66496 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

Dated: December 14. 1995.

Robert C. Livingston,

Director, Office of New Animal Drug

Evaluation, Center for Veterinary Medicine.

[FR Doc. 95–31199 Filed 12–21–95; 8:45 am]

BILLING CODE 4160–01–F

21 CFR Part 558

New Animal Drugs; Change of Sponsor

AGENCY: Food and Drug Administration,

HHS.

ACTION: Final rule.

SUMMARY: The Food and Drug

Administration (FDA) is amending the

animal drug regulations to reflect a

change of sponsor for two new animal

drug applications (NADA’s) from

Farmland Industries, Inc., to A. L.

Pharma, Inc.

EFFECTIVE DATE: December 22, 1995.

FOR FURTHER INFORMATION CONTACT:

Thomas J. McKay, Center for Veterinary

Medicine (HFV–102), Food and Drug

Administration, 7500 Standish Pl.,

Rockville, MD 20855, 301–827–0213.

SUPPLEMENTARY INFORMATION: Farmland

Industries, Inc., Kansas City, MS 64116,

has informed FDA that it has transferred

the ownership of, and all rights and

interests in, approved NADA’s 46–415

(Tylosin Premixes) and 91–749

(Tylosin-Sulfa Premixes) to A. L.

Pharma, Inc., One Executive Dr., Fort

Lee, NJ 07024. Accordingly, the agency

is amending the regulations in 21 CFR

558.625 and 558.630.

List of Subject in 21 CFR Part 558

Animal drugs, Animal feeds.

Therefore, under the Federal Food,

Drug, and Cosmetic Act and under

authority delegated to the Commissioner

of Food and Drugs and redelegated to

the Center for Veterinary Medicine, 21

CFR part 558 is amended as follows:

PART 558—NEW ANIMAL DRUGS FOR

USE IN ANIMAL FEEDS

1. The authority citation for 21 CFR

part 558 continues to read as follows:

Authority: Secs. 512, 701 of the Federal

Food, Drug, and Cosmetic Act (21 U.S.C.

360b, 371).

§ 558.625 [Amended]

2. Section 558.625 Tylosin is

amended in paragraph (b)(83) by

removing ‘‘021676’’ and adding in its

place ‘‘046573’’.

§ 558.630 [Amended]

3. Section 558.630 Tylosin and

sulfamethazine is amended in

paragraph (b)(10) by removing ‘‘021676’’

and by adding ‘‘046573’’ in numerical

order.

Dated: December 14, 1995.

Robert C. Livingston,

Director, Office of New Animal Drug

Evaluation, Center for Veterinary Medicine.

[FR Doc. 95–31198 Filed 12–21–95; 8:45 am]

BILLING CODE 4160–01–F

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8645]

RIN 1545–AS38

Rules for Certain Rental Real Estate

Activities

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations providing rules for rental

real estate activities of taxpayers

engaged in certain real property trades

or businesses. The regulations reflect

changes to the law made by the

Omnibus Budget Reconciliation Act of

1993, and affect taxpayers subject to the

limitations on passive activity losses

and passive activity credits.

DATES: These regulations are effective

on January 1, 1995. See § 1.469–11 for

applicability.

ADDRESSES: Send submissions to:

CC:DOM:CORP:T:R (TD 8645), room

5228, Internal Revenue Service, POB

7604, Ben Franklin Station, Washington,

DC 20044. In the alternative,

submissions may be hand delivered

between the hours of 8:00 a.m. and 5:00

p.m. to: CC:DOM:CORP:T:R (TD 8645),

Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue NW,

Washington, DC.

FOR FURTHER INFORMATION CONTACT:

William M. Kostak at (202) 622–3080

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information

contained in these final regulations has

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork

Reduction Act (44 U.S.C. 3504(h)) under

control number 1545–AS38. The

estimated annual burden per respondent

varies from 0.10 hours to 0.25 hours,

depending on individual circumstances,

with an estimated average of 0.15 hours.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, PC:FP,

Washington, DC 20224, and to the

Office of Management and Budget, Attn:

Desk Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503.

Background

This document amends 26 CFR part 1

to provide rules relating to the treatment

of rental real estate activities of certain

taxpayers under the passive activity loss

and credit limitations of section 469.

Section 469 disallows losses from

passive activities to the extent they

exceed income from passive activities

and similarly disallows credits from

passive activities to the extent they

exceed tax liability allocable to passive

activities. In general, passive activities

are activities in which the taxpayer does

not materially participate. In addition,

until the enactment of the Omnibus

Budget Reconciliation Act of 1993

(OBRA 1993), all rental activities

(including those in which a taxpayer

materially participated) were passive.

OBRA 1993 added section 469(c)(7),

which provides that rental real estate

activities of qualifying taxpayers are not

subject to the rule that treats all rental

activities as passive. Thus, a rental real

estate activity of a qualifying taxpayer is

not passive if the taxpayer materially

participates in the activity. Further,

section 469(c)(7) provides that each of a

qualifying taxpayer’s interests in rental

real estate is treated as a separate

activity unless the taxpayer elects to

treat all interests in rental real estate as

a single activity.

On January 10, 1995, the IRS

published in the Federal Register a

notice of proposed rulemaking (60 FR

2557) to provide guidance regarding

section 469(c)(7). A number of public

comments were received concerning the

proposed regulations, and a public

hearing was held on May 11, 1995. After

consideration of the comments received,

the proposed regulations are adopted as

revised by this Treasury decision.

Explanation of Provisions

I. General Background

The proposed regulations provide

rules for determining whether a

taxpayer qualifies for treatment under

section 469(c)(7). The proposed

regulations also provide rules for

determining the rental real estate

activities of qualifying taxpayers for

purposes of section 469. Except for

modifications in response to comments

received on the proposed regulations,
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66497

the final regulations generally adopt the

rules contained in the proposed

regulations.

II. Public Comments

Several comments requested that the

Service reconsider the rule in the

proposed regulations prohibiting

qualifying taxpayers from grouping

rental real estate activities with other

activities in determining whether the

taxpayers materially participate in the

rental real estate activities. After careful

consideration, the final regulations

adopt the rule in the proposed

regulations because that position is

consistent with the statutory language

and the legislative history.

Several comments suggested that the

rule in the proposed regulations

prohibiting the grouping of rental real

estate activities with other activities be

modified to allow qualifying taxpayers

to group the activities of development or

construction of rental real estate with

rental real estate activities. The final

regulations do not adopt this

modification because in most cases

development and construction activities

are separate and distinct from rental

activities. In addition, this modification

would introduce significant

administrative difficulties in

determining which development

activities or construction activities

qualify. However, the IRS and Treasury

Department invite comments

concerning whether the material

participation tests in § 1.469–5T(a)

should be amended to include a lookback material participation test for

taxpayers significantly involved in the

development or construction of their

rental real estate interests.

Several comments requested

clarification regarding whether a

qualifying taxpayer’s participation in a

management activity may count towards

material participation in a rental real

estate activity if the management

activity includes the management of

rental real estate owned by the taxpayer.

The final regulations clarify that a

qualifying taxpayer may participate in a

rental real estate activity through

participation in a management activity.

In determining whether the taxpayer

materially participates in the rental real

estate activity, however, work the

taxpayer performs in the management

activity is taken into account only to the

extent it is performed in managing the

taxpayer’s own rental real estate. The

final regulations also clarify that a

qualifying taxpayer who owns rental

real estate through an entity, including

a C corporation that is subject to section

469, may count work performed by the

taxpayer in managing the rental real

estate of the entity in establishing

material participation in the taxpayer’s

rental real estate activities. Thus, if a

qualifying taxpayer owns some interests

in rental real estate through a closely

held C corporation and makes the

election to treat all interests in rental

real estate as a single activity, the

aggregate rental real estate activity will

include those interests held through the

closely held C corporation for purposes

of material participation.

One comment requested that the

regulations modify the definition of

trade or business to clarify that a

taxpayer’s real property trades or

businesses are determined without

regard to the taxpayer’s grouping of

activities under § 1.469–4. The final

regulations clarify that a taxpayer’s

grouping of activities under § 1.469–4

does not control the determination of

the taxpayer’s real property trades or

businesses for purposes of this section.

Several comments requested that the

regulations provide a detailed definition

of real property trades or businesses

beyond the cross-reference to section

469(c)(7)(C). However, to avoid complex

and mechanical rules, the final

regulations do not adopt a detailed

definition of real property trades or

businesses. Instead, the regulations

provide that taxpayers may use any

reasonable method for determining their

real property trades or businesses.

Several comments requested that the

final regulations modify the rule in the

proposed regulations providing that

only employees who are five-percent

owners of their employer at all times

during the taxable year may treat

personal services performed as an

employee as services performed in a real

property trade or business. The

comments suggested that the regulations

should take into account personal

services performed by employees that

are five-percent owners for a significant

portion of a taxable year. In response to

these comments, the final regulations

are modified to provide that an

employee may count services performed

in a real property trade or business

during the portion of the taxable year

that the employee is a five-percent

owner in the employer.

Several comments requested

clarification concerning whether a

qualifying taxpayer that makes an

election to treat all interests in rental

real estate as a single activity will be

treated as having a single rental real

estate activity for purposes of the former

passive activity rule under section 469

(f). In addition, comments requested

that the regulations be modified to

provide that qualifying taxpayers that

make the aggregation election will be

treated as having separate activities for

purposes of the disposition rules under

section 469(g) and § 1.469–4(g). In

response to these comments, the final

regulations clarify that a qualifying

taxpayer that makes the election to treat

all interests in rental real estate as a

single rental real estate activity will be

treated as having a single activity for all

purposes of section 469, including

sections 469(f) and (g). The statutory

language and the legislative history do

not support a rule allowing a qualifying

taxpayer to treat all interests in rental

real estate as a single activity for

purposes of material participation and

section 469(f), but as separate activities

for purposes of section 469(g).

In addition, in response to comments,

the final regulations provide an example

illustrating the operation of the former

passive activity rule for qualifying

taxpayers that make the election to treat

all interests in rental real estate as a

single activity. This example illustrates

that qualifying taxpayers that make the

aggregation election may use current net

income from the aggregate rental real

estate activity to offset the prior-year

disallowed passive losses of the

aggregate rental real estate activity,

regardless of which rental real estate

interests within that activity produced

the income or prior-year losses.

Some comments requested that the

regulations permit qualifying taxpayers

to make or revoke the aggregation

election on an amended income tax

return. After careful consideration of

this issue, the final regulations adopt

the rule in the proposed regulations that

aggregation elections must be made or

revoked on an original return. The final

regulations provide, however, that the

election may be revoked in any year in

which the facts are materially changed

from those in the taxable year for which

the election was made.

In addition, one comment requested

clarification as to what constitutes a

material change in the facts and

circumstances that would allow a

taxpayer to revoke an aggregation

election. However, the final regulations

do not provide an example or bright-line

rule for determining when a material

change in the facts and circumstances

has occurred, because this

determination is intended to be a broad

factual inquiry. Providing an example or

bright-line rule may inappropriately

restrict the scope of that inquiry.

One comment requested the

modification of the rule in the proposed

regulations that the aggregation election

has no effect in years the taxpayer is not

a qualifying taxpayer. Instead, the

comment suggested that, for ease of

administration and compliance, the
66498 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

aggregation election should be binding

and irrevocable for all future years,

including years in which the taxpayer is

not a qualifying taxpayer. However, the

final regulations adopt the rule in the

proposed regulations because the

position advocated by the comment

would be unfavorable to many taxpayers

and would not significantly improve

administration.

Several comments requested that the

regulations modify the rule in the

proposed regulations treating each

rental real estate interest of a

passthrough entity as a separate interest

of a person owning a fifty-percent or

greater interest in the capital, gain, loss,

income, deduction, or credit of the

entity at any time during a taxable year.

A commentator stated that this rule is

burdensome on many passthrough

entities and should be eliminated or

modified. The final regulations modify

this rule so that it applies only when a

qualifying taxpayer owns a fifty-percent

or greater interest in the capital, profits,

or losses of a passthrough entity for a

taxable year. Accordingly, this rule will

not apply if a qualifying taxpayer owns

a fifty-percent or greater interest in a

single item of income or deduction but

does not own a fifty-percent or greater

interest in the overall capital, profits, or

losses of the passthrough entity.

In response to one comment, the final

regulations also clarify the application

of the fifty-percent ownership rule to

tiered passthrough entities. The final

regulations provide that if a passthrough

entity owns a fifty-percent or greater

interest in the capital, profits, or losses

of another passthrough entity for a

taxable year, each interest in rental real

estate of the lower-tier entity will be a

separate interest in rental real estate of

the upper-tier entity.

In response to another comment, the

final regulations clarify that section

469(i) applies after the rules of section

469(c)(7) are applied. Accordingly, the

$25,000 offset will be applied only

against passive losses from rental real

estate activities, and not against losses

that are allowable as a result of section

469(c)(7). In addition, the final

regulations clarify that adjusted gross

income for purposes of section 469(i) is

not reduced by any losses from rental

real estate that are allowable as a result

of section 469(c)(7).

Several comments requested a

modification to the effective date

provision, to provide that aggregation

elections made for taxable years

beginning before January 1, 1995, are

not binding for future years. Because

taxpayers had sufficient notice of the

rules of section 469(c)(7) and these

regulations, this modification is

unnecessary and would add

administrative complexity. Accordingly,

the final regulations adopt the effective

date provision of the proposed

regulations.

Finally, in response to a comment, the

activity regrouping rule of § 1.469–

4(e)(2) is clarified to provide that a

taxpayer may not regroup activities

unless the taxpayer’s original grouping

was clearly inappropriate or there has

been a material change in the facts and

circumstances that makes the original

grouping clearly inappropriate.

III. Effective Dates

In general, section 469(c)(7) applies

for taxable years beginning after

December 31, 1993. These regulations

are effective for taxable years beginning

on or after January 1, 1995. These

regulations are also effective for

elections under section 469(c)(7)(A) and

paragraph (g) of these regulations that

are made with returns filed on or after

January 1, 1995.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in EO

12866. Therefore, a regulatory

assessment is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) and the Regulatory

Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and,

therefore, a Regulatory Flexibility

Analysis is not required. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notice of proposed rulemaking

preceding these regulations was

submitted to the Small Business

Administration for comment on its

impact on small business.

Drafting Information

The principal author of these

regulations is William M. Kostak, Office

of Assistant Chief Counsel

(Passthroughs and Special Industries),

IRS. However, other personnel from the

IRS and Treasury Department

participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read as follows:

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

Section 1.469–9 also issued under 26

U.S.C. 469(c)(6), (h)(2), and (l)(1).

Par. 2. Section 1.469–0 is amended

by:

1. Revising the entry for § 1.469–4(h).

2. Revising the heading for § 1.469–9

and adding entries for paragraphs (a)

through (j) of § 1.469–9.

3. Revising the entry for § 1.469–

11(b)(2) and removing the entries for

§ 1.469–11(b)(2)(i) and (ii).

4. Revising the entry for § 1.469–

11(b)(3).

5. Adding an entry for § 1.469–

11(b)(4).

6. The revisions and additions read as

follows:

§ 1.469–0 Table of contents.

* * * * *

§ 1.469–4 Definition of Activity.

* * * * *

(h) Rules for grouping rental real estate

activities for taxpayers qualifying under

section 469(c)(7).

* * * * *

§ 1.469–9 Rules for certain rental real estate

activities.

(a) Scope and purpose.

(b) Definitions.

(1) Trade or business.

(2) Real property trade or business.

(3) Rental real estate.

(4) Personal services.

(5) Material participation.

(6) Qualifying taxpayer.

(c) Requirements for qualifying taxpayers.

(1) In general.

(2) Closely held C corporations.

(3) Requirement of material participation

in the real property trades or businesses.

(4) Treatment of spouses.

(5) Employees in real property trades or

businesses.

(d) General rule for determining real

property trades or businesses.

(1) Facts and circumstances.

(2) Consistency requirement.

(e) Treatment of rental real estate activities

of a qualifying taxpayer.

(1) In general.

(2) Treatment as a former passive activity.

(3) Grouping rental real estate activities

with other activities.

(i) In general.

(ii) Special rule for certain management

activities.

(4) Example.

(f) Limited partnership interests in rental

real estate activities.

(1) In general.

(2) De minimis exception.

(g) Election to treat all interests in rental

real estate as a single rental real estate

activity.

(1) In general.

(2) Certain changes not material.

(3) Filing a statement to make or revoke the

election.

(h) Interests in rental real estate held by

certain passthrough entities.
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66499

(1) General rule.

(2) Special rule if a qualifying taxpayer

holds a fifty-percent or greater interest in a

passthrough entity.

(3) Special rule for interests held in tiered

passthrough entities.

(i) [Reserved].

(j) $25,000 offset for rental real estate

activities of qualifying taxpayers.

(1) In general.

(2) Example.

* * * * *

§ 1.469–11 Effective date and transition rules.

* * * * *

(b) * * *

(2) Additional transition rule for 1992

amendments.

(3) Fresh starts under consistency rules.

(i) Regrouping when tax liability is first

determined under Project PS–1–89.

(ii) Regrouping when tax liability is first

determined under § 1.469–4.

(iii) Regrouping when taxpayer is first

subject to section 469(c)(7).

(4) Certain investment credit property.

* * * * *

Par. 3. Section 1.469–4 is amended by

revising paragraphs (e) (1) and (2) and

(h). The revisions read as follows:

§ 1.469–4 Definition of Activity.

* * * * *

(e) * * *

(1) Original groupings. Except as

provided in paragraph (e)(2) of this

section and § 1.469–11, once a taxpayer

has grouped activities under this

section, the taxpayer may not regroup

those activities in subsequent taxable

years. Taxpayers must comply with

disclosure requirements that the

Commissioner may prescribe with

respect to both their original groupings

and the addition and disposition of

specific activities within those chosen

groupings in subsequent taxable years.

(2) Regroupings. If it is determined

that a taxpayer’s original grouping was

clearly inappropriate or a material

change in the facts and circumstances

has occurred that makes the original

grouping clearly inappropriate, the

taxpayer must regroup the activities and

must comply with disclosure

requirements that the Commissioner

may prescribe.

* * * * *

(h) Rules for grouping rental real

estate activities for taxpayers qualifying

under section 469(c)(7). See § 1.469–9

for rules for certain rental real estate

activities.

Par. 4. Section 1.469–9 is revised to

read as follows:

§ 1.469–9 Rules for certain rental real

estate activities.

(a) Scope and purpose. This section

provides guidance to taxpayers engaged

in certain real property trades or

businesses on applying section 469(c)(7)

to their rental real estate activities.

(b) Definitions. The following

definitions apply for purposes of this

section:

(1) Trade or business. A trade or

business is any trade or business

determined by treating the types of

activities in § 1.469–4(b)(1) as if they

involved the conduct of a trade or

business, and any interest in rental real

estate, including any interest in rental

real estate that gives rise to deductions

under section 212.

(2) Real property trade or business.

Real property trade or business is

defined in section 469(c)(7)(C).

(3) Rental real estate. Rental real

estate is any real property used by

customers or held for use by customers

in a rental activity within the meaning

of § 1.469–1T(e)(3). However, any rental

real estate that the taxpayer grouped

with a trade or business activity under

§ 1.469–4(d)(1)(i)(A) or (C) is not an

interest in rental real estate for purposes

of this section.

(4) Personal services. Personal

services means any work performed by

an individual in connection with a trade

or business. However, personal services

do not include any work performed by

an individual in the individual’s

capacity as an investor as described in

§ 1.469–5T(f)(2)(ii).

(5) Material participation. Material

participation has the same meaning as

under § 1.469–5T. Paragraph (f) of this

section contains rules applicable to

limited partnership interests in rental

real estate that a qualifying taxpayer

elects to aggregate with other interests

in rental real estate of that taxpayer.

(6) Qualifying taxpayer. A qualifying

taxpayer is a taxpayer that owns at least

one interest in rental real estate and

meets the requirements of paragraph (c)

of this section.

(c) Requirements for qualifying

taxpayers—(1) In general. A qualifying

taxpayer must meet the requirements of

section 469(c)(7)(B).

(2) Closely held C corporations. A

closely held C corporation meets the

requirements of paragraph (c)(1) of this

section by satisfying the requirements of

section 469(c)(7)(D)(i). For purposes of

section 469(c)(7)(D)(i), gross receipts do

not include items of portfolio income

within the meaning of § 1.469–2T(c)(3).

(3) Requirement of material

participation in the real property trades

or businesses. A taxpayer must

materially participate in a real property

trade or business in order for the

personal services provided by the

taxpayer in that real property trade or

business to count towards meeting the

requirements of paragraph (c)(1) of this

section.

(4) Treatment of spouses. Spouses

filing a joint return are qualifying

taxpayers only if one spouse separately

satisfies both requirements of section

469(c)(7)(B). In determining the real

property trades or businesses in which

a married taxpayer materially

participates (but not for any other

purpose under this paragraph (c)), work

performed by the taxpayer’s spouse in a

trade or business is treated as work

performed by the taxpayer under

§ 1.469–5T(f)(3), regardless of whether

the spouses file a joint return for the

year.

(5) Employees in real property trades

or businesses. For purposes of

paragraph (c)(1) of this section, personal

services performed during a taxable year

as an employee generally will be treated

as performed in a trade or business but

will not be treated as performed in a real

property trade or business, unless the

taxpayer is a five-percent owner (within

the meaning of section 416(i)(1)(B)) in

the employer. If an employee is not a

five-percent owner in the employer at

all times during the taxable year, only

the personal services performed by the

employee during the period the

employee is a five-percent owner in the

employer will be treated as performed

in a real property trade or business.

(d) General rule for determining real

property trades or businesses—(1) Facts

and circumstances. The determination

of a taxpayer’s real property trades or

businesses for purposes of paragraph (c)

of this section is based on all of the

relevant facts and circumstances. A

taxpayer may use any reasonable

method of applying the facts and

circumstances in determining the real

property trades or businesses in which

the taxpayer provides personal services.

Depending on the facts and

circumstances, a real property trade or

business consists either of one or more

than one trade or business specifically

described in section 469(c)(7)(C). A

taxpayer’s grouping of activities under

§ 1.469–4 does not control the

determination of the taxpayer’s real

property trades or businesses under this

paragraph (d).

(2) Consistency requirement. Once a

taxpayer determines the real property

trades or businesses in which personal

services are provided for purposes of

paragraph (c) of this section, the

taxpayer may not redetermine those real

property trades or businesses in

subsequent taxable years unless the

original determination was clearly

inappropriate or there has been a

material change in the facts and
66500 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

circumstances that makes the original

determination clearly inappropriate.

(e) Treatment of rental real estate

activities of a qualifying taxpayer—(1)

In general. Section 469(c)(2) does not

apply to any rental real estate activity of

a taxpayer for a taxable year in which

the taxpayer is a qualifying taxpayer

under paragraph (c) of this section.

Instead, a rental real estate activity of a

qualifying taxpayer is a passive activity

under section 469 for the taxable year

unless the taxpayer materially

participates in the activity. Each interest

in rental real estate of a qualifying

taxpayer will be treated as a separate

rental real estate activity, unless the

taxpayer makes an election under

paragraph (g) of this section to treat all

interests in rental real estate as a single

rental real estate activity. Each separate

rental real estate activity, or the single

combined rental real estate activity if

the taxpayer makes an election under

paragraph (g), will be an activity of the

taxpayer for all purposes of section 469,

including the former passive activity

rules under section 469(f) and the

disposition rules under section 469(g).

However, section 469 will continue to

be applied separately with respect to

each publicly traded partnership, as

required under section 469(k),

notwithstanding the rules of this

section.

(2) Treatment as a former passive

activity. For any taxable year in which

a qualifying taxpayer materially

participates in a rental real estate

activity, that rental real estate activity

will be treated as a former passive

activity under section 469(f) if

disallowed deductions or credits are

allocated to the activity under § 1.469–

1(f)(4).

(3) Grouping rental real estate

activities with other activities—(i) In

general. For purposes of this section, a

qualifying taxpayer may not group a

rental real estate activity with any other

activity of the taxpayer. For example, if

a qualifying taxpayer develops real

property, constructs buildings, and

owns an interest in rental real estate, the

taxpayer’s interest in rental real estate

may not be grouped with the taxpayer’s

development activity or construction

activity. Thus, only the participation of

the taxpayer with respect to the rental

real estate may be used to determine if

the taxpayer materially participates in

the rental real estate activity under

§ 1.469–5T.

(ii) Special rule for certain

management activities. A qualifying

taxpayer may participate in a rental real

estate activity through participation,

within the meaning of §§ 1.469–5(f) and

5T(f), in an activity involving the

management of rental real estate (even

if this management activity is conducted

through a separate entity). In

determining whether the taxpayer

materially participates in the rental real

estate activity, however, work the

taxpayer performs in the management

activity is taken into account only to the

extent it is performed in managing the

taxpayer’s own rental real estate

interests.

(4) Example. The following example

illustrates the application of this

paragraph (e).

Example. (i) Taxpayer B owns interests in

three rental buildings, U, V and W. In 1995,

B has $30,000 of disallowed passive losses

allocable to Building U and $10,000 of

disallowed passive losses allocable to

Building V under § 1.469–1(f)(4). In 1996, B

has $5,000 of net income from Building U,

$5,000 of net losses from Building V, and

$10,000 of net income from Building W. Also

in 1996, B is a qualifying taxpayer within the

meaning of paragraph (c) of this section. Each

building is treated as a separate activity of B

under paragraph (e)(1) of this section, unless

B makes the election under paragraph (g) to

treat the three buildings as a single rental real

estate activity. If the buildings are treated as

separate activities, material participation is

determined separately with respect to each

building. If B makes the election under

paragraph (g) to treat the buildings as a single

activity, all participation relating to the

buildings is aggregated in determining

whether B materially participates in the

combined activity.

(ii) Effective beginning in 1996, B makes

the election under paragraph (g) to treat the

three buildings as a single rental real estate

activity. B works full-time managing the

three buildings and thus materially

participates in the combined activity in 1996

(even if B conducts this management

function through a separate entity, including

a closely held C corporation). Accordingly,

the combined activity is not a passive activity

of B in 1996. Moreover, as a result of the

election under paragraph (g), disallowed

passive losses of $40,000 ($30,000+$10,000)

are allocated to the combined activity. B’s net

income from the activity for 1996 is $10,000

($5,000¥$5,000+$10,000). This net income

is nonpassive income for purposes of section

469. However, under section 469(f), the net

income from a former passive activity may be

offset with the disallowed passive losses

from the same activity. Because Buildings U,

V and W are treated as one activity for all

purposes of section 469 due to the election

under paragraph (g), and this activity is a

former passive activity under section 469(f),

B may offset the $10,000 of net income from

the buildings with an equal amount of

disallowed passive losses allocable to the

buildings, regardless of which buildings

produced the income or losses. As a result,

B has $30,000 ($40,000¥$10,000) of

disallowed passive losses remaining from the

buildings after 1996.

(f) Limited partnership interests in

rental real estate activities—(1) In

general. If a taxpayer elects under

paragraph (g) of this section to treat all

interests in rental real estate as a single

rental real estate activity, and at least

one interest in rental real estate is held

by the taxpayer as a limited partnership

interest (within the meaning of § 1.469–

5T(e)(3)), the combined rental real estate

activity will be treated as a limited

partnership interest of the taxpayer for

purposes of determining material

participation. Accordingly, the taxpayer

will not be treated under this section as

materially participating in the combined

rental real estate activity unless the

taxpayer materially participates in the

activity under the tests listed in § 1.469–

5T(e)(2) (dealing with the tests for

determining the material participation

of a limited partner).

(2) De minimis exception. If a

qualifying taxpayer elects under

paragraph (g) of this section to treat all

interests in rental real estate as a single

rental real estate activity, and the

taxpayer’s share of gross rental income

from all of the taxpayer’s limited

partnership interests in rental real estate

is less than ten percent of the taxpayer’s

share of gross rental income from all of

the taxpayer’s interests in rental real

estate for the taxable year, paragraph

(f)(1) of this section does not apply.

Thus the taxpayer may determine

material participation under any of the

tests listed in § 1.469–5T(a) that apply to

rental real estate activities.

(g) Election to treat all interests in

rental real estate as a single rental real

estate activity—(1) In general. A

qualifying taxpayer may make an

election to treat all of the taxpayer’s

interests in rental real estate as a single

rental real estate activity. This election

is binding for the taxable year in which

it is made and for all future years in

which the taxpayer is a qualifying

taxpayer under paragraph (c) of this

section, even if there are intervening

years in which the taxpayer is not a

qualifying taxpayer. The election may

be made in any year in which the

taxpayer is a qualifying taxpayer, and

the failure to make the election in one

year does not preclude the taxpayer

from making the election in a

subsequent year. In years in which the

taxpayer is not a qualifying taxpayer,

the election will not have effect and the

taxpayer’s activities will be those

determined under § 1.469–4. If there is

a material change in the taxpayer’s facts

and circumstances, the taxpayer may

revoke the election using the procedure

described in paragraph (g)(3) of this

section.

(2) Certain changes not material. The

fact that an election is less advantageous

to the taxpayer in a particular taxable

year is not, of itself, a material change
Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations 66501

in the taxpayer’s facts and

circumstances. Similarly, a break in the

taxpayer’s status as a qualifying

taxpayer is not, of itself, a material

change in the taxpayer’s facts and

circumstances.

(3) Filing a statement to make or

revoke the election. A qualifying

taxpayer makes the election to treat all

interests in rental real estate as a single

rental real estate activity by filing a

statement with the taxpayer’s original

income tax return for the taxable year.

This statement must contain a

declaration that the taxpayer is a

qualifying taxpayer for the taxable year

and is making the election pursuant to

section 469(c)(7)(A). The taxpayer may

make this election for any taxable year

in which section 469(c)(7) is applicable.

A taxpayer may revoke the election only

in the taxable year in which a material

change in the taxpayer’s facts and

circumstances occurs or in a subsequent

year in which the facts and

circumstances remain materially

changed from those in the taxable year

for which the election was made. To

revoke the election, the taxpayer must

file a statement with the taxpayer’s

original income tax return for the year

of revocation. This statement must

contain a declaration that the taxpayer

is revoking the election under section

469(c)(7)(A) and an explanation of the

nature of the material change.

(h) Interests in rental real estate held

by certain passthrough entities—(1)

General rule. Except as provided in

paragraph (h)(2) of this section, a

qualifying taxpayer’s interest in rental

real estate held by a partnership or an

S corporation (passthrough entity) is

treated as a single interest in rental real

estate if the passthrough entity grouped

its rental real estate as one rental

activity under § 1.469–4(d)(5). If the

passthrough entity grouped its rental

real estate into separate rental activities

under § 1.469–4(d)(5), each rental real

estate activity of the passthrough entity

will be treated as a separate interest in

rental real estate of the qualifying

taxpayer. However, the qualifying

taxpayer may elect under paragraph (g)

of this section to treat all interests in

rental real estate, including the rental

real estate interests held through

passthrough entities, as a single rental

real estate activity.

(2) Special rule if a qualifying

taxpayer holds a fifty-percent or greater

interest in a passthrough entity. If a

qualifying taxpayer owns, directly or

indirectly, a fifty-percent or greater

interest in the capital, profits, or losses

of a passthrough entity for a taxable

year, each interest in rental real estate

held by the passthrough entity will be

treated as a separate interest in rental

real estate of the qualifying taxpayer,

regardless of the passthrough entity’s

grouping of activities under § 1.469–

4(d)(5). However, the qualifying

taxpayer may elect under paragraph (g)

of this section to treat all interests in

rental real estate, including the rental

real estate interests held through

passthrough entities, as a single rental

real estate activity.

(3) Special rule for interests held in

tiered passthrough entities. If a

passthrough entity owns a fifty-percent

or greater interest in the capital, profits,

or losses of another passthrough entity

for a taxable year, each interest in rental

real estate held by the lower-tier entity

will be treated as a separate interest in

rental real estate of the upper-tier entity,

regardless of the lower-tier entity’s

grouping of activities under § 1.469–

4(d)(5).

(i) [Reserved].

(j) $25,000 offset for rental real estate

activities of qualifying taxpayers—(1) In

general. A qualifying taxpayer’s passive

losses and credits from rental real estate

activities (including prior-year

disallowed passive activity losses and

credits from rental real estate activities

in which the taxpayer materially

participates) are allowed to the extent

permitted under section 469(i). The

amount of losses or credits allowable

under section 469(i) is determined after

the rules of this section are applied.

However, losses allowable by reason of

this section are not taken into account

in determining adjusted gross income

for purposes of section 469(i)(3).

(2) Example. The following example

illustrates the application of this

paragraph (j).

Example. (i) Taxpayer A owns building X

and building Y, both interests in rental real

estate. In 1995, A is a qualifying taxpayer

within the meaning of paragraph (c) of this

section. A does not elect to treat X and Y as

one activity under section 469(c)(7)(A) and

paragraph (g) of this section. As a result, X

and Y are treated as separate activities

pursuant to section 469(c)(7)(A)(ii). A

materially participates in X which has

$100,000 of passive losses disallowed from

prior years and produces $20,000 of losses in

1995. A does not materially participate in Y

which produces $40,000 of income in 1995.

A also has $50,000 of income from other

nonpassive sources in 1995. A otherwise

meets the requirements of section 469(i).

(ii) Because X is not a passive activity in

1995, the $20,000 of losses produced by X in

1995 are nonpassive losses that may be used

by A to offset part of the $50,000 of

nonpassive income. Accordingly, A is left

with $30,000 ($50,000–$20,000) of

nonpassive income. In addition, A may use

the prior year disallowed passive losses of X

to offset any income from X and passive

income from other sources. Therefore, A may

offset the $40,000 of passive income from Y

with $40,000 of passive losses from X.

(iii) Because A has $60,000 ($100,000–

$40,000) of passive losses remaining from X

and meets all of the requirements of section

469(i), A may offset up to $25,000 of

nonpassive income with passive losses from

X pursuant to section 469(i). As a result, A

has $5,000 ($30,000–$25,000) of nonpassive

income remaining and disallowed passive

losses from X of $35,000 ($60,000–$25,000)

in 1995.

Par. 5. Section 1.469–11 is amended

as follows:

1. Paragraph (a)(2) is amended by

removing ‘‘; and’’ and adding ‘‘;’’ in its

place.

2. Paragraph (a)(3) is redesignated as

paragraph (a)(4) and a new paragraph

(a)(3) is added.

3. Paragraph (b)(1) is revised.

4. The heading for paragraph (b)(2) is

revised; the headings for paragraphs

(b)(2)(i) and (b)(2)(ii) are removed;

paragraph (b)(2)(ii) is removed, and

paragraph (b)(2)(i) is redesignated as

paragraph (b)(2).

5. Paragraph (b)(3) is redesignated as

paragraph (b)(4).

6. A new paragraph (b)(3) is added.

The added and revised provisions

read as follows:

§ 1.469–11 Effective date and transition

rules.

(a) * * *

(3) The rules contained in § 1.469–9

apply for taxable years beginning on or

after January 1, 1995, and to elections

made under § 1.469–9(g) with returns

filed on or after January 1, 1995; and

* * * * *

(b) * * * (1) Application of 1992

amendments for taxable years beginning

before October 4, 1994. Except as

provided in paragraph (b)(2) of this

section, for taxable years that end after

May 10, 1992, and begin before October

4, 1994, a taxpayer may determine tax

liability in accordance with Project PS–

1–89 published at 1992–1 C.B. 1219 (see

§ 601.601(d)(2)(ii)(b) of this chapter).

(2) Additional transition rule for 1992

amendments. * * *

(3) Fresh starts under consistency

rules—(i) Regrouping when tax liability

is first determined under Project PS–1–

89. For the first taxable year in which

a taxpayer determines its tax liability

under Project PS–1–89, the taxpayer

may regroup its activities without regard

to the manner in which the activities

were grouped in the preceding taxable

year and must regroup its activities if

the grouping in the preceding taxable

year is inconsistent with the rules of

Project PS–1–89.

(ii) Regrouping when tax liability is

first determined under § 1.469–4. For

the first taxable year in which a
66502 Federal Register / Vol. 60, No. 246 / Friday, December 22, 1995 / Rules and Regulations

taxpayer determines its tax liability

under § 1.469–4, rather than under the

rules of Project PS–1–89, the taxpayer

may regroup its activities without regard

to the manner in which the activities

were grouped in the preceding taxable

year and must regroup its activities if

the grouping in the preceding taxable

year is inconsistent with the rules of

§ 1.469–4.

(iii) Regrouping when taxpayer is first

subject to section 469(c)(7). For the first

taxable year beginning after December

31, 1993, a taxpayer may regroup its

activities to the extent necessary or

appropriate to avail itself of the

provisions of section 469(c)(7) and

without regard to the manner in which

the activities were grouped in the

preceding taxable year.

* * * * *

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: December 12, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury (Tax

Policy).

[FR Doc. 95–30872 Filed 12–21–95; 8:45 am]

BILLING CODE 4830–01-U

26 CFR Part 1

[TD 8646]

RIN 1545–AT49

Allocation and Apportionment of

Research and Experimental

Expenditures

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document provides

guidance concerning the allocation and

apportionment of research and

experimental expenditures for purposes

of determining taxable income from

sources within and without the United

States. This document affects taxpayers

that have income from United States

and foreign sources and that have made

expenditures for research and

experimentation that the taxpayer

deducts under section 174 of the

Internal Revenue Code of 1986.

EFFECTIVE DATE: January 1, 1996.

FOR FURTHER INFORMATION CONTACT: Carl

Cooper at (202) 622–3840 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of

Provisions

On May 24, 1995, the IRS published

a notice of proposed rulemaking and

notice of public hearing in the Federal

Register (60 FR 27453) proposing

amendments to the Income Tax

Regulations (26 CFR part 1) under

section 861 of the Internal Revenue

Code of 1986. Section 1.861–8(e)(3) of

the Income Tax Regulations provides

rules regarding the allocation and

apportionment of research and

experimental expenditures for purposes

of determining taxable income from

sources inside and outside the United

States.

The notice of proposed rulemaking

proposed three principal changes to the

existing regulations. First, allocation of

research and experimental expenditures

to three-digit SIC code product

categories of gross income would be

permitted. Second, the percentage of

research and experimental expenditures

that may be exclusively apportioned to

United States source income under the

sales method of apportionment under

§ 1.861–8(e)(3)(ii) would be increased

from 30 percent to 50 percent. Third,

use of the optional gross income

methods of apportionment would

constitute a binding election to use such

methods in subsequent years. The

election would not be revocable without

the prior consent of the Commissioner.

The three changes were proposed in

part on the basis of an economic study

performed by the Treasury Department

pursuant to Rev. Proc. 92–56 (1992–2

C.B. 409), ‘‘The Relationship Between

U.S. Research and Development and

Foreign Income,’’ which was published

by the Treasury Department

simultaneously with the proposed

regulations.

Written comments responding to the

notice were received, and a public

hearing was held on September 8, 1995.

Regarding the determination of

product categories under § 1.861–

8(e)(3)(i)(B) of the proposed regulations,

commenters suggested that the rule

requiring a taxpayer to determine

relevant product categories by reference

to the three-digit classification of the

Standard Industrial Classification

Manual should be modified to allow

determinations by reference to the fivedigit classifications of the Manual. This

suggestion was not adopted, because

such a rule would too narrowly restrict

the necessarily broad scope of the

deduction. The IRS continues to believe

that research and experimentation is an

inherently speculative activity, that

findings may contribute unexpected

benefits, and that gross income derived

from successful research and

experimentation must bear the cost of

unsuccessful research and

experimentation.

Commenters suggested that the

regulations permit taxpayers to

determine product categories by

reference to two- or three-digit

categories at the annual election of the

taxpayer. This suggestion was not

adopted. The regulations provide that a

taxpayer may determine product

categories by reference to two- or threedigit categories. A taxpayer may

aggregate, disaggregate or change a

previously selected SIC code category if

the taxpayer establishes to the

satisfaction of the Commissioner that,

due to changes in the relevant facts, a

change in product category is

appropriate. This rule provides a simple

and workable format for balancing the

need for consistency with the desire for

flexibility.

Referring to current § 1.861–8(g)

Example 6 (which has been

redesignated § 1.861–17(h) Example 4),

commenters suggested that the

regulations allow the use of the

Wholesale Trade SIC code category with

respect to sales from any other category.

The current § 1.861–8(g) Example 6 was

not correct on this point and does not

override the rule stated parenthetically

in the list of two digit SIC code

categories in present § 1.861–

8(e)(3)(i)(A) that wholesale trade may

not be combined with other product

categories. The final regulations include

this rule along with Example 6

corrected to conform to the rule.

Regarding the exclusive place of

performance apportionment rule under

§ 1.861–8(e)(3)(ii)(A) of the proposed

regulations, commenters suggested

adding a rule providing that if the ratio

of foreign research and experimental

expenditures in a three digit SIC code

category of all foreign affiliates of a

United States consolidated group over

foreign affiliate sales in that SIC code

category exceed fifty percent of the ratio

of United States consolidated group

research and experimental expenditures

in that SIC code category over United

States consolidated group sales in that

SIC code category, then the United

States consolidated group research and

experimental expenditures should be

exclusively apportioned to United

States source gross income. This

suggestion has not been adopted.

Although a foreign affiliate may incur

substantial research and experimental

expenditures in a given product

category, the foreign affiliate may still

benefit from the research and

experimental expenditures of the United

States consolidated group. See PerkinElmer Corporation v. Commissioner,

103 T.C. 464 (1994).

Regarding the optional gross income

methods of apportionment under

§ 1.861–8(e)(3)(iii) of the proposed

regulations, commenters suggested that