale of all of its S stock in 2025 is a
“sale or other disposition” for purposes of paragraph
(b)(1)(ii)(D) of this section. However, pursuant to
paragraph (b)(1)(iv)(D)(1) of this section, no further
adjustment to the P group’s tentative taxable income
is required in 2025 under paragraph (b)(1)(ii)(D) of
this section.
(3) Disposition of S stock prior to S’s asset dis-
position. The facts are the same as in paragraph (b)
(1)(viii)(C)(1) of this section, except that, in 2024,
P sells all of its S stock to a member of another
consolidated group and, in 2025, S sells Asset Z to
an unrelated third party. Pursuant to paragraph (b)
(1)(ii)(D) of this section, the P group must subtract
$100x from its tentative taxable income in comput-
ing its ATI for its 2024 taxable year. Pursuant to
paragraph (b)(1)(iv)(D)(2) of this section, no ad-
justment to the acquiring group’s tentative taxable
income is required in 2025 under paragraph (b)(1)
(ii)(C) of this section.
(4) Transfer of S stock in nonrecognition trans-
action. The facts are the same as in paragraph (b)
(1)(vii)(C)(3) of this section, except that, rather than
sell all of S’s stock to a member of another consol-
idated group, P causes S to merge with and into a
member of another consolidated group in a transac-
tion described in section 368(a)(1)(A). As provided
in paragraph (b)(1)(iv)(A) of this section, the merger
transaction is treated as a “sale or other disposition”
for purposes of paragraph (b)(1)(ii)(D) of this sec-
tion because S leaves the P group. Thus, the results
are the same as in paragraph (b)(1)(vii)(C)(3) of this
section.
(D) Example 4—(1) Facts. P wholly owns T,
which wholly owns S. In 2021, S purchases a de-
preciable asset (Asset AA) for $100x and fully de-
preciates Asset AA under section 168(k). T reduces
its basis in its S stock, and P reduces its basis in its
T stock, by $100x under §1.1502-32 to reflect S’s
depreciation deductions. For the 2021 taxable year,
the P group’s ATI (after adding back S’s depreciation
deductions with respect to Asset AA under paragraph
(b)(1)(i)(D) of this section) is $150x. The P group
incurs $45x of business interest expense in 2021. In
2024, T sells all of its S stock to a member of another
consolidated group. In 2025, P sells all of its T stock
to a member of another consolidated group.
(2) Analysis. Pursuant to paragraph (b)(1)(ii)(D)
of this section, the P group must subtract $100x from
its tentative taxable income in computing its ATI
for its 2024 taxable year. Pursuant to paragraph (b)
(1)(iv)(D)(1) of this section, no adjustment to the P
group’s tentative taxable income is required in 2025
under paragraph (b)(1)(ii)(D) of this section.
(2) Applicable CFC. The term appli-
cable CFC means a foreign corporation
described in section 957, but only if the
foreign corporation has at least one United
States shareholder that owns, within the
meaning of section 958(a), stock of the
foreign corporation.
(3) Business interest expense—(i) In
general. The term business interest ex-
pense means interest expense that is prop-
erly allocable to a non-excepted trade or
business or that is floor plan financing in-
terest expense. Business interest expense
also includes disallowed business interest
expense carryforwards (as defined in para-
graph (b)(11) of this section). However,
business interest expense does not include
amounts of interest expense carried for-
ward to the taxable year from a prior tax-
able year due to the application of section
465 or section 469, which apply after the
application of section 163(j). For the treat-
ment of investment interest, see section
163(d); and for the treatment of personal
interest, see section 163(h).
(ii) Special rules. For special rules for
defining business interest expense in cer-
tain circumstances, see §§1.163(j)-3(b)(2)
(regarding disallowed interest expense),
1.163(j)-4(b) (regarding C corporations)
and 1.163(j)-4(d)(2)(iii) (regarding con-
solidated groups), 1.163(j)-1(b)(9) (re-
garding current-year business interest
expense), and 1.163(j)-6(c) (regarding
partnerships and S corporations).
(4) Business interest income—(i) In
general. The term business interest in-
come means interest income includible
in the gross income of a taxpayer for the
taxable year which is properly allocable to
a non-excepted trade or business. For the
treatment of investment income, see sec-
tion 163(d).
(ii) Special rules. For special rules de-
fining business interest income in certain
circumstances, see §§1.163(j)-4(b) (re-
garding C corporations), 1.163(j)-4(d)(2)
(iii) (regarding consolidated groups), and
1.163(j)-6(c) (regarding partnerships and
S corporations).
(5) C corporation. The term C corpo-
ration has the meaning provided in section
1361(a)(2).
(6) Cleared swap. The term cleared
swap means a swap that is cleared by a
derivatives clearing organization, as such
term is defined in section 1a of the Com-
modity Exchange Act (7 U.S.C. 1a), or by
a clearing agency, as such term is defined
in section 3 of the Securities Exchange
Act of 1934 (15 U.S.C. 78c), that is reg-
istered as a derivatives clearing organiza-
tion under the Commodity Exchange Act
or as a clearing agency under the Securi-
ties Exchange Act of 1934, respectively,
if the derivatives clearing organization or
clearing agency requires the parties to the
swap to post and collect margin or collat-
eral.
(7) Consolidated group. The term con-
solidated group has the meaning provided
in §1.1502-1(h).
(8) Consolidated return year. The term
consolidated return year has the meaning
provided in §1.1502-1(d).
(9) Current-year business interest ex-
pense. The term current-year business
interest expense means business interest
expense that would be deductible in the
current taxable year without regard to
section 163(j) and that is not a disallowed

Bulletin No. 2020–40 703 September 28, 2020
business interest expense carryforward
from a prior taxable year.
(10) Disallowed business interest ex-
pense. The term disallowed business
interest expense means the amount of
business interest expense for a taxable
year in excess of the amount allowed as
a deduction for the taxable year under
section 163(j)(1) and §1.163(j)-2(b). For
purposes of section 163(j) and the regu-
lations in this part under section 163(j) of
the Internal Revenue Code (Code) disal-
lowed business interest expense is treated
as “paid or accrued” in the taxable year in
which the expense is deductible for Fed-
eral income tax purposes (without regard
to section 163(j)) or in the taxable year in
which a deduction for the business interest
expense is permitted under section 163(j),
as the context may require.
(11) Disallowed business interest ex-
pense carryforward. The term disallowed
business interest expense carryforward
means any business interest expense de-
scribed in §1.163(j)-2(c).
(12) Disallowed disqualified interest.
The term disallowed disqualified interest
means interest expense, including car-
ryforwards, for which a deduction was
disallowed under old section 163(j) (as
defined in paragraph (b)(27) of this sec-
tion) in the taxpayer’s last taxable year
beginning before January 1, 2018, and
that was carried forward pursuant to old
section 163(j).
(13) Electing farming business. The
term electing farming business means a
trade or business that makes an election as
provided in §1.163(j)-9 or other published
guidance and that is—
(i) A farming business, as defined in
section 263A(e)(4) or §1.263A-4(a)(4);
(ii) Any trade or business of a specified
agricultural or horticultural cooperative,
as defined in section 199A(g)(4); or
(iii) Specifically designated by the Sec-
retary in guidance published in the Feder-
al Register or the Internal Revenue Bulle-
tin (see §601.601(d) of this chapter) as a
farming business for purposes of section
163(j).
(14) Electing real property trade or
business. The term electing real property
trade or business means a trade or busi-
ness that makes an election as provided in
§1.163(j)-9 or other published guidance
and that is—
(i) A real property trade or business
described in section 469(c)(7)(C) and
§1.469-9(b)(2); or
(ii) A REIT that qualifies for the safe
harbor described in §1.163(j)-9(h); or
(iii) A trade or business specifically
designated by the Secretary in guidance
published in the Federal Register or the In-
ternal Revenue Bulletin (see §601.601(d)
of this chapter) as a real property trade or
business for purposes of section 163(j).
(15) Excepted regulated utility trade
or business—(i) In general. The term ex-
cepted regulated utility trade or business
means:
(A) Automatically excepted regulat-
ed utility trades or businesses. A trade or
business—
(1) That furnishes or sells—
(i) Electrical energy, water, or sewage
disposal services;
(ii) Gas or steam through a local distri-
bution system; or
(iii) Transportation of gas or steam by
pipeline; but only
(2) To the extent that the rates for the
furnishing or sale of the items in para-
graph (b)(15)(i)(A)(1) of this section—
(i) Have been established or approved
by a State or political subdivision thereof,
by any agency or instrumentality of the
United States, or by a public service or
public utility commission or other similar
body of any State or political subdivision
thereof and are determined on a cost of
service and rate of return basis; or
(ii) Have been established or approved
by the governing or ratemaking body of an
electric cooperative; or
(B) Electing regulated utility trades or
businesses. A trade or business that makes
a valid election under paragraph (b)(15)
(iii) of this section; or
(C) Designated excepted regulated
utility trades or businesses. A trade or
business that is specifically designated by
the Secretary in guidance published in the
Federal Register or the Internal Revenue
Bulletin as an excepted regulated utility
trade or business (see §601.601(d) of this
chapter) for section 163(j) purposes.
(ii) Depreciation and excepted and
non-excepted utility trades or businesses.
(A) Depreciation. Taxpayers engaged
in an excepted trade or business described
in paragraph (b)(15)(i) of this section can-
not claim the additional first-year depreci-
ation deduction under section 168(k) for
any property that is primarily used in the
excepted regulated utility trade or busi-
ness.
(B) Allocation of items. If a taxpayer
is engaged in one or more excepted trades
or businesses, as described in paragraph
(b)(15)(i) of this section, and one or more
non-excepted trades or businesses, the
taxpayer must allocate items between
the excepted and non-excepted utility
trades or businesses. See §§1.163(j)-1(b)
(44) and 1.163(j)-10(c)(3)(iii)(C). Some
trades or businesses with de minimis
furnishing or sales of items described in
paragraph (b)(15)(i)(A)(1) of this section
that are not sold pursuant to rates that
are determined on a cost of service and
rate of return basis or established or ap-
proved by the governing or ratemaking
body of an electric cooperative, and are
not subject to an election in paragraph
(b)(15)(iii), are treated as excepted trades
or businesses. See §1.163(j)-10(c)(3)(iii)
(C)(3). For look-through rules applicable
to certain CFCs that furnish or sell items
described in paragraph (b)(15)(i)(A)(1)
of this section that are not sold pursuant
to rates that are determined on a cost of
service and rate of return basis or estab-
lished or approved by the governing or
ratemaking body of an electric coopera-
tive as described in paragraph (b)(15)(i)
(A)(2) of this section, see §1.163(j)-10(c)
(5)(ii)(C).
(iii) Election to be an excepted reg-
ulated utility trade or business. (A) In
general. A trade or business that is not an
excepted regulated utility trade or busi-
ness described in paragraph (b)(15)(i)(A)
or (C) of this section and that furnishes
or sells items described in paragraph (b)
(15)(i)(A)(1) of this section is eligible to
make an election to be an excepted regu-
lated utility trade or business to the extent
that the rates for furnishing or selling the
items described in paragraph (b)(15)(i)(A)
(1) of this section have been established or
approved by a regulatory body described
in paragraph (b)(15)(i)(A)(2)(i) of this
section.
(B) Scope and effect of election—(1) In
general. An election under paragraph (b)
(15)(iii) of this section is made with re-
spect to each eligible trade or business of
the taxpayer and applies only to the trade
or business for which the election is made.

September 28, 2020 704 Bulletin No. 2020–40
An election under paragraph (b)(15)(iii)
of this section applies to the taxable year
in which the election is made and to all
subsequent taxable years.
(2) Irrevocability. An election under
paragraph (b)(15)(iii) of this section is ir-
revocable.
(C) Time and manner of making elec-
tion—(1) In general. Subject to paragraph
(b)(15)(iii)(C)(5) of this section, a taxpay-
er makes an election under paragraph (b)
(15)(iii) by attaching an election statement
to the taxpayer’s timely filed original Fed-
eral income tax return, including exten-
sions. A taxpayer may make elections for
multiple trades or businesses on a single
election statement.
(2) Election statement contents. The
election statement should be titled “Sec-
tion 1.163(j)-1(b)(15)(iii) Election” and
must contain the following information
for each trade or business:
(i) The taxpayer’s name;
(ii) The taxpayer’s address;
(iii) The taxpayer’s social security
number (SSN) or employer identification
number (EIN);
(iv) A description of the taxpayer’s
electing trade or business sufficient to
demonstrate qualification for an election
under this section, including the principal
business activity code; and
(v) A statement that the taxpayer is
making an election under section 1.163(j)-
1(b)(15)(iii).
(3) Consolidated group’s or partner-
ship’s trade or business. The rules in
§1.163(j)-9(d)(3) and (4) apply with re-
spect to an election under paragraph (b)
(15)(iii) of this section for a consolidated
group’s or partnership’s trade or business.
(4) Termination of election. The rules
in §1.163(j)-9(e) apply to determine when
an election under paragraph (b)(15)(iii) of
this section terminates.
(5) Additional guidance. The rules and
procedures regarding the time and manner
of making an election under paragraph (b)
(15)(iii) of this section and the election
statement contents in paragraph (b)(15)
(iii)(C)(2) of this section may be modified
through other guidance (see §§601.601(d)
and 601.602 of this chapter). Additional
situations in which an election may ter-
minate under paragraph (b)(15)(iii)(C)(4)
of this section may be provided through
guidance published in the Federal Regis-
ter or in the Internal Revenue Bulletin (see
§601.601(d) of this chapter).
(16) Excess business interest expense.
For any partnership, the term excess busi-
ness interest expense means the amount
of disallowed business interest expense
of the partnership for a taxable year under
section §1.163(j)-2(b). With respect to a
partner, see §1.163(j)-6(g) and (h).
(17) Excess taxable income. With re-
spect to any partnership or S corporation,
the term excess taxable income means the
amount which bears the same ratio to the
partnership’s ATI as—
(i) The excess (if any) of—
(A) The amount determined for the
partnership or S corporation under section
163(j)(1)(B); over
(B) The amount (if any) by which the
business interest expense of the partner-
ship, reduced by the floor plan financing
interest expense, exceeds the business in-
terest income of the partnership or S cor-
poration; bears to
(ii) The amount determined for the
partnership or S corporation under section
163(j)(1)(B).
(18) Floor plan financing indebted-
ness. The term floor plan financing indebt-
edness means indebtedness—
(i) Used to finance the acquisition of
motor vehicles held for sale or lease; and
(ii) Secured by the motor vehicles so
acquired.
(19) Floor plan financing interest ex-
pense. The term floor plan financing inter-
est expense means interest paid or accrued
on floor plan financing indebtedness. For
purposes of the section 163(j) regulations,
all floor plan financing interest expense is
treated as business interest expense. See
paragraph (b)(3) of this section.
(20) Group. The term group has the
meaning provided in §1.1502-1(a).
(21) Intercompany transaction. The
term intercompany transaction has the
meaning provided in §1.1502-13(b)(1)(i).
(22) Interest. The term interest means
any amount described in paragraph (b)
(22)(i), (ii), (iii), or (iv) of this section.
(i) In general. Interest is an amount
paid, received, or accrued as compensa-
tion for the use or forbearance of money
under the terms of an instrument or con-
tractual arrangement, including a series of
transactions, that is treated as a debt in-
strument for purposes of section 1275(a)
and §1.1275-1(d), and not treated as stock
under §1.385-3, or an amount that is treat-
ed as interest under other provisions of
the Code or the Income Tax Regulations.
Thus, interest includes, but is not limited
to, the following:
(A) Original issue discount (OID), as
adjusted by the holder for any acquisition
premium or amortizable bond premium;
(B) Qualified stated interest, as adjust-
ed by the holder for any amortizable bond
premium or by the issuer for any bond is-
suance premium;
(C) Acquisition discount;
(D) Amounts treated as taxable OID
under section 1286 (relating to stripped
bonds and stripped coupons);
(E) Accrued market discount on a mar-
ket discount bond to the extent includible
in income by the holder under either sec-
tion 1276(a) or 1278(b);
(F) OID includible in income by a
holder that has made an election under
§1.1272-3 to treat all interest on a debt in-
strument as OID;
(G) OID on a synthetic debt instrument
arising from an integrated transaction un-
der §1.1275-6;
(H) Repurchase premium to the extent
deductible by the issuer under §1.163-
7(c) (determined without regard to section
163(j));
(I) Deferred payments treated as inter-
est under section 483;
(J) Amounts treated as interest under a
section 467 rental agreement;
(K) Amounts treated as interest under
section 988;
(L) Forgone interest under section
7872;
(M) De minimis OID taken into ac-
count by the issuer;
(N) Amounts paid or received in con-
nection with a sale-repurchase agree-
ment treated as indebtedness under Fed-
eral tax principles; however, in the case
of a sale-repurchase agreement relating
to tax-exempt bonds, the amount is not
tax-exempt interest;
(O) Redeemable ground rent treated as
interest under section 163(c); and
(P) Amounts treated as interest under
section 636.
(ii) Swaps with significant nonperi-
odic payments—(A) In general. Except
as provided in paragraphs (b)(22)(ii)(B)
and (C) of this section, a swap with sig-

Bulletin No. 2020–40 705 September 28, 2020
nificant nonperiodic payments is treated
as two separate transactions consisting of
an on-market, level payment swap and a
loan. The loan must be accounted for by
the parties to the contract independently
of the swap. The time value component
associated with the loan, determined in
accordance with §1.446-3(f)(2)(iii)(A), is
recognized as interest expense to the pay-
or and interest income to the recipient.
(B) Exception for cleared swaps. Para-
graph (b)(22)(ii)(A) of this section does
not apply to a cleared swap (as defined in
paragraph (b)(6) of this section).
(C) Exception for non-cleared swaps
subject to margin or collateral require-
ments. Paragraph (b)(22)(ii)(A) of this
section does not apply to a non-cleared
swap that requires the parties to meet the
margin or collateral requirements of a fed-
eral regulator or that provides for margin
or collateral requirements that are sub-
stantially similar to a cleared swap or a
non-cleared swap subject to the margin or
collateral requirements of a federal regula-
tor. For purposes of this paragraph (b)(22)
(ii)(C), the term federal regulator means
the Securities and Exchange Commission
(SEC), the Commodity Futures Trading
Commission (CFTC), or a prudential reg-
ulator, as defined in section 1a(39) of the
Commodity Exchange Act (7 U.S.C. 1a),
as amended by section 721 of the Dodd-
Frank Wall Street Reform and Consumer
Protection Act of 2010, Public Law No.
111-203, 124 Stat. 1376, Title VII.
(iii) Other amounts treated as inter-
est—(A) Treatment of premium—(1) Issu-
er. If a debt instrument is issued at a pre-
mium within the meaning of §1.163-13,
any ordinary income under §1.163-13(d)
(4) is treated as interest income of the is-
suer.
(2) Holder. If a taxable debt instru-
ment is acquired at a premium within the
meaning of §1.171-1 and the holder elects
to amortize the premium, any amount de-
ductible as a bond premium deduction un-
der section 171(a)(1) and §1.171-2(a)(4)
(i)(A) or (C) is treated as interest expense
of the holder.
(B) Treatment of ordinary income or
loss on certain debt instruments. If an
issuer of a contingent payment debt in-
strument subject to §1.1275-4(b), a non-
functional currency contingent payment
debt instrument subject to §1.988-6, or an
inflation-indexed debt instrument subject
to §1.1275-7 recognizes ordinary income
on the debt instrument in accordance with
the rules in §1.1275-4(b), §1.988-6(b)(2),
or §1.1275-7(f), whichever is applicable,
the ordinary income is treated as interest
income of the issuer. If a holder of a con-
tingent payment debt instrument subject
to §1.1275-4(b), a nonfunctional currency
contingent payment debt instrument sub-
ject to §1.988-6, or an inflation-indexed
debt instrument subject to §1.1275-7 rec-
ognizes an ordinary loss on the debt in-
strument in accordance with the rules in
§1.1275-4(b), §1.988-6(b)(2), or §1.1275-
7(f), whichever is applicable, the ordinary
loss is treated as interest expense of the
holder.
(C) Substitute interest payments. A
substitute interest payment described in
§1.861-2(a)(7) is treated as interest ex-
pense to the payor only if the payment
relates to a sale-repurchase agreement or
a securities lending transaction that is not
entered into by the payor in the ordinary
course of the payor’s business. A substi-
tute interest payment described in §1.861-
2(a)(7) is treated as interest income to the
recipient only if the payment relates to a
sale-repurchase agreement or a securities
lending transaction that is not entered into
by the recipient in the ordinary course of
the recipient’s business; however, in the
case of a sale-repurchase agreement or a
securities lending transaction relating to
tax-exempt bonds, the recipient of a sub-
stitute payment does not receive tax-ex-
empt interest income. This paragraph (b)
(22)(iii)(C) does not apply to an amount
described in paragraph (b)(22)(i)(N) of
this section.
(D) Section 1258 gain. Any gain treat-
ed as ordinary gain under section 1258 is
treated as interest income.
(E) Factoring income. The excess of
the amount that a taxpayer collects on a
factored receivable (or realizes upon the
sale or other disposition of the factored
receivable) over the amount paid for the
factored receivable by the taxpayer is
treated as interest income. For purposes
of this paragraph (b)(22)(iii)(E), the term
factored receivable includes any account
receivable or other evidence of indebted-
ness, whether or not issued at a discount
and whether or not bearing stated interest,
arising out of the disposition of proper-
ty or the performance of services by any
person, if such account receivable or ev-
idence of indebtedness is acquired by a
person other than the person who disposed
of the property or provided the services
that gave rise to the account receivable
or evidence of indebtedness. This para-
graph (b)(22)(iii)(E) does not apply to an
amount described in paragraph (b)(22)(i)
(C) or (E) of this section.
(F) [Reserved]
(iv) Anti-avoidance rules—(A) Princi-
pal purpose to reduce interest expense—
(1) Treatment as interest expense. Any
expense or loss economically equivalent
to interest is treated as interest expense
if a principal purpose of structuring the
transaction(s) is to reduce an amount in-
curred by the taxpayer that otherwise
would have been described in paragraph
(b)(22)(i), (ii), or (iii) of this section. For
this purpose, the fact that the taxpayer has
a business purpose for obtaining the use of
funds does not affect the determination of
whether the manner in which the taxpayer
structures the transaction(s) is with a prin-
cipal purpose of reducing the taxpayer’s
interest expense. In addition, the fact that
the taxpayer has obtained funds at a lower
pre-tax cost based on the structure of the
transaction(s) does not affect the deter-
mination of whether the manner in which
the taxpayer structures the transaction(s)
is with a principal purpose of reducing
the taxpayer’s interest expense. For pur-
poses of this paragraph (b)(22)(iv)(A)
(1), any expense or loss is economically
equivalent to interest to the extent that the
expense or loss is—
(i) Deductible by the taxpayer;
(ii) Incurred by the taxpayer in a trans-
action or series of integrated or related
transactions in which the taxpayer secures
the use of funds for a period of time;
(iii) Substantially incurred in consider-
ation of the time value of money; and
(iv) Not described in paragraph (b)(22)
(i), (ii), or (iii) of this section.
(2) Corresponding treatment of
amounts as interest income. If a taxpayer
knows that an expense or loss is treated
by the payor as interest expense under
paragraph (b)(22)(iv)(A)(1) of this sec-
tion, the taxpayer provides the use of
funds for a period of time in the trans-
action(s) subject to paragraph (b)(22)
(iv)(A)(1) of this section, the taxpayer

September 28, 2020 706 Bulletin No. 2020–40
earns income or gain with respect to the
transaction(s), and such income or gain
is substantially earned in consideration
of the time value of money provided by
the taxpayer, such income or gain is treat-
ed as interest income to the extent of the
expense or loss treated by the payor as
interest expense under paragraph (b)(22)
(iv)(A)(1) of this section.
(B) Interest income artificially in-
creased. Notwithstanding paragraphs (b)
(22)(i) through (iii) of this section, any
income realized by a taxpayer in a trans-
action or series of integrated or related
transactions is not treated as interest in-
come of the taxpayer if and to the extent
that a principal purpose for structuring the
transaction(s) is to artificially increase the
taxpayer’s business interest income. For
this purpose, the fact that the taxpayer has
a business purpose for holding interest
generating assets does not affect the deter-
mination of whether the manner in which
the taxpayer structures the transaction(s)
is with a principal purpose of artificially
increasing the taxpayer’s business interest
income.
(C) Principal purpose. Whether a
transaction or a series of integrated or
related transactions is entered into with a
principal purpose described in paragraph
(b)(22)(iv)(A) or (B) of this section de-
pends on all the facts and circumstances
related to the transaction(s), except for
those facts described in paragraph (b)
(22)(iv)(A) or (B) of this section. A pur-
pose may be a principal purpose even
though it is outweighed by other purpos-
es (taken together or separately). Factors
to be taken into account in determining
whether one of the taxpayer’s principal
purposes for entering into the transac-
tion(s) include the taxpayer’s normal
borrowing rate in the taxpayer’s func-
tional currency, whether the taxpayer
would enter into the transaction(s) in the
ordinary course of the taxpayer’s trade
or business, whether the parties to the
transaction(s) are related persons (within
the meaning of section 267(b) or section
707(b)), whether there is a significant
and bona fide business purpose for the
structure of the transaction(s), whether
the transactions are transitory, for ex-
ample, due to a circular flow of cash or
other property, and the substance of the
transaction(s).
(D) Coordination with anti-avoidance
rule in §1.163(j)-2(j). The anti-avoidance
rules in paragraphs (b)(22)(iv)(A) through
(C) of this section, rather than the an-
ti-avoidance rules in §1.163(j)-2(j), apply
to determine whether an item is treated as
interest expense or interest income.
(v) Examples. The examples in this
paragraph (b)(22)(v) illustrate the applica-
tion of paragraph (b)(22)(iv) of this sec-
tion. Unless otherwise indicated, A, B, C,
D, and Bank are domestic C corporations
that are publicly traded; the exemption for
certain small businesses in §1.163(j)-2(d)
does not apply; A is not engaged in an ex-
cepted trade or business; and all amounts
of interest expense are deductible except
for the potential application of section
163(j).
(A) Example 1—(1) Facts. A is engaged in a
manufacturing business and uses the calendar year
as its annual accounting period. A’s functional cur-
rency is the U.S. dollar and A conducts virtually all
of its business in the U.S. dollar. A has no connection
to Japan or the Japanese yen in the ordinary course of
business. A projects that it will have business inter-
est expense of $100x on an existing loan obligation
with a stated principal amount of $2,000x (Loan 1)
and no business interest income in its taxable year
ending December 31, 2021. In early 2021, A enters
into the following transactions, which A would not
have entered into in the ordinary course of A’s trade
or business:
(i) A enters into a loan obligation in which A bor-
rows Japanese yen from Bank in an amount equiv-
alent to $2,000x with an interest rate of 1 percent
(Loan 2) (at the time of the loan, the U.S. dollar
equivalent interest rate on a loan of $2,000x is 5 per-
cent);
(ii) A enters into a foreign currency swap transac-
tion (FX Swap) with Bank with a notional principal
amount of $2,000x under which A receives Japa-
nese yen at 1 percent multiplied by the amount of
Japanese yen borrowed from Bank (which for 2021
equals $20x) and pays U.S. dollars at 5 percent mul-
tiplied by a notional amount of $2,000x ($100x per
year);
(iii) The FX Swap is not integrated with Loan 2
under §1.988-5; and
(iv) A enters into a spot transaction with Bank
to convert the proceeds of Loan 2 into $2,000x U.S.
dollars and A uses the U.S. dollars to repay Loan 1.
(2) Analysis. A principal purpose of A entering
into the transactions with Bank was to try to reduce
the amount incurred by A that otherwise would be
interest expense; in effect, A sought to alter A’s cost
of borrowing by converting a substantial portion of
its interest expense deductions on Loan 1 into sec-
tion 165 deductions on the FX Swap ($100x interest
expense related to Loan 1 compared to $20x interest
expense related to Loan 2 and $80x section 165 de-
duction). A’s functional currency is the U.S. dollar
and A conducts virtually all of its business in the U.S.
dollar. A has no connection to Japan or the Japanese
yen and would not have entered into the transactions
in the ordinary course of A’s trade or business. The
section 165 deductions related to the FX Swap were
incurred by A in a series of transactions in which
A secured the use of funds for a period of time and
were substantially incurred in consideration of the
time value of money. As a result, under paragraph (b)
(22)(iv)(A)(1) of this section, for purposes of section
163(j), the $80x paid by A to Bank on the FX Swap
is treated by A as interest expense.
(B) Example 2—(1) Facts. A is engaged in a
manufacturing business and uses the calendar year
as its annual accounting period. A does not use gold
in its manufacturing business. In 2021, A expects to
borrow $1,000x for six months. In January 2021, A
borrows from B two ounces of gold at a time when
the spot price for gold is $500x per ounce. A agrees
to return the two ounces of gold in six months. A
sells the two ounces of gold to C for $1,000x. A then
enters into a contract with D to purchase two ounces
of gold six months in the future for $1,013x. In ex-
change for the use of $1,000x in cash for six months,
A has sustained a loss of $13x in connection with
these related transactions. A would not have entered
into the gold transactions in the ordinary course of
A’s trade or business.
(2) Analysis. In a series of related transactions,
A has obtained the use of $1,000x for six months
and created a loss of $13x substantially incurred in
consideration of the time value of money. A would
not have entered into the gold transactions in the or-
dinary course of A’s trade or business. A entered into
the transactions with a principal purpose of structur-
ing the transactions to reduce its interest expense (in
effect, A sought to convert what otherwise would be
interest expense into a loss through the transactions).
As a result, under paragraph (b)(22)(iv)(A)(1) of this
section, for purposes of section 163(j), the loss of
$13x is treated by A as interest expense.
(C) Example 3—(1) Facts. A is engaged in a
manufacturing business and uses the calendar year
as its annual accounting period. A’s functional cur-
rency is the U.S. dollar and A conducts virtually all
of its business in the U.S. dollar. A has no connection
to Argentina or the Argentine peso as part of its ordi-
nary course of business. As of January 1, 2021, A ex-
pects to have adjusted taxable income (as defined in
paragraph (b)(1) of this section) of $200x in the tax-
able year ending December 31, 2021. A also projects
that it will have business interest expense of $70x on
an existing loan in 2021. A has cash equivalents of
$100x on which A expects to earn $5x of business
interest income. In early 2021, A enters into the fol-
lowing transactions, which A would not have entered
into in the ordinary course of A’s trade or business:
(i) A enters into a spot transaction with Bank to
convert the $100x of cash equivalents into an amount
in Argentine pesos equivalent to $100x and A uses
the Argentine pesos to purchase an Argentine peso
note (Note) issued by a subsidiary of Bank for the
Argentine peso equivalent of $100x; the Note pays
interest at a 10 percent rate; and
(ii) A enters into a foreign currency swap trans-
action (FX Swap) with Bank with a notional princi-
pal amount of $100x under which A pays Argentine
pesos at 10 percent multiplied by the amount of Ar-
gentine peso principal amount on the Note (which
for 2021 equals $10x) and receives U.S. dollars at
5 percent multiplied by a notional amount of $100x
($5x per year).

Bulletin No. 2020–40 707 September 28, 2020
(2) Analysis. A principal purpose of A entering
into the transactions was to increase the amount of
business interest income received by A; in effect, A
increased its business interest income by separate-
ly accounting for its net deduction of $5x per year
on the FX Swap. A’s functional currency is the U.S.
dollar and A conducts virtually all of its business in
the U.S. dollar. A has no connection to Argentina or
the Argentine peso and would not have entered into
the transactions in the ordinary course of A’s trade or
business. The FX Swap was incurred by A as a part
of a transaction that A entered into with a principal
purpose of artificially increasing its business interest
income. As a result, under paragraph (b)(22)(iv)(B) of
this section, for purposes of section 163(j), the $10x
business interest income earned on the Note by A is re-
duced by $5x (the net $5x paid by A on the FX Swap).
(D) Example 4—(1) Facts. A is wholly owned
by FC, a foreign corporation organized in foreign
country X. A uses the calendar year for its annual ac-
counting period. FC has a better credit rating than A.
A needs to borrow $2,000x in the taxable year ending
December 31, 2021, to fund its business operations.
A also projects that, if it borrows $2,000x on January
1, 2021, and pays a market rate of interest, it will
have business interest expense of $100x in its taxable
year ending December 31, 2021. In early 2021, A en-
ters into the following transactions:
(i) A enters into a loan obligation in which A bor-
rows $2,000x from Bank with an interest rate of 3
percent (Loan 1);
(ii) FC and Bank enter into a guarantee arrange-
ment (Guarantee) under which FC agrees to guar-
antee Bank that Bank will be timely paid all of the
amounts due on Loan 1; and
(iii) A enters into a guarantee fee agreement
with FC (Guarantee Fee Agreement) under which A
agrees to pay FC $40x in return for FC entering into
the Guarantee, which was not an agreement that A
would have entered into in the ordinary course of A’s
trade or business.
(2) Analysis. A principal purpose of A entering
into the transactions was to reduce the amount in-
curred by A that otherwise would be interest expense;
in effect, A sought to convert a substantial portion of
its interest expense deductions on Loan 1 into sec-
tion 162 deductions on the Guarantee Fee Agreement
($100x interest expense had A borrowed without the
Guarantee compared to $60x interest expense related
to Loan 1 and $40x section 162 deduction). A would
not have entered into the Guarantee Fee Agreement
in the ordinary course of A’s trade or business. The
$40x section 162 deductions related to the Guaran-
tee Fee Agreement were incurred by A in a series of
transactions in which A secured the use of funds for
a period of time and were substantially incurred in
consideration of the time value of money. As a result,
under paragraph (b)(22)(iv)(A)(1) of this section, for
purposes of section 163(j), the $40x paid by A to FC
on the Guarantee Fee Agreement is treated by A as
interest expense.
(E) Example 5—(1) Facts. A, B, and C are equal
partners in ABC partnership. ABC is considering ac-
quiring an additional loan from a third-party lender
to expand its business operations. However, ABC
already has significant debt and interest expense.
For the purpose of reducing the amount of additional
interest expense ABC would have otherwise incurred
by borrowing, A agrees to make an additional con-
tribution to ABC for use in its business operations
in exchange for a guaranteed payment for the use of
capital under section 707(c).
(2) Analysis. The guaranteed payment is deduct-
ible by ABC, incurred by ABC in a transaction in
which ABC secures the use of funds for a period of
time, substantially incurred in consideration of the
time value of money, and not described in paragraph
(b)(22)(i), (ii), or (iii) of this section. As a result, the
guaranteed payment to A is economically equivalent
to the interest that ABC would have incurred on an
additional loan from a third-party lender. A principal
purpose of A making a contribution in exchange for
a guaranteed payment for the use of capital was to
reduce the amount incurred by ABC that otherwise
would be interest expense. As a result, under para-
graph (b)(22)(iv)(A)(1) of this section, for purposes
of section 163(j), such guaranteed payment is treated
as interest expense of ABC for purposes of section
163(j). In addition, under paragraph (b)(22)(iv)(A)
(2) of this section, if A knows that the guaranteed
payment is treated as interest expense of ABC, be-
cause A provides the use of funds for a period of
time in a transaction subject to paragraph (b)(22)(iv)
(A)(1) of this section, A earns income or gain with
respect to the transaction, and such income or gain
is substantially earned in consideration of the time
value of money provided by A, the guaranteed pay-
ment is treated as interest income of A for purposes
of section 163(j).
(23) Interest expense. The term interest
expense means interest that is paid or ac-
crued, or treated as paid or accrued, for the
taxable year.
(24) Interest income. The term interest
income means interest that is included in
gross income for the taxable year.
(25) Member. The term member has the
meaning provided in §1.1502-1(b).
(26) Motor vehicle. The term motor ve-
hicle means a motor vehicle as defined in
section 163(j)(9)(C).
(27) Old section 163(j). The term old
section 163(j) means section 163(j) imme-
diately prior to its amendment by Public
Law No. 115-97, 131 Stat. 2054 (2017).
(28) Ownership change. The term own-
ership change has the meaning provided
in section 382 and the regulations in this
part under section 382 of the Code.
(29) Ownership date. The term own-
ership date has the meaning provided in
section 382 and the regulations in this part
under section 382 of the Code.
(30) Real estate investment trust. The
term real estate investment trust (REIT)
has the meaning provided in section 856.
(31) Real property. The term real prop-
erty includes—
(i) Real property as defined in §1.469-
9(b)(2); and
(ii) Any direct or indirect right, includ-
ing a license or other contractual right, to
share in the appreciation in value of, or the
gross or net proceeds or profits generated
by, an interest in real property, including
net proceeds or profits associated with
tolls, rents or other similar fees.
(32) Regulated investment company.
The term regulated investment company
(RIC) has the meaning provided in section
851.
(33) Relevant foreign corporation. The
term relevant foreign corporation means
any foreign corporation whose classifica-
tion is relevant under §301.7701-3(d)(1)
for a taxable year, other than solely pursu-
ant to section 881 or 882.
(34) S corporation. The term S corpo-
ration has the meaning provided in section
1361(a)(1).
(35) [Reserved]
(36) Section 163(j) limitation. The
term section 163(j) limitation means the
limit on the amount of business interest
expense that a taxpayer may deduct in
a taxable year under section 163(j) and
§1.163(j)-2(b).
(37) Section 163(j) regulations. The
term section 163(j) regulations means this
section and §§1.163(j)-2 through 1.163(j)-
11.
(38) Separate return limitation year.
The term separate return limitation year
(SRLY) has the meaning provided in
§1.1502-1(f).
(39) Separate return year. The term
separate return year has the meaning pro-
vided in §1.1502-1(e).
(40) Separate tentative taxable in-
come. The term separate tentative taxable
income with respect to a taxpayer and a
taxable year has the meaning provided
in §1.1502-12, but for this purpose com-
puted without regard to the application
of the section 163(j) limitation and with
the addition of the adjustments made in
paragraph (b)(43)(ii) of this section and
§1.163(j)-4(d)(2)(iv).
(41) Tax-exempt corporation. The term
tax-exempt corporation means any tax-ex-
empt organization that is organized as a
corporation.
(42) Tax-exempt organization. The
term tax-exempt organization means any
entity subject to tax under section 511.
(43) Tentative taxable income—(i) In
general. The term tentative taxable in-

September 28, 2020 708 Bulletin No. 2020–40
come, with respect to a taxpayer and a
taxable year, generally is determined in
the same manner as taxable income under
section 63 but for this purpose computed
without regard to the application of the
section 163(j) limitation. Tentative taxable
income is computed without regard to any
disallowed business interest expense car-
ryforwards.
(ii) [Reserved]
(iii) Special rules for defining tenta-
tive taxable income. (A) For special rules
defining the tentative taxable income of a
RIC or REIT, see §1.163(j)-4(b)(4)(ii).
(B) For special rules defining the ten-
tative taxable income of consolidated
groups, see §1.163(j)-4(d)(2)(iv).
(C) For special rules defining the ten-
tative taxable income of a partnership, see
§1.163(j)-6(d)(1).
(D) For special rules defining the ten-
tative taxable income of an S corporation,
see §1.163(j)-6(l)(3).
(E) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§1.163(j)-3(b)(4).
(F) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§1.163(j)-3(b)(4).
(G) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§1.163(j)-3(b)(4).
(44) Trade or business—(i) In general.
The term trade or business means a trade
or business within the meaning of section
162.
(ii) Excepted trade or business. The
term excepted trade or business means the
trade or business of performing services
as an employee, an electing real proper-
ty trade or business, an electing farming
business, or an excepted regulated utili-
ty trade or business. For additional rules
related to excepted trades or businesses,
including elections made under section
163(j)(7)(B) and (C), see §1.163(j)-9.
(iii) Non-excepted trade or business.
The term non-excepted trade or business
means any trade or business that is not an
excepted trade or business.
(45) Unadjusted basis. The term unad-
justed basis means the basis as determined
under section 1012 or other applicable
sections of chapter 1 of subtitle A of the
Code, including subchapters O (relating to
gain or loss on dispositions of property),
C (relating to corporate distributions and
adjustments), K (relating to partners and
partnerships), and P (relating to capital
gains and losses) of the Code. Unadjusted
basis is determined without regard to any
adjustments described in section 1016(a)
(2) or (3), any adjustments for tax credits
claimed by the taxpayer (for example, un-
der section 50(c)), or any adjustments for
any portion of the basis that the taxpayer
has elected to treat as an expense (for ex-
ample, under section 179, 179B, or 179C).
(46) United States shareholder. The
term United States shareholder has the
meaning provided in section 951(b).
(c) Applicability date—(1) In gener-
al. Except as provided in paragraphs (c)
(2) and (3) of this section, this section ap-
plies to taxable years beginning on or after
November 13, 2020 . However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section to
a taxable year beginning after December
31, 2017, and before November 13, 2020
so long as the taxpayers and their related
parties consistently apply the rules of the
section 163(j) regulations, and, if appli-
cable, §§1.263A-9, 1.263A-15, 1.381(c)
(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-
6, 1.383-0, 1.383-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4, to that taxable year.
Additionally, taxpayers and their related
parties within the meaning of sections
267(b) and 707(b)(1), otherwise relying
on the notice of proposed rulemaking that
was published on December 28, 2018, in
the Federal Register (83 FR 67490) in its
entirety under §1.163(j)-1(c), may alterna-
tively choose to follow §1.163(j)-1(b)(1)
(iii), rather than proposed §1.163(j)-1(b)
(1)(iii).
(2) Anti-avoidance rules. The an-
ti-avoidance rules in paragraph (b)(22)(iv)
of this section apply to transactions en-
tered into on or after September 14, 2020.
(3) Swaps with significant nonperiodic
payments—(i) In general. Except as pro-
vided in paragraph (c)(3)(ii) of this sec-
tion, the rules provided in paragraph (b)
(22)(ii) of this section apply to notional
principal contracts entered into on or after
September 14, 2021. However, taxpayers
may choose to apply the rules provided
in paragraph (b)(22)(ii) of this section to
notional principal contracts entered into
before September 14, 2021.
(ii) Anti-avoidance rule. The an-
ti-avoidance rules in paragraph (b)(22)(iv)
of this section (applied without regard to
the references to paragraph (b)(22)(ii) of
this section) apply to a notional principal
contract entered into on or after Septem-
ber 14, 2020.
§1.163(j)-2 Deduction for business
interest expense limited.
(a) Overview. This section provides
general rules regarding the section 163(j)
limitation. Paragraph (b) of this section
provides rules regarding the basic com-
putation of the section 163(j) limitation.
Paragraph (c) of this section provides
rules for disallowed business interest ex-
pense carryforwards. Paragraph (d) of
this section provides rules regarding the
small business exemption from the sec-
tion 163(j) limitation. Paragraph (e) of
this section that is part of provides rules
regarding real estate mortgage investment
conduits (REMICs). Paragraph (f) of this
section provides rules regarding the cal-
culation of ATI with respect to certain
beneficiaries. Paragraph (g) of this section
provides rules regarding tax-exempt or-
ganizations. Paragraph (h) of this section
provides examples illustrating the appli-
cation of this section. Paragraph (i) of this
section is reserved. Paragraph (j) of this
section provides an anti-avoidance rule.
(b) General rule—(1) In general. Ex-
cept as otherwise provided in this section
or in §§1.163(j)-3 through 1.163(j)-11, the
amount allowed as a deduction for busi-
ness interest expense for the taxable year
cannot exceed the sum of—
(i) The taxpayer’s business interest in-
come for the taxable year;
(ii) 30 percent of the taxpayer’s ATI for
the taxable year, or zero if the taxpayer’s
ATI for the taxable year is less than zero;
and
(iii) The taxpayer’s floor plan financing
interest expense for the taxable year.
(2) 50 percent ATI limitation for tax-
able years beginning in 2019 or 2020—(i)

Bulletin No. 2020–40 709 September 28, 2020
In general. Except as otherwise provided
in section 163(j)(10) and paragraph (b)
(2) of this section, for any taxable year
beginning in 2019 or 2020, paragraph (b)
(1)(ii) of this section is applied by substi-
tuting 50 percent for 30 percent. The 50
percent ATI limitation does not apply to
partnerships for taxable years beginning
in 2019. Further, for a partnership taxable
year beginning in 2020 for which an elec-
tion out of section 163(j)(10)(A)(i) has
not been made, §1.163(j)-6(f)(2)(xi) is
applied by substituting two for ten-thirds
when grossing up each partner’s final ATI
capacity excess amount.
(ii) Election out of the 50 percent ATI
limitation. A taxpayer may elect to not
have paragraph (b)(2)(i) of this section ap-
ply for any taxable year beginning in 2019
or 2020. In the case of a partnership, the
election must be made by the partnership
and may be made only for taxable years
beginning in 2020.
(3) Election to use 2019 ATI in 2020—
(i) In general. Subject to paragraph (b)(3)
(ii), a taxpayer may elect to use the tax-
payer’s ATI for the last taxable year begin-
ning in 2019 (2019 ATI) as the ATI for any
taxable year beginning in 2020.
(ii) Short taxable years. If an elec-
tion is made under paragraph (b)(3)(i) of
this section for a taxable year beginning
in 2020 that is a short taxable year, the
ATI for such taxable year is equal to the
amount that bears the same ratio to 2019
ATI as the number of months in the short
taxable year bears to 12.
(4) Time and manner of making or re-
voking the elections. The rules and proce-
dures regarding the time and manner of
making, or revoking, an election under
paragraphs (b)(2) and (3) of this section
are provided in Revenue Procedure 2020-
22, 2020-18 I.R.B. 745, or in other guid-
ance that may be issued (see §§601.601(d)
and 601.602 of this chapter).
(c) Disallowed business interest ex-
pense carryforward—(1) In general. Any
business interest expense disallowed un-
der paragraph (b) of this section, or any
disallowed disqualified interest that is
properly allocable to a non-excepted
trade or business under §1.163(j)-10, is
carried forward to the succeeding taxable
year as a disallowed business interest
expense carryforward, and is therefore
business interest expense that is subject
to paragraph (b) of this section in such
succeeding taxable year. Disallowed
business interest expense carryforwards
are not re-allocated between non-except-
ed and excepted trades or businesses in a
succeeding taxable year. Instead, the car-
ryforwards continue to be treated as allo-
cable to a non-excepted trade or business.
See §1.163(j)-10(c)(4).
(2) Coordination with small business
exemption. If disallowed business interest
expense is carried forward under the rules
of paragraph (c)(1) of this section to a tax-
able year in which the small business ex-
emption in paragraph (d) of this section ap-
plies to the taxpayer, then the general rule
in paragraph (b) of this section does not
apply to limit the deduction of the disal-
lowed business interest expense carryfor-
ward of the taxpayer in that taxable year.
See §1.163(j)-6(m)(3) for rules applicable
to the treatment of excess business inter-
est expense from a partnership that is not
subject to section 163(j) in a succeeding
taxable year, and see §1.163(j)-6(m)(4)
for rules applicable to S corporations with
disallowed business interest expense car-
ryforwards that are not subject to section
163(j) in a succeeding taxable year.
(3) Cross-references—(i) For spe-
cial rules regarding disallowed business
interest expense carryforwards for tax-
payers that are C corporations, including
members of a consolidated group, see
§1.163(j)-5.
(ii) For special rules regarding disal-
lowed business interest expense carryfor-
wards of S corporations, see §§1.163(j)-
5(b)(2) and 1.163(j)-6(l)(5).
(iii) For special rules regarding disal-
lowed business interest expense carryfor-
wards from partnerships, see §1.163(j)-6.
(iv)-(v) [Reserved]
(d) Small business exemption—(1) Ex-
emption. The general rule in paragraph (b)
of this section does not apply to any tax-
payer, other than a tax shelter as defined
in section 448(d)(3), in any taxable year
in which the taxpayer meets the gross re-
ceipts test of section 448(c) and the regu-
lations in this part under section 448 of the
Code for the taxable year. See §1.163(j)-
9(b) for elections available under section
163(j)(7)(B) and 163(j)(7)(C) for real
property trades or businesses or farming
businesses that also may be exempt small
businesses. See §1.163(j)-6(m) for rules
applicable to partnerships and S corpora-
tions not subject to section 163(j).
(2) Application of the gross receipts
test—(i) In general. In the case of any tax-
payer that is not a corporation or a partner-
ship, and except as provided in paragraphs
(d)(2)(ii), (iii), and (iv) of this section, the
gross receipts test of section 448(c) and
the regulations in this part under section
448 of the Code are applied in the same
manner as if such taxpayer were a corpo-
ration or partnership.
(ii) Gross receipts of individuals. Ex-
cept as provided in paragraph (d)(2)(iii)
of this section (regarding partnership and
S corporation interests), an individual tax-
payer’s gross receipts include all items
specified as gross receipts in regulations
under section 448(c), whether or not de-
rived in the ordinary course of the taxpay-
er’s trade or business. For purposes of sec-
tion 163(j), an individual taxpayer’s gross
receipts do not include inherently person-
al amounts, including, but not limited to,
personal injury awards or settlements with
respect to an injury of the individual tax-
payer, disability benefits, Social Security
benefits received by the taxpayer during
the taxable year, and wages received as an
employee that are reported on Form W-2.
(iii) Partners and S corporation share-
holders. Except when the aggregation
rules of section 448(c) apply, each partner
in a partnership includes a share of part-
nership gross receipts in proportion to
such partner’s distributive share (as deter-
mined under section 704) of items of gross
income that were taken into account by the
partnership under section 703. Additional-
ly, each shareholder in an S corporation
includes a pro rata share of S corporation
gross receipts.
(iv) Tax-exempt organizations. For pur-
poses of section 163(j), the gross receipts
of a tax-exempt organization include only
gross receipts taken into account in deter-
mining its unrelated business taxable in-
come.
(e) REMICs. For the treatment of in-
terest expense by a REMIC as defined in
section 860D, see §1.860C-2(b)(2)(ii).
(f) Trusts—(i) Calculation of ATI with
respect to certain trusts and estates. The
ATI of a trust or a decedent’s estate tax-
able under section 641 is computed with-
out regard to deductions under sections
642(c), 651, and 661.

September 28, 2020 710 Bulletin No. 2020–40
(ii) Calculation of ATI with respect to
certain beneficiaries. The ATI of a benefi-
ciary (including a tax-exempt beneficiary)
of a trust or a decedent’s estate is reduced
by any income (including any distribut-
able net income) received from the trust
or estate by the beneficiary to the extent
such income was necessary to permit a
deduction under section 163(j)(1)(B) and
§1.163(j)-2(b) for any business interest
expense of the trust or estate that was in
excess of any business interest income of
the trust or estate.
(g) Tax-exempt organizations. Except
as provided in paragraph (d) of this sec-
tion, the section 163(j) limitation applies
to tax-exempt organizations for purpos-
es of computing their unrelated business
taxable income under section 512. For
rules on determining the gross receipts
of a tax-exempt organization for purpos-
es of the small business exemption, see
paragraph (d)(2)(iv) of this section. For
special rules applicable to tax-exempt
beneficiaries of a trust or a decedent’s es-
tate, see §1.163(j)-2(f). For special rules
applicable to tax-exempt corporations, see
§1.163(j)-4. For special allocation rules
applicable to tax-exempt organizations,
see §1.163(j)-10(a)(5).
(h) Examples. The examples in this
paragraph (h) illustrate the application
of section 163(j) and the provisions of
this section. Unless otherwise indicated,
X and Y are domestic C corporations; C
and D are U.S. resident individuals not
subject to any foreign income tax; PRS
is a domestic partnership with partners
who are all individuals; all taxpayers
use a calendar taxable year; the exemp-
tion for certain small businesses in sec-
tion 163(j)(3) and paragraph (d) of this
section does not apply; and the interest
expense would be deductible but for sec-
tion 163(j).
(1) Example 1: Limitation on business interest
expense deduction—(i) Facts. During its taxable
year ending December 31, 2021, X has ATI of $100x.
X has business interest expense of $50x, which in-
cludes $10x of floor plan financing interest expense,
and business interest income of $20x.
(ii) Analysis. For the 2021 taxable year, X’s sec-
tion 163(j) limitation is $60x, which is the sum of its
business interest income ($20x), plus 30 percent of its
ATI ($100x x 30 percent = $30x), plus its floor plan
financing interest expense ($10x). See §1.163(j)-
2(b). Because X’s business interest expense ($50x)
does not exceed X’s section 163(j) limitation ($60x),
X can deduct all $50x of its business interest expense
for the 2021 taxable year.
(2) Example 2: Carryforward of business inter-
est expense—(i) Facts. The facts are the same as in
Example 1 in paragraph (h)(1)(i) of this section, ex-
cept that X has $80x of business interest expense,
which includes $10x of floor plan financing interest
expense.
(ii) Analysis. As in Example 1 in paragraph (h)
(1)(ii) of this section, X’s section 163(j) limitation is
$60x. Because X’s business interest expense ($80x)
exceeds X’s section 163(j) limitation ($60x), X may
only deduct $60x of its business interest expense for
the 2021 taxable year, and the remaining $20x of its
business interest expense will be carried forward to
the succeeding taxable year as a disallowed business
interest expense carryforward. See §1.163(j)-2(c).
(3) Example 3: ATI computation—(i) Facts.
During the 2020 taxable year, Y has tentative taxable
income of $30x, which is determined without regard
to the application of the section 163(j) limitation
on business interest expense. Y’s tentative taxable
income includes the following: $20x of business
interest income; $50x of business interest expense,
which includes $10x of floor plan financing interest
expense; $25x of net operating loss deduction under
section 172; and $15x of depreciation under section
167, of which $10x is capitalized to inventory under
section 263A. Of the $10x capitalized to inventory,
only $7x is recovered through cost of goods sold
during the 2020 taxable year and $3x remains in end-
ing inventory at the end of the 2020 taxable year. The
$3x of ending inventory is recovered through cost of
goods sold during the 2021 taxable year. Y also has
a disallowed business interest expense carryforward
from the prior year of $8x.
(ii) Analysis. (A) For purposes of determining
the section 163(j) limitation for 2020, Y’s disallowed
business interest expense carryforward is not taken
into account in determining tentative taxable income
or ATI. Y’s ATI is $90x, calculated as follows:
Table 1 to paragraph (h)(3)(ii)(A)
Tentative taxable income: $30x
Less:
Floor plan financing interest 10x
Business interest income 20x
0x
(B) Plus:
Table 2 to paragraph (h)(3)(ii)(B)
Business interest expense $50x
Net operating loss deduction 25x
Depreciation 15x
ATI $90x
(C) For Y’s 2021 taxable year, the $3x of end-
ing inventory that is recovered through cost of goods
sold in 2021 is not added back to tentative taxable
income (TTI) in determining ATI because it was
already included as an addback in ATI in Y’s 2020
taxable year. See §1.163(j)-1(b)(1)(iii).
(4) Example 4: Floor plan financing interest
expense—(i) Facts. C is the sole proprietor of an
automobile dealership that uses a cash method of
accounting. In the 2021 taxable year, C paid $30x
of interest on a loan that was obtained to purchase
sedans for sale by the dealership. The indebtedness
is secured by the sedans purchased with the loan pro-
ceeds. In addition, C paid $20x of interest on a loan,
secured by the dealership’s office equipment, which
C obtained to purchase convertibles for sale by the
dealership.
(ii) Analysis. For the purpose of calculating C’s
section 163(j) limitation, only the $30x of interest
paid on the loan to purchase the sedans is floor plan
financing interest expense. The $20x paid on the loan
to purchase the convertibles is not floor plan financ-
ing interest expense for purposes of section 163(j)
because the indebtedness was not secured by the
inventory of convertibles. However, because under
§1.163(j)-10 the interest paid on the loan to purchase
the convertibles is properly allocable to C’s dealer-
ship trade or business, and because floor plan financ-
ing interest expense is also business interest expense,
C has $50x of business interest expense for the 2021
taxable year.
(5) Example 5: Interest not properly allocable to
non-excepted trade or business—(i) Facts. The facts
are the same as in Example 4 in paragraph (h)(4)(i) of
this section, except that the $20x of interest C pays is
on acquisition indebtedness obtained to purchase C’s
personal residence and not to purchase convertibles
for C’s dealership trade or business.
(ii) Analysis. Because the $20x of interest ex-
pense is not properly allocable to a non-excepted
trade or business, and therefore is not business in-
terest expense, C’s only business interest expense is
the $30x that C pays on the loan used to purchase
sedans for sale in C’s dealership trade or business. C
deducts the $20x of interest related to his residence
under the rules of section 163(h), without regard to
section 163(j).
(6) Example 6: Small business exemption—(i)
Facts. During the 2021 taxable year, D, the sole pro-
prietor of a trade or business reported on Schedule
C, has interest expense properly allocable to that
trade or business. D does not conduct an electing
real property trade or business or an electing farm-
ing business. D also earns gross income from pro-
viding services as an employee that is reported on a
Form W-2. Under section 448(c) and the regulations
in this part under section 448, D has average annual
gross receipts of $21 million, including $1 million
of wages in each of the three prior taxable years and
$2 million of income from investments not related to
a trade or business in each of the three prior taxable
years. Also, in each of the three prior taxable years, D
received $5 million in periodic payments of compen-
satory damages awarded in a personal injury lawsuit.
(ii) Analysis. Section 163(j) does not apply to D
for the taxable year, because D qualifies for the small
business exemption under §1.163(j)-2(d). The wag-
es that D receives as an employee and the compen-
satory damages that D received from D’s personal
injury lawsuit are not gross receipts, as provided in
§1.163(j)-2(d)(2)(ii). D may deduct all of its business
interest expense for the 2021 taxable year without re-
gard to section 163(j).
(7) Example 7: Partnership with excess busi-
ness interest expense qualifies for the small busi-
ness exemption in a succeeding taxable year—(i)
Facts. X and Y are equal partners in partnership

Bulletin No. 2020–40 711 September 28, 2020
PRS. In addition to being partners in PRS, X and
Y each operate their own sole proprietorships. For
the taxable year ending December 31, 2021, PRS
is subject to section 163(j) and has excess business
interest expense of $10x. For the taxable year end-
ing December 31, 2022, PRS has $40x of business
interest expense, and X and Y have $20x of busi-
ness interest expense from their respective sole pro-
prietorships. For the taxable year ending December
31, 2022, PRS and Y qualify for the small business
exemption under §1.163(j)-2(d), while X is subject
to section 163(j) and has a section 163(j) limitation
of $22x.
(ii) Partnership-level analysis. For the 2021 tax-
able year, PRS allocates the $10x of excess business
interest expense equally to X and Y ($5x each). See
§1.163(j)-6(f)(2). For the 2022 taxable year, section
163(j) does not apply to PRS because PRS qualifies
for the small business exemption. As a result, none of
PRS’s $40x of business interest expense for the 2022
taxable year is subject to the section 163(j) limitation
at the partnership level.
(iii) Partner-level analysis. For the 2022 taxable
year, each partner treats its $5x of excess business
interest expense from PRS as paid or accrued in that
year. See §1.163(j)-6(m)(3). This amount becomes
business interest expense that each partner must sub-
ject to its own section 163(j) limitation, if any. With
this $5x, each partner has $25x of business interest
expense for the 2022 taxable year ($20x from its sole
proprietorship, plus $5x of excess business interest
expense treated as paid or accrued in the 2020 tax-
able year). X deducts $22x of its business interest
expense pursuant to its section 163(j) limitation and
carries forward the remainder ($3x) as a disallowed
business interest expense carryforward to the taxable
year ending December 31, 2023. Y is not subject to
section 163(j) because Y qualifies for the small busi-
ness exemption. Y therefore deducts all $25x of its
business interest expense for the 2022 taxable year.
(8) Example 8: Aggregation of gross receipts—
(i) Facts. X and Y are domestic C corporations under
common control, within the meaning of section 52(a)
and §1.52-1(b). X’s only trade or business is a farm-
ing business described in §1.263A-4(a)(4). During
the taxable year ending December 31, 2020, X has
average annual gross receipts under section 448(c)
of $6 million. During the same taxable year, Y has
average annual gross receipts under section 448(c)
of $21 million.
(ii) Analysis. Because X and Y are under com-
mon control, they must aggregate gross receipts for
purposes of section 448(c) and the small business
exemption in §1.163(j)-2(d). See section 448(c)(2).
Therefore, X and Y are both considered to have $27
million in average annual gross receipts for 2020. X
and Y must separately apply section 163(j) to deter-
mine any limitation on the deduction for business
interest expense. Assuming X otherwise meets the
requirements in §1.163(j)-9 in 2020, X may elect
for its farming business to be an excepted trade or
business.
(i) [Reserved]
(j) Anti-avoidance rule—(1) In gen-
eral. Arrangements entered into with a
principal purpose of avoiding the rules of
section 163(j) or the section 163(j) regula-
tions, including the use of multiple entities
to avoid the gross receipts test of section
448(c), may be disregarded or recharacter-
ized by the Commissioner of the IRS to
the extent necessary to carry out the pur-
poses of section 163(j).
(2) Examples. The examples in this
paragraph (j)(2) illustrate the application
of this section.
(i) Example 1—(A) Facts. Individual A operates
an excepted trade or business (Business X) and a
non-excepted trade or business (Business Y). With
a principal purpose of avoiding the rules of section
163(j) or the regulations in this part under section
163(j) of the Code, A contributes Business X to new-
ly-formed C corporation B in exchange for stock;
A then causes B to borrow funds from a third party
and distributes a portion of the borrowed funds to A
for use in Business Y. B takes the position that its
interest payments on the debt are not subject to the
section 163(j) limitation because B is engaged solely
in an excepted trade or business.
(B) Analysis. A has entered into an arrangement
with a principal purpose of avoiding the rules of
section 163(j) or the regulations in this part under
section 163(j). Thus, under paragraph (j)(1) of this
section, the Commissioner of the IRS may disregard
or recharacterize this transaction to the extent nec-
essary to carry out the purposes of section 163(j). In
this case, payments of interest on the debt may be
recharacterized as payments of interest properly al-
locable to a non-excepted trade or business subject
to the section 163(j) limitation.
(ii) Example 2—(A) Facts. Partnership UTP has
two non-excepted trades or businesses. Business A
has gross income of $1000x and gross deductions of
$200x. Business B has gross income of $100x and
gross deductions of $600x. With a principal purpose
of avoiding the rules in section 163(j) or the regu-
lations in this part under section 163(j), UTP and a
partner of UTP form partnership LTP and UTP con-
tributes Business B to LTP prior to borrowing funds.
UTP takes the position that it does not take its share
of LTP gross deductions into account when comput-
ing its ATI.
(B) Analysis. UTP has entered into an arrange-
ment with a principal purpose of avoiding the rules
of section 163(j) or the regulations in this part under
section 163(j). Thus, under paragraph (j)(1) of this
section, the Commissioner of the IRS may disregard
or recharacterize this transaction to the extent nec-
essary to carry out the purposes of section 163(j). In
this case, UTP’s share of gross deductions from LTP
may be recharacterized as gross deductions incurred
directly by UTP solely for purposes of computing
UTP’s ATI.
(k) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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.
§1.163(j)-3 Relationship of the section
163(j) limitation to other provisions
affecting interest.
(a) Overview. This section contains
rules regarding the relationship between
section 163(j) and certain other provisions
of the Code. Paragraph (b) of this section
provides the general rules concerning the
relationship between section 163(j) and
certain other provisions of the Code. Para-
graph (c) of this section provides exam-
ples illustrating the application of this sec-
tion. For rules regarding the relationship
between sections 163(j) and 704(d), see
§1.163(j)-6(h)(1) and (2).
(b) Coordination of section 163(j) with
certain other provisions—(1) In general.
Section 163(j) and the regulations in this
part under section 163(j) of the Code gen-
erally apply only to business interest ex-
pense that would be deductible in the cur-
rent taxable year without regard to section
163(j). Thus, for example, a taxpayer must
apply §1.163-8T, if applicable, to deter-
mine which items of interest expense are
investment interest under section 163(d)
before applying the rules in this section
to interest expense. Except as otherwise
provided in this section, section 163(j)
applies after the application of provisions
that subject interest expense to disallow-
ance, deferral, capitalization, or other lim-
itation. For the rules that must be applied
in determining whether excess business
interest is paid or accrued by a partner, see
section 163(j)(4)(B)(ii) and §1.163(j)-6.
(2) Disallowed interest provisions. For
purposes of section 163(j), business in-
terest expense does not include interest
expense that is permanently disallowed
as a deduction under another provision of
the Code, such as in section 163(e)(5)(A)
(i), (f), (l), or (m), or section 264(a), 265,
267A, or 279.

September 28, 2020 712 Bulletin No. 2020–40
(3) Deferred interest provisions. Other
than sections 461(l), 465, and 469, Code
provisions that defer the deductibility of
interest expense, such as section 163(e)(3)
and (e)(5)(A)(ii), 267(a)(2) and (3), 1277,
or 1282, apply before the application of
section 163(j).
(4) At risk rules, passive activity loss
provisions, and limitation on excess busi-
ness losses of noncorporate taxpayers.
Section 163(j) generally applies to limit
the deduction for business interest ex-
pense before the application of sections
461(l), 465, and 469. However, in deter-
mining tentative taxable income for pur-
poses of computing ATI, sections 461(l),
465, and 469 are taken into account.
(5) Capitalized interest expenses. Sec-
tion 163(j) applies after the application of
provisions that require the capitalization
of interest, such as sections 263A and
263(g). Capitalized interest expense under
those sections is not treated as business
interest expense for purposes of section
163(j). For ordering rules that determine
whether interest expense is capitalized
under section 263A(f), see the regula-
tions under section 263A(f), including
§1.263A-9(g).
(6) Reductions under section 246A.
Section 246A applies before section
163(j). Any reduction in the dividends re-
ceived deduction under section 246A re-
duces the amount of interest expense tak-
en into account under section 163(j).
(7) Section 381. Disallowed busi-
ness interest expense carryforwards are
items to which an acquiring corporation
succeeds under section 381(a). See sec-
tion 381(c)(20) and §§1.163(j)-5(c) and
1.381(c)(20)-1.
(8) Section 382. For rules governing the
interaction of sections 163(j) and 382, see
section 382(d)(3) and (k)(1), §§1.163(j)-
5(e) and 1.163(j)-11(c), the regulations in
this part under sections 382 and 383 of the
Code, and §§1.1502-91 through 1.1502-
99.
(c) Examples. The examples in this
paragraph (c) illustrate the application of
section 163(j) and the provisions of this
section. Unless otherwise indicated, X and
Y are calendar-year domestic C corpora-
tions; D is a U.S. resident individual not
subject to any foreign income tax; none
of the taxpayers have floor plan financing
interest expense; and the exemption for
certain small businesses in §1.163(j)-2(d)
does not apply.
(1) Example 1: Disallowed interest expense—
(i) Facts. In 2021, X has $30x of interest expense.
Of X’s interest expense, $10x is permanently disal-
lowed under section 265. X’s business interest in-
come is $3x and X’s ATI is $90x.
(ii) Analysis. Under paragraph (b)(2) of this sec-
tion, the $10x interest expense that is permanently
disallowed under section 265 cannot be taken into
consideration for purposes of section 163(j) in the
2021 taxable year. X’s section 163(j) limitation, or
the amount of business interest expense that X may
deduct is limited to $30x under §1.163(j)-2(b), deter-
mined by adding X’s business interest income ($3x)
and 30 percent of X’s 2019 ATI ($27x). Therefore, in
the 2021 taxable year, none of the $20x of X’s deduc-
tion for its business interest expense is disallowed
under section 163(j).
(2) Example 2: Deferred interest expense—(i)
Facts. In 2021, Y has no business interest income,
$120x of ATI, and $70x of interest expense. Of Y’s
interest expense, $30x is not currently deductible un-
der section 267(a)(2). The $30x expense is allowed
as a deduction under section 267(a)(2) in 2022.
(ii) Analysis. Under paragraph (b)(3) of this
section, section 267(a)(2) is applied before section
163(j). Accordingly, $30x of Y’s interest expense
cannot be taken into consideration for purposes of
section 163(j) in 2021 because it is not currently
deductible under section 267(a)(2). Accordingly, in
2021, if the interest expense is properly allocable to
a non-excepted trade or business, Y will have $4x
of disallowed business interest expense because the
$40x of business interest expense in 2021 ($70x -
$30x) exceeds 30 percent of its ATI for the taxable
year ($36x). The $30x of interest expense not al-
lowed as a deduction in the 2021 taxable year under
section 267(a)(2) will be taken into account in deter-
mining the business interest expense deduction un-
der section 163(j) in 2022, the taxable year in which
it is allowed as a deduction under section 267(a)(2),
if it is allocable to a trade or business. Additional-
ly, the $4x of disallowed business interest expense
in 2021 will be carried forward to 2022 as a disal-
lowed business interest expense carryforward. See
§1.163(j)-2(c).
(3) Example 3: Passive activity loss—(i) Facts.
D is engaged in a rental activity treated as a passive
activity within the meaning of section 469. For the
2021 taxable year, D receives $200x of rental income
and incurs $300x of expenses all properly allocable
to the rental activity, consisting of $150x of interest
expense, $60x of maintenance expenses, and $90x of
depreciation expense. D’s ATI is $400x.
(ii) Analysis. Under paragraph (b)(4) of this sec-
tion, section 163(j) is applied before the section 469
passive loss rules apply, except that section 469 is
taken into account in the determination of tentative
taxable income for purposes of computing ATI. D’s
section 163(j) limitation is $120x, determined by
adding to D’s business interest income ($0), floor
plan financing ($0), and 30 percent of D’s ATI
($120x). See §1.163(j)-2(b). Because D’s business
interest expense of $150x exceeds D’s section 163(j)
limitation for 2021, $30x of D’s business interest
expense is disallowed under section 163(j) and will
be carried forward as a disallowed business interest
expense carryforward. See §1.163(j)-2(c). Because
the section 163(j) limitation is applied before the
limitation under section 469, only $120x of the busi-
ness interest expense allowable under section 163(j)
is included in determining D’s passive activity loss
limitation for the 2021 tax year under section 469.
The $30x of disallowed business interest expense is
not an allowable deduction under section 163(j) and,
therefore, is not a deduction under section 469 in the
current taxable year. See §1.469-2(d)(8).
(4) Example 4: Passive activity loss by taxpayer
that also participates in a non-passive activity—(i)
Facts. For 2021, D has no business interest income
and ATI of $1,000x, entirely attributable to a pas-
sive activity within the meaning of section 469. D
has business interest expense of $1,000x, $900x of
which is properly allocable to a passive activity and
$100x of which is properly allocable to a non-pas-
sive activity in which D materially participates. D
has other business deductions that are not subject to
section 469 of $600x, and a section 469 passive loss
from the previous year of $250x.
(ii) Analysis. Under paragraph (b)(4) of this sec-
tion, section 163(j) is applied before the section 469
passive loss rules apply. D’s section 163(j) limitation
is $300x, determined by adding D’s business interest
income ($0), floor plan financing ($0), and 30 per-
cent of D’s ATI ($300x)). Next, applying the limita-
tion under section 469 to the $300x business interest
expense deduction allowable under section 163(a)
and (j), $270x (a proportionate amount of the $300x
(0.90 x $300x)) is business interest expense included
in determining D’s passive activity loss limitation
under section 469, and $30x (a proportionate amount
of the $300x (0.10 x $300)) is business interest
expense not included in determining D’s passive
activity loss limitation under section 469. Because
D’s interest expense of $1,000x exceeds 30 percent
of its ATI for 2021, $700x of D’s interest expense is
disallowed under section 163(j) and will be carried
forward as a disallowed business interest expense
carryforward. Section 469 does not apply to any
portion of the $700x disallowed business interest ex-
pense because that business interest expense is not an
allowable deduction under section 163(j) and, there-
fore, is not an allowable deduction under section 469
in the current taxable year. See §1.469-2(d)(8).
(5) Example 5: ATI calculation with passive ac-
tivity loss—(i) Facts. D is an individual who engages
in a trade or business, V, as a sole proprietorship. D
relies on employees to perform most of the work and,
as a result, D does not materially participate in V.
Therefore, V is a passive activity of D. V is not an
excepted trade or business. In Year 1, V generates
$500x of passive income, $400x of business interest
expense, and $600x of ordinary and necessary ex-
penses deductible under section 162 (not including
any interest described in §1.163(j)-1(b)(22)). No
disallowed business interest expense carryforward
has been carried to Year 1 from a prior year, and no
amounts have been carried over to Year 1 from a
prior year under either section 465(a)(2) or section
469(b).
(ii) Tentative taxable income. Under §1.163(j)-
1(b)(43), tentative taxable income is determined as
though all business interest expense was not sub-
ject to the section 163(j) limitation. Sections 461(l),
465, and 469 apply in the determination of tentative

Bulletin No. 2020–40 713 September 28, 2020
taxable income. For year 1, D has $500x of allow-
able deductions and a $500x tentative passive ac-
tivity loss under section 469, because D’s $1000x
of passive expenses exceeds D’s $500x of passive
income from V. The tentative disallowance of $500x
is generally allocated pro rata between D’s passive
expenses under §1.469-1T(f)(2)(ii)(A). In this case,
fifty percent ($500x of passive activity loss divided
by $1000x of total passive expenses) of each cate-
gory of passive expense is tentatively disallowed:
$200x of business interest expense and $300x of
section 162 expense. D’s tentative taxable income is
$0 (zero), which is determined by reducing $500x
of gross income by the remaining $200x of business
interest expense and $300x of section 162 expense
($500x - $200x - $300x).
(iii) ATI. Under section §1.163(j)-1(b)(1), to
determine ATI, D must add business interest ex-
pense to tentative taxable income, but only to the
extent that the business interest expense reduced
tentative taxable income, or $200x. The $200x of
business interest expense that was tentatively dis-
allowed under section 469 is not added to tentative
taxable income to determine ATI. D’s ATI is $200x,
which is determined by adding the $200x of busi-
ness interest expense that reduced tentative taxable
income to D’s tentative taxable income, or $0 (0
+ $200x).
(iv) Section 163(j) limitation. D’s section 163(j)
limitation in Year 1 is D’s business interest income,
or $0, plus 30 percent of ATI, or $60x (30 percent
x $200x ATI), plus D’s floor plan financing, or $0,
for a total of $60x ($0 + $60x + $0). Before the
application of section 469, D has $60x of deduct-
ible business interest expense and $340x of disal-
lowed business interest expense carryforward under
§1.163(j)-2(c).
(v) Passive activity loss. Because D’s passive
deductions exceed the passive income from V, and
D does not have any passive income from other
sources, section 469 applies to limit D’s passive
loss from V. Having first applied section 163(j),
D has $660x of passive expenses, determined by
adding D’s $60x of business interest expense that is
allowed by section 163(j) as a deduction and $600x
of section 162 expense ($60x + $600x). D offsets
$500x of the passive expenses against $500x of
passive income; therefore, D has a passive activity
loss of $160x in Year 1, determined as the excess of
D’s total passive expenses over D’s passive income
($660x – $500x).
The amount of D’s loss from the passive activ-
ity that is disallowed under section 469 ($160x) is
generally ratably allocated to each of D’s passive
activity deductions under §1.469-1T(f)(2)(ii)(A).
As a general rule, each deduction is multiplied by
the ratio of the total passive loss to total passive ex-
penses (160x / 660x). Of D’s $60x business interest
expense, $14.55x (($160x / $660x) x $60x) is disal-
lowed in Year 1. Additionally, of D’s $600x section
162 expense, $145.45x (($160x / $660x) x $600x)
is disallowed. The amounts disallowed under section
469(a)(1) and §1.469-2T(f)(2) are carried over to the
succeeding taxable year under section 469(b) and
§1.469-1(f)(4).
(6) Example 6: Effect of passive activity loss car-
ryforwards—(i) Facts. The facts are the same as in
Example 5 in paragraph (c)(5)(i) of this section. In
Year 2, V generates $500x of passive income, $100x
of business interest expense, and $0 (zero) of other
deductible expenses. D is not engaged in any other
trade or business activities. A disallowed business
interest expense carryforward of $340x has been car-
ried to Year 2 from Year 1. Under section 469, D has
a suspended loss from Year 1 that includes $14.55x
of business interest expense and $145.45x of section
162 expense. These amounts are treated as passive
activity deductions in Year 2.
(ii) Tentative taxable income. To determine D’s
tentative taxable income, D must first determine
D’s allowable deductions. In year 2, D has $260x
of allowable deductions, which includes $100x of
business interest expense generated Year 2, $14.55x
of business interest expense disallowed in Year 1
by section 469, and $145.45x of section 162 ex-
pense disallowed in Year 1 by section 469 ($100x
+ $14.55x + $145.45x)). D’s disallowed business
interest expense carryforward from Year 1 is not
taken into account in determining tentative taxable
income. See §1.163(j)-1(b)(43). Additionally, the
$14.55x of business interest expense disallowed in
Year 1 by section 469 is not business interest ex-
pense in Year 2 because it was deductible after the
application of section 163(j) (but before the appli-
cation of section 469) in Year 1. D does not have
a tentative passive activity loss in Year 2, because
D’s $500x of passive income from V exceeds D’s
$260x of tentative passive expenses. Therefore,
D’s tentative taxable income in Year 2 is $240x,
which is determined by subtracting D’s allowable
deductions other than disallowed business interest
expense carryforwards, or $260x, from D’s gross
income, or $500x ($500x - $260x).
(iii) ATI. D’s ATI in Year 2 is $340x, which is
determined by adding D’s business interest expense,
or $100x, to D’s tentative taxable income, or $240x
($240x + $100x). Because disallowed business inter-
est expense carryforwards are not taken into account
in determining tentative taxable income, there is no
corresponding adjustment for disallowed business
interest expense carryforwards in calculating ATI.
Therefore, there is no adjustment for D’s $340x of
disallowed business interest expense carryforward in
calculating D’s ATI. D has no other adjustments to
determine ATI.
(iv) Section 163(j) limitation. D’s section 163(j)
limitation in Year 2 is $102x, which is determined
by adding D’s business interest income, or $0, 30
percent of D’s ATI for year 2, $102 ($340x x 30 per-
cent), and D’s floor plan financing for Year 2, or $0
($0 + ($102x) + $0). Accordingly, before the applica-
tion of section 469 in Year 2, $102x of D’s $440x of
total business interest expense (determined by add-
ing $340x of disallowed business interest expense
carryforward from Year 1 and $100x of business in-
terest expense in Year 2) is deductible. D has $338x
of disallowed business interest expense carryforward
that will carry forward to subsequent taxable years
under §1.163(j)-2(c), determined by subtracting D’s
deductible business interest expense in Year 2, or
$102x, from D’s total business interest expense in
Year 2, or $440x ($440x - $102x).
(v) Section 469. After applying the section 163(j)
limitation, D applies section 469 to determine if any
amount of D’s expense is a disallowed passive activi-
ty loss. For Year 2, D has $262x of passive expenses,
determined by adding D’s business interest expense
deduction allowed by section 163(j) ($102x), D’s
section 162 expense carried forward from Year 1
under section 469 ($145.45x), and D’s interest ex-
pense carried forward from Year 1 under section 469
which is not business interest expense in Year 2, or
$14.55x ($102x + $145.45x + $14.55x). Therefore,
D has $238x of net passive income in Year 2, deter-
mined by reducing D’s total passive income in Year
2 ($500x), by D’s disallowed passive activity loss, or
$262x ($500x - $262x). D does not have a passive
activity loss in Year 2, and no part of D’s $262x of
passive expenses is disallowed in Year 2 under sec-
tion 469.
(7) Example 7: Capitalized interest expense—
(i) Facts. In 2020, X has $50x of interest expense.
Of X’s interest expense, $10x is required to be
capitalized under section 263A. X capitalizes this
interest expense to a depreciable asset. X’s busi-
ness interest income is $9x and X’s ATI is $80x.
X makes the election in §1.163(j)-2(b)(2)(ii) to use
30 percent, rather than 50 percent, of ATI in deter-
mining X’s section 163(j) limitation for the 2020
taxable year.
(ii) Analysis. Under paragraph (b)(5) of this sec-
tion, section 263A is applied before section 163(j).
Accordingly, $10x of X’s interest expense cannot
be taken into consideration for purposes of section
163(j) in 2020. Additionally, under paragraph (b)(5)
of this section, X’s $10 of capitalized interest ex-
pense is not business interest expense for purposes
of section 163(j). As a result, when X recovers its
capitalized interest expense through depreciation de-
ductions, such capitalized interest expense will not
be taken into account as business interest expense in
determining X’s section 163(j) limitation. X’s sec-
tion 163(j) limitation in 2020, or the amount of busi-
ness interest expense that X may deduct, is limited
to $33x under §1.163(j)-2(b), determined by adding
X’s business interest income ($9x) and 30 percent
of X’s 2020 ATI ($24x). X therefore has $7x of dis-
allowed business interest expense in 2020 that will
be carried forward to 2021 as a disallowed business
interest expense carryforward.
(d) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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.

September 28, 2020 714 Bulletin No. 2020–40
§1.163(j)-4 General rules applicable to
C corporations (including REITs, RICs,
and members of consolidated groups)
and tax-exempt corporations.
(a) Scope. This section provides rules
regarding the computation of items of in-
come and expense under section 163(j)
for taxpayers that are C corporations, in-
cluding, for example, members of a con-
solidated group, REITs, RICs, tax-exempt
corporations, and cooperatives. Paragraph
(b) of this section provides rules regarding
the characterization of items of income,
gain, deduction, or loss. Paragraph (c) of
this section provides rules regarding ad-
justments to earnings and profits. Para-
graph (d) of this section provides rules
applicable to members of a consolidated
group. Paragraph (e) of this section pro-
vides rules governing the ownership of
partnership interests by members of a
consolidated group. Paragraph (f) of this
section provides cross-references to oth-
er rules within the 163(j) regulations that
may be applicable to C corporations.
(b) Characterization of items of in-
come, gain, deduction, or loss—(1) Inter-
est expense and interest income. Solely for
purposes of section 163(j), all interest ex-
pense of a taxpayer that is a C corporation
is treated as properly allocable to a trade
or business. Similarly, solely for purposes
of section 163(j), all interest income of a
taxpayer that is a C corporation is treated
as properly allocable to a trade or busi-
ness. For rules governing the allocation of
interest expense and interest income be-
tween excepted and non-excepted trades
or businesses, see §1.163(j)-10.
(2) Adjusted taxable income. Solely
for purposes of section 163(j), all items of
income, gain, deduction, or loss of a tax-
payer that is a C corporation are treated as
properly allocable to a trade or business.
For rules governing the allocation of tax
items between excepted and non-excepted
trades or businesses, see §1.163(j)-10.
(3) Investment interest, investment in-
come, investment expenses, and certain
other tax items of a partnership with a
C corporation partner—(i) Character-
ization as expense or income properly
allocable to a trade or business. For pur-
poses of section 163(j), any investment in-
terest, investment income, or investment
expense (within the meaning of section
163(d)) that a partnership pays, receives,
or accrues and that is allocated to a C cor-
poration partner as a separately stated item
is treated by the C corporation partner as
properly allocable to a trade or business of
that partner. Similarly, for purposes of sec-
tion 163(j), any other tax items of a part-
nership that are neither properly allocable
to a trade or business of the partnership
nor described in section 163(d) and that
are allocated to a C corporation partner as
separately stated items are treated as prop-
erly allocable to a trade or business of that
partner.
(ii) Effect of characterization on part-
nership. The characterization of a part-
ner’s tax items pursuant to paragraph (b)
(3)(i) of this section does not affect the
characterization of these items at the part-
nership level.
(iii) Separately stated interest expense
and interest income of a partnership not
treated as excess business interest expense
or excess taxable income of a C corpora-
tion partner. Investment interest expense
and other interest expense of a partner-
ship that is treated as business interest
expense by a C corporation partner under
paragraph (b)(3)(i) of this section is not
treated as excess business interest expense
of the partnership. Investment interest in-
come and other interest income of a part-
nership that is treated as business interest
income by a C corporation partner under
paragraph (b)(3)(i) of this section is not
treated as excess taxable income of the
partnership. For rules governing excess
business interest expense and excess tax-
able income, see §1.163(j)-6.
(iv) Treatment of deemed inclusions of
a domestic partnership that are not allo-
cable to any trade or business. If a United
States shareholder that is a domestic part-
nership includes amounts in gross income
under sections 951(a) or 951A(a) that are
not properly allocable to a trade or busi-
ness of the domestic partnership, then,
notwithstanding paragraph (b)(3)(i) of
this section, to the extent a C corporation
partner, including an indirect partner in
the case of tiered partnerships, takes such
amounts into account as a distributive
share in accordance with section 702 and
§1.702-1(a)(8)(ii), the C corporation part-
ner may not treat such amounts as proper-
ly allocable to a trade or business of the C
corporation partner.
(4) Application to RICs and REITs—(i)
In general. Except as otherwise provided
in paragraphs (b)(4)(ii) and (iii) of this
section, the rules in this paragraph (b) ap-
ply to RICs and REITs.
(ii) Tentative taxable income of RICs
and REITs. The tentative taxable income
of a RIC or REIT for purposes of calculat-
ing ATI is the tentative taxable income of
the corporation, without any adjustment
that would be made under section 852(b)
(2) or 857(b)(2) to compute investment
company taxable income or real estate
investment trust taxable income, respec-
tively. For example, the tentative taxable
income of a RIC or REIT is not reduced
by the deduction for dividends paid, but
is reduced by the dividends received de-
duction (DRD) and the other deductions
described in sections 852(b)(2)(C) and
857(b)(2)(A). See paragraph (b)(4)(iii) of
this section for an adjustment to ATI in re-
spect of these items.
(iii) Other adjustments to adjusted tax-
able income for RICs and REITs. In the
case of a taxpayer that, for a taxable year,
is a RIC to which section 852(b) applies
or a REIT to which section 857(b) applies,
the taxpayer’s ATI for the taxable year is
increased by the amounts of any deduc-
tions described in section 852(b)(2)(C) or
857(b)(2)(A).
(5) Application to tax-exempt corpo-
rations. The rules in this paragraph (b)
apply to a tax-exempt corporation only
with respect to that corporation’s items of
income, gain, deduction, or loss that are
taken into account in computing the cor-
poration’s unrelated business taxable in-
come, as defined in section 512.
(6) Adjusted taxable income of co-
operatives. Solely for purposes of com-
puting the ATI of a cooperative under
§1.163(j)-1(b)(1), tentative taxable
income is not reduced by the amount
of any patronage dividend under sec-
tion 1382(b)(1) or by any amount paid
in redemption of nonqualified written
notices of allocation distributed as pa-
tronage dividends under section 1382(b)
(2) (for cooperatives subject to taxation
under sections 1381 through 1388), any
amount described in section 1382(c)
(for cooperatives described in section
1381(a)(1) and section 521), or any
equivalent amount deducted by an orga-
nization that operates on a cooperative

Bulletin No. 2020–40 715 September 28, 2020
basis but is not subject to taxation under
sections 1381 through 1388.
(7) Examples. The principles of this
paragraph (b) are illustrated by the fol-
lowing examples. For purposes of the ex-
amples in this paragraph (b)(7) of this sec-
tion, T is a taxable domestic C corporation
whose taxable year ends on December 31;
T is neither a consolidated group member
nor a RIC or a REIT; neither T nor PS1,
a domestic partnership, owns at least 80
percent of the stock of any corporation;
neither T nor PS1 qualifies for the small
business exemption in §1.163(j)-2(d) or is
engaged in an excepted trade or business;
T has no floor plan financing expense; all
interest expense is deductible except for
the potential application of section 163(j);
and the facts set forth the only corporate
or partnership activity.
(i) Example 1: C corporation items properly al-
locable to a trade or business—(A) Facts. In taxable
year 2021, T’s tentative taxable income (without re-
gard to the application of section 163(j)) is $320x.
This amount is comprised of the following tax items:
$1,000x of revenue from inventory sales; $500x of
ordinary and necessary business expenses (excluding
interest and depreciation); $200x of interest expense;
$50x of interest income; $50x of depreciation deduc-
tions under section 168; and a $20x gain on the sale
of stock.
(B) Analysis. For purposes of section 163(j),
each of T’s tax items is treated as properly allocable
to a trade or business. Thus, T’s ATI for the 2021
taxable year is $520x ($320x of tentative taxable in-
come + $200x business interest expense - $50x busi-
ness interest income + $50x depreciation deductions
= $520x), and its section 163(j) limitation for the
2021 taxable year is $206x ($50x of business interest
income + 30 percent of its ATI (30 percent x $520x)
= $206x). As a result, all $200x of T’s interest ex-
pense is deductible in the 2021 taxable year under
section 163(j).
(C) Taxable year beginning in 2022. The facts
are the same as in Example 1 in paragraph (b)(7)(i)
(A) of this section, except that the taxable year be-
gins in 2022 and therefore depreciation deductions
are not added back to ATI under §1.163(j)-1(b)(1)(i)
(E). As a result, T’s ATI for 2022 is $470x ($320x of
tentative taxable income + $200x business interest
expense - $50x business interest income = $470x),
and its section 163(j) limitation for the 2022 taxable
year is $191x ($50x of business interest income +
30 percent of its ATI (30 percent x $470x) = $191x).
As a result, T may only deduct $191x of its business
interest expense for the taxable year, and the remain-
ing $9x is carried forward to the 2023 taxable year as
a disallowed business interest expense carryforward.
See §1.163(j)-2(c).
(ii) Example 2: C corporation partner—(A)
Facts. T and individual A each own a 50 percent
interest in PS1, a general partnership. PS1 borrows
funds from a third party (Loan 1) and uses those
funds to buy stock in publicly-traded corporation X.
PS1’s only activities are holding X stock (and receiv-
ing dividends) and making payments on Loan 1. In
the 2021 taxable year, PS1 receives $150x in divi-
dends and pays $100x in interest on Loan 1.
(B) Analysis. For purposes of section 163(d) and
(j), PS1 has investment interest expense of $100x
and investment income of $150x, and PS1 has no
interest expense or interest income that is properly
allocable to a trade or business. PS1 allocates its
investment interest expense and investment income
equally to its two partners pursuant to §1.163(j)-6(k).
Pursuant to paragraph (b)(3) of this section, T’s al-
locable share of PS1’s investment interest expense
is treated as a business interest expense of T, and
T’s allocable share of PS1’s investment income is
treated as properly allocable to a trade or business
of T. This business interest expense is not treated as
excess business interest expense, and this income is
not treated as excess taxable income. See paragraph
(b)(3)(iii) of this section. T’s treatment of its alloca-
ble share of PS1’s investment interest expense and
investment income as business interest expense and
income properly allocable to a trade or business,
respectively, does not affect the character of these
items at the PS1 level and does not affect the charac-
ter of A’s allocable share of PS1’s investment interest
and investment income.
(C) Partnership engaged in a trade or business.
The facts are the same as in Example 2 in paragraph
(b)(7)(ii)(A) of this section, except that PS1 also is
engaged in Business 1, and PS1 borrows funds from
a third party to finance Business 1 (Loan 2). In 2021,
Business 1 earns $150x of net income (excluding
interest expense and depreciation), and PS1 pays
$100x of interest on Loan 2. For purposes of section
163(d) and (j), PS1 treats the interest paid on Loan
2 as properly allocable to a trade or business. As a
result, PS1 has investment interest expense of $100x
(attributable to Loan 1), business interest expense
of $100x (attributable to Loan 2), $150x of invest-
ment income, and $150x of income from Business 1.
PS1’s ATI is $150x (its net income from Business 1
excluding interest and depreciation), and its section
163(j) limitation is $45x (30 percent x $150x). Pur-
suant to §1.163(j)-6, PS1 has $55x of excess busi-
ness interest expense ($100x - $45x), half of which
($27.5x) is allocable to T. Additionally, pursuant
to paragraph (b)(3)(i) of this section, T’s allocable
share of PS1’s investment interest expense ($50x) is
treated as a business interest expense of T for purpos-
es of section 163(j), and T’s allocable share of PS1’s
investment income ($75x) is treated as properly al-
locable to a trade or business of T. Therefore, with
respect to T’s interest in PS1, T is treated as having
$50x of business interest expense that is not treated
as excess business interest expense, $75x of income
that is properly allocable to a trade or business, and
$27.5x of excess business interest expense.
(c) Effect on earnings and profits—(1)
In general. In the case of a taxpayer that is
a domestic C corporation, except as other-
wise provided in paragraph (c)(2) of this
section, the disallowance and carryfor-
ward under §1.163(j)-2 (and §1.163(j)-5,
in the case of a taxpayer that is a consol-
idated group member) of a deduction for
business interest expense of the taxpayer
or of a partnership in which the taxpayer is
a partner does not affect whether or when
the business interest expense reduces the
taxpayer’s earnings and profits. In the case
of a foreign corporation, the disallowance
and carryforward of a deduction for the
corporation’s business interest expense
under §1.163(j)-2 does not affect whether
and when such business interest expense
reduces the corporation’s earnings and
profits. Thus, for example, if a United
States person has elected under section
1295 to treat a passive foreign investment
company (as defined in section 1297)
(PFIC) as a qualified electing fund, then
the disallowance and carryforward of a
deduction for the PFIC’s business interest
expense under §1.163(j)-2 does not affect
whether or when such business interest
expense reduces the PFIC’s earnings and
profits.
(2) Special rule for RICs and REITs. In
the case of a taxpayer that is a RIC or a
REIT for the taxable year in which a de-
duction for the taxpayer’s business inter-
est expense is disallowed under §1.163(j)-
2(b), or in which the RIC or REIT is
allocated any excess business interest
expense from a partnership under section
163(j)(4)(B)(i) and §1.163(j)-6, the tax-
payer’s earnings and profits are adjusted
in the taxable year or years in which the
business interest expense is deductible or,
if earlier, in the first taxable year for which
the taxpayer no longer is a RIC or a REIT.
(3) Special rule for partners that are
C corporations. If a taxpayer that is a C
corporation is allocated any excess busi-
ness interest expense from a partnership,
and if all or a portion of the excess busi-
ness interest expense has not yet been
treated as business interest expense by
the taxpayer at the time of the taxpayer’s
disposition of all or a portion of its inter-
est in the partnership, the taxpayer must
increase its earnings and profits immedi-
ately prior to the disposition by an amount
equal to the amount of the basis adjust-
ment required under section 163(j)(4)(B)
(iii)(II) and §1.163(j)-6(h)(3).
(4) Examples. The principles of this
paragraph (c) are illustrated by the fol-
lowing examples. For purposes of the ex-
amples in this paragraph (c)(4), except as
otherwise provided in the examples, X is
a taxable domestic C corporation whose
taxable year ends on December 31; X is

September 28, 2020 716 Bulletin No. 2020–40
not a member of a consolidated group; X
does not qualify for the small business ex-
emption under §1.163(j)-2(d); X is not en-
gaged in an excepted trade or business; X
has no floor plan financing indebtedness;
all interest expense is deductible except
for the potential application of section
163(j); X has no accumulated earnings
and profits at the beginning of the 2021
taxable year; and the facts set forth the
only corporate activity.
(i) Example 1: Earnings and profits of a tax-
able domestic C corporation other than a RIC or a
REIT—(A) Facts. X is a corporation that does not
intend to qualify as a RIC or a REIT for its 2021
taxable year. In that year, X has tentative taxable in-
come (without regard to the application of section
163(j)) of $0, which includes $100x of gross income
and $100x of interest expense on a loan from an un-
related third party. X also makes a $100x distribution
to its shareholders that year.
(B) Analysis. The $100x of interest expense is
business interest expense for purposes of section
163(j) (see paragraph (b)(1) of this section). X’s ATI
in the 2021 taxable year is $100x ($0 of tentative
taxable income computed without regard to $100x
of business interest expense). Thus, X may deduct
$30x of its $100x of business interest expense in the
2021 taxable year under §1.163(j)-2(b) (30 percent
x $100x), and X may carry forward the remainder
($70x) to X’s 2022 taxable year as a disallowed busi-
ness interest expense carryforward under §1.163(j)-
2(c). Although X may not currently deduct all $100x
of its business interest expense in the 2021 taxable
year, X must reduce its earnings and profits in that
taxable year by the full amount of its business inter-
est expense ($100x) in that taxable year. As a result,
no portion of X’s distribution of $100x to its share-
holders in the 2021 taxable year is a dividend within
the meaning of section 316(a).
(ii) Example 2: RIC adjusted taxable income and
earnings and profits—(A) Facts. X is a corporation
that intends to qualify as a RIC for its 2021 taxable
year. In that taxable year, X’s only items are $100x
of interest income, $50x of dividend income from
C corporations that only issue common stock and in
which X has less than a twenty percent interest (by
vote and value), $10x of net capital gain, and $125x
of interest expense. None of the dividends are re-
ceived on debt financed portfolio stock under section
246A. The DRD determined under section 243(a)
with respect to X’s $50x of dividend income is $25x.
X pays $42x in dividends to its shareholders, meet-
ing the requirements of section 562 during X’s 2021
taxable year, including $10x that X reports as capital
gain dividends in written statements furnished to X’s
shareholders.
(B) Analysis. (1) Under paragraph (b) of this sec-
tion, all of X’s interest expense is considered busi-
ness interest expense, all of X’s interest income is
considered business interest income, and all of X’s
other income is considered to be properly allocable
to a trade or business. Under paragraph (b)(4)(ii) of
this section, prior to the application of section 163(j),
X’s tentative taxable income is $10x ($100x business
interest income + $50x dividend income + $10x net
capital gain - $125x business interest expense - $25x
DRD = $10x). Under paragraph (b)(4)(iii) of this
section, X’s ATI is increased by the DRD. As such,
X’s ATI for the 2021 taxable year is $60x ($10x ten-
tative taxable income + $125x business interest ex-
pense - $100x business interest income + $25x DRD
= $60x).
(2) X may deduct $118x of its $125x of business
interest expense in the 2021 taxable year under sec-
tion 163(j)(1) ($100x business interest income + (30
percent x $60x of ATI) = $118x), and X may car-
ry forward the remainder ($7x) to X’s 2022 taxable
year. See §1.163(j)-2(b) and (c).
(3) After the application of section 163(j), X has
taxable income of $17x ($100x interest income +
$50x dividend income + $10x capital gain - $25x
DRD - $118x allowable interest expense = $17x)
for the 2021 taxable year. X will have investment
company taxable income (ICTI) in the amount
of $0 ($17x taxable income - $10x capital gain +
$25x DRD - $32x dividends paid deduction for or-
dinary dividends = $0). The excess of X’s net cap-
ital gain ($10x) over X’s dividends paid deduction
determined with reference to capital gain dividends
($10x) is also $0.
(4) Under paragraph (c)(2) of this section, X will
not reduce its earnings and profits by the amount of
interest expense disallowed as a deduction in the
2021 taxable year under section 163(j). Thus, X has
current earnings and profits in the amount of $42x
($100x interest income + $50x dividend income +
$10x capital gain - $118x allowable business interest
expense = $42x) before giving effect to dividends
paid during the 2021 taxable year.
(iii) Example 3: Carryforward of disallowed in-
terest expense—(A) Facts. The facts are the same as
the facts in Example 2 in paragraph (c)(4)(ii)(A) of
this section for the 2021 taxable year. In addition,
X has $50x of interest income and $20x of interest
expense for the 2022 taxable year.
(B) Analysis. Under paragraph (b) of this sec-
tion, all of X’s interest expense is considered busi-
ness interest expense, all of X’s interest income is
considered business interest income, and all of X’s
other income is considered to be properly allocable
to a trade or business. Because X’s $50x of business
interest income exceeds the $20x of business interest
expense from the 2022 taxable year and the $7x of
disallowed business interest expense carryforward
from the 2021 taxable year, X may deduct $27x of
business interest expense in the 2022 taxable year.
Under paragraph (c)(2) of this section, X must re-
duce its current earnings and profits for the 2022
taxable year by the full amount of the deductible
business interest expense ($27x).
(iv) Example 4: REIT adjusted taxable income
and earnings and profits—(A) Facts. X is a corpo-
ration that intends to qualify as a REIT for its 2021
taxable year.

X is not engaged in an excepted trade
or business and is not engaged in a trade or business
that is eligible to make any election under section
163(j)(7). In that year, X’s only items are $100x of
mortgage interest income, $30x of dividend income
from C corporations that only issue common stock
and in which X has less than a ten percent interest
(by vote and value), $10x of net capital gain from the
sale of mortgages on real property that is not prop-
erty described in section 1221(a)(1), and $125x of
interest expense. None of the dividends are received
on debt financed portfolio stock under section 246A.
The DRD determined under section 243(a) with
respect to X’s $30x of dividend income is $15x. X
pays $28x in dividends meeting the requirements of
section 562 during X’s 2021 taxable year, including
$10x that X properly designates as capital gain divi-
dends under section 857(b)(3)(B).
(B) Analysis. (1) Under paragraph (b) of this sec-
tion, all of X’s interest expense is considered business
interest expense, all of X’s interest income is consid-
ered business interest income, and all of X’s other
income is considered to be properly allocable to a
trade or business. Under paragraph (b)(4)(ii) of this
section, prior to the application of section 163(j), X’s
tentative taxable income is $0 ($100x business interest
income + $30x dividend income + $10x net capital
gain - $125x business interest expense - $15x DRD
= $0). Under paragraph (b)(4)(iii) of this section, X’s
ATI is increased by the DRD. As such, X’s ATI for the
2021 taxable year is $40x ($0 tentative taxable income
+ $125x business interest expense - $100x business
interest income + $15x DRD = $40x).
(2) X may deduct $112x of its $125x of business
interest expense in the 2021 taxable year under sec-
tion 163(j)(1) ($100x business interest income + (30
percent x $40x of ATI) = $112x), and X may carry
forward the remainder of its business interest ex-
pense ($13x) to X’s 2022 taxable year.
(3) After the application of section 163(j), X has
taxable income of $13x ($100x business interest in-
come + $30x dividend income + $10x capital gain
- $15x DRD - $112x allowable business interest ex-
pense = $13x) for the 2021 taxable year. X will have
real estate investment trust taxable income (REITTI)
in the amount of $0 ($13x taxable income + $15x of
DRD - $28x dividends paid deduction = $0).
(4) Under paragraph (c)(2) of this section, X
will not reduce earnings and profits by the amount
of business interest expense disallowed as a deduc-
tion in the 2021 taxable year. Thus, X has current
earnings and profits in the amount of $28x ($100x
business interest income + $30x dividend income +
$10x capital gain - $112x allowable business interest
expense = $28x) before giving effect to dividends
paid during X’s 2021 taxable year.
(v) Example 5: Carryforward of disallowed in-
terest expense—(A) Facts. The facts are the same
as in Example 4 in paragraph (c)(4)(iv)(A) of this
section for the 2021 taxable year. In addition, X has
$50x of mortgage interest income and $20x of inter-
est expense for the 2022 taxable year. X has no other
tax items for the 2022 taxable year.
(B) Analysis. Because X’s $50x of business in-
terest income exceeds the $20x of business interest
expense from the 2022 taxable year and the $13x of
disallowed business interest expense carryforwards
from the 2021 taxable year, X may deduct $33x of
business interest expense in 2022. Under paragraph
(c)(2) of this section, X must reduce its current earn-
ings and profits for 2022 by the full amount of the
deductible interest expense ($33x).
(d) Special rules for consolidated
groups—(1) Scope. This paragraph (d)
provides rules applicable to members of
a consolidated group. For all members of
a consolidated group for a consolidated

Bulletin No. 2020–40 717 September 28, 2020
return year, the computations required
by section 163(j) and the regulations in
this part under section 163(j) are made
in accordance with the rules of this para-
graph (d) unless otherwise provided
elsewhere in the section 163(j) regula-
tions. For rules governing the ownership
of partnership interests by members of a
consolidated group, see paragraph (e) of
this section.
(2) Calculation of the section 163(j)
limitation for members of a consolidat-
ed group—(i) In general. A consolidated
group has a single section 163(j) limita-
tion,

the absorption of which is governed
by §1.163(j)-5(b)(3)(ii).
(ii) Interest. For purposes of deter-
mining whether amounts, other than
amounts in respect of intercompany ob-
ligations (as defined in §1.1502-13(g)
(2)(ii)), intercompany items (as defined
in §1.1502-13(b)(2)), or corresponding
items (as defined in §1.1502-13(b)(3)),
are treated as interest within the meaning
of §1.163(j)-1(b)(22), all members of a
consolidated group are treated as a single
taxpayer.
(iii) Calculation of business interest
expense and business interest income for
a consolidated group. For purposes of
calculating the section 163(j) limitation
for a consolidated group, the consolidat-
ed group’s current-year business interest
expense and business interest income, re-
spectively, are the sum of each member’s
current-year business interest expense
and business interest income, including
amounts treated as business interest ex-
pense and business interest income under
paragraph (b)(3) of this section.
(iv) Calculation of adjusted taxable
income. For purposes of calculating the
ATI for a consolidated group, the tenta-
tive taxable income is the consolidated
group’s consolidated taxable income,
determined under §1.1502-11 but with-
out regard to any carryforwards or dis-
allowances under section 163(j). Further,
for purposes of calculating the ATI of
the group, intercompany items and cor-
responding items are disregarded to the
extent that they offset in amount. Thus,
for example, certain portions of the inter-
company items and corresponding items
of a group member engaged in a non-ex-
cepted trade or business will not be in-
cluded in ATI to the extent that the coun-
terparties to the relevant intercompany
transactions are engaged in one or more
excepted trades or businesses.
(v) Treatment of intercompany obli-
gations—(A) In general. Except as oth-
erwise provided in paragraph (d)(2)(v)
(B) of this section, for purposes of de-
termining a member’s business interest
expense and business interest income,
and for purposes of calculating the con-
solidated group’s ATI, all intercompany
obligations, as defined in §1.1502-13(g)
(2)(ii), are disregarded. Therefore, ex-
cept as otherwise provided in paragraph
(d)(2)(v)(B) of this section, interest ex-
pense and interest income from inter-
company obligations are not treated as
business interest expense and business
interest income.
(B) Repurchase premium. This para-
graph (d)(2)(v)(B) applies if a member
of a consolidated group purchases an ob-
ligation of another member of the same
consolidated group in a transaction to
which §1.1502-13(g)(5) applies. Notwith-
standing the general rule of paragraph (d)
(2)(v)(A) of this section, if, as a result of
the deemed satisfaction of the obligation
under §1.1502-13(g)(5)(ii), the debtor
member has repurchase premium that is
deductible under §1.163-7(c), such repur-
chase premium is treated as interest that
is subject to the section 163(j) limitation.
See §1.163(j)-1(b)(22)(i)(H).
(3) Investment adjustments.

For rules
governing investment adjustments within
a consolidated group, see §1.1502-32(b).
(4) Examples. The principles in this
paragraph (d) are illustrated by the fol-
lowing examples. For purposes of the
examples in this paragraph (d)(4), S is a
member of the calendar-year consolidat-
ed group of which P is the common par-
ent; the P group does not qualify for the
small business exemption in §1.163(j)-
2(d); no member of the P group is en-
gaged in an excepted trade or business;
all interest expense is deductible except
for the potential application of section
163(j); and the facts set forth the only
corporate activity.
(i) Example 1: Calculation of the section 163(j)
limitation—(A) Facts. In the 2021 taxable year, P
has $50x of separate tentative taxable income after
taking into account $65x of interest paid on a loan
from a third party (without regard to any disallow-
ance under section 163(j)) and $35x of depreciation
deductions under section 168. In turn, S has $40x of
separate tentative taxable income in the 2021 taxable
year after taking into account $10x of depreciation
deductions under section 168. S has no interest ex-
pense in the 2021 taxable year. The P group’s ten-
tative taxable income the 2021 taxable year is $90x,
determined under §1.1502-11 without regard to any
disallowance under section 163(j).
(B) Analysis. As provided in paragraph (b)(1)
of this section, P’s interest expense is treated as
business interest expense for purposes of section
163(j). If P and S were to apply the section 163(j)
limitation on a separate-entity basis, then P’s ATI
would be $150x ($50x + $65x + $35x = $150x),
its section 163(j) limitation would be $45x (30
percent x $150x = $45x), and a deduction for $20x
of its $65x of business interest expense would be
disallowed in the 2021 taxable year under section
163(j). However, as provided in paragraph (d)(2) of
this section, the P group computes a single section
163(j) limitation, and that computation begins with
the P group’s tentative taxable income (as deter-
mined prior to the application of section 163(j)), or
$90x. The P group’s ATI is $200x ($50x + $40x +
$65x + $35x + $10x = $200x). Thus, the P group’s
section 163(j) limitation for the 2021 taxable year
is $60x (30 percent x $200x = $60x). As a result, all
but $5x of the P group’s business interest expense is
deductible in the 2021 taxable year. P carries over
the $5x of disallowed business interest expense to
the succeeding taxable year.
(ii) Example 2: Intercompany obligations—(A)
Facts. On January 1, 2021, G, a corporation unre-
lated to P and S, lends P $100x in exchange for a
note that accrues interest at a 10 percent annual rate.
A month later, P lends $100x to S in exchange for a
note that accrues interest at a 12 percent annual rate.
In 2021, P accrues and pays $10x of interest to G on
P’s note, and S accrues and pays $12x of interest to
P on S’s note. For that year, the P group’s only other
items of income, gain, deduction, and loss are $40x
of income earned by S from the sale of inventory,
and a $30x deductible expense arising from P’s pay-
ment of tort liability claims.
(B) Analysis. As provided in paragraph (d)(2)
(v) of this section, the intercompany obligation be-
tween P and S is disregarded in determining P and
S’s business interest expense and business interest
income and in determining the P group’s ATI. For
purposes of section 163(j), P has $10x of business
interest expense and a $30x deduction for the pay-
ment of tort liability claims, and S has $40x of in-
come. The P group’s ATI is $10x ($40x - $30x =
$10x), and its section 163(j) limitation is $3x (30
percent x $10x = $3x). The P group may deduct $3x
of its business interest expense in the 2021 taxable
year. A deduction for P’s remaining $7x of business
interest expense is disallowed in the 2021 taxable
year, and this amount is carried forward to the 2022
taxable year.
(e) Ownership of partnership interests
by members of a consolidated group.
(1) [Reserved]
(2) Change in status of a member. A
change in status of a member (that is, be-
coming or ceasing to be a member of the
group) is not treated as a disposition for
purposes of section 163(j)(4)(B)(iii)(II)
and §1.163(j)-6(h)(3).

September 28, 2020 718 Bulletin No. 2020–40
(3) Basis adjustments under §1.1502-
32. A member’s allocation of excess busi-
ness interest expense from a partnership
and the resulting decrease in basis in the
partnership interest under section 163(j)(4)
(B)(iii)(I) is not a noncapital, nondeduct-
ible expense for purposes of §1.1502-32(b)
(3)(iii). Additionally, an increase in a mem-
ber’s basis in a partnership interest under
section 163(j)(4)(B)(iii)(II) to reflect ex-
cess business interest expense not deducted
by the consolidated group is not tax-exempt
income for purposes of §1.1502-32(b)(3)
(ii). Investment adjustments are made un-
der §1.1502-32(b)(3)(i) when the excess
business interest expense from the part-
nership is converted into business interest
expense, deducted, and absorbed by the
consolidated group. See §1.1502-32(b).
(4) Excess business interest expense
and §1.1502-36. Excess business interest
expense is a Category D asset within the
meaning of §1.1502-36(d)(4)(i).
(f) Cross-references. For rules govern-
ing the treatment of disallowed business
interest expense carryforwards for C cor-
porations, including rules governing the
treatment of disallowed business interest
expense carryforwards when members
enter or leave a consolidated group, see
§1.163(j)-5. For rules governing the appli-
cation of section 163(j) to a C corporation
or a consolidated group engaged in both
excepted and non-excepted trades or busi-
nesses, see §1.163(j)-10.
(g) Applicability date—(1) In general.
This section applies to taxable years be-
ginning 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 ap-
ply 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 appli-
cable, §§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 ef-
fectuate the rules of §§1.382-2, 1.382-5,
1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year.
(2) [Reserved]
§1.163(j)-5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
(a) Scope and definitions—(1) Scope.
This section provides rules regarding
disallowed business interest expense car-
ryforwards for taxpayers that are C cor-
porations, including members of a consol-
idated group. Paragraph (b) of this section
provides rules regarding the treatment of
disallowed business interest expense car-
ryforwards. Paragraph (c) of this section
provides a cross-reference to other rules
regarding disallowed business interest
expense carryforwards in transactions to
which section 381(a) applies. Paragraph
(d) of this section provides rules regarding
limitations on disallowed business interest
expense carryforwards from separate re-
turn limitation years (SRLYs). Paragraph
(e) of this section provides cross-referenc-
es to other rules regarding the application
of section 382 to disallowed business in-
terest expense carryforwards. Paragraph
(f) of this section provides a cross-refer-
ence to other rules regarding the overlap
of the SRLY limitation with section 382.
Paragraph (g) of this section references
additional rules that may limit the deduct-
ibility of interest or the use of disallowed
business interest expense carryforwards.
(2) Definitions—(i) Allocable share of
the consolidated group’s remaining sec-
tion 163(j) limitation. The term allocable
share of the consolidated group’s remain-
ing section 163(j) limitation means, with
respect to any member of a consolidated
group, the product of the consolidated
group’s remaining section 163(j) limita-
tion and the member’s remaining cur-
rent-year interest ratio.
(ii) Consolidated group’s remaining sec-
tion 163(j) limitation. The term consolidat-
ed group’s remaining section 163(j) limita-
tion means the amount of the consolidated
group’s section 163(j) limitation calculated
pursuant to §1.163(j)-4(d)(2), reduced by
the amount of interest deducted by mem-
bers of the consolidated group pursuant to
paragraph (b)(3)(ii)(C)(2) of this section.
(iii) Remaining current-year interest
ratio. The term remaining current-year
interest ratio means, with respect to any
member of a consolidated group for a
particular taxable year, the ratio of the
remaining current-year business interest
expense of the member after applying the
rule in paragraph (b)(3)(ii)(C)(2) of this
section, to the sum of the amounts of re-
maining current-year business interest ex-
pense for all members of the consolidated
group after applying the rule in paragraph
(b)(3)(ii)(C)(2) of this section.
(b) Treatment of disallowed business
interest expense carryforwards—(1) In
general. The amount of any business in-
terest expense of a C corporation not al-
lowed as a deduction for any taxable year
as a result of the section 163(j) limitation
is carried forward to the succeeding tax-
able year as a disallowed business interest
expense carryforward under section 163(j)
(2) and §1.163(j)-2(c).
(2) Deduction of business interest ex-
pense. For a taxpayer that is a C corpo-
ration, current-year business interest ex-
pense is deducted in the current taxable
year before any disallowed business in-
terest expense carryforwards from a pri-
or taxable year are deducted in that year.
Disallowed business interest expense car-
ryforwards are deducted in the order of the
taxable years in which they arose, begin-
ning with the earliest taxable year, subject
to certain limitations (for example, the
limitation under section 382). For purpos-
es of section 163(j), disallowed disquali-
fied interest is treated as carried forward
from the taxable year in which a deduction
was disallowed under old section 163(j).
(3) Consolidated groups—(i) In general.
A consolidated group’s disallowed business
interest expense carryforwards for the cur-
rent consolidated return year (the current
year) are the carryforwards from the group’s
prior consolidated return years plus any car-
ryforwards from separate return years.
(ii) Deduction of business interest ex-
pense—(A) General rule. All current-year
business interest expense of members of
a consolidated group is deducted in the
current year before any disallowed busi-
ness interest expense carryforwards from
prior taxable years are deducted in the
current year. Disallowed business interest
expense carryforwards from prior taxable
years are deducted in the order of the tax-
able years in which they arose, beginning
with the earliest taxable year, subject to
the limitations described in this section.
(B) Section 163(j) limitation equals or
exceeds the current-year business interest
expense and disallowed business interest

Bulletin No. 2020–40 719 September 28, 2020
expense carryforwards from prior tax-
able years. If a consolidated group’s sec-
tion 163(j) limitation for the current year
equals or exceeds the aggregate amount
of its members’ current-year business
interest expense and disallowed busi-
ness interest expense carryforwards from
prior taxable years that are available for
deduction, then none of the current-year
business interest expense or disallowed
business interest expense carryforwards
is subject to disallowance in the current
year under section 163(j). However, a de-
duction for the members’ business inter-
est expense may be subject to limitation
under other provisions of the Code or the
Income Tax Regulations (see, for exam-
ple, paragraphs (c), (d), (e), and (f) of this
section).
(C) Current-year business interest ex-
pense and disallowed business interest
expense carryforwards exceed section
163(j) limitation. If the aggregate amount
of members’ current-year business interest
expense and disallowed business interest
expense carryforwards from prior taxable
years exceeds the consolidated group’s
section 163(j) limitation for the current
year, then the following rules apply in the
order provided:
(1) The group first determines whether
its section 163(j) limitation for the cur-
rent year equals or exceeds the aggregate
amount of the members’ current-year
business interest expense.
(i) If the group’s section 163(j) limita-
tion for the current year equals or exceeds
the aggregate amount of the members’ cur-
rent-year business interest expense, then
no amount of the group’s current-year
business interest expense is subject to dis-
allowance in the current year under section
163(j). Once the group has taken into ac-
count its members’ current-year business
interest expense, the group applies the rules
of paragraph (b)(3)(ii)(C)(4) of this section.
(ii) If the aggregate amount of mem-
bers’ current-year business interest ex-
pense exceeds the group’s section 163(j)
limitation for the current year, then the
group applies the rule in paragraph (b)(3)
(ii)(C)(2) of this section.
(2) If this paragraph (b)(3)(ii)(C)(2)
applies (see paragraph (b)(3)(ii)(C)(1)(ii)
of this section), then each member with
current-year business interest expense and
with current-year business interest income
or floor plan financing interest expense
deducts current-year business interest ex-
pense in an amount that does not exceed
the sum of the member’s business interest
income and floor plan financing interest
expense for the current year.
(3) After applying the rule in paragraph
(b)(3)(ii)(C)(2) of this section, if the group
has any section 163(j) limitation remain-
ing for the current year, then each mem-
ber with remaining current-year business
interest expense deducts a portion of its
expense based on its allocable share of the
consolidated group’s remaining section
163(j) limitation.
(4) If this paragraph (b)(3)(ii)(C)(4)
applies (see paragraph (b)(3)(ii)(C)(1)(i)
of this section), and if the group has any
section 163(j) limitation remaining for
the current year after applying the rules in
paragraph (b)(3)(ii)(C)(1) of this section,
then disallowed business interest expense
carryforwards permitted to be deducted
(including under paragraph (d)(1)(A) of
this section) in the current year are to be
deducted in the order of the taxable years
in which they arose, beginning with the
earliest taxable year. Disallowed business
interest expense carryforwards from tax-
able years ending on the same date that
are available to offset tentative taxable
income for the current year generally are
to be deducted on a pro rata basis under
the principles of paragraph (b)(3)(ii)(C)
(3) of this section. For example, assume
that P and S are the only members of a
consolidated group with a section 163(j)
limitation for the current year (Year 2) of
$200x; the amount of current-year busi-
ness interest expense deducted in Year 2
is $100x; and P and S, respectively, have
$140x and $60x of disallowed business
interest expense carryforwards from Year
1 that are not subject to limitation under
paragraph (c), (d), or (e) of this section.
Under these facts, P would be allowed
to deduct $70x of its carryforwards from
Year 1 ($100x x ($140x / ($60x + $140x))
= $70x), and S would be allowed to de-
duct $30x of its carryforwards from Year 1
($100x x ($60x / ($60x + $140x)) = $30x).
But see §1.383-1(d)(1)(ii), providing that,
if losses subject to and not subject to the
section 382 limitation are carried from the
same taxable year, losses subject to the
limitation are deducted before losses not
subject to the limitation.
(5) Each member with remaining busi-
ness interest expense after applying the
rules of this paragraph (b)(3)(ii), taking
into account the limitations in paragraphs
(c), (d), (e), and (f) of this section, carries
the expense forward to the succeeding
taxable year as a disallowed business in-
terest expense carryforward under section
163(j)(2) and §1.163(j)-2(c).
(iii) Departure from group. If a cor-
poration ceases to be a member during a
consolidated return year, the corporation’s
current-year business interest expense from
the taxable period ending on the day of the
corporation’s change in status as a member,
as well as the corporation’s disallowed busi-
ness interest expense carryforwards from
prior taxable years that are available to offset
tentative taxable income in the consolidated
return year, are first made available for de-
duction during that consolidated return year.
See §1.1502-76(b)(1)(i); see also §1.1502-
36(d) (regarding reductions of deferred
deductions on the transfer of loss shares of
subsidiary stock). Only the amount that is
neither deducted by the group in that consol-
idated return year nor otherwise reduced un-
der the Code or regulations may be carried
to the corporation’s first separate return year
after its change in status.
(iv) Example: Deduction of interest expense—
(A) Facts. (1) P wholly owns A, which is a member
of the consolidated group of which P is the common
parent. P and A each borrow money from Z, an unre-
lated third party. The business interest expense of P
and A in Years 1, 2, and 3, and the P group’s section
163(j) limitation for those years, are as follows:
Table 1 to paragraph (b)(3)(iv)(A)(1)
YearP’s business interest expenseA’s business interest expenseP group’s section 163(j) limitation
1$150x$50x$100x
260x90x120x
325x50x185x

September 28, 2020 720 Bulletin No. 2020–40
(2) P and A have neither business interest income
nor floor plan financing interest expense in Years 1,
2, and 3. Additionally, the P group is neither eligible
for the small business exemption in §1.163(j)-2(d)
nor engaged in an excepted trade or business.
(B) Analysis—(1) Year 1. In Year 1, the aggre-
gate amount of the P group members’ current-year
business interest expense ($150x + $50x) exceeds
the P group’s section 163(j) limitation ($100x). As
a result, the rules of paragraph (b)(3)(ii)(C) of this
section apply. Because the P group members’ cur-
rent-year business interest expense exceeds the
group’s section 163(j) limitation for Year 1, P and
A must apply the rule in paragraph (b)(3)(ii)(C)(2)
of this section. Pursuant to paragraph (b)(3)(ii)(C)(2)
of this section, each of P and A must deduct its cur-
rent-year business interest expense to the extent of
its business interest income and floor plan financing
interest expense. Neither P nor A has business inter-
est income or floor plan financing interest expense
in Year 1. Next, pursuant to paragraph (b)(3)(ii)(C)
(3) of this section, each of P and A must deduct a
portion of its current-year business interest expense
based on its allocable share of the consolidated
group’s remaining section 163(j) limitation ($100x).
P’s allocable share is $75x ($100x x ($150x / $200x)
= $75x), and A’s allocable share is $25x ($100x x
($50x / $200x) = $25x). Accordingly, in Year 1, P
deducts $75x of its current-year business interest
expense, and A deducts $25x of its current-year busi-
ness interest expense. P has a disallowed business
interest expense carryforward from Year 1 of $75x
($150x - $75x = $75x), and A has a disallowed busi-
ness interest expense carryforward from Year 1 of
$25x ($50x - $25x = $25x).
(2) Year 2. In Year 2, the aggregate amount of
the P group members’ current-year business inter-
est expense ($60x + $90x) and disallowed busi-
ness interest expense carryforwards ($75x + $25x)
exceeds the P group’s section 163(j) limitation
($120x). As a result, the rules of paragraph (b)(3)
(ii)(C) of this section apply. Because the P group
members’ current-year business interest expense
exceeds the group’s section 163(j) limitation for
Year 2, P and A must apply the rule in paragraph
(b)(3)(ii)(C)(2) of this section. Pursuant to para-
graph (b)(3)(ii)(C)(2) of this section, each of P and
A must deduct its current-year business interest ex-
pense to the extent of its business interest income
and floor plan financing interest expense. Neither
P nor A has business interest income or floor plan
financing interest expense in Year 2. Next, pursuant
to paragraph (b)(3)(ii)(C)(3) of this section, each of
P and A must deduct a portion of its current-year
business interest expense based on its allocable
share of the consolidated group’s remaining sec-
tion 163(j) limitation ($120x). P’s allocable share
is $48x (($120x x ($60x / $150x)) = $48x), and A’s
allocable share is $72x (($120x x ($90x / $150x))
= $72x). Accordingly, in Year 2, P deducts $48x
of current-year business interest expense, and A
deducts $72x of current-year business interest ex-
pense. P has a disallowed business interest expense
carryforward from Year 2 of $12x ($60x - $48x
= $12x), and A has a disallowed business interest
expense carryforward from Year 2 of $18x ($90x -
$72x = $18x). Additionally, because the P group has
no section 163(j) limitation remaining after deduct-
ing current-year business interest expense in Year
2, the full amount of P and A’s disallowed business
interest expense carryforwards from Year 1 ($75x
and $25x, respectively) also are carried forward to
Year 3. As a result, at the beginning of Year 3, P and
A’s respective disallowed business interest expense
carryforwards are as follows:
Table 2 to paragraph (b)(3)(iv)(B)(2)
Year 1 disallowed business interest expense
carryforwards
Year 2 disallowed business interest expense
carryforwards
Total disallowed business interest expense
carryforwards
P$75x$12x$87x
A25x18x43x
Total100x30x130x
(3) Year 3. In Year 3, the aggregate amount of
the P group members’ current-year business interest
expense ($25x + $50x = $75x) and disallowed busi-
ness interest expense carryforwards ($130x) exceeds
the P group’s section 163(j) limitation ($185x). As
a result, the rules of paragraph (b)(3)(ii)(C) of this
section apply. Because the P group’s section 163(j)
limitation for Year 3 equals or exceeds the P group
members’ current-year business interest expense, no
amount of the members’ current-year business inter-
est expense is subject to disallowance under section
163(j) (see paragraph (b)(3)(ii)(C)(1) of this section).
After each of P and A deducts its current-year busi-
ness interest expense, the P group has $110x of sec-
tion 163(j) limitation remaining for Year 3 ($185x
- $25x - $50x = $110x). Next, pursuant to paragraph
(b)(3)(ii)(C)(4) of this section, $110x of disallowed
business interest expense carryforwards are deduct-
ed on a pro rata basis, beginning with carryforwards
from Year 1. Because the total amount of carryfor-
wards from Year 1 ($100x) is less than the section
163(j) limitation remaining after the deduction of
Year 3 business interest expense ($110x), all of the
Year 1 carryforwards are deducted in Year 3. After
current-year business interest expense and Year 1
carryforwards are deducted, the P group’s remaining
section 163(j) limitation in Year 3 is $10x. Because
the Year 2 carryforwards ($30x) exceed the remain-
ing section 163(j) limitation ($10x), under paragraph
(b)(3)(ii)(C)(4) of this section, each of P and A will
deduct a portion of its Year 2 carryforwards based
on its allocable share of the consolidated group’s
remaining section 163(j) limitation. P’s allocable
share is $4x (($10x x ($12x / $30x)) = $4x), and
A’s allocable share is $6x (($10x x ($18x / $30x))
= $6x). Accordingly, P and A may deduct $4x and
$6x, respectively, of their Year 2 carryforwards. For
Year 4, P and A have $8x and $12x of disallowed
business interest expense carryforwards from Year 2,
respectively.
(c) Disallowed business interest ex-
pense carryforwards in transactions to
which section 381(a) applies. For rules
governing the application of section
381(c)(20) to disallowed business in-
terest expense carryforwards, including
limitations on an acquiring corporation’s
use of the disallowed business interest
expense carryforwards of the transferor
or distributor corporation in the acquiring
corporation’s first taxable year ending af-
ter the date of distribution or transfer, see
§1.381(c)(20)-1.
(d) Limitations on disallowed business
interest expense carryforwards from sep-
arate return limitation years—(1) Gen-
eral rule—(A) Cumulative section 163(j)
SRLY limitation. This paragraph (d) ap-
plies to disallowed business interest ex-
pense carryforwards of a member arising
in a SRLY (see §1.1502-1(f))) or treated
as arising in a SRLY under the principles
of §1.1502-21(c) and (g). The amount of
the carryforwards described in the pre-
ceding sentence that are included in the
consolidated group’s business interest ex-
pense deduction for any taxable year un-
der paragraph (b) of this section may not
exceed the aggregate section 163(j) lim-
itation for all consolidated return years of
the group, determined by reference only
to the member’s items of income, gain,
deduction, and loss, and reduced (includ-
ing below zero) by the member’s business
interest expense (including disallowed
business interest expense carryforwards)
absorbed by the group in all consolidated
return years (cumulative section 163(j)
SRLY limitation). For purposes of com-
puting the member’s cumulative section
163(j) SRLY limitation, intercompany
items referred to in §1.163(j)-4(d)(2)
(iv) are included, with the exception of
interest items with regard to intercompa-

Bulletin No. 2020–40 721 September 28, 2020
ny obligations. See §1.163(j)-4(d)(2)(v).
Thus, for purposes of this paragraph (d),
income and expense items arising from
intercompany transactions (other than in-
terest income and expense with regard to
intercompany obligations) are included in
the calculation of the cumulative section
163(j) SRLY limitation. In addition, items
of interest expense with regard to inter-
company obligations are not characterized
as business interest expense for purposes
of the reduction described in the second
sentence of this paragraph (d)(1)(A).
(B) Subgrouping. For purposes of this
paragraph (d), the SRLY subgroup prin-
ciples of §1.1502-21(c)(2)(i) (with regard
to carryovers of SRLY losses) apply with
appropriate adjustments.
(2) Deduction of disallowed business
interest expense carryforwards arising in
a SRLY. Notwithstanding paragraph (d)(1)
of this section, disallowed business inter-
est expense carryforwards of a member
arising in a SRLY are available for de-
duction by the consolidated group in the
current year only to the extent the group
has remaining section 163(j) limitation
for the current year after the deduction
of current-year business interest expense
and disallowed business interest expense
carryforwards from earlier taxable years
that are permitted to be deducted in the
current year (see paragraph (b)(3)(ii)(A)
of this section). SRLY-limited disallowed
business interest expense carryforwards
are deducted on a pro rata basis (under
the principles of paragraph (b)(3)(ii)(C)
(3) of this section) with non-SRLY limited
disallowed business interest expense car-
ryforwards from taxable years ending on
the same date. See also §1.1502-21(b)(1).
(3) Examples. The principles of this
paragraph (d) are illustrated by the fol-
lowing examples. For purposes of the
examples in this paragraph (d)(3), unless
otherwise stated, P, R, S, and T are taxable
domestic C corporations that are not RICs
or REITs and that file their tax returns on
a calendar-year basis; none of P, R, S, or T
qualifies for the small business exemption
under section 163(j)(3) or is engaged in an
excepted trade or business; all interest ex-
pense is deductible except for the poten-
tial application of section 163(j); and the
facts set forth the only corporate activity.
(i) Example 1: Determination of SRLY limita-
tion—(A) Facts. Individual A owns P. In 2021, A
forms T, which pays or accrues a $100x business
interest expense for which a deduction is disallowed
under section 163(j) and that is carried forward to
2022. P does not pay or accrue business interest
expense in 2021, and P has no disallowed business
interest expense carryforwards from prior taxable
years. At the close of 2021, P acquires all of the
stock of T, which joins with P in filing a consolidated
return beginning in 2022. Neither P nor T pays or
accrues business interest expense in 2022, and the P
group has a section 163(j) limitation of $300x in that
year. This limitation would be $70x if determined by
reference solely to T’s items for all consolidated re-
turn years of the P group.
(B) Analysis. T’s $100x of disallowed business
interest expense carryforwards from 2021 arose in
a SRLY. P’s acquisition of T was not an ownership
change as defined by section 382(g); thus, T’s dis-
allowed business interest expense carryforwards are
subject to the SRLY limitation in paragraph (d)(1) of
this section. T’s cumulative section 163(j) SRLY lim-
itation for 2022 is the P group’s section 163(j) limita-
tion, determined by reference solely to T’s items for
all consolidated return years of the P group ($70x).
See paragraph (d)(1) of this section. Thus, $70x of
T’s disallowed business interest expense carryfor-
wards are available to be deducted by the P group in
2022, and the remaining $30x of T’s disallowed busi-
ness interest expense carryforwards are carried for-
ward to 2023. After the P group deducts $70x of T’s
disallowed business interest expense carryforwards,
T’s cumulative section 163(j) SRLY limitation is re-
duced by $70x to $0.
(C) Cumulative section 163(j) SRLY limitation of
$0. The facts are the same as in Example 1 in para-
graph (d)(3)(i)(A) of this section, except that T’s cu-
mulative section 163(j) SRLY limitation for 2022 is
$0. Because the amount of T’s disallowed business
interest expense carryforwards that may be deducted
by the P group in 2022 may not exceed T’s cumu-
lative section 163(j) SRLY limitation, none of T’s
carryforwards from 2021 may be deducted by the P
group in 2022. Because none of T’s disallowed busi-
ness interest expense carryforwards are absorbed by
the P group in 2022, T’s cumulative section 163(j)
SRLY limitation remains at $0 entering 2023.
(ii) Example 2: Cumulative section 163(j) SRLY
limitation less than zero—(A) Facts. P and S are
the only members of a consolidated group. P has
neither current-year business interest expense nor
disallowed business interest expense carryforwards.
For the current year, the P group has a section 163(j)
limitation of $150x, $25x of which is attributable
to P, and $125x of which is attributable to S. S has
$100x of disallowed business interest expense car-
ryforwards that arose in a SRLY and $150x of cur-
rent-year business interest expense. S’s cumulative
section 163(j) SRLY limitation entering the current
year (computed by reference solely to S’s items for
all consolidated return years of the P group) is $0.
(B) Analysis. Under paragraph (d)(1) of this sec-
tion, S’s cumulative section 163(j) SRLY limitation
is increased by $125x to reflect S’s tax items for the
current year. The P group’s section 163(j) limitation
permits the P group to deduct all $150x of S’s cur-
rent-year business interest expense. S’s cumulative
section 163(j) SRLY limitation is reduced by the
$150x of S’s business interest expense absorbed by
the P group in the current year, which results in a
-$25x balance. Thus, none of S’s SRLY’d disallowed
business interest expense carryforwards may be de-
ducted by the P group in the current year. Entering
the subsequent year, S’s cumulative section 163(j)
SRLY limitation remains -$25x.
(iii) Example 3: Pro rata absorption of SR-
LY-limited disallowed business interest expense
carryforwards—(A) Facts. P, R, and S are the only
members of a consolidated group, and no member
has floor plan financing or business interest income.
P has $60x of current-year business interest ex-
pense and $40x of disallowed business interest ex-
pense carryforwards from the previous year, which
was not a separate return year. R has $120x of
current-year business interest expense and $80x of
disallowed business interest expense carryforwards
from the previous year, which was not a separate
return year. S has $70x of current-year business
interest expense and $30x of disallowed business
interest expense carryforwards from the previous
year, which was a separate return year. The P group
has a section 163(j) limitation of $300x, $50x of
which is attributable to P, $90x to R, and $160x to
S. S’s cumulative section 163(j) SRLY limitation
entering the current year (computed by reference
solely to S’s items for all consolidated return years
of the P group) is $0.
Table 3 to paragraph (d)(3)(iii)(A)
Current-year business interest expenseDisallowed business interest expense carryforwards
from prior taxable year
Section 163(j) limitation
P$60x$40x$50x
R$120x$80x$90x
S$70x(SRLY) $30x$160x
Total$250x$150x$300x
(B) Analysis. Under paragraph (d)(1) of this
section, S’s cumulative section 163(j) SRLY limita-
tion is increased in the current year by $160x. The P
group’s section 163(j) limitation permits the P group
to deduct all $70x of S’s current-year business inter-
est expense (and all $180x of P and R’s current-year

September 28, 2020 722 Bulletin No. 2020–40
business interest expense). S’s cumulative section
163(j) SRLY limitation is reduced by the $70x of S’s
business interest expense absorbed by the P group in
the current year, resulting in a $90x balance. Because
the P group has $50x of section 163(j) limitation re-
maining after the absorption of current-year business
interest expense, the P group can absorb $50x of its
members’ disallowed business interest expense car-
ryforwards. Under paragraph (d)(2) of this section,
SRLY-limited disallowed business interest expense
carryforwards are deducted on a pro rata basis with
other disallowed business interest expense carryfor-
wards from the same taxable year. Accordingly, the
P group can deduct $10x ($50x x ($30x / $150x))
of S’s SRLY-limited disallowed business interest ex-
pense carryforwards. S’s cumulative section 163(j)
SRLY limitation is reduced (to $80x) by the $10x of
SRLY-limited disallowed business interest carryfor-
wards absorbed by the P group in the current year.
(C) Cumulative section 163(j) SRLY limitation
of -$75x. The facts are the same as in Example 3 in
paragraph (d)(3)(iii)(A) of this section, except that
S’s cumulative section 163(j) SRLY limitation en-
tering the current year is -$75x. After adjusting for
S’s tax items for the current year ($160x) and the P
group’s absorption of S’s current-year business in-
terest expense ($70x), S’s cumulative section 163(j)
SRLY limitation is $15x (-$75x + $160x - $70x).
Because S’s cumulative section 163(j) SRLY lim-
itation ($15x) is less than the amount of S’s SR-
LY-limited disallowed business interest expense
carryforwards ($30x), the pro rata calculation under
paragraph (d)(2) of this section is applied to $15x
(rather than $30x) of S’s carryforwards. According-
ly, the P group can deduct $5.56x ($50x x ($15x
/ $135x)) of S’s SRLY-limited disallowed business
interest expense carryforwards. S’s cumulative sec-
tion 163(j) SRLY limitation is reduced (to $9.44x)
by the $5.56x of SRLY-limited disallowed business
interest carryforwards absorbed by the P group in
the current year.
(e) Application of section 382—(1)
Pre-change loss. For rules governing the
treatment of a disallowed business interest
expense as a pre-change loss for purpos-
es of section 382, see §§1.382-2(a) and
1.382-6. For rules governing the applica-
tion of section 382 to disallowed disquali-
fied interest carryforwards, see §1.163(j)-
11(c)(4).
(2) Loss corporation. For rules govern-
ing when a disallowed business interest
expense causes a corporation to be a loss
corporation within the meaning of sec-
tion 382(k)(1), see §1.382-2(a). For the
application of section 382 to disallowed
disqualified interest carryforwards, see
§1.163(j)-11(c)(4).
(3) Ordering rules for utilization of
pre-change losses and for absorption of
the section 382 limitation. For ordering
rules for the utilization of disallowed busi-
ness interest expense, net operating losses,
and other pre-change losses, and for the
absorption of the section 382 limitation,
see §1.383-1(d).
(4) Disallowed business interest ex-
pense from the pre-change period in the
year of a testing date. For rules governing
the treatment of disallowed business in-
terest expense from the pre-change period
(within the meaning of §1.382-6(g)(2)) in
the year of a testing date, see §1.382-2.
(5) Recognized built-in loss. For a rule
providing that a section 382 disallowed
business interest carryforward (as defined
in §1.382-2(a)(7)) is not treated as a rec-
ognized built-in loss for purposes of sec-
tion 382, see §1.382-7(d)(5).
(f) Overlap of SRLY limitation with
section 382. For rules governing the over-
lap of the application of section 382 and
the application of the SRLY rules, see
§1.1502-21(g).
(g) Additional limitations. Addition-
al rules provided under the Code or reg-
ulations also apply to limit the use of
disallowed business interest expense
carryforwards. For rules governing the re-
lationship between section 163(j) and oth-
er provisions affecting the deductibility of
interest, see §1.163(j)-3.
(h) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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.
§1.163(j)-6 Application of the section
163(j) limitation to partnerships and
subchapter S corporations.
(a) Overview. If a deduction for busi-
ness interest expense of a partnership or
an S corporation is subject to the section
163(j) limitation, section 163(j)(4) pro-
vides that the section 163(j) limitation
applies at the partnership or S corporation
level and any deduction for business in-
terest expense is taken into account in de-
termining the nonseparately stated taxable
income or loss of the partnership or S cor-
poration. Once a partnership or an S cor-
poration determines its business interest
expense, business interest income, ATI,
and floor plan financing interest expense,
the partnership or S corporation calculates
its section 163(j) limitation by applying
the rules of §1.163(j)-2(b) and this sec-
tion. Paragraph (b) of this section provides
definitions used in this section. Paragraph
(c) of this section provides rules regarding
the character of a partnership’s deduct-
ible business interest expense and excess
business interest expense. Paragraph (d)
of this section provides rules regarding
the calculation of a partnership’s ATI
and floor plan financing interest expense.
Paragraph (e) of this section provides
rules regarding a partner’s ATI and busi-
ness interest income. Paragraph (f) of this
section provides an eleven-step compu-
tation necessary for properly allocating a
partnership’s deductible business interest
expense and section 163(j) excess items to
its partners. Paragraph (g) of this section
applies carryforward rules at the partner
level if a partnership has excess business
interest expense. Paragraph (h) of this
section provides basis adjustment rules,
and paragraph (k) of this section provides
rules regarding investment items of a
partnership. Paragraph (l) of this section
provides rules regarding S corporations.
Paragraph (m) of this section provides
rules for partnerships and S corporations
not subject to section 163(j). Paragraph
(o) of this section provides examples il-
lustrating the rules of this section.
(b) Definitions. In addition to the defi-
nitions contained in §1.163(j)-1, the fol-
lowing definitions apply for purposes of
this section.
(1) Section 163(j) items. The term sec-
tion 163(j) items means the partnership or
S corporation’s business interest expense,
business interest income, and items com-
prising ATI.
(2) Partner basis items. The term part-
ner basis items means any items of in-
come, gain, loss, or deduction resulting
from either an adjustment to the basis of
partnership property used in a non-ex-

Bulletin No. 2020–40 723 September 28, 2020
cepted trade or business made pursuant
to section 743(b) or the operation of sec-
tion 704(c)(1)(C)(i) with respect to such
property. Partner basis items also include
section 743(b) basis adjustments used to
increase or decrease a partner’s share of
partnership gain or loss on the sale of part-
nership property used in a non-excepted
trade or business (as described in §1.743-
1(j)(3)(i)) and amounts resulting from the
operation of section 704(c)(1)(C)(i) used
to decrease a partner’s share of partner-
ship gain or increase a partner’s share of
partnership loss on the sale of such prop-
erty.
(3) Remedial items. The term remedial
items means any allocation to a partner of
remedial items of income, gain, loss, or
deduction pursuant to section 704(c) and
§1.704-3(d).
(4) Excess business interest income.
The term excess business interest income
means the amount by which a partner-
ship’s or S corporation’s business interest
income exceeds its business interest ex-
pense in a taxable year.
(5) Deductible business interest ex-
pense. The term deductible business in-
terest expense means the amount of a
partnership’s or S corporation’s business
interest expense that is deductible under
section 163(j) in the current taxable year
following the application of the limitation
contained in §1.163(j)-2(b).
(6) Section 163(j) excess items. The
term section 163(j) excess items means the
partnership’s excess business interest ex-
pense, excess taxable income, and excess
business interest income.
(7) Non-excepted assets. The term
non-excepted assets means assets from a
non-excepted trade or business.
(8) Excepted assets. The term except-
ed assets means assets from an excepted
trade or business.
(c) Business interest income and busi-
ness interest expense of a partnership—
(1)–(2) [Reserved]
(3) Character of business interest ex-
pense. If a partnership has deductible
business interest expense, such deductible
business interest expense is not subject
to any additional application of section
163(j) at the partner-level because it is
taken into account in determining the non-
separately stated taxable income or loss
of the partnership. However, for all other
purposes of the Code, deductible business
interest expense and excess business inter-
est expense retain their character as busi-
ness interest expense at the partner-level.
For example, for purposes of section 469,
such business interest expense retains its
character as either passive or non-passive
in the hands of the partner. Additionally,
for purposes of section 469, deductible
business interest expense and excess busi-
ness interest expense from a partnership
remain interest derived from a trade or
business in the hands of a partner even if
the partner does not materially participate
in the partnership’s trade or business ac-
tivity. For additional rules regarding the
interaction between sections 465, 469, and
163(j), see §1.163(j)-3.
(d) Adjusted taxable income of a part-
nership—(1) Tentative taxable income of
a partnership. For purposes of comput-
ing a partnership’s ATI under §1.163(j)-
1(b)(1), the tentative taxable income of
a partnership is the partnership’s taxable
income determined under section 703(a),
but computed without regard to the appli-
cation of the section 163(j) limitation.
(2) Section 734(b), partner basis items,
and remedial items. A partnership takes
into account items resulting from adjust-
ments made to the basis of its property
pursuant to section 734(b) for purposes of
calculating its ATI pursuant to §1.163(j)-
1(b)(1). However, partner basis items and
remedial items are not taken into account
in determining a partnership’s ATI under
§1.163(j)-1(b)(1). Instead, partner basis
items and remedial items are taken into
account by the partner in determining the
partner’s ATI pursuant to §1.163(j)-1(b)
(1). See Example 6 in paragraph (o)(6) of
this section.
(e) Adjusted taxable income and busi-
ness interest income of partners—(1)
Modification of adjusted taxable income
for partners. The ATI of a partner in a
partnership generally is determined in ac-
cordance with §1.163(j)-1(b)(1), without
regard to such partner’s distributive share
of any items of income, gain, deduction, or
loss of such partnership, except as provid-
ed for in paragraph (m) of this section, and
is increased by such partner’s distributive
share of such partnership’s excess taxable
income determined under paragraph (f) of
this section. For rules regarding corporate
partners, see §1.163(j)-4(b)(3).
(2) Partner basis items and remedial
items. Partner basis items and remedial
items are taken into account as items de-
rived directly by the partner in determin-
ing the partner’s ATI for purposes of the
partner’s section 163(j) limitation. If a
partner is allocated remedial items, such
partner’s ATI is increased or decreased by
the amount of such items. Additionally, to
the extent a partner is allocated partner ba-
sis items, such partner’s ATI is increased
or decreased by the amount of such items.
See Example 6 in paragraph (o)(6) of this
section.
(3) Disposition of partnership interests.
If a partner recognizes gain or loss upon
the disposition of interests in a partner-
ship, and the partnership in which the in-
terest is being disposed owns only non-ex-
cepted trade or business assets, the gain or
loss on the disposition of the partnership
interest is included in the partner’s ATI.
See §1.163(j)-10(b)(4)(ii) for dispositions
of interests in partnerships that own—
(i) Non-excepted assets and excepted
assets; or
(ii) Investment assets; or
(iii) Both.
(4) Double counting of business in-
terest income and floor plan financing
interest expense prohibited. For purposes
of calculating a partner’s section 163(j)
limitation, the partner does not include—
(i) Business interest income from
a partnership that is subject to section
163(j), except to the extent the partner is
allocated excess business interest income
from that partnership pursuant to para-
graph (f)(2) of this section; and
(ii) The partner’s allocable share of the
partnership’s floor plan financing interest
expense, because such floor plan financ-
ing interest expense already has been
taken into account by the partnership in
determining its nonseparately stated tax-
able income or loss for purposes of section
163(j).
(f) Allocation and determination of
section 163(j) excess items made in the
same manner as nonseparately stated tax-
able income or loss of the partnership—
(1) Overview—(i) In general. The purpose
of this paragraph is to provide guidance
regarding how a partnership must allocate
its deductible business interest expense
and section 163(j) excess items, if any,
among its partners. For purposes of sec-

September 28, 2020 724 Bulletin No. 2020–40
tion 163(j)(4) and this section, allocations
and determinations of deductible business
interest expense and section 163(j) excess
items are considered made in the same
manner as the nonseparately stated tax-
able income or loss of the partnership if,
and only if, such allocations and determi-
nations are made in accordance with the
eleven-step computation set forth in para-
graphs (f)(2)(i) through (xi) of this section.
A partnership first determines its section
163(j) limitation, total amount of deduct-
ible business interest expense, and section
163(j) excess items under paragraph (f)
(2)(i) of this section. The partnership then
applies paragraphs (f)(2)(ii) through (xi)
of this section, in that order, to determine
how those items of the partnership are
allocated among its partners. At the con-
clusion of the eleven-step computation set
forth in paragraphs (f)(2)(i) through (xi)
of this section, the total amount of deduct-
ible business interest expense and sec-
tion 163(j) excess items allocated to each
partner will equal the partnership’s total
amount of deductible business interest ex-
pense and section 163(j) excess items.
(ii) Relevance solely for purposes of
section 163(j). No rule set forth in para-
graph (f)(2) of this section prohibits a
partnership from making an allocation to a
partner of any item of partnership income,
gain, loss, or deduction that is otherwise
permitted under section 704 and the reg-
ulations under section 704 of the Code.
Accordingly, any calculations in para-
graphs (f)(2)(i) through (xi) of this section
are solely for the purpose of determining
each partner’s deductible business interest
expense and section 163(j) excess items
and do not otherwise affect any other pro-
vision under the Code, such as section
704(b). Additionally, floor plan financing
interest expense is not allocated in accor-
dance with paragraph (f)(2) of this sec-
tion. Instead, floor plan financing interest
expense of a partnership is allocated to its
partners under section 704(b) and is tak-
en into account as a nonseparately stated
item of loss for purposes of section 163(j).
(2) Steps for allocating deductible
business interest expense and section
163(j) excess items—(i) Partnership-level
calculation required by section 163(j)(4)
(A). First, a partnership must determine
its section 163(j) limitation pursuant to
§1.163(j)-2(b). This calculation deter-
mines a partnership’s total amounts of
excess business interest income, excess
taxable income, excess business interest
expense (that is, the partnership’s section
163(j) excess items), and deductible busi-
ness interest expense under section 163(j)
for a taxable year.
(ii) Determination of each partner’s
relevant section 163(j) items. Second, a
partnership must determine each part-
ner’s allocable share of each section
163(j) item under section 704(b) and
the regulations under section 704 of the
Code, including any allocations under
section 704(c), other than remedial items.
Only section 163(j) items that were ac-
tually taken into account in the partner-
ship’s section 163(j) calculation under
paragraph (f)(2)(i) of this section are
taken into account for purposes of this
paragraph (f)(2)(ii). Partner basis items,
allocations of investment income and ex-
pense, remedial items, and amounts de-
termined for the partner under §1.163-8T
are not taken into account for purposes of
this paragraph (f)(2)(ii). For purposes of
paragraphs (f)(2)(ii) through (xi) of this
section, the term allocable ATI means a
partner’s distributive share of the part-
nership’s ATI (that is, a partner’s dis-
tributive share of gross income and gain
items comprising ATI less such partner’s
distributive share of gross loss and de-
duction items comprising ATI), the term
allocable business interest income means
a partner’s distributive share of the part-
nership’s business interest income, and
the term allocable business interest ex-
pense means a partner’s distributive share
of the partnership’s business interest
expense that is not floor plan financing
interest expense. If the partnership de-
termines that each partner has a pro rata
share of allocable ATI, allocable business
interest income, and allocable business
interest expense, then the partnership
may bypass paragraphs (f)(2)(iii) through
(xi) of this section and allocate its section
163(j) excess items in the same propor-
tion. See Example 1 through Example
16 in paragraphs (o)(1) through (16), re-
spectively. This pro-rata exception does
not result in allocations of section 163(j)
excess items that vary from the array of
allocations of section 163(j) excess items
that would have resulted had paragraphs
(f)(2)(iii) through (xi) been applied.
(iii) Partner-level comparison of busi-
ness interest income and business interest
expense. Third, a partnership must com-
pare each partner’s allocable business in-
terest income to such partner’s allocable
business interest expense. Paragraphs (f)
(2)(iii) through (v) of this section deter-
mine how a partnership must allocate its
excess business interest income among
its partners, as well as the amount of each
partner’s allocable business interest ex-
pense that is not deductible business inter-
est expense after taking the partnership’s
business interest income into account. To
the extent a partner’s allocable business
interest income exceeds its allocable busi-
ness interest expense, the partner has an
allocable business interest income excess.
The aggregate of all the partners’ allocable
business interest income excess amounts
is the total allocable business interest in-
come excess. To the extent a partner’s al-
locable business interest expense exceeds
its allocable business interest income, the
partner has an allocable business inter-
est income deficit. The aggregate of all
the partners’ allocable business interest
income deficit amounts is the total allo-
cable business interest income deficit.
These amounts are required to perform
calculations in paragraphs (f)(2)(iv) and
(v) of this section, which appropriately re-
allocate allocable business interest income
excess to partners with allocable business
interest income deficits in order to rec-
oncile the partner-level calculation under
paragraph (f)(2)(iii) of this section with
the partnership-level result under para-
graph (f)(2)(i) of this section.
(iv) Matching partnership and ag-
gregate partner excess business interest
income. Fourth, a partnership must deter-
mine each partner’s final allocable busi-
ness interest income excess. A partner’s
final allocable business interest income
excess is determined by reducing, but not
below zero, such partner’s allocable busi-
ness interest income excess (if any) by the
partner’s step four adjustment amount. A
partner’s step four adjustment amount is
the product of the total allocable business
interest income deficit and the ratio of
such partner’s allocable business interest
income excess to the total allocable busi-
ness interest income excess. The rules of
this paragraph (f)(2)(iv) ensure that, fol-
lowing the application of paragraph (f)(2)

Bulletin No. 2020–40 725 September 28, 2020
(xi) of this section, the aggregate of all the
partners’ allocations of excess business in-
terest income equals the total amount of
the partnership’s excess business interest
income as determined in paragraph (f)(2)
(i) of this section.
(v) Remaining business interest ex-
pense determination. Fifth, a partnership
must determine each partner’s remaining
business interest expense. A partner’s re-
maining business interest expense is de-
termined by reducing, but not below zero,
such partner’s allocable business interest
income deficit (if any) by such partner’s
step five adjustment amount. A partner’s
step five adjustment amount is the prod-
uct of the total allocable business interest
income excess and the ratio of such part-
ner’s allocable business interest income
deficit to the total allocable business inter-
est income deficit. Generally, a partner’s
remaining business interest expense is a
partner’s allocable business interest in-
come deficit adjusted to reflect a realloca-
tion of allocable business interest income
excess from other partners. Determining
a partner’s remaining business interest
expense is necessary to perform an ATI
calculation that begins in paragraph (f)(2)
(vii) of this section.
(vi) Determination of final allocable
ATI. Sixth, a partnership must determine
each partner’s final allocable ATI. Para-
graphs (f)(2)(vi) through (x) of this section
determine how a partnership must allocate
its excess taxable income and excess busi-
ness interest expense among its partners.
(A) Positive allocable ATI. To the ex-
tent a partner’s income and gain items
comprising its allocable ATI exceed its
deduction and loss items comprising its
allocable ATI, the partner has positive al-
locable ATI. The aggregate of all the part-
ners’ positive allocable ATI amounts is the
total positive allocable ATI.
(B) Negative allocable ATI. To the ex-
tent a partner’s deduction and loss items
comprising its allocable ATI exceed its in-
come and gain items comprising its allo-
cable ATI, the partner has negative alloca-
ble ATI. The aggregate of all the partners’
negative allocable ATI amounts is the to-
tal negative allocable ATI.
(C) Final allocable ATI. Any partner
with a negative allocable ATI, or an allo-
cable ATI of $0, has a positive allocable
ATI of $0. Any partner with a positive al-
locable ATI of $0 has a final allocable ATI
of $0. The final allocable ATI of any part-
ner with a positive allocable ATI greater
than $0 is such partner’s positive alloca-
ble ATI reduced, but not below zero, by
the partner’s step six adjustment amount.
A partner’s step six adjustment amount
is the product of the total negative allo-
cable ATI and the ratio of such partner’s
positive allocable ATI to the total positive
allocable ATI. The total of the partners’ fi-
nal allocable ATI amounts must equal the
partnership’s ATI amount used to compute
its section 163(j) limitation pursuant to
§1.163(j)-2(b).
(vii) Partner-level comparison of 30
percent of adjusted taxable income and
remaining business interest expense. Sev-
enth, a partnership must compare each
partner’s ATI capacity to such partner’s
remaining business interest expense as de-
termined under paragraph (f)(2)(v) of this
section. A partner’s ATI capacity is the
amount that is 30 percent of such partner’s
final allocable ATI as determined under
paragraph (f)(2)(vi) of this section. A part-
ner’s final allocable ATI is grossed down
to 30 percent prior to being compared to
its remaining business interest expense
in this calculation to parallel the partner-
ship’s adjustment to its ATI under section
163(j)(1)(B). To the extent a partner’s ATI
capacity exceeds its remaining business
interest expense, the partner has an ATI
capacity excess. The aggregate of all the
partners’ ATI capacity excess amounts is
the total ATI capacity excess. To the extent
a partner’s remaining business interest ex-
pense exceeds its ATI capacity, the partner
has an ATI capacity deficit. The aggregate
of all the partners’ ATI capacity deficit
amounts is the total ATI capacity deficit.
These amounts (which may be subject to
adjustment under paragraph (f)(2)(viii) of
this section) are required to perform cal-
culations in paragraphs (f)(2)(ix) and (x)
of this section, which appropriately reallo-
cate ATI capacity excess to partners with
ATI capacity deficits in order to reconcile
the partner-level calculation under para-
graph (f)(2)(vii) of this section with the
partnership-level result under paragraph
(f)(2)(i) of this section.
(viii) Partner priority right to ATI ca-
pacity excess determination. (A) Eighth,
the partnership must determine whether it
is required to make any adjustments de-
scribed in this paragraph (f)(2)(viii) and,
if it is, make such adjustments. The rules
of this paragraph (f)(2)(viii) are necessary
to account for adjustments made to a part-
ner’s allocable ATI in paragraph (f)(2)(vi)
of this section to ensure that the partners
who had a negative allocable ATI do not
inappropriately benefit under the rules of
paragraphs (f)(2)(ix) through (xi) of this
section to the detriment of the partners
who had positive allocable ATI. The part-
nership must perform the calculations and
make the necessary adjustments described
under paragraphs (f)(2)(viii)(B) and (C) or
paragraph (f)(2)(viii)(D) of this section if,
and only if, there is—
(1) An excess business interest expense
amount greater than $0 under paragraph
(f)(2)(i) of this section;
(2) A total negative allocable ATI
amount greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATI capacity excess amount
greater than $0 under paragraph (f)(2)(vii)
of this section.
(B) A partnership must determine each
partner’s priority amount and usable pri-
ority amount. A partner’s priority amount
is 30 percent of the amount by which a
partner’s positive allocable ATI under
paragraph (f)(2)(vi)(A) of this section
exceeds such partner’s final allocable
ATI under paragraph (f)(2)(vi)(C) of this
section. However, only partners with an
ATI capacity deficit as determined under
paragraph (f)(2)(vii) of this section can
have a priority amount greater than $0.
The aggregate of all the partners’ prior-
ity amounts is the total priority amount.
A partner’s usable priority amount is the
lesser of such partner’s priority amount
or such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section. The aggregate of all the
partners’ usable priority amounts is the
total usable priority amount. If the total
ATI capacity excess amount, as deter-
mined under paragraph (f)(2)(vii) of this
section, is greater than or equal to the to-
tal usable priority amount, then the part-
nership must perform the adjustments
described in paragraph (f)(2)(viii)(C) of
this section. If the total usable priority
amount is greater than the total ATI ca-
pacity excess amount, as determined un-
der paragraph (f)(2)(vii) of this section,
then the partnership must perform the

September 28, 2020 726 Bulletin No. 2020–40
adjustments described in paragraph (f)(2)
(viii)(D) of this section.
(C) For purposes of paragraph (f)(2)
(ix) of this section, each partner’s final
ATI capacity excess amount is $0. For
purposes of paragraph (f)(2)(x) of this
section, the following terms have the fol-
lowing meanings for each partner:
(1) Each partner’s ATI capacity deficit
is such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii) of
this section, reduced by such partner’s us-
able priority amount.
(2) The total ATI capacity deficit is the
total ATI capacity deficit as determined
under paragraph (f)(2)(vii) of this sec-
tion, reduced by the total usable priority
amount.
(3) The total ATI capacity excess is the
total ATI capacity excess as determined
under paragraph (f)(2)(vii) of this sec-
tion, reduced by the total usable priority
amount.
(D) Any partner with a priority amount
greater than $0 is a priority partner. Any
partner that is not a priority partner is a
non-priority partner. For purposes of
paragraph (f)(2)(ix) of this section, each
partner’s final ATI capacity excess amount
is $0. For purposes of paragraph (f)(2)(x)
of this section, each non-priority partner’s
final ATI capacity deficit amount is such
partner’s ATI capacity deficit as deter-
mined under paragraph (f)(2)(vii) of this
section. For purposes of paragraph (f)(2)
(x) of this section, the following terms
have the following meanings for priority
partners.
(1) Each priority partner must deter-
mine its step eight excess share. A part-
ner’s step eight excess share is the prod-
uct of the total ATI capacity excess as
determined under paragraph (f)(2)(vii)
of this section and the ratio of the part-
ner’s priority amount to the total priority
amount.
(2) To the extent a priority partner’s
step eight excess share exceeds its ATI
capacity deficit as determined under para-
graph (f)(2)(vii) of this section, such ex-
cess amount is the priority partner’s ATI
capacity excess for purposes of paragraph
(f)(2)(x) of this section. The total ATI ca-
pacity excess is the aggregate of the prior-
ity partners’ ATI capacity excess amounts
as determined under this paragraph (f)(2)
(viii)(D)(2).
(3) To the extent a priority partner’s
ATI capacity deficit as determined under
paragraph (f)(2)(vii) of this section ex-
ceeds its step eight excess share, such ex-
cess amount is the priority partner’s ATI
capacity deficit for purposes of paragraph
(f)(2)(x) of this section. The total ATI ca-
pacity deficit is the aggregate of the prior-
ity partners’ ATI capacity deficit amounts
as determined under this paragraph (f)(2)
(viii)(D)(3).
(ix) Matching partnership and ag-
gregate partner excess taxable income.
Ninth, a partnership must determine
each partner’s final ATI capacity excess.
A partner’s final ATI capacity excess
amount is determined by reducing, but
not below zero, such partner’s ATI capac-
ity excess (if any) by the partner’s step
nine adjustment amount. A partner’s step
nine adjustment amount is the product of
the total ATI capacity deficit and the ratio
of such partner’s ATI capacity excess to
the total ATI capacity excess. The rules
of this paragraph (f)(2)(ix) ensure that,
following the application of paragraph
(f)(2)(xi) of this section, the aggregate of
all the partners’ allocations of excess tax-
able income equals the total amount of
the partnership’s excess taxable income
as determined in paragraph (f)(2)(i) of
this section.
(x) Matching partnership and ag-
gregate partner excess business interest
expense. Tenth, a partnership must de-
termine each partner’s final ATI capac-
ity deficit. A partner’s final ATI capacity
deficit amount is determined by reducing,
but not below zero, such partner’s ATI ca-
pacity deficit (if any) by the partner’s step
ten adjustment amount. A partner’s step
ten adjustment amount is the product of
the total ATI capacity excess and the ra-
tio of such partner’s ATI capacity deficit
to the total ATI capacity deficit. Generally,
a partner’s final ATI capacity deficit is a
partner’s ATI capacity deficit adjusted to
reflect a reallocation of ATI capacity ex-
cess from other partners. The rules of this
paragraph (f)(2)(x) ensure that, following
the application of paragraph (f)(2)(xi) of
this section, the aggregate of all the part-
ners’ allocations of excess business inter-
est expense equals the total amount of the
partnership’s excess business interest ex-
pense as determined in paragraph (f)(2)(i)
of this section.
(xi) Final section 163(j) excess item
and deductible business interest expense
allocation. Eleventh, a partnership must
allocate section 163(j) excess items and
deductible business interest expense to its
partners. Excess business interest income
calculated under paragraph (f)(2)(i) of this
section, if any, is allocated dollar for dol-
lar by the partnership to its partners with
final allocable business interest income
excess amounts. Excess business interest
expense calculated under paragraph (f)(2)
(i) of this section, if any, is allocated dollar
for dollar to partners with final ATI capac-
ity deficit amounts. After grossing up each
partner’s final ATI capacity excess amount
by ten-thirds, excess taxable income cal-
culated under paragraph (f)(2)(i) of this
section, if any, is allocated dollar for dollar
to partners with final ATI capacity excess
amounts. A partner’s allocable business
interest expense is deductible business in-
terest expense to the extent it exceeds such
partner’s share of excess business interest
expense. See Example 17 through Exam-
ple 21 in paragraphs (o)(17) through (21)
of this section, respectively.
(g) Carryforwards—(1) In general.
The amount of any business interest ex-
pense not allowed as a deduction to a part-
nership by reason of §1.163(j)-2(b) and
paragraph (f)(2) of this section for any
taxable year is–
(i) Not treated as business interest ex-
pense of the partnership in the succeeding
taxable year; and
(ii) Subject to paragraph (g)(2) of this
section, treated as excess business interest
expense, which is allocated to each part-
ner pursuant to paragraph (f)(2) of this
section.
(2) Treatment of excess business in-
terest expense allocated to partners. If a
partner is allocated excess business inter-
est expense from a partnership under para-
graph (f)(2) of this section for any taxable
year and the excess business interest ex-
pense is treated as such under paragraph
(h)(2) of this section–
(i) Solely for purposes of section
163(j), such excess business interest ex-
pense is treated as business interest ex-
pense paid or accrued by the partner in the
next succeeding taxable year in which the
partner is allocated excess taxable income
or excess business interest income from
such partnership, but only to the extent

Bulletin No. 2020–40 727 September 28, 2020
of such excess taxable income or excess
business interest income; and
(ii) Any portion of such excess busi-
ness interest expense remaining after the
application of paragraph (g)(2)(i) of this
section is excess business interest expense
that is subject to the limitations of para-
graph (g)(2)(i) of this section in succeed-
ing taxable years, unless paragraph (m)
(3) of this section applies. See Example 1
through Example 16 in paragraphs (o)(1)
through (16) of this section, respectively.
(3) Excess taxable income and excess
business interest income ordering rule.
In the event a partner has excess business
interest expense from a prior taxable year
and is allocated excess taxable income or
excess business interest income from the
same partnership in a succeeding taxable
year, the partner must treat, for purpos-
es of section 163(j), the excess business
interest expense as business interest ex-
pense paid or accrued by the partner in
an amount equal to the partner’s share of
the partnership’s excess taxable income or
excess business interest income in such
succeeding taxable year. See Example 2
through Example 16 in paragraphs (o)(2)
through (16) of this section, respectively.
(h) Basis adjustments—(1) Section
704(d) ordering. Deductible business in-
terest expense and excess business interest
expense are subject to section 704(d). If
a partner is subject to a limitation on loss
under section 704(d) and a partner is allo-
cated losses from a partnership in a tax-
able year, §1.704-1(d)(2) requires that the
limitation on losses under section 704(d)
be apportioned amongst these losses
based on the character of each loss (each
grouping of losses based on character be-
ing a section 704(d) loss class). If there
are multiple section 704(d) loss classes in
a given year, §1.704-1(d)(2) requires the
partner to apportion the limitation on loss-
es under section 704(d) to each section
704(d) loss class proportionately. For pur-
poses of applying this proportionate rule,
any deductible business interest expense
and business interest expense of an exempt
entity (whether allocated to the partner in
the current taxable year or suspended un-
der section 704(d) in a prior taxable year),
any excess business interest expense allo-
cated to the partner in the current taxable
year, and any excess business interest ex-
pense from a prior taxable year that was
suspended under section 704(d) (negative
section 163(j) expense) shall comprise the
same section 704(d) loss class. Once the
partner determines the amount of limita-
tion on losses apportioned to this section
704(d) loss class, any deductible business
interest expense is taken into account be-
fore any excess business interest expense
or negative section 163(j) expense. See
Example 7 in paragraph (o)(7) of this sec-
tion.
(2) Excess business interest expense
basis adjustments. The adjusted basis of a
partner in a partnership interest is reduced,
but not below zero, by the amount of ex-
cess business interest expense allocated to
the partner pursuant to paragraph (f)(2) of
this section. Negative section 163(j) ex-
pense is not treated as excess business in-
terest expense in any subsequent year un-
til such negative section 163(j) expense is
no longer suspended under section 704(d).
Therefore, negative section 163(j) expense
does not affect, and is not affected by, any
allocation of excess taxable income to the
partner. Accordingly, any excess taxable
income allocated to a partner from a part-
nership while the partner still has negative
section 163(j) expense will be included in
the partner’s ATI. However, once the neg-
ative section 163(j) expense is no longer
suspended under section 704(d), it be-
comes excess business interest expense,
which is subject to the general rules in
paragraph (g) of this section. See Example
8 in paragraph (o)(8) of this section.
(3) Partner basis adjustment upon
disposition of partnership interest. If a
partner (transferor) disposes of an inter-
est in a partnership, the adjusted basis of
the partnership interest being disposed of
(transferred interest) is increased immedi-
ately before the disposition by the amount
of the excess (if any) of the amount of the
basis reduction under paragraph (h)(2) of
this section over the portion of any excess
business interest expense allocated to the
transferor under paragraph (f)(2) of this
section which has previously been treat-
ed under paragraph (g) of this section as
business interest expense paid or accrued
by the transferor, multiplied by the ratio
of the fair market value of the transferred
interest to the total fair market value of
the transferor’s partnership interest imme-
diately prior to the disposition. Therefore,
the adjusted basis of the transferred inter-
est is not increased immediately before
the disposition by any allocation of excess
business interest expense from the part-
nership that did not reduce the transferor’s
adjusted basis in its partnership interest
pursuant to paragraph (h) of this section
prior to the disposition, or by any excess
business interest expense that was treat-
ed under paragraph (g) of this section as
business interest expense paid or accrued
by the transferor prior to the disposition. If
the transferor disposes of all of its partner-
ship interest, no deduction under section
163(j) is allowed to the transferor or trans-
feree under chapter 1 of subtitle A of the
Code for any excess business interest ex-
pense or negative section 163(j) expense.
If the transferor disposes of a portion of its
partnership interest, no deduction under
section 163(j) is allowed to the transferor
or transferee under chapter 1 of subtitle
A of the Code for the amount of excess
business interest expense proportionate
to the transferred interest. The amount of
excess business interest expense propor-
tionate to the partnership interest retained
by the transferor shall remain as excess
business interest expense of the transfer-
or until such time as such excess business
interest expense is treated as business
interest expense paid or accrued by the
transferor pursuant to paragraph (g) of
this section. Further, if the transferor dis-
poses of a portion of its partnership inter-
est, any negative section 163(j) expense
shall remain negative section 163(j) ex-
pense of the transferor partner until such
negative section 163(j) expense is no lon-
ger suspended under section 704(d). For
purposes of this paragraph, a disposition
includes a distribution of money or other
property by the partnership to a partner in
complete liquidation of its interest in the
partnership. Further, solely for purposes
of this section, each partner is considered
to have disposed of its partnership interest
if the partnership terminates under section
708(b)(1). See Example 9 and Example
10 in paragraphs (o)(9) and (o)(10) of this
section, respectively.
(i)-(j) [Reserved]
(k) Investment items and certain other
items. Any item of a partnership’s income,
gain, deduction, or loss that is investment
interest income or expense pursuant to
§1.163-8T, and any other tax item of a
partnership that is neither properly alloca-

September 28, 2020 728 Bulletin No. 2020–40
ble to a trade or business of the partner-
ship nor described in section 163(d), is al-
located to each partner in accordance with
section 704(b) and the regulations under
section 704 of the Code, and the effect
of such allocation for purposes of section
163 is determined at the partner-level.
See §1.163(j)-4(b)(3), section 163(d), and
§1.163-8T.
(l) S corporations—(1) In general—(i)
Corporate level limitation. In the case of
any S corporation, the section 163(j) lim-
itation is applied at the S corporation lev-
el, and any deduction allowed for business
interest expense is taken into account in
determining the nonseparately stated tax-
able income or loss of the S corporation.
An S corporation determines its section
163(j) limitation in the same manner as set
forth in §1.163(j)-2(b). Allocations of ex-
cess taxable income and excess business
interest income are made in accordance
with the shareholders’ pro rata interests
in the S corporation pursuant to section
1366(a)(1) after determining the S corpo-
ration’s section 163(j) limitation pursuant
to §1.163(j)-2(b). See Example 22 and Ex-
ample 23 in paragraphs (o)(22) and (23) of
this section, respectively.
(ii) Short taxable periods For rules
on applying the section 163(j) limitation
where an S corporation has a two short
taxable periods or where its taxable year
consists of two separate taxable years see
§§ 1.1362-3(c), 1.1368-1(g), and 1.1377-
1(b).
(2) Character of deductible business
interest expense. If an S corporation has
deductible business interest expense, such
deductible business interest expense is not
subject to any additional application of
section 163(j) at the shareholder-level be-
cause such deductible business interest ex-
pense is taken into account in determining
the nonseparately stated taxable income
or loss of the S corporation. However, for
all other purposes of the Code, deductible
business interest expense retains its char-
acter as business interest expense at the
shareholder-level. For example, for pur-
poses of section 469, such deductible busi-
ness interest expense retains its character
as either passive or non-passive in the
hands of the shareholder. Additionally, for
purposes of section 469, deductible busi-
ness interest expense from an S corpora-
tion remains interest derived from a trade
or business in the hands of a shareholder
even if the shareholder does not materially
participate in the S corporation’s trade or
business activity. For additional rules re-
garding the interaction between sections
465, 469, and 163(j), see §1.163(j)-3.
(3) Adjusted taxable income of an
S corporation. The ATI of an S corpora-
tion generally is determined in accordance
with §1.163(j)-1(b)(1). For purposes of
computing the S corporation’s ATI, the
tentative taxable income of the S corpora-
tion is determined under section 1363(b)
and includes—
(i) Any item described in section
1363(b)(1); and
(ii) Any item described in §1.163(j)-
1(b)(1), to the extent such item is consis-
tent with subchapter S of the Code.
(4) Adjusted taxable income and busi-
ness interest income of S corporation
shareholders—(i) Adjusted taxable in-
come of S corporation shareholders. The
ATI of an S corporation shareholder is
determined in accordance with §1.163(j)-
1(b)(1) without regard to such sharehold-
er’s distributive share of any items of
income, gain, deduction, or loss of such
S corporation, except as provided in para-
graph (m), and is increased by such share-
holder’s distributive share of such S cor-
poration’s excess taxable income.
(ii) Disposition of S corporation stock.
If a shareholder of an S corporation rec-
ognizes gain or loss upon the disposition
of stock of the S corporation, and the cor-
poration the stock of which is being dis-
posed of only owns non-excepted trade
or business assets, the gain or loss on the
disposition of the stock is included in the
shareholder’s ATI. See §1.163(j)-10(b)(4)
(ii) for dispositions of stock of S corpora-
tions that own—
(A) Non-excepted assets and excepted
assets; or
(B) Investment assets; or
(C) Both.
(iii) Double counting of business inter-
est income and floor plan financing inter-
est expense prohibited. For purposes of
calculating an S corporation shareholder’s
section 163(j) limitation, the shareholder
does not include—
(A) Business interest income from an
S corporation that is subject to section
163(j), except to the extent the sharehold-
er is allocated excess business interest in-
come from that S corporation pursuant to
paragraph (l)(1) of this section; and
(B) The shareholder’s share of the
S corporation’s floor plan financing in-
terest expense, because such floor plan fi-
nancing interest expense already has been
taken into account by the S corporation in
determining its nonseparately stated tax-
able income or loss for purposes of section
163(j).
(5) Carryforwards. The amount of any
business interest expense not allowed as a
deduction for any taxable year by reason
of the limitation contained in §1.163(j)-
2(b) is carried forward in the succeeding
taxable year as a disallowed business in-
terest expense carryforward under the
rules set forth in §1.163(j)-2(c) (wheth-
er to an S corporation taxable year or a
C corporation taxable year). For purposes
of applying section 163(j), S corporations
are subject to the same ordering rules as
a C corporation that is not a member of a
consolidated group. See §1.163(j)-5(b)(2).
(6) Basis adjustments and disallowed
business interest expense carryforwards.
An S corporation shareholder’s adjusted
basis in its S corporation stock is reduced,
but not below zero, when a disallowed
business interest expense carryforward
becomes deductible under section 163(j).
(7) Accumulated adjustment accounts.
The accumulated adjustment account of
an S corporation is adjusted to take into
account business interest expense in the
year in which the S corporation treats such
business interest expense as deductible
under the section 163(j) limitation. See
section 1368(e)(1).
(8) Termination of qualified subchap-
ter S subsidiary election. If a corpora-
tion’s qualified subchapter S subsidiary
election terminates and any disallowed
business interest expense carryforward is
attributable to the activities of the quali-
fied subchapter S subsidiary at the time of
termination, such disallowed business in-
terest expense carryforward remains with
the parent S corporation, and no portion
of these items is allocable to the former
qualified subchapter S subsidiary.
(9) Investment items. Any item of an
S corporation’s income, gain, deduction,
or loss that is investment interest income
or expense pursuant to §1.163-8T is allo-
cated to each shareholder in accordance
with the shareholders’ pro rata interests

Bulletin No. 2020–40 729 September 28, 2020
in the S corporation pursuant to sec-
tion 1366(a)(1). See section 163(d) and
§1.163-8T.
(10) Application of section 382. In the
event of an ownership change, within the
meaning of section 382(g), the S corpora-
tion’s business interest expense is subject
to section 382. Therefore, the allocation
of the S corporation’s business interest ex-
pense between the pre-change period (as
defined in §1.382-6(g)(2)) and the post-
change period (as defined in §1.382-6(g)
(3)), and the determination of the amount
that is deducted and carried forward, is de-
termined pursuant to §1.382-6. If the date
of the ownership change is also the date
of a qualifying disposition (as defined in
§1.1368-1(g)(2)) or the date for a termina-
tion of shareholder interest (as defined in
§1.1377-1(b)(4)), then—
(i) The rules of this paragraph govern
the S corporation’s business interest ex-
pense;
(ii) The S corporation must make an
election under §1.382-6(b) with respect
to such date if it also makes an election
under §1.1368-1(g)(2) or a shareholder
termination election to apply normal tax
accounting rules, as applicable, with re-
spect to such date; and
(iii) The S corporation may not make
an election under §1.382-6(b) with respect
to such date if it does not make an election
under §1.1368-1(g)(2) or a termination
election under §1.1377-1(b)(1), as appli-
cable, with respect to such date.
(m) Partnerships and S corporations
not subject to section 163(j)—(1) Exempt
partnerships and S corporations. If the
small business exemption in §1.163(j)-
2(d) applies to a partnership or an S cor-
poration in a taxable year (exempt enti-
ty), the general rule in §1.163(j)-2 and
this section does not apply to limit the
deduction for business interest expense
of the exempt entity in that taxable year.
Additionally, if a partner or S corporation
shareholder is allocated business inter-
est expense from an exempt entity, such
business interest expense is not subject to
the section 163(j) limitation at the part-
ner’s or S corporation shareholder’s lev-
el. However, see paragraph (h)(1) of this
section. Further, a partner or S corporation
shareholder of an exempt entity includes
its share of non-excepted trade or business
items of income, gain, loss, and deduction
(including business interest expense and
business interest income) of such exempt
entity when calculating its ATI. However,
if a partner’s or S corporation sharehold-
er’s allocations of non-excepted trade or
business items of loss and deduction from
an exempt entity exceed its allocations of
non-excepted trade or business items of
income and gain from such exempt enti-
ty (net loss allocation), then such net loss
allocation will not reduce a partner’s or S
corporation shareholder’s ATI. See Exam-
ple 11 and Example 12 in paragraphs (o)
(11) and (12) of this section, respectively.
(2) Partnerships and S corporations
engaged in excepted trades or businesses.
To the extent a partnership or an S corpo-
ration is engaged in an excepted trade or
business, the general rule in §1.163(j)-2
and this section does not apply to limit the
deduction for business interest expense
that is allocable to such excepted trade
or business. If a partner or S corporation
shareholder is allocated any section 163(j)
item that is allocable to an excepted trade
or business of the partnership or S corpo-
ration (excepted 163(j) items), such ex-
cepted 163(j) items are excluded from the
partner’s or shareholder’s section 163(j)
deduction calculation. See §1.163(j)-10(c)
(regarding the allocation of items between
excepted and non-excepted trades or busi-
nesses). See also Example 13 in paragraph
(o)(13) of this section.
(3) Treatment of excess business inter-
est expense from partnerships that are ex-
empt entities in a succeeding taxable year.
If a partner is allocated excess business
interest expense from a partnership and,
in a succeeding taxable year, such partner-
ship is an exempt entity, then the partner
shall treat any of its excess business inter-
est expense that was previously allocated
from such partnership as business interest
expense paid or accrued by the partner in
such succeeding taxable year, which is po-
tentially subject to limitation at the partner
level under section 163(j). However, if a
partner is allocated excess business inter-
est expense from a partnership and, in a
succeeding taxable year, such partnership
engages in excepted trades or businesses,
then the partner shall not treat any of its
excess business interest expense that was
previously allocated from such partner-
ship as business interest expense paid or
accrued by the partner in such succeeding
taxable year by reason of the partnership
engaging in excepted trades or businesses.
See Example 14 through Example 16 in
paragraphs (o)(14) through (o)(16) of this
section, respectively. For rules regarding
the treatment of excess business interest
expense from a partnership that terminates
under section 708(b)(1), see paragraph (h)
(3) of this section.
(4) S corporations with disallowed
business interest expense carryforwards
prior to becoming exempt entities. If an
S corporation has a disallowed business
interest expense carryforward for a tax-
able year and, in a succeeding taxable
year, such S corporation is an exempt en-
tity, then such disallowed business interest
expense carryforward—
(i) Continues to be carried forward at
the S corporation level;
(ii) Is no longer subject to the section
163(j) limitation; and
(iii) Is taken into account in determin-
ing the nonseparately stated taxable in-
come or loss of the S corporation.
(n) [Reserved]
(o) Examples. The examples in this
paragraph illustrate the provisions of sec-
tion 163(j) as applied to partnerships and
subchapter S corporations. For purposes
of these examples, unless stated other-
wise, each partnership and S corporation is
subject to the provisions of section 163(j),
is only engaged in non-excepted trades
or businesses, was created or organized
in the United States, and uses the calen-
dar year for its annual accounting period.
Unless stated otherwise, all partners and
shareholders are subject to the provisions
of section 163(j), are not subject to a lim-
itation under section 704(d) or 1366(d),
have no tax items other than those listed in
the example, are U.S. citizens, and use the
calendar year for their annual accounting
period. The phrase “section 163(j) limit”
shall equal the maximum potential de-
duction allowed under section 163(j)(1).
Unless stated otherwise, business interest
expense means business interest expense
that is not floor plan financing interest
expense. With respect to partnerships, all
allocations are in accordance with section
704(b) and the regulations in this part un-
der section 704 of the Code.
(1) Example 1—(i) Facts. X and Y are equal part-
ners in partnership PRS. In Year 1, PRS has $100 of
ATI and $40 of business interest expense. PRS allo-
cates the items comprising its $100 of ATI $50 to X

September 28, 2020 730 Bulletin No. 2020–40
and $50 to Y. PRS allocates its $40 of business inter-
est expense $20 to X and $20 to Y. X has $100 of ATI
and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business
interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 1, PRS’s section
163(j) limit is 30 percent of its ATI, or $30 ($100 x
30 percent). Thus, PRS has $30 of deductible busi-
ness interest expense and $10 of excess business
interest expense. Such $30 of deductible business in-
terest expense is includable in PRS’s nonseparately
stated income or loss, and is not subject to further
limitation under section 163(j) at the partners’ level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $15 of
deductible business interest expense and $5 of ex-
cess business interest expense. At the end of Year
1, X and Y each have $5 of excess business interest
expense from PRS, which is not treated as paid or
accrued by the partner until such partner is allocat-
ed excess taxable income or excess business inter-
est income from PRS in a succeeding taxable year.
Pursuant to §1.163(j)-6(e)(1), X and Y, in computing
their limit under section 163(j), do not increase any
of their section 163(j) items by any of PRS’s section
163(j) items. X and Y each increase their outside ba-
sis in PRS by $30 ($50 - $20).
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $100 of ATI and
$20 of business interest expense from its sole propri-
etorship. X’s section 163(j) limit is $30 ($100 x 30
percent). Thus, X’s $20 of business interest expense
is deductible business interest expense. Y, in comput-
ing its limit under section 163(j), has $20 of business
interest expense from its sole proprietorship. Y’s sec-
tion 163(j) limit is $0 ($0 x 30 percent). Thus, Y’s
$20 of business interest expense is not allowed as a
deduction and is treated as business interest expense
paid or accrued by Y in Year 2.
(2) Example 2—(i) Facts. The facts are the same
as in Example 1 in paragraph (o)(1)(i) of this section.
In Year 2, PRS has $200 of ATI, $0 of business in-
terest income, and $30 of business interest expense.
PRS allocates the items comprising its $200 of ATI
$100 to X and $100 to Y. PRS allocates its $30 of
business interest expense $15 to X and $15 to Y. X
has $100 of ATI and $20 of business interest expense
from its sole proprietorship. Y has $0 of ATI and $20
of business interest expense from its sole proprietor-
ship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $60 ($200 x 30 percent). Thus,
PRS has $100 of excess taxable income, $30 of de-
ductible business interest expense, and $0 of excess
business interest expense. Such $30 of deductible
business interest expense is includable in PRS’s non-
separately stated income or loss, and is not subject to
further limitation under section 163(j) at the partners’
level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $50 of
excess taxable income, $15 of deductible business
interest expense, and $0 of excess business interest
expense. As a result, X and Y each increase their ATI
by $50. Because X and Y are each allocated $50 of
excess taxable income from PRS, and excess busi-
ness interest expense from a partnership is treated as
paid or accrued by a partner to the extent excess tax-
able income and excess business interest income are
allocated from such partnership to a partner, X and Y
each treat $5 of excess business interest expense (the
carryforward from Year 1) as paid or accrued in Year
2. X and Y each increase their outside basis in PRS
by $85 ($100 - $15).
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $150 of ATI ($100
from its sole proprietorship, plus $50 excess taxable
income) and $25 of business interest expense ($20
from its sole proprietorship, plus $5 excess business
interest expense treated as paid or accrued in Year
2). X’s section 163(j) limit is $45 ($150 x 30 per-
cent). Thus, X’s $25 of business interest expense is
deductible business interest expense. At the end of
Year 2, X has $0 of excess business interest expense
from PRS ($5 from Year 1, less $5 treated as paid
or accrued in Year 2). Y, in computing its limit un-
der section 163(j), has $50 of ATI ($0 from its sole
proprietorship, plus $50 excess taxable income) and
$45 of business interest expense ($20 from its sole
proprietorship, plus $20 disallowed business interest
expense from Year 1, plus $5 excess business interest
expense treated as paid or accrued in Year 2). Y’s
section 163(j) limit is $15 ($50 x 30 percent). Thus,
$15 of Y’s business interest expense is deductible
business interest expense. The $30 of Y’s business
interest expense not allowed as a deduction ($45
business interest expense, less $15 section 163(j)
limit) is treated as business interest expense paid
or accrued by Y in Year 3. At the end of Year 2, Y
has $0 of excess business interest expense from PRS
($5 from Year 1, less $5 treated as paid or accrued
in Year 2).
(3) Example 3—(i) Facts. The facts are the same
as in Example 1 in paragraph (o)(1)(i) of this section.
In Year 2, PRS has $0 of ATI, $60 of business interest
income, and $40 of business interest expense. PRS
allocates its $60 of business interest income $30 to X
and $30 to Y. PRS allocates its $40 of business inter-
est expense $20 to X and $20 to Y. X has $100 of ATI
and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business
interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $60 (($0 x 30 percent) + $60).
Thus, PRS has $20 of excess business interest in-
come, $0 of excess taxable income, $40 of deductible
business interest expense, and $0 of excess business
interest expense. Such $40 of deductible business in-
terest expense is includable in PRS’s nonseparately
stated income or loss, and is not subject to further
limitation under section 163(j) at the partners’ level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $10 of
excess business interest income, and $20 of deduct-
ible business interest expense. As a result, X and Y
each increase their business interest income by $10.
Because X and Y are each allocated $10 of excess
business interest income from PRS, and excess busi-
ness interest expense from a partnership is treated as
paid or accrued by a partner to the extent excess tax-
able income and excess business interest income are
allocated from such partnership to a partner, X and Y
each treat $5 of excess business interest expense (the
carryforward from Year 1) as paid or accrued in Year
2. X and Y each increase their outside basis in PRS
by $10 ($30 - $20).
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $100 of ATI (from
its sole proprietorship), $10 of business interest in-
come (from the allocation of $10 of excess business
interest income from PRS), and $25 of business in-
terest expense ($20 from its sole proprietorship, plus
$5 excess business interest expense treated as paid
or accrued in Year 2). X’s section 163(j) limit is $40
(($100 x 30 percent) + $10). Thus, X’s $25 of busi-
ness interest expense is deductible business interest
expense. At the end of Year 2, X has $0 of excess
business interest expense from PRS ($5 from Year
1, less $5 treated as paid or accrued in Year 2). Y, in
computing its limit under section 163(j), has $0 of
ATI (from its sole proprietorship), $10 of business
interest income, and $45 of business interest expense
($20 from its sole proprietorship, plus $20 disallowed
business interest expense from Year 1, plus $5 excess
business interest expense treated as paid or accrued
in Year 2). Y’s section 163(j) limit is $10 (($0 x 30
percent) + $10). Thus, $10 of Y’s business interest
expense is deductible business interest expense. The
$35 of Y’s business interest expense not allowed as
a deduction ($45 business interest expense, less $10
section 163(j) limit) is treated as business interest ex-
pense paid or accrued by Y in Year 3. At the end of
Year 2, Y has $0 of excess business interest expense
from PRS ($5 from Year 1, less $5 treated as paid or
accrued in Year 2).
(4) Example 4—(i) Facts. The facts are the same
as in Example 1 in paragraph (o)(1)(i) of this section.
In Year 2, PRS has $100 of ATI, $60 of business in-
terest income, and $40 of business interest expense.
PRS allocates the items comprising its $100 of ATI
$50 to X and $50 to Y. PRS allocates its $60 of busi-
ness interest income $30 to X and $30 to Y. PRS al-
locates its $40 of business interest expense $20 to X
and $20 to Y. X has $100 of ATI and $20 of business
interest expense from its sole proprietorship. Y has
$0 of ATI and $20 of business interest expense from
its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its busi-
ness interest income, or $90 (($100 x 30 percent)) +
$60). Thus, PRS has $20 of excess business interest
income, $100 of excess taxable income, $40 of de-
ductible business interest expense, and $0 of excess
business interest expense. Such $40 of deductible
business interest expense is includable in PRS’s non-
separately stated income or loss, and is not subject to
further limitation under section 163(j) at the partners’
level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $10 of
excess business interest income, $50 of excess taxable
income, and $20 of deductible business interest ex-
pense. As a result, X and Y each increase their busi-
ness interest income by $10 and ATI by $50. Because
X and Y are each allocated $10 of excess business in-
terest income and $50 of excess taxable income from
PRS, and excess business interest expense from a part-
nership is treated as paid or accrued by a partner to
the extent excess taxable income and excess business
interest income are allocated from such partnership to
a partner, X and Y each treat $5 of excess business
interest expense (the carryforward from Year 1) as

Bulletin No. 2020–40 731 September 28, 2020
paid or accrued in Year 2. X and Y each increase their
outside basis in PRS by $60 ($80 - $20).
(iv) Partner-level computations. X, in comput-
ing its limit under section 163(j), has $150 of ATI
($100 from its sole proprietorship, plus $50 excess
taxable income), $10 of business interest income,
and $25 of business interest expense ($20 from its
sole proprietorship, plus $5 excess business interest
expense treated as paid or accrued in Year 2). X’s
section 163(j) limit is $55 (($150 x 30 percent) +
$10). Thus, $25 of X’s business interest expense is
deductible business interest expense. At the end of
Year 2, X has $0 of excess business interest expense
from PRS ($5 from Year 1, less $5 treated as paid
or accrued in Year 2). Y, in computing its limit un-
der section 163(j), has $50 of ATI ($0 from its sole
proprietorship, plus $50 excess taxable income), $10
of business interest income, and $45 of business in-
terest expense ($20 from its sole proprietorship, plus
$20 disallowed business interest expense from Year
1, plus $5 excess business interest expense treated as
paid or accrued in Year 2). Y’s section 163(j) limit
is $25 (($50 x 30 percent) + $10). Thus, $25 of Y’s
business interest expense is deductible business in-
terest expense. Y’s $20 of business interest expense
not allowed as a deduction ($45 business interest
expense, less $25 section 163(j) limit) is treated as
business interest expense paid or accrued by Y in
Year 3. At the end of Year 2, Y has $0 of excess busi-
ness interest expense from PRS ($5 from Year 1, less
$5 treated as paid or accrued in Year 2).
(5) Example 5—(i) Facts. The facts are the
same as in Example 1 in paragraph (o)(1)(i) of this
section. In Year 2, PRS has $100 of ATI, $11.20 of
business interest income, and $40 of business inter-
est expense. PRS allocates the items comprising its
$100 of ATI $50 to X and $50 to Y. PRS allocates its
$11.20 of business interest income $5.60 to X and
$5.60 to Y. PRS allocates its $40 of business interest
expense $20 to X and $20 to Y. X has $100 of ATI
and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business
interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $41.20 (($100 x 30 percent) +
$11.20). Thus, PRS has $0 of excess business inter-
est income, $4 of excess taxable income, and $40 of
deductible business interest expense. Such $40 of
deductible business interest expense is includable in
PRS’s nonseparately stated income or loss, and is not
subject to further limitation under section 163(j) at
the partners’ level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $2 of
excess taxable income, $20 of deductible business
interest expense, and $0 of excess business interest
expense. As a result, X and Y each increase their ATI
by $2. Because X and Y are each allocated $2 of ex-
cess taxable income from PRS, and excess business
interest expense from a partnership is treated as paid
or accrued by a partner to the extent excess taxable
income and excess business interest income are al-
located from such partnership to a partner, X and Y
each treat $2 of excess business interest expense (a
portion of the carryforward from Year 1) as paid or
accrued in Year 2. X and Y each increase their out-
side basis in PRS by $35.60 ($55.60 - $20).
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $102 of ATI ($100
from its sole proprietorship, plus $2 excess taxable
income), $0 of business interest income, and $22 of
business interest expense ($20 from its sole propri-
etorship, plus $2 excess business interest expense
treated as paid or accrued). X’s section 163(j) limit
is $30.60 ($102 x 30 percent). Thus, X’s $22 of busi-
ness interest expense is deductible business interest
expense. At the end of Year 2, X has $3 of excess
business interest expense from PRS ($5 from Year
1, less $2 treated as paid or accrued in Year 2). Y, in
computing its limit under section 163(j), has $2 of
ATI ($0 from its sole proprietorship, plus $2 excess
taxable income), $0 of business interest income, and
$42 of business interest expense ($20 from its sole
proprietorship, plus $20 disallowed business interest
expense from Year 1, plus $2 excess business interest
expense treated as paid or accrued in Year 2). Y’s
section 163(j) limit is $0.60 ($2 x 30 percent). Thus,
$0.60 of Y’s business interest expense is deductible
business interest expense. Y’s $41.40 of business
interest expense not allowed as a deduction ($42
business interest expense, less $0.60 section 163(j)
limit) is treated as business interest expense paid or
accrued by Y in Year 3. At the end of Year 2, Y has
$3 of excess business interest expense from PRS
($5 from Year 1, less $2 treated as paid or accrued
in Year 2).
(6) Example 6—(i) Facts. In Year 1, X, Y, and
Z formed partnership PRS. Upon formation, X and
Y each contributed $100, and Z contributed non-ex-
cepted and non-depreciable trade or business proper-
ty with a basis of $0 and fair market value of $100
(Blackacre). PRS allocates all items pro rata between
its partners. Immediately after the formation of PRS,
Z sold all of its interest in PRS to A for $100 (assume
the interest sale is respected for U.S. Federal income
tax purposes). In connection with the interest trans-
fer, PRS made a valid election under section 754.
Therefore, after the interest sale, A had a $100 posi-
tive section 743(b) adjustment in Blackacre. In Year
1, PRS had $0 of ATI, $15 of business interest ex-
pense, and $0 of business interest income. Pursuant
to §1.163(j)-6(f)(2), PRS allocated each of the part-
ners $5 of excess business interest expense. In Year
2, PRS sells Blackacre for $100 which generated
$100 of ATI. The sale of Blackacre was PRS’s only
item of income in Year 2. In accordance with section
704(c), PRS allocates all $100 of gain resulting from
the sale of Blackacre to A. Additionally, PRS has $15
of business interest expense, all of which it allocates
to X. A has $50 of ATI and $20 of business interest
expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI, or $30 ($100
x 30 percent). Thus, PRS has $15 of deductible
business interest expense and $50 of excess taxable
income. Such $15 of deductible business interest
expense is includable in PRS’s nonseparately stated
income or loss, and is not subject to further limitation
under section 163(j) at X’s level.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X is allocated $15 of deductible
business interest expense and X’s outside basis in
PRS is reduced by $15. A is allocated $50 of excess
taxable income and, as a result, A increases its ATI
by $50. Because A is allocated $50 of excess taxable
income, and excess business interest expense from a
partnership is treated as paid or accrued by a partner
to the extent excess taxable income and excess busi-
ness interest income are allocated from such partner-
ship to a partner, A treats $5 of excess business inter-
est expense (the carryforward from Year 1) as paid or
accrued in Year 2. PRS’s $100 of gain allocated to A
in Year 2 is fully reduced by A’s $100 section 743(b)
adjustment. Therefore, at the end of Year 2, there is
no change to A’s outside basis in PRS.
(iv) Partner-level. A, in computing its limit un-
der section 163(j), has $0 of ATI ($50 from its sole
proprietorship, plus $50 excess taxable income, less
$100 ATI reduction as a result of A’s section 743(b)
adjustment under §1.163(j)-6(e)(2)) and $25 of busi-
ness interest expense ($20 from its sole proprietor-
ship, plus $5 excess business interest expense treated
as paid or accrued in Year 2). A’s section 163(j) limit
is $0 ($0 x 30 percent). Thus, all $25 of A’s business
interest expense is not allowed as a deduction and is
treated as business interest expense paid or accrued
by A in Year 3.
(7) Example 7—(i) Facts. X and Y are equal part-
ners in partnership PRS. At the beginning of Year 1,
X and Y each have an outside basis in PRS of $5. In
Year 1, PRS has $0 of ATI, $20 of business interest
income, and $40 of business interest expense. PRS
allocates its $20 of business interest income $10 to X
and $10 to Y. PRS allocates $40 of business interest
expense $20 to X and $20 to Y. X has $100 of ATI
and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business
interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 1, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $20 (($0 x 30 percent) + $20).
Thus, PRS has $0 of excess business interest income,
$0 of excess taxable income, $20 of deductible busi-
ness interest expense, and $20 of excess business
interest expense. Such $20 of deductible business
interest expense is includable in nonseparately stated
income or loss of PRS, and not subject to further lim-
itation under section 163(j) by the partners.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $10
of deductible business interest expense and $10 of
excess business interest expense. After adjusting
each partner’s respective basis for business inter-
est income under section 705(a)(1)(A), pursuant to
§1.163(j)-6(h)(1), X and Y each take their $10 of
deductible business interest expense into account
when reducing their outside basis in PRS before
taking the $10 of excess business interest expense
into account. Following each partner’s reduction in
outside basis due to the $10 of deductible business
interest expense, each partner has $5 of outside ba-
sis remaining in PRS. Pursuant to §1.163(j)-6(h)
(2), each partner has $5 of excess business interest
expense and $5 of negative section 163(j) expense.
In sum, at the end of Year 1, X and Y each have $5
of excess business interest expense from PRS which
reduces each partner’s outside basis to $0 (and is not
treated as paid or accrued by the partners until such
partner is allocated excess taxable income or excess
business interest income from PRS in a succeeding
taxable year), and $5 of negative section 163(j) ex-
pense (which is suspended under section 704(d) and
not treated as excess business interest expense of

September 28, 2020 732 Bulletin No. 2020–40
the partners until such time as the negative section
163(j) expense is no longer subject to a limitation
under section 704(d)).
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $100 of ATI (from
its sole proprietorship) and $20 of business interest
expense (from its sole proprietorship). X’s section
163(j) limit is $30 ($100 x 30 percent). Thus, $20
of X’s business interest expense is deductible busi-
ness interest expense. Y, in computing its limit under
section 163(j), has $20 of business interest expense
(from its sole proprietorship). Y’s section 163(j) lim-
it is $0 ($0 x 30 percent). Thus, $20 of Y’s business
interest expense is not allowed as a deduction in Year
1, and is treated as business interest expense paid or
accrued by Y in Year 2.
(8) Example 8—(i) Facts. The facts are the same
as in Example 7 in paragraph (o)(7)(i) of this section.
In Year 2, PRS has $20 of gross income that is tak-
en into account in determining PRS’s ATI (in other
words, properly allocable to a trade or business), $30
of gross deductions from an investment activity, and
$0 of business interest expense. PRS allocates the
items comprising its $20 of ATI $10 to X and $10
to Y. PRS allocates the items comprising its $30 of
gross deductions $15 to X and $15 to Y. X has $100
of ATI and $20 of business interest expense from its
sole proprietorship. Y has $0 of ATI and $20 of busi-
ness interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $6 ($20 x 30 percent). Because
PRS has no business interest expense, all $20 of its
ATI is excess taxable income.
(iii) Partner-level allocations. Pursuant to
§1.163(j)-6(f)(2), X and Y are each allocated $10 of
excess taxable income. Because X and Y are each
allocated $10 of excess taxable income from PRS,
X and Y each increase their ATI by $10. Pursuant to
§1.704-(1)(d)(2), each partner’s limitation on losses
under section 704(d) must be allocated to its dis-
tributive share of each such loss. Thus, each partner
reduces its adjusted basis of $10 (attributable to the
allocation of items comprising PRS’s ATI in Year 2)
by $7.50 of gross deductions from Year 2 ($10 x ($15
of total gross deductions from Year 2 / $20 of total
losses disallowed)), and $2.50 of excess business in-
terest expense that was carried over as negative sec-
tion 163(j) expense from Year 1 ($10 x ($5 of nega-
tive section 163(j) expense treated as excess business
interest expense solely for the purposes of section
704(d) / $20 of total losses disallowed)). Following
the application of section 704(d), each partner has
$7.50 of excess business interest expense from PRS
($5 excess business interest expense from Year 1,
plus $2.50 of excess business interest expense that
was formerly negative section 163(j) expense carried
over from Year 1). Excess business interest expense
from a partnership is treated as paid or accrued by
a partner to the extent excess taxable income and
excess business interest income are allocated from
such partnership to the partner. As a result, X and Y
each treat $7.50 of excess business interest expense
as paid or accrued in Year 2.
(iv) Partner-level computations. X, in computing
its limit under section 163(j), has $110 of ATI ($100
from its sole proprietorship, plus $10 excess taxable
income) and $27.50 of business interest expense
($20 from its sole proprietorship, plus $7.50 excess
business interest expense treated as paid or accrued
in Year 2). X’s section 163(j) limit is $33 ($110 x
30 percent). Thus, $27.50 of X’s business interest
expense is deductible business interest expense. At
the end of Year 2, X has $0 of excess business inter-
est expense from PRS ($5 from Year 1, plus $2.50
treated as excess business interest expense in Year
2, less $7.50 treated as paid or accrued in Year 2),
and $2.50 of negative section 163(j) expense from
PRS. Y, in computing its limit under section 163(j),
has $10 of ATI ($0 from its sole proprietorship, plus
$10 excess taxable income) and $47.50 of business
interest expense ($20 from its sole proprietorship,
plus $20 disallowed business interest expense from
Year 1, plus $7.50 excess business interest expense
treated as paid or accrued in Year 2). Y’s section
163(j) limit is $3 ($10 x 30 percent). Thus, $3 of Y’s
business interest expense is deductible business in-
terest expense. The $44.50 of Y’s business interest
expense not allowed as a deduction ($47.50 business
interest expense, less $3 section 163(j) limit) is treat-
ed as business interest expense paid or accrued by Y
in Year 3. At the end of Year 2, Y has $0 of excess
business interest expense from PRS ($5 from Year
1, plus $2.50 treated as excess business interest ex-
pense in Year 2, less $7.50 treated as paid or accrued
in Year 2), and $2.50 of negative section 163(j) ex-
pense from PRS.
(9) Example 9—(i) Facts. X and Y are equal part-
ners in partnership PRS, and are not members of a
consolidated group. At the beginning of Year 1, X
and Y each have $120 of outside basis in PRS. Nei-
ther X nor Y’s share of partnership liabilities exceeds
the adjusted basis of its entire interest. In Year 1, X
is allocated $20 of excess business interest expense,
which reduces its outside basis from $120 to $100.
In Year 2, X sells 80 percent of its interest in PRS to
Z for $160. Immediately prior to the sale, X’s entire
PRS interest had a fair market value of $200 and the
transferred portion of the interest had a fair market
value of $160.
(ii) Basis adjustment. Immediately before the
sale to Z, X increases its basis in the portion of the
interest sold by 80 percent of the amount of the ex-
cess of the amount of the basis reduction under para-
graph (h)(2) of this section ($20) over the portion of
any excess business interest expense allocated the
partner under paragraph (f)(2) of this section that
has previously been treated under paragraph (g) of
this section as business interest expense paid or ac-
crued by X ($0). Therefore, X’s basis in the portion
of its interest sold is $96 (($100 x 80%) + ($20 x
80%)), and X’s gain is $64 ($160 - $96). Following
the sale, X has $20 of outside basis in its remaining
partnership interest and $4 of excess business inter-
est expense.
(10) Example 10—(i) Facts. X and Y are equal
partners in partnership PRS, and are not members of
a consolidated group. At the beginning of Year 1, X
and Y each have an outside basis in PRS of $10. Nei-
ther X nor Y’s share of partnership liabilities exceeds
the adjusted basis of its entire interest. In Year 1, X
is allocated $8 of excess business interest expense
and $12 of loss from PRS. As a result, X has $4 of
excess business interest expense, $4 of negative sec-
tion 163(j) expense, $6 of allowable loss, $6 of loss
suspended under section 704(d), and $0 of outside
basis in PRS at the end of Year 1. In Year 2, X sells
50 percent of its interest in PRS to Z for $20. Imme-
diately prior to the sale, X’s entire partnership inter-
est had a fair market value of $40 and the transferred
portion of the interest had a fair market value of $20.
(ii) Basis adjustment. Immediately before the
sale to Z, X increases its basis in the portion of the
interest sold by 50 percent of the amount of the ex-
cess of the amount of the basis reduction under para-
graph (h)(2) of this section ($4) over the portion of
any excess business interest expense allocated the
partner under paragraph (f)(2) of this section that has
previously been treated under paragraph (g) of this
section as business interest expense paid or accrued
by X ($0). Therefore, X’s basis in the portion of its
interest sold is $2 (($0 x 50%) + $2), and X’s gain
is $18 ($20 - $2). Following the sale, X has $0 of
outside basis in its remaining partnership interest, $2
of excess business interest expense, $4 of negative
section 163(j) expense, and $6 of loss suspended un-
der section 704(d).
(11) Example 11—(i) Facts. X (a corporation), Y
(an individual), and Z (an individual) are equal part-
ners in partnership PRS. X, Y, and Z are subject to
section 163(j). PRS is not subject to section 163(j)
under section 163(j)(3). In 2021, PRS has $150 of
trade or business income (not taking into account
business interest income or business interest ex-
pense), $30 of business interest income, and $45 of
business interest expense. PRS also has $75 of in-
vestment income and $60 of investment interest ex-
pense. PRS allocates its items of income, gain, loss,
and deduction equally among its partners. X, Y, and
Z each have $10 of business interest expense from
their respective businesses.
(ii) Partnership-level. PRS is not subject to sec-
tion 163(j) by reason of section 163(j)(3). As a re-
sult, none of PRS’s $45 of business interest expense
is subject to the section 163(j) limitation.
(iii) Partner-level allocations. Because PRS is
not subject to section 163(j) by reason of section
163(j)(3), PRS’s $45 of business interest expense
does not retain its character as business interest ex-
pense for purposes of section 163(j). As a result, such
business interest expense is not subject to the section
163(j) limitation at the level of either the partnership
or partner. Additionally, pursuant to §1.163(j)-6(m)
(1), each partner includes its share of non-excepted
trade or business items of income, gain, loss, and
deduction (including business interest expense and
business interest income) of PRS when calculating
its ATI. As a result, each partner increases its ATI by
$45 (one third of $150 + $30 - $45). Also, X increas-
es its ATI by an additional $25 because its items of
investment income and loss from PRS are recharac-
terized as non-excepted trade or business income and
loss at its level pursuant to §§1.163(j)-4(b)(3)(i) and
1.163(j)-10(b)(6). Further, X increases its business
interest expense by its $20 allocation of investment
interest expense from PRS pursuant to §§1.163(j)-
4(b)(3)(i) and 1.163(j)-10(b)(6).
(iv) Partner-level computations. X, in comput-
ing its limit under section 163(j), has $70 of ATI and
$30 of business interest expense. X’s section 163(j)
limit is $21 ($70 x 30 percent). Thus, X has $21 of
deductible business interest expense. X’s $9 of busi-
ness interest expense not allowed as a deduction is
treated as business interest expense paid or accrued

Bulletin No. 2020–40 733 September 28, 2020
by X in 2020. Y and Z, in computing their respective
limits under section 163(j), each have $45 of ATI and
$10 of business interest expense. Y and Z each have
a section 163(j) limit of $13.50 ($45 x 30 percent).
Thus, Y and Z each have $10 of deductible business
interest expense.
(12) Example 12—(i) Facts. The facts are the
same as in Example 11 in paragraph (o)(11)(i) of this
section, except PRS has $200 of depreciation deduc-
tions in addition to its other items of income, gain,
loss, and deduction.
(ii) Partnership-level. Same analysis as Example
11 in paragraph (o)(11)(ii) of this section.
(iii) Partner-level allocations. Because PRS is
not subject to section 163(j) by reason of section
163(j)(3), PRS’s $45 of business interest expense
does not retain its character as business interest ex-
pense for purposes of section 163(j). As a result, such
business interest expense is not subject to the section
163(j) limitation at the level of either the partnership
or partner. Additionally, pursuant to §1.163(j)-6(m)
(1), each partner includes its share of non-excepted
trade or business items of income, gain, loss, and
deduction (including business interest expense and
business interest income) of PRS when calculating
its ATI; however, a net loss allocation of trade or
business items from an exempt entity does not re-
duce a partner’s ATI. Because each of the partners
has a net loss allocation of trade or business items
from PRS, none of the partners adjust their ATI for
the trade or business items of PRS. X, the corporate
partner, increases its ATI by $25 because its items
of investment income and loss from PRS are rechar-
acterized as trade or business income and loss at its
level pursuant to §§1.163(j)-4(b)(3)(i) and 1.163(j)-
10(b)(6). Further, X increases its business interest
expense by its $20 allocation of investment interest
expense from PRS pursuant to §§1.163(j)-4(b)(3)(i)
and 1.163(j)-10(b)(6).
(iv) Partner-level computations. In computing its
limit under section 163(j), each partner has $0 of ATI
and $10 of business interest expense. Each partner’s
section 163(j) limit is $0 ($0 x 30 percent). Thus,
each partner’s $10 of business interest expense is not
allowed as a deduction and is treated as business in-
terest expense paid or accrued by the partner in 2020.
X, in computing its limit under section 163(j), has
$25 of ATI and $30 of business interest expense. X’s
section 163(j) limit is $7.50 ($25 x 30 percent). Thus,
X has $7.50 of deductible business interest expense.
X’s $22.50 of business interest expense not allowed
as a deduction is treated as business interest expense
paid or accrued by X in 2020. Y and Z, in comput-
ing their respective limits under section 163(j), each
have $0 of ATI and $10 of business interest expense.
Thus, Y and Z each have $10 of business interest ex-
pense not allowed as a deduction that is treated as
business interest expense paid or accrued in 2020.
(13) Example 13—(i) Facts. X, Y, and Z are
equal partners in partnership PRS. X, Y, and Z are
each individuals subject to section 163(j). PRS is
not subject to section 163(j) under section 163(j)(3).
PRS has one excepted and one non-excepted trade or
business. In Year 1, PRS has $200 of income and $10
of business interest expense from its excepted trade
or business, and $60 of business interest income and
$30 of business interest expense from its non-ex-
cepted trade or business. PRS allocates its items of
income, gain, loss, and deduction equally among its
partners. X, Y, and Z each have $10 of business inter-
est expense from their respective businesses.
(ii) Partnership-level. PRS is not subject to sec-
tion 163(j) by reason of section 163(j)(3). As a result,
none of PRS’s business interest expense is subject to
the section 163(j) limitation.
(iii) Partner-level allocations. Because PRS’s
business interest expense is not subject to the section
163(j) limitation, such business interest expense is
not subject to the section 163(j) limitation at the lev-
el of either the partnership or partner. Additionally,
pursuant to §1.163(j)-6(m)(1), each partner includes
its share of non-excepted trade or business items of
income, gain, loss, and deduction (including busi-
ness interest expense and business interest income)
of PRS when calculating its ATI. Therefore, each
partner increases its ATI by $10 (each partner’s share
of $20 of non-excepted income less each partner’s
share of $10 of non-excepted loss).
(iv) Partner-level computations. In computing its
limit under section 163(j), each partner has $10 of
ATI and $10 of business interest expense. Each part-
ner’s section 163(j) limit is $3 ($10 x 30 percent).
Thus, each partner has $3 of deductible business in-
terest expense. Each partner has $7 of business inter-
est expense not allowed as a deduction that is treated
as business interest expense paid or accrued by the
partner in Year 2.
(14) Example 14—(i) Facts. The facts are the
same as in Example 5 in paragraph (o)(5)(i) of this
section, except in Year 2 Y is not subject to section
163(j) under section 163(j)(3).
(ii) Partnership-level. Same analysis as Example
5 in paragraph (o)(5)(ii) of this section.
(iii) Partner-level allocations. Same analysis as
Example 5 in paragraph (o)(5)(iii) of this section.
(iv) Partner-level computations. For X, same
analysis as Example 5 in paragraph (o)(5)(iv) of this
section. Y is not subject to section 163(j) under sec-
tion 163(j)(3). Thus, all $42 of business interest ex-
pense ($20 from its sole proprietorship, plus $20 dis-
allowed business interest expense from Year 1, plus
$2 excess business interest expense treated as paid
or accrued in Year 2) is not subject to limitation un-
der §1.163(j)-2(d). At the end of Year 2, Y has $3 of
excess business interest expense from PRS ($5 from
Year 1, less $2 treated as paid or accrued in Year 2).
(15) Example 15—(i) Facts. The facts are the
same as in Example 5 in paragraph (o)(5)(i) of this
section, except in Year 2 PRS and Y become not sub-
ject to section 163(j) by reason of section 163(j)(3).
(ii) Partnership-level. In Year 2, PRS is not sub-
ject to section 163(j) by reason of section 163(j)(3).
As a result, none of PRS’s $40 of business interest
expense is subject to the section 163(j) limitation at
the level of either the partnership or partner.
(iii) Partner-level allocations. Because PRS is
not subject to section 163(j) by reason of section
163(j)(3), PRS’s $40 of business interest expense
does not retain its character as business interest ex-
pense for purposes of section 163(j). As a result, such
business interest expense is not subject to the section
163(j) limitation at the level of either the partnership
or partner. Additionally, pursuant to §1.163(j)-6(m)
(1), each partner includes its share of non-excepted
trade or business items of income, gain, loss, and
deduction (including business interest expense and
business interest income) of PRS when calculating
its ATI. As a result, X and Y each increase their ATI
by $35.60. Further, because PRS is not subject to sec-
tion 163(j) by reason of section 163(j)(3), the excess
business interest expense from Year 1 is treated as
paid or accrued by the partners pursuant to §1.163(j)-
6(m)(3). As a result, X and Y each treat their $5 of
excess business interest expense from Year 1 as paid
or accrued in Year 2, and increase their business in-
terest expense by $5.
(iv) Partner-level computations. X, in comput-
ing its limit under section 163(j), has $135.60 of ATI
($100 from its sole proprietorship, plus $35.60 ATI
from PRS) and $25 of business interest expense ($20
from its sole proprietorship, plus $5 of excess busi-
ness interest expense treated as paid or accrued in
Year 2). X’s section 163(j) limit is $40.68 ($135.60
x 30 percent). Thus, $25 of X’s business interest ex-
pense is deductible business interest expense. Y is
not subject to section 163(j) under section 163(j)(3).
As a result, Y’s business interest expense is not sub-
ject to the section 163(j) limitation. Thus, all $45 of
Y’s business interest expense ($20 from its sole pro-
prietorship, plus $20 disallowed from year 1, plus $5
of excess business interest expense treated as paid or
accrued in Year 2) is not subject to the section 163(j)
limitation.
(16) Example 16—(i) Facts. The facts are the
same as in Example 1 in paragraph (o)(1)(i) of this
section, except that PRS’s only trade or business is
a real property trade or business for which PRS does
not make the election provided for in section 163(j)
(7)(B). In Year 2, when PRS’s only trade or business
is still its real property trade or business, PRS makes
the election provided for in section 163(j)(7)(B).
Further, in Year 2, PRS has $100 of income and $40
of business interest expense. PRS allocates its items
of income, gain, deduction, and loss equally between
X and Y. X has $100 of ATI and $20 of business in-
terest expense from its sole proprietorship. Y has $0
of ATI and $20 of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS is not sub-
ject to section 163(j) because its only trade or busi-
ness is an excepted trade or business. As a result,
none of PRS’s $40 of business interest expense is
subject to the section 163(j) limitation at the level of
either the partnership or partner.
(iii) Partner-level allocations. Because PRS is
not subject to section 163(j), PRS’s $40 of business
interest expense does not retain its character as busi-
ness interest expense for purposes of section 163(j).
As a result, such business interest expense is not sub-
ject to the section 163(j) limitation at the partners’
level. Pursuant to §1.163(j)-6(m)(1), the partners do
not include their respective $50 shares of income
from PRS when calculating their own ATI because
such $50 is excepted trade or business income.
(iv) Partner-level computations. X, in com-
puting its limit under section 163(j), has $100 of
ATI ($100 from its sole proprietorship) and $20 of
business interest expense ($20 from its sole propri-
etorship). X’s section 163(j) limit is $30 ($100 x
30 percent). Thus, $20 of X’s business interest ex-
pense is deductible business interest expense. At the
end of Year 2, X has $5 of excess business interest
expense from PRS ($5 from Year 1). Y, in comput-
ing its limit under section 163(j), has $0 of ATI and

September 28, 2020 734 Bulletin No. 2020–40
$40 of business interest expense ($20 from its sole
proprietorship, plus $20 disallowed business inter-
est expense from Year 1). Y’s section 163(j) limit is
$0. Thus, Y’s $40 of business interest expense not
allowed as a deduction is treated as business inter-
est expense paid or accrued by Y in Year 3. At the
end of Year 2, Y has $5 of excess business interest
expense from PRS ($5 from Year 1).
(17) Example 17: Facts. A (an individual) and
B (a corporation) own all of the interests in partner-
ship PRS. At the beginning of Year 1, A and B each
have $100 section 704(b) capital account and $100
of basis in PRS. In Year 1, PRS has $100 of ATI,
$10 of investment interest income, $20 of business
interest income (BII), $60 of business interest ex-
pense (BIE), and $10 of floor plan financing inter-
est expense. PRS’s ATI consists of $100 of gross
income and $0 of gross deductions. PRS allocates
its items comprising ATI $100 to A and $0 to B.
PRS allocates its business interest income $10 to
A and $10 to B. PRS allocates its business interest
expense $30 to A and $30 to B. PRS allocates all
$10 of its investment interest income and all $10 of
its floor plan financing interest expense to B. A has
ATI from a sole proprietorship, unrelated to PRS, in
the amount of $300.
(i) First, PRS determines its limitation pursu-
ant to §1.163(j)-2. PRS’s section 163(j) limit is 30
percent of its ATI plus its business interest income,
or $50 (($100 x 30 percent) + $20). Thus, PRS has
$0 of excess business interest income (EBII), $0 of
excess taxable income, $50 of deductible business
interest expense, and $10 of excess business interest
expense. PRS takes its $10 of floor plan financing
into account in determining its nonseparately stated
taxable income or loss.
(ii) Second, PRS determines each partner’s allo-
cable share of section 163(j) items used in its own
section 163(j) calculation. B’s $10 of investment
interest income is not included in B’s allocable busi-
ness interest income amount because the $10 of in-
vestment interest income was not taken into account
in PRS’s section 163(j) calculation. B’s $10 of floor
plan financing interest expense is not included in B’s
allocable business interest expense. The $300 of ATI
from A’s sole proprietorship is not included in A’s al-
locable ATI amount because the $300 was not taken
into account in PRS’s section 163(j) calculation.
Table 1 to paragraph (o)(17)(ii)
ABTotal
Allocable ATI$100 $0$100
Allocable BII $10$10 $20
Allocable BIE $30$30 $60
(iii) Third, PRS compares each partner’s allocable
business interest income to such partner’s allocable
business interest expense. Because each partner’s al-
locable business interest expense exceeds its alloca-
ble business interest income by $20 ($30 - $10), each
partner has an allocable business interest income defi-
cit of $20. Thus, the total allocable business interest
income deficit is $40 ($20 + $20). No partner has allo-
cable business interest income excess because no part-
ner has allocable business interest income in excess of
its allocable business interest expense. Thus, the total
allocable business interest income excess is $0.
Table 2 to paragraph (o)(17)(iii)
ABTotal
Allocable BII$10$10N/A
Allocable BIE$30$30N/A
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess $0 $0 $0
If allocable BIE exceeds allocable BII, then such amount = Allocable BII deficit$20$20$40
(iv) Fourth, PRS determines each partner’s final
allocable business interest income excess. Because
no partner had any allocable business interest in-
come excess, each partner has final allocable busi-
ness interest income excess of $0.
(v) Fifth, PRS determines each partner’s re-
maining business interest expense. PRS determines
A’s remaining business interest expense by reduc-
ing, but not below $0, A’s allocable business inter-
est income deficit ($20) by the product of the total
allocable business interest income excess ($0) and
the ratio of A’s allocable business interest income
deficit to the total business interest income deficit
($20/$40). Therefore, A’s allocable business inter-
est income deficit of $20 is reduced by $0 ($0 x
50 percent). As a result, A’s remaining business in-
terest expense is $20. PRS determines B’s remain-
ing business interest expense by reducing, but not
below $0, B’s allocable business interest income
deficit ($20) by the product of the total allocable
business interest income excess ($0) and the ratio
of B’s allocable business interest income deficit to
the total business interest income deficit ($20/$40).
Therefore, B’s allocable business interest income
deficit of $20 is reduced by $0 ($0 x 50 percent).
As a result, B’s remaining business interest expense
is $20.
Table 3 to paragraph (o)(17)(v)
ABTotal
Allocable BII deficit$20$20$40
Less: (Total allocable BII excess) x (Allocable BII deficit / Total allocable BII deficit) $0 $0N/A
= Remaining BIE$20$20$40
(vi) Sixth, PRS determines each partner’s final
allocable ATI. Any partner with a negative alloca-
ble ATI, or an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, B has a positive
allocable ATI of $0. Because A’s allocable ATI is
comprised of $100 of income and gain and $0 of
deduction and loss, A has positive allocable ATI
of $100. Thus, the total positive allocable ATI is
$100 ($100 + $0). PRS determines A’s final alloca-
ble ATI by reducing, but not below $0, A’s positive
allocable ATI ($100) by the product of total nega-
tive allocable ATI ($0) and the ratio of A’s positive
allocable ATI to the total positive allocable ATI
($100/$100). Therefore, A’s positive allocable ATI
is reduced by $0 ($0 x 100 percent). As a result,
A’s final allocable ATI is $100. Because B has a
positive allocable ATI of $0, B’s final allocable
ATI is $0.

Bulletin No. 2020–40 735 September 28, 2020
Table 4 to paragraph (o)(17)(vi)
ABTotal
Allocable ATI$100$0$100
If deduction and loss items comprising allocable ATI exceed income and gain items
comprising allocable ATI, then such excess amount = Negative allocable ATI
$0$0 $0
If income and gain items comprising allocable ATI equal or exceed deduction and loss
items comprising allocable ATI, then such amount = Positive allocable ATI
$100$0$100
Table 5 to paragraph (o)(17)(vi)
ABTotal
Positive allocable ATI$100$0$100
Less: (Total negative allocable ATI) x (Positive allocable ATI / Total positive allocable
ATI)
$0$0N/A
= Final allocable ATI$100$0$100
(vii) Seventh, PRS compares each partner’s ATI
capacity (ATIC) amount to such partner’s remaining
business interest expense. A’s ATIC amount is $30
($100 x 30 percent) and B’s ATIC amount is $0 ($0 x
30 percent). Because A’s ATIC amount exceeds its re-
maining business interest expense by $10 ($30 - $20),
A has an ATIC excess of $10. B does not have any
ATIC excess. Thus, the total ATIC excess is $10 ($10
+ $0). A does not have any ATIC deficit. Because B’s
remaining business interest expense exceeds its ATIC
amount by $20 ($20 - $0), B has an ATIC deficit of
$20. Thus, the total ATIC deficit is $20 ($0 + $20).
Table 6 to paragraph (o)(17)(vii)
ABTotal
ATIC (Final allocable ATI x 30 percent)$30$0N/A
Remaining BIE$20$20N/A
If ATIC exceeds remaining BIE, then such excess = ATIC excess$10 $0$10
If remaining BIE exceeds ATIC, then such excess = ATIC deficit $0$20$20
(viii)(A) Eighth, PRS must perform the calcula-
tions and make the necessary adjustments described
under paragraph (f)(2)(viii) of this section if, and
only if, PRS has—
(1) An excess business interest expense greater
than $0 under paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0
under paragraph (f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0
under paragraph (f)(2)(vii) of this section.
(B) Because PRS does not meet all three require-
ments in paragraph (o)(17)(viii)(A) of this section,
PRS does not perform the calculations or adjustments
described in paragraph (f)(2)(viii) of this section. In
sum, the correct amounts to be used in paragraphs (o)
(17)(ix) and (x) of this section are as follows.
Table 7 to paragraph (o)(17)(viii)(B)
ABTotal
ATIC excess$10 $0$10
ATIC deficit $0$20$20
(ix) Ninth, PRS determines each partner’s final
ATIC excess amount. Because A has an ATIC excess,
PRS must determine A’s final ATIC excess amount.
A’s final ATIC excess amount is A’s ATIC excess
($10), reduced, but not below $0, by the product of
the total ATIC deficit ($20) and the ratio of A’s ATIC
excess to the total ATIC excess ($10/$10). Therefore,
A has $0 of final ATIC excess ($10 – ($20 x 100 per-
cent)).
Table 8 to paragraph (o)(17)(ix)
ABTotal
ATIC excess$10$0N/A
Less: (Total ATIC deficit) x (ATIC excess / Total ATIC excess)$20$0N/A
= Final ATIC excess $0$0$0
(x) Tenth, PRS determines each partner’s final
ATIC deficit amount. Because B has an ATIC deficit,
PRS must determine B’s final ATIC deficit amount.
B’s final ATIC deficit amount is B’s ATIC deficit
($20), reduced, but not below $0, by the product of
the total ATIC excess ($10) and the ratio of B’s ATIC
deficit to the total ATIC deficit ($20/$20). Therefore,
B has $10 of final ATIC deficit ($20 – ($10 x 100
percent)).

September 28, 2020 736 Bulletin No. 2020–40
(xi) Eleventh, PRS allocates deductible business
interest expense and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i) of this sec-
tion, PRS has $10 of excess business interest expense.
PRS allocates the excess business interest expense
dollar for dollar to the partners with final ATIC defi-
cits amounts. Thus, PRS allocates all $10 of its excess
business interest expense to B. A partner’s allocable
business interest expense is deductible business in-
terest expense to the extent it exceeds such partner’s
share of excess business interest expense. Therefore,
A has deductible business interest expense of $30 ($30
- $0) and B has deductible business interest expense
of $20 ($30 - $10). As a result of its allocations from
PRS, A increases its section 704(b) capital account
and basis in PRS by $80 to $180. As a result of its
allocations from PRS, B decreases its capital account
and basis in PRS by $20 to $80.
Table 9 to paragraph (o)(17)(x)
ABTotal
ATIC deficit$0$20N/A
Less: (Total ATIC excess) x (ATIC deficit / Total ATIC deficit)$0$10N/A
= Final ATIC deficit$0$10$10
Table 10 to paragraph (o)(17)(xi)
ABTotal
Deductible BIE$30$20$50
EBIE allocated $0$10$10
ETI allocated $0 $0 $0
EBII allocated $0 $0 $0
(18) Example 18: Facts. A, B, and C own all of
the interests in partnership PRS. In Year 1, PRS has
$150 of ATI, $10 of business interest income, and
$40 of business interest expense. PRS’s ATI consists
of $200 of gross income and $50 of gross deductions.
PRS allocates its items comprising ATI ($50) to A,
$200 to B, and $0 to C. PRS allocates its business
interest income $0 to A, $0 to B, and $10 to C. PRS
allocates its business interest expense $30 to A, $10
to B, and $0 to C.
(i) First, PRS determines its limitation pursu-
ant to §1.163(j)-2. PRS’s section 163(j) limit is 30
percent of its ATI plus its business interest income,
or $55 (($150 x 30 percent) + $10). Thus, PRS has
$0 of excess business interest income, $50 of ex-
cess taxable income, $40 of deductible business
interest expense, and $0 of excess business interest
expense.
(ii) Second, PRS determines each partner’s allo-
cable share of section 163(j) items used in its own
section 163(j) calculation.
Table 11 to paragraph (o)(18)(ii)
ABCTotal
Allocable ATI($50)$200 $0$150
Allocable BII $0 $0$10 $10
Allocable BIE$30 $10 $0 $40
(iii) Third, PRS compares each partner’s allocable
business interest income to such partner’s allocable
business interest expense. Because A’s allocable busi-
ness interest expense exceeds its allocable business
interest income by $30 ($30 - $0), A has an allocable
business interest income deficit of $30. Because B’s
allocable business interest expense exceeds its alloca-
ble business interest income by $10 ($10 - $0), B has
an allocable business interest income deficit of $10. C
does not have any allocable business interest income
deficit. Thus, the total allocable business interest in-
come deficit is $40 ($30 + $10 + $0). A and B do not
have any allocable business interest income excess.
Because C’s allocable business interest income ex-
ceeds its allocable business interest expense by $10
($10 - $0), C has an allocable business interest income
excess of $10. Thus, the total allocable business inter-
est income excess is $10 ($0 + $0 + $10).
Table 12 to paragraph (o)(18)(iii)
ABCTotal
Allocable BII $0 $0$10N/A
Allocable BIE$30$10 $0N/A
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess
$0 $0$10$10
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit
$30$10 $0$40
(iv) Fourth, PRS determines each partner’s final
allocable business interest income excess. Because
A and B do not have any allocable business interest
income excess, each partner has final allocable busi-
ness interest income excess of $0. PRS determines
C’s final allocable business interest income excess
by reducing, but not below $0, C’s allocable busi-
ness interest income excess ($10) by the product of
the total allocable business interest income deficit
($40) and the ratio of C’s allocable business interest
income excess to the total allocable business interest
income excess ($10/$10). Therefore, C’s allocable
business interest income excess of $10 is reduced by
$10 ($40 x 100 percent). As a result, C’s allocable
business interest income excess is $0.

Bulletin No. 2020–40 737 September 28, 2020
(v) Fifth, PRS determines each partner’s remain-
ing business interest expense. PRS determines A’s
remaining business interest expense by reducing, but
not below $0, A’s allocable business interest income
deficit ($30) by the product of the total allocable
business interest income excess ($10) and the ratio
of A’s allocable business interest income deficit to
the total business interest income deficit ($30/$40).
Therefore, A’s allocable business interest income
deficit of $30 is reduced by $7.50 ($10 x 75 percent).
As a result, A’s remaining business interest expense
is $22.50. PRS determines B’s remaining business
interest expense by reducing, but not below $0, B’s
allocable business interest income deficit ($10) by
the product of the total allocable business interest
income excess ($10) and the ratio of B’s allocable
business interest income deficit to the total business
interest income deficit ($10/$40). Therefore, B’s
allocable business interest income deficit of $10 is
reduced by $2.50 ($10 x 25 percent). As a result,
B’s remaining business interest expense is $7.50.
Because C does not have any allocable business in-
terest income deficit, C’s remaining business interest
expense is $0.
Table 13 to paragraph (o)(18)(iv)
ABCTotal
Allocable BII excess$0$0$10N/A
Less: (Total allocable BII deficit) x (Allocable BII excess /
Total allocable BII excess)
$0$0$40N/A
= Final Allocable BII Excess$0$0 $0$10
Table 14 to paragraph (o)(18)(v)
ABCTotal
Allocable BII deficit$30$10$0$40
Less: (Total allocable BII excess) x (Allocable BII deficit /
Total allocable BII deficit)
$7.50$2.50$0N/A
= Remaining BIE$22.50$7.50$0N/A
(vi) Sixth, PRS determines each partner’s final
allocable ATI. Because A’s allocable ATI is com-
prised of $50 of items of deduction and loss and $0
of income and gain, A has negative allocable ATI of
$50. A is the only partner with negative allocable
ATI. Thus, the total negative allocable ATI amount
is $50. Any partner with a negative allocable ATI, or
an allocable ATI of $0, has a positive allocable ATI
of $0. Therefore, A and C have a positive allocable
ATI of $0. Because B’s allocable ATI is comprised of
$200 of items of income and gain and $0 of deduc-
tion and loss, B has positive allocable ATI of $200.
Thus, the total positive allocable ATI is $200 ($0 +
$200 + $0). PRS determines B’s final allocable ATI
by reducing, but not below $0, B’s positive allocable
ATI ($200) by the product of total negative alloca-
ble ATI ($50) and the ratio of B’s positive allocable
ATI to the total positive allocable ATI ($200/$200).
Therefore, B’s positive allocable ATI is reduced by
$50 ($50 x 100 percent). As a result, B’s final alloca-
ble ATI is $150.
Table 15 to paragraph (o)(18)(vi)
ABCTotal
Allocable ATI($50)$200$0$150
If deduction and loss items comprising allocable ATI exceed
income and gain items comprising allocable ATI, then such
excess amount = Negative allocable ATI
$50$0$0$50
If income and gain items comprising allocable ATI equal or
exceed deduction and loss items comprising allocable ATI,
then such amount = Positive allocable ATI
$0$200$0$200
Table 16 to paragraph (o)(18)(vi)
ABCTotal
Positive allocable ATI$0$200$0$200
Less: (Total negative allocable ATI) x (Positive allocable ATI
/ Total positive allocable ATI)
$0$50$0N/A
= Final allocable ATI$0$150$0$150
(vii) Seventh, PRS compares each partner’s ATI
capacity (ATIC) amount to such partner’s remaining
business interest expense. A’s ATIC amount is $0 ($0
x 30 percent), B’s ATIC amount is $45 ($150 x 30
percent), and C’s ATIC amount is $0 ($0 x 30 per-
cent). A does not have any ATIC excess. Because B’s
ATIC amount exceeds its remaining business interest
expense by $37.50 ($45 - $7.50), B has an ATIC ex-
cess amount of $37.50. C does not have any ATIC
excess. Thus, the total ATIC excess amount is $37.50
($0 + $37.50 + $0). Because A’s remaining business
interest expense exceeds its ATIC amount by $22.50
($22.50 - $0), A has an ATIC deficit of $22.50. B and
C do not have any ATIC deficit. Thus, the total ATIC
deficit is $22.50 ($22.50 + $0 + $0).

September 28, 2020 738 Bulletin No. 2020–40
(viii)(A) Eighth, PRS must perform the calcula-
tions and make the necessary adjustments described
under paragraph (f)(2)(viii) of this section if, and
only if, PRS has—
(1) An excess business interest expense greater
than $0 under paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0
under paragraph (f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0
under paragraph (f)(2)(vii) of this section.
(B) Because PRS does not meet all three require-
ments in paragraph (o)(18)(viii)(A) of this section,
PRS does not perform the calculations or adjustments
described in paragraph (f)(2)(viii) of this section. In
sum, the correct amounts to be used in paragraphs (o)
(18)(ix) and (x) of this section are as follows.
Table 17 to paragraph (o)(18)(vii)
ABCTotal
ATIC (Final allocable ATI x 30 percent)$0$45$0N/A
Remaining BIE$22.50$7.50$0N/A
If ATIC exceeds remaining BIE, then such excess = ATIC
excess
$0$37.50$0$37.50
If remaining BIE exceeds ATIC, then such excess = ATIC
deficit
$22.50$0$0$22.50
Table 18 to paragraph (o)(18)(viii)(B)
ABCTotal
ATIC excess$0$37.50$0$37.50
ATIC deficit$22.50$0$0$22.50
(ix) Ninth, PRS determines each partner’s fi-
nal ATIC excess amount. Because B has ATIC ex-
cess, PRS must determine B’s final ATIC excess
amount. B’s final ATIC excess amount is B’s ATIC
excess ($37.50), reduced, but not below $0, by the
product of the total ATIC deficit ($22.50) and the
ratio of B’s ATIC excess to the total ATIC excess
($37.50/$37.50). Therefore, B has $15 of final ATIC
excess ($37.50 – ($22.50 x 100 percent)).
Table 19 to paragraph (o)(18)(ix)
ABCTotal
ATIC excess$0$37.50$0N/A
Less: (Total ATIC deficit) x (ATIC excess / Total ATIC
excess)
$0$22.50$0N/A
= Final ATIC excess$0$15$0$15
(x) Tenth, PRS determines each partner’s fi-
nal ATIC deficit amount. Because A has an ATIC
deficit, PRS must determine A’s final ATIC deficit
amount. A’s final ATIC deficit amount is A’s ATIC
deficit ($22.50), reduced, but not below $0, by the
product of the total ATIC excess ($37.50) and the
ratio of A’s ATIC deficit to the total ATIC deficit
($22.50/$22.50). Therefore, A has $0 of final ATIC
deficit ($22.50 – ($37.50 x 100 percent)).
Table 20 to paragraph (o)(18)(x)
ABCTotal
ATIC deficit$22.50$0$0N/A
Less: (Total ATIC excess) x (ATIC deficit / Total ATIC deficit)$37.50$0$0N/A
= Final ATIC deficit$0$0$0$0
(xi) Eleventh, PRS allocates deductible busi-
ness interest expense and section 163(j) excess
items to the partners. Pursuant to paragraph (f)(2)
(i) of this section, PRS has $50 of excess taxable
income and $40 of deductible business interest ex-
pense. After grossing up each partner’s final ATIC
excess amounts by ten-thirds, excess taxable in-
come is allocated dollar for dollar to partners with
final ATIC excess amounts. Thus, PRS allocates
its excess taxable income $50 to B. A partner’s
allocable business interest expense is deductible
business interest expense to the extent it exceeds
such partner’s share of excess business interest
expense. Therefore, A has deductible business in-
terest expense of $30 ($30 - $0), B has deductible
business interest expense of $10 ($10 - $0), and
C has deductible business interest expense of $0
($0 - $0).
Table 21 to paragraph (o)(18)(xi)
ABCTotal
Deductible BIE$30$10$0$40
EBIE allocated$0$0$0$0
ETI allocated$0$50$0$50
EBII allocated$0$0$0$0

Bulletin No. 2020–40 739 September 28, 2020
(19) Example 19: Facts. A, B, and C own all
of the interests in partnership PRS. In Year 1, PRS
has $100 of ATI, $0 of business interest income,
and $50 of business interest expense. PRS’s ATI
consists of $200 of gross income and $100 of gross
deductions. PRS allocates its items comprising ATI
$100 to A, $100 to B, and ($100) to C. PRS allo-
cates its business interest expense $0 to A, $25 to
B, and $25 to C.
(i) First, PRS determines its limitation pursuant
to §1.163(j)-2. PRS’s section 163(j) limit is 30 per-
cent of its ATI plus its business interest income, or
$30 ($100 x 30 percent). Thus, PRS has $30 of de-
ductible business interest expense and $20 of excess
business interest expense.
(ii) Second, PRS determines each partner’s allo-
cable share of section 163(j) items used in its own
section 163(j) calculation.
Table 22 to paragraph (o)(19)(ii)
ABCTotal
Allocable ATI$100$100($100)$100
Allocable BII$0$0$0$0
Allocable BIE$0$25$25$50
(iii) Third, PRS compares each partner’s allocable
business interest income to such partner’s allocable
business interest expense. No partner has allocable
business interest income. Consequently, each part-
ner’s allocable business interest income deficit is equal
to such partner’s allocable business interest expense.
Thus, A’s allocable business interest income deficit is
$0, B’s allocable business interest income deficit is
$25, and C’s allocable business interest income defi-
cit is $25. The total allocable business interest income
deficit is $50 ($0 + $25 + $25). No partner has alloca-
ble business interest income excess because no partner
has allocable business interest income in excess of its
allocable business interest expense. Thus, the total al-
locable business interest income excess is $0.
Table 23 to paragraph (o)(19)(iii)
ABCTotal
Allocable BII$0$0$0N/A
Allocable BIE$0$25$25N/A
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess
$0$0$0$0
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit
$0$25$25$50
(iv) Fourth, PRS determines each partner’s final
allocable business interest income excess. Because
no partner had any allocable business interest in-
come excess, each partner has final allocable busi-
ness interest income excess of $0.
(v) Fifth, PRS determines each partner’s re-
maining business interest expense. Because no
partner has any allocable business interest income
excess, each partner’s remaining business interest
expense equals its allocable business interest in-
come deficit. Thus, A’s remaining business interest
expense is $0, B’s remaining business interest ex-
pense is $25, and C’s remaining business interest
expense is $25.
Table 24 to paragraph (o)(19)(v)
ABCTotal
Allocable BII deficit$0$25$25$50
Less: (Total allocable BII excess) x (Allocable BII deficit /
Total allocable BII deficit)
$0$0$0N/A
= Remaining BIE$0$25$25N/A
(vi) Sixth, PRS determines each partner’s final
allocable ATI. Because C’s allocable ATI is com-
prised of $100 of items of deduction and loss and $0
of income and gain, C has negative allocable ATI of
$100. C is the only partner with negative allocable
ATI. Thus, the total negative allocable ATI amount
is $100. Any partner with a negative allocable ATI,
or an allocable ATI of $0, has a positive allocable
ATI of $0. Therefore, C has a positive allocable ATI
of $0. Because A’s allocable ATI is comprised of
$100 of items of income and gain and $0 of deduc-
tion and loss, A has positive allocable ATI of $100.
Because B’s allocable ATI is comprised of $100 of
items of income and gain and $0 of deduction and
loss, B has positive allocable ATI of $100. Thus, the
total positive allocable ATI is $200 ($100 + $100 +
$0). PRS determines A’s final allocable ATI by re-
ducing, but not below $0, A’s positive allocable ATI
($100) by the product of total negative allocable
ATI ($100) and the ratio of A’s positive allocable
ATI to the total positive allocable ATI ($100/$200).
Therefore, A’s positive allocable ATI is reduced
by $50 ($100 x 50 percent). As a result, A’s final
allocable ATI is $50. PRS determines B’s final al-
locable ATI by reducing, but not below $0, B’s pos-
itive allocable ATI ($100) by the product of total
negative allocable ATI ($100) and the ratio of B’s
positive allocable ATI to the total positive allocable
ATI ($100/$200). Therefore, B’s positive allocable
ATI is reduced by $50 ($100 x 50 percent). As a
result, B’s final allocable ATI is $50. Because C has
a positive allocable ATI of $0, C’s final allocable
ATI is $0.

September 28, 2020 740 Bulletin No. 2020–40
(vii) Seventh, PRS compares each partner’s ATI
capacity (ATIC) amount to such partner’s remain-
ing business interest expense. A’s ATIC amount is
$15 ($50 x 30 percent), B’s ATIC amount is $15
($50 x 30 percent), and C’s ATIC amount is $0 ($0
x 30 percent). Because A’s ATIC amount exceeds
its remaining business interest expense by $15 ($15
- $0), A has an ATIC excess of $15. B and C do
not have any ATIC excess. Thus, the total ATIC
excess is $15 ($15 + $0 + $0). A does not have
any ATIC deficit. Because B’s remaining business
interest expense exceeds its ATIC amount by $10
($25 - $15), B has an ATIC deficit of $10. Because
C’s remaining business interest expense exceeds its
ATIC amount by $25 ($25 - $0), C has an ATIC
deficit of $25. Thus, the total ATIC deficit is $35
($0 + $10 + $25).
Table 25 to paragraph (o)(19)(vi)
ABCTotal
Allocable ATI$100$100($100)$100
If deduction and loss items comprising allocable ATI exceed income and
gain items comprising allocable ATI, then such excess amount = Negative
allocable ATI
$0$0$100$100
If income and gain items comprising allocable ATI equal or exceed
deduction and loss items comprising allocable ATI, then such amount =
Positive allocable ATI
$100$100$0$200
Table 26 to paragraph (o)(19)(vi)
ABCTotal
Positive allocable ATI$100$100$0$200
Less: (Total negative allocable ATI) x (Positive allocable ATI
/ Total positive allocable ATI)
$50$50$0N/A
= Final allocable ATI$50$50$0$100
Table 27 to paragraph (o)(19)(vii)
ABCTotal
ATIC (Final allocable ATI x 30 percent)$15$15$0N/A
Remaining BIE$0$25$25N/A
If ATIC exceeds remaining BIE, then such excess = ATIC
excess
$15$0$0$15
If remaining BIE exceeds ATIC, then such excess = ATIC
deficit
$0$10$25$35
(viii)(A) Eighth, PRS must perform the calcula-
tions and make the necessary adjustments described
under paragraph (f)(2)(viii) of this section if, and
only if, PRS has—
(1) An excess business interest expense greater
than $0 under paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0
under paragraph (f)(2)(vi) of this section; and
(3) A total ATIC excess greater than $0 under
paragraph (f)(2)(vii) of this section. Because PRS
satisfies each of these three requirements, PRS must
perform the calculations and make the necessary ad-
justments described under paragraphs (f)(2)(viii)(B)
and (C) or (D) of this section.
(B) PRS must determine each partner’s priority
amount and usable priority amount. Only partners
with an ATIC deficit under paragraph (f)(2)(vii) of
this section can have a priority amount greater than
$0. Thus, only partners B and C can have a priori-
ty amount greater than $0. PRS determines a part-
ner’s priority amount as 30 percent of the amount by
which such partner’s allocable positive ATI exceeds
its final allocable ATI. Therefore, A’s priority amount
is $0, B’s priority amount is $15 (($100 - $50) x 30
percent), and C’s priority amount is $0 (($0 - $0) x
30 percent). Thus, the total priority amount is $15
($0 + $15 + $0). Next, PRS must determine each
partner’s usable priority amount. Each partner’s us-
able priority amount is the lesser of such partner’s
priority amount or ATIC deficit. Thus, A has a usable
priority amount of $0, B has a usable priority amount
of $10, and C has a usable priority amount of $0. As
a result, the total usable priority amount is $10 ($0 +
$10 + $0). Because the total ATIC excess under para-
graph (f)(2)(vii) of this section ($15) is greater than
the total usable priority amount ($10), PRS must per-
form the adjustments described in paragraph (f)(2)
(viii)(C) of this section.
Table 28 to paragraph (o)(19)(viii)(B)
ABCTotal
(Positive allocable ATI - Final allocable ATI)$0$50$0N/A
Multiplied by 30 percent30%30%30%N/A
= Priority amount$0$15$0$15

Bulletin No. 2020–40 741 September 28, 2020
(C) For purposes of paragraph (f)(2)(ix) of this
section, each partner’s final ATIC excess is $0. For
purposes of paragraph (f)(2)(x) of this section, the
following terms have the following meanings. Each
partner’s ATIC deficit is such partner’s ATIC deficit
as determined pursuant to paragraph (f)(2)(vii) of
this section reduced by such partner’s usable priority
amount. Thus, A’s ATIC deficit is $0 ($0 - $0), B’s
ATIC deficit is $0 ($10 - $10), and C’s ATIC defi-
cit is $25 ($25 - $0). The total ATIC deficit is the
total ATIC deficit determined pursuant to paragraph
(f)(2)(vii) ($35) reduced by the total usable priori-
ty amount ($10). Thus, the total ATIC deficit is $25
($35 - $10). The total ATIC excess is the total ATIC
excess determined pursuant to paragraph (f)(2)(vii)
of this section ($15) reduced by the total usable pri-
ority amount ($10). Thus, the total ATIC excess is
$5 ($15 - $5).
Table 29 to paragraph (o)(19)(viii)(B)
ABCTotal
Priority amount$0$15$0N/A
ATIC deficit$0$10$25N/A
Lesser of priority amount or ATIC deficit = Usable priority
amount
$0$10$0$10
Table 30 to paragraph (o)(19)(viii)(C)
ABCTotal
ATIC deficit$0$10$25N/A
Less: Usable priority amount$0$10$0N/A
= ATIC deficit for purposes of paragraph (f)(2)(x) of this
section
$0$0$25$25
(D)(1) In light of the fact that the total ATIC ex-
cess was greater than the total usable priority amount
under paragraph (f)(2)(viii)(B) of this section, para-
graph (f)(2)(viii)(D) of this section does not apply.
(2) In sum, the correct amounts to be used in para-
graphs (o)(19)(ix) and (x) of this section are as follows.
Table 31 to paragraph (o)(19)(viii)(D)(2)
ABCTotal
ATIC excess$5$0$0$5
ATIC deficit$0$0$25$25
(ix) Ninth, PRS determines each partner’s final
ATIC excess amount. Pursuant to paragraph (f)(2)
(viii)(C) of this section, each partner’s final ATIC
excess amount is $0.
(x) Tenth, PRS determines each partner’s final
ATIC deficit amount. Because C has an ATIC deficit,
PRS must determine C’s final ATIC deficit amount. C’s
final ATIC deficit amount is C’s ATIC deficit ($25), re-
duced, but not below $0, by the product of the total
ATIC excess ($5) and the ratio of C’s ATIC deficit to
the total ATIC deficit ($25/$25). Therefore, C has $20
of final ATIC deficit ($25 – ($5 x 100 percent)).
Table 32 to paragraph (o)(19)(x)
ABCTotal
ATIC deficit$0$0$25N/A
Less: (Total ATIC excess) x (ATIC deficit / Total ATIC deficit)$0$0$5N/A
= Final ATIC deficit$0$0$20$20
(xi) Eleventh, PRS allocates deductible business
interest expense and section 163(j) excess items to
the partners. Pursuant to paragraph (f)(2)(i) of this
section, PRS has $20 of excess business interest
expense. PRS allocates the excess business interest
expense dollar for dollar to the partners with final
ATIC deficits. Thus, PRS allocates its excess busi-
ness interest expense $20 to C. A partner’s allocable
business interest expense is deductible business in-
terest expense to the extent it exceeds such partner’s
share of excess business interest expense. Therefore,
A has deductible business interest expense of $0 ($0
- $0), B has deductible business interest expense of
$25 ($25 - $0), and C has deductible business interest
expense of $5 ($25 - $20).
Table 33 to paragraph (o)(19)(xi)
ABCTotal
Deductible BIE$0$25$5$30
EBIE allocated$0$0$20$20
ETI allocated$0$0$0$0
EBII allocated$0$0$0$0

September 28, 2020 742 Bulletin No. 2020–40
(20) Example 20: Facts. A, B, C, and D own all
of the interests in partnership PRS. In Year 1, PRS
has $200 of ATI, $0 of business interest income,
and $140 of business interest expense. PRS’s ATI
consists of $600 of gross income and $400 of gross
deductions. PRS allocates its items comprising ATI
$100 to A, $100 to B, $400 to C, and ($400) to D.
PRS allocates its business interest expense $0 to A,
$40 to B, $60 to C, and $40 to D.
(i) First, PRS determines its limitation pursuant
to §1.163(j)-2. PRS’s section 163(j) limit is 30 per-
cent of its ATI plus its business interest income, or
$60 ($200 x 30 percent). Thus, PRS has $60 of de-
ductible business interest expense and $80 of excess
business interest expense.
(ii) Second, PRS determines each partner’s allo-
cable share of section 163(j) items used in its own
section 163(j) calculation.
Table 34 to paragraph (o)(20)(ii)
ABCDTotal
Allocable ATI$100$100$400($400)$200
Allocable BII$0$0$0$0$0
Allocable BIE$0$40$60$40$140
(iii) Third, PRS compares each partner’s allo-
cable business interest income to such partner’s
allocable business interest expense. No partner has
allocable business interest income. Consequently,
each partner’s allocable business interest income
deficit is equal to such partner’s allocable business
interest expense. Thus, A’s allocable business in-
terest income deficit is $0, B’s allocable business
interest income deficit is $40, C’s allocable busi-
ness interest income deficit is $60, and D’s allo-
cable business interest income deficit is $40. The
total allocable business interest income deficit is
$140 ($0 + $40 + $60 + $40). No partner has allo-
cable business interest income excess because no
partner has allocable business interest income in
excess of its allocable business interest expense.
Thus, the total allocable business interest income
excess is $0.
Table 35 to paragraph (o)(20)(iii)
ABCDTotal
Allocable BII$0$0$0$0N/A
Allocable BIE$0$40$60$40N/A
If allocable BII exceeds allocable BIE, then such
amount = Allocable BII excess
$0$0$0$0$0
If allocable BIE exceeds allocable BII, then such
amount = Allocable BII deficit
$0$40$60$40$140
(iv) Fourth, PRS determines each partner’s final
allocable business interest income excess. Because
no partner has any allocable business interest income
excess, each partner has final allocable business in-
terest income excess of $0.
(v) Fifth, PRS determines each partner’s re-
maining business interest expense. Because no
partner has any allocable business interest income
excess, each partner’s remaining business interest
expense equals its allocable business interest in-
come deficit. Thus, A’s remaining business interest
expense is $0, B’s remaining business interest ex-
pense is $40, C’s remaining business interest ex-
pense is $60, and D’s remaining business interest
expense is $40.
Table 36 to paragraph (o)(20)(v)
ABCDTotal
Allocable BII deficit$0$40$60$40$140
Less: (Total allocable BII excess) x (Allocable BII
deficit / Total allocable BII deficit)
$0$0$0$0N/A
= Remaining BIE$0$40$60$40N/A
(vi) Sixth, PRS determines each partner’s final
allocable ATI. Because D’s allocable ATI is com-
prised of $400 of items of deduction and loss and $0
of income and gain, D has negative allocable ATI of
$400. D is the only partner with negative allocable
ATI. Thus, the total negative allocable ATI amount
is $400. Any partner with a negative allocable ATI,
or an allocable ATI of $0, has a positive allocable
ATI of $0. Therefore, D has a positive allocable
ATI of $0. PRS determines A’s final allocable ATI
by reducing, but not below $0, A’s positive allocable
ATI ($100) by the product of total negative alloca-
ble ATI ($400) and the ratio of A’s positive allocable
ATI to the total positive allocable ATI ($100/$600).
Therefore, A’s positive allocable ATI is reduced by
$66.67 ($400 x 16.67 percent). As a result, A’s final
allocable ATI is $33.33. PRS determines B’s final
allocable ATI by reducing, but not below $0, B’s
positive allocable ATI ($100) by the product of to-
tal negative allocable ATI ($400) and the ratio of B’s
positive allocable ATI to the total positive allocable
ATI ($100/$600). Therefore, B’s positive allocable
ATI is reduced by $66.67 ($400 x 16.67 percent).
As a result, B’s final allocable ATI is $33.33. PRS
determines C’s final allocable ATI by reducing, but
not below $0, C’s positive allocable ATI ($400) by
the product of total negative allocable ATI ($400)
and the ratio of C’s positive allocable ATI to the total
positive allocable ATI ($400/$600). Therefore, C’s
positive allocable ATI is reduced by $266.67 ($400 x
66.67 percent). As a result, C’s final allocable ATI is
$133.33. Because D has a positive allocable ATI of
$0, D’s final allocable ATI is $0.

Bulletin No. 2020–40 743 September 28, 2020
(vii) Seventh, PRS compares each partner’s ATI
capacity (ATIC) amount to such partner’s remain-
ing business interest expense. A’s ATIC amount
is $10 ($33.33 x 30 percent), B’s ATIC amount
is $10 ($33.33 x 30 percent), C’s ATIC amount is
$40 ($133.33 x 30 percent), and D’s ATIC amount
is $0 ($0 x 30 percent). Because A’s ATIC amount
exceeds its remaining business interest expense by
$10 ($10 - $0), A has an ATIC excess of $10. B, C,
and D do not have any ATIC excess. Thus, the total
ATIC excess is $10 ($10 + $0 + $0 + $0). A does
not have any ATIC deficit. Because B’s remaining
business interest expense exceeds its ATIC amount
by $30 ($40 - $10), B has an ATIC deficit of $30.
Because C’s remaining business interest expense
exceeds its ATIC amount by $20 ($60 - $40), C
has an ATIC deficit of $20. Because D’s remaining
business interest expense exceeds its ATIC amount
by $40 ($40 - $0), D has an ATIC deficit of $40.
Thus, the total ATIC deficit is $90 ($0 + $30 + $20
+ $40).
Table 37 to paragraph (o)(20)(vi)
ABCDTotal
Allocable ATI$100$100$400($400)$200
If deduction and loss items comprising allocable ATI exceed income
and gain items comprising allocable ATI, then such excess amount =
Negative allocable ATI
$0$0$0$400$400
If income and gain items comprising allocable ATI equal or exceed
deduction and loss items comprising allocable ATI, then such
amount = Positive allocable ATI
$100$100$400$0$600
Table 38 to paragraph (o)(20)(vi)
ABCDTotal
Positive allocable ATI$100$100$400$0$600
Less: (Total negative allocable ATI) x (Positive allocable ATI / Total
positive allocable ATI)
$66.67$66.67$266.67$0N/A
= Final allocable ATI$33.33$33.33$133.33$0$200
Table 39 to paragraph (o)(20)(vii)
ABCDTotal
ATIC (Final allocable ATI x 30 percent)$10$10$40$0N/A
Remaining BIE$0$40$60$40N/A
If ATIC exceeds remaining BIE, then such excess = ATIC excess$10$0$0$0$10
If remaining BIE exceeds ATIC, then such excess = ATIC deficit$0$30$20$40$90
(viii)(A) Eighth, PRS must perform the calcula-
tions and make the necessary adjustments described
under paragraph (f)(2)(viii) of this section if, and only
if, PRS has (1) an excess business interest expense
greater than $0 under paragraph (f)(2)(i) of this sec-
tion, (2) a total negative allocable ATI greater than $0
under paragraph (f)(2)(vi) of this section, and (3) a
total ATIC excess amount greater than $0 under para-
graph (f)(2)(vii) of this section. Because PRS satisfies
each of these three requirements, PRS must perform
the calculations and make the necessary adjustments
described under paragraphs (f)(2)(viii)(B) and (C) or
paragraph (f)(2)(viii)(D) of this section.
(B) PRS must determine each partner’s priority
amount and usable priority amount. Only partners
with an ATIC deficit under paragraph (f)(2)(vii) of
this section can have a priority amount greater than
$0. Thus, only partners B, C, and D can have a pri-
ority amount greater than $0. PRS determines a part-
ner’s priority amount as 30 percent of the amount
by which such partner’s allocable positive ATI ex-
ceeds its final allocable ATI. Therefore, B’s priority
amount is $20 (($100 - $33.33) x 30 percent), C’s
priority amount is $80 (($400 - $133.33) x 30 per-
cent), and D’s priority amount is $0 (($0 - $0) x 30
percent). Thus, the total priority amount is $100 ($0
+ $20 + $80 + $0). Next, PRS must determine each
partner’s usable priority amount. Each partner’s us-
able priority amount is the lesser of such partner’s
priority amount or ATIC deficit. Thus, A has a usable
priority amount of $0, B has a usable priority amount
of $20, C has a usable priority amount of $20, and D
has a usable priority amount of $0. As a result, the
total usable priority amount is $40 ($0 + $20 + $20
+ $0). Because the total usable priority amount ($40)
is greater than the total ATIC excess under paragraph
(f)(2)(vii) of this section ($10), PRS must perform
the adjustments described in paragraph (f)(2)(viii)
(D) of this section.
Table 40 to paragraph (o)(20)(viii)(B)
ABCDTotal
(Positive allocable ATI - Final allocable ATI)$0$66.67$266.67$0N/A
Multiplied by 30 percent30%30%30%30%N/A
= Priority amount$0$20$80$0$100

September 28, 2020 744 Bulletin No. 2020–40
(C) In light of the fact that the total usable priori-
ty amount is greater than the total ATIC excess under
paragraph (f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(C) of this section does not apply.
(D)(1) Because B and C are the only partners
with priority amounts greater than $0, B and C are
priority partners, while A and D are non-priori-
ty partners. For purposes of paragraph (f)(2)(ix)
of this section, each partner’s final ATIC excess
amount is $0. For purposes of paragraph (f)(2)(x) of
this section, each non-priority partner’s final ATIC
deficit amount is such partner’s ATIC deficit deter-
mined pursuant to paragraph (f)(2)(vii) of this sec-
tion. Therefore, A has a final ATIC deficit of $0 and
D has a final ATIC deficit of $40. Additionally, for
purposes of paragraph (f)(2)(x) of this section, PRS
must determine each priority partner’s step eight
excess share. A priority partner’s step eight excess
share is the product of the total ATIC excess and
the ratio of the partner’s priority amount to the total
priority amount. Thus, B’s step eight excess share
is $2 ($10 x ($20/$100)) and C’s step eight excess
share is $8 ($10 x ($80/$100)). To the extent a pri-
ority partner’s step eight excess share exceeds its
ATIC deficit, the excess will be the partner’s ATIC
excess for purposes of paragraph (f)(2)(x) of this
section. Thus, B and C each have an ATIC excess
of $0, resulting in a total ATIC excess is $0. To the
extent a priority partner’s ATIC deficit exceeds its
step eight excess share, the excess will be the part-
ner’s ATIC deficit for purposes of paragraph (f)(2)
(x) of this section. Because B’s ATIC deficit ($30)
exceeds its step eight excess share ($2), B’s ATIC
deficit for purposes of paragraph (f)(2)(x) of this
section is $28 ($30 - $2). Because C’s ATIC deficit
($20) exceeds its step eight excess share ($8), C’s
ATIC deficit for purposes of paragraph (f)(2)(x) of
this section is $12 ($20 - $8). Thus, the total ATIC
deficit is $40 ($28 + $12).
Table 41 to paragraph (o)(20)(viii)(B)
ABCDTotal
Priority amount$0$20$80$0N/A
ATIC deficit$0$30$20$40N/A
Lesser of priority amount or ATIC deficit = Usable priority amount$0$20$20$0$40
Table 42 to paragraph (o)(20)(viii)(D)(1)
ABCDTotal
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) = Final
ATIC deficit for purposes of paragraph (f)(2)(x) of this section
$0N/AN/A$40N/A
Table 43 to paragraph (o)(20)(viii)(D)(1)
ABCDTotal
Priority partners step eight excess share = (Total ATIC excess) x
(Priority / Total priority)
N/A$2$8N/AN/A
ATIC deficitN/A$30$20N/AN/A
If step eight excess share exceeds ATIC deficit, then such excess =
ATIC excess for purposes of paragraph (f)(2)(x) of this section
N/A$0$0N/A$0
If ATIC deficit exceeds step eight excess share, then such excess =
ATIC deficit for purposes of paragraph (f)(2)(x) of this section
N/A$28$12N/A$40
(2) In sum, the correct amounts to be used in
paragraphs (o)(20)(ix) and (x) of this section are as
follows.
Table 44 to paragraph (o)(20)(viii)(D)(2)
ABCDTotal
ATIC excess$0$0$0$0$0
ATIC deficit$0$28$12$0$40
Non-priority partner final ATIC deficit$0$0$0$40 N/A
(ix) Ninth, PRS determines each partner’s final
ATIC excess amount. Pursuant to paragraph (f)(2)
(viii)(D) of this section, each priority and non-priori-
ty partner’s final ATIC excess amount is $0.
(x) Tenth, PRS determines each partner’s final
ATIC deficit amount. Because B has an ATIC deficit,
PRS must determine B’s final ATIC deficit amount.
B’s final ATIC deficit amount is B’s ATIC deficit
($28), reduced, but not below $0, by the product of
the total ATIC excess ($0) and the ratio of B’s ATIC
deficit to the total ATIC deficit ($28/$40). There-
fore, B has $28 of final ATIC deficit ($28 – ($0 x
70 percent)). Because C has an ATIC deficit, PRS
must determine C’s final ATIC deficit amount. C’s
final ATIC deficit amount is C’s ATIC deficit ($12),
reduced, but not below $0, by the product of the total
ATIC excess ($0) and the ratio of C’s ATIC deficit
to the total ATIC deficit ($12/$40). Therefore, C has
$12 of final ATIC deficit ($12 – ($0 x 30 percent)).
Pursuant to paragraph (f)(2)(viii)(D) of this section,
D’s final ATIC deficit amount is $40.
Table 45 to paragraph (o)(20)(x)
ABCDTotal
ATIC deficitN/A$28$12N/AN/A
Less: (Total ATIC excess) x (ATIC deficit / Total ATIC deficit)N/A$0$0N/AN/A
= Final ATIC deficit$0$28$12$40$80

Bulletin No. 2020–40 745 September 28, 2020
(xi) Eleventh, PRS allocates deductible business
interest expense and section 163(j) excess items to
the partners. Pursuant to paragraph (f)(2)(i) of this
section, PRS has $80 of excess business interest
expense. PRS allocates the excess business interest
expense dollar for dollar to the partners with final
ATIC deficits. Thus, PRS allocates its excess busi-
ness interest expense $28 to B, $12 to C, and $40 to
D. A partner’s allocable business interest expense is
deductible business interest expense to the extent it
exceeds such partner’s share of excess business in-
terest expense. Therefore, A has deductible business
interest expense of $0 ($0 - $0), B has deductible
business interest expense of $12 ($40 - $28), C has
deductible business interest expense of $48 ($60 -
$12), and D has deductible business interest expense
of $0 ($40 - $40).
Table 46 to paragraph (o)(20)(xi)
ABCDTotal
Deductible BIE$0$12$48$0$60
EBIE allocated$0$28$12$40$80
ETI allocated$0$0$0$0$0
EBII allocated$0$0$0$0$0
(21) Example 21: Facts. A, B, C, and D own all
of the interests in partnership PRS. In Year 1, PRS
has $200 of ATI, $0 of business interest income,
and $150 of business interest expense. PRS’s ATI
consists of $500 of gross income and $300 of gross
deductions. PRS allocates its items comprising ATI
$50 to A, $50 to B, $400 to C, and ($300) to D. PRS
allocates its business interest expense $0 to A, $50 to
B, $50 to C, and $50 to D.
(i) First, PRS determines its limitation pursuant
to §1.163(j)-2. PRS’s section 163(j) limit is 30 per-
cent of its ATI plus its business interest income, or
$60 ($200 x 30 percent). Thus, PRS has $60 of de-
ductible business interest expense, and $90 of excess
business interest expense.
(ii) Second, PRS determines each partner’s allo-
cable share of section 163(j) items used in its own
section 163(j) calculation.
Table 47 to paragraph (o)(21)(ii)
ABCDTotal
Allocable ATI$50$50$400($300)$200
Allocable BII$0$0$0$0$0
Allocable BIE$0$50$50$50$150
(iii) Third, PRS compares each partner’s allo-
cable business interest income to such partner’s
allocable business interest expense. No partner has
allocable business interest income. Consequently,
each partner’s allocable business interest income
deficit is equal to such partner’s allocable business
interest expense. Thus, A’s allocable business in-
terest income deficit is $0, B’s allocable business
interest income deficit is $50, C’s allocable busi-
ness interest income deficit is $50, and D’s allo-
cable business interest income deficit is $50. The
total allocable business interest income deficit is
$150 ($0 + $50 + $50 + $50). No partner has allo-
cable business interest income excess because no
partner has allocable business interest income in
excess of its allocable business interest expense.
Thus, the total allocable business interest income
excess is $0.
Table 48 to paragraph (o)(21)(iii)
ABCDTotal
Allocable BII$0$0$0$0N/A
Allocable BIE$0$50$50$50N/A
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess
$0$0$0$0$0
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit
$0$50$50$50$150
(iv) Fourth, PRS determines each partner’s final
allocable business interest income excess. Because
no partner has any allocable business interest income
excess, each partner has final allocable business in-
terest income excess of $0.
(v) Fifth, PRS determines each partner’s re-
maining business interest expense. Because no
partner has any allocable business interest income
excess, each partner’s remaining business interest
expense equals its allocable business interest in-
come deficit. Thus, A’s remaining business interest
expense is $0, B’s remaining business interest ex-
pense is $50, C’s remaining business interest ex-
pense is $50, and D’s remaining business interest
expense is $50.
Table 49 to paragraph (o)(21)(v)
ABCDTotal
Allocable BII deficit$0$50$50$50$150
Less: (Total allocable BII excess) x (Allocable BII deficit / Total
allocable BII deficit)
$0$0$0$0N/A
= Remaining BIE$0$50$50$50N/A

September 28, 2020 746 Bulletin No. 2020–40
(vi) Sixth, PRS determines each partner’s final
allocable ATI. Because D’s allocable ATI is com-
prised of $300 of items of deduction and loss and $0
of income and gain, D has negative allocable ATI of
$300. D is the only partner with negative allocable
ATI. Thus, the total negative allocable ATI amount is
$300. Any partner with a negative allocable ATI, or
an allocable ATI of $0, has a positive allocable ATI of
$0. Therefore, D has a positive allocable ATI of $0.
PRS determines A’s final allocable ATI by reducing,
but not below $0, A’s positive allocable ATI ($50)
by the product of total negative allocable ATI ($300)
and the ratio of A’s positive allocable ATI to the to-
tal positive allocable ATI ($50/$500). Therefore, A’s
positive allocable ATI is reduced by $30 ($300 x 10
percent). As a result, A’s final allocable ATI is $20.
PRS determines B’s final allocable ATI by reducing,
but not below $0, B’s positive allocable ATI ($50)
by the product of total negative allocable ATI ($300)
and the ratio of B’s positive allocable ATI to the to-
tal positive allocable ATI ($50/$500). Therefore, B’s
positive allocable ATI is reduced by $30 ($300 x 10
percent). As a result, B’s final allocable ATI is $20.
PRS determines C’s final allocable ATI by reducing,
but not below $0, C’s positive allocable ATI ($400)
by the product of total negative allocable ATI ($300)
and the ratio of C’s positive allocable ATI to the total
positive allocable ATI ($400/$500). Therefore, C’s
positive allocable ATI is reduced by $240 ($300 x 80
percent). As a result, C’s final allocable ATI is $160.
Because D has a positive allocable ATI of $0, D’s
final allocable ATI is $0.
Table 50 to paragraph (o)(21)(vi)
ABCDTotal
Allocable ATI$50$50$400($300)$200
If deduction and loss items comprising allocable ATI exceed income
and gain items comprising allocable ATI, then such excess amount =
Negative allocable ATI
$0$0$0$300$300
If income and gain items comprising allocable ATI equal or exceed
deduction and loss items comprising allocable ATI, then such
amount = Positive allocable ATI
$50$50$400$0$500
Table 51 to paragraph (o)(21)(vi)
ABCDTotal
Positive allocable ATI$50$50$400$0$500
Less: (Total negative allocable ATI) x (Positive allocable ATI / Total
positive allocable ATI)
$30$30$240$0N/A
= Final allocable ATI$20$20$160$0$200
(vii) Seventh, PRS compares each partner’s ATI
capacity (ATIC) amount to such partner’s remain-
ing business interest expense. A’s ATIC amount is
$6 ($20 x 30 percent), B’s ATIC amount is $6 ($20
x 30 percent), C’s ATIC amount is $48 ($160 x 30
percent), and D’s ATIC amount is $0 ($0 x 30 per-
cent). Because A’s ATIC amount exceeds its remain-
ing business interest expense by $6 ($6 - $0), A has
an ATIC excess of $6. B, C, and D do not have any
ATIC excess. Thus, the total ATIC excess amount is
$6 ($6 + $0 + $0 + $0). A does not have any ATIC
deficit. Because B’s remaining business interest ex-
pense exceeds its ATIC amount by $44 ($50 - $6), B
has an ATIC deficit of $44. Because C’s remaining
business interest expense exceeds its ATIC amount
by $2 ($50 - $48), C has an ATIC deficit of $2. Be-
cause D’s remaining business interest expense ex-
ceeds its ATIC amount by $50 ($50 - $0), D has an
ATIC deficit of $50. Thus, the total ATIC deficit is
$96 ($0 + $44 + $2 + $50).
Table 52 to paragraph (o)(21)(vii)
ABCDTotal
ATIC (Final allocable ATI x 30 percent)$6$6$48$0N/A
Remaining BIE$0$50$50$50N/A
If ATIC exceeds remaining BIE, then such excess = ATIC excess$6$0$0$0$6
If remaining BIE exceeds ATIC, then such excess = ATIC deficit$0$44$2$50$96
(viii)(A) Eighth, PRS must perform the calcula-
tions and make the necessary adjustments described
under paragraph (f)(2)(viii) of this section if, and
only if, PRS has—
(1) An excess business interest expense greater
than $0 under paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0
under paragraph (f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0
under paragraph (f)(2)(vii) of this section. Because
PRS satisfies each of these three requirements, PRS
must perform the calculations and make the neces-
sary adjustments described under paragraph (f)(2)
(viii) of this section.
(B) PRS must determine each partner’s priority
amount and usable priority amount. Only partners
with an ATIC deficit under paragraph (f)(2)(vii) of
this section of this section can have a priority amount
greater than $0. Thus, only partners B, C, and D can
have a priority amount greater than $0. PRS deter-
mines a partner’s priority amount as 30 percent of
the amount by which such partner’s allocable posi-
tive ATI exceeds its final allocable ATI. Therefore,
B’s priority amount is $9 (($50 - $20) x 30 percent),
C’s priority amount is $72 (($400 - $160) x 30 per-
cent), and D’s priority amount is $0 (($0 - $0) x 30
percent). Thus, the total priority amount is $81 ($0
+ $9 + $72 + $0). Next, PRS must determine each
partner’s usable priority amount. Each partner’s us-
able priority amount is the lesser of such partner’s
priority amount or ATIC deficit. Thus, B has a usable
priority amount of $9, C has a usable priority amount
of $2, and D has a usable priority amount of $0. As
a result, the total usable priority amount is $11 ($0
+ $9 + $2 + $0). Because the total usable priority
amount ($11) is greater than the total ATIC excess
($6) under paragraph (f)(2)(vii) of this section, PRS
must perform the adjustments described in paragraph
(f)(2)(viii)(D) of this section.

Bulletin No. 2020–40 747 September 28, 2020
(C) In light of the fact that the total usable priori-
ty amount is greater than the total ATIC excess under
paragraph (f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(C) of this section does not apply.
(D)(1) Because B and C are the only partners with
priority amounts greater than $0, B and C are priori-
ty partners, while A and D are non-priority partners.
For purposes of paragraph (f)(2)(ix) of this section,
each partner’s final ATIC excess amount is $0. For
purposes of paragraph (f)(2)(x) of this section, each
non-priority partner’s final ATIC deficit amount is
such partner’s ATIC deficit determined pursuant to
paragraph (f)(2)(vii) of this section. Therefore, A has
a final ATIC deficit of $0 and D has a final ATIC defi-
cit of $50. Additionally, for purposes of paragraph
(f)(2)(x) of this section, PRS must determine each
priority partner’s step eight excess share. A priority
partner’s step eight excess share is the product of the
total ATIC excess and the ratio of the partner’s pri-
ority amount to the total priority amount. Thus, B’s
step eight excess share is $0.67 ($6 x ($9/$81)) and
C’s step eight excess share is $5.33 ($6 x ($72/$81)).
To the extent a priority partner’s step eight excess
share exceeds its ATIC deficit, the excess will be the
partner’s ATIC excess for purposes of paragraph (f)
(2)(x) of this section. B’s step eight excess share does
not exceed its ATIC deficit. Because C’s step eight
excess share ($5.33) exceeds its ATIC deficit ($2),
C’s ATIC excess for purposes of paragraph (f)(2)(x)
of this section is $3.33 ($5.33 - $2). Thus, the total
ATIC excess for purposes of paragraph (f)(2)(x) of
this section is $3.33 ($0 + $3.33). To the extent a
priority partner’s ATIC deficit exceeds its step eight
excess share, the excess will be the partner’s ATIC
deficit for purposes of paragraph (f)(2)(x) of this sec-
tion. Because B’s ATIC deficit ($44) exceeds its step
eight excess share ($0.67), B’s ATIC deficit for pur-
poses of paragraph (f)(2)(x) of this section is $43.33
($44 - $0.67). C’s ATIC deficit does not exceed its
step eight excess share. Thus, the total ATIC deficit
for purposes of paragraph (f)(2)(x) of this section is
$43.33 ($43.33 + $0).
Table 53 to paragraph (o)(21)(viii)(B)
ABCDTotal
(Positive allocable ATI - Final allocable ATI)$0$30$240$0N/A
Multiplied by 30 percent30%30%30%30%N/A
= Priority amount$0$9$72$0$81
Table 54 to paragraph (o)(21)(viii)(B)
ABCDTotal
Priority amount$0$9$72$0N/A
ATIC deficit$0$44$2$50N/A
Lesser of priority amount or ATIC deficit = Usable priority amount$0$9$2$0$11
Table 55 to paragraph (o)(21)(viii)(D)(1)
ABCDTotal
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) = Final ATIC
deficit for purposes of paragraph (f)(2)(x) of this section
$0N/AN/A$50N/A
Table 56 to paragraph (o)(21)(viii)(D)(1)
ABCDTotal
Priority partners step eight excess share = (Total ATIC excess) x
(Priority / Total priority)
N/A$0.67$5.33N/AN/A
ATIC deficitN/A$44$2N/AN/A
If step eight excess share exceeds ATIC deficit, then such excess = ATIC
excess for purposes of paragraph (f)(2)(x) of this section
N/A$0$3.33N/A$3.33
If ATIC deficit exceeds step eight excess share, then such excess = ATIC
deficit for purposes of paragraph (f)(2)(x) of this section
N/A$43.33$0N/A$43.33
(2) In sum, the correct amounts to be used in
paragraphs (o)(21)(ix) and (x) of this section are as
follows.
Table 57 to paragraph (o)(21)(viii)(D)(2)
ABCDTotal
ATIC excess$0$0$3.33$0$3.33
ATIC deficit$0$43.33$0$0$43.33
Non-priority partner final ATIC deficit$0$0$0$50 N/A
(ix) Ninth, PRS determines each partner’s final
ATIC excess amount. Pursuant to paragraph (f)(2)
(viii)(D) of this section, each priority and non-priori-
ty partner’s final ATIC excess amount is $0.
(x) Tenth, PRS determines each partner’s fi-
nal ATIC deficit amount. Because B has an ATIC

September 28, 2020 748 Bulletin No. 2020–40
deficit, PRS must determine B’s final ATIC deficit
amount. B’s final ATIC deficit amount is B’s ATIC
deficit ($43.33), reduced, but not below $0, by the
product of the total ATIC excess ($3.33) and the
ratio of B’s ATIC deficit to the total ATIC deficit
($43.33/$43.33). Therefore, B has $40 of final ATIC
deficit ($43.33 – ($3.33 x 100 percent)). Pursuant
to paragraph (f)(2)(viii)(D) of this section, D’s final
ATIC deficit amount is $40.
Table 58 to paragraph (o)(21)(x)
ABCDTotal
ATIC deficit$0$43.33$0N/AN/A
Less: (Total ATIC excess) x (ATIC deficit / Total ATIC deficit)$0$3.33$0N/AN/A
= Final ATIC deficit$0$40$0$50$90
(xi) Eleventh, PRS allocates deductible business
interest expense and section 163(j) excess items to
the partners. Pursuant to paragraph (f)(2)(i) of this
section, PRS has $90 of excess business interest
expense. PRS allocates the excess business interest
expense dollar for dollar to the partners with final
ATIC deficits. Thus, PRS allocates its excess busi-
ness interest expense $40 to B and $50 to D. A part-
ner’s allocable business interest expense is deduct-
ible business interest expense to the extent it exceeds
such partner’s share of excess business interest ex-
pense. Therefore, A has deductible business interest
expense of $0 ($0 - $0), B has deductible business
interest expense of $10 ($50 - $40), C has deductible
business interest expense of $50 ($50 - $0), and D
has deductible business interest expense of $0 ($50
- $50).
Table 59 to paragraph (o)(21)(xi)
ABCDTotal
Deductible BIE$0$10$50$0$60
EBIE allocated$0$40$0$50$90
ETI allocated$0$0$0$0$0
EBII allocated$0$0$0$0$0
(22) Example 22—(i) Facts. A and B are equal
shareholders in X, a subchapter S corporation. In
Year 1, X has $100 of ATI and $40 of business inter-
est expense. A has $100 of ATI and $20 of business
interest expense from its sole proprietorship. B has
$0 of ATI and $20 of business interest expense from
its sole proprietorship.
(ii) S corporation-level. In Year 1, X’s section
163(j) limit is 30 percent of its ATI, or $30 ($100
x 30 percent). Thus, X has $30 of deductible busi-
ness interest expense and $10 of disallowed business
interest expense. Such $30 of deductible business
interest expense is includable in X’s nonseparately
stated income or loss, and is not subject to further
limitation under section 163(j). X carries forward the
$10 of disallowed business interest expense to Year
2 as a disallowed business interest expense carryfor-
ward under §1.163(j)-2(c). X may not currently de-
duct all $40 of its business interest expense in Year 1.
X only reduces its accumulated adjustments account
in Year 1 by the $30 of deductible business interest
expense in Year 1 under §1.163(j)-6(l)(7).
(iii) Shareholder allocations. A and B are each
allocated $35 of nonseparately stated taxable income
($50 items of income or gain, less $15 of deductible
business interest expense) from X. A and B do not
reduce their basis in X by the $10 of disallowed busi-
ness interest expense.
(iv) Shareholder-level computations. A, in com-
puting its limit under section 163(j), has $100 of ATI
and $20 of business interest expense from its sole
proprietorship. A’s section 163(j) limit is $30 ($100
x 30 percent). Thus, A’s $20 of business interest ex-
pense is deductible business interest expense. B, in
computing its limit under section 163(j), has $20 of
business interest expense from its sole proprietor-
ship. B’s section 163(j) limit is $0 ($0 x 30 percent).
Thus, B’s $20 of business interest expense is not al-
lowed as a deduction and is treated as business inter-
est expense paid or accrued by B in Year 2.
(23) Example 23—(i) Facts. The facts are the
same as in Example 22 in paragraph (o)(22)(i) of
this section. In Year 2, X has $233.33 of ATI, $0 of
business interest income, and $30 of business inter-
est expense. A has $100 of ATI and $20 of business
interest expense from its sole proprietorship. B has
$0 of ATI and $20 of business interest expense from
its sole proprietorship.
(ii) S corporation-level. In Year 2, X’s section
163(j) limit is 30 percent of its ATI plus its business
interest income, or $70 ($233.33 x 30 percent). Be-
cause X’s section 163(j) limit exceeds X’s $40 of
business interest expense ($30 from Year 2, plus the
$10 disallowed business interest expense carryfor-
wards from Year 1), X may deduct all $40 of business
interest expense in Year 2. Such $40 of deductible
business interest expense is includable in X’s non-
separately stated income or loss, and is not subject
to further limitation under section 163(j). Pursuant to
§1.163(j)-6(l)(7), X must reduce its accumulated ad-
justments account by $40. Additionally, X has $100
of excess taxable income under §1.163(j)-1(b)(17).
(iii) Shareholder allocations. A and B are each
allocated $96.67 of nonseparately stated taxable in-
come ($116.67 items of income or gain, less $20 of
deductible business interest expense) from X. Addi-
tionally, A and B are each allocated $50 of excess
taxable income under §1.163(j)-6(l)(4). As a result,
A and B each increase their ATI by $50.
(iv) Shareholder-level computations. A, in com-
puting its limit under section 163(j), has $150 of ATI
($100 from its sole proprietorship, plus $50 excess
taxable income) and $20 of business interest expense
(from its sole proprietorship). A’s section 163(j) limit
is $45 ($150 x 30 percent). Thus, A’s $20 of business
interest expense is deductible business interest ex-
pense. B, in computing its limit under section 163(j),
has $50 of ATI ($0 from its sole proprietorship, plus
$50 excess taxable income) and $40 of business in-
terest expense ($20 from its sole proprietorship, plus
$20 disallowed business interest expense from its
sole proprietorship in Year 1). B’s section 163(j) lim-
it is $15 ($50 x 30 percent). Thus, $15 of B’s busi-
ness interest expense is deductible business interest
expense. The $25 of B’s business interest expense
not allowed as a deduction ($40 business interest
expense, less $15 section 163(j) limit) is treated as
business interest expense paid or accrued by B in
Year 3.
(p) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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-

Bulletin No. 2020–40 749 September 28, 2020
5, 1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year.
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
(a) Overview. This section provides
rules for the application of section 163(j) to
relevant foreign corporations with share-
holders that are United States persons.
Paragraph (b) of this section describes
the general rule regarding the application
of section 163(j) to relevant foreign cor-
porations. Paragraphs (c) through (f) of
this section are reserved. Paragraph (g) of
this section provides rules concerning the
computation of ATI of a relevant foreign
corporation. Paragraphs (h) through (k) of
this section are reserved.
(b) General rule regarding the appli-
cation of section 163(j) to relevant for-
eign corporations. Except as otherwise
provided in this section, section 163(j)
and the section 163(j) regulations apply
to determine the deductibility of a rele-
vant foreign corporation’s business inter-
est expense for purposes of computing
its taxable income for U.S. income tax
purposes (if any) in the same manner as
those provisions apply to determine the
deductibility of a domestic C corpora-
tion’s business interest expense for pur-
poses of computing its taxable income.
See also §1.952-2. If a relevant foreign
corporation is a direct or indirect partner
in a partnership, see §1.163(j)-6 (con-
cerning the application of section 163(j)
to partnerships).
(c)-(f) [Reserved]
(g) Rules concerning the computation
of adjusted taxable income of a relevant
foreign corporation—(1) Tentative tax-
able income. For purposes of computing
the tentative taxable income of a relevant
foreign corporation for a taxable year,
the relevant foreign corporation’s gross
income and allowable deductions are de-
termined under the principles of §1.952-2
or under the rules of section 882 for deter-
mining income that is, or deductions that
are allocable to, effectively connected in-
come, as applicable.
(2) Treatment of certain dividends.
For purposes of computing the ATI of a
relevant foreign corporation for a taxable
year, any dividend included in gross in-
come that is received from a related per-
son, within the meaning of section 954(d)
(3), with respect to the distributee is sub-
tracted from tentative taxable income.
(h)-(l) [Reserved]
(m) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing 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 ap-
plicable, §§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.
§1.163(j)-8. [Reserved]
§1.163(j)-9 Elections for excepted trades
or businesses; safe harbor for certain
REITs.
(a) Overview. The limitation in section
163(j) applies to business interest, which
is defined under section 163(j)(5) as inter-
est properly allocable to a trade or busi-
ness. The term trade or business does not
include any electing real property trade or
business or any electing farming business.
See section 163(j)(7). This section pro-
vides the rules and procedures for taxpay-
ers to follow in making an election under
section 163(j)(7)(B) for a trade or busi-
ness to be an electing real property trade
or business and an election under section
163(j)(7)(C) for a trade or business to be
an electing farming business.
(b) Availability of election—(1) In gen-
eral. An election under section 163(j)(7)
(B) for a real property trade or business to
be an electing real property trade or busi-
ness is available to any trade or business
that is described in §1.163(j)-1(b)(14)(i),
(ii), or (iii), and an election under section
163(j)(7)(C) for a farming business to be
an electing farming business is available
to any trade or business that is described
in §1.163(j)-1(b)(13)(i), (ii), or (iii).
(2) Special rules—(i) Exempt small
businesses. An election described in
paragraph (b)(1) of this section is avail-
able regardless of whether the real prop-
erty trade or business or farming business
making the election also meets the re-
quirements of the small business exemp-
tion in section 163(j)(3) and §1.163(j)-
2(d). See paragraph (c)(2) of this section
for the effect of the election relating to
depreciation.
(ii) Section 162 trade or business not
required for electing real property trade
or business. An election described in
paragraph (b)(1) of this section to be an
electing real property trade or business is
available regardless of whether the trade
or business with respect to which the elec-
tion is made is a trade or business under
section 162. For example, a taxpayer en-
gaged in activities described in section
469(c)(7)(C) and §1.469-9(b)(2), as re-
quired in §1.163(j)-1(b)(14)(i), may make
an election for a trade or business to be
an electing real property trade or business,
regardless of whether its activities rise to
the level of a section 162 trade or busi-
ness.
(c) Scope and effect of election—(1) In
general. An election under this section is
made with respect to each eligible trade
or business of the taxpayer and applies
only to such trade or business for which
the election is made. An election under
this section applies to the taxable year in
which the election is made and to all sub-
sequent taxable years. See paragraph (e)
of this section for terminations of elec-
tions.
(2) Irrevocability. An election under
this section is irrevocable.
(3) Depreciation. Taxpayers making
an election under this section are required
to use the alternative depreciation system
for certain types of property under section
163(j)(11) and cannot claim the addition-
al first-year depreciation deduction under
section 168(k) for those types of property.
(d) Time and manner of making elec-
tion—(1) In general. Subject to paragraph
(f) of this section, a taxpayer makes an
election under this section by attaching
an election statement to the taxpayer’s
timely filed original Federal income tax
return, including extensions. A taxpayer
may make elections for multiple trades or
businesses on a single election statement.

September 28, 2020 750 Bulletin No. 2020–40
(2) Election statement contents. The
election statement should be titled “Sec-
tion 1.163(j)-9 Election” and must contain
the following information for each trade
or business:
(i) The taxpayer’s name;
(ii) The taxpayer’s address;
(iii) The taxpayer’s social security
number (SSN) or employer identification
number (EIN);
(iv) A description of the taxpayer’s
electing trade or business sufficient to
demonstrate qualification for an election
under this section, including the principal
business activity code; and
(v) A statement that the taxpayer is
making an election under section 163(j)
(7)(B) or (C), as applicable.
(3) Consolidated group’s trade or busi-
ness. For a consolidated group’s trade or
business, the election under this section is
made by the agent for the group, as de-
fined in §1.1502-77, on behalf of itself and
members of the consolidated group. Only
the name and taxpayer identification num-
ber (TIN) of the agent for the group, as
defined in §1.1502-77, must be provided
on the election statement.
(4) Partnership’s trade or business. An
election for a partnership must be made
on the partnership’s return for a trade or
business that the partnership conducts. An
election by a partnership does not apply to
a trade or business conducted by a partner
outside the partnership.
(e) Termination of election—(1) In
general. An election under this section
automatically terminates if a taxpayer
ceases to engage in the electing trade
or business. A taxpayer is considered to
cease to engage in an electing trade or
business if the taxpayer sells or transfers
substantially all of the assets of the elect-
ing trade or business to an acquirer that
is not a related party in a taxable asset
transfer. A taxpayer is also considered to
cease to engage in an electing trade or
business if the taxpayer terminates its ex-
istence for Federal income tax purposes
or ceases operation of the electing trade
or business, except to the extent that such
termination or cessation results in the
sale or transfer of substantially all of the
assets of the electing trade or business to
an acquirer that is a related party, or in
a transaction that is not a taxable asset
transfer.
(2) Taxable asset transfer defined. For
purposes of this paragraph (e), the term
taxable asset transfer means a transfer in
which the acquirer’s basis or adjusted ba-
sis in the assets is not determined, directly
or indirectly, in whole or in part, by refer-
ence to the transferor’s basis in the assets.
(3) Related party defined. For purposes
of this paragraph (e), the term related par-
ty means any person who bears a relation-
ship to the taxpayer which is described in
section 267(b) or 707(b)(1).
(4) Anti-abuse rule. If, within 60
months of a sale or transfer of assets de-
scribed in paragraph (e)(1) of this section,
the taxpayer or a related party reacquires
substantially all of the assets that were
used in the taxpayer’s prior electing trade
or business, or substantially similar as-
sets, and resumes conducting such prior
electing trade or business, the taxpayer’s
previously terminated election under this
section is reinstated and is effective on the
date the prior electing trade or business is
reacquired.
(f) Additional guidance. The rules and
procedures regarding the time and manner
of making an election under this section
and the election statement contents in para-
graph (d) of this section may be modified
through other guidance (see §§601.601(d)
and 601.602 of this chapter). Additional
situations in which an election may ter-
minate under paragraph (e) of this section
may be provided through guidance pub-
lished in the Federal Register or in the In-
ternal Revenue Bulletin (see §601.601(d)
of this chapter).
(g) Examples. The examples in this
paragraph (g) illustrate the application of
this section. Unless otherwise indicated,
X and Y are domestic C corporations; D
and E are U.S. resident individuals not
subject to any foreign income tax; and the
exemption for certain small businesses in
§1.163(j)-2(d) does not apply.
(1) Example 1: Scope of election—(i) Facts. For
the taxable year ending December 31, 2021, D, a sole
proprietor, owned and operated a dairy farm and an
orchard as separate farming businesses described in
section 263A(e)(4). D filed an original Federal in-
come tax return for the 2021 taxable year on August
1, 2022, and included with the return an election
statement meeting the requirements of paragraph (d)
(2) of this section. The election statement identified
D’s dairy farm business as an electing trade or busi-
ness under this section. On March 1, 2023, D sold
some but not all or substantially all of the assets from
D’s dairy farm business to D’s neighbor, E, who is
unrelated to D. After the sale, D continued to operate
the dairy farm trade or business.
(ii) Analysis. D’s election under this section was
properly made and is effective for the 2021 taxable
year and subsequent years. D’s dairy farm business
is an excepted trade or business because D made the
election with D’s timely filed Federal income tax re-
turn. D’s orchard business is a non-excepted trade or
business, because D did not make an election for the
orchard business to be an excepted trade or business.
The sale of some but not all or substantially all of the
assets from D’s dairy farm business does not affect
D’s election under this section.
(2) Example 2: Availability of election—(i)
Facts. E, an individual, operates a dairy business
that is a farming business under section 263A and
also owns real property that is not part of E’s dairy
business that E leases to an unrelated party through
a triple net lease. E’s average gross receipts, exclud-
ing inherently personal amounts, for the three years
prior to 2021 are approximately $25 million, but E is
unsure of the exact amount.
(ii) Analysis. Under paragraph (b)(2)(i) of this
section, E may make an election under this sec-
tion for the dairy business to be an electing farm-
ing business, even though E is unsure whether the
small business exemption of §1.163(j)-2(d) applies.
Additionally, under paragraph (b)(2)(ii) of this sec-
tion, assuming the requirements of section 163(j)(7)
(C) and this section are otherwise satisfied, E may
make an election under this section for its triple net
lease property to be an electing real property trade
or business, even though E may not be engaged in a
trade or business under section 162 with respect to
the real property.
(3) Example 3: Cessation of entire trade or busi-
ness—(i) Facts. X has a real property trade or busi-
ness for which X made an election under this section
by attaching an election statement to A’s 2021 Fed-
eral income tax return. On March 1, 2022, X sold all
of the assets used in its real property trade or busi-
ness to Y, an unrelated party, and ceased to engage
in the electing trade or business. On June 1, 2027,
X started a new real property trade or business that
was substantially similar to X’s prior electing trade
or business.
(ii) Analysis. X’s election under this section ter-
minated on March 1, 2022, under paragraph (e)(1)
of this section. X may choose whether to make an
election under this section for X’s new real property
trade or business that A started in 2027.
(4) Example 4: Anti-abuse rule—(i) Facts. The
facts are the same as in Example 3 in paragraph (g)
(3)(i) of this section, except that X re-started its pre-
vious real property trade or business on February 1,
2023, when X reacquired substantially all of the as-
sets that X had sold on March 1, 2022.
(ii) Analysis. X’s election under this section ter-
minated on March, 1, 2022, under paragraph (e)(1)
of this section. On February 1, 2023, X’s election
was reinstated under paragraph (e)(4) of this section.
X’s new real property trade or business is treated as
a resumption of X’s prior electing trade or business
and is therefore treated as an electing real property
trade or business.
(5) Example 5: Trade or business continuing af-
ter acquisition—(i) Facts. X has a farming business
for which X made an election under this section by

Bulletin No. 2020–40 751 September 28, 2020
attaching an election statement to X’s timely filed
2021 Federal income tax return. Y, unrelated to X,
also has a farming business, but Y has not made an
election under this section. On July 1, 2022, X trans-
ferred all of its assets to Y in a transaction described
in section 368(a)(1)(D). After the transfer, Y contin-
ues to operate the farming trade or business acquired
from X.
(ii) Analysis. Under paragraph (e)(1) of this sec-
tion, Y is subject to X’s election under this section
for the trade or business that uses X’s assets because
the sale or transfer was not in a taxable transaction.
Y cannot revoke X’s election, but X’s election has no
effect on Y’s existing farming business for which Y
has not made an election under this section.
(6) Example 6: Trade or business merged after
acquisition—(i) Facts. The facts are the same as
in Example 5 in paragraph (g)(5)(i) of this section,
except that Y uses the assets acquired from X in a
trade or business that is neither a farming business
(as defined in section 263A(e)(4) or §1.263A-4(a)
(4)) nor a trade or business of a specified agricultur-
al or horticultural cooperative (as defined in section
199A(g)(4)).
(ii) Analysis. Y is not subject to X’s election for
Y’s farming business because the farming trade or
business ceased to exist after the acquisition.
(h) Safe harbor for REITs—(1) In gen-
eral. If a REIT holds real property, as
defined in §1.856-10, interests in one or
more partnerships directly or indirectly
holding real property (through interests in
other partnerships or shares in other RE-
ITs), as defined in §1.856-10, or shares
in one or more other REITs directly or
indirectly holding real property (through
interests in partnerships or shares in other
REITs), as defined in §1.856-10, the REIT
is eligible to make the election described
in paragraph (b)(1) of this section to be
an electing real property trade or business
for purposes of sections 163(j)(7)(B) and
168(g)(1)(F) for all or part of its assets.
The portion of the REIT’s assets eligible
for this election is determined under para-
graph (h)(2) or (3) of this section.
(2) REITs that do not significantly in-
vest in real property financing assets. If a
REIT makes the election under paragraph
(h)(1) of this section and the value of the
REIT’s real property financing assets, as
defined in paragraphs (h)(5) and (6) of this
section, at the close of the taxable year is
10 percent or less of the value of the RE-
IT’s total assets at the close of the taxable
year, as determined under section 856(c)
(4)(A), then all of the REIT’s assets are
treated as assets of an excepted trade or
business.
(3) REITs that significantly invest in
real property financing assets. If a REIT
makes the election under paragraph (h)
(1) of this section and the value of the
REIT’s real property financing assets, as
defined in paragraphs (h)(5) and (6) of
this section, at the close of the taxable
year is more than 10 percent of the value
of the REIT’s total assets at the close of
the taxable year, as determined under sec-
tion 856(c)(4)(A), then for the allocation
of interest expense, interest income, and
other items of expense and gross income
to excepted and non-excepted trades or
businesses, the REIT must apply the rules
set forth in §1.163(j)-10 as modified by
paragraph (h)(4) of this section.
(4) REIT real property assets, interests
in partnerships, and shares in other RE-
I Ts—(i) Real property assets. Assets held
by a REIT described in paragraph (h)(3)
of this section that meet the definition of
real property under §1.856-10 are treated
as assets of an excepted trade or business.
(ii) Partnership interests. If a REIT de-
scribed in paragraph (h)(3) of this section
holds an interest in a partnership, in ap-
plying the partnership look-through rule
described in §1.163(j)-10(c)(5)(ii)(A)(2),
the REIT treats assets of the partnership
that meet the definition of real property
under §1.856-10 as assets of an excepted
trade or business. This application of the
definition of real property under §1.856-
10 does not affect the characterization of
the partnership’s assets at the partnership
level or for any non-REIT partner. How-
ever, no portion of the adjusted basis of
the REIT’s interest in the partnership is
allocated to a non-excepted trade or busi-
ness if the partnership makes an election
under paragraph (h)(7) of this section and
if all of the partnership’s assets are treated
as assets of an excepted trade or business
under paragraph (h)(2) of this section.
(iii) Shares in other REITs—(A) In
general. If a REIT (shareholder REIT) de-
scribed in paragraph (h)(3) of this section
holds an interest in another REIT, then for
purposes of applying the allocation rules
in §1.163(j)-10, the partnership look-
through rule described in §1.163(j)-10(c)
(5)(ii)(A)(2), as modified by paragraph (h)
(4)(ii) of this section, applies to the assets
of the other REIT (as if the other REIT
were a partnership) in determining the
portion of shareholder REIT’s adjusted
basis in the shares of the other REIT that
is allocable to an excepted or non-except-
ed trade or business of shareholder REIT.
However, no portion of the adjusted basis
of shareholder REIT’s shares in the other
REIT is allocated to a non-excepted trade
or business if all of the other REIT’s assets
are treated as assets of an excepted trade
or business under paragraph (h)(2) of this
section.
(B) Information necessary. If share-
holder REIT does not receive, either di-
rectly from the other REIT or indirectly
through the analysis of an applicable fi-
nancial statement (within the meaning
of section 451(b)(3)) of the other REIT,
the information necessary to determine
whether and to what extent the assets of
the other REIT are investments in real
property financing assets, then sharehold-
er REIT’s shares in the other REIT are
treated as assets of a non-excepted trade
or business under §1.163(j)-10(c).
(iv) Tiered entities. In applying
§1.163(j)-10(c)(5)(ii)(E), the rules in para-
graphs (h)(4)(ii) and (h)(4)(iii)(A) and (B)
of this section apply to any partnerships
and other REITs within the tier.
(5) Value of shares in other REITs—(i)
In general. If a REIT (shareholder REIT)
holds shares in another REIT, then solely for
purposes of applying the value tests under
paragraphs (h)(2) and (3) of this section, the
value of shareholder REIT’s real property
financing assets includes the portion of the
value of shareholder REIT’s shares in the
other REIT that is attributable to the other
REIT’s investments in real property financ-
ing assets. However, no portion of the value
of shareholder REIT’s shares in the other
REIT is included in the value of sharehold-
er REIT’s real property financing assets if
all of the other REIT’s assets are treated as
assets of an excepted trade or business un-
der paragraph (h)(2) of this section.
(ii) Information necessary. If share-
holder REIT does not receive, either di-
rectly from the other REIT or indirectly
through the analysis of an applicable fi-
nancial statement (within the meaning
of section 451(b)(3)) of the other REIT,
the information necessary to determine
whether and to what extent the assets of
the other REIT are investments in real
property financing assets, then sharehold-
er REIT’s shares in the other REIT are
treated as real property financing assets
for purposes of paragraphs (h)(2) and (3)
of this section.

September 28, 2020 752 Bulletin No. 2020–40
(iii) Tiered REITs. The rules in para-
graphs (h)(5)(i) and (ii) of this section
apply successively to the extent that the
other REIT, and any other REIT in the tier,
holds shares in another REIT.
(6) Real property financing assets.
For purposes of this paragraph (h), real
property financing assets include inter-
ests, including participation interests, in
the following: mortgages, deeds of trust,
and installment land contracts; mortgage
pass-through certificates guaranteed by
Government National Mortgage Associ-
ation (GNMA), Federal National Mort-
gage Association (FNMA), Federal Home
Loan Mortgage Corporation (FHLMC), or
Canada Mortgage and Housing Corpora-
tion (CMHC); REMIC regular interests;
other interests in investment trusts classi-
fied as trusts under §301.7701-4(c) of this
chapter that represent undivided beneficial
ownership in a pool of obligations princi-
pally secured by interests in real property
and related assets that would be permitted
investments if the investment trust were a
REMIC; obligations secured by manufac-
tured housing treated as single family res-
idences under section 25(e)(10), without
regard to the treatment of the obligations
or the properties under state law; and debt
instruments issued by publicly offered
REITs.
(7) Application of safe harbor for part-
nerships controlled by REITs. A partner-
ship is eligible to make the election under
paragraph (h)(1) of this section if one or
more REITs own directly or indirectly at
least 50 percent of the partnership’s cap-
ital and profits, the partnership meets the
requirements of section 856(c)(2), (3), and
(4) as if the partnership were a REIT, and
the partnership satisfies the requirements
described in paragraph (h)(1) of this sec-
tion as if the partnership were a REIT. The
portion of the partnership’s assets eligible
for this election is determined under para-
graph (h)(2) or (3) of this section, treating
the partnership as if it were a REIT.
(8) REITs or partnerships controlled by
REITs that do not apply the safe harbor. A
REIT or a partnership that is eligible but
chooses not to apply the safe harbor pro-
visions of paragraph (h)(1) or (7) of this
section, respectively, may still elect, under
paragraph (b)(1) of this section, for one or
more of its trades or businesses to be an
electing real property trade or business,
provided that such trade or business is oth-
erwise eligible to elect under paragraph (b)
(1) of this section. A REIT or partnership
that makes the election under paragraph
(b)(1) of this section without utilizing the
safe harbor provisions of paragraph (h) of
this section may not rely on any portion
of paragraphs (h)(1) through (7) of this
section.
(i) [Reserved]
(j) Special anti-abuse rule for certain
real property trades or businesses—(1) In
general. Except as provided in paragraph
(j)(2) of this section, a trade or business
(lessor) does not constitute a trade or busi-
ness eligible for an election described in
paragraph (b)(1) of this section to be an
electing real property trade or business
if at least 80 percent, determined by fair
market rental value, of the real property
used in the business is leased to a trade or
business (lessee) under common control
with the lessor, regardless of whether the
arrangement is pursuant to a written lease
or pursuant to a service contract or anoth-
er agreement that is not denominated as a
lease. For purposes of this paragraph (j),
fair market rental value is the amount of
rent that a prospective lessee that is unre-
lated to the lessor would be willing to pay
for a rental interest in real property, taking
into account the geographic location, size,
and type of the real property. For purposes
of this paragraph (j), two trades or busi-
nesses are under common control if 50
percent of the direct and indirect owner-
ship of both businesses are held by relat-
ed parties within the meaning of sections
267(b) and 707(b).
(2) Exceptions—(i) De minimis ex-
ception. The limitation in paragraph (j)
(1) of this section does not apply, and the
lessor is eligible to make an election un-
der paragraph (b)(1) of this section, if the
lessor leases, regardless of whether the
arrangement is pursuant to a written lease
or pursuant to a service contract or anoth-
er agreement that is not denominated as
a lease, at least 90 percent of the lessor’s
real property, determined by fair market
rental value, to one or more of the follow-
ing:
(A) A party not under common control
with the lessor or lessee;
(B) A party under common control
with the lessor or lessee that has made an
election described in paragraph (b)(1) of
this section for a trade or business to be
an electing real property trade or business
or electing farming business, but only to
the extent that the real property is used as
part of its electing real property trade or
business or electing farming business; or
(C) A party under common control with
the lessor or lessee that is an excepted reg-
ulated utility trade or business, but only to
the extent that the real property is used as
part of its excepted regulated utility trade
or business.
(ii) Look-through exception. If the de
minimis exception in paragraph (j)(2)(i)
of this section does not apply because less
than 90 percent of the lessor’s real prop-
erty is leased to parties described in para-
graphs (j)(2)(i)(A), (B), and (C), the lessor
is eligible to make the election under para-
graph (b)(1) of this section to the extent
that the lessor leases the real property to
parties described in paragraph (j)(2)(A),
(B), or (C), and to the extent that the lessee
subleases (or lessees ultimately sublease)
the real property to:
(A) A party not under common control
with the lessor or lessee;
(B) A party under common control
with the lessor or lessee that has made an
election described in paragraph (b)(1) of
this section for a trade or business to be
an electing real property trade or business
or electing farming business to the extent
that the real property is used as part of its
electing real property trade or business or
electing farming business; or
(C) A party under common control with
the lessor or lessee that is an excepted reg-
ulated utility trade or business to the ex-
tent that the real property is used as part
of its excepted regulated utility trade or
business.
(iii) Inapplicability of exceptions to
consolidated groups. The exceptions in
paragraphs (j)(2)(i) and (ii) of this section
do not apply when the lessor and lessee
are members of the same consolidated
group.
(iv) Exception for certain REITs. The
special anti-abuse rule in paragraph (j)(1)
of this section does not apply to REITs or
to partnerships making an election under
paragraph (h)(7) of this section that lease
qualified lodging facilities, as defined in
section 856(d)(9)(D), and qualified health
care properties, as defined in section
856(e)(6)(D).

Bulletin No. 2020–40 753 September 28, 2020
(3) Allocations. See §1.163(j)-10(c)(3)
(iii)(D) for rules related to the allocation
of the basis of assets used in lessor trades
or businesses described in paragraphs (j)
(1) and (j)(2)(i) of this section.
(4) Examples. The examples in this
paragraph (j)(4) illustrate the application
of paragraphs (j)(1), (2), and (3) of this
section. Unless otherwise indicated, the
parties are all domestic entities and are not
members of a single consolidated group
within the meaning of §1.1502-1(h).
(i) Example 1: Related party lease of hotel—(A)
Facts. X and Y are under common control, as defined
in paragraph (j)(1) of this section. X owns one piece
of real property, a hotel, that X leases to Y. Y oper-
ates the hotel and provides hotel rooms and associ-
ated amenities to third party guests of the hotel. The
form of the arrangement with third party hotel guests
is a license to use rooms in the hotel and associated
amenities. Y is a real property trade or business that
has made an election under paragraph (b)(1) of this
section.
(B) Analysis. Because X leases at least 80 per-
cent of X’s real property to a party under common
control, X is subject to the anti-abuse rule in para-
graph (j)(1) of this section. However, under the de
minimis exception under paragraph (j)(2)(i) of this
section, 100 percent of the fair market rental value of
the building is leased to a party under common con-
trol that has made an election to be an electing real
property trade or business. Accordingly, X is eligible
to make the election described in paragraph (b)(1) of
this section for its entire trade or business.
(ii) Example 2—(A) Facts. The facts are the
same as in Example 1 in paragraph (j)(4)(i)(A) of
this section, except that Y has not made an election
under paragraph (b)(1) of this section, and is not oth-
erwise using the real property in an excepted trade
or business.
(B) Analysis. Because X leases at least 80 per-
cent of X’s real property, determined by fair market
rental value, to Y, a party under common control, X
is subject to the anti-abuse rule in paragraph (j)(1)
of this section. X is not eligible for the de minimis
exception under paragraph (j)(2)(i) of this section
because X does not lease at least 90 percent of its real
property to a party under common control, as defined
in paragraph (j)(1) of this section, such as Y, and Y
is not using the property in an otherwise excepted
trade or business. However, X is eligible for the
look-through exception under paragraph (j)(2)(ii) of
this section because X leases 100 percent of its real
property to Y, a party that is under common control,
and Y subleases 100 percent of the real property to
parties that are not under common control with X or
Y. The fact that the license provided to hotel guests
is not denominated as a lease does not prevent these
licenses from being treated as a lease for purposes
of paragraph (j) of this section. Accordingly, under
the look-through exception under paragraph (j)(2)
(ii) of this section, X is eligible to make the election
described in paragraph (b)(1) of this section with re-
gard to its entire trade or business.
(iii) Example 3: Sublease to related party and
unrelated third party—(A) Facts. X owns one piece
of real property that X leases to Y, a party under
common control, as defined in paragraph (j)(1) of
this section. Y does not operate an excepted trade or
business. Y subleases 80 percent of the real property,
determined by the fair market rental value, to a party
under common control with Y that does not operate
an excepted trade or business and 20 percent of the
real property, determined by the fair market rental
value, to an unrelated third party.
(B) Analysis. Because X leases at least 80 per-
cent of X’s real property, determined by fair market
rental value, to a party under common control, X
is subject to the anti-abuse rule in paragraph (j)(1)
of this section. X is not eligible for the de minimis
exception in paragraph (j)(2)(i) of this section be-
cause X is not leasing at least 90 percent of the real
property, determined by fair market rental value, to a
party under common control that operates an except-
ed trade or business and/or unrelated parties. Under
the look-through exception under paragraph (j)(2)
(ii) of this section, X is eligible to make the election
described in paragraph (b)(1) of this section with re-
spect to the 20 percent of the fair market rental value
of the real property subleased to an unrelated party
because X is treated as directly leasing this portion
to an unrelated party. X is not eligible to make the
election described in paragraph (b)(1) of this section
with respect to the 80 percent of the building sub-
leased to a party under common control because X
is still treated as directly leasing this portion to a re-
lated party. Under §1.163(j)-10(c)(3)(iii)(D), X must
allocate 80 percent of the basis in the real property
as a non-excepted trade or business and 20 percent
of the basis in the real property as an excepted trade
or business.
(iv) Example 4: Multiple subleases—(A) Facts.
X owns a building that X leases to Y, a party under
common control as defined in paragraph (j)(1) of this
section. Y does not operate an excepted trade or busi-
ness. Y subleases 80 percent of the building, deter-
mined by fair market rental value, to Z, a party under
common control with both X and Y. Y subleases the
remaining 20 percent of the building, determined by
fair market rental value, to unrelated parties. Z sub-
leases 50 percent of its leasehold interest, determined
by fair market rental value, to parties unrelated to X,
Y and Z, and uses the remaining leasehold interest
in its retail business. Z does not operate an excepted
trade or business.
(B) Analysis. Because X leases at least 80 per-
cent of X’s real property, determined by fair market
rental value, to a party under common control, X is
subject to the anti-abuse rule in paragraph (j)(1) of
this section. X is not eligible for the de minimis ex-
ception in paragraph (j)(2)(i) because X is not leas-
ing at least 90 percent of the building, determined by
fair market rental value, to a party under common
control that operates an excepted trade or business
and/or unrelated parties. Under the look-through ex-
ception under paragraph (j)(2)(ii) of this section, X is
eligible to make the election described in paragraph
(b)(1) of this section with respect to the 60 percent
of the building that is subleased to unrelated parties,
determined by adding 40 percent (50 percent of the
80 percent leasehold interest) from Z’s sublease to an
unrelated party and 20 percent from Y’s sublease to
unrelated parties (40 + 20). X is not eligible to make
the election described in paragraph (b)(1) of this sec-
tion with respect to the 40 percent of the building
subleased to Z, because Z is a related party that does
not operate an excepted trade or business.
(v) Example 5: Lessee’s Trade or Business—(A)
Facts. X owns a building that X leases to W, a party
under common control as defined in paragraph (j)(1)
of this section. W operates the building as a widget
manufacturing plant and does not sublease any por-
tion of the building.
(B) Analysis. X is not eligible to make the elec-
tion described in paragraph (b)(1) of this section be-
cause X leases the entire building to a party under
common control. X is not eligible for the de minimis
exception in paragraph (j)(2)(i) of this section be-
cause X is not leasing at least 90 percent of the real
property to a party under common control that oper-
ates an excepted trade or business and/or unrelated
parties. W’s trade or business cannot be an electing
real property trade or business. X is not eligible for
the look-through exception under paragraph (j)(2)(ii)
of this section because W is not subleasing any part
of the building.
(k) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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.
§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) Pur-
poses. Except as provided in §1.163(j)-
6(m) or §1.163(j)-9(h), this section pro-
vides 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 ex-
pense that is properly allocable to except-
ed trades or businesses is not subject to the
section 163(j) limitation. The amount of a
taxpayer’s other items of income, gain,

September 28, 2020 754 Bulletin No. 2020–40
deduction, or loss, including interest in-
come, that is properly allocable to except-
ed 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 gener-
al method of allocation set forth in para-
graph (c) of this section is based on the
approach that money is fungible and that
interest expense is attributable to all activ-
ities and property, regardless of any spe-
cific 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 tax-
able year.
(ii) Application of section. The amount
of a taxpayer’s tax items properly alloca-
ble to a trade or business, other than in-
terest 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 para-
graph (b) of this section. The amount of
a taxpayer’s interest expense and interest
income that is properly allocable to ex-
cepted trades or businesses for purposes
of section 163(j) generally is determined
as set forth in paragraph (c) of this sec-
tion, except as otherwise provided in para-
graph (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 pro-
vision 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 exam-
ple, if a taxpayer engaged in a manufac-
turing trade or business has in-house legal
personnel that provide legal services sole-
ly with respect to the taxpayer’s manufac-
turing 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 sen-
tence constructs or acquires real property
solely for use by the taxpayer’s manufac-
turing 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 al-
locable 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 alloca-
ble to a trade or business. For instance, a
taxpayer must apply §1.163-8T, if appli-
cable, to determine which items of inter-
est 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. Af-
ter determining whether its tax items are
properly allocable to a trade or business,
a taxpayer that is engaged in both except-
ed and non-excepted trades or business-
es 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 deter-
mine which items are included or exclud-
ed in computing its section 163(j) limita-
tion.
(ii) Treatment of investment interest,
investment income, investment expenses,
and certain other tax items of a partner-
ship with a C corporation or tax-exempt
corporation as a partner. For rules gov-
erning the treatment of investment in-
terest, 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 part-
nerships. The rules of this section apply
to foreign corporations and foreign part-
nerships.
(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 un-
der section 163(j) of the Code general-
ly 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 consol-
idated group are treated as one corpora-
tion. Therefore, the rules of this section
apply to the activities conducted by the
group as if those activities were conduct-
ed by a single corporation. For example,
the group (rather than a particular mem-
ber) is treated as engaged in excepted or
non-excepted trades or businesses. In the
case of intercompany obligations, with-
in the meaning of §1.1502-13(g)(2)(ii),
for purposes of allocating asset basis be-
tween excepted and non-excepted trades
or businesses, the obligation of the mem-
ber borrower is not considered an asset of
the creditor member. Similarly, intercom-
pany transactions, within the meaning of
§1.1502-13(b)(1)(i), are disregarded for
purposes of this section, as are the result-
ing offsetting items, and property is allo-
cated 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 mem-
ber 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 de-
termined the percentage of the group’s in-
terest expense allocable to excepted trades
or businesses for the taxable year (and thus
not subject to the section 163(j) limita-
tion), this exempt percentage is applied to
the interest paid or accrued by each mem-
ber 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 qual-
ified 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 sec-
tion, 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

Bulletin No. 2020–40 755 September 28, 2020
§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 taxpay-
er 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 in-
terest was paid or accrued (the historical
approach); or
(ii) Treating all of the taxpayer’s dis-
allowed disqualified interest as if it were
paid or accrued in the taxpayer’s first tax-
able 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 in-
come 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. How-
ever, the interest expense on T’s car loan is personal
interest within the meaning of section 163(h)(2) rath-
er than interest properly allocable to a trade or busi-
ness. 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 elect-
ing real property trade or business (Business X), and
S conducts a non-excepted trade or business (Busi-
ness 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 transac-
tions are disregarded for purposes of this section.
As a result, the lease of Building V by P to S is dis-
regarded. 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 allo-
cation 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 pro-
duction to P, which produces electricity at its natural
gas-fired power plants, and S sells the rest of its nat-
ural 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 dis-
regarded for purposes of this section. As a result, the
intercompany sales of natural gas by S to P are disre-
garded. 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 allocat-
ed 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. Like-
wise, 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 inter-
est—(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 farm-
ing 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 alloca-
ble 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 sec-
tion, the P group may allocate disallowed disquali-
fied 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 begin-
ning 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 sec-
tion 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) lim-
itation.
(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 in-
come other than dividends and interest in-
come 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 sat-
isfies the minimum ownership threshold
in paragraph (c)(7) of this section, then,
solely for purposes of allocating amounts
received as a dividend during the tax-
able 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 rel-
ative amounts of the payor corporation’s
adjusted basis in the assets used in its
trades or businesses, determined pur-
suant to paragraph (c) of this section. If
at least 90 percent of the payor corpora-
tion’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

September 28, 2020 756 Bulletin No. 2020–40
or non-excepted trades or businesses, re-
spectively.
(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 tax-
payer does not satisfy the minimum own-
ership 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 corpora-
tions. (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 ex-
cepted or non-excepted trades or busi-
nesses 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 pur-
suant to paragraph (c) of this section, is
allocable to either excepted trades or busi-
nesses or to non-excepted trades or busi-
nesses, 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-con-
solidated C corporation that is not proper-
ty 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 sec-
tion.
(ii) Partnerships and S corporations.
(A) If a taxpayer recognizes gain or loss
upon the disposition of interests in a part-
nership 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 propor-
tionate share of the amount properly allo-
cable 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 pur-
suant to paragraph (c) of this section, is
allocable to either excepted trades or busi-
nesses or to non-excepted trades or busi-
nesses, 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 partner-
ship 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-ex-
empt corporation, a partnership’s invest-
ment 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 enti-
ty are included in the income of its owners
or beneficiaries.
(5) Expenses, losses, and other de-
ductions—(i) Expenses, losses, and oth-
er 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 de-
duction 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 busi-
nesses based upon the relative amounts of
the taxpayer’s adjusted basis in the assets
used in those trades or businesses, as de-
termined under paragraph (c) of this sec-
tion.
(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 busi-
ness.
(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 al-
locable to a trade or business of a C corpo-
ration partner under §1.163(j)-4(b)(3)(i) is
treated as properly allocable to a non-ex-
cepted trade or business of the C corpora-
tion partner, except that any item with re-
spect 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 il-
lustrate the principles of this paragraph
(b):
(i) Example 1: Allocation of income and ex-
pense 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 sec-
tion, 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 para-

Bulletin No. 2020–40 757 September 28, 2020
graph (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 le-
gal 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 busi-
ness. 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 prop-
erty 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 sec-
tion, 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 al-
locable to a non-excepted trade or business of the C
corporation partner. Because PRS generates its in-
come 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 in-
terest income that is properly allocable to
a trade or business—(1) General rule—
(i) In general. Except as otherwise pro-
vided 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 adjust-
ed basis in the assets, as determined under
paragraph (c)(5) of this section, used in its
excepted or non-excepted trades or busi-
nesses. 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 in-
terest income if all of the taxpayer’s inter-
est income and expense is allocable to ex-
cepted 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, re-
spectively.
(2) Example. The following example
illustrates the principles of paragraph (c)
(1) of this section:
(i) Facts. T is a calendar-year C corporation en-
gaged 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 ex-
cept for the potential application of section 163(j).
Based upon determinations made on the determi-
nation 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 tax-
payer’s adjusted basis in the asset is allo-
cated to each trade or business using the
permissible methodology under this para-
graph (c)(3) that most reasonably reflects
the use of the asset in each trade or busi-
ness 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 as-
sets used in a trade or business. If none of
the permissible methodologies set forth in
paragraph (c)(3)(ii) of this section reason-
ably reflects the use of the asset in each
trade or business, the taxpayer’s basis in
the asset is not taken into account for pur-
poses of this paragraph (c).
(ii) Permissible methodologies for allo-
cating 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 ba-
sis in an asset used in two or more trades
or businesses during a determination pe-
riod may be allocated to those trades or
businesses based upon—
(A) The relative amounts of gross in-
come that an asset generates, has generat-
ed, or may reasonably be expected to gen-
erate, within the meaning of §1.861-9T(g)
(3), with respect to the trades or business-
es;
(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 gener-
ate the same unit of output, the relative
amounts of output of those trades or busi-
nesses (for example, if an asset is used in
two trades or businesses, one of which is
an excepted regulated utility trade or busi-
ness, and the other of which is a non-ex-
cepted 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 al-
location methodologies—(1) In general.
Except as otherwise provided in para-
graph (c)(3)(iii)(A)(2) of this section, a
taxpayer must maintain the same alloca-
tion methodology for a period of at least
five taxable years.
(2) Consent to change allocation meth-
odology. 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

September 28, 2020 758 Bulletin No. 2020–40
consent of the Commissioner. If a taxpay-
er has used the same allocation method-
ology 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 except-
ed trades or businesses or non-excepted
trades or businesses during a determina-
tion period pursuant to this paragraph (c)
(3), the taxpayer’s entire basis in the asset
for the determination period must be allo-
cated to either excepted or non-excepted
trades or businesses, respectively. This
rule applies before the application of para-
graph (c)(1)(ii) of this section.
(C) Allocations of excepted regulated
utility trades or businesses—(1) In gener-
al. Except as provided in the de minimis
rule in paragraph (c)(3)(iii)(C)(3) of this
section, a taxpayer is engaged in an ex-
cepted regulated utility trade or business
only to the extent that the taxpayer is en-
gaged 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, elec-
tricity 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 regulat-
ed 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-ex-
cepted 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 taxpay-
er’s basis in assets used in both the except-
ed 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 util-
ity trades or businesses. If a taxpayer is
engaged in a utility trade or business de-
scribed 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 regulat-
ed utility trade or business, and paragraph
(c)(3)(iii)(C)(2) of this section does not
apply. This rule applies before the appli-
cation 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 pub-
lic utility commission explicitly state that the public
utility commission is deemed to have approved the
rates. The public utility has taken no action with re-
spect to the negotiated rate. The remaining 20 per-
cent 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 made an election under §1.163(j)-1(b)(15)
(iii). None of the assets used in X’s utility genera-
tion 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 busi-
ness is a non-excepted utility trade or business. Un-
der 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 leas-
es 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-except-
ed portions of its trade or business, as de-
termined 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 proper-
ty trade or business based on the relative
fair market rental value of the real proper-
ty that is attributable to the excepted and
non-excepted portions of the trade or busi-
ness, 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 sec-
tion 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, mea-
sured 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 arrange-
ment with Y.
(ii) Analysis. Under §1.163(j)-9(j)(2)(ii), X is el-
igible to make an election for 20 percent of its busi-
ness 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 remain-
ing 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 ex-
pense carryforwards; floor plan financing
interest expense. Disallowed business in-
terest expense carryforwards (which were
treated as allocable to a non-excepted

Bulletin No. 2020–40 759 September 28, 2020
trade or business in a prior taxable year)
are not re-allocated between non-except-
ed 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 busi-
ness. Floor plan financing interest expense
also is not subject to allocation between
excepted and non-excepted trades or busi-
nesses (see §1.163(j)-1(b)(19)) and is al-
ways treated as allocable to non-excepted
trades or businesses.
(5) Additional rules relating to ba-
sis—(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 ba-
sis 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 intan-
gible assets are not taken into account for
purposes of this paragraph (c).
(B) Depreciable property other than
inherently permanent structures. For pur-
poses 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 struc-
tures, is determined by using the alter-
native depreciation system under section
168(g) before any application of the ad-
ditional 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 meth-
od of computing depreciation for the asset
under former section 168. The deprecia-
tion deduction with respect to the prop-
erty 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 appli-
cable.
(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, in-
cluding nondepreciable improvements to
land, or an inherently permanent structure
is its unadjusted basis.
(D) Depreciable or amortizable intan-
gible 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 ap-
plication of the additional first-year de-
preciation 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 ac-
count 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 tak-
en into account for purposes of under this
paragraph (c) until the building is placed
in service. This rule does not apply to in-
terests in a partnership or stock in a cor-
poration.
(F) Trusts established to fund specific
liabilities. Trusts required to fund specif-
ic liabilities (for example, pension trusts,
and nuclear decommissioning funds (in-
cluding, but not limited to, those funds for
which an election is made under section
468A)) are not taken into account for pur-
poses 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 sec-
tion, a partner’s interest in a partnership
is treated as an asset of the partner. For
these purposes, the partner’s adjusted ba-
sis in a partnership interest is reduced, but
not below zero, by the partner’s share of
partnership liabilities, as determined un-
der 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 re-
quired to apply the rules in this paragraph
(c)(5)(ii)(A) to look through to a partner-
ship’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 ba-
sis 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 sec-
tions 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 pre-
ceding 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 part-
ner 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 be-
tween 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

September 28, 2020 760 Bulletin No. 2020–40
assets is allocated between excepted and
non-excepted trade or business assets.
(ii) De minimis rule. If, after apply-
ing 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-ex-
cepted trades or businesses, without re-
gard to assets not properly allocable to a
trade or business, the partner’s entire basis
in its partnership interest is treated as al-
locable to either excepted or non-except-
ed trades or businesses, respectively. For
purposes of the preceding sentence, such
partner’s share of partnership assets is de-
termined using a reasonable method tak-
ing into account special allocations under
section 704(b).
(iii) Partnership assets not properly
allocable to a trade or business. For pur-
poses 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 cor-
poration, such partner’s share of a part-
nership’s assets that are not properly allo-
cable 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 re-
spect 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 ex-
ample, 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 corpo-
ration, a partnership’s assets that are not
properly allocable to a trade or business
are treated as neither excepted nor non-ex-
cepted trade or business assets; instead,
such partner’s adjusted basis in its partner-
ship interest is decreased by that partner’s
share of the excess of the partnership’s ba-
sis in those assets over the partnership’s
debt that is traced to such assets in accor-
dance 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 para-
graph (c)(5)(ii)(A)(2)(iii), such partner’s
share of a partnership’s assets is deter-
mined under a reasonable method taking
into account special allocations under sec-
tion 704(b).
(iv) Inapplicability of partnership
look-through rule. If a partner, other than
a C corporation or a tax-exempt corpora-
tion, chooses not to look through to the
partnership’s basis in the partnership’s as-
sets 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 pre-
cluded 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 purpos-
es 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 as-
set of the taxpayer.
(2) Domestic non-consolidated C cor-
porations—(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-except-
ed 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 min-
imum ownership threshold in paragraph
(c)(7) of this section for stock in a do-
mestic 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 div-
idends 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-except-
ed 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 per-
cent 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 in-
terest in the corporation’s stock is treated
as allocable to either excepted or non-ex-
cepted trades or businesses, respectively.
(iii) Inapplicability of corporate look-
through rule. If a shareholder other than
a C corporation or a tax-exempt corpora-
tion is ineligible to look through or choos-
es not to look through to a corporation’s
basis in its assets under paragraph (c)(5)
(ii)(B)(2)(i) of this section, the sharehold-
er 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-con-
solidated C corporation under paragraph

Bulletin No. 2020–40 761 September 28, 2020
(c)(5)(ii)(B)(2)(i) of this section, deter-
mined 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 as-
set 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 para-
graph (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 as-
set basis look-through approach, it must
do so for all domestic non-consolidated
C corporations for which the sharehold-
er is eligible to use this approach, and it
must report its use of this approach on the
information statement described in para-
graph (c)(6)(iii) of this section. The share-
holder 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 sec-
tion, a shareholder’s share of stock in an
S corporation is treated as an asset of the
shareholder. Additionally, for these pur-
poses, 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 re-
spect 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 struc-
ture owned by the S corporation).
(ii) Allocation of asset basis. For pur-
poses of determining the extent to which
a shareholder’s basis in its stock of an
S corporation is allocable to an except-
ed 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, allo-
cated on a pro rata basis, adjusted to the
extent required under paragraph (d)(4) of
this section, except as otherwise provid-
ed in paragraph (c)(5)(ii)(D) of this sec-
tion. 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 val-
ue, 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 per-
cent of a shareholder’s share of an S cor-
poration’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 corpora-
tion stock is treated as allocable to either
excepted or non-excepted trades or busi-
nesses, respectively.
(iv) Inapplicability of S corporation
look-through rule. If a shareholder choos-
es not to look through to the S corpora-
tion’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 corpora-
tions—(1) In general. The rules applica-
ble to domestic non-consolidated C cor-
porations 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. Sole-
ly 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 except-
ed 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 enti-
ty described in §1.163(j)-1(b)(15)(i)(A)
(2), a foreign government, a public ser-
vice 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) Inapplicability of look-through
rule to partnerships or non-consolidated
C corporations to which the small busi-
ness exemption applies. A taxpayer may
not apply the look-through rules in para-
graphs (b)(3) and (c)(5)(ii)(A), (B), and
(C) of this section to a partnership, S cor-
poration, or non-consolidated C corpora-
tion 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.
(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 indirect-
ly, 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-ti-
er entity.
(iii) Cash and cash equivalents and
customer receivables. Except as otherwise
provided in the last sentence of this para-
graph (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 tax-
payer 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, commer-
cial paper, any interest in an investment
company registered under the Investment
Company Act of 1940 (1940 Act) and reg-
ulated 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 se-
cured by an obligation of a government,
or any similar asset. For purposes of this
paragraph (c)(5)(iii), a derivative is a de-
rivative described in section 59A(h)(4)
(A), without regard to section 59A(h)(4)
(C). For purposes of this paragraph (c)

September 28, 2020 762 Bulletin No. 2020–40
(5)(iii), the term government means the
United States or any agency or instrumen-
tality of the United States; a State, a ter-
ritory, 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 pur-
poses 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 informa-
tion statement required by paragraph (c)
(6)(iii)(B) of this section, that the acquisi-
tion qualified for such an election and that,
immediately before the acquisition, the ac-
quired 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 Commis-
sioner may make appropriate adjustments
to prevent a taxpayer from intentionally
and artificially increasing its basis in as-
sets attributable to an excepted trade or
business.
(6) Determination dates; determina-
tion 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 deter-
mination 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 de-
termination 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 de-
termination 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 demon-
strates that its total adjusted basis (as de-
termined 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 ad-
justed 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 sec-
tion has a different taxable year than the
partnership or non-consolidated C cor-
poration to which the taxpayer is apply-
ing 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 cor-
poration. 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 deter-
mination 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 ba-
sis 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 main-
tain 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 indica-
tion that a particular asset is used in a par-
ticular 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 ex-
cepted 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 tax-
payer that is making an allocation under
this paragraph (c), including any taxpay-
er 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 time-
ly filed Federal income tax return for the
taxable year:
(1) The taxpayer’s adjusted basis in the
assets used in its excepted and non-ex-
cepted businesses, determined as set forth
in this section, including detailed infor-
mation 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 tax-
able year;
(3) The names and taxpayer identifi-
cation 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 consol-
idated 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 cor-
porations or partnerships if the taxpay-
er looks through to the corporation’s or
partnership’s basis in the corporation’s or

Bulletin No. 2020–40 763 September 28, 2020
partnership’s assets under paragraph (c)
(5)(ii) of this section;
(5) A summary of the method or meth-
ods used to determine asset basis in prop-
erty used in both excepted and non-ex-
cepted businesses, as well as information
regarding any deemed sale under para-
graph (c)(5)(iv) of this section;
(6) Whether the taxpayer used the his-
torical approach or the effective date ap-
proach for all of its disallowed disquali-
fied interest; and
(7) If the taxpayer changed its method-
ology 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 descrip-
tion 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 meth-
odology change.
(iv) Failure to file statement. If a tax-
payer 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 Commission-
er 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 rea-
sonable 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 ac-
count all pertinent facts and circumstanc-
es.
(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 cor-
poration 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 be-
tween excepted and non-excepted trades
or businesses regardless of the share-
holder’s direct and indirect interest in the
S corporation.
(B) Dividends. A shareholder must
look through to the activities of a domes-
tic non-consolidated C corporation or a
relevant foreign corporation under para-
graph (b)(3) of this section if the share-
holder’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 domes-
tic 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 share-
holder may look through to the activities
of an S corporation under paragraph (b)
(3) of this section regardless of the share-
holder’s direct interest in the S corpora-
tion.
(ii) Partnerships. A partner may look
through to the assets of a partnership un-
der paragraph (c)(5)(ii) of this section for
purposes of allocating the partner’s basis
in its partnership interest between except-
ed and non-excepted trades or businesses
regardless of the partner’s direct and indi-
rect interest in the partnership.
(iii) Inapplicability of look-through
rule. For circumstances in which a taxpay-
er 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 pur-
pose for the acquisition, disposition, or
change in use of an asset was to artifi-
cially 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 al-
locable to the excepted trade or business,
the change in use is disregarded for pur-
poses of this section. A purpose may be a
principal purpose even though it is out-
weighed by other purposes (taken togeth-
er or separately). In determining whether
a taxpayer has a principal purpose de-
scribed 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 tempo-
rarily on or around a determination date.
A principal purpose is presumed to be
present in any case in which the acquisi-
tion, disposition, or change in use lacks a
substantial business purpose and increas-
es 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 gener-
al. It is not necessary to allocate interest
expense under this paragraph (d) if all of
the taxpayer’s interest expense is alloca-
ble to excepted trades or businesses or if
all of the taxpayer’s interest expense is
allocable to non-excepted trades or busi-
nesses.
(2) Qualified nonrecourse indebt-
edness. For purposes of this section, a
taxpayer with qualified nonrecourse in-
debtedness must directly allocate inter-
est 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 sim-
ilar 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.

September 28, 2020 764 Bulletin No. 2020–40
(4) Adjustments to basis of assets to
account for direct allocations. In deter-
mining the amount of a taxpayer’s basis in
the assets used in its excepted and non-ex-
cepted trades or businesses for purposes
of paragraph (c) of this section, adjust-
ments must be made to reflect direct al-
locations 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 direct-
ly allocated under this paragraph (d). The
amount of the taxpayer’s basis in these as-
sets must be reduced, but not below zero,
by the amount of qualified nonrecourse in-
debtedness secured by these assets. These
adjustments must be made before the tax-
payer averages the adjusted basis in its as-
sets as determined on each determination
date during the taxable year.
(5) Example: Direct allocation of interest ex-
pense—(i) Facts. T conducts an electing real prop-
erty 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 ac-
quiring 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 ac-
quire Building B for $1,200x, and T uses Building B
in Business X. During Year 1, T pays $500x of inter-
est, 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 deter-
mined under paragraph (c) of this section) is $800x
(excluding cash and cash equivalents). Each of Busi-
ness X and Business Y also has $100x of cash and
cash equivalents.
(ii) Analysis. Because Note A is qualified non-
recourse indebtedness that is secured by Building
B, in allocating interest expense between Business-
es 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 remain-
ing $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 Busi-
nesses 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 allo-
cated 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 exam-
ples, 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 in-
debtedness within the meaning of §1.861-
10T(b).
(1) Example 1: Interest allocation within a con-
solidated group—(i) Facts. S is a member of a con-
solidated 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 inter-
est 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) limita-
tion, 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 ex-
cepted 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 con-
solidated group with assets used in more than one
trade or business—(i) Facts. S is a member of a con-
solidated 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 ex-
pense, and S pays or accrues $100x of interest ex-
pense (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 Business-
es X and Y is $180x and $620x, respectively. The
P group’s basis in Building V for purposes of allo-
cating 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 remain-
der, or 60 percent). Accordingly, $120x of the basis
in Building V is allocated to excepted trades or busi-
nesses (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) limita-
tion. In turn, $30x ($100x x 30 percent) of S’s inter-
est 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 corpora-
tion 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 per-
cent. 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 farm-
ing 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 mini-
mum 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 part-
nerships; 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

Bulletin No. 2020–40 765 September 28, 2020
percent of the interests in PS1, and Corp B indirect-
ly 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 en-
gaged 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 al-
locable 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 inter-
est 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 busi-
ness 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 busi-
ness (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 ex-
cepted 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 Business-
es 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 Busi-
nesses 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 al-
locable to an excepted trade or business ($27x), and
the remaining 82 percent of the P group’s total inter-
est expense is business interest expense properly al-
locable 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 al-
located 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 de-
duct $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 treat-
ed 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). Ac-
cordingly, 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 sec-
tion, 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 business-
es 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 Busi-
ness Y according to the use of T’s bus by these busi-
nesses. 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 di-
rectly 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 per-
cent. 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 con-
duct 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 share-
holder’s direct and indirect interest in the corpora-
tion 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

September 28, 2020 766 Bulletin No. 2020–40
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 para-
graph (e)(6)(i) of this section, except that U distrib-
utes 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 share-
holder’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 deter-
mining 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 direct-
ly 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 equip-
ment leasing business (Business L) that is a non-ex-
cepted trade or business. After the end of a farming
season, the P group, with a principal purpose of shift-
ing 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 farm-
ing equipment back to V for use in Business L.
(ii) Analysis. Under paragraph (c)(8) of this sec-
tion, 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-except-
ed 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 equip-
ment to U for storage in Business F’s facilities is
undertaken with a principal purpose of shifting basis
from Business L to Business F, the additional basis
Business F receives from these transactions will not
be taken into account for purposes of this section.
Instead, the basis of the farming equipment will be
allocated as though the farming equipment continued
to be used in Business L.
(f) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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 purpos-
es 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.
§1.163(j)-11 Transition rules.
(a) Overview. This section provides
transition rules regarding the section
163(j) limitation. Paragraph (b) of this
section provides rules regarding the ap-
plication of the section 163(j) limitation
to a corporation that joins a consolidated
group during a taxable year of the group
beginning before January 1, 2018 and is
subject to the section 163(j) limitation at
the time of its change in status. Paragraph
(c) of this section provides rules regarding
the treatment of carryforwards of disal-
lowed disqualified interest.
(b) Application of section 163(j) lim-
itation if a corporation joins a consol-
idated group during a taxable year of
the group beginning before January 1,
2018—(1) In general. If a corporation
(S) joins a consolidated group during a
taxable year of the group beginning be-
fore January 1, 2018, and if S is subject
to the section 163(j) limitation at the time
of its change in status, then section 163(j)
will apply to S’s short taxable year that
ends on the day of S’s change in status,
but section 163(j) will not apply to S’s
short taxable year that begins the next
day (when S is a member of the acquir-
ing consolidated group). Any business
interest expense paid or accrued (with-
out regard to section 163(j)) by S in its
short taxable year ending on the day of
S’s change in status for which a deduc-
tion is disallowed under section 163(j)
will be carried forward to the acquiring
group’s first taxable year beginning after
December 31, 2017. Those disallowed
business interest expense carryforwards
may be subject to limitation under other
provisions of these regulations (see, for
example, §1.163(j)-5(c), (d), (e), and (f)).
(2) Example. Acquiring Group is a consolidated
group with a fiscal year end of November 30; Target
is a stand-alone calendar-year C corporation. On May
31, 2018, Acquiring Group acquires Target in a trans-
action that is not an ownership change for purposes
of section 382. Acquiring Group is not subject to the
section 163(j) limitation during its taxable year begin-
ning December 1, 2017. As a result of the acquisition,
Target has a short taxable year beginning January 1,
2018 and ending May 31, 2018. Target is subject to the
section 163(j) limitation during this short taxable year.
However, Target (as a member of Acquiring Group)
is not subject to the section 163(j) limitation during
Acquiring Group’s taxable year ending November
30, 2018. Any disallowed business interest expense
carryforwards from Target’s taxable year ending May
31, 2018, will not be available for use in Acquiring
Group’s taxable year ending November 30, 2018.
However, that disallowed business interest expense
is carried forward to Acquiring Group’s taxable year
beginning December 1, 2018, and can be deducted by
the group, subject to the separate return limitation year
(SRLY) limitation. See §1.163(j)-5(d).
(c) Treatment of disallowed disquali-
fied interest—(1) In general. Disallowed
disqualified interest is carried forward to
the taxpayer’s first taxable year beginning
after December 31, 2017. Disallowed
disqualified interest is subject to disal-
lowance as a disallowed business interest
expense carryforward under section 163(j)
and §1.163(j)-2 to the extent the interest is
properly allocable to a non-excepted trade
or business under §1.163(j)-10. Disal-
lowed disqualified interest that is properly
allocable to an excepted trade or business
is not subject to the section 163(j) lim-
itation. See §1.163(j)-10(a)(6) for rules
governing the allocation of disallowed
disqualified interest between excepted and
non-excepted trades or businesses.
(2) Earnings and profits. A taxpayer
may not reduce its earnings and profits
in a taxable year beginning after Decem-
ber 31, 2017, to reflect any disallowed
disqualified interest carryforwards to the
extent the payment or accrual of the dis-
allowed disqualified interest reduced the
earnings and profits of the taxpayer in a
prior taxable year.
(3) Disallowed disqualified interest of
members of an affiliated group—(i) Scope.
This paragraph (c)(3)(i) applies to corpora-
tions that were treated as a single taxpayer
under old section 163(j)(6)(C) and that had
disallowed disqualified interest.

Bulletin No. 2020–40 767 September 28, 2020
(ii) Allocation of disallowed disqual-
ified interest to members of the affiliated
group—(A) In general. Each member of
the affiliated group is allocated its alloca-
ble share of the affiliated group’s disal-
lowed disqualified interest as provided in
paragraph (c)(3)(ii)(B) of this section.
(B) Definitions. The following defini-
tions apply for purposes of paragraph (c)
(3)(ii) of this section.
(1) Allocable share of the affiliated
group’s disallowed disqualified interest.
The term allocable share of the affiliated
group’s disallowed disqualified interest
means, with respect to any member of
an affiliated group for the member’s last
taxable year beginning before January
1, 2018, the product of the total amount
of the disallowed disqualified interest of
all members of the affiliated group under
old section 163(j)(6)(C) and the mem-
ber’s disallowed disqualified interest
ratio.
(2) Disallowed disqualified interest ra-
tio. The term disallowed disqualified inter-
est ratio means, with respect to any mem-
ber of an affiliated group for the member’s
last taxable year beginning before January
1, 2018, the ratio of the exempt related
person interest expense of the member for
the last taxable year beginning before Jan-
uary 1, 2018, to the sum of the amounts of
exempt related person interest expense for
all members of the affiliated group.
(3) Exempt related person interest ex-
pense. The term exempt related person
interest expense means interest expense
that is, or is treated as, paid or accrued by
a domestic C corporation, or by a foreign
corporation with income, gain, or loss that
is effectively connected, or treated as ef-
fectively connected, with the conduct of a
trade or business in the United States, to—
(i) Any person related to the taxpay-
er, within the meaning of sections 267(b)
or 707(b)(1), applying the constructive
ownership and attribution rules of sec-
tion 267(c), if no U.S. tax is imposed with
respect to the interest under subtitle A of
the Code, determined without regard to
net operating losses or net operating loss
carryovers, and taking into account any
applicable treaty obligation of the Unit-
ed States. For this purpose, interest that
is subject to a reduced rate of tax under
any treaty obligation of the United States
applicable to the recipient is treated as, in
part, subject to the statutory tax rate un-
der sections 871 or 881 and, in part, not
subject to tax, based on the proportion that
the rate of tax under the treaty bears to the
statutory tax rate. Thus, for purposes of
section 163(j), if the statutory tax rate is
30 percent, and pursuant to a treaty U.S.
tax is instead limited to a rate of 10 per-
cent, two-thirds of the interest is consid-
ered interest not subject to U.S. tax under
subtitle A of the Code;
(ii) A person that is not related to the
taxpayer, within the meaning of section
267(b) or 707(b)(1), applying the con-
structive ownership and attribution rules
of section 267(c), with respect to indebt-
edness on which there is a disqualified
guarantee, within the meaning of para-
graph (6)(D) of old section 163(j), of such
indebtedness, and no gross basis U.S. tax
is imposed with respect to the interest.
For purposes of this paragraph (c)(3)(ii)
(B)(3)(ii), a gross basis U.S. tax means
any tax imposed by this subtitle A of the
Code that is determined by reference to
the gross amount of any item of income
without any reduction for any deduction
allowed by subtitle A of the Code. Interest
that is subject to a gross basis U.S. tax that
is eligible for a reduced rate of tax under
any treaty obligation of the United States
applicable to the recipient is treated as, in
part, subject to the statutory tax rate under
section 871 or 881 and, in part, not sub-
ject to a gross basis U.S. tax, based on the
proportion that the rate of tax under the
treaty bears to the statutory tax rate. Thus,
for purposes of section 163(j), if the stat-
utory tax rate is 30 percent, and pursuant
to a treaty U.S. tax is instead limited to a
rate of 10 percent, two-thirds of the inter-
est is considered interest not subject to a
gross basis U.S. tax under subtitle A of the
Code; or
(iii) A REIT, directly or indirectly, to
the extent that the domestic C corpora-
tion, or a foreign corporation with income,
gain, or loss that is effectively connected,
or treated as effectively connected, with
the conduct of a trade or business in the
United States, is a taxable REIT subsidi-
ary, as defined in section 856(l), with re-
spect to the REIT.
(iii) Treatment of carryforwards. The
amount of disallowed disqualified interest
allocated to a taxpayer pursuant to para-
graph (c)(3)(ii) of this section is treated
in the same manner as described in para-
graph (c)(1) of this section.
(4) Application of section 382—(i)
Ownership change occurring before No-
vember 13, 2020—(A) Pre-change loss.
For purposes of section 382(d)(3), unless
the rules of §1.382-2(a)(7) apply, disal-
lowed disqualified interest is not a pre-
change loss under §1.382-2(a) subject to
a section 382 limitation with regard to an
ownership change on a change date occur-
ring before November 13, 2020. But see
section 382(h)(6)(B) (regarding built-in
deduction items).
(B) Loss corporation. For purposes
of section 382(k)(1), unless the rules of
§1.382-2(a)(7) apply, disallowed disquali-
fied interest is not a carryforward of disal-
lowed interest described in section 381(c)
(20) with regard to an ownership change
on a change date occurring before No-
vember 13, 2020. But see section 382(h)
(6) (regarding built-in deductions).
(ii) Ownership change occurring on
or after November 13, 2020—(A) Pre-
change loss. For rules governing the treat-
ment of disallowed disqualified interest as
a pre-change loss for purposes of section
382 with regard to an ownership change
on a change date occurring on or after No-
vember 13, 2020, see §§1.382-2(a)(2) and
1.382-6(c)(3).
(B) Loss corporation. For rules gov-
erning when disallowed disqualified inter-
est causes a corporation to be a loss corpo-
ration with regard to an ownership change
occurring on or after November 13, 2020,
see §1.382-2(a)(1)(i)(A).
(5) Treatment of excess limitation from
taxable years beginning before January
1, 2018. No amount of excess limitation
under old section 163(j)(2)(B) may be
carried forward to taxable years beginning
after December 31, 2017.
(6) Example: Members of an affiliated group—
(i) Facts. A, B, and C are calendar-year domestic
C corporations that are members of an affiliated
group (within the meaning of section 1504(a)) that
was treated as a single taxpayer under old section
163(j)(6)(C) and the proposed regulations in this
part under old section 163(j) (see formerly proposed
§1.163(j)-5). For the taxable year ending December
31, 2017, the separately determined amounts of ex-
empt related person interest expense of A, B, and C
were $0, $600x, and $150x, respectively (for a total
of $750x). The affiliated group has $200x of disal-
lowed disqualified interest in that year.
(ii) Analysis. The affiliated group’s disallowed
disqualified interest expense for the 2017 taxable
year ($200x) is allocated among A, B, and C based

September 28, 2020 768 Bulletin No. 2020–40
on the ratio of each member’s exempt related per-
son interest expense to the group’s exempt related
person interest expense. Because A has no exempt
related person interest expense, no disallowed dis-
qualified interest is allocated to A. Disallowed dis-
qualified interest of $160x is allocated to B (($600x
/ $750x) x $200x), and disallowed disqualified in-
terest of $40x is allocated to C (($150x / $750x) x
$200x). Thus, B and C have $160x and $40x, re-
spectively, of disallowed disqualified interest that
is carried forward to the first taxable year beginning
after December 31, 2017. No excess limitation that
was allocated to A, B, or C under old section 163(j)
will carry forward to a taxable year beginning after
December 31, 2017.
(iii) Carryforward of disallowed disqualified in-
terest to 2018 taxable year. The facts are the same as
in the Example in paragraph (c)(7)(i) of this section,
except that, for the taxable year ending December
31, 2018, A, B, and C are members of a consolidated
group that has a section 163(j) limitation of $140x,
current-year business interest expense (as defined in
§1.163(j)-1(b)(9)) of $80x, and no excepted trade
or business. Under paragraph (c)(1) of this section,
disallowed disqualified interest is carried to the tax-
payer’s first taxable year beginning after December
31, 2017, and is subject to disallowance under sec-
tion 163(j) and §1.163(j)-2. Under §1.163(j)-5(b)
(3)(ii)(D)(1), a consolidated group that has section
163(j) limitation remaining for the current year after
deducting all current-year business interest expense
deducts each member’s disallowed disqualified in-
terest carryforwards from prior taxable years, start-
ing with the earliest taxable year, on a pro rata basis
(subject to certain limitations). In accordance with
paragraph (c)(1) of this section, the rule in §1.163(j)-
5(b)(3)(ii)(D)(1) applies to disallowed disqualified
interest carried forward to the taxpayer’s first taxable
year beginning after December 31, 2017. Accord-
ingly, after deducting $80x of current-year business
interest expense in 2018, the group may deduct $60x
of its $200x disallowed disqualified interest carry-
forwards. Under paragraph (c)(3) of this section, B
has $160x of disallowed disqualified interest carry-
forwards, and C has $40x of disallowed disqualified
interest carryforwards. Thus, $48x (($160x / $200x)
x $60x) of B’s disallowed disqualified interest car-
ryforwards, and $12x (($40x / $200x) x $60x) of
C’s disallowed disqualified interest carryforwards,
are deducted by the consolidated group in the 2018
taxable year.
(d) Applicability date. This section ap-
plies to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after Decem-
ber 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.
Par. 4. Section 1.263A-9 is amended
by revising the first and third sentences of
paragraph (g)(1)(i) to read as follows:
§1.263A-9 The avoided cost method.
* * * * *
(g) * * *
(1) * * *
(i) * * * Interest must be capitalized
under section 263A(f) before the appli-
cation of section 163(d) (regarding the
investment interest limitation), section
163(j) (regarding the limitation on busi-
ness interest expense), section 266 (re-
garding the election to capitalize carry-
ing charges), section 469 (regarding the
limitation on passive losses), and section
861 (regarding the allocation of interest
to United States sources). * * * Howev-
er, in applying section 263A(f) with re-
spect to the excess expenditure amount,
the taxpayer must capitalize all interest
that is neither investment interest under
section 163(d), business interest expense
under section 163(j), nor passive interest
under section 469 before capitalizing any
interest that is either investment interest,
business interest expense, or passive in-
terest. * * *
* * * * *
Par. 5. Section 1.263A-15 is amended
by adding paragraph (a)(4) to read as fol-
lows:
§1.263A-15 Effective dates, transitional
rules, and anti-abuse rules.
(a) * * *
(4) Section 1.263A-9(g)(1)(i) applies
to taxable years beginning on or after No-
vember 13, 2020. However, taxpayers and
their related parties, within the meaning of
sections 267(b) and 707(b)(1), may choose
to apply the rules of that section to a tax-
able year beginning after December 31,
2017, so long as the taxpayers and their
related parties consistently apply the rules
of the section 163(j) regulations (as de-
fined in §1.163(j)-1(b)(37)), and, if appli-
cable, §§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.
* * * * *
Par. 6. Section 1.381(c)(20)-1 is added
to read as follows:
§1.381(c)(20)-1 Carryforward of
disallowed business interest.
(a) Carryover requirement. Section
381(c)(20) provides that the acquiring
corporation in a transaction described in
section 381(a) will succeed to and take
into account the carryover of disallowed
business interest described in section
163(j)(2) to taxable years ending after the
date of distribution or transfer.
(b) Carryover of disallowed business
interest described in section 163(j)(2). For
purposes of section 381(c)(20) and this
section, the term carryover of disallowed
business interest described in section
163(j)(2) means the disallowed business
interest expense carryforward (as defined
in §1.163(j)-1(b)(11)), including any dis-
allowed disqualified interest (as defined in
§1.163(j)-1(b)(12)), and including the dis-
tributor or transferor corporation’s disal-
lowed business interest expense from the
taxable year that ends on the date of dis-
tribution or transfer. For the application of
section 382 to disallowed business interest
expense described in section 163(j)(2), see
the regulations in this part under section
382 of the Code, including but not limited
to §1.382-2.
(c) Limitation on use of disallowed
business interest expense carryforwards
in the acquiring corporation’s first tax-
able year ending after the date of distri-
bution or transfer—(1) In general. In
determining the extent to which the ac-
quiring corporation may use disallowed
business interest expense carryforwards
in its first taxable year ending after the
date of distribution or transfer, the princi-
ples of §§1.381(c)(1)-1 and 1.381(c)(1)-2
apply with appropriate adjustments, in-
cluding but not limited to the adjustments
described in paragraphs (c)(2) and (3) of
this section.

Bulletin No. 2020–40 769 September 28, 2020
(2) One date of distribution or trans-
fer within the acquiring corporation’s
taxable year. If the acquiring corpora-
tion succeeds to the disallowed business
interest expense carryforwards of one or
more distributor or transferor corporations
on a single date of distribution or transfer
within one taxable year of the acquiring
corporation, then, for the acquiring corpo-
ration’s first taxable year ending after the
date of distribution or transfer, that part
of the acquiring corporation’s business
interest expense deduction (if any) that
is attributable to the disallowed business
interest expense carryforwards of the dis-
tributor or transferor corporation is limit-
ed under this paragraph (c) to an amount
equal to the post-acquisition portion of the
acquiring corporation’s section 163(j) lim-
itation, as defined in paragraph (c)(4) of
this section.
(3) Two or more dates of distribution or
transfer in the taxable year. If the acquir-
ing corporation succeeds to the disallowed
business interest expense carryforwards of
two or more distributor or transferor cor-
porations on two or more dates of distribu-
tion or transfer within one taxable year of
the acquiring corporation, the limitation
to be applied under this paragraph (c) is
determined by applying the principles of
§1.381(c)(1)-2(b) to the post-acquisition
portion of the acquiring corporation’s sec-
tion 163(j) limitation, as defined in para-
graph (c)(4) of this section.
(4) Definition. For purposes of this
paragraph (c), the term post-acquisi-
tion portion of the acquiring corpora-
tion’s section 163(j) limitation means the
amount that bears the same ratio to the
acquiring corporation’s section 163(j) lim-
itation (within the meaning of §1.163(j)-
1(b)(31)) (or, if the acquiring corporation
is a member of a consolidated group, the
consolidated group’s section 163(j) limita-
tion) for the first taxable year ending after
the date of distribution or transfer (taking
into account items to which the acquiring
corporation succeeds under section 381,
other than disallowed business interest
expense carryforwards) as the number of
days in that year after the date of distribu-
tion or transfer bears to the total number
of days in that year.
(5) Examples. For purposes of this
paragraph (c)(5), unless otherwise stated,
X, Y, and Z are taxable domestic C corpo-
rations that were incorporated on January
1, 2021 and that file their tax returns on a
calendar-year basis; none of X, Y, or Z is a
member of a consolidated group; the small
business exemption in §1.163(j)-2(d) does
not apply; interest expense is deductible
except to the extent of the potential appli-
cation of section 163(j); and the facts set
forth the only corporate activity. The prin-
ciples of this paragraph (c) are illustrated
by the following examples.
(i) Example 1: Transfer before last day of ac-
quiring corporation’s taxable year—(A) Facts. On
October 31, 2022, X transferred all of its assets to Y
in a statutory merger to which section 361 applies.
For the 2021 taxable year, X had $400x of disal-
lowed business interest expense, and Y had $0 of
disallowed business interest expense. For the taxable
year ending October 31, 2022, X had an addition-
al $350x of disallowed business interest expense
(X did not deduct any of its 2021 carryforwards in
its 2022 taxable year). For the taxable year ending
December 31, 2022, Y had business interest expense
of $100x, business interest income of $200x, and
ATI of $1,000x. Y’s section 163(j) limitation for the
2022 taxable year was $500x ($200x + (30 percent x
$1,000x) = $500x).
(B) Analysis. Pursuant to §1.163(j)-5(b)(2), Y
deducts its $100x of current-year business interest
expense (as defined in §1.163(j)-1(b)(9)) before any
disallowed business interest expense carryforwards
(including X’s carryforwards) from a prior taxable
year are deducted. The aggregate disallowed busi-
ness interest expense of X carried forward under
section 381(c)(20) to Y’s taxable year ending De-
cember 31, 2022, is $750x. However, pursuant to
paragraph (c)(2) of this section, for Y’s first taxable
year ending after the date of distribution or transfer,
the maximum amount of X’s disallowed business
interest expense carryforwards that Y can deduct is
equal to the post-acquisition portion of Y’s section
163(j) limitation. Pursuant to paragraph (c)(4) of this
section, the post-acquisition portion of Y’s section
163(j) limitation means Y’s section 163(j) limitation
times the ratio of the number of days in the taxable
year after the date of distribution or transfer to the to-
tal number of days in that year. Therefore, only $84x
of the aggregate amount ($500x x (61/365) = $84x)
may be deducted by Y in that year, and the remaining
$666x ($750x - $84x = $666x) is carried forward to
the succeeding taxable year.
(C) Transfer on last day of acquiring corpo-
ration’s taxable year. The facts are the same as in
Example 1 in paragraph (c)(5)(i)(A) of this section,
except that X’s transfer of its assets to Y occurred
on December 31, 2022. For the taxable year ending
December 31, 2022, X had an additional $350x of
disallowed business interest expense (X did not de-
duct any of its 2021 carryforwards in its 2022 tax-
able year). For the taxable year ending December 31,
2023, Y had business interest expense of $100x, busi-
ness interest income of $200x, and ATI of $1,000x.
Y’s section 163(j) limitation for the 2023 taxable
year was $500x ($200x + (30 percent x $1,000x) =
$500x). The aggregate disallowed business interest
expense of X carried under section 381(c)(20) to Y’s
taxable year ending December 31, 2023, is $750x.
Paragraph (c)(2) of this section does not limit the
amount of X’s disallowed business interest expense
carryforwards that may be deducted by Y in the 2023
taxable year. Since the amount of Y’s section 163(j)
limit for the 2023 taxable year was $500x, Y may
deduct the full amount ($100x) of its own business
interest expense for the 2023 taxable year, along with
$400x of X’s disallowed business interest expense
carryforwards.
(ii) Example 2: Multiple transferors on same
date—(A) Facts. On October 31, 2022, X and Y
transferred all of their assets to Z in statutory mergers
to which section 361 applies. For the 2021 taxable
year, X had $300x of disallowed business interest
expense, Y had $200x, and Z had $0. For the taxable
year ending October 31, 2022, each of X and Y had
an additional $125x of disallowed business interest
expense (neither X nor Y deducted any of its 2021
carryforwards in 2022). For the taxable year ending
December 31, 2022, Z had business interest expense
of $100x, business interest income of $200x, and
ATI of $1,000x. Z’s section 163(j) limitation for the
2022 taxable year was $500x ($200x + (30 percent x
$1,000x) = $500x).
(B) Analysis. The aggregate disallowed business
interest expense of X and Y carried under section
381(c)(20) to Z’s taxable year ending December
31, 2022, is $750x. However, pursuant to paragraph
(c)(2) of this section, only $84x of the aggregate
amount ($500x x (61/365) = $84x) may be deducted
by Z in that year. Moreover, under paragraph (b)(2)
of this section, this amount only may be deducted
by Z in that year after Z has deducted its $100x of
current-year business interest expense (as defined in
§1.163(j)-1(b)(9)).
(d) Applicability date. This section
applies to taxable years beginning on
or after November 13, 2020. Howev-
er, 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 (as defined in
§1.163(j)-1(b)(37)), and, if applicable,
§§1.263A-9, 1.263A-15, 1.382-1, 1.382-
2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1,
1.882-5, 1.1362-3, 1.1368-1, 1.1377-
1, 1.1502-13, 1.1502-21, 1.1502-36,
1.1502-79, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§§1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4, to that taxable year.
Par. 7. Section 1.382-1 is amended by:
1. Adding an entry for §1.382-2(a)(1)
(vi) and (a)(7) and (8);
2. Revising the entry for §1.382-2(b)
(3);

September 28, 2020 770 Bulletin No. 2020–40
3. Adding entries for §1.382-6(a)(1)
and (2) and (b)(4);
4. Revising the entry for §1.382-6(h);
and
5. Adding an entry for §1.382-7(c), (d),
(d)(1) through (5), (e) through (g), and (g)
(1) through (4).
The additions and revisions read as fol-
lows:
§1.382-1 Table of contents.
* * * * *
§1.382-2 General rules for ownership
change.
(a) * * *
(1) * * *
(vi) Any section 382 disallowed busi-
ness interest carryforward.
* * * * *
(7) Section 382 disallowed business in-
terest carryforward.
(8) Testing period.
(b) * * *
(3) Rules provided in paragraphs (a)(1)
(i)(A), (a)(1)(ii), (iv), and (v), (a)(2)(iv)
through (vi), (a)(3)(i), and (a)(4) through
(8) of this section.
* * * * *
§1.382-6 Allocation of income and loss to
periods before and after the change date
for purposes of section 382.
(a) * * *
(1) In general.
(2) Allocation of business interest ex-
pense.
(i) Scope.
(ii) Deductibility of business interest
expense.
* * * * *
(b) * * *
(4) Allocation of business interest ex-
pense.
(i) Scope.
(ii) Deductibility of business interest
expense.
(iii) Example.
* * * * *
(h) Applicability date.
(1) In general.
(2) Paragraphs (a) and (b)(1) and (4) of
this section.
* * * * *
§1.382-7
* * * * *
(c) [Reserved]
(d) Special rules.
(1)-(4) [Reserved]
(5) Section 382 disallowed business in-
terest carryforwards.
(e)-(f) [Reserved]
(g) Applicability dates.
(1)-(3) [Reserved]
(4) Paragraph (d)(5) of this section.
* * * * *
Par. 8. Section 1.382-2 is amended by:
1. Revising paragraph (a)(1)(i)(A);
2. Removing “, or” and adding “; or”
in its place at the end of paragraph (a)(1)
(i)(B);
3. Revising paragraphs (a)(1)(ii) intro-
ductory text and (a)(1)(ii)(A);
4. Removing “, and” and adding “;
and” in its place at the end of paragraph
(a)(1)(ii)(B);
5. Removing the last sentence in para-
graphs (a)(1)(iv) and (v);
6. Removing the commas and adding
semicolons in their place at the end of
paragraphs (a)(2)(i) and (iii);
7. Removing the period and adding a
semicolon in its place at the end of para-
graph (a)(2)(ii);
8. Removing “, and” and adding a
semicolon in its place at the end of para-
graph (a)(2)(iv);
9. Removing the period and adding “;
and” in its place at the end of paragraph
(a)(2)(v);
10. Adding paragraph (a)(2)(vi);
11. Removing the last sentence in para-
graphs (a)(3)(i), (a)(4)(i), and (a)(5) and
(6);
12. Adding paragraphs (a)(7) and (8);
and
13. Revising paragraph (b)(3).
The revisions and additions read as fol-
lows:
§1.382-2 General rules for ownership
change.
(a) * * *
(1) * * *
(i) * * *
(A) Is entitled to use a net operating
loss carryforward, a capital loss carry-
over, a carryover of excess foreign taxes
under section 904(c), a carryforward of
a general business credit under section
39, a carryover of a minimum tax credit
under section 53, or a section 382 dis-
allowed business interest carryforward
described in paragraph (a)(7) of this sec-
tion;
* * * * *
(ii) Distributor or transferor loss cor-
poration in a transaction under section
381. Notwithstanding that a loss corpora-
tion ceases to exist under state law, if its
disallowed business interest expense car-
ryforwards, net operating loss carryfor-
wards, excess foreign taxes, or other items
described in section 381(c) are succeeded
to and taken into account by an acquiring
corporation in a transaction described in
section 381(a), such loss corporation will
be treated as continuing in existence un-
til—
(A) Any pre-change losses (excluding
pre-change credits described in §1.383-
1(c)(3)), determined as if the date of such
transaction were the change date, are ful-
ly utilized or expire under section 163(j),
172, or 1212;
* * * * *
(2) * * *
(vi) Any section 382 disallowed busi-
ness interest carryforward.
* * * * *
(7) Section 382 disallowed business in-
terest carryforward. The term section 382
disallowed business interest carryforward
includes the following items:
(i) The loss corporation’s disallowed
business interest expense carryforwards
(as defined in §1.163(j)-1(b)(11)), includ-
ing disallowed disqualified interest (as de-
fined in §1.163(j)-1(b)(12)), as of the date
of the ownership change.
(ii) The loss corporation’s current-year
business interest expense (as defined in
§1.163(j)-1(b)(9)) in the change year (as
defined in §1.382-6(g)(1)) that is alloca-
ble to the pre-change period (as defined
in §1.382-6(g)(2)) under §1.382-6(a) or
(b) and that becomes disallowed business
interest expense (as defined in §1.163(j)-
1(b)(10)).
(8) Testing period. Notwithstanding the
temporal limitations provided in §1.382-
2T(d)(3)(i), the testing period for a loss
corporation can begin as early as the first
day of the first taxable year from which
there is a section 382 disallowed business
interest carryforward to the first taxable
year ending after the testing date.
(b) * * *

Bulletin No. 2020–40 771 September 28, 2020
(3) Rules provided in paragraphs (a)
(1)(i)(A), (a)(1)(ii), (iv), and (v), (a)(2)
(iv) through (vi), (a)(3)(i), and (a)(4)
through (8) of this section. The rules pro-
vided in paragraphs (a)(1)(i)(A), (a)(1)
(ii), (iv), and (v), (a)(2)(iv) through (vi),
(a)(3)(i), and (a)(4) through (8) of this
section apply to testing dates occurring
on or after November 13, 2020. For loss
corporations that have testing dates oc-
curring before November 13, 2020, see
§1.382-2 as contained in 26 CFR part 1,
revised April 1, 2019. However, taxpay-
ers and their related parties, within the
meaning of sections 267(b) and 707(b)
(1), may choose to apply the rules of this
section to testing dates occurring during
a taxable year beginning after December
31, 2017, and before November 13, 2020,
so long as the taxpayers and their relat-
ed parties consistently apply the rules of
this section, the section 163(j) regula-
tions (as defined in §1.163(j)-1(b)(37)),
§§1.382-1, 1.382-5, 1.382-6, 1.382-7,
1.383-0, and 1.383-1, and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-
1, 1.469-9, 1.469-11, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-
13, 1.1502-21, 1.1502-36, 1.1502-79,
1.1502-91 through 1.1502-99 (to the ex-
tent 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.
Par. 9. Section 1.382-5 is amended by
revising the first and second sentences of
paragraph (d)(1) and by adding three sen-
tences to the end of paragraph (f) to read
as follows:
§1.382-5 Section 382 limitation.
* * * * *
(d) * * *
(1) * * * If a loss corporation has two
(or more) ownership changes, any losses
or section 382 disallowed business inter-
est carryforwards ((within the meaning of
§1.382-2(a)(7)) attributable to the period
preceding the earlier ownership change
are treated as pre-change losses with re-
spect to both ownership changes. Thus,
the later ownership change may result in a
lesser (but never in a greater) section 382
limitation with respect to such pre-change
losses. * * *
* * * * *
(f) * * * Paragraph (d)(1) of this sec-
tion applies with respect to an ownership
change occurring on or after November
13, 2020. For loss corporations that have
undergone an ownership change before or
after November 13, 2020, see §1.382-5 as
contained in 26 CFR part 1, revised April
1, 2019. However, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose
to apply the rules of this section to testing
dates occurring during a taxable year be-
ginning after December 31, 2017, so long
as the taxpayers and their related parties
consistently apply the rules of this section,
the section 163(j) regulations (as defined
in §1.163(j)-1(b)(37)), §§1.382-1, 1.382-
2, 1.382-6, 1.382-7, 1.383-0, and 1.383-1,
and, if applicable, §§1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, 1.382-5, 1.382-6, and 1.383-
1), and 1.1504-4, to that taxable year.
Par. 10. Section 1.382-6 is amended by:
1. Redesignating the text of paragraph
(a) as paragraph (a)(1);
2. Adding a subject heading to newly
redesignated paragraph (a)(1);
3. Adding paragraph (a)(2);
4. Removing the language “Subject to
paragraphs (b)(3)(ii) and (d)” in the first
sentence of paragraph (b)(1) and adding
“Subject to paragraphs (b)(3)(ii), (b)(4),
and (d)” in its place;
5. Adding paragraph (b)(4); and
6. Revising paragraph (h).
The additions and revision read as fol-
lows:
§1.382-6 Allocation of income and loss to
periods before and after the change date
for purposes of section 382.
(a) * * *
(1) In general. * * *
(2) Allocation of business interest ex-
pense—(i) Scope. Except as provided in
paragraph (b)(4) of this section, this para-
graph (a)(2) applies if a loss corporation
has business interest expense (as defined
in §1.163(j)-1(b)(3)) in the change year.
The rules of this paragraph (a)(2) apply
to determine the amount of current-year
business interest expense (as defined in
§1.163(j)-1(b)(9)) that is deducted in the
change year. These rules also apply to de-
termine the amount of any current-year
business interest expense that is charac-
terized as disallowed business interest
expense (as defined in §1.163(j)-1(b)(10))
allocable to the pre-change period and the
post-change period, and to allocate disal-
lowed business interest expense carryfor-
wards (as defined in §1.163(j)-1(b)(11)) to
the change year for deduction in the pre-
change period and the post-change period.
(ii) Deductibility of business interest
expense. The rules of this paragraph (a)(2)
(ii) apply in the following order.
(A) First, the loss corporation calcu-
lates its section 163(j) limitation (as de-
fined in §1.163(j)-1(b)(36)) for the change
year.
(B) Second, the loss corporation cal-
culates its deductible current-year BIE
and deducts this amount in determining
its taxable income or net operating loss
for the change year. For purposes of this
paragraph (a)(2)(ii), the term deductible
current-year BIE means the loss corpo-
ration’s current-year business interest ex-
pense (including its floor plan financing
interest expense, as defined in §1.163(j)-
1(b)(19)), to the extent of its section 163(j)
limitation.
(C) Third, if the loss corporation has
disallowed business interest expense paid
or accrued (without regard to section
163(j)) in the change year that is carried
forward to post-change years, it allocates
an equal portion of that disallowed busi-
ness interest expense to each day in the
change year. Any amount of disallowed
business interest expense that is allocated
to the pre-change period pursuant to this
paragraph (a)(2)(ii)(C) is carried forward
subject to section 382(d)(3). Any amount
of disallowed business interest expense
that is allocated to the post-change period
pursuant to this paragraph (a)(2)(ii)(C) is
carried forward and is not subject to sec-
tion 382(d)(3).
(D) Fourth, if the loss corporation has
excess section 163(j) limitation, then the
loss corporation calculates its deductible
disallowed business interest expense
carryforward and allocates an equal por-
tion to each day in the change year. For
purposes of this paragraph (a)(2)(ii), the
term excess section 163(j) limitation
means the excess, if any, of the loss cor-

September 28, 2020 772 Bulletin No. 2020–40
poration’s section 163(j) limitation over
its deductible current-year BIE, and the
term deductible disallowed business in-
terest expense carryforward means the
loss corporation’s disallowed business
interest expense carryforward to the ex-
tent of its excess section 163(j) limita-
tion.
(E) Fifth, the loss corporation deducts
its deductible disallowed business interest
expense carryforward that was allocated
to the pre-change period under paragraph
(a)(2)(ii)(D) of this section. Subject to
the application of sections 382(b)(3)(B)
and 382(d)(3), the loss corporation de-
ducts its deductible disallowed business
interest expense carryforward that was
allocated to the post-change period under
paragraph (a)(2)(ii)(D) of this section.
Any amount of disallowed business in-
terest expense carryforward that is not
deducted pursuant to this paragraph (a)
(2)(ii)(E) is carried forward subject to
section 382(d)(3).
* * * * *
(b) * * *
(4) Allocation of business interest ex-
pense—(i) Scope. This paragraph (b)
(4) applies if a loss corporation makes a
closing-of-the-books election pursuant to
paragraph (b) of this section and has busi-
ness interest expense in the change year.
The rules of this paragraph (b)(4) apply to
determine the amount of deductible cur-
rent-year business interest expense that
is allocable to the pre-change period and
the post-change period for purposes of the
allocations referred to in paragraph (b)(1)
of this section. These rules also apply to
determine the amount of any current-year
business interest expense that is charac-
terized as disallowed business interest ex-
pense allocable to the pre-change period
and the post-change period, and to allo-
cate disallowed business interest expense
carryforwards to the change year between
the pre-change period and the post-change
period for deduction.
(ii) Deductibility of business interest
expense. The rules of this paragraph (b)(4)
(ii) apply in the order provided.
(A) The loss corporation calculates its
ATI limit, which is the product of its ATI
(as defined in §1.163(j)-1(b)(1)) for the
change year and 30 percent. For purpos-
es of this paragraph (b)(4)(ii), the terms
pre-change ATI limit and post-change
ATI limit mean the amount of ATI limit
allocated to the pre-change period or the
post-change period, respectively, com-
puted by allocating an equal portion of
the ATI limit to each day in the change
year.
(B) Pursuant to paragraph (b)(1) of this
section, the loss corporation allocates its
current-year business interest expense (in-
cluding its floor plan financing interest ex-
pense) and its business interest income (as
defined in §1.163(j)-1(b)(4)) to the pre-
change and post-change periods as if the
loss corporation’s books were closed on
the change date. For purposes of this para-
graph (b)(4)(ii), the terms pre-change BIE
and post-change BIE mean the amount of
the loss corporation’s current-year busi-
ness interest expense that is allocated to
the pre-change period or the post-change
period, respectively, under this paragraph
(b)(4)(ii)(B).
(C) The loss corporation deducts its
pre-change BIE to the extent of its pre-
change section 163(j) limit, and the loss
corporation deducts its post-change BIE to
the extent of its post-change section 163(j)
limit. For purposes of this paragraph (b)
(4)(ii), the term pre-change section 163(j)
limit means the sum of the pre-change ATI
and the amount of business interest in-
come and floor plan financing interest ex-
pense allocated to the pre-change period;
the term post-change section 163(j) limit
means the sum of the post-change ATI
limit and the amount of business interest
income and floor plan financing interest
expense allocated to the post-change pe-
riod.
(D) If any pre-change BIE or post-
change BIE has not been deducted under
paragraph (b)(4)(ii)(C) of this section, the
loss corporation deducts either any pre-
change BIE that has not been deducted to
the extent of its surplus post-change sec-
tion 163(j) limit or any post-change BIE
that has not been deducted to the extent of
its surplus pre-change section 163(j) limit.
For purposes of this paragraph (b)(4)(ii),
the term surplus pre-change section 163(j)
limit means the amount by which the pre-
change section 163(j) limit exceeds the
amount of pre-change BIE deducted pur-
suant to paragraph (b)(4)(ii)(C) of this
section; the term surplus post-change
section 163(j) limit means the amount by
which the post-change section 163(j) limit
exceeds the amount of post-change BIE
deducted pursuant to paragraph (b)(4)(ii)
(C) of this section.
(E) If the loss corporation has any ex-
cess pre-change section 163(j) limit or ex-
cess post-change section 163(j) limit, the
loss corporation allocates its disallowed
business interest expense carryforward, if
any, ratably between the pre-change and
post-change periods based upon the rel-
ative amounts of excess pre-change sec-
tion 163(j) limit and excess post-change
section 163(j) limit. For purposes of this
paragraph (b)(4)(ii), the term excess pre-
change section 163(j) limit means the
amount by which the surplus pre-change
section 163(j) limit exceeds the amount
of post-change BIE deducted pursuant to
paragraph (b)(4)(ii)(D) of this section; the
term excess post-change section 163(j)
limit means the amount by which the sur-
plus post-change section 163(j) limit ex-
ceeds the amount of pre-change BIE de-
ducted pursuant to paragraph (b)(4)(ii)(D)
of this section.
(F) The loss corporation deducts its
disallowed business interest expense car-
ryforward that was allocated to the pre-
change period under paragraph (b)(4)(ii)
(E) of this section to the extent of its ex-
cess pre-change section 163(j) limit. Sub-
ject to the application of sections 382(b)
(3)(B) and 382(d)(3), the loss corporation
deducts its disallowed business interest
expense carryforward that was allocated
to the post-change period under paragraph
(b)(4)(ii)(E) of this section to the extent
of its excess post-change section 163(j)
limit. Any amount of disallowed business
interest expense carryforward that is not
deducted pursuant to this paragraph (b)
(4)(ii)(F) is subject to section 382(d)(3)
irrespective of the period to which it was
allocated pursuant to paragraph (b)(4)(ii)
(E) of this section.
(iii) Example 1—(A) Facts. X is a calendar-year
domestic C corporation that is not a member of a
consolidated group. As of January 1, 2021, X has no
disallowed business interest expense carryforwards.
On October 19, 2021, X experiences an ownership
change under section 382(g). For calendar year
2021, X’s ATI is $500. For the period beginning on
January 1, 2021 and ending on October 19, 2021, X
pays or accrues $250 of current-year business inter-
est expense that is deductible but for the potential
application of section 163(j), including $50 of floor
plan financing interest expense, and X has $60 of
business interest income. For the period beginning
on October 20, 2021 and ending on December 31,

Bulletin No. 2020–40 773 September 28, 2020
2021, X pays or accrues $100 of current-year busi-
ness interest expense that is deductible but for the
potential application of section 163(j), including $40
of floor plan financing interest expense, and X has
$70 of business interest income. X makes a closing-
of-the-books election pursuant to paragraph (b) of
this section.
(B) Analysis—(1) Calculation and allocation of
ATI limit. For purposes of allocating its net operating
loss or taxable income for the change year between
the pre-change period and the post-change period
under §1.382-6, X applies paragraph (b)(4) of this
section to allocate items related to section 163(j). X’s
ATI for calendar year 2021 is $500x. Therefore, pur-
suant to paragraph (b)(4)(ii)(A) of this section, X’s
ATI limit is $150 ($500 x 30 percent). Additionally,
pursuant to paragraph (b)(4)(ii)(A) of this section,
X’s pre-change ATI limit is $120 ($150 x (292 days
/ 365 days)), and X’s post-change ATI limit is $30
($150 x (73 days / 365 days)).
(2) Determination of pre-change BIE and post-
change BIE. Pursuant to paragraph (b)(4)(ii)(B) of
this section, X’s pre-change BIE and post-change
BIE are $250 and $100, respectively.
(3) Determination of pre-change section 163(j)
limit and post-change section 163(j) limit. Pursuant
to paragraph (b)(4)(ii)(C) of this section, X’s pre-
change section 163(j) limit is $230 ($120 (X’s pre-
change ATI limit) + $60 (X’s business interest in-
come allocated to the pre-change period) + $50 (X’s
floor plan financing interest expense allocated to the
pre-change period)). Additionally, pursuant to para-
graph (b)(4)(ii)(C) of this section, X’s post-change
section 163(j) limit is $140 ($30 (X’s post-change
ATI limit) + $70 (X’s business interest income al-
located to the post-change period) + $40 (X’s floor
plan financing interest expense allocated to the post-
change period)).
(4) Initial deduction of BIE. Pursuant to para-
graph (b)(4)(ii)(C) of this section, X deducts $230
(its pre-change section 163(j) limit) of its $250 pre-
change BIE and all $100 (less than its $140 post-
change section 163(j) limit) of its post-change BIE.
(5) Deduction of BIE due to surplus post-change
section 163(j) limit. After applying paragraph (b)(4)
(ii)(C) of this section, X has $20 of pre-change BIE
that has not been deducted ($250 - $230) and a sur-
plus post-change section 163(j) limit of $40 ($140
- $100). As a result, pursuant to paragraph (b)(4)(ii)
(D) of this section, X deducts its remaining $20 of
pre-change BIE. (If, after applying paragraph (b)(4)
(ii)(C) of this section, X instead had $20 of post-
change BIE that had not yet been deducted and a
$40 surplus pre-change section 163(j) limit, then X
would deduct its remaining $20 of post-change BIE
pursuant to paragraph (b)(4)(ii)(D) of this section.)
(iv) Example 2—Potential deduction of dis-
allowed business interest expense carryforwards.
The facts are the same as in paragraph (b)(4)(iii)
(A) of this section, except that, as of January 1,
2021, X has $90 of disallowed business inter-
est expense carryforwards and $150 (rather than
$250) of pre-change BIE. X’s pre-change section
163(j) limit and post-change section 163(j) limit
are the same as in paragraph (b)(4)(iii)(B)(3) of
this section. Pursuant to paragraph (b)(4)(ii)(C) of
this section, X deducts all $150 of its pre-change
BIE and all $100 of its post-change BIE. X has no
remaining pre-change BIE or post-change BIE to
deduct under paragraph (b)(4)(ii)(D) of this sec-
tion. Paragraph (b)(4)(ii)(E) of this section applies
because X has $80 of excess pre-change section
163(j) limit ($230 - $150) and $40of excess post-
change section 163(j) limit ($140 - $100). Under
paragraph (b)(4)(ii)(E) of this section, X allocates
$60 of its disallowed business interest expense car-
ryforwards to the pre-change period ($90 x ($80 /
($80 + $40))) and $30 of its disallowed business
interest expense carryforwards to the post-change
period ($90 x ($40 / ($80 + $40))). As provided in
paragraph (b)(4)(ii)(F) of this section, X deducts
all $60 of its disallowed business interest expense
carryforwards that are allocated to the pre-change
period; subject to the application of section 382,
X deducts all $30 of its disallowed business inter-
est expense carryforwards that are allocated to the
post-change period.
* * * * *
(h) Applicability date—(1) In general.
This section applies to ownership changes
occurring on or after June 22, 1994.
(2) Ownership changes. Paragraphs (a)
and (b)(1) and (4) of this section apply with
respect to an ownership change occurring
during a taxable year beginning on or af-
ter November 13, 2020. For ownership
changes occurring during a taxable year
beginning before November 13, 2020, see
§1.382-6 as contained in 26 CFR part 1,
revised April 1, 2019. However, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to testing dates occurring during a taxable
year beginning after December 31, 2017,
so long as the taxpayers and their related
parties consistently apply the rules of this
section, the section 163(j) regulations (as
defined in §1.163(j)-1(b)(37)), §§1.382-1,
1.382-2, 1.382-5, 1.383-0, and 1.383-1,
and, if applicable, §§1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, 1.382-5, 1.382-6, 1.382-7,
and 1.383-1), and 1.1504-4, to taxable
years beginning after December 31, 2017.
Par. 11. Section 1.382-7 is amended by
adding paragraphs (c), (d), (e), (f), and (g)
to read as follows:
§1.382-7 Built-in gains and losses.
* * * * *
(c) [Reserved]
(d) Special rules. This paragraph (d)
contains special rules regarding the identi-
fication of recognized built-in losses.
(1)-(4) [Reserved]
(5) Section 382 disallowed business
interest carryforwards. Section 382 disal-
lowed business interest carryforwards are
not treated as recognized built-in losses.
(e)-(f) [Reserved]
(g) Applicability dates.
(1)-(3) [Reserved]
(4) Paragraph (d)(5) of this section.
Paragraph (d)(5) of this section applies with
respect to an ownership change occurring
on or after November 13, 2020. For loss
corporations that have undergone an own-
ership change before or after November 13,
2020, see §1.382-7 as contained in 26 CFR
part 1, revised April 1, 2019. However, tax-
payers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of paragraph
(d)(5) of this section to testing dates occur-
ring during a taxable year beginning after
December 31, 2017.
Par. 12. Section 1.383-0 is amended by
revising paragraph (a) to read as follows:
§1.383-0 Effective date.
(a) The regulations in this part under
section 383 of the Code (other than the reg-
ulations described in paragraph (b) of this
section) reflect the amendments made to
sections 382 and 383 by the Tax Reform Act
of 1986 and the amendments made to sec-
tion 382 by Public Law No. 115-97 (2017).
See §1.383-1(j) for effective date rules.
* * * * *
Par. 13. Section 1.383-1 is amended by:
1. In paragraph (a):
a. Adding entries for paragraphs (d)(1)
(i) and (ii);
b. Revising the entries for paragraphs
(e)(3) and (j);
c. Adding entries for paragraphs (j)(1)
and (2); and
d. Removing the entry for paragraph
(k).
2. Removing “(iv)” and adding “(v)” in
its place in paragraph (c)(6)(i)(B).
3. Revising paragraphs (c)(6)(ii) and
(d)(1).
4. Removing the commas and adding
semicolons in their place at ends of para-
graphs (d)(2)(i), (ii), and (vi).
5. Revising paragraph (d)(2)(iii).

September 28, 2020 774 Bulletin No. 2020–40
6. Redesignating paragraphs (d)(2)
(iv) through (vii) as paragraphs (d)(2)(v)
through (viii), respectively.
7. Adding a new paragraph (d)(2)(iv).
8. Revising newly redesignated para-
graph (d)(2)(v) and paragraph (d)(3)(ii).
9. Removing “(iv)” and adding “(v)” in
its place in paragraph (e)(1).
10. In paragraph (e)(2):
a. Removing “sections 11(b)(2) and
(15)” and adding “section 15” in its place
in the fourth sentence; and
b. Removing the last two sentences.
11. Removing and reserving paragraph
(e)(3).
12. In paragraph (f):
a. Removing Example 4;
b. Designating Examples 1 through 3
as paragraphs (f)(1) through (3), respec-
tively; and
c. Revising newly designated para-
graphs (f)(2) and (3).
13. In the last sentence of paragraph
(g), removing “(e.g., 0.34 for taxable
years beginning in 1989)”.
14. In paragraph (j):
a. Revising the subject heading;
b. Designating the text of paragraph (j)
as paragraph (j)(1) and adding a heading
to newly designated paragraph (j)(1); and
c. Adding paragraph (j)(2).
15. Removing paragraph (k).
The revisions and additions read as fol-
lows:
§1.383-1 Special limitations on certain
capital losses and excess credits.
(a) * * *
* * * * *
(d) * * *
(1) * * *
(i) In general.
(ii) Ordering rule for losses or credits
from same taxable year.
* * * * *
(e) * * *
(3) [Reserved]
* * * * *
(j) Applicability date.
(1) In general.
(2) Interaction with section 163(j).
* * * * *
(c) * * *
(6) * * *
(ii) Example. L, a new loss corporation, is a
calendar-year taxpayer. L has an ownership change
on December 31, 2021. For 2022, L has taxable in-
come (prior to the use of any pre-change losses) of
$100,000. In addition, L has a section 382 limitation
of $25,000, a pre-change net operating loss carry-
over of $12,000, a pre-change general business cred-
it carryforward under section 39 of $50,000, and no
items described in §1.383-1(d)(2)(i) through (iv). L’s
section 383 credit limitation for 2022 is the excess
of its regular tax liability computed after allowing
a $12,000 net operating loss deduction (taxable in-
come of $88,000; regular tax liability of $18,480),
over its regular tax liability computed after allowing
an additional deduction in the amount of L’s section
382 limitation remaining after the application of
paragraphs (d)(2)(i) through (v) of this section, or
$13,000 (taxable income of $75,000; regular tax lia-
bility of $15,750). L’s section 383 credit limitation is
therefore $2,730 ($18,480 minus $15,750).
(d) * * *
(1) In general—(i) General rule. The
amount of taxable income of a new loss
corporation for any post-change year that
may be offset by pre-change losses shall
not exceed the amount of the section 382
limitation for the post-change year. The
amount of the regular tax liability of a new
loss corporation for any post-change year
that may be offset by pre-change credits
shall not exceed the amount of the section
383 credit limitation for the post-change
year.
(ii) Ordering rule for losses or cred-
its from same taxable year. A loss corpo-
ration’s taxable income is offset first by
losses subject to a section 382 limitation,
to the extent the section 382 limitation for
that taxable year has not yet been absorbed,
before being offset by losses of the same
type from the same taxable year that are
not subject to a section 382 limitation. For
example, assume that Corporation X has
an ownership change in Year 1 and carries
over disallowed business interest expense
as defined in §1.163(j)-1(b)(10), some of
which constitutes a section 382 disallowed
business interest carryforward, from Year 1
to Year 2. To the extent of its section 163(j)
limitation, as defined in §1.163(j)-1(b)(36),
and its remaining section 382 limitation,
Corporation X offsets its Year 2 income
with the section 382 disallowed business
interest carryforward before using any of
the disallowed business interest expense
that is not a section 382 disallowed busi-
ness interest carryforward. Similar princi-
ples apply to the use of tax credits.
(2) * * *
(iii) Pre-change losses that are de-
scribed in §1.382-2(a)(2)(iii), other than
losses that are pre-change capital losses,
that are recognized and are subject to the
section 382 limitation in such post-change
year;
(iv)(A) With respect to an owner-
ship change date occurring prior to No-
vember 13, 2020, but during the taxable
year which includes November 13, 2020,
the pre-change loss described in section
382(d)(3);
(B) With respect to an ownership
change date occurring on or after Novem-
ber 13, 2020, section 382 disallowed busi-
ness interest carryforwards (within the
meaning of §1.382-2(a)(7));
(v) Pre-change losses not described in
paragraphs (d)(2)(i) through (iv) of this
section;
* * * * *
(3) * * *
(ii) Example. L, a calendar-year taxpayer, has
an ownership change on December 31, 2021. For
2022, L has taxable income of $300,000 and a reg-
ular tax liability of $63,000. L has no pre-change
losses, but it has a business credit carryforward from
2020 of $25,000. L has a section 382 limitation for
2022 of $50,000. L’s section 383 credit limitation is
$10,500, an amount equal to the excess of L’s regu-
lar tax liability ($63,000) over its regular tax liability
calculated by allowing an additional deduction of
$50,000 ($52,500). Pursuant to the limitation con-
tained in section 38(c), however, L is entitled to use
only $9,500 (($63,000 - $25,000) x 25 percent) of
its business credit carryforward in 2022. The unab-
sorbed portion of L’s section 382 limitation, $1,000
(computed pursuant to paragraph (e) of this section),
is carried forward under section 382(b)(2). The un-
used portion of L’s business credit carryforward,
$14,500, is carried forward to the extent provided in
section 39.
* * * * *
(f) * * *
(2) Example 2—(i) Facts. L, a calendar-year
taxpayer, has an ownership change on December 31,
2021. For 2022, L has $750,000 of ordinary taxable
income (before the application of carryovers) and a
section 382 limitation of $1,500,000. L’s only carry-
overs are from pre-2021 taxable years and consist of
a $500,000 net operating loss (NOL) carryover, and
a $200,000 foreign tax credit carryover (all of which
may be used under the section 904 limitation). The
NOL carryover is a pre-change loss, and the foreign
tax credit carryover is a pre-change credit. L has no
other pre-change losses or credits that can be used
in 2022.
(ii) Analysis. The following computation illus-
trates the application of this section for 2022:

Bulletin No. 2020–40 775 September 28, 2020
(3) Example 3—(i) Facts. L, a calendar-year
taxpayer, has an ownership change on December 31,
2021. L has $80,000 of ordinary taxable income (be-
fore the application of carryovers) and a section 382
limitation of $25,000 for 2022, a post-change year.
L’s only carryover is from a pre-2021 taxable year
and is a general business credit carryforward under
section 39 in the amount of $10,000 (no portion of
which is attributable to the investment tax credit un-
der section 46). The general business credit carryfor-
ward is a pre-change credit. L has no other credits
which can be used in 2022.
(ii) Analysis. The following computation illus-
trates the application of this section:
Table 1 to paragraph (f)(2)(ii)
1. Taxable income before carryovers$750,000
2. Pre-change NOL carryover$500,000
3. Section 382 limitation$1,500,000
4. Amount of pre-change NOL carryover that can be used (least of line 1, 2, or 3)$500,000
5. Taxable income (line 1 minus line 4)$250,000
6. Section 382 limitation remaining (line 3 minus line 4)$1,000,000
7. Pre-change credit carryover$200,000
8. Regular tax liability (line 5 x section 11 rates)$52,500
9. Modified tax liability (line 5 minus line 6 (but not less than zero) x section 11 rates)$0
10. Section 383 credit limitation (line 8 minus line 9)$52,500
11. Amount of pre-change credits that can be used in 2022 (lesser of line 7 or line 10)$52,500
12. Amount of pre-change credits to be carried over to 2023 under section 904(c) (line 7 minus line 11)$147,500
13. Section 383 credit reduction amount: $52,500/0.21$250,000
14. Section 382 limitation to be carried to 2023 under section 382(b)(2) (line 6 minus line 13)$750,000
Table 2 to paragraph (f)(3)(ii)
1. Taxable income before carryovers$80,000
2. Section 382 limitation$25,000
3. Pre-change credit carryover$10,000
4. Regular tax liability (line 1 x section 11 rates)$16,800
5. Modified tax liability ((line 1 minus line 2) x section 11 rates)$11,550
6. Section 383 credit limitation (line 4 minus line 5)$5,250
7. Amount of pre-change credits that can be used (lesser of line 3 or line 6)$5,250
8. Amount of pre-change credits to be carried over to 2023 under sections 39 and 382(l)(2) (line 3 minus line 7)$4,750
9. Regular tax payable (line 4 minus line 7)$11,550
10. Section 383 credit reduction amount: $5,250/0.21$25,000
11. Section 382 limitation to be carried to 2023 under section 382(b)(2) (line 2 minus line 10)$0
* * * * *
(j) Applicability date—(1) In general.
* * *
(2) Interaction with section 163(j).
Paragraphs (c)(6)(i)(B) and (c)(6)(ii), (d)
(1), (d)(2)(iii) through (viii), (d)(3)(ii), (e)
(1) through (3), (f), and (g) of this section
apply with respect to ownership changes
occurring during a taxable year begin-
ning on or after November 13, 2020. For
loss corporations that have undergone an
ownership change during a taxable year
beginning before November 13, 2020, see
§1.383-1 as contained in 26 CFR part 1,
revised April 1, 2019. However, taxpay-
ers and their related parties, within the
meaning of sections 267(b) and 707(b)
(1), may choose to apply the rules of this
section to an ownership change occurring
during a taxable year beginning after De-
cember 31, 2017, so long as the taxpayers
and their related parties consistently ap-
ply either the rules of this section (except
paragraph (d)(2)(iv)(B) of this section),
the section 163(j) regulations (as defined
in §1.163(j)-1(b)(37)), §§1.382-1, 1.382-
2, 1.382-5, 1.382-6, 1.382-7, and 1.383-0,
and, if applicable, §§1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-
99 (to the extent they effectuate the rules
of §§1.382-2, §1.382-5, 1.382-6, and
1.383-1), and 1.1504-4; or the rules of
this section (except paragraph (d)(2)(iv)
(A) of this section), the section 163(j)
regulations (as defined in §1.163(j)-1(b)
(37)) and §§1.382-1, 1.382-2, 1.382-5,
1.382-6, and 1.383-0, and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-
1, 1.469-9, 1.469-11, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-
5, 1.382-6, 1.382-7, and 1.383-1), and
1.1504-4, to those ownership changes.
Par. 14. Section 1.446-3 is amended
by revising paragraphs (g)(4) and (j)(2) to
read as follows:

September 28, 2020 776 Bulletin No. 2020–40
§1.446-3 Notional principal contracts.
* * * * *
(g) * * *
(4) Swaps with significant nonperiod-
ic payments—(i) General rule. Except as
provided in paragraph (g)(4)(ii) of this
section, a swap with significant nonperi-
odic payments is treated as two separate
transactions consisting of an on-market,
level payment swap and a loan. The loan
must be accounted for by the parties to the
contract independently of the swap. The
time value component associated with the
loan, determined in accordance with para-
graph (f)(2)(iii)(A) of this section, is rec-
ognized as interest expense to the payor
and interest income to the recipient.
(ii) Exception for cleared swaps and
non-cleared swaps subject to margin or
collateral requirements. Paragraph (g)(4)
(i) of this section does not apply to a swap
if the contract is described in paragraph
(g)(4)(ii)(A) or (B) of this section.
(A) The swap is cleared by a deriva-
tives clearing organization, as such term
is defined in section 1a of the Commod-
ity Exchange Act (7 U.S.C. 1a), or by a
clearing agency, as such term is defined in
section 3 of the Securities Exchange Act
of 1934 (15 U.S.C. 78c), that is registered
as a derivatives clearing organization un-
der the Commodity Exchange Act or as a
clearing agency under the Securities Ex-
change Act of 1934, respectively, and the
derivatives clearing organization or clear-
ing agency requires the parties to the swap
to post and collect margin or collateral.
(B) The swap is a non-cleared swap
that requires the parties to meet the mar-
gin or collateral requirements of a federal
regulator or that provides for margin or
collateral requirements that are substan-
tially similar to a cleared swap or a non-
cleared swap subject to the margin or
collateral requirements of a federal regu-
lator. For purposes of this paragraph (g)(4)
(ii)(B), the term federal regulator means
the Securities and Exchange Commission
(SEC), the Commodity Futures Trading
Commission (CFTC), or a prudential reg-
ulator, as defined in section 1a(39) of the
Commodity Exchange Act (7 U.S.C. 1a),
as amended by section 721 of the Dodd-
Frank Wall Street Reform and Consumer
Protection Act of 2010, Public Law No.
111-203, 124 Stat. 1376, Title VII.
(iii) Coordination with section 163(j).
For the treatment of swaps with signifi-
cant nonperiodic payments under section
163(j), see §1.163(j)-1(b)(22)(ii).
* * * * *
(j) * * *
(2) The rules provided in paragraph (g)
(4) of this section apply to notional princi-
pal contracts entered into on or after Sep-
tember 14, 2021. Taxpayers may choose
to apply the rules provided in paragraph
(g)(4) of this section to notional principal
contracts entered into before September
14, 2021.
Par. 15. Section 1.469-9 is amended by
revising paragraph (b)(2) to read as fol-
lows:
§1.469-9 Rules for certain rental real
estate activities.
* * * * *
(b) * * *
(2) Real property trade or business.
The following terms have the following
meanings in determining whether a trade
or business is a real property trade or busi-
ness for purposes of section 469(c)(7)(C)
and this section.
(i) Real property—(A) In general. The
term real property includes land, build-
ings, and other inherently permanent
structures that are permanently affixed
to land. Any interest in real property, in-
cluding fee ownership, co-ownership, a
leasehold, an option, or a similar interest
is real property under this section. Tenant
improvements to land, buildings, or other
structures that are inherently permanent
or otherwise classified as real property
under this section are real property for
purposes of section 469(c)(7)(C). How-
ever, property manufactured or produced
for sale that is not real property in the
hands of the manufacturer or producer,
but that may be incorporated into real
property through installation or any sim-
ilar process or technique by any person
after the manufacture or production of
such property (for example, bricks, nails,
paint, and windowpanes), is not treated
as real property in the hands of any per-
son (including any person involved in the
manufacture, production, sale, incorpora-
tion or installation of such property) prior
to the completed incorporation or instal-
lation of such property into the real prop-
erty for purposes of section 469(c)(7)(C)
and this section.
(B) Land. The term land includes wa-
ter and air space superjacent to land and
natural products and deposits that are un-
severed from the land. Natural products
and deposits, such as plants, crops, trees,
water, ores, and minerals, cease to be real
property when they are harvested, sev-
ered, extracted, or removed from the land.
Accordingly, any trade or business that
involves the cultivation and harvesting of
plants, crops, or certain types of trees in
a farming operation as defined in section
464(e), or severing, extracting, or remov-
ing natural products or deposits from land
is not a real property trade or business
for purposes of section 469(c)(7)(C) and
this section. The storage or maintenance
of severed or extracted natural products
or deposits, such as plants, crops, trees,
water, ores, and minerals, in or upon real
property does not cause the stored proper-
ty to be recharacterized as real property,
and any trade or business relating to or
involving such storage or maintenance
of severed or extracted natural products
or deposits is not a real property trade
or business, even though such storage or
maintenance otherwise may occur upon or
within real property.
(C) Inherently permanent structure.
The term inherently permanent structure
means any permanently affixed building
or other permanently affixed structure.
If the affixation is reasonably expected
to last indefinitely, based on all the facts
and circumstances, the affixation is con-
sidered permanent. However, an asset that
serves an active function, such as an item
of machinery or equipment (for example,
HVAC system, elevator or escalator), is
not a building or other inherently perma-
nent structure, and therefore is not real
property for purposes of section 469(c)(7)
(C) and this section, even if such item of
machinery or equipment is permanently
affixed to or becomes incorporated within
a building or other inherently permanent
structure. Accordingly, a trade or business
that involves the manufacture, installa-
tion, operation, maintenance, or repair of
any asset that serves an active function
will not be a real property trade or busi-
ness, or a unit or component of another
real property trade or business, for purpos-
es of section 469(c)(7)(C) and this section.

Bulletin No. 2020–40 777 September 28, 2020
(D) Building—(1) In general. A build-
ing encloses a space within its walls and is
generally covered by a roof or other exter-
nal upper covering that protects the walls
and inner space from the elements.
(2) Types of buildings. Buildings in-
clude the following assets if permanently
affixed to land: houses; townhouses; apart-
ments; condominiums; hotels; motels;
stadiums; arenas; shopping malls; factory
and office buildings; warehouses; barns;
enclosed garages; enclosed transportation
stations and terminals; and stores.
(E) Other inherently permanent struc-
tures—(1) In general. Other inherently
permanent structures include the follow-
ing assets if permanently affixed to land:
parking facilities; bridges; tunnels; road-
beds; railroad tracks; pipelines; storage
structures such as silos and oil and gas
storage tanks; and stationary wharves and
docks.
(2) Facts and circumstances determi-
nation. The determination of whether an
asset is an inherently permanent structure
is based on all the facts and circumstances.
In particular, the following factors must be
taken into account:
(i) The manner in which the asset is
affixed to land and whether such manner
of affixation allows the asset to be easily
removed from the land;
(ii) Whether the asset is designed to be
removed or to remain in place indefinitely
on the land;
(iii) The damage that removal of the as-
set would cause to the asset itself or to the
land to which it is affixed;
(iv) Any circumstances that suggest the
expected period of affixation is not indef-
inite (for example, a lease that requires or
permits removal of the asset from the land
upon the expiration of the lease); and
(v) The time and expense required to
move the asset from the land.
(ii) Other definitions—(A) through (G)
[Reserved]
(H) Real property operation. The term
real property operation means handling,
by a direct or indirect owner of the real
property, the day-to-day operations of a
trade or business, under paragraph (b)
(1) of this section, relating to the mainte-
nance and occupancy of the real property
that affect the availability and functional-
ity of that real property used, or held out
for use, by customers where payments
received from customers are principally
for the customers’ use of the real proper-
ty. The principal purpose of such business
operations must be the provision of the
use of the real property, or physical space
accorded by or within the real property, to
one or more customers, and not the provi-
sion of other significant or extraordinary
personal services, under §1.469-1T(e)(3)
(iv) and (v), to customers in conjunction
with the customers’ incidental use of the
real property or physical space. If the real
property or physical space is provided
to a customer to be used to carry on the
customer’s trade or business, the principal
purpose of the business operations must
be to provide the customer with exclusive
use of the real property or physical space
in furtherance of the customer’s trade or
business, and not to provide other signifi-
cant or extraordinary personal services to
the customer in addition to or in conjunc-
tion with the use of the real property or
physical space, regardless of whether the
customer pays for the services separately.
However, for purposes of and with respect
to the preceding sentence, other incidental
personal services may be provided to the
customer in conjunction with the use of
real property or physical space, as long as
such services are insubstantial in relation
to the customer’s use of the real property
or physical space.
(I) Real property management. The
term real property management means
handling, by a professional manager,
the day-to-day operations of a trade or
business, under paragraph (b)(1) of this
section, relating to the maintenance and
occupancy of real property that affect
the availability and functionality of that
property used, or held out for use, by cus-
tomers where payments received from
customers are principally for the custom-
ers’ use of the real property. The princi-
pal purpose of such business operations
must be the provision of the use of the
real property, or physical space accorded
by or within the real property, to one or
more customers, and not the provision of
other significant or extraordinary personal
services, under §1.469-1T(e)(3)(iv) and
(v), to customers in conjunction with the
customers’ incidental use of the real prop-
erty or physical space. If the real property
or physical space is provided to a custom-
er to be used to carry on the customer’s
trade or business, the principal purpose of
the business operations must be to provide
the customer with exclusive use of the real
property or physical space in furtherance
of the customer’s trade or business, and
not to provide other significant or extraor-
dinary personal services to the customer
in addition to or in conjunction with the
use of the real property or physical space,
regardless of whether the customer pays
for the services separately. However, for
purposes of and with respect to the pre-
ceding sentence, other incidental personal
services may be provided to the customer
in conjunction with the use of real prop-
erty or physical space, as long as such
services are insubstantial in relation to
the customer’s use of the real property or
physical space. A professional manager is
a person responsible, on a full-time basis,
for the overall management and oversight
of the real property or properties and who
is not a direct or indirect owner of the real
property or properties.
(iii) Examples. The following exam-
ples illustrate the operation of this para-
graph (b)(2):
(A) Example 1. A owns farmland and uses the
land in A’s farming business to grow and harvest
crops of various kinds. As part of this farming busi-
ness, A utilizes a greenhouse that is an inherently
permanent structure to grow certain crops during the
winter months. Under the rules of this section, any
trade or business that involves the cultivation and
harvesting of plants, crops, or trees is not a real prop-
erty trade or business for purposes of section 469(c)
(7)(C) and this section, even though the cultivation
and harvesting of crops occurs upon or within real
property. Accordingly, under these facts, A is not en-
gaged in a real property trade or business for purpos-
es of section 469(c)(7)(C) and this section.
(B) Example 2. B is a retired farmer and owns
farmland that B rents exclusively to C to operate a
farm. The arrangement between B and C is a trade
or business (under paragraph (b)(1) of this section)
where payments by C are principally for C’s use of
B’s real property. B also provides certain farm equip-
ment for C’s use. However, C is solely responsible
for the maintenance and repair of the farm equipment
along with any costs associated with operating the
equipment. B also occasionally provides oral ad-
vice to C regarding various aspects of the farm op-
eration, based on B’s prior experience as a farmer.
Other than the provision of this occasional advice,
B does not provide any significant or extraordinary
personal services to C in connection with the rental
of the farmland to C. Under these facts, B is engaged
in a real property trade or business (which does not
include the use or deemed rental of any farm equip-
ment) for purposes of section 469(c)(7)(C) and this
section, and B’s oral advice is an incidental personal
service that B provides in conjunction with C’s use
of the real property. Nevertheless, under these facts,

September 28, 2020 778 Bulletin No. 2020–40
C is not engaged in a real property trade or business
for purposes of section 469(c)(7)(C) and this section
because C is engaged in the business of farming.
(C) Example 3. D owns a building in which D
operates a restaurant and bar. Even though D pro-
vides customers with use of the physical space inside
the building, D is not engaged in a trade or business
where payments by customers are principally for
the use of real property or physical space. Instead,
the payments by D’s customers are principally for
the receipt of significant or extraordinary personal
services (under §1.469-1T(e)(3)(iv) and (v)), main-
ly food and beverage preparation and presentation
services, and the use of the physical space by cus-
tomers is incidental to the receipt of these personal
services. Under the rules of this section, any trade or
business that involves the provision of significant or
extraordinary personal services to customers in con-
junction with the customers’ incidental use of real
property or physical space is not a real property trade
or business, even though the business operations oc-
cur upon or within real property. Accordingly, under
these facts, D is not engaged in a real property trade
or business for purposes of section 469(c)(7)(C) and
this section.
(D) Example 4. E owns a majority interest in an
S corporation, X, that is engaged in the trade or busi-
ness of manufacturing industrial cooling systems for
installation in commercial buildings and for other
uses. E also owns a majority interest in an S corpo-
ration, Y, that purchases the industrial cooling sys-
tems from X and that installs, maintains, and repairs
those systems in both existing commercial buildings
and commercial buildings under construction. Under
the rules of this section, any trade or business that
involves the manufacture, installation, operation,
maintenance, or repair of any machinery or equip-
ment that serves an active function will not be a real
property trade or business (or a unit or component of
another real property trade or business) for purposes
of section 469(c)(7)(C) and this section, even though
the machinery or equipment will be permanently
affixed to real property once it is installed. In this
case, the industrial cooling systems are machinery or
equipment that serves an active function. According-
ly, under these facts, E, X and Y will not be treated
as engaged in one or more real property trades or
businesses for purposes of section 469(c)(7)(C) and
this section.
(E) Example 5. (1) F owns an interest in P, a
limited partnership. P owns and operates a luxury
hotel. In addition to providing rooms and suites for
use by customers, the hotel offers many additional
amenities such as in-room food and beverage ser-
vice, maid and linen service, parking valet service,
concierge service, front desk and bellhop service,
dry cleaning and laundry service, and in-room bar-
ber and hairdresser service. P contracted with M to
provide maid and janitorial services to P’s hotel. M
is an S corporation principally engaged in the trade
or business of providing maid and janitorial services
to various types of businesses, including hotels. G is
a professional manager employed by M who handles
the day-to-day business operations relating to M’s
provision of maid and janitorial services to M’s vari-
ous customers, including P.
(2) Even though the personal services that P
provides to the customers of its hotel are significant
personal services under §1.469-1T(e)(3)(iv), the
principal purpose of P’s hotel business operations is
the provision of use of the hotel’s rooms and suites
to customers, and not the provision of the significant
personal services to P’s customers in conjunction
with the customers’ incidental use of those rooms
or suites. The provision of these significant personal
services by P to P’s customers is incidental to the
customers’ use of the hotel’s real property. Accord-
ingly, under these facts, F is treated as owning an
interest in a real property trade or business conducted
by or through P and P is treated as engaged in a real
property trade or business for purposes of section
469(c)(7)(C) and this section.
(3) With respect to the maid and janitorial ser-
vices provided by M, M’s operations affect the
availability and functionality of real property used,
or held out for use, by customers in a trade or busi-
ness where payments by customers are principally
for the use of real property (in this case, P’s hotel).
However, M does not operate or manage real prop-
erty. Instead, M is engaged in a trade or business of
providing maid and janitorial services to customers,
such as P, that are engaged in real property trades
or businesses. Thus, M’s business operations are
merely ancillary to real property trades or business-
es. Therefore, M is not engaged in real property op-
erations or management as defined in this section.
Accordingly, under these facts, M is not engaged in
a real property trade or business under section 469(c)
(7)(C) and this section.
(4) With respect to the day-to-day business op-
erations that G handles as a professional manager of
M, the business operations that G manages is not the
provision of use of P’s hotel rooms and suites to cus-
tomers. G does not operate or manage real property.
Instead, G manages the provision of maid and janito-
rial services to customers, including P’s hotel. There-
fore, G is not engaged in real property management
as defined in this section. Accordingly, under these
facts, G is not engaged in a real property trade or
business under section 469(c)(7)(C) and this section.
* * * * *
Par. 16. Section 1.469-11 is amended
by:
1. Revising the section heading;
2. Removing the period at the end of
paragraph (a)(1) and adding a semicolon
in its place;
3. Revising paragraph (a)(3);
4. Redesignating paragraphs (a)(4) and
(5) as paragraphs (a)(5) and (6), respec-
tively; and
5. Adding a new paragraph (a)(4).
The revision and addition read as fol-
lows:
§1.469-11 Applicability date and
transition rules.
(a) * * *
(3) The rules contained in §1.469–9,
other than paragraph (b)(2), apply for
taxable years beginning on or after Janu-
ary 1, 1995, and to elections made under
§1.469–9(g) with returns filed on or after
January 1, 1995;
(4) The rules contained in §1.469-9(b)
(2) apply to taxable years beginning on
or after November 13, 2020 . However,
taxpayers and their related parties, un-
der sections 267(b) and 707(b)(1), may
choose to apply the rules of §1.469-9(b)
(2) for a taxable year beginning after De-
cember 31, 2017, so long as they consis-
tently apply the rules of §1.469-9(b)(2),
the section 163(j) regulations (as defined
in §1.163(j)-1(b)(37)), 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, 1.704-1,
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, 1.382-7, and 1.383-1), and
1.1504-4 to that taxable year;
* * * * *
Par. 17. Section 1.704-1 is amended
by adding paragraph (b)(4)(xi) to read as
follows:
§1.704-1 Partner’s distributive share.
* * * * *
(b) * * *
(4) * * *
(xi) Section 163(j) excess items. Allo-
cations of section 163(j) excess items as
defined in §1.163(j)-6(b)(6) do not have
substantial economic effect under para-
graph (b)(2) of this section and, accord-
ingly, such expenditures must be allocated
in accordance with the partners’ interests
in the partnership. See paragraph (b)(3)
(iv) of this section. Allocations of section
163(j) excess items will be deemed to be
in accordance with the partners’ interests
in the partnership if such allocations are
made in accordance with §1.163(j)-6(f).
*****
Par. 18. Section 1.860C-2 is amended
by revising paragraph (b)(2) to read as
follows:
§1.860C-2 Determination of REMIC
taxable income or net loss.
* * * * *
(b) * * *

Bulletin No. 2020–40 779 September 28, 2020
(2) Deduction allowable under section
163—(i) A REMIC is allowed a deduc-
tion, determined without regard to section
163(d), for any interest expense accrued
during the taxable year.
(ii) For taxable years beginning after
December 31, 2017, a REMIC is allowed
a deduction, determined without regard to
section 163(j), for any interest expense ac-
crued during the taxable year.
* * * * *
Par. 19. Section 1.1362-3 is amended
by:
1. Redesignating the text in paragraph
(c)(3) as paragraph (c)(3)(i), adding a sub-
ject heading to newly redesignated para-
graph (c)(3)(i), and adding paragraph (c)
(3)(ii); and
2. Designating Examples 1 through
4 of paragraph (d) as paragraphs (d)(1)
through (d)(4), respectively.
The additions read as follows:
§1.1362-3 Treatment of S termination
year.
* * * * *
(c) * * *
(3) * * *
(i) In general. * * *
(ii) Application of section 163(j). For
purposes of section 163(j), a separate lim-
itation (as defined in §1.163(j)-1(b)(36))
applies to each S short year and each C
short year. Any items necessary to de-
termine the amount of business interest
expense (as defined in §1.163(j)-1(b)(3))
that are deducted in each S short year or C
short year must be allocated between the S
short year and C short year in accordance
with an allocation methodology provided
in section 1362(e).
* * * * *
Par. 20. Section 1.1368-1 is amended
by adding a sentence to the end of para-
graph (g)(2)(ii) to read as follows:
§1.1368-1 Distributions by S
corporations.
* * * * *
(g) * * *
(2) * * *
(ii) * * * In the case of a taxable year
for which an election is made under para-
graph (g)(2)(i), for purposes of section
163(j), a separate section 163(j) limita-
tion (as defined in §1.163(j)-1(b)(36))
applies to each separate taxable year. Any
items necessary to determine the amount
of business interest expense (as defined
in §1.163(j)-1(b)(3)) that are deducted in
each separate taxable year must be allocat-
ed between the two separate taxable years
in accordance with an allocation method-
ology provided in this paragraph (g).
* * * * *
Par. 21. Section 1.1377-1 is amended
by:
1. Redesignating paragraphs (b)(3)
(ii) through (iv) as paragraphs (b)(3)(iii)
through (v), respectively; and
2. Adding a new paragraph (b)(3)(ii).
The addition reads as follows:
§1.1377-1 Pro rata share.
* * * * *
(b) * * *
(3) * * *
(ii) Section 163(j). If a terminating
election is made to treat the S corpora-
tion’s taxable year as consisting of sepa-
rate taxable years, for purposes of section
163(j), a separate limitation (as defined in
§1.163(j)-1(b)(36)) will apply to each sep-
arate taxable year. Any items necessary to
determine the amount of business interest
expense (as defined in §1.163(j)-1(b)(3))
that are deducted in each separate taxable
year must be allocated between the sepa-
rate taxable years in accordance with an
allocation methodology provided in this
section.
* * * * *
Par. 22. Section 1.1502-13 is amended:
1. In paragraph (a)(6)(ii), under the
heading “Anti-avoidance rules. (§1.1502-
13(h)(2))”, by:
i. Designating Examples 1 through 5 as
entries (i) through (v); and
ii. Adding an entry (vi);
2. In paragraph (h)(2) by:
a. Designating Examples 1 through 5
as paragraphs (h)(2)(i) through (v), re-
spectively.
b. In newly designated paragraphs (h)
(2)(i) through (v):
i. Redesignating paragraphs (h)(2)(i)
(a) and (b) as paragraphs (h)(2)(i)(A) and
(B);
ii. Redesignating paragraphs (h)(2)(ii)
(a) and (b) as paragraphs (h)(2)(ii)(A) and
(B);
iii. Redesignating paragraphs (h)(2)
(iii)(a) and (b) as paragraphs (h)(2)(iii)(A)
and (B);
iv. Redesignating paragraphs (h)(2)(iv)
(a) and (b) as paragraphs (h)(2)(iv)(A) and
(B);
v. Redesignating paragraphs (h)(2)(v)
(a) and (b) as paragraphs (h)(2)(iv)(A) and
(B); and
c. Adding paragraph (h)(2)(vi).
The additions read as follows:
§1.1502-13 Intercompany transactions.
(a) * * *
(6) * * *
(ii) * * *
Anti-avoidance rules. (§1.1502-13(h)
(2))
* * * * *
(vi) Example 6. Section 163(j) interest
limitation.
* * * * *
(h) * * *
(2) * * *
(vi) Example 6: Section 163(j) interest limita-
tion—(A) Facts. S1 and S2 are members of a con-
solidated group of which P is the common parent.
S1 is engaged in an excepted trade or business, and
S2 is engaged in a non-excepted trade or business.
If S1 were to lend funds directly to S2 in an inter-
company transaction, under §1.163(j)-10(a)(4)(i),
the intercompany obligation of S2 would not be con-
sidered an asset of S1 for purposes of §1.163(j)-10
(concerning allocations of interest and other taxable
items between excepted and non-excepted trades or
businesses for purposes of section 163(j)). With a
principal purpose of avoiding treatment of a lending
transaction between S1 and S2 as an intercompany
transaction (and increasing the P group’s basis in its
assets allocable to excepted trades or businesses), S1
lends funds to X (an unrelated third party). X then
on-lends funds to S2 on substantially similar terms.
(B) Analysis. A principal purpose of the steps
undertaken was to avoid treatment of a lending
transaction between S1 and S2 as an intercompany
transaction. Therefore, under paragraph (h)(1) of this
section, appropriate adjustments are made, and the X
obligation in the hands of S1 is not treated as an asset
of S1 for purposes of §1.163(j)-10, to the extent of
the loan from X to S2.
* * * * *
Par. 23. Section 1.1502-21 is amended
by adding new paragraph (c)(3) to read as
follows:
§1.1502-21 Net operating losses.
* * * * *
(c) * * *

September 28, 2020 780 Bulletin No. 2020–40
(3) Cross-reference. For rules govern-
ing the application of a SRLY limitation
to business interest expense for which
a deduction is disallowed under section
163(j), see §1.163(j)-5(d) and (f).
* * * * *
Par. 24. Section 1.1502-36 is amended
by:
1. Revising the second sentence of
paragraph (f)(2);
2. Revising the paragraph (h) heading;
3. Designating the text of paragraph (h)
as paragraph (h)(1) and adding a heading
to newly designated paragraph (h)(1); and
4. Adding paragraph (h)(2).
The revisions and addition read as fol-
lows:
§1.1502-36 Unified loss rule.
* * * * *
(f) * * *
(2) * * * Such provisions include, for
example, sections 163(j), 267(f), and 469,
and §1.1502-13. * * *
* * * * *
(h) Applicability date—(1) In general.
* * *
(2) Definition in paragraph (f)(2) of
this section. Paragraph (f)(2) of this sec-
tion applies to taxable years beginning on
or after November 13, 2020. For taxable
years beginning before November 13,
2020, see §1.1502-36 as contained in 26
CFR part 1, revised April 1, 2019. How-
ever, taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b)(1), may choose to apply the rules
of this section to a taxable year beginning
after December 31, 2017, and before No-
vember 13, 2020, so long as the taxpayers
and their related parties consistently apply
the rules of this section, the section 163(j)
regulations (as defined in §1.163(j)-1(b)
(37)), 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, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.382-
5, 1.382-6, 1.382-7, and 1.383-1), and
1.1504-4, to that taxable year.
Par. 25. Section 1.1502-79 is amended
by adding paragraph (f) to read as follows:
§1.1502-79 Separate return years.
* * * * *
(f) Disallowed business interest ex-
pense carryforwards. For the treatment of
disallowed business interest expense car-
ryforwards (as defined in §1.163(j)-1(b)
(11)) of a member arising in a separate
return limitation year, see §1.163(j)-5(d)
and (f).
Par. 26. Section 1.1502-90 is amended
by revising the entry for §1.1502-98 and
adding an entry for §1.1502-99(d) to read
as follows:
§1.1502-90 Table of contents.
* * * * *
§1.1502-98 Coordination with sections
383 and 163(j).
§1.1502-99 Effective dates.
* * * * *
(d) Application to section 163(j).
Par. 27. Section 1.1502-91 is amended
by revising paragraph (e)(2) to read as fol-
lows:
§1.1502-91 Application of section 382
with respect to a consolidated group.
* * * * *
(e) * * *
(2) Example—(i) Facts. The L group has a con-
solidated net operating loss arising in Year 1 that is
carried over to Year 2. The L loss group has an own-
ership change at the beginning of Year 2.
(ii) Analysis. The net operating loss carryover of
the L loss group from Year 1 is a pre-change con-
solidated attribute because the L group was entitled
to use the loss in Year 2 and therefore the loss was
described in paragraph (c)(1)(i) of this section. Un-
der paragraph (a)(2)(i) of this section, the amount of
consolidated taxable income of the L group for Year
2 that may be offset by this loss carryover may not
exceed the consolidated section 382 limitation of the
L group for that year. See §1.1502-93 for rules relat-
ing to the computation of the consolidated section
382 limitation.
(iii) Business interest expense. The facts are the
same as in the Example in paragraph (e)(2)(i) of
this section, except that, rather than a consolidated
net operating loss, a member of the L group pays
or accrues a business interest expense in Year 1 for
which a deduction is disallowed in that year under
section 163(j) and §1.163(j)-2(b). The disallowed
business interest expense is carried over to Year 2
under section 163(j)(2) and §1.163(j)-2(c). Thus, the
disallowed business interest expense carryforward is
a pre-change loss. Under section 163(j), the L loss
group is entitled to deduct the carryforward in Year
2; however, the amount of consolidated taxable in-
come of the L group for Year 2 that may be offset by
this carryforward may not exceed the consolidated
section 382 limitation of the L group for that year.
See §1.1502-98(b) (providing that §§1.1502-91
through 1.1502-96 apply section 382 to business in-
terest expense, with appropriate adjustments).
* * * * *
Par. 28. Section 1.1502-95 is amended
in paragraph (b)(4) by:
1. Designating Examples 1 and 2 as
paragraphs (b)(4)(i) and (ii), respectively;
2. In newly designated paragraph (b)
(4)(i), redesignating paragraphs (b)(4)(i)
(i) and (ii) as paragraphs (b)(4)(i)(A) and
(B), respectively;
3. In newly designated paragraph (b)
(4)(ii), redesignating paragraphs (b)(4)(ii)
(i) and (ii) as paragraphs (b)(4)(ii)(A) and
(B), respectively; and
4. Adding two sentences at the end of
newly redesignated paragraph (b)(4)(ii)
(B).
The additions read follows:
§1.1502-95 Rules on ceasing to be a
member of a consolidated group (or loss
subgroup).
* * * * *
(b) * * *
(4) * * *
(ii) * * *
(B) * * * The analysis would be sim-
ilar if the L loss group had an ownership
change under §1.1502-92 in Year 2 with
respect to disallowed business interest ex-
pense paid or accrued by L2 in Year 1 and
carried forward under section 163(j)(2)
to Year 2 and Year 3. See §1.1502-98(b)
(providing that §§1.1502-91 through
1.1502-96 apply section 382 to business
interest expense, with appropriate adjust-
ments).
* * * * *
Par. 29. Section 1.1502-98 is amended
by:
1. Revising the section heading;
2. Designating the undesignated text as
paragraph (a) and adding a subject head-
ing for newly designated paragraph (a);
and
3. Adding paragraph (b).
The revision and additions read as fol-
lows:
§1.1502-98 Coordination with sections
383 and 163(j).
(a) Coordination with section 383. * *
*

Bulletin No. 2020–40 781 September 28, 2020
(b) Application to section 163(j)—(1)
In general. The regulations in this part
under sections 163(j), 382, and 383 of the
Code contain rules governing the appli-
cation of section 382 to interest expense
governed by section 163(j) and the regu-
lations in this part under section 163(j) of
the Code. See, for example, §§1.163(j)-
11(c), 1.382-2, 1.382-6, 1.382-7, and
1.383-1. The rules contained in §§1.1502-
91 through 1.1502-96 apply these rules to
members of a consolidated group, or cor-
porations that join or leave a consolidated
group, with appropriate adjustments. For
example, for purposes of §§1.1502-91
through 1.1502-96, the term loss group
includes a consolidated group in which
any member is entitled to use a disallowed
business interest expense carryforward,
as defined in §1.163(j)-1(b)(11), that did
not arise, and is not treated as arising, in
a SRLY with regard to that group. Ad-
ditionally, a reference to net operating
loss carryovers in §§1.1502-91 through
1.1502-96 generally includes a reference
to disallowed business interest expense
carryforwards. References to a loss or
losses in §§1.1502-91 through 1.1502-96
include references to disallowed business
interest expense carryforwards or section
382 disallowed business interest carryfor-
wards, within the meaning of §1.382-2(a)
(7), as appropriate.
(2) Appropriate adjustments. For pur-
poses of applying the rules in §§1.1502-
91 through 1.1502-96 to current-year
business interest expense (as defined in
§1.163(j)-1(b)(9)), disallowed business
interest expense carryforwards, and sec-
tion 382 disallowed business interest car-
ryforwards, appropriate adjustments are
required.
Par. 30. Section 1.1502-99 is amended
by adding paragraph (d) to read as fol-
lows:
§1.1502-99 Effective/applicability dates.
* * * * *
(d) Application to section 163(j)—(1)
Sections 1.382-2 and 1.382-5. To the ex-
tent the rules of §§1.1502-91 through
1.1502-99 effectuate the rules of §§1.382-
2 and 1.382-5, the provisions apply with
respect to ownership changes occurring
on or after November 13, 2020. For loss
corporations that have ownership chang-
es occurring before November 13, 2020,
see §§1.1502-91 through 1.1502-99 as
contained in 26 CFR part 1, revised April
1, 2019. However, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose
to apply the rules of §§1.1502-91 through
1.1502-99 to the extent they apply the
rules of §§1.382-2 and 1.382-5, to own-
ership changes occurring during a taxable
year beginning after December 31, 2017,
as well as consistently applying the rules
of the §§1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§§1.382-6 and 1.383-1), the section 163(j)
regulations (as defined in §1.163(j)-1(b)
(37)), and, if applicable, §§1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.382-7,
1.469-9, 1.469-11, 1.704-1, 1.882-5,
1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-79, and 1.1504-4, to
that taxable year.
(2) Sections 1.382-6 and 1.383-1.
To the extent the rules of §§1.1502-91
through 1.1502-98 effectuate the rules
of §§1.382-6 and 1.383-1, the provisions
apply with respect to ownership changes
occurring during a taxable year beginning
on or after November 13, 2020. For the
application of these rules to an owner-
ship change with respect to an ownership
change occurring during a taxable year
beginning before November 13, 2020,
see §§1.1502-91 through 1.1502-99 as
contained in 26 CFR part 1, revised April
1, 2019. However, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose
to apply the rules of §§1.1502-91 through
1.1502-99 (to the extent that those rules
effectuate the rules of §§1.382-6 and
1.383-1), to ownership changes occurring
during a taxable year beginning after De-
cember 31, 2017, so long as the taxpayers
and their related parties consistently apply
the rules of 1.1502-91 through 1.1502-99
(to the extent that those rules effectuate
the rules of §§1.382-2 and 1.382-5), the
section 163(j) regulations (as defined in
§1.163(j)-1(b)(37)), and, if applicable,
§§1.263A-9, 1.263A-15, 1.381(c)(20)-
1, 1.382-7, 1.469-9, 1.469-11, 1.704-1,
1.882-5, 1.1362-3, 1.1368-1, 1.1377-1,
1.1502-13, 1.1502-21, 1.1502-36, 1.1502-
79, and 1.1504-4, to a taxable year begin-
ning after December 31, 2017.
Par. 31. Section 1.1504-4 is amended
by:
1. Removing “163(j), 864(e),” from the
first sentence of paragraph (a)(2) and add-
ing “864(e)” in its place; and
2. Adding two sentences at the end of
paragraph (i).
The additions read as follows:
§1.1504-4 Treatment of warrants,
options, convertible obligations, and
other similar interests.
* * * * *
(i) * * * Paragraph (a)(2) of this sec-
tion applies with respect to taxable years
beginning on or after November 13, 2020.
However, taxpayers and their related par-
ties, within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year be-
ginning after December 31, 2017, so long
as the taxpayers and their related parties
consistently apply the rules of this section,
the section 163(j) regulations (as defined
in §1.163(j)-1(b)(37)), 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, 1.382-7,
and 1.383-1), to that taxable year.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: July 14, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on Sep-
tember 3, 2020, 4:15 p.m., and published in the issue
of the Federal Register for September 14, 2020, 85
F.R. 56686)

September 28, 2020 782 Bulletin No. 2020–40
Part III
Notice 2020-59
SECTION 1. PURPOSE
This notice contains a proposed reve-
nue procedure providing a safe harbor for a
trade or business that manages or operates
a qualified residential living facility, as de-
fined in section 3.01 of the proposed reve-
nue procedure, to be treated as a real prop-
erty trade or business solely for purposes of
qualifying as an electing real property trade
or business under section 163(j)(7)(B) of
the Internal Revenue Code (Code).
SECTION 2. BACKGROUND
On December 22, 2017, section 163(j)
of the Code was revised by § 13301(a) of
Public Law No. 115-97, 131 Stat. 2054,
commonly referred to as the Tax Cuts and
Jobs Act (TCJA), effective for tax years
beginning after December 31, 2017. On
March 27, 2020, section 163(j) was fur-
ther amended by § 2306 of the Corona-
virus Aid, Relief, and Economic Security
Act, Public Law No. 116-136, 134 Stat.
281 (CARES Act), to provide special
rules for applying section 163(j) to taxable
years beginning in 2019 or 2020.
Section 163(j) generally limits the
amount of a taxpayer’s business interest
expense that can be deducted in the cur-
rent taxable year. The deduction limitation
is calculated as the sum of: (1) the taxpay-
er’s business interest income, as defined in
section 163(j)(6), for the taxable year; (2)
30 percent of the taxpayer’s adjusted tax-
able income, as defined in section 163(j)
(8), for the taxable year, or 50 percent of
the taxpayer’s adjusted taxable income (if
applicable, as provided in section 163(j)
(10)); and (3) the taxpayer’s floor plan
financing interest, as defined in section
163(j)(9), for the taxable year.
The term “business interest” means
any interest that is properly allocable to a
trade or business. For purposes of section
163(j), the term “trade or business” does
not include certain trades or businesses
listed in section 163(j)(7). Section 163(j)
(7)(A)(ii) provides that, for purposes of
the limitation on the deduction for busi-
ness interest, the term “trade or business”
does not include an “electing real property
trade or business.” Section 163(j)(7)(B)
defines an electing real property trade or
business as a trade or business defined in
section 469(c)(7)(C) that makes a proper
election. Taxpayers that make an election
under section 163(j)(7)(B) must use the
alternative depreciation system under sec-
tion 168, and cannot claim bonus depreci-
ation. See section 163(j)(11)(A).
Section 1.163(j)-9 of the Income Tax
Regulations provides the rules and pro-
cedures for making an election under
section 163(j)(7)(B) to be an electing real
property trade or business. In addition, the
Department of the Treasury (Treasury De-
partment) and the Internal Revenue Ser-
vice (IRS) released Rev. Proc. 2020-22,
2020-18 I.R.B. 745, (April 27, 2020) to
provide the time and manner of making
a late election, or withdrawing an elec-
tion under section 163(j)(7)(B) to be an
electing real property trade or business for
taxable years beginning in 2018, 2019, or
2020. Rev. Proc. 2020-22 also provides
the time and manner of making or revok-
ing elections provided by the CARES Act
under section 163(j)(10) for taxable years
beginning in 2019 or 2020. See Rev. Proc.
2020-22 for more information regarding
the time and manner of making, revoking,
or withdrawing elections under section
163(j)(7) and section 163(j)(10).
The Treasury Department and the IRS
are aware that taxpayers have uncertainty
about whether residential living facilities
that include the provision of supplemental
assistive, nursing, or routine medical ser-
vices qualify as electing real property trades
or businesses under section 163(j)(7)(B).
To mitigate this uncertainty, the pro-
posed revenue procedure in section 6 of
this notice provides a safe harbor under
which a qualified residential living facil-
ity, as defined in section 3.01 of the pro-
posed revenue procedure, is treated as el-
igible to be an electing real property trade
or business under section 163(j)(7)(B).
SECTION 3. REQUEST FOR
COMMENTS
The Treasury Department and the IRS
request comments on the proposed reve-
nue procedure set forth in section 6 of this
notice. Interested parties are invited to
submit comments on this notice by Sep-
tember 28, 2020. The Treasury Depart-
ment and the IRS will publish for public
availability any comment received to its
public docket, whether submitted elec-
tronically or in hard copy.
WHERE TO SEND COMMENTS
Commenters are strongly encouraged
to submit public comments electronically.
Persons may submit comments electroni-
cally via the Federal eRulemaking Portal
at www.regulations.gov (indicate IRS and
NOT-126369-19). Once submitted to the
Federal eRulemaking Portal, comments
cannot be edited or withdrawn.
Send hard copy submissions to:
CC:PA:LPD:PR (NOT-126369-19), Room
5203, Internal Revenue Service, P.O. Box
7604, Ben Franklin Station, Washington,
DC 20044.
The IRS expects to have limited per-
sonnel available to process public com-
ments that are submitted on paper through
mail. Until further notice, any comments
submitted on paper will be considered to
the extent practicable.
SECTION 4. APPLICABILITY AND
IMMEDIATE RELIANCE
The proposed revenue procedure is
proposed to apply to taxable years begin-
ning after December 31, 2017.
Until the date on which the proposed
revenue procedure is published as a rev-
enue procedure in the Internal Revenue
Bulletin, taxpayers may rely on the safe
harbor described in the proposed revenue
procedure for purposes of determining
whether a qualified residential living fa-
cility, as defined in section 3.01 of the pro-
posed revenue procedure, is eligible to be
an electing real property trade or business
solely for purposes of section 163(j).
SECTION 5. DRAFTING
INFORMATION
The principal authors of this notice
are Susie Bird, Charles Gorham, and Jus-
tin Grill of the Office of Associate Chief
Counsel (Income Tax & Accounting) and

Bulletin No. 2020–40 783 September 28, 2020
Adrienne Mikolashek and William Kostak
of the Office of Associate Chief Counsel
(Passthroughs and Special Industries). For
further information regarding this notice,
contact Mr. Grill at (202) 317-7003, or
Mr. Kostak at (202) 317-5279 (not toll-
free calls).
SECTION 6. FORM OF PROPOSED
REVENUE PROCEDURE
Set forth below is the form of the pro-
posed revenue procedure that is proposed
in this notice:
FORM OF PROPOSED
REVENUE PROCEDURE
26 CFR 601.601. Rules and regulations.
(Also Part I, §163(j).)
Rev. Proc. 2020-[__]
SECTION 1. PURPOSE
This revenue procedure provides a safe
harbor that allows a trade or business that
manages or operates a qualified residential
living facility, as defined in section 3.01 of
this revenue procedure, to be treated as a
real property trade or business, solely for
purposes of qualifying as an electing real
property trade or business under section
163(j)(7)(B) of the Internal Revenue Code
(Code).
SECTION 2. BACKGROUND
.01 On December 22, 2017, section
163(j) of the Code was amended by
§ 13301 of Pubic Law No. 115-97, 131
Stat. 2054, commonly referred to as the
Tax Cuts and Jobs Act (TCJA). Section
163(j), as amended by the TCJA, provides
rules limiting the amount of business in-
terest expense that can be deducted for
taxable years beginning after December
31, 2017. See TCJA § 13301(a).
.02 On March 27, 2020, section 163(j)
of the Code was further amended by
§ 2306 of the Coronavirus Aid, Relief, and
Economic Security Act, Public Law No.
116-136, 134 Stat. 281 (CARES Act), to
provide special rules for applying section
163(j) to taxable years beginning in 2019
or 2020.
.03 Under section 163(j)(1) of the
Code, the amount allowed as a deduction
for business interest expense is limited to
the sum of: (1) the taxpayer’s business in-
terest income, as defined in section 163(j)
(6), for the taxable year; (2) 30 percent of
the taxpayer’s adjusted taxable income, as
defined in section 163(j)(8), for such tax-
able year, or 50 percent of the taxpayer’s
adjusted taxable income (if applicable, as
provided in section 163(j)(10)); and (3)
the taxpayer’s floor plan financing inter-
est, as defined in section 163(j)(9), for
such taxable year.
.04 The limitation under section 163(j)
of the Code on the deductibility of busi-
ness interest expense applies to all tax-
payers with business interest, as defined
in section 163(j)(5), except for taxpay-
ers, other than tax shelters under section
448(a)(3), that meet the gross receipts test
in section 448(c).
.05 Section 163(j)(5) of the Code gen-
erally provides that the term “business
interest” means any interest properly allo-
cable to a trade or business. Section 163(j)
(7)(A)(ii) provides that, for purposes of
the limitation on the deduction for busi-
ness interest, the term “trade or business”
does not include an “electing real property
trade or business.” Thus, interest expense
that is properly allocable to an elect-
ing real property trade or business is not
properly allocable to a trade or business
for purposes of section 163(j), and is not
business interest expense that is subject to
section 163(j)(1).
.06 The term “electing real property
trade or business” under section 163(j)(7)
(B) of the Code means any trade or busi-
ness that is described in section 469(c)(7)
(C) that makes an election to be an elect-
ing real property trade or business.
.07 Section 168(g)(1)(F) of the Code
provides that an electing real property
trade or business within the meaning of
section 163(j)(7)(B) must use the alterna-
tive depreciation system for property de-
scribed in section 168(g)(8). See section
163(j)(11)(A).
.08 The Department of the Treasury
(Treasury Department) and the Internal
Revenue Service (IRS) published (1) pro-
posed regulations under section 163(j) of
the Code in a notice of proposed rulemak-
ing (REG-106089-18) (proposed regu-
lations) in the Federal Register (83 FR
67490) on December 28, 2018, (2) final
regulations on September 14, 2020 (final
regulations) in the Federal Register (85 FR
56686), and (3) concurrently with the pub-
lication of the final regulations, a notice of
proposed rulemaking providing additional
proposed regulations under section 163(j)
(REG-107911-18) (85 FR 56846).
.09 Section 1.163(j)-9 of the Income
Tax Regulations provides the rules and
procedures for making an election under
section 163(j)(7)(B) of the Code to be an
electing real property trade or business. In
addition, the Treasury Department and the
IRS released Rev. Proc. 2020-22, 2020-18
I.R.B. 745, (April 27, 2020) to provide the
time and manner of making a late election,
or withdrawing an election under section
163(j)(7)(B) to be an electing real prop-
erty trade or business for taxable years
beginning in 2018, 2019, or 2020. Rev.
Proc. 2020-22 also provides the time and
manner of making or revoking elections
provided by the CARES Act under section
163(j)(10) for taxable years beginning in
2019 or 2020. See Rev. Proc. 2020-22 for
more information regarding the time and
manner of making, revoking, or with-
drawing elections under section 163(j)(7)
and section 163(j)(10).
.10 Section 469(c)(7)(C) of the Code
defines a real property trade or business
as any real property development, rede-
velopment, construction, reconstruction,
acquisition, conversion, rental, operation,
management, leasing, or brokerage trade
or business.
.11 In response to the proposed regu-
lations, commenters expressed concern as
to whether a trade or business that manag-
es or operates a residential living facility
and also provides supplemental assistive,
nursing or routine medical services to its
customers or patients is eligible to make
the election to be an electing real property
trade or business under section 163(j)(7)
(B) of the Code.
.12 In light of these comments in the
context of section 163(j) of the Code, this
revenue procedure provides a safe harbor
that allows a taxpayer engaged in a trade
or business that manages or operates a
qualified residential living facility, as de-
fined in section 3.01 of this revenue pro-
cedure, to treat the trade or business as a
real property trade or business solely for
purposes of qualifying to make an elec-

September 28, 2020 784 Bulletin No. 2020–40
tion to be an electing real property trade
or business under sections 163(j)(7)(B)
and 168(g)(1)(F) (residential living facil-
ity safe harbor).
SECTION 3. DEFINITIONS FOR
RESIDENTIAL LIVING FACILITY
SAFE HARBOR
The following definitions apply for
purposes of this revenue procedure:
.01 Qualified Residential Living Facil-
ity. A qualified residential living facility is
a facility that:
(1) Consists of multiple rental dwell-
ing units within one or more buildings or
structures that generally serve as primary
residences on a permanent or semi-per-
manent basis to individual customers or
patients;
(2) Includes the provision of supple-
mental assistive, nursing, or other routine
medical services; and
(3) Has an average period of custom-
er or patient use of the individual rental
dwelling units that is 90 days or more.
.02 Average period of customer or pa-
tient use.
(1) In general. The average period of
customer or patient use is determined by
dividing (i) the sum of the total number of
days in the taxable year that each customer
or patient resides in a rental dwelling unit
of the residential living facility (which
may be determined by reference to a rent-
al contract or other formal written lease
agreement); by (ii) the total number of in-
dividual residential customers or patients
that reside in all of the rental dwelling
units of the facility for the taxable year.
For this purpose, a married couple resid-
ing in a single rental dwelling unit of the
residential living facility will be counted
as one individual customer or patient,
unless each spouse is separately properly
treated as an individual customer or pa-
tient of the residential living facility that
receives supplemental assistive, nursing,
or other routine medical services from or
on behalf of the residential living facility.
(2) Example. Facility has 100 rent-
al dwelling units. Of the 100 units, 60
units are occupied by the same customer
or patient for the entire year, 25 units are
occupied by each customer or patient for
three months (90 days) of the year, and
15 units are occupied for only 10 months
(300 days) of the year (for a total of 100
customers for the year). Of the 15 units
occupied for only 10 months of the year,
10 units are occupied by customers or pa-
tients for 5 months (150 days) each (for
a total of 20 customers for the 10-month
period). For the remaining 5 of 15 units
that are occupied for only 10 months of
the year, 5 customers or patients occupy
the units for 8 months (240 days) of the
year, and 5 other customers or patients oc-
cupy the units for 2 months (60 days) of
the year. The average period of customer
or patient use is determined by dividing
the sum of the total number of days in the
taxable year that each customer resides in
a rental dwelling unit, by the total number
of individual residential customers or pa-
tients that reside in all of the rental dwell-
ing units for the taxable year. The total
number of days in the taxable year that the
customers or patients reside in the rental
dwelling unit is 35,400 days [21,900 days
(60 units that are occupied for the entire
year x 365 days per year) + 9,000 days (25
units that are occupied for 90 days each
x 90 days x 4 90-day periods in a year)
+ 4,500 days (15 units that are occupied
for only 10 months x 300 days)]. The total
number of individual residential custom-
ers or patients is 190 [60 customers or pa-
tients occupying a unit for the entire year
+ 100 (25 customers or patients occupying
units for 90 days each x 4 90-day periods
in a year) + 20 customers or patients that
occupy a unit for a 5-month period + 5
customers or patients that occupy a unit
for a 8-month period + 5 customers or pa-
tients that occupy a unit for a 2-month pe-
riod]. Accordingly, the average period of
customer or patient use is approximately
186 days (35,400/190).
.03 Supplemental assistive, nursing,
or other routine medical services. Sup-
plemental assistive, nursing, or other
routine medical services are personal and
professional services that are customarily
and routinely provided to individual res-
idential customers or patients of nursing
homes, assisted living facilities, memory
care residences, continuing care retire-
ment communities, skilled nursing facili-
ties, or similar facilities, as needed, on a
day-to-day basis. Such services general-
ly do not include surgical, radiological,
or other intensive or specialized medical
services that are usually only provided
in emergency or short-term in-patient or
out-patient hospital or surgical settings.
.04 Permanent or semi-permanent ba-
sis. The rental dwelling units of a residen-
tial living facility serve as primary resi-
dences on a permanent or semi-permanent
basis to customers or patients whose use
of the units is generally long-term (more
than 90 days) in nature, even though
some customers or patients may arrive at
the residential living facility with signifi-
cantly shortened life expectancies due to
advanced age or terminal medical con-
ditions, and some customers or patients
otherwise may be expected to periodically
reside away from the residential living fa-
cility (such as at the primary residence of
a spouse or other relative) for short peri-
ods or durations of time.
SECTION 4. RESIDENTIAL LIVING
FACILITY SAFE HARBOR
.01 Safe harbor for certain residential
living facility trades or businesses. A tax-
payer engaged in a trade or business that
manages or operates a qualified residential
living facility, as defined in section 3.01
of this revenue procedure, may treat such
trade or business as a real property trade
or business solely for purposes of the elec-
tion to be an electing real property trade
or business under sections 163(j)(7)(B)
and 168(g)(1)(F) of the Code. Satisfying
the requirements of the safe harbor is not a
determination that the taxpayer is engaged
in a real property trade or business under
section 469 of the Code.
.02 Effect of election and how to make
the election. If a taxpayer makes the
election pursuant to this safe harbor, the
provisions in § 1.163(j)-9 of the regu-
lations apply, and the taxpayer must use
the alternative depreciation system of
section 168(g) of the Code to depreciate
the property described in section 168(g)
(8). The taxpayer makes the election at
the time, and in the manner prescribed by
§ 1.163(j)-9(d). See also Rev. Proc. 2020-
22.
.03 Substantiation. A trade or business
that manages or operates a residential liv-
ing facility to which this revenue proce-
dure applies must retain books and records
to substantiate that all the requirements of
this section 4 have been met in accordance
with section 6001 of the Code.

Bulletin No. 2020–40 785 September 28, 2020
.04 Anti-abuse. Arrangements en-
tered into with a principal purpose of
avoiding the rules of section 163(j) of
the Code or the regulations under sec-
tion 163(j) may be disregarded or re-
characterized by the Commissioner of
Internal Revenue to the extent neces-
sary to carry out the purposes of section
163(j). See § 1.163(j)-2(j).
SECTION 5. APPLICABILITY
This revenue procedure applies to tax-
able years beginning after December 31,
2017.
SECTION 6. PAPERWORK
REDUCTION ACT
.01 This revenue procedure does not
impose any additional information collec-
tion requirements in the form of reporting,
recordkeeping requirements or third-party
disclosure requirements to the burden that
is accounted for in the final regulations.
However, this revenue procedure provides
that qualified residential living facilities,
as defined in section 3.01 of this revenue
procedure, may be treated as real property
trades or businesses, within the meaning
of section 469(c)(7)(C) of the Code, sole-
ly for purposes of qualifying as an elect-
ing real property trade or business under
section 163(j)(7)(B). Taxpayers taking
advantage of this revenue procedure must
file a statement with their return under the
procedures set forth in and containing the
information required by § 1.163(j)-9 of
the regulations and Rev. Proc. 2020-22,
if applicable. That collection of informa-
tion has been reviewed and approved by
the Office of Management and Budget in
accordance with the Paperwork Reduction
Act (44 U.S.C. 3507) under control num-
ber 1545–0123.
.02 This information is required to be
collected and retained for compliance pur-
poses, namely, to determine whether the
taxpayer has made an election for one of
its trades or businesses to be an electing
real property trade or business.
.03 The Treasury Department and the
IRS estimate that approximately 30,210
respondents are likely. This number was
determined by examining, for the 2017
tax year, Form 1120, Form 1120-S, Form
1065, and Form 1120-REIT filers with
NAICS codes of 623110 (nursing care fa-
cilities (skilled nursing facilities)), 623311
(continuing care retirement communities),
623312 (assisted living facilities for the
elderly) and 623990 (other residential care
facilities) with gross receipts of at least
$10 million.
.04 The estimated number of respon-
dents is 30,210. The estimated annual
burden per respondent/recordkeeper var-
ies from 0 to 30 minutes, depending on
individual circumstances, with an estimat-
ed average of 15 minutes. The estimated
total annual reporting and/or recordkeep-
ing burden is 7,552.5 hours (30,210 re-
spondents x 15 minutes). The estimated
annual cost burden to respondents is $95
per hour. Accordingly, we expect the total
annual cost burden for the election state-
ments to be $717,487.50 (30,210 * .25 *
$95). The estimated annual frequency of
responses is once because the statements
only have to be filed once.
SECTION 7. DRAFTING
INFORMATION
The principal authors of this revenue
procedure are Susie Bird, Charles Gor-
ham, and Justin Grill of the Office of As-
sociate Chief Counsel (Income Tax & Ac-
counting) and Adrienne Mikolashek and
William Kostak of the Office of Associate
Chief Counsel (Passthroughs and Special
Industries). For further information re-
garding this revenue procedure, contact
Mr. Grill at (202) 317-7003, or Mr. Kostak
at (202) 317-5279 (not toll-free numbers).
Guidance regarding the
premium tax credit and
Medicaid coverage of
COVID-19 testing and
diagnostic services
Notice 2020-66
SECTION 1. PURPOSE
This notice provides interim guid-
ance addressing whether certain Medicaid
coverage of Coronavirus Disease 2019
(COVID-19) testing and diagnostic services
is minimum essential coverage for purposes
of the premium tax credit under section 36B
of the Internal Revenue Code (Code). This
notice also announces that the Department
of the Treasury (Treasury Department) and
the Internal Revenue Service (IRS) intend
to amend § 1.5000A-2 of the Income Tax
Regulations to add Medicaid coverage of
COVID-19 testing and diagnostic services
to the list of health care coverage that is not
minimum essential coverage under a gov-
ernment-sponsored program.
SECTION 2. BACKGROUND
Section 6004(a)(3) of the Families
First Coronavirus Response Act (Families
First Act), Pub. L. No. 116-127, 134 Stat.
178 (March 18, 2020), authorizes states to
provide COVID-19 testing and diagnostic
services to uninsured individuals under
the Medicaid program in Title XIX of the
Social Security Act.
Beginning in 2014, under the Patient
Protection and Affordable Care Act, Pub-
lic Law 111-148 (124 Stat. 119 (2010)),
and the Health Care and Education Rec-
onciliation Act of 2010, Public Law 111-
152 (124 Stat. 1029 (2010)) (collectively,
PPACA), eligible individuals who pur-
chase coverage under a qualified health
plan through a Health Insurance Exchange
(Exchange) established under section
1311 of the PPACA may claim a premium
tax credit under section 36B. Section 36B
and § 1.36B-3(a) of the Income Tax Reg-
ulations provide that a taxpayer is allowed
a premium tax credit only for months
that are coverage months for individuals
in the taxpayer’s family, as defined in
§ 1.36B-1(d). Under § 1.36B-3(c)(1)(ii), a
coverage month for an individual includes
only those months the individual is not
eligible for minimum essential coverage,
except coverage in the individual market.
Minimum essential coverage is de-
fined in section 5000A(f) of the Code
and generally includes coverage under
government-sponsored programs, in-
cluding Medicaid coverage under title
XIX of the Social Security Act. Howev-
er, the Treasury Department and the IRS
have determined that certain health care
coverage providing limited benefits is
not minimum essential coverage under
a government-sponsored program. See
§ 1.5000A-2(b)(2).

September 28, 2020 786 Bulletin No. 2020–40
SECTION 3. INTERIM
GUIDANCE
The Treasury Department and the IRS
have determined that Medicaid coverage
limited to COVID-19 testing and diagnos-
tic services under section 6004(a)(3) of the
Families First Act is not minimum essen-
tial coverage under a government-spon-
sored program. Thus, an individual’s eli-
gibility for this coverage for one or more
months does not prevent those months
from qualifying as coverage months for
purposes of determining eligibility for the
premium tax credit under section 36B.
SECTION 4. EFFECTIVE/
APPLICABILITY DATE
This notice applies to taxable years be-
ginning in or after 2020. Until further guid-
ance is issued, taxpayers may rely on the
interim guidance described in this notice.
Pursuant to Section IV. of the Policy
Statement on the Tax Regulatory Pro-
cess issued by the Treasury Department
and the IRS on March 5, 2019, if no pro-
posed regulations or other guidance is
released within 18 months after Septem-
ber 28, 2020, taxpayers may continue to
rely on the interim guidance described in
this notice but, until additional guidance
is issued, the Treasury Department and
the IRS will not assert a position adverse
to any taxpayer, including an applica-
ble large employer under section 4980H,
based in whole or in part on this notice.
SECTION 5. DRAFTING
INFORMATION
The principal author of this notice
is Steve Toomey of the Office of Chief
Counsel (Income Tax and Accounting).
For further information regarding this
notice, contact Steve Toomey at 202-317-
4718 (not a toll-free number).
2020-2021 Special Per
Diem Rates
Notice 2020-71
SECTION 1. PURPOSE
This annual notice provides the 2020-
2021 special per diem rates for taxpayers
to use in substantiating the amount of or-
dinary and necessary business expenses
incurred while traveling away from home,
specifically (1) the special transportation
industry meal and incidental expenses
(M&IE) rates, (2) the rate for the inciden-
tal expenses only deduction, and (3) the
rates and list of high-cost localities for
purposes of the high-low substantiation
method.
SECTION 2. BACKGROUND
Rev. Proc. 2019-48, 2019-51 I.R.B.
1392 (or successor), provides rules for us-
ing a per diem rate to substantiate, under
§ 274(d) of the Internal Revenue Code and
§ 1.274-5 of the Income Tax Regulations,
the amount of ordinary and necessary
business expenses paid or incurred while
traveling away from home. Taxpayers us-
ing the rates and list of high-cost localities
provided in this notice must comply with
Rev. Proc. 2019-48 (or successor). Notice
2019-55, 2019-42 I.R.B. 937, provides the
rates and list of high-cost localities for the
period October 1, 2019, to September 30,
2020.
SECTION 3. SPECIAL M&IE RATES
FOR TRANSPORTATION INDUSTRY
The special M&IE rates for taxpayers
in the transportation industry are $66 for
any locality of travel in the continental
United States (CONUS) and $71 for any
locality of travel outside the continental
United States (OCONUS). See section
4.04 of Rev. Proc. 2019-48 (or successor).
SECTION 4. RATE FOR INCIDENTAL
EXPENSES ONLY DEDUCTION
The rate for any CONUS or OCONUS
locality of travel for the incidental ex-
penses only deduction is $5 per day. See
section 4.05 of Rev. Proc. 2019-48 (or
successor).
SECTION 5. HIGH-LOW
SUBSTANTIATION METHOD
1. Annual high-low rates. For purpos-
es of the high-low substantiation method,
the per diem rates in lieu of the rates de-
scribed in Notice 2019-55 (the per diem
substantiation method) are $292 for trav-
el to any high-cost locality and $198 for
travel to any other locality within CO-
NUS. The amount of the $292 high rate
and $198 low rate that is treated as paid
for meals for purposes of § 274(n) is $71
for travel to any high-cost locality and $60
for travel to any other locality within CO-
NUS. See section 5.02 of Rev. Proc. 2019-
48 (or successor). The per diem rates in
lieu of the rates described in Notice 2019-
55 (the meal and incidental expenses only
substantiation method) are $71 for travel
to any high-cost locality and $60 for travel
to any other locality within CONUS.
2. High-cost localities. The following lo-
calities have a federal per diem rate of $245
or more, and are high-cost localities for the
specified portion of the calendar year.

Bulletin No. 2020–40 787 September 28, 2020
Key City
County or Other
Defined Location
Portion of Calendar Year
Arizona
SedonaCity Limits of Sedona
October 1 – December 1, March 1 – April 30, and Sep-
tember 1 – September 30
California
Los Angeles
Los Angeles, Orange, Ventura, Ed-
wards AFB less the city of Santa
Monica
October 1 - October 31 and January 1 - September 30
Mill Valley/San Rafael/NovatoMarinOctober 1 – October 31 and June 1 – September 30
MontereyMontereyJune 1 – August 31
NapaNapaOctober 1 – November 30 and April 1 – September 30
OaklandAlamedaOctober 1 – September 30
San DiegoSan DiegoFebruary 1 – July 31
San FranciscoSan FranciscoOctober 1 – September 30
San Mateo/Foster City/BelmontSan MateoOctober 1 – September 30
Santa BarbaraSanta BarbaraOctober 1 – September 30
Santa MonicaCity limits of Santa MonicaOctober 1 – September 30
Sunnyvale/Palo Alto/San JoseSanta ClaraOctober 1 – September 30
Colorado
AspenPitkinOctober 1 – March 31 and June 1 – September 30
Crested Butte/GunnisonGunnisonDecember 1 – March 31
Denver/Aurora
Denver, Adams, Arapahoe, and Jef-
ferson
October 1 – October 31 and April 1 – September 30
Grand LakeGrandDecember 1 – March 31
Silverthorne/BreckenridgeSummitDecember 1 – March 31
TellurideSan MiguelOctober 1 – September 30
VailEagleOctober 1 – September 30
Delaware
LewesSussexJuly 1 – August 31
District of Columbia
Washington D.C. (also the cities of Alexandria, Falls Church, and Fair-
fax, and the counties of Arlington and Fairfax, in Virginia; and the coun-
ties of Montgomery and Prince George's in Maryland) (See also Mary-
land and Virginia)
October 1 – September 30
Florida
Boca Raton/Delray Beach/Jupi-
ter
Palm Beach and HendryDecember 1 – April 30
Fort LauderdaleBrowardJanuary 1 – April 30
Fort MeyersLeeFebruary 1 – March 31
Fort Walton Beach/De Funiak
Springs
Okaloosa and WaltonJune 1 – July 31
Gulf BreezeSanta RosaJune 1 – July 31
Key WestMonroeOctober 1 – July 31
MiamiMiami-DadeDecember 1 – March 31
NaplesCollierDecember 1 – April 30
Vero BeachIndian RiverDecember 1 – April 30

September 28, 2020 788 Bulletin No. 2020–40
Key City
County or Other
Defined Location
Portion of Calendar Year
Georgia
Jekyll Island/BrunswickGlynnMarch 1 – July 31
Illinois
ChicagoCook and LakeOctober 1 – November 30 and April 1 – September 30
Maine
Bar Harbor/RockportHancock and KnoxJuly 1 – August 31
Kennebunk/Kittery/SanfordYorkJuly 1 – August 31
Maryland
Ocean CityWorcesterJuly 1 – August 31
Washington, DC Metro AreaMontgomery and Prince George’sOctober 1 – September 30
Massachusetts
Boston/CambridgeSuffolk, City of CambridgeOctober 1 – September 30
FalmouthCity limits of FalmouthJuly 1 – August 31
HyannisBarnstable less the city of FalmouthJuly 1 – August 31
Martha's VineyardDukesJune 1 – September 30
NantucketNantucketJune 1 – September 30
Michigan
PetoskeyEmmetJuly 1 – August 31
Traverse CityGrand TraverseJuly 1 – August 31
Montana
Big Sky/West Yellowstone/
Gardiner
Gallatin and ParkJune 1 – September 30
New Mexico
CarlsbadEddyOctober 1 – September 30
New York
Lake PlacidEssexJuly 1 – August 31
New York City
Bronx, Kings, New York, Queens,
and Richmond
October 1 – December 31 and March 1 – September 30
Oregon
PortlandMultnomahOctober 1 – October 31 and June 1 – September 30
SeasideClatsopJuly 1 – August 31
Pennsylvania
HersheyHersheyJune 1 – August 31
PhiladelphiaPhiladelphia
October 1 – November 30, March 1 – June 30, and Sep-
tember 1 – September 30
Rhode Island
Jamestown/Middletown/NewportNewportOctober 1 – October 31 and June 1 – September 30
South Carolina
CharlestonCharleston, Berkeley, and DorchesterOctober 1 – November 30 and March 1 – September 30
Tennessee
NashvilleDavidsonOctober 1 – September 30
Utah
Park CitySummitDecember 1 – March 31

Bulletin No. 2020–40 789 September 28, 2020
Key City
County or Other
Defined Location
Portion of Calendar Year
Virginia
Virginia BeachCity of Virginia BeachJune 1 – August 31
Wallops IslandAccomackJuly 1 – August 31
Washington, DC Metro Area
Cities of Alexandria, Fairfax, and
Falls Church; Counties of Arlington
and Fairfax
October 1 – September 30
Washington
SeattleKingOctober 1 – September 30
VancouverClark, Cowlitz, and SkamaniaOctober 1 – October 31 and June 1 – September 30
Wyoming
CodyParkJune 1 – September 30
Jackson/PinedaleTeton and SubletteJune 1 – September 30
3. Changes in high-cost localities. The
list of high-cost localities in this notice
differs from the list of high-cost localities
in section 5 of Notice 2019-55.
a. The following localities have been
added to the list of high-cost locali-
ties: Los Angeles, California; San Di-
ego, California; Gulf Breeze, Florida;
Kennebunk/Kittery/Sanford, Maine;
Virginia Beach, Virginia.
b. The following localities have
changed the portion of the year in
which they are high-cost localities:
Sedona, Arizona; Monterey, Califor-
nia; Santa Barbara, California; Dis-
trict of Columbia (see also Maryland
and Virginia); Naples, Florida; Jekyll
Island/Brunswick, Georgia; Boston/
Cambridge, Massachusetts; Phila-
delphia, Pennsylvania; Jamestown/
Middletown/Newport, Rhode Island;
Charleston, South Carolina.
c. The following localities have been
removed from the list of high-cost
localities: Midland/Odessa, Texas;
Pecos, Texas.
SECTION 6. EFFECTIVE DATE
This notice is effective for per diem al-
lowances for lodging, meal and incidental
expenses, or for meal and incidental ex-
penses only, that are paid to any employ-
ee on or after October 1, 2020, for trav-
el away from home on or after October
1, 2020. For purposes of computing the
amount allowable as a deduction for trav-
el away from home, this notice is effective
for meal and incidental expenses or for
incidental expenses only paid or incurred
on or after October 1, 2020. See sections
4.06 and 5.04 of Rev. Proc. 2019-48 (or
successor) for transition rules for the last
3 months of calendar year 2020.
SECTION 7. EFFECT ON OTHER
DOCUMENTS
Notice 2019-55 is superseded.
DRAFTING INFORMATION
The principal author of this notice is
James Liechty of the Office of Associate
Chief Counsel (Income Tax & Account-
ing). For further information regarding
this notice contact James Liechty at (202)
317-7005 (not a toll-free number).
Update for Weighted
Average Interest Rates,
Yield Curves, and Segment
Rates
Notice 2020-72
This notice provides guidance on the
corporate bond monthly yield curve, the
corresponding spot segment rates used
under § 417(e)(3), and the 24-month aver-
age segment rates under § 430(h)(2) of the
Internal Revenue Code. In addition, this
notice provides guidance as to the interest
rate on 30-year Treasury securities under
§ 417(e)(3)(A)(ii)(II) as in effect for plan
years beginning before 2008 and the 30-
year Treasury weighted average rate under
§ 431(c)(6)(E)(ii)(I).
YIELD CURVE AND SEGMENT
RATES
Section 430 specifies the minimum
funding requirements that apply to sin-
gle-employer plans (except for CSEC
plans under § 414(y)) pursuant to § 412.
Section 430(h)(2) specifies the inter-
est rates that must be used to determine
a plan’s target normal cost and funding
target. Under this provision, present val-
ue is generally determined using three
24-month average interest rates (“segment
rates”), each of which applies to cash
flows during specified periods. To the ex-
tent provided under § 430(h)(2)(C)(iv),
these segment rates are adjusted by the ap-
plicable percentage of the 25-year average
segment rates for the period ending Sep-
tember 30 of the year preceding the cal-
endar year in which the plan year begins.
1

However, an election may be made under
§ 430(h)(2)(D)(ii) to use the monthly yield
curve in place of the segment rates.
1
Pursuant to § 433(h)(3)(A), the 3
rd
segment rate determined under § 430(h)(2)(C) is used to determine the current liability of a CSEC plan (which is used to calculate the minimum amount
of the full funding limitation under § 433(c)(7)(C)).

September 28, 2020 790 Bulletin No. 2020–40
Notice 2007-81, 2007-44 I.R.B. 899,
provides guidelines for determining the
monthly corporate bond yield curve, and
the 24-month average corporate bond
segment rates used to compute the target
normal cost and the funding target. Con-
sistent with the methodology specified in
Notice 2007-81, the monthly corporate
bond yield curve derived from August
2020 data is in Table 2020-8 at the end
of this notice. The spot first, second, and
third segment rates for the month of Au-
gust 2020 are, respectively, 0.52, 2.22, and
3.03.
The 24-month average segment rates
determined under § 430(h)(2)(C)(i)
through (iii) must be adjusted pursuant
to § 430(h)(2)(C)(iv) to be within the
applicable minimum and maximum per-
centages of the corresponding 25-year
average segment rates. For plan years be-
ginning before 2021, the applicable min-
imum percentage is 90% and the appli-
cable maximum percentage is 110%. The
25-year average segment rates for plan
years beginning in 2019 and 2020 were
published in Notice 2018-73, 2018-40
I.R.B. 526, and Notice 2019-51, 2019-41
I.R.B. 866, respectively. For plan years
beginning in 2021, the applicable min-
imum percentage is 85% and the appli-
cable maximum percentage is 115%. For
plan years beginning in 2021, based on
the segment rates applicable for October
1995 to September 2020, the 25-year av-
erages for the period ending September
30, 2020, of the first, second, and third
segment rates are 3.90, 5.64, and 6.43
percent, respectively.
24-MONTH AVERAGE CORPORATE
BOND SEGMENT RATES
The three 24-month average corporate
bond segment rates applicable for Sep-
tember 2020 without adjustment for the
25-year average segment rate limits are as
follows:
24-Month Average Segment Rates Without 25-Year Average Adjustment
Applicable Month First Segment Second Segment Third Segment
September 2020 2.22 3.38 3.92
Based on § 430(h)(2)(C)(iv), the
24-month averages applicable for Sep-
tember 2020, adjusted to be within the ap-
plicable minimum and maximum percent-
ages of the corresponding 25-year average
segment rates, are as follows:
Adjusted 24-Month Average Segment Rates
For Plan Years
Beginning In
Applicable
Month
First
Segment
Second
Segment
Third
Segment
2019September 20203.745.356.11
2020September 20203.645.215.94
2021September 20203.324.795.47
30-YEAR TREASURY SECURITIES
INTEREST RATES
Section 431 specifies the minimum
funding requirements that apply to mul-
tiemployer plans pursuant to § 412. Sec-
tion 431(c)(6)(B) specifies a minimum
amount for the full-funding limitation
described in § 431(c)(6)(A), based on the
plan’s current liability. Section 431(c)(6)
(E)(ii)(I) provides that the interest rate
used to calculate current liability for this
purpose must be no more than 5 percent
above and no more than 10 percent be-
low the weighted average of the rates of
interest on 30-year Treasury securities
during the four-year period ending on the
last day before the beginning of the plan
year. Notice 88-73, 1988-2 C.B. 383,
provides guidelines for determining the
weighted average interest rate. The rate
of interest on 30-year Treasury securities
for August 2020 is 1.36 percent The Ser-
vice determined this rate as the average
of the daily determinations of yield on
the 30-year Treasury bond maturing in
May 2050 determined each day through
August 12, 2020 and the yield on the 30-
year Treasury bond maturing in August
2050 determined each day for the balance
of the month. For plan years beginning
in September 2020, the weighted average
of the rates of interest on 30-year Trea-
sury securities and the permissible range
of rates used to calculate current liability
are as follows:
Treasury Weighted Average Rates
For Plan Years
Beginning In
30-Year Treasury
Weighted Average
Permissible Range
90% to 105%
September 20202.472.22 to 2.59

Bulletin No. 2020–40 791 September 28, 2020
DRAFTING INFORMATION
The principal author of this notice is
Tom Morgan of the Office of the Asso-
ciate Chief Counsel (Employee Benefits,
Exempt Organizations, and Employment
Taxes). However, other personnel from
the IRS participated in the development
of this guidance. For further information
regarding this notice, contact Mr. Morgan
at 202-317-6700 or Paul Stern at 202-317-
8702 (not toll-free numbers).
Minimum Present Value Segment Rates
Month First Segment Second Segment Third Segment
August 2020 0.52 2.22 3.03
MINIMUM PRESENT VALUE
SEGMENT RATES
In general, the applicable interest rates
under § 417(e)(3)(D) are segment rates
computed without regard to a 24-month
average. Notice 2007-81 provides guide-
lines for determining the minimum pres-
ent value segment rates. Pursuant to that
notice, the minimum present value seg-
ment rates determined for August 2020
are as follows:

September 28, 2020 792 Bulletin No. 2020–40
Table 2020-8
Monthly Yield Curve for August 2020
Derived from August 2020 Data
MaturityYieldMaturityYieldMaturityYieldMaturityYieldMaturityYield
0.50.1920.52.8540.53.0560.53.1380.53.17
1.00.3021.02.8641.03.0661.03.1381.03.17
1.50.4021.52.8741.53.0661.53.1381.53.17
2.00.4722.02.8842.03.0662.03.1382.03.17
2.50.5222.52.8842.53.0662.53.1482.53.17
3.00.5523.02.8943.03.0763.03.1483.03.17
3.50.5923.52.9043.53.0763.53.1483.53.17
4.00.6424.02.9044.03.0764.03.1484.03.17
4.50.7124.52.9144.53.0764.53.1484.53.17
5.00.7925.02.9245.03.0865.03.1485.03.18
5.50.8925.52.9245.53.0865.53.1485.53.18
6.01.0126.02.9346.03.0866.03.1486.03.18
6.51.1326.52.9346.53.0866.53.1486.53.18
7.01.2627.02.9447.03.0967.03.1587.03.18
7.51.4027.52.9447.53.0967.53.1587.53.18
8.01.5328.02.9548.03.0968.03.1588.03.18
8.51.6628.52.9648.53.0968.53.1588.53.18
9.01.7829.02.9649.03.0969.03.1589.03.18
9.51.9029.52.9749.53.1069.53.1589.53.18
10.02.0130.02.9750.03.1070.03.1590.03.18
10.52.1130.52.9850.53.1070.53.1590.53.18
11.02.2031.02.9851.03.1071.03.1591.03.18
11.52.2831.52.9951.53.1071.53.1591.53.18
12.02.3632.02.9952.03.1072.03.1692.03.18
12.52.4232.53.0052.53.1172.53.1692.53.18
13.02.4833.03.0053.03.1173.03.1693.03.18
13.52.5433.53.0153.53.1173.53.1693.53.19
14.02.5834.03.0154.03.1174.03.1694.03.19
14.52.6234.53.0154.53.1174.53.1694.53.19
15.02.6635.03.0255.03.1175.03.1695.03.19
15.52.6935.53.0255.53.1275.53.1695.53.19
16.02.7236.03.0256.03.1276.03.1696.03.19
16.52.7436.53.0356.53.1276.53.1696.53.19
17.02.7637.03.0357.03.1277.03.1697.03.19
17.52.7837.53.0457.53.1277.53.1697.53.19
18.02.8038.03.0458.03.1278.03.1798.03.19
18.52.8138.53.0458.53.1278.53.1798.53.19
19.02.8239.03.0459.03.1379.03.1799.03.19
19.52.8339.53.0559.53.1379.53.1799.53.19
20.02.8440.03.0560.03.1380.03.17100.03.19

Bulletin No. 2020–40 793 September 28, 2020
26 CFR 601.105: Examination of returns and claims
for refund, credit or abatement; determination of tax
liability (Also: 842(b))
Rev. Proc. 2020-41
SECTION 1. PURPOSE
This revenue procedure provides the
domestic asset/liability percentages and
domestic investment yields needed by
foreign life insurance companies and for-
eign property and liability insurance com-
panies to compute their minimum effec-
tively connected net investment income
under section 842(b) of the Internal Rev-
enue Code for taxable years beginning
after December 31, 2018. Instructions are
provided for computing foreign insurance
companies’ liabilities for the estimated
tax and installment payments of estimated
tax for taxable years beginning after De-
cember 31, 2018. For more specific guid-
ance regarding the computation of the
amount of net investment income to be
included by a foreign insurance company
on its U.S. income tax return, see Notice
89-96, 1989-2 C.B. 417. For the domes-
tic asset/liability percentage and domestic
investment yield, as well as instructions
for computing foreign insurance compa-
nies’ liabilities for estimated tax and in-
stallment payments of estimated tax for
taxable years beginning after December
31, 2017, see Rev. Proc. 2019-36, 2019-
38 I.R.B. 729.
SECTION 2. PERCENTAGES AND
YIELDS
.01 DOMESTIC ASSET/LIABILITY
PERCENTAGES FOR 2019. The Secre-
tary determines the domestic asset/liabili-
ty percentage separately for life insurance
companies and property and liability in-
surance companies. For the first taxable
year beginning after December 31, 2018,
the relevant domestic asset/liability per-
centages are:
124.8 percent for foreign life insurance
companies, and
197.9 percent for foreign property and
liability insurance companies.
.02 DOMESTIC INVESTMENT
YIELDS FOR 2019. The Secretary pre-
scribes separate domestic investment
yields for foreign life insurance compa-
nies and for foreign property and liability
insurance companies. For the first taxable
year beginning after December 31, 2018,
the relevant domestic investment yields
are:
4.5 percent for foreign life insurance
companies, and
3.4 percent for foreign property and li-
ability insurance companies.
.03 SOURCE OF DATA FOR 2019.
The section 842(b) percentages to be used
for the 2019 tax year are based on tax re-
turn data following the same methodology
used for the 2018 year.
SECTION 3. ESTIMATED TAXES
To compute estimated tax and the in-
stallment payments of estimated tax due
for taxable years beginning after Decem-
ber 31, 2018, a foreign insurance compa-
ny must compute its estimated tax pay-
ments by adding to its income other than
net investment income the greater of (i)
its net investment income as determined
under section 842(b)(5) that is actually
effectively connected with the conduct
of a trade or business within the United
States for the relevant period, or (ii) the
minimum effectively connected net in-
vestment income under section 842(b)
that would result from using the most
recently available domestic asset/liabil-
ity percentage and domestic investment
yield. Thus, for installment payments
due after the publication of this revenue
procedure, the domestic asset/liability
percentages and the domestic investment
yields provided in this revenue procedure
must be used to compute the minimum
effectively connected net investment
income. However, if the due date of an
installment is less than 20 days after the
date this revenue procedure is published
in the Internal Revenue Bulletin, the
asset/liability percentages and domes-
tic investment yields provided in Rev.
Proc. 2019-36 may be used to compute
the minimum effectively connected net
investment income for such installment.
For further guidance in computing esti-
mated tax, see Notice 89-96.
SECTION 4. EFFECTIVE DATE
This revenue procedure is effective for
taxable years beginning after December
31, 2018.
SECTION 5. DRAFTING
INFORMATION
The principal author of this revenue
procedure is Sheila Ramaswamy of the
Office of Associate Chief Counsel (Inter-
national). For further information regard-
ing this revenue procedure contact Shei-
la Ramaswamy at (202) 317-6938 (not a
toll-free number).

September 28, 2020 794 Bulletin No. 2020–40
Part IV
Due date postponed for
reporting and payment
of excise taxes relating
to minimum required
contributions delayed
under § 3608(a) of the
CARES Act
Announcement 2020-17
The Department of the Treasury
(Treasury Department) and the Internal
Revenue Service (IRS) are postponing
until January 15, 2021, the due dates for
reporting and paying the excise taxes
under §§ 4971(a)(1) and 4971(f)(1) of
the Internal Revenue Code with respect
to certain delayed minimum required
contributions to a single employer de-
fined benefit plan. This postponement
applies with respect to a required con-
tribution to which the extended due date
under § 3608(a) of the Coronavirus Aid,
Relief, and Economic Security Act, Pub.
L. No. 116-136 (134 Stat. 281) (CARES
Act), applies.
Section 4971(a)(1) imposes an ex-
cise tax on an employer that maintains
a single employer defined benefit plan,
equal to 10 percent of the aggregate un-
paid minimum required contributions
(as defined in § 4971(c)(4)) for all plan
years remaining unpaid as of the end of
any plan year ending with or within a
taxable year. Section 4971(f)(1) impos-
es an excise tax on an employer main-
taining such a plan equal to 10 percent
of the amount of the liquidity shortfall
as of the last day of any quarter that is
not paid by the due date for the required
installment for that quarter.
Section 54.6011-1(a) provides that
any employer liable for tax under § 4971
must file an annual return on Form 5330
and include on it the information re-
quired by that form and those instruc-
tions. The § 4971(a)(1) excise tax is re-
ported on line 8a and Schedule D, line 2,
of Form 5330. The § 4971(f)(1) excise
tax is reported on line 9a and Schedule
E, line 4, of Form 5330. Form 5330 and
the Form 5330 instructions provide that
these taxes must be reported and paid by
the last day of the 7th month after the
end of the employer’s tax year or 8-1/2
months after the last day of the plan year
that ends with or within the filer’s tax
year.
Section 3608(a)(1) of the CARES
Act provides that the due date for pay-
ing any minimum required contribution
under § 430(j) (including quarterly in-
stallments) that would otherwise be due
during calendar year 2020 is extended
until January 1, 2021. Without this ex-
tension, the due date for paying the min-
imum required contribution for a plan
year ending December 31, 2019, would
be September 15, 2020, and the determi-
nation of whether a plan has an unpaid
minimum required contribution for that
plan year also would be made as of that
date. On August 6, 2020, the Treasury
Department and the IRS issued Notice
2020-61, 2020-35 IRB 468, which pro-
vides guidance regarding § 3608 of the
CARES Act, including the extended due
date under § 3608(a)(1) for making a
minimum required contribution.
As a result of the extension of the
due date for making a minimum re-
quired contribution under § 3608(a) of
the CARES Act, if an employer that is
a calendar year taxpayer maintains a
single employer defined benefit plan
that is subject to § 430 with a calendar
year plan year fails to pay the minimum
required contribution for the 2019 plan
year by the extended due date of January
1, 2021, then there would be an unpaid
minimum required contribution for the
2019 plan year and the employer would
become subject to the excise tax under
§ 4971(a). Similarly, if the employer
fails to pay a required installment under
§ 430(j)(3) to satisfy a liquidity short-
fall by the delayed due date of January
1, 2021, the excise tax under § 4971(f)
would apply. However, absent the relief
provided in this announcement, the due
date for the employer’s reporting and
payment obligations for the excise taxes
with respect to these unpaid contribu-
tions would be September 15, 2020.
In order to coordinate the due date for
reporting and paying the §§ 4971(a)(1)
and 4971(f)(1) excise taxes with the ex-
tended due date for paying the minimum
required contributions to which those
excise taxes apply (January 1, 2021,
pursuant to § 3608(a) of the CARES
Act), the Treasury Department and the
IRS are postponing the reporting and
payment due date for those taxes. The
new due date for reporting and paying
the §§ 4971(a)(1) and 4971(f)(1) excise
taxes with respect to a minimum re-
quired contribution to which § 3608(a)
of the CARES Act applies is January 15,
2021.
This announcement overrides the due
date provided on Form 5330 and under
the Form 5330 instructions for report-
ing and paying the excise taxes under
§§ 4971(a)(1) and 4971(f)(1) with re-
spect to a minimum required contribu-
tion to which § 3608(a) of the CARES
Act applies. This announcement does
not apply to the due dates for other ex-
cise taxes required to be reported on
Form 5330.
The principal author of this an-
nouncement is Diane S. Bloom of the
Office of the Associate Chief Coun-
sel (Employee Benefits, Exempt Or-
ganizations, and Employment Taxes).
However, other personnel from the IRS
participated in the development of this
guidance. For further information re-
garding this announcement, please con-
tact Ms. Bloom at 202-317-6700 (not a
toll-free number).

Bulletin No. 2020–40 795 September 28, 2020
Notice of Proposed
Rulemaking
Limitation on Deduction for
Business Interest Expense;
Allocation of Interest
Expense by Passthrough
Entities; Dividends Paid
by Regulated Investment
Companies; Application of
Limitation on Deduction
for Business Interest
Expense to United States
Shareholders of Controlled
Foreign Corporations and
to Foreign Persons with
Effectively Connected
Income
REG-107911-18
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This notice of proposed
rulemaking provides rules concerning
the limitation on the deduction for busi-
ness interest expense after amendment of
the Internal Revenue Code (Code) by the
provisions commonly known as the Tax
Cuts and Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus
Aid, Relief, and Economic Security Act,
which was enacted on March 27, 2020.
Specifically, these proposed regulations
address application of the limitation in
contexts involving passthrough entities,
regulated investment companies (RICs),
United States shareholders of controlled
foreign corporations, and foreign persons
with effectively connected income in the
United States. These proposed regula-
tions also provide guidance regarding the
definitions of real property development,
real property redevelopment, and a syn-
dicate. These proposed regulations affect
taxpayers that have business interest ex-
pense, particularly passthrough entities,
their partners and shareholders, as well
as foreign corporations and their United
States shareholders and foreign persons
with effectively connected income. These
proposed regulations also affect RICs
that have business interest income, RIC
shareholders that have business interest
expense, and members of a consolidated
group.
DATES: Written or electronic comments
and requests for a public hearing must be
received by November 2, 2020, which is
60 days after the date of filing for public
inspection with the Office of the Federal
Register.
ADDRESSES: Commenters are strongly
encouraged to submit public comments
electronically. Submit electronic submis-
sions via the Federal eRulemaking Portal
at www.regulations.gov (indicate IRS and
REG-107911-18) by following the online
instructions for submitting comments.
Once submitted to the Federal eRulemak-
ing Portal, comments cannot be edited or
withdrawn. The IRS expects to have lim-
ited personnel available to process public
comments that are submitted on paper
through mail. The Department of the Trea-
sury (Treasury Department) and the IRS
will publish for public availability any
comment submitted electronically, and
when practicable on paper, to its public
docket.
Send paper submissions to: CC:PA:LP-
D:PR (REG-107911-18), Room 5203,
Internal Revenue Service, P.O. Box 7604,
Ben Franklin Station, Washington, D.C.
20044.
FOR FURTHER INFORMATION CON-
TACT: Concerning §1.163(j)-1, Steven
Harrison, (202) 317-6842, Michael Chin,
(202) 317-6842 or John Lovelace, (202)
317-5363; concerning §1.163(j)-2, Sophia
Wang, (202) 317-4890 or John Lovelace,
(202) 317-5363, concerning §1.163-14,
§1.163(j)-6, or §1.469-9, William Kostak,
(202) 317-5279 or Anthony McQuillen,
(202) 317-5027; concerning §1.163-15,
Sophia Wang, (202) 317-4890; concern-
ing §1.163(j)-7 or §1.163(j)-8, Azeka J.
Abramoff, (202) 317-3800 or Raphael
J. Cohen, (202) 317-6938, concerning
§1.1256(e)-2, Sophia Wang, (202) 317-
4890 or Pamela Lew, (202) 317-7053;
concerning submissions of comments and/
or requests for a public hearing, Regina L.
Johnson, (202) 317-5177 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed
amendments to the Income Tax Regu-
lations (26 CFR part 1) under sections
163 (in particular section 163(j)), 469
and 1256(e) of the Code. Section 163(j)
was amended as part of Public Law
No. 115-97, 131 Stat. 2054 (December
22, 2017), commonly referred to as the
Tax Cuts and Jobs Act (TCJA), and the
Coronavirus Aid, Relief, and Economic
Security Act, Public Law No. 116-136
(2020) (CARES Act). Section 13301(a)
of the TCJA amended section 163(j) by
removing prior section 163(j)(1) through
(9) and adding section 163(j)(1) through
(10). The provisions of section 163(j) as
amended by section 13301 of the TCJA
are effective for tax years beginning af-
ter December 31, 2017. The CARES Act
further amended section 163(j) by redes-
ignating section 163(j)(10), as amended
by the TCJA, as new section 163(j)(11),
and adding a new section 163(j)(10) pro-
viding special rules for applying section
163(j) to taxable years beginning in 2019
or 2020.
Section 163(j) generally limits the
amount of business interest expense (BIE)
that can be deducted in the current taxable
year (also referred to in this Preamble as
the current year). Under section 163(j)(1),
the amount allowed as a deduction for BIE
is limited to the sum of (1) the taxpayer’s
business interest income (BII) for the tax-
able year; (2) 30 percent of the taxpayer’s
adjusted taxable income (ATI) for the
taxable year (30 percent ATI limitation);
and (3) the taxpayer’s floor plan financ-
ing interest expense for the taxable year
(in sum, the section 163(j) limitation). As
further described later in this Background
section, section 163(j)(10), as amended
by the CARES Act, provides special rules
relating to the ATI limitation for taxable
years beginning in 2019 or 2020. Under
section 163(j)(2), the amount of any BIE
that is not allowed as a deduction in a tax-
able year due to the section 163(j) limita-

September 28, 2020 796 Bulletin No. 2020–40
tion is treated as business interest paid in
the succeeding taxable year.
The section 163(j) limitation applies
to all taxpayers, except for certain small
businesses that meet the gross receipts
test in section 448(c) and certain trades
or businesses listed in section 163(j)(7).
Section 163(j)(3) provides that the section
163(j) limitation does not apply to any
taxpayer that meets the gross receipts test
under section 448(c), other than a tax shel-
ter prohibited from using the cash receipts
and disbursements method of accounting
under section 448(a)(3).
Section 163(j)(4) provides special rules
for applying section 163(j) in the case of
passthrough entities. Section 163(j)(4)(A)
requires that the section 163(j) limitation
be applied at the partnership level, and
that a partner’s ATI be increased by the
partner’s share of excess taxable income,
as defined in section 163(j)(4)(C), but
not by the partner’s distributive share of
income, gain, deduction, or loss. Section
163(j)(4)(B) provides that the amount of
partnership BIE limited by section 163(j)
(1) (EBIE) is carried forward at the part-
ner level. Section 163(j)(4)(B)(ii) pro-
vides that EBIE allocated to a partner and
carried forward is available to be deduct-
ed in a subsequent year only to the extent
that the partnership allocates excess tax-
able income to the partner. As further de-
scribed later in this Background section,
section 163(j)(10), as amended by the
CARES Act, provides a special rule for
excess business interest expense allocated
to a partner in a taxable year beginning in
2019. Section 163(j)(4)(B)(iii) provides
rules for the adjusted basis in a partnership
of a partner that is allocated EBIE. Section
163(j)(4)(D) provides that rules similar to
the rules of section 163(j)(4)(A) and (C)
apply to S corporations and S corporation
shareholders.
Section 163(j)(5) and (6) define “busi-
ness interest” and “business interest in-
come,” respectively, for purposes of sec-
tion 163(j). Generally, these terms include
interest expense and interest includible in
gross income that is properly allocable to
a trade or business (as defined in section
163(j)(7)) and do not include investment
income or investment expense within the
meaning of section 163(d). The legisla-
tive history states that “a corporation has
neither investment interest nor investment
income within the meaning of section
163(d). Thus, interest income and interest
expense of a corporation is properly allo-
cable to a trade or business, unless such
trade or business is otherwise explicitly
excluded from the application of the pro-
vision.” H. Rept. 115-466, at 386, fn. 688
(2017).
Under section 163(j)(7), the limitation
on the deduction for business interest ex-
pense in section 163(j)(1) does not apply
to certain trades or businesses (excepted
trades or businesses). The excepted trades
or businesses are the trade or business of
providing services as an employee, elect-
ing real property businesses, electing
farming businesses, and certain regulated
utility businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without re-
gard to the following: items not properly
allocable to a trade or business; business
interest and business interest income; net
operating loss (NOL) deductions; and
deductions for qualified business income
under section 199A. ATI also general-
ly excludes deductions for depreciation,
amortization, and depletion with respect
to taxable years beginning before January
1, 2022, and it includes other adjustments
provided by the Secretary of the Treasury.
Section 163(j)(9) defines “floor plan
financing interest” as interest paid or ac-
crued on “floor plan financing indebted-
ness.” These provisions allow taxpayers
incurring interest expense for the purpose
of securing an inventory of motor vehicles
held for sale or lease to deduct the full ex-
pense without regard to the section 163(j)
limitation.
Under section 163(j)(10)(A)(i), the
amount of business interest that is de-
ductible under section 163(j)(1) for tax-
able years beginning in 2019 or 2020 is
computed using 50 percent, rather than
30 percent, of the taxpayer’s ATI for the
taxable year (50 percent ATI limitation).
A taxpayer may elect not to apply the 50
percent ATI limitation to any taxable year
beginning in 2019 or 2020, and instead
apply the 30 percent ATI limitation. This
election must be made separately for each
taxable year. Once the taxpayer makes the
election, the election may not be revoked
without the consent of the Secretary of
the Treasury or his delegate. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)
(10)(A)(iii) provide that, in the case of a
partnership, the 50 percent ATI limitation
does not apply to partnerships for taxable
years beginning in 2019, and the election
to not apply the 50 percent ATI limitation
may be made only for taxable years be-
ginning in 2020, and may be made only
by the partnership. Under section 163(j)
(10)(A)(ii)(II), however, a partner treats
50 percent of its allocable share of a part-
nership’s excess business interest expense
for 2019 as a business interest expense in
the partner’s first taxable year beginning
in 2020 that is not subject to the section
163(j) limitation (50 percent EBIE rule).
The remaining 50 percent of the partner’s
allocable share of the partnership’s excess
business interest expense remains subject
to the section 163(j) limitation applicable
to excess business interest expense carried
forward at the partner level. A partner may
elect out of the 50 percent EBIE rule.
Section 163(j)(10)(B)(i) allows a tax-
payer to elect to substitute its ATI for the
last taxable year beginning in 2019 (2019
ATI) for the taxpayer’s ATI for a taxable
year beginning in 2020 (2020 ATI) in de-
termining the taxpayer’s section 163(j)
limitation for the taxable year beginning
in 2020.
Section 163(j)(11) provides cross-ref-
erences to provisions requiring that elect-
ing farming businesses and electing real
property businesses excepted from the
section 163(j) limitation use the alterna-
tive depreciation system (ADS), rather
than the general depreciation system, for
certain types of property. The required use
of ADS results in the inability of these
electing trades or businesses to use the
additional first-year depreciation deduc-
tion under section 168(k) for those types
of property.
On December 28, 2018, the Depart-
ment of the Treasury (Treasury Depart-
ment) and the IRS (1) published pro-
posed regulations under section 163(j),
as amended by the TCJA, in a notice of
proposed rulemaking (REG-106089-18)
(2018 Proposed Regulations) in the Fed-
eral Register (83 FR 67490), and (2)
withdrew the notice of proposed rulemak-
ing (1991-2 C.B. 1040) published in the
Federal Register on June 18, 1991 (56
FR 27907 as corrected by 56 FR 40285
(August 14, 1991)) to implement rules

Bulletin No. 2020–40 797 September 28, 2020
under section 163(j) before amendment
by the TCJA. The 2018 Proposed Regu-
lations were issued following guidance
announcing and describing regulations in-
tended to be issued under section 163(j).
See Notice 2018-28, 2018-16 I.R.B. 492
(April 16, 2018).
A public hearing on the 2018 Pro-
posed Regulations was held on February
27, 2019. The Treasury Department and
the IRS also received written comments
responding to the 2018 Proposed Regula-
tions (available at http://www.regulations.
gov). In response to certain comments, the
Treasury Department and the IRS are pub-
lishing this notice of proposed rulemaking
to provide additional proposed regulations
(these Proposed Regulations) under sec-
tion 163(j).
Concurrently with the publication of
these Proposed Regulations, the Treasury
Department and the IRS are publishing
in the Rules and Regulations section of
this edition of the Federal Register (RIN
1545-BO73) final regulations under sec-
tion 163(j) (the Final Regulations).
On April 10, 2020, the Treasury De-
partment and the IRS released Revenue
Procedure 2020-22, 2020-18 I.R.B. 745,
to provide the time and manner of making
a late election, or withdrawing an elec-
tion, under section 163(j)(7)(B) to be an
electing real property trade or business
or section 163(j)(7)(C) to be an electing
farming business for taxable years begin-
ning in 2018, 2019, or 2020. Revenue Pro-
cedure 2020-22 also provides the time and
manner of making or revoking elections
provided by the CARES Act under section
163(j)(10) for taxable years beginning in
2019 or 2020. As described earlier in this
Background section, these elections are:
(1) to not apply the 50 percent ATI limita-
tion under section 163(j)(10)(A)(iii); (2)
to use the taxpayer’s 2019 ATI to calculate
the taxpayer’s section 163(j) limitation for
any taxable year beginning in 2020 under
section 163(j)(10)(B); and (3) for a part-
ner to elect out of the 50 percent EBIE rule
under section 163(j)(10)(A)(ii)(II).
Explanation of Provisions
These Proposed Regulations would
provide guidance in addition to the Final
Regulations regarding the section 163(j)
limitation. These Proposed Regulations
would also add or amend regulations under
certain other provisions of the Code where
necessary to provide conformity across
the Income Tax Regulations. A signifi-
cant number of the terms used throughout
these Proposed Regulations are defined in
§1.163(j)-1 of the Final Regulations and
discussed in the Explanation of Provisions
section of the 2018 Proposed Regulations
and the Summary of Comments and Ex-
planation of Revisions section of the Final
Regulations. Some of these terms are fur-
ther discussed in this Explanation of Pro-
visions section as they relate to specific
provisions of these Proposed Regulations.
Part I of this Explanation of Provi-
sions describes proposed rules that would
allocate interest expense for purposes of
sections 469, 163(d), 163(h), and 163(j)
in connection with certain transactions
involving passthrough entities. Part II
provides proposed rules relating to dis-
tributions of debt proceeds from any tax-
payer account or from cash so that interest
expense may be allocated for purposes of
sections 469, 163(d), 163(h), and 163(j).
Part III describes proposed modifications
to the definitions and general guidance
in §1.163(j)-1, including proposed rules
permitting taxpayers to apply a different
computational method in determining
adjustments to tentative taxable income
to address sales or other dispositions of
depreciable property, stock of a consol-
idated group member, or interests in a
partnership, and proposed rules allowing
RIC shareholders to treat certain RIC div-
idends as interest income for purposes of
section 163(j). Part IV describes proposed
modifications to §1.163(j)-6, relating to
the applicability of the section 163(j) lim-
itation to passthrough entities, including
proposed rules on the applicability of the
section 163(j) limitation to trading part-
nerships and publicly traded partnerships,
the application of the section 163(j) lim-
itation in partnership self-charged lending
transactions, proposed rules relating to
the treatment of excess business interest
expense in tiered partnerships, proposed
rules relating to partnership basis adjust-
ments upon partner dispositions, proposed
rules regarding the election to substitute
2019 ATI for the partnership’s 2020 ATI
in determining the partnership’s section
163(j) limitation for a taxable year be-
ginning in 2020, and proposed rules re-
garding excess business interest expense
allocated to a partner in a taxable year be-
ginning in 2019.
Part V discusses re-proposed rules
regarding the application of the section
163(j) limitation to foreign corporations
and United States shareholders (as defined
in section 951(b) (U.S. shareholders) of
controlled foreign corporations (as de-
fined in section 957(a)) (CFCs). Part VI
discusses re-proposed rules regarding the
application of the section 163(j) limita-
tion to nonresident alien individuals and
foreign corporations with effectively con-
nected income in the United States. Part
VII describes proposed modifications to
the definition of a real property trade or
business under §1.469-9 for purposes of
the passive activity loss rules and the defi-
nition of an electing real property trade or
business under section 163(j)(7)(B). Part
VIII describes proposed rules regarding
the definition of a “tax shelter” for pur-
poses of §1.163(j)-2 and section 1256(e),
as well as proposed rules regarding the
election to use 2019 ATI in determining
the taxpayer’s section 163(j) limitation for
a taxable year beginning in 2020. Part IX
describes proposed modifications regard-
ing the application of the corporate look-
through rules to tiered structures.
I. Proposed §1.163-14: Allocation
of Interest Expense with Respect to
Passthrough Entities
Section 1.163-8T provides rules re-
garding the allocation of interest expense
for purposes of applying the passive ac-
tivity loss limitation in section 469, the
investment interest limitation in section
163(d), and the personal interest limita-
tion in section 163(h) (such purposes,
collectively, §1.163-8T purposes). Under
§1.163-8T, debt generally is allocated by
tracing disbursements of the debt proceeds
to specific expenditures and interest ex-
pense associated with debt is allocated for
§1.163-8T purposes in the same manner
as the debt to which such interest expense
relates. When debt proceeds are deposited
to the borrower’s account, and the account
also contains unborrowed funds, §1.163-
8T(c) provides that the debt generally is
allocated to expenditures by treating sub-
sequent expenditures from the account as
made first from the debt proceeds to the

September 28, 2020 798 Bulletin No. 2020–40
extent thereof. The rules further provide
that if the proceeds of two or more debts
are deposited in the account, the proceeds
are treated as expended in the order in
which they were deposited. In addition to
these rules, §1.163-8T also provides spe-
cific rules to address reallocation of debt,
repayments and refinancing.
The preamble to §1.163-8T (52 FR
24996) stated that “interest expense of
partnerships and S corporations, and of
partners and S corporation shareholders,
is generally allocated in the same manner
as the interest expense of other taxpayers.”
The preamble acknowledged the need for
special rules for debt financed distribu-
tions to owners of partnerships and S cor-
porations, and for cases in which taxpay-
ers incur debt to acquire or increase their
capital interest in the passthrough entity,
but reserved on these issues and requested
comments.
In a series of notices, the Treasury De-
partment and the IRS provided further
guidance with respect to the allocation of
interest expense in connection with cer-
tain transactions involving passthrough
entities and owners of passthrough en-
tities. See Notice 88-20, 1988-1 C.B.
487, Notice 88-37, 1988-1 C.B. 522, and
Notice 89-35, 1989-1 C.B. 675. Specif-
ically, Notice 89-35 provides, in part,
rules addressing the treatment of (1) a
passthrough entity owner’s debt allocated
to contributions to, or purchases of, inter-
ests in a passthrough entity (debt-financed
contributions or acquisitions), and (2)
passthrough entity debt allocated to distri-
butions by the entity to its owners (debt-fi-
nanced distributions).
In the case of a debt-financed acquisi-
tion of an interest in a passthrough enti-
ty by purchase (rather than by way of a
contribution to the capital of the entity),
Notice 89-35 provides that the interest ex-
pense of the owner of the passthrough en-
tity, for §1.163-8T purposes, is allocated
among the assets of the entity using any
reasonable method. A reasonable method
for this purpose includes, for example, al-
locating the debt among all of the assets
of the passthrough entity based on the fair
market value, the book value, or the ad-
justed basis of the assets, reduced by the
amount of any debt of the entity or the
amount of any debt that the owner of the
entity allocates to such assets. Notice 89-
35 also provides that interest expense on
debt proceeds allocated to a contribution to
the capital of a passthrough entity shall be
allocated using any reasonable method for
§1.163-8T purposes. For this purpose, any
reasonable method includes allocating the
debt among the assets of the passthrough
entity or tracing the debt proceeds to the
expenditures of the passthrough entity.
In the case of debt-financed distribu-
tions, Notice 89-35 provides a general
allocation rule and an optional allocation
rule. The general allocation rule applies
the principles of §1.163-8T to interest ex-
pense associated with debt-financed dis-
tributions by applying a tracing approach
to determine the character of the interest
expense for §1.163-8T purposes. Under
this approach, the debt proceeds and the
associated interest expense related to a
debt-financed distribution are allocated
under §1.163-8T in accordance with the
use of the distributed debt proceeds by
the distributee owner of the passthrough
entity. To the extent an owner’s share of
a passthrough entity’s interest expense
related to the debt-financed distribution
exceeds the entity’s interest expense on
the portion of the debt proceeds distribut-
ed to that particular owner, Notice 89-35
provides that the passthrough entity may
allocate such excess interest expense us-
ing any reasonable method.
The optional allocation rule applica-
ble to debt-financed distributions allows a
passthrough entity to allocate distributed
debt proceeds and the associated interest
expense to one or more expenditures, oth-
er than distributions, of the entity that are
made during the same taxable year of the
entity as the distribution, to the extent that
debt proceeds, including other distributed
debt proceeds, are not otherwise allocated
to such expenditures. Under the optional
allocation rule, distributed debt proceeds
are traced to the owner’s use of the bor-
rowed funds to the extent that such distrib-
uted debt proceeds exceed the entity’s ex-
penditures, not including distributions, for
the taxable year to which debt proceeds
are not otherwise allocated.
While the 2018 Proposed Regulations
did not include rules to further address the
application of §1.163-8T to passthrough
entities, the Treasury Department and the
IRS received comments indicating that,
for purposes of section 163(j), a tracing
rule based on how a passthrough enti-
ty owner uses the proceeds of a debt-fi-
nanced distribution does not align well
with the statutory mandate in section
163(j)(4) to apply section 163(j) at the
passthrough entity level. Based on these
comments and a review of the rules under
§1.163-8T, the Treasury Department and
the IRS have determined that additional
rules, specific to passthrough entities and
their owners, are needed to clarify how the
rules under §1.163-8T work when applied
to a passthrough entity and to account for
the entity-level limitation under section
163(j)(4).
A. In General
The rules of §1.163-8T generally apply
to partnerships, S corporations, and their
owners and the rules in proposed §1.163-
14 would provide additional rules for pur-
poses of applying the §1.163-8T rules to
passthrough entities. As with the rules un-
der §1.163-8T, proposed §1.163-14 would
provide that interest expense on a debt in-
curred by a passthrough entity is allocated
in the same manner as the debt to which
such interest relates is allocated, and that
debt is generally allocated by tracing dis-
bursements of the debt proceeds to specif-
ic expenditures.
The Treasury Department and the IRS
have determined that the scope of §1.163-
8T(a)(4) and (b) is not appropriate in the
passthrough entity context. Section 1.163-
8T(a)(4) generally provides rules regard-
ing the treatment of interest expense allo-
cated to specific expenditures, which are
described in §1.163-8T(b). However, the
list of expenditures described in §1.163-
8T(b) is based on an allocation of interest
for purposes of applying sections 163(d),
163(h), and 469, and does not adequately
account for the uses of debt proceeds by a
passthrough entity (for example, distribu-
tions to owners).
To more accurately account for the types
of expenditures made by passthrough en-
tities, proposed §1.163-14(b) would pro-
vide rules tailored to passthrough entities.
In addition, the framework that proposed
§1.163-14(b) would provide is needed for
a passthrough entity to determine how
much of its interest expense is allocable
to a trade or business for purposes of ap-
plying section 163(j). These proposed reg-

Bulletin No. 2020–40 799 September 28, 2020
ulations would apply before a passthrough
entity applies any of the rules in section
163(j) (including §1.163(j)-10).
In application, a passthrough entity
would continue to apply the operative
rules in §1.163-8T to allocate debt and the
interest expense associated with such debt.
However, instead of generally tracing debt
proceeds to the types of expenditures de-
scribed under §1.163-8T(b) and treating
any interest expense associated with such
debt proceeds in the manner described un-
der §1.163-8T(a)(4), a passthrough entity
would generally trace debt proceeds to
the types of expenditures described under
proposed §1.163-14(b)(2) and treat any
interest expense associated with such debt
proceeds in the manner provided under
proposed §1.163-14(b)(1).
B. Debt Financed Distributions
Proposed §1.163-14 would provide
that when debt proceeds of a passthrough
entity are allocated under §1.163-8T to
distributions to owners of the entity, the
debt proceeds distributed to any owner
and the associated interest expense shall
be allocated under proposed §1.163-14(d).
In general, proposed §1.163-14(d) would
adopt a rule similar to Notice 89-35, but
with the following modifications. First,
instead of providing that passthrough en-
tities may use the optional allocation rule,
proposed §1.163-14(d) would generally
provide that passthrough entities are re-
quired to apply a rule that is similar to the
optional allocation rule. Second, instead
of providing that the passthrough entity
may allocate excess interest expense using
any reasonable method, proposed §1.163-
14(d) would generally provide that the
passthrough entity must allocate excess
interest expense based on the adjusted tax
basis of the passthrough entity’s assets.
Specifically, proposed §1.163-14(d)
(1) would provide a rule based in prin-
ciple on the optional allocation rule in
Notice 89-35. Under this proposed rule,
distributed debt proceeds (debt proceeds
of a passthrough entity allocated under
§1.163-8T to distributions to owners of
the entity) would first be allocated un-
der proposed §1.163-14(d)(1)(i) to the
passthrough entity’s available expendi-
tures. Available expenditures are those
expenditures of a passthrough entity
made in the same taxable year as the dis-
tribution, but only to the extent that debt
proceeds (including other distributed debt
proceeds) are not otherwise allocated to
such expenditure. This approach is con-
sistent with the concept that money is fun-
gible (a passthrough entity may be fairly
treated as distributing non-debt proceeds
rather than debt proceeds and using debt
proceeds rather than non-debt proceeds to
finance its non-distribution expenditures)
and seeks to coordinate the interest allo-
cation rules with the entity-level approach
to passthroughs adopted in section 163(j).
Where the distributed debt proceeds ex-
ceed the passthrough entity’s available ex-
penditures, this excess amount of distrib-
uted debt proceeds would be allocated to
distributions to owners of the passthrough
entity (debt financed distributions) under
proposed §1.163-14(d)(1)(ii).
After determining the amount of its
distributed debt proceeds allocated to
available expenditures and debt financed
distributions, a passthrough entity would
use this information to determine the tax
treatment of each owner’s allocable inter-
est expense (that is, an owner’s share of in-
terest expense associated with the distrib-
uted debt proceeds allocated under section
704(b) or 1366(a)). To aid the passthrough
entity and owner in determining the tax
treatment of each owner’s allocable in-
terest expense, proposed §1.163-14(d)(2)
would provide rules for determining the
portion of each owner’s allocable interest
expense that is (1) debt financed distribu-
tion interest expense, (2) expenditure in-
terest expense, and (3) excess interest ex-
pense. These three categories of allocable
interest expense are mutually exclusive
– e.g., a given dollar of allocable interest
expense cannot simultaneously be both
debt financed distribution interest expense
and expenditure interest expense. The
computations in proposed §1.163-14(d)
(2) would ensure this outcome.
Once a passthrough entity categorizes
each owner’s allocable interest expense
as described earlier, it would apply pro-
posed §1.163-14(d)(3) to determine the
tax treatment of such interest expense.
The manner in which the tax treatment of
allocable interest expense is determined
depends on how such allocable interest
expense was categorized under proposed
§1.163-14(d)(2).
Conceptually, each of the three catego-
ries described earlier, as well as the pre-
scribed tax treatment of interest expense
in each category, is discussed in Notice
89-35. Debt financed distribution interest
expense is referred to in Notice 89-35 as
an owner’s share of a passthrough entity’s
interest expense on debt proceeds allocat-
ed to such owner. Similar to Notice 89-35,
proposed §1.163-14(d)(3)(i) would gener-
ally provide that such interest expense is
allocated under §1.163-8T in accordance
with the owner’s use of the debt proceeds.
Further, expenditure interest expense is
referred to in Notice 89-35 as interest ex-
pense allocated under the optional allo-
cation rule. Similar to Notice 89-35, pro-
posed §1.163-14(d)(3)(ii) would generally
provide that the tax treatment of such in-
terest expense is determined based on how
the distributed debt proceeds were allocat-
ed among available expenditures. Finally,
both Notice 89-35 and proposed §1.163-
14(d) would use the term excess interest
expense to refer to an owner’s share of
allocable interest expense in excess of the
entity’s interest expense on the portion of
the debt proceeds distributed to that par-
ticular owner. Unlike Notice 89-35, which
generally allows any reasonable method
for determining the tax treatment of excess
interest expense, proposed §1.163-14(d)
(3)(iii) would generally provide that the
tax treatment of excess interest expense
is determined by allocating the distributed
debt proceeds among all the assets of the
passthrough entity, pro-rata, based on the
adjusted basis of such assets.
Proposed §1.163-14(d)(4) also would
provide rules addressing the tax treatment
of the interest expense of a transferee
owner where the transferor had previously
been allocated debt financed distribution
interest expense. In the case of a transfer
of an interest in a passthrough entity, any
debt financed distribution interest expense
of the transferor generally shall be treated
as excess interest expense by the transfer-
ee. However, in the case of a transfer of an
interest in a passthrough entity to a person
who is related to the transferor, any debt
financed distribution interest expense of
the transferor shall continue to be treated
as debt financed distribution interest ex-
pense by the related party transferee, and
the tax treatment of such debt financed
distribution expense shall be the same to

September 28, 2020 800 Bulletin No. 2020–40
the related party transferee as it was to the
transferor. The term related party means
any person who bears a relationship to
the taxpayer which is described in section
267(b) or 707(b)(1).
The proposed regulations also would
include an anti-avoidance rule to rechar-
acterize arrangements entered into with
a principal purpose of avoiding the rules
of proposed §1.163-14(d), including the
transfer of an interest in a passthrough
entity by an owner who treated a portion
of its allocable interest expense as debt fi-
nanced distribution interest expense to an
unrelated party pursuant to a plan to trans-
fer the interest back to the owner who re-
ceived the debt financed distribution inter-
est expense or to a party who is related to
the owner who received the debt financed
distribution interest expense.
C. Operational Rules
Proposed §1.163-14 also would in-
clude several operational rules that clar-
ify the application of certain rules under
§1.163-8T as they apply to passthrough
entities. Proposed §1.163-14(e) would
provide an ordering rule applicable to re-
payment of debt by passthrough entities
similar to the rules in §1.163-8T(d)(1).
Proposed §1.163-14(g) would provide
that any transfer of an ownership interest
in a passthrough entity is not a realloca-
tion event for purposes of § 1.163-8T(j),
except as provided for in §1.163-14(d)(4).
D. Debt-Financed Acquisitions
Proposed §1.163-14(f) would adopt a
rule providing that the tax treatment of an
owner’s interest expense associated with
a debt financed acquisition (either by pur-
chase or contribution) will be determined
by allocating the debt proceeds among the
assets of the entity. The owner would allo-
cate the debt proceeds (1) in proportion to
the relative adjusted tax basis of the enti-
ty’s assets reduced by any debt allocated
to such assets, or (2) based on the adjusted
basis of the entity’s assets in accordance
with the rules in §1.163(j)-10(c)(5)(i) re-
duced by any debt allocated to such assets.
The Treasury Department and the IRS re-
quest comments regarding whether asset
basis (either adjusted tax basis or adjusted
tax basis based on the rules in §1.163(j)-
10(c)(5)(i)) less the amount of debt al-
located to assets under §§1.163-14 and
1.163-8T is appropriate as the sole meth-
od for allocating interest expense in this
context.
II. Proposed §1.163-15: Debt Proceeds
Distributed from Any Taxpayer Account
or from Cash
Proposed §1.163-15 supplements the
rules in §1.163-8T regarding debt pro-
ceeds distributed from any taxpayer ac-
count or from cash proceeds. Section
1.163-8T(c)(4)(iii)(B) provides that a
taxpayer may treat any expenditure made
from an account within 15 days after the
debt proceeds are deposited in such ac-
count as being made from such proceeds,
regardless of any other rules in §1.163-
8T(c)(4). Under §1.163-8T(c)(5)(i), if a
taxpayer receives debt proceeds in cash,
the taxpayer may treat any cash expendi-
ture made within 15 days after receiving
the cash as being made from such debt
proceeds, and may treat such expenditure
as being made on the date the taxpayer
received the cash. Commenters have sug-
gested that the 15-day limit in §1.163-8T
could encourage taxpayers to keep sepa-
rate accounts, rather than commingled ac-
counts for tracing purposes.
In Notice 88-20, 1988-1 C.B. 487, the
IRS announced the intention to issue reg-
ulations providing that, for debt proceeds
deposited in an account on or before De-
cember 31, 1987, taxpayers could treat
any expenditure made from any account
of the taxpayer or from cash within 30
days before or after debt proceeds are de-
posited in such account or any other ac-
count of the taxpayer as made from such
proceeds. The Notice states that the reg-
ulations also would provide that for debt
proceeds received in cash on or before De-
cember 31, 1987, taxpayers may treat any
expenditure made from any account of the
taxpayer or from cash within 30 days be-
fore or after debt proceeds are received in
cash as made from such proceeds. Section
VI of Notice 89-35 adopts the standard de-
scribed in Notice 88-20 without the date
limitation, although no regulations have
been issued.
Consistent with Notice 89-35, pro-
posed §1.163-15 provides that taxpayers
may treat any expenditure made from an
account of the taxpayer or from cash with-
in 30 days before or after debt proceeds
are deposited in any account of the tax-
payer or received in cash as made from
such proceeds.
III. Proposed Modifications to §1.163(j)-
1(b): Definitions
A. Adjustments to Tentative Taxable
Income
Section 1.163(j)-1(b)(1) requires tax-
payers to make certain adjustments to ten-
tative taxable income in computing ATI,
including adjustments to address certain
sales or other dispositions of depreciable
property, stock of a consolidated group
member (member stock), or interests in a
partnership. More specifically, §1.163(j)-
1(b)(1)(ii)(C) provides that, if property is
sold or otherwise disposed of, the greater
of the allowed or allowable depreciation,
amortization, or depletion of the proper-
ty for the taxpayer (or, if the taxpayer is
a member of a consolidated group, the
consolidated group) for taxable years
beginning after December 31, 2017, and
before January 1, 2022 (such years, the
EBITDA period), with respect to such
property is subtracted from tentative tax-
able income. Section 1.163(j)-1(b)(1)(ii)
(D) provides that, with respect to the sale
or other disposition of stock of a member
of a consolidated group by another mem-
ber, the investment adjustments under
§1.1502-32 with respect to such stock that
are attributable to deductions described
in §1.163(j)-1(b)(1)(ii)(C) are subtracted
from tentative taxable income. Section
1.163(j)-1(b)(1)(ii)(E) provides that, with
respect to the sale or other disposition of
an interest in a partnership, the taxpayer’s
distributive share of deductions described
in §1.163(j)-1(b)(1)(ii)(C) with respect
to property held by the partnership at the
time of such sale or other disposition is
subtracted from tentative taxable income
to the extent such deductions were allow-
able under section 704(d). See the pream-
ble to the Final Regulations for a discus-
sion of the rationale for these adjustments.
The preamble to the Final Regulations
noted that, in the 2018 Proposed Regula-
tions, §1.163(j)-1(b)(1)(ii)(C) incorporat-
ed a “lesser of” standard. In other words,
the lesser of (i) the amount of gain on

Bulletin No. 2020–40 801 September 28, 2020
the sale or other disposition of property,
or (ii) the amount of depreciation deduc-
tions with respect to such property for
the EBITDA period, was required to be
subtracted from tentative taxable income
to determine ATI. As explained in the
preamble to the Final Regulations, com-
menters raised several questions regarding
this “lesser of” standard. The Final Regu-
lations removed the “lesser of” approach
due in part to concerns that this approach
would be more difficult to administer than
the approach reflected in the Final Regu-
lations.
However, the Treasury Department and
the IRS recognize that, in certain cases,
the “lesser of” approach might not create
administrative difficulties for taxpayers.
Thus, these Proposed Regulations permit
taxpayers to choose whether to compute
the amount of their adjustment using a
“lesser of” standard. While the 2018 Pro-
posed Regulations applied this standard
solely to dispositions of property, these
Proposed Regulations extend this standard
to dispositions of partnership interests and
member stock to eliminate the discontinu-
ity between the amount of the adjustment
for these different types of dispositions.
Taxpayers opting to use this alternative
computation method must do so for all
sales or other dispositions that otherwise
would be subject to §1.163(j)-1(b)(1)(ii)
(C), (D), or (E) when the taxpayer com-
putes tentative taxable income.
The Treasury Department and the IRS
request comments on the “lesser of” ap-
proach, including how such an approach
should apply to dispositions of member
stock and partnership interests.
B. Dividends from Regulated Investment
Company (RIC) Shares
Some commenters on the 2018 Pro-
posed Regulations recommended that
dividend income from a RIC be treated
as interest income for a shareholder in a
RIC, to the extent that the income earned
by the RIC is interest income. Because a
RIC is a subchapter C corporation, section
163(j) applies at the RIC level, and any
BIE that is disallowed at the RIC level is
carried forward to subsequent years at the
RIC level. Furthermore, because a RIC is
a subchapter C corporation, a sharehold-
er in a RIC generally does not take into
account a share of the RIC’s items of in-
come, deduction, gain, or loss. Thus, if
a RIC’s BII exceeds its BIE in a taxable
year, the RIC may not directly allocate the
excess amount to its shareholders (unlike
a partnership, which may allocate excess
BII to its partners).
Under part 1 of subchapter M and oth-
er Code provisions, however, a RIC that
has certain items of income or gain may
pay dividends that a shareholder in the
RIC may treat in the same manner (or a
similar manner) as the shareholder would
treat the underlying items of income or
gain if the shareholder realized the items
directly. Although this treatment differs
fundamentally from the passthrough treat-
ment of partners or trust beneficiaries,
this Explanation of Provisions refers to
this treatment as “conduit treatment.” For
example, under sections 871(k)(1) and
881(e)(1), a RIC that has qualified inter-
est income within the meaning of section
871(k)(1)(E) may pay interest-related
dividends, and no tax generally would be
imposed under sections 871(a)(1)(A) or
881(a)(1) on an interest-related dividend
paid to a nonresident alien individual or
foreign corporation. Section 871(k)(1)
provides necessary limits and procedures
that apply to interest-related dividends.
The Code provides similar conduit treat-
ment for capital gain dividends in section
852(b)(3), exempt-interest dividends in
section 852(b)(5), short-term capital gain
dividends in section 871(k)(2), dividends
eligible for the dividends received deduc-
tion in section 854(b)(1)(A), and qualified
dividend income in section 854(b)(1)(B).
In response to comments, these Pro-
posed Regulations provide rules under
which a RIC that earns BII may pay section
163(j) interest dividends. A shareholder
that receives a section 163(j) interest divi-
dend may treat the dividend as interest in-
come for purposes of section 163(j), sub-
ject to holding period requirements and
other limitations. A section 163(j) interest
dividend that meets these requirements is
treated as BII if it is properly allocable to
a non-excepted trade or business of the
shareholder. A section 163(j) interest div-
idend is treated as interest income solely
for purposes of section 163(j).
The rules under which a RIC may report
section 163(j) interest dividends are based
on the rules for reporting exempt-interest
dividends in section 852(b)(5) and inter-
est-related dividends in section 871(k)
(1). The total amount of a RIC’s section
163(j) interest dividends for a taxable year
is limited to the excess of the RIC’s BII for
the taxable year over the sum of the RIC’s
BIE for the taxable year and the RIC’s
other deductions for the taxable year that
are properly allocable to the RIC’s BII.
For some types of income and gain to
which conduit treatment applies, the gross
amount of the RIC’s income or gain of that
type serves as the limit on the RIC’s cor-
responding dividends. It would be incon-
sistent with the purposes of section 163(j)
to permit a RIC to pay section 163(j) in-
terest dividends in an amount based on
the RIC’s gross BII, unreduced by the
RIC’s BIE. Further reducing the limit on a
RIC’s section 163(j) interest dividends by
the amount of the RIC’s other deductions
that are properly allocable to the RIC’s
BII is consistent with the provisions of
the Code that provide conduit treatment
for types of interest earned by a RIC. For
example, the limit on interest-related div-
idends in section 871(k)(1)(D) is reduced
by the deductions properly allocable to the
RIC’s qualified interest income. Similar-
ly, the limit on exempt-interest dividends
in section 852(b)(5)(A)(iv)(V) is reduced
by the amounts disallowed as deductions
under sections 265 and 171(a)(2). Taking
into account the appropriate share of de-
ductions also reduces the likelihood that
the sum of a RIC’s items that are eligible
for conduit treatment and that are relevant
to a particular shareholder will exceed the
amount of the dividend distribution paid
to the particular shareholder.
These Proposed Regulations contain
an additional limit to prevent inconsistent
treatment of RIC dividends by RIC share-
holders. Revenue Ruling 2005-31, 2005-1
C.B. 1084, allows a RIC to report the max-
imum amount of capital gain dividends,
exempt-interest dividends, interest-related
dividends, short-term capital gain divi-
dends, dividends eligible for the dividends
received deduction, and qualified divi-
dend income for a taxable year, even if the
sum of the reported amounts exceeds the
amount of the RIC’s dividends for the tax-
able year. The ruling allows different cate-
gories of shareholders (United States per-
sons and nonresident aliens) to report the
dividends they receive by giving effect to

September 28, 2020 802 Bulletin No. 2020–40
the conduit treatment of the items relevant
to them. A single shareholder, however,
generally does not benefit from the con-
duit treatment of amounts in excess of the
dividend paid to that shareholder, because
to do so would require the shareholder to
include in its taxable income amounts ex-
ceeding the dividend it received. Conduit
treatment of BII, however, differs from the
conduit treatment of other items, because
a section 163(j) interest dividend is treat-
ed as interest income only for purposes of
section 163(j). Thus, absent a limit, a RIC
shareholder could obtain an inappropri-
ate benefit by treating a portion of a RIC
dividend as interest income for purposes
of section 163(j) while treating the same
portion of the dividend as another non-in-
terest type of income, such as a dividend
eligible for the dividends received deduc-
tion under sections 243 and 854(b). There-
fore, these Proposed Regulations limit the
amount of a section 163(j) interest divi-
dend that a shareholder may treat as inter-
est income for purposes of section 163(j)
to the excess of the amount of the RIC
dividend that includes the section 163(j)
interest dividend over the sum of the por-
tions of that dividend affected by conduit
treatment in the hands of that shareholder,
other than interest-related dividends under
section 871(k)(1)(C) and section 163(j)
interest dividends.
Under these Proposed Regulations, a
shareholder generally may not treat a sec-
tion 163(j) interest dividend as interest
income unless it meets certain holding pe-
riod and similar requirements. The hold-
ing period requirements do not apply to
(i) dividends paid by a RIC regulated as a
money market fund under 17 CFR 270.2a-
7 or (ii) certain regular dividends paid by
a RIC that declares section 163(j) interest
dividends on a daily basis and distributes
such dividends on a monthly or more fre-
quent basis. The Treasury Department and
the IRS request comments on whether
there are other categories of section 163(j)
interest dividends for which the holding
period requirements should not apply or
should be modified. The Treasury Depart-
ment and the IRS also request comments
on whether any payments that are substi-
tutes for section 163(j) interest dividends
(for example, in a securities lending or
sale-repurchase transaction with respect
to RIC shares) should be treated for pur-
poses of section 163(j) as interest expense
of taxpayers making the payments or in-
terest income to taxpayers receiving the
payments. Cf. §1.163(j)-1(b)(22)(iii)(C)
(addressing certain payments that are sub-
stitutes for interest).
These Proposed Regulations, to the ex-
tent they concern the payment of section
163(j) interest dividends by a RIC and the
treatment of such dividends as interest by
a RIC shareholder, are proposed to ap-
ply to taxable years beginning on or after
the date that is 60 days after the date the
Treasury decision adopting these regula-
tions as final regulations is published in
the Federal Register. Solely in the case
of section 163(j) interest dividends that
would be exempt from the holding period
rules under these Proposed Regulations,
the RIC paying such dividends and the
shareholders receiving such dividends
may rely on the provisions of these Pro-
posed Regulations pertaining to section
163(j) interest dividends for taxable years
ending on or after September 14, 2020,
and beginning before the date that is 60
days after the date the Treasury decision
adopting these regulations as final regula-
tions is published in the Federal Register.
IV. Proposed §1.163(j)-6: Application of
the Business Interest Expense Deduction
Limitations to Partnerships and
Subchapter S Corporations
A. Trading Partnerships
The preamble to the 2018 Proposed
Regulations states that the business in-
terest expense of certain passthrough en-
tities, including S corporations, allocable
to trade or business activities that are de-
scribed in section 163(d)(5)(A)(ii) (i.e.,
activities that are per se non-passive under
section 469 in which the taxpayer does
not materially participate) and illustrated
in Revenue Ruling 2008-12, 2008-1 C.B.
520 (March 10, 2008) (trading activities),
will be subject to section 163(j) at the en-
tity level, even if the interest expense is
later subject to limitation under section
163(d) at the individual partner or share-
holder level. Accordingly, at least with
respect to partnerships, to the extent that
interest expense from a trading activity is
limited under section 163(j) and becomes
a carryover item of partners who do not
materially participate in the trading activ-
ity, the interest expense will be treated as
investment interest in the hands of those
partners for purposes of section 163(d)
once the interest expense is no longer lim-
ited under section 163(j). As a result, the
interest expense would be subject to two
section 163 limitations.
The Treasury Department and the IRS
received multiple comments questioning
this interpretation of section 163(j)(5) and
its interaction with section 163(d)(5)(A)
(ii). Specifically, commenters stated that
the interpretation improperly results in the
application of section 163(j) to partner-
ships engaged in a trade or business activ-
ity of trading personal property (including
marketable securities) for the account of
owners of interests in the activity, as de-
scribed in §1.469-1T(e)(6) (trading part-
nerships). At issue is the extent to which
BIE of trading partnerships should be
subject to limitation under section 163(j).
This issue involves the definition of BIE
under section 163(j)(5) and, more spe-
cifically, the second sentence of section
163(j)(5), which generally provides that
BIE shall not include investment interest
within the meaning of section 163(d).
The approach described in the pre-
amble to the 2018 Proposed Regulations
interprets section 163(j)(5) as simply
providing that interest expense cannot
be both BIE and investment interest ex-
pense in the hands of the same taxpayer.
Under this interpretation, section 163(j)
(5) will treat interest as investment in-
terest where conflicting provisions may
otherwise subject an amount of interest
expense to limitation under both section
163(j) and section 163(d) with respect to
the same taxpayer (for example, interest
expense allocable to business assets com-
prising “working capital” as that term is
used in section 469(e)(1)(B)). In addition,
this approach views the partnership as an
entity separate from its partners for pur-
poses of section 163(j) to the partnership
and section 163(d) at the individual part-
ner level. Several commenters disagreed
with this interpretation of section 163(j)
(5), asserting that the second sentence of
section 163(j)(5) unequivocally provides
that interest expense can never be subject
to limitation under both section 163(j) and
section 163(d) under any circumstances.
Based on these comments, the Treasury

Bulletin No. 2020–40 803 September 28, 2020
Department and the IRS considered three
alternative approaches for interpreting
section 163(j)(5).
One approach would require a partner-
ship engaged in a trading activity to apply
section 163(j) at the partnership level to all
of the partnership’s interest expense from
the trading activity. Under this approach,
any deductible interest expense from the
partnership’s trading activity would not
be subject to any further limitation under
section 163(d) at the individual partner
level. This interpretation would respect
the partnership as an entity separate from
its partners for purposes of section 163(j),
but would treat section 163(j)(4) and (5)
as superseding section 163(d)(5)(A)(ii).
A second approach would require a
partnership engaged in a trading activity
to bifurcate its interest expense from a
trading activity between partners that ma-
terially participate in the trading activity
and partners that are passive investors in
the activity, and subject only the portion
that is allocable to the materially partici-
pating partners to limitation under section
163(j). Under this approach, to the extent
any interest expense is allocable to pas-
sive investors in the trading activity, the
interest expense would be subject only
to section 163(d) at the partner level and
would never be subject to section 163(j) at
the partnership level.
A third approach would require a part-
nership to treat all of the interest expense
from a trading activity as investment in-
terest under section 163(d), regardless of
whether any individual partners material-
ly participate in the trading activity. Under
this approach, the interest expense prop-
erly allocable to materially participating
partners would never be subject to lim-
itation under section 163(j), even though
interest expense allocable to materially
participating partners would also not be
subject to limitation under section 163(d)
at the individual partner level.
After considering the comments, Trea-
sury Department and the IRS have con-
cluded that the approach described in
the preamble to the 2018 Proposed Reg-
ulations is inconsistent with the statutory
language and intent of section 163(j)(5)
because the second sentence of section
163(j)(5) specifically states that BIE shall
not include investment interest expense.
In addition, the Treasury Department and
the IRS have determined that the second
alternative approach, as described earli-
er, appears to be the most consistent with
the intent of sections 163(d) and 163(j).
Accordingly, these Proposed Regulations
would interpret section 163(j)(5) as re-
quiring a trading partnership to bifurcate
its interest expense from a trading activity
between partners that materially partic-
ipate in the trading activity and partners
that are passive investors, and as subject-
ing only the portion of the interest expense
that is allocable to the materially partici-
pating partners to limitation under section
163(j) at the partnership level. The portion
of interest expense from a trading activ-
ity allocable to passive investors will be
subject to limitation under section 163(d)
at the partner level, as provided in section
163(d)(5)(A)(ii).
In addition, these Proposed Regula-
tions require that a trading partnership
bifurcate all of its other items of income,
gain, loss and deduction from its trading
activity between partners that materially
participate in the partnership’s trading ac-
tivity and partners that are passive inves-
tors. The portion of the partnership’s other
items of income, gain, loss or deduction
from its trading activity properly alloca-
ble to the passive investors in the partner-
ship will not be taken into account at the
partnership level as items from a trade or
business for purposes of applying section
163(j) at the partnership level. Instead,
all such partnership items properly allo-
cable to passive investors will be treated
as items from an investment activity of
the partnership, for purposes of sections
163(j) and 163(d).
This approach, in order to be effective,
adopts the presumption that a trading part-
nership generally will possess knowledge
regarding whether its individual partners
are material participants in its trading ac-
tivity. No rules currently exist requiring a
partner to inform the partnership whether
the partner has grouped activities of the
partnership with other activities of the
partner outside of the partnership. There-
fore, the partnership might possess little or
no knowledge regarding whether an indi-
vidual partner has made such a grouping.
Without this information, a trading part-
nership may presume that an individual
partner is a passive investor in the partner-
ship’s trading activity based solely on the
partnership’s understanding as to the lack
of work performed by the partner in that
activity, whereas the partner may in fact
be treated as a material participant in the
partnership’s trading activity by grouping
that activity with one or more activities
of the partner in which the partner mate-
rially participates. In order to avoid this
result and the potential for abuse, a new
rule is proposed for the section 469 ac-
tivity grouping rules to provide that any
activity described in section 163(d)(5)(A)
(ii) may not be grouped with any other ac-
tivity of the taxpayer, including any other
activity described in section 163(d)(5)(A)
(ii). The Treasury Department and the IRS
invite comments regarding whether other
approaches may be feasible and preferable
to a special rule that prohibits the grouping
of trading activities with other activities of
a partner, such as adoption of a rule or re-
porting regime requiring all partners in the
partnership to annually certify or report to
the partnership whether they are material
participants in a grouped activity that in-
cludes the partnership’s trading activity.
The Treasury Department and the IRS
further invite comments regarding wheth-
er similar rules should be adopted with
respect to S corporations that may also be
involved in trading activities, and wheth-
er such rules would be compatible with
Subchapter S (for example, whether the
bifurcation of items from the S corpora-
tion’s trading activity between material
participants and passive investors would
run afoul of the second class of stock pro-
hibition).
B. Fungibility of Publicly Traded
Partnerships
In order to be freely marketable, each
unit of a publicly traded partnership
(PTP), as defined in §1.7704-1, must have
identical economic and tax characteris-
tics so that such PTP units are fungible.
For PTP units to be fungible, the section
704(b) capital account associated with
each unit must be economically equiva-
lent to the section 704(b) capital account
of all other units of the same class, and a
PTP unit buyer must receive equivalent
tax allocations regardless of the specific
unit purchased. In other words, from the
perspective of a buyer, a PTP unit cannot
have variable tax attributes depending

September 28, 2020 804 Bulletin No. 2020–40
on the identity of the PTP unit seller. In
general, to achieve fungibility, a PTP (1)
makes a section 754 election, pursuant to
which a purchaser can insulate itself from
its predecessor’s allocable section 704(c)
gain or loss through a section 743(b) basis
adjustment, and (2) adopts the remedial
allocation method under section 704(c)
for all of its assets.
Pursuant to §1.704-3(d)(1), a partner-
ship adopts the section 704(c) remedial
allocation method to eliminate distortions
caused by the application of the ceiling
rule, as defined in §1.704-3(b)(1), under
the section 704(c) traditional method. A
partnership adopting the remedial alloca-
tion method eliminates ceiling rule distor-
tions by creating remedial items and allo-
cating those items to its partners. Under
the remedial allocation method, a partner-
ship first determines the amount of section
704(b) book items under §1.704-3(d)(2)
and the partners’ section 704(b) distribu-
tive shares of such items. The partnership
then allocates the corresponding tax items
recognized by the partnership, if any, us-
ing the traditional method described in
§1.704-3(b)(1). If the ceiling rule causes
the section 704(b) book allocation of an
item to a noncontributing partner to differ
from the tax allocation of the same item
to the noncontributing partner, the part-
nership creates a remedial item of income,
gain, loss, or deduction equal to the full
amount of the difference and allocates it to
the noncontributing partner. The partner-
ship simultaneously creates an offsetting
remedial item in an identical amount and
allocates it to the contributing partner. In
sum, by coupling the remedial allocation
method with a section 754 election, PTP
units remain fungible from a net tax per-
spective, regardless of the PTP unit sell-
er’s section 704(c) position.
However, even when the remedial al-
location method is coupled with a section
754 election, the application of section
163(j) in the partnership context results
in variable tax attributes for a buyer de-
pending upon the tax characteristics of the
interest held by the seller. The Treasury
Department and the IRS have determined
this is an inappropriate result for PTPs
because PTPs, unlike other partnerships,
always require that tax attributes be pro-
portionate to economic attributes to retain
the fungibility of their units. The Treasury
Department and the IRS have determined
that the manner in which section 163(j)
applies in the partnership context should
not result in the non-fungibility of PTP
units. Accordingly, these Proposed Regu-
lations provide a method, solely for PTPs,
for applying section 163(j) in a manner
that does not result in PTP units lacking
fungibility.
Specifically, commenters identified
three ways in which the 2018 Proposed
Regulations may cause PTP units to be
non-fungible. First, the method for allo-
cating excess items may cause PTP units
to be non-fungible. In general, under
§1.163(j)-6(f)(2), the allocation of the
components of ATI dictate the allocation
of a partnership’s deductible BIE and sec-
tion 163(j) excess items. Consequently, the
unequal sharing of inside basis, including
cost-recovery deductions, amortization,
gain, and loss affects the ratio in which a
partnership’s section 163(j) excess items,
as defined in §1.163(j)-6(b)(6), are shared.
A partner’s share of section 163(j) excess
items affects the tax treatment and eco-
nomic consequences of the partner. For
example, a greater share of excess taxable
income enables a partner subject to sec-
tion 163(j) to deduct more interest.
The Treasury Department and the IRS
recognize that a non-pro rata sharing of
inside basis could result in a non-pro rata
allocation of excess items, which may
result in PTP units lacking fungibility.
Therefore, these Proposed Regulations
would amend §1.163(j)-6(f)(1)(iii) to pro-
vide that, solely for purposes of section
163(j), a PTP allocates section 163(j) ex-
cess items in accordance with the partners’
shares of corresponding section 704(b)
items that comprise ATI.
Second, the required adjustments to
partner ATI for partner basis items (e.g.,
section 743(b) income and loss) may
cause PTP units to lack fungibility. A
non-pro rata sharing of inside basis may
result in a different allocation of partner
basis items, as defined in §1.163(j)-6(b)
(2), and section 704(c) remedial items,
as defined in §1.163(j)-6(b)(3), among
partners. Pursuant to §1.163(j)-6(d)(2),
partner basis items and remedial items
are not taken into account in determining
a partnership’s ATI under §1.163(j)-1(b)
(1). Instead, partner basis items and sec-
tion 704(c) remedial items affect the tax
treatment and economic consequences of
the partner. Similar to the disproportionate
sharing of excess items discussed earlier,
the disproportionate sharing of partner
basis items and section 704(c) remedi-
al items among partners may cause PTP
units to lack fungibility.
The Treasury Department and the IRS
recognize that a non-pro rata sharing of
inside basis could result in different part-
ner basis items and remedial items being
allocated to different partners. Therefore,
these Proposed Regulations would amend
§1.163(j)-6(e)(2)(ii) to provide that, sole-
ly for the purpose of determining remedial
items under section 163(j), a PTP either
allocates gain or loss that would other-
wise be allocated under section 704(c)
to a specific partner to all partners based
on each partner’s section 704(b) sharing
ratio, or, for purposes of allocating cost
recovery deductions under section 704(c),
determines each partner’s remedial items
based on an allocation of the partnership’s
inside basis items among its partners in
proportion to their share of corresponding
section 704(b) items, rather than apply-
ing the traditional method as described in
§1.704-3(b).
Third, the treatment of section 704(c)
remedial income allocations for taxable
years beginning before 2022 may cause
PTP units to lack fungibility. For taxable
years beginning before January 1, 2022,
when tentative taxable income is not re-
duced by depreciation and amortization
deductions for purposes of determining
ATI, a buyer acquiring PTP units with
section 704(c) remedial income alloca-
tions (and an offsetting section 743(b) ad-
justment) will have an increase to its ATI
that exceeds that of a buyer of the same
number of otherwise fungible units that is
not stepping into section 704(c) remedial
income (with no corresponding section
743(b) deduction). While the net amount
of the section 743(b) and section 704(c)
remedial items is the same to both buyers,
for taxable years beginning before Janu-
ary 1, 2022, different units would affect a
buyer’s ATI differently. The section 704(c)
remedial income of a buyer of units with
section 704(c) remedial income would
be included in its ATI, while the section
743(b) deductions would not. Thus, a buy-
er of units with section 704(c) remedial
income would increase its ATI each year

Bulletin No. 2020–40 805 September 28, 2020
(before 2022). A buyer of units with no
section 704(c) remedial income, however,
would add back any remedial depreciation
and amortization deductions before 2022,
and its ATI would be unaffected by the re-
medial deductions for such years.
The Treasury Department and the IRS
recognize that, before 2022, a buyer of
PTP units with inherent section 704(c)
gain would include any remedial income
and would not include section 743(b)
deductions in its ATI. Therefore, these
Proposed Regulations would amend
§1.163(j)-6(d)(2)(ii) to provide that,
solely for purposes of section 163(j),
a PTP treats the amount of any section
743(b) adjustment of a purchaser of a
partnership unit that relates to a remedial
item that the purchaser inherits from the
seller as an offset to the related section
704(c) remedial item. The Treasury De-
partment and the IRS request comments
as to whether the approaches outlined
adequately resolves the fungibility issues
created by section 163(j).
C. Treatment of Business Interest Income
and Business Interest Expense with
Respect to Lending Transactions Between
a Partnership and a Partner (Self-Charged
Lending Transactions)
The 2018 Proposed Regulations re-
served on the treatment of BII and BIE with
respect to lending transactions between a
partnership and a partner (self-charged
lending transactions). The preamble to
the 2018 Proposed Regulations requested
comments regarding self-charged lend-
ing transactions. One commenter rec-
ommended the final regulations include
rules under §1.163(j)-6(n) akin to those
contained in §1.469-7 to identify self-
charged interest income and expense and
further allow such self-charged interest
income and expense to be excluded from
the definition of BIE and BII under section
163(j)(5) and (6), respectively. The same
commenter recommended that the final
regulations retain the rule in §1.163(j)-
3(b)(4), as set forth in the 2018 Proposed
Regulations, which applies the section
163(j) limitation prior to the application
of the passive activity loss rules of section
469. Other commenters recommended the
Final Regulations exclude BIE and BII
from the section 163(j) calculation where
a partner or S-corporation shareholder
lends to, or borrows from, a passthrough
entity. These commenters recommended
that the amount excluded be based on the
amount of income or expense recognized
by partners or shareholders that are lend-
ers or borrowers, as well as partners or
shareholders that are related to a lender
or borrower partner within the meaning of
section 267(b) because it would be appro-
priate to exclude the BII and BIE realized
by the related parties for purposes of the
section 163(j) calculation.
In response to these comments, the
Treasury Department and the IRS propose
adding a rule in proposed §1.163(j)-6(n) to
provide that, in the case of a lending trans-
action between a partner (lending partner)
and partnership (borrowing partnership)
in which the lending partner owns a direct
interest (self-charged lending transaction),
any BIE of the borrowing partnership at-
tributable to the self-charged lending
transaction is BIE of the borrowing part-
nership for purposes of §1.163(j)-6. If in
a given taxable year the lending partner is
allocated EBIE from the borrowing part-
nership and has interest income attribut-
able to the self-charged lending transac-
tion (interest income), the lending partner
shall treat such interest income as an allo-
cation of excess business interest income
(EBII) from the borrowing partnership in
such taxable year, but only to the extent
of the lending partner’s allocation of EBIE
from the borrowing partnership in such
taxable year. To prevent the double count-
ing of BII, the lending partner includes in-
terest income that was re-characterized as
EBII pursuant to proposed §1.163(j)-6(n)
only once when calculating the lending
partner’s own section 163(j) limitation. In
cases where the lending partner is not a C
corporation, to the extent that any inter-
est income exceeds the lending partner’s
allocation of EBIE from the borrowing
partnership for the taxable year, and such
interest income otherwise would be prop-
erly treated as investment income of the
lending partner for purposes of section
163(d) for that year, such excess amount
of interest income will continue to be
treated as investment income of the lend-
ing partner for that year for purposes of
section 163(d).
The Treasury Department and the
IRS generally agree that lending partners
should not be adversely affected by the
fact that, without special rules, the inter-
est income received at the partner level
from such lending transactions general-
ly will be treated as investment income
if the partner is not engaged in the trade
or business of lending money, while the
BIE of the partnership will be subject to
section 163(j) and potentially limited at
the partner level as EBIE. This situation
would create a mismatch between the
character of the interest income and of the
interest expense at the partner level from
the same lending transaction. These pro-
posed rules would apply only to items of
interest income attributable to the lend-
ing transaction and EBIE from the same
partnership that arise in the same taxable
year of the lending partner. By applying
these proposed rules only to correct a mis-
match in character that may occur at the
partner level during a single taxable year,
these proposed rules otherwise ensure that
a partnership engaged in a self-charged
lending transaction will be subject to the
rules of section 163(j) to the same extent
regardless of the sources of its loans.
These proposed rules will not apply in
the case of an S corporation because BIE
of an S corporation is carried over by the S
corporation as a corporate-level attribute
rather than immediately passed through
to its shareholders. In the year such dis-
allowed BIE is deductible at the corpo-
rate level, it is not separately stated, and
it is not subject to further limitation under
section 163(j) at either the S corporation
or shareholder level. Therefore, a limited
self-charged rule to ensure proper match-
ing of the character of interest income and
BIE at the shareholder level is not neces-
sary. This approach is consistent with the
treatment of S corporations as separate
entities from their owners, both general-
ly and specifically with respect to section
163(j).
However, the Treasury Department and
the IRS recognize that issues analogous to
the issues faced by partnerships in self-
charged lending transactions exist with
respect to lending transactions between S
corporations and their shareholders. The
Treasury Department and the IRS request
comments on whether a similar rule is ap-
propriate for S corporations in light of sec-
tion 163(j)(4)(B) not applying and, if so,
how such rule should be structured.

September 28, 2020 806 Bulletin No. 2020–40
D. Partnership Basis Adjustments upon
Partner Dispositions
In general, a partnership’s disallowed
BIE is allocated to its partners as EBIE
rather than carried forward at the partner-
ship level in order to prevent the traffick-
ing of deductions for BIE carryforwards
in the partnership context. To achieve this,
section 163(j)(4)(B)(iii)(I) provides that
the adjusted basis of a partner in a part-
nership interest is reduced (but not below
zero) by the amount of EBIE allocated
to the partner. If a partner disposes of a
partnership interest, section 163(j)(4)(B)
(iii)(II) provides that the adjusted basis
of the partner in the partnership interest is
increased immediately before the disposi-
tion by the amount of any EBIE that was
not treated as BIE paid or accrued by the
partner prior to the disposition. Further,
under section 163(j)(4)(B)(iii)(II), no de-
duction shall be allowed to the transferor
or transferee for any EBIE resulting in a
basis increase.
The Treasury Department and the IRS
have determined that the basis increase
required by section 163(j)(4)(B)(iii)(II) is
not fully descriptive of what is occurring
when a partner with EBIE disposes of its
partnership interest. If EBIE is not treated
as BIE paid or accrued by the partner pur-
suant to §1.163(j)-6(g) prior to the partner
disposing of its partnership interest (non-
deductible EBIE), section 163(j)(4)(B)
(iii)(II) treats such nondeductible EBIE as
though it were a nondeductible expense of
the partnership.
This nondeductible expense is not a
nondeductible, non-capitalizable expense
under section 705(a)(2)(B). If it were, the
partner’s basis in its partnership interest at
the time of the disposition would already
reflect such an expense. Instead, section
163(j)(4)(B)(iii)(II) requires the partner to
increase its basis immediately before the
disposition – in effect, treating the partner
as though the partnership made a payment
that decreased the value of the partnership
interest but did not affect the partner’s ba-
sis in its partnership interest. Thus, upon
a disposition, section 163(j)(4) treats non-
deductible EBIE as though it were a non-
deductible, capitalizable expense of the
partnership.
While the statute is clear that a part-
ner increases the basis in its partnership
interest immediately prior to a disposi-
tion by any nondeductible EBIE, it does
not specifically state that there must also
be a corresponding increase to the basis
of partnership assets to account for the
nondeductible, capitalized expense (i.e.,
the nondeductible EBIE). The absence
of a corresponding increase to the part-
nership’s basis immediately before the
partner’s disposition would create distor-
tions that are inconsistent with the intent
of both section 163(j) and subchapter K of
the Code.
For example, the basis increase attrib-
utable to nondeductible EBIE immediately
before a liquidating distribution results in
less gain recognized under section 731(a)
(1) (or more loss recognized under sec-
tion 731(a)(2)) for the partner disposing
of its partnership interest. Consequently,
following a liquidating distribution to a
partner with EBIE, section 163(j)(4)(B)
(iii)(II) causes a reduced section 734(b)
adjustment if the partnership has a section
754 election in effect (versus the partner
basis increase not occurring), resulting in
basis disparity between the partnership’s
basis in its assets and the aggregate out-
side basis of the remaining partners.
To illustrate, consider the following ex-
ample. In Year 1, A, B, and C formed part-
nership PRS by each contributing $1,000
cash. PRS borrowed $900, causing each
partner’s basis in PRS to increase by $300.
Also in Year 1, PRS purchased Capital As-
set X for $200. In Year 2, PRS pays $300
of BIE, all of which is disallowed and
treated as EBIE. PRS allocated the $300
of EBIE to its partners, $100 each. Pur-
suant to §1.163(j)-6(h)(2), each partner
reduced its outside basis by its $100 allo-
cation of EBIE to $1,200. In Year 3, when
the fair market value of Capital Asset X is
$3,200 and no partner’s basis in PRS has
changed, PRS distributed $1,900 to C in
complete liquidation of C’s partnership
interest. PRS has a section 754 election in
effect in Year 3.
Pursuant to §1.163(j)-6(h)(3), C in-
creases the adjusted basis of its partner-
ship interest by $100 immediately before
the disposition. Thus, C’s section 731(a)
(1) gain recognized on the disposition of
its partnership interest is $900 (($1,900
cash + $300 relief of liabilities) – ($1,200
outside basis + $100 EBIE add-back)).
Because the election under section 754
is in effect, PRS has a section 734(b) in-
crease to the basis of its assets of $900 (the
amount of section 731(a)(1) gain recog-
nized by C). Under section 755, the entire
adjustment is allocated to Capital Asset X.
As a result, PRS’s basis for Capital Asset
X is $1,100 ($200 + $900 section 734(b)
adjustment). Following the liquidation
of C, PRS’s basis in its assets ($1,500 of
cash + $1,100 of Capital Asset X) does not
equal the aggregate outside basis of part-
ners A and B ($2,700).
The Treasury Department and the
IRS have determined that basis dispar-
ity resulting from the absence of a cor-
responding inside basis increase, as de-
scribed earlier, is an inappropriate result.
Accordingly, these Proposed Regula-
tions would provide for a corresponding
inside basis increase that would serve as
the partnership analog of section 163(j)
(4)(B)(iii)(II). Specifically, proposed
§1.163(j)-6(h)(5) would provide that if a
partner (transferor) disposes of its part-
nership interest, the partnership shall
increase the adjusted basis of partner-
ship property by an amount equal to the
amount of the increase required under
§1.163(j)-6(h)(3), if any, to the adjusted
basis of the partnership interest being
disposed of by the transferor. Such in-
crease in the adjusted basis of partner-
ship property (§1.163(j)-6(h)(5) basis
adjustment) shall be allocated among
partnership properties in the same man-
ner as a positive section 734(b) adjust-
ment. Because a §1.163(j)-6(h)(5) basis
adjustment is taken into account when
determining the gain or loss upon a sale
of the asset, a §1.163(j)-6(h)(5) basis ad-
justment prevents the shifting of built-in
gain to the remaining partners.
These Proposed Regulations would
adopt an approach that treats the increase
in the adjusted basis of any partnership
property resulting from a §1.163(j)-6(h)
(5) basis adjustment as not depreciable
or amortizable under any section of the
Code, regardless of whether the partner-
ship property allocated such §1.163(j)-
6(h)(5) basis adjustment is otherwise
generally depreciable or amortizable. This
approach perceives EBIE as a deduction
that was disallowed to the partnership
(consistent with section 163(j)(4)(B)(iii)
(II)), and thus should not result in a de-
preciable section 734(b) basis adjustment.

Bulletin No. 2020–40 807 September 28, 2020
The Treasury Department and the IRS
request comments on this approach. An
alternative approach considered by the
Treasury Department and the IRS would
treat a §1.163(j)-6(h)(5) basis adjustment
as depreciable or amortizable if it is allo-
cated to depreciable or amortizable prop-
erty. However, section 163(j)(4)(B)(iii)
(II) provides that no deduction shall be
allowed to the transferor or transferee for
any EBIE resulting in a basis increase to
the partner that disposed of its interest. If
a §1.163(j)-6(h)(5) basis adjustment were
depreciable or amortizable, a partnership
– which can arguably be viewed as a trans-
feree in a transaction in which a partner
receives a distribution in complete liqui-
dation of its partnership interest – could
effectively deduct an expense that section
163(j)(4)(B)(iii)(II) states is permanent-
ly disallowed. The Treasury Department
and the IRS request comments on whether
treating a §1.163(j)-6(h)(5) basis adjust-
ment as potentially depreciable or amor-
tizable is consistent with section 163(j)(4)
(B)(iii)(II).
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
1. Entity Approach
The preamble to the 2018 Proposed
Regulations reserved and requested com-
ments on the application of section 163(j)
(4) to tiered partnership structures. Specif-
ically, the preamble to the 2018 Proposed
Regulations requested comments regard-
ing whether, in a tiered partnership struc-
ture, EBIE should be allocated through an
upper-tier partnership to the partners of
upper-tier partnership. Additionally, com-
ments were requested regarding how and
when the basis of an upper-tier partnership
partner should be adjusted when a low-
er-tier partnership has BIE that is limited
under section 163(j).
In response, commenters recommend-
ed approaches that, in general, either (1)
allocated EBIE through upper-tier part-
nership to the partners of upper-tier part-
nership (Aggregate Approach), or (2) did
not allocate EBIE through upper-tier part-
nership to the partners of upper-tier part-
nership (Entity Approach). Commenters
stated that both approaches reasonably
implement Congressional intent of apply-
ing section 163(j) at the partnership lev-
el; however, the Entity Approach reflects
a stronger allegiance to entity treatment
of partnerships for purposes of section
163(j). Commenters noted that the ulti-
mate determination of which approach
is more appropriate should rest, in large
part, on whether partnerships or partners
are more able to comply with the provi-
sion. The Entity Approach places more
of that burden on partnerships, and the
Aggregate Approach places more of the
burden on partners. Commenters recom-
mended that partnerships are better able
to comply with an Entity Approach than
partners are able to comply with an Aggre-
gate Approach. Further, because the Entity
Approach centers a significant portion of
the compliance effort with partnerships,
the Entity Approach may increase compli-
ance and simplify Service review.
The Treasury Department and the IRS
have concluded that an Entity Approach
is the most consistent with the approach
taken to partnerships under section 163(j)
(4). Further, the Treasury Department and
the IRS agree with commenters that part-
nerships are better able to comply with
section 163(j) tiered partnership rules
than partners. Accordingly, proposed
§1.163(j)-6(j)(3) would provide that if
lower-tier partnership allocates excess
business interest expense to upper-tier
partnership, then upper-tier partnership
reduces its basis in lower-tier partnership
pursuant to §1.163(j)-6(h)(2). Upper-tier
partnership partners do not, however, re-
duce the bases of their upper-tier partner-
ship interests pursuant to §1.163(j)-6(h)
(2) until upper-tier partnership treats such
excess business interest expense as busi-
ness interest expense paid or accrued pur-
suant to §1.163(j)-6(g).
Although proposed §1.163(j)-6(j)(3)
would provide that EBIE allocated from
a lower-tier partnership to an upper-tier
partnership is not subject to further allo-
cation by the upper-tier partnership, such
EBIE necessarily reflects a reduction in
the value of lower-tier partnership by the
amount of the economic outlay that result-
ed in such EBIE. Accordingly, proposed
§1.163(j)-6(j)(2) would provide that if
lower-tier partnership pays or accrues
business interest expense and allocates
such business interest expense to upper-ti-
er partnership, then both upper-tier part-
nership and any direct or indirect partners
of upper-tier partnership shall, solely for
purposes of section 704(b) and the reg-
ulations thereunder, treat such business
interest expense as a section 705(a)(2)
(B) expenditure. Any section 704(b) cap-
ital account reduction resulting from such
treatment occurs regardless of whether
such business interest expense is char-
acterized under this section as excess
business interest expense or deductible
business interest expense by lower-tier
partnership. If upper-tier partnership sub-
sequently treats any excess business inter-
est expense allocated from lower-tier part-
nership as business interest expense paid
or accrued pursuant to §1.163(j)-6(g), the
section 704(b) capital accounts of any di-
rect or indirect partners of upper-tier part-
nership are not further reduced.
2. Basis and Carryforward Component of
EBIE
Some commenters stated that an En-
tity Approach – that is, the approach
these Proposed Regulations would adopt
– would result in basis disparity between
upper-tier partnership’s basis in its assets
and the aggregate basis of the upper-tier
partners’ interests in upper-tier partner-
ship. The Treasury Department and the
IRS do not agree. EBIE is neither an item
of deduction nor a section 705(a)(2)(B)
expense. If an allocation of EBIE from
lower-tier partnership results in a reduc-
tion of the upper-tier partnership’s basis in
its lower-tier partnership interest, there is
not a net reduction in the tax attributes of
the upper-tier partnership. Rather, in such
an event, upper-tier partnership merely
exchanges one tax attribute (tax basis in
its lower-tier partnership interest) for a
different tax attribute (EBIE, which, in a
subsequent year, could result in either a
deduction or a basis adjustment). Thus,
basis is preserved in this exchange.
Accordingly, proposed §1.163(j)-6(j)
(4) would provide that if lower-tier part-
nership allocates excess business interest
expense to upper-tier partnership and such
excess business interest expense is not
suspended under section 704(d), then up-
per-tier partnership shall treat such excess
business interest expense (UTP EBIE) as
a nondepreciable capital asset, with a fair
market value of zero and basis equal to the

September 28, 2020 808 Bulletin No. 2020–40
amount by which upper-tier partnership
reduced its basis in lower-tier partnership
pursuant to §1.163(j)-6(h)(2) due to the
allocation of such excess business inter-
est expense. The fair market value of UTP
EBIE, described in the preceding sen-
tence, is not adjusted by any revaluations
occurring under §1.704-1(b)(2)(iv)(f).
In addition to generally treating UTP
EBIE as having a basis component in ex-
cess of fair market value and, thus, built-
in loss property, proposed §1.163(j)-6(j)
(4) would also provide that upper-tier
partnership shall also treat UTP EBIE as
having a carryforward component associ-
ated with it. The carryforward component
of UTP EBIE shall equal the amount of
excess business interest expense allocated
from lower-tier partnership to upper-tier
partnership under §1.163(j)-6(f)(2) that is
treated as such under §1.163(j)-6(h)(2) by
upper-tier partnership.
The carryforward component of UTP
EBIE and the basis component of such
UTP EBIE will always be equal imme-
diately following the allocation of such
EBIE from lower-tier partnership to up-
per-tier partnership if, at the time of such
allocation, upper-tier partnership was re-
quired to reduce its section 704(b) capital
account pursuant to proposed §1.163(j)-
6(j)(2) due to such allocation. However,
subsequent to such initial allocation of
EBIE from lower-tier partnership to up-
per-tier partnership, disparities between
the carryforward component of UTP EBIE
and the basis component of such UTP
EBIE may arise as a result of proposed
§1.163(j)-6(j)(7).
Similar to the treatment of partner ba-
sis items (which do not affect the ATI of
a partnership), proposed §1.163(j)-6(j)
(7)(i) would provide that negative basis
adjustments under sections 734(b) and
743(b) allocated to UTP EBIE do not af-
fect the carryforward component of such
UTP EBIE; rather, negative basis adjust-
ments under sections 734(b) and 743(b)
affect only the basis component of such
UTP EBIE. Although section 734(b) ad-
justments do affect a partnership’s com-
putation of ATI, the Treasury Department
and the IRS have determined that negative
section 734(b) adjustments, if allocated to
UTP EBIE, should not reduce the carry-
forward component of such UTP EBIE.
The purpose of proposed §1.163(j)-6(j)(7)
– in addition to preventing the duplication
of loss – is to make partners indifferent
for section 163(j) purposes as to wheth-
er a partner exiting upper-tier partnership
sells its interest or receives a liquidating
distribution from upper-tier partnership.
Excluding negative section 734(b) adjust-
ments from proposed §1.163(j)-6(j)(7)
would frustrate this purpose.
3. UTP EBIE Conversion Events
Proposed §1.163(j)-6(j)(4) would fur-
ther provide that if an allocation of excess
business interest expense from lower-ti-
er partnership is treated as UTP EBIE of
upper-tier partnership, upper-tier partner-
ship shall treat such allocation of excess
business interest expense from lower-tier
partnership as UTP EBIE until the occur-
rence of an UTP EBIE conversion event
described in proposed §1.163(j)-6(j)(5).
In the non-tiered context, EBIE generally
has two types of conversion events. The
first EBIE conversion event is when EBIE
is treated as BIE paid or accrued pursuant
to §1.163(j)-6(g). The second EBIE con-
version event is the basis addback that oc-
curs pursuant to proposed §1.163(j)-6(h)
(3) when a partner disposes of its interest
in a partnership. Proposed §1.163(j)-6(j)
(5)(i) and (ii), respectively, would provide
guidance regarding these two types of
conversion events in the tiered partnership
context.
a. First Type of Conversion Event - UTP
EBIE Treated as Paid or Accrued
Regarding the first type of conver-
sion event, proposed §1.163(j)-6(j)(5)(i)
would provide that to the extent upper-tier
partnership is allocated excess taxable in-
come (or excess business interest income)
from lower-tier partnership, or §1.163(j)-
6 (m)(3) applies, upper-tier partnership
shall apply proposed §1.163(j)-6(j)(5)
(i)(A) through (C). First, pro-
posed §1.163(j)-6(j)(5)(i)(A) requires
upper-tier partnership to apply the rules
in §1.163(j)-6(g) to its UTP EBIE, using
any reasonable method (including, for
example, FIFO and LIFO) to determine
which UTP EBIE is treated as business
interest expense paid or accrued pursuant
§1.163(j)-6(g). If §1.163(j)-6(m)(3) ap-
plies, upper-tier partnership shall treat all
of its UTP EBIE from lower-tier partner-
ship as paid or accrued.
Proposed §1.163(j)-6(j)(5)(i)(A)
would provide that upper-tier partner-
ship must determine which of its UTP
EBIE is treated as paid or accrued, as
opposed to just providing that upper-ti-
er partnership reduces its UTP EBIE,
because UTP EBIE is not necessarily a
unified tax attribute of upper-tier part-
nership. UTP EBIE of upper-tier part-
nership could have been allocated in
different years, have different bases, and
have different specified partners (defined
in the next paragraph). For example, as-
sume $30 of UTP EBIE was allocated a
negative $10 section 734(b) adjustment,
resulting in the aggregate of upper-tier
partnership’s UTP EBIE having a car-
ryforward component of $30 and ba-
sis component of $20. Thus, such UTP
EBIE could, at most, result in $20 of de-
duction (the basis of such UTP EBIE).
However, upper-tier partnership does
not necessarily need $100 of ETI (or $30
of EBII) to deduct such $20. Rather, if
upper-tier partnership was allocated $20
of EBII, upper-tier partnership could de-
duct $20 of business interest expense if,
using a reasonable method, it determined
the $20 of UTP EBIE with full basis was
the UTP EBIE treated as business inter-
est expense paid or accrued pursuant to
§1.163(j)-6(j)(5)(i)(A). Following such
treatment, upper-tier partnership would
still have $10 of UTP EBIE with $0 basis
remaining (that is, $10 of carryforward
component and $0 of basis component).
Second, with respect to any UTP EBIE
treated as business interest expense paid
or accrued in proposed §1.163(j)-6(j)
(5)(i)(A), proposed §1.163(j)-6(j)(5)(i)
(B) would require upper-tier partnership
to allocate any business interest expense
that was formerly such UTP EBIE to its
specified partner. For purposes of pro-
posed §1.163(j)-6(j), the term specified
partner refers to the partner of upper-tier
partnership that, due to the initial alloca-
tion of excess business interest expense
from lower-tier partnership to upper-tier
partnership, was required to reduce its
section 704(b) capital account pursuant to
proposed §1.163(j)-6(j)(2). Similar princi-
ples apply if the specified partner of such
business interest expense is itself a part-
nership.

Bulletin No. 2020–40 809 September 28, 2020
Proposed §1.163(j)-6(j)(6) would pro-
vide rules if a specified partner dispos-
es of its interest. Specifically, proposed
§1.163(j)-6(j)(6)(i) would provide that if
a specified partner (transferor) disposes of
an upper-tier partnership interest (or an in-
terest in a partnership that itself is a speci-
fied partner), the portion of any UTP EBIE
to which the transferor’s status as speci-
fied partner relates is not reduced pursuant
to proposed §1.163(j)-6(j)(5)(ii). Stated
otherwise, if a partner of an upper-tier
partnership disposes of its interest in the
upper-tier partnership, an interest in the
lower-tier partnership held by upper-tier
partnership is not deemed to have been
similarly disposed of for purposes of pro-
posed §1.163(j)-6(j)(5)(ii). See Rev. Rul.
87-115. Rather, such UTP EBIE attribut-
able to the interest disposed of is retained
by upper-tier partnership and the transfer-
ee is treated as the specified partner for
purposes of proposed §1.163(j)-6(j) with
respect to such UTP EBIE. Thus, upper-ti-
er partnership must allocate any business
interest expense that was formerly such
UTP EBIE to the transferee.
Additionally, proposed §1.163(j)-6(j)
(6)(ii) would provide special rules regard-
ing the specified partner of UTP EBIE
following certain nonrecognition trans-
actions. Proposed §1.163(j)-6(j)(6)(ii)(A)
would provide that if a specified partner
receives a distribution of property in com-
plete liquidation of an upper-tier partner-
ship interest, the portion of UTP EBIE of
upper-tier partnership attributable to the
liquidated interest shall not have a spec-
ified partner. If a specified partner (trans-
feree) receives a distribution of an inter-
est in upper-tier partnership in complete
liquidation of a partnership interest, the
transferee is the specified partner with re-
spect to UTP EBIE of upper-tier partner-
ship only to the same extent it was prior to
the distribution. Similar principles apply
where an interest in a partnership that is a
specified partner is distributed in complete
liquidation of a transferee’s partnership
interest.
Proposed §1.163(j)-6(j)(6)(ii)(B)
would further provide that if a specified
partner (transferor) contributes an up-
per-tier partnership interest to a partner-
ship (transferee), the transferee is treated
as the specified partner for purposes of
proposed §1.163(j)-6(j) with respect to
the portion of the UTP EBIE attributable
to the contributed interest. Following the
transaction, the transferor continues to be
the specified partner with respect to the
UTP EBIE attributable to the contributed
interest. Similar principles apply where an
interest in a partnership that is a specified
partner is contributed to a partnership.
Finally, after determining the speci-
fied partner of the UTP EBIE treated as
business interest expense paid or accrued
in proposed §1.163(j)-6(j)(5)(i)(A) and
allocating such business interest expense
to its specified partner pursuant to pro-
posed §1.163(j)-6(j)(5)(i)(B), proposed
§1.163(j)-6(j)(5)(i)(C) would require up-
per-tier partnership to, in the manner pro-
vided in proposed §1.163(j)-6(j)(7)(ii) (or
(iii), as the case may be), take into account
any negative basis adjustments under sec-
tion 734(b) previously made to the UTP
EBIE treated as business interest expense
paid or accrued in (A) earlier. Addition-
ally, persons treated as specified partners
with respect to the UTP EBIE treated as
business interest expense paid or accrued
in (A) earlier shall take any negative basis
adjustments under section 743(b) into ac-
count in the manner provided in proposed
§1.163(j)-6(j)(7)(ii) (or (iii), as the case
may be).
Proposed §1.163(j)-6(j)(7)(ii) would
provide that if UTP EBIE that was allocat-
ed a negative section 734(b) adjustment is
subsequently treated as deductible busi-
ness interest expense, then such deduct-
ible business interest expense does not
result in a deduction to the upper-tier part-
nership or the specified partner of such de-
ductible business interest expense. If UTP
EBIE that was allocated a negative section
743(b) adjustment is subsequently treated
as deductible business interest expense,
the specified partner of such deductible
business interest expense recovers any
negative section 743(b) adjustment attrib-
utable to such deductible business interest
expense (effectively eliminating any de-
duction for such deductible business inter-
est expense).
Proposed §1.163(j)-6(j)(7)(iii) would
provide that if UTP EBIE that was allocat-
ed a negative section 734(b) or 743(b) ad-
justment is subsequently treated as excess
business interest expense, the specified
partner’s basis decrease in its upper-tier
partnership interest required under pro-
posed §1.163(j)-6(h)(2) is reduced by the
amount of the negative section 734(b) or
743(b) adjustment previously made to
such excess business interest expense. If
such excess business interest expense is
subsequently treated as business interest
expense paid or accrued by the specified
partner, no deduction shall be allowed for
any of such business interest expense. If
the specified partner of such excess busi-
ness interest expense is a partnership, such
excess business interest expense is consid-
ered UTP EBIE that was previously allo-
cated a negative section 734(b) adjustment
for purposes of proposed §1.163(j)-6(j).
b. Second Type of Conversion Event -
UTP EBIE Reduction
Regarding the second type of con-
version event, proposed §1.163(j)-6(j)
(5)(ii) would provide that if upper-tier
partnership disposes of a lower-tier part-
nership interest (transferred interest), up-
per-tier partnership shall apply proposed
§1.163(j)-6(j)(5)(ii)(A) through (C).
First, proposed §1.163(j)-6(j)(5)(ii)(A)
would require upper-tier partnership to
apply the rules in §1.163(j)-6(h)(3) (ex-
cept as provided in (B) and (C) later), us-
ing any reasonable method (including, for
example, FIFO and LIFO) to determine
which UTP EBIE is reduced pursuant to
§1.163(j)-6 (h)(3). Stated otherwise, pro-
posed §1.163(j)-6(j)(5)(ii)(A) would re-
quire upper-tier partnership to apply all
of the rules in §1.163(j)-6(h)(3), except
for the rule that determines the amount of
the basis increase immediately before the
disposition to the disposed of interest (the
first sentence of §1.163(j)-6(h)(3)). In lieu
of applying the first sentence of §1.163(j)-
6(h)(3), upper-tier partnership would ap-
ply proposed §1.163(j)-6(j)(5)(ii)(B) and
(C) to determine the amount of such basis
increase.
Second, proposed §1.163(j)-6(j)(5)
(ii)(B) would require upper-tier partner-
ship to increase the adjusted basis of the
transferred interest immediately before
the disposition by the total amount of the
UTP EBIE that was reduced in (A) earlier
(the amount of UTP EBIE proportionate
to the transferred interest). For example,
if upper-tier partnership disposed of half
of its lower-tier partnership interest while
it held $40 of UTP EBIE allocated from

September 28, 2020 810 Bulletin No. 2020–40
lower tier partnership, upper-tier partner-
ship would increase the adjusted basis
of the disposed of lower-tier partnership
interest by $20. However, immediately
before the disposition, such $20 increase
may be reduced pursuant to proposed
§1.163(j)-6(j)(5)(ii)(C).
Third, proposed §1.163(j)-6(j)(5)(ii)
(C) would require upper-tier partnership
to, in the manner provided in proposed
§1.163(j)-6(j)(7)(iv), take into account
any negative basis adjustments under
sections 734(b) and 743(b) previously
made to the UTP EBIE that was reduced
in (A) earlier. Proposed §1.163(j)-6(j)(7)
(iv) would provide that if UTP EBIE that
was allocated a negative section 734(b)
or 743(b) adjustment is reduced pursuant
to proposed §1.163(j)-6(j)(5)(ii)(A), the
amount of upper-tier partnership’s basis
increase under proposed §1.163(j)-6(j)(5)
(ii)(B) to the disposed of lower-tier part-
nership interest is reduced by the amount
of the negative section 734(b) or 743(b)
adjustment previously made to such UTP
EBIE.
Continuing with the previous example,
assume that $5 of the $20 of UTP EBIE
reduced pursuant to proposed §1.163(j)-
6(j)(5)(ii)(A) was previously allocated a
$5 negative section 743(b) adjustment.
Pursuant to proposed §1.163(j)-6(j)(5)(ii)
(C), upper-tier partnership would reduce
the $20 increase it determined under pro-
posed §1.163(j)-6(j)(5)(ii)(B) by $5. Thus,
the adjusted basis of the lower-tier part-
nership interest being disposed of would
be increased by $15 immediately before
the disposition. Consequently, lower-tier
partnership would have a corresponding
§1.163(j)-6(h)(5) basis adjustment to its
property of $15.
4. Anti-loss Trafficking Rules
Proposed §1.163(j)-6(j) generally
relies on negative sections 734(b) and
743(b) adjustments to prevent a partner
from deducting business interest expense
that was formerly UTP EBIE if such part-
ner did not bear the economic cost of such
business interest expense payment. To the
extent a negative section 734(b) or 743(b)
adjustment fails to prohibit such a deduc-
tion (or basis increase under proposed
§1.163(j)-6(j)(5)(ii)), the anti-loss traf-
ficking rules in proposed §1.163(j)-6(j)(8)
would prohibit such a deduction (or basis
addback under proposed §1.163(j)-6(j)(5)
(ii)).
The anti-loss trafficking rule under
proposed §1.163(j)-6(j)(8)(i) would pro-
hibit the trafficking of business interest
expense by providing that no deduction
shall be allowed to any transferee speci-
fied partner for any business interest ex-
pense derived from a transferor’s share
of UTP EBIE. For purposes of proposed
§1.163(j)-6(j), the term transferee spec-
ified partner refers to any specified part-
ner that did not reduce its section 704(b)
capital account upon the initial allocation
of excess business interest expense from
lower-tier partnership to upper-tier part-
nership pursuant to proposed §1.163(j)-
6(j)(2). However, the transferee described
in proposed §1.163(j)-6(j) (ii)(B) is not a
transferee specified partner for purposes
of proposed §1.163(j)-6(j).
Proposed §1.163(j)-6(j)(8)(i) would
also provide the mechanism for disallow-
ing such BIE. Proposed §1.163(j)-6(j)(8)
(i) would provide that if, pursuant to pro-
posed §1.163(j)-6(j)(5)(i)(B), a transfer-
ee specified partner is allocated business
interest expense derived from a transfer-
or’s share of UTP EBIE (business inter-
est expense to which the partner’s status
as transferee specified partner relates), the
transferee specified partner is deemed to
recover a negative section 743(b) adjust-
ment with respect to, and in the amount of,
such business interest expense and takes
such negative section 743(b) adjustment
into account in the manner provided in
proposed §1.163(j)-6(j)(7)(ii) (or (iii), as
the case may be), regardless of whether
a section 754 election was in effect or a
substantial built-in loss existed at the time
of the transfer by which the transferee
specified partner acquired the transferred
interest. However, to the extent a negative
section 734(b) or 743(b) adjustment was
previously made to such business interest
expense, the transferee specified partner
does not recover an additional negative
section 743(b) adjustment pursuant to this
paragraph.
Additionally, the anti-loss trafficking
rule under proposed §1.163(j)-6(j)(8)(ii)
would prohibit the trafficking of BIE that
was formerly the UTP EBIE of a speci-
fied partner that received a distribution in
complete liquidation of its upper-tier part-
nership interest. Specifically, proposed
§1.163(j)-6(j)(8)(ii) would provide that if
UTP EBIE does not have a specified part-
ner (as the result of a transaction described
in proposed §1.163(j)-6(j)(6)(ii)(A)), up-
per-tier partnership shall not allocate any
business interest expense that was former-
ly such UTP EBIE to its partners. Rather,
for purposes of applying §1.163(j)-6(f)
(2), upper-tier partnership shall treat such
business interest expense as the allocable
business interest expense (as defined in
§1.163(j)-6(f)(2)(ii)) of a §1.163(j)-6(j)(8)
(ii) account.
Any deductible business interest ex-
pense and excess business interest expense
allocated to a §1.163(j)-6(j)(8)(ii) account
at the conclusion of the eleven-step com-
putation set forth in §1.163(j)-6(f)(2) is not
tracked in future years. Treating such busi-
ness interest expense as the allocable busi-
ness interest expense of a separate account
for purposes of applying §1.163(j)-6(f)
(2)(ii) ensures that partners of upper-tier
partnership do not support a deduction for
such business interest expense (for which
no deduction will be allowed) using their
shares of allocable ATI and allocable busi-
ness interest income before supporting a
deduction for their own shares of alloca-
ble business interest expense (for which a
deduction may be allowed).
Additionally, if UTP EBIE that does
not have a specified partner (as the re-
sult of a transaction described in pro-
posed §1.163(j)-6(j)(6)(ii)(A)) is treated
as paid or accrued pursuant to §1.163(j)-
6(g), upper-tier partnership shall make a
§1.163(j)-6(h)(5) basis adjustment to its
property in the amount of the adjusted
basis (if any) of such UTP EBIE at the
time such UTP EBIE is treated as business
interest expense paid or accrued pursu-
ant to §1.163(j)-6(g). The purpose of this
§1.163(j)-6(h)(5) basis adjustment is to
preserve basis in the system.
Thus, any time upper-tier partner-
ship treats UTP EBIE as business inter-
est expense paid or accrued pursuant to
proposed §1.163(j)-6(j)(5)(i)(A) it must
apply proposed §1.163(j)-6(j)(8)(i) and
(ii). In application, upper-tier partner-
ship would generally undertake the fol-
lowing analysis when applying proposed
§1.163(j)-6(j)(8)(i) and (ii). With respect
to any UTP EBIE treated as business in-
terest expense paid or accrued pursuant

Bulletin No. 2020–40 811 September 28, 2020
to proposed §1.163(j)-6(j)(5)(i)(A) (UTP
BIE), upper-tier partnership must first
determine whether such UTP BIE has
a specified partner. If it does not have a
specified partner, upper-tier partnership
must apply proposed §1.163(j)-6(j)(8)(ii),
which, in general, requires upper-tier part-
nership to capitalize the basis (if any) of
such UTP BIE into the basis of upper-tier
partnership property via a §1.163(j)-6(h)
(5) basis adjustment.
If UTP BIE does have a specified part-
ner, upper-tier partnership must next de-
termine whether the specified partner of
such UTP BIE reduced its section 704(b)
capital account upon the initial alloca-
tion of such excess business interest ex-
pense from lower-tier partnership to up-
per-tier partnership pursuant to proposed
§1.163(j)-6 (j)(2). If the specified partner
did reduce its section 704(b) capital ac-
count upon such initial allocation, then
any deduction for such UTP BIE is not
disallowed under proposed §1.163(j)-6(j)
(8)(i). However, if the specified partner
did not reduce its section 704(b) capital
account upon such initial allocation, up-
per-tier partnership must next determine
whether such specified partner is a trans-
feree described in proposed §1.163(j)-6(j)
(6)(ii)(B). If it is, then any deduction for
such UTP BIE is not disallowed under
proposed §1.163(j)-6(j)(8)(i). However,
if the specified partner is not a transferee
described in proposed §1.163(j)-6(j)(6)(ii)
(B), then it is a transferee specified part-
ner, as defined in proposed §1.163(j)-6(j)
(8)(i). As a result, any deduction for such
UTP BIE is disallowed under proposed
§1.163(j)-6(j)(8)(i). If there are multiple
tiers of partnerships, each tier must apply
these rules.
Finally, proposed §1.163(j)-6(j)(8)(iii)
would provide a similar mechanism to
proposed §1.163(j)-6(j)(8)(i) for disallow-
ing basis addbacks under §1.163(j)-6(h)
(3) for certain UTP EBIE. Specifically,
proposed §1.163(j)-6(j)(8)(iii) would pro-
vide that no basis increase under proposed
§1.163(j)-6(j)(5)(ii) shall be allowed to
upper-tier partnership for any disallowed
UTP EBIE. For purposes of §1.163(j)-6,
the term disallowed UTP EBIE refers to
any UTP EBIE that has a specified partner
that is a transferee specified partner (as
defined in proposed §1.163(j)-6(j)(8)(i))
and any UTP EBIE that does not have a
specified partner (as the result of a trans-
action described in proposed §1.163(j)-6
(j)(6)(ii)(A)). For purposes of applying
proposed §1.163(j)-6 (j)(5)(ii), upper-ti-
er partnership shall treat any disallowed
UTP EBIE in the same manner as UTP
EBIE that has previously been allocated a
negative section 734(b) adjustment. How-
ever, upper-tier partnership does not treat
disallowed UTP EBIE as though it were
allocated a negative section 734(b) ad-
justment pursuant to this paragraph to the
extent a negative section 734(b) or 743(b)
adjustment was previously made to such
disallowed UTP EBIE.
5. Foundational Determinations
In general, the rules under proposed
§1.163(j)-6(j) are derived from the fol-
lowing three foundational determinations
made by the Treasury Department and the
IRS. First, basis is preserved when up-
per-tier partnership exchanges basis in its
lower-tier partnership for EBIE allocated
from lower-tier partnership (UTP EBIE).
Thus, upper-tier partnership generally
must treat UTP EBIE in the same man-
ner as built-in loss property. Second, UTP
EBIE has two components – a basis com-
ponent and a carryforward component. In
general, negative basis adjustments under
section 734(b) and 743(b) reduce the basis
component of UTP EBIE (and thus, any
possible deduction for UTP EBIE), but
do not reduce the carryforward compo-
nent of UTP EBIE; only the two conver-
sion events in proposed §1.163(j)-6(j)(5)
are capable of reducing the carryforward
component of UTP EBIE. Third, upper-ti-
er partnership must allocate any business
interest expense that was formerly UTP
EBIE to its specified partner – that is, the
partner that reduced its section 704(b)
capital account at the time of the initial
allocation of the UTP EBIE from lower-ti-
er partnership to upper-tier partnership. If
there is a transfer of a partnership inter-
est, the transferor generally steps into the
shoes of the transferee’s status as specified
partner, but may not deduct any business
interest expense derived from the transfer-
or’s share of UTP EBIE.
The Treasury Department and the IRS
request comments on this approach. Spe-
cifically, the Treasury Department and the
IRS request comments on whether further
guidance on the treatment of UTP EBIE
under the rules of subchapter K of the
Code is necessary.
F. Partner Basis Adjustments upon a
Distribution
Under the 2018 Proposed Regulations,
if a partner disposed of all or substantially
all of its partnership interest, the adjust-
ed basis of the partnership interest was
increased immediately before the disposi-
tion by the entire amount of the EBIE not
previously treated as paid or accrued by
the partner. If a partner disposed of less
than substantially all of its interest in a
partnership, the partner could not increase
its basis by any portion of the EBIE not
previously treated as paid or accrued by
the partner. The Treasury Department and
the IRS requested comments on this ap-
proach in the preamble to the 2018 Pro-
posed Regulations.
As discussed in the preamble to Final
Regulations, commenters cited multiple
concerns with the approach adopted in the
2018 Proposed Regulations and recom-
mended that the Final Regulations adopt
a proportionate approach. Under such an
approach, a partial disposition of a part-
nership interest would trigger a propor-
tionate EBIE basis addback and corre-
sponding decrease in such partner’s EBIE
carryover. The Treasury Department and
the IRS agreed with commenters. Accord-
ingly, §1.163(j)-6(h)(3) provides for a
proportionate approach.
In general, a distribution from a part-
nership is either a current distribution or
a liquidating distribution; the concept of
a redemptive distribution does not exist
in the partnership context. Accordingly,
proposed §1.163(j)-6(h)(4) would pro-
vide that, for purposes of §1.163(j)-6(h)
(3), a disposition includes a distribution
of money or other property by the partner-
ship to a partner in complete liquidation
of the partner’s interest in the partnership.
Proposed §1.163(j)-6(h)(4) would further
provide that, for purposes of §1.163(j)-
6(h)(3), a current distribution of money
or other property by the partnership to a
continuing partner is not a disposition
for purposes of §1.163(j)-6(h)(3). The
Treasury Department and the IRS request
comments on whether a current distribu-
tion of money or other property by the

September 28, 2020 812 Bulletin No. 2020–40
partnership to a continuing partner as con-
sideration for an interest in the partnership
should also trigger an addback and, if so,
how to determine the appropriate amount
of the addback.
G. Allocable ATI and Allocable Business
Interest Income of Upper-tier Partnership
Partners
Section 1.163(j)-6(f)(2) provides an
eleven-step computation necessary for
properly allocating a partnership’s de-
ductible BIE and section 163(j) excess
items among its partners. Pursuant to
§1.163(j)-6(f)(2)(ii), a partnership must
determine each of its partner’s allocable
share of each section 163(j) item under
section 704(b) and the regulations under
section 704 of the Code, including any al-
locations under section 704(c), other than
remedial items. Further, §1.163(j)-6(f)(2)
(ii) provides that the term allocable ATI
means a partner’s distributive share of the
partnership’s ATI (that is, a partner’s dis-
tributive share of gross income and gain
items comprising ATI less such partner’s
distributive share of gross loss and deduc-
tion items comprising ATI), and the term
allocable business interest income means
a partner’s distributive share of the part-
nership’s business interest income.
In general, if a partnership is not a part-
ner in a partnership, each dollar of taxable
income that is properly allocable to a trade
or business will have a corresponding dol-
lar of ATI associated with it. Accordingly,
in the non-tiered partnership context, if a
partner’s share of gross income and gain
items comprising ATI less such partner’s
share of gross loss and deduction items
comprising ATI equals $1, such partner
will have $1 of allocable ATI for purposes
of §1.163(j)-6(f)(2)(ii).
However, if a partnership is a partner
in a partnership, each dollar of taxable in-
come that is properly allocable to a trade
or business may not have a full dollar of
ATI associated with it. Section 163(j)(4)
(A)(ii)(I) provides that the ATI of a partner
in a partnership is determined without re-
gard to such partner’s distributive share of
any items of income, gain, deduction, or
loss of such partnership. Further, section
163(j)(4)(A)(ii)(II) provides that a partner
only increases its ATI by its distributive
share of a partnership’s ETI.
To illustrate, consider the following
example. LTP has $100 of income and
$100 of loss properly allocable to a trade
or business. Thus, LTP has $0 of ATI. LTP
specially allocates the $100 of income to
partner UTP. Under section 163(j)(4)(A)
(ii)(I), UTP does not treat such $100 of in-
come as ATI. Additionally, UTP has $300
of income properly allocable to a trade or
business, which UTP properly treats as
ATI. Here, UTP’s taxable income that is
properly allocable to a trade or business
($400) does not equal the amount of its
ATI ($300).
The Treasury Department and the IRS
recognize that a special rule is necessary
to coordinate situations like the one illus-
trated earlier with the general requirement
under §1.163(j)-6(f)(2)(ii) for partner-
ships to determine a partner’s allocable
ATI based on such partner’s allocation of
items comprising the ATI of the partner-
ship. Accordingly, proposed §1.163(j)-
6(j)(9) would provide that, when applying
§1.163(j)-6(f)(2)(ii), an upper-tier part-
nership determines the allocable ATI and
allocable business interest income of each
of its partners in the manner provided in
proposed §1.163(j)-6(j)(9). Specifically,
if an upper-tier partnership’s net amount
of tax items that comprise (or have ever
comprised) ATI is greater than or equal
to its ATI, upper-tier partnership applies
the rules in paragraph (j)(9)(ii)(A) to de-
termine each partner’s allocable ATI.
However, if an upper-tier partnership’s
net amount of tax items that comprise (or
have ever comprised) ATI is less than its
ATI, upper-tier partnership applies the
rules in proposed §1.163(j)-6(j)(9)(ii)
(B) to determine each partner’s allocable
ATI. To determine each partner’s alloca-
ble business interest income, an upper-tier
partnership applies the rules in proposed
§1.163(j)-6(j)(9)(iii).
H. Qualified Expenditures
The 2018 Proposed Regulations pro-
vided that partnership ATI is reduced by
deductions claimed under sections 173
(relating to circulation expenditures),
174(a) (relating to research and experi-
mental expenditures), 263(c) (relating to
intangible drilling and development ex-
penditures), 616(a) (relating to mine de-
velopment expenditures), and 617(a) (re-
lating to mining exploration expenditures)
(collectively “qualified expenditures”). As
a result, deductions for qualified expendi-
tures reduced the amount of business in-
terest expense a partnership could poten-
tially deduct.
A partner may elect to capitalize its dis-
tributive share of any qualified expendi-
tures of a partnership under section 59(e)
(4)(C) or may be required to capitalize
a portion of its distributive share of cer-
tain qualified expenditures of a partner-
ship under section 291(b). As a result, the
taxable income reported by a partner in a
taxable year attributable to the ownership
of a partnership interest may exceed the
amount of taxable income reported to the
partner on a Schedule K-1.
Commenters on the 2018 Proposed
Regulations recommended that a distrib-
utive share of partnership deductions cap-
italized by a partner under section 59(e)
or section 291(b) increase the ATI of the
partner because qualified expenditures
reduce both partnership ATI and excess
taxable income, but may not reduce the
taxable income of a partner. Two different
approaches for achieving this result were
suggested: (1) adjust the excess taxable
income of the partnership, resulting in an
increase to partner ATI, and (2) increase
the ATI of the partner directly, without
making any adjustments to partnership
excess taxable income.
The Treasury Department and IRS
agree that a distributive share of partner-
ship deductions capitalized by a partner
under section 59(e) should increase the
ATI of the partner and adopt the recom-
mended approach of increasing the ATI of
the partner directly, without making any
adjustments to partnership excess taxable
income. The approach of increasing part-
ner ATI by adjusting partnership excess
taxable income is rejected, as it would re-
sult in partnerships with more excess tax-
able income than ATI – a result not possi-
ble under the current statutory conceptual
framework. The Treasury Department and
IRS have the authority to adjust ATI, but
do not have a similar grant of authority to
make adjustments to partnership excess
taxable income, which is explicitly de-
fined by statute.
Accordingly, proposed §1.163(j)-6(e)
(6) would provide that the ATI of a part-
ner is increased by the portion of such

Bulletin No. 2020–40 813 September 28, 2020
partner’s allocable share of qualified ex-
penditures (as defined in section 59(e)(2))
to which an election under section 59(e)
applies. Any deduction allowed under sec-
tion 59(e)(1) would be taken into account
in determining a partner’s ATI pursuant to
§1.163(j)-1(b). Proposed §1.163(j)-6(l)(4)
(iv) would provide a similar rule in the S
corporation context.
The Treasury Department and IRS are
aware that a similar issue exists in the con-
text of depletion and request comments as
to whether a similar partner level add-
back is appropriate. The Treasury Depart-
ment and IRS are also aware that a partner
may be required to capitalize certain qual-
ified expenditures of a partnership under
section 291(b) and request comments as to
whether a similar partner level add-back is
appropriate.
I. CARES Act Partnership Rules
As stated in the Background section of
this preamble, section 163(j)(10), as en-
acted by the CARES Act, provides spe-
cial rules for partners and partnerships
for taxable years beginning in 2019 or
2020. Under sections 163(j)(10)(A)(i)
and 163(j)(10)(A)(ii)(I), for partnerships,
the amount of business interest that may
be deductible under section 163(j)(1)
for taxable years beginning in 2020 is
computed using the 50 percent ATI lim-
itation. The 50 percent ATI limitation
does not apply to partnerships for tax-
able years beginning in 2019. See section
163(j)(10)(A)(ii)(I). Under section 163(j)
(10)(A)(iii), a partnership may elect to
not apply the 50 percent ATI limitation
and, instead, to apply the 30 percent ATI
limitation. This election is made by the
partnership.
Under section 163(j)(10)(A)(ii)(II), a
partner treats 50 percent of its allocable
share of a partnership’s excess business
interest expense for 2019 as a business in-
terest expense in the partner’s first taxable
year beginning in 2020 that is not subject
to the section 163(j) limitation (50 percent
EBIE rule). The remaining 50 percent of
the partner’s allocable share of the part-
nership’s 2019 excess business interest
expense remains subject to the section
163(j) limitation applicable to excess
business interest expense carried forward
at the partner level. A partner may elect
out of the 50 percent EBIE rule. Proposed
§1.163(j)-6(g)(4) provides further guid-
ance on the 50 percent EBIE rule.
Additionally, section 163(j)(10)(B)(i)
allows a taxpayer to elect to substitute its
2019 ATI for the taxpayer’s 2020 ATI in
determining the taxpayer’s section 163(j)
limitation for any taxable year beginning
in 2020. Section 1.163(j)-2(b)(3) and (4)
of the Final Regulations provide general
rules regarding this election. Proposed
§1.163(j)-6(d)(5) provides further guid-
ance on this election in the partnership
context. The Treasury Department and the
IRS request comments on these proposed
rules and on whether further guidance is
necessary.
V. Proposed §1.163(j)-7: Application
of the Section 163(j) Limitation to
Foreign Corporations and United States
Shareholders
Proposed §1.163(j)-7 in these Pro-
posed Regulations (Proposed §1.163(j)-7)
provides general rules regarding the appli-
cation of the section 163(j) limitation to
foreign corporations and U.S. sharehold-
ers of CFCs. This section V describes pro-
posed §1.163(j)-7 contained in the 2018
Proposed Regulations, the comments re-
ceived on proposed §1.163(j)-7 contained
in the 2018 Proposed Regulations, and
Proposed §1.163(j)-7.
A. Overview of Proposed §1.163(j)-
7 Contained in the 2018 Proposed
Regulations
1. General Application of Section 163(j)
Limitation to Applicable CFCs
The 2018 Proposed Regulations clari-
fy that, consistent with §1.952-2, section
163(j) and the section 163(j) regulations
apply to determine the deductibility of an
applicable CFC’s BIE in the same manner
as these provisions apply to determine
the deductibility of a domestic C corpo-
ration’s BIE. The 2018 Proposed Regula-
tions define an applicable CFC as a CFC
in which at least one U.S. shareholder
owns stock within the meaning of sec-
tion 958(a). However, in certain cases, the
2018 Proposed Regulations allow certain
applicable CFCs to make a CFC group
election and be treated as part of a CFC
group for purposes of computing the ap-
plicable CFC’s section 163(j) limitation.
2. Limitation on Amount of Business
Interest Expense of a CFC Group
Member Subject to the Section 163(j)
Limitation
Under the 2018 Proposed Regulations,
if a CFC group election is in effect, the
amount of BIE of a CFC group member
that is subject to the section 163(j) limita-
tion is limited to the amount of the CFC
group member’s allocable share of the
CFC group’s applicable net BIE (which is
equal to the sum of the BIE of all CFC
group members, reduced by the BII of all
CFC group members). Thus, for example,
if a CFC group has no debt other than loans
between CFC group members, no portion
of the BIE of a CFC group member would
be subject to the section 163(j) limitation.
A CFC group member’s allocable share is
computed by multiplying the applicable
net BIE of the CFC group by a fraction,
the numerator of which is the CFC group
member’s net BIE (computed on a sepa-
rate company basis), and the denominator
of which is the sum of the amounts of the
net BIE of each CFC group member with
net BIE (computed on a separate company
basis).
After applying the CFC group rules to
determine each CFC group member’s al-
locable share of the CFC group’s applica-
ble net BIE, each CFC group member that
has BIE is required to perform a stand-
alone section 163(j) calculation to deter-
mine whether any BIE is disallowed under
the section 163(j) limitation.
3. Membership in a CFC Group
Under the 2018 Proposed Regulations,
in general, a CFC group means two or
more applicable CFCs if at least 80 per-
cent of the value of the stock of each ap-
plicable CFC is owned, within the mean-
ing of section 958(a), by a single U.S.
shareholder or, in the aggregate, by re-
lated U.S. shareholders that own stock of
each member in the same proportion. The
2018 Proposed Regulations also generally
treat a controlled partnership (in general, a
partnership in which CFC group members
own, in the aggregate, at least 80 percent
of the interests) as a CFC group member.

September 28, 2020 814 Bulletin No. 2020–40
For purposes of identifying a CFC group,
members of a consolidated group are
treated as a single person, as are individ-
uals filing a joint return, and stock owned
by certain passthrough entities is treated
as owned proportionately by the owners
or beneficiaries of the passthrough entity.
The 2018 Proposed Regulations ex-
clude from the definition of a CFC group
member an applicable CFC that has any
income that is effectively connected with
the conduct of a trade or business in the
United States. In addition, if one or more
CFC group members conduct a financial
services business, those entities are treated
as comprising a separate subgroup.
Under the 2018 Proposed Regulations,
a CFC group election is made by apply-
ing the rules applicable to CFC groups for
purposes of computing each CFC group
member’s deduction for BIE. Once made,
the CFC group election is irrevocable.
4. Roll-up of CFC Excess Taxable
Income to Other CFC Group Members
and U.S. Shareholders
Under the 2018 Proposed Regulations,
if a CFC group election is in effect with
respect to a CFC group, then an upper-tier
CFC group member takes into account a
proportionate share of any “CFC excess
taxable income” of a lower-tier CFC group
member in which it directly owns stock
for purposes of computing the upper-tier
member’s ATI. The meaning of the term
“CFC excess taxable income” is analo-
gous to the meaning of the term “excess
taxable income” in the context of a part-
nership and S corporation, and, in general,
means the amount of a CFC group mem-
ber’s ATI in excess of the amount need-
ed to prevent any BIE of the CFC group
member from being disallowed under sec-
tion 163(j).
Under the 2018 Proposed Regulations,
a U.S. shareholder is not permitted to in-
clude in its ATI amounts included in gross
income under section 951(a) (subpart F
inclusions), section 951A(a) (GILTI in-
clusions), or section 78 (section 78 in-
clusions) that are properly allocable to a
non-excepted trade or business (collec-
tively, deemed income inclusions). How-
ever, the 2018 Proposed Regulations pro-
vide that a portion of CFC excess taxable
income of the highest-tier applicable CFC
is permitted to be used to increase the ATI
of its U.S. shareholders. That portion is
equal to the U.S. shareholder’s interest in
the highest-tier applicable CFC multiplied
by its specified ETI ratio. The numerator
of the specified ETI ratio is the sum of the
U.S. shareholder’s income inclusions un-
der sections 951(a) and 951A(a) with re-
spect to the specified highest-tier member
and specified lower-tier members, and the
denominator is the sum of the taxable in-
come of the specified highest-tier member
and specified lower-tier members.
B. Summary of Comments on Proposed
§1.163(j)-7 Contained in the 2018
Proposed Regulations
The Treasury Department and the IRS
requested comments in the preamble to
the 2018 Proposed Regulations regarding
whether it would be appropriate to further
modify the application of section 163(j)
to applicable CFCs and whether there
are particular circumstances in which it
may be appropriate to exempt an applica-
ble CFC from the application of section
163(j). Some commenters recommended
that section 163(j) not apply to applicable
CFCs. Those comments are addressed in
part VIII of the Summary of Comments
and Explanation of Revisions section in
the Final Regulations.
A number of commenters broadly re-
quested changes to the roll-up of CFC
excess taxable income. Many of these
commenters expressed concern about the
administrability of rolling up CFC ex-
cess taxable income. Some commenters
suggested that the CFC group election be
available to a stand-alone applicable CFC
in order to allow its CFC excess taxable
income to be used to increase the ATI of
a U.S. shareholder, or that an applicable
CFC be permitted to use any CFC excess
taxable income to increase the ATI of a
shareholder without regard to whether it is
a CFC group member. Furthermore, some
commenters asserted that the nature of
the roll-up compels multinationals to re-
structure their operations in order to move
CFCs with relatively high amounts of
ATI and low amounts of interest expense
to the bottom of the ownership chain and
CFCs with relatively low amounts of ATI
and high amounts of interest expense to
the top of the ownership chain, in order
to maximize the benefits of the roll-up of
CFC excess taxable income.
Some commenters asserted that be-
cause multinational organizations may
own hundreds of CFCs, applying the sec-
tion 163(j) limitation on a CFC-by-CFC
basis, without regard to whether a CFC
group election has been made under the
2018 Proposed Regulations, represents a
significant administrative burden. Many
comments suggested that CFC groups
should be permitted to apply section
163(j) on a group basis, with a single
group-level section 163(j) calculation
similar to the rules applicable to a con-
solidated group. A few commenters sug-
gested that this rule should be applied in
addition to the roll-up of CFC excess tax-
able income, but most commenters rec-
ommended that the group rule be applied
instead of the roll-up.
A number of commenters asserted
that the requirements to be a member of
a CFC group under the 2018 Proposed
Regulations are overly restrictive. Some
of these commenters recommended that
the 80-percent ownership threshold be re-
placed with the ownership requirements
of affiliated groups under section 1504(a),
the rules of which are well-known and
understood. Others recommended that
the 80-percent ownership requirement be
reduced to 50 percent, consistent with the
standard for treatment of a foreign corpo-
ration as a CFC. Still others asserted that
U.S. shareholders owning stock in appli-
cable CFCs should not each be required
to own the same proportion of stock in
each applicable CFC in order for their
ownership interests to count towards the
80-percent ownership requirement, or that
the attribution rules of section 958(b),
rather than section 958(a), should apply
for purposes of determining whether the
ownership requirements are met. Finally,
some of these commenters requested that
a CFC group election be permitted when
one applicable CFC meets the ownership
requirements for other applicable CFCs,
even if no U.S. shareholder meets the
ownership requirements for a highest-tier
applicable CFC.
Some commenters requested the CFC
financial services subgroups not be segre-
gated from the CFC group and their BIE
and BII be included in the general CFC
group.

Bulletin No. 2020–40 815 September 28, 2020
Some commenters requested that an
applicable CFC with effectively connect-
ed income be permitted to be a member
of a CFC group and that only its effec-
tively connected income items should
be excluded. Alternatively, commenters
requested a de minimis rule that would
permit an applicable CFC to be a member
of a CFC group if the applicable CFC’s
effectively connected income is below a
certain threshold of total income, such as
10 percent.
Some commenters requested that the
CFC group election be revocable. The
commenters proposed either making the
CFC group election an annual election or
providing that the election applies for a
certain period, for example, three or five
years, before it can be revoked.
Finally, commenters requested a safe
harbor or exclusion providing that if a
CFC group would not be limited under
section 163(j) either because the CFC
group has no net BIE or because its BIE
does not exceed 30 percent of the CFC
group’s ATI, a U.S. shareholder would not
have to apply section 163(j) for the appli-
cable CFC or be subject to applicable CFC
section 163(j) reporting requirements.
C. Proposed §1.163(j)-7
1. Overview
As noted in the preamble to the Final
Regulations, the Treasury Department and
the IRS have determined, based on a plain
reading of section 163(j) and §1.952-2,
that section 163(j) applies to foreign cor-
porations where relevant under current law
and has applied to such corporations since
the effective date of the new provision.
1

Congress expressly provided that section
163(j) should not apply to certain small
businesses or to certain excepted trades or
businesses. Nothing in the Code or legis-
lative history indicates that Congress in-
tended to except other persons with trades
or businesses, as defined in section 163(j)
(7), from the application of section 163(j).
Accordingly, the Treasury Department
and the IRS have determined that, consis-
tent with a plain reading of section 163(j)
and §1.952-2, it is appropriate for section
163(j) to apply to applicable CFCs and
other foreign corporations whose taxable
income is relevant for Federal tax purpos-
es (other than by reason of having ECI or
income described in section 881 (FDAP))
(relevant foreign corporations).
2
In the
case of CFCs with ECI, see proposed
§1.163(j)-8. For further discussion of the
Treasury Department and the IRS’s deter-
mination that there is not a statutory basis
for exempting applicable CFCs from the
application of section 163(j), see part VIII
of the Summary of Comments and Expla-
nation of Revisions section of the Final
Regulations.
A number of comments were received
asserting that there are other mechanisms
that eliminate the policy need for section
163(j) to apply to limit leverage in CFCs.
For example, some commenters have cited
tax rules in foreign jurisdictions limiting
interest deductions, including thin capital-
ization rules (or similar rules intended to
implement the Organisation for Economic
Co-operation and Development (OECD)
recommendations under Action 4 of the
Base Erosion and Profits Shifting Project).
The Treasury Department and the IRS dis-
agree with these assertions. The Treasury
Department and the IRS note that these
rules are not universally applied in other
jurisdictions, that many jurisdictions do
not have any meaningful interest expense
limitation rules, and that some jurisdic-
tions have no interest expense limitation
rules of any kind.
Even if some CFCs owned by a U.S.
shareholder are in foreign jurisdictions
with meaningful thin capitalization rules,
in the absence of section 163(j), it would
still be possible to use leverage to reduce
or eliminate a U.S. shareholder’s global
intangible low-taxed income (GILTI) un-
der section 951A for these CFCs. This is
because for purposes of computing a U.S.
shareholder’s GILTI under section 951A,
tested income of CFCs may be offset by
tested losses of CFCs owned by the U.S.
shareholder. See section 951A(c). The
ability to deduct interest without limita-
tion under section 163(j) would result
in tested losses in CFCs with significant
leverage. Because of this aggregation, one
overleveraged CFC in a single jurisdiction
that does not have rules limiting interest
expense can, without the application of
section 163(j), reduce or eliminate tested
income from all CFCs owned by a U.S.
shareholder regardless of jurisdiction.
Other comments suggested that, to
the extent that debt of a CFC is held by
a related party, transfer pricing princi-
ples would discipline the amount of in-
terest expense. Comments also note that
to the extent that debt of a CFC is held
by a third party, market forces would
discipline the leverage present in the
CFC. While both of these concepts may
discipline the amount of leverage pres-
ent in a CFC, they would also discipline
the amount of leverage in any entity. If
Congress believed that market forces and
transfer pricing principles were sufficient
disciplines to prevent overleverage, sec-
tion 163(j) would not have been amended
as part of TCJA to clearly apply to inter-
est expense paid or accrued to both third
parties and related parties. In addition,
if transfer pricing were sufficient to po-
lice interest expense in the related party
context, old section 163(j) (as enacted in
1989 and subsequently revised prior to
TCJA) would not have been necessary.
However, the Treasury Department
and the IRS also have determined that it
is appropriate, while still carrying out the
provisions of the statute and the policies
of section 163(j), to reduce the adminis-
trative and compliance burdens of apply-
ing section 163(j) to applicable CFCs.
Accordingly, Proposed §1.163(j)-7 allows
for an election to be made to apply sec-
tion 163(j) on a group basis with respect
to applicable CFCs that are “specified
group members” of a “specified group.” If
the election is made, the specified group
members are referred to as “CFC group
members” and all of the CFC group mem-
bers collectively are referred to as a “CFC
1
Section 1.952-2(b) generally provides that the taxable income for a foreign corporation is determined by treating the foreign corporation as a domestic corporation but with certain enumer-
ated exceptions. Section 1.952-2(c) provides for a number of exceptions, but none of the exceptions affects the application of section 163(j).
2
For purposes of Proposed §1.163(j)-7, the term effectively connected income (or ECI) means income or gain that is ECI, as defined in §1.884-1(d)(1)(iii), and deduction or loss that is
allocable to, ECI, as defined in §1.884-1(d)(1)(iii).

September 28, 2020 816 Bulletin No. 2020–40
group.” The rules for determining a spec-
ified group and specified group members
are discussed in part V.C.3. of this Expla-
nation of Provisions section. The rules and
procedures for treating specified group
members as CFC group members and for
determining a CFC group are discussed in
part V.C.4. of this Explanation of Provi-
sions section.
In addition, Proposed §1.163(j)-7 pro-
vides a safe harbor election that exempts
certain applicable CFCs from application
of section 163(j). The safe-harbor election
is available for stand-alone applicable
CFCs (which is an applicable CFC that is
not a specified group member of a speci-
fied group) and CFC group members. The
election is not available for an applicable
CFC that is a specified group member but
not a CFC group member because a CFC
group election is not in effect. See part
V.C.7. of this Explanation of Provisions
section.
Proposed §1.163(j)-7 also provides an
anti-abuse rule that increases ATI in cer-
tain circumstances.
Finally, Proposed §1.163(j)-7 allows
a U.S. shareholder of a stand-alone ap-
plicable CFC or a CFC group member of
a CFC group to include a portion of its
deemed income inclusions attributable to
the applicable CFC in the U.S. sharehold-
er’s ATI. This rule does not apply with re-
spect to an applicable CFC that is a spec-
ified group member but not a CFC group
member because a CFC group election is
not in effect. See part V.C.9. of this Expla-
nation of Provisions section.
The Treasury Department and the IRS
anticipate that, in many instances, Pro-
posed §1.163(j)-7 will significantly re-
duce the administrative and compliance
burdens of applying section 163(j) to
applicable CFCs relative to the 2018 Pro-
posed Regulations.
Unlike Proposed §1.163(j)-8, which
provides rules for allocating disallowed
BIE to ECI and non-ECI, Proposed
§1.163(j)-7 does not allocate disallowed
BIE among classes of income. The Trea-
sury Department and the IRS request
comments on appropriate methods of al-
locating disallowed BIE among classes
of income, such as subpart F income, as
defined in section 952, and tested income,
as defined in section 951A(c)(2)(A) and
§1.951A-2(b)(1), as well as comments
on whether and the extent to which rules
implementing such methods may be nec-
essary.
In addition, the Treasury Department
and the IRS request comments on appro-
priate methods of allocating disallowed
BIE for other purposes, including between
items described in §1.163(j)-1(b)(22)(i)
and other items described in §1.163(j)-
1(b)(22) (defining interest), as well as
comments on whether and the extent to
which rules implementing such methods
may be necessary.
The Treasury Department and the IRS
do not anticipate that section 163(j) will
affect the tax liability of a passive foreign
investment company, within the meaning
of section 1297(a) (PFIC), or its share-
holders, solely because the PFIC is a rel-
evant foreign corporation. See §1.163(j)-
4(c)(1) (providing that section 163(j) does
not affect earnings and profits). The Trea-
sury Department and the IRS request com-
ments on whether any additional guidance
is needed to reduce the compliance burden
of section 163(j) on PFICs and their share-
holders.
2. Application of Section 163(j) to CFC
Group Members
a. Single Section 163(j) Limitation for a
CFC Group
Proposed §1.163(j)-7(c) provides
rules for applying section 163(j) to CFC
group members of a CFC group. Under
the Proposed Regulations, a single sec-
tion 163(j) limitation is computed for a
CFC group. See proposed §1.163(j)-7(c)
(2). For this purpose, the current-year
BIE, disallowed BIE carryforwards, BII,
floor plan financing interest expense,
and ATI of a CFC group are equal to the
sums of the current-year amounts of such
items for each CFC group member for its
specified taxable year with respect to the
specified period. (The terms “specified
taxable year” and “specified period” are
discussed in part V.C.3. of this Explana-
tion of Provisions section.) A CFC group
member’s current-year BIE, BII, floor
plan financing interest expense, and ATI
for a specified taxable year are generally
determined on a separate-company basis
before being included in the CFC group
calculation.
b. Allocation of CFC Group’s Section
163(j) Limitation to Business Interest
Expense of CFC Group Members
The extent to which a CFC group’s sec-
tion 163(j) limitation is allocated to a par-
ticular CFC group member’s current-year
BIE and disallowed BIE carryforwards is
determined using the rules that apply to
consolidated groups under §1.163(j)-5(a)
(2) and (b)(3)(ii) (consolidated BIE rules),
subject to certain modifications. See pro-
posed §1.163(j)-7(c)(3)(i). Because many
CFC groups will be owned by consolidat-
ed groups, many taxpayers will be famil-
iar with the consolidated BIE rules.
If the sum of the CFC group’s cur-
rent-year BIE and disallowed BIE carry-
forwards exceeds the CFC group’s section
163(j) limitation, then current-year BIE
is deducted first. If the CFC group’s cur-
rent-year BIE exceeds the CFC group’s
section 163(j) limitation, then each CFC
group member deducts the amount of its
current-year BIE not in excess of the sum
of its BII and floor plan financing interest
expense, if any. Then, if the CFC group
has any section 163(j) limitation remain-
ing for the current year, each applicable
CFC with remaining current-year BIE de-
ducts a pro rata portion thereof.
If the CFC group’s section 163(j) lim-
itation exceeds its current-year BIE, then
CFC group members may deduct all of
their current-year BIE and may deduct
disallowed BIE carryforwards not in ex-
cess of the CFC group’s remaining sec-
tion 163(j) limitation. The disallowed BIE
carryforwards are deducted in the order of
the taxable years in which they arose, be-
ginning with the earliest taxable year, and
disallowed BIE carryforwards that arose
in the same taxable year are deducted on
a pro rata basis. This taxable year order-
ing rule is consistent with the consolidated
BIE rules. However, Proposed §1.163(j)-7
provides special rules for disallowed BIE
carryforwards when CFC group members
have different taxable years, or a CFC
group member has multiple taxable years
with respect to the specified period of the
CFC group. Unlike members of a consol-
idated group, not all CFC group members
will have the same taxable years, and not
all CFC group members will have the
same taxable year as the parent of the CFC
group. As discussed in part V.C.3 of this

Bulletin No. 2020–40 817 September 28, 2020
Explanation of Provisions section, a CFC
group member is included in a CFC group
for its entire taxable year that ends with or
within a specified period.
3
c. Limitation on Pre-Group Disallowed
Business Interest Expense Carryforwards
The disallowed BIE carryforwards of a
CFC group member when it joins a CFC
group (pre-group disallowed BIE carry-
forwards) are subject to the same CFC
group section 163(j) limitation and are
deducted pro rata with other CFC group
disallowed BIE carryforwards. However,
pre-group disallowed BIE carryforwards
are subject to additional limitations, sim-
ilar to the limitations on deducting the dis-
allowed BIE carryforwards of a consoli-
dated group arising in a SRLY, as defined
in §1.1502-1(f), or treated as arising in a
SRLY under the principles of §1.1502-
21(c) and (g). The policy of the limitation
imposed on pre-group BIE carryforwards
is analogous to the policy of the SRLY
limitation for consolidated groups.
The rules and principles of §1.163(j)-
5(d)(1)(B), which applies SRLY subgroup
principles to disallowed BIE carryfor-
wards of a consolidated group, apply
to pre-group subgroups. If a CFC group
member with pre-group disallowed BIE
carryforwards (loss member) leaves one
CFC group (former group) and joins an-
other CFC group (current group), the loss
member and each other CFC group mem-
ber that left the former group and joined
the current group for a specified taxable
year with respect to the same specified pe-
riod consists of a “pre-group subgroup.”
Unlike SRLY subgroups, it is not required
that all members of a pre-group subgroup
join the CFC group at the same time, since
each applicable CFC that joins a CFC
group is treated as joining on the first day
of its taxable year. As a result, even if
multiple applicable CFCs are acquired on
the same day in a single transaction, they
would join the CFC group on different
days if they have different taxable years.
d. Special Rules for Specified Periods
Beginning in 2019 or 2020
Proposed §1.163(j)-7(c)(5) provides
special rules for applying section 163(j)
(10) to CFC groups. The proposed reg-
ulations provide that elections under
section 163(j)(10) are made for a CFC
group (rather than for each CFC group
member). For a specified period of a CFC
group beginning in 2019 or 2020, unless
the election described in §1.163(j)-2(b)
(2)(ii)(A) is made, the CFC group sec-
tion 163(j) limitation is determined by
using 50 percent (rather than 30 percent)
of the CFC group’s ATI for the specified
period, without regard to whether the tax-
able years of CFC group members begin
in 2019 or 2020. If the election described
in §1.163(j)-2(b)(2)(ii)(A) is made for a
specified period of a CFC group, the CFC
group section 163(j) limitation is deter-
mined by using 30 percent (rather than 50
percent) of the CFC group’s ATI for the
specified period, without regard to wheth-
er the taxable years of CFC group mem-
bers begin in 2019 or 2020. The election
is made for the CFC group by each desig-
nated U.S. person.
The election under §1.163(j)-2(b)(3)(i)
to use 2019 ATI (that is, ATI for the last
taxable year beginning in 2019) rather
than 2020 ATI (that is, ATI for a taxable
year beginning in 2020) is made for a
specified period of a CFC group begin-
ning in 2020 (2020 specified period) and
applies to the specified taxable years of
CFC group members with respect to the
2020 specified period. Accordingly, if
a specified taxable year of a CFC group
member with respect to a CFC group’s
2020 specified period begins in 2020, then
the election is applied to such taxable year
using the CFC group member’s ATI for
its last taxable year beginning in 2019. In
some cases, the specified taxable year of a
CFC group member with respect to a CFC
group’s 2020 specified period will begin
in 2019 or 2021. If the specified taxable
year of the CFC group member begins in
2019, then the election is applied to such
taxable year using the CFC group mem-
ber’s ATI for its last taxable year begin-
ning in 2018; if the specified taxable year
of the CFC group member begins in 2021,
then the election is applied to such taxable
year using the CFC group member’s ATI
for its last taxable year beginning in 2020.
For example, assume a CFC group
has two CFC group members, CFC1 and
CFC2, and has a specified period that is
the calendar year. CFC1 has a taxable year
that is the calendar year, and CFC2 has a
taxable year that ends November 30. The
election under §1.163(j)-2(b)(3)(i) is in
effect for the specified period beginning
January 1, 2020, and ending December
31, 2020 (which is the 2020 specified
period). As a result, the ATI of the CFC
group for the 2020 specified period is
determined by reference to the specified
taxable year of CFC1 beginning January
1, 2019, and ending December 31, 2019
(the last taxable year beginning in 2019),
and the specified taxable year of CFC2
beginning December 1, 2018, and ending
November 30, 2019 (the last taxable year
beginning in 2018).
Alternatively, assume (i) the same CFC
group instead has a 2020 specified peri-
od that begins on December 1, 2020, and
ends on November 30, 2021; (ii) in 2019
and 2020, CFC1 has a taxable year that is
the calendar year, but in 2021, CFC1 has a
short taxable year that begins on January
1, 2021, and ends on June 30, 2021; and
(iii) CFC2 has a taxable year ending No-
vember 30 (for all years). Further assume
that the election under §1.163(j)-2(b)(3)
(i) is in effect for the 2020 specified peri-
od. In this case, the election applies to the
specified taxable year of CFC1 that begins
on January 1, 2020, and ends on Decem-
ber 31, 2020; the specified taxable year of
CFC1 that begins on January 1, 2021, and
ends on June 30, 2021; and the specified
taxable year of CFC2 that begins on De-
cember 1, 2020, and ends on November
30, 2021. As a result of the election, the
ATI of the CFC group for the 2020 spec-
3
For example, assume a U.S. multinational group parented by a consolidated group with a taxable year that is the calendar year includes applicable CFCs with November 30 taxable years and
other applicable CFCs with calendar year taxable years. In this case, as discussed in more detail in part V.C.3.b. of the Explanation of Provisions section, the specified period of the CFC group
for 2020 would begin on January 1, 2020, and end on December 31, 2020. Furthermore, the specified taxable year of a CFC group member with a taxable year that is the calendar year is its
taxable year ending December 31, 2020, and the specified taxable year of a CFC group member with a November 30 taxable year is its taxable year ending November 30, 2020 (the taxable
years that end with or within the specified period). A CFC group member can also have multiple taxable years with respect to a specified period. For example, a CFC group member may have
a short taxable year due to an election under §1.245A-5T(e)(3)(i) (elective exception to close a CFC’s taxable year in the case of an extraordinary reduction).

September 28, 2020 818 Bulletin No. 2020–40
ified period is determined by reference
to the specified taxable year of CFC1
beginning January 1, 2019, and ending
December 31, 2019, the specified taxable
year of CFC1 beginning January 1, 2020,
and ending December 31, 2020, and the
specified taxable year of CFC2 beginning
December 1, 2019, and ending November
30, 2020.
If the election under §1.163(j)-2(b)(3)
(i) to use 2019 ATI rather than 2020 ATI
is made for a CFC group, the CFC group’s
ATI for the 2020 specified period is deter-
mined by reference to the 2019 ATI of all
CFC group members (except to the extent
that 2018 or 2020 ATI is used, as described
earlier), including any CFC group mem-
ber that joins the CFC group during the
2020 specified period. Therefore, a CFC
group’s ATI for the 2020 specified period
may be determined by reference to a prior
taxable year of a new CFC group member
even though the CFC group member was
not a CFC group member in the prior tax-
able year. If a CFC group member leaves
the CFC group during the 2020 specified
period, the ATI of the CFC group for the
2020 specified period is determined with-
out regard to the ATI of the departing CFC
group member.
As stated in the Background section of
this preamble, Revenue Procedure 2020-
22 generally provides the time and man-
ner of making or revoking elections under
section 163(j)(10), including elections
with respect to applicable CFCs. Refer-
ences in Revenue Procedure 2020-22 to
CFC groups and CFC group members
are to CFC groups and applicable CFCs
for which a CFC group election is made
under the 2018 Proposed Regulations.
The rules described in this part V.C.2.d of
this Explanation of Provisions section and
proposed §1.163(j)-7(c)(5) modify the ap-
plication of Revenue Procedure 2020-22
and the elections under section 163(j)(10)
for CFC groups and applicable CFCs for
which a CFC group election is made under
Proposed §1.163(j)-7.
Thus, for example, if a CFC group
has two designated U.S. persons that are
U.S. corporations, pursuant to proposed
§1.163(j)-7(c)(5), the election to not ap-
ply the 50 percent ATI limitation to the
CFC group for a specified period begin-
ning in 2020 is made for the specified
period of the CFC group by each desig-
nated U.S. person, and pursuant to Reve-
nue Procedure 2020-22, section 6.01(2),
the election to not apply the 50 percent
ATI limitation is made by the each desig-
nated U.S. person timely filing a Federal
income tax return, including extensions,
using the 30 percent ATI limitation for
purposes of determining the taxable in-
come of the CFC group.
For purposes of applying §1.964-
1(c), the elections described in proposed
§1.163(j)-7(c)(5) are treated as if made
for each CFC group member. Thus, the
requirements to provide a statement and
written notice as provided under §1.964-
1(c)(3)(i)(B) and (C) apply.
3. Specified Groups and Specified Group
Members
a. In General
Proposed §1.163(j)-7(d) provides rules
for determining a specified group and
specified group members. The determi-
nation of a specified group and specified
group members is the basis for determin-
ing a CFC group and CFC group members.
This is because a CFC group member is
a specified group member of a specified
group for which a CFC group election is
in effect, and a CFC group consists of all
the CFC group members. See proposed
§1.163(j)-7(e)(2).
b. Specified Group
Under proposed §1.163(j)-7(d)(2),
a specified group includes one or more
chains of applicable CFCs connected
through stock ownership with a specified
group parent, but only if the specified
group parent owns stock meeting the re-
quirements of section 1504(a)(2)(B) (per-
taining to value) in at least one applicable
CFC, and stock meeting the requirements
of section 1504(a)(2)(B) in each of the
applicable CFCs (except the specified
group parent) is owned by one or more of
the other applicable CFCs or the specified
group parent.
Unlike the general rules in section
1504, in order to avoid breaking affili-
ation with a partnership or foreign trust
or foreign estate, for purposes of deter-
mining whether stock in an applicable
CFC meeting the requirements of section
1504(a)(2)(B) is owned by the specified
group parent or other applicable CFCs,
proposed §1.163(j)-7(d)(2) takes into
account both stock owned directly and
stock owned indirectly under section
318(a)(2)(A) through a domestic or for-
eign partnership or under section 318(a)
(2)(A) or (a)(2)(B) through a foreign
estate or trust (the look-through rule).
For example, assume CFC1 and CFC2
is each an applicable CFC and a speci-
fied group member of a specified group.
If CFC1 and CFC2 each own 50 percent
of the capital and profits interests in a
partnership, and the partnership wholly
owns CFC3, an applicable CFC, then, by
reason of the look-through rule, CFC3 is
also included in the specified group, al-
though the partnership is not.
The specified group rules also differ
from the affiliated group rules in sec-
tion 1504 in that they require only that
80 percent of the total value (pursuant to
section 1504(a)(2)(B)), not 80 percent of
both vote and value (pursuant to section
1504(a)(2)(A) and (a)(2)(B)), of an ap-
plicable CFC be owned by the specified
group parent or other applicable CFCs in
the specified group in order for the appli-
cable CFC to be included in the specified
group. The Treasury Department and the
IRS determined that limiting the 80-per-
cent threshold to value is appropriate to
prevent taxpayers from breaking affili-
ation by diluting voting power below 80
percent.
The specified group has a single spec-
ified group parent, which may be either
a qualified U.S. person or an applicable
CFC. However, the specified group parent
is included in the specified group only if it
is an applicable CFC. For this purpose, a
qualified U.S. person means a U.S. person
that is a citizen or resident of the United
States or a domestic corporation. For pur-
poses of determining the specified group
parent, members of a consolidated group
are treated as a single corporation and in-
dividuals whose filing status is “married
filing jointly” are treated as a single indi-
vidual (aggregation rule). The Treasury
Department and the IRS have determined
that the aggregation rule is appropriate be-
cause all deemed inclusions with respect
to applicable CFCs included in gross in-
come of members of a consolidated group
or of individuals filing a joint return, as

Bulletin No. 2020–40 819 September 28, 2020
applicable, are reported on a single U.S.
tax return. The Treasury Department and
the IRS determined that it is appropriate
for an S corporation to be a qualified U.S.
person because an S corporation can have
only a single class of stock and therefore
the economic rights of its shareholders in
all applicable CFCs owned by the S cor-
poration are proportionate to share own-
ership. On the other hand, the Treasury
Department and the IRS have determined
that it is not appropriate for a domestic
partnership to be a qualified U.S. person
because of the ability of partnerships to
make disproportionate or special alloca-
tions and therefore the economic rights of
partners in the partnership with respect to
all applicable CFCs owned by a partner-
ship will not necessarily be proportion-
ate to ownership. However, if, for exam-
ple, a domestic partnership wholly owns
an applicable CFC, which wholly owns
multiple other applicable CFCs, and no
qualified U.S. person owns stock in the
top-tier CFC meeting the requirements of
section 1504(a)(2)(B), taking into account
the look-through rule, then the applicable
CFCs are included in a specified group
of which the top-tier CFC is the specified
group parent.
The Treasury Department and the IRS
request comments regarding whether, and
to what extent, the definition of a “qual-
ified U.S. person” should be expanded
to include domestic estates and trusts
or whether and to what extent the look-
through rule should apply if stock of ap-
plicable CFCs is owned by domestic es-
tates and trusts.
Each specified group has a specified
period. A specified period is similar to a
taxable year but determined with respect
to a specified group. A specified group
does not have a taxable year because the
specified group members may not have
the same taxable year. If the specified
group parent is a qualified U.S. person,
the specified period generally ends on the
last day of the taxable year of the speci-
fied group parent and begins on the first
day after the last day of the prior specified
period. Thus, for example, if the spec-
ified group parent is a domestic corpo-
ration with a calendar year taxable year,
the specified period generally begins on
January 1 and ends on December 31. If
the specified group parent is an applica-
ble CFC, the specified period generally
ends on the last day of the required year
of the specified group parent, determined
under section 898(c)(1), without regard to
section 898(c)(2), and begins on the first
day after the last day of the prior specified
period. However, a specified period never
begins before the first day on which the
specified group exists or ends after the last
day on which the specified group exists.
Like a taxable year, a specified period can
never be longer than 12 months.
The principles of §1.1502-75(d)(1),
(d)(2)(i) through (d)(2)(ii), and (d)(3)
(i) through (d)(3)(iv) (regarding when a
consolidated group remains in existence)
(§1.1502-75(d) principles) apply for pur-
poses of determining when a specified
group ceases to exist. Solely for purpos-
es of applying the §1.1502-75(d) princi-
ples, each applicable CFC that is treated
as a specified group member for a taxable
year of the applicable CFC with respect
to a specified period is treated as affiliat-
ed with the specified group parent from
the beginning to the end of the specified
period, without regard to the beginning
or end of its taxable year. This rule does
not affect the general rule that, for pur-
poses other than §1.1502-75(d) (such as
the application of section 163(j) to a CFC
group), an applicable CFC is a specified
group member with respect to a specified
period for its taxable year ending with or
within the specified period.
4
The Treasury Department and the IRS
request comments as to whether any mod-
ifications to the §1.1502-75(d) principles
should be made for specified groups.
c. Specified Group Members
Proposed §1.163(j)-7(d)(3) provides
rules for determining specified group
members with respect to a specified group.
The determination as to whether an appli-
cable CFC is a specified group member is
made with respect to a taxable year of the
applicable CFC and specified period of a
specified group. Specifically, if the appli-
cable CFC is included in a specified group
on the last day of its taxable year that ends
with or within the specified period, the ap-
plicable CFC is a specified group member
with respect to the specified period for the
entire taxable year.
5
The Treasury Department and the IRS
are concerned about the potential for
abuse that may arise if taxpayers cause
an applicable CFC that otherwise would
be treated as a specified group member
and a CFC group member to avoid being
treated as a CFC group member. For ex-
ample, the Treasury Department and the
IRS have determined that it is not appro-
priate for taxpayers to prevent an applica-
ble CFC with high ATI and low BIE from
being part of a CFC group with a goal of
increasing its CFC excess taxable income
and its U.S. shareholders’ ATI inclusions,
rather than allowing the applicable CFC’s
ATI to be used by the CFC group. The
Treasury Department and the IRS request
comments on appropriate methods of pre-
venting an applicable CFC from avoiding
being a CFC group member for purposes
of increasing the ATI of its U.S. share-
holders. The Treasury Department and the
4
For example, assume a specified group parent with a specified period that is the calendar year acquires all of the stock of CFC1, an applicable CFC, on June 30, Year 1, and sells all of the
stock of CFC1 on June 30, Year 3. CFC1 has a November 30 taxable year, and the specified period is the calendar year. CFC1 is included in the specified group on November 30, Year 1, and
November 30, Year 2 (but not November 30, Year 3). As a result, CFC1 is a specified group member for its taxable year ending November 30, Year 1, with respect to the specified period ending
December 31, Year 1, and for its taxable year ending November 30, Year 2, with respect to the specified period ending December 31, Year 2. Solely for purposes of applying the §1.1502-75(d)
principles, CFC1 is treated as affiliated with the specified group parent from the beginning to the end of the specified period ending December 31, Year 1, and from the beginning to the end
of the specified period ending December 31, Year 2. In other words, CFC1 is treated as affiliated with the specified group parent from January 1, Year 1, to December 31, Year 2.
5
For example, assume CFC1, an applicable CFC, has a taxable year beginning December 1, Year 1, and ending November 30, Year 2, and a specified group has a specified period beginning
January 1, Year 2, and ending December 31, Year 2. If CFC1 is included in the specified group on November 30, Year 2, then CFC1 is a specified group member with respect to the specified
period for its entire taxable year ending November 30, Year 2. This is the case even if CFC1 is not included in the specified group during part of its taxable year ending November 30, Year
2 (for example, because all of the stock of CFC2 is purchased by the specified group on June 1, Year 2, and its taxable year does not close as a result of joining the specified group), or if
CFC1 ceases to be included in the specified group after November 30, Year 2, but before December 31, Year 2 (for example, because all of the stock of CFC1 is sold by the specified group
on December 15, Year 2).

September 28, 2020 820 Bulletin No. 2020–40
IRS also request comments on whether a
rule similar to the rule in section 1504(a)
(3), which prevents domestic corporations
from rejoining a consolidated group for 60
months, should apply to prevent applica-
ble CFCs from rejoining a CFC group.
4. CFC Groups and CFC Group Members
a. In General
Proposed §1.163(j)-7(e) provides rules
and procedures for treating specified group
members as CFC group members and for
determining a CFC group. A CFC group
member means a specified group member
of a specified group for which a CFC group
election is in effect. The specified group
member is a CFC group member for a spec-
ified taxable year with respect to a speci-
fied period. A CFC group means all CFC
group members for their specified taxable
years with respect to a specified period. See
proposed §1.163(j)-7(e)(2) (defining CFC
group and CFC group member). Thus, if a
CFC group election is in place, the terms
“specified group members,” “CFC group
members,” and a “CFC group” refer to the
same applicable CFCs. The term “specified
group,” which is determined at any mo-
ment in time, may not necessarily refer to
the exact same applicable CFCs.
Once a CFC group election is made, the
CFC group continues until the CFC group
election is revoked or until the end of the
last specified period with respect to the
specified group. See proposed §1.163(j)-
7(e)(3). When a CFC group election is in
effect, if an applicable CFC becomes a
specified group member with respect to a
specified period of the specified group, the
CFC group election applies to the appli-
cable CFC and it becomes a CFC group
member. When an applicable CFC ceases
to be a specified group member with re-
spect to a specified period of a specified
group, the CFC group election terminates
solely with respect to the applicable CFC.
See proposed §1.163(j)-7(e)(4) (joining or
leaving a CFC group).
b. Making or Revoking a CFC Group
Election
Proposed §1.163(j)-7(e)(5) provides
rules for making and revoking a CFC
group election. Proposed §1.163(j)-7(e)
(5)(i) provides that a CFC group election
applies with respect to a specified peri-
od of a specified group. Accordingly, the
CFC group election applies to each speci-
fied group member for its entire specified
taxable year that ends with or within the
specified period. In response to comments
to the 2018 Proposed Regulations, the
CFC group election is not irrevocable. In-
stead, once made, a CFC group election
cannot be revoked with respect to any
specified period of the specified group that
begins during the 60-month period follow-
ing the last day of the first specified period
for which the election was made. Similar-
ly, once revoked, a CFC group election
cannot be made again with respect to any
specified period of the specified group
that begins during the 60-month period
following the last day of the first specified
period for which the election was revoked.
The Treasury Department and the IRS
request comments regarding whether a
specified group that does not make a CFC
group election when it first comes into
existence (or for the first specified period
following 60 days after the date of publi-
cation of the Treasury decision adopting
these regulations as final in the Federal
Register) should be prohibited from mak-
ing the CFC group election for any speci-
fied period beginning during the 60-month
period following that specified period.
Thus, under the Proposed Regulations,
in the case of a specified group, taxpayers
choose to apply section 163(j) to specified
group members on a CFC group basis or
on a stand-alone basis for no less than a
60-month period. The Treasury Depart-
ment and the IRS have determined that a
60-month period is an appropriate balance
between making the choice irrevocable
and providing an annual election, the latter
of which may facilitate inappropriate tax
planning (in this regard, see, for example,
the discussion in part C.7 of this part V of
the Explanation of Provisions section).
c. Specified Financial Services Subgroup
Rules
In response to comments, Proposed
§1.163(j)-7 does not provide for CFC fi-
nancial services subgroups. Instead, appli-
cable CFCs that otherwise qualify as CFC
group members are treated as part of the
same CFC group.
d. Interaction of the CFC Group Election
in Proposed §1.163(j)-7 with the CFC
Group Election in the 2018 Proposed
Regulations
The CFC group election can be made
only in accordance with the method pre-
scribed in proposed §1.163(j)-7(e)(5). The
2018 Proposed Regulations also contained
an election called a “CFC group election”
(old CFC group election). The old CFC
group election is a different election than
the CFC group election contained in Pro-
posed §1.163(j)-7. Accordingly, the old
CFC group election may be relied on only
for taxable years in which the taxpayer
relies on the 2018 Proposed Regulations.
Whether an old CFC group election was
made under the 2018 Proposed Regulations
has no effect on whether a CFC group elec-
tion under proposed §1.163(j)-7(e)(5) is in
effect for any taxable year in which the tax-
payer relies on Proposed §1.163(j)-7.
5. Exclusion of ECI from Application of
Section 163(j) to a CFC Group
In response to comments, proposed
§1.163(j)-7 provides that an applicable CFC
with ECI is not precluded from being a CFC
group member. However, under proposed
§1.163(j)-7(f), only the ATI, BII, BIE, and
floor plan financing of the applicable CFC
that are not attributable to ECI are included
in the CFC group’s section 163(j) calcula-
tions. The ECI items of the applicable CFC
are not included in the CFC group calcu-
lations. Instead, the ECI of the applicable
CFC is treated as income of a separate CFC,
an “ECI deemed corporation,” that has the
same taxable year and shareholders as the
applicable CFC, but that is not a CFC group
member. The ECI deemed corporation must
do a separate section 163(j) calculation
for its ECI in accordance with Proposed
§1.163(j)-8. See Proposed §1.163(j)-8 and
part VI of this Explanation of Provisions
section for rules applicable to foreign cor-
porations with ECI.
6. Treatment of Foreign Taxes for
Purposes of Computing ATI
Proposed §1.163(j)-7(g)(3) provides
that, for purposes of computing its ATI, ten-
tative taxable income of a relevant foreign
corporation is determined by taking into

Bulletin No. 2020–40 821 September 28, 2020
account a deduction for foreign taxes. This
rule is consistent with §1.952-2, which pro-
vides that the taxable income of a foreign
corporation for any taxable year is deter-
mined by treating the foreign corporation as
a domestic corporation, and section 164(a),
which allows a deduction for foreign tax-
es. The Treasury Department and the IRS
request comments regarding whether, and
the extent to which, the ATI of a relevant
foreign corporation should be determined
by adding to tentative taxable income any
deductions for foreign income taxes.
7. Anti-abuse Rule
The Treasury Department and the IRS
are concerned that, in certain situations,
U.S. shareholders may inappropriately af-
firmatively plan to limit BIE deductions as
part of a tax-planning transaction, includ-
ing by not making a CFC group election for
purposes of increasing the disallowed BIE
of a specified group member or of a partner-
ship substantially owned by specified group
members of the same specified group. For
example, in a taxable year in which a U.S.
shareholder would otherwise have foreign
tax credits in the section 951A category in
excess of the section 904 limitation, a U.S.
shareholder might inappropriately cause
one specified group member to pay interest
to another specified group member in an
amount in excess of the borrowing speci-
fied group member’s section 163(j) limita-
tion. As a result, the U.S. shareholder’s pro
rata share of tested income of the borrow-
ing specified group member for the taxable
year would be increased without increasing
the U.S. shareholder’s Federal income tax
because excess foreign tax credits in the
section 951A category in the taxable year
that cannot be carried forward to a future
taxable year would offset the Federal in-
come tax on the incremental increase in the
U.S. shareholder’s pro rata share of tested
income, while also enabling the borrowing
specified group member to generate a disal-
lowed BIE carryforward that may be used
in a subsequent taxable year.
Accordingly, under proposed §1.163(j)-
7(g)(4), if certain conditions are met, when
one specified group member or applicable
partnership (specified borrower) pays inter-
est to another specified group member or
applicable partnership (specified lender),
and the payment is BIE to the specified
borrower and income to the specified lend-
er, then the ATI of the specified borrower
is increased by the amount necessary such
that the BIE of the specified borrower is not
limited under section 163(j). This amount
is determined by multiplying the lesser of
the payment amount or the disallowed BIE
(computed without regard to this ATI ad-
justment) by 3 1/3 (or by 2, in the case of
taxable years or specified taxable years with
respect to a specified period for which the
section 163(j) limitation is determined by
reference to 50 percent of ATI). A partner-
ship is an applicable partnership if at least
80 percent of the capital or profits interests
is owned, in aggregate, by direct or direct
partners that are specified group members
of the same specified group. The conditions
for this rule to apply are as follows: (i) the
BIE is incurred with a principal purpose of
reducing the Federal income tax liability of
a U.S. shareholder (including over multiple
taxable years); (ii) the effect of the speci-
fied borrower treating the payment amount
as disallowed BIE would be to reduce the
Federal income tax of a U.S. shareholder;
and (iii) either no CFC group election is in
effect or the specified borrower is an appli-
cable partnership.
8. The Safe-harbor Election
Proposed §1.163(j)-7(h) provides a
safe-harbor election for stand-alone ap-
plicable CFCs and CFC groups. If the
safe-harbor election is in effect for a tax-
able year, no portion of the BIE of the
stand-alone applicable CFC or of each
CFC group member, as applicable, is dis-
allowed under the section 163(j) limita-
tion. The safe-harbor election is an annual
election. If the election is made, then no
portion of any CFC excess taxable income
is included in a U.S. shareholder’s ATI.
See proposed §1.163(j)-7(j)(2)(iv).
The safe-harbor election cannot be
made with respect to any foreign corpo-
ration that is not a stand-alone applicable
CFC or a CFC group member. As a result,
if a CFC group election is not in effect for
a specified period, a specified group mem-
ber of the specified group is not eligible
for the safe-harbor election.
In the case of a stand-alone applicable
CFC, the safe-harbor election may be made
for a taxable year of the stand-alone appli-
cable CFC if its BIE does not exceed 30 per-
cent of the lesser of (i) its tentative taxable
income attributable to non-excepted trades
or businesses (referred to as “qualified ten-
tative taxable income”), and (ii) its “eligible
amount” for the taxable year. In the case of
a CFC group, the safe-harbor election may
be made for the specified taxable years of
each CFC group member with respect to
a specified period if the CFC group’s BIE
does not exceed 30 percent of the lesser of
(i) the sum of the qualified tentative taxable
income of each CFC group member, and
(ii) the sum of the eligible amounts of each
CFC group member. For taxable years of a
stand-alone applicable CFC or specified pe-
riods of a CFC group beginning in 2019 or
2020, the 30 percent limitation is replaced
with a 50 percent limitation, consistent with
the change in the section 163(j) limitation
to take into account 50 percent, rather than
30 percent, of ATI for such taxable years or
specified periods.
The “eligible amount” is a CFC-level de-
termination. In general, the eligible amount
is the sum of the applicable CFC’s subpart
F income plus the approximate amount
of GILTI inclusions its U.S. shareholders
would have were the applicable CFC whol-
ly owned by domestic corporations that had
no tested losses and that were not subject to
the section 250(a)(2) limitation on the sec-
tion 250(a)(1) deduction. Amounts used in
the determination of the eligible amount are
computed without regard to the application
of section 163(j) and the section 163(j) reg-
ulations. While the eligible amount of an ap-
plicable CFC cannot be negative, qualified
tentative taxable income can be negative.
Thus, limiting the safe-harbor to 30 percent
of qualified tentative taxable income en-
sures that losses of a stand-alone applicable
CFC or a CFC group are taken into account
in determining whether the stand-alone ap-
plicable CFC or the CFC group qualifies for
the safe-harbor.
6
6
For example, assume that, before taking into account BIE, a stand-alone applicable CFC has net income of $0x, consisting of $100x of subpart F income, a $100x loss attributable to foreign
oil and gas extraction income, as defined in section 907(c)(1). It also has $20x of BIE, no BII, and no floor plan financing interest expense. The ATI of the CFC is zero and the section 163(j)
limitation would be zero. However, the eligible amount of the CFC is $100x. Thus, absent a rule limiting the safe harbor to 30 percent of qualified tentative taxable income, the CFC would
be permitted to deduct its $20x of business interest expense under the safe harbor, even though none of the BIE would be deductible under the section 163(j) limitation.

September 28, 2020 822 Bulletin No. 2020–40
The safe-harbor election does not ap-
ply to EBIE, as described in §1.163(j)-6(f)
(2), and EBIE is not taken into account
for purposes of determining whether the
safe-harbor election is available for a
stand-alone applicable CFC or a CFC
group, until such business interest ex-
pense is treated as paid or accrued by an
applicable CFC in a succeeding year (that
is, until the applicable CFC is allocated
excess taxable income or excess business
interest income from such partnership in
accordance with §1.163(j)-6(g)(2)(i)).
The safe-harbor election is intended to
reduce the compliance burden on applica-
ble CFCs that would not have disallowed
BIE if they applied the section 163(j)
calculation. However, the Treasury De-
partment and the IRS are concerned that
the safe-harbor election might be used to
deduct pre-group disallowed BIE carry-
forwards that would be limited under pro-
posed §1.163(j)-7(c)(3)(iv) (rules similar
to the consolidated SRLY rules). Accord-
ingly, the proposed regulations provide
that a safe-harbor election cannot be made
for a CFC group that has pre-group dis-
allowed BIE carryforward. The Treasury
Department and the IRS request com-
ments on whether the safe-harbor elec-
tion should be available for CFC groups
with pre-group disallowed BIE carryfor-
wards and, if so, appropriate methods of
preventing pre-group disallowed BIE
carryforwards that would be limited un-
der proposed §1.163(j)-7(c)(3)(iv) from
being deductible by CFC group members
of CFC groups that apply the safe-harbor
election.
The Treasury Department and the IRS
also request comments on appropriate
modifications, if any, to the safe-harbor
election that would further the goal of re-
ducing the compliance burden on stand-
alone applicable CFCs and CFC groups
that would not have disallowed BIE if
they applied the section 163(j) limitation.
9. Increase in Adjusted Taxable Income
of U.S. Shareholders
As a general matter, a U.S. sharehold-
er does not include in its ATI any portion
of its specified deemed inclusions. Spec-
ified deemed inclusions include the U.S.
shareholder’s deemed income inclusions
attributable to an applicable CFC and
a non-excepted trade or business of the
U.S. shareholder. See §1.163(j)-1(b)(2)
(ii)(G). Specified deemed inclusions also
include amounts included in a domestic C
corporation’s allocable share of a domes-
tic partnership’s gross income inclusions
under sections 951(a) and 951A(a) with
respect to an applicable CFC that are in-
vestment income to the partnership, to the
extent that such amounts are treated as
properly allocable to a non-excepted trade
or business of the domestic C corporation
under §§1.163(j)-4(b)(3) and 1.163(j)-
10.
7
However, consistent with comments
received, proposed §1.163(j)-7(j) allows
a U.S. shareholder to include in its ATI a
portion of its specified deemed inclusions
that are attributable to either a stand-alone
applicable CFC or a CFC group member,
except to the extent attributable to section
78 “gross-up” inclusions. That portion is
equal to the ratio of the applicable CFC’s
CFC excess taxable income over its ATI.
In the case of a stand-alone applicable
CFC, CFC excess taxable income is equal
to an amount that bears the same ratio to
the applicable CFC’s ATI as (i) the excess
of 30 percent of the applicable CFC’s ATI
over the amount, if any, by which its BIE
exceeds its BII and floor plan financing in-
terest expense, bears to (ii) 30 percent of
its ATI. In the case of a CFC group, each
applicable CFC’s CFC excess taxable
income is determined by calculating the
excess taxable income of the CFC group
and allocating it to each CFC group mem-
ber pro rata on the basis of the CFC group
member’s ATI. For any taxable year or
specified period to which the 50 percent
(rather than 30 percent) limitation applies
under section 163(j)(10), the formula for
calculating CFC excess taxable income is
adjusted accordingly.
The Treasury Department and the IRS
are concerned that taxpayers may inappro-
priately attempt to aggregate debt in cer-
tain specified group members for which a
CFC group election is not in effect, thereby
overleveraging some specified group mem-
bers and artificially creating CFC excess
taxable income in other specified group
members for purposes of increasing the
ATI of a U.S. shareholder.
8
Accordingly,
the Treasury Department and the IRS have
determined that any excess taxable income
of a specified group member should not
become available to increase the ATI of a
U.S. shareholder unless a CFC group elec-
tion is in effect and the CFC group has not
exceeded its section 163(j) limitation. Ac-
cordingly, under proposed §1.163(j)-7(j)(4)
(ii), only U.S. shareholders of stand-alone
applicable CFCs and CFC group members
can increase their ATI for a portion of their
specified deemed inclusion. To the extent
that a CFC group election is not in effect,
a U.S. shareholder may not increase its
ATI for any portion of its specified deemed
inclusion attributable to a specified group
member of the specified group.
In addition, if a safe-harbor election is
in effect with respect to the taxable year of
a stand-alone applicable CFC or the spec-
ified period of a CFC group, CFC excess
taxable income is not calculated for the
stand-alone applicable CFC or the CFC
group members. As a result, proposed
§1.163(j)-7(j)(4)(i) provides that a U.S.
shareholder of a stand-alone applicable
CFC or of a CFC group member for which
the safe-harbor election is in effect does
not increase its ATI for any portion of its
specified deemed inclusion attributable to
the stand-alone applicable CFC or CFC
group member.
7
The Treasury Department and the IRS anticipate that a domestic partnership’s gross income inclusions under sections 951(a) and 951A(a) will virtually always be investment income to the
partnership. See section 163(j)(5), excluding “investment interest” subject to section 163(d) from the definition of business interest, and sections 163(d)(3)(A) and (d)(5), treating as invest-
ment interest any interest properly allocable to “property which produces income of a type described in section 469(e)(1).” See also §1.469-2T(c)(3).
8
For example, assume a U.S. shareholder wholly owns CFC1, which wholly owns CFC2. CFC1 and CFC2 each have $100x of ATI and no business interest income or floor plan financing
interest expense. CFC1 and CFC2 have not made a CFC group election. If CFC1 and CFC2 each have $35x of business interest expense, under section 163(j), CFC1 and CFC2 could each
deduct $30x of business interest expense and have a $5x disallowed business interest expense carryforward. Neither CFC1 nor CFC2 would have CFC excess taxable income. As a result,
the U.S. shareholder would have no ATI inclusion from CFC1 or CFC2. However, if the CFCs move all of CFC2’s debt to CFC1, CFC1 would deduct $30x of business interest expense and
have a $40x disallowed business interest expense carryforward. Absent rules providing otherwise, CFC2 would have $100x of CFC excess taxable income and $100x of ATI, allowing the
U.S. shareholder to include in its ATI its CFC income inclusion attributable to CFC2 (to the extent attributable to a non-excepted trade or business and not attributable to section 78 “gross-
up” inclusions).

Bulletin No. 2020–40 823 September 28, 2020
VI. Section 1.163(j)-8: Application of the
Business Interest Deduction Limitation
to Foreign Persons with Effectively
Connected Income
A. Proposed §1.163(j)-8 Contained in the
2018 Proposed Regulations
The 2018 Proposed Regulations under
§1.163(j)-8 provide rules for how section
163(j) applies to a nonresident alien indi-
vidual or foreign corporation that is not an
applicable CFC (specified foreign person)
with ECI. Although the regulations under
section 163(j) generally apply to specified
foreign persons, a number of the general
rules under section 163(j) need to be ad-
justed to take into account the fact that a
specified foreign person is taxed only on
its ECI rather than all of its income. Ac-
cordingly, the definitions for ATI, BIE,
BII, and floor plan financing interest ex-
pense are modified to limit such amounts
to items that are, or are allocable to, ECI.
The 2018 Proposed Regulations also
modify §1.163(j)-10(c) to provide that a
specified foreign person’s interest expense
and interest income are only allocable to
excepted or non-excepted trades or busi-
nesses that have ECI.
Under the 2018 Proposed Regulations,
a specified foreign person that is a partner
in a partnership that has ECI (specified
foreign partner) is required to modify the
application of the general allocation rules
in §1.163(j)-6 with respect to ETI, EBIE,
and EBII of the partnership to take into ac-
count only the partnership’s items that are,
or are allocable to, ECI. Although the sec-
tion 163(j) limitation is determined on an
entity basis by a partnership, the Treasury
Department and the IRS determined that
excess items of a partnership should only
be used by the specified foreign partner to
the extent that the excess items arise from
partnership items that are ECI with re-
spect to the specified foreign partner. The
amount of ETI and EBIE to be used by a
specified foreign partner was determined
by multiplying the amount of the ETI or
the EBIE allocated under §1.163(j)-6 to
the specified foreign partner by a frac-
tion, the numerator of which is the ATI
of the partnership, with the adjustments
described previously to limit such amount
to only items that are ECI, and the denom-
inator of which is the ATI of the partner-
ship determined under §1.163(j)-6(d). The
amount of EBII that could be used by a
specified foreign partner was limited to
the amount of allocable BII that is ECI
from the partnership that exceeds alloca-
ble BIE that is allocable to income that is
ECI from the partnership.
Lastly, the 2018 Proposed Regulations
provide that an applicable CFC that has
ECI must first apply the general rules of
section 163(j) and the section 163(j) reg-
ulations to determine how section 163(j)
applies to the applicable CFC. If the ap-
plicable CFC has disallowed BIE, the ap-
plicable CFC then must apportion a part
of its disallowed BIE to BIE allocable to
income that is ECI. The amount of disal-
lowed BIE allocable to income that is ECI
is equal to the disallowed BIE multiplied
by a fraction, the numerator of which is
the applicable CFC’s ECI ATI, and the de-
nominator of which is the CFC’s ATI.
No comments were received on
the 2018 Proposed Regulations under
§1.163(j)-8. Nonetheless, the Treasury
Department and the IRS have become
aware of certain distortions that can re-
sult under the 2018 Proposed Regulations.
Accordingly, proposed §1.163(j)-8 has
been revised, and re-proposed, to alleviate
these distortions and to provide addition-
al guidance and clarity on the manner in
which these rules apply to specified for-
eign partners and CFCs with ECI.
B. Proposed §1.163(j)-8 in the Proposed
Regulations
Proposed §1.163(j)-8 in the Proposed
Regulations (Proposed §1.163(j)-8) pro-
vides rules concerning the application
of section 163(j) to foreign persons with
ECI.
9
Similar to proposed §1.163(j)-8(b)
in the 2018 Proposed Regulations, pro-
posed §1.163(j)-8(b)(1)-(5) provides that,
for purposes of applying section 163(j)
and the section 163(j) regulations to a
specified foreign person, certain defini-
tions (ATI, BIE, BII, and floor plan financ-
ing interest expense) are modified to take
into account only ECI items. Additional-
ly, proposed §1.163(j)-8(b)(6) provides
that, for purposes of applying §1.163(j)-
10(c) to a specified foreign person, only
ECI items and assets that are U.S. assets
are taken into account in determining the
amount of interest income and interest ex-
pense allocable to a trade or business.
Proposed §1.163(j)-8(c) determines
the portion of a specified foreign part-
ner’s allocable share of ETI, EBIE, and
EBII (as determined under §1.163(j)-6)
that is treated as ECI and the portion that
is not treated as ECI. The portion of the
specified foreign partner’s allocable share
of ETI that is ECI is equal to its alloca-
ble share of ETI multiplied by a fraction,
the specified ATI ratio (which compares
the specified foreign partner’s distributive
share of the partnership’s ECI to its dis-
tributive share of the partnership’s total
income). The remainder of the specified
foreign partner’s allocable share of ETI is
not ECI. See proposed §1.163(j)-8(c)(1).
Similar to ETI, the portion of the speci-
fied foreign partner’s allocable share of
EBII that is ECI is equal to its allocable
share of EBII multiplied by a fraction, the
specified BII ratio (which compares the
specified foreign partner’s allocable share
of BII that is ECI to its allocable share of
total BII). See proposed §1.163(j)-8(c)(4).
The portion of the specified foreign
partner’s allocable share of EBIE that
is ECI is determined by subtracting the
portion of the specified foreign partner’s
allocable share of deductible BIE that is
characterized as ECI from the amount of
the specified foreign partner’s allocable
share of BIE that is characterized as ECI.
See proposed §1.163(j)-8(c)(2). A similar
rule applies for purposes of determining
the portion of EBIE that is not ECI. A
specified foreign partner’s allocable share
of deductible BIE that is characterized as
ECI or not ECI is determined by allocating
the deductible BIE pro rata between the
respective amounts of deductible BIE that
the specified foreign partner would have
if the specified foreign partner’s allocable
share of the ECI items of the partnership
and the non-ECI items of the partnership
9
For purposes of Proposed §1.163(j)-8, the term effectively connected income (or ECI) means income or gain that is ECI, as defined in §1.884-1(d)(1)(iii), and deduction or loss that is allo-
cable to, ECI, as defined in §1.884-1(d)(1)(iii).

September 28, 2020 824 Bulletin No. 2020–40
were treated as separate partnerships and
a 163(j) limitation was applied to each
hypothetical partnership. However, no
more deductible BIE can be characterized
as ECI or not ECI than the specified for-
eign partner’s allocable share of BIE that
is ECI or the specified foreign partner’s
allocable share of BIE that is not ECI, re-
spectively. Any deductible BIE in excess
of the hypothetical partnership limitations
is characterized as ECI or not ECI pro rata
in proportion to the remaining amounts of
the specified foreign partner’s allocable
share of BIE that is ECI and not ECI.
Proposed §1.163(j)-8(d) determines the
portion of deductible and disallowed BIE
of a relevant foreign corporation (as de-
fined in §1.163(j)-1(b)(33)) that is charac-
terized as ECI or not ECI. These rules are
similar to the rules in proposed §1.163(j)-
8(c) for characterizing a specified foreign
partner’s allocable share of excess items
of a partnership as ECI or not ECI in that
they calculate the hypothetical section
163(j) limitation for two hypothetical for-
eign corporations—a foreign corporation
with ECI and a foreign corporation with
non-ECI—and allocate the deductible BIE
between the two hypothetical limitations.
The portion of the relevant foreign corpo-
ration’s disallowed BIE that is ECI is de-
termined by subtracting the portion of the
relevant foreign corporation’s deductible
BIE that is characterized as ECI from the
relevant foreign corporation’s BIE that is
ECI. A similar rule applies for purposes of
determining the portion of disallowed BIE
that is characterized as not ECI.
Proposed §1.163(j)-8(e) provides rules
regarding disallowed BIE. These rules
provide that disallowed BIE is charac-
terized as ECI or not ECI in the year in
which it arises and retains its characteriza-
tion in subsequent years. Additionally, an
ordering rule determines the EBIE that is
treated as paid or accrued by a specified
foreign partner in a subsequent year. Spe-
cifically, the specified foreign partner’s al-
locable share of EBIE is treated as paid or
accrued by the specified foreign partner in
a subsequent year pursuant to §1.163(j)-
6(g)(2)(i) in the order of the taxable years
in which the allocable EBIE arose and pro
rata between the specified foreign part-
ner’s allocable share of EBIE that is ECI
and not ECI that arose in the same taxable
year.
Proposed §1.163(j)-8(e)(2) provides
that, for purposes of characterizing de-
ductible BIE and EBIE as ECI or not
ECI, a specified foreign partner’s BIE is
deemed to include its allocable share of
EBIE of partnerships in which it is a di-
rect or indirect partner. As a result, EBIE
of both top-tier partnerships and lower-ti-
er partnerships is characterized as ECI or
not ECI in the year in which it arises, even
if it is not included in the specified foreign
partner’s allocable share of EBIE.
Proposed §1.163(j)-8(f) provides rules
coordinating the application of section
163(j) with §1.882-5 and similar rules
and with the branch profits tax. Proposed
§1.163(j)-8(f)(1)(i) provides that a foreign
corporation first determines its interest
expense on liabilities that are allocable to
ECI under §1.882-5 before applying sec-
tion 163(j). Similarly, interest expense, as
defined in §1.163(j)-1(b)(23), that is not
allocable to ECI under §1.882-5 must be
allocable to income that is ECI under the
regulations under section 861 before sec-
tion 163(j) is applied.
Proposed §1.163(j)-8(f)(1)(ii) pro-
vides rules for determining the portion
of a specified foreign partner’s BIE that
is ECI, as determined under §1.882-5(b)
through (d) or §1.882-5(e) (§1.882-5 in-
terest expense), that is treated as attribut-
able to a partner’s allocable share of inter-
est expense of a partnership. As a general
matter, the determination as to whether a
partnership’s items of income and expense
are allocable to ECI is made by the part-
nership. However, the determination as to
the amount of interest expense that is allo-
cable to ECI is made by a partner, not the
partnership. Because section 163(j) ap-
plies separately to partnerships and their
partners, a determination must be made
as to the source of §1.882-5 interest ex-
pense. If the BIE is attributable to BIE of
the partnership, it is subject to the rules of
§§1.163(j)-6 and 1.163(j)-8(c).
The §1.882-5 interest expense is first
treated as attributable to interest expense
on U.S. booked liabilities, determined un-
der §1.882-5(d)(2)(vii), of the partner or
a partnership. Any remaining §1.882-5
interest expense (excess §1.882-5 interest
expense) is treated as attributable to inter-
est expense on liabilities of the partner in
proportion to its U.S. assets (other than
partnership interests) over all of its U.S.
assets, and as attributable to interest ex-
pense on liabilities of the partner’s direct
or indirect partnership interests in propor-
tion to the portion of the partnership in-
terest that is a U.S. asset over all of the
partner’s U.S. assets. The total amount
of §1.882-5 interest expense attributed to
the partner or a partnership (taking into
account both interest expense on U.S.
booked liabilities and excess §1.882-5
interest expense) and interest expense on
a liability described in §1.882-5(a)(1)(ii)
(A) or (B) (direct allocations) may never
exceed the amount of the partner’s interest
expense on liabilities or the partner’s al-
locable share of the partnership’s interest
expense on liabilities (the interest expense
limitation). The interest expense limita-
tion prevents more §1.882-5 interest ex-
pense from being attributed to the partner
or the partner’s allocable share of interest
expense of a partnership than the actual
amount of such interest expense. Any ex-
cess §1.882-5 interest expense that would
have been attributed to the partner or a
partnership, but for the interest expense
limitation, is re-attributed in accordance
with these attribution rules.
When excess §1.882-5 interest expense
has been attributed to all of the interest ex-
pense on liabilities of the foreign corpora-
tion and its allocable share of partnership
interests that have U.S. assets, the remain-
ing excess §1.882-5 interest expense, if
any, is first attributed to interest expense
on liabilities of the foreign corporation
(but not in excess of the interest expense
limitation), and then, pro rata, to its alloca-
ble share of interest expense on liabilities
of its partnership interests that do not have
U.S. assets, subject to the interest expense
limitation. See proposed §1.163(j)-8(f)(1)
(iii). These rules merely characterize inter-
est expense of the foreign corporation and
its partnership interests as ECI or not ECI.
These rules do not change the amount of
interest expense of the foreign corporation
or its partnership interests.
The rule in proposed §1.163(j)-8(f)(1)
of 2018 Proposed Regulations providing
that the disallowance and carryforwards
of BIE does not affect effectively con-
nected earnings and profits of a foreign
corporation is not retained in Proposed
§1.163(j)-8. This rule is not necessary in
Proposed §1.163(j)-8 because the general
rule regarding the effect of section 163(j)

Bulletin No. 2020–40 825 September 28, 2020
on earnings and profits in §1.163(j)-4(c)
(1) applies to effectively connected earn-
ings and profits.
VII. Proposed §1.469-9: Definition of
Real Property Trade or Business
Section 469(c)(7)(C) defines real prop-
erty trade or business by reference to elev-
en undefined terms. The Final Regulations
amended §1.469-9 to define two of the
eleven terms – management and opera-
tions. In response to questions received
about the application of section 469(c)(7)
(C) to timberlands, these proposed regu-
lations would provide definitions for two
additional terms – development and rede-
velopment – to further clarify what con-
stitutes a real property trade or business.
The Treasury Department and IRS
have determined that real property de-
velopment and redevelopment trades or
businesses should be defined to include
business activities that involve the pres-
ervation, maintenance, and improvement
of forest-covered areas (timberland).
Congress most likely intended and ex-
pected that such business activities would
be excepted from section 163(j), through
election, similar to other real property and
farming businesses. However, because
timber is specifically excluded from the
definition of farming under other Code
provisions (such as section 464(e)), the
Treasury Department and IRS have de-
termined that such business activities are
more properly described by and should be
included in the definition of real property
trade or business for this purpose. These
proposed regulations would clarify that
“real property development” is the main-
tenance and improvement of raw land to
make the land suitable for subdivision,
further development, or construction of
residential or commercial buildings, or to
establish, cultivate, maintain or improve
timberlands (generally defined as parcels
of land covered by forest). Similarly, these
proposed regulations would clarify that
“real property redevelopment” is the dem-
olition, deconstruction, separation, and re-
moval of existing buildings, landscaping,
and infrastructure on a parcel of land to
return the land to a raw condition or oth-
erwise prepare the land for new develop-
ment or construction, or for the establish-
ment and cultivation of new timberlands.
VIII. Proposed §1.163(j)-2 and
§1.1256(e)-2: Section 1256 and
Determination of Tax Shelter Status;
Election to use 2019 ATI to Determine
2020 Section 163(j) Limitation
A. Section 1256 and Determination of
Tax Shelter Status
Several commenters raised questions
regarding the exclusion of “a tax shelter
that is not permitted to use a cash meth-
od of accounting” from the small business
exemption provided in section 163(j)(3).
Section 448 and §1.448-1T describe lim-
itations on the use of the cash method of
accounting, including an explicit prohibi-
tion on the use of the cash method of ac-
counting by a tax shelter. Section 448(d)
(3) defines a tax shelter by cross reference
to section 461(i)(3), which defines a tax
shelter, in part, as a syndicate within the
meaning of section 1256(e)(3)(B). Under
§1.448-1T(b)(3), a syndicate is defined
as an entity that is not a C corporation
if more than 35 percent of the losses of
such entity during the taxable year are al-
located to limited partners or limited en-
trepreneurs. Section 1256(e)(3)(B) refers
instead to losses that are allocable to lim-
ited partners or limited entrepreneurs. As
a result, the scope of the small business
exemption in section 163(j)(3) is unclear.
To provide clarity, and to make these rules
consistent, the Treasury Department and
the IRS would define the term syndicate
for purposes of section 1256 using the ac-
tual allocation rule from the definition in
§1.448-1T(b)(3). This proposed definition
is also consistent with the definition of a
syndicate used in a number of private let-
ter rulings that were issued under section
1256. See proposed §1.1256(e)-2(a).
One commenter asked for clarification
on how to compute the amount of losses to
be allocated for purposes of determining
syndicate status under section 1256(e)(3)
(A). The commenter provided a particu-
lar fact pattern in which a small business
would be caught in an iterative loop of (a)
having net losses due to an interest deduc-
tion, (b) which would trigger disallowance
of the exemption in section 163(j)(3), (c)
which would trigger the application of sec-
tion 163(j)(1) to reduce the amount of the
interest deduction, (d) which would then
lead to the taxpayer having no net losses
and therefore being eligible for the appli-
cation of section 163(j)(3). To address this
fact pattern, the Treasury Department and
the IRS have added rules providing that,
for purposes of section 1256(e)(3)(B),
losses are determined without regard to
section 163(j). See proposed §§1.163(j)-
2(d)(3) and 1.1256(e)-2(b).
Several commenters requested that
the exemption in section 163(j)(3) be
broadened to apply to all small business-
es without regard to the parenthetical that
denies the section 163(j)(3) exemption for
a small business that is “a tax shelter that
is not permitted to use a cash method of
accounting.” See section 163(j)(3). One
commenter specifically requested that,
for a small business meeting the gross re-
ceipts test in section 448(c), all interests
held by limited partners or limited en-
trepreneurs be treated as held by owners
actively managing the business even if
those interests would not qualify for the
active management exception under sec-
tion 1256(e)(3)(C). After considering the
comments, the Treasury Department and
the IRS have determined that the requests
are contrary to both the statutory language
in section 163(j)(3) and the accompanying
legislative history and therefore decline to
adopt the comments.
B. Election to use 2019 ATI to Determine
2020 Section 163(j) Limitation
As stated in the Background section
of this preamble, section 163(j)(10)(B)(i)
allows a taxpayer to elect to use its 2019
ATI in determining the taxpayer’s section
163(j) limitation for its taxable year be-
ginning in 2020. Section 1.163(j)-2(b)(3)
and (4) of the Final Regulations provide
general rules regarding this election.
These proposed regulations clarify that,
if the acquiring corporation in a transac-
tion to which section 381 applies makes
an election under section 163(j)(10)(B)
(i), the acquiring corporation’s 2019 ATI
for purposes of section 163(j)(10)(B)(i) is
its ATI for its last taxable year beginning
in 2019 (subject to the limitation for short
taxable years in section 163(j)(10)(B)
(ii)). For example, assume that T’s 2019
ATI is $100 and A’s 2019 ATI is $200. If
T merges into A during A’s 2020 taxable
year in a transaction described in section
368(a)(1)(A), and if A makes an election

September 28, 2020 826 Bulletin No. 2020–40
under section 163(j)(10)(B)(i), A’s 2019
ATI for purposes of this election is $200.
Similarly, these proposed regulations clar-
ify that a consolidated group’s 2019 ATI
for purposes of section 163(j)(10)(B)(i) is
the consolidated group’s ATI for its last
taxable year beginning in 2019 (subject
to the limitation in section 163(j)(10)(B)
(ii)). The Treasury Department and the
IRS request comments on these proposed
rules. The Treasury Department and the
IRS also request comments on (1) wheth-
er the 2019 ATI of an acquired corporation
in a transaction to which section 381 ap-
plies should be included in the acquiring
corporation’s 2019 ATI for purposes of
section 163(j)(10)(B)(i) and (2) how such
a rule would address more complex fact
patterns, such as situations where the ac-
quiring corporation is acquired in a sub-
sequent transaction described in section
381, or where the acquired corporation
and the acquiring corporation have differ-
ent tax years.
IX. Proposed §1.163(j)-10: Application
of Corporate Look-Through Rules to
Tiered Structures
For purposes of determining the ex-
tent to which a shareholder’s basis in the
stock of a domestic non-consolidated C
corporation or CFC is allocable to an ex-
cepted or non-excepted trade or business,
§1.163(j)-10(c)(5)(ii)(B) provides several
look-through rules whereby the share-
holder “looks through” to the corpora-
tion’s basis in its assets.
A commenter pointed out that the ap-
plication of these look-through rules may
produce distortive results in certain situ-
ations. For example, assume Corporation
X’s basis in its assets is split equally be-
tween X’s excepted and non-excepted
trades or businesses, and that (as a result)
X has a 50 percent exempt percentage
applied to its interest expense. However,
rather than operate its excepted trade or
business directly, X operates its excepted
trade or business through a wholly owned,
non-consolidated subsidiary (Corporation
Y), and each of X and Y borrows funds
from external lenders. Assuming for pur-
poses of this example that neither the
anti-avoidance rule in §1.163(j)-2(h) nor
the anti-abuse rule in §1.163(j)-10(c)(8)
applies, Y’s interest expense would not be
subject to the section 163(j) limitation be-
cause Y is engaged solely in an excepted
trade or business. Moreover, a portion of
X’s interest expense also would be alloca-
ble to an excepted trade or business by vir-
tue of the application of the look-through
rule in proposed §1.163(j)-10(c)(5)(ii)(B)
(2) to X’s basis in Y’s stock.
The anti-avoidance rule in proposed
§1.163(j)-2(h) and the anti-abuse rule in
proposed §1.163(j)-10(c)(8) would pre-
clude the foregoing result in certain cir-
cumstances. However, these proposed reg-
ulations would modify the look-through
rule for domestic non-consolidated C
corporations and CFCs to limit the poten-
tially distortive effect of this look-through
rule on tiered structures in situations to
which the anti-avoidance and anti-abuse
rules do not apply. More specifically, these
proposed regulations would modify the
look-through rule for non-consolidated C
corporations to provide that, for purpos-
es of determining a taxpayer’s basis in its
assets used in excepted and non-excepted
trades or businesses, any such corporation
whose stock is being looked through may
not itself apply the look-through rule.
For example, P wholly and directly
owns S1, which wholly and directly owns
S2. Each of these entities is a non-consol-
idated C corporation to which the small
business exemption does not apply. In de-
termining the extent to which its interest
expense is subject to the section 163(j)
limitation, S1 may look through the stock
of S2 for purposes of allocating S1’s ba-
sis in its S2 stock between excepted and
non-excepted trades or businesses. How-
ever, in determining the extent to which
P’s interest expense is subject to the sec-
tion 163(j) limitation, S1 may not look
through the stock of S2 for purposes of al-
locating P’s basis in its S1 stock between
excepted and non-excepted trades or busi-
nesses.
However, the Treasury Department
and the IRS are aware that taxpayers are
organized into multi-tiered structures for
legitimate, non-tax reasons. The Treasury
Department and the IRS request com-
ments on the proposed limitation on the
application of the corporate look-through
rules. The Treasury Department and the
IRS also request comments on wheth-
er there are other situations in which the
look-through rules for domestic non-con-
solidated C corporations or CFCs should
apply and whether there are other ap-
proaches for addressing the distortions
that these proposed rules are intended to
minimize.
Proposed Applicability Dates
These Proposed Regulations are pro-
posed to apply to taxable years beginning
on or after 60 days after the date the Trea-
sury Decision adopting these rules as final
regulations is published in the Federal
Register.
Taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b)(1), may rely on §1.163-14, 1.163-
15, 1.163(j)-2(d)(3), or §1.1256(e)-2 of
these Proposed Regulations for a taxable
year beginning after December 31, 2017,
and before 60 days after the date the Trea-
sury Decision adopting these rules as final
regulations is published in the Federal
Register, provided taxpayers and their
related parties consistently follow all of
the rules of the relevant section of the Pro-
posed Regulations for that taxable year
and for each subsequent taxable year. Tax-
payers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may choose to apply §1.163-14, 1.163-15,
1.163(j)-2(d)(3), or 1.1256(e)-2 of the fi-
nal version of these Proposed Regulations
for a taxable year beginning after Decem-
ber 31, 2017, and before 60 days after the
date the Treasury Decision adopting these
rules as final regulations is published in
the Federal Register, provided that tax-
payers and their related parties consis-
tently apply all of the rules of the relevant
section, as applicable, to that taxable year
and each subsequent taxable year. See also
§§1.163-14(i), 1.163-15(b), 1.163(j)-2(k)
(2), and 1.1256(e)-2(d) of these Proposed
Regulations.
Taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), who apply the Final Reg-
ulations (as defined in the Explanation of
Provisions) published elsewhere in this
issue of the Federal Register to a taxable
year beginning after December 31, 2017,
and before 60 days after the Treasury De-
cision adopting these rules as final regula-
tions is published in the Federal Register
may rely on §§1.163(j)-1(b)(1)(iv)(B) and
1.163(j)-1(b)(1)(iv)(E) of these Proposed

Bulletin No. 2020–40 827 September 28, 2020
Regulations for a taxable year beginning
after December 31, 2017, and before 60
days after the Treasury Decision adopting
these rules as final regulations is published
in the Federal Register, provided that
taxpayers and their related parties consis-
tently apply the rules of both §§1.163(j)-
1(b)(1)(iv)(B) and 1.163(j)-1(b)(1)(iv)
(E) of these Proposed 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 ef-
fectuate the rules of §§1.382-2, 1.382-5,
1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year and each subsequent tax-
able year. See also §1.163(j)-1(c)(4)(i) of
these Proposed Regulations.
Taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), who apply the Final Reg-
ulations published elsewhere in this issue
of the Federal Register to a taxable year
beginning after December 31, 2017, and
before 60 days after the Treasury Decision
adopting these rules as final regulations is
published in the Federal Register, may
rely on the rules in §1.163(j)-2(b)(3)(iii)
and (iv) of these Proposed Regulations for
such taxable year, provided that taxpay-
ers and their related parties consistently
follow the rules of both §1.163(j)-2(b)(3)
(iii) and (iv) for that taxable year and for
each subsequent taxable year beginning
before 60 days after the Treasury Decision
adopting these rules as final regulations is
published in the Federal Register. Tax-
payers not applying the Final Regulations
to taxable years beginning before Novem-
ber 13, 2020 may not rely on the rules
in §1.163(j)-2(b)(3)(iii) and (iv) of these
Proposed Regulations for those taxable
years. See also §1.163(j)-2(k)(2) of these
Proposed Regulations.
Taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b), who apply the Final Regu-
lations published elsewhere in this issue
of the Federal Register to a taxable year
beginning after December 31, 2017, and
before 60 days after the Treasury Decision
adopting these rules as final regulations
is published in the Federal Register may
rely on the rules in §1.163(j)-10(c)(5)(ii)
(D)(2), 1.469-4(d)(6), or 1.469-9(b)(2)
of these Proposed Regulations for a tax-
able year beginning after December 31,
2017, and before 60 days after the Trea-
sury Decision adopting these rules as fi-
nal regulations is published in the Feder-
al Register, provided that taxpayers and
their related parties consistently follow
the rules of §1.163(j)-10(c)(5)(ii)(D)(2),
1.469-4(d)(6), or 1.469-9(b)(2) of these
Proposed Regulations, as applicable, 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-
4, 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, for
that taxable year and for each subsequent
taxable year. See also §§1.163(j)-10(f)(2)
and 1.469-11(a)(1) and (4) of these Pro-
posed Regulations.
Taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b), may rely on the rules in §1.163(j)-
6 of these Proposed Regulations for a
taxable year beginning after December
31, 2017, and before 60 days after the
Treasury Decision adopting these rules as
final regulations is published in the Fed-
eral Register, provided that taxpayers and
their related parties also apply the rules of
§1.163(j)-6 in the Final Regulations and
consistently follow all of those rules for
that taxable year and for each subsequent
taxable year. See also §1.163(j)-6(p)(2) of
these Proposed Regulations.
Taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), who apply the Final Reg-
ulations published elsewhere in this issue
of the Federal Register to a taxable year
beginning after December 31, 2017, and
before 60 days after the date the Final
Regulations are published in the Federal
Register, may rely on §§1.163(j)-7 and
1.163(j)-8 of these Proposed Regulations
for that taxable year, provided the tax-
payers and their related parties also rely
on §§1.163(j)-7 and 1.163(j)-8 of these
Proposed Regulations and apply the Final
Regulations for each subsequent taxable
year. Taxpayers who choose not to apply
the Final Regulations to a taxable year
beginning after December 31, 2017, and
before 60 days after the date the Final
Regulations are published in the Federal
Register may not rely on either §1.163(j)-
7 or 1.163(j)-8 of these Proposed Regula-
tions for that taxable year. For any taxable
year beginning on or after 60 days after the
date the Final Regulations are published
in the Federal Register and before 60
days after the date the Treasury Decision
adopting these Proposed Regulations as fi-
nal regulations is published in the Federal
Register, taxpayers and their related par-
ties, within the meaning of sections 267(b)
and 707(b)(1), may rely on §§1.163(j)-7
and 1.163(j)-8 of these Proposed Regula-
tions provided they consistently follow all
of the rules of §§1.163(j)-7 and 1.163(j)-8
for such taxable year and for each subse-
quent taxable year beginning before 60
days after the Treasury Decision adopting
these Proposed Regulations as final regula-
tions is published in the Federal Register.
See also §§1.163(j)-7(m) and 1.163(j)-8(j)
of these Proposed Regulations. Taxpay-
ers and their related parties who rely on
§1.163(j)-7 of these Proposed Regulations
for any taxable year ending before No-
vember 13, 2020 can make a CFC group
election or a safe-harbor election even if
the deadline provided in §1.163(j)-7(e)(5)
(iii) or (h)(5)(i) of these Proposed Regula-
tions has passed. Such taxpayers and their
related parties are permitted to make the
election on an amended Federal income
tax return filed on or before the due date
(taking into account extensions, if any) of
the original Federal income tax return for
the first taxable year ending after Novem-
ber 13, 2020.
See part III.B of the Explanation of
Provisions for rules concerning reliance
on these Proposed Regulations with re-
spect to section 163(j) interest dividends.
Special Analyses
I. Regulatory Planning and Review –
Economic Analysis
Executive Orders 13771, 13563, and
12866 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to se-
lect regulatory approaches that maximize
net benefits, including potential economic,
environmental, public health and safety
effects, distributive impacts, and equi-

September 28, 2020 828 Bulletin No. 2020–40
ty. Executive Order 13563 emphasizes
the importance of quantifying both costs
and benefits, reducing costs, harmonizing
rules, and promoting flexibility. The Ex-
ecutive Order 13771 designation for any
final rule resulting from these proposed
regulations will be informed by comments
received. The preliminary Executive Or-
der 13771 designation for this proposed
rule is regulatory.
These proposed regulations have been
designated by the Office of Information
and Regulatory Affairs as subject to review
under Executive Order 12866 pursuant to
the Memorandum of Agreement (MOA,
April 11, 2018) between the Treasury De-
partment and the Office of Management
and Budget (OMB) regarding review of
tax regulations. OMB has designated the
proposed regulations as economically sig-
nificant under section 1(c) of the MOA.
Accordingly, the proposed regulations
have been reviewed by OMB’s Office of
Information and Regulatory Affairs.
A. Background and Need for these
Proposed Regulations
Section 163(j), substantially revised by
the Tax Cuts and Jobs Act (TCJA), pro-
vides a set of relatively complex statuto-
ry rules that impose a limitation on the
amount of business interest expense that
a taxpayer may deduct for Federal tax
purposes. This limitation does not apply
to businesses with gross receipts of $25
million or less (inflation adjusted). This
provision has the general effect of putting
debt-financed investment by businesses on
a more equal footing with equity-financed
investment, a treatment that Congress be-
lieved will lead to a more efficient capi-
tal structure for firms. See Senate Budget
Explanation of the Bill as Passed by SFC
(2017-11-20) at pp. 163-4.
As described in the Background sec-
tion earlier, the Coronavirus Aid, Relief,
and Economic Security Act (CARES Act)
amended section 163(j) to provide spe-
cial rules relating to the adjusted taxable
income (ATI) limitation for taxable years
beginning in 2019 or 2020.
Because this limitation on deduction
for business interest expense is new, tax-
payers would benefit from regulations that
explain key terms and calculations. The
Treasury Department and the IRS pub-
lished proposed regulations in December
2018 (2018 Proposed Regulations) and
are issuing final regulations simultaneous-
ly with the current proposed regulations.
This current set of proposed regulations
covers topics that were reserved in the
2018 Proposed Regulations, were raised
by commenters to the proposed regula-
tions, or need to be re-proposed.
B. Overview of the Proposed Regulations
The proposed regulations provide
guidance on the definition of interest as it
relates to income flowing through regulat-
ed investment companies (RICs); debt-fi-
nanced distributions from pass-through
entities; the treatment of business interest
expense for publicly traded partnerships
and trading partnerships
10
; the application
of the section 163(j) limitation in the con-
text of self-charged interest; and the treat-
ment of excess business interest expense
in tiered-partnership structures. The pro-
posed regulations also modify the defini-
tion of real property development and real
property redevelopment in section 1.469-
9 of the regulations and the definition of
syndicate for purposes of applying the
small business exception in section 163(j)
(3). The proposed regulations also re-pro-
pose rules regarding the application of the
interest limitation to foreign corporations
(including controlled foreign corporations
as defined in section 957(a)) and United
States shareholders of controlled foreign
corporations, and the applicability of the
section 163(j) limitation to foreign per-
sons with U.S. effectively connected in-
come.
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS
have assessed the benefits and costs of
these proposed regulations relative to a
no-action baseline that reflects anticipated
Federal income tax-related behavior in the
absence of these regulations.
2. Summary of Economic Effects
The proposed regulations provide cer-
tainty and clarity to taxpayers regarding
terms and calculations that are contained
in section 163(j), which was substantially
modified by TCJA. In the absence of this
clarity, the likelihood that different tax-
payers would interpret the rules regarding
the deductibility of business interest ex-
pense differently would be exacerbated.
In general, overall economic performance
is enhanced when businesses face more
uniform signals about tax treatment. Cer-
tainty and clarity over tax treatment also
reduce compliance costs for taxpayers.
For those situations where taxpayers
would generally adopt similar interpreta-
tions of the statute even in the absence of
guidance, the proposed regulations pro-
vide value by helping to ensure that those
interpretations are consistent with the in-
tent and purpose of the statute. For exam-
ple, the proposed regulations may specify
a tax treatment that few or no taxpayers
would adopt in the absence of specific
guidance.
The Treasury Department and the IRS
project that the proposed regulations will
have an annual economic effect greater
than $100 million ($2019). This determi-
nation is based on the substantial volume
of business interest payments in the econ-
omy
11
and the general responsiveness of
business investment to effective tax rates,
12

one component of which is the deductibil-
ity of interest expense. Based on these two
magnitudes, even modest changes in the
deductibility of interest payments (and in
the certainty of that deductibility) provided
by the proposed regulations, relative to the
no-action baseline, can be expected to have
annual effects greater than $100 million.
This claim is particularly likely to hold for
the first set of general section 163(j) guid-
ance that is promulgated following major
legislation, such as TCJA, and for other
10
A trading partnership is a partnership engaged in the per se non-passive activity of trading personal property (including market securities) for the account of owners of interests in the activity,
as described in section 1.469-1T(e)(6)(trading partnerships).
11
Interest deductions in tax year 2013 for corporations, partnerships, and sole proprietorships were approximately $800 billion.
12
See E. Zwick and J. Mahon, “Tax Policy and Heterogeneous Investment Behavior,” at American Economic Review 2017, 107(1): 217-48 and articles cited therein.

Bulletin No. 2020–40 829 September 28, 2020
major guidance, which we have deter-
mined includes these proposed regulations.
Regarding the nature of the economic ef-
fects, the Treasury Department and the IRS
project that the proposed regulations will
increase investment in the United States
and increase the proportion that is debt-fi-
nanced, relative to the no-action baseline.
We have further determined that these
effects are consistent with the intent and
purpose of the statute. Because taxpayer
favorable provisions will lead to a decrease
in Federal tax revenue relative to the no-ac-
tion baseline, there may be an increase in
the Federal deficit relative to the no-action
baseline. This may lead to a decrease in in-
vestment by taxpayers not directly affected
by these proposed regulations, relative to
the no-action baseline. This effect should
be weighed against the enhanced efficien-
cy arising from the clarity and enhanced
consistency with the intent and purpose of
the statute provided by these regulations.
The Treasury Department and the IRS have
determined that the proposed regulations
provide a net benefit to the U.S. economy.
The Treasury Department and the IRS
have not undertaken more precise quanti-
tative estimates of these effects because
many of the definitions and calculations
under 163(j) are new and many of the
economic decisions that are implicated by
these proposed regulations involve highly
specific taxpayer circumstances. We do
not have readily available data or models
to estimate with reasonable precision the
types and volume of different financing
arrangements that taxpayers might under-
take under the proposed regulations ver-
sus the no-action baseline.
In the absence of such quantitative es-
timates, the Treasury Department and the
IRS have undertaken a qualitative analy-
sis of the economic effects of the proposed
regulations relative to the no-action base-
line and relative to alternative regulatory
approaches. This analysis is presented in
Part I.C.3 of this Special Analyses.
The Treasury Department and the IRS
solicit comments on these findings and
more generally on the economic effects
of these proposed regulations. The Trea-
sury Department and the IRS particular-
ly solicit data, other evidence, or models
that could be used to enhance the rigor of
the process by which the final regulations
might be developed.
3. Economic Effects of Specific
Provisions
a. Definition of Interest
The final regulations set forth several
categories of amounts and transactions
that generate interest for purposes of
section 163(j). The proposed regulations
provide further guidance on the definition
of interest relevant to the calculation of
interest expense and interest income. In
particular, the proposed regulations pro-
vide rules under which the dividends paid
by a RIC that earns net business interest
income (referred to as section 163(j) inter-
est dividends) are to be treated as interest
income by the RIC’s shareholders. That is,
under the proposed regulations, certain in-
terest income earned by the RIC and paid
to a shareholder as a dividend is treated
as if the shareholder earned the interest
income directly for purposes of section
163(j).
To the extent that taxpayers believed,
in the absence of the proposed regula-
tions, that dividends paid by RICs are not
treated as business interest income for the
purposes of the section 163(j) limitation,
then taxpayers will likely respond to the
proposed regulations by reducing their
holding of other debt instruments and in-
creasing investment in RICs. The Treasury
Department and the IRS have determined
that this treatment is consistent with the
intent and purpose of the statute.
Number of Affected Taxpayers. The
Treasury Department and the IRS have
determined that the rules regarding sec-
tion 163(j) interest dividends will poten-
tially affect approximately 10,000 RICs.
The Treasury Department and the IRS
do not have readily available data on the
number of RIC shareholders that would
receive section 163(j) interest dividends
that the shareholder could treat as busi-
ness interest income for purposes of the
shareholder’s section 163(j) limitation.
b. Provisions related to Partnerships
i. Trading Partnerships
Section 163(j) limits the deductibil-
ity of interest expense at the partnership
level. These proposed regulations address
commenter concerns about the interaction
between this section 163(j) limitation and
the section 163(d) partner level limitation
on interest expense that existed prior to
TJCA. Under logic described in the pre-
amble to the 2018 Proposed Regulations,
section 163(j) limitations would apply at
the partnership level while section 163(d)
limitations would apply at the partner
level and these tests would be applied
independently. Commenters suggested
and Treasury has agreed that the correct
interpretation of the statute is to exempt
interest expense that is limited at the part-
ner level by section 163(d) from the part-
nership level section 163(j) limitation in
accordance with the language of section
163(j)(5).
These proposed regulations provide
that interest expense at the partnership
level that is allocated to non-materially
participating partners subject to section
163(d) is not included in the section 163(j)
limitation calculation of the partnership.
Generally, the section 163(d) limitation
is more generous than the section 163(j)
limitation. Relative to the 2018 Proposed
Regulations, this change may encourage
these partners to incur additional interest
expense because they will be less likely
to be limited in their ability to use it to
offset other income. Commenters argued
that exempting from section 163(j) any
interest expense allocated to non-materi-
ally participating partners subject to sec-
tion 163(d) will treat this interest expense
in the same way as the interest expense
generated through separately managed
accounts, which are not subject to section
163(j) limitations.
The Treasury Department and the IRS
project that these proposed regulations
will result in additional investment in
trading partnerships and generally higher
levels of debt in any given trading partner-
ship relative to the 2018 Proposed Regu-
lations. Because investments in trading
partnerships may be viewed as economi-
cally similar to investments in separately
managed accounts arrangements, we fur-
ther project that the proposed regulations,
by making the tax treatments of these two
arrangements generally similar, will im-
prove U.S. economic performance relative
to the no-action baseline.
Number of Affected Taxpayers. The
Treasury Department and the IRS have
determined that the rules regarding trad-

September 28, 2020 830 Bulletin No. 2020–40
ing partnerships will potentially affect
approximately 275,000 taxpayers. This
number was reached by determining, us-
ing data for the 2017 taxable year, the
number of Form 1065 and Form 1065-B
filers that (1) completed Schedule B to
Form 1065 and marked box b, c, or d in
question 1 to denote limited partnership,
limited liability company, or limited li-
ability partnership status; and (2) have a
North American Industry Classification
System (NAICS) code starting with 5231
(securities and commodity contracts in-
termediation and brokerage), 5232 (secu-
rities and commodity exchanges), 5239
(other financial investment activities), or
5259 (other investment pools and funds).
Additionally, the Treasury Department
and the IRS have determined that the rules
regarding publicly traded partnerships
will potentially affect approximately 80
taxpayers. This number was reached by
determining, using data for the 2017 tax-
able year, the number of Form 1065 and
1065-B filers with gross receipts exceed-
ing $25 million that answered “yes” to
question 5 on Schedule B to Form 1065
denoting that the entity is a publicly traded
partnership. The Treasury Department and
the IRS do not have readily available data
on the number of filers that are tax shel-
ters that are potentially affected by these
provisions.
ii. Debt-financed Distributions
Prior to TCJA, partners were respon-
sible for determining the applicability of
any limitations on the use of proceeds
from debt because limitations on interest
expense deductibility were determined
at the partner level. Under section 163(j)
as amended by TCJA, the partnership is
required to complete a calculation to de-
termine its limitation on trade or business
interest expense. These proposed regula-
tions provide guidance on the method that
partnerships and partners should use to
allocate interest expense in cases where
a partner receives a distribution financed
from debt. The Treasury Department and
the IRS project that this guidance will re-
duce taxpayer uncertainty regarding the
application of section 163(j) in this situa-
tion relative to the no-action baseline.
The proposed regulations require that
partnerships allocate the interest expense
of the partners not receiving a debt-fi-
nanced distribution first. This interest
expense is allocated to trade or business
expense to the extent of the partnership’s
expenses. The character of any remain-
ing interest expense is determined based
on the partnership’s asset basis. Next, the
proposed regulations allocate the inter-
est expense of the partner receiving the
debt-financed distribution. If there is any
remaining business expense that was not
used by the other partners it is used first
to allocate the interest expense. Then the
partner receiving the debt financed distri-
bution looks to the use of the proceeds of
the distribution to determine the character
of any additional interest expense.
This procedure provides lower compli-
ance costs relative to alternative regula-
tory approaches. Any alternative method
that required information on the partner’s
use of the proceeds to determine the part-
nership level section 163(j) limitation
would have increased compliance costs
for partnerships and partners because it
would require a new reporting from part-
ners to partnerships. In cases of tiered
partnerships, this reporting could become
extremely complex. The method outlined
in these proposed regulations avoids the
need for partnerships and other partners to
have information about the use the debt-fi-
nanced distribution proceeds. However, it
maintains that interest expense allocated
to the partner receiving the debt-financed
distribution could still be subject to other
limitations besides section 163(j) based
on the use of the proceeds. For example,
proceeds used for personal expenditures
would still be subject to section 163(h)
limitations on interest expense, which
may be seen as an important existing an-
ti-abuse provision.
The proposed procedure bases the al-
location rules on optional and general
allocation rules outlined in a previously
issued notice, Notice 89-35, which will
minimize compliance costs to partner-
ships (relative to the no-action baseline)
to the extent that they are already familiar
with allocating interest expense first to the
partnership’s business expenses and sub-
sequently based on assets. Relative to the
no-action baseline, the Treasury Depart-
ment and the IRS expect these proposed
regulations will reduce taxpayer uncer-
tainty regarding the application of section
163(j). Treasury and IRS expect that this
resolution of uncertainty itself will reduce
taxpayer compliance costs and encourage
similarly situated taxpayers to interpret
section 163(j) similarly.
Number of Affected Taxpayers. The
Treasury Department and the IRS are not
currently able to determine the number
of taxpayers affected by rules regarding
debt financed distributions because debt
financed distributions are not separately
identified on tax forms, and therefore us-
ing the numbers of entities reporting inter-
est on a Form K-1, Schedule C or Sched-
ule E would produce overly broad results.
iii. Tiered Partnerships
Section 163(j) does not explicitly ad-
dress how the interest deduction limitation
should be applied to tiered partnerships.
The 2018 Proposed Regulations request-
ed comments on the treatment of tiered
partnership structures. Suppose that an
upper-tier partnership (UTP) is a partner
of a lower-tier partnership (LTP), and that
the LTP has business interest expense that
is limited under section 163(j). Under
the 2018 Proposed Regulations, the UTP
would receive an excess business interest
expense (EBIE) carryforward from the
LTP. In response to comments received,
these proposed regulations adopt the En-
tity Approach and specify that this EBIE
carryforward should not be allocated to
the partners of the UTP for purposes of
section 163(j).
While some commenters favored the
Entity Approach that these proposed reg-
ulations adopt, others favored an alterna-
tive under which the EBIE carryforward
would be allocated to the UTP’s partners
(Aggregate Approach). Additionally, if
the UTP’s partner were itself a partner-
ship, the EBIE would again be allocated
to that partnership’s partners. This would
continue until the EBIE is eventually al-
located to a non-partnership partner. Rel-
ative to the Entity Approach, the Aggre-
gate Approach generally places greater
compliance burden on partners. Under
the Aggregate Approach, partners would
be required to keep records linking sepa-
rate amounts of EBIE to the partnerships
that generated them. In simple partnership
structures, this is not onerous; however,
in a partnership structure with many tiers

Bulletin No. 2020–40 831 September 28, 2020
and many partners, this would prove cum-
bersome. In contrast, under the Entity Ap-
proach, only the UTP keeps a record of the
EBIE carryforward.
In summary, the Treasury Department
and the IRS project lower record-keeping
requirements, higher compliance rates,
and easier compliance monitoring of tiered
partnerships under the Entity Approach
relative to the Aggregate Approach, with
no meaningful difference in the economic
decisions that taxpayers would make un-
der the two approaches.
Moreover, relative to the no-action
baseline, the Treasury Department and the
IRS expect these proposed regulations for
tiered partnerships will reduce taxpayer
uncertainty regarding the application of
section 163(j). Treasury and IRS expect
that this resolution of uncertainty itself
will reduce taxpayer compliance costs and
encourage similarly situated taxpayers to
interpret section 163(j) similarly.
iv. Self-charged Lending
The 2018 Proposed Regulations re-
quested comments on the treatment of
lending transactions between a partner-
ship and a partner (self-charged lending
transactions). Suppose that a partnership
receives a loan from a partner and allo-
cates the resulting interest expense to that
partner. Prior to the TCJA, the interest in-
come and interest expense from this loan
would net precisely to zero on the lending
partner’s tax return. Under section 163(j)
as revised by TCJA, however, the part-
nership’s interest expense deduction may
now be limited. Therefore, in absence of
specific regulatory guidance, the lend-
ing partner may receive interest income
from the partnership accompanied by
less-than-fully-offsetting interest expense.
Instead, the lending partner would receive
EBIE, which would not be available to
offset his personal interest income. This
outcome has the effect of increasing the
cost of lending transactions between part-
ners and their partnerships relative to oth-
erwise similar financing arrangements.
To avoid this outcome, these proposed
regulations treat the lending partner’s
interest income from the loan as excess
business interest income (EBII) from the
partnership, but only to the extent of the
partner’s share of any EBIE from the part-
nership for the taxable year. This allows
the interest income from the loan to be
offset by the EBIE. The business interest
expense (BIE) of the partnership attribut-
able to the lending transaction will thus
be treated as BIE of the partnership for
purposes of applying section 163(j) to the
partnership.
The Treasury Department and the IRS
expect that these proposed regulations will
lead a higher proportion of self-charged
lending transactions in partnership financ-
ing, relative to the no-action baseline.
We further project that these proposed
regulations will increase the proportion
of partnership financing that is debt-fi-
nanced relative to the no-action baseline.
We have determined that these effects are
consistent with the intent and purpose of
the statute.
Number of Affected Taxpayers. The
Treasury Department and the IRS do not
have readily available data to determine
the number of taxpayers affected by rules
regarding self-charged interest because no
reporting modules currently connect these
payments by and from partnerships.
c. Provisions related to Controlled
Foreign Corporations (CFCs)
i. How to Apply Section 163(j) when
CFCs have shared ownership
The Final Regulations clarify that sec-
tion 163(j) and the section 163(j) regula-
tions apply to determine the deductibility
of a CFC’s business interest expense for
tax purposes in the same manner as these
provisions apply to a domestic corpora-
tion. These proposed regulations provide
further rules and guidance on how section
163(j) applies to CFCs when CFCs have
shared ownership and are eligible to be
members of CFC groups.
The Treasury Department and the IRS
considered three options with respect to
the application of section 163(j) to CFC
groups. The first option was to apply the
163(j) limitation to CFCs on an individu-
al basis, regardless of whether CFCs have
shared ownership. However, if section
163(j) is applied on an individual basis,
business interest deductions of individu-
al CFCs may be limited by section 163(j)
even when, if calculated on a group basis,
business interest deductions would not
be limited. Taxpayers could restructure
or “self-help” to mitigate the effects of
the section 163(j) limitation, but that op-
tion involves economically restructuring
costs for the taxpayer (relative to the third
option, described subsequently) with no
corresponding economically productive
activity.
The second option, which was proposed
in the 2018 Proposed Regulations, was to
allow an election to treat related CFCs and
their U.S. shareholders as a group. Under
this option, while the section 163(j) rules
would still be computed at the individual
CFC level, the “excess taxable income” of
a CFC could be passed up from lower-tier
CFCs to upper-tier CFCs and U.S. share-
holders in the same group. Excess taxable
income is the amount of income by which
a CFC’s adjusted taxable income (ATI)
exceeds the threshold amount of ATI be-
low which there would be disallowed
business expense.
Many comments suggested that com-
puting a section 163(j) limitation for each
CFC and rolling up CFC excess taxable
income would be burdensome for taxpay-
ers, especially since some multinational
organizations have hundreds of CFCs. In
addition, comments noted that the ability
to pass up excess taxable income would
encourage multinational organizations
to restructure such that CFCs with low
interest payments and high ATI are low-
er down the ownership chain and CFCs
with high interest payments and low ATI
are higher up in the chain of ownership.
Similar to the first option, this restruc-
turing would be expensive to taxpayers
without any corresponding productive
economic activity.
The third option was to allow taxpayers
to elect to apply the section 163(j) rules to
CFC groups on an aggregate basis, similar
to the rules applicable to U.S. consolidat-
ed groups. This option was suggested by
many comments and is the approach tak-
en in the proposed regulations. Under this
option, a single 163(j) limitation is com-
puted for a CFC group by summing the
items necessary for this computation (e.g.,
current-year business interest expense and
ATI) across all CFC group members. The
CFC group’s limitation is then allocated to
each CFC member using allocation rules
similar to those that apply to U.S. consol-
idated groups.

September 28, 2020 832 Bulletin No. 2020–40
This option reduces the compliance
burden on taxpayers in comparison to
applying the section 163(j) rules on an
individual CFC basis and calculating the
excess taxable income to be passed up
from lower tier CFCs to higher tier CFCs.
In comparison to the first and second
options, this option also removes the in-
centive for taxpayers to undertake costly
restructuring, since the location of inter-
est payments and ATI among CFC group
members will not affect the interest disal-
lowance for the group.
The proposed regulations also set out
a number of rules to govern member-
ship in a CFC group. These rules specify
which CFCs can be members of the same
CFC group, how CFCs with U.S. effec-
tively connected income (ECI) should
be treated, and the timing for making or
revoking a CFC group election. These
rules provide clarity and certainty to tax-
payers regarding the CFC group election
for section 163(j). In the absence of these
regulations, taxpayers would face un-
certainty regarding CFC group member-
ship, and may make financing decisions
or undertake restructuring that would be
inefficient relative to the proposed regu-
lations.
Number of Affected Taxpayers. The
population affected by this proposed rule
includes any taxpayer with ownership in
a CFC group, consisting of two or more
CFCs that has average gross receipts over
a three year period in excess of $25 mil-
lion. The Treasury Department and the
IRS estimate that there are approximately
7,500 taxpayers with two or more CFCs
based on counts of e-filed tax returns for
tax years 2015-2017. This estimate in-
cludes C corporations, S corporations,
partnerships, and individuals with CFC
ownership.
ii. CFC excess taxable income and ATI of
U.S. shareholders
Generally, for the purposes of com-
puting interest expense disallowed under
section 163(j), deemed income inclusions,
such as subpart F and GILTI inclusions,
are excluded from a U.S. shareholder’s
ATI under the Final Regulations. The pro-
posed regulations allow a U.S. sharehold-
er to add back to its ATI a percentage of
its deemed income inclusions attributable
to an applicable CFC. That percentage is
equal to the ratio of the CFC’s excess tax-
able income to its ATI.
The Treasury Department and the IRS
considered three options with respect to
the addition of deemed income inclu-
sions to a U.S. shareholder’s ATI. The
first option is to allow such inclusions to
be added to ATI with respect to any of a
taxpayer’s applicable CFCs regardless of
whether a CFC group election is made.
However, under this option, taxpayers
with a number of highly leveraged CFCs
would have the incentive to not make
a CFC group election and concentrate
debt in certain CFCs. The taxpayer could
thereby reduce the leverage of other
CFCs in order to create excess taxable
income in those CFCs. This excess tax-
able income could be then passed up to
increase the U.S. shareholder’s ATI. This
incentive could lead to costly debt shift-
ing among CFCs with no corresponding
productive economic activity.
The second option considered was to
allow such income inclusions to be added
to ATI with respect to CFC group mem-
bers only. Deemed income attributable
to CFCs that are not members of groups
would not be allowed to be added to a U.S.
shareholder’s ATI. This would remove the
incentive for taxpayers to aggregate debt
in certain CFCs, since if CFCs are treated
as members of a group, then the distribu-
tion of interest payments across members
will not affect the total excess taxable in-
come of the group. However, comments
noted that this option would not allow
deemed income from stand-alone CFCs,
which do not meet the requirements to
join a CFC group, to increase sharehold-
ers’ ATI.
The third option, which is proposed by
the Treasury Department and the IRS, is
to allow such income inclusions to be add-
ed to ATI with respect to both CFC group
members and stand-alone CFCs. Under
this option, if CFCs are eligible to be
members of a CFC group, then the group
election must be made in order for deemed
inclusions attributable to these CFCs to
increase shareholder ATI. The ATI of a
U.S. shareholder can also be increased
with respect to CFCs that are not eligi-
ble to be members of CFC groups. In this
way, the rule does not penalize, relative to
shareholders of CFC groups, shareholders
which own only one CFC or own CFCs
which for other reasons are not eligible for
group membership.
Number of Affected Taxpayers. The
population of affected taxpayers includes
any taxpayer with a CFC since the pro-
posed rule affects both stand-alone CFCs
as well as CFC groups. The Treasury De-
partment and the IRS estimate that there
are approximately 10,000 to 11,000 affect-
ed taxpayers based on a count of e-filed
tax returns for tax years 2015-2017. These
counts include C corporations, S corpora-
tions, partnerships, and individuals with
CFC ownership that meet a $25 million
three-year average gross receipts thresh-
old. The Treasury Department and the IRS
do not have readily available data on the
number of filers that are tax shelters that
are potentially affected by these provi-
sions.
d. Election to use 2019 ATI to determine
2020 section 163(j) limitation for
consolidated groups
The proposed regulations provide that
if a taxpayer filing as a consolidated group
elects to substitute its 2019 ATI for its 2020
ATI, that group can use the consolidated
group ATI for the 2019 taxable year, even
if membership of the consolidated group
changed in the 2020 taxable year. For ex-
ample, suppose consolidated group C has
three members in the 2019 taxable year,
P, the common parent of the consolidat-
ed group, and S1 and S2, which are both
wholly owned by P. In the 2019 taxable
year, each member of consolidated group
C had $100 of ATI on a stand-alone basis,
for a total of $300 of ATI for the consol-
idated group C. In the 2020 taxable year,
consolidated group C sells all of the stock
of S2 and acquires all of the stock of a new
member, S3. In the 2019 taxable year, S3
had $50 in ATI on a stand-alone basis. Un-
der the proposed regulations, consolidated
group C may elect to use $300 in ATI from
2019 as a substitute for its ATI in the 2020
taxable year.
The Treasury Department and the IRS
considered as an alternative basing the
2019 ATI on the membership of the con-
solidated group in the 2020 taxable year.
In the example in the previous paragraph,
this approach would subtract out the $100
in ATI from S2 and add the $50 in ATI

Bulletin No. 2020–40 833 September 28, 2020
from S3, for a total of $250 in 2019 ATI
that could potentially be substituted for
2020 ATI for consolidated group C. This
approach would add burden to taxpayers
relative to the proposed regulations by re-
quiring additional calculations and track-
ing of ATI on a member-by-member ba-
sis to determine the amount of 2019 ATI
that can be used in the 2020 taxable year
without providing any general economic
benefit.
In addition, the 2019 tax year will
have closed for many taxpayers by the
time these proposed regulations will be
published. This implies that proposed
rule of basing the consolidated group
composition on the 2019 taxable year
to calculate the amount of 2019 ATI that
can be used in the 2020 taxable year will,
relative to the alternative approach of us-
ing the composition in the 2020 taxable
year, reduce the incentive for taxpayers
to engage in costly mergers, acquisitions,
or divestures to achieve a favorable tax
result.
Number of Affected Taxpayers. The
Treasury Department and the IRS esti-
mate that approximately 34,000 corpo-
rate taxpayers filed a consolidated group
tax return for tax year 2017. This rep-
resents an upper-bound of the number of
taxpayers affected by the proposed rule
as not all consolidated groups would
need to calculate the amount of section
163(j) interest limitation in tax years
2019 and 2020.
D. Paperwork Reduction Act
The collection of information in these
Proposed Regulations has been submitted
to the Office of Management and Budget
for review in accordance with the Paper-
work Reduction Act of 1995 (44 U.S.C.
3507(d)). An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information un-
less it displays a valid OMB control num-
ber. The collection of information in these
Proposed Regulations has been submitted
to the Office of Management and Budget
for review in accordance with the Paper-
work Reduction Act of 1995 (44 U.S.C.
3507(d)).
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
return information are confidential, as re-
quired by section 6103.
1. Collections of Information
The collections of information subject
to the Paperwork Reduction Act in these
Proposed Regulations are in proposed
§§1.163(j)-6(d)(5), 1.163(j)-6(g)(4), and
1.163(j)-7.
The collections of information in pro-
posed §§1.163(j)-6(d)(5) and 1.163(j)-
6(g)(4) are required to make two elec-
tions relating to changes made to section
163(j) by the CARES Act. The election
under proposed §1.163(j)-6(d)(5) is for a
passthrough taxpayer to use the taxpay-
er’s ATI for the last taxable year begin-
ning in 2019 as its ATI for any taxable
year beginning in 2020, in accordance
with section 163(j)(10)(B). The election
under proposed §1.163(j)-6(g)(4) relates
to excess business interest expense of a
partnership for any taxable year begin-
ning in 2019 that is allocated to a part-
ner. Section 163(j)(10)(A)(ii)(II) pro-
vides that, unless the partner elects out,
in 2020, the partner treats 50 percent of
the excess business interest expense as
not subject to the section 163(j) limita-
tion. If the partner elects out, the partner
treats all excess business interest expense
as subject to the same limitations as other
excess business interest expense allocat-
ed to the partner.
Revenue Procedure 2020-22 describes
the time and manner for making these
elections. For both elections, taxpayers
make the election by timely filing a Fed-
eral income tax return or Form 1065, in-
cluding extensions, an amended Federal
income tax return, amended Form 1065,
or administrative adjustment request, as
applicable. More specifically, taxpayers
complete the Form 8990, “Limitation on
Business Interest Expense under Section
163(j),” using the taxpayer’s 2019 ATI
and/or not applying the rule in section
163(j)(10)(ii)(II), as applicable. No for-
mal statements are required to make these
elections. Accordingly, the reporting bur-
den associated with the collections of
information in proposed §1.163(j)-6(d)
(5) and -6(g)(4) will be reflected in the
IRS Form 8990 Paperwork Reduction
Act Submissions (OMB control number
1545-0123).
The collections of information in pro-
posed §1.163(j)-7 are required for tax-
payers to make an election to apply sec-
tion 163(j) to a CFC group (CFC group
election) or an annual election to exempt
a CFC or CFC group from the section
163(j) limitation (safe-harbor election).
The elections are made by attaching a
statement to the US shareholder’s annual
return. The CFC group election remains
in place until revoked and may not be re-
voked for any period beginning prior to 60
months following the period for which it
is made. The safe-harbor election is made
on an annual basis.
Under §1.964-1(c)(3)(i), no election
of a foreign corporation is effectuated un-
less the controlling domestic sharehold-
er provides a statement with their return
and notice of the election to the minority
shareholders under §1.964-1(c)(3)(ii) and
(iii). See also, §1.952-2(b)-(c). These col-
lections are necessary to ensure that the
election is properly effectuated, and that
taxpayers properly report the amount of
interest that is potentially subject to the
limitation.
2. Future Modifications to Forms to
Collect Information
At this time, no modifications to any
forms, including the Form 8990, “Lim-
itation on Business Interest Expense IRC
163(j),” are proposed with regard to the
elections under section 163(j)(10), or the
CFC group or safe-harbor elections. The
Treasury Department and the IRS are
considering revisions to the Instructions
for Form 8990 to reflect changes made to
section 163(j)(10) regarding the elections
under proposed §§1.163(j)-6(d)(5) and
1.163(j)–6(g)(4). For purposes of the Pa-
perwork Reduction Act of 1995 (44 U.S.C.
3507(d)), the reporting burden of Form
8990 is associated with OMB control num-
ber 1545-0123. In the 2018 Proposed Reg-
ulations, Form 8990 was estimated to be
required by fewer than 92,500 taxpayers.
If an additional information collection
requirement is imposed through these reg-
ulations in the future, for purposes of the
Paperwork Reduction Act, any reporting
burden associated with these regulations
will be reflected in the aggregated burden

September 28, 2020 834 Bulletin No. 2020–40
estimates and the OMB control numbers
for general income tax forms or the Form
8990, “Limitation on Business Interest
Expense Under Section 163(j)”.
The forms are available on the IRS
website at:
FormOMB NumberIRS Website Link
Form 1040
1545-0074
https://www.irs.gov/pub/irs-pdf/f1040.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf)
Form 1120
1545-0123
https://www.irs.gov/pub/irs-pdf/f1120.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1120.pdf)
Form 1120Shttps://www.irs.gov/pub/irs-pdf/f1120s.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1120s.pdf)
Form 1065https://www.irs.gov/pub/irs-pdf/f1065.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1065.pdf)
Form 1120-REIThttps://www.irs.gov/pub/irs-prior/f1120rei—2018.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1120rei.pdf)
Form 8990https://www.irs.gov/pub/irs-access/f8990_accessible.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i8990.pdf)
In addition, when available, drafts
of IRS forms are posted for comment at
https://apps.irs.gov/app/picklist/list/draft-
TaxForms.htm. IRS forms are available
at https://www.irs.gov/forms-instructions.
Forms will not be finalized until after they
have been approved by OMB under the
PRA.
3. Burden Estimates
The following estimates for the col-
lections of information in these proposed
regulations are based on the most recently
available Statistics of Income (SOI) tax
data.
For the collection of income in
proposed §1.163(j)-6(d)(5), where a
passthrough taxpayer elects to use the
taxpayer’s ATI for the last taxable begin-
ning in 2019 as the taxpayer’s ATI for any
taxable year beginning in 2020, the most
recently available 2017 SOI tax data in-
dicates that, on the high end, the estimat-
ed number of respondents is 49,202. This
number was determined by examining, for
the 2017 tax year, Form 1065 and Form
1120-S filers with greater than $26 million
in gross receipts that have reported interest
expense, and do not have an NAICS code
that is associated with a trade or business
that normally would be excepted from the
section 163(j) limitation.
For the collection of information un-
der §1.163(j)-6(g)(4), in which a partner
elects out of treating 50 percent of any ex-
cess business interest expense allocated to
the partner in 2019 as not subject to a lim-
itation in 2020, the Treasury Department
and the IRS estimate that only taxpayers
that actively want to reduce their deduc-
tions will make this election. The appli-
cation of the base erosion minimum tax
under section 59A depends, in part, on the
amount of a taxpayer’s deductions. Ac-
cordingly, the Treasury Department and
the IRS estimate that taxpayers that are
subject to both the base erosion minimum
tax under section 59A and section 163(j)
are the potential filers of this election. Us-
ing the 2017 SOI tax data, the Treasury
Department estimate that 1,182 firms will
make the election. This estimate was de-
termined by examining three criteria: first,
the number of taxpayers subject to section
59A, namely, C corporations with at least
$500,000,000 in gross receipts, second,
the portion of those taxpayers that do not
have an NAICS code associated with a
trade or business that is generally not sub-
ject to the section 163(j) limitation (2211
(electric power generation, transmission
and distribution), 2212 (natural gas dis-
tribution), 2213 (water, sewage and other
systems), 111 or 112 (farming), 531 (real
property)), and, third, the portion of tax-
payers satisfying the first two criteria that
received a Form K-1, “Partner’s Share of
Income, Deductions, Credits, etc.”
For the collections of information in
proposed §1.163(j)-7, namely the CFC
and safe-harbor elections, and the corre-
sponding notice under §1.964-1(c)(3)(iii),
the most recently available 2017 SOI tax
data indicates that, on the high end, the
estimated number of respondents is 4,980
firms. This number was determined by
examining, for the 2017 tax year, Form
1040, Form 1120, Form 1120-S, and Form
1065 filers with greater than $26 million
in gross receipts that filed a Form 5471,
Information Return of U.S. Persons With
Respect to Certain Foreign Corporations,
where an interest expense amount was re-
ported on Schedule C of the Form 5471.
The estimated number of respon-
dents that could be subject to the collec-
tion of information for the CFC group or
safe-harbor election is 4,980. The estimat-
ed annual burden per respondent/record-
keeper varies from 0 to 30 minutes, de-
pending on individual circumstances, with
an estimated average of 15 minutes. The
estimated total annual reporting and/or re-
cordkeeping burden is 1,245 hours (4,980
respondents x 15 minutes). The estimated
annual cost burden to respondents is $95
per hour. Accordingly, we expect the to-
tal annual cost burden for the CFC group
election and safe-harbor election state-
ments to be $118,275 (4,980 * .25 * $95).
The Treasury Department and the IRS
request comment on the assumptions,
methodology, and burden estimates re-
lated to this information collection. Com-
ments on the collection of information
should be sent to the Office of Manage-
ment and Budget, Attn: Desk Officer for

Bulletin No. 2020–40 835 September 28, 2020
the Department of the Treasury, Office
of Information and Regulatory Affairs,
Washington, DC 20503, with copies
to the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, SE:W:-
CAR:MP:T:T:SP, Washington, DC 20224.
Comments on the collection of informa-
tion should be received by November 2,
2020, which is 60 days after the date of
filing for public inspection with the Office
of the Federal Register.
Comments are specifically requested
concerning—
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the IRS, in-
cluding whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information;
How the quality, utility, and clarity of
the information to be collected may be en-
hanced;
How the burden of complying with
the proposed collection of information
may be minimized, including through the
application of automated collection tech-
niques or other forms of information tech-
nology; and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide informa-
tion.
II. Regulatory Flexibility Act
It is hereby certified that these Pro-
posed Regulations, if adopted as final, will
not have a significant economic impact on
a substantial number of small entities.
This certification can be made because
the Treasury Department and the IRS have
determined that the number of small en-
tities that are affected as a result of the
regulations is not substantial. These rules
do not disincentivize taxpayers from their
operations, and any burden imposed is not
significant because the cost of implement-
ing the rules, if any, is low.
As discussed in the 2018 Proposed
Regulations, section 163(j) provides ex-
ceptions for which many small entities will
qualify. First, under section 163(j)(3), the
limitation does not apply to any taxpay-
er, other than a tax shelter under section
448(a)(3), which meets the gross receipts
test under section 448(c) for any taxable
year. A taxpayer meets the gross receipts
test under section 448(c) if the taxpayer
has average annual gross receipts for the
3-taxable year period ending with the tax-
able year that precedes the current taxable
year that do not exceed $26,000,000. The
gross receipts threshold is indexed annu-
ally for inflation. Because of this thresh-
old, the Treasury Department and the IRS
project that entities with 3-year average
gross receipts below $26 million will not
be affected by these regulations except in
rare cases.
Section 163(j) provides that certain
trades or businesses are not subject to the
limitation, including the trade or busi-
ness of performing services as an em-
ployee, electing real property trades or
businesses, electing farming businesses,
and certain utilities as defined in section
163(j)(7)(A)(iv). Under the 2018 Pro-
posed Regulations, taxpayers that oth-
erwise qualified as real property trades
or businesses or farming businesses that
satisfied the small business exemption in
section 448(c) were not eligible to make
an election to be an electing real proper-
ty trade or business or electing farming
business. Under the Final Regulations,
however, those taxpayers are eligible
to make an election to be an electing
real property trade or business or elect-
ing farming business. Additionally, the
Final Regulations provide that certain
utilities not otherwise excepted from
the limitation can elect for a portion of
their non-excepted utility trade or busi-
ness to be excepted from the limitation.
Any economic impact on any small en-
tities as a result of the requirements in
these Proposed Regulations, not just the
requirements that impose a Paperwork
Reduction Act burden, is not expected to
be significant because the cost of imple-
menting the rules, if any, is low.
The Treasury Department and the IRS
do not have readily available data on the
number of filers that are tax shelters, as
defined in section 448(a)(3), that are po-
tentially affected by these provisions. As
described in more detail earlier in this Pre-
amble, these Proposed Regulations cover
several topics, including, but not limit-
ed to, debt financed distributions from
passthrough entities, self-charged interest,
the treatment of section 163(j) in rela-
tion to trader funds, the impact of section
163(j) on publicly traded partnerships, and
the application of section 163(j) to United
States shareholders of controlled foreign
corporations and to foreign persons with
effectively connected income in the Unit-
ed States.
The Treasury Department and the IRS
do not have readily available data to de-
termine the number of taxpayers affected
by rules regarding self-charged interest
because no reporting modules currently
connect these payments by and from part-
nerships.
The Treasury Department and the IRS
likewise do not have precise data on the
number of taxpayers affected by rules re-
garding debt financed distributions. The
Treasury Department and the IRS esti-
mate that the number of taxpayers affect-
ed by the rules regarding debt-financed
distributions is 50,036. This number was
reached first by adding the number of
Form 1065 filers that reported code W on
line 13b of schedule K of the Form 1065,
or approximately 410,996 using 2018 tax-
able year data, and the number of Form
1120-S filers that reported code S on line
12d of schedule K of the Form 1120-S, or
approximately 89,367 using 2018 taxable
year data. Those codes are used to report
interest expense allocated to debt financed
distributions. Using the result of the two
numbers, 500,363 (410,996 + 89,367),
produces overly broad results because the
codes referenced above are used to report
more than just interest expense allocated
to debt financed distributions. Code W on
line 13b of schedule K of the Form 1065
also is used to report at least nine other
items, including, but not limited to, item-
ized deductions that Form 1040 or 1040-
SR filers report on Schedule A, soil and
water conservation expenditures, and the
domestic productions activities deduc-
tions. Code S on line 12d of schedule K of
the Form 1120-S also is used to report at
least eleven other items, including, but not
limited to, itemized deductions that Form
1040 or 1040-SR filers report on Schedule
A, expenditures for the removal of archi-
tectural and transportation barriers for the
elderly and disabled that the corporation
elected to treat as a current expense, and
film, television, and live theatrical produc-
tion expenses. Considering the number of
other items reported under those codes,

September 28, 2020 836 Bulletin No. 2020–40
the Treasury Department and the IRS esti-
mate that approximately 10% of the filers
using those codes report interest expense
allocated to debt financed distributions
(500,363 * 0.10 = 50,036).
Despite not having precise data, these
rules do not impose a significant paper-
work or implementation cost burden on
taxpayers. Under Notice 89-35, taxpayers
have been required to maintain books and
records to properly report the tax treat-
ment of interest associated with debt fi-
nanced acquisitions and contributions by
partners, and debt financed distributions
to partners. Additional reporting require-
ments are needed to allow passthrough
entities and their owners to comply with
the interest tracing rules under § 1.163-
8T. Without additional reporting, the
mechanism for determining the tax treat-
ment of interest under § 1.163-8T is
burdensome and unclear. For example,
in some cases, partners would need to
report back to the partnership how they
used debt financed distribution to allow
the partnership to properly report its in-
terest expense. This notice of proposed
rules would provide consistent reporting
and compliance by passthrough entities
and their owners, which would reduce
their overall burden. The estimated time
to determine whether a distribution is a
debt financed distribution and to comply
with these rules would be 0 minutes to
30 minutes per taxpayer, depending on
individual circumstances, for an average
of 15 minutes. The 2018 monetization
rates for this group of filers is $57.53.
Accordingly, the Treasury Department
and the IRS estimate the burden to be
$719,642.77 (50,036 respondents * 0.25
hours * $57.53).
The Treasury Department and the IRS
have determined that, on the high end, the
rules regarding trading partnerships might
affect approximately 309 small entities.
This number was reached by determining,
using data for the 2017 taxable year, the
number of Form 1065 and Form 1065-B
filers, with more than $26 million in gross
receipts, that (1) completed Schedule B to
Form 1065 and marked box b, c, or d in
question 1 to denote limited partnership,
limited liability company or limited lia-
bility partnership status; (2) have a North
American Industry Classification System
(NAICS) code starting with 5231, 5232,
5239 or 5259, and (3) do not have gross
receipts exceeding the small business
thresholds for the various NAICS codes.
The following table provides a breakdown
of the potentially affected taxpayers by
NAICS code.
NAICS CodeTitlesGross Receipts ThresholdNumber of Respondents
5231Securities and Commodity Contracts Intermediation
and Brokerage, including Investment Bank and Se-
curities Dealing; Securities Brokerage; Commodity
Contract Dealing; Commodity Contracts Brokerage
$41.5M42
5232Securities and Commodities Exchanges$41.5M0
5239Other Financial Investment Activities, including
Miscellaneous Intermediation; Portfolio Manage-
ment; Investment Advice; Trust, Fiduciary, and Cus-
tody Activities; Miscellaneous Financial Investment
Activities
$41.5M267
5259Other Investment Pools and Funds, including Open-
End Investment Funds; Trusts, Estates, and Agency
Accounts; Other Financial Vehicles
$35M[d]
Total Respondents309
Source: SOI Partnership Study, 2017
[d] Data is suppressed based on disclosure rules detailed in Publication 1075.
Additionally, the Treasury Department
and the IRS have determined that the rules
regarding publicly traded partnerships
might affect approximately 83 taxpayers.
This number was reached by determining,
using data for the 2017 taxable year, the
number of Form 1065 and 1065-B filers
with gross receipts exceeding $25 mil-
lion that answered “yes” to question 5 on
Schedule B to Form 1065 denoting that
the entity is a publicly traded partnership.
As noted earlier, these Proposed Regu-
lations do not impose any new collection
of information on these entities. These
Proposed Regulations actually assist small
entities in meeting their filing obligations
by providing definitive advice on which
they can rely.
For the section 163(j)(10) elections for
passthrough taxpayers under proposed
§§1.163(j)-6(d)(5) and 1.163(j)-6(g)
(4), most small taxpayers do not need to
make the elections because, as discussed
earlier, they are not subject to the section
163(j) limitation. For small taxpayers
that are subject to the limitation, the cost
to implement the election is low. Pursu-
ant to Revenue Procedure 2020-22, these
passthrough taxpayers simply complete
the Form 8990 as if the election has been
made. Accordingly, the burden of comply-
ing with the elections, if needed, is no dif-
ferent than for taxpayers who do not make
the elections.
The persons potentially subject to pro-
posed §1.163(j)-7 are U.S. shareholders
in one or more CFCs for which BIE is
reported, and that (1) have average an-
nual gross receipts for the 3-taxable year

Bulletin No. 2020–40 837 September 28, 2020
period ending with the taxable year that
precedes the current taxable year exceed-
ing $26,000,000, and (2) want to make
the CFC group election or safe-harbor
election. Proposed §1.163(j)-7 requires
such taxpayers to attach a statement to
their return providing basic information
regarding the CFC group or standalone
CFC.
As discussed in the Paperwork Re-
duction Act section of this Preamble, the
reporting burden for both statements is es-
timated at 0 to 30 minutes, depending on
individual circumstances, with an estimat-
ed average of 15 minutes for all affected
entities, regardless of size. The estimated
monetized burden for compliance is $95
per hour.
For these reasons, the Treasury Depart-
ment and the IRS have determined that
these Proposed Regulations will not have
a significant economic impact on a sub-
stantial number of small entities. Notwith-
standing this certification, the Treasury
Department and the IRS invite comments
from interested members of the public on
both the number of small entities affected
and the economic impact on those small
entities.
E. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 requires that agencies
assess anticipated costs and benefits and
take certain other actions before issuing a
final rule that includes any Federal man-
date that may result in expenditures in any
one year by a state, local, or tribal govern-
ment, in the aggregate, or by the private
sector, of $100 million in 1995 dollars,
updated annually for inflation. In 2019,
that threshold was approximately $154
million. These Proposed Regulations do
not include any Federal mandate that may
result in expenditures by state, local, or
tribal governments, or by the private sec-
tor in excess of that threshold.
F Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the con-
sultation and funding requirements of
section 6 of the Executive Order. These
Proposed Regulations do not have fed-
eralism implications and do not impose
substantial direct compliance costs on
state and local governments or preempt
state law within the meaning of the Ex-
ecutive Order.
Comments and Requests for a Public
Hearing
Before these proposed amendments
to the regulations are adopted as final
regulations, consideration will be given
to comments that are submitted timely
to the IRS as prescribed in the preamble
under the “ADDRESSES” section. The
Treasury Department and the IRS request
comments on all aspects of the proposed
regulations. Any electronic comments
submitted, and to the extent practicable
any paper comments submitted, will be
made available at www.regulations.gov or
upon request.
A public hearing will be scheduled if
requested in writing by any person who
timely submits electronic or written com-
ments. Requests for a public hearing are
also encouraged to be made electronically.
If a public hearing is scheduled, notice of
the date and time for the public hearing
will be published in the Federal Register.
Announcement 2020-4, 2020-17 I.R.B.
667 (April 20, 2020), provides that until
further notice, public hearings conducted
by the IRS will be held telephonically.
Any telephonic hearing will be made ac-
cessible to people with disabilities.
Drafting Information
The principal authors of these regula-
tions are Susie Bird, Charles Gorham, Jai-
me Park, Joanna Trebat and Sophia Wang
(Income Tax & Accounting), Anthony
McQuillen, Adrienne M. Mikolashek, and
William Kostak (Passthroughs and Spe-
cial Industries), Azeka J. Abramoff (Inter-
national), Russell Jones, and John Love-
lace (Corporate), and Pamela Lew, Steven
Harrison, and Michael Chin (Financial
Institutions & Products). Other personnel
from the Treasury Department and the
IRS participated in their development.
Effect on Other Documents
Notice 89-35, 1989-1 C.B. 675, is pro-
posed to be obsoleted.
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings notices, and other guidance cit-
ed in this document are published in the
Internal Revenue Bulletin (or Cumulative
Bulletin) and are available from the Su-
perintendent of Documents, U.S. Govern-
ment Publishing Office, Washington, DC
20402, or by visiting the IRS website at
http://www.irs.gov.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1 – INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.163-14 is added to
read as follows:
§1.163-14 Allocation of interest expense
among expenditures – Passthrough
Entities.
(a) In general—(1) Application. This
section prescribes rules for allocating in-
terest expense associated with debt pro-
ceeds of a partnership or S corporation (a
passthrough entity). In general, interest
expense on a debt of a passthrough enti-
ty is allocated in the same manner as the
debt to which such interest expense relates
is allocated. Debt is allocated by tracing
disbursements of the debt proceeds to spe-
cific expenditures. This section prescribes
rules for tracing debt proceeds to specific
expenditures of a passthrough entity.
(2) Cross-references. This paragraph
provides the general manner in which in-
terest expense of a passthrough entity is

September 28, 2020 838 Bulletin No. 2020–40
allocated. See paragraph (b) of this section
for the treatment of interest expense allo-
cated under the rules of this section, para-
graph (c) for the manner in which debt
proceeds of a passthrough entity are allo-
cated and the manner in which interest ex-
pense allocated under this section is treat-
ed, paragraph (d) for rules relating to debt
allocated under the rules of §1.163-8T to
distributions to owners of a passthrough
entity, paragraph (e) for rules relating to
debt repayments, paragraph (f) for rules
relating to debt allocated under the rules
of §1.163-8T to expenditures for interests
in passthrough entities, paragraph (g) for
change of ownership rules for interest ex-
pense allocation purposes, and paragraph
(h) for examples.
(b) Treatment of interest expense—(1)
General rule. Except as otherwise pro-
vided in section §1.163(j)-8T(m), interest
expense allocated under the rules of this
section is treated in the following manner:
(i) Interest expense allocated to trade or
business expenditures (as defined in para-
graph (b)(2)(v) of this section) is taken
into account under section 163(j) by the
passthrough entity;
(ii) Interest expense allocated to oth-
er trade or business expenditures (as
defined in paragraph (b)(2)(ii) of this
section) is taken into account under the
rules of §1.163-8T, as applicable, by the
passthrough entity owner allocated such
interest expense;
(iii) Interest expense allocated to rental
expenditures (as defined in paragraph (b)
(2)(iv) of this section) is taken into ac-
count under the rules of §1.163-8T, as ap-
plicable, by the passthrough entity owner
allocated such interest expense;
(iv) Interest expense allocated to in-
vestment expenditures (as defined in para-
graph (b)(2)(i) of this section) is taken into
account under the rules of §1.163-8T, as
applicable, by the passthrough entity own-
er allocated such interest expense;
(v) Interest expense allocated to per-
sonal expenditures (as defined in para-
graph (b)(2)(iii) of this section) is taken
into account under the rules of §1.163-8T,
as applicable, by the passthrough entity
owner allocated such interest expense;
(vi) Interest expense allocated to distri-
butions to owners of a passthrough entity
is taken into account in the manner pro-
vided under paragraph (d) of this section.
(2) Definitions. For purposes of this
section –
(i) Investment expenditure means an
expenditure defined in §1.163-8T(b)(3),
including any expenditure made with re-
spect to a trade or business described in
section 163(d)(5)(A)(ii) to the extent such
expenditure is properly allocable under
section 704(b) to partners that do not ma-
terially participate (within the meaning
and for purposes of section 469) in the
trade or business.
(ii) Other trade or business expenditure
means an expenditure made with respect
to any activity described in §1.469-4(b)(1)
(ii) and (iii).
(iii) Personal expenditure means an
expenditure (other than a distribution) not
described in paragraphs (b)(2)(i), (ii), (iv)
and (v) of this section.
(iv) Rental expenditure means an ex-
penditure made with respect to any activi-
ty described in §1.469-4(b)(2) that is not a
trade or business, as defined in §1.163(j)-
1(b)(44).
(v) Trade or business expenditure
means an expenditure made with re-
spect to a trade or business, as defined in
§1.163(j)-1(b)(44), except for an expendi-
ture made with respect to a trade or busi-
ness described in section 163(d)(5)(A)(ii)
to the extent such expenditure is properly
allocable under section 704(b) to partners
that do not materially participate (within
the meaning and for purposes of section
469) in the trade or business.
(c) Allocation of debt and interest ex-
pense. Except as otherwise provided in
this section, the rules of §1.163-8T apply
to partnerships, S Corporations, and their
owners.
(d) Debt allocated to distributions
by passthrough entities—(1) Alloca-
tion of distributed debt proceeds—(i)
Available expenditures. To the extent
a passthrough entity has available ex-
penditures (as defined in paragraph (d)
(5)(ii) of this section), the passthrough
entity shall first allocate distributed debt
proceeds (as defined in paragraph (d)
(5)(iii) of this section) to such available
expenditures. If a passthrough entity
has multiple available expenditures, the
passthrough entity shall allocate distrib-
uted debt proceeds to such available ex-
penditures in proportion to the amount
of each expenditure.
(ii) Debt financed distributions. If a
passthrough entity’s distributed debt pro-
ceeds exceeds its available expenditures,
the passthrough entity shall allocate such
excess amount of distributed debt proceeds
to distributions to owners of the passthrough
entity (debt financed distributions).
(2) Allocation of interest expense—
(i) Interest expense allocated to debt fi-
nanced distributions. If distributed debt
proceeds are allocated to distributions to
owners of the passthrough entity (pursu-
ant to paragraph (d)(1)(ii) of this section),
the passthrough entity shall determine the
portion of each passthrough entity own-
er’s allocable interest expense that is debt
financed distribution interest expense. The
amount of a passthrough entity owner’s
debt financed distribution interest expense
equals the lesser of such passthrough en-
tity owner’s allocable interest expense (as
defined in paragraph (d)(5)(i) of this sec-
tion) or the product of –
(A) The portion of the debt proceeds
distributed to that particular passthrough
entity owner; multiplied by
(B) A fraction, the numerator of which
is the portion of the passthrough entity’s
distributed debt proceeds allocated to
debt financed distributions (determined
under paragraph (d)(1)(ii) of this sec-
tion), and the denominator of which is the
passthrough entity’s total amount of dis-
tributed debt proceeds; multiplied by
(C) The distributed debt proceeds inter-
est rate (as defined in paragraph (d)(5)(iv)
of this section).
(ii) Interest expense allocated to avail-
able expenditures. If distributed debt pro-
ceeds are allocated to available expendi-
tures (pursuant to paragraph (d)(1)(i) of
this section), the passthrough entity shall
determine the portion of each passthrough
entity owner’s allocable interest expense
that is expenditure interest expense. The
amount of a passthrough entity owner’s
expenditure interest expense equals the
product of –
(A) The portion of the passthrough
entity’s distributed debt proceeds allocat-
ed to available expenditures (determined
under paragraph (d)(1)(i) of this section);
multiplied by
(B) The distributed debt proceeds inter-
est rate; multiplied by
(C) A fraction, the numerator of which
is the excess of that particular passthrough

Bulletin No. 2020–40 839 September 28, 2020
entity owner’s allocable interest expense
over its debt financed distribution interest
expense (determined under paragraph (d)
(2)(i) of this section) (remaining interest
expense), and the denominator of which is
aggregate of all the passthrough owners’
remaining interest expense amounts.
(iii) Excess interest expense. To the ex-
tent a passthrough entity owner’s alloca-
ble interest expense is not treated as either
debt financed distribution interest expense
(determined under paragraph (d)(2)(i) of
this section) or expenditure interest ex-
pense (determined under paragraph (d)(2)
(ii) of this section), such allocable interest
expense is excess interest expense.
(3) Tax treatment of interest expense—
(i) Debt financed distribution interest ex-
pense. The tax treatment of a passthrough
entity owner’s debt financed distribution
interest expense (determined under para-
graph (d)(2)(i) of this section), if any,
shall be determined by the passthrough
entity owner under the rules of §1.163-
8T, as applicable, in accordance with such
passthrough entity owner’s use of its por-
tion of the passthrough entity’s distribut-
ed debt proceeds. The passthrough entity
shall separately state the amount of each
owner’s debt financed distribution inter-
est expense. Debt financed distribution
interest expense is not treated as interest
expense of the entity for purposes of this
section.
(ii) Expenditure interest expense. The
tax treatment of a passthrough entity own-
er’s expenditure interest expense (deter-
mined under paragraph (d)(2)(ii) of this
section), if any, shall be determined based
on how the distributed debt proceeds were
allocated among available expenditures
(pursuant to paragraph (d)(1)(i) of this
section). For example, if distributed debt
proceeds are allocated to a rental activity
under paragraph (d)(1)(i) of this section,
the interest expense associated with such
debt should be taken into account by the
passthrough entity in computing income
or loss from the rental activity that is re-
ported to the owner.
(iii) Excess interest expense. The tax
treatment of a passthrough entity owner’s
excess interest expense (determined under
paragraph (d)(2)(iii) of this section), if
any, shall be determined by allocating the
distributed debt proceeds among all the
assets of the passthrough entity, pro-rata,
based on the adjusted basis of such assets.
For purposes of the preceding sentence,
the passthrough entity shall use either the
adjusted tax bases of its assets reduced by
any debt of the passthrough entity allocat-
ed to such assets, or determine its adjusted
basis in its assets in accordance with the
rules in §1.163(j)-10(c)(5)(i), reduced by
any debt of the passthrough entity allo-
cated to such assets. Once a passthrough
entity chooses a method for determining
its adjusted basis in its assets for this pur-
pose, the passthrough entity must consis-
tently apply the same method in all subse-
quent tax years. Any assets purchased in
the same taxable year as the distribution
(such that the expenditure for those assets
was taken into account in §1.163-14(b)
(1)) are not included in this allocation.
(4) Treatment of transfers of interests
in a passthrough entity by an owner that
received a debt financed distribution—(i)
In general. In the case of a transfer of an
interest in a passthrough entity, any debt
financed distribution interest expense of
the transferor shall be treated as excess
interest expense by the transferee. How-
ever, in the case of a transfer of an interest
in a passthrough entity to a person who is
related to the transferor, any debt financed
distribution interest expense of the trans-
feror shall continue to be treated as debt
financed distribution interest expense by
the related party transferee, and the tax
treatment of such debt financed distribu-
tion expense under paragraph (d)(3) of
this section shall be the same to the related
party transferee as it was to the transferor.
The term related party means any person
who bears a relationship to the taxpayer
which is described in section 267(b) or
707(b)(1).
(ii) Anti-avoidance rule. Arrangements
entered into with a principal purpose of
avoiding the rules of this paragraph, in-
cluding the transfer of an interest in a
passthrough entity by an owner who treat-
ed a portion of its allocable interest ex-
pense as debt financed distribution inter-
est expense to an unrelated party pursuant
to a plan to transfer the interest back to
the owner who received the debt financed
distribution interest expense or to a party
who is related to the owner who received
the debt financed distribution interest ex-
pense, may be disregarded or recharacter-
ized by the Commissioner of the IRS to
the extent necessary to carry out the pur-
poses of this paragraph.
(5) Definitions. For purposes of this
paragraph –
(i) Allocable interest expense means a
passthrough entity owner’s share of inter-
est expense associated with the distributed
debt proceeds allocated under section 704
or section 1366(a).
(ii) Available expenditure means an
expenditure of a passthrough entity de-
scribed in paragraph (b)(2) of this section
made in the same taxable year of the entity
as the distribution, to the extent that debt
proceeds (including other distributed debt
proceeds) are not otherwise allocated to
such expenditure.
(iii) Distributed debt proceeds means
debt proceeds of a passthrough entity that
are allocated under §1.163-8T and this
section to distributions to owners of the
passthrough entity in a taxable year. If
debt proceeds from multiple borrowings
are allocated under §1.163-8T to distribu-
tions to owners of the passthrough entity
in a taxable year, then all such borrowings
are treated as a single borrowing for pur-
poses of this section.
(iv) Distributed debt proceeds interest
rate means a fraction, the numerator of
which is the amount of interest expense
associated with distributed debt proceeds,
and the denominator of which is the
amount of distributed debt proceeds.
(e) Repayment of passthrough entity
debt—(1) In general. If any portion of
passthrough entity debt is repaid at a time
when such debt is allocated to more than
one expenditure, the debt is treated for
purposes of this section as repaid in the
following order:
(i) Amounts allocated to one or more
expenditures described in paragraph (b)
(2)(iii);
(ii) Amounts allocated to one or more
expenditures described in paragraph (b)
(2)(i) (relating to investment expenditures
as defined in §1.163-8T(b)(3));
(iii) Amounts allocated to one or more
expenditures described in paragraphs (b)
(2)(ii) and (iv) (relating to expenditures
with respect to any activities described in
§1.469-4(b)(1)(ii) and (iii), and §1.469-
4(b)(2)); and
(iv) Amounts allocated to one or more
expenditures described in paragraph (b)
(2)(v) (generally relating to expenditures

September 28, 2020 840 Bulletin No. 2020–40
made with respect to a trade or business as
defined in §1.163(j)-1(b)(44)).
(2) Repayment of debt used to finance
a distribution. Any repayment of debt of
a passthrough entity that has been allo-
cated to debt financed distributions under
paragraph (d)(1)(ii) of this section and to
one or more available expenditures under
paragraph (d)(1)(i) of this section may, at
the option of the passthrough entity, be
treated first as a repayment of the portion
of the debt that had been allocated to such
debt financed distributions.
(f) Debt allocated to expenditures for
interests in passthrough entities. In the
case of debt proceeds allocated under
the rules of §1.163-8T and this section
to contributions to the capital of or to the
purchase of an interest in a passthrough
entity, the character of the debt proceeds
and any associated interest expense shall
be determined by allocating the debt pro-
ceeds among the adjusted tax bases of the
entity’s assets. For purposes of this para-
graph, the owner must allocate the debt
proceeds either in proportion to the rela-
tive adjusted tax basis of the entity’s as-
sets reduced by any debt allocated to such
assets, or based on the adjusted basis of
the entity’s assets in accordance with the
rules in §1.163(j)-10(c)(5)(i) reduced by
any debt allocated to such assets. Once the
owner chooses a method for allocating the
debt proceeds for this purpose, the owner
must consistently apply the same method
in all subsequent tax years. Individuals
shall report interest expense paid or in-
curred in connection with debt-financed
acquisitions on their individual income
tax return in accordance with the asset to
which the interest expense is allocated un-
der this paragraph.
(g) Change in ownership. Any transfer
of an ownership interest in a passthrough
entity is not a reallocation event for pur-
poses of §1.163-8T(j), except as provided
for in paragraph (d)(4) of this section.
(h) Examples—(1) Example 1—(i) Facts. A (an
individual) and B (an individual) are partners in part-
nership PRS. PRS conducts two businesses; a man-
ufacturing business, which is a trade or business as
defined in §1.163(j)-1(b)(44) (manufacturing), and
a separate commercial real estate leasing business,
which is an activity described in §1.469-4(b)(2)
(leasing). In Year 1, PRS borrowed $100,000 from
an unrelated third-party lender (the loan). Other than
the loan, PRS does not have any outstanding debt.
During Year 1, PRS paid $80,000 in manufacturing
expenses, $120,000 in leasing expenses, and made a
$100,000 distribution to A, the proceeds of which A
used to make a personal expenditure. Under §1.163-
8T, PRS treated the $100,000 of loan proceeds as
having been distributed to A. As a result, in Year
1 PRS had $200,000 of available expenditures (as
defined in paragraph (d)(5)(ii) of this section) and
$100,000 of distributed debt proceeds (as defined
in paragraph (d)(5)(iii) of this section). PRS paid
$10,000 in interest expense that accrued during Year
1 on the loan, and allocated such interest expense
under section 704(b) equally to A and B ($5,000
each). Thus, A and B each had $5,000 of allocable
interest expense (as defined in paragraph (d)(5)(i) of
this section).
(ii) Applicability. Because PRS treated all
$100,000 of the loan proceeds as having been dis-
tributed under §1.163-8T, PRS allocated all $10,000
of the interest expense associated with the loan to the
distribution. Thus, pursuant to paragraph (b)(1)(vi)
of this section, PRS must determine the tax treatment
of such $10,000 of interest expense in the manner
provided in paragraph (d) of this section.
(iii) Debt allocated to distributions. Under
paragraph (d)(1)(i) of this section, to the extent
PRS has available expenditures (as defined un-
der paragraph (d)(5)(ii) of this section), it must
allocate any distributed debt proceeds (as defined
under paragraph (d)(5)(iii) of this section) to such
available expenditures. Here, PRS has distributed
debt proceeds of $100,000 and available expendi-
tures of $200,000 (manufacturing expenditures of
$80,000, plus leasing expenditures of $120,000).
Thus, PRS allocates all $100,000 of the distributed
debt proceeds to available expenditures as follows:
$40,000 to manufacturing expenditures ($100,000
x ($80,000/$200,000)) and $60,000 to leasing ex-
penditures ($100,000 x ($120,000/$200,000)).
Because the amount of PRS’s distributed debt pro-
ceeds is less than its available expenditures, none of
the distributed debt proceeds are allocated to debt
financed distributions pursuant to paragraph (d)(1)
(ii) of this section.
(iv) Allocation of interest expense. Because all
of PRS’s distributed debt proceeds are allocated to
available expenditures (pursuant to paragraph (d)(1)
(i) of this section), A and B each treat all $5,000 of
their allocable interest expense as expenditure inter-
est expense.
(v) Tax treatment of interest expense. Pursuant
to paragraph (d)(3)(ii) of this section, each partner
treats its expenditure interest expense (determined
under paragraph (d)(2)(ii) of this section) in the same
manner as the distributed debt proceeds that were al-
located to available expenditures under paragraph
(d)(1)(i) of this section. Thus, A’s $5,000 of expendi-
ture interest expense comprises of $2,000 of business
interest expense ($5,000 x ($40,000/$100,000)) and
$3,000 of interest expense allocated to rental expen-
ditures ($5,000 x ($60,000/$100,000)). B’s $5,000 of
expenditure interest expense similarly comprises of
$2,000 of business interest expense and $3,000 of in-
terest expense allocated to rental expenditures. As a
result, $4,000 of interest expense associated with the
distributed debt proceeds (A’s $2,000 plus B’s $2,000
of expenditure interest expense treated as business
interest expense) is business interest expense of PRS,
subject to section 163(j) at the PRS level.
Table 1 to paragraph (h)(2)(vii)
Partner APartner B
Allocable interest expense
Debt financed distribution interest expense
N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$0$0
Expenditure interest expense
Business interest (to PRS) . . . . . . . . . . . . . .$2,000$2,000
Rental activity interest expense . . . . . . . . . . .$3,000$3,000
Excess interest expense
N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$0$0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000$5,000
(2) Example 2—(i) Facts. The facts are the same as
in Example 1 in paragraph (h)(1)(i) of this section, ex-
cept PRS did not have any rental expenditures in Year
1. As a result, in Year 1 PRS had $80,000 of available
expenditures (as defined in paragraph (d)(5)(ii) of this
section) and $100,000 of distributed debt proceeds (as
defined in paragraph (d)(5)(iii) of this section).
(ii) Applicability. Because PRS treated all
$100,000 of the loan proceeds as having been dis-
tributed to A under §1.163-8T, PRS allocated all
$10,000 of the interest expense associated with the
loan to the distribution. Thus, pursuant to paragraph
(b)(1)(vi) of this section, PRS must determine the tax
treatment of such $10,000 of interest expense in the
manner provided in paragraph (d) of this section.

Bulletin No. 2020–40 841 September 28, 2020
(iii) Debt allocated to distributions. Under para-
graph (d)(1)(i) of this section, to the extent PRS has
available expenditures (as defined under paragraph
(d)(5)(ii) of this section), it must allocate any dis-
tributed debt proceeds (as defined under paragraph
(d)(5)(i) of this section) to such available expendi-
tures. Here, PRS has distributed debt proceeds of
$100,000 and available expenditures of $80,000.
Thus, $80,000 of the distributed debt proceeds are
allocated to such available expenditures. Pursuant to
paragraph (d)(1)(ii) of this section, PRS allocates the
remaining $20,000 of the distributed debt proceeds
to debt financed distributions.
(iv) Allocation of interest expense – debt financed
distribution interest expense. Pursuant to paragraph
(d)(2)(i) of this section, A treats $2,000 of its allocable
interest expense as debt financed distribution inter-
est expense, which is the lesser of $5,000 or $2,000
((A) the portion of debt proceeds distributed to A
($100,000), multiplied by (B) a fraction, the numer-
ator of which is the portion of PRS’s distributed debt
proceeds allocated to debt financed distributions pur-
suant to paragraph (d)(1)(ii) of this section ($20,000),
and the denominator of which is PRS’s total amount
of distributed debt proceeds ($100,000), multiplied
by (C) the distributed debt proceeds interest rate,
as defined in paragraph (d)(5)(iii) of this section, of
10% (the amount of interest expense associated with
distributed debt proceeds ($10,000), divided by the
amount of distributed debt proceeds ($100,000))) and
B treats $0 of its allocable interest expense as debt
financed distribution interest expense, which is the
lesser of $5,000 or $0 ((A) $0 x (B) 20% x (C) 10%).
Table 2 to paragraph (h)(2)(iv)
The portion of partner A's allocable interest expense that is debt financed distribution interest expense equals the lesser of:
Partner A's allocable interest expense; or=$5,000
(d)(2)(i)(A)Portion of debt proceeds
=$100,000
allocated to partner A
(d)(2)(i)(B)
Debt financed distributions
=
$20,000
Distributed debt proceeds$100,000
(d)(2)(i)(C)Distributed debt proceeds
=
$10,000
interest rate$100,000
The product of (d)(2)(i)(A), (B), and (C).=$2,000
Table 3 to paragraph (h)(2)(iv)
The portion of partner B's allocable interest expense that is debt financed distribution interest expense equals the lesser of:
Partner B's allocable interest expense; or=$5,000
(d)(2)(i)(A)Portion of debt proceeds
=$0
allocated to partner B
(d)(2)(i)(B)
Debt financed distributions
=
$20,000
Distributed debt proceeds$100,000
(d)(2)(i)(C)Distributed debt proceeds
=
$10,000
interest rate$100,000
The product of (d)(2)(i)(A), (B), and (C).=$0
(v) Allocation of interest expense – expenditure
interest expense. Pursuant to paragraph (d)(2)(ii) of
this section, A treats $3,000 of its allocable interest
expense as expenditure interest expense ((A) the por-
tion of PRS’s distributed debt proceeds allocated to
available expenditures pursuant to paragraph (d)(1)
(i) of this section ($80,000), multiplied by (B) the
distributed debt proceeds interest rate (10%), mul-
tiplied by (C) a fraction, the numerator of which is
A’s remaining interest expense (that is, the excess of
A’s allocable interest expense ($5,000) over its debt
financed distribution interest expense as determined
under paragraph (d)(2)(i) of this section ($2,000)),
and the denominator of which is the aggregate of A’s
and B’s remaining interest expense amounts ($3,000
+ $5,000)) and B treats $5,000 of its allocable inter-
est expense as expenditure interest expense ((A) $80
x (B) 10% x (C) 62.5%).

September 28, 2020 842 Bulletin No. 2020–40
(vi) Allocation of interest expense – excess inter-
est expense. Neither partner treats any of its alloca-
ble interest expense as excess interest expense under
paragraph (d)(2)(iii) of this section.
(vii) Tax treatment of interest expense. Pursuant
to paragraph (d)(3)(i) of this section, each partner de-
termines the tax treatment of its debt financed distri-
bution interest expense (determined under paragraph
(d)(2)(i) of this section) based on its use of the dis-
tributed debt proceeds. Because A used its $100,000
of distributed debt proceeds on a personal expendi-
ture, A’s $2,000 of debt financed distribution interest
expense is personal interest subject to section 163(h)
at A’s level. Pursuant to paragraph (d)(3)(ii) of this
section, each partner treats its expenditure interest
expense (determined under paragraph (d)(2)(ii) of
this section) in the same manner as the distributed
debt proceeds that were allocated to available ex-
penditures under paragraph (d)(1)(i) of this section.
Thus, all $3,000 of A’s expenditure interest expense
and all $5,000 of B’s expenditure interest expense
is business interest expense. As a result, $8,000 in-
terest expense associated with the distributed debt
proceeds (A’s $3,000 plus B’s $5,000 of expenditure
interest expense treated as business interest expense)
is business interest expense of PRS, subject to sec-
tion 163(j) at the PRS level.
Table 4 to paragraph (h)(2)(v)
The portion of partner A's allocable interest expense that is expenditure interest expense equals the product of:
(d)(2)(ii)(A)Distributed debt proceeds allocated to
=$80,000
available expenditures
(d)(2)(ii)(B)Distributed debt proceeds interest rate=
$10,000
$100,000
(d)(2)(ii)(C)
Partner A’s remaining interest expense
=
$3,000
Aggregate remaining interest expense$8,000
The product of (d)(2)(ii)(A), (B), and (C).=$3,000
Table 5 to paragraph (h)(2)(v)
The portion of partner B's allocable interest expense that is expenditure interest expense equals the product of:
(d)(2)(ii)(A)Distributed debt proceeds allocated to
=$80,000
available expenditures
(d)(2)(ii)(B)Distributed debt proceeds interest rate=
$10,000
$100,000
(d)(2)(ii)(C)
Partner B’s remaining interest expense
=
$5,000
Aggregate remaining interest expense$8,000
The product of (d)(2)(ii)(A), (B), and (C).=$5,000
Table 6 to paragraph (h)(2)(vii)
Partner APartner B
Allocable interest expense
Debt financed distribution interest expense
Personal interest . . . . . . . . . . . . . . . . . . . . . .$2,000$0
Expenditure interest expense
Business interest (to PRS) . . . . . . . . . . . . . .$3,000$5,000
Excess interest expense
N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$0$0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000$5,000

Bulletin No. 2020–40 843 September 28, 2020
(3) Example 3—(i) Facts. The facts are the
same as in Example 2 in paragraph (h)(2)(i) of this
section, except PRS paid $20,000 in manufacturing
expenses, made a distribution of $75,000 to A (the
proceeds of which A used on a personal expendi-
ture), and made a distribution of $25,000 to B (the
proceeds of which B used on a trade or business ex-
penditure). As a result, in Year 1 PRS had $20,000
of available expenditures (as defined in paragraph
(d)(5)(ii) of this section) and $100,000 of distribut-
ed debt proceeds (as defined in paragraph (d)(5)(iii)
of this section). The $20,000 manufacturing expen-
diture was to acquire assets used in PRS’s manufac-
turing business. At the end of Year 1, the adjusted
tax basis of PRS’s assets used in manufacturing was
$720,000 and the adjusted tax basis of PRS’s assets
used in leasing was $200,000. In addition, at the
end of Year 1, the adjusted basis of PRS’s assets
held for investment (within the meaning of section
163(d)(5)) was $100,000.
(ii) Applicability. Because PRS treated all
$100,000 of the loan proceeds as having been dis-
tributed under §1.163-8T, PRS allocated all $10,000
of the interest expense associated with the loan to the
distribution. Thus, pursuant to paragraph (b)(1)(vi)
of this section, PRS must determine the tax treatment
of such $10,000 of interest expense in the manner
provided in paragraph (d) of this section.
(iii) Debt allocated to distributions. Under para-
graph (d)(1)(i) of this section, to the extent PRS has
available expenditures (as defined under paragraph
(d)(5)(ii) of this section), it must allocate any distrib-
uted debt proceeds (as defined under paragraph (d)
(5)(i) of this section) to such available expenditures.
Here, PRS has distributed debt proceeds of $100,000
and available expenditures of $20,000. Thus, PRS
allocates $20,000 of the distributed debt proceeds
to available expenditures. Pursuant to paragraph (d)
(1)(ii) of this section, PRS allocates the remaining
$80,000 of distributed debt proceeds to debt financed
distributions.
(iv) Allocation of interest expense – debt fi-
nanced distribution interest expense. Pursuant to
paragraph (d)(2)(i) of this section, A treats $5,000 of
its allocable interest expense as debt financed distri-
bution interest expense, which is the lesser of $5,000
or $6,000 ((A) $75,000 x (B) 80% x (C) 10%) and B
treats $2,000 of its allocable interest expense as debt
financed distribution interest expense, which is the
lesser of $5,000 or $2,000 ((A) $25,000 x (B) 80%
x (C) 10%).
Table 7 to paragraph (h)(3)(iv)
The portion of partner A's allocable interest expense that is debt financed distribution interest expense equals the lesser of:
Partner A's allocable interest expense; or=$5,000
(d)(2)(i)(A)Portion of debt proceeds
=$75,000
allocated to partner A
(d)(2)(i)(B)
Debt financed distributions
=
$80,000
Distributed debt proceeds$100,000
(d)(2)(i)(C)Distributed debt proceeds
=
$10,000
interest rate$100,000
The product of (d)(2)(i)(A), (B), and (C).=$6,000
Table 8 to paragraph (h)(3)(iv)
The portion of partner B's allocable interest expense that is debt financed distribution interest expense equals the lesser of:
Partner B's allocable interest expense; or=$5,000
(d)(2)(i)(A)Portion of debt proceeds
=$25,000
allocated to partner B
(d)(2)(i)(B)
Debt financed distributions
=
$80,000
Distributed debt proceeds$100,000
(d)(2)(i)(C)Distributed debt proceeds
=
$10,000
interest rate$100,000
The product of (d)(2)(i)(A), (B), and (C).=$2,000

September 28, 2020 844 Bulletin No. 2020–40
(v) Allocation of interest expense – expenditure
interest expense. Pursuant to paragraph (d)(2)(ii) of
this section, A does not treat any of its allocable in-
terest expense as expenditure interest expense ((A)
$20,000 x (B) 10% x (C) 0%) and B treats $2,000 of
its allocable interest expense as expenditure interest
expense ((A) $20,000 x (B) 10% x (C) 100%).
Table 9 to paragraph (h)(3)(v)
The portion of partner A's allocable interest expense that is expenditure interest expense equals the product of:
(d)(2)(ii)(A)
Distributed debt proceeds allocated to
available expenditures
=$20,000
(d)(2)(ii)(B)Distributed debt proceeds interest rate=
$10,000
$100,000
(d)(2)(ii)(C)
Partner A’s remaining interest expense
=
$0
Aggregate remaining interest expense$3,000
The product of (d)(2)(ii)(A), (B), and (C).=$0
Table 10 to paragraph (h)(3)(v)
The portion of partner B's allocable interest expense that is expenditure interest expense equals the product of:
(d)(2)(ii)(A)Distributed debt proceeds allocated to
=$20,000
available expenditures
(d)(2)(ii)(B)Distributed debt proceeds interest rate=
$10,000
$100,000
(d)(2)(ii)(C)
Partner B’s remaining interest expense
=
$3,000
Aggregate remaining interest expense$3,000
The product of (d)(2)(ii)(A), (B), and (C).=$2,000
(vi) Allocation of interest expense – excess inter-
est expense. Pursuant to paragraph (d)(2)(iii) of this
section, A does not treat any of its allocable interest
expense as excess interest expense ($5,000 of allo-
cable interest expense, less $5,000 of debt financed
distribution interest expense, less $0 of expenditure
interest expense) and B treats $1,000 of its allocable
interest expense as excess interest expense ($5,000
of allocable interest expense, less $2,000 of debt fi-
nanced distribution interest expense, less $2,000 of
expenditure interest expense).
(vii) Tax treatment of interest expense. Pursuant
to paragraph (d)(3)(i) of this section, each partner
determines the tax treatment of its debt financed
distribution interest expense based on its use of the
distributed debt proceeds. A used its share of the
distributed debt proceeds to make personal expen-
ditures. Thus, A’s $5,000 of debt financed distribu-
tion interest expense is subject to section 163(h) at
A’s level. B used its share of the distributed debt
proceeds to make trade or business expenditures.
Thus, B’s $2,000 of debt financed distribution in-
terest expense is subject to section 163(j) at B’s
level. Pursuant to paragraph (d)(3)(ii) of this sec-
tion, B treats its $2,000 of expenditure interest ex-
pense in the same manner as the distributed debt
proceeds were allocated to available expenditures
under paragraph (d)(1)(i) of this section. Thus, B’s
$2,000 of expenditure interest expense is business
interest expense, subject to section 163(j) at the lev-
el of PRS. Pursuant to paragraph (d)(3)(iii) of this
section, B determines the tax treatment of its $1,000
of excess interest expense by allocating distributed
debt proceeds among the adjusted basis of PRS’s
assets, reduced by any debt allocated to such assets.
For purposes of paragraph (d)(3)(iii) of this section,
PRS’s has $700,000 ($720,000 - $20,000 debt pro-
ceeds allocated to such assets) of basis in its man-
ufacturing assets, $200,000 of basis in its leasing
assets, and $100,000 of basis in its assets held for
investment. Thus, B’s $1,000 of excess interest ex-
pense is treated as $700 of business interest expense
subject to 163(j) at the PRS level, $200 of interest
expense related to a rental activity, and $100 of in-
vestment interest expense.

Bulletin No. 2020–40 845 September 28, 2020
(4) Example 4. The facts are the same as in Ex-
ample 2 in paragraph (h)(2)(i) of this section. In Year
2, A sells its interest in PRS to C. C is not related to
either A or B under the rules of either section 267(b)
or section 707(b)(1). No facts have changed with
respect to PRS’s loan. Under these facts, and only
for purposes of this section, C’s share of the debt fi-
nanced distribution interest expense will be treated
as excess interest expense pursuant to paragraph (d)
(4)(i) of this section. Accordingly, C will determine
the character of its share of this interest expense by
allocating the debt proceeds associated with this in-
terest expense among the assets of PRS under para-
graph (d)(3)(iii) of this section.
(5) Example 5. The facts are the same as in Ex-
ample 4 in paragraph (h)(4) of this section, except
that C is a party that is related to A under the rules
of either section 267(b) or section 707(b)(1). Under
these facts, and only for purposes of this section, A’s
$2,000 of debt financed distribution interest expense
shall, pursuant to paragraph (d)(4)(i) of this section,
continue to be treated as debt financed distribution
interest expense of C, subject to the same tax treat-
ment as it was to the transferor (personal interest
expense).
(6) Example 6. The facts are the same as in Ex-
ample 2 in paragraph (h)(2)(i) of this section, except
that in Year 2 B sells its interest in PRS to D. D is not
related to either A or B under the rules of either sec-
tion 267(b) or section 707(b)(1). No other facts have
changed with respect to PRS’s loan. Under these
facts, the tax treatment of the expenditure interest ex-
pense does not change with respect to PRS or any of
the partners as a result of the ownership change pur-
suant to paragraph (g) of this section. Accordingly,
the tax treatment of the expenditure interest expense
allocable to D under section 704(b) is identical to the
expenditure interest expense that had been allocable
to B prior to the sale.
(7) Example 7—(i) Facts. A (an individual) and
B (an individual) are equal shareholders in S cor-
poration X. X conducts a manufacturing business,
which is a trade or business as defined in §1.163(j)-
1(b)(44) (manufacturing). In Year 1, X borrowed
$100,000 from an unrelated third-party lender (the
loan). Other than the loan, X does not have any out-
standing debt. During Year 1, X paid $100,000 in
manufacturing expenses and made a $50,000 distri-
bution to each of its shareholders, A and B, which
each shareholder used to make a personal expendi-
ture. Under §1.163-8T, X treated all $100,000 of the
loan proceeds as having been distributed to A and B.
As a result, in Year 1 X had $100,000 of available
expenditures (as defined in paragraph (d)(5)(ii) of
this section) and $100,000 of distributed debt pro-
ceeds (as defined in paragraph (d)(5)(iii) of this sec-
tion). X paid $10,000 in interest expense that accrued
during Year 1 on the loan, and allocated such interest
expense under section 1366(a) equally to A and B
($5,000 each). Thus, A and B each had $5,000 of al-
locable interest expense (as defined in paragraph (d)
(5)(i) of this section).
(ii) Applicability. Because X treated all $100,000
of the loan proceeds as having been distributed to A
and B under §1.163-8T, PRS allocated all $10,000 of
the interest expense associated with the loan to the
distributions. Thus, pursuant to paragraph (b)(1)(vi)
of this section, PRS must determine the tax treatment
of such $10,000 of interest expense in the manner
provided in paragraph (d) of this section.
(iii) Debt allocated to distributions. Under para-
graph (d)(1)(i) of this section, to the extent X has
available expenditures (as defined under paragraph
(d)(5)(ii) of this section), it must allocate any dis-
tributed debt proceeds (as defined under paragraph
(d)(5)(iii) of this section) to such available expen-
ditures. Here, X has distributed debt proceeds of
$100,000 and available expenditures of $100,000.
Thus, PRS allocates all $100,000 of the distributed
debt proceeds to available expenditures
(iv) Allocation of interest expense. Because all of
X’s distributed debt proceeds are allocated to avail-
able expenditures (pursuant to paragraph (d)(1)(i) of
this section), A and B each treat all $5,000 of their
allocable interest expense as expenditure interest
expense.
(v) Tax treatment of interest expense. Pursuant
to paragraph (d)(3)(ii) of this section, each partner
treats its expenditure interest expense (determined
under paragraph (d)(2)(ii) of this section) in the same
manner as the distributed debt proceeds that were al-
located to available expenditures under paragraph
(d)(1)(i) of this section. Thus, A’s $5,000 of expen-
diture interest expense and B’s $5,000 of expendi-
ture interest expense is treated as business interest
expense of X, subject to section 163(j) at X’s level.
Table 11 to paragraph (h)(3)(vii)
Partner APartner B
Allocable interest expense
Debt financed distribution interest expense
Personal interest . . . . . . . . . . . . . . . . . . . . . .$5,000$0
Business interest (but not to PRS). . . . . . . . .$0$2,000
Expenditure interest expense
Business interest (to PRS). . . . . . . . . . . . . . .$0$2,000
Excess interest expense
Business interest (to PRS). . . . . . . . . . . . . . .$0$700
Rental activity interest expense. . . . . . . . . . .$0$200
Investment interest expense . . . . . . . . . . . . .$0$100
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000$5,000
Table 12 to paragraph (h)(7)(v)
Partner APartner B
Allocable interest expense
Debt financed distribution interest expense
N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$0$0
Expenditure interest expense
Business interest (to X) . . . . . . . . . . . . . .$5,000$5,000
Excess interest expense
N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$0$0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$5,000$5,000

September 28, 2020 846 Bulletin No. 2020–40
(i) Applicability date. This section
applies to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER]. However, taxpayers and their relat-
ed parties, within the meaning of sections
267(b) and 707(b)(1), may choose to ap-
ply the rules of this section to a taxable
year beginning after December 31, 2017,
and before [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL
REGISTER], provided that they consis-
tently apply the rules of this section to that
taxable year and each subsequent taxable
year.
Par. 3. Section 1.163-15 is added to
read as follows:
§1.163-15 Debt Proceeds Distributed
from Any Taxpayer Account or from
Cash.
(a) In general. Regardless of para-
graphs (c)(4) and (5) of §1.163-8T, in
the case of debt proceeds deposited in
an account, a taxpayer that is applying
§1.163-8T or §1.163-14 may treat any ex-
penditure made from any account of the
taxpayer, or from cash, within 30 days
before or 30 days after debt proceeds are
deposited in any account of the taxpayer
as made from such proceeds to the extent
thereof. Similarly, in the case of debt pro-
ceeds received in cash, a taxpayer that is
applying §1.163-8T or §1.163-14 may
treat any expenditure made from any ac-
count of the taxpayer, or from cash, within
30 days before or 30 days after debt pro-
ceeds are received in cash as made from
such proceeds to the extent thereof. For
purposes of this section, terms used have
the same meaning as in §1.163-8T(c)(4)
and (5).
(b) Applicability date. This section
applies to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER]. However, taxpayers and their relat-
ed parties, within the meaning of sections
267(b) and 707(b)(1), may choose to ap-
ply the rules of this section to a taxable
year beginning after December 31, 2017,
and before [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL
REGISTER], provided that they consis-
tently apply the rules of this section to that
taxable year and each subsequent taxable
year.
Par. 4. As added in a final rule pub-
lished elsewhere in this issue of the Feder-
al Register, effective November 13, 2020,
§1.163(j)-0 is amended by:
1. Revising the entries for §1.163(j)-
1(b)(1)(iv)(B), (b)(22)(iii)(F), and (b)
(35);
2. Adding entries for §§1.163(j)-1(b)
(1)(iv)(E), (c)(4), and (c)(4)(i) and (ii);
3. Adding an entry for §1.163(j)-2(d)
(3);
4. Revising the entries for §§1.163(j)-
2(k) and 1.163(j)-6(c)(1) and (2);
5. Adding an entry for §1.163(j)-6(d)
(3), (4), and (5) and (e)(5);
6. Revising the entries for §§1.163(j)-
6(f)(1)(iii), (g)(4), (h)(4) and (5), (j), and
(n) and 1.163(j)-7;
7. Adding an entry for §1.163(j)-8;
8. Revising the entries for §1.163(j)-
10(c)(5)(ii)(D) and (f).
The revisions and additions read as fol-
lows:
§1.163(j)-0 Table of Contents.
* * * * *
§1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(B) Deductions by members of a con-
solidated group.
(1) In general.
(2) Application of the alternative com-
putation method.
* * * * *
(E) Alternative computation method.
(1) Alternative computation method for
property dispositions.
(2) Alternative computation method for
dispositions of member stock.
(3) Alternative computation method for
dispositions of partnership interests.
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends.
(1) In general.
(2) Limitation on amount treated as in-
terest income.
(3) Conduit amounts.
(4) Holding period.
(5) Exception to holding period re-
quirement for money market funds and
certain regularly declared dividends.
* * * * *
(35) Section 163(j) interest dividend.
(i) In general.
(ii) Reduction in the case of excess re-
ported amounts.
(iii) Allocation of excess reported
amount.
(A) In general.
(B) Special rule for noncalendar year
RICs.
(iv) Definitions.
(A) Reported section 163(j) interest
dividend amount.
(B) Excess reported amount.
(C) Aggregate reported amount.
(D) Post-December reported amount.
(E) Excess section 163(j) interest in-
come.
(v) Example.
* * * * *
(c) * * *
* * * * *
(4) Alternative computation for certain
adjustments to tentative taxable income,
and section 163(j) interest dividends.
(i) Alternative computation for certain
adjustments to tentative taxable income.
(ii) Section 163(j) interest dividends.
* * * * *
§1.163(j)-2 Deduction for business
interest expense limited.
* * * * *
(b) * * *
* * * * *
(3) * * *
* * * * *
(iii) Transactions to which section 381
applies.
(iv) Consolidated groups.
* * * * *
(d) * * *
* * * * *
(3) Determining a syndicate’s loss
amount.
* * * * *
(k) Applicability dates.
(1) In general.

Bulletin No. 2020–40 847 September 28, 2020
(2) Paragraphs (b)(iii), (b)(iv), and (d)
(3).
§1.163(j)-6 Application of the
business interest deduction limitation
to partnerships and subchapter S
Corporations
* * * * *
(c) * * *
(1) Modification of business interest
income for partnerships.
(2) Modification of business interest
expense for partnerships.
* * * * *
(d) * * *
* * * * *
(3) Section 743(b) adjustments and
publicly traded partnerships.
(4) Modification of adjusted taxable in-
come for partnerships.
(5) Election to use 2019 adjusted tax-
able income for taxable years beginning
in 2020.
* * * * *
(e) * * *
* * * * *
(5) Partner basis items, remedial items,
and publicly traded partnerships..
(6) Partnership deductions capitalized
by a partner.
* * * * *
(f) * * *
(1) * * *
(iii) Exception applicable to publicly
traded partnerships.
* * * * *
(g) * * *
(4) Special rule for taxable years begin-
ning in 2019 and 2020.
* * * * *
(h) * * *
(4) Partner basis adjustments upon liq-
uidating distribution.
(5) Partnership basis adjustments upon
partner dispositions.
* * * * *
(j) Tiered partnerships.
(1) Purpose.
(2) Section 704(b) capital account ad-
justments.
(3) Basis adjustments of upper-tier
partnership.
(4) Treatment of excess business inter-
est expense allocated by lower-tier part-
nership to upper-tier partnership.
(5) UTP EBIE conversion events.
(i) Allocation to upper-tier partnership
by lower-tier partnership of excess tax-
able income (or excess business interest
income).
(ii) Upper-tier partnership disposition
of lower-tier partnership interest.
(6) Disposition of specified partner’s
partnership interest.
(i) General rule.
(ii) Special rules.
(A) Distribution in liquidation of a
specified partner’s partnership interest.
(B) Contribution of a specified part-
ner’s partnership interest.
(7) Effect of basis adjustments allocat-
ed to UTP EBIE.
(i) In general.
(ii) UTP EBIE treated as deductible
business interest expense.
(iii) UTP EBIE treated as excess busi-
ness interest expense.
(iv) UTP EBIE reduced due to a dis-
position.
(8) Anti-loss trafficking.
(i) Transferee specified partner.
(ii) UTP EBIE without a specified part-
ner.
(iii) Disallowance of addback.
(9) Determining allocable ATI and al-
locable business interest income of up-
per-tier partnership partners.
(i) In general.
(ii) Upper-tier partner’s allocable ATI.
(iii) Upper-tier partner’s allocable busi-
ness interest income.
(l) * * *
* * * * *
(4) * * *
(iv) S corporation deductions capital-
ized by an S corporation shareholder.
* * * * *
(n) Treatment of self-charged lending
transactions between partnerships and
partners.
(o) * * *
* * * * *
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
(a) Overview.
* * * * *
(c) Application of section 163(j) to
CFC group members of a CFC group.
(1) Scope.
(2) Calculation of section 163(j) lim-
itation for a CFC group for a specified
period.
(i) In general.
(ii) Certain transactions between CFC
group members disregarded.
(iii) CFC group treated as a single C
corporation for purposes of allocating
items to an excepted trade or business.
(iv) CFC group treated as a single tax-
payer for purposes of determining interest.
(3) Deduction of business interest ex-
pense.
(i) CFC group business interest ex-
pense.
(A) In general.
(B) Modifications to relevant terms.
(ii) Carryforwards treated as attribut-
able to the same taxable year.
(iii) Multiple specified taxable years
of a CFC group member with respect to a
specified period.
(iv) Limitation on pre-group disal-
lowed business interest expense carryfor-
ward.
(A) General rule.
(1) CFC Group member pre-group dis-
allowed business interest expense carry-
forward.
(2) Subgrouping.
(B) Deduction of pre-group disallowed
business interest expense carryforwards.
(4) Currency translation.
(5) Special rule for specified periods
beginning in 2019 or 2020.
(i) 50 percent ATI limitation applies to
a specified period of a CFC group.
(ii) Election to use 2019 ATI applies to
a specified period of a CFC group.
(A) In general.
(B) Specified taxable years that do not
begin in 2020.
(d) Determination of a specified group
and specified group members.
(1) Scope.
(2) Rules for determining a specified
group.
(i) Definition of a specified group.
(ii) Indirect ownership.
(iii) Specified group parent.
(iv) Qualified U.S. person.
(v) Stock.
(vi) Options treated as exercised.
(vii) When a specified group ceases to
exist.
(3) Rules for determining a specified
group member.

September 28, 2020 848 Bulletin No. 2020–40
(e) Rules and procedures for treating a
specified group as a CFC group.
(1) Scope.
(2) CFC group and CFC group mem-
ber.
(i) CFC group.
(ii) CFC group member.
(3) Duration of a CFC group.
(4) Joining or leaving a CFC group.
(5) Manner of making or revoking a
CFC group election.
(i) In general.
(ii) Revocation by election.
(iii) Timing.
(iv) Election statement.
(v) Effect of prior CFC group election.
(f) Treatment of a CFC group member
that has ECI.
(1) In general.
(2) Ordering rule.
(g) * * *
* * * * *
(3) Treatment of certain taxes.
(4) Anti-abuse rule.
(i) In general.
(ii) ATI adjustment amount.
(A) In general.
(B) Special rule for taxable years or
specified periods beginning in 2019 or
2020.
(iii) Applicable partnership.
(h) Election to apply safe-harbor.
(1) In general.
(2) Eligibility for safe-harbor election.
(i) Stand-alone applicable CFC.
(ii) CFC group.
(A) In general.
(B) Currency translation.
(3) Eligible amount.
(i) In general.
(ii) Amounts properly allocable to a
non-excepted trade or business.
(4) Qualified tentative taxable income.
(5) Manner of making a safe-harbor
election.
(i) In general.
(ii) Election statement.
(6) Special rule for taxable years or
specified periods beginning in 2019 or
2020.
* * * * *
(j) Rules regarding the computation of
ATI of certain United States shareholders
of applicable CFCs.
(1) In general.
(2) Rules for determining CFC excess
taxable income.
(i) In general.
(ii) Applicable CFC is a stand-alone
applicable CFC.
(iii) Applicable CFC is a CFC group
member.
(iv) ATI percentage.
(3) Cases in which an addition to tenta-
tive taxable income is not allowed.
(4) Special rule for taxable years or
specified periods beginning in 2019 or
2020.
(k) Definitions.
(1) Applicable partnership.
(2) Applicable specified taxable year.
(3) ATI adjustment amount.
(4) ATI percentage.
(5) CFC excess taxable income.
(6) CFC group.
(7) CFC group election.
(8) CFC group member.
(9) CFC-level net deemed tangible in-
come return.
(i) In general.
(ii) Amounts properly allocable to a
non-excepted trade or business.
(10) Cumulative section 163(j) pre-
group carryforward limitation.
(11) Current group.
(12) Designated U.S. person.
(13) ECI deemed corporation.
(14) Effectively connected income.
(15) Eligible amount.
(16) Former group.
(17) Loss member.
(18) Payment amount.
(19) Pre-group disallowed business in-
terest expense carryforward.
(20) Qualified tentative taxable in-
come.
(21) Qualified U.S. person.
(22) Relevant period.
(23) Safe-harbor election.
(24) Specified borrower.
(25) Specified group.
(26) Specified group member.
(27) Specified group parent.
(28) Specified lender.
(29) Specified period.
(i) In general.
(ii) Short specified period.
(30) Specified taxable year.
(31) Stand-alone applicable CFC.
(32) Stock.
(l) Examples.
(m) Applicability dates.
(1) General applicability date.
(2) Exception.
§1.163(j)-8 Application of the section
163(j) limitation to foreign persons with
effectively connected income.
(a) Overview.
(b) Application to a specified foreign
person with ECI.
(1) In general.
(2) Modification of adjusted taxable
income.
(3) Modification of business interest
expense.
(4) Modification of business interest
income.
(5) Modification of floor plan financing
interest expense.
(6) Modification of allocation of inter-
est expense and interest income that is al-
locable to a trade or business.
(c) Rules for a specified foreign partner.
(1) Characterization of excess taxable
income.
(i) In general.
(ii) Specified ATI ratio.
(iii) Distributive share of ECI.
(iv) Distributive share of non-ECI.
(2) Characterization of excess business
interest expense.
(i) Allocable ECI excess BIE.
(ii) Allocable non-ECI excess BIE.
(3) Characterization of deductible busi-
ness interest expense.
(i) In general.
(ii) Allocation between allocable ECI
deductible BIE and allocable non-ECI de-
ductible BIE.
(A) Allocation to hypothetical deduct-
ible amounts.
(1) In general.
(2) Limitation.
(B) Allocation of remaining deductible
amounts.
(iii) Hypothetical partnership deduct-
ible business interest expense.
(A) Hypothetical partnership ECI de-
ductible BIE.
(B) Hypothetical partnership non-ECI
deductible BIE.
(4) Characterization of excess business
interest income.
(i) In general.
(ii) Specified BII ratio.
(iii) Allocable ECI BII.
(5) Rules for determining ECI.
(d) Characterization of disallowed
business interest expense by a relevant
foreign corporation with ECI.

Bulletin No. 2020–40 849 September 28, 2020
(1) Scope.
(2) Characterization of disallowed
business interest expense.
(i) FC ECI disallowed BIE.
(ii) FC non-ECI disallowed BIE.
(3) Characterization of deductible busi-
ness interest expense.
(i) In general.
(ii) Allocation between FC ECI deduct-
ible BIE and FC non-ECI deductible BIE.
(A) Allocation to hypothetical deduct-
ible amounts.
(1) In general.
(2) Limitation.
(B) Allocation of remaining deductible
amounts.
(iii) Hypothetical FC deductible busi-
ness interest expense.
(A) Hypothetical FC ECI deductible BIE.
(B) Hypothetical FC non-ECI deduct-
ible BIE.
(e) Rules regarding disallowed busi-
ness interest expense.
(1) Retention of character in a succeed-
ing taxable year.
(2) Deemed allocation of excess busi-
ness interest expense of a partnership to a
specified foreign partner.
(3) Ordering rule for conversion of ex-
cess business interest expense to business
interest expense paid or accrued by a part-
ner.
(4) Allocable ECI excess BIE and al-
locable non-ECI excess BIE retains its
character when treated as business interest
expense paid or accrued in a succeeding
taxable year.
(f) Coordination of the application of
section 163(j) with §1.882-5 and similar
provisions and with the branch profits tax.
(1) Coordination of section 163(j) with
§1.882-5 and similar provisions.
(i) Ordering rule.
(ii) Treatment of excess business inter-
est expense.
(iii) Attribution of certain §1.882-5 in-
terest expense among the foreign corpora-
tion and its partnership interests.
(A) In general.
(B) Attribution of interest expense on
U.S. booked liabilities.
(C) Attribution of excess §1.882-5
three-step interest expense.
(1) In general.
(2) Attribution of excess §1.882-5
three-step interest expense to the foreign
corporation.
(3) Attribution of excess §1.882-5
three-step interest expense to partnerships.
(i) In general.
(ii) Direct and indirect partnership in-
terests.
(4) Limitation on attribution of excess
§1.882-5 three-step interest expense.
(2) Coordination with the branch prof-
its tax.
(g) Definitions.
(1) §1.882-5 and similar provisions.
(2) §1.882-5 three-step interest ex-
pense.
(3) Allocable ECI BIE.
(4) Allocable ECI BII.
(5) Allocable ECI deductible BIE.
(6) Allocable ECI excess BIE.
(7) Allocable non-ECI BIE.
(8) Allocable non-ECI deductible BIE.
(9) Allocable non-ECI excess BIE.
(10) Distributive share of ECI.
(11) Distributive share of non-ECI.
(12) Effectively connected income.
(13) Excess §1.882-5 three-step inter-
est expense.
(14) FC ECI BIE.
(15) FC ECI deductible BIE.
(16) FC ECI disallowed BIE.
(17) FC non-ECI BIE.
(18) FC non-ECI deductible BIE.
(19) FC non-ECI disallowed BIE.
(20) Hypothetical partnership ECI de-
ductible BIE.
(21) Hypothetical partnership non-ECI
deductible BIE.
(22) Hypothetical FC ECI deductible
BIE.
(23) Hypothetical FC non-ECI deduct-
ible BIE.
(24) Specified ATI ratio.
(25) Specified BII ratio.
(26) Specified foreign partner.
(27) Specified foreign person.
(28) Successor.
(h) Examples.
(i) [Reserved]
(j) Applicability date.
§1.163(j)-10 Allocation of interest
expense, interest income, and other
items of expense and gross income to an
excepted trade or business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-
through rules.
(1) Inapplicability of look-through rule
to partnerships or non-consolidated C cor-
porations to which the small business ex-
emption applies.
(2) Limitation on application of look-
through rule to C corporations.
* * * * *
(f) Applicability dates.
(1) In general.
(2) Paragraph (c)(5)(ii)(D)(2).
Par. 5. As added in a final rule pub-
lished elsewhere in this issue of the Feder-
al Register, effective November 13, 2020,
§ 1.163(j)-1 is amended by:
1. Revising paragraph (b)(1)(iv)(B).
2. Adding paragraphs (b)(1)(iv)(E), (b)
(22)(iii)(F), and (b)(35)
3. In paragraph (c)(1), removing “para-
graphs (c)(2) and (3)” from the first sen-
tence and adding “paragraphs (c)(2), (3),
and (4)” in its place.
4. Adding paragraph (c)(4).
The revisions and additions read as fol-
lows:
§1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(B) Deductions by members of a con-
solidated group—(1) In general. If para-
graph (b)(1)(ii)(C), (D), or (E) of this sec-
tion applies to adjust the tentative taxable
income of a taxpayer, and if the taxpayer
does not use the computation method in
paragraph (b)(1)(iv)(E) of this section,
the amount of the adjustment under para-
graph (b)(1)(ii)(C) of this section equals
the greater of the allowed or allowable
depreciation, amortization, or depletion
of the property, as provided under sec-
tion 1016(a)(2), for any member of the
consolidated group for the taxable years
beginning after December 31, 2017, and
before January 1, 2022, with respect to
such property.
(2) Application of the alternative com-
putation method. If paragraph (b)(1)(ii)
(C), (D), or (E) of this section applies
to adjust the tentative taxable income of
a taxpayer, and if the taxpayer uses the
computation method in paragraph (b)(1)
(iv)(E) of this section, the amount of the

September 28, 2020 850 Bulletin No. 2020–40
adjustment under paragraph (b)(1)(ii)(C)
of this section equals the lesser of
(i) any gain recognized on the sale or
other disposition of such property by the
taxpayer (or, if the taxpayer is a member
of a consolidated group, the consolidated
group), and
(ii) the greater of the allowed or allow-
able depreciation, amortization, or deple-
tion of the property, as provided under
section 1016(a)(2), for the taxpayer (or, if
the taxpayer is a member of a consolidated
group, the consolidated group) for the tax-
able years beginning after December 31,
2017, and before January 1, 2022, with
respect to such property.
* * * * *
(E) Alternative computation method.
If paragraph (b)(1)(ii)(C), (D), or (E)
of this section applies to adjust the ten-
tative taxable income of a taxpayer, the
taxpayer may compute the amount of the
adjustments required by such paragraph
using the formulas in paragraph (b)(1)
(iv)(E)(1), (2), and (3) of this section,
respectively, provided that the taxpayer
applies such formulas to all dispositions
for which an adjustment is required un-
der paragraph (b)(1)(ii)(C), (D), or (E) of
this section.
(1) Alternative computation method for
property dispositions. With respect to the
sale or other disposition of property, the
lesser of
(i) any gain recognized on the sale or
other disposition of such property by the
taxpayer (or, if the taxpayer is a member
of a consolidated group, the consolidated
group), and
(ii) the greater of the allowed or allow-
able depreciation, amortization, or deple-
tion of the property, as provided under
section 1016(a)(2), for the taxpayer (or, if
the taxpayer is a member of a consolidated
group, the consolidated group) for the tax-
able years beginning after December 31,
2017, and before January 1, 2022, with
respect to such property.
(2) Alternative computation method
for dispositions of member stock. With
respect to the sale or other disposition of
stock of a member of a consolidated group
by another member, the lesser of (i) any
gain recognized on the sale or other dis-
position of such stock, and (ii) the invest-
ment adjustments under §1.1502-32 with
respect to such stock that are attributable
to deductions described in paragraph (b)
(1)(ii)(C) of this section.
(3) Alternative computation method
for dispositions of partnership interests.
With respect to the sale or other dispo-
sition of an interest in a partnership, the
lesser of (i) any gain recognized on the
sale or other disposition of such interest,
and (ii) the taxpayer’s (or, if the taxpayer
is a consolidated group, the consolidated
group’s) distributive share of deductions
described in paragraph (b)(1)(ii)(C) of
this section with respect to property held
by the partnership at the time of such sale
or other disposition to the extent such
deductions were allowable under section
704(d).
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends—
(1) In general. Except as otherwise pro-
vided in this paragraph (b)(22)(iii)(F), a
section 163(j) interest dividend is treated
as interest income.
(2) Limitation on amount treated as
interest income. A shareholder may not
treat any part of a section 163(j) interest
dividend as interest income to the extent
the amount of the section 163(j) interest
dividend exceeds the excess of the amount
of the entire dividend that includes the
section 163(j) interest dividend over the
sum of the conduit amounts other than
interest-related dividends under section
871(k)(1)(C) and section 163(j) interest
dividends that affect the shareholder’s
treatment of that dividend.
(3) Conduit amounts. For purposes of
paragraph (b)(22)(iii)(F)(2) of this sec-
tion, the term conduit amounts means,
with respect to any category of income
(including tax-exempt interest) earned by
a RIC for a taxable year, the amounts iden-
tified by the RIC (generally in a designa-
tion or written report) in connection with
dividends paid by the RIC for that taxable
year that are subject to a limit determined
by reference to that category of income.
For example, a RIC’s conduit amount with
respect to its net capital gain is the amount
of capital gain dividends that the RIC pays
under section 852(b)(3)(C).
(4) Holding period. Except as provid-
ed in paragraph (b)(22)(iii)(F)(5) of this
section, no dividend is treated as interest
income under paragraph (b)(22)(iii)(F)(1)
of this section if the dividend is received
with respect to a share of RIC stock—
(i) That is held by the shareholder for
180 days or less (taking into account the
principles of section 246(c)(3) and (4))
during the 361-day period beginning on
the date which is 180 days before the date
on which the share becomes ex-dividend
with respect to such dividend; or
(ii) To the extent that the shareholder is
under an obligation (whether pursuant to
a short sale or otherwise) to make related
payments with respect to positions in sub-
stantially similar or related property.
(5) Exception to holding period re-
quirement for money market funds and
certain regularly declared dividends.
Paragraph (b)(22)(iii)(F)(4)(i) of this
section does not apply to dividends dis-
tributed by any RIC regulated as a mon-
ey market fund under 17 CFR 270.2a-7
(Rule 2a-7 under the 1940 Act) or to
regular dividends paid by a RIC that de-
clares section 163(j) interest dividends
on a daily basis in an amount equal to
at least 90 percent of its excess section
163(j) interest income, as defined in para-
graph (b)(35)(iv)(E) of this section, and
distributes such dividends on a monthly
or more frequent basis.
* * * * *
(35) Section 163(j) interest dividend.
The term section 163(j) interest dividend
means a dividend paid by a RIC for a tax-
able year for which section 852(b) applies
to the RIC, to the extent described in para-
graph (b)(35)(i) or (ii) of this section, as
applicable.
(i) In general. Except as provided in
paragraph (b)(35)(ii) of this section, a sec-
tion 163(j) interest dividend is any divi-
dend, or part of a dividend, that is reported
by the RIC as a section 163(j) interest div-
idend in written statements furnished to its
shareholders.
(ii) Reduction in the case of excess re-
ported amounts. If the aggregate reported
amount with respect to the RIC for the
taxable year exceeds the excess section
163(j) interest income of the RIC for such
taxable year, the section 163(j) interest
dividend is—
(A) The reported section 163(j) interest
dividend amount; reduced by
(B) The excess reported amount that
is allocable to that reported section 163(j)
interest dividend amount.

Bulletin No. 2020–40 851 September 28, 2020
(iii) Allocation of excess reported
amount—(A) In general. Except as pro-
vided in paragraph (b)(35)(iii)(B) of this
section, the excess reported amount, if
any, that is allocable to the reported sec-
tion 163(j) interest dividend amount is
that portion of the excess reported amount
that bears the same ratio to the excess
reported amount as the reported section
163(j) interest dividend amount bears to
the aggregate reported amount.
(B) Special rule for noncalendar year
RICs. In the case of any taxable year that
does not begin and end in the same cal-
endar year, if the post-December report-
ed amount equals or exceeds the excess
reported amount for that taxable year,
paragraph (b)(35)(iii)(A) of this section
is applied by substituting “post-December
reported amount” for “aggregate reported
amount,” and no excess reported amount
is allocated to any dividend paid on or be-
fore December 31 of such taxable year.
(iv) Definitions. The following defini-
tions apply for purposes of this paragraph
(b)(35):
(A) Reported section 163(j) inter-
est dividend amount. The term reported
section 163(j) interest dividend amount
means the amount of a dividend distri-
bution reported to the RIC’s shareholders
under paragraph (b)(35)(i) of this section
as a section 163(j) interest dividend.
(B) Excess reported amount. The term
excess reported amount means the excess
of the aggregate reported amount over the
RIC’s excess section 163(j) interest in-
come for the taxable year.
(C) Aggregate reported amount. The
term aggregate reported amount means
the aggregate amount of dividends report-
ed by the RIC under paragraph (b)(35)(i)
of this section as section 163(j) interest
dividends for the taxable year (including
section 163(j) interest dividends paid after
the close of the taxable year described in
section 855).
(D) Post-December reported amount.
The term post-December reported amount
means the aggregate reported amount
determined by taking into account only
dividends paid after December 31 of the
taxable year.
(E) Excess section 163(j) interest in-
come. The term excess section 163(j) in-
terest income means, with respect to a tax-
able year of a RIC, the excess of the RIC’s
business interest income for the taxable
year over the sum of the RIC’s business
interest expense for the taxable year and
the RIC’s other deductions for the tax-
able year that are properly allocable to the
RIC’s business interest income.
(v) Example—(A) Facts. X is a domestic C cor-
poration that has elected to be a RIC. For its taxable
year ending December 31, 2021, X has $100x of
business interest income (all of which is qualified
interest income for purposes of section 871(k)(1)(E))
and $10x of dividend income (all of which is quali-
fied dividend income within the meaning of section
1(h)(11) and would be eligible for the dividends
received deduction under section 243, determined
as described in section 854(b)(3)). X has $10x of
business interest expense and $20x of other deduc-
tions. X has no other items for the taxable year. On
December 31, 2021, X pays a dividend of $80x to
its shareholders, and reports, in written statements to
its shareholders, $71.82x as a section 163(j) interest
dividend; $10x as dividends that may be treated as
qualified dividend income or as dividends eligible
for the dividends received deduction; and $72.73x
as interest-related dividends under section 871(k)(1)
(C). Shareholder A, a domestic C corporation, meets
the holding period requirements in paragraph (b)(22)
(iii)(F)(4) of this section with respect to the stock of
X, and receives a dividend of $8x from X on Decem-
ber 31, 2021.
(B) Analysis. X determines that $18.18x of oth-
er deductions are properly allocable to X’s business
interest income. X’s excess section 163(j) interest
income under paragraph (b)(35)(iv)(E) of this sec-
tion is $71.82x ($100x business interest income
– ($10x business interest expense + $18.18x other
deductions allocated) = $71.82x). Thus, X may re-
port up to $71.82x of its dividends paid on December
31, 2021, as section 163(j) interest dividends to its
shareholders. X may also report up to $10x of its div-
idends paid on December 31, 2021, as dividends that
may be treated as qualified dividend income or as
dividends that are eligible for the dividends received
deduction. X determines that $9.09x of interest ex-
pense and $18.18x of other deductions are properly
allocable to X’s qualified interest income. Therefore,
X may report up to $72.73x of its dividends paid on
December 31, 2021, as interest-related dividends
under section 871(k)(1)(C) ($100x qualified interest
income - $27.27x deductions allocated = $72.73x).
A treats $1x of its $8x dividend as a dividend eligi-
ble for the dividends received deduction and no part
of the dividend as an interest-related dividend under
section 871(k)(1)(C). Therefore, under paragraph (b)
(22)(iii)(F)(2) of this section, A may treat $7x of the
section 163(j) interest dividend as interest income
for purposes of section 163(j) ($8x dividend - $1x
conduit amount = $7x limitation).
* * * * *
(c) * * *
(4) Alternative computation for certain
adjustments to tentative taxable income,
and section 163(j) interest dividends—
(i) Alternative computation for certain
adjustments to tentative taxable income.
Paragraphs (b)(1)(iv)(B) and (E) of this
section apply to taxable years beginning
on or after [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL
REGISTER]. Taxpayers and their relat-
ed parties, within the meaning of sections
267(b) and 707(b)(1), may choose to ap-
ply the rules in paragraphs (b)(1)(iv)(B)
and (E) of this section to a taxable year
beginning after December 31, 2017, and
before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER], 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 and each subsequent
taxable year.
(ii) Section 163(j) interest dividends.
Paragraphs (b)(22)(iii)(F) and (b)(35) of
this section apply to taxable years begin-
ning on or after [DATE 60 DAYS AF-
TER DATE OF PUBLICATION OF
THE FINAL RULE IN THE FEDER-
AL REGISTER]. Taxpayers and their
related parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose to
apply the rules in paragraphs (b)(22)(iii)
(F) and (b)(35) of this section for a taxable
year beginning after December 31, 2017,
and before [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL
REGISTER], so long as the taxpayers
and their related parties consistently apply
the rules of the section 163(j) regulations.
Par. 6. As added in a final rule pub-
lished elsewhere in this issue of the Feder-
al Register, effective November 13, 2020,
§1.163(j)-2 is amended by:
1. Adding paragraphs (b)(3)(iii) and
(iv) and (d)(3).
2. Redesignating paragraph (k) as para-
graph (k)(1).
3. Adding a new subject heading for
paragraph (k).
4. Revising the subject heading of re-
designated paragraph (k)(1).

September 28, 2020 852 Bulletin No. 2020–40
5. Adding paragraph (k)(2).
The additions and revision read as fol-
lows:
§1.163(j)-2 Deduction for business
interest expense limited.
* * * * *
(b) * * *
(3) * * *
(iii) Transactions to which section
381 applies. For purposes of the election
described in paragraph (b)(3)(i) of this
section, and subject to the limitation in
paragraph (b)(3)(ii) of this section, the
2019 ATI of the acquiring corporation in
a transaction to which section 381 applies
equals the amount of the acquiring corpo-
ration’s ATI for its last taxable year begin-
ning in 2019.
(iv) Consolidated groups. For purpos-
es of the election described in paragraph
(b)(3)(i) of this section, and subject to the
limitation in paragraph (b)(3)(ii) of this
section, the 2019 ATI of a consolidated
group equals the amount of the consoli-
dated group’s ATI for its last taxable year
beginning in 2019.
* * * * *
(d) * * *
(3) Determining a syndicate’s loss
amount. For purposes of section 163(j),
losses allocated under section 1256(e)(3)
(B) and §1.448-1T(b)(3) are determined
without regard to section 163(j). See also
§1.1256(e)-2(b).
* * * * *
(k) Applicability dates.
(1) In general. * * *
(2) Paragraphs (b)(3)(iii), (b)(3)(iv),
and (d)(3). Paragraphs (b)(3)(iii) and (iv)
and (d)(3) of this section apply to taxable
years beginning on or after [DATE 60
DAYS AFTER DATE OF PUBLICA-
TION OF THE FINAL RULE IN THE
FEDERAL REGISTER]. However,
taxpayers and their related parties, with-
in the meaning of sections 267(b) and
707(b)(1), may choose to apply the rules
of paragraphs (b)(3)(iii) and (iv) of this
section to a taxable year beginning after
December 31, 2017, and before [DATE
60 DAYS AFTER DATE OF PUBLI-
CATION OF THE FINAL RULE IN
THE FEDERAL REGISTER], provid-
ed that they consistently apply the rules
of paragraphs (b)(3)(iii) and (iv) of this
section and the rules in the section 163(j)
regulations for that taxable year and for
each subsequent taxable year. Taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b), may
choose to apply the rules of paragraph
(d)(3) of this section to a taxable year
beginning after December 31, 2017, and
before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER], provided that they consistently
apply the rules of paragraph (d)(3) of this
section for that taxable year and for each
subsequent taxable year.
Par. 7. As added in a final rule pub-
lished elsewhere in this issue of the Feder-
al Register, effective November 13, 2020,
§1.163(j)-6 is amended by:
1. Adding paragraphs (c)(1) and (2), (d)
(3) through (5), (e)(5) and (6), (f)(1)(iii),
(g)(4), (h)(4) and (5), (j), (l)(4)(iv), (n),
and (o)(24) through (29).
2. Redesignating paragraph (p) as para-
graph (p)(1).
3. Adding a new subject heading for
paragraph (p).
4. Revising the subject heading of new-
ly redesignated paragraph (p)(1).
5. Adding paragraph (p)(2).
The additions and revision read as fol-
lows:
§1.163(j)-6 Application of the
business interest deduction limitation
to partnerships and subchapter S
corporations.
* * * * *
(c) * * *
(1) Modification of business interest
income for partnerships. The business
interest income of a partnership gener-
ally is determined in accordance with
§1.163(j)-1(b)(3). To the extent that in-
terest income of a partnership that is
properly allocable to trades or businesses
that are per se non-passive activities and
is allocated to partners that do not ma-
terially participate (within the meaning
of section 469), as described in section
163(d)(5)(A)(ii), such interest income
shall not be considered business interest
income for purposes of determining the
section 163(j) limitation of a partner-
ship pursuant to §1.163(j)-2(b). A per se
non-passive activity is an activity that is
not treated as a passive activity for pur-
poses of section 469 regardless of wheth-
er the owners of the activity materially
participate in the activity.
(2) Modification of business interest
expense for partnerships. The business in-
terest expense of a partnership generally is
determined in accordance with §1.163(j)-
1(b)(2). To the extent that interest expense
of a partnership that is properly alloca-
ble to trades or businesses that are per
se non-passive activities is allocated to
partners that do not materially participate
within the meaning of section 469, as de-
scribed in section 163(d)(5)(A)(ii), such
interest expense shall not be considered
business interest expense for purposes of
determining the section 163(j) limitation
of a partnership pursuant to §1.163(j)-
2(b).
* * * * *
(d) * * *
(3) Section 743(b) adjustments and
publicly traded partnerships. Solely for
purposes of §1.163(j)-6, a publicly trad-
ed partnership, as defined in §1.7704-
1, shall treat the amount of any section
743(b) adjustment of a purchaser of a
partnership unit that relates to a remedial
item that the purchaser inherits from the
seller as an offset to the related section
704(c) remedial item. For this purpose,
§1.163(j)-6(e)(2)(ii) applies. See Exam-
ple 25 in paragraph (o)(25) of this sec-
tion.
(4) Modification of adjusted taxable in-
come for partnerships. The adjusted tax-
able income of a partnership generally is
determined in accordance with §1.163(j)-
1(b)(1). To the extent that the items com-
prising the adjusted taxable income of a
partnership are properly allocable to trades
or businesses that are per se non-passive
activities and are allocated to partners that
do not materially participate (within the
meaning of section 469), as described in
section 163(d)(5)(A)(ii), such partnership
items shall not be considered adjusted tax-
able income for purposes of determining
the section 163(j) limitation of a partner-
ship pursuant to §1.163(j)-2(b).
(5) Election to use 2019 adjusted tax-
able income for taxable years beginning
in 2020. In the case of any taxable year
beginning in 2020, a partnership may elect
to apply this section by substituting its ad-
justed taxable income for the last taxable

Bulletin No. 2020–40 853 September 28, 2020
year beginning in 2019 for the adjusted
taxable income for such taxable year. See
§1.163(j)-2(b)(4) for the time and man-
ner of making or revoking this election.
An electing partnership determines each
partner’s allocable ATI (as defined in para-
graph (f)(2)(ii) of this section) pursuant to
paragraph (j)(9) of this section in the same
manner as an upper-tier partnership. See
Example 34 in paragraph (o)(34) of this
section.
* * * * *
(e) * * *
(5) Partner basis items, remedial
items, and publicly traded partnerships.
Solely for purposes of §1.163(j)-6, a
publicly traded partnership, as defined in
§1.7704-1, shall either allocate gain that
would otherwise be allocated under sec-
tion 704(c) based on a partner’s section
704(b) sharing ratios, or, for purposes of
allocating cost recovery deductions un-
der section 704(c), determine a partner’s
remedial items, as defined in §1.163(j)-
6(b)(3), based on an allocation of the
partnership’s asset basis (inside basis)
items among its partners in proportion
to their share of corresponding section
704(b) items (rather than applying the
traditional method, described in §1.704-
3(b)). See Example 24 in paragraph (o)
(24) of this section.
(6) Partnership deductions capitalized
by a partner. The ATI of a partner is in-
creased by the portion of such partner’s
allocable share of qualified expenditures
(as defined in section 59(e)(2)) to which
an election under section 59(e) applies.
* * * * *
(f) * * *
(1) * * *
(iii) Exception applicable to publicly
traded partnerships. Publicly traded part-
nerships, as defined in §1.7704-1, do not
apply the rules in paragraph (f)(2) of this
section to determine a partner’s share of
section 163(j) excess items. Rather, pub-
licly traded partnerships determine a part-
ner’s share of section 163(j) excess items
by applying the same percentage used to
determine the partner’s share of the cor-
responding section 704(b) items that com-
prise ATI.
* * * * *
(g) * * *
(4) Special rule for taxable years be-
ginning in 2019 and 2020. In the case of
any excess business interest expense of
a partnership for any taxable year begin-
ning in 2019 that is allocated to a partner
under paragraph (f)(2) of this section, 50
percent of such excess business inter-
est expense (§1.163(j)-6(g)(4) business
interest expense) is treated as business
interest expense that, notwithstanding
paragraph (g)(2) of this section, is paid
or accrued by the partner in the partner’s
first taxable year beginning in 2020. Ad-
ditionally, §1.163(j)-6(g)(4) business in-
terest expense is not subject to the sec-
tion 163(j) limitation at the level of the
partner. For purposes of paragraph (h)
(1) of this section, any §1.163(j)-6(g)(4)
business interest expense is, similar to de-
ductible business interest expense, taken
into account before any excess business
interest expense. This paragraph applies
after paragraph (n) of this section. If a
partner disposes of a partnership interest
in the partnership’s 2019 or 2020 taxable
year, §1.163(j)-6(g)(4) business interest
expense is deductible by the partner and
thus does not result in a basis increase
under paragraph (h)(3) of this section.
See Example 35 and Example 36 in para-
graphs (o)(35) and (o)(36), respectively,
of this section. A taxpayer may elect to
not have this provision apply. The rules
and procedures regarding the time and
manner of making, or revoking, such an
election are provided in Revenue Proce-
dure 2020-22, 2020-18 I.R.B. 745, and
may be further modified through other
guidance (see §§601.601(d) and 601.602
of this chapter).
* * * * *
(h) * * *
(4) Partner basis adjustments upon
liquidating distribution. For purposes of
paragraph (h)(3) of this section, a dis-
position includes a distribution of mon-
ey or other property by the partnership
to a partner in complete liquidation of
the partner’s interest in the partnership.
However, a current distribution of mon-
ey or other property by the partnership to
a continuing partner is not a disposition
for purposes of paragraph (h)(3) of this
section.
(5) Partnership basis adjustments
upon partner dispositions. If a partner
(transferor) disposes of its partnership
interest, the partnership shall increase
the adjusted basis of partnership proper-
ty by an amount equal to the amount of
the increase required under paragraph (h)
(3) (or, if the transferor is a partnership,
(j)(5)(ii)) of this section (if any) to the
adjusted basis of the partnership interest
being disposed of by the transferor. Such
increase in the adjusted basis of partner-
ship property (§1.163(j)-6(h)(5) basis ad-
justment) shall be allocated among capi-
tal gain property of the partnership in the
same manner as a positive section 734(b)
adjustment. However, the increase in the
adjusted basis of any partnership proper-
ty resulting from a §1.163(j)-6(h)(5) ba-
sis adjustment is not depreciable or amor-
tizable under any section of the Code,
regardless of whether the partnership
property allocated such §1.163(j)-6(h)(5)
basis adjustment is otherwise generally
depreciable or amortizable. In general,
a partnership allocates its §1.163(j)-6(h)
(5) basis adjustment immediately before
the disposition (simultaneous with the
transferor’s basis increase required un-
der paragraph (h)(3) or (j)(5)(ii) of this
section). However, if the disposition was
the result of a distribution by the partner-
ship of money or other property to the
transferor in complete liquidation of the
transferor’s interest in the partnership,
the partnership allocates its §1.163(j)-
6(h)(5) basis adjustment among its prop-
erties only after it has allocated its sec-
tion 734(b) adjustment (if any) among its
properties. See Example 31 in paragraph
(o)(31) of this section.
* * * * *
(j) Tiered partnerships—(1) Purpose.
The purpose of this section is to provide
guidance regarding the treatment of busi-
ness interest expense of a partnership
(lower-tier partnership) that is allocated
to a partner that is a partnership (upper-ti-
er partnership). Specifically, this section
clarifies that disparities are not created
between an upper-tier partner’s basis in
its upper-tier partnership interest and such
partner’s share of the adjusted basis of up-
per-tier partnership’s property following
the allocation of excess business interest
expense from lower-tier partnership to
upper-tier partnership. Further, these rules
disallow any deduction for business inter-
est expense that was formerly excess busi-
ness interest expense to any person that is
not the specified partner of such business
interest expense. See Example 27 through

September 28, 2020 854 Bulletin No. 2020–40
Example 30 in paragraphs (o)(27) through
(30), respectively.
(2) Section 704(b) capital account ad-
justments. If lower-tier partnership pays
or accrues business interest expense and
allocates such business interest expense
to upper-tier partnership, then both up-
per-tier partnership and any direct or in-
direct partners of upper-tier partnership
shall, solely for purposes of section 704(b)
and the regulations thereunder, treat such
business interest expense as a section
705(a)(2)(B) expenditure. Any section
704(b) capital account reduction resulting
from such treatment occurs regardless of
whether such business interest expense is
characterized under this section as excess
business interest expense or deductible
business interest expense by lower-ti-
er partnership. If upper-tier partnership
subsequently treats any excess business
interest expense allocated from lower-tier
partnership as business interest expense
paid or accrued pursuant to paragraph (g)
of this section, the section 704(b) capital
accounts of any direct or indirect partners
of upper-tier partnership are not further
reduced.
(3) Basis adjustments of upper-tier
partnership. If lower-tier partnership al-
locates excess business interest expense
to upper-tier partnership, then upper-tier
partnership reduces its basis in lower-ti-
er partnership pursuant to paragraph (h)
(2) of this section. Upper-tier partner-
ship partners do not, however, reduce
the bases of their upper-tier partnership
interests pursuant to paragraph (h)(2) of
this section until upper-tier partnership
treats such excess business interest ex-
pense as business interest expense paid
or accrued pursuant to paragraph (g) of
this section.
(4) Treatment of excess business in-
terest expense allocated by lower-tier
partnership to upper-tier partnership.
Except as provided in paragraph (j)(7) of
this section, if lower-tier partnership al-
locates excess business interest expense
to upper-tier partnership and such excess
business interest expense is not suspend-
ed under section 704(d), then upper-tier
partnership shall treat such excess busi-
ness interest expense (UTP EBIE) as a
nondepreciable capital asset, with a fair
market value of zero and basis equal to
the amount by which upper-tier partner-
ship reduced its basis in lower-tier part-
nership pursuant to paragraph (h)(2) of
this section due to the allocation of such
excess business interest expense. The fair
market value of UTP EBIE, described in
the preceding sentence, is not adjusted by
any revaluations occurring under §1.704-
1(b)(2)(iv)(f). In addition to generally
treating UTP EBIE as having a basis com-
ponent in excess of fair market value and,
thus, built-in loss property, upper-tier
partnership shall also treat UTP EBIE as
having a carryforward component asso-
ciated with it. The carryforward compo-
nent of UTP EBIE shall equal the amount
of excess business interest expense allo-
cated from lower-tier partnership to up-
per-tier partnership under paragraph (f)
(2) of this section that is treated as such
under paragraph (h)(2) of this section by
upper-tier partnership. If an allocation
of excess business interest expense from
lower-tier partnership is treated as UTP
EBIE of upper-tier partnership, upper-ti-
er partnership shall treat such allocation
of excess business interest expense from
lower-tier partnership as UTP EBIE until
the occurrence of an event described in
paragraph (j)(5) of this section.
(5) UTP EBIE conversion events—(i)
Allocation to upper-tier partnership by
lower-tier partnership of excess taxable
income (or excess business interest in-
come). To the extent upper-tier partner-
ship is allocated excess taxable income
(or excess business interest income) from
lower-tier partnership, or paragraph (m)
(3) of this section applies, upper-tier part-
nership shall –
(A) First, apply the rules in paragraph
(g) of this section to its UTP EBIE, using
any reasonable method (including, for
example, FIFO and LIFO) to determine
which UTP EBIE is treated as business
interest expense paid or accrued pursuant
paragraph (g) of this section. If paragraph
(m)(3) of this section applies, upper-tier
partnership shall treat all of its UTP EBIE
from lower-tier partnership as business in-
terest expense paid or accrued.
(B) Second, with respect to any UTP
EBIE treated as business interest ex-
pense paid or accrued in paragraph (j)(5)
(i)(A) of this section, allocate any busi-
ness interest expense that was formerly
such UTP EBIE to its specified partner.
For purposes of this section, the term
specified partner refers to the partner of
upper-tier partnership that, due to the ini-
tial allocation of excess business interest
expense from lower-tier partnership to
upper-tier partnership, was required to
reduce its section 704(b) capital account
pursuant to paragraph (j)(2) of this sec-
tion. Similar principles apply if the spec-
ified partner of such business interest
expense is itself a partnership. See para-
graph (j)(6) of this section for rules that
apply if a specified partner disposes of its
partnership interest.
(C) Third, in the manner provided in
paragraph (j)(7)(ii) (or (iii), as the case
may be) of this section, take into account
any negative basis adjustments under sec-
tion 734(b) previously made to the UTP
EBIE treated as business interest expense
paid or accrued in paragraph (j)(5)(i)(A)
of this section. Additionally, persons treat-
ed as specified partners with respect to the
UTP EBIE treated as business interest ex-
pense paid or accrued in paragraph (j)(5)
(i)(A) shall take any negative basis adjust-
ments under section 743(b) into account
in the manner provided in paragraph (j)
(7)(ii) (or (iii), as the case may be) of this
section.
(ii) Upper-tier partnership disposi-
tion of lower-tier partnership interest. If
upper-tier partnership disposes of a low-
er-tier partnership interest (transferred in-
terest), upper-tier partnership shall—
(A) First, apply the rules in paragraph
(h)(3) of this section (except as provided
in paragraphs (j)(5)(ii)(B) and (C) of this
section), using any reasonable method
(including, for example, FIFO and LIFO)
to determine which UTP EBIE is reduced
pursuant paragraph (h)(3) of this section.
(B) Second, increase the adjusted ba-
sis of the transferred interest immediately
before the disposition by the total amount
of the UTP EBIE that was reduced in
paragraph (j)(5)(ii)(A) of this section (the
amount of UTP EBIE proportionate to the
transferred interest).
(C) Third, in the manner provided in
paragraph (j)(7)(iv) of this section, take
into account any negative basis adjust-
ments under sections 734(b) and 743(b)
previously made to the UTP EBIE that
was reduced in (A) earlier.
(6) Disposition of a specified partner’s
partnership interest—(i) General rule. If
a specified partner (transferor) disposes

Bulletin No. 2020–40 855 September 28, 2020
of an upper-tier partnership interest (or
an interest in a partnership that itself is a
specified partner), the portion of any UTP
EBIE to which the transferor’s status as
specified partner relates is not reduced
pursuant to paragraph (j)(5)(ii) of this
section. Rather, such UTP EBIE attribut-
able to the interest disposed of is retained
by upper-tier partnership and the trans-
feree is treated as the specified partner
for purposes of this section with respect
to such UTP EBIE. Thus, upper-tier part-
nership must allocate any business inter-
est expense that was formerly such UTP
EBIE to the transferee. However, see
paragraph (j)(8) of this section for rules
regarding the deductibility of such trans-
feree’s business interest expense that was
formerly UTP EBIE.
(ii) Special rules—(A) Distribution
in liquidation of a specified partner’s
partnership interest. If a specified part-
ner receives a distribution of property in
complete liquidation of an upper-tier part-
nership interest, the portion of UTP EBIE
of upper-tier partnership attributable to
the liquidated interest shall not have a
specified partner. If a specified partner
(transferee) receives a distribution of an
interest in upper-tier partnership in com-
plete liquidation of a partnership inter-
est, the transferee is the specified partner
with respect to UTP EBIE of upper-tier
partnership only to the same extent it was
prior to the distribution. Similar principles
apply where an interest in a partnership
that is a specified partner is distributed
in complete liquidation of a transferee’s
partnership interest. See paragraph (j)(8)
of this section for rules regarding the treat-
ment of UTP EBIE that does not have a
specified partner.
(B) Contribution of a specified part-
ner’s partnership interest. If a specified
partner (transferor) contributes an up-
per-tier partnership interest to a partner-
ship (transferee), the transferee is treated
as the specified partner with respect to
the portion of the UTP EBIE attributable
to the contributed interest. Following the
transaction, the transferor continues to be
the specified partner with respect to the
UTP EBIE attributable to the contributed
interest. Similar principles apply where
an interest in a partnership that is a spec-
ified partner is contributed to a partner-
ship.
(7) Effect of basis adjustments allocat-
ed to UTP EBIE—(i) In general. Negative
basis adjustments under sections 734(b)
and 743(b) allocated to UTP EBIE do
not affect the carryforward component
(described in paragraph (j)(4) of this sec-
tion) of such UTP EBIE. Rather, negative
basis adjustments under sections 734(b)
and 743(b) affect only the basis compo-
nent of such UTP EBIE. For purposes of
§§1.743-1(d), 1.755-1(b), and 1.755-1(c),
the amount of tax loss that would be allo-
cated to a transferee from a hypothetical
disposition by upper-tier partnership of its
UTP EBIE equals the adjusted basis of the
UTP EBIE to which the transferee’s status
as specified partner relates. Additionally,
solely for purposes of §1.755-1(b), up-
per-tier partnership shall treat UTP EBIE
as an ordinary asset of upper-tier partner-
ship.
(ii) UTP EBIE treated as deduct-
ible business interest expense. If UTP
EBIE that was allocated a negative sec-
tion 734(b) adjustment is subsequently
treated as deductible business interest
expense, then such deductible business
interest expense does not result in a de-
duction to the upper-tier partnership or
the specified partner of such deductible
business interest expense. If UTP EBIE
that was allocated a negative section
743(b) adjustment is subsequently treated
as deductible business interest expense,
the specified partner of such deductible
business interest expense recovers any
negative section 743(b) adjustment at-
tributable to such deductible business
interest expense (effectively eliminating
any deduction for such deductible busi-
ness interest expense).
(iii) UTP EBIE treated as excess busi-
ness interest expense. If UTP EBIE that
was allocated a negative section 734(b) or
743(b) adjustment is subsequently treated
as excess business interest expense, the
specified partner’s basis decrease in its
upper-tier partnership interest required
under paragraph (h)(2) of this section is
reduced by the amount of the negative
section 734(b) or 743(b) adjustment pre-
viously made to such excess business
interest expense. If such excess business
interest expense is subsequently treated as
business interest expense paid or accrued
by the specified partner, no deduction
shall be allowed for any of such business
interest expense. If the specified partner
of such excess business interest expense
is a partnership, such excess business in-
terest expense is considered UTP EBIE
that was previously allocated a negative
section 734(b) adjustment for purposes of
this section.
(iv) UTP EBIE reduced due to a dis-
position. If UTP EBIE that was allocat-
ed a negative section 734(b) or 743(b)
adjustment is reduced pursuant to para-
graph (j)(5)(ii)(A) of this section, the
amount of upper-tier partnership’s basis
increase under paragraph (j)(5)(ii)(B) of
this section to the disposed of lower-ti-
er partnership interest is reduced by the
amount of the negative section 734(b) or
743(b) adjustment previously made to
such UTP EBIE.
(8) Anti-loss trafficking—(i) Transfer-
ee specified partner. No deduction shall
be allowed to any transferee specified
partner for any business interest expense
derived from a transferor’s share of UTP
EBIE. For purposes of this section, the
term transferee specified partner refers to
any specified partner that did not reduce
its section 704(b) capital account due to
the initial allocation of excess business
interest expense from lower-tier partner-
ship to upper-tier partnership pursuant to
paragraph (j)(2) of this section. However,
the transferee described in paragraph (j)
(6)(ii)(B) of this section is not a transfer-
ee specified partner for purposes of this
section. If pursuant to paragraph (j)(5)(i)
(B) of this section a transferee specified
partner is allocated business interest ex-
pense derived from a transferor’s share
of UTP EBIE (business interest expense
to which the partner’s status as transferee
specified partner relates), the transferee
specified partner is deemed to recov-
er a negative section 743(b) adjustment
with respect to, and in the amount of,
such business interest expense and takes
such negative section 743(b) adjustment
into account in the manner provided in
paragraph (j)(7)(ii) (or (iii), as the case
may be) of this section, regardless of
whether a section 754 election was in ef-
fect or a substantial built-in loss existed
at the time of the transfer by which the
transferee specified partner acquired the
transferred interest. However, to the ex-
tent a negative section 734(b) or 743(b)
adjustment was previously made to such

September 28, 2020 856 Bulletin No. 2020–40
business interest expense, the transferee
specified partner does not recover an ad-
ditional negative section 743(b) adjust-
ment pursuant to this paragraph.
(ii) UTP EBIE without a specified
partner. If UTP EBIE does not have a
specified partner (as the result of a trans-
action described in paragraph (j)(6)(ii)
(A) of this section), upper-tier partner-
ship shall not allocate any business inter-
est expense that was formerly such UTP
EBIE to its partners. Rather, for purpos-
es of applying paragraph (f)(2) of this
section, upper-tier partnership shall treat
such business interest expense as the al-
locable business interest expense (as de-
fined in paragraph (f)(2)(ii) of this sec-
tion) of a §1.163(j)-6(j)(8)(ii) account.
Additionally, if UTP EBIE that does not
have a specified partner (as the result of
a transaction described in paragraph (j)
(6)(ii)(A) of this section) is treated as
paid or accrued pursuant to paragraph
(g) of this section, upper-tier partnership
shall make a §1.163(j)-6(h)(5) basis ad-
justment to its property in the amount of
the adjusted basis (if any) of such UTP
EBIE at the time such UTP EBIE is treat-
ed as business interest expense paid or
accrued pursuant to paragraph (g) of this
section.
(iii) Disallowance of addback. No
basis increase under paragraph (j)(5)(ii)
of this section shall be allowed to up-
per-tier partnership for any disallowed
UTP EBIE. For purposes of this section,
the term disallowed UTP EBIE refers to
any UTP EBIE that has a specified part-
ner that is a transferee specified partner
(as defined in paragraph (j)(8)(i) of this
section) and any UTP EBIE that does not
have a specified partner (as the result of
a transaction described in paragraph (j)
(6)(ii)(A) of this section). For purposes
of applying paragraph (j)(5)(ii) of this
section, upper-tier partnership shall treat
any disallowed UTP EBIE in the same
manner as UTP EBIE that has previously
been allocated a negative section 734(b)
adjustment and take such negative sec-
tion 734(b) adjustment into account in
the manner provided in paragraph (j)(7)
(iv) of this section. However, upper-ti-
er partnership does not treat disallowed
UTP EBIE as though it were allocated a
negative section 734(b) adjustment pur-
suant to this paragraph to the extent a
negative section 734(b) or 743(b) adjust-
ment was previously made to such disal-
lowed UTP EBIE.
(9) Determining allocable ATI and
allocable business interest income of up-
per-tier partnership partners—(i) In gen-
eral. When applying paragraph (f)(2)(ii)
of this section, an upper-tier partnership
determines the allocable ATI and alloca-
ble business interest income of each of its
partners in the manner provided in this
paragraph. Specifically, if an upper-ti-
er partnership’s net amount of tax items
that comprise (or have ever comprised)
ATI is greater than or equal to its ATI,
upper-tier partnership applies the rules in
paragraph (j)(9)(ii)(A) of this section to
determine each partner’s allocable ATI.
See Example 32 in paragraph (o)(32) of
this section. However, if an upper-tier
partnership’s net amount of tax items that
comprise (or have ever comprised) ATI is
less than its ATI, upper-tier partnership
applies the rules in paragraph (j)(9)(ii)
(B) of this section to determine each part-
ner’s allocable ATI. See Example 33 in
paragraph (o)(33) of this section. To de-
termine each partner’s allocable business
interest income, an upper-tier partnership
applies the rules in paragraph (j)(9)(iii)
of this section.
(ii) Upper-tier partner’s allocable
ATI—(A) If an upper-tier partnership’s
net amount of tax items that comprise (or
have ever comprised) ATI is greater than
or equal to its ATI (as determined under
§1.163(j)-1(b)(1)), then an upper-tier part-
ner’s allocable ATI (for purposes of para-
graph (f)(2)(ii) of this section) is equal to
the product of–
(1) Such partner’s distributive share
of gross income and gain items that
comprise (or have ever comprised) ATI,
minus such partner’s distributive share
of gross loss and deduction items that
comprise (or have ever comprised) ATI;
multiplied by
(2) A fraction, the numerator of which
is upper-tier partnership’s ATI (as deter-
mined under §163(j)-1(b)(1)), and the
denominator of which is upper-tier part-
nership’s net amount of tax items that
comprise (or have ever comprised) ATI.
(B) If an upper-tier partnership’s net
amount of tax items that comprise (or
have ever comprised) ATI is less than its
ATI (as determined under §1.163(j)-1(b)
(1)), then an upper-tier partner’s allocable
ATI (for purposes of paragraph (f)(2)(ii)
of this section) is equal to–
(1) The excess (if any) of such part-
ner’s distributive share of gross income
and gain items that comprise (or have ever
comprised) ATI, over such partner’s dis-
tributive share of gross loss and deduction
items that comprise (or have ever com-
prised) ATI; increased by
(2) The product of–
(i) Such partner’s share of residual
profits expressed as a fraction; multiplied
by
(ii) Upper-tier partnership’s ATI (as de-
termined under §1.163(j)-1(b)(1)), minus
the aggregate of all the partners’ amounts
determined under paragraph (j)(9)(ii)(B)
(1) of this section.
(iii) Upper-tier partner’s allocable
business interest income. An upper-tier
partner’s allocable business interest in-
come (for purposes of paragraph (f)(2)(ii)
of this section) is equal to the product of–
(A) Such partner’s distributive share
of items that comprise (or have ever com-
prised) business interest income; multi-
plied by
(B) A fraction, the numerator of which
is upper-tier partnership’s business interest
income (as determined under §1.163(j)-
1(b)(4)), and the denominator of which
is the upper-tier partnership’s amount of
items that comprise (or have ever com-
prised) business interest income.
* * * * *
(l) * * *
(4) * * *
(iv) S corporation deductions capi-
talized by an S corporation shareholder.
The ATI of an S corporation shareholder
is increased by the portion of such S cor-
poration shareholder’s allocable share of
qualified expenditures (as defined in sec-
tion 59(e)(2)) to which an election under
section 59(e) applies.
* * * * *
(n) Treatment of self-charged lending
transactions between partnerships and
partners. In the case of a lending transac-
tion between a partner (lending partner)
and partnership (borrowing partnership)
in which the lending partner owns a di-
rect interest (self-charged lending trans-
action), any business interest expense of
the borrowing partnership attributable
to the self-charged lending transaction

Bulletin No. 2020–40 857 September 28, 2020
is business interest expense of the bor-
rowing partnership for purposes of this
section. If in a given taxable year the
lending partner is allocated excess busi-
ness interest expense from the borrow-
ing partnership and has interest income
attributable to the self-charged lending
transaction (interest income), the lending
partner is deemed to receive an alloca-
tion of excess business interest income
from the borrowing partnership in such
taxable year. The amount of the lending
partner’s deemed allocation of excess
business interest income is the lesser of
such lending partner’s allocation of ex-
cess business interest expense from the
borrowing partnership in such taxable
year or the interest income attributable
to the self-charged lending transaction in
such taxable year. To prevent the double
counting of business interest income, the
lending partner includes interest income
that was treated as excess business in-
terest income pursuant to this paragraph
(n) only once when calculating its own
section 163(j) limitation. In cases where
the lending partner is not a C corporation,
to the extent that any interest income ex-
ceeds the lending partner’s allocation of
excess business interest expense from
the borrowing partnership for the taxable
year, and such interest income otherwise
would be properly treated as investment
income of the lending partner for purpos-
es of section 163(d) for that year, such
excess amount of interest income will
continue to be treated as investment in-
come of the lending partner for that year
for purposes of section 163(d). See Ex-
ample 26 in paragraph (o)(26) of this
section.
(o) * * *
(24) Example 24—(i) Facts. On January 1,
2020, L and M form LM, a publicly traded part-
nership (as defined in §1.7704-1), and agree that
each will be allocated a 50 percent share of all LM
items. The partnership agreement provides that LM
will make allocations under section 704(c) using
the remedial allocation method under §1.704-3(d).
L contributes depreciable property with an adjust-
ed tax basis of $4,000 and a fair market value of
$10,000. The property is depreciated using the
straight-line method with a 10-year recovery peri-
od and has 4 years remaining on its recovery peri-
od. M contributes $10,000 in cash, which LM uses
to purchase land. Except for the depreciation de-
ductions, LM’s expenses equal its income in each
year of the 10 years commencing with the year LM
is formed. LM has a valid section 754 election in
effect.
(ii) Section 163(j) remedial items and partner
basis items. LM sells the asset contributed by L in a
fully taxable transaction at a time when the adjusted
basis of the property is $4,000. Under §1.163(j)-6(e)
(2)(ii), solely for purposes of §1.163(j)-6, the tax
gain of $6,000 is allocated equally between L and M
($3,000 each). To avoid shifting built-in gain to the
non-contributing partner (M) in a manner consistent
with the rule in section 704(c), a remedial deduction
of $3,000 is allocated to M (leaving M with no net
tax gain), and remedial income of $3,000 is allocated
to L (leaving L with total tax gain of $6,000).
(25) Example 25—(i) Facts. The facts are the
same as Example 24 in paragraph (o)(24) of this
section except the property contributed by L had an
adjusted tax basis of zero. For each of the 10 years
following the contribution, there would be $500 of
section 704(c) remedial income allocated to L and
$500 of remedial deductions allocated to M with re-
spect to the contributed asset. A buyer of M’s units
would step into M’s shoes with respect to the $500
of annual remedial deductions. A buyer of L’s units
would step into L’s shoes with respect to the $500
of annual remedial income and would have an an-
nual section 743(b) deduction of $1,000 (net $500
of deductions).
(ii) Analysis. Pursuant to §1.163(j)-6(d)(2)(ii),
solely for purposes of §1.163(j)-6, a buyer of L’s
units immediately after formation of LM would off-
set its $500 annual section 704(c) remedial income
allocation with $500 of annual section 743(b) ad-
justment (leaving the buyer with net $500 of section
743(b) deduction). As a result, such buyer would be
in the same position as a buyer of M’s units. Each
buyer would have net deductions of $500 per year,
which would not affect ATI before 2022.
(26) Example 26—(i) Facts. X and Y are part-
ners in partnership PRS. In Year 1, PRS had $200
of excess business interest expense. Pursuant to
§1.163(j)-6(f)(2), PRS allocated $100 of such
excess business interest expense to each of its
partners. In Year 2, X lends $10,000 to PRS and
receives $1,000 of interest income for the taxable
year (self-charged lending transaction). X is not in
the trade or business of lending money. The $1,000
of interest expense resulting from this loan is allo-
cable to PRS’s trade or business assets. As a result,
such $1,000 of interest expense is business interest
expense of PRS. X and Y are each allocated $500
of such business interest expense as their distrib-
utive share of PRS’s business interest expense for
the taxable year. Additionally, in Year 2, PRS has
$3,000 of ATI. PRS allocates the items comprising
its $3,000 of ATI $0 to X and $3,000 to Y.
(ii) Partnership-level. In Year 2, PRS’s sec-
tion 163(j) limit is 30 percent of its ATI plus its
business interest income, or $900 ($3,000 x 30
percent). Thus, PRS has $900 of deductible busi-
ness interest expense, $100 of excess business in-
terest expense, $0 of excess taxable income, and
$0 of excess business interest income. Pursuant
to §1.163(j)-6(f)(2), $400 of X’s allocation of
business interest expense is treated as deductible
business interest expense, $100 of X’s allocation
of business interest expense is treated as excess
business interest expense, and $500 of Y’s allo-
cation of business interest expense is treated as
deductible business interest expense.
(iii) Lending partner. Pursuant to §1.163(j)-6(n),
X treats $100 of its $1,000 of interest income as ex-
cess business interest income allocated from PRS in
Year 2. Because X is deemed to have been allocated
$100 of excess business interest income from PRS,
and excess business interest expense from a partner-
ship is treated as paid or accrued by a partner to the ex-
tent excess business interest income is allocated from
such partnership to a partner, X treats its $100 alloca-
tion of excess business interest expense from PRS in
Year 2 as business interest expense paid or accrued in
Year 2. X, in computing its limit under section 163(j),
has $100 of business interest income ($100 deemed
allocation of excess business interest income from
PRS in Year 2) and $100 of business interest expense
($100 allocation of excess business interest expense
treated as paid or accrued in Year 2). Thus, X’s $100
of business interest expense is deductible business in-
terest expense. At the end of Year 2, X has $100 of ex-
cess business interest expense from PRS ($100 from
Year 1). X treats $900 of its $1,000 of interest income
as investment income for purposes of section 163(d).
(27) Example 27—(i) Formation. A, B, and C
formed partnership UTP in Year 1, each contribut-
ing $1,000 cash in exchange for a one third interest.
Also in Year 1, UTP, D, and E formed partnership
LTP, each contributing $1,200 cash in exchange for
a one third interest. LTP borrowed $9,000, resulting
in each of its partners increasing its basis in LTP by
$3,000. Further, the partners of UTP each increased
their bases in UTP by $1,000 each as a result of the
LTP borrowing.
(ii) Application of section 163(j) to LTP. In Year
1, LTP’s only item of income, gain, loss, or deduction
was $900 of BIE. As a result, LTP had $900 of excess
business interest expense. Pursuant to §1.163(j)-6(f)
(2), LTP allocated $300 of excess business interest
expense to each of its partners.
(iii) Section 704(b) capital account adjust-
ments. Solely for purposes of section 704(b) and
the regulations thereunder, each direct and indirect
partner of LTP treats its allocation of excess busi-
ness interest expense from LTP as a section 705(a)
(2)(B) expenditure pursuant to §1.163(j)-6(j)(2).
Further, each indirect partner of LTP that reduced
its section 704(b) capital account as a result of the
$300 allocation of excess business interest expense
to UTP is the specified partner of such UTP EBIE,
as defined in §1.163(j)-6(j)(5)(i)(B). Each partner
of UTP reduced its capital account by $100 as a re-
sult of the $300 allocation of excess business inter-
est expense from LTP to UTP. As a result, A, B, and
C are each a specified partner with respect to $100
of UTP EBIE.
(iv) Basis adjustments. Pursuant to §1.163(j)-
6(h)(2), D, E, and UTP each reduce its basis in
LTP by the amount of its allocation of excess
business interest expense from LTP. As a result,
each partner’s basis in its LTP interest is $3,900.
Pursuant to §1.163(j)-6(j)(3), the direct partners of
UTP (A, B, and C) do not reduce the bases of their
interests in UTP as a result of the allocation of ex-
cess business interest expense from LTP to UTP.
UTP treats its $300 allocation of excess business
interest expense from LTP as UTP EBIE, as de-
fined in §1.163(j)-6(j)(4). At the end of Year 1, the
section 704(b) and tax basis balance sheets of LTP
and UTP are as follows:

September 28, 2020 858 Bulletin No. 2020–40
Table 60 to paragraph (o)(27)(iv)—UTP Balance Sheet - End of Year 1
AssetsLiabilities and Capital
TaxBookTaxBook
Cash$1,800$1,800Liability$3,000$3,000
LT P3,9003,900Capital:Basis
UTP EBIE3000A1,000900$2,000
B1,0009002,000
C1,0009002,000
Total6,0005,700Total6,0005,7006,000
Table 61 to paragraph (o)(27)(iv)—LTP Balance Sheet - End of Year 1
AssetsLiabilities and Capital
TaxBookTaxBook
Cash$11,700$11,700Liability$9,000$9,000
Capital:Basis
D900900$3,900
E9009003,900
UTP9009003,900
Total11,70011,700Total11,70011,70011,700
Table 62 to paragraph (o)(27)(iv)—UTP EBIE - End of Year 1
Specified partnerPartnership
BasisCarryforwardBasisCarryforward
A$100$100UTP$300$300
B100100
C100100
Total300300Total300300
(28) Example 28—(i) Facts. The facts are the
same as Example 27 in paragraph (o)(27) of this sec-
tion. In Year 2, while a section 754 election was in
effect, C sold its UTP interest to D for $900. In Year
3, LTP’s only item of income, gain, loss, or deduc-
tion was $240 of income, which it allocated to UTP.
Such $240 of income resulted in $240 of excess tax-
able income, which LTP allocated to UTP pursuant
to §1.163(j)-f(2). Further, in Year 3, UTP’s only item
of income, gain, loss, or deduction was its $240 allo-
cation of income from LTP. UTP allocated such $240
of income equally among its partners. In Year 4, UTP
sold its interest in LTP to X for $1,140.
(ii) Sale of specified partner’s UTP interest.
C’s section 741 loss recognized on the sale of its
partnership interest to D in Year 2 is $100 (amount
realized of $900 cash, plus $1,000 relief of liabili-
ties, less $2,000 basis in UTP). D’s initial adjusted
basis in the UTP interest acquired from C in Year 2
is $1,900 (the cash paid for C’s interest, $900, plus
$1,000, D’s share of UTP liabilities). D’s interest in
UTP’s previously taxed capital is $1,000 ($900, the
amount of cash D would receive if PRS liquidated
immediately after the hypothetical transaction, de-
creased by $0, the amount of tax gain allocated to
D from the hypothetical transaction, and increased
by $100, the amount of tax loss that would be allo-
cated to D from the hypothetical transaction). D’s
share of the adjusted basis to the partnership of the
partnership’s property is $2,000 ($1,000 share of
previously taxed capital, plus $1,000 share of the
partnership’s liabilities). Therefore, the amount of
the basis adjustment under section 743(b) to part-
nership property is negative $100 (the difference
between $1,900 and $2,000). D’s negative $100
section 743(b) adjustment is allocated among
UTP’s assets under section 755. Under §1.755-1(b)
(2), the amount of D’s section 743(b) adjustment
allocated to ordinary income property is equal to
the total amount of income or loss that would be
allocated to D from the sale of all ordinary income
property in a hypothetical transaction. Solely for
purposes of §1.755-1(b), any UTP EBIE is treated
as ordinary income property. Thus, D’s negative
$100 section 743(b) basis adjustment is allocated
to UTP EBIE.
(iii) Application of section 163(j) to UTP. In Year
3, UTP was allocated excess taxable income from
LTP. Thus, UTP applies the rules in §1.163(j)-6(j)
(5)(i). First, pursuant to §1.163(j)-6(j)(5)(i)(A), UTP
applies the rules in §1.163(j)-6(g) to its UTP EBIE.
Because UTP was allocated $240 of excess taxable
income from LTP in Year 3, UTP treats $240 of its
UTP EBIE as business interest expense paid or ac-
crued in Year 3. Specifically, UTP treats $80 of each
partner’s share of UTP EBIE as business interest ex-
pense paid or accrued. Under these circumstances,
UTP’s method for determining which UTP EBIE is
treated as business interest expense paid or accrued
is reasonable. Second, pursuant to §1.163(j)-6(j)(5)
(i)(B), UTP allocates such business interest expense
that was formerly UTP EBIE to its specified partner.
Accordingly, A and B are each allocated $80 of busi-
ness interest expense. Pursuant to §1.163(j)-6(j)(6)
(i), D is treated as the specified partner with respect
to $100 of UTP EBIE (C’s share of UTP EBIE prior
to the sale). Further, pursuant to §1.163(j)-6(j)(5)(i)
(A), $80 of the UTP EBIE to which D is the specified
partner was treated as business interest expense paid
or accrued. Accordingly, D is allocated such $80 of
business interest expense. After determining each
partner’s allocable share of section 163(j) items used
in its own section 163(j) calculation, UTP determines
each partner’s allocable share of excess items pursu-
ant to §1.163(j)-6(f)(2).

Bulletin No. 2020–40 859 September 28, 2020
Table 62 to paragraph (o)(28)(iii)—UTP’s application of §1.163(j)-6(f)(2)(ii) in Year 3
ABDTotal
Allocable ATI$80$80$80$240
Allocable BII0000
Allocable BIE808080240
Table 63 to paragraph (o)(28)(iii)—UTP’s application of §1.163(j)-6(f)(2)(xi) in Year 3
ABDTotal
Deductible BIE$24$24$24$72
EBIE allocated565656168
ETI allocated0000
EBII allocated0000
(iv) Treatment of business interest expense that
was formerly UTP EBIE. After determining each
partner’s share of deductible business interest ex-
pense and section 163(j) excess items, UTP takes
into account any basis adjustments under section
734(b) and the partners take into account any ba-
sis adjustments under section 743(b) to business
interest expense that was formerly UTP EBIE pur-
suant to §1.163(j)-6(j)(5)(i)(C). None of the UTP
EBIE treated as business interest expense paid or
accrued in Year 3 was allocated a section 734(b)
adjustment. Additionally, neither A’s nor B’s share
of business interest expense that was formerly
UTP EBIE was allocated a section 743(b) basis
adjustment. Further, neither A nor B is a transferee
specified partner, as defined in §1.163(j)-6(j)(8)
(i). Therefore, no special adjustments are required
to A’s or B’s $24 of deductible business interest
expense and $56 of excess business interest ex-
pense. At the end of Year 3, A and B each has an
adjusted basis in UTP of $2,000 and each is the
specified partner with respect to $20 of UTP EBIE.
D’s share of business interest expense that was
formerly UTP EBIE was allocated a negative $80
section 743(b) adjustment. Pursuant to §1.163(j)-
6(j)(7)(ii), D recovers $24 of the negative section
743(b) adjustment, effectively eliminating the $24
deduction resulting from its $24 allocation of de-
ductible business interest expense. Additionally,
pursuant to §1.163(j)-6(j)(7)(iii), the $56 basis
decrease required under §1.163(j)-6(h)(2) for D’s
allocation of excess business interest expense is
reduced by the negative section 743(b) adjust-
ment attributable to such excess business interest
expense ($56). Consequently, D does not reduce
the basis of its interest in UTP pursuant §1.163(j)-
6(h)(2) upon being allocated such excess business
interest expense. As a result, D has $56 of excess
business interest expense with a basis of $0. At the
end of Year 3, D has an adjusted basis in UTP of
$1,980 and is the specified partner with respect to
$20 of UTP EBIE.
(v) Application of anti-loss trafficking rules.
Although D is a transferee specified partner, as de-
fined in §1.163(j)-6(j)(8)(i), with respect to its $80
allocation of business interest expense from UTP, no
special basis adjustments under §1.163(j)-6(j)(8)(i)
are required because all $80 of such business interest
expense was already fully offset by negative section
743(b) adjustment. However, if such $80 of business
interest expense was not fully offset by a negative
section 743(b) adjustment, D’s status as transferee
specified partner would cause such business inter-
est expense to be fully offset by a negative section
743(b) adjustment pursuant to §1.163(j)-6(j)(8)(i),
regardless of whether a section 754 election was not
in effect with respect to the sale of UTP from C to
D. Such negative section 743(b) adjustment would
be taken into account in the manner described in
§1.163(j)-6(j)(7).
Table 64 to paragraph (o)(28)(v)—UTP EBIE - End of Year 3
Specified partnerPartnership
Basis743(b)CarryforwardBasisCarryforward
A$20$20UTP$60$60
B2020
D20(20)20
Total6060Total6060
(vi) Sale of LTP interest. In Year 4, UTP disposed
of its interest in LTP. Thus, UTP applies the rules in
§1.163(j)-6(j)(5)(ii). First, pursuant to §1.163(j)-6(j)
(5)(ii)(A), UTP applies the rules in §1.163(j)-6(h)
(3) to its UTP EBIE. Because UTP disposed of all
of its LTP interest, UTP reduces its UTP EBIE by
$60. Second, pursuant to §1.163(j)-6(j)(5)(ii)(B),
UTP increases the adjusted basis of its LTP inter-
est by $60 (the total amount of UTP EBIE that was
reduced pursuant to §1.163(j)-6(j)(5)(ii)(A)). Third,
pursuant to §1.163(j)-6(j)(5)(ii)(C), this $60 in-
crease is reduced by $20 to take into account the
negative $20 section 743(b) adjustment allocated in
Year 2 to the $20 of UTP EBIE reduced pursuant to
§1.163(j)-6(j)(5)(ii)(A). As a result, UTP’s adjusted
basis in its LTP interest immediately prior to the sale
to X is $4,180 ($3,900 at the end of Year 1, plus
$240 allocation of income from LTP in Year 3, plus
$40 increase immediately prior to the sale attribut-
able to the basis of UTP EBIE). UTP’s section 741
loss recognized on the sale is $40 (amount realized
of $1,140 cash, plus $3,000 relief of liabilities, less
$4,180 adjusted basis in LTP). No deduction under
section 163(j) is allowed to the UTP or X under
chapter 1 of subtitle A of the Code for any of such
UTP EBIE reduced under §1.163(j)-6(h)(3). Pursu-
ant to §1.163(j)-6(h)(5), LTP has a §1.163(j)-6(h)(5)
basis adjustment of $40. LTP does not own property
of the character required to be adjusted. Thus, under
§1.755-1(c)(4), the adjustment is made when LTP
subsequently acquires capital gain property to which
an adjustment can be made. Regardless of whether
a $20 negative section 743(b) adjustment was allo-
cated to the $20 of UTP EBIE reduced pursuant to
§1.163(j)-6(j)(5)(ii)(A), UTP would only increase its
basis in LTP pursuant to §1.163(j)-6(j)(5)(ii) by $40.
The specified partner of such $20 of UTP EBIE is a
transferee specified partner. Therefore, it is treated
as disallowed UTP EBIE under §1.163(j)-6(j)(8)(iii)
of this section. As a result, UTP would treat such
$20 of UTP EBIE for purposes of §1.163(j)-6(j)(5)
(ii) as though it were allocated a negative section
734(b) adjustment of $20.
(29) Example 29—(i) Facts. The facts are the
same as Example 27 in paragraph (o)(27) of this sec-

September 28, 2020 860 Bulletin No. 2020–40
tion. In Year 2, while a section 754 election was in ef-
fect, UTP distributed $900 to C in complete liquida-
tion of C’s partnership interest. In Year 3, LTP’s only
item of income, gain, loss, or deduction was $240
of income, which it allocated to UTP. Such $240 of
income resulted in $240 of excess taxable income,
which LTP allocated to UTP pursuant to §1.163(j)-
f(2). Further, in Year 3, UTP’s only item of income,
gain, loss, or deduction was its $240 allocation of in-
come from LTP. UTP allocated such $240 of income
equally among its partners. In Year 4, UTP sold its
interest in LTP to X for $1,140.
(ii) Liquidating distribution to specified partner.
C’s section 731(a)(2) loss recognized on the dispo-
sition of its partnership interest is $100 ($2,000 ba-
sis in UTP, less amount realized of $900 cash, plus
$1,000 relief of liabilities). Because the election un-
der section 754 is in effect, UTP has a section 734(b)
decrease to the basis of its assets of $100 (the amount
of section 731(a)(2) loss recognized by C). Under
section 755, the entire negative $100 section 734(b)
adjustment is allocated to UTP EBIE. Following the
liquidation of C, UTP’s basis in its assets ($900 of
cash, plus $3,900 interest in LTP, plus $200 basis
of UTP EBIE) equals the aggregate outside basis of
partners A and B ($5,000).
(iii) Application of section 163(j) to UTP. In
Year 3, UTP was allocated excess taxable income
from LTP. Thus, UTP applies the rules in §1.163(j)-
6(j)(5)(i). First, pursuant to §1.163(j)-6(j)(5)(i)(A),
UTP applies the rules in §1.163(j)-6(g) to its UTP
EBIE. Because UTP was allocated $240 of excess
taxable income from LTP in Year 3, UTP treats
$240 of its UTP EBIE as business interest expense
paid or accrued in Year 3. Specifically, UTP treats
$100 of A’s share, $100 of B’s share, and $40 of the
UTP EBIE that does not have a specified partner
as business interest expense paid or accrued. Under
these circumstances, UTP’s method for determin-
ing which UTP EBIE is treated as business interest
expense paid or accrued is reasonable. Second, pur-
suant to §1.163(j)-6(j)(5)(i)(B), UTP allocates such
business interest expense that was formerly UTP
EBIE to its specified partner. Accordingly, each of
A and B is allocated $100 of business interest ex-
pense.
(iv) Application of anti-loss trafficking rules.
Following the liquidating distribution to C in Year 2
(a transaction described in §1.163(j)-6(j)(6)(ii)(A)),
the $100 of UTP EBIE to which C was formerly the
specified partner does not have a specified partner.
Thus, UTP does not allocate any deductible business
interest expense or excess business interest expense
that was formerly C’s share of UTP EBIE to A or B.
Rather, pursuant to §1.163(j)-6(j)(8)(ii), UTP treats
such business interest expense as the allocable busi-
ness interest expense, as defined in §1.163(j)-6(f)(2)
(ii), of a §1.163(j)-6(j)(8)(ii) account for purposes of
applying §1.163(j)-6(f)(2). After determining each
partner’s allocable share of section 163(j) items used
in its own section 163(j) calculation, UTP determines
each partner’s allocable share of excess items pursu-
ant to §1.163(j)-6(f)(2).
Table 65 to paragraph (o)(29)(iv)—UTP’s application of §1.163(j)-6(f)(2)(ii) in Year 3
AB§1.163(j)-6(j)(8)(ii) accountTotal
Allocable ATI$120$120$0$240
Allocable BII0000
Allocable BIE10010040240
Table 65 to paragraph (o)(29)(iv)—UTP’s application of §1.163(j)-6(f)(2)(xi) in Year 3
AB §1.163(j)-6(j)(8)(ii) accountTotal
Deductible BIE$36$36$0$72
EBIE allocated646440168
ETI allocated0000
EBII allocated0000
(v) Treatment of business interest expense
that was formerly UTP EBIE. After determining
each partner’s share of deductible business inter-
est expense and section 163(j) excess items, UTP
takes into account any basis adjustments under
section 734(b) and the partners take into account
any basis under section 743(b) to business inter-
est expense that was formerly UTP EBIE pursu-
ant to §1.163(j)-6(j)(5)(i)(C). None of the UTP
EBIE treated as business interest expense paid or
accrued in Year 3 was allocated a section 743(b)
adjustment. Further, neither A nor B is a transfer-
ee specified partner, as defined in §1.163(j)-6(j)
(8)(i). Therefore, no special basis adjustments are
required under §1.163(j)-6(j)(8)(i). The $40 of
excess business interest expense allocated to the
§1.163(j)-6(j)(8)(ii) account is not allocated to A
or B and is not carried over by UTP. Additional-
ly, UTP does not have a §1.163(j)-6(h)(5) basis
adjustment because such $40 of business interest
expense does not have any basis. Thus, A and B
each has $36 of deductible business interest ex-
pense and $64 of excess business interest expense.
At the end of Year 3, A and B each has an adjusted
basis in UTP of $2,520 ($2,500 outside basis, plus
$120 allocation of income, less $36 of deductible
business interest expense, less $64 of excess busi-
ness interest expense), and neither A nor B is a
specified partner with respect to any of UTP’s $60
of UTP EBIE.
Table 66 to paragraph (o)(29)(v)—UTP EBIE - End of Year 3
Specified partnerPartnership
BasisCarryforwardBasisCarryforward
A$0$0UTP$0$60
B00
§1.163(j)-6(j)(8)(ii) account060
Total060Total060
(vi) Sale of LTP interest. In Year 4, UTP disposed
of its interest in LTP. Thus, UTP applies the rules in
§1.163(j)-6(j)(5)(ii). First, pursuant to §1.163(j)-6(j)
(5)(ii)(A), UTP applies the rules in §1.163(j)-6(h)
(3) to its UTP EBIE. Because UTP disposed of all of
its LTP interest, UTP reduces its UTP EBIE by $60.
Second, pursuant to §1.163(j)-6(j)(5)(ii)(B), UTP in-
creases the adjusted basis of its LTP interest by $60
(the total amount of UTP EBIE that was reduced pur-
suant to §1.163(j)-6(j)(5)(ii)(A)). Third, pursuant to
§1.163(j)-6(j)(5)(ii)(C), this $60 increase is reduced
by $60 to take into account the negative $60 section
734(b) adjustment allocated in Year 2 to the $60 of
UTP EBIE reduced pursuant to §1.163(j)-6(j)(5)(ii)
(A). As a result, UTP’s adjusted basis in its LTP in-

Bulletin No. 2020–40 861 September 28, 2020
terest immediately prior to the sale to X is $4,140
($3,900 at the end of Year 1, plus $240 allocation
of income from LTP in Year 3). UTP has no section
741 gain or loss recognized on the sale (amount real-
ized of $1,140 cash, plus $3,000 relief of liabilities,
equals $4,140 adjusted basis in LTP). No deduction
under section 163(j) is allowed to the UTP or X un-
der chapter 1 of subtitle A of the Code for any of
such UTP EBIE reduced under §1.163(j)-6(h)(3).
Regardless of whether the $60 of UTP EBIE’s basis
was reduced by a $60 negative section 734(b) ad-
justment, UTP would not increase its basis in LTP
pursuant to §1.163(j)-6(j)(5)(ii) of this section as a
result of the sale to X. The $60 of UTP EBIE does
not have a specified partner. Therefore, it is treated
as disallowed UTP EBIE under §1.163(j)-6(j)(8)(iii)
of this section. As a result, UTP would treat such $60
of UTP EBIE for purposes of §1.163(j)-6(j)(5)(ii) as
though it were allocated a negative section 734(b)
adjustment of $60.
(30) Example 30—(i) X, Y and Z are partners
in partnership PRS, PRS and A are partners in UTP,
and UTP is a partner in LTP. LTP allocates $15 of
excess business interest expense to UTP. Pursuant
to §1.163(j)-6(j)(2), UTP reduces its section 704(b)
capital account (capital account) in LTP by $15, A
reduces its capital account in UTP by $5, PRS re-
duces its capital account in UTP by $10, X reduces
its capital account in PRS by $4, and Y reduces its
capital account in PRS by $6. Thus, A, PRS, X, and
Y are the specified partner with respect to $5, $10,
$4, and $6 of UTP EBIE, respectively.
(ii) Assume the same facts in (i) except that PRS
distributed cash to Y in complete liquidation of Y’s
interest in PRS. As a result, pursuant to §1.163(j)-
6(j)(6)(ii)(A), Y’s share of UTP EBIE would not
have a specified partner. In a subsequent year, if
LTP allocated UTP $15 of excess business interest
income, UTP would apply the rules in §1.163(j)-6(j)
(5)(i) and allocate $5 of deductible business interest
expense to A and $10 of deductible business interest
expense to PRS (the specified partners of such de-
ductible business interest expense). Because the $10
of deductible business interest expense allocated to
PRS was formerly UTP EBIE, PRS must also apply
the rules in §1.163(j)-6(j)(5)(i). PRS would allocate
$4 of such deductible business interest expense to
X (the specified partner of such $4). However, as
a result of the liquidating distribution to Y, the re-
maining $6 of deductible business interest expense
does not have a specified partner. Thus, pursuant to
§1.163(j)-6(j)(8)(ii), PRS would make a §1.163(j)-
6(h)(5) basis adjustment to its property in the amount
of the adjusted basis (if any) of such $6 of deductible
business interest expense.
(iii) Assume the same facts as in (i) except that
PRS distributed its interest in UTP to Y in com-
plete liquidation of Y’s interest in PRS. Pursuant to
§1.163(j)-6(j)(6)(ii)(A), Y is the specified partner
with respect to UTP EBIE of UTP only to the same
extent it was prior to the distribution ($6). As a result,
the UTP EBIE of UTP in excess of the UTP EBIE
for which Y is the specified partner (X’s $4) does
not have a specified partner. If in a subsequent year
LTP allocated UTP $15 of excess business interest
income, UTP would apply the rules in §1.163(j)-6(j)
(5)(i) and allocate $5 of deductible business interest
expense to A and $6 of deductible business interest
expense to Y. Regarding the $4 of DBIE without
a specified partner, UTP would apply the rules in
§1.163(j)-6(j)(8)(ii) and make a §1.163(j)-6(h)(5)
basis adjustment to its property in the amount of the
adjusted basis (if any) of such $4 of deductible busi-
ness interest expense.
(iv) Assume the same facts as in (i) except that
A contributes its UTP interest to a new partnership,
PRS2. Following the contribution, PRS2 is treated
as the specified partner with respect to the portion
of the UTP EBIE attributable to the contributed in-
terest ($5). Further, A continues to be the specified
partner with respect to the UTP EBIE attributable to
the contributed interest ($5). If in a subsequent year
LTP allocated UTP $15 of excess business interest
income, UTP would apply the rules in §1.163(j)-6(j)
(5)(i) and allocate $5 of deductible business interest
expense to PRS2, and PRS2 would allocate such $5
of deductible business interest expense to A.
(31) Example 31—(i) Facts. In Year 1, A, B,
and C formed partnership PRS by each contributing
$1,000 cash. PRS borrowed $900, causing each part-
ner’s basis in PRS to increase by $300 under section
752. Also in Year 1, PRS purchased Capital Asset X
for $200. In Year 2, PRS pays $300 of business inter-
est expense, all of which is disallowed and treated as
excess business interest expense. PRS allocated the
$300 of excess business interest expense to its part-
ners, $100 each. Pursuant to §1.163(j)-6(h)(2), each
partner reduced its adjusted basis in its PRS inter-
est by its $100 allocation of excess business interest
expense to $1,200. In Year 3, when the fair market
value of Capital Asset X is $3,200 and no partner’s
basis in PRS has changed, PRS distributed $1,900 to
C in complete liquidation of C’s partnership interest
in a distribution to which section 737 does not apply.
PRS had a section 754 election in effect in Year 3.
(ii) Consequences to selling partner. Pursuant to
§1.163(j)-6(h)(3), C increases the adjusted basis of
its interest in PRS by $100 immediately before the
disposition. Thus, C’s section 731(a)(1) gain recog-
nized on the disposition of its interest in PRS is $900
(($1,900 cash + $300 relief of liabilities) – ($1,200
outside basis + $100 excess business interest ex-
pense add-back)).
(iii) Partnership basis. Pursuant to §1.163(j)-
6(h)(5), PRS has a $100 increase to the basis of its
assets attributable to a §1.163(j)-6(h)(5) basis in-
crease immediately before C’s disposition. Under
section 755, the entire $100 adjustment is allocated
to Capital Asset X. Pursuant to §1.163(j)-6(h)(5), re-
gardless of whether Capital Asset X is a depreciable
or amortizable asset, none of the $100 of §1.163(j)-
6(h)(5) basis increase allocated to Capital Asset X is
depreciable or amortizable. Additionally, PRS has a
section 734(b) increase to the basis of its assets of
$900 (the amount of section 731(a)(1) gain recog-
nized by C). Under section 755, the entire $900 ad-
justment is allocated to Capital Asset X. As a result,
PRS’s basis in Capital Asset X is $1,200 ($200 +
$100 §1.163(j)-6(h)(5) basis increase + $900 section
734(b) adjustment). Following the liquidation of C,
PRS’s basis in its assets ($600 cash + $1,200 Capital
Asset X) equals the aggregate adjusted basis of part-
ners A and B in PRS ($1,800).
(32) Example 32—(i) Facts. X and Y are equal
partners in partnership UTP, which is a partner in
partnership LTP. In Year 1, LTP allocated $100 of in-
come to UTP. LTP, in computing its limit under sec-
tion 163(j), treated such $100 of income as ATI. Ac-
cordingly, in LTP’s §1.163(j)-6(f)(2)(ii) calculation,
UTP’s allocable ATI was $100. Additionally, pursu-
ant to §1.163(j)-6(f)(2), LTP allocated $50 of excess
taxable income to UTP. UTP’s only items of income,
gain, loss or deduction in Year 1, other than the $100
allocation from LTP, were $100 of trade or business
income and $30 of business interest expense. UTP
allocated its $200 of income and gain items $100 to
X and $100 to Y, and all $30 of its business interest
expense to X.
(ii) Partnership-level. Pursuant to §1.163(j)-6(e)
(1), UTP, in computing its limit under section 163(j),
does not increase or decrease any of its section 163(j)
items by any of LTP’s section 163(j) items. Pursuant
to §1.163(j)-1(b)(1), UTP determines it has $150 of
ATI in Year 1 ($100 of ATI resulting from its $100 of
trade or business income, plus $50 of excess taxable
income from LTP). UTP’s section 163(j) limit is 30
percent of its ATI, or $45 ($150 x 30 percent). Thus,
UTP has $50 of excess taxable income and $30 of
deductible business interest expense.
(iii) Partner-level allocations. UTP allocates its
$50 of excess taxable income and $30 of deductible
business interest expense to X and Y pursuant to
§1.163(j)-6(f)(2). To determine each partner’s share
of the $50 of excess taxable income, UTP must de-
termine each partner’s allocable ATI and allocable
business interest expense (as defined in §1.163(j)-
6(f)(2)(ii)). X’s allocable business interest expense
is $30 and Y’s allocable business interest expense is
$0. Because UTP is an upper-tier partnership, UTP
determines the allocable ATI of each of its partners in
the manner provided in §1.163(j)-6(j)(9). Specifical-
ly, because UTP’s net amount of tax items that com-
prise (or have ever comprised) ATI is $200 ($100 of
trade or business income that UTP treated as ATI,
plus UTP’s $100 allocation from LTP of items that
comprised ATI to LTP), which is greater than its
$150 of ATI, UTP must apply the rules in §1.163(j)-
6(j)(9)(ii)(A) to determine each of its partner’s allo-
cable ATI. UTP determines X’s allocable ATI is $75
(X’s $100 distributive share of gross income and
gain items that comprise (or have ever comprised)
ATI, multiplied by ($150/$200), the ratio of UTP’s
ATI to its tax items that comprise (or have ever com-
prised) ATI). In a similar manner, UTP determines
Y’s allocable ATI also equals $75. Therefore, pursu-
ant to §1.163(j)-6(f)(2), X is allocated $30 of deduct-
ible business interest expense and Y is allocated $50
of excess taxable income.
(33) Example 33—(i) Facts. X and Y are equal
partners in partnership UTP, which is a partner in
partnership LTP. Further, X and Y share the resid-
ual profits of UTP equally. In Year 1, LTP allocated
($99) of income to UTP. LTP, in computing its limit
under section 163(j), treated such ($99) of income as
ATI. Accordingly, in LTP’s §1.163(j)-6(f)(2)(ii) cal-
culation, UTP’s allocable ATI was ($99). UTP’s only
items of income, gain, loss or deduction in Year 1,
other than the ($99) allocation from LTP, were $100
of trade or business income and $15 of business in-
terest expense. UTP allocated $1 of income to X and
$0 to Y pursuant to section 704(c), the ($99) of loss
and remaining $99 of income equally pursuant to
section 704(b), and all $15 of its business interest
expense to X.

September 28, 2020 862 Bulletin No. 2020–40
(ii) Partnership-level. Pursuant to §1.163(j)-6(e)
(1), UTP, in computing its limit under section 163(j),
does not increase or decrease any of its section 163(j)
items by any of LTP’s section 163(j) items. Pursuant
to §1.163(j)-1(b)(1), UTP determines it has $100 of
ATI in Year 1 ($100 of ATI resulting from its $100 of
trade or business income). UTP’s section 163(j) limit
is 30 percent of its ATI, or $30 ($100 x 30 percent).
Thus, UTP has $50 of excess taxable income and $15
of deductible business interest expense.
(iii) Partner-level allocations. UTP allocates its
$50 of excess taxable income and $15 of deductible
business interest expense to X and Y pursuant to
§1.163(j)-6(f)(2). To determine each partner’s share
of the $50 of excess taxable income, UTP must de-
termine each partner’s allocable ATI and allocable
business interest expense (as defined in §1.163(j)-
6(f)(2)(ii)). X’s allocable business interest expense
is $15 and Y’s allocable business interest expense is
$0. Because UTP is an upper-tier partnership, UTP
determines the allocable ATI of each of its partners
in the manner provided in §1.163(j)-6(j)(9). Specif-
ically, because UTP’s net amount of tax items that
comprise (or have ever comprised) ATI is $1 ($100
of trade or business income that UTP treated as ATI,
plus UTP’s ($99) allocation from LTP of items that
comprised ATI to LTP), which is less than its $100
of ATI, UTP must apply the rules in §1.163(j)-6(j)
(9)(ii)(B) to determine each of its partner’s alloca-
ble ATI. UTP determines X’s allocable ATI is $50.50
($1, which is the excess of X’s distributive share of
gross income and gain items that comprise (or have
ever comprised) ATI, $100, over X’s distributive
share of gross loss and deduction items that comprise
(or have ever comprised) ATI, $99; increased by
$49.50, which is the product of 50 percent, X’s resid-
ual profit sharing percentage, and $99, UTP’s $100
of ATI minus $1, which is the aggregate of all the
partners’ amounts determined under §1.163(j)-6(j)
(9)(ii)(B)(1)). In a similar manner, UTP determines
Y’s allocable ATI is $49.50. Therefore, pursuant to
§1.163(j)-6(f)(2), X is allocated $15 of deductible
business interest expense and $0.50 of excess taxable
income, and Y is allocated $49.50 of excess taxable
income.
(34) Example 34—(i) Facts. X and Y are equal
partners in partnership PRS. Further, X and Y share
the profits of PRS equally. In 2019, PRS had ATI of
$100. In 2020, PRS’s only items of income, gain,
loss or deduction was $1 of trade or business income,
which it allocated to X pursuant to section 704(c).
(ii) Partnership-level. In 2020, PRS makes the
election described in §1.163(j)-6(d)(5) to use its
2019 ATI in 2020. As a result, PRS has $100 of ATI
in 2020. PRS does not have any business interest
expense. Therefore, PRS has $100 of excess taxable
income in 2020.
(iii) Partner-level allocations. PRS allocates its
$100 of excess taxable income to X and Y pursuant
to §1.163(j)-6(f)(2). To determine each partner’s
share of the $100 of excess taxable income, PRS
must determine each partner’s allocable ATI (as de-
fined in §1.163(j)-6(f)(2)(ii)). Because PRS made the
election described in §1.163(j)-6(d)(5), PRS must
determine the allocable ATI of each of its partners
pursuant to paragraph (j)(9) of this section in the
same manner as an upper-tier partnership. Specifical-
ly, because PRS’s amount of tax items that comprise
ATI before the election is $1, which is less than its
$100 of ATI following the election, PRS must ap-
ply the rules in §1.163(j)-6(j)(9)(ii)(B) to determine
each of its partner’s allocable ATI. PRS determines
X’s allocable ATI is $50.50 ($1, which is the excess
of X’s distributive share of gross income and gain
items that would have comprised ATI had PRS not
made the election, $1, over X’s distributive share
of gross loss and deduction items that would have
comprised ATI had PRS not made the election, $0;
increased by $49.50, which is the product of 50%,
X’s residual profit share, and $99, PRS’s $100 of ATI
minus $1, the aggregate of all the partners’ amounts
determined under §1.163(j)-6(j)(9)(ii)(B)(1)). In a
similar manner, PRS determines Y’s allocable ATI is
$49.50. Therefore, pursuant to §1.163(j)-6(f)(2), X is
allocated $50.50 of excess taxable income, and Y is
allocated $49.50 of excess taxable income.
(35) Example 35—(i) Facts. X, a partner in part-
nership PRS, was allocated $20 of excess business
interest expense from PRS in 2018 and $10 of excess
business interest expense from PRS in 2019. In 2020,
PRS allocated $16 of excess taxable income to X.
(ii) Analysis. X treats 50 percent of its $10 of ex-
cess business interest expense allocated from PRS in
2019 as §1.163(j)-6(g)(4) business interest expense.
Thus, $5 of §1.163(j)-6(g)(4) business interest ex-
pense is treated as paid or accrued by X in 2020 and
is not subject to the section 163(j) limitation at X’s
level. Because X was allocated $16 of excess taxable
income from PRS in 2020, X treats $16 of its $25 of
excess business interest expense as business interest
expense paid or accrued pursuant to §1.163(j)-6(g)
(2). X, in computing its limit under section 163(j)
in 2020, has $16 of ATI (as a result of its allocation
of $16 of excess taxable income from PRS), $0 of
business interest income, and $16 of business inter-
est expense ($16 of excess business interest expense
treated as paid or accrued in 2020). Pursuant to
§1.163(j)-2(b)(2)(i), X’s section 163(j) limit in 2020
is $8 ($16 x 50 percent). Thus, X has $8 of busi-
ness interest expense that is deductible under section
163(j). The $8 of X’s business interest expense not
allowed as a deduction ($16 business interest ex-
pense subject to section 163(j), less $8 section 163(j)
limit) is treated as business interest expense paid or
accrued by X in 2021. At the end of 2020, X has $9
of excess business interest expense from PRS ($20
from 2018, plus $10 from 2019, less $5 treated as
paid or accrued pursuant to §1.163(j)-6(g)(4), less
$16 treated as paid or accrued pursuant to §1.163(j)-
6(g)(2)).
(36) Example 36—(i) Facts. X is a partner in
partnership PRS. At the beginning of 2018, X’s out-
side basis in PRS was $100. X was allocated $20 of
excess business interest expense from PRS in 2018
and $10 of excess business interest expense from
PRS in 2019. X sold its PRS interest in 2019 for $70.
(ii) Analysis. X treats 50 percent of its $10 of ex-
cess business interest expense allocated from PRS in
2019 as §1.163(j)-6(g)(4) business interest expense.
Thus, $5 of §1.163(j)-6(g)(4) business interest ex-
pense is treated as paid or accrued by X in 2020 and
is not subject to the section 163(j) limitation at X’s
level. Pursuant to paragraph (h)(3) of this section,
immediately before the disposition, X increases the
basis of its PRS interest to $95. Thus, X has a $25
section 741 loss recognized on the sale ($70 - $95).
(p) Applicability dates—(1) In general.
* * *
(2) Paragraphs (c)(1) and (2), (d)(3)
through (5), (e)(5) and (6), (f)(1)(iii), (g)
(4), (h)(4) and (5), (j), (l)(4)(iv), (n), and
(o)(24) through (29). Paragraphs (c)(1)
and (2), (d)(3) through (5), (e)(5) and (6),
(f)(1)(iii), (g)(4), (h)(4) and (5), (j), (l)(4)
(iv), (n), and (o)(24) through (29) of this
section apply to taxable years beginning
on or after [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE FI-
NAL RULE IN THE FEDERAL REG-
ISTER]. However, taxpayers and their
related parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose
to apply the rules of those paragraphs to
a taxable year beginning after December
31, 2017, and before [DATE 60 DAYS
AFTER DATE OF PUBLICATION OF
THE FINAL RULE IN THE FEDER-
AL REGISTER], provided that they also
apply the provisions of §1.163(j)-6 in the
section 163(j) regulations, and consistent-
ly apply all of the rules of §1.163(j)-6 in
the section 163(j) regulations to that tax-
able year and to each subsequent taxable
year.
* * * * *
Par. 8. As added in a final rule else-
where in this issue of the Federal Register,
effective November 13, 2020, §1.163(j)-
7 is amended by revising paragraph (a),
adding paragraphs (c) through (f), (g)(3)
and (4), (h), and (j) through (l), and revis-
ing paragraph (m) to read as follows:
§1.163(j)-7 Application of the section
163(j) limitation to foreign corporations
and United States shareholders.
(a) Overview. This section provides
rules for the application of section 163(j)
to relevant foreign corporations and
United States shareholders of relevant
foreign corporations. Paragraph (b) of
this section provides the general rule re-
garding the application of section 163(j)
to a relevant foreign corporation. Para-
graph (c) of this section provides rules
for applying section 163(j) to CFC group
members of a CFC group. Paragraph (d)
of this section provides rules for deter-
mining a specified group and specified
group members. Paragraph (e) of this
section provides rules and procedures for
treating a specified group member as a

Bulletin No. 2020–40 863 September 28, 2020
CFC group member and for determining
a CFC group. Paragraph (f) of this sec-
tion provides rules regarding the treat-
ment of a CFC group member that has
ECI. Paragraph (g) of this section pro-
vides rules concerning the computation
of ATI of an applicable CFC. Paragraph
(h) of this section provides a safe-harbor
that exempts certain stand-alone applica-
ble CFCs and CFC groups from the ap-
plication of section 163(j) for a taxable
year. Paragraph (i) of this section is re-
served. Paragraph (j) of this section pro-
vides rules concerning the computation
of ATI of a United States shareholder of
an applicable CFC. Paragraph (k) of this
section provides definitions that apply for
purposes of this section. Paragraph (l) of
this section provides examples illustrat-
ing the application of this section.
* * * * *
(c) Application of section 163(j) to
CFC group members of a CFC group—(1)
Scope. This paragraph (c) provides rules
for applying section 163(j) to a CFC group
member. Paragraph (c)(2) of this section
provides rules for computing a single sec-
tion 163(j) limitation for a specified pe-
riod of a CFC group. Paragraph (c)(3) of
this section provides rules for allocating
a CFC group’s section 163(j) limitation
to CFC group members for specified tax-
able years. Paragraph (c)(4) of this section
provides currency translation rules. Para-
graph (c)(5) of this section provides spe-
cial rules for specified periods beginning
in 2019 or 2020.
(2) Calculation of section 163(j) lim-
itation for a CFC group for a specified
period—(i) In general. A single section
163(j) limitation is computed for a spec-
ified period of a CFC group. For purposes
of applying section 163(j) and the section
163(j) regulations, the current-year busi-
ness interest expense, disallowed business
interest expense carryforwards, business
interest income, floor plan financing inter-
est expense, and ATI of a CFC group for
a specified period equal the sums of each
CFC group member’s respective amounts
for its specified taxable year with respect
to the specified period. A CFC group
member’s current-year business interest
expense, business interest income, floor
plan financing interest expense, and ATI
for a specified taxable year are generally
determined on a separate-company basis.
(ii) Certain transactions between
CFC group members disregarded. Any
transaction between CFC group mem-
bers of a CFC group that is entered into
with a principal purpose of affecting a
CFC group or a CFC group member’s
section 163(j) limitation by increasing
or decreasing a CFC group or a CFC
group member’s ATI for a specified tax-
able year is disregarded for purposes of
applying section 163(j) and the section
163(j) regulations.
(iii) CFC group treated as a single C
corporation for purposes of allocating
items to an excepted trade or business. For
purposes of allocating items to an except-
ed trade or business under §1.163(j)-10,
all CFC group members of a CFC group
are treated as a single C corporation.
(iv) CFC group treated as a single tax-
payer for purposes of determining inter-
est. For purposes of determining whether
amounts, other than amounts in respect of
transactions between CFC group members
of a CFC group, are treated as interest
within the meaning of §1.163(j)-1(b)(22),
all CFC group members of a CFC group
are treated as a single taxpayer.
(3) Deduction of business interest ex-
pense—(i) CFC group business inter-
est expense—(A) In general. The extent
to which a CFC group member’s cur-
rent-year business interest expense and
disallowed business interest expense car-
ryforwards for a specified taxable year
that ends with or within a specified period
may be deducted under section 163(j) is
determined under the rules and principles
of §1.163(j)-5(a)(2) and (b)(3)(ii), subject
to the modifications described in para-
graph (c)(3)(i)(B) of this section.
(B) Modifications to relevant terms.
For purposes of paragraph (c)(3)(i)(A)
of this section, the rules and principles of
§1.163(j)-5(b)(3)(ii) are applied by—
(1) Replacing “§1.163(j)-4(d)(2)” in
§1.163(j)-5(a)(2)(ii) with “§1.163(j)-7(c)
(2)(i)”;
(2) Replacing the term “allocable share
of the consolidated group’s remaining
section 163(j) limitation” with “allocable
share of the CFC group’s remaining sec-
tion 163(j) limitation”;
(3) Replacing the terms “consolidated
group” and “group” with “CFC group”;
(4) Replacing the term “consolidated
group’s remaining section 163(j) limita-
tion” with “CFC group’s remaining sec-
tion 163(j) limitation”;
(5) Replacing the term “consolidated
return year” with “specified period”;
(6) Replacing the term “current year”
or “current-year” with “current specified
period” or “specified taxable year with re-
spect to the current specified period,” as
the context requires;
(7) Replacing the term “member” with
“CFC group member”; and
(8) Replacing the term “taxable year”
with “specified taxable year with respect
to a specified period.”
(ii) Carryforwards treated as attribut-
able to the same taxable year. For purpos-
es of applying the principles of §1.163(j)-
5(b)(3)(ii), as required under paragraph
(c)(3)(i) of this section, CFC group mem-
bers’ disallowed business interest expense
carryforwards that arose in specified tax-
able years with respect to the same speci-
fied period are treated as disallowed busi-
ness interest expense carryforwards from
taxable years ending on the same date and
are deducted on a pro rata basis, under
the principles of §1.163(j)-5(b)(3)(ii)(C)
(3), pursuant to paragraph (c)(3)(i) of this
section.
(iii) Multiple specified taxable years
of a CFC group member with respect to
a specified period. If a CFC group mem-
ber has more than one specified taxable
year (each year, an applicable specified
taxable year) with respect to a single
specified period of a CFC group, then all
such applicable specified taxable years are
taken into account for purposes of apply-
ing the principles of §1.163(j)-5(b)(3)(ii),
as required under paragraph (c)(3)(i) of
this section, with respect to the specified
period. The portion of the section 163(j)
limitation allocable to disallowed business
interest expense carryforwards of the CFC
group member for its applicable specified
taxable years is prorated among the appli-
cable specified taxable years in proportion
to the number of days in each applicable
specified taxable year.
(iv) Limitation on pre-group disallowed
business interest expense carryforward—
(A) General rule—(1) CFC group mem-
ber pre-group disallowed business interest
expense carryforward. This paragraph (c)
(3)(iv) applies to pre-group disallowed
business interest expense carryforwards of
a CFC group member. The amount of the

September 28, 2020 864 Bulletin No. 2020–40
pre-group disallowed business interest ex-
pense carryforwards described in the pre-
ceding sentence that are included in any
CFC group member’s business interest
expense deduction for any specified tax-
able year under this paragraph (c)(3) may
not exceed the aggregate section 163(j)
limitation for all specified periods of the
CFC group, determined by reference
only to the CFC group member’s items
of income, gain, deduction, and loss, and
reduced (including below zero) by the
CFC group member’s business interest
expense (including disallowed business
interest expense carryforwards) taken into
account as a deduction by the CFC group
member in all specified taxable years in
which the CFC group member has con-
tinuously been a CFC group member of
the CFC group (cumulative section 163(j)
pre-group carryforward limitation).
(2) Subgrouping. In the case of a CFC
group member with a pre-group disal-
lowed business interest expense carry-
forward (the loss member) that joined
the CFC group (the current group) for a
specified taxable year with respect to a
specified period (the relevant period), if
the loss member was a CFC group mem-
ber of a different CFC group (the former
group) immediately prior to joining the
current group, a pre-group subgroup is
composed of the loss member and each
other CFC group member that became a
CFC group member of the current group
for a specified taxable year with respect
to the relevant period and was a member
of the former group immediately prior to
joining the current group. For purposes
of this paragraph (c), the rules and prin-
ciples of §1.163(j)-5(d)(1)(B) apply to a
pre-group subgroup as if the pre-group
subgroup were a SRLY subgroup.
(B) Deduction of pre-group disallowed
business interest expense carryforwards.
Notwithstanding paragraph (c)(3)(iv)(A)
(1) of this section, pre-group disallowed
business interest expense carryforwards
are available for deduction by a CFC group
member in its specified taxable year only
to the extent the CFC group has remaining
section 163(j) limitation for the specified
period after the deduction of current-year
business interest expense and disallowed
business interest expense carryforwards
from earlier taxable years that are per-
mitted to be deducted in specified taxable
years of CFC group members with respect
to the specified period. See paragraph (c)
(3)(i) of this section and §1.163(j)-5(b)(3)
(ii)(A). Pre-group disallowed business in-
terest expense carryforwards are deducted
on a pro rata basis (under the principles
of paragraph (c)(3)(i) of this section and
§1.163(j)-5(b)(3)(ii)(C)(3)) with other
disallowed business interest expense car-
ryforwards from taxable years ending on
the same date.
(4) Currency translation. For purposes
of applying this paragraph (c), items of
a CFC group member are translated into
a single currency for the CFC group and
back to the functional currency of the CFC
group member using the average rate for
the CFC group member’s specified tax-
able year, using any reasonable method,
consistently applied. The single currency
for the CFC group may be the U.S. dollar
or the functional currency of a plurality of
the CFC group members.
(5) Special rule for specified periods
beginning in 2019 or 2020—(i) 50 per-
cent ATI limitation applies to a specified
period of a CFC group. In the case of a
CFC group, §1.163(j)-2(b)(2) (includ-
ing the election under §1.163(j)-2(b)(2)
(ii)) applies to a specified period of the
CFC group beginning in 2019 or 2020,
rather than to a specified taxable year of
a CFC group member. An election under
§1.163(j)-2(b)(2)(ii) for a specified pe-
riod of a CFC group is not effective un-
less made by each designated U.S. per-
son. Except as otherwise provided in this
paragraph (c)(5)(i), the election is made
in accordance with Revenue Procedure
2020-22, 2020-18 I.R.B. 745. For purpos-
es of applying §1.964-1(c), the election
is treated as if made for each CFC group
member.
(ii) Election to use 2019 ATI applies to
a specified period of a CFC group—(A)
In general. In the case of a CFC group, for
purposes of applying paragraph (c)(2) of
this section, an election under §1.163(j)-
2(b)(3)(i) is made for a specified period of
a CFC group beginning in 2020 and ap-
plies to the specified taxable years of each
CFC group member with respect to such
specified period, taking into account the
application of paragraph (c)(5)(ii)(B) of
this section. The election under §1.163(j)-
2(b)(3)(i) does not apply to any specified
taxable year of a CFC group member oth-
er than those described in the preceding
sentence. An election under §1.163(j)-
2(b)(3)(i) for a specified period of a CFC
group is not effective unless made by each
designated U.S. person. Except as other-
wise provided in this paragraph (c)(5)(ii)
(A), the election is made in accordance
with Revenue Procedure 2020-22, 2020-
18 I.R.B. 745. For purposes of applying
§1.964-1(c), the election is treated as if
made for each CFC group member.
(B) Specified taxable years that do not
begin in 2020. If a specified taxable year
of a CFC group member with respect to
the specified period described in para-
graph (c)(5)(ii)(A) of this section begins
in 2019, then, for purposes of applying
paragraph (c)(2) of this section, §1.163(j)-
2(b)(3) is applied to such specified taxable
year by substituting “2018” for “2019”
and “2019” for “2020.” If a specified tax-
able year of a CFC group member with
respect to the specified period described
in paragraph (c)(5)(ii)(A) of this section
begins in 2021, then, for purposes of ap-
plying paragraph (c)(2) of this section,
§1.163(j)-2(b)(3) is applied to such spec-
ified taxable year by substituting “2020”
for “2019” and “2021” for “2020.”
(d) Determination of a specified group
and specified group members—(1) Scope.
This paragraph (d) provides rules for de-
termining a specified group and specified
group members. Paragraph (d)(2) of this
section provides rules for determining a
specified group. Paragraph (d)(3) of this
section provides rules for determining
specified group members.
(2) Rules for determining a specified
group—(i) Definition of a specified group.
Subject to paragraph (d)(2)(ii) of this sec-
tion, the term specified group means one
or more chains of applicable CFCs con-
nected through stock ownership with a
specified group parent (which is included
in the specified group only if it is an appli-
cable CFC), but only if—
(A) The specified group parent owns
directly or indirectly stock meeting the re-
quirements of section 1504(a)(2)(B) in at
least one applicable CFC; and
(B) Stock meeting the requirements of
section 1504(a)(2)(B) in each of the ap-
plicable CFCs (except the specified group
parent) is owned directly or indirectly by
one or more of the other applicable CFCs
or the specified group parent.

Bulletin No. 2020–40 865 September 28, 2020
(ii) Indirect ownership. For purpos-
es of applying paragraph (d)(2)(i) of this
section, stock is owned indirectly only if
it is owned under section 318(a)(2)(A)
through a partnership or under section
318(a)(2)(A) or (B) through an estate or
trust not described in section 7701(a)(30).
(iii) Specified group parent. The term
specified group parent means a qualified
U.S. person or an applicable CFC.
(iv) Qualified U.S. person. The term
qualified U.S. person means a United
States person described in section 7701(a)
(30)(A) or (C). For purposes of this para-
graph (d), members of a consolidated
group that file (or that are required to file)
a consolidated U.S. federal income tax re-
turn are treated as a single qualified U.S
person and individuals described in sec-
tion 7701(a)(30)(A) whose filing status is
married filing jointly are treated as a sin-
gle qualified U.S. person.
(v) Stock. For purposes of paragraph
(d)(3)(i) of this section, the term stock has
the same meaning as “stock” in section
1504 (without regard to §1.1504-4, except
as provided in paragraph (d)(2)(vi) of this
section) and all shares of stock within a
single class are considered to have the
same value. Thus, control premiums and
minority and blockage discounts within a
single class are not taken into account.
(vi) Options treated as exercised. For
purposes of this paragraph (d)(2), options
that are reasonably certain to be exercised,
as determined under §1.1504-4(g), are
treated as exercised. For purposes of this
paragraph (d)(2)(vi), options include call
options, warrants, convertible obligations,
put options, and any other instrument
treated as an option under §1.1504-4(d),
determined by replacing the term “a prin-
cipal purpose of avoiding the application
of section 1504 and this section” with “a
principal purpose of avoiding the applica-
tion of section 163(j).”
(vii) When a specified group ceases to
exist. The principles of §1.1502-75(d)(1),
(d)(2)(i) through (d)(2)(ii), and (d)(3)(i)
through (d)(3)(iv), apply for purposes of
determining when a specified group ceas-
es to exist. Solely for purposes of apply-
ing these principles, each applicable CFC
that is treated as a specified group member
for a taxable year with respect to a speci-
fied period is treated as affiliated with the
specified group parent from the beginning
to the end of the specified period, without
regard to the beginning or end of its tax-
able year.
(3) Rules for determining a specified
group member. If an applicable CFC is in-
cluded in a specified group on the last day
of a taxable year of the applicable CFC
that ends with or within a specified period,
the applicable CFC is a specified group
member with respect to the specified pe-
riod for its entire taxable year ending with
or within the specified period. If an appli-
cable CFC has multiple taxable years that
end with or within a specified period, this
paragraph (d)(3) is applied separately to
each taxable year to determine if the ap-
plicable CFC is a specified group member
for such taxable year.
(e) Rules and procedures for treating
a specified group as a CFC group—(1)
Scope. This paragraph (e) provides rules
and procedures for treating a specified
group member as a CFC group member
and for determining a CFC group for pur-
poses of applying section 163(j) and the
section 163(j) regulations.
(2) CFC group and CFC group mem-
ber—(i) CFC group. The term CFC group
means, with respect to a specified period,
all CFC group members for their specified
taxable years.
(ii) CFC group member. The term CFC
group member means, with respect to a
specified taxable year and a specified pe-
riod, a specified group member of a speci-
fied group for which a CFC group election
is in effect.
(3) Duration of a CFC group. A CFC
group continues until the CFC group elec-
tion is revoked, or there is no longer a
specified period with respect to the spec-
ified group.
(4) Joining or leaving a CFC group.
If an applicable CFC becomes a speci-
fied group member for a specified taxable
year with respect to a specified period of
a specified group for which a CFC group
election is in effect, the CFC group elec-
tion applies to the applicable CFC and the
applicable CFC becomes a CFC group
member. If an applicable CFC ceases to be
a specified group member for a specified
taxable year with respect to a specified pe-
riod of a specified group for which a CFC
group election is in effect, the CFC group
election terminates solely with respect to
the applicable CFC.
(5) Manner of making or revoking a
CFC group election—(i) In general. An
election is made or revoked under this
paragraph (e)(5) (a CFC group election)
with respect to a specified period of a
specified group. A CFC group election re-
mains in effect for each specified period of
the specified group until revoked. A CFC
group election that is in effect with respect
to a specified period of a specified group
applies to each specified group member
for its specified taxable year that ends with
or within the specified period. The making
or revoking of a CFC group election is not
effective unless made or revoked by each
designated U.S. person.
(ii) Revocation by election. A CFC
group election cannot be revoked with
respect to any specified period beginning
prior to 60 months following the last day
of the specified period for which the elec-
tion was made. Once a CFC group elec-
tion has been revoked, a new CFC group
election cannot be made with respect to
any specified period beginning prior to 60
months following the last day of the spec-
ified period for which the election was re-
voked.
(iii) Timing. A CFC group election
must be made or revoked with respect to
a specified period of a specified group no
later than the due date (taking into account
extensions, if any) of the original Federal
income tax return for the taxable year of
each designated U.S. person in which or
with which the specified period ends.
(iv) Election statement. Except as oth-
erwise provided in publications, forms,
instructions, or other guidance, to make or
revoke a CFC group election for a specified
period of a specified group, each designat-
ed U.S. person must attach a statement to
its relevant Federal tax or information re-
turn. The statement must include the name
and taxpayer identification number of all
designated U.S. persons, a statement that
the CFC group election is being made or
revoked, as applicable, the specified pe-
riod for which the CFC group election is
being made or revoked, and the name of
each CFC group member and its specified
taxable year with respect to the specified
period. The statement must be filed in the
manner prescribed in publications, forms,
instructions, or other guidance.
(v) Effect of prior CFC group election.
A CFC group election is made solely pur-

September 28, 2020 866 Bulletin No. 2020–40
suant to the provisions of this paragraph
(e)(5), without regard to whether the elec-
tion described in proposed §1.163(j)-7(f)
(7) that was included in a notice of pro-
posed rulemaking (REG-106089-18) that
was published on December 28, 2018, in
the Federal Register (83 FR 67490) was
in effect.
(f) Treatment of a CFC group member
that has ECI—(1) In general. If a CFC
group member has ECI in its specified
taxable year, then for purposes of section
163(j) and the section 163(j) regulations—
(i) The items, disallowed business in-
terest expense carryforwards, and other at-
tributes of the CFC group member that are
ECI are treated as items, disallowed busi-
ness interest expense carryforwards, and
attributes of a separate applicable CFC
(such deemed corporation, an ECI deemed
corporation), subject to §1.163(j)-8(d),
that has same taxable year and sharehold-
ers as the applicable CFC; and
(ii) The ECI deemed corporation is not
treated as a specified group member for
the specified taxable year.
(2) Ordering rule. Paragraph (f)(1) of
this section applies before application of
§1.163(j)-8(d).
(g) * * *
(3) Treatment of certain taxes. For pur-
poses of computing the ATI of a relevant
foreign corporation for a taxable year, ten-
tative taxable income takes into account
any deduction for foreign taxes. See sec-
tion 164(a).
(4) Anti-abuse rule—(i) In general. If
a specified group member of a specified
group or an applicable partnership (speci-
fied lender) includes an amount (the pay-
ment amount) in income and such amount
is attributable to business interest expense
incurred by another specified group mem-
ber or an applicable partnership of the
specified group (a specified borrower)
during its taxable year, then the ATI of the
specified borrower for the taxable year is
increased by the ATI adjustment amount
if—
(A) The business interest expense is in-
curred with a principal purpose of reduc-
ing the Federal income tax liability of any
United States shareholder of a specified
group member (including over multiple
taxable years);
(B) Absent the application of this
paragraph (g)(4), the effect of the speci-
fied borrower treating all or part of the
payment amount as disallowed business
interest expense would be to reduce the
Federal income tax liability of any Unit-
ed States shareholder of a specified group
member; and
(C) Either no CFC group election is in
effect with respect to the specified group
or the specified borrower is an applicable
partnership.
(ii) ATI adjustment amount—(A) In
general. For purposes of this paragraph
(g)(4), the term ATI adjustment amount
means, with respect to a specified borrow-
er and a taxable year, the product of 3 1/3
and the lesser of the payment amount or
the disallowed business interest expense,
computed without regard to this paragraph
(g)(4).
(B) Special rule for taxable years
or specified periods beginning in 2019
or 2020. For any taxable year of an ap-
plicable CFC or specified taxable year
of a CFC group member with respect to
a specified period for which the section
163(j) limitation is determined based, in
part, on 50 percent of ATI, in accordance
with §1.163(j)-2(b)(2), paragraph (g)(4)
(ii)(A) of this section is applied by substi-
tuting “2” for “3 1/3.”
(iii) Applicable partnership. For pur-
poses of this paragraph (g)(4), the term
applicable partnership means, with re-
spect to a specified group, a partnership in
which at least 80 percent of the interests
in capital or profits is owned, directly or
indirectly through one or more other part-
nerships, by specified group members of
the specified group.
(h) Election to apply safe-harbor—(1)
In general. If an election to apply this
paragraph (h)(1) (safe-harbor election) is
in effect with respect to a taxable year of a
stand-alone applicable CFC or a specified
taxable year of a CFC group member, as
applicable, then, for such year, no portion
of the applicable CFC’s business interest
expense is disallowed under the section
163(j) limitation. This paragraph (h) does
not apply to excess business interest ex-
pense, as described in §1.163(j)-6(f)(2),
until the taxable year in which it is treated
as paid or accrued by an applicable CFC
under §1.163(j)-6(g)(2)(i). Furthermore,
excess business interest expense is not
taken into account for purposes of deter-
mining whether the safe-harbor election
is available for a stand-alone applicable
CFC or a CFC group until the taxable year
in which it is treated as paid or accrued by
an applicable CFC under §1.163(j)-6(g)
(2)(i).
(2) Eligibility for safe-harbor elec-
tion—(i) Stand-alone applicable CFC.
The safe-harbor election may be made for
the taxable year of a stand-alone applica-
ble CFC only if business interest expense
of the applicable CFC is less than or equal
to 30 percent of the lesser of qualified
tentative taxable income or the eligible
amount of the applicable CFC for its tax-
able year.
(ii) CFC group—(A) In general. The
safe-harbor election may be made for the
specified period of a CFC group only if
the business interest expense of the CFC
group for the specified period is less than
or equal to 30 percent of the lesser of the
sum of qualified tentative taxable income
or the sum of the eligible amounts of each
CFC group member for its specified tax-
able year with respect to the specified
period, and no CFC group member has
pre-group disallowed business interest ex-
pense carryforward.
(B) Currency translation. For purpos-
es of applying paragraph (h)(2)(ii) of this
section, qualified tentative taxable in-
come and eligible amounts of each CFC
group member are translated into the cur-
rency in which the business interest ex-
pense of the CFC group is denominated
using the method used under paragraph
(c)(4) of this section. See paragraph (c)
(2)(i) of this section for rules for deter-
mining the business interest expense of
a CFC group.
(3) Eligible amount—(i) In gener-
al. Subject to paragraph (h)(3)(ii) of this
section, the term eligible amount means,
with respect to the taxable year of an ap-
plicable CFC, the sum of the following
amounts, computed without regard to the
application of section 163(j) and the sec-
tion 163(j) regulations (including without
regard to any disallowed business interest
expense carryforwards)—
(A) Subpart F income (within the
meaning of section 952);
(B) The product of—
(1) The excess of 100 percent over the
percentage described in section 250(a)(1)
(B), taking into account section 250(a)(3)
(B), and

Bulletin No. 2020–40 867 September 28, 2020
(2) The excess, if any, of tested income
(within the meaning of section 951A(c)
(2)(A) and §1.951A-2(b)(1)), over the
CFC-level net deemed tangible income
return.
(ii) Amounts properly allocable to a
non-excepted trade or business. For pur-
poses of computing an eligible amount,
subpart F income and tested income are
determined by only taking into account
items properly allocable to a non-excepted
trade or business.
(4) Qualified tentative taxable income.
The term qualified tentative taxable in-
come means, with respect to a taxable
year of an applicable CFC, the applicable
CFC’s tentative taxable income, deter-
mined by only taking into account items
properly allocable to a non-excepted trade
or business.
(5) Manner of making a safe-harbor
election—(i) In general. A safe-harbor
election is an annual election made under
this paragraph (h)(5) with respect to a tax-
able year of a stand-alone applicable CFC
or with respect to a specified period of a
CFC group. A safe-harbor election that is
made with respect to a specified period of
a CFC group is effective with respect to
each CFC group member for its specified
taxable year. A safe-harbor election is only
effective if made by each designated U.S.
person with respect to a stand-alone appli-
cable CFC or a CFC group. A safe-harbor
election is made with respect to a taxable
year of a stand-alone applicable CFC, or
a specified period of a CFC group, no lat-
er than the due date (taking into account
extensions, if any) of the original Federal
income tax return for the taxable year of
each designated U.S. person, respectively,
in which or with which the taxable year of
the stand-alone applicable CFC ends or the
specified period of the CFC group ends.
(ii) Election statement. Unless oth-
erwise provided in publications, forms,
instructions, or other guidance, to make
a safe-harbor election, each designated
U.S. person must attach to its relevant
Federal income tax return or information
return a statement that includes the name
and taxpayer identification number of all
designated U.S. persons, a statement that a
safe-harbor election is being made pursu-
ant to §1.163(j)-7(h) and that the require-
ments for making the election are satisfied,
and the taxable year of the stand-alone ap-
plicable CFC or the specified period of the
CFC group, as applicable, for which the
safe-harbor election is being made. In the
case of a CFC group, the statement must
also include the name of each CFC group
member and its specified taxable year that
ends with or within the specified period
for which the safe-harbor election is being
made. The statement must be filed in the
manner prescribed in publications, forms,
instructions, or other guidance.
(6) Special rule for taxable years or
specified periods beginning in 2019 or
2020. In the case of a stand-alone appli-
cable CFC, for any taxable year beginning
in 2019 or 2020, paragraph (h)(2)(i) of
this section is applied by substituting “50
percent” for “30 percent.” In the case of a
CFC group, for any specified period be-
ginning in 2019 or 2020, paragraph (h)(2)
(ii)(A) of this section is applied by substi-
tuting “50 percent” for “30 percent.”
* * * * *
(j) Rules regarding the computation of
ATI of certain United States shareholders
of applicable CFCs—(1) In general. For
purposes of computing ATI of a United
States shareholder of an applicable CFC,
for the taxable year of the United States
shareholder in which or with which the
taxable year of the applicable CFC ends,
there is added to the United States share-
holder’s tentative taxable income the
product of–
(i) The portion of the adjustment, if
any, made to the United States share-
holder’s tentative taxable income under
§1.163(j)-1(b)(1)(ii)(G) (regarding speci-
fied deemed inclusions) that is attributable
to the applicable CFC, but for this purpose
excluding the portion of the adjustment
that is attributable to an inclusion under
section 78 with respect to the applicable
CFC; and
(ii) A fraction, expressed as a percent-
age, but not greater than 100 percent, the
numerator of which is CFC excess taxable
income and the denominator of which is
the ATI of the applicable CFC for the tax-
able year.
(2) Rules for determining CFC excess
taxable income—(i) In general. The term
CFC excess taxable income means, with
respect to a taxable year of an applicable
CFC, the amount described in paragraph
(j)(2)(ii) or (j)(2)(iii) of this section, as ap-
plicable.
(ii) Applicable CFC is a stand-alone
applicable CFC. If an applicable CFC is a
stand-alone applicable CFC for a taxable
year, its CFC excess taxable income for
the taxable year is the amount that bears
the same ratio to the applicable CFC’s ATI
as—
(A) The excess (if any) of—
(1) 30 percent of the applicable CFC’s
ATI; over
(2) The amount (if any) by which the
applicable CFC’s business interest ex-
pense exceeds its business interest income
and floor plan financing interest expense;
bears to
(B) 30 percent of the applicable CFC’s
ATI.
(iii) Applicable CFC is a CFC group
member. If an applicable CFC is a CFC
group member for a specified taxable year,
its CFC excess taxable income is equal to
the product of the CFC group member’s
ATI percentage and the amount that bears
the same ratio to the CFC group’s ATI for
the specified period as—
(A) The excess (if any) of—
(1) 30 percent of the CFC group’s ATI;
over
(2) The amount (if any) by which the
CFC group’s business interest expense
exceeds the CFC group’s business interest
income and floor plan financing interest
expense; bears to
(B) 30 percent of the CFC group’s ATI.
(iv) ATI percentage. For purposes of
this paragraph (j), the term ATI percentage
means, with respect to a specified taxable
year of a CFC group member and a spec-
ified period of the CFC group, a fraction
(expressed as a percentage), the numera-
tor of which is the ATI of the CFC group
member for the specified taxable year, and
the denominator of which is the ATI of the
CFC group for the specified period. If ei-
ther the numerator or denominator of the
fraction is less than or equal to zero, the
ATI percentage is zero.
(3) Cases in which an addition to ten-
tative taxable income is not allowed. Para-
graph (j)(1) of this section is not applica-
ble for a taxable year of a United States
shareholder if, with respect to the taxable
year of the applicable CFC described in
paragraph (j)(1) of this section—
(i) A safe-harbor election (as described
in paragraph (h) of this section) is in ef-
fect; or

September 28, 2020 868 Bulletin No. 2020–40
(ii) The applicable CFC is neither a
stand-alone applicable CFC nor a CFC
group member.
(4) Special rule for taxable years or
specified periods beginning in 2019 or
2020. In the case of a stand-alone ap-
plicable CFC, for any taxable year be-
ginning in 2019 or 2020 to which the
election described in §1.163(j)-2(b)(2)
(ii) does not apply, paragraph (j)(2)(ii)
of this section is applied by substituting
“50 percent” for “30 percent” each place
it appears. In the case of a CFC group
member, for any specified taxable year
with respect to a specified period be-
ginning in 2019 or 2020 to which the
election described in §1.163(j)-2(b)(2)
(ii) does not apply, paragraph (j)(2)(iii)
of this section is applied by substituting
“50 percent” for “30 percent” each place
it appears.
(k) Definitions. The following defini-
tions apply for purposes of this section.
(1) Applicable partnership. The term
applicable partnership has the meaning
provided in paragraph (g)(4)(iii) of this
section.
(2) Applicable specified taxable year.
The term applicable specified taxable year
has the meaning provided in paragraph (c)
(3)(iii) of this section.
(3) ATI adjustment amount. The term
ATI adjustment amount has the meaning
provided in paragraph (g)(4)(ii) of this
section.
(4) ATI percentage. The term ATI per-
centage has the meaning provided in para-
graph (j)(2)(iv) of this section.
(5) CFC excess taxable income. The
term CFC excess taxable income has the
meaning provided in paragraph (j)(2)(i) of
this section.
(6) CFC group. The term CFC group
has the meaning provided in paragraph (e)
(2)(i) of this section.
(7) CFC group election. The term CFC
group election means the election de-
scribed in paragraph (e)(5) of this section.
(8) CFC group member. The term CFC
group member has the meaning provided
in paragraph (e)(2)(ii) of this section.
(9) CFC-level net deemed tangible
income return—(i) In general. The term
CFC-level net deemed tangible income re-
turn means, with respect to a taxable year
of an applicable CFC, the excess (if any)
of—
(A) 10 percent of the qualified business
asset investment, as defined in section
951A(d)(1) and §1.951A-3(b), of the ap-
plicable CFC, over
(B) The excess, if any, of—
(1) Tested interest expense, as defined
in §1.951A-4(b)(1), of the applicable
CFC, over
(2) Tested interest income, as defined in
§1.951A-4(b)(2), of the applicable CFC.
(ii) Amounts properly allocable to a
non-excepted trade or business. For pur-
poses of computing CFC-level net deemed
tangible income return, qualified business
asset investment is determined by only tak-
ing into account assets properly allocable to
a non-excepted trade or business, as deter-
mined in §1.163(j)-10(c)(3), and tested in-
terest expense and tested interest income are
determined by only taking into account items
properly allocable to a non-excepted trade or
business, as determined in §1.163(j)-10(c).
(10) Cumulative section 163(j) pre-
group carryforward limitation. The term
cumulative section 163(j) pre-group car-
ryforward limitation has the meaning pro-
vided in paragraph (c)(3)(iv)(A)(1) of this
section.
(11) Current group. The term current
group has the meaning provided in para-
graph (c)(3)(iv)(A)(2) of this section.
(12) Designated U.S. person. The term
designated U.S. person means—
(i) With respect to a stand-alone ap-
plicable CFC, each controlling domestic
shareholder, as defined in §1.964-1(c)(5)
of the applicable CFC; or
(ii) With respect to a specified group,
the specified group parent, if the specified
group parent is a qualified U.S. person, or
each controlling domestic shareholder, as
defined in §1.964-1(c)(5), of the specified
group parent, if the specified group parent
is an applicable CFC.
(13) ECI deemed corporation. The
term ECI deemed corporation has the
meaning provided in paragraph (f)(1)(i) of
this section.
(14) Effectively connected income.
The term effectively connected income (or
ECI) means income or gain that is ECI,
as defined in §1.884-1(d)(1)(iii), and de-
duction or loss that is allocable to, ECI, as
defined in §1.884-1(d)(1)(iii).
(15) Eligible amount. The term eligible
amount has the meaning provided in para-
graph (h)(3)(i) of this section.
(16) Former group. The term former
group has the meaning provided in para-
graph (c)(3)(iv)(A)(2) of this section.
(17) Loss member. The term loss mem-
ber has the meaning provided in paragraph
(c)(3)(iv)(A)(2) of this section.
(18) Payment amount. The term pay-
ment amount has the meaning provided in
paragraph (g)(4)(i) of this section.
(19) Pre-group disallowed business
interest expense carryforward. The term
pre-group disallowed business interest
expense carryforward means, with respect
to a CFC group member and a specified
taxable year, any disallowed business in-
terest expense carryforward of the CFC
group member that arose in a taxable year
during which the CFC group member (or
its predecessor) was not a CFC group
member of the CFC group.
(20) Qualified tentative taxable in-
come. The term qualified tentative taxable
income has the meaning provided in para-
graph (h)(4) of this section.
(21) Qualified U.S. person. The term
qualified U.S. person has the meaning
provided in paragraph (d)(2)(iv) of this
section.
(22) Relevant period. The term rele-
vant period has the meaning provided in
paragraph (c)(3)(iv)(A)(2) of this section.
(23) Safe-harbor election. The term
safe-harbor election has the meaning
provided in paragraph (h)(1) of this sec-
tion.
(24) Specified borrower. The term
specified borrower has the meaning pro-
vided in paragraph (g)(4)(i) of this section.
(25) Specified group. The term spec-
ified group has the meaning provided in
paragraph (d)(2)(i) of this section.
(26) Specified group member. The term
specified group member has the meaning
provided in paragraph (d)(3) of this sec-
tion.
(27) Specified group parent. The term
specified group parent has the meaning
provided in paragraph (d)(2)(iii) of this
section.
(28) Specified lender. The term spec-
ified lender has the meaning provided in
paragraph (g)(4)(i) of this section
(29) Specified period—(i) In general.
Except as otherwise provided in para-
graph (k)(29)(ii) of this section, the term
specified period means, with respect to a
specified group—

Bulletin No. 2020–40 869 September 28, 2020
(A) If the specified group parent is a
qualified U.S. person, the period ending
on the last day of the taxable year of the
specified group parent and beginning on
the first day after the last day of the speci-
fied group’s immediately preceding spec-
ified period; or
(B) If the specified group parent is an
applicable CFC, the period ending on the
last day of the specified group parent’s
required year described in section 898(c)
(1), without regard to section 898(c)(2),
and beginning on the first day after the last
day of the specified group’s immediately
preceding specified period.
(ii) Short specified period. A specified
period begins no earlier than the first date
on which a specified group exists. A spec-
ified period ends on the date a specified
group ceases to exist under paragraph (d)
(2)(vii) of this section. If the last day of
a specified period, as determined under
paragraph (k)(29)(i) of this section, chang-
es, and, but for this paragraph (k)(29)(ii),
the change in the last day of the specified
period would result in the specified period
being longer than 12 months, the speci-
fied period ends on the date on which the
specified period would have ended had the
change not occurred.
(30) Specified taxable year. The term
specified taxable year means, with respect
to an applicable CFC that is a specified
group member of a specified group and a
specified period, a taxable year of the ap-
plicable CFC that ends with or within the
specified period.
(31) Stand-alone applicable CFC. The
term stand-alone applicable CFC means
any applicable CFC that is not a specified
group member.
(32) Stock. The term stock has the
meaning provided in paragraph (d)(2)(v)
of this section.
(l) Examples. The following examples
illustrate the application of this section.
For each example, unless otherwise stat-
ed, no exemptions from the application
of section 163(j) are available, no foreign
corporation has ECI, and all relevant tax-
able years and specified periods begin af-
ter December 31, 2020.
(1) Example 1. Specified taxable years included
in specified period of a specified group—(i) Facts.
As of June 30, Year 1, USP, a domestic corporation,
owns 60 percent of the common stock of FP, which
owns all of the stock of FC1, FC2, and FC3. The re-
maining 40 percent of the common stock of FP is
owned by an unrelated foreign corporation. FP has
a single class of stock. FP acquired the stock of FC3
from an unrelated person on March 22, Year 1. The
acquisition did not result in a change in FC3’s tax-
able year or a close of its taxable year. USP’s interest
in FP and FP’s interest in FC1 and FC2 has been the
same for a number of years. USP has a taxable year
ending June 30, Year 1, which is not a short taxable
year. Each of FP, FC1, FC2, and FC3 are applicable
CFCs. Pursuant to section 898(c)(2), FP and FC1
have taxable years ending May 31, Year 1. Pursu-
ant to section 898(c)(1), FC2 and FC3 have taxable
years ending June 30, Year 1.
(ii) Analysis—(A) Determining a specified group
and specified period of the specified group. Pursu-
ant to paragraph (d) of this section, FP, FC1, FC2,
and FC3 are members of a specified group, and FP
is the specified group parent. Because the specified
group parent, FP, is an applicable CFC, the specified
period of the specified group is the period ending on
June 30, Year 1, which is the last day of FP’s required
year described in section 898(c)(1), without regard
to section 898(c)(2), and on beginning July 1, Year
0, which is the first day following the last day of the
specified group’s immediately preceding specified
period (June 30, Year 0). See paragraph (k)(29)(i)(B)
of this section.
(B) Determining the specified taxable years with
respect to the specified period. Pursuant to paragraph
(d)(3) of this section, because each of FP and FC1
are included in the specified group on the last day of
their taxable years ending May 31, Year 1 and such
taxable years end with or within the specified peri-
od ending June 30, Year 1, FP and FC1 are specified
group members with respect to the specified period
ending June 30, Year 1, for their entire taxable years
ending May 31, Year 1, and those taxable years are
specified taxable years. Similarly, because each of
FC2 and FC3 are included in the specified group on
the last day of their taxable years ending June 30,
Year 1, and such taxable years end with or within
the specified period ending June 30, Year 1, FC2 and
FC3 are specified group members with respect to the
specified period ending June 30, Year 1, for their en-
tire taxable years ending June 30, Year 1, and those
taxable years are specified taxable years. The fact
that FC3 was acquired on March 22, Year 1, does not
prevent FC3 from being a specified group member
with respect to the specified period for the portion of
its specified taxable year prior to March 22, Year 1.
(2) Example 2. CFC groups—(i) Facts. The facts
are the same as in Example 1 in paragraph (l)(1)(i)
of this section. In addition, a CFC group election is
in place with respect to the specified period ending
June 30, Year 1.
(ii) Analysis. Because a CFC group election is in
place for the specified period ending June 30, Year
1, pursuant to paragraph (e)(2)(ii) of this section,
each specified group member is a CFC group mem-
ber with respect to its specified taxable year ending
with or within the specified period. Accordingly, FP,
FC1, FC2, and FC3 are CFC group members with
respect to the specified period ending June 30, Year
1, for their specified taxable years ending May 31,
Year 1, and June 30, Year 1, respectively. Pursuant to
paragraph (e)(2)(i) of this section, the CFC group for
the specified period ending June 30, Year 1, consists
of FP, FC1, FC2, and FC3 for their specified taxable
years ending May 31, Year 1, and June 30, Year 1,
respectively. Pursuant to paragraph (c)(2) of this sec-
tion, a single section 163(j) limitation is computed
for the specified period ending June 30, Year 1. That
section 163(j) calculation will include FP and FC1’s
specified taxable years ending May 31, Year 1, and
FC2 and FC3’s specified taxable years ending June
30, Year 1.
(3) Example 3. Application of anti-abuse rule—
(i) Facts. USP, a domestic corporation, is the speci-
fied group parent of a specified group. The specified
group members include CFC1 and CFC2. USP owns
(within the meaning of section 958(a)) all of the stock
of all specified group members. USP has a calendar
year taxable year. All specified group members also
have a calendar year taxable year and a functional
currency of the U.S. dollar. CFC1 is organized in,
and a tax resident of, a jurisdiction that imposes no
tax on certain types of income, including interest in-
come. With respect to Year 1, USP expects to pay no
residual U.S. tax on its income inclusion under sec-
tion 951A(a) (GILTI inclusion) and expects to have
unused foreign tax credits in the category described
in section 904(d)(1)(A). A CFC group election is
not in effect for Year 1. With a principal purpose
of reducing USP’s Federal income tax liability, on
January 1, Year 1, CFC1 loans $100x to CFC2. On
December 31, Year 1, CFC2 pays interest of $10x to
CFC1 and repays the principal of $100x. Absent ap-
plication of paragraph (g)(4)(i) of this section, CFC2
would treat all $10x of interest expense as disal-
lowed business interest expense and therefore would
have $10x of disallowed business interest expense
carryforward to Year 2. In Year 2, CFC2 disposes of
one of its businesses at a substantial gain that gives
rise to tested income (within the meaning of section
951A(c)(2)(A) and §1.951A-2(b)(1)). Assume that
as a result of the gain being included in the ATI of
CFC2, absent application of paragraph (g)(3)(i) of
this section, CFC2 would be allowed to deduct the
entire $10x of disallowed business interest expense
carryforward and therefore reduce the amount of
CFC2’s tested income. Also, assume that USP would
have residual U.S. tax on its GILTI inclusion in Year
2, without regard to the application of paragraph (g)
(4)(i) of this section.
(ii) Analysis. The $10x of interest expense paid in
Year 1 is a payment amount described in paragraph
(g)(4)(i) of this section because it is between speci-
fied group members, CFC1 and CFC2. Furthermore
the requirements of paragraph (g)(4)(i)(A), (B), and
(C) of this section are satisfied because the business
interest expense is incurred with a principal pur-
pose of reducing USP’s Federal income tax liabil-
ity; absent the application of paragraph (g)(4)(i) of
this section, the effect of CFC2 treating the $10x of
business interest expense as disallowed business in-
terest expense in Year 1 would be to reduce USP’s
Federal income tax liability in Year 2; and no CFC
group election is in effect with respect to the spec-
ified group in Year 1. Because the requirements of
paragraph (g)(4)(i)(A), (B), and (C) of this section
are satisfied, CFC2’s ATI for Year 1 is increased by
$33.33x, which is the amount equal to 3 1/3 multi-
plied by $10x (the lesser of the payment amount of
$10x and the disallowed business interest expense of
$10x). As a result, the $10x of business interest ex-
pense is not treated by CFC2 as disallowed business

September 28, 2020 870 Bulletin No. 2020–40
interest expense in Year 1, and therefore does not
give rise to a disallowed business interest expense
carryforward to Year 2.
(m) Applicability dates—(1) Gener-
al applicability date. Except as provided
in paragraph (m)(2) of this section, this
section applies to taxable years of a for-
eign corporation beginning on or after
November 13, 2020. However, except as
provided in paragraph (m)(2) of this sec-
tion, 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 con-
sistently apply the rules of this section to
each subsequent taxable year and the sec-
tion 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 and
each subsequent taxable year.
(2) Exception. Paragraphs (a), (c)
through (f), (g)(3) and (4), and (h) through
(k) of this section apply to taxable years
beginning on or after [DATE 60 DAYS
AFTER DATE OF PUBLICATION
OF THE FINAL RULE IN THE FED-
ERAL REGISTER]. However, taxpay-
ers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may choose to apply paragraphs (a), (c)
through (f), (g)(3) and (4), and (h) through
(k) of this section in their entirety for a
taxable year beginning after December 31,
2017, so long as the taxpayers and their re-
lated parties also apply §1.163(j)-8 for the
taxable year. For taxable years beginning
before November 13, 2020, taxpayers and
their related parties may not choose to ap-
ply paragraphs (a), (c) through (f), (g)(3)
and (4), and (h) through (k) of this section
unless they also apply paragraphs (b) and
(g)(1) and (2) of this section in accordance
with the second sentence of paragraph (m)
(1) of this section. Notwithstanding para-
graph (e)(5)(iii) or (h)(5)(i) of this sec-
tion, in the case of a specified period of
a specified group or a taxable year of a
stand-alone applicable CFC that ends with
or within a taxable year of a designated
U.S. person ending before November 13,
2020, a CFC group election or a safe-har-
bor election may be made on an amend-
ed Federal income tax return filed on or
before the due date (taking into account
extensions, if any) of the original Federal
income tax return for the first taxable year
of each designated U.S. person ending af-
ter November 13, 2020.
Par. 9. As reserved in a final rule else-
where in this issue of the Federal Register,
effective November 13, 2020, §1.163(j)-8
is added to read as follows:
§1.163(j)-8 Application of the section
163(j) limitation to foreign persons with
effectively connected income.
(a) Overview. This section provides
rules concerning the application of section
163(j) to foreign persons with ECI. Para-
graph (b) of this section modifies the ap-
plication of section 163(j) for a specified
foreign person with ECI. Paragraph (c) of
this section sets forth rules for a specified
foreign partner in a partnership with ECI.
Paragraph (d) of this section allocates dis-
allowed business interest expense for rele-
vant foreign corporations with ECI. Para-
graph (e) of this section provides rules
concerning disallowed business interest
expense. Paragraph (f) of this section co-
ordinates the application of section 163(j)
with §1.882-5 and the branch profits tax
under section 884. Paragraph (g) of this
section provides definitions that apply for
purposes of this section. Paragraph (h) of
this section illustrates the application of
this section through examples.
(b) Application to a specified foreign
person with ECI—(1) In general. If a tax-
payer is a specified foreign person, then
the taxpayer applies the modifications de-
scribed in this paragraph (b), taking into
account the application of paragraph (c) of
this section.
(2) Modification of adjusted taxable
income. Adjusted taxable income for a
specified foreign person for a taxable year
means the specified foreign person’s ad-
justed taxable income, as determined un-
der §1.163(j)-1(b)(1), taking into account
only items that are ECI.
(3) Modification of business interest
expense. Business interest expense for a
specified foreign person means business
interest expense described in §1.163(j)-
1(b)(3) that is ECI, taking into account the
application of paragraph (f)(1)(iii) of this
section.
(4) Modification of business interest in-
come. The business interest income of a
specified foreign person means business
interest income described in §1.163(j)-
1(b)(4) that is ECI.
(5) Modification of floor plan financing
interest expense. The floor plan financing
interest expense of a specified foreign per-
son means floor plan financing interest
expense described §1.163(j)-1(b)(19) that
is ECI.
(6) Modification of allocation of in-
terest expense and interest income that
is allocable to a trade or business. For
purposes of applying §1.163(j)-10(c) to
a specified foreign person, only inter-
est income and interest expense that are
ECI and only assets that are U.S. assets,
as defined in §1.884-1(d), are taken into
account. If the specified foreign person is
also a specified foreign partner, this para-
graph (b)(6) does not apply to any trade or
business of the partnership.
(c) Rules for a specified foreign part-
ner—(1) Characterization of excess tax-
able income—(i) In general. The portion
of excess taxable income allocated to a
specified foreign partner from a partner-
ship pursuant to §1.163(j)-6(f)(2) that
is ECI is equal to the specified foreign
partner’s allocation of excess taxable in-
come from the partnership multiplied by
its specified ATI ratio with respect to the
partnership, and the remainder is not ECI.
(ii) Specified ATI ratio. The term speci-
fied ATI ratio means the fraction described
in this paragraph (c)(1)(ii). If the specified
foreign partner’s distributive share of ECI
and distributive share of non-ECI are both
positive, the numerator of this fraction is
the specified foreign partner’s distribu-
tive share of ECI and the denominator is
the specified foreign partner’s distribu-
tive share of partnership items of income,
gain, deduction, and loss. If the specified
foreign partner’s distributive share of ECI
is negative or zero and its distributive
share of non-ECI is positive, this fraction
is treated as zero. If the specified foreign
partner’s distributive share of non-ECI is
negative or zero and its distributive share
of ECI is positive, this fraction is treated
as one. If the specified foreign partner’s

Bulletin No. 2020–40 871 September 28, 2020
distributive share of ECI and distributive
share of non-ECI are both negative, the
numerator of this fraction is its distribu-
tive share of non-ECI and the denomina-
tor is its distributive share of partnership
items of income, gain, deduction, and loss.
(iii) Distributive share of ECI. The
term distributive share of ECI means the
net amount of the specified foreign part-
ner’s distributive share of partnership
items of income, gain, deduction, and loss
that are ECI.
(iv) Distributive share of non-ECI. The
term distributive share of non-ECI means
the net amount of the specified foreign
partner’s distributive share of partnership
items of income, gain, deduction, and loss
that are not ECI.
(2) Characterization of excess business
interest expense—(i) Allocable ECI ex-
cess BIE. The portion of excess business
interest expense allocated to a specified
foreign partner from a partnership pursu-
ant to §1.163(j)-6(f)(2) or paragraph (e)(2)
of this section that is ECI (allocable ECI
excess BIE) is equal to the excess, if any,
of allocable ECI BIE over allocable ECI
deductible BIE.
(ii) Allocable non-ECI excess BIE.
The portion of excess business interest
expense allocated to a specified foreign
partner from a partnership pursuant to
§1.163(j)-6(f)(2) or paragraph (e)(2) of
this section that is not ECI (allocable non-
ECI excess BIE) is equal to the excess, if
any, of allocable non-ECI BIE over allo-
cable non-ECI deductible BIE.
(3) Characterization of deductible
business interest expense—(i) In general.
The portion of deductible business interest
expense, if any, that is allocated to a spec-
ified foreign partner from a partnership
pursuant to §1.163(j)-6(f)(2) that is ECI
(allocable ECI deductible BIE) is equal to
the sum of the amounts described in para-
graphs (c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)
(1) of this section. The portion of deduct-
ible business interest expense, if any, that
is allocated to a specified foreign partner
from a partnership pursuant to §1.163(j)-
6(f)(2) that is not ECI (allocable non-ECI
deductible BIE) is equal to the sum of the
amounts described in paragraphs (c)(3)(ii)
(A)(1)(ii) and (c)(3)(ii)(B)(2) of this sec-
tion.
(ii) Allocation between allocable ECI
deductible BIE and allocable non-ECI de-
ductible BIE. For purposes of paragraph
(c)(3)(i) of this section—
(A) Allocation to hypothetical deduct-
ible amounts—(1) In general. Subject
to paragraph (c)(3)(ii)(A)(2) of this sec-
tion, deductible business interest expense
that is allocated to the specified foreign
partner from the partnership pursuant to
§1.163(j)-6(f)(2) is allocated pro rata to—
(i) Hypothetical partnership ECI de-
ductible BIE; and
(ii) Hypothetical partnership non-ECI
deductible BIE.
(2) Limitation. The amount allocated
to hypothetical partnership ECI deduct-
ible BIE in paragraph (c)(3)(ii)(A)(1)(i)
of this section cannot exceed the lesser
of hypothetical partnership ECI deduct-
ible BIE or allocable ECI BIE, and the
amount allocated to hypothetical part-
nership non-ECI deductible BIE in para-
graph (c)(3)(ii)(A)(1)(ii) of this section
cannot exceed the lesser of hypothetical
partnership non-ECI deductible BIE or
allocable non-ECI BIE.
(B) Allocation of remaining deduct-
ible amounts. Deductible business interest
expense that is allocated to the specified
foreign partner from the partnership pur-
suant to §1.163(j)-6(f)(2) in excess of the
amount allocated in paragraph (c)(3)(ii)
(A) of this section, if any, is allocated pro
rata to—
(1) Allocable ECI BIE, reduced by the
amount described in paragraph (c)(3)(ii)
(A)(1)(i) of this section; and
(2) Allocable non-ECI BIE, reduced by
the amount described in paragraph (c)(3)
(ii)(A)(1)(ii) of this section.
(iii) Hypothetical partnership deduct-
ible business interest expense—(A) Hypo-
thetical partnership ECI deductible BIE.
The term hypothetical partnership ECI
deductible BIE means the deductible busi-
ness interest expense of the partnership, as
defined in §1.163(j)-6(b)(5), determined
by only taking into account the specified
foreign partner’s allocable share of items
that are ECI (including by reason of para-
graph (f)(1)(iii) of this section).
(B) Hypothetical partnership non-
ECI deductible BIE. The term hypotheti-
cal partnership non-ECI deductible BIE
means the deductible business interest
expense of the partnership, as defined in
§1.163(j)-6(b)(5), determined by only tak-
ing into account the specified foreign part-
ner’s allocable share of items that are not
ECI (including by reason of paragraph (f)
(1)(iii) of this section).
(4) Characterization of excess business
interest income—(i) In general. The por-
tion of excess business interest income al-
located to a specified foreign partner from
a partnership pursuant to §1.163(j)-6(f)(2)
that is ECI is equal to the specified foreign
partner’s allocation of excess business in-
terest income from the partnership multi-
plied by its specified BII ratio with respect
to the partnership, and the remainder is
not ECI.
(ii) Specified BII ratio. The term speci-
fied BII ratio means the ratio of the speci-
fied foreign partner’s allocable ECI BII to
allocable business interest income (deter-
mined under §1.163(j)-6(f)(2)(ii)).
(iii) Allocable ECI BII. The term allo-
cable ECI BII means the specified foreign
partner’s allocable BII, as determined
under §1.163(j)-6(f)(2)(ii), computed by
only taking into account income that is
ECI.
(5) Rules for determining ECI. Except
as described in paragraph (f)(1) of this
section, if the determination as to wheth-
er partnership items are ECI is made by a
direct or indirect partner, rather than the
partnership itself, then for purposes of this
paragraph (c), the partnership must use a
reasonable method to characterize such
items as ECI or as not ECI.
(d) Characterization of disallowed
business interest expense by a relevant for-
eign corporation with ECI—(1) Scope. A
relevant foreign corporation that has ECI
and disallowed business interest expense
for a taxable year determines the portion
of its disallowed business interest expense
and deductible business interest expense
that is characterized as ECI or as not ECI
under this paragraph (d). A relevant for-
eign corporation that is a specified foreign
partner also applies the rules in paragraph
(c) of this section. See also §1.163(j)-7(f)
for rules regarding CFC group members
with ECI.
(2) Characterization of disallowed
business interest expense—(i) FC ECI
disallowed BIE. For purposes of this sec-
tion, the portion of disallowed business
interest expense of a relevant foreign cor-
poration that is ECI (FC ECI disallowed
BIE) is equal to the excess, if any, of FC
ECI BIE over FC ECI deductible BIE.

September 28, 2020 872 Bulletin No. 2020–40
(ii) FC non-ECI disallowed BIE. For
purposes of this section, the portion of dis-
allowed business interest expense of a rel-
evant foreign corporation that is not ECI
(FC non-ECI disallowed BIE) is equal
to the excess, if any, of FC non-ECI BIE
over FC non-ECI deductible BIE.
(3) Characterization of deductible
business interest expense—(i) In general.
The portion of deductible business inter-
est expense, if any, that is ECI (FC ECI
deductible BIE) is equal to the sum of the
amounts described in paragraphs (d)(3)(ii)
(A)(1)(i) and (d)(3)(ii)(B)(1) of this sec-
tion. The portion of deductible business
interest expense, if any, that is allocable
to income that is not ECI (FC non-ECI
deductible BIE) is equal to the sum of the
amounts described in paragraphs (d)(3)(ii)
(A)(1)(ii) and (d)(3)(ii)(B)(2) of this sec-
tion.
(ii) Allocation between FC ECI deduct-
ible BIE and FC non-ECI deductible BIE.
For purposes of paragraph (d)(3)(i) of this
section—
(A) Allocation to hypothetical deduct-
ible amounts—(1) In general. Subject to
paragraph (d)(3)(ii)(A)(2) of this section,
deductible business interest expense is al-
located pro rata to—
(i) Hypothetical FC ECI deductible
BIE; and
(ii) Hypothetical FC non-ECI deduct-
ible BIE.
(2) Limitation. The amount allocated
to hypothetical FC ECI deductible BIE in
paragraph (d)(3)(ii)(A)(1)(i) of this sec-
tion cannot exceed the lesser of hypotheti-
cal FC ECI deductible BIE or FC ECI BIE,
and the amount allocated to hypothetical
FC non-ECI deductible BIE in paragraph
(d)(3)(ii)(A)(1)(ii) of this section cannot
exceed the lesser of hypothetical FC non-
ECI deductible BIE or FC non-ECI BIE.
(B) Allocation of remaining deductible
amounts. Deductible business interest ex-
pense in excess of the amount allocated in
paragraph (d)(3)(ii)(A) of this section, if
any, is allocated pro rata to—
(1) FC ECI BIE, reduced by the amount
described in paragraph (d)(3)(ii)(A)(1)(i)
of this section; and
(2) FC non-ECI BIE, reduced by the
amount described in paragraph (d)(3)(ii)
(A)(1)(ii) of this section.
(iii) Hypothetical FC deductible busi-
ness interest expense—(A) Hypothetical
FC ECI deductible BIE. The term hypo-
thetical FC ECI deductible BIE means the
deductible business interest expense of the
relevant foreign corporation determined
by only taking into account its items that
are ECI.
(B) Hypothetical FC non-ECI deduct-
ible BIE. The term hypothetical FC non-
ECI deductible BIE means the deductible
business interest expense of the relevant
foreign corporation determined by only
taking into account its items that are not
ECI.
(e) Rules regarding disallowed busi-
ness interest expense—(1) Retention of
character in a succeeding taxable year.
Disallowed business interest expense of
a specified foreign person or a relevant
foreign corporation for a taxable year (in-
cluding excess business interest expense
allocated to a specified foreign partner un-
der §1.163(j)-6(f)(2) or paragraph (e)(2)
of this section) that is ECI or is not ECI
retains its character as ECI or as not ECI
in a succeeding taxable year.
(2) Deemed allocation of excess busi-
ness interest expense of a partnership to a
specified foreign partner. For purposes of
this paragraph (e) and paragraphs (c)(2),
(g)(3), and (g)(7) of this section, a spec-
ified foreign partner’s allocable share of
business interest expense is deemed to in-
clude its allocable share of excess business
interest expense of a partnership in which
it is a direct or indirect partner. For pur-
poses of this paragraph (e)(2), a specified
foreign partner’s allocable share of excess
business interest expense of a partnership
in which it is a direct or indirect partner
is determined as if the excess business
interest expense of the partnership were
deductible in the taxable year in which the
interest expense is first paid or accrued.
(3) Ordering rule for conversion of
excess business interest expense to busi-
ness interest expense paid or accrued by
a partner. A specified foreign partner’s
allocable share of excess business interest
expense (determined under §1.163(j)-6(f)
(2) or paragraph (e)(2) of this section) is
treated as business interest expense paid
or accrued under §1.163(j)-6(g)(2)(i) in
the order of the taxable years in which the
excess business interest expense arose,
and pro rata between allocable ECI excess
BIE and allocable non-ECI excess BIE
that arose in the same taxable year. This
paragraph (e)(3) applies before applica-
tion of paragraph (b)(3) of this section.
(4) Allocable ECI excess BIE and allo-
cable non-ECI excess BIE retains its char-
acter when treated as business interest
expense paid or accrued in a succeeding
taxable year. If excess business interest
expense of a partnership in which a spec-
ified foreign partner is a direct or indirect
partner is treated as business interest ex-
pense paid or accrued by the specified
foreign partner or a partnership in which
it is a direct or indirect partner under
§1.163(j)-6(g)(2)(i), then allocable ECI
excess BIE is treated as business interest
expense allocable to ECI and allocable
non-ECI excess BIE is treated as business
interest expense allocable to income that
is not ECI.
(f) Coordination of the application of
section 163(j) with §1.882-5 and similar
provisions and with the branch profits
tax—(1) Coordination of section 163(j)
with §1.882-5 and similar provisions—(i)
Ordering rule. A foreign corporation first
determines its business interest expense
allocable to ECI under §1.882-5 or any
other relevant provision (§1.882-5 and
similar provisions) before applying sec-
tion 163(j) to the foreign corporation. If a
foreign corporation has a disallowed busi-
ness interest expense carryforward from
a taxable year, then none of that business
interest expense is taken into account for
purposes of determining business interest
expense under §1.882-5 and similar provi-
sions in a succeeding taxable year.
(ii) Treatment of excess business in-
terest expense. For purposes of applying
§1.882-5 and similar provisions, the busi-
ness interest expense of a specified foreign
partner that is a direct or indirect partner
in a partnership is determined without re-
gard to the application of section 163(j) to
the partnership. As a result, for purposes
of applying §1.882-5 and similar provi-
sions, the specified foreign partner’s share
of business interest expense on liabilities
of a partnership in which it is a direct or
indirect partner is determined as if any
excess business interest expense of the
partnership (determined under §1.163(j)-
6(f)(2) or paragraph (e)(2) of this section)
were deductible in the taxable year in
which the business interest expense is first
paid or accrued and not in a succeeding
taxable year.

Bulletin No. 2020–40 873 September 28, 2020
(iii) Attribution of certain §1.882-5 in-
terest expense among the foreign corpo-
ration and its partnership interests—(A)
In general. If a foreign corporation is a
specified foreign partner in one or more
partnerships, then, for purposes of section
163(j) and the section 163(j) regulations,
interest expense determined under §1.882-
5(b) through (d) or §1.882-5(e) (§1.882-5
three-step interest expense) is treated as
attributable to liabilities of the foreign cor-
poration or the foreign corporation’s share
of liabilities of each partnership in accor-
dance with paragraphs (f)(1)(iii)(B) and
(f)(1)(iii)(C) of this section. Accordingly,
the portion of the §1.882-5 three-step in-
terest expense attributable to liabilities of
the foreign corporation described in this
paragraph (f)(1)(iii) is subject to section
163(j) and the section 163(j) regulations
at the level of the foreign corporation. The
portion of the §1.882-5 three-step interest
expense interest attributable to liabilities
of a partnership described in this para-
graph (f)(1)(iii) is subject to section 163(j)
and the section 163(j) regulations at the
partnership-level. See §1.163(j)-6. This
paragraph (f)(1)(iii) merely characterizes
interest expense of the foreign corporation
and its partnership interests as ECI or not
ECI. It does not change the amount of in-
terest expense of the foreign corporation
or its partnership interests.
(B) Attribution of interest expense on
U.S. booked liabilities. The §1.882-5
three-step interest expense is treated as at-
tributable, pro rata, to interest expense on
U.S. booked liabilities of a foreign corpo-
ration, determined under §1.882-5(d)(2)
(ii)-(iii) or its interest expense on its share
of U.S. booked liabilities of a partnership,
determined under §1.882-5(d)(2)(vii), as
applicable, to the extent thereof (without
regard to whether the foreign corporation
uses the method described in §1.882-5(b)
through (d) or the method described in
§1.882-5(e) for purposes of determining
§1.882-5 interest expense).
(C) Attribution of excess §1.882-5
three-step interest expense—(1) In gen-
eral. The §1.882-5 three-step interest
expense in excess of interest expense at-
tributable to U.S. booked liabilities de-
scribed in §1.882-5(d)(2), if any (excess
§1.882-5 three-step interest expense), is
treated as attributable to liabilities of the
foreign corporation or the foreign corpo-
ration’s allocable share of liabilities of one
or more partnerships, in accordance with
paragraphs (f)(1)(iii)(C)(2) and (f)(1)(iii)
(C)(3) of this section, subject to the lim-
itation in paragraph (f)(1)(iii)(C)(4) of this
section. For purposes of this paragraph (f)
(1)(iii)(C), the term “U.S. assets” means
U.S. assets described in §1.882-5(b).
(2) Attribution of excess §1.882-5
three-step interest expense to the foreign
corporation. Excess §1.882-5 three-step
interest expense is treated as attributable
to interest expense on liabilities of the for-
eign corporation (and not its partnership
interests) in proportion to its U.S. assets
other than its partnership interests over all
of its U.S. assets.
(3) Attribution of excess §1.882-5 three-
step interest expense to partnerships—(i)
In general. Excess §1.882-5 three-step
interest expense is treated as attributable
to interest expense on the foreign corpora-
tion’s direct or indirect allocable share of
liabilities of a partnership in proportion to
the portion of the partnership interest that
is treated as a U.S. asset under paragraph
(f)(1)(iii)(C)(3)(ii) of this section over all
of the foreign corporation’s U.S. assets.
(ii) Direct and indirect partnership in-
terests. If a foreign corporation owns an
interest in a partnership that does not own
an interest in any other partnerships, the
portion of the partnership interest that is
a U.S. asset is determined under §1.882-
5(b). If a foreign corporation owns an in-
terest in a partnership (the top-tier partner-
ship) that owns an interest in one or more
other partnerships, directly or indirectly
(the lower-tier partnerships), the portion
of the foreign corporation’s direct or indi-
rect interest in the top-tier partnership and
lower-tier partnerships that is a U.S. asset
is determined by re-attributing the portion
of the top-tier partnership interest that is
a U.S. asset, as determined under §1.882-
5(b), among the foreign corporation’s di-
rect interest in the top-tier partnership and
indirect interests in each lower-tier part-
nership in proportion to their contribution
to the portion of the foreign corporation’s
interest in the upper-tier partnership that
is a U.S. asset. Each partnership interest’s
contribution is determined based on a rea-
sonable method consistent with the meth-
od used to determine the portion of the
top-tier partnership interest that is a U.S.
asset under §1.882-5(b).
(4) Limitation on attribution of excess
§1.882-5 three-step interest expense. The
portion of excess §1.882-5 three-step in-
terest expense attributable to a foreign
corporation under paragraph (f)(1)(iii)(C)
(2) of this section or to a partnership under
paragraph (f)(1)(iii)(C)(2) or (f)(1)(iii)(C)
(3) of this section, as applicable, is limit-
ed to interest on liabilities of the foreign
corporation or the foreign corporation’s
allocable share of liabilities of the partner-
ship, reduced by the sum of the amounts
of interest expense on its U.S. booked li-
abilities described in §1.882-5(d)(2) and
interest expense on liabilities described
in §1.882-5(a)(1)(ii)(A) or (B) (regarding
direct allocations of interest expense). The
portion of any excess §1.882-5 three-step
interest expense that would be treated as
attributable to the foreign corporation or
a partnership interest, as applicable, but
for this paragraph (f)(1)(iii)(C)(4) is re-at-
tributable in accordance with the rules
and principles of this paragraph (f)(1)(iii)
(C). The portion of any excess §1.882-5
three-step interest expense that cannot be
re-attributed under the rules of (f)(1)(iii)
(C)(1) through (3) of this section because
of the application of the first sentence of
this paragraph (f)(1)(iii)(C)(4) is attribut-
able, first to interest on liabilities of the
foreign corporation, and then, pro rata, to
the foreign corporation’s allocable share
of interest on liabilities of its direct or in-
direct partnership interests, to the extent
such attribution is not in excess of the lim-
itation described in this paragraph (f)(1)
(iii)(C)(4), and without regard to whether
the foreign corporation or its partnership
interests have U.S. assets.
(2) Coordination with the branch prof-
its tax. The disallowance and carryfor-
ward of business interest expense under
§1.163(j)-2(b) and (c) will not affect the
computation of the U.S. net equity of a
foreign corporation, as defined in §1.884-
1(c).
(g) Definitions. The following defini-
tions apply for purposes of this section.
(1) §1.882-5 and similar provisions.
The term §1.882-5 and similar provisions
has the meaning provided in paragraph (f)
(1)(i) of this section.
(2) §1.882-5 three-step interest ex-
pense. The term §1.882-5 three-step inter-
est expense has the meaning provided in
paragraph (f)(1)(iii)(A) of this section.

September 28, 2020 874 Bulletin No. 2020–40
(3) Allocable ECI BIE. The term allo-
cable ECI BIE means, with respect to a
partnership, the specified foreign partner’s
allocable share of the partnership’s busi-
ness interest expense that is ECI, taking
into account the application of paragraph
(e)(2) of this section.
(4) Allocable ECI BII. The term alloca-
ble ECI BII has the meaning provided in
paragraph (c)(4)(ii) of this section.
(5) Allocable ECI deductible BIE. The
term allocable ECI deductible BIE has the
meaning provided in paragraph (c)(3)(i)
of this section.
(6) Allocable ECI excess BIE. The term
allocable ECI excess BIE has the mean-
ing provided in paragraph (c)(2)(i) of this
section.
(7) Allocable non-ECI BIE. The term
allocable non-ECI BIE means, with re-
spect a partnership, the specified foreign
partner’s allocable share of the partner-
ship’s business interest expense that is not
ECI, taking into account the application of
paragraph (e)(2) of this section.
(8) Allocable non-ECI deductible BIE.
The term allocable non-ECI deductible
BIE has the meaning provided in para-
graph (c)(3)(i) of this section.
(9) Allocable non-ECI excess BIE. The
term allocable non-ECI excess BIE has
the meaning provided in paragraph (c)(2)
(ii) of this section.
(10) Distributive share of ECI. The
term distributive share of ECI has the
meaning provided in paragraph (c)(1)(iii)
of this section.
(11) Distributive share of non-ECI. The
term distributive share of non-ECI has the
meaning provided in paragraph (c)(1)(iv)
of this section.
(12) Effectively connected income.
The term effectively connected income (or
ECI) means income or gain that is ECI,
as defined in §1.884-1(d)(1)(iii), and de-
duction or loss that is allocable to, ECI, as
defined in §1.884-1(d)(1)(iii).
(13) Excess §1.882-5 three-step inter-
est expense. The term excess §1.882-5
three-step interest expense has the mean-
ing provided in paragraph (f)(1)(iii)(C)(1)
of this section.
(14) FC ECI BIE. The term FC ECI
BIE means, with respect to a relevant
foreign corporation and a taxable year,
business interest expense that is ECI, de-
termined without regard to the application
of section 163(j) and the section 163(j)
regulations except for the application of
paragraph (f)(1)(iii) of this section.
(15) FC ECI deductible BIE. The term
FC ECI deductible BIE has the meaning
provided in paragraph (d)(3)(i) of this sec-
tion.
(16) FC ECI disallowed BIE. The term
FC ECI disallowed BIE has the meaning
provided in paragraph (d)(2)(i) of this sec-
tion.
(17) FC non-ECI BIE. The term FC
non-ECI BIE means, with respect to a
relevant foreign corporation and a tax-
able year, business interest expense that
is not ECI, determined without regard to
the application of section 163(j) and the
section 163(j) regulations except for the
application of paragraph (f)(1)(iii) of this
section.
(18) FC non-ECI deductible BIE. The
term FC non-ECI deductible BIE has the
meaning provided in paragraph (d)(3)(i)
of this section.
(19) FC non-ECI disallowed BIE. The
term FC non-ECI disallowed BIE has the
meaning provided in paragraph (d)(2)(ii)
of this section.
(20) Hypothetical partnership ECI de-
ductible BIE. The term hypothetical part-
nership ECI deductible BIE has the mean-
ing provided in paragraph (c)(3)(iii)(A) of
this section.
(21) Hypothetical partnership non-ECI
deductible BIE. The term hypothetical
partnership non-ECI deductible BIE has
the meaning provided in paragraph (c)(3)
(iii)(B) of this section.
(22) Hypothetical FC ECI deductible
BIE. The term hypothetical FC ECI de-
ductible BIE has the meaning provided in
paragraph (d)(3)(iii)(A) of this section.
(23) Hypothetical FC non-ECI de-
ductible BIE. The term hypothetical FC
non-ECI deductible BIE has the meaning
provided in paragraph (d)(3)(iii)(B) of this
section.
(24) Specified ATI ratio. The term spec-
ified ATI ratio has the meaning provided
in paragraph (c)(1)(ii) of this section.
(25) Specified BII ratio. The term spec-
ified BII ratio has the meaning provided in
paragraph (c)(4)(ii) of this section.
(26) Specified foreign partner. The
term specified foreign partner means, with
respect to a partnership that has ECI, a di-
rect or indirect partner that is a specified
foreign person or a relevant foreign cor-
poration.
(27) Specified foreign person. The term
specified foreign person means a nonresi-
dent alien individual, as defined in section
7701(b) and the regulations under section
7701(b), or a foreign corporation other
than a relevant foreign corporation.
(28) Successor. The term successor
includes, with respect to a foreign cor-
poration, the acquiring corporation in a
transaction described in section 381(a) in
which the foreign corporation is the dis-
tributor or transferor corporation.
(h) Examples. The following examples
illustrate the application of this section.
For all examples, assume that all refer-
enced interest expense is deductible but for
the application of section 163(j), the small
business exemption under §1.163(j)-2(d)
is not available, no entity is engaged in
an excepted trade or business, no business
interest expense is floor plan financing in-
terest expense, all entities have the same
taxable year, all entities use the U.S. dol-
lar as their functional currency, no foreign
corporation is a relevant foreign corpora-
tion, all relevant taxable years begin after
December 31, 2020, and, for purposes of
computing ATI, none of the adjustments
described in §1.163(j)-1(b) are relevant
other than the adjustment for business in-
terest expense.
(1) Example 1. Limitation on business interest
deduction of a foreign corporation—(i) Facts. FC,
a foreign corporation, has $100x of gross income
that is ECI. FC has $60x of other income which is
not ECI. FC has total expenses of $100x, of which
$50x is business interest expense. Assume that FC
has $30x of §1.882-5 three-step interest expense.
Under section 882(c) and the regulations, FC has
$40x of other expenses that are ECI, none of which
are business interest expense. FC does not have any
business interest income. All amounts described in
this paragraph (h)(1)(i) are with respect to a single
taxable year of FC.
(ii) Analysis. FC is a specified foreign person un-
der paragraph (g)(27) of this section. The amount of
FC’s business interest expense that is disallowed for
the taxable year is determined under §1.163(j)-2(b)
with respect to business interest expense described in
paragraph (b)(3) of this section. Under paragraph (b)
(3) of this section, FC has business interest expense
of $30x. Under paragraph (b)(2) of this section, FC
has ATI of $60x ($100x - $40x). Accordingly, FC’s
section 163(j) limitation is $18x ($60x x 30 percent).
Because FC’s business interest expense ($30x) that
is ECI exceeds the section 163(j) limitation ($18x),
FC may only deduct $18x of business interest ex-
pense. Under §1.163(j)-2(c), the remaining $12x is
disallowed business interest expense carryforward,
and under paragraph (f)(1)(i) of this section, the

Bulletin No. 2020–40 875 September 28, 2020
$12x is not taken into account for purposes of apply-
ing §1.882-5 in the succeeding taxable year.
(2) Example 2. Use of a disallowed business in-
terest expense carryforward—(i) Facts. The facts are
the same as in Example 1 in paragraph (h)(1)(i) of
this section except that for the taxable year FC has
$300x of gross income that is all ECI. Furthermore,
assume that for the taxable year FC has a disallowed
business interest expense carryforward of $25x with
respect to business interest expense described in
paragraph (b)(3) of this section.
(ii) Analysis. Under paragraph (f)(1)(i) of this
section, FC’s $25x of disallowed business interest
expense carryforward is not taken into account for
purposes of determining FC’s interest expense un-
der §1.882-5 for the taxable year. Therefore, FC has
$30x of §1.882-5 three-step interest expense. Under
paragraph (b)(2) of this section, FC has ATI of $260x
($300x of gross income reduced by $40 of expenses
other than business interest expense). Accordingly,
FC’s section 163(j) limitation is $78x ($260x x 30
percent). Because FC’s business interest expense
($55x) does not exceed the section 163(j) limitation
($78x), FC may deduct all $55x of business interest
expense.
(3) Example 3. Foreign corporation is engaged
in a U.S. trade or business and is also a specified
foreign partner—(i) Facts. FC, a foreign corpora-
tion, owns a 50-percent interest in ABC, a partner-
ship that has ECI. In addition to owning a 50-percent
interest in ABC, FC conducts a separate business
that is engaged in a trade or business in the Unit-
ed States, Business Y. Business Y produces $65x of
taxable income before taking into account business
interest expense and has U.S. assets with an adjusted
basis of $300x, business interest expense of $15x on
$160x of liabilities, and no business interest income.
All of the liabilities of Business Y are U.S. booked
liabilities for purposes of §1.882-5(d). FC also has
various foreign operations, some of which have
U.S. dollar denominated debt. ABC has two lines
of business, Business S and Business T. FC is allo-
cated 50 percent of all items of income and expense
of Business S and Business T. Business S produces
$140x of taxable income before taking into account
business interest expense, and Business T produces
$80x of taxable income before taking into account
business interest expense. Business S has business
interest expense of $20x on $400x of liabilities and
no business interest income. Business T has business
interest expense of $10x on $150x of liabilities and
no business interest income. With respect to FC, only
Business S produces ECI. FC has an outside basis of
$600x in the portion of its ABC partnership interest
that is a U.S. asset for purposes of §1.882-5(b), step
1. All of the liabilities of Business S are U.S. booked
liabilities for purposes of §1.882-5(d). FC computes
its interest expense under the three-step method de-
scribed in §1.882-5(b) through (d) and for purposes
of §1.882-5(c), step 2, FC uses the fixed ratio of 50
percent described in §1.882-5(c)(4) for taxpayers
that are neither a bank nor an insurance company.
Under §1.882-5(d)(5)(ii), FC’s interest rate on ex-
cess U.S. connected liabilities is 5 percent. For the
taxable year, assume FC has total interest expense of
$100x for purposes of §1.882-5(a)(3). All amounts
described in this paragraph (h)(3)(i) are with respect
to a single taxable year of FC or ABC, as applicable.
(ii) Analysis—(A) Application of §1.882-5 to
FC. FC is a specified foreign person under paragraph
(g)(27) of this section and a specified foreign partner
under paragraph (g)(26) of this section. Under para-
graph (f)(1) of this section, FC first determines its
§1.882-5 three-step interest expense and then applies
section 163(j). Under §1.882-5(b), step 1, FC has
U.S. assets of $900x ($600x of basis in the portion
of its ABC partnership interest that is a U.S. asset de-
termined using the asset method described in §1.884-
1(d)(3)(ii) + $300x basis in U.S. assets of Business
Y). Under §1.882-5(c), step 2, applying the 50-per-
cent fixed ratio described in §1.882-5(c)(4), FC has
U.S. connected liabilities of $450x ($900x x 50 per-
cent). Under §1.882-5(d), step 3, FC has U.S. booked
liabilities of $360x ($200x attributable to its 50-per-
cent share of Business S liabilities of ABC + $160x
of Business Y liabilities) and interest on U.S. booked
liabilities of $25x ($10x attributable to its 50-percent
share of $20x interest expense of Business S + $15x
of Business Y interest expense). FC has excess U.S.
connected liabilities of $90x ($450x – $360x) and
under §1.882-5(d)(5) has interest expense on excess
U.S. connected liabilities of $4.50x ($90x x 5 per-
cent), which is excess §1.882-5 three-step interest
expense. FC’s §1.882-5 three-step interest expense
is $29.50x ($25x + $4.50x).
(B) Attribution of §1.882-5 business interest ex-
pense between FC and ABC. Under paragraph (f)(1)
(iii) of this section, FC’s §1.882-5 three-step interest
expense is attributable to interest on its liabilities or
on its share of ABC liabilities. Under paragraph (f)
(1)(iii)(B), FC’s §1.882-5 three-step interest expense
of $29.50x is first attributable to $15 of interest ex-
pense on FC’s (Business Y) U.S. booked liabilities
and $10x of interest expense on FC’s share of U.S.
booked liabilities of ABC. Under paragraph (f)(1)
(iii)(C)(2) of this section, of the excess §1.882-5
three-step interest expense of $4.50x ($29.50x - $15x
- $10x), 66.67 percent ($600x of basis in the portion
of the ABC partnership interest that is a U.S. asset
/ $900x of total U.S. assets), or $3.00x, is attribut-
able to interest expense on FC’s share of liabilities of
ABC and 33.33 percent ($300x U.S. assets other than
partnership interests / $900x of total U.S. assets), or
$1.50x, is attributable to interest expense on liabili-
ties of FC. As a result, $16.50x of business interest
expense ($15x + $1.50x) is attributed to FC and $13x
of business interest expense ($10x + $3x) is attribut-
ed to ABC. The limitation under paragraph (f)(1)(iii)
(C)(4) of this section does not change the result de-
scribed in the preceding sentence. Specifically, under
paragraph (f)(1)(iii)(C)(4) of this section, the amount
attributed to ABC (tentatively, $3.00x) is limited to
$5x (FC’s 50-percent share of the $30x of business
interest expense of ABC or $15x, reduced by FC’s
50-percent share of the $20x of business interest ex-
pense on U.S. booked liabilities of Business S), and
the amount attributed to FC (tentatively, $1.50x) is
limited to $70x (FC’s business interest expense of
$100x, reduced by $15x of business interest expense
on U.S. booked liabilities of Business Y and its $15x
allocable share of ABC’s business interest expense).
(C) Application of the section 163(j) limitation to
ABC. Under §1.163(j)-6(a), ABC computes a section
163(j) limitation at the partnership level. ABC has
business interest expense of $30x ($20x from Busi-
ness S and $10x from Business T). Under §1.163(j)-
6(d), ABC has ATI of $220x ($140 + $80). Under
§1.163(j)-2(b), ABC’s section 163(j) limitation is
$66x ($220x x 30 percent). Because ABC’s business
interest expense ($30x) does not exceed the section
163(j) limitation ($66x), all of ABC’s business inter-
est expense is deductible for the taxable year.
(D) Excess taxable income of ABC. Under
§1.163(j)-1(b)(15), ABC has excess taxable income
of $120x ($220x x ($36x/$66x)). Under §1.163(j)-
6(f)(2), FC is allocated 50 percent of the $120x of
ABC’s excess taxable income or $60x of alloca-
ble excess taxable income. Under paragraph (c)(1)
of this section, the amount of the allocable excess
taxable income of $60x that is ECI is equal to FC’s
allocable excess taxable income multiplied by the
specified ATI ratio. Under paragraph (c)(1)(iii) of
this section, FC’s distributive share of ECI of ABC
is $57x (FC’s 50-percent share of $140x (Business
S income computed without regard to business in-
terest expense) or $70x - $13x of business interest
expense that is ECI). Under paragraph (c)(1)(iv) of
this section, FC’s distributive share of non-ECI of
ABC is $38x (FC’s 50-percent share of $80x (Busi-
ness T income computed without regard to business
interest expense) or $40x - $2x of business interest
expense that is not ECI). FC’s distributive share of
partnership items of income, gain, deduction, and
loss of ABC is $95x ($57x distributive share of ECI
and $38x distributive share of non-ECI). Because
both FC’s distributive share of ECI and distributive
share of non-ECI are positive, under paragraph (c)
(1)(ii) of this section, the specified ATI ratio is 60
percent ($57x distributive share of ECI / $95x dis-
tributive share of partnership items of income, gain,
deduction, and loss of ABC). As a result, the amount
of FC’s allocable excess taxable income from ABC
that is ECI is $36x ($60 of allocable excess taxable
income x 60 percent specified ATI ratio).
(E) Application of section 163(j) to FC. Under
paragraph (b)(3) of this section, FC’s business in-
terest expense is $16.50x. Under §1.163(j)-6(e)(1),
FC’s ATI is determined under §1.163(j)-1(b)(1) with-
out regard to FC’s distributive share of any items of
income, gain, deduction, or loss of ABC. Under para-
graph (b)(2) of this section, FC’s ATI is $101x ($65x
of ECI from Business Y + $36x of allocable excess
taxable income from ABC that is ECI). FC’s section
163(j) limitation is $30.30x ($101x x 30 percent).
Because FC’s business interest expense ($16.50x)
is less than FC’s section 163(j) limitation ($30.30x)
and all of its share of ABC’s business interest ex-
pense that is allocable to ECI ($13x) is deductible,
FC may deduct all $29.50x of §1.882-5 three-step
interest expense determined under paragraph (h)(3)
(ii)(A) of this section.
(4) Example 4. Specified foreign partner with ex-
cess business interest expense from a partnership—
(i) Facts—(A) In general. FC, a foreign corporation,
owns a 50-percent interest in ABC, a partnership that
has ECI. In addition to owning a 50-percent inter-
est in ABC, FC conducts a separate business that is
engaged in a trade or business in the United States,
Business Y. Business Y produces $56x of taxable
income before taking into account business interest
expense and has U.S. assets with an adjusted basis of
$800x, business interest expense of $16x on $200x
of liabilities, and no business interest income. All of
the liabilities of Business Y are U.S. booked liabili-

September 28, 2020 876 Bulletin No. 2020–40
ties for purposes of §1.882-5(d). FC also has various
foreign operations, some of which have U.S. dollar
denominated debt.
(B) ABC Partnership. ABC has two lines of busi-
ness, Business S and Business T, and owns a 50-per-
cent interest in DEF, a partnership. FC is allocated 50
percent of all items of income and expenses of Busi-
ness S and Business T and ABC’s allocable share of
items from partnership DEF. Business S produces
$80x of taxable income before taking into account
business interest expense, and Business T produces
$90x of taxable income before taking into account
business interest expense. Business S has business
interest expense of $30x on $500x of liabilities and
no business interest income. Business T has business
interest expense of $50x on $500x of liabilities and
no business interest income. With respect to FC,
only Business S produces ECI. All of the liabilities
of Business S are U.S. booked liabilities for purposes
of §1.882-5(d).
(C) DEF Partnership. DEF has two lines of busi-
ness, Business U and Business V. ABC is allocated
50 percent of all items of income and expenses of
Business U and Business V. Business U produces
$100x of taxable income before taking into account
business interest expense and Business V produces
$140x of taxable income before taking into account
business interest expense. Business U has business
interest expense of $40x on $600x of liabilities and
no business interest income. Business V has business
interest expense of $60x on $600x of liabilities and
no business interest income. With respect to FC, only
Business U produces ECI. All of the liabilities of
Business U are U.S. booked liabilities for purposes
of §1.882-5(d).
(D) Section 1.882-5. FC has an outside basis of
$600x in the portion of its ABC partnership inter-
est that is a U.S. asset for purposes of §1.882-5(b),
step 1, determined using the asset method described
in §1.884-1(d)(3)(ii). For purposes of §1.884-1(d)
(3)(ii), ABC has a total basis of $500 in assets that
would be treated as U.S. assets if ABC were a for-
eign corporation, including a basis of $250x in the
portion of its interest in DEF partnership interest that
would be treated as a U.S. asset if ABC were a for-
eign corporation. FC computes its interest expense
under the three-step method described in §1.882-5(b)
through (d), and for purposes of §1.882-5(c), step 2,
FC uses the fixed ratio of 50 percent described in
§1.882-5(c)(4) for taxpayers that are neither a bank
nor an insurance company. FC has total interest ex-
pense of $100x for purposes of §1.882-5(a)(3). Un-
der §1.882-5(d)(5)(ii), FC’s interest rate on excess
U.S. connected liabilities is 6 percent. All amounts
described in this paragraph (h)(4)(i) are with respect
to a single taxable year of FC, ABC, or DEF, as ap-
plicable.
(ii) Analysis—(A) Application of §1.882-5 to
FC. FC is a specified foreign person under paragraph
(g)(27) of this section and a specified foreign partner
under paragraph (g)(26) of this section. Under para-
graph (f)(1) of this section, FC first determines its
§1.882-5 three-step interest expense and then applies
section 163(j). Under §1.882-5(b), step 1, FC has
U.S. assets of $1400x ($600x of basis in the portion
of its ABC partnership interest that is a U.S. asset
+ $800x basis in U.S. assets of Business Y). Under
§1.882-5(c), step 2, applying the 50-percent fixed ra-
tio described in §1.882-5(c)(4), FC has U.S. connect-
ed liabilities of $700x ($1400x x 50 percent). Under
§1.882-5(d), step 3, FC has U.S. booked liabilities of
$600x ($250x attributable to its 50-percent share of
Business S liabilities of ABC + $150x attributable to
its indirect 25-percent share of Business U liabilities
of DEF + $200x of Business Y liabilities), and inter-
est on U.S. booked liabilities of $41x ($15x attribut-
able to its 50-percent share of $30x interest expense
of Business S + $10x attributable to its 25-percent
share of $40 interest expense of Business U + $16x
of Business Y interest expense). FC has excess U.S.
connected liabilities of $100x ($700x – $600x) and
under §1.882-5(d)(5), interest expense on excess
U.S. connected liabilities of $6x ($100x x 6 percent),
which is excess §1.882-5 three-step interest expense.
FC’s §1.882-5 three-step interest expense is $47x
($41x + $6x).
(B) Attribution of certain §1.882-5 business in-
terest expense among FC, ABC, and DEF. Under
paragraph (f)(1)(iii) of this section, FC’s §1.882-5
three-step interest expense is attributable to interest
on its liabilities or on its share of ABC and DEF’s lia-
bilities. Under paragraph (f)(1)(iii)(B) of this section,
FC’s §1.882-5 three-step interest expense of $47x is
first attributable to $16x of interest expense on FC’s
U.S. booked liabilities, $15x of interest expense
on FC’s share of U.S. booked liabilities of ABC,
and $10x of interest expense on FC’s share of U.S.
booked liabilities of DEF. Under paragraph (f)(1)(iii)
(C)(2) of this section, of the excess §1.882-5 three-
step interest expense of $6x ($47x - $16x - $15x -
$10x), 42.86 percent ($600x of basis in the portion
of the ABC partnership interest that is a U.S. asset /
$1400x of total U.S. assets) or $2.57x is attributable
to interest expense on FC’s share of liabilities of ABC
(and its partnership interests), and 57.14 percent
($800x U.S. assets other than partnership interests /
$1400x of total U.S. assets) or $3.43x is attributable
to interest expense on liabilities of FC. Under para-
graph (f)(1)(iii)(C)(3) of this section, of the $2.57x
of business interest expense that is ECI and that is at-
tributable to interest expense on FC’s share of liabili-
ties of ABC (and its partnership interests), 50 percent
($250x of basis in the portion of the DEF partnership
interest that would be a U.S. asset if ABC were a
foreign corporation / $500x total basis in assets that
would be U.S. assets if ABC were a foreign corpo-
ration), or $1.29x, is attributable to interest expense
on FC’s share of liabilities of ABC and 50 percent
($250x of basis in assets other than partnership inter-
ests that would be U.S. assets if ABC were a foreign
corporation / $500x of total basis in assets that would
be U.S. assets if ABC were a foreign corporation),
or $1.29x is attributable to interest expense on FC’s
share of liabilities of DEF. As a result, $19.43x ($16x
+ $3.43x) of business interest expense is attributed
to FC, $16.29x ($15x + $1.29x) of business interest
expense is attributed to ABC, and $11.29x ($10x +
$1.29x) of business interest expense is attributed to
DEF. The limitation under paragraph (f)(1)(iii)(C)(4)
of this section does not change the result described
in the preceding sentence. Specifically, under para-
graph (f)(1)(iii)(C)(4) of this section, the amount at-
tributed to FC (tentatively, $3.43x) is limited to $19x
(FC’s business interest expense of $100x, reduced
by $16x of business interest expense on U.S. booked
liabilities of Business Y, its $40x allocable share
of ABC’s business interest expense, and its $25x
allocable share of DEF’s business interest expense);
the amount attributed to ABC (tentatively, $1.29x) is
limited to $25x (FC’s 50-percent share of the $80x of
business interest expense of ABC, or $40x, reduced
by FC’s 50-percent share of the $30x of business in-
terest expense on U.S. booked liabilities of Business
S, or $15x); and the amount attributed to DEF (ten-
tatively, $1.29x) is limited to $15x (FC’s 25-percent
share of the $100x of business interest expense of
DEF, or $25x, reduced by FC’s 25-percent share of
the $40x of business interest expense on U.S. booked
liabilities of Business U, or $10x).
(C) Application of section 163(j) to DEF—(1)
In general. Under §1.163(j)-6(a), DEF computes a
section 163(j) limitation at the partnership-level.
DEF has business interest expense of $100x ($40x
from Business U + $60x from Business V). Under
§1.163(j)-6(d), DEF has ATI of $240x ($100x +
$140x). Under §1.163(j)-2(b), DEF’s section 163(j)
limitation is $72x ($240x x 30 percent). Because
DEF’s business interest expense ($100x) exceeds the
section 163(j) limitation ($72x), only $72x of DEF’s
business interest expense is deductible and $28x is
disallowed under section 163(j). Pursuant to para-
graph (e)(2) of this section, FC is allocated $7x of
excess business interest expense (25 percent x $28x)
and $18x of deductible business interest expense (25
percent x $72x).
(2) Deductible business interest expense. Under
paragraph (c)(3) of this section, in order to determine
the portion of FC’s allocable deductible business in-
terest expense ($18x) that is allocable ECI deduct-
ible BIE and the portion that is allocable non-ECI
deductible BIE, the hypothetical partnership ECI de-
ductible BIE and hypothetical partnership non-ECI
deductible BIE must be determined. Under para-
graph (c)(3)(iii)(A) of this section, FC’s hypothetical
partnership ECI deductible BIE with respect to DEF
is $7.50x ($25x of FC’s allocable share of ECI before
taking into account interest expense x 30 percent).
Under paragraph (c)(3)(iii)(B) of this section, FC’s
hypothetical partnership non-ECI deductible BIE
with respect to DEF is $10.50x ($35x of FC’s allo-
cable share of income that is not ECI before taking
into account interest expense x 30 percent). Under
paragraph (c)(3)(i) of this section, allocable ECI
deductible BIE is equal to the amounts described in
paragraphs (c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of
this section and allocable non-ECI deductible BIE is
equal to the amounts described in paragraphs (c)(3)
(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of this section. Un-
der paragraph (c)(3)(ii)(A)(1) of this section, FC’s
allocable deductible business interest expense ($18x)
is allocated pro rata between hypothetical partnership
ECI deductible BIE ($7.50x) and hypothetical part-
nership non-ECI deductible BIE ($10.50x). Howev-
er, the amount allocated to hypothetical partnership
ECI deductible BIE cannot exceed the lesser of hy-
pothetical partnership ECI deductible BIE ($7.50x)
or allocable ECI BIE ($11.29x), and the amount allo-
cated to hypothetical partnership non-ECI deductible
BIE cannot exceed the lesser of hypothetical part-
nership non-ECI deductible BIE ($10.50x) or allo-
cable non-ECI BIE (total allocable business interest
expense of $25x reduced by allocable ECI BIE of
$11.29x, or $13.71x). The portion of FC’s allocable
deductible business interest expense ($18x) from

Bulletin No. 2020–40 877 September 28, 2020
DEF that is allocable ECI deductible BIE is 41.67
percent ($7.50x of hypothetical partnership ECI de-
ductible BIE / $18x of total hypothetical partnership
deductible BIE), or $7.5x. The portion of FC’s allo-
cable deductible business interest expense from DEF
($18x) that is allocable non-ECI deductible BIE is
58.33 percent ($10.50x of hypothetical partnership
ECI deductible BIE / $18x of total hypothetical part-
nership deductible BIE), or $10.50x. Because the full
amount of FC’s allocable deductible business inter-
est expense ($18x) is allocable under paragraph (c)
(3)(ii)(A)(1) of this section, no portion is allocated
under paragraph (c)(3)(ii)(B) of this section.
(3) Excess business interest expense. Under para-
graph (c)(2)(i) of this section, the portion of excess
business interest expense allocated to FC from DEF
pursuant to paragraph (e)(2) of this section ($7x) that
is allocable ECI excess BIE is $3.79x ($11.29x of
allocable ECI BIE - $7.50x allocable ECI deductible
BIE). Under paragraph (c)(2)(ii) of this section, the
portion of excess business interest expense allocated
to FC from DEF pursuant to paragraph (e)(2) of this
section ($7x) that is allocable non-ECI excess BIE is
$3.21x ($13.71x of allocable non-ECI BIE - $10.50x
allocable non-ECI deductible BIE).
(D) Application of section 163(j) to ABC—(1)
In general. Under §1.163(j)-6(a), ABC computes
a section 163(j) limitation at the partnership-level.
ABC has business interest expense of $80x ($30x
from Business S + $50x from Business T). Un-
der §1.163(j)-6(d), ABC has ATI of $170x ($80x +
$90x). Under §1.163(j)-2(b), ABC’s section 163(j)
limitation is $51x ($170x x 30 percent). Because
ABC’s business interest expense ($80x) exceeds
the section 163(j) limitation ($51x), ABC may
only deduct $51x of business interest expense, and
$29x is disallowed under section 163(j). Pursuant to
§1.163(j)-6(f)(2), FC is allocated $14.50x of excess
business interest expense (50 percent x $29x) and
$25.50x of deductible business interest expense (50
percent x $51x).
(2) Deductible business interest expense. Under
paragraph (c)(3) of this section, in order to deter-
mine the portion of FC’s allocable deductible busi-
ness interest expense ($25.50x) that is allocable
ECI deductible BIE and the portion that is allocable
non-ECI deductible BIE, the hypothetical partner-
ship ECI deductible BIE and hypothetical partner-
ship non-ECI deductible BIE must be determined.
Under paragraph (c)(3)(iii)(A) of this section, FC’s
hypothetical partnership ECI deductible BIE with re-
spect to ABC is $12x ($40x of FC’s allocable share
of ECI before taking into account interest expense
x 30 percent). Under paragraph (c)(3)(iii)(B) of this
section, FC’s hypothetical partnership non-ECI de-
ductible BIE with respect to ABC is $13.50x ($45x
of FC’s allocable share of income that is not ECI
before taking into account interest expense x 30
percent). Under paragraph (c)(3)(i) of this section,
allocable ECI deductible BIE is equal to the amounts
described in paragraphs (c)(3)(ii)(A)(1)(i) and (c)
(3)(ii)(B)(1) of this section and allocable non-ECI
deductible BIE is equal to the amounts described in
paragraphs (c)(3)(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of
this section. Under paragraph (c)(3)(ii)(A)(1) of this
section, FC’s allocable deductible business interest
expense ($25.50x) is allocated pro rata between hy-
pothetical partnership ECI deductible BIE ($12x)
and hypothetical partnership non-ECI deductible
BIE ($13.50x). However, the amount allocated to
hypothetical partnership ECI deductible BIE cannot
exceed the lesser of hypothetical partnership ECI de-
ductible BIE ($12x) or allocable ECI BIE ($16.29x),
and the amount allocated to hypothetical partnership
non-ECI deductible BIE cannot exceed the lesser of
hypothetical partnership non-ECI deductible BIE
($13.50x) or allocable non-ECI BIE (total allocable
business interest expense of $40x reduced by alloca-
ble ECI BIE of $16.29x, or $23.71x). The portion of
FC’s allocable deductible business interest expense
from ABC ($25.50x) that is allocable ECI deductible
BIE is 47.06 percent ($12x of hypothetical partner-
ship ECI deductible BIE / $25.50x of total hypo-
thetical partnership deductible BIE), or $12x. The
portion of FC’s allocable deductible business interest
expense from ABC that is allocable non-ECI deduct-
ible BIE is 52.94 percent ($13.50x of hypothetical
partnership ECI deductible BIE / $25.50x of total hy-
pothetical partnership deductible BIE), or $13.50x.
Because the full amount of FC’s allocable deduct-
ible business interest expense ($25.50x) is allocable
under paragraph (c)(3)(ii)(A)(1) of this section, no
portion is allocated under paragraph (c)(3)(ii)(B) of
this section.
(3) Excess business interest expense. Under para-
graph (c)(2)(i) of this section, the portion of excess
business interest expense allocated to FC from ABC
pursuant to §1.163(j)-6(f)(2)($14.50x) that is alloca-
ble ECI excess BIE is $4.29x ($16.29x of allocable
ECI BIE - $12x allocable ECI deductible BIE). Un-
der paragraph (c)(2)(ii) of this section, the portion
of excess business interest expense allocated to FC
from ABC pursuant to §1.163(j)-6(f)(2) ($14.50x)
that is allocable non-ECI excess BIE is $10.21x
($23.71x of allocable non-ECI BIE - $13.50x alloca-
ble non-ECI deductible BIE).
(E) Application of section 163(j) to FC. Un-
der paragraph (b)(3) of this section, FC’s business
interest expense is $19.43x. Under §1.163(j)-6(e)
(1), FC’s ATI is determined under §1.163(j)-1(b)(1)
without regard to FC’s distributive share of any items
of income, gain, deduction, or loss of ABC or DEF.
Under paragraph (b)(2) of this section, FC’s ATI is
$56x ($56x of ECI of Business Y before taking into
account interest expense). FC’s section 163(j) lim-
itation is $16.80x ($56x x 30 percent). Because the
portion of FC’s business interest expense determined
under §1.882-5 that is attributed to FC ($19.43x)
exceeds the section 163(j) limitation ($16.80x), FC
may only deduct $16.80x of business interest ex-
pense, and $2.63x is disallowed business interest
expense carryforward. After taking into account
FC’s allocable share of deductible business interest
expense, FC may deduct $36.30x ($16.80x from FC
+ $12x allocable ECI deductible BIE from ABC +
$7.50x allocable ECI deductible BIE from DEF). FC
also has $2.63x disallowed business interest expense
carryforward characterized as ECI, $4.29x allocable
ECI excess BIE from ABC, $10.21x allocable non-
ECI excess BIE from ABC, and, under paragraph (e)
(2) of this section, is deemed to have $3.79x alloca-
ble ECI excess BIE from DEF and $3.21x allocable
non-ECI excess BIE from DEF.
(i) [Reserved]
(j) Applicability date. This section
applies to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER]. However, taxpayers and their re-
lated parties, within the meaning of sec-
tions 267(b) and 707(b)(1), may choose
to apply this section in its entirety for a
taxable year beginning after December 31,
2017, so long as the taxpayers and their
related parties also apply §1.163(j)-7(a),
(c) through (f), (g)(3) and (4), and (h)
through (k) for the taxable year. For a tax-
able year beginning before November 13,
2020, taxpayers and their related parties
may not choose to apply this section un-
less they also apply §1.163(j)-7(b) and (g)
(1) and (2) in accordance with the second
sentence of §1.163(j)-7(m)(1).
Par. 10. As added in a final rule else-
where in this issue of the Federal Register,
effective November 13, 2020, §1.163(j)-
10 is amended by:
1. Designating paragraph (c)(5)(ii)(D)
as paragraph (c)(5)(ii)(D)(1).
2. Adding a subject heading for para-
graph (c)(5)(ii)(D).
3. Adding paragraph (c)(5)(ii)(D)(2).
4. Designating paragraph (f) as para-
graph (f)(1).
5. Adding a subject heading for para-
graph (f).
6. Revising the subject heading of new-
ly redesignated paragraph (f)(1).
7. Adding paragraph (f)(2).
The additions and revision read as fol-
lows:
1.163(j)-10 Allocation of interest expense,
interest income, and other items of
expense and gross income to an excepted
trade or business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-
through rules. * * *
(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 apply-
ing the look-through rules in paragraph
(c)(5)(ii)(B) and (C) of this section to a
non-consolidated C corporation (upper-ti-

September 28, 2020 878 Bulletin No. 2020–40
er entity), that upper-tier entity may not
apply these look-through rules to a low-
er-tier non-consolidated C corporation.
For example, assume that P wholly and
directly owns S1 (the upper-tier entity),
which wholly and directly owns S2. Fur-
ther assume that each of these entities is a
non-consolidated C corporation to which
the small business exemption does not
apply. 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 pur-
poses 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-ex-
cepted 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.
* * * * *
(f) Applicability dates.
(1) In general. * * *
(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 [DATE 60 DAYS
AFTER DATE OF PUBLICATION OF
THE FINAL RULE IN THE FEDER-
AL REGISTER]. However, taxpayers
may choose to apply the rules of para-
graph (c)(5)(ii)(D)(2) of this section to a
taxable year beginning after December
31, 2017, and before [DATE 60 DAYS
AFTER DATE OF PUBLICATION
OF THE FINAL RULE IN THE FED-
ERAL REGISTER], so long as they
consistently apply the rules in the sec-
tion 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, 1.383-
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 to that taxable
year and each subsequent taxable year.
Par. 11. Section 1.469-4 is amended by
adding paragraph (d)(6) to read as follows:
§1.469-4 Definition of activity.
* * * * *
(d) * * *
(6) Activities described in section
163(d)(5)(A)(ii). An activity described in
section 163(d)(5)(A)(ii) that involves the
conduct of a trade or business which is not
a passive activity of the taxpayer and with
respect to which the taxpayer does not
materially participate may not be grouped
with any other activity or activities of the
taxpayer, including any other activity de-
scribed in section 163(d)(5)(A)(ii).
* * * * *
Par. 12. As amended in a final rule else-
where in this issue of the Federal Register,
effective November 13, 2020, §1.469-9 is
further amended by revising paragraphs
(b)(2)(ii)(A) and (B) to read as follows:
§1.469-9 Rules for certain rental real
estate activities.
* * * * *
(b) * * *
(2) * * *
(ii) * * *
(A) Real property development. The
term real property development means
the maintenance and improvement of raw
land to make the land suitable for subdivi-
sion, further development, or construction
of residential or commercial buildings,
or to establish, cultivate, maintain or im-
prove timberlands (that is, land covered
by timber-producing forest). Improvement
of land may include any clearing (such as
through the mechanical separation and
removal of boulders, rocks, brush, brush-
wood, and underbrush from the land);
excavation and gradation work; diversion
or redirection of creeks, streams, rivers,
or other sources or bodies of water; and
the installation of roads (including high-
ways, streets, roads, public sidewalks, and
bridges), utility lines, sewer and drainage
systems, and any other infrastructure that
may be necessary for subdivision, further
development, or construction of residen-
tial or commercial buildings, or for the
establishment, cultivation, maintenance or
improvement of timberlands.
(B) Real property redevelopment. The
term real property redevelopment means
the demolition, deconstruction, separa-
tion, and removal of existing buildings,
landscaping, and infrastructure on a par-
cel of land to return the land to a raw con-
dition or otherwise prepare the land for
new development or construction, or for
the establishment and cultivation of new
timberlands.
* * * * *
Par. 13. Section 1.469-11 is amended
by revising paragraphs (a)(1) and (4) to
read as follows:
§1.469-11 Applicability date and
transition rules.
(a) * * *
(1) The rules contained in §§1.469-1,
1.469-1T, 1.469-2, 1.469-2T, 1.469-3,
1.469-3T, 1.469-4, but not §1.469-4(d)(6),
1.469-5 and 1.469-5T apply for taxable
years ending after May 10, 1992. The rules
contained in §1.469-4(d)(6) apply for tax-
able years beginning on or after [DATE
60 DAYS AFTER DATE OF PUBLICA-
TION OF THE FINAL RULE IN THE
FEDERAL REGISTER]. However, tax-
payers and their related parties, within the
meaning of sections 267(b) and 707(b),
may choose to apply the rules of §1.469-
4(d)(6) to a taxable year beginning after
December 31, 2017, and before [DATE
60 DAYS AFTER DATE OF PUBLICA-
TION OF THE FINAL RULE IN THE
FEDERAL REGISTER], so long as they
consistently apply the rules in the sec-
tion 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, 1.383-
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 to that taxable
year and each subsequent taxable year.
* * * * *
(4) The rules contained in §1.469-9(b)
(2), other than paragraphs (b)(2)(ii)(A)
and (B), apply to taxable years beginning
on or after November 13, 2020. Section
1.469-9(b)(2)(ii)(A) and (B) applies to
taxable years beginning on or after [DATE
60 DAYS AFTER DATE OF PUBLICA-
TION OF THE FINAL RULE IN THE
FEDERAL REGISTER]. However, tax-
payers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of §1.469-
9(b)(2), other than paragraphs (b)(2)(ii)
(A) and (B), to a taxable year beginning
after December 31, 2017, and before No-
vember 13, 2020 and may choose to apply

Bulletin No. 2020–40 879 September 28, 2020
the rules contained in §1.469-9(b)(2)(ii)
(A) and (B) to taxable years beginning af-
ter December 31, 2017, and before [DATE
60 DAYS AFTER DATE OF PUBLICA-
TION OF THE FINAL RULE IN THE
FEDERAL REGISTER], so long as they
consistently apply the rules of the sec-
tion 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, 1.383-
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 to that taxable
year and each subsequent taxable year.
* * * * *
Par. 14. Section 1.1256(e)-2 is added to
read as follows:
§1.1256(e)-2 Special rules for syndicates.
(a) Allocation of losses. For purposes
of section 1256(e)(3), syndicate means
any partnership or other entity (other than
a corporation that is not an S corporation)
if more than 35 percent of the losses of
such entity during the taxable year are al-
located to limited partners or limited en-
trepreneurs (within the meaning of section
461(k)(4)).
(b) Determination of loss amount.
For purposes of section 1256(e)(3), the
amount of losses to be allocated under
paragraph (a) of this section is calculated
without regard to section 163(j).
(c) Example. The following example
illustrates the rules in this section:
(1) Facts. Entity is an S corporation that is equal-
ly owned by individuals A and B. A provides all of
the goods and services provided by Entity. B provid-
ed all of the capital for Entity but does not participate
in Entity’s business. For the current taxable year,
Entity has gross receipts of $5,000,000, non-inter-
est expenses of $4,500,000, and interest expense of
$600,000.
(2) Analysis. Under paragraph (b) of this section,
Entity has a net loss of $100,000 ($5,000,000 minus
$5,100,000) for the current taxable year. One half (50
percent) of this loss is allocated to B, a limited owner.
Therefore, for the current taxable year, Entity is a syn-
dicate within the meaning of section 1256(e)(3)(B).
(d) Applicability date. This section
applies to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER]. However, taxpayers and their re-
lated parties, under sections 267(b) and
707(b)(1), may choose to apply the rules
of this section for a taxable year begin-
ning after December 31, 2017, and be-
fore [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGIS-
TER], provided that they consistently
apply the rules of this section to that tax-
able year and each subsequent taxable
year.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
(Filed by the Office of the Federal Register on Sep-
tember 3, 2020, 4:15 p.m., and published in the issue
of the Federal Register for September 14, 2020, 85
F.R. 56846)

Bulletin No. 2020–40 i September 28, 2020
Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle also applies to B, the
earlier ruling is amplified. (Compare with
modified, below).
Clarified is used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion. It
is not used where a position in a prior rul-
ing is being changed.
Distinguished describes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
with amplified and clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transactions.
This term is most commonly used in a ruling
that lists previously published rulings that
are obsoleted because of changes in laws or
regulations. A ruling may also be obsoleted
because the substance has been included in
regulations subsequently adopted.
Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the
new ruling does more than restate the sub-
stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previous-
ly published ruling in a new ruling that is
self contained. In this case, the previously
published ruling is first modified and then,
as modified, is superseded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of cas-
es in litigation, or the outcome of a Ser-
vice study.
Abbreviations
The following abbreviations in current use
and formerly used will appear in material
published in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.

September 28, 2020 ii Bulletin No. 2020–40
Numerical Finding List
1
Bulletin 2020–40
Announcements:
2020-8, 2020-32 I.R.B. 244
2020-9, 2020-32 I.R.B. 244
2020-10, 2020-33 I.R.B. 385
2020-11, 2020-33 I.R.B. 385
2020-13, 2020-35 I.R.B. 492
2020-14, 2020-36 I.R.B. 549
2020-15, 2020-38 I.R.B. 577
2020-16, 2020-38 I.R.B. 578
2020-17, 2020-40 I.R.B. 794
Notices:
2020-43, 2020-27 I.R.B. 1
2020-45, 2020-27 I.R.B. 3
2020-46, 2020-27 I.R.B. 7
2020-47, 2020-27 I.R.B. 7
2020-49, 2020-27 I.R.B. 8
2020-50, 2020-28 I.R.B. 35
2020-48, 2020-29 I.R.B. 72
2020-51, 2020-29 I.R.B. 73
2020-52, 2020-29 I.R.B. 79
2020-53, 2020-30 I.R.B. 151
2020-54, 2020-31 I.R.B. 226
2020-56, 2020-32 I.R.B. 239
2020-57, 2020-32 I.R.B. 240
2020-58, 2020-34 I.R.B. 419
2020-55, 2020-35 I.R.B. 467
2020-61, 2020-35 I.R.B. 468
2020-62, 2020-35 I.R.B. 476
2020-63, 2020-35 I.R.B. 491
2020-60, 2020-36 I.R.B. 514
2020-64, 2020-36 I.R.B. 519
2020-65, 2020-38 I.R.B. 567
2020-68, 2020-38 I.R.B. 567
2020-69, 2020-39 I.R.B. 604
2020-59, 2020-40 I.R.B. 782
2020-66, 2020-40 I.R.B. 785
2020-71, 2020-40 I.R.B. 786
2020-72, 2020-40 I.R.B. 789
Proposed Regulations:
REG-119307-19, 2020-28 I.R.B. 44
REG-112339-19, 2020-30 I.R.B. 155
REG-117589-18, 2020-30 I.R.B. 184
REG-125716-18, 2020-30 I.R.B. 197
REG-123027-19, 2020-31 I.R.B. 229
REG-130081-19, 2020-32 I.R.B. 246
REG-127732-19, 2020-33 I.R.B. 385
REG-111879-20, 2020-34 I.R.B. 421
REG-112042-19, 2020-34 I.R.B. 422
REG-132766-18, 2020-34 I.R.B. 436
REG-132434-17, 2020-35 I.R.B. 508
Proposed Regulations:—Continued
REG-116475-19, 2020-37 I.R.B. 553
REG-107911-18, 2020-40 I.R.B. 795
Revenue Procedures:
2020-16, 2020-27 I.R.B. 10
2020-31, 2020-27 I.R.B. 12
2020-35, 2020-29 I.R.B. 82
2020-36, 2020-32 I.R.B. 243
2020-37, 2020-33 I.R.B. 381
2020-38, 2020-36 I.R.B. 522
2020-39, 2020-36 I.R.B. 546
2020-40, 2020-38 I.R.B. 575
2020-41, 2020-40 I.R.B. 793
Revenue Rulings:
2020-14, 2020-28 I.R.B. 33
2020-15, 2020-32 I.R.B. 233
2020-16, 2020-37 I.R.B. 550
2020-17, 2020-37 I.R.B. 552
2020-18, 2020-39 I.R.B. 584
2020-19, 2020-40 I.R.B. 611
Treasury Decisions:
9899, 2020-29 I.R.B. 62
9900, 2020-30 I.R.B. 143
9903, 2020-32 I.R.B. 235
9901, 2020-33 I.R.B. 266
9902, 2020-33 I.R.B. 349
9904, 2020-34 I.R.B. 413
9907, 2020-38 I.R.B. 559
9906, 2020-39 I.R.B. 579
9905, 2020-40 I.R.B. 614
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2019–27 through 2019–52 is in Internal Revenue Bulletin
2019–52, dated December 27, 2019.

Bulletin No. 2020–40 iii September 28, 2020
Finding List of Current Actions on
Previously Published Items
1
Bulletin 2020–40
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2019–27 through 2019–52 is in Internal Revenue Bulletin
2019–52, dated December 27, 2019.

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