Federal law contains several requirements that are not applicable for California. If indebtedness qualifies as QNI for federal purposes, then it probably meets the California requirements for specific allocation. However, just because interest expense does not qualify as QNI does not necessarily mean that it won't meet the California criteria for direct allocation. If the taxpayer asserts that additional interest expense should be specifically allocated for California purposes, the auditor should ask the taxpayer to provide documentation to substantiate that the California criteria is met. The proceeds must be actually applied to purchase, construct, or improve the property.
Creditors can look only to the identified property as security for interest and principal.
The cash flow from the property in all years is reasonably expected to cover interest, original issue discount, and principal. Temporary Treasury Reg. A taxpayer may elect to value assets on the basis of tax book value or fair market value. Under the asset method in the temporary regulations, interest expense is apportioned to the various statutory groupings based on the average total value of assets in each grouping for the taxable year. Domestic corporations must use the asset method to apportion interest expense.