Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations 67081

Authority: Secs. 702(a)(5), 1601, 1602,

1611(c) and (e), and 1631(a)–(d) and (g) of the

Social Security Act (42 U.S.C. 902(a)(5),

1381, 1381a, 1382(c) and (e), and 1383(a)–(d)

and (g)); 31 U.S.C. 3720A.

2. Section 416.590 is added to read as

follows:

§ 416.590 Are there additional methods for

recovery of title XVI benefit overpayments?

(a) General. In addition to the

methods specified in §§ 416.560,

416.570 and 416.580, we may recover an

overpayment under title XVI of the Act

from you under the rules in subpart D

of part 422, provided:

(1) The overpayment occurred after

you attained age 18;

(2) You are no longer entitled to

benefits under title XVI of the Act; and

(3) Pursuant to paragraph (b) of this

section, we have determined that the

overpayment is otherwise unrecoverable

under section 1631(b) of the Act.

(b) When we consider an overpayment

to be otherwise unrecoverable. We

consider an overpayment under title

XVI of the Act to be otherwise

unrecoverable under section 1631(b) of

the Act if all of the following conditions

are met:

(1) We have completed our billing

system sequence (i.e., we have sent you

an initial notice of the overpayment, a

reminder notice, and a past-due notice)

or we have suspended or terminated

collection activity under applicable

rules, such as, the Federal Claims

Collection Standards in 31 CFR 903.2 or

903.3.

(2) We have not entered into an

installment payment arrangement with

you or, if we have entered into such an

arrangement, you have failed to make

any payment for two consecutive

months.

(3) You have not requested waiver

pursuant to § 416.550 or § 416.582 or,

after a review conducted pursuant to

those sections, we have determined that

we will not waive collection of the

overpayment.

(4) You have not requested

reconsideration of the initial

overpayment determination pursuant to

§§ 416.1407 and 416.1409 or, after a

review conducted pursuant to

§ 416.1413, we have affirmed all or part

of the initial overpayment

determination.

(5) We cannot recover your

overpayment pursuant to § 416.570 by

adjustment of benefits payable to any

individual other than you. For purposes

of this paragraph, if you are a member

of an eligible couple that is legally

separated and/or living apart, we will

deem unrecoverable from the other

person that part of your overpayment

which he or she did not receive.

3. The authority citation for subpart N

of part 416 is revised to read as follows:

Authority: Secs. 702(a)(5), 1631, and 1633

of the Social Security Act (42 U.S.C.

902(a)(5), 1383, and 1383b).

4. Section 416.1403 is amended by

removing the word ‘‘and’’ at the end of

paragraph (a)(16), removing the first

period in paragraph (a)(17), removing

‘‘See’’ and adding ‘‘see’’ in its place in

the parenthetical in paragraph (a)(17),

removing the second period at the end

of paragraph (a)(17) and adding a

semicolon in its place, and adding new

paragraphs (a)(18) and (19) to read as

follows:

§ 416.1403 Administrative actions that are

not initial determinations.

(a) * * *

* * * * *

(18) Determining whether we will

refer information about your

overpayment to a consumer reporting

agency (see §§ 416.590 and 422.305 of

this chapter); and

(19) Determining whether we will

refer your overpayment to the

Department of the Treasury for

collection by offset against Federal

payments due you (see §§ 416.590 and

422.310 of this chapter).

* * * * *

PART 422—ORGANIZATION AND

PROCEDURES

5. The authority citation for subpart D

of part 422 is revised to read as follows:

Authority: Secs. 204(f), 205(a), 702(a)(5),

and 1631(b) of the Social Security Act (42

U.S.C. 404(f), 405(a), 902(a)(5), and 1383(b));

31 U.S.C. 3711(e); 31 U.S.C. 3716.

6. Section 422.301(b) is amended by

removing the words ‘‘title II’’ and by

removing ‘‘§ 404.527’’ and adding

‘‘§§ 404.527 and 416.590’’ in its place.

7. Section 422.305 is amended by

removing the reference to ‘‘title II’’ in

the heading and in paragraph (a).

[FR Doc. 01–31897 Filed 12–27–01; 8:45 am]

BILLING CODE 4191–02–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8973]

RIN 1545–AW09

Allocation of Loss With Respect to

Stock and Other Personal Property

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations and removal of

temporary regulations.

SUMMARY: This document contains final

Tax Regulations which remove

temporary regulations relating to the

allocation of loss recognized on the

disposition of stock and other personal

property. The loss allocation regulations

primarily will affect taxpayers that

claim the foreign tax credit and that

incur losses with respect to personal

property and are necessary to modify

existing guidance with respect to loss

allocation.

DATES: Effective dates: These regulations

are effective January 8, 2002.

Applicability Dates: For dates of

applicability, see §§ 1.865–1(f) and

1.865–2(e).

FOR FURTHER INFORMATION CONTACT:

David A. Juster, (202) 622–3850 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments

to 26 CFR part 1. On January 11, 1999,

final regulations (TD 8805, 1999–1 C.B.

371, the 1999 final regulations)

addressing the allocation of loss on the

disposition of stock (§ 1.865–2) and

amending the foreign tax credit passive

limitation grouping rules under § 1.904–

4(c) were published in the Federal

Register (64 FR 1505), together with

temporary regulations relating to the

allocation of loss on the disposition of

personal property other than stock

(§ 1.865–1T) and providing a special

matching rule with respect to the

allocation of certain stock losses

(§ 1.865–2T). A notice of proposed

rulemaking (REG–106905–98) crossreferencing the temporary regulations

was published in the Federal Register

for the same day (64 FR 1571). No

public hearing was requested or held.

One written comment responding to the

notice of proposed rulemaking was

received. After consideration of the

comment, the regulations are finalized

substantially as proposed, and the

corresponding temporary regulations are

removed. This Treasury decision also

67082 Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations

contains minor clarifying amendments

to § 1.865–2 of the 1999 final

regulations. The revisions are discussed

below.

Explanation of Provisions

Section 1.865–1: Loss With Respect to

Personal Property Other Than Stock

Section 1.865–1(a): General Rules

Taxpayers have inquired whether the

regulations apply to section 166 bad

debt deductions. Section 1.865–1 is

intended to apply to all recognized

losses with respect to personal property,

unless otherwise excepted, whether or

not the loss results from an actual sale

or disposition. Although section 166

does not use the term loss in the context

of describing worthless debts giving rise

to a deduction under the statute,

worthlessness deductions reflect

economically sustained losses similar to

losses described in section 165(g) with

respect to worthless securities. Section

1.865–1(a)(1) of the final regulations

clarifies that the loss allocation rules of

§ 1.865–1 apply to section 166 bad debt

deductions, as well as losses on

property that is marked-to-market (such

as under section 475) and not excluded

from the scope of these regulations (as

are inventory property and certain

derivative contracts).

One commentator requested that the

final regulations clarify the proper

allocation of a loss from the disposition

of a partnership interest. Treasury and

the Service do not believe that a special

rule is required. Instead, loss on the

disposition of a partnership interest is

subject to the general rule of § 1.865–

1(a) that allocates loss to the class of

gross income to which gain from the

sale of such property would give rise in

the seller’s hands, i.e., on a reciprocalto-gain basis.

Section 1.865–1(b)(2): Contingent

Payment Debt Instruments

Section 1.865–1(b)(2), explaining the

particular application of the reciprocalto-gain loss allocation rule to contingent

payment debt instruments, provides that

loss on an instrument to which

§ 1.1275–4(b) applies is allocated and

apportioned to the class of interest

income to which the instrument would

give rise. The final regulation adopts the

rule of the temporary regulation,

reworded to clarify the interaction of

this section with § 1.1275–4(b)(9)(iv)(A).

Section 1.865–1(c)(4): Unamortized

Bond Premium

Section 1.865–1(c)(4) provides an

exception from the general reciprocalto-gain rule with respect to unamortized

bond premium. The final regulations

modify the text and add a new Example

3 in § 1.865–1(e) to clarify that loss on

a debt instrument is allocated against

interest only to the extent of the amount

of bond premium that could have been,

but was not, amortized by the taxpayer

before the loss was recognized.

Section 1.865–1(c)(6)(iii): Matching Rule

For discussion of modifications to the

matching rule in response to comments,

see the discussion below in connection

with the stock loss matching rule of

§ 1.865–2(b)(4)(iii).

Section 1.865–1(f): Effective Dates

The final regulations apply to losses

recognized on or after January 8, 2002.

A taxpayer may apply the regulations,

however, to loss recognized in taxable

years beginning on or after January 1,

1987, subject to certain conditions.

Section 1.865–2: Loss With Respect to

Stock

Section 1.865–2(a)(1): General Rules

A sentence is added to § 1.865–2(a)(1)

to clarify that the loss allocation rules of

§ 1.865–2 apply to loss on stock (other

than inventory) that is marked-to-market

(such as under section 475).

Section 1.865–2(a)(3)(ii): Bona Fide

Residents of Puerto Rico

Under section 933, a U.S. citizen or

resident alien that is a bona fide

resident of Puerto Rico is generally

exempt from U.S. tax with respect to

Puerto Rican source income, but

remains subject to U.S. tax with respect

to income derived from other sources.

Consistent with the general rule of the

1999 final regulations allocating losses

against gains and taking account of the

special source rule of section 865(g)(3),

§ 1.865–2(a)(3)(ii) provides that a loss

recognized by a U.S. citizen or resident

alien that is a bona fide resident of

Puerto Rico with respect to stock of a

corporation that is engaged in a trade or

business within Puerto Rico shall be

allocated to reduce foreign source

income. The final regulation, however,

did not specifically state whether the

stock loss is allocated against Puerto

Rican source income that is exempt

from tax under section 933 or against all

of the bona fide resident’s foreign source

income. Section 1.865–2(a)(3)(ii) is

clarified to provide that if gain from the

sale of such stock would be Puerto

Rican source income that is exempt

from tax under section 933, the loss

with respect to such stock shall be

allocated to Puerto Rican source

income. Under section 933(1), a loss

allocated to Puerto Rican source income

that is excluded from gross income

under section 933 is not allowed as a

deduction. See § 1.933–1(c).

Sections 1.865–1(c)(6)(iii) and 1.865–

2(b)(4)(iii): Matching Rule

The temporary regulations provided

that, to the extent a taxpayer recognizes

foreign source income for tax purposes

that results in the creation of a

corresponding loss with respect to stock

or other personal property, as the case

may be, the loss shall be allocated and

apportioned against such income. The

preamble to the temporary regulations

explained that this rule is intended to

prevent taxpayers from avoiding the

dividend recapture rule of § 1.865–

2(b)(1) or from accelerating foreign

source income and recognizing an

offsetting U.S. loss.

One commenter characterized the rule

as overly broad and the examples as

unrealistic. The commenter

recommended that the matching rule be

eliminated from the final regulations or

revised to target identified abuses more

narrowly.

Taking these considerations into

account, §§ 1.865–1(c)(6)(iii) and 1.865–

2(b)(4)(iii) are modified to provide that

the matching rule will only apply if a

taxpayer engages in a transaction or

series of transactions with a principal

purpose of recognizing foreign source

income that results in the creation of a

corresponding loss. As an anti-abuse

rule, the matching rule targets

transactions that are designed to

produce an artificial or accelerated

recognition of income that directly

results in the creation of a

corresponding built-in loss. The stepdown preferred transactions described

in Examples 4 and 5 of § 1.865–

2T(b)(4)(iv) are transactions of this type;

however, because those transactions are

now expressly addressed by regulations

at § 1.7701(l)–3, the final regulations

omit Examples 4 and 5. In addition,

Example 6 of § 1.865–2T(b)(4)(iv) is

revised and redesignated as Example 6

of paragraph (b)(1)(iv) of § 1.865–2 to

illustrate an amendment to the

definition of the recapture period in

§ 1.865–2(d)(3) discussed below.

Section 1.865–2(b)(4)(iii) is also

revised to clarify the interaction of the

matching rule and the exceptions to the

dividend recapture rule for de minimis

or passive dividends. In the temporary

regulations, the matching rule applied

to amounts that otherwise were

exempted from the dividend recapture

rule under the passive or de minimis

exceptions only if the taxpayer held the

stock with a principal purpose of

producing foreign source income and

corresponding loss. Because the final

regulations revise the matching rule to

Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations 67083

incorporate a principal purpose test in

all instances, the specific requirement of

a principal purpose to apply the

matching rule to de minimis or passive

dividends is no longer necessary.

Section 1.865–2(d)(3): Recapture Period

The dividend recapture period set

forth in § 1.865–2(d)(3) is revised to

provide that the 24-month period ends

on the date on which a taxpayer

recognizes a loss with respect to stock.

In addition, in connection with the

revisions to the matching rule discussed

above, the definition of the recapture

period in § 1.865–2(d)(3) is expanded to

provide that the recapture period is

extended if the assets of the corporation

are converted to low-risk investments

with a principal purpose of enabling the

taxpayer to hold the stock without

significant risk of loss until the

recapture period has expired. As noted

above, Example 6 of § 1.865–2T(b)(4)(iv)

has been redesignated as Example 6 of

§ 1.865–2(b)(1)(iv) and revised to

illustrate the operation of this change to

the definition of the recapture period.

Finally, § 1.865–2(d)(3) is revised to

clarify that the dividend recapture rule

applies to a dividend paid after the date

a loss is recognized, if the loss is

incurred after the dividend was

declared (i.e., when the stock is sold exdividend).

Section 1.865–2(e): Effective Dates

The final regulations retain the

January 11, 1999 effective date of the

identical provisions of the temporary

regulations and provide that the

amendments made by the final

regulations apply to losses recognized

on or after January 8, 2002. A taxpayer

may apply the regulations, however, to

loss recognized in any taxable year

beginning on or after January 1, 1987,

subject to certain conditions.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in

Executive Order 12866. Therefore, a

regulatory assessment is not required. A

final regulatory flexibility analysis

under 5 U.S.C. 604 has been prepared

for the portion of this Treasury decision

with respect to regulations issued under

section 865 of the Internal Revenue

Code. This analysis is set forth below.

Pursuant to section 7805(f) of the

Internal Revenue Code, the notice of

proposed rulemaking preceding this

regulation was submitted to the Small

Business Administration for comment

on its impact on small business.

Regulatory Flexibility Analysis

It has been determined that a final

regulatory flexibility analysis is required

under 5 U.S.C. 604 with respect to this

Treasury decision issued under section

865 of the Internal Revenue Code. These

regulations will affect small entities

such as small businesses but not other

small entities, such as local government

or tax exempt organizations, which do

not pay taxes. The IRS and Treasury

Department are not aware of any federal

rules that duplicate, overlap or conflict

with these regulations. The final

regulations address the allocation of loss

with respect to stock and other personal

property. These regulations are

necessary primarily for the proper

computation of the foreign tax credit

limitation under section 904 of the

Internal Revenue Code. With respect to

U.S. resident taxpayers, the regulations

generally allocate losses against U.S.

source income. Generally, this

allocation simplifies the computation of

the foreign tax credit limitation. None of

the significant alternatives considered

in drafting the regulations would have

significantly altered the economic

impact of the regulations on small

entities. There are no alternative rules

that are less burdensome to small

entities but that accomplish the

purposes of the statute.

Drafting Information

Various personnel from the Office of

Associate Chief Counsel (International)

within the Office of Chief Counsel, the

IRS and Treasury Department

participated in developing these

regulations.

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 removing the

entries for ‘‘1.865–1T’’ and ‘‘1.865–2T’’,

revising the entry for ‘‘1.865–2’’, and

adding entries in numerical order to

read in part as follows:

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

Section 1.861–8 also issued under 26

U.S.C. 882(c). * * *

Section 1.865–1 also issued under 26

U.S.C. 863(a) and 865(j)(1).

Section 1.865–2 also issued under 26

U.S.C. 863(a) and 865(j)(1). * * *

Par. 2. Section 1.861–8 is amended

by:

1. Revising paragraphs (e)(7)(iii) and

(e)(8).

2. Removing the authority citation at

the end of the section.

The revisions read as follows:

§ 1.861–8 Computation of taxable income

from sources within the United States and

from other sources and activities.

* * * * *

(e) * * *

(7) * * *

(iii) Allocation of loss recognized in

taxable years after 1986. See §§ 1.865–

1 and 1.865–2 for rules regarding the

allocation of certain loss recognized in

taxable years beginning after December

31, 1986.

(8) Net operating loss deduction. A

net operating loss deduction allowed

under section 172 shall be allocated and

apportioned in the same manner as the

deductions giving rise to the net

operating loss deduction.

* * * * *

Par. 3. Section 1.861–8T is amended

as follows:

1. Paragraphs (e)(1) and (e)(3) through

(e)(11) are revised.

2. Paragraph (h) is amended by

removing the last sentence of the

concluding text.

3. The authority citation at the end of

the section is removed.

The revisions read as follows:

§ 1.861–8T Computation of taxable income

from sources within the United States and

for other sources and activities (temporary).

* * * * *

(e) * * *

(1) [Reserved]. For further guidance,

see § 1.861–8(e)(1).

* * * * *

(3) through (11) [Reserved]. For

further guidance, see § 1.861–8(e)(3)

through (e)(11).

* * * * *

Par. 4. Section 1.865–1 is added to

read as follows:

§ 1.865–1 Loss with respect to personal

property other than stock.

(a) General rules for allocation of

loss—(1) Allocation against gain. Except

as otherwise provided in § 1.865–2 and

paragraph (c) of this section, loss

recognized with respect to personal

property shall be allocated to the class

of gross income and, if necessary,

apportioned between the statutory

grouping of gross income (or among the

statutory groupings) and the residual

grouping of gross income, with respect

to which gain from a sale of such

property would give rise in the hands of

the seller. For purposes of this section,

loss includes bad debt deductions under

section 166 and loss on property that is

67084 Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations

marked-to-market (such as under

section 475) and subject to the rules of

this section. Thus, for example, loss

recognized by a United States resident

on the sale or worthlessness of a bond

generally is allocated to reduce United

States source income.

(2) Loss attributable to foreign office.

Except as otherwise provided in

§ 1.865–2 and paragraph (c) of this

section, and except with respect to loss

subject to paragraph (b) of this section,

in the case of loss recognized by a

United States resident with respect to

property that is attributable to an office

or other fixed place of business in a

foreign country within the meaning of

section 865(e)(3), the loss shall be

allocated to reduce foreign source

income if a gain on the sale of the

property would have been taxable by

the foreign country and the highest

marginal rate of tax imposed on such

gains in the foreign country is at least

10 percent. However, paragraph (a)(1) of

this section and not this paragraph (a)(2)

will apply if gain on the sale of such

property would be sourced under

section 865(c), (d)(1)(B), or (d)(3).

(3) Loss recognized by United States

citizen or resident alien with foreign tax

home. Except as otherwise provided in

§ 1.865–2 and paragraph (c) of this

section, and except with respect to loss

subject to paragraph (b) of this section,

in the case of loss with respect to

property recognized by a United States

citizen or resident alien that has a tax

home (as defined in section 911(d)(3)) in

a foreign country, the loss shall be

allocated to reduce foreign source

income if a gain on the sale of such

property would have been taxable by a

foreign country and the highest

marginal rate of tax imposed on such

gains in the foreign country is at least

10 percent.

(4) Allocation for purposes of section

904. For purposes of section 904, loss

recognized with respect to property that

is allocated to foreign source income

under this paragraph (a) shall be

allocated to the separate category under

section 904(d) to which gain on the sale

of the property would have been

assigned (without regard to section

904(d)(2)(A)(iii)(III)). For purposes of

§ 1.904–4(c)(2)(ii)(A), any such loss

allocated to passive income shall be

allocated (prior to the application of

§ 1.904–4(c)(2)(ii)(B)) to the group of

passive income to which gain on a sale

of the property would have been

assigned had a sale of the property

resulted in the recognition of a gain

under the law of the relevant foreign

jurisdiction or jurisdictions.

(5) Loss recognized by partnership. A

partner’s distributive share of loss

recognized by a partnership with

respect to personal property shall be

allocated and apportioned in

accordance with this section as if the

partner had recognized the loss. If loss

is attributable to an office or other fixed

place of business of the partnership

within the meaning of section 865(e)(3),

such office or fixed place of business

shall be considered to be an office of the

partner for purposes of this section.

(b) Special rules of application—(1)

Depreciable property. In the case of a

loss recognized with respect to

depreciable personal property, the gain

referred to in paragraph (a)(1) of this

section is the gain that would be

sourced under section 865(c)(1)

(depreciation recapture).

(2) Contingent payment debt

instrument. Loss described in the last

sentence of § 1.1275–4(b)(9)(iv)(A) that

is recognized with respect to a

contingent payment debt instrument to

which § 1.1275–4(b) applies

(instruments issued for money or

publicly traded property) shall be

allocated to the class of gross income

and, if necessary, apportioned between

the statutory grouping of gross income

(or among the statutory groupings) and

the residual grouping of gross income,

with respect to which interest income

from the instrument (in the amount of

the loss subject to this paragraph (b)(2))

would give rise.

(c) Exceptions—(1) Foreign currency

and certain financial instruments. This

section does not apply to loss governed

by section 988 and loss recognized with

respect to options contracts or

derivative financial instruments,

including futures contracts, forward

contracts, notional principal contracts,

or evidence of an interest in any of the

foregoing.

(2) Inventory. This section does not

apply to loss recognized with respect to

property described in section 1221(a)(1).

(3) Interest equivalents and trade

receivables. Loss subject to § 1.861–

9T(b) (loss equivalent to interest

expense and loss on trade receivables)

shall be allocated and apportioned

under the rules of § 1.861–9T and not

under the rules of this section.

(4) Unamortized bond premium. If a

taxpayer recognizing loss with respect

to a bond (within the meaning of

§ 1.171–1(b)) did not amortize bond

premium to the full extent permitted by

section 171 and the regulations

thereunder, then, to the extent of the

amount of bond premium that could

have been, but was not, amortized by

the taxpayer, loss recognized with

respect to the bond shall be allocated to

the class of gross income and, if

necessary, apportioned between the

statutory grouping of gross income (or

among the statutory groupings) and the

residual grouping of gross income, with

respect to which interest income from

the bond was assigned.

(5) Accrued interest. Loss attributable

to accrued but unpaid interest on a debt

obligation shall be allocated to the class

of gross income and, if necessary,

apportioned between the statutory

grouping of gross income (or among the

statutory groupings) and the residual

grouping of gross income, with respect

to which interest income from the

obligation was assigned. For purposes of

this section, whether loss is attributable

to accrued but unpaid interest (rather

than to principal) shall be determined

under the principles of §§ 1.61–7(d) and

1.446–2(e).

(6) Anti-abuse rules—(i) Transactions

involving built-in losses. If one of the

principal purposes of a transaction is to

change the allocation of a built-in loss

with respect to personal property by

transferring the property to another

person, qualified business unit, office or

other fixed place of business, or branch

that subsequently recognizes the loss,

the loss shall be allocated by the

transferee as if it were recognized by the

transferor immediately prior to the

transaction. If one of the principal

purposes of a change of residence is to

change the allocation of a built-in loss

with respect to personal property, the

loss shall be allocated as if the change

of residence had not occurred. If one of

the principal purposes of a transaction

is to change the allocation of a built-in

loss on the disposition of personal

property by converting the original

property into other property and

subsequently recognizing loss with

respect to such other property, the loss

shall be allocated as if it were

recognized with respect to the original

property immediately prior to the

transaction. Transactions subject to this

paragraph shall include, without

limitation, reorganizations within the

meaning of section 368(a), liquidations

under section 332, transfers to a

corporation under section 351, transfers

to a partnership under section 721,

transfers to a trust, distributions by a

partnership, distributions by a trust,

transfers to or from a qualified business

unit, office or other fixed place of

business, or branch, or exchanges under

section 1031. A person may have a

principal purpose of affecting loss

allocation even though this purpose is

outweighed by other purposes (taken

together or separately).

(ii) Offsetting positions. If a taxpayer

recognizes loss with respect to personal

property and the taxpayer (or any

person described in section 267(b) (after

Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations 67085

application of section 267(c)), 267(e),

318 or 482 with respect to the taxpayer)

holds (or held) offsetting positions with

respect to such property with a

principal purpose of recognizing foreign

source income and United States source

loss, the loss shall be allocated and

apportioned against such foreign source

income. For purposes of this paragraph

(c)(6)(ii), positions are offsetting if the

risk of loss of holding one or more

positions is substantially diminished by

holding one or more other positions.

(iii) Matching rule. If a taxpayer (or a

person described in section

1059(c)(3)(C) with respect to the

taxpayer) engages in a transaction or

series of transactions with a principal

purpose of recognizing foreign source

income that results in the creation of a

corresponding loss with respect to

personal property (as a consequence of

the rules regarding the timing of

recognition of income, for example), the

loss shall be allocated and apportioned

against such income to the extent of the

recognized foreign source income. For

an example illustrating a similar rule

with respect to stock loss, see § 1.865–

2(b)(4)(iv) Example 3.

(d) Definitions—(1) Contingent

payment debt instrument. A contingent

payment debt instrument is any debt

instrument that is subject to § 1.1275–4.

(2) Depreciable personal property.

Depreciable personal property is any

property described in section

865(c)(4)(A).

(3) Terms defined in § 1.861–8. See

§ 1.861–8 for the meaning of class of

gross income, statutory grouping of

gross income, and residual grouping of

gross income.

(e) Examples. The application of this

section may be illustrated by the

following examples:

Example 1. On January 1, 2000, A, a

domestic corporation, purchases for $1,000 a

machine that produces widgets, which A

sells in the United States and throughout the

world. Throughout A’s holding period, the

machine is located and used in Country X.

During A’s holding period, A incurs

depreciation deductions of $400 with respect

to the machine. Under § 1.861–8, A allocates

and apportions depreciation deductions of

$250 against foreign source general limitation

income and $150 against U.S. source income.

On December 12, 2002, A sells the machine

for $100 and recognizes a loss of $500.

Because the machine was used

predominantly outside the United States,

under sections 865(c)(1)(B) and

865(c)(3)(B)(ii) gain on the disposition of the

machine would be foreign source general

limitation income to the extent of the

depreciation adjustments. Therefore, under

paragraph (b)(1) of this section, the entire

$500 loss is allocated against foreign source

general limitation income.

Example 2. On January 1, 2002, A, a

domestic corporation, loans $2,000 to N, its

wholly-owned controlled foreign

corporation, in exchange for a contingent

payment debt instrument subject to § 1.1275–

4(b). During 2002 through 2004, A accrues

and receives interest income of $630, $150 of

which is foreign source general limitation

income and $480 of which is foreign source

passive income under section 904(d)(3).

Assume there are no positive or negative

adjustments pursuant to § 1.1275–4(b)(6) in

2002 through 2004. On January 1, 2005, A

disposes of the debt instrument and

recognizes a $770 loss. Under § 1.1275–

4(b)(8)(ii), $630 of the loss is treated as

ordinary loss and $140 is treated as capital

loss. Assume that $140 of interest income

earned in 2005 with respect to the debt

instrument would be foreign source passive

income under section 904(d)(3). Under

§ 1.1275–4(b)(9)(iv), $150 of the ordinary loss

is allocated against foreign source general

limitation income and $480 of the ordinary

loss is allocated against foreign source

passive income. Under paragraph (b)(2) of

this section, the $140 capital loss is allocated

against foreign source passive income.

Example 3. (i) On January 1, 2003, A, a

domestic corporation, purchases for $1,200 a

taxable bond maturing on December 31,

2008, with a stated principal amount of

$1,000, payable at maturity. The bond

provides for unconditional payments of

interest of $100, payable December 31 of each

year. The issuer of the bond is a foreign

corporation and interest on the bond is thus

foreign source. Interest payments for 2003

and 2004 are timely made. A does not elect

to amortize its bond premium under section

171 and the regulations thereunder, which

would have permitted A to offset the $100 of

interest income by $28.72 of bond premium

in 2003, and by $30.42 in 2004. On January

1, 2005, A sells the bond and recognizes a

$100 loss. Under paragraph (c)(4) of this

section, $59.14 of the loss is allocated against

foreign source income. Under paragraph

(a)(1) of this section, the remaining $40.86 of

the loss is allocated against U.S. source

income.

(ii) The facts are the same as in paragraph

(i) of this Example 3, except that A made the

election to amortize its bond premium

effective for taxable year 2004 (see § 1.171–

4(c)). Under paragraph (c)(4) of this section,

$28.72 of the loss is allocated against foreign

source income. Under paragraph (a)(1) of this

section, the remaining $71.28 of the loss is

allocated against U.S. source income.

Example 4. On January 1, 2002, A, a

domestic corporation, purchases for $1,000 a

bond maturing December 31, 2014, with a

stated principal amount of $1,000, payable at

maturity. The bond provides for

unconditional payments of interest of $100,

payable December 31 of each year. The issuer

of the bond is a foreign corporation and

interest on the bond is thus foreign source.

Between 2002 and 2006, A accrues and

receives foreign source interest income of

$500 with respect to the bond. On January 1,

2007, A sells the bond and recognizes a $500

loss. Under paragraph (a)(1) of this section,

the $500 loss is allocated against U.S. source

income.

Example 5. On January 1, 2002, A, a

domestic corporation on the accrual method

of accounting, purchases for $1,000 a bond

maturing December 31, 2012, with a stated

principal amount of $1,000, payable at

maturity. The bond provides for

unconditional payments of interest of $100,

payable December 31 of each year. The issuer

of the bond is a foreign corporation and

interest on the bond is thus foreign source.

On June 10, 2002, after A has accrued $44 of

interest income, but before any interest has

been paid, the issuer suddenly becomes

insolvent and declares bankruptcy. A sells

the bond (including the accrued interest) for

$20. Assuming that A properly accrued $44

of interest income, A treats the $20 proceeds

from the sale of the bond as payment of

interest previously accrued and recognizes a

$1,000 loss with respect to the bond

principal and a $24 loss with respect to the

accrued interest. See § 1.61–7(d). Under

paragraph (a)(1) of this section, the $1,000

loss with respect to the principal is allocated

against U.S. source income. Under paragraph

(c)(5) of this section, the $24 loss with

respect to accrued but unpaid interest is

allocated against foreign source interest

income.

(f) Effective date—(1) In general.

Except as provided in paragraph (f)(2) of

this section, this section is applicable to

loss recognized on or after January 8,

2002. For purposes of this paragraph (f),

loss that is recognized but deferred (for

example, under section 267 or 1092)

shall be treated as recognized at the time

the loss is taken into account.

(2) Application to prior periods. A

taxpayer may apply the rules of this

section to losses recognized in any

taxable year beginning on or after

January 1, 1987, and all subsequent

years, provided that—

(i) The taxpayer’s tax liability as

shown on an original or amended tax

return is consistent with the rules of this

section for each such year for which the

statute of limitations does not preclude

the filing of an amended return on June

30, 2002; and

(ii) The taxpayer makes appropriate

adjustments to eliminate any double

benefit arising from the application of

this section to years that are not open

for assessment.

(3) Examples. See § 1.865–2(e)(3) for

examples illustrating an applicability

date provision similar to the

applicability date provided in this

paragraph (f).

§ 1.865–1T [Removed]

Par. 5. Section 1.865–1T is removed.

Par. 6. Section 1.865–2 is amended

by:

1. Adding a sentence after the first

sentence of paragraph (a)(1).

2. Adding two sentences at the end of

paragraph (a)(3)(ii).

3. Adding Example 6 to paragraph

(b)(1)(iv).

67086 Federal Register / Vol. 66, No. 249 / Friday, December 28, 2001 / Rules and Regulations

4. Revising paragraph (b)(4)(iii).

5. Adding Example 3 to paragraph

(b)(4)(iv).

6. Revising paragraphs (d)(3), (e)(1),

and (e)(2)(i).

The revisions and additions read as

follows:

§ 1.865–2 Loss with respect to stock.

(a)(1) * * * For purposes of this

section, loss includes loss on property

that is marked-to-market (such as under

section 475) and subject to the rules of

this section. * * *

* * * * *

(3) * * *

(ii) * * * If gain from a sale of such

stock would give rise to income exempt

from tax under section 933, the loss

with respect to such stock shall be

allocated to amounts that are excluded

from gross income under section 933(1)

and therefore shall not be allowed as a

deduction from gross income. See

section 933(1) and § 1.933–1(c).

* * * * *

(b) * * *

(1) * * *

(iv) * * *

Example 6. (i) On January 1, 1998, P, a

domestic corporation, purchases N, a foreign

corporation, for $1,000. On March 1, 1998, P

causes N to sell its operating assets,

distribute a $400 general limitation dividend

to P, and invest its remaining $600 in shortterm government securities. P converted the

N assets into low-risk investments with a

principal purpose of holding the N stock

without significant risk of loss until the

recapture period expired. N earns interest

income from the securities. The income

constitutes subpart F income that is included

in P’s income under section 951, increasing

P’s basis in the N stock under section 961(a).

On March 1, 2002, P sells N and recognizes

a $400 loss.

(ii) Pursuant to paragraph (d)(3) of this

section, the recapture period is increased by

the period in which N’s assets were held as

low-risk investments because P caused N’s

assets to be converted into and held as lowrisk investments with a principal purpose of

enabling P to hold the N stock without

significant risk of loss. Accordingly, under

paragraph (b)(1)(i) of this section the $400

loss is allocated against foreign source

general limitation income.

* * * * *

(4) * * *

(iii) Matching rule. If a taxpayer (or a

person described in section

1059(c)(3)(C) with respect to the

taxpayer) engages in a transaction or

series of transactions with a principal

purpose of recognizing foreign source

income that results in the creation of a

corresponding loss with respect to stock

(as a consequence of the rules regarding

the timing of recognition of income, for

example), the loss shall be allocated and

apportioned against such income to the

extent of the recognized foreign source

income. This paragraph (b)(4)(iii)

applies to any portion of a loss that is

not allocated under paragraph (b)(1)(i)

of this section (dividend recapture rule),

including a loss in excess of the

dividend recapture amount and a loss

that is related to a dividend recapture

amount described in paragraph (b)(1)(ii)

(de minimis exception) or (b)(1)(iii)

(passive dividend exception) of this

section.

(iv) Examples. ***

Example 3. (i) Facts. On January 1, 2002,

P and Q, domestic corporations, form R, a

domestic partnership. The corporations and

partnership use the calendar year as their

taxable year. P contributes $900 to R in

exchange for a 90-percent partnership

interest and Q contributes $100 to R in

exchange for a 10-percent partnership

interest. R purchases a dance studio in

country X for $1,000. On January 2, 2002, R

enters into contracts to provide dance lessons

in Country X for a 5-year period beginning

January 1, 2003. These contracts are prepaid

by the dance studio customers on December

31, 2002, and R recognizes foreign source

taxable income of $500 from the prepayments

(R’s only income in 2002). P takes into

income its $450 distributive share of

partnership taxable income. On January 1,

2003, P’s basis in its partnership interest is

$1,350 ($900 from its contribution under

section 722, increased by its $450

distributive share of partnership income

under section 705). On September 22, 2003,

P contributes its R partnership interest to S,

a newly-formed domestic corporation, in

exchange for all the stock of S. Under section

358, P’s basis in S is $1,350. On December

1, 2003, P sells S to an unrelated party for

$1050 and recognizes a $300 loss.

(ii) Loss allocation. P recognized foreign

source income for tax purposes before the

income had economically accrued, and the

accelerated recognition of income increased

P’s basis in R without increasing its value by

a corresponding amount, which resulted in

the creation of a built-in loss with respect to

the S stock. Under paragraph (b)(4)(iii) of this

section the $300 loss is allocated against

foreign source income if P had a principal

purpose of recognizing foreign source income

and corresponding loss.

* * * * *

(d) * * *

(3) Recapture period. A recapture

period is the 24-month period ending on

the date on which a taxpayer recognized

a loss with respect to stock. For

example, if a taxpayer recognizes a loss

on March 15, 2002, the recapture period

begins on and includes March 16, 2000,

and ends on and includes March 15,

2002. A recapture period is increased by

any period of time in which the

taxpayer has diminished its risk of loss

in a manner described in section

246(c)(4) and the regulations thereunder

and by any period in which the assets

of the corporation are hedged against

risk of loss (or are converted into and

held as low-risk investments) with a

principal purpose of enabling the

taxpayer to hold the stock without

significant risk of loss until the

recapture period has expired. In the case

of a loss recognized after a dividend is

declared but before such dividend is

paid, the recapture period is extended

through the date on which the dividend

is paid.

* * * * *

(e) Effective date—(1) In general. This

section is applicable to loss recognized

on or after January 11, 1999, except that

paragraphs (a)(3)(ii), (b)(1)(iv) Example

6, (b)(4)(iii), (b)(4)(iv) Example 3, and

(d)(3) of this section are applicable to

loss recognized on or after January 8,

2002. For purposes of this paragraph (e),

loss that is recognized but deferred (for

example, under section 267 or 1092)

shall be treated as recognized at the time

the loss is taken into account.

(2) * * *

(i) The taxpayer’s tax liability as

shown on an original or amended tax

return is consistent with the rules of this

section for each such year for which the

statute of limitations does not preclude

the filing of an amended return on June

30, 2002; and

* * * * *

§ 1.865–2T [Removed]

Par. 7. Section 1.865–2T is removed.

§ 1.904–4 [Amended]

Par. 8. In § 1.904–4, paragraph

(c)(2)(ii)(A), remove the language

‘‘1.865–1T through 1.865–2T’’ at the end

of the first sentence and add ‘‘1.865–1

and 1.865–2’’ in its place.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Approved: December 19, 2001.

Mark Weinberger,

Assistant Secretary of the Treasury.

[FR Doc. 01–31819 Filed 12–27–01; 8:45 am]

BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY

31 CFR Part 103

[FinCEN Issuance 2001–2]

Financial Crimes Enforcement

Network; Bank Secrecy Act

Regulations—Issuance Concerning the

Requirement that Money Transmitters

and Money Order and Traveler’s Check

Issuers, Sellers, and Redeemers

Report Suspicious Transactions;

Effective Date and Reporting Form

AGENCY: Financial Crimes Enforcement

Network (‘‘FinCEN’’), Treasury.