Reg. § 1.951A-3 Qualified business asset investment.
(a) Scope This section provides rules for determining the qualified business asset investment of a controlled foreign corporation for purposes of determining a United States shareholder's deemed tangible income return under . of this section defines qualified business asset investment. of this section defines tangible property and specified tangible property. of this section provides rules for determining the portion of tangible property that is specified tangible property when the property is used in the production of both gross tested income and gross income that is not gross tested income. of this section provides rules for determining the adjusted basis in specified tangible property. of this section provides rules for determining qualified business asset investment of a tested income CFC with a short taxable year. of this section provides rules for increasing the qualified business asset investment of a tested income CFC by reason of property owned by a partnership. of this section provides anti-avoidance rules that disregard the basis in property transferred in certain transactions when determining the qualified business asset investment of a tested income CFC.
(b) Qualified business asset investment The term qualified business asset investment means the average of a tested income CFC's aggregate adjusted bases as of the close of each quarter of a CFC inclusion year in specified tangible property that is used in a trade or business of the tested income CFC and is of a type with respect to which a deduction is allowable under section . In the case of partially depreciable property, only the depreciable portion of the property is of a type with respect to which a deduction is allowable under section . A tested loss CFC has no qualified business asset investment.
(c) Specified tangible property
(1) In general The term specified tangible property means, with respect to a tested income CFC and a CFC inclusion year, tangible property of the tested income CFC used in the production of gross tested income for the CFC inclusion year. For purposes of the preceding sentence, tangible property of a tested income CFC is used in the production of gross tested income for a CFC inclusion year if some or all of the depreciation or cost recovery allowance with respect to the tangible property is either allocated and apportioned to the gross tested income of the tested income CFC for the CFC inclusion year under or capitalized to inventory or other property held for sale, some or all of the gross income or loss from the sale of which is taken into account in determining tested income of the tested income CFC for the CFC inclusion year. None of the tangible property of a tested loss CFC is specified tangible property.
(2) Tangible property The term tangible property means property for which the depreciation deduction provided by section is eligible to be determined under section without regard to section , (2), or (5), section , (IV), or (V), and the date placed in service.
(d) Dual use property
(1) In general The amount of the adjusted basis in dual use property of a tested income CFC for a CFC inclusion year that is treated as adjusted basis in specified tangible property for the CFC inclusion year is the average of the tested income CFC's adjusted basis in the property multiplied by the dual use ratio with respect to the property for the CFC inclusion year.
(2) Definition of dual use property The term dual use property means, with respect to a tested income CFC and a CFC inclusion year, specified tangible property of the tested income CFC that is used in both the production of gross tested income and the production of gross income that is not gross tested income for the CFC inclusion year. For purposes of the preceding sentence, specified tangible property of a tested income CFC is used in the production of gross tested income and the production of gross income that is not gross tested income for a CFC inclusion year if less than all of the depreciation or cost recovery allowance with respect to the property is either allocated and apportioned to the gross tested income of the tested income CFC for the CFC inclusion year under or capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining the tested income of the tested income CFC for the CFC inclusion year.
(3) Dual use ratio The term dual use ratio means, with respect to dual use property, a tested income CFC, and a CFC inclusion year, a ratio (expressed as a percentage) calculated as—
(i) The sum of—
(A) The depreciation deduction or cost recovery allowance with respect to the property that is allocated and apportioned to the gross tested income of the tested income CFC for the CFC inclusion year under , and
(B) The depreciation or cost recovery allowance with respect to the property that is capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining the tested income of the tested income CFC for the CFC inclusion year, divided by
(ii) The sum of—
(A) The total amount of the tested income CFC's depreciation deduction or cost recovery allowance with respect to the property for the CFC inclusion year, and
(B) The total amount of the tested income CFC's depreciation or cost recovery allowance with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining the income or loss of the tested income CFC for the CFC inclusion year.
(4) Example The following example illustrates the application of this .
(i) Facts FS is a tested income CFC and a wholesale distributor of Product A. FS owns a warehouse and trucks that store and deliver Product A, respectively. The warehouse has an average adjusted basis for Year 1 of $20,000x. The depreciation with respect to the warehouse for Year 1 is $2,000x, which is capitalized to inventory of Product A. Of the $2,000x depreciation capitalized to inventory of Product A, $500x is capitalized to FS's ending inventory of Product A, $1,200x is capitalized to inventory of Product A, the gross income or loss from the sale of which is taken into account in determining FS's tested income for Year 1, and $300x is capitalized to inventory of Product A, the gross income or loss from the sale of which is taken into account in determining FS's foreign base company sales income for Year 1. The trucks have an average adjusted basis for Year 1 of $4,000x. FS does not capitalize depreciation with respect to the trucks to inventory or other property held for sale. FS's depreciation deduction with respect to the trucks is $20x for Year 1, $15x of which is allocated and apportioned to FS's gross tested income under .
(ii) Analysis
(A) Dual use property The warehouse and trucks are property for which the depreciation deduction provided by section is eligible to be determined under section (without regard to section , (2), or (5), section , (IV), or (V), and the date placed in service). Therefore, under of this section, the warehouse and trucks are tangible property. Furthermore, because the warehouse and trucks are used in the production of gross tested income in Year 1 within the meaning of of this section, the warehouse and trucks are specified tangible property. Finally, because the warehouse and trucks are used in both the production of gross tested income and the production of gross income that is not gross tested income in Year 1 within the meaning of of this section, the warehouse and trucks are dual use property. Therefore, under of this section, the amount of FS's adjusted basis in the warehouse and trucks that is treated as adjusted basis in specified tangible property for Year 1 is determined by multiplying FS's adjusted basis in the warehouse and trucks by FS's dual use ratio with respect to the warehouse and trucks determined under of this section.
(B) Depreciation not capitalized to inventory Because none of the depreciation with respect to the trucks is capitalized to inventory or other property held for sale, FS's dual use ratio with respect to the trucks is determined entirely by reference the depreciation deduction with respect to the trucks. Therefore, under of this section, FS's dual use ratio with respect to the trucks for Year 1 is 75%, which is FS's depreciation deduction with respect to the trucks that is allocated and apportioned to gross tested income under for Year 1 ($15x), divided by the total amount of FS's depreciation deduction with respect to the trucks for Year 1 ($20x). Accordingly, under of this section, $3,000x ($4,000x × 0.75) of FS's average adjusted bases in the trucks is taken into account under of this section in determining FS's qualified business asset investment for Year 1.
(C) Depreciation capitalized to inventory Because all of the depreciation with respect to the warehouse is capitalized to inventory, FS's dual use ratio with respect to the warehouse is determined entirely by reference to the depreciation with respect to the warehouse that is capitalized to inventory and included in cost of goods sold. Therefore, under of this section, FS's dual use ratio with respect to the warehouse for Year 1 is 80%, which is FS's depreciation with respect to the warehouse that is capitalized to inventory of Product A, the gross income or loss from the sale of which is taken into account in determining in FS's tested income for Year 1 ($1,200x), divided by FS's depreciation with respect to the warehouse that is capitalized to inventory of Product A, the gross income or loss from the sale of which is taken into account in determining FS's income for Year 1 ($1,500x). Accordingly, under of this section, $16,000x ($20,000x × 0.8) of FS's average adjusted basis in the warehouse is taken into account under of this section in determining FS's qualified business asset investment for Year 1.
(e) Determination of adjusted basis in specified tangible property
(1) In general Except as provided in of this section, the adjusted basis in specified tangible property for purposes of this section is determined by using the cost capitalization methods of accounting used by the controlled foreign corporation for purposes of determining the gross income and allowable deductions of the controlled foreign corporation under and the alternative depreciation system under section , and by allocating the depreciation deduction with respect to such property for a CFC inclusion year ratably to each day during the period in the CFC inclusion year to which such depreciation relates. For purposes of the preceding sentence, the period in the CFC inclusion year to which such depreciation relates is determined without regard to the applicable convention under section .
(2) Effect of change in law The adjusted basis in specified tangible property is determined without regard to any provision of law enacted after December 22, 2017, unless such later enacted law specifically and directly amends the definition of qualified business asset investment under section . For purposes of applying section and this , the technical amendment to section (to provide a recovery period of 20 years for qualified improvement property for purposes of the alternative depreciation system) enacted in section 2307(a) of the Coronavirus Aid, Relief, and Economic Security Act, Public Law 116-136 (2020) is treated as enacted on December 22, 2017.
(3) Specified tangible property placed in service before enactment of section 951A
(i) In general Except as provided in of this section, the adjusted basis in specified tangible property placed in service before December 22, 2017, is determined using the alternative depreciation system under section , as if this system had applied from the date that the property was placed in service.
(ii) Election to use income and earnings and profits depreciation method for property placed in service before the first taxable year beginning after December 22, 2017
(A) In general If a controlled foreign corporation is not required to use, and does not in fact use, the alternative depreciation system under section for purposes of determining income under and earnings and profits under with respect to property placed in service before the first taxable year beginning after December 22, 2017, and the controlling domestic shareholders (as defined in ) of the controlled foreign corporation make an election described in this , the adjusted basis in specified tangible property of the controlled foreign corporation that was placed in service before the first taxable year of the controlled foreign corporation beginning after December 22, 2017, and the partner adjusted basis in partnership specified tangible property of any partnership of which the controlled foreign corporation is a partner that was placed in service before the first taxable year of the partnership beginning after December 22, 2017, is determined for purposes of this section based on the method of accounting for depreciation used by the controlled foreign corporation for purposes of determining income under , subject to the modification described in this . If the controlled foreign corporation's method of accounting for depreciation takes into account salvage value of the property, the salvage value is reduced to zero by allocating the salvage value ratably to each day of the taxable year immediately after the last taxable year in which the method of accounting determined an amount of depreciation deduction for the property.
(B) Manner of making the election The controlling domestic shareholders making the election described in this must file a statement that meets the requirements of with their income tax returns for the taxable year that includes the last day of the controlled foreign corporation's applicable taxable year and follow the notice requirements of . The controlled foreign corporation's applicable taxable year is the first CFC inclusion year that begins after December 31, 2017, and ends within the controlling domestic shareholder's taxable year. For purposes of (addressing requests for extensions of time for filing certain regulatory elections), a controlling domestic shareholder is qualified to make the election described in this only if the shareholder determined the adjusted basis in specified tangible property placed in service before the first taxable year beginning after December 22, 2017, by applying the method described in of this section with respect to the first taxable year of the controlled foreign corporation beginning after December 22, 2017, and each subsequent taxable year. The election statement must be filed in accordance with the rules provided in forms or instructions.
(f) Special rules for short taxable years
(1) In general In the case of a tested income CFC that has a CFC inclusion year that is less than twelve months (a short taxable year), the rules for determining the qualified business asset investment of the tested income CFC under this section are modified as provided in and of this section with respect to the CFC inclusion year.
(2) Determination of quarter closes For purposes of determining quarter closes, in determining the qualified business asset investment of a tested income CFC for a short taxable year, the quarters of the tested income CFC for purposes of this section are the full quarters beginning and ending within the short taxable year (if any), determining quarter length as if the tested income CFC did not have a short taxable year, plus one or more short quarters (if any).
(3) Reduction of qualified business asset investment The qualified business asset investment of a tested income CFC for a short taxable year is the sum of—
(i) The sum of the tested income CFC's aggregate adjusted bases in specified tangible property as of the close of each full quarter (if any) in the CFC inclusion year divided by four, plus
(ii) The tested income CFC's aggregate adjusted bases in specified tangible property as of the close of each short quarter (if any) in the CFC inclusion year multiplied by the sum of the number of days in each short quarter divided by 365.
(4) Example The following example illustrates the application of this .
(i) Facts USP1, a domestic corporation, owns all of the stock of FS, a controlled foreign corporation. USP1 owns FS from the beginning of Year 1. On July 15, Year 1, USP1 sells FS to USP2, an unrelated person. USP2 makes a section election with respect to the purchase of FS, as a result of which FS's taxable year is treated as ending on July 15. USP1, USP2, and FS all use the calendar year as their taxable year. FS's aggregate adjusted bases in specified tangible property is $250x as of March 31, $300x as of June 30, $275x as of July 15, $500x as of September 30, and $450x as of December 31.
(ii) Analysis
(A) Determination of short taxable years and quarters FS has two short taxable years in Year 1. The first short taxable year is from January 1 to July 15, with two full quarters (January 1 through March 31 and April 1 through June 30) and one short quarter (July 1 through July 15). The second taxable year is from July 16 to December 31, with one short quarter (July 16 through September 30) and one full quarter (October 1 through December 31).
(B) Calculation of qualified business asset investment for the first short taxable year Under of this section, for the first short taxable year in Year 1, FS has three quarter closes (March 31, June 30, and July 15). Under of this section, the qualified business asset investment of FS for the first short taxable year is $148.80x, the sum of $137.50x (($250x + $300x)/4) attributable to the two full quarters and $11.30x ($275x × 15/365) attributable to the short quarter.
(C) Calculation of qualified business asset investment for the second short taxable year Under of this section, for the second short taxable year in Year 1, FS has two quarter closes (September 30 and December 31). Under of this section, the qualified business asset investment of FS for the second short taxable year is $217.98x, the sum of $112.50x ($450x/4) attributable to the one full quarter and $105.48x ($500x × 77/365) attributable to the short quarter.
(g) Partnership property
(1) In general If a tested income CFC holds an interest in one or more partnerships during a CFC inclusion year (including indirectly through one or more partnerships that are partners in a lower-tier partnership), the qualified business asset investment of the tested income CFC for the CFC inclusion year (determined without regard to this ) is increased by the sum of the tested income CFC's partnership QBAI with respect to each partnership for the CFC inclusion year. A tested loss CFC has no partnership QBAI for a CFC inclusion year.
(2) Determination of partnership QBAI For purposes of of this section, the term partnership QBAI means, with respect to a partnership, a tested income CFC, and a CFC inclusion year, the sum of the tested income CFC's partner adjusted basis in each partnership specified tangible property of the partnership for each partnership taxable year that ends with or within the CFC inclusion year. If a partnership taxable year is less than twelve months, the principles of of this section apply in determining a tested income CFC's partnership QBAI with respect to the partnership.
(3) Determination of partner adjusted basis
(i) In general For purposes of of this section, the term partner adjusted basis means the amount described in of this section with respect to sole use partnership property or of this section with respect to dual use partnership property. The principles of section apply to this determination.
(ii) Sole use partnership property
(A) In general The amount described in this , with respect to sole use partnership property, a partnership taxable year, and a tested income CFC, is the sum of the tested income CFC's proportionate share of the partnership adjusted basis in the sole use partnership property for the partnership taxable year and the tested income CFC's partner-specific QBAI basis in the sole use partnership property for the partnership taxable year.
(B) Definition of sole use partnership property The term sole use partnership property means, with respect to a partnership, a partnership taxable year, and a tested income CFC, partnership specified tangible property of the partnership that is used in the production of only gross tested income of the tested income CFC for the CFC inclusion year in which or with which the partnership taxable year ends. For purposes of the preceding sentence, partnership specified tangible property of a partnership is used in the production of only gross tested income for a CFC inclusion year if all the tested income CFC's distributive share of the partnership's depreciation deduction or cost recovery allowance with respect to the property (if any) for the partnership taxable year that ends with or within the CFC inclusion year is allocated and apportioned to the tested income CFC's gross tested income for the CFC inclusion year under and, if any of the partnership's depreciation or cost recovery allowance with respect to the property is capitalized to inventory or other property held for sale, all the tested income CFC's distributive share of the partnership's gross income or loss from the sale of such inventory or other property for the partnership taxable year that ends with or within the CFC inclusion year is taken into account in determining the tested income of the tested income CFC for the CFC inclusion year.
(iii) Dual use partnership property
(A) In general The amount described in this , with respect to dual use partnership property, a partnership taxable year, and a tested income CFC, is the sum of the tested income CFC's proportionate share of the partnership adjusted basis in the property for the partnership taxable year and the tested income CFC's partner-specific QBAI basis in the property for the partnership taxable year, multiplied by the tested income CFC's dual use ratio with respect to the property for the partnership taxable year determined under the principles of of this section, except that the ratio described in of this section is determined by reference to the tested income CFC's distributive share of the amounts described in of this section.
(B) Definition of dual use partnership property The term dual use partnership property means partnership specified tangible property other than sole use partnership property.
(4) Determination of proportionate share of the partnership's adjusted basis in partnership specified tangible property
(i) In general For purposes of of this section, the tested income CFC's proportionate share of the partnership adjusted basis in partnership specified tangible property for a partnership taxable year is the partnership adjusted basis in the property multiplied by the tested income CFC's proportionate share ratio with respect to the property for the partnership taxable year. Solely for purposes of determining the proportionate share ratio under of this section, the partnership's calculation of, and a partner's distributive share of, any income, loss, depreciation, or cost recovery allowance is determined under section .
(ii) Proportionate share ratio The term proportionate share ratio means, with respect to a partnership, a partnership taxable year, and a tested income CFC, the ratio (expressed as a percentage) calculated as—
(A) The sum of—
(1) The tested income CFC's distributive share of the partnership's depreciation deduction or cost recovery allowance with respect to the property for the partnership taxable year, and
(2) The amount of the partnership's depreciation or cost recovery allowance with respect to the property that is capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining the tested income CFC's distributive share of the partnership's income or loss for the partnership taxable year, divided by
(B) The sum of—
(1) The total amount of the partnership's depreciation deduction or cost recovery allowance with respect to the property for the partnership taxable year, and
(2) The total amount of the partnership's depreciation or cost recovery allowance with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining the partnership's income or loss for the partnership taxable year.
(5) Definition of partnership specified tangible property The term partnership specified tangible property means, with respect to a tested income CFC, tangible property (as defined in of this section) of a partnership that is—
(i) Used in the trade or business of the partnership,
(ii) Of a type with respect to which a deduction is allowable under section , and
(iii) Used in the production of gross income included in the tested income CFC's gross tested income.
(6) Determination of partnership adjusted basis For purposes of this , the term partnership adjusted basis means, with respect to a partnership, partnership specified tangible property, and a partnership taxable year, the amount equal to the average of the partnership's adjusted basis in the partnership specified tangible property as of the close of each quarter in the partnership taxable year determined without regard to any adjustments under section except for adjustments under section or section that are attributable to distributions of tangible property (as defined in of this section) and for adjustments under section or . The principles of and of this section apply for purposes of determining a partnership's adjusted basis in partnership specified tangible property and the proportionate share of the partnership's adjusted basis in partnership specified tangible property.
(7) Determination of partner-specific QBAI basis For purposes of this , the term partner-specific QBAI basis means, with respect to a tested income CFC, a partnership, and partnership specified tangible property, the amount that is equal to the average of the basis adjustment under section that is allocated to the partnership specified tangible property of the partnership with respect to the tested income CFC as of the close of each quarter in the partnership taxable year. For this purpose, a negative basis adjustment under section is expressed as a negative number. The principles of and of this section apply for purposes of determining the partner-specific QBAI basis with respect to partnership specified tangible property.
(8) Examples The following examples illustrate the rules of this .
(i) Facts Except as otherwise stated, the following facts are assumed for purposes of the examples:
(A) FC, FC1, FC2, and FC3 are tested income CFCs.
(B) PRS is a partnership and its allocations satisfy the requirements of section .
(C) All properties are partnership specified tangible property.
(D) All persons use the calendar year as their taxable year.
(E) There is neither disqualified basis nor partner-specific QBAI basis with respect to any property.
(ii) Example 1: Sole use partnership property
(A) Facts FC is a partner in PRS. PRS owns two properties, Asset A and Asset B. The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset A is $100x and in Asset B is $500x. In Year 1, PRS's section depreciation deduction is $10x with respect to Asset A and $5x with respect to Asset B, and FC's section distributive share of the depreciation deduction is $8x with respect to Asset A and $1x with respect to Asset B. None of the depreciation with respect to Asset A or Asset B is capitalized to inventory or other property held for sale. FC's entire distributive share of the depreciation deduction with respect to Asset A and Asset B is allocated and apportioned to FC's gross tested income for Year 1 under .
(B) Analysis
(1) Sole use partnership property Because all of FC's distributive share of the depreciation deduction with respect to Asset A and B is allocated and apportioned to gross tested income for Year 1, Asset A and Asset B are sole use partnership property within the meaning of of this section. Therefore, under of this section, FC's partner adjusted basis in Asset A and Asset B is equal to the sum of FC's proportionate share of PRS's partnership adjusted basis in Asset A and Asset B for Year 1 and FC's partner-specific QBAI basis in Asset A and Asset B for Year 1, respectively.
(2) Proportionate share Under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset A and Asset B is PRS's partnership adjusted basis in Asset A and Asset B for Year 1, multiplied by FC's proportionate share ratio with respect to Asset A and Asset B for Year 1, respectively. Because none of the depreciation with respect to Asset A or Asset B is capitalized to inventory or other property held for sale, FC's proportionate share ratio with respect to Asset A and Asset B is determined entirely by reference to the depreciation deduction with respect to Asset A and Asset B. Therefore, FC's proportionate share ratio with respect to Asset A for Year 1 is 80%, which is the ratio of FC's section distributive share of PRS's section depreciation deduction with respect to Asset A for Year 1 ($8x), divided by the total amount of PRS's section depreciation deduction with respect to Asset A for Year 1 ($10x). FC's proportionate share ratio with respect to Asset B for Year 1 is 20%, which is the ratio of FC's section distributive share of PRS's section depreciation deduction with respect to Asset B for Year 1 ($1x), divided by the total amount of PRS's section depreciation deduction with respect to Asset B for Year 1 ($5x). Accordingly, under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset A is $80x ($100x × 0.8), and FC's proportionate share of PRS's partnership adjusted basis in Asset B is $100x ($500x × 0.2).
(3) Partner adjusted basis Because FC has no partner-specific QBAI basis with respect to Asset A and Asset B, FC's partner adjusted basis in Asset A and Asset B is determined entirely by reference to its proportionate share of PRS's partnership adjusted basis in Asset A and Asset B. Therefore, under of this section, FC's partner adjusted basis in Asset A is $80x, FC's proportionate share of PRS's partnership adjusted basis in Asset A, and FC's partner adjusted basis in Asset B is $100x, FC's proportionate share of PRS's partnership adjusted basis in Asset A.
(4) Partnership QBAI Under of this section, FC's partnership QBAI with respect to PRS is $180x, the sum of FC's partner adjusted basis in Asset A ($80x) and FC's partner adjusted basis in Asset B ($100x). Accordingly, under of this section, FC increases its qualified business asset investment for Year 1 by $180x.
(iii) Example 2: Dual use partnership property
(A) Facts FC owns a 50% interest in PRS. All section and tax items are identical and are allocated equally between FC and its other partner. PRS owns three properties, Asset C, Asset D, and Asset E. PRS sells two products, Product A and Product B. All of FC's distributive share of the gross income or loss from the sale of Product A is taken into account in determining FC's tested income, and none of FC's distributive share of the gross income or loss from the sale of Product B is taken into account in determining FC's tested income.
(1) Asset C The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset C is $100x. In Year 1, PRS's depreciation is $10x with respect to Asset C, none of which is capitalized to inventory or other property held for sale. FC's distributive share of the depreciation deduction with respect to Asset C is $5x ($10x × 0.5), $3x of which is allocated and apportioned to FC's gross tested income under .
(2) Asset D The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset D is $500x. In Year 1, PRS's depreciation is $50x with respect to Asset D, $10x of which is capitalized to inventory of Product A and $40x is capitalized to inventory of Product B. None of the $10x depreciation with respect to Asset D capitalized to inventory of Product A is capitalized to ending inventory. However, of the $40x capitalized to inventory of Product B, $10x is capitalized to ending inventory. Therefore, the amount of depreciation with respect to Asset D capitalized to inventory of Product A that is taken into account in determining FC's distributive share of the income or loss of PRS for Year 1 is $5x ($10x × 0.5), and the amount of depreciation with respect to Asset D capitalized to inventory of Product B that is taken into account in determining FC's distributive share of the income or loss of PRS for Year 1 is $15x ($30x × 0.5).
(3) Asset E The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset E is $600x. In Year 1, PRS's depreciation is $60x with respect to Asset E. Of the $60x depreciation with respect to Asset E, $20x is allowed as a deduction, $24x is capitalized to inventory of Product A, and $16x is capitalized to inventory of Product B. FC's distributive share of the depreciation deduction with respect to Asset E is $10x ($20x × 0.5), $8x of which is allocated and apportioned to FC's gross tested income under . None of the $24x depreciation with respect to Asset E capitalized to inventory of Product A is capitalized to ending inventory. However, of the $16x depreciation with respect to Asset E capitalized to inventory of Product B, $10x is capitalized to ending inventory. Therefore, the amount of depreciation with respect to Asset E capitalized to inventory of Product A that is taken into account in determining FC's distributive share of the income or loss of PRS for Year 1 is $12x ($24x × 0.5), and the amount of depreciation with respect to Asset E capitalized to inventory of Product B that is taken into account in determining FC's distributive share of the income or loss of PRS for Year 1 is $3x ($6x × 0.5).
(B) Analysis Because Asset C, Asset D, and Asset E are not used in the production of only gross tested income in Year 1 within the meaning of of this section, Asset C, Asset D, and Asset E are partnership dual use property within the meaning of of this section. Therefore, under of this section, FC's partner adjusted basis in Asset C, Asset D, and Asset E is the sum of FC's proportionate share of PRS's partnership adjusted basis in Asset C, Asset D, and Asset E, respectively, for Year 1, and FC's partner-specific QBAI basis in Asset C, Asset D, and Asset E, respectively, for Year 1, multiplied by FC's dual use ratio with respect to Asset C, Asset D, and Asset E, respectively, for Year 1, determined under the principles of of this section, except that the ratio described in of this section is determined by reference to FC's distributive share of the amounts described in of this section.
(1) Asset C
(i) Proportionate share Under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset C is PRS's partnership adjusted basis in Asset C for Year 1, multiplied by FC's proportionate share ratio with respect to Asset C for Year 1. Because none of the depreciation with respect to Asset C is capitalized to inventory or other property held for sale, FC's proportionate share ratio with respect to Asset C is determined entirely by reference to the depreciation deduction with respect to Asset C. Therefore, FC's proportionate share ratio with respect to Asset C is 50%, which is the ratio calculated as the amount of FC's section distributive share of PRS's section depreciation deduction with respect to Asset C for Year 1 ($5x), divided by the total amount of PRS's section depreciation deduction with respect to Asset C for Year 1 ($10x). Accordingly, under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset C is $50x ($100x × 0.5).
(ii) Dual use ratio Because none of the depreciation with respect to Asset C is capitalized to inventory or other property held for sale, FC's dual use ratio with respect to Asset C is determined entirely by reference to the depreciation deduction with respect to Asset C. Therefore, FC's dual use ratio with respect to Asset C is 60%, which is the ratio calculated as the amount of FC's distributive share of PRS's depreciation deduction with respect to Asset C that is allocated and apportioned to FC's gross tested income under for Year 1 ($3x), divided by the total amount of FC's distributive share of PRS's depreciation deduction with respect to Asset C for Year 1 ($5x).
(iii) Partner adjusted basis Because FC has no partner-specific QBAI basis with respect to Asset C, FC's partner adjusted basis in Asset C is determined entirely by reference to FC's proportionate share of PRS's partnership adjusted basis in Asset C, multiplied by FC's dual use ratio with respect to Asset C. Under of this section, FC's partner adjusted basis in Asset C is $30x, FC's proportionate share of PRS's partnership adjusted basis in Asset C for Year 1 ($50x), multiplied by FC's dual use ratio with respect to Asset C for Year 1 (60%).
(3) Asset D
(i) Proportionate share Under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset D is PRS's partnership adjusted basis in Asset D for Year 1, multiplied by FC's proportionate share ratio with respect to Asset D for Year 1. Because all of the depreciation with respect to Asset D is capitalized to inventory, FC's proportionate share ratio with respect to Asset D is determined entirely by reference to the depreciation with respect to Asset D that is capitalized to inventory and included in cost of goods sold. Therefore, FC's proportionate share ratio with respect to Asset D is 50%, which is the ratio calculated as the amount of PRS's section depreciation with respect to Asset D capitalized to Product A and Product B that is taken into account in determining FC's section distributive share of PRS's income or loss for Year 1 ($20x), divided by the total amount of PRS's section depreciation with respect to Asset D capitalized to Product A and Product B that is taken into account in determining PRS's section income or loss for Year 1 ($40x). Accordingly, under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset D is $250x ($500x × 0.5).
(ii) Dual use ratio Because all of the depreciation with respect to Asset D is capitalized to inventory, FC's dual use ratio with respect to Asset D is determined entirely by reference to the depreciation with respect to Asset D that is capitalized to inventory and included in cost of goods sold. Therefore, FC's dual use ratio with respect to Asset D is 25%, which is the ratio calculated as the amount of depreciation with respect to Asset D capitalized to inventory of Product A and Product B that is taken into account in determining FC's tested income for Year 1 ($5x), divided by the total amount of depreciation with respect to Asset D capitalized to inventory of Product A and Product B that is taken into account in determining FC's income or loss for Year 1 ($20x).
(iii) Partner adjusted basis Because FC has no partner-specific QBAI basis with respect to Asset D, FC's partner adjusted basis in Asset D is determined entirely by reference to FC's proportionate share of PRS's partnership adjusted basis in Asset D, multiplied by FC's dual use ratio with respect to Asset D. Under of this section, FC's partner adjusted basis in Asset D is $62.50x, FC's proportionate share of PRS's partnership adjusted basis in Asset D for Year 1 ($250x), multiplied by FC's dual use ratio with respect to Asset D for Year 1 (25%).
(4) Asset E
(i) Proportionate share Under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset E is PRS's partnership adjusted basis in Asset E for Year 1, multiplied by FC's proportionate share ratio with respect to Asset E for Year 1. Because the depreciation with respect to Asset E is partly deducted and partly capitalized to inventory, FC's proportionate share ratio with respect to Asset E is determined by reference to both the depreciation that is deducted and the depreciation that is capitalized to inventory and included in cost of goods sold. Therefore, FC's proportionate share ratio with respect to Asset E is 50%, which is the ratio calculated as the sum ($25x) of the amount of FC's section distributive share of PRS's section depreciation deduction with respect to Asset E for Year 1 ($10x) and the amount of PRS's section depreciation with respect to Asset E capitalized to inventory of Product A and Product B that is taken into account in determining FC's section distributive share of PRS's income or loss for Year 1 ($15x), divided by the sum ($50x) of the total amount of PRS's section depreciation deduction with respect to Asset E for Year 1 ($20x) and the total amount of PRS's section depreciation with respect to Asset E capitalized to inventory of Product A and Product B that is taken into account in determining PRS's section income or loss for Year 1 ($30x). Accordingly, under of this section, FC's proportionate share of PRS's partnership adjusted basis in Asset E is $300x ($600x × 0.5).
(ii) Dual use ratio Because the depreciation with respect to Asset E is partly deducted and partly capitalized to inventory, FC's dual use ratio with respect to Asset E is determined by reference to the depreciation that is deducted and the depreciation that is capitalized to inventory and included in cost of goods sold. Therefore, FC's dual use ratio with respect to Asset E is 80%, which is the ratio calculated as the sum ($20x) of the amount of FC's distributive share of PRS's depreciation deduction with respect to Asset E that is allocated and apportioned to FC's gross tested income under for Year 1 ($8x) and the amount of depreciation with respect to Asset E capitalized to inventory of Product A and Product B that is taken into account in determining FC's tested income for Year 1 ($12x), divided by the sum ($25x) of the total amount of FC's distributive share of PRS's depreciation deduction with respect to Asset E for Year 1 ($10x) and the total amount of depreciation with respect to Asset E capitalized to inventory of Product A and Product B that is taken into account in determining FC's income or loss for Year 1 ($15x).
(iii) Partner adjusted basis Because FC has no partner-specific QBAI basis with respect to Asset E, FC's partner adjusted basis in Asset E is determined entirely by reference to FC's proportionate share of PRS's partnership adjusted basis in Asset E, multiplied by FC's dual use ratio with respect to Asset E. Under of this section, FC's partner adjusted basis in Asset E is $240x, FC's proportionate share of PRS's partnership adjusted basis in Asset E for Year 1 ($300x), multiplied by FC's dual use ratio with respect to Asset E for Year 1 (80%).
(5) Partnership QBAI Under of this section, FC's partnership QBAI with respect to PRS is $332.50x, the sum of FC's partner adjusted basis in Asset C ($30x), FC's partner adjusted basis in Asset D ($62.50x), and FC's partner adjusted basis in Asset E ($240x). Accordingly, under of this section, FC increases its qualified business asset investment for Year 1 by $332.50x.
(iv) Example 3: Sole use partnership specified tangible property; section 743(b) adjustments
(A) Facts The facts are the same as in of this section (the facts in Example 1), except that there is an average of $40x positive adjustment to the adjusted basis in Asset A as of the close of each quarter of PRS's taxable year with respect to FC under section and an average of $20x negative adjustment to the adjusted basis in Asset B as of the close of each quarter of PRS's taxable year with respect to FC under section .
(B) Analysis Under of this section, FC's partner adjusted basis in Asset A is $120x, which is the sum of $80x (FC's proportionate share of PRS's partnership adjusted basis in Asset A as illustrated in of this section (paragraph (B)(2) of the analysis in Example 1)) and $40x (FC's partner-specific QBAI basis in Asset A). Under of this section, FC's partner adjusted basis in Asset B is $80x, the sum of $100x (FC's proportionate share of the partnership adjusted basis in the property as illustrated in of this section (paragraph (B)(2) of the analysis in Example 1)) and (−$20x) (FC's partner-specific QBAI basis in Asset B). Therefore, under of this section, FC's partnership QBAI with respect to PRS is $200x ($120x + $80x). Accordingly, under of this section, FC increases its qualified business asset investment for Year 1 by $200x.
(v) Example 4: Tested income CFC with distributive share of loss from a partnership
(A) Facts FC owns a 50% interest in PRS. All section and tax items are identical and are allocated equally between FC and its other partner. PRS owns Asset F. None of the depreciation with respect to Asset F is capitalized to inventory or other property held for sale. The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset F is $220x. PRS has $20x of gross income, a $22x depreciation deduction with respect to Asset F, and no other income or expense in Year 1. FC's distributive share of the gross income is $10x, all of which is includible in FC's gross tested income in Year 1, and FC's distributive share of PRS's depreciation deduction with respect to Asset F is $11x in Year 1, all of which is allocated and apportioned to FC's gross tested income under . FC's distributive share of loss from PRS is $1x. FC also has $8x of gross tested income from other sources in Year 1 and no other deductions. Therefore, FC has tested income of $7x for Year 1.
(B) Analysis FC's partner adjusted basis in Asset F is $110x, which is the sum of FC's proportionate share of the partnership adjusted basis in the property ($220x × 0.5) and FC's partnership-specific QBAI basis in Asset F ($0). Therefore, FC's partnership QBAI with respect to PRS is $110x. Accordingly, under of this section, FC increases its qualified business asset investment by $110x, notwithstanding that FC would not be a tested income CFC but for its $8x of gross tested income from other sources.
(vi) Example 5: Tested income CFC sale of partnership interest before CFC inclusion date
(A) Facts FC1 owns a 50% interest in PRS on January 1 of Year 1. On July 1 of Year 1, FC1 sells its entire interest in PRS to FC2. PRS owns Asset G. The average of PRS's adjusted basis as of the close of each quarter of PRS's taxable year in Asset G is $100x. FC1's section distributive share of the depreciation deduction with respect to Asset G is 25% with respect to PRS's entire year. FC2's section distributive share of the depreciation deduction with respect to Asset G is also 25% with respect to PRS's entire year. Both FC1's and FC2's entire distributive shares of the depreciation deduction with respect to Asset G are allocated and apportioned under to FC1's and FC2's gross tested income, respectively, for Year 1. PRS's allocations satisfy section .
(B) Analysis
(1) FC1 Because FC1 owns an interest in PRS during FC1's CFC inclusion year and receives a distributive share of partnership items of the partnership under section , FC1 has partnership QBAI with respect to PRS in the amount determined under of this section. Under of this section, FC1's partner adjusted basis in Asset G is $25x, the product of $100x (the partnership's adjusted basis in the property) and 25% (FC1's section distributive share of depreciation deduction with respect to Asset G). Therefore, FC1's partnership QBAI with respect to PRS is $25x. Accordingly, under of this section, FC1 increases its qualified business asset investment by $25x for Year 1.
(2) FC2 FC2's partner adjusted basis in Asset G is also $25x, the product of $100x (the partnership's adjusted basis in the property) and 25% (FC2's section distributive share of depreciation deduction with respect to Asset G). Therefore, FC2's partnership QBAI with respect to PRS is $25x. Accordingly, under of this section, FC2 increases its qualified business asset investment by $25x for Year 1.
(vii) Example 6: Partnership adjusted basis; distribution of property in liquidation of partnership interest
(A) Facts FC1, FC2, and FC3 are equal partners in PRS, a partnership. FC1 and FC2 each has an adjusted basis of $100x in its partnership interest. FC3 has an adjusted basis of $50x in its partnership interest. PRS has a section election in effect. PRS owns Asset H with a fair market value of $50x and an adjusted basis of $0, Asset I with a fair market value of $100x and an adjusted basis of $100x, and Asset J with a fair market value of $150x and an adjusted basis of $150x. Asset H and Asset J are tangible property, but Asset I is not tangible property. PRS distributes Asset I to FC3 in liquidation of FC3's interest in PRS. None of FC1, FC2, FC3, or PRS recognizes gain on the distribution. Under section , FC3's adjusted basis in Asset I is $50x. PRS's adjusted basis in Asset H is increased by $50x to $50x under section , which is the amount by which PRS's adjusted basis in Asset I immediately before the distribution exceeds FC3's adjusted basis in Asset I.
(B) Analysis Under of this section, PRS's adjusted basis in Asset H is determined without regard to any adjustments under section except for adjustments under section or section that are attributable to distributions of tangible property and for adjustments under section or . The adjustment to the adjusted basis in Asset H is under section and is attributable to the distribution of Asset I, which is not tangible property. Accordingly, for purposes of applying of this section, PRS's adjusted basis in Asset H is $0.
(h) Anti-avoidance rules related to certain transfers of property
(1) Disregard of adjusted basis in specified tangible property held temporarily
(i) In general For purposes of determining a controlled foreign corporation's aggregate adjusted bases in specified tangible property as of the close of a quarter (tested quarter close), the adjusted basis in specified tangible property is disregarded as of the tested quarter close if the controlled foreign corporation (acquiring CFC) acquires the property temporarily before the tested quarter close with a principal purpose of increasing the deemed tangible income return of a U.S. shareholder (applicable U.S. shareholder) for a U.S. shareholder year, and the holding of the property by the acquiring CFC as of the tested quarter close would, without regard to this , increase the deemed tangible income return of the applicable U.S. shareholder for the U.S. shareholder inclusion year.
(ii) Disregard of first quarter close The adjusted basis in specified tangible property may be disregarded under of this section for purposes of multiple tested quarter closes that follow an acquisition and on which the acquiring CFC holds the property. However, if the holding of specified tangible property would, without regard to of this section, increase the deemed tangible income return of an applicable U.S. shareholder because the adjusted basis in such property is taken into account for only one additional quarter close of a tested income CFC of the applicable U.S. shareholder in determining the deemed tangible income return of the applicable U.S. shareholder of the U.S. shareholder inclusion year, the adjusted basis in the property is disregarded for purposes of determining the acquiring CFC's aggregate adjusted bases in specified tangible property only as of the first tested quarter close that follows the acquisition.
(iii) Safe harbor for certain transfers involving CFCs The holding of specified tangible property as of a tested quarter close does not increase the deemed tangible income return of an applicable U.S. shareholder within the meaning of of this section if each of the following conditions is satisfied with respect to the acquisition and subsequent transfer of property by the acquiring CFC—
(A) A controlled foreign corporation (predecessor CFC) holds the property on a quarter close of the predecessor CFC (preceding quarter close) that occurs on the same date as the last quarter close of the acquiring CFC preceding the acquisition.
(B) A controlled foreign corporation (successor CFC) holds the property on a quarter close of the successor CFC (succeeding quarter close) that occurs on the same date as the first quarter close of the acquiring CFC following the subsequent transfer.
(C) The proportion of the stock that the applicable U.S. shareholder owns (within the meaning of section ) of the acquiring CFC on the tested quarter close does not exceed the proportion of the stock that the applicable U.S. shareholder owns of either the predecessor CFC on the preceding quarter close or the successor CFC on the succeeding quarter close; and
(D) Each of the predecessor CFC and the successor CFC is a tested income CFC for its CFC inclusion year that includes the date of the tested quarter close.
(iv) Determination of principal purpose and transitory holding
(A) Presumption for ownership less than 12 months For purposes of of this section, specified tangible property is presumed to be acquired temporarily with a principal purpose of increasing the deemed tangible income return of an applicable U.S. shareholder for a U.S. shareholder inclusion year if the property is held by the acquiring CFC for less than 12 months and the holding of the property by the acquiring CFC as of the tested quarter close would have the effect of increasing the deemed tangible income return of the applicable U.S. shareholder for a U.S. shareholder inclusion year. The presumption described in the preceding sentence may be rebutted only if the facts and circumstances clearly establish that the subsequent transfer of the property by the acquiring CFC was not contemplated when the property was acquired by the acquiring CFC and that a principal purpose of the acquisition of the property was not to increase the deemed tangible income return of the applicable U.S. shareholder for a U.S. shareholder inclusion year. In order to rebut the presumption, a statement must be attached to the Form 5471 filed by the taxpayer for the taxable year of the CFC in which the subsequent transfer occurs and include any information required by applicable administrative announcements, forms or instructions. The statement must explain the facts and circumstances supporting the rebuttal and be in accordance with any rules provided in forms and instructions.
(B) Presumption for ownership greater than 36 months For purposes of of this section, specified tangible property is presumed not to be acquired temporarily with a principal purpose of increasing the deemed tangible income return of an applicable U.S. shareholder for a U.S. shareholder inclusion year if the property is held by the acquiring CFC for more than 36 months. The presumption described in the preceding sentence may be rebutted only if the facts and circumstances clearly establish that the subsequent transfer of the property by the acquiring CFC was contemplated when the property was acquired by the acquiring CFC and that a principal purpose of the acquisition of the property was to increase the deemed tangible income return of the applicable U.S. shareholder for a U.S. shareholder inclusion year.
(v) Determination of holding period For purposes of this , the period during which an acquiring CFC holds specified tangible property is determined without regard to section .
(vi) Treatment as single applicable U.S. shareholder For purposes of this , all U.S. persons that are related persons are treated as a single applicable U.S. shareholder. For purposes of the preceding sentence, U.S. persons are related if they bear a relationship described in section or immediately before or immediately after a transaction.
(vii) Examples The following examples illustrate the application of this .
(A) Facts Except as otherwise stated, the following facts are assumed for purposes of the examples:
(1) USP is a domestic corporation.
(2) CFC1, CFC2 and CFC3 are tested income CFCs.
(3) R is unrelated to USP.
(4) All persons use the calendar year as their taxable year.
(5) Asset A is specified tangible property.
(6) Both Year 1 and Year 2 begin on or after January 1, 2018, and have 365 days.
(7) USP has no specified interest expense (as defined in ).
(B) Example 1: Qualification for safe harbor
(1) Facts USP owns all of the stock of CFC1, which owns all of the stock of CFC2, which owns all the stock of CFC3. As of January 1, Year 1, CFC1 owns Asset A, which is specified tangible property. On December 30, Year 1, CFC1 transfers Asset A to CFC2. On April 10, Year 2, CFC2 transfers Asset A to CFC3. CFC3 holds Asset A for the rest of Year 2.
(2) Analysis Under the safe harbor of of this section, CFC2's holding of Asset A as of each of the December 31, Year 1 tested quarter close and the March 31, Year 2 tested quarter close does not increase the deemed tangible income return of USP, the applicable United States shareholder, for Year 1 or Year 2 because each of the requirements in through of this section is satisfied. The requirement in of this section is satisfied because CFC1, a predecessor CFC, held Asset A on September 30, Year 1, a quarter close of CFC1 that occurs on the same date as the last quarter close of CFC2, the acquiring CFC, preceding the December 30, Year 1 acquisition of Asset A. The requirement in of this section is satisfied because CFC3, a successor CFC, holds Asset A on June 30, Year 2, a quarter close of CFC3 that occurs on the same date as the first quarter close of CFC2 following April 10, Year 2, the date of the subsequent transfer of Asset A. The requirement in of this section is satisfied because the proportion of stock that USP, the applicable U.S. shareholder, owns (within the meaning of section ) of CFC2, the acquiring CFC, on each of the December 31, Year 1 tested quarter close and the March 31, Year 2 tested quarter close (100%), does not exceed the proportion of the stock that USP owns of either CFC1 (100%) on the preceding quarter close (September 30, Year 1) or of CFC3 (100%) on the succeeding quarter close (June 30, Year 2). Finally, the requirement in of this section is satisfied because each of CFC1 and CFC3 is a tested income CFC for Year 1 and Year 2, the CFC inclusion years that include the December 31, Year 1 tested quarter close and the March 31, Year 2 tested quarter close. Accordingly, of this section does not apply to disregard the adjusted basis in Asset A in determining CFC2's aggregate adjusted basis in specified tangible property as of December 31, Year 1, or March 30, Year 2.
(C) Example 2: Transfers between CFCs with different taxable year ends
(1) Facts The facts are the same as in of this section (the facts in Example 1), except that CFC1 has a taxable year ending November 30, and the facts and circumstances do not clearly establish that the April 10, Year 2 transfer of Asset A by CFC2 was not contemplated when Asset A was acquired by CFC2 and that a principal purpose of the acquisition of the property was not to increase the deemed tangible income return of USP, the applicable U.S. shareholder.
(2) Analysis CFC2's holding of Asset A as of each of the December 31, Year 1 tested quarter close and the March 31, Year 2 tested quarter close does not satisfy the safe harbor under of this section because CFC1, the predecessor CFC, does not hold Asset A on a quarter close of CFC1 that occurs on the same date as the September 30, Year 1, quarter close of CFC2, the acquiring CFC, which is the last quarter close of CFC2 preceding the December 30, Year 1 acquisition of Asset A. In addition, because CFC2 held Asset A for less than 12 months (from December 31, Year 1, until April 10, Year 2), the presumption in of this section applies such that CFC2 is presumed to have acquired Asset A temporarily with a principal purpose of increasing the deemed tangible income return of USP for the shareholder inclusion year, and the facts and circumstances do not clearly establish that CFC2 did not acquire Asset A with such a principal purpose. Because CFC2 holds Asset A as of December 31, Year 1, the tested quarter close, the adjusted basis in Asset A would be, without regard to of this section, taken into account for purposes of determining USP's deemed tangible income return for its Year 1 taxable year as of five quarter closes (CFC1's quarter closes on February 28, May 31, August 31, and November 30, and CFC2's quarter close on December 31). If instead CFC1 had retained Asset A during the period CFC2 temporarily held the asset and had transferred Asset A directly to CFC3 on January 10, Year 2, the adjusted basis in Asset A would have been taken into account for purposes of determining USP's deemed tangible income return for its Year 1 taxable year as of only four quarter closes (CFC1's quarter closes on February 28, May 30, August 30, and November 30). Under of this section, because the adjusted basis in Asset A would (without regard to of this section) be taken into account for only one additional quarter close of a tested income CFC of USP in determining USP's deemed tangible income return for Year 1 and Year 2, the adjusted basis in Asset A is disregarded for purposes of determining CFC's aggregate adjusted bases in specified tangible property only as of December 31, Year 1, the first tested quarter close that follows the acquisition. Accordingly, under of this section, the adjusted basis in Asset A is disregarded in determining CFC2's aggregate adjusted basis in specified tangible property as of December 31, Year 1.
(D) Example 3: Acquisition from unrelated person
(1) Facts USP owns all of the stock of CFC1 and CFC2. CFC1 has a taxable year ending November 30. On October 30, Year 1, CFC1 acquires Asset B from R. On December 30, Year 1, CFC1 transfers Asset B to CFC2. The facts and circumstances do not clearly establish that the December 31, Year 1, transfer of Asset B by CFC1 was not contemplated when Asset B was acquired by CFC1 and that a principal purpose of the acquisition of the property was not to increase the deemed tangible income return of USP, the applicable U.S. shareholder.
(2) Analysis CFC1's holding of Asset B as of the November 30, Year 1 tested quarter close does not satisfy the safe harbor under of this section because the requirements in through of this section are not satisfied. Because CFC1 held Asset B for less than 12 months (from October 30, Year 1, until December 30, Year 1), the presumption in of this section applies such that CFC1 is presumed to have held Asset B temporarily with a principal purpose of increasing the deemed tangible income return of USP for the taxable year, and the facts and circumstances do not clearly establish that CFC1 did not acquire Asset B with a principal purpose of increasing the deemed tangible income return of USP. Because CFC1 holds Asset B as of November 30, Year 1, the adjusted basis in Asset B would be, without regard to of this section, taken into account for purposes of determining USP's deemed tangible income return for its Year 1 taxable year as of two quarter closes (CFC1's quarter close on November 30, Year 1, and CFC2's quarter close on December 31, Year 1). If instead CFC2 had acquired Asset B directly from R, the adjusted basis in Asset B would have been taken into account for purposes of determining USP's deemed tangible income return for its Year 1 taxable year as of only one quarter close (CFC2's quarter close on December 31, Year 1). Accordingly, under of this section, the adjusted basis in Asset B is disregarded in determining CFC1's aggregate adjusted basis in specified tangible property as of November 30, Year 1.
(E) Example 4: Acquisitions from tested loss CFCs
(1) Facts USP owns all of the stock of CFC1 and CFC2. As of January 1, Year 1, CFC1 owns Asset C. On March 30, Year 1, CFC1 transfers Asset C to CFC2. For Year 1, CFC1 is a tested loss CFC and CFC2 is a tested income CFC. On March 30, Year 2, CFC2 transfers Asset C back to CFC1. For Year 2, both CFC1 and CFC2 are tested income CFCs. A principal purpose of CFC2 holding Asset C as of March 31, Year 1, June 30, Year 1, September 30, Year 1, and December 31, Year 1, was to increase USP's deemed tangible income return.
(2) Analysis CFC2's holding of Asset C as of March 31, Year 1, June 30, Year 1, September 30, Year 1, and December 31, Year 1 does not satisfy the safe harbor under of this section because CFC1 is not a tested income CFC for Year 1 and thus the requirement in of this section is not satisfied. Because CFC2 acquired Asset C before, and temporarily held as of, March 31, Year 1, June 30, Year 1, September 30, Year 1, December 31, Year 1 and the holding of the property by CFC2 as of each such tested quarter close would increase the deemed tangible income return of USP, under of this section, the adjusted basis in Asset C is disregarded in determining CFC2's aggregate adjusted basis in specified tangible property as of each of March 31, Year 1, June 30, Year 1, September 30, Year 1, and December 31, Year 1.
(2) Disregard of adjusted basis in property transferred during the disqualified period
(i) Operative rules
(A) In general For purposes of determining the qualified business asset investment of a tested income CFC for any CFC inclusion year, disqualified basis in property is disregarded.
(B) Application to dual use property In the case of dual use property (as defined in of this section), of this section applies by reducing the amount of the adjusted basis in the property treated as adjusted basis in specified tangible property for the CFC inclusion year under of this section by the amount of the disqualified basis in the property. For purposes of determining the amount described in of this section, including for purposes of determining whether tangible property is dual use property within the meaning of of this section and for purposes of determining the dual use ratio with respect to dual use property under of this section, the rules of are not taken into account.
(C) Application to partnership specified tangible property In the case of partnership specified tangible property (as defined in of this section), of this section applies by reducing a tested income CFC's partner adjusted basis with respect to partnership specified tangible property under of this section by the tested income CFC's share of the disqualified basis in the partnership specified tangible property. A tested income CFC's share of disqualified basis in partnership specified tangible property is the sum of the tested income CFC's proportionate share of the disqualified basis in the partnership specified tangible property determined under the principles of of this section and the tested income CFC's partner-specific QBAI basis in the property determined under the principles of of this section that is disqualified basis. For purposes of determining the amount described in of this section, including for purposes of determining whether partnership specified tangible property is sole use partnership property within the meaning of of this section or dual use partnership property within the meaning of of this section and for purposes of determining the dual use ratio with respect to dual use partnership property under the principles of of this section, the rules of are not taken into account.
(ii) Determination of disqualified basis
(A) In general Subject to the adjustments described in of this section, the term disqualified basis means, with respect to property (other than property described in section ), the excess (if any) of the property's adjusted basis immediately after a disqualified transfer, over the sum of the property's adjusted basis immediately before the disqualified transfer and the qualified gain amount with respect to the disqualified transfer. For this purpose, the adjusted basis in property immediately after a disqualified transfer includes a positive adjustment to the adjusted basis in partnership property with respect to a partner under section or .
(B) Adjustments to disqualified basis
(1) Reduction or elimination of disqualified basis
(i) In general Except to the extent provided in this , disqualified basis in property is reduced or eliminated to the extent that such basis reduces taxable income through, for example, depreciation, amortization, and taxable sales or exchanges, or is otherwise reduced or eliminated, for example, through the application of section or or (b). In such circumstances, in the case of property with disqualified basis and adjusted basis other than disqualified basis, disqualified basis in the property is reduced or eliminated in the same proportion that the disqualified basis bears to the total adjusted basis in the property. However, in the case of a loss from a taxable sale or exchange, disqualified basis in the property is reduced or eliminated to the extent the loss is treated as attributable to disqualified basis under .
(ii) Exception for related party transfers Disqualified basis in property is not reduced or eliminated by reason of any transfer of the property to a related person, except to the extent any loss recognized on the transfer of such property is treated as attributable to the disqualified basis under , or the basis is reduced or eliminated in a nonrecognition transaction within the meaning of section , for example, through the application of section or or (b).
(2) Increase to disqualified basis for nonrecognition transactions
(i) Increase corresponding to adjustments in other property If the adjusted basis in property is increased by reason of a nonrecognition transaction (as defined in section ), for example, through the application of section or section , the disqualified basis in the property is increased by a proportionate share of the aggregate reduction to the disqualified basis (if any) in one or more other properties by reason of such nonrecognition transaction under of this section.
(ii) Exchanged basis property Disqualified basis in exchanged basis property (as defined in section ) includes the amount of the disqualified basis in any property by reference to which the adjusted basis in the exchanged basis property was determined, in whole or in part, provided that the nonrecognition transaction giving rise to such exchanged basis did not also increase the disqualified basis in the exchanged basis property under of this section.
(iii) Increase by reason of section 732(d) Disqualified basis in property is increased by the amount of a positive adjustment to the adjusted basis in property under section to the extent that, if an election provided in section were in effect at the time of the acquisition described in section , the adjusted basis in the property immediately after the acquisition would have been disqualified basis under of this section.
(3) Election to eliminate disqualified basis
(i) In general If an election made under this with respect to a controlled foreign corporation or a partnership is effective, the adjusted basis in each property with disqualified basis held by the controlled foreign corporation or the partnership is reduced by the amount of the disqualified basis and the disqualified basis in each property is eliminated. The reduction of the adjusted basis and the elimination of the disqualified basis described in the preceding sentence is treated as occurring immediately after the disqualified transfer of each property.
(ii) Manner of making the election with respect to a controlled foreign corporation The election described in this with respect to a controlled foreign corporation is made by each controlling domestic shareholder (as defined in ) of the controlled foreign corporation by filing a statement as described in with its income tax return for its taxable year that includes the last day of the taxable year of the controlled foreign corporation that includes the disqualified transfer and follow the notice requirements of . If the return for the taxable year has been filed before July 22, 2019, the statement must be included with an amended return filed within 180 days June 21, 2019. The election statement must be filed in accordance with the rules provided in forms or instructions.
(iii) Manner of making the election with respect to a partnership The election described in this with respect to a partnership is made by the partnership by filing a statement as described in for the taxable year that includes the date of the disqualified transfer. If a return for the taxable year has been filed before July 22, 2019, the statement must be included with an amended return filed within 180 days of June 21, 2019. The election statement must be filed in accordance with the rules provided in forms or instructions.
(iv) Conditions of making an election An election under this with respect to a controlled foreign corporation or a partnership is not effective unless the election is made with respect to each controlled foreign corporation or partnership that holds property with disqualified basis and that is related (within the meaning of section and ) to the controlled foreign corporation or partnership and unless any return that has been filed that is inconsistent with the elimination of the adjusted basis and disqualified basis immediately after the disqualified transfer by reason of this is amended to take into account the elimination of the adjusted basis and disqualified basis immediately after the disqualified transfer by reason of this .
(C) Definitions related to disqualified basis The following definitions apply for purposes of this .
(1) Disqualified period The term disqualified period means, with respect to a transferor CFC, the period beginning on January 1, 2018, and ending as of the close of the transferor CFC's last taxable year that is not a CFC inclusion year. A transferor CFC that has a CFC inclusion year beginning January 1, 2018, has no disqualified period.
(2) Disqualified transfer The term disqualified transfer means a transfer of property during a transferor CFC's disqualified period by the transferor CFC to a related person in which gain was recognized, in whole or in part, by the transferor CFC.
(3) Qualified gain amount The term qualified gain amount means, with respect to a disqualified transfer by a transferor CFC, the sum of the following amounts:
(i) The amount of gain recognized by the transferor CFC on the disqualified transfer of property that is subject to Federal income tax under section (except to the extent the gain is exempt from tax pursuant to an applicable treaty obligation of the United States); and
(ii) Any United States shareholder's pro rata share of the gain recognized by the transferor CFC on the disqualified transfer of property (determined without regard to properly allocable deductions) taken into account in determining the United States shareholder's inclusion under section , excluding any amount that is described in of this section.
(4) Related person The term related person means, with respect to a person that transfers property, any person that bears a relationship to such person described in section or immediately before or immediately after the transfer.
(5) Transfer The term transfer includes any disposition of property, including any sale, exchange, contribution, or distribution of property, and includes an indirect transfer. For example, a transfer of an interest in a partnership is treated as an indirect transfer of the property of the partnership and a transfer by or to a partnership is treated as an indirect transfer by or to its partners. In addition, a distribution of property to a partner with respect to which gain is recognized to the distributee partner under section is treated as an indirect transfer of the property of the partnership.
(6) Transferor CFC The term transferor CFC means any controlled foreign corporation that transfers property during the disqualified period of the controlled foreign corporation.
(iii) Examples The following examples illustrate the application of this .
(A) Example 1: Sale of asset; disqualified period
(1) Facts USP, a domestic corporation, owns all of the stock of CFC1 and CFC2, each a controlled foreign corporation. Both USP and CFC2 use the calendar year as their taxable year. CFC1 uses a taxable year ending November 30. On November 1, 2018, before the start of its first CFC inclusion year, CFC1 sells Asset A, which has an adjusted basis of $10x in the hands of CFC1, to CFC2 in exchange for $100x of cash. CFC1 recognizes $90x of gain as a result of the sale ($100x − $10x), $30x of which is foreign base company income. USP includes in gross income under section its pro rata share of the subpart F income of $30x. CFC1's gain is not otherwise subject to U.S. tax or taken into account in determining USP's inclusion under section .
(2) Analysis The transfer of Asset A is a disqualified transfer of Asset A because it is a transfer of property (other than property described in section ) by CFC1; CFC1 and CFC2 are related persons; and the transfer occurs during the disqualified period, the period that begins on January 1, 2018, and ends the last day before the first CFC inclusion year of CFC1 (November 30, 2018). Accordingly, under of this section, the disqualified basis in Asset A immediately after the disqualified transfer is $60x, the excess of CFC2's adjusted basis in Asset A immediately after the disqualified transfer ($100x), over the sum of CFC1's adjusted basis in Asset A immediately before the transfer ($10x) and USP's pro rata share of the gain recognized by CFC1 on the transfer of the property taken into account by USP under section ($30x).
(B) Example 2: Sale of asset; no disqualified period
(1) Facts The facts are the same as in of this section (the facts in Example 1), except that CFC1 uses the calendar year as its taxable year.
(2) Analysis Because CFC1 has a taxable year beginning January 1, 2018, CFC1 has no disqualified period. Accordingly, the property was not transferred during a disqualified period of CFC1, and there is no disqualified basis with respect to the property.
(C) Example 3: Sale of partnership interest
(1) Facts USP, a domestic corporation, owns all of the stock of CFC1, CFC2, and CFC3, each a controlled foreign corporation. CFC1 and CFC2 are equal partners in PRS, a partnership. PRS owns Asset B with an adjusted basis of $20x and a fair market value of $100x. PRS has a section election in effect. USP, CFC2, and CFC3 all use the calendar year as their taxable year. CFC1 uses a taxable year ending November 30. On November 1, 2018, before the start of its first CFC inclusion year, CFC1 sells its interest in the partnership to CFC3 for $50x of cash. CFC1 has an adjusted basis of $10x in its partnership interest, and thus CFC1 recognizes $40x of gain as a result of the sale ($50x − $10x), none of which is foreign base company income or otherwise subject to U.S. tax. As a result of the sale, there is a $40x adjustment to the adjusted basis in Asset B with respect to CFC3 under section .
(2) Analysis The transfer of the PRS partnership interest is a disqualified transfer of Asset B because it is an indirect transfer of property (other than property described in section ) by CFC1; CFC1 and CFC3 are related persons; and the transfer occurs during the disqualified period, the period that begins on January 1, 2018, and ends the last day before the first CFC inclusion year of CFC1 (November 30, 2018). Accordingly, under of this section, the disqualified basis in Asset B immediately after the disqualified transfer is $40x, the excess of CFC3's share of adjusted basis in Asset B immediately after the disqualified transfer ($50x), taking into account the basis adjustment with respect to CFC3 under section , over CFC1's share of adjusted basis in the property immediately before the transfer ($10x).
(D) Example 4: Distribution of property in liquidation of partnership interest
(1) Facts FC1, FC2, and FC3 are controlled foreign corporations that are equal partners in PRS, a partnership. FC1's adjusted basis in its partnership interest in PRS is $0, FC2's basis is $50x, and FC3's basis is $50x. PRS has a section election in effect. PRS owns Asset C with a fair market value of $50x and an adjusted basis of $0, Asset D with a fair market value of $50x and an adjusted basis of $50x, and Asset E with a fair market value of $50x and an adjusted basis of $50x, and all the adjusted basis in Asset D and Asset E is disqualified basis. PRS distributes Asset C to FC3 in liquidation of FC3's interest in PRS. None of FC1, FC2, FC3, or PRS recognizes gain on the distribution. Under section , FC3's adjusted basis in Asset C is $50x. PRS's adjusted bases in Asset D and Asset E are decreased, in the aggregate, by $50x under section , which is the amount by which FC3's adjusted basis in Asset C exceeds PRS's adjusted basis in Asset C immediately before the distribution.
(2) Analysis The distribution of Asset C is a nonrecognition transaction under section . Under of this section, the disqualified bases in Asset D and Asset E are reduced, in the aggregate, by $50x. Further, under of this section, the disqualified basis in Asset C is increased by $50x, the aggregate reduction to the disqualified basis in Asset D and Asset E.
(E) Example 5: Distribution of property to a partner in basis reduction transaction
(1) Facts The facts are the same as in of this section (the facts in Example 4), except PRS distributes Asset D to FC1. Under section , FC1's adjusted basis in Asset D is $0. PRS's adjusted basis in Asset C is increased by $50x under section , which is the amount by which PRS's adjusted basis in Asset D immediately before the distribution exceeds FC1's adjusted basis in Asset D under section .
(2) Analysis The distribution of Asset D is a nonrecognition transaction under section . Under of this section, the disqualified basis in Asset D is reduced by $50x. Further, under of this section, the disqualified basis in Asset C is increased by $50x, the reduction to the disqualified basis in Asset D.
(F) Example 6: Dual use property with disqualified basis
(1) Facts FS is a tested income CFC and a wholesale distributor of Product A. FS owns trucks that deliver Product A. The trucks are specified tangible property. In Year 1, FS earns $250x in total gross income from inventory sales of Product A, $200x of which is included in gross tested income. The trucks have an average adjusted basis for Year 1 of $4,000x, of which $2,500x is disqualified basis. FS does not capitalize depreciation with respect to the trucks to inventory or other property held for sale. The depreciation deduction with respect to the trucks is $20x, $15x of which would be allocated and apportioned to gross tested income under without regard to .
(2) Analysis Because the trucks are used in both the production of gross tested income and the production of gross income that is not gross tested income in Year 1, the trucks are dual use property within the meaning of of this section. Under of this section, the disqualified basis in the trucks is disregarded for purposes of determining FS's qualified business asset investment for Year 1. Under of this section, of this section applies by reducing the amount of FS's adjusted basis in the trucks treated as adjusted basis in specified tangible property for Year 1 under of this section (determined without regard to ) by the amount of the disqualified basis in the trucks. Without regard to , FS's adjusted basis in the trucks treated as adjusted basis in specified tangible property for Year 1 under of this section is FS's adjusted basis in the trucks multiplied by FS's dual use ratio with respect to the trucks for Year 1. Because none of the depreciation with respect to the trucks is capitalized into inventory or other property held for sale, FS's dual use ratio with respect to the trucks is determined entirely by reference to the depreciation deduction with respect to the trucks. Therefore, under of this section, without regard to , FS's dual use ratio with respect to the trucks for Year 1 is 75%, which is FS's depreciation deduction with respect to the trucks that is allocated and apportioned to gross tested income under for Year 1 ($15x), divided by FS's depreciation deduction with respect to the trucks for Year 1 ($20x). Accordingly, of this section, without regard to of this section, FS's adjusted basis in the trucks treated as adjusted basis in specified tangible property is $3,000x ($4,000x × 0.75). Under and of this section, the amount of the adjusted basis in the trucks treated as adjusted basis in specified tangible property is reduced by the $2,500x of disqualified basis in the trucks. Accordingly, $500x ($3,000x − $2,500x) of FS's average adjusted basis in the trucks is taken into account under of this section in determining FS's qualified business asset investment for Year 1.
[T.D. 9866, 84 FR 29341, June 21, 2019, as amended by T.D. 9956, 86 FR 52973, Sept. 24, 2021]