Bulletin No. 2004-28July 12, 2004

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

T.D. 9132, page 16.Final regulations under section 168 of the Code provide guid-ance on how to depreciate property for which the use changesin the hands of the same taxpayer. These regulations explainwhen a change in use occurs and how a taxpayer should de-termine depreciation in the year of the change in use, and insubsequent years.

T.D. 9133, page 25.Final and temporary regulations under section 280F of theCode exclude vans and trucks that are qualified nonpersonaluse vehicles (as defined in section 1.274–5T(k)) from thedefinition of “passenger automobile” for purposes of section280F(a), including transition rules for property placed inservice prior to July 7, 2003.

REG–131486–03, page 36.Proposed regulations under section 1374 of the Code providefor an adjustment to the amount that may be subject to tax incertain cases in which an S corporation acquires assets froma C corporation in an acquisition to which section 1374(d)(8)applies. These regulations provide guidance to certain S corpo-rations that acquire assets from a C corporation in a carryoverbasis transaction.

REG–117307–04, page 39.Proposed regulations under section 864 of the Code relate tothe application of the asset-use test to stock held by foreigninsurance companies. The regulations provide that the excep-tion to the asset-use test for stock does not apply in determin-ing whether the income, gain, or loss from portfolio stock heldby foreign insurance companies constitutes income effectivelyconnected with the conduct of a trade or business within theUnited States.

Notice 2004–41, page 31.Charitable contributions and conservation easements.This notice informs taxpayers that the Service will, in appropri-ate cases, reduce or disallow deductions claimed by taxpayersunder section 170 of the Code for transfers in connection withconservation easements. This notice also informs participantsin these transactions that they may be subject to other adversetax consequences, including penalties, excise taxes, and lossof tax-exempt status, as appropriate.

Notice 2004–44, page 32.Section 368(a)(1)(B). The Service is requesting public com-ments regarding Rev. Proc. 81–70, 1981–2 C.B. 729, whichcontains the guidelines for estimating the basis of stock ac-quired in a B reorganization.

Notice 2004–45, page 33.This notice advises taxpayers that the Service will challengethe meritless filing position of certain U.S. citizens who claimto be residents of the U.S. Virgin Islands and to have incomefrom sources in the U.S. Virgin Islands or income effectivelyconnected to the conduct of a trade or business in the U.S.Virgin Islands.

(Continued on the next page)

Finding Lists begin on page ii.

EMPLOYEE PLANS

Rev. Rul. 2004–67, page 28.Group or pooled trusts; participation; tax-exempt status,model language. This ruling provides that a governmentalsection 457(b) plan may invest in a second tier group or pooledtrust as long as the criteria enumerated in the ruling are met.In addition, the ruling sets forth model language that may beadopted by existing group or pooled trusts so that they neednot request determination letters merely to add a provisionpermitting participation by a governmental section 457(b) plan.Rev. Rul. 81–100 clarified and modified.

EXEMPT ORGANIZATIONS

Announcement 2004–56, page 41.This announcement is a public notice of the suspension of thefederal tax exemption under section 501(p) of the Code of acertain organization that has been designated as supportingor engaging in terrorist activity or supporting terrorism. Contri-butions made to this organization during the period that the or-ganization’s tax-exempt status is suspended are not deductiblefor federal tax purposes.

July 12, 2004 2004–28 I.R.B.

The IRS MissionProvide America’s taxpayers top quality service by helpingthem understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions and Other Related Items, and Subpart B, Leg-islation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasury’s Office of the Assistant Sec-retary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2004–28 I.R.B. July 12, 2004

Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 168.—AcceleratedCost Recovery System26 CFR 1.168(i)–1: General asset accounts.

T.D. 9132

DEPARTMENT OFTHE TREASURYInternal Revenue Service26 CFR Part 1

Changes in Use Under Section168(i)(5)

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final and temporary regula-tions.

SUMMARY: This document contains fi-nal and temporary regulations relating tothe depreciation of property subject to sec-tion 168 of the Internal Revenue Code(MACRS property). Specifically, theseregulations provide guidance on how todepreciate MACRS property for which theuse changes in the hands of the same tax-payer. The regulations reflect changes tothe law made by the Tax Reform Act of1986.

DATES: Effective Date: These regulationsare effective June 17, 2004.

Applicability Date: For dates of ap-plicability, see §§1.168(i)–1(l)(2) and1.168(i)–4(g).

FOR FURTHER INFORMATIONCONTACT: Sara Logan or Kathleen Reed,(202) 622–3110 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendmentsto 26 CFR part 1. On July 21, 2003, theIRS and Treasury Department published anotice of proposed rulemaking in the Fed-eral Register (REG–138499–02, 2003–37I.R.B. 541 [68 FR 43047]), relating to achange in the use of MACRS property in

the hands of the same taxpayer (change inthe use) under section 168(i)(5) of the In-ternal Revenue Code (Code) and relatingto a change in the use of assets in a gen-eral asset account under section 168(i)(4).On March 1, 2004, §§1.168(a)–1 and1.168(b)–1 that were contained in thisnotice of proposed rulemaking were with-drawn (REG–138499–02, 2004–14 I.R.B.704 [69 FR 9560]). No public hearingwas requested or held. Written or elec-tronic comments responding to the noticeof proposed rulemaking were received.After consideration of all the comments,the proposed regulations are adopted asamended by this Treasury decision. Therevisions are discussed below.

Explanation of Provisions

Scope

The final regulations provide the rulesfor determining the annual depreciation al-lowance under section 168 for MACRSproperty as a result of a change in the use ofsuch property. Changes in the use includea conversion of personal use property to abusiness or income-producing use, a con-version of MACRS property to personaluse, or a change in the use of MACRSproperty that results in a different recoveryperiod, depreciation method, or both.

I. Conversion to Business Use

The final regulations retain the rulescontained in the proposed regulations,providing that personal use property con-verted to business or income-producinguse is treated as being placed in service bythe taxpayer on the date of the conversion.Thus, the property is depreciated by usingthe applicable depreciation method, re-covery period, and convention prescribedunder section 168 for the property begin-ning in the taxable year the change in theuse occurs (year of change). No commentswere received suggesting changes to theserules. The final regulations, however,clarify that these rules do not apply whenanother section of the Code (or regulationsunder that section) prescribes the deprecia-tion treatment for a change to business use.For example, if listed property (as defined

in section 280F(d)(4)) is predominantlyused by a taxpayer in a qualified businessuse in a taxable year, then in a subsequenttaxable year is exclusively used by thetaxpayer for personal purposes, and thenin a later taxable year is predominantlyused by the taxpayer in a qualified busi-ness use, section 280F(b)(2)(A) requiresthat the property be depreciated under thealternative depreciation system of section168(g) in the later taxable year and subse-quent taxable years.

II. Conversion to Personal Use

The final regulations retain the rule con-tained in the proposed regulations provid-ing that a conversion of MACRS prop-erty from business or income-producinguse to personal use is treated as a dispo-sition of the property. Depreciation forthe year of change is computed by tak-ing into account the applicable conven-tion. No gain, loss, or depreciation re-capture is recognized upon the conversion.A commentator questioned whether recap-ture of excess depreciation under section280F(b)(2) occurs upon a conversion oflisted property from business use to onlypersonal use. Upon this conversion, thelisted property is not predominantly usedin a qualified business use for that tax-able year for purposes of section 280F(b)and, consequently, section 280F(b)(2) re-quires any excess depreciation (as definedin section 280F(b)(2)(B)) to be included ingross income for the taxable year in whichthe listed property is converted to personaluse. Accordingly, the IRS and TreasuryDepartment have included a cross-refer-ence to section 280F(b)(2) in the final reg-ulations.

III. MACRS Property—Use Changes AfterPlaced-In-Service Year

The final regulations provide rules forMACRS property if a change in the useof the property occurs after the property’splaced-in-service year but the propertycontinues to be MACRS property in thehands of the taxpayer.

2004–28 I.R.B. 16 July 12, 2004

A. Determination of a change in the use

The final regulations remain unchangedfrom the proposed regulations. Conse-quently, a change in the use of MACRSproperty generally occurs when the pri-mary use of the MACRS property in thetaxable year is different from its primaryuse in the immediately preceding taxableyear. However, in determining whether ataxpayer begins or ceases to use MACRSproperty predominantly outside the UnitedStates, the predominant use, instead of theprimary use, of the MACRS property gov-erns. A commentator questioned how thispredominant use test is applied to rollingstock (for example, locomotives, freightand passenger train cars) that is not de-scribed under section 168(g)(4)(B) andthat is used within and without the UnitedStates. This question concerns how totrace the movement of this rolling stock todetermine its physical location, which theIRS and Treasury Department believe isbeyond the scope of these regulations.

B. Change in the use of MACRS propertyresulting in a different recovery periodand/or depreciation method

The final regulations retain the rulescontained in the proposed regulations fordetermining the applicable depreciationmethod, recovery period, and conven-tion used to determine the depreciationallowances for the MACRS property forthe year of change and subsequent taxableyears. Consequently, if a change in the useof MACRS property results in a shorterrecovery period and/or a more acceler-ated depreciation method (for example,MACRS property ceases to be used pre-dominantly outside the United States), theadjusted depreciable basis of the MACRSproperty as of the beginning of the yearof change is depreciated over the shorterrecovery period and/or by the more accel-erated depreciation method beginning withthe year of change as though the MACRSproperty is placed in service by the tax-payer in the year of change. If a changein the use of MACRS property results in alonger recovery period and/or a slower de-preciation method (for example, MACRSproperty begins to be used predominantlyoutside the United States), the adjusteddepreciable basis of the MACRS propertyas of the beginning of the year of change

is depreciated over the longer recoveryperiod and/or by the slower depreciationmethod beginning with the year of changeas though the taxpayer originally placedthe MACRS property in service with thelonger recovery period and/or slower de-preciation method.

A commentator suggested that the de-preciation allowances for all changes inthe use of MACRS property resulting in adifferent recovery period and/or deprecia-tion method be determined beginning withthe year of change by treating the new de-preciation method and/or recovery periodas though they applied from the date theMACRS property was originally placedin service by the taxpayer. The commen-tator, in effect, is requesting that the rulecontained in the proposed regulations fora change in the use of MACRS propertythat results in a longer recovery periodand/or slower depreciation method alsoapply to a change in the use of MACRSproperty that results in a shorter recoveryperiod and/or a more accelerated depre-ciation method. The IRS and TreasuryDepartment continue to believe that therules contained in the proposed regula-tions are reasonable because the rulesdetermine the depreciation allowance forany taxable year based on the primary useof the MACRS property by the taxpayerduring that year. Further, for a changein the use of MACRS property that re-sults in a shorter recovery period and/or amore accelerated depreciation method, thetaxpayer either may determine the depre-ciation allowances as though the MACRSproperty is placed-in-service by the tax-payer in the year of change or may electto disregard the change in the use anddetermine the depreciation allowances asthough the change in the use had not oc-curred. As a result, the final regulationsdo not require a recovery period that islonger than the recovery period applicablefor the MACRS property in the taxableyear immediately preceding the year ofchange. Accordingly, the commentator’ssuggestion was not accepted.

Another commentator requested thatExample 4 in §1.168(i)–5(d)(6) be clari-fied by stating which optional depreciationtables the transaction coefficient factorsare drawn from. The IRS and TreasuryDepartment have adopted this suggestion.

IV. Change in the Use During thePlaced-in-Service Year

The final regulations retain the rulescontained in the proposed regulations ifa change in the use of MACRS propertyoccurs during the taxable year the prop-erty is placed in service and the propertycontinues to be MACRS property in thehands of the taxpayer. Accordingly, ifthe use of MACRS property changes dur-ing its placed-in-service year, the depre-ciation allowance generally is determinedby the primary use of the property dur-ing that taxable year. However, in deter-mining whether MACRS property is usedwithin or outside the United States dur-ing the placed-in-service year, the predom-inant use, instead of the primary use, ofthe MACRS property governs. Further, indetermining whether MACRS property istax-exempt use property or imported prop-erty covered by an Executive order duringthe placed-in-service year, the use of theproperty at the end of the placed-in-serviceyear governs. Moreover, MACRS prop-erty is tax-exempt bond financed prop-erty during the placed-in-service year if atax-exempt bond for the MACRS propertyis issued during the placed-in-service year.

V. General Asset Accounts

Finally, the regulations amend the finalregulations under section 168(i)(4) (T.D.8566, 1994–2 C.B. 20 [59 FR 51369](1994)) and the temporary regulations un-der section 168(i)(4) (T.D. 9115, 2004–14I.R.B. 680 [69 FR 9529] (2004)) forproperty accounted for in a general assetaccount for which the use of the propertychanges, resulting in a different recoveryperiod and/or depreciation method. Theseamendments are the same rules containedin the proposed regulations.

Effective Dates

These regulations are applicable forany change in the use of MACRS prop-erty in a taxable year ending on or afterJune 17, 2004. For any change in the useof MACRS property after December 31,1986, in a taxable year ending before June17, 2004, the IRS will allow any reason-able method of depreciating the propertyunder section 168 in the year of change andthe subsequent taxable years that is con-sistently applied to the MACRS property

July 12, 2004 17 2004–28 I.R.B.

for which the use changes in the hands ofthe same taxpayer. However, a taxpayermay choose, on a property-by-propertybasis, to apply the final regulations to achange in the use of MACRS propertyafter December 31, 1986, in a taxableyear ending before June 17, 2004. In thiscase and consistent with Chief CounselNotice 2004–007, Change in LitigatingPosition—Application of Section 446(e)to Changes in Computing Depreciation(CC–2004–007, January 28, 2004, at theIRS Internet site at www.irs.gov/foia), achange to the method of accounting for de-preciation provided in the final regulationsdue to a change in the use of MACRSproperty in a taxable year ending on orafter December 30, 2003, is a change inmethod of accounting and a change tothe method of accounting for depreciationprovided in the final regulations due toa change in the use of MACRS propertyafter December 31, 1986, in a taxable yearending before December 30, 2003, maybe treated by the taxpayer as a change inmethod of accounting.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It also has been determinedthat section 553(b) of the AdministrativeProcedure Act (5 U.S.C. chapter 5) doesnot apply to these regulations and, becausethese regulations do not impose on smallentities a collection of information require-ment, the Regulatory Flexibility Act (5U.S.C. chapter 6) does not apply to theseregulations. Therefore, a Regulatory Flex-ibility Analysis is not required. Pursuant tosection 7805(f) of the Code, the notice ofproposed rulemaking was submitted to theChief Counsel for Advocacy of the SmallBusiness Administration for comment onits impact on small business.

Drafting Information

The principal author of these regula-tions is Sara Logan, Office of AssociateChief Counsel (Passthroughs and SpecialIndustries). However, other personnelfrom the IRS and Treasury Departmentparticipated in their development.

* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by adding an entry innumerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.168(i)–4 also issued under 26

U.S.C. 168(i)(5). * * *Par. 2. Section 1.168(i)–0 is amended

by revising the entry for §1.168(i)–1(h)(2)and adding entries for §1.168(i)–1(h)(2)(i)through (h)(2)(iii) to read as follows:

§1.168(i)–0 Table of contents for thegeneral asset account rules.

* * * * *

§1.168(i)–1 General asset accounts.

* * * * *(h) * * *(2) Change in use results in a differ-

ent recovery period and/or depreciationmethod.

(i) No effect on general asset accountelection.

(ii) Asset is removed from the generalasset account.

(iii) New general asset account is estab-lished.

* * * * *Par. 3. Section 1.168(i)–1 is amended

by:1. Revising paragraph (b)(1).2. Amending paragraph (c)(2)(ii) by:a. Removing the language “and” from

the end of paragraph (c)(2)(ii)(C).b. Removing the period “.” from the

end of paragraph (c)(2)(ii)(D) and adding“; and” in its place.

c. Revising paragraph (c)(2)(ii)(E).3. Removing the language “the change

in use occurs and” from the last sentence ofparagraph (h)(1) and adding “the change inuse occurs (the year of change) and” in itsplace.

4. Revising paragraph (h)(2).5. Removing the language “(h)(1)”

from paragraph (k)(1) and adding “(h)” inits place.

6. Revising paragraph (l).The revisions read as follows:

§1.168(i)–1 General asset accounts.

* * * * *(b) * * *(1) Unadjusted depreciable basis is the

basis of an asset for purposes of section1011 without regard to any adjustments de-scribed in section 1016(a)(2) and (3). Thisbasis reflects the reduction in basis for thepercentage of the taxpayer’s use of prop-erty for the taxable year other than in thetaxpayer’s trade or business (or for the pro-duction of income), for any portion of thebasis the taxpayer properly elects to treatas an expense under section 179, and forany adjustments to basis provided by otherprovisions of the Internal Revenue Codeand the regulations under the Internal Rev-enue Code (other than section 1016(a)(2)and (3)) (for example, a reduction in basisby the amount of the disabled access creditpursuant to section 44(d)(7)). For propertysubject to a lease, see section 167(c)(2).

* * * * *(c) * * *(2) * * *(ii) * * *(E) Assets subject to paragraph

(h)(2)(iii)(A) of this section (change inuse results in a shorter recovery periodand/or a more accelerated depreciationmethod) for which the depreciation al-lowance for the year of change (as definedin §1.168(i)–4(a)) is not determined byusing an optional depreciation table mustbe grouped into a separate general assetaccount.

* * * * *(h) * * *(2) Change in use results in a differ-

ent recovery period and/or depreciationmethod—(i) No effect on general asset ac-count election. A change in the use de-scribed in §1.168(i)–4(d) (change in useresults in a different recovery period and/ordepreciation method) of an asset in a gen-eral asset account shall not cause or permitthe revocation of the election made underthis section.

(ii) Asset is removed from the generalasset account. Upon a change in the usedescribed in §1.168(i)–4(d), the taxpayermust remove the asset from the generalasset account as of the first day of theyear of change and must make the ad-justments to the general asset accountdescribed in paragraphs (e)(3)(iii)(C)(2)

2004–28 I.R.B. 18 July 12, 2004

through (4) of this section. If, however,the result of the change in use is describedin §1.168(i)–4(d)(3) (change in use re-sults in a shorter recovery period and/ora more accelerated depreciation method)and the taxpayer elects to treat the assetas though the change in use had not oc-curred pursuant to §1.168(i)–4(d)(3)(ii),no adjustment is made to the general assetaccount upon the change in use.

(iii) New general asset account is es-tablished—(A) Change in use results in ashorter recovery period and/or a more ac-celerated depreciation method. If the re-sult of the change in use is described in§1.168(i)–4(d)(3) (change in use results ina shorter recovery period and/or a moreaccelerated depreciation method) and ad-justments to the general asset account aremade pursuant to paragraph (h)(2)(ii) ofthis section, the taxpayer must establish anew general asset account for the asset inthe year of change in accordance with therules in paragraph (c) of this section, ex-cept that the adjusted depreciable basis ofthe asset as of the first day of the year ofchange is included in the general asset ac-count. For purposes of paragraph (c)(2)of this section, the applicable depreciationmethod, recovery period, and conventionare determined under §1.168(i)–4(d)(3)(i).

(B) Change in use results in a longerrecovery period and/or a slower depreci-ation method. If the result of the changein use is described in §1.168(i)–4(d)(4)(change in use results in a longer recov-ery period and/or a slower depreciationmethod), the taxpayer must establish a sep-arate general asset account for the asset inthe year of change in accordance with therules in paragraph (c) of this section, ex-cept that the unadjusted depreciable basisof the asset, and the greater of the depre-ciation of the asset allowed or allowablein accordance with section 1016(a)(2), asof the first day of the year of change areincluded in the newly established generalasset account. Consequently, this generalasset account as of the first day of theyear of change will have a beginning bal-ance for both the unadjusted depreciablebasis and the depreciation reserve of thegeneral asset account. For purposes ofparagraph (c)(2) of this section, the appli-cable depreciation method, recovery pe-riod, and convention are determined under§1.168(i)–4(d)(4)(ii).

* * * * *(l) Effective dates—(1) [Reserved]. For

further guidance, see §1.168(i)–1T(l)(1).(2) Exceptions—(i) In general—(A)

Paragraph (b)(1) of this section applies onor after June 17, 2004. For the applica-bility of §1.168(i)–1(b)(1) before June 17,2004, see §1.168(i)–1(b)(1) in effect priorto June 17, 2004 (§1.168(i)–1(b)(1) ascontained in 26 CFR part 1 edition revisedas of April 1, 2004).

(B) Paragraphs (c)(2)(ii)(E) and (h)(2)of this section apply to any change inthe use of depreciable assets pursuant to§1.168(i)–4(d) in a taxable year ending onor after June 17, 2004. For any changein the use of depreciable assets as de-scribed in §1.168(i)–4(d) after December31, 1986, in a taxable year ending beforeJune 17, 2004, the Internal Revenue Ser-vice will allow any reasonable method thatis consistently applied to the taxpayer’sgeneral asset accounts or the taxpayer maychoose, on an asset-by-asset basis, to ap-ply paragraphs (c)(2)(ii)(E) and (h)(2) ofthis section.

(ii) Change in method of account-ing—(A) In general. If a taxpayer adopteda method of accounting for general as-set account treatment due to a changein the use of depreciable assets pursuantto §1.168(i)–4(d) in a taxable year end-ing on or after December 30, 2003, andthe method adopted is not in accordancewith the method of accounting providedin paragraphs (c)(2)(ii)(E) and (h)(2)of this section, a change to the methodof accounting provided in paragraphs(c)(2)(ii)(E) and (h)(2) of this section is achange in method of accounting to whichthe provisions of section 446(e) and theregulations under section 446(e) apply.However, if a taxpayer adopted a methodof accounting for general asset accounttreatment due to a change in the use of de-preciable assets pursuant to §1.168(i)–4(d)after December 31, 1986, in a taxable yearending before December 30, 2003, andthe method adopted is not in accordancewith the method of accounting provided inparagraphs (c)(2)(ii)(E) and (h)(2) of thissection, the taxpayer may treat the changeto the method of accounting provided inparagraphs (c)(2)(ii)(E) and (h)(2) of thissection as a change in method of account-ing to which the provisions of section446(e) and the regulations under section446(e) apply.

(B) Automatic consent to changemethod of accounting. A taxpayer chang-ing its method of accounting in accordancewith this paragraph (l)(2)(ii) must followthe applicable administrative proceduresissued under §1.446–1(e)(3)(ii) for ob-taining the Commissioner’s automaticconsent to a change in method of account-ing (for further guidance, for example, seeRev. Proc. 2002–9, 2002–1 C.B. 327, asmodified by Rev. Proc. 2004–11, 2004–3I.R.B. 311 (see §601.601(d)(2)(ii)(b) ofthis chapter)). Because this change doesnot change the adjusted depreciable basisof the asset, the method change is madeon a cut-off basis and, therefore, no ad-justment under section 481(a) is requiredor allowed. For purposes of Form 3115,Application for Change in AccountingMethod, the designated number for theautomatic accounting method change au-thorized by this paragraph (l)(2)(ii) is“87.” If Form 3115 is revised or renum-bered, any reference in this section to thatform is treated as a reference to the revisedor renumbered form.

(3) [Reserved]. For further guidance,see §1.168(i)–1T(l)(3).

Par. 4. Section 1.168(i)–1T is amendedby:

1. Revising paragraphs (c)(2)(ii)(E)and (l)(2).

2. Removing the language “(h)(1) (con-version to personal use)” from paragraphs(d)(2) and (i) and adding “(h) (changes inuse)” in its place.

3. Removing the language “(h)(1)”from paragraph (j) and adding “(h)” in itsplace.

The revisions read as follows:

§1.168(i)–1T General asset accounts(temporary).

* * * * *(c) * * *(2) * * *(ii) * * *(E) [Reserved]. For further guidance,

see §1.168(i)–1(c)(2)(ii)(E).

* * * * *(l) * * *(2) [Reserved]. For further guidance,

see §1.168(i)–1(l)(2).

* * * * *Par. 5. Section 1.168(i)–4 is added to

read as follows:

July 12, 2004 19 2004–28 I.R.B.

§1.168(i)–4 Changes in use.

(a) Scope. This section provides therules for determining the depreciation al-lowance for MACRS property (as definedin §1.168(b)–1T(a)(2)) for which the usechanges in the hands of the same taxpayer(change in the use). The allowance fordepreciation under this section constitutesthe amount of depreciation allowable un-der section 167(a) for the year of changeand any subsequent taxable year. For pur-poses of this section, the year of change isthe taxable year in which a change in theuse occurs.

(b) Conversion to business or in-come-producing use—(1) Depreciationdeduction allowable. This paragraph(b) applies to property that is convertedfrom personal use to use in a taxpayer’strade or business, or for the productionof income, during a taxable year. Thisconversion includes property that waspreviously used by the taxpayer for per-sonal purposes, including real property(other than land) that is acquired before1987 and converted from personal use tobusiness or income-producing use after1986, and depreciable property that waspreviously used by a tax-exempt entitybefore the entity changed to a taxableentity. Except as otherwise provided bythe Internal Revenue Code or regulationsunder the Internal Revenue Code, upona conversion to business or income-pro-ducing use, the depreciation allowancefor the year of change and any subse-quent taxable year is determined as thoughthe property is placed in service by thetaxpayer on the date on which the con-version occurs. Thus, except as otherwiseprovided by the Internal Revenue Codeor regulations under the Internal Rev-enue Code, the taxpayer must use anyapplicable depreciation method, recoveryperiod, and convention prescribed undersection 168 for the property in the yearof change, consistent with any electionmade under section 168 by the taxpayerfor that year (see, for example, section168(b)(5)). See §§1.168(k)–1T(f)(6)(iii)and 1.1400L(b)–1T(f)(6) for the additionalfirst year depreciation deduction rules ap-plicable to a conversion to business orincome-producing use. The depreciablebasis of the property for the year of changeis the lesser of its fair market value or itsadjusted depreciable basis (as defined in

§1.168(b)–1T(a)(4)), as applicable, at thetime of the conversion to business or in-come-producing use.

(2) Example. The application of thisparagraph (b) is illustrated by the follow-ing example:

Example. A, a calendar-year taxpayer, purchasesa house in 1985 that she occupies as her principalresidence. In February 2004, A ceases to occupythe house and converts it to residential rental prop-erty. At the time of the conversion to residentialrental property, the house’s fair market value (ex-cluding land) is $130,000 and adjusted depreciablebasis attributable to the house (excluding land) is$150,000. Pursuant to this paragraph (b), A is con-sidered to have placed in service residential rentalproperty in February 2004 with a depreciable basisof $130,000. A depreciates the residential rentalproperty under the general depreciation system byusing the straight-line method, a 27.5-year recoveryperiod, and the mid-month convention. Pursuant to§§1.168(k)–1T(f)(6)(iii)(B) or 1.1400L(b)–1T(f)(6),this property is not eligible for the additional firstyear depreciation deduction provided by section168(k) or section 1400L(b). Thus, the deprecia-tion allowance for the house for 2004 is $4,137,after taking into account the mid-month convention(($130,000 adjusted depreciable basis multiplied bythe applicable depreciation rate of 3.636% (1/27.5))multiplied by the mid-month convention fractionof 10.5/12). The amount of depreciation computedunder section 168, however, may be limited underother provisions of the Internal Revenue Code, suchas, section 280A.

(c) Conversion to personal use. Theconversion of MACRS property frombusiness or income-producing use to per-sonal use during a taxable year is treatedas a disposition of the property in that tax-able year. The depreciation allowance forMACRS property for the year of changein which the property is treated as beingdisposed of is determined by first mul-tiplying the adjusted depreciable basisof the property as of the first day of theyear of change by the applicable depreci-ation rate for that taxable year (for furtherguidance, for example, see section 6 ofRev. Proc. 87–57, 1987–2 C. B. 687, 692(see §601.601(d)(2)(ii)(b) of this chap-ter)). This amount is then multiplied bya fraction, the numerator of which is thenumber of months (including fractionsof months) the property is deemed to beplaced in service during the year of change(taking into account the applicable con-vention) and the denominator of whichis 12. No depreciation deduction is al-lowable for MACRS property placed inservice and disposed of in the same tax-able year. See §§1.168(k)–1T(f)(6)(ii) and1.1400L(b)–1T(f)(6) for the additional

first year depreciation deduction rulesapplicable to property placed in serviceand converted to personal use in the sametaxable year. Upon the conversion to per-sonal use, no gain, loss, or depreciationrecapture under section 1245 or section1250 is recognized. However, the pro-visions of section 1245 or section 1250apply to any disposition of the convertedproperty by the taxpayer at a later date.For listed property (as defined in section280F(d)(4)), see section 280F(b)(2) forthe recapture of excess depreciation uponthe conversion to personal use.

(d) Change in the use results in a differ-ent recovery period and/or depreciationmethod—(1) In general. This paragraph(d) applies to a change in the use ofMACRS property during a taxable yearsubsequent to the placed-in-service year,if the property continues to be MACRSproperty owned by the same taxpayer and,as a result of the change in the use, hasa different recovery period, a differentdepreciation method, or both. For exam-ple, this paragraph (d) applies to MACRSproperty that—

(i) Begins or ceases to be used predom-inantly outside the United States;

(ii) Results in a reclassification of theproperty under section 168(e) due to achange in the use of the property; or

(iii) Begins or ceases to be tax-exemptuse property (as defined in section 168(h)).

(2) Determination of change in theuse—(i) In general. Except as providedin paragraph (d)(2)(ii) of this section, achange in the use of MACRS property oc-curs when the primary use of the MACRSproperty in the taxable year is differentfrom its primary use in the immediatelypreceding taxable year. The primary useof MACRS property may be determinedin any reasonable manner that is consis-tently applied to the taxpayer’s MACRSproperty.

(ii) Alternative depreciation systemproperty—(A) Property used within oroutside the United States. A change in theuse of MACRS property occurs when ataxpayer begins or ceases to use MACRSproperty predominantly outside the UnitedStates during the taxable year. The deter-mination of whether MACRS propertyis used predominantly outside the UnitedStates is made in accordance with the testin §1.48–1(g)(1)(i) for determining pre-dominant use.

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(B) Tax-exempt bond financed property.A change in the use of MACRS propertyoccurs when the property changes totax-exempt bond financed property, as de-scribed in section 168(g)(1)(C) and (g)(5),during the taxable year. For purposesof this paragraph (d), MACRS propertychanges to tax-exempt bond financedproperty when a tax-exempt bond is firstissued after the MACRS property is placedin service. MACRS property continuesto be tax-exempt bond financed propertyin the hands of the taxpayer even if thetax-exempt bond (including any refund-ing issue) is no longer outstanding or isredeemed.

(C) Other mandatory alternative de-preciation system property. A change inthe use of MACRS property occurs whenthe property changes to, or changes from,property described in section 168(g)(1)(B)(tax-exempt use property) or (D) (im-ported property covered by an Executiveorder) during the taxable year.

(iii) Change in the use deemed to oc-cur on first day of the year of change. If achange in the use of MACRS property oc-curs under this paragraph (d)(2), the depre-ciation allowance for that MACRS prop-erty for the year of change is determinedas though the use of the MACRS prop-erty changed on the first day of the yearof change.

(3) Change in the use results in ashorter recovery period and/or a moreaccelerated depreciation method—(i)Treated as placed in service in the year ofchange—(A) In general. If a change in theuse results in the MACRS property chang-ing to a shorter recovery period and/or adepreciation method that is more acceler-ated than the method used for the MACRSproperty before the change in the use, thedepreciation allowances beginning in theyear of change are determined as thoughthe MACRS property is placed in serviceby the taxpayer in the year of change.

(B) Computation of depreciation al-lowance. The depreciation allowances forthe MACRS property for any 12-monthtaxable year beginning with the year ofchange are determined by multiplying theadjusted depreciable basis of the MACRSproperty as of the first day of each taxableyear by the applicable depreciation ratefor each taxable year. In determining theapplicable depreciation rate for the year ofchange and subsequent taxable years, the

taxpayer must use any applicable depre-ciation method and recovery period pre-scribed under section 168 for the MACRSproperty in the year of change, consistentwith any election made under section 168by the taxpayer for that year (see, for ex-ample, section 168(b)(5)). If there is achange in the use of MACRS property, theapplicable convention that applies to theMACRS property is the same as the con-vention that applied before the change inthe use of the MACRS property. However,the depreciation allowance for the year ofchange for the MACRS property is de-termined without applying the applicableconvention, unless the MACRS propertyis disposed of during the year of change.See paragraph (d)(5) of this section forthe rules relating to the computation of thedepreciation allowance under the optionaldepreciation tables. If the year of changeor any subsequent taxable year is less than12 months, the depreciation allowancedetermined under this paragraph (d)(3)(i)must be adjusted for a short taxable year(for further guidance, for example, seeRev. Proc. 89–15, 1989–1 C.B. 816 (see§601.601(d)(2)(ii)(b) of this chapter)).

(C) Special rules. MACRS prop-erty affected by this paragraph (d)(3)(i)is not eligible in the year of changefor the election provided under section168(f)(1), 179, or 1400L(f), or for theadditional first year depreciation de-duction provided in section 168(k) or1400L(b). See §§1.168(k)–1T(f)(6)(iv)and 1.1400L(b)–1T(f)(6) for other addi-tional first year depreciation deductionrules applicable to a change in the useof MACRS property subsequent to itsplaced-in-service year. For purposes ofdetermining whether the mid-quarter con-vention applies to other MACRS propertyplaced in service during the year of change,the unadjusted depreciable basis (as de-fined in §1.168(b)–1T(a)(3)) or the ad-justed depreciable basis of MACRS prop-erty affected by this paragraph (d)(3)(i) isnot taken into account.

(ii) Option to disregard the change inthe use. In lieu of applying paragraph(d)(3)(i) of this section, the taxpayer mayelect to determine the depreciation al-lowance as though the change in the usehad not occurred. The taxpayer electsthis option by claiming on the taxpayer’stimely filed (including extensions) Federalincome tax return for the year of change

the depreciation allowance for the prop-erty as though the change in the use hadnot occurred. See paragraph (g)(2) of thissection for the manner for revoking thiselection.

(4) Change in the use results in a longerrecovery period and/or a slower depre-ciation method—(i) Treated as originallyplaced in service with longer recovery pe-riod and/or slower depreciation method.If a change in the use results in a longerrecovery period and/or a depreciationmethod for the MACRS property that isless accelerated than the method used forthe MACRS property before the changein the use, the depreciation allowancesbeginning with the year of change aredetermined as though the MACRS prop-erty had been originally placed in serviceby the taxpayer with the longer recov-ery period and/or the slower depreciationmethod. MACRS property affected bythis paragraph (d)(4) is not eligible in theyear of change for the election providedunder section 168(f)(1), 179, or 1400L(f),or for the additional first year depreciationdeduction provided in section 168(k) or1400L(b). See §§1.168(k)–1T(f)(6)(iv)and 1.1400L(b)–1T(f)(6) for other addi-tional first year depreciation deductionrules applicable to a change in the useof MACRS property subsequent to itsplaced-in-service year.

(ii) Computation of the depreciation al-lowance. The depreciation allowances forthe MACRS property for any 12-monthtaxable year beginning with the year ofchange are determined by multiplying theadjusted depreciable basis of the MACRSproperty as of the first day of each tax-able year by the applicable depreciationrate for each taxable year. If there is achange in the use of MACRS property, theapplicable convention that applies to theMACRS property is the same as the con-vention that applied before the change inthe use of the MACRS property. If theyear of change or any subsequent taxableyear is less than 12 months, the deprecia-tion allowance determined under this para-graph (d)(4)(ii) must be adjusted for a shorttaxable year (for further guidance, for ex-ample, see Rev. Proc. 89–15, 1989–1C.B. 816 (see §601.601(d)(2)(ii)(b) of thischapter)). See paragraph (d)(5) of this sec-tion for the rules relating to the computa-tion of the depreciation allowance underthe optional depreciation tables. In deter-

July 12, 2004 21 2004–28 I.R.B.

mining the applicable depreciation rate forthe year of change and any subsequent tax-able year—

(A) The applicable depreciation methodis the depreciation method that would ap-ply in the year of change and any subse-quent taxable year for the MACRS prop-erty had the taxpayer used the longer re-covery period and/or the slower deprecia-tion method in the placed-in-service yearof the property. If the 200- or 150-per-cent declining balance method would haveapplied in the placed-in-service year butthe method would have switched to thestraight line method in the year of changeor any prior taxable year, the applicable de-preciation method beginning with the yearof change is the straight line method; and

(B) The applicable recovery period iseither—

(1) The longer recovery period result-ing from the change in the use if the ap-plicable depreciation method is the 200- or150-percent declining balance method (asdetermined under paragraph (d)(4)(ii)(A)of this section) unless the recovery perioddid not change as a result of the change inthe use, in which case the applicable recov-ery period is the same recovery period thatapplied before the change in the use; or

(2) The number of years remaining asof the beginning of each taxable year (tak-ing into account the applicable conven-tion) had the taxpayer used the longer re-covery period in the placed-in-service yearof the property if the applicable deprecia-tion method is the straight line method (asdetermined under paragraph (d)(4)(ii)(A)of this section) unless the recovery perioddid not change as a result of the change inthe use, in which case the applicable re-covery period is the number of years re-maining as of the beginning of each tax-able year (taking into account the applica-ble convention) based on the recovery pe-riod that applied before the change in theuse.

(5) Using optional depreciation ta-bles—(i) Taxpayer not bound by prior useof table. If a taxpayer used an optional de-preciation table for the MACRS propertybefore a change in the use, the taxpayeris not bound to use the appropriate newtable for that MACRS property begin-ning in the year of change (for furtherguidance, for example, see section 8 ofRev. Proc. 87–57, 1987–2 C.B. 687, 693(see §601.601(d)(2)(ii)(b) of this chap-

ter)). If a taxpayer did not use an optionaldepreciation table for MACRS propertybefore a change in the use and the changein the use results in a shorter recoveryperiod and/or a more accelerated depreci-ation method (as described in paragraph(d)(3)(i) of this section), the taxpayer mayuse the appropriate new table for thatMACRS property beginning in the yearof change. If a taxpayer chooses not touse the optional depreciation table, thedepreciation allowances for the MACRSproperty beginning in the year of changeare determined under paragraph (d)(3)(i)or (4) of this section, as applicable.

(ii) Taxpayer chooses to use optionaldepreciation table after a change in theuse. If a taxpayer chooses to use an op-tional depreciation table for the MACRSproperty after a change in the use, thedepreciation allowances for the MACRSproperty for any 12-month taxable year be-ginning with the year of change are deter-mined as follows:

(A) Change in the use results in ashorter recovery period and/or a moreaccelerated depreciation method. If achange in the use results in a shorterrecovery period and/or a more acceler-ated depreciation method (as describedin paragraph (d)(3)(i) of this section), thedepreciation allowances for the MACRSproperty for any 12-month taxable yearbeginning with the year of change aredetermined by multiplying the adjusteddepreciable basis of the MACRS propertyas of the first day of the year of changeby the annual depreciation rate for eachrecovery year (expressed as a decimalequivalent) specified in the appropriateoptional depreciation table. The appro-priate optional depreciation table for theMACRS property is based on the de-preciation system, depreciation method,recovery period, and convention applica-ble to the MACRS property in the yearof change as determined under paragraph(d)(3)(i) of this section. The depreciationallowance for the year of change for theMACRS property is determined by takinginto account the applicable convention(which is already factored into the op-tional depreciation tables). If the year ofchange or any subsequent taxable year isless than 12 months, the depreciation al-lowance determined under this paragraph(d)(5)(ii)(A) must be adjusted for a shorttaxable year (for further guidance, for

example, see Rev. Proc. 89–15, 1989–1C.B. 816 (see §601.601(d)(2)(ii)(b) of thischapter)).

(B) Change in the use results in a longerrecovery period and/or a slower depreci-ation method—(1) Determination of theappropriate optional depreciation table.If a change in the use results in a longerrecovery period and/or a slower depreci-ation method (as described in paragraph(d)(4)(i) of this section), the deprecia-tion allowances for the MACRS propertyfor any 12-month taxable year beginningwith the year of change are determinedby choosing the optional depreciation ta-ble that corresponds to the depreciationsystem, depreciation method, recoveryperiod, and convention that would haveapplied to the MACRS property in theplaced-in-service year had that propertybeen originally placed in service by thetaxpayer with the longer recovery periodand/or the slower depreciation method. Ifthere is a change in the use of MACRSproperty, the applicable convention thatapplies to the MACRS property is thesame as the convention that applied be-fore the change in the use of the MACRSproperty. If the year of change or anysubsequent taxable year is less than 12months, the depreciation allowance deter-mined under this paragraph (d)(5)(ii)(B)must be adjusted for a short taxable year(for further guidance, for example, seeRev. Proc. 89–15, 1989–1 C.B. 816 (see§601.601(d)(2)(ii)(b) of this chapter)).

(2) Computation of the depreciation al-lowance. The depreciation allowances forthe MACRS property for any 12-monthtaxable year beginning with the year ofchange are computed by first determiningthe appropriate recovery year in the tableidentified under paragraph (d)(5)(ii)(B)(1)of this section. The appropriate recoveryyear for the year of change is the year thatcorresponds to the year of change. For ex-ample, if the recovery year for the year ofchange would have been Year 4 in the ta-ble that applied before the change in theuse of the MACRS property, then the re-covery year for the year of change is Year4 in the table identified under paragraph(d)(5)(ii)(B)(1) of this section. Next, theannual depreciation rate (expressed as adecimal equivalent) for each recovery yearis multiplied by a transaction coefficient.The transaction coefficient is the formula(1 / (1 - x)) where x equals the sum of

2004–28 I.R.B. 22 July 12, 2004

the annual depreciation rates from the tableidentified under paragraph (d)(5)(ii)(B)(1)of this section (expressed as a decimalequivalent) for the taxable years begin-ning with the placed-in-service year of theMACRS property through the taxable yearimmediately prior to the year of change.The product of the annual depreciation rateand the transaction coefficient is multi-plied by the adjusted depreciable basis ofthe MACRS property as of the beginningof the year of change.

(6) Examples. The application of thisparagraph (d) is illustrated by the follow-ing examples:

Example 1. Change in the use results in a shorterrecovery period and/or a more accelerated depreci-ation method and optional depreciation table is notused—(i) X, a calendar-year corporation, places inservice in 1999 equipment at a cost of $100,000 anduses this equipment from 1999 through 2003 primar-ily in its A business. X depreciates the equipmentfor 1999 through 2003 under the general deprecia-tion system as 7-year property by using the 200-per-cent declining balance method (which switched to thestraight-line method in 2003), a 7-year recovery pe-riod, and a half-year convention. Beginning in 2004,X primarily uses the equipment in its B business. As aresult, the classification of the equipment under sec-tion 168(e) changes from 7-year property to 5-yearproperty and the recovery period of the equipmentunder the general depreciation system changes from7 years to 5 years. The depreciation method does notchange. On January 1, 2004, the adjusted deprecia-ble basis of the equipment is $22,311. X depreciatesits 5-year recovery property placed in service in 2004under the general depreciation system by using the200-percent declining balance method and a 5-yearrecovery period. X does not use the optional depreci-ation tables.

(ii) Under paragraph (d)(3)(i) of this section, X’sallowable depreciation deduction for the equipmentfor 2004 and subsequent taxable years is determinedas though X placed the equipment in service in 2004for use primarily in its B business. The deprecia-ble basis of the equipment as of January 1, 2004, is$22,311 (the adjusted depreciable basis at January 1,2004). Because X does not use the optional depreci-ation tables, the depreciation allowance for 2004 (thedeemed placed-in-service year) for this equipmentonly is computed without taking into account the half-year convention. Pursuant to paragraph (d)(3)(i)(C)of this section, this equipment is not eligible for theadditional first year depreciation deduction providedby section 168(k) or section 1400L(b). Thus, X’s al-lowable depreciation deduction for the equipment for2004 is $8,924 ($22,311 adjusted depreciable basisat January 1, 2004, multiplied by the applicable de-preciation rate of 40% (200/5)). X’s allowable de-preciation deduction for the equipment for 2005 is$5,355 ($13,387 adjusted depreciable basis at Jan-uary 1, 2005, multiplied by the applicable depreci-ation rate of 40% (200/5)).

(iii) Alternatively, under paragraph (d)(3)(ii) ofthis section, X may elect to disregard the change in theuse and, as a result, may continue to treat the equip-

ment as though it is used primarily in its A business.If the election is made, X’s allowable depreciation de-duction for the equipment for 2004 is $8,924 ($22,311adjusted depreciable basis at January 1, 2004, mul-tiplied by the applicable depreciation rate of 40%(1/2.5 years remaining at January 1, 2004)). X’s al-lowable depreciation deduction for the equipment for2005 is $8,925 ($13,387 adjusted depreciable basisat January 1, 2005, multiplied by the applicable de-preciation rate of 66.67% (1/1.5 years remaining atJanuary 1, 2005)).

Example 2. Change in the use results in a shorterrecovery period and/or a more accelerated depre-ciation method and optional depreciation table isused—(i) Same facts as in Example 1, except that Xused the optional depreciation tables for computingdepreciation for 1999 through 2003. Pursuant toparagraph (d)(5) of this section, X chooses to con-tinue to use the optional depreciation table for theequipment. X does not make the election provided inparagraph (d)(3)(ii) of this section to disregard thechange in use.

(ii) In accordance with paragraph (d)(5)(ii)(A) ofthis section, X must first identify the appropriate op-tional depreciation table for the equipment. This tableis table 1 in Rev. Proc. 87–57 because the equipmentwill be depreciated in the year of change (2004) underthe general depreciation system using the 200-percentdeclining balance method, a 5-year recovery period,and the half-year convention (which is the conventionthat applied to the equipment in 1999). Pursuant toparagraph (d)(3)(i)(C) of this section, this equipmentis not eligible for the additional first year deprecia-tion deduction provided by section 168(k) or section1400L(b). For 2004, X multiplies its adjusted depre-ciable basis in the equipment as of January 1, 2004, of$22,311, by the annual depreciation rate in table 1 forrecovery year 1 for a 5-year recovery period (.20), todetermine the depreciation allowance of $4,462. For2005, X multiplies its adjusted depreciable basis inthe equipment as of January 1, 2004, of $22,311, bythe annual depreciation rate in table 1 for recoveryyear 2 for a 5-year recovery period (.32), to determinethe depreciation allowance of $7,140.

Example 3. Change in the use results in alonger recovery period and/or a slower depreciationmethod—(i) Y, a calendar-year corporation, placesin service in January 2002, equipment at a cost of$100,000 and uses this equipment in 2002 and 2003only within the United States. Y elects not to deductthe additional first year depreciation under section168(k). Y depreciates the equipment for 2002 and2003 under the general depreciation system by usingthe 200-percent declining balance method, a 5-yearrecovery period, and a half-year convention. Begin-ning in 2004, Y uses the equipment predominantlyoutside the United States. As a result of this changein the use, the equipment is subject to the alternativedepreciation system beginning in 2004. Under thealternative depreciation system, the equipment isdepreciated by using the straight line method and a9-year recovery period. The adjusted depreciablebasis of the equipment at January 1, 2004, is $48,000.

(ii) Pursuant to paragraph (d)(4) of this section,Y’s allowable depreciation deduction for 2004 andsubsequent taxable years is determined as thoughthe equipment had been placed in service in Jan-uary 2002, as property used predominantly outsidethe United States. Further, pursuant to paragraph

(d)(4)(i) of this section, the equipment is not eligiblein 2004 for the additional first year depreciationdeduction provided by section 168(k) or section1400L(b). In determining the applicable deprecia-tion rate for 2004, the applicable depreciation methodis the straight line method and the applicable recov-ery period is 7.5 years, which is the number of yearsremaining at January 1, 2004, for property placed inservice in 2002 with a 9-year recovery period (takinginto account the half-year convention). Thus, thedepreciation allowance for 2004 is $6,398 ($48,000adjusted depreciable basis at January 1, 2004, multi-plied by the applicable depreciation rate of 13.33%(1/7.5 years)). The depreciation allowance for 2005is $6,398 ($41,602 adjusted depreciable basis atJanuary 1, 2005, multiplied by the applicable de-preciation rate of 15.38% (1/6.5 years remaining atJanuary 1, 2005)).

Example 4. Change in the use results in a longerrecovery period and/or a slower depreciation methodand optional depreciation table is used—(i) Samefacts as in Example 3, except that Y used the op-tional depreciation tables for computing depreciationin 2002 and 2003. Pursuant to paragraph (d)(5) of thissection, Y chooses to continue to use the optional de-preciation table for the equipment. Further, pursuantto paragraph (d)(4)(i) of this section, the equipment isnot eligible in 2004 for the additional first year depre-ciation deduction provided by section 168(k) or sec-tion 1400L(b).

(ii) In accordance with paragraph (d)(5)(ii)(B)of this section, Y must first determine the appro-priate optional depreciation table for the equipmentpursuant to paragraph (d)(5)(ii)(B)(1) of this sec-tion. This table is table 8 in Rev. Proc. 87–57,which corresponds to the alternative depreciationsystem, the straight line method, a 9-year recoveryperiod, and the half-year convention (because Y de-preciated 5-year property in 2002 using a half-yearconvention). Next, Y must determine the appropriaterecovery year in table 8. Because the year of changeis 2004, the depreciation allowance for the equipmentfor 2004 is determined using recovery year 3 of table8. For 2004, Y multiplies its adjusted depreciablebasis in the equipment as of January 1, 2004, of$48,000, by the product of the annual depreciationrate in table 8 for recovery year 3 for a 9-year recov-ery period (.1111) and the transaction coefficient of1.200 [1/(1–(.0556 (table 8 for recovery year 1 for a9-year recovery period) +.1111 (table 8 for recoveryyear 2 for a 9-year recovery period)))], to determinethe depreciation allowance of $6,399. For 2005,Y multiplies its adjusted depreciable basis in theequipment as of January 1, 2004, of $48,000, by theproduct of the annual depreciation rate in table 8 forrecovery year 4 for a 9-year recovery period (.1111)and the transaction coefficient (1.200), to determinethe depreciation allowance of $6,399.

(e) Change in the use of MACRSproperty during the placed-in-serviceyear—(1) In general. Except as providedin paragraph (e)(2) of this section, if achange in the use of MACRS propertyoccurs during the placed-in-service yearand the property continues to be MACRSproperty owned by the same taxpayer, thedepreciation allowance for that property

July 12, 2004 23 2004–28 I.R.B.

for the placed-in-service year is deter-mined by its primary use during that year.The primary use of MACRS property maybe determined in any reasonable mannerthat is consistently applied to the tax-payer’s MACRS property. For purposesof this paragraph (e), the determinationof whether the mid-quarter conventionapplies to any MACRS property placed inservice during the year of change is madein accordance with §1.168(d)–1.

(2) Alternative depreciation systemproperty—(i) Property used within andoutside the United States. The deprecia-tion allowance for the placed-in-serviceyear for MACRS property that is usedwithin and outside the United States isdetermined by its predominant use duringthat year. The determination of whetherMACRS property is used predominantlyoutside the United States during theplaced-in-service year shall be made in ac-cordance with the test in §1.48–1(g)(1)(i)for determining predominant use.

(ii) Tax-exempt bond financed prop-erty. The depreciation allowance for theplaced-in-service year for MACRS prop-erty that changes to tax-exempt bondfinanced property, as described in sec-tion 168(g)(1)(C) and (g)(5), during thattaxable year is determined under the alter-native depreciation system. For purposesof this paragraph (e), MACRS propertychanges to tax-exempt bond financedproperty when a tax-exempt bond is firstissued after the MACRS property is placedin service. MACRS property continuesto be tax-exempt bond financed propertyin the hands of the taxpayer even if thetax-exempt bond (including any refundingissue) is not outstanding at, or is redeemedby, the end of the placed-in-service year.

(iii) Other mandatory alternative de-preciation system property. The depreci-ation allowance for the placed-in-serviceyear for MACRS property that changes to,or changes from, property described in sec-tion 168(g)(1)(B) (tax-exempt use prop-erty) or (D) (imported property coveredby an Executive order) during that taxableyear is determined under—

(A) The alternative depreciation systemif the MACRS property is described in sec-tion 168(g)(1)(B) or (D) at the end of theplaced-in-service year; or

(B) The general depreciation systemif the MACRS property is not describedin section 168(g)(1)(B) or (D) at the end

of the placed-in-service year, unless otherprovisions of the Internal Revenue Codeor regulations under the Internal RevenueCode require the depreciation allowancefor that MACRS property to be determinedunder the alternative depreciation system(for example, section 168(g)(7)).

(3) Examples. The application of thisparagraph (e) is illustrated by the follow-ing examples:

Example 1. (i) Z, a utility and calendar-year cor-poration, acquires and places in service on January 1,2004, equipment at a cost of $100,000. Z uses thisequipment in its combustion turbine production plantfor 4 months and then uses the equipment in its steamproduction plant for the remainder of 2004. Z’s com-bustion turbine production plant assets are classifiedas 15-year property and are depreciated by Z underthe general depreciation system using a 15-year re-covery period and the 150-percent declining balancemethod of depreciation. Z’s steam production plantassets are classified as 20-year property and are de-preciated by Z under the general depreciation systemusing a 20-year recovery period and the 150-percentdeclining balance method of depreciation. Z usesthe optional depreciation tables. The equipment is50-percent bonus depreciation property for purposesof section 168(k).

(ii) Pursuant to this paragraph (e), Z must deter-mine depreciation based on the primary use of theequipment during the placed-in-service year. Z hasconsistently determined the primary use of all of itsMACRS properties by comparing the number of fullmonths in the taxable year during which a MACRSproperty is used in one manner with the number offull months in that taxable year during which thatMACRS property is used in another manner. Apply-ing this approach, Z determines the depreciation al-lowance for the equipment for 2004 is based on theequipment being classified as 20-year property be-cause the equipment was used by Z in its steam pro-duction plant for 8 months in 2004. If the half-yearconvention applies in 2004, the appropriate optionaldepreciation table is table 1 in Rev. Proc. 87–57,which is the table for MACRS property subject tothe general depreciation system, the 150-percent de-clining balance method, a 20-year recovery period,and the half-year convention. Thus, the deprecia-tion allowance for the equipment for 2004 is $51,875,which is the total of $50,000 for the 50-percent ad-ditional first year depreciation deduction allowable(the unadjusted depreciable basis of $100,000 mul-tiplied by .50), plus $1,875 for the 2004 depreciationallowance on the remaining adjusted depreciable ba-sis of $50,000 [(the unadjusted depreciable basis of$100,000 less the additional first year depreciationdeduction of $50,000) multiplied by the annual de-preciation rate of .0375 in table 1 for recovery year 1for a 20-year recovery period].

Example 2. T, a calendar year corporation, placesin service on January 1, 2004, several computersat a total cost of $100,000. T uses these comput-ers within the United States for 3 months in 2004and then moves and uses the computers outside theUnited States for the remainder of 2004. Pursuantto §1.48–1(g)(1)(i), the computers are consideredas used predominantly outside the United States

in 2004. As a result, for 2004, the computers arerequired to be depreciated under the alternative de-preciation system of section 168(g) with a recoveryperiod of 5 years pursuant to section 168(g)(3)(C). Tuses the optional depreciation tables. If the half-yearconvention applies in 2004, the appropriate optionaldepreciation table is table 8 in Rev. Proc. 87–57,which is the table for MACRS property subject tothe alternative depreciation system, the straight linemethod, a 5-year recovery period, and the half-yearconvention. Thus, the depreciation allowance forthe computers for 2004 is $10,000, which is equalto the unadjusted depreciable basis of $100,000multiplied by the annual depreciation rate of .10 intable 8 for recovery year 1 for a 5-year recoveryperiod. Because the computers are required to bedepreciated under the alternative depreciation systemin their placed-in-service year, pursuant to section168(k)(2)(C)(i) and §1.168(k)–1T(b)(2)(ii), the com-puters are not eligible for the additional first yeardepreciation deduction provided by section 168(k).

(f) No change in accounting method.A change in computing the depreciationallowance in the year of change for prop-erty subject to this section is not a changein method of accounting under section446(e). See §1.446–1T(e)(2)(ii)(d)(3)(ii).

(g) Effective dates—(1) In general.This section applies to any change in theuse of MACRS property in a taxable yearending on or after June 17, 2004. For anychange in the use of MACRS propertyafter December 31, 1986, in a taxable yearending before June 17, 2004, the InternalRevenue Service will allow any reason-able method of depreciating the propertyunder section 168 in the year of changeand the subsequent taxable years that isconsistently applied to any property forwhich the use changes in the hands of thesame taxpayer or the taxpayer may choose,on a property-by-property basis, to applythe provisions of this section.

(2) Change in method of account-ing—(i) In general. If a taxpayer adopteda method of accounting for depreciationdue to a change in the use of MACRSproperty in a taxable year ending on orafter December 30, 2003, and the methodadopted is not in accordance with themethod of accounting for depreciationprovided in this section, a change to themethod of accounting for depreciationprovided in this section is a change inmethod of accounting to which the provi-sions of sections 446(e) and 481 and theregulations under sections 446(e) and 481apply. Also, a revocation of the electionprovided in paragraph (d)(3)(ii) of thissection to disregard a change in the useis a change in method of accounting to

2004–28 I.R.B. 24 July 12, 2004

which the provisions of sections 446(e)and 481 and the regulations under sections446(e) and 481 apply. However, if a tax-payer adopted a method of accounting fordepreciation due to a change in the useof MACRS property after December 31,1986, in a taxable year ending before De-cember 30, 2003, and the method adoptedis not in accordance with the method ofaccounting for depreciation provided inthis section, the taxpayer may treat thechange to the method of accounting fordepreciation provided in this section as achange in method of accounting to whichthe provisions of sections 446(e) and 481and the regulations under sections 446(e)and 481 apply.

(ii) Automatic consent to changemethod of accounting. A taxpayer chang-ing its method of accounting in accordancewith this paragraph (g)(2) must followthe applicable administrative proceduresissued under §1.446–1(e)(3)(ii) for ob-taining the Commissioner’s automaticconsent to a change in method of account-ing (for further guidance, for example, seeRev. Proc. 2002–9, 2002–1 C.B. 327, asmodified by Rev. Proc. 2004–11, 2004–3I.R.B. 311 (see §601.601(d)(2)(ii)(b) ofthis chapter)). Any change in method ofaccounting made under this paragraph(g)(2) must be made using an adjustmentunder section 481(a). For purposes ofForm 3115, Application for Change inAccounting Method, the designated num-ber for the automatic accounting methodchange authorized by this paragraph (g)(2)is “88.” If Form 3115 is revised or renum-bered, any reference in this section to thatform is treated as a reference to the revisedor renumbered form.

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.

Approved June 7, 2004.

Gregory F. Jenner,Acting Assistant Secretary of the

Treasury (Tax Policy).

(Filed by the Office of the Federal Register on June 16, 2004,8:45 a.m., and published in the issue of the Federal Registerfor June 17, 2004, 69 F.R. 33840)

Section 280F.—Limitationon Depreciation for LuxuryAutomobiles; LimitationWhere Certain PropertyUsed for Personal Purposes26 CFR 1.280F–1T: Limitations on investment taxcredit and recovery deductions under section 168 forpassenger automobiles and certain other listed prop-erty; overview of regulations (temporary).

T.D. 9133

DEPARTMENT OFTHE TREASURYInternal Revenue Service26 CFR Part 1

Depreciation of Vans and LightTrucks

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final and temporary regula-tions.

SUMMARY: This document contains reg-ulations relating to the definition of pas-senger automobile for purposes of the dol-lar limits on depreciation deductions forpassenger automobiles. These regulationsaffect certain taxpayers that use vans andlight trucks in their trade or business.

DATES: Effective Date: These regulationsare effective June 25, 2004.

Applicability Dates: These regula-tions apply to property placed in serviceby a taxpayer on or after July 7, 2003.For regulations applicable to propertyplaced in service before July 7, 2003,see §1.280F–6T as in effect prior to July7, 2003 (§1.280F–6T as contained in26 CFR part 1, revised as of April 1,2003). Taxpayers may choose to apply§1.280F–6(c)(3)(iii) to property placedin service prior to July 7, 2003, and ifnecessary may either amend returns foropen taxable years or file a Form 3115 inorder to apply §1.280F–6(c)(3)(iii) to suchproperty.

FOR FURTHER INFORMATIONCONTACT: Bernard P. Harvey, (202)622–3110 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On July 7, 2003, the IRS published tem-porary regulations (T.D. 9069, 2003–37I.R.B. 525) in the Federal Register (68 FR40129) containing amendments to 26 CFRpart 1 under section 280F of the InternalRevenue Code of 1986 (Code), includingthe addition of §1.280F–6T(c)(3)(iii). Onthe same date, the IRS published proposedregulations (REG–138495–02, 2003–37I.R.B. 541) in the Federal Register (68FR 40224) inviting comments under sec-tion 280F and inviting requests to hold apublic hearing. Several comments werereceived, but no requests to hold a publichearing. After consideration of all thecomments, the rules in T.D. 9069 and theproposed regulations are made retroac-tive for taxpayers that choose to applythe rules to property placed in servicebefore the proposed effective date andare adopted as final regulations. In addi-tion, a conforming amendment is made to§1.280F–6T, and §1.280F–6T is redesig-nated as §1.280F–6.

Explanation of Provisions

Section 280F(a) of the Code imposesannual dollar limits on the depreciation de-duction allowable with respect to passen-ger automobiles. T.D. 9069 and the pro-posed regulations provide that a truck orvan is not subject to these limits if it isa qualified nonpersonal use vehicle as de-fined in §1.274–5T(k). This rule applies tovehicles placed in service on or after July7, 2003.

Commentators suggested that the ruleannounced by T.D. 9069 and the proposedregulations be made available retroac-tively to owners of qualified nonpersonaluse vehicles placed in service during theperiod beginning January 1, 2003, andending July 6, 2003, and that taxpayerswho have filed fiscal-year returns be al-lowed to amend those returns to claimadditional deductions for such vehicles.Commentators have also requested thatwe give some measure of audit protectionto taxpayers who placed qualified nonper-sonal use vehicles in service prior to 2003and depreciated the vehicles in a mannerconsistent with T.D. 9069 and the pro-posed regulations. We have amended theeffective date provision to allow taxpayers

July 12, 2004 25 2004–28 I.R.B.

to use the exclusion for qualified nonper-sonal use vehicles for vehicles placed inservice prior to July 7, 2003, and to permittaxpayers either to amend tax returns foropen taxable years, or to treat the changeas a change in method of accounting by fil-ing a Form 3115, “Application for Changein Accounting Method”.

Comments received from the funeralservices industry requested amendments tothe definition of qualified nonpersonal usevehicles in the temporary regulations un-der section 274 to clarify that certain ve-hicles used in the funeral services indus-try are qualified nonpersonal use vehiclesfor purposes of the substantiation require-ments under that section. We believe thatsuch an amendment is beyond the scopeof these regulations, which are specific tosection 280F(a).

Another commentator indicated that therelief afforded by T.D. 9069 and the pro-posed regulations is too narrow, and re-quested that we amend the regulations toestablish a use-based test that would ex-clude more trucks and vans from section280F(a). The comment suggested a testthat would exclude all trucks and vans forwhich the taxpayer could demonstrate aspecific business need, and which are usedfor a valid business purpose. We believethat the proposed test is inherently subjec-tive and would cause administrative diffi-culty of the type that the proposed regu-lations were designed to avoid. We con-tinue to encourage suggestions for objec-tive use-based tests that could serve as thebasis for future guidance.

We were asked by the Office of Advo-cacy of the U.S. Small Business Admin-istration (Advocacy) to perform a regu-latory flexibility analysis because Advo-cacy believes that T.D. 9069 and the pro-posed regulations constitute a legislativerule as defined in the Regulatory Flexi-bility Act. A Regulatory Flexibility Act(RFA) analysis must be performed for leg-islative rules having a significant impacton small business, but not for interpretiverules or for legislative rules with no signif-icant impact on small businesses. It is theposition of the IRS and Treasury that T.D.9069 and the proposed regulations consti-tute an interpretive rule for which no reg-ulatory flexibility analysis is necessary. Inany event, the rule proposed in the regula-tions is in all cases beneficial to taxpayers

and does not have a significant impact onsmall business for purposes of the Regula-tory Flexibility Act.

Special Analyses

It has been determined that this Trea-sury decision is not a significant regula-tory action as defined in Executive Order12866. Therefore, a regulatory assessmentis not required. It also has been determinedthat section 553(b) of the AdministrativeProcedure Act (5 U.S.C. chapter 5) doesnot apply to these regulations, and becausethe regulations do not impose a collectionof information on small entities, the Regu-latory Flexibility Act (5 U.S.C. chapter 6)does not apply. Pursuant to section 7805(f)of the Code, the notice of proposed rule-making was submitted to the Chief Coun-sel for Advocacy of the Small BusinessAdministration for comment on its impacton small business.

Drafting Information

The principal author of these regula-tions is Bernard P. Harvey, Office of As-sociate Chief Counsel (Passthroughs andSpecial Industries). However, other per-sonnel from the IRS and Treasury Depart-ment participated in their development.

* * * * *

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amendedby adopting the rules of section 1.280F–6Tas final regulations, by making conform-ing amendments to sections 1.280F–1Tthrough 1.280F–7, and by updating theauthority citation as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by removing the entryfor “Section 1.280F–6T” and adding an en-try in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *Section 1.280F–6 also issued under 26

U.S.C. 280F. * * *

§1.280F–1T [Amended]

Par. 2 Section 1.280F–1T is amendedas follows:

1. The heading in the fifth columnof the table of paragraph (b) is amended

by removing “§1.280F–6T” and adding“§1.280F–6” in its place.

2. The first sentence in paragraph (c)(1)is amended by removing “1.280F–6T” andadding “1.280F–6” in its place.

3. The first sentence in paragraph (c)(2)is amended by removing “1.280F–6T” andadding “1.280F–6” in its place.

§1.280F–2T [Amended]

Par. 3 Section 1.280F–2T is amendedas follows:

The first sentence in para-graph (i) is amended by remov-ing “§1.280F–6T(d)(3)” and adding“§1.280F–6(d)(3)” in its place.

§1.280F–3T [Amended]

Par. 4 Section 1.280F–3T is amendedas follows:

1. The first sentence in paragraph (a)is amended by removing “§1.280F–6T(b)”and adding “§1.280F–6(b)” in its place.

2. The last sentence in paragraph (a)is amended by removing “§1.280F–6T(d)”and adding “§1.280F–6(d)” in its place.

3. The first sentence in para-graph (b)(1) is amended by remov-ing “§1.280F–6T(d)(1)” and adding“§1.280F–6(d)(1)” in its place.

4. The third sentence in para-graph (b)(1) is amended by remov-ing “§1.280F–6T(d)(3)” and adding“§1.280F–6(d)(3)” in its place, and by re-moving “§1.280F–6T(d)(2)(i)” and adding“§1.280F–6(d)(2)(i)” in its place.

5. The first sentence in para-graph (b)(2) is amended by remov-ing “§1.280F–6T(d)(3)” and adding“§1.280F–6(d)(3)” in its place.

6. The third sentence in para-graph (b)(2) is amended by remov-ing “§1.280F–6T(d)(1)” and adding“§1.280F–6(d)(1)” in its place.

7. The first sentence in paragraph (c)(1)is amended by removing “§1.280F–6T(b)”and adding “§1.280F–6(b)” in its place,and by removing “§1.280F–6T(d)(4)” andadding “§1.280F–6(d)(4)” in its place.

8. The first sentence in para-graph (c)(2) is amended by remov-ing “§1.280F–6T(d)(4)” and adding“§1.280F–6(d)(4)” in its place.

9. Paragraph (d)(1) is amended by re-moving “§1.280F–6T(d)(4)” and adding“§1.280F–6(d)(4)” in its place.

2004–28 I.R.B. 26 July 12, 2004

§1.280F–4T [Amended]

Par. 5 Section 1.280F–4T is amendedas follows:

The fifth sentence in paragraph(a)(1) is amended by removing“§1.280F–6T(d)(2)” and adding“§1.280F–6(d)(2)” in its place.

§1.280F–5T [Amended]

Par. 6 Section 1.280F–5T is amendedas follows:

The first sentence in paragraph(d)(1) is amended by removing“§1.280F–6T(d)(3)(i)” and adding“§1.280F–6(d)(3)(i)” in its place.

§1.280F–6T [Redesignated as §1.280F–6and amended]

Par. 7 Section 1.280F–6T is redesig-nated as §1.280F–6 and the word “(tem-porary)” is removed from the sectionheading. Newly-designated §1.280F–6 isamended as follows:

1. Paragraph (b)(1)(iv) is amendedby removing “section 168(j)(5)(D)” andadding “section 168(i)(2)(B)” in its place.

2. Paragraph (f) is added.The addition reads as follows:

§1.280F–6 Special rules and definitions.

* * * * *(f) Effective date—(1) In general. Ex-

cept as provided in paragraph (f)(2) of thissection, this section applies to propertyplaced in service by a taxpayer on or af-ter July 7, 2003. For regulations applicableto property placed in service before July 7,2003, see §1.280F–6T as in effect prior toJuly 7, 2003 (§1.280F–6T as contained in26 CFR part 1, revised as of April 1, 2003).

(2) Property placed in service beforeJuly 7, 2003. The following rules applyto property that is described in paragraph(c)(3)(iii) of this section, was placed in ser-vice by the taxpayer before July 7, 2003,and was treated by the taxpayer as a pas-senger automobile under §1.280F–6T as ineffect prior to July 7, 2003 (pre-effectivedate vehicle):

(i) Except as provided in paragraphs(f)(2)(ii), (iii), and (iv) of this section, apre-effective date vehicle will be treatedas a passenger automobile to which section280F(a) applies.

(ii) A pre-effective date vehicle willbe treated as property to which section280F(a) does not apply if the taxpayeradopts that treatment in determining de-preciation deductions on the taxpayer’soriginal return for the year in which thevehicle is placed in service.

(iii) A pre-effective date vehicle willbe treated, to the extent provided in thisparagraph (f)(2)(iii), as property to whichsection 280F(a) does not apply if the tax-payer adopts that treatment on an amendedFederal tax return in accordance withthis paragraph (f)(2)(iii). This paragraph(f)(2)(iii) applies only if, on or beforeDecember 31, 2004, the taxpayer files,for all applicable taxable years, amendedFederal tax returns (or qualified amendedreturns, if applicable (for further guidance,see Rev. Proc. 94–69, 1994–2 C.B. 804,and §601.601(d)(2)(ii)(b) of this chapter))treating the vehicle as property to whichsection 280F(a) does not apply. The ap-plicable taxable years for this purpose arethe taxable year in which the vehicle wasplaced in service by the taxpayer (or, if theperiod of limitation for assessment undersection 6501 has expired for such yearor any subsequent year (a closed year),the first taxable year following the mostrecent closed year) and all subsequenttaxable years in which the vehicle wastreated on the taxpayer’s return as prop-erty to which section 280F(a) applies. Ifthe earliest applicable taxable year is notthe year in which the vehicle was placedin service, the adjusted depreciable basisof the property as of the beginning of thefirst applicable taxable year is recoveredover the remaining recovery period. If theremaining recovery period as of the be-ginning of the first applicable taxable yearis less than 12 months, the entire adjusteddepreciable basis of the property as of thebeginning of the first applicable taxableyear is recovered in that year.

(iv) A pre-effective date vehicle willbe treated, to the extent provided in thisparagraph (f)(2)(iv), as property to whichsection 280F(a) does not apply if the tax-payer adopts that treatment on Form 3115,Application for Change in AccountingMethod, in accordance with this para-graph (f)(2)(iv). The taxpayer must followthe applicable administrative proceduresissued under §1.446–1(e)(3)(ii) for ob-taining the Commissioner’s automatic

consent to a change in method of account-ing (for further guidance, for example, seeRev. Proc. 2002–9, 2002–1 C.B. 327,and §601.601(d)(2)(ii)(b) of this chap-ter). If the taxpayer files a Form 3115treating the vehicle as property to whichsection 280F(a) does not apply, the tax-payer will be permitted to treat the changeas a change in method of accounting undersection 446(e) of the Internal RevenueCode and to take into account the section481 adjustment resulting from the methodchange. For purposes of Form 3115, thedesignated number for the automatic ac-counting method change authorized forthis paragraph (f)(2)(iv) is 89.

§1.280F–7 [Amended]

Par. 8 Section 1.280F–7 is amended asfollows:

1. Paragraph (a)(2)(iii) is amendedby removing “§1.280F–6T(d)(3)(i)” andadding “§1.280F–6(d)(3)(i)” in its place.

2. The second sentence in para-graph (b)(1) is amended by remov-ing “§1.280F–6T(d)(1)” and adding“§1.280F–6(d)(1)” in its place.

3. Paragraph (b)(2)(i)(B) is amendedby removing “§1.280F–6T(d)(3)(i)” andadding “§1.280F–6(d)(3)(i)” in its place,and by removing “§1.280F–6T(d)(1)” andadding “§1.280F–6(d)(1)” in its place.

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.

Approved June 17, 2004.

Gregory F. Jenner,Acting Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on June 24, 2004,8:45 a.m., and published in the issue of the Federal Registerfor June 25, 2004, 69 F.R. 35513)

Section 457.—DeferredCompensation Plansof State and LocalGovernments andTax-Exempt Organizations26 CFR 1.457–8: Funding rules for eligible plans.

Whether a governmental plan described in§ 457(b) of the Code may invest in a group trust. SeeRev. Rul. 2004-67, page 28.

July 12, 2004 27 2004–28 I.R.B.

Section 501.—ExemptionFrom Tax on Corporations,Certain Trusts, etc.26 CFR 1.501(a)–1: Exemption from taxation.(Also, §§ 457; 1.457–8.)

Group or pooled trusts; participa-tion; tax-exempt status, model lan-guage. This ruling provides that a gov-ernmental section 457(b) plan may investin a second tier group or pooled trust aslong as the criteria enumerated in the rul-ing are met. In addition, the ruling setsforth model language that may be adoptedby existing group or pooled trusts so thatthey need not request determination let-ters merely to add a provision permittingparticipation by a governmental section457(b) plan. Rev. Rul. 81–100 clarifiedand modified.

Rev. Rul. 2004–67

PURPOSE

This revenue ruling extends the abilityto participate in group trusts described inRev. Rul. 81–100, 1981–1 C.B. 326, to el-igible governmental plans under § 457(b)of the Internal Revenue Code and clari-fies the ability of Roth individual retire-ment accounts described in § 408A anddeemed individual retirement accounts de-scribed in § 408(q) to participate in thesegroup trusts. In addition, this revenue rul-ing provides related model language for el-igible governmental plans under § 457(b).

ISSUE

Whether the assets of eligible govern-mental plan trusts described in § 457(b)may be pooled with the assets of a grouptrust described in Rev. Rul. 81–100, with-out affecting the tax status of the eligiblegovernmental plan trust or the group trust(including its current participants).

LAW AND ANALYSIS

Section 501(a) provides, in part, that atrust described in § 401(a) is exempt fromincome tax.

Section 401(a)(1) provides that a trustor trusts created or organized in the UnitedStates and forming a part of a stock bonus,pension, or profit-sharing plan of an em-ployer for the exclusive benefit of itsemployees or their beneficiaries is qual-

ified under § 401(a) if contributions aremade to the trust or trusts by the applicableemployer, or employees, or both for thepurpose of distributing to such employ-ees or their beneficiaries the corpus andincome of the fund accumulated in accor-dance with such plan. Section 401(a)(2)provides, in part, that under each trustinstrument it must be impossible, at anytime prior to the satisfaction of all liabil-ities with respect to employees and theirbeneficiaries under the plan and the trustor trusts, for any part of the corpus or in-come of the trust, to be used for or divertedto purposes other than for the exclusivebenefit of the employees or their benefi-ciaries.

Section 401(a)(24) provides that anygroup trust that otherwise meets the re-quirements of § 401(a) will not fail to sat-isfy such requirements due to the participa-tion or inclusion of a plan or governmentalunit described in § 818(a)(6) in the grouptrust. Section 818(a)(6) provides, in part,that for these purposes the trust of a pen-sion plan contract includes a governmentalplan within the meaning of § 414(d) and aneligible deferred compensation plan withinthe meaning of § 457(b).

Section 401(f) provides that a custo-dial account, an annuity contract and cer-tain other contracts issued by an insurancecompany will be treated as a qualified trustif the custodial account or contract would,except for the fact that it is not a trust, con-stitute a qualified trust under § 401, and,if the assets in any such custodial accountare held by a bank or another person whodemonstrates that he will hold the assets ina manner consistent with the requirementsof § 401.

Section 408(e) provides for the exemp-tion from taxation of an individual retire-ment account that meets the requirementsof § 408. Section 408(a)(5) provides thatthe assets of an individual retirement ac-count may not be commingled with otherproperty except in a common trust fund orcommon investment fund.

Section 408A provides that, except asotherwise provided in § 408A, a RothIRA is treated for purposes of the Codeas an individual retirement plan, whichincludes an individual retirement accountthat meets the requirement of § 408. Con-sequently, a Roth IRA that is an individualretirement account is exempt from taxunder § 408(e).

Section 408(q) provides, in part, that ifa qualified employer plan, as defined in§ 408(q)(3)(A), elects to allow employeesto make voluntary employee contributionsto a separate account established under theplan and, under the terms of the qualifiedemployer plan, the account meets the re-quirements of § 408 or 408A for an in-dividual retirement account, then that ac-count is treated as an individual retirementaccount (deemed individual retirement ac-count), and not as a qualified employerplan. An individual retirement account de-scribed in § 408(q) is exempt from taxationunder § 408(e).

Rev. Rul. 81–100 holds that if certainrequirements are satisfied, a group trustis exempt from taxation under § 501(a)with respect to its funds that equitably be-long to participating trusts described in§ 401(a) and also is exempt from taxationunder § 408(e) with respect to its funds thatequitably belong to individual retirementaccounts that satisfy the requirements of§ 408. Also, the status of individual trustsas qualified under § 401(a), or as meetingthe requirements of § 408 and as being ex-empt from tax under § 501(a) or § 408(e),are not affected by the pooling of theirfunds in a group trust.

Section 457 provides that compensationdeferred under an eligible deferred com-pensation plan of an eligible employer thatis a State or political subdivision, agency,or instrumentality thereof (an eligible gov-ernmental plan) and any income attribut-able to the amounts deferred, is includi-ble in gross income only in the taxableyear in which it is paid to the plan par-ticipant or beneficiary. Section 457(g)(1)requires an eligible governmental plan un-der § 457(b) to hold all assets and in-come of the plan in a trust for the exclu-sive benefit of participants and their ben-eficiaries. Section 457(g)(2) provides, inpart, that a trust described in § 457(g)(1)is treated as an organization exempt fromfederal income tax under § 501(a). Sec-tion 457(g)(3) provides that custodial ac-count and contracts described in § 401(f)are treated as trusts under rules similar tothe rules under § 401(f).

This revenue ruling extends the holdingof Rev. Rul. 81–100 to eligible govern-mental plans described in § 457(b). There-fore, if the requirements below are satis-fied, the funds from qualified plan trusts,individual retirement accounts (including

2004–28 I.R.B. 28 July 12, 2004

a Roth individual retirement account de-scribed in § 408A and a deemed individualretirement account described in § 408(q))that are tax-exempt under § 408(e), and eli-gible governmental plan trusts described in§ 457(b) and § 457(g) may be pooled with-out adversely affecting the tax status of thegroup trust or the tax status of the separatetrusts.

HOLDING

The assets of eligible governmentalplan trusts described in § 457(b) may bepooled with the assets of a group trustdescribed in Rev. Rul. 81–100 withoutaffecting the tax status of the eligible gov-ernmental plan trust or the group trust(including its current participants).

Accordingly, under Rev. Rul. 81–100and this revenue ruling, if the five crite-ria below are satisfied, a trust that is partof a qualified retirement plan, an individ-ual retirement account (including a Rothindividual retirement account described in§ 408A and a deemed individual retire-ment account described in § 408(q)) that isexempt from taxation under § 408(e), or aneligible governmental plan under § 457(b)may pool its assets in a group trust with-out adversely affecting the tax status of anyof the separate trusts or the group trust.For this purpose, a trust includes a custo-dial account that is treated as a trust un-der § 401(f), under § 408(h), or under§ 457(g)(3).

1. The group trust is adopted as a partof each adopting employer’s plan oreach adopting individual retirementaccount.

2. The group trust instrument ex-pressly limits participation to pen-sion, profit-sharing, and stock bonustrusts or custodial accounts qualify-ing under § 401(a) that are exemptunder § 501(a); individual retire-ment accounts that are exempt under§ 408(e); and eligible governmentalplan trusts or custodial accounts un-der § 457(b) that are exempt under§ 457(g) (adopting entities).

3. The group trust instrument prohibitsany part of its corpus or income thatequitably belongs to any adopting en-tity from being used for or diverted

to any purpose other than for the ex-clusive benefit of the employees (andthe individual for whom an individualretirement account is maintained) andtheir beneficiaries who are entitled tobenefits under such adopting entity.

4. The group trust instrument prohibitsassignment by an adopting entity ofany part of its equity or interest in thegroup trust.

5. The group trust is created or organizedin the United States and is maintainedat all times as a domestic trust in theUnited States.

MODEL AMENDMENTS

There are two model amendments setforth below. One is for those group truststhat have received favorable determinationletters from the Service that the group trustsatisfies Rev. Rul. 81–100. The other isfor those trusts of eligible governmentalplans under § 457(b) that have receiveda letter ruling from the Service (in eachinstance issued prior to July 12, 2004).

AMENDMENT 1—FOR GROUPTRUST

A sponsor of a group trust that satisfiesRev. Rul. 81–100 may amend its grouptrust to include the model language belowto reflect this revenue ruling:

“This group trust is operated or main-tained exclusively for the comminglingand collective investment of funds fromother trusts that it holds. Notwithstand-ing any contrary provision in this grouptrust, the trustee of this group trust ispermitted, unless restricted in writingby the named fiduciary, to hold in thisgroup trust funds that consist exclu-sively of trust assets held under plansqualified under Code section 401(a),individual retirement accounts that areexempt under Code section 408(e),and eligible governmental plans thatmeet the requirements of Code section457(b). For this purpose, a trust in-cludes a custodial account that is treatedas a trust under Code section 401(f) orunder Code section 457(g)(3).”

“For purposes of valuation, the valueof the interest maintained by the fund

with respect to any plan or account insuch group trust shall be the fair marketvalue of the portion of the fund heldfor that plan or account, determined inaccordance with generally recognizedvaluation procedures.”

RELIANCE BY TRUSTEES WITHPRIOR DETERMINATION LETTER

A trustee entitled to rely on a favor-able determination letter issued to it priorto July 12, 2004, regarding eligibility of itsgroup trust under Rev. Rul. 81–100 willnot lose its right to rely on its determina-tion letter merely because it adopts ModelAmendment 1 set forth above in this rev-enue ruling on a word-for-word basis (oradopts an amendment that is substantiallysimilar in all material respects). The grouptrust sponsor may adopt Model Amend-ment 1 on a word-for-word basis (or adoptan amendment that is substantially simi-lar in all material respects) and continueto rely on the previously issued determina-tion letter regarding its group trust withoutfiling another request with the Service fora new determination letter.

A sponsor that satisfies the above re-quirements and amends its group trust toinclude Model Amendment 1 on a word-for-word basis (or adopts an amendmentthat is substantially similar in all materialrespects) will also not lose its right to relyon its prior determination letter merely be-cause it becomes necessary, as a result ofthe adoption of such model amendment (oran amendment that is substantially sim-ilar in all material respects), to delete aprior provision that is inconsistent withthe model amendment so adopted (or anamendment that is substantially similar inall material respects that is so adopted).

Generally, the group trust instrumentwill provide that amendments to the grouptrust will automatically pass through to thetrusts of qualified plans under § 401(a); in-dividual retirement accounts that are ex-empt under § 408(e); and trusts of eligi-ble governmental plans under § 457(b).However, a group trust that has received afavorable determination letter under Rev.Proc. 2004–6, 2004–1 I.R.B. 204, (or itspredecessors) that does not contain sucha pass-through provision may not adoptModel Amendment 1 and automaticallycontinue to rely on its determination letter.In addition, further guidance will be issued

July 12, 2004 29 2004–28 I.R.B.

to address the transition necessary to bringinto compliance a group trust that has re-ceived a favorable determination letter un-der Rev. Proc. 2004–6, 2004–1 I.R.B. 204,(or its predecessors) that does not complywith this revenue ruling.

AMENDMENT 2 — FOR ELIGIBLEGOVERNMENTAL PLAN UNDER§ 457(b)

A plan sponsor of a trust that funds aneligible governmental plan under § 457(b)may amend the trust agreement to includethe model language below to reflect thisrevenue ruling:

“Notwithstanding any contrary provi-sion in the instrument governing the[NAME OF ELIGIBLE GOVERN-MENTAL PLAN UNDER § 457(b)],the plan trustee may, unless restricted inwriting by the named fiduciary, transferassets of the plan to a group trust that isoperated or maintained exclusively forthe commingling and collective invest-ment of monies provided that the fundsin the group trust consist exclusively oftrust assets held under plans qualifiedunder Code section 401(a), individualretirement accounts that are exemptunder Code section 408(e), and eligiblegovernmental plans that meets the re-quirements of Code section 457(b). Forthis purpose, a trust includes a custodialaccount that is treated as a trust under

Code section 401(f) or under Code sec-tion 457(g)(3).”

“For purposes of valuation, the value ofthe interest maintained by the [NAMEOF ELIGIBLE GOVERNMENTALPLAN UNDER §457] in such grouptrust shall be the fair market value ofthe portion of the group trust held forthe [NAME OF ELIGIBLE GOVERN-MENTAL PLAN UNDER § 457(b)],determined in accordance with gener-ally recognized valuation procedures.”

RELIANCE BY EMPLOYER ONPRIOR § 457(b) RULING

An employer described in section457(e)(1)(A) entitled to rely on a favor-able private letter ruling issued to it priorto July 12, 2004, regarding the eligibilityof its plan under § 457(b) will not loseits right to rely on its letter ruling merelybecause it adopts Model Amendment 2 setforth above on a word-for-word basis (oradopts an amendment that is substantiallysimilar in all material respects). Such anemployer may adopt Model Amendment2 on a word-for-word basis (or adopt anamendment that is substantially similarin all material respects) and continue torely on the previously issued letter rulingregarding its § 457(b) plan without filinganother request with the Service for a newletter ruling.

An employer described in§ 457(e)(1)(A) that satisfies the aboverequirements and amends the trust ofits eligible governmental plan under§ 457(b) to include Model Amendment 2on a word-for-word basis (or adopts anamendment that is substantially similar inall material respects) will not lose its rightto rely on its prior letter ruling merelybecause it becomes necessary as a resultof the adoption of such model amendment(or an amendment that is substantiallysimilar in all material respects), to deletea prior provision that is inconsistent withthe model amendment so adopted.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 81–100 is clarified and mod-ified.

DRAFTING INFORMATION

The principal author of this revenueruling is Dana A. Barry of the EmployeePlans, Tax Exempt and Government Enti-ties Division. For further information re-garding this revenue ruling, please contactthe Employee Plans’ taxpayer assistancetelephone service at 1–877–829–5500(a toll-free number) between the hoursof 8:00 a.m. and 6:30 p.m. EasternTime, Monday through Friday (a toll-freecall). Ms. Barry may be reached at (202)283–9888 (not a toll-free call).

2004–28 I.R.B. 30 July 12, 2004

Part III. Administrative, Procedural, and MiscellaneousCharitable Contributions andConservation Easements

Notice 2004–41

The Internal Revenue Service is awarethat taxpayers who (1) transfer an ease-ment on real property to a charitableorganization, or (2) make payments to acharitable organization in connection witha purchase of real property from the char-itable organization, may be improperlyclaiming charitable contribution deduc-tions under § 170 of the Internal RevenueCode. The purpose of this notice is toadvise participants in these transactionsthat, in appropriate cases, the Service in-tends to disallow such deductions and mayimpose penalties and excise taxes. Fur-thermore, the Service may, in appropriatecases, challenge the tax-exempt status ofa charitable organization that participatesin these transactions. In addition, this no-tice advises promoters and appraisers thatthe Service intends to review promotionsof transactions involving these improperdeductions, and that the promoters andappraisers may be subject to penalties.

Contributions of Conservation Easements

Section 170(a)(1) allows as a deduc-tion, subject to certain limitations and re-strictions, any charitable contribution (asdefined in § 170(c)) that is made within thetaxable year. Generally, to be deductibleas a charitable contribution under § 170, atransfer to a charitable organization mustbe a gift of money or property without re-ceipt or expectation of receipt of adequateconsideration, made with charitable intent.See U.S. v. American Bar Endowment, 477U.S. 105, 117–18 (1986); Hernandez v.Commissioner, 490 U.S. 680, 690 (1989);see also § 1.170A–1(h)(1) and (2) of theIncome Tax Regulations.

Section 170(f)(3) provides generallythat no charitable contribution deduc-tion is allowed for a transfer to a char-itable organization of less than the tax-payer’s entire interest in property. Section170(f)(3)(B)(iii) provides an exception tothis rule in the case of a qualified conser-vation contribution.

A qualified conservation contributionis a contribution of a qualified real prop-

erty interest to a qualified organizationexclusively for certain conservation pur-poses. Section 170(h)(1), (2), (3), and (4);§ 1.170A–14(a). A qualified real propertyinterest includes a restriction (granted inperpetuity) on the use that may be madeof the real property. Section 170(h)(2)(C);see also § 1.170A–14(b)(2). For purposesof this notice, qualified real property in-terests described in § 170(h)(2)(C) arereferred to as conservation easements.

One of the permitted conservationpurposes listed in § 170(h)(4) is the pro-tection of a relatively natural habitat offish, wildlife, or plants, or similar ecosys-tem. Section 170(h)(4)(A)(ii); see also§ 1.170A–14(d)(1)(ii) and (3). Another ofthe permitted conservation purposes is thepreservation of open space (“open spaceeasement”), including farmland and forestland, for the scenic enjoyment of the gen-eral public or pursuant to a clearly delin-eated governmental conservation policy.However, if the public benefit of an openspace easement is not significant, the char-itable contribution deduction will be dis-allowed. See § 170(h)(4)(A)(iii); see also§ 1.170A–14(d)(1)(iii) and (4)(iv), (v),and (vi). Section 170(h) and § 1.170A–14contain many other requirements thatmust be satisfied for a contribution of aconservation easement to be allowed as adeduction.

A charitable contribution is allowed asa deduction only if substantiated in accor-dance with regulations prescribed by theSecretary. Section 170(a)(1) and (f)(8).Under § 170(f)(8), a taxpayer must sub-stantiate its contributions of $250 or moreby obtaining from the charitable organi-zation a statement that includes (1) a de-scription of any return benefit provided bythe charitable organization, and (2) a goodfaith estimate of the benefit’s fair marketvalue. See § 1.170A–13 for additional sub-stantiation requirements. In appropriatecases, the Service will disallow deductionsfor conservation easement transfers if thetaxpayer fails to comply with the substanti-ation requirements. The Service is consid-ering changes to forms to facilitate compli-ance with and enforcement of the substan-tiation requirements.

If all requirements of § 170 are satisfiedand a deduction is allowed, the amount of

the deduction may not exceed the fairmarket value of the contributed property(in this case, the contributed easement)on the date of the contribution (reducedby the fair market value of any consid-eration received by the taxpayer). See§ 1.170A–1(c)(1), (h)(1) and (2). Fairmarket value is the price at which thecontributed property would change handsbetween a willing buyer and a willingseller, neither being under any compulsionto buy or sell, and each having reason-able knowledge of relevant facts. Section1.170A–1(c)(2). See § 1.170A–14(h)(3)and (4) for a discussion of valuation.

If the donor (or a related person) rea-sonably can expect to receive financial oreconomic benefits greater than those thatwill inure to the general public as a re-sult of the donation of a conservation ease-ment, no deduction is allowable. Section1.170A–14(h)(3)(i). If the donation of aconservation easement has no material ef-fect on the value of real property, or en-hances rather than reduces the value of realproperty, no deduction is allowable. Sec-tion 1.170A–14(h)(3)(ii).

Purchases of Real Property fromCharitable Organizations

Some taxpayers are claiming inappro-priate charitable contribution deductionsunder § 170 for cash payments or ease-ment transfers to charitable organizationsin connection with the taxpayers’ pur-chases of real property.

In some of these questionable cases,the charitable organization purchases theproperty and places a conservation ease-ment on the property. Then, the charita-ble organization sells the property subjectto the easement to a buyer for a price thatis substantially less than the price paid bythe charitable organization for the prop-erty. As part of the sale, the buyer makes asecond payment, designated as a “charita-ble contribution,” to the charitable organi-zation. The total of the payments from thebuyer to the charitable organization fullyreimburses the charitable organization forthe cost of the property.

In appropriate cases, the Service willtreat these transactions in accordance withtheir substance, rather than their form.Thus, the Service may treat the total of the

July 12, 2004 31 2004–28 I.R.B.

buyer’s payments to the charitable organ-ization as the purchase price paid by thebuyer for the property.

Penalties, Excise Taxes, and Tax-ExemptStatus

Taxpayers are advised that the Serviceintends to disallow all or part of any im-proper deductions and may impose penal-ties under § 6662.

The Service intends to assess excisetaxes under § 4958 against any disquali-fied person who receives an excess benefitfrom a conservation easement transaction,and against any organization manager whoknowingly participates in the transaction.In appropriate cases, the Service may chal-lenge the tax-exempt status of the organi-zation, based on the organization’s opera-tion for a substantial nonexempt purposeor impermissible private benefit.

In addition, the Service intends to re-view promotions of transactions involvingimproper deductions for conservationeasements. Promoters, appraisers, andother persons involved in these transac-tions may be subject to penalties under§§ 6700, 6701, and 6694.

DRAFTING INFORMATION

The principal author of this notice isPatricia M. Zweibel of the Office of As-sociate Chief Counsel (Income Tax & Ac-counting). For further information regard-ing this notice, contact Ms. Zweibel at(202) 622–5020 (not a toll-free call).

Request For CommentsRegarding Rev. Proc. 81–70,1981–2 C.B. 729

Notice 2004–44

Section 368(a)(1)(B) of the InternalRevenue Code defines as a reorganizationthe acquisition by one corporation, in ex-change solely for all or part of its votingstock (or in exchange solely for all or a partof the voting stock of a corporation whichis in control of the acquiring corporation),of stock of another corporation if, imme-diately after the acquisition, the acquiringcorporation has control of such other cor-poration (whether or not such acquiringcorporation had control immediately be-fore the acquisition) (a B reorganization).

Section 362(b) generally provides that thebasis of property acquired by a corporationin connection with a reorganization shallbe the same as it would be in the handsof the transferor. Therefore, the acquiringcorporation’s basis in the stock acquiredin a B reorganization is determined byreference to the basis of the former share-holders in such stock.

In Rev. Proc. 81–70, 1981–2 C.B.729, the Internal Revenue Service set forthguidelines for estimating the basis of stockacquired by an acquiring corporation in aB reorganization. That revenue procedurepermits the acquiring corporation in a Breorganization to apply certain statisticalsampling techniques to determine its ba-sis in the acquired stock. The guidelinesreflect the recognition that the informationneeded by the acquiring corporation to es-tablish the basis of the acquired corpora-tion’s stock is in the possession of the for-mer shareholders of the acquired corpo-ration, who may not respond to basis in-quiries. They also reflect the recognitionthat, in certain cases, it may be time con-suming, burdensome and costly for the ac-quiring corporation to contact each formershareholder of the acquired corporation.

The Service is concerned that changesin the marketplace since Rev. Proc. 81–70was issued may have rendered compliancewith its requirements for statistical sam-pling unduly burdensome or impossibleand that, therefore, taxpayers are not com-plying with those requirements. For exam-ple, the Service understands that the waystock is held today may prevent or hin-der access to the information necessary todetermine the shareholder’s basis in suchstock.

A number of commentators have sug-gested that the Service revise Rev. Proc.81–70. The Service requests commentsregarding problems taxpayers are encoun-tering in their effort to comply with therequirements of Rev. Proc. 81–70 andwhether it should be modified.

The Service particularly seeks com-ments from those who perform basisstudies that are intended to comply withthe requirements of Rev. Proc. 81–70,those engaged in providing services andinformation to the investment community(including those who maintain custodialinformation that may be used in such stud-ies, such as broker/dealers, banks, and

similar organizations), and other inter-ested parties.

In addition, from those that perform ba-sis studies that are intended to comply withthe requirements of Rev. Proc. 81–70,the following information is specificallyrequested: (i) descriptions of the sourcesof information, both historic and recent,available for use in performing basis stud-ies; and (ii) descriptions of the methodolo-gies utilized to determine the basis of stockheld by persons that do not respond to re-quests for basis information.

From record keepers, the following in-formation is specifically requested: (i) de-scriptions of the kinds of information thatare maintained that may be used to per-form basis studies and of the sources ofthis information; (ii) statements describ-ing the length of time that this informationis generally maintained and available foruse; and (iii) descriptions of confidential-ity concerns, if any, that may impair or de-lay a response to a basis inquiry.

Please submit all comments by Septem-ber 30, 2004. Written comments should besent to:

Internal Revenue ServiceAttn: CC:PA:LPD:PR(Notice 2004–44)

Room 5203P. O. Box 7604Ben Franklin StationWashington, DC 20044

Or hand delivered between the hours of8 a.m. and 4 p.m. to:

Courier’s DeskInternal Revenue ServiceAttn: CC:PA:LPD:PR(Notice 2004–44)

1111 Constitution Avenue, N.W.Washington, D.C. 20224

Alternatively, comments maybe submitted electronically viae-mail to the following address:Notice.Comments@irscounsel.treas.gov.Please include “Notice 2004–44” in thesubject line. All comments will be avail-able for public inspection and copying intheir entirety.

FOR FURTHER INFORMATION

For information regarding estimatesand sampling techniques, please con-

2004–28 I.R.B. 32 July 12, 2004

tact Edward Cohen at (212) 719–6693(not a toll-free call). For further in-formation regarding this notice gener-ally, please contact George Johnson orReginald Mombrun at (202) 622–7930(not a toll-free call).

Meritless Filing Position Basedon Sections 932(c) and 934(b)

Notice 2004–45

The Internal Revenue Service is awarethat certain promoters are advising tax-payers to take highly questionable, and inmost cases meritless, positions describedbelow in order to avoid U.S. taxation andclaim a tax benefit under the laws of theUnited States Virgin Islands (USVI). Pro-moters may also be advising taxpayers totake similar positions with respect to otherU.S. possessions. This notice alerts tax-payers that the Service intends to challengethese positions in appropriate cases. TheService may impose civil penalties on tax-payers or persons who participated in thepromotion or reporting of these positions.In addition to being subject to other penal-ties, any person who willfully attempts toevade or defeat tax by means of an arrange-ment such as the one described in this no-tice, or who willfully counsels or advisessuch evasion or defeat, may be guilty of acriminal offense under federal law.

Background

Section 934, which was enacted in1960, provides that the USVI may re-duce its territorial income tax only incertain limited cases. The USVI may not,however, reduce the tax liability of U.S.citizens or residents who are not bona fideresidents of the USVI. In the case of U.S.citizens or residents who are bona fide res-idents of the USVI, it may reduce their taxliability only with respect to income fromsources in the USVI or income effectivelyconnected with the conduct of a trade orbusiness within the USVI.

The legislative history of § 934 indi-cates that the statute was enacted in partbecause of concerns that certain local in-come tax programs, which were intendedto provide incentives to corporations andUSVI residents that made new investmentsin the USVI, were having the effect of

reducing the tax liability attributable notonly to income from sources within theUSVI but also to income from sourceswithin the United States. While recogniz-ing the goal of encouraging economic de-velopment in the USVI through appropri-ate income tax reductions, the legislativehistory to § 934 indicates that

in no case should this [goal] be attainedby granting windfall gains to taxpayerswith respect to income derived from in-vestments in corporations in the con-tinental United States, or with respectto income in any other manner derivedfrom sources outside of the Virgin Is-lands.

S. Rep. No. 1767, 86th Cong., 2nd Sess. 4(1960).

Typical Promotion

The highly questionable positions de-scribed in this notice may be promoted totaxpayers in a variety of forms. The Ser-vice is aware, however, that they have fre-quently been promoted in the followingmanner:

Promoters typically approach a tax-payer (Taxpayer) living and working inthe United States and advise Taxpayer to(i) purport to become a USVI residentby establishing certain contacts with theUSVI, (ii) purport to terminate his or herexisting employment relationship with hisor her employer (Employer) and (iii) pur-port to become a partner of a Virgin Islandslimited liability partnership (“V.I.LLP”)that is treated as a partnership for U.S. taxpurposes. V.I.LLP then purports to enterinto a contract with Employer to provideEmployer with substantially the same ser-vices that were provided by Taxpayer priorto the creation of this arrangement. Typi-cally, after entering into the arrangement,Taxpayer continues to provide substan-tially the same services for Employer thathe or she provided before entering into thearrangement, but Taxpayer is nominally apartner of V.I.LLP instead of an employeeof Employer.

Under this arrangement, Employermakes payments to V.I.LLP for Taxpayer’sservices and no longer treats the paymentsas wages paid to Taxpayer subject to thewithholding and payment of employmenttaxes and reporting on Taxpayer’s FormW–2. V.I.LLP, in turn, makes paymentsto Taxpayer for his or her services to

Employer. V.I.LLP typically treats thesepayments for tax accounting purposes ei-ther as guaranteed payments for servicesor as distributions of Taxpayer’s alloca-ble share of partnership income. Underthis arrangement, the promoter may be ageneral partner in V.I.LLP and may retaina percentage of the fees received fromEmployer.

V.I.LLP either has or secures a reduc-tion, up to 90 percent, in USVI incometax liability under the Economic Develop-ment Program (EDP) of the USVI. Tax-payer takes the position that the EDP ben-efits granted to V.I.LLP provide a corre-sponding reduction in the income tax lia-bility that Taxpayer reports on his or herUSVI income tax return with respect toguaranteed payments from the partnershipor distributive shares of the partnership’snet income, or both. Taxpayer pays taxto the USVI in an amount approximatelyequal to 10% of the U.S. income tax lia-bility that otherwise would be imposed onTaxpayer’s income from performing theservices. Taxpayer claims that, for pur-poses of computing his or her U.S. incometax liability, gross income does not in-clude guaranteed payments received fromV.I.LLP or Taxpayer’s distributive share,if any, of the partnership’s net income, orboth.

Positions Promoted

In situations such as those describedabove, as well as in other situations, thefollowing highly questionable positionsare being promoted:

—“You can continue to live andwork in the United States and, nev-ertheless, be a bona fide resident ofthe USVI.” The concept of a “bonafide resident of the Virgin Islands” wasan integral part of the predecessor to§ 934(b), and as such, its meaning hasbeen well established. See § 934(c) asenacted by P.L. 86–779, §4(a) (1960).When Congress enacted the current ver-sions of §§ 932 and 934(b), it retainedthis concept, but noted that Treasuryhas the authority to modify its mean-ing when necessary to prevent abuse.See H.R. Rep. No. 99–426 (1985)and General Explanation of the Tax Re-form Act of 1986, JCS–10–87 (1987)(“Similarly, where appropriate, the Sec-retary may treat an individual as not

July 12, 2004 33 2004–28 I.R.B.

a bona fide resident of the Virgin Is-lands.”) The determination of whetheran individual is a bona fide resident ofthe USVI turns on the facts and cir-cumstances and, specifically, on an in-dividual’s intentions with respect to thelength and nature of his or her stay in theUSVI. See § 1.934–1(c)(2) (generallyapplying the principles of §§ 1.871–2through –5). Promoters typically repre-sent that a taxpayer need not make ma-jor lifestyle changes in order to becomea bona fide resident of the USVI, andmay represent that the taxpayer needonly spend a few weeks or less out ofthe year in the USVI to become a res-ident for income tax purposes. Theserepresentations, however, have no basisin the well-established meaning of theterm “bona fide resident of the VirginIslands.” Accordingly, a claim of USVIresidency for income tax purposes maybe considered without merit or fraudu-lent when the taxpayer continues to liveand work in the United States.

—“USVI source income includesincome from services performed inthe United States.” The principles thatgenerally apply for determining grossand taxable income from sources withinand without the United States (in par-ticular, the rules of §§ 1.861–1 through1.863–5) also generally apply in deter-mining gross and taxable income fromsources within and without a possessionof the United States. See § 1.863–6 andFrancisco v. Commissioner, 119 T.C.317 (2002) aff’d, No. 03–1210 (D.C.Cir. June 18, 2004). With certain lim-ited exceptions, compensation for la-bor or personal services performed inthe United States is gross income fromsources within the United States. See§ 861(a)(3) and § 1.861–4(a)(1). Theresult does not change if the compensa-tion is received in the form of a guaran-teed payment from a partnership ratherthan in the form of a fee for servicesunder an employment contract. SeeMiller v. Commissioner, 52 T.C. 752(1969), acq. 1972–2 C.B. 2. Promot-ers typically claim that taxpayers arefree to argue, under a variety of the-ories, that income from services per-formed in the United States constitutesincome from USVI sources because “norules exist under section 934” for deter-mining whether income is from USVI

sources. Based on the foregoing dis-cussion, however, such arguments arewithout merit.

—“For purposes of determiningthe source of income, USVI includesthe United States.” Section 932 pro-vides coordination rules for filing ofreturns for U.S. and USVI incometaxes by bona fide residents of theUSVI and U.S. citizens and residentswho have income derived from sourceswithin the USVI or income effectivelyconnected with the conduct of a tradeor business within the USVI. To fa-cilitate this coordination, § 932(c)(3)states that the USVI includes the UnitedStates for certain tax purposes. Section932(c)(3) was modeled after § 935(c),which was enacted fourteen years ear-lier and which provides an equivalentrule with respect to Guam. For anillustration of the types of purposesfor which these provisions apply, see§ 1.935–1(c)(1)(ii). Notably, these pro-visions do not apply for purposes ofdetermining the source of income. SeeH.R. Rep. No. 92–1479, 92d Cong., 2dSess. 5 (Oct. 2, 1972) (“In determin-ing the source of income for purposesof the special tax system providedin the bill (new code sec. 935), theprinciples contained in secs. 861–863are to be applied without referenceto sec. 935(c).”) Based on an incor-rect reading of § 932(c)(3), promotersmay claim that compensation for ser-vices performed in the United Statesis considered for tax purposes to becompensation for services performedin the USVI. This claim is withoutmerit. Section 932 does not apply todetermine the source of income onwhich the USVI tax liability of bonafide residents may be reduced under§ 934(b)(1). Thus, § 932(c)(3) doesnot operate to transform compensationfrom the performance of personal ser-vices in the United States into incomefrom sources in the USVI.

—“Non-USVI source income canbe treated as effectively connectedwith the conduct of a trade or busi-ness within the USVI even if, underequivalent circumstances, such in-come would not be considered effec-tively connected with the conduct ofa trade or business within the UnitedStates.” As noted above, § 934(b)(1)

grants limited authority to the USVIto reduce the USVI tax liability withrespect to income from USVI sourcesor income effectively connected with atrade or business within the USVI. Theuse of the term “effectively connectedwith the conduct of a trade or business”in § 934 indicates that Congress gener-ally intended for the rules under § 934to follow the well-established rulesthat apply for purposes of determin-ing the taxation of nonresidents, suchas the definition of effectively con-nected income under § 864(c). Section934(b)(4), however, provides Treasurywith the authority to issue regulationsproviding an alternative definition ofthe term. The legislative history of§ 934 makes clear that this grant of reg-ulatory authority was for the purposeof preventing abuse, and that Congressanticipated that it would be used toprovide further limitations on the typeof income that would be treated asfrom USVI sources or as effectivelyconnected with the conduct of a tradeor business within the USVI. S. Rep.No. 99–313, at 484, 1986–3 C.B. (vol.3) 484. Taxpayers have no legal basisfor claiming that the scope of the term“income effectively connected withthe conduct of a trade or business” isbroader under § 934 than it is under§ 864. In particular, taxpayers have nolegal basis for disregarding the rulesof § 864(c)(4), which generally limitthe amount of foreign source incomethat is treated as effectively connectedwith a U.S. trade or business to certain,very narrow categories of income. Ac-cordingly, with the exception of thosenarrow categories, and in the absenceof regulations to the contrary, income,gain, or loss from sources withoutthe USVI cannot be treated as effec-tively connected with the conduct ofa trade or business within the USVIfor purposes of § 934. For example,income from the performance of per-sonal services without the USVI cannotunder any circumstances be treated aseffectively connected with the con-duct of a trade or business within theUSVI. Promoters typically interpret thephrase “effectively connected to theconduct of a trade or business withinthe USVI” broadly, and inconsistentlywith § 864(c)(4), in order to claim a

2004–28 I.R.B. 34 July 12, 2004

tax reduction with respect to incomefrom non-USVI sources. As indicatedabove, however, these interpretationshave no merit.The IRS intends to challenge these po-

sitions and other similar claims that dis-regard the statutory and regulatory provi-sions concerning the limitations on the re-duction of USVI income tax. Where tax-payers in order to make these claims en-ter into arrangements such as the one de-scribed in this notice, the Internal RevenueService may disregard such arrangementson the grounds that they lack economicsubstance or that they have no purposeother than tax avoidance or evasion. TheService also may assert that the arrange-ment does not serve to terminate the em-

ployment relationship between a taxpayerand Employer for federal employment taxpurposes, with the result that Employer re-mains liable for employment taxes and ap-plicable penalties and interest.

In addition to liability for tax due plusstatutory interest, taxpayers that claim tohave no requirement to file a federal in-come tax return or pay federal income taxliability based on the positions describedherein may be subject to penalties includ-ing, but not limited to, the accuracy-re-lated penalty under § 6662, failure to fileor pay penalties under § 6651 and civilfraud penalties under § 6663. Further, per-sons who participate in the promoting orreporting of these positions may be sub-ject to aiding and abetting penalties under

§ 6701. In addition to other penalties, anyperson who willfully attempts to evade ordefeat tax by taking the positions describedin this notice, or who willfully counselsor advises such evasion or defeat, may beguilty of a criminal offense under §§ 7201,7203, 7206, or 7212(a) or other provisionsof federal law. Promoters and others whoassist taxpayers in taking these positionsalso may be enjoined from doing so under§ 7408.

The principal author of this notice isW. Edward Williams of the Office ofAssociate Chief Counsel (International).For further information regarding this no-tice, contact W. Edward Williams at (202)622–3295 (not a toll-free call).

July 12, 2004 35 2004–28 I.R.B.

Part IV. Items of General InterestNotice of ProposedRulemaking

Adjustment to Net UnrealizedBuilt-in Gain

REG–131486–03

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains pro-posed regulations under section 1374 thatprovide for an adjustment to the amountthat may be subject to tax under section1374 in certain cases in which an S cor-poration acquires assets from a C corpo-ration in an acquisition to which section1374(d)(8) applies. These proposed reg-ulations provide guidance to certain S cor-porations that acquire assets from a C cor-poration in a carryover basis transaction.

DATES: Written or electronic commentsmust be received by September 23, 2004.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–131486–03), room5203, Internal Revenue Service, PO Box7604, Ben Franklin Station, Washing-ton, DC 20044. Submissions may behand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to CC:PA:LPD:PR (REG–131486–03),Courier’s Desk, Internal Revenue Service,1111 Constitution Avenue, NW, Wash-ington, DC, or sent electronically, viathe IRS Internet site at www.irs.gov/regsor via the Federal eRulemaking Por-tal at www.regulations.gov (IRS —REG–131486–03). The public hearingwill be held in the IRS Auditorium, Inter-nal Revenue Building, 1111 ConstitutionAvenue, NW, Washington, DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the proposed reg-ulations, Jennifer Sledge, (202) 622–7750;concerning submissions of comments,Treena Garrett, (202) 622–7180 (nottoll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation ofProvisions

Section 1374 of the Internal RevenueCode of 1986 (Code) generally imposes acorporate level tax on the income or gain ofan S corporation that formerly was a C cor-poration to the extent the income or gainis attributable to the period during whichthe corporation was a C corporation. Con-gress amended section 1374 to provide thisrule as part of the Tax Reform Act of 1986,which repealed the General Utilities doc-trine. Under the General Utilities doctrine,a C corporation, in certain cases, could dis-tribute appreciated assets to its sharehold-ers, or sell appreciated assets and distrib-ute the sale proceeds in connection witha complete liquidation to its shareholders,without recognizing gain. Section 1374prevents a corporation from circumvent-ing General Utilities repeal by convertingto S corporation status before distributingits appreciated assets to its shareholders, orselling its appreciated assets and distribut-ing the sale proceeds in connection with acomplete liquidation to its shareholders.

Specifically, section 1374 imposes atax on an S corporation’s net recognizedbuilt-in gain attributable to assets that itheld on the date it converted from a Ccorporation to an S corporation for the10-year recognition period beginning onthe first day the corporation is an S cor-poration. Under section 1374, the totalamount subject to tax is limited to the Scorporation’s net unrealized built-in gain(NUBIG), which is the “aggregate netbuilt-in gain of the corporation at the timeof conversion to S corporation status.” SeeH.R. Conf. Rep. No. 99–841, at II–203(1986). Section 1374 also imposes a tax onan S corporation’s net recognized built-ingain attributable to assets that it acquiredin a carryover basis transaction from a Ccorporation for the 10-year recognition pe-riod beginning on the day of the carryoverbasis transaction. The legislative historyof section 1374 provides that each acqui-sition of assets from a C corporation issubject to a separate determination of the

amount of net unrealized built-in gain andis subject to a separate 10-year recognitionperiod. See H.R. Rep. No. 100–795, at 63(1988).

Sections 337(d) and 1374(e) authorizethe Secretary of the Treasury to prescriberegulations as necessary to carry out thepurposes of General Utilities repeal gen-erally and section 1374 specifically. TheTreasury Department and the IRS havepromulgated regulations consistent withthese provisions. See, e.g., §§1.337(d)–4through 1.337(d)–7, 1.1374–1 through1.1374–10.

Under §1.1374–3, an S corporation’sNUBIG generally is the amount of gainthe S corporation would recognize on theconversion date if it sold all of its assetsat fair market value to an unrelated partythat assumed all of its liabilities on thatdate. Consistent with the legislative his-tory of section 1374, section 1374(d)(8)and §1.1374–8 require a separate determi-nation of the amount subject to tax undersection 1374 for the pool of assets the Scorporation held on the date it converted toC status and each pool of assets acquired ina carryover basis transaction from a C cor-poration.

Under the current rules, therefore, if X,a C corporation, elects to be an S corpora-tion when it owns all of the stock of Y, aC corporation, X’s NUBIG will reflect thebuilt-in gain or built-in loss in the Y stock.That built-in gain or built-in loss may beduplicative of the built-in gain or built-inloss in Y’s assets. If Y later transfers its as-sets to X in a liquidation to which sections332 and 337(a) apply, the built-in gain andbuilt-in loss in Y’s assets may be reflectedtwice: once in the NUBIG attributable tothe assets X owned on the date of its con-version (including the stock of Y) and asecond time in the NUBIG attributable toY’s former assets acquired by X in the liq-uidation of Y. A similar result would obtainif, on the date of its conversion to an S cor-poration, X owned less than 80 percent ofthe stock of Y and later acquired the assetsof Y in a reorganization to which section368(a) applies. These results are inconsis-tent with the fact that a liquidation to which

2004–28 I.R.B. 36 July 12, 2004

sections 332 and 337(a) apply, and theacquisition of the assets of a corporationsome or all of the stock of which is ownedby the acquiring corporation in a reorgani-zation under section 368(a), generally havethe effect of eliminating the built-in gain orbuilt-in loss in the redeemed or canceledstock of the liquidated or target corpora-tion.

In the course of developing these pro-posed regulations, the Treasury Depart-ment and the IRS considered a numberof approaches to address the issue raisedby the situations described above. In par-ticular, the Treasury Department and theIRS considered adopting an approach thatwould provide for a single determinationof NUBIG for all of the assets of an S cor-poration and, thus, a single determinationof the amount subject to tax under section1374. While this approach may have pro-duced results similar to those that wouldhave been produced had the S corporationremained a C corporation and acquired theassets of another C corporation, it was re-jected because such an approach appears tobe inconsistent with the legislative historyof section 1374, which seems to mandate aseparate determination of tax for each poolof assets. See H.R. Rep. No. 100–795, at63.

Instead, these regulations adopt an ap-proach that adjusts (increases or decreases)the NUBIG of the pool of assets that in-cluded the stock of the liquidated or ac-quired C corporation to reflect the extent towhich the built-in gain or built-in loss in-herent in the redeemed or canceled C cor-poration stock at the time the pool of assetsbecame subject to the tax under section1374 has been eliminated from the corpo-rate tax system in the liquidation or re-organization. These proposed regulationsprovide that, if section 1374(d)(8) appliesto an S corporation’s acquisition of assets,some or all of the stock of the C corpora-tion from which such assets were acquiredwas taken into account in the computationof NUBIG for a pool of assets of the S cor-poration, and some or all of such stock isredeemed or canceled in such transaction,subject to certain limitations, the NUBIGof the pool of assets that included the Ccorporation stock redeemed or canceled inthe transaction (other than stock with re-spect to which a loss under section 165 isclaimed) is adjusted to eliminate any ef-fect any built-in gain or built-in loss in the

redeemed or canceled C corporation stockhad on the initial computation of NUBIGfor that pool of assets. For this purpose,stock that has an adjusted basis that is de-termined (in whole or in part) by refer-ence to the adjusted basis of any other as-set held by the S corporation as of the firstday of the recognition period (i.e., stockdescribed in section 1374(d)(6)) is treatedas taken into account in the computation ofthe NUBIG for the pool of assets of the Scorporation.

Adjustments to NUBIG under theseproposed regulations, however, are sub-ject to two limitations. First, the NUBIGis only adjusted to reflect the amount ofthe built-in gain or built-in loss that wasinherent in the redeemed or canceled stockat the time the pool of assets became sub-ject to tax under section 1374 that hasnot resulted in recognized built-in gainor recognized built-in loss at any timeduring the recognition period, includingon the date of the acquisition to whichsection 1374(d)(8) applies. For example,suppose that on the date X, a C corpo-ration, converts to S corporation status,it owns the stock of Y, which has a ba-sis of $0 and a value of $100. The gaininherent in the Y stock contributes $100to X’s NUBIG. During the recognitionperiod and prior to the liquidation of Y,Y distributes $20 to X in a distributionto which section 301(c)(3) applies. Thatamount is recognized built-in gain undersection 1374(d)(3). If Y later distributesits assets to X in a distribution to whichsections 332 and 337(a) apply, pursuant tothese regulations, X must adjust its orig-inal NUBIG to reflect the elimination ofthe Y stock. X will reduce that NUBIGby $80, the original built-in gain in suchstock ($100) minus the recognized built-ingain with respect to such stock during therecognition period ($20).

Second, an adjustment cannot be madeif it is duplicative of another adjustment tothe NUBIG for a pool of assets. This ruleis intended to prevent more than one ad-justment to the NUBIG of a pool of assetsfor the same built-in gain or built-in lossstock.

Any adjustment to NUBIG under theseproposed rules will only affect computa-tions of the amount subject to tax undersection 1374 for taxable years that end onor after the date of the liquidation or reor-ganization. It will not affect computations

of the amount subject to tax under section1374 for taxable years that end before thedate of the liquidation or reorganization.

The Treasury Department and IRS re-quest comments regarding whether therule proposed in these regulations shouldbe expanded to apply in other cases inwhich the stock basis that was taken intoaccount in the computation of NUBIG iseliminated. This may occur, for example,where an S corporation owns stock of a Ccorporation on the date of its conversion toan S corporation and later distributes thestock of the C corporation in a distributionto which section 355 applies. In addition,the Treasury Department and IRS requestcomments concerning whether there areany situations other than those identifiedin these proposed regulations in whichadjustments to NUBIG should be less thanthe built-in gain or the built-in loss in theredeemed or canceled stock as of the be-ginning of the recognition period.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It also has beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulationsand, because the regulations do not im-pose a collection of information on smallentities, the Regulatory Flexibility Act (5U.S.C. chapter 6) does not apply. There-fore, a Regulatory Flexibility Analysis isnot required. Pursuant to section 7805(f)of the Code, these proposed regulationswill be submitted to the Chief Counsel forAdvocacy of the Small Business Admin-istration for comment on their impact onsmall business.

Public Comment

Before these proposed regulations areadopted as final regulations, considerationwill be given to any written comments(a signed original and eight (8) copies)or electronic comments that are submittedtimely to the IRS. All comments will bemade available for public inspection andcopying. A public hearing may be sched-uled. If a public hearing is scheduled, no-tice of the date, time, and place for the pub-

July 12, 2004 37 2004–28 I.R.B.

lic hearing will be published in the FederalRegister.

Drafting Information

The principal author of these regula-tions is Marie Byrne of the Office of As-sociate Chief Counsel (Corporate). Otherpersonnel from Treasury and the IRS par-ticipated in their development.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 is proposedto be amended as follows:

PART 1 — INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.1374–3 is amended

by:1. Revising paragraph (b).2. Adding paragraph (c).The revision and addition read as fol-

lows:

§1.1374–3 Net unrealized built-in gain.

* * * * *

(b) Adjustment to net unrealizedbuilt-in gain — (1) In general. If sec-tion 1374(d)(8) applies to an S corpora-tion’s acquisition of assets, some or all ofthe stock of the corporation from whichsuch assets were acquired was taken intoaccount in the computation of the net un-realized built-in gain for a pool of assetsof the S corporation, and some or all ofsuch stock is redeemed or canceled in suchtransaction, then, subject to the limitationsof paragraph (b)(2) of this section, suchnet unrealized built-gain is adjusted toeliminate any effect any built-in gain orbuilt-in loss in the redeemed or canceledstock (other than stock with respect towhich a loss under section 165 is claimed)had on the initial computation of net unre-alized built-in gain for that pool of assets.For purposes of this paragraph, stockdescribed in section 1374(d)(6) shall betreated as taken into account in the com-putation of the net unrealized built-in gainfor a pool of assets of the S corporation.

(2) Limitations on adjustment — (i)Recognized built-in gain or loss. Netunrealized built-in gain for a pool of as-sets of the S corporation is only adjustedunder paragraph (b)(1) of this section toreflect built-in gain or built-in loss in theredeemed or canceled stock that has notresulted in recognized built-in gain or

recognized built-in loss during the recog-nition period.

(ii) Anti-duplication rule. Paragraph(b)(1) of this section shall not be appliedto duplicate an adjustment to the net un-realized built-in gain for a pool of assetsmade pursuant to paragraph (b)(1) of thissection.

(3) Effect of adjustment. Any adjust-ment to the net unrealized built-in gainmade pursuant to this paragraph (b) onlyaffects computations of the amount subjectto tax under section 1374 for taxable yearsthat end on or after the date of the acquisi-tion to which section 1374(d)(8) applies.

(4) Pool of assets. For purposes of thissection, a pool of assets means —

(i) The assets held by the corporation onthe first day it became an S corporation, ifthe corporation was previously a C corpo-ration; or

(ii) The assets the S corporation ac-quired from a C corporation in a section1374(d)(8) transaction.

(c) Examples. The following examplesillustrate the rules of this section:

Example 1. Computation of net unrealizedbuilt-in gain. (i)(A) X, a calendar year C corporationusing the cash method, elects to become an S corpo-ration on January 1, 1996. On December 31, 1995,X has assets and liabilities as follows:

Assets FMV BasisFactory $500,000 $900,000Accounts Receivable 300,000 0Goodwill 250,000 0

Total 1,050,000 900,000

Liabilities AmountMortgage $200,000Accounts Payable 100,000

Total 300,000

(B) Further, X must include a total of $60,000 intaxable income in 1996, 1997, and 1998 under section481(a).

(ii) If, on December 31, 1995, X sold all its assetsto a third party that assumed all its liabilities, X’samount realized would be $1,050,000 ($750,000

cash received + $300,000 liabilities assumed =$1,050,000). Thus, X’s net unrealized built-in gainis determined as follows:

Amount realized $1,050,000Deduction allowed (100,000)Basis of X’s assets (900,000)Section 481 adjustments 60,000

Net unrealized built-in gain 110,000

Example 2. Adjustment to net unrealized built-ingain for built-in gain in eliminated C corporation

stock. (i) X, a calendar year C corporation, elects tobecome an S corporation effective January 1, 2005.

On that date, X’s assets (the first pool of assets) havea net unrealized built-in gain of $15,000. Among the

2004–28 I.R.B. 38 July 12, 2004

assets in the first pool of assets is all of the outstand-ing stock of Y, a C corporation, with a fair marketvalue of $33,000 and an adjusted basis of $18,000.On March 1, 2009, X sells an asset that it owned onJanuary 1, 2005, and as a result has $10,000 of rec-ognized built-in gain. X has had no other recognizedbuilt-in gain or built-in loss. X’s taxable income lim-itation for 2009 is $50,000. Effective June 1, 2009, Xelects under section 1362 to treat Y as a qualified sub-chapter S subsidiary (QSub). The election is treatedas a transfer of Y’s assets to X in a liquidation towhich sections 332 and 337(a) apply.

(ii) Under paragraph (b) of this section, the netunrealized built in-gain of the first pool of assets isadjusted to account for the elimination of the Y stockin the liquidation. The net unrealized built-in gainof the first pool of assets, therefore, is decreased by$15,000, the amount by which the fair market value ofthe Y stock exceeded its adjusted basis as of January1, 2005. Accordingly, for taxable years ending afterJune 1, 2009, the net unrealized built-in gain of thefirst pool of assets is $0.

(iii) Under §1.1374–2(a), X’s net recognizedbuilt-in gain for any taxable year equals the leastof X’s pre-limitation amount, taxable income lim-itation, and net unrealized built-in gain limitation.In 2009, X’s pre-limitation amount is $10,000, X’staxable income limitation is $50,000, and X’s netunrealized built-in gain limitation is $0. Becausethe net unrealized built-in gain of the first pool ofassets has been adjusted to $0, despite the $10,000of recognized built-in gain in 2009, X has $0 netrecognized built-in gain for the taxable year endingon December 31, 2009.

Example 3. Adjustment to net unrealized built-ingain for built-in loss in eliminated C corporationstock. (i) X, a calendar year C corporation, elects tobecome an S corporation effective January 1, 2005.On that date, X’s assets (the first pool of assets) havea net unrealized built-in gain of negative $5,000.Among the assets in the first pool of assets is 10 per-cent of the outstanding stock of Y, a C corporation,with a fair market value of $18,000 and an adjustedbasis of $33,000. On March 1, 2009, X sells an assetthat it owned on January 1, 2005, resulting in $8,000of recognized built-in gain. X has had no other rec-ognized built-in gains or built-in losses. X’s taxableincome limitation for 2009 is $50,000. On June 1,2009, Y transfers its assets to X in a reorganizationunder section 368(a)(1)(C).

(ii) Under paragraph (b) of this section, the netunrealized built in-gain of the first pool of assets isadjusted to account for the elimination of the Y stockin the reorganization. The net unrealized built-in gainof the first pool of assets, therefore, is increased by$15,000, the amount by which the adjusted basis ofthe Y stock exceeded its fair market value as of Jan-uary 1, 2005. Accordingly, for taxable years endingafter June 1, 2009, the net unrealized built-in gain ofthe first pool of assets is $10,000.

(iii) Under §1.1374–2(a), X’s net recognizedbuilt-in gain for any taxable year equals the least ofX’s pre-limitation amount, taxable income limitation,and net unrealized built-in gain limitation. In 2009,X’s pre-limitation amount is $8,000 and X’s taxableincome limitation is $50,000. The net unrealizedbuilt-in gain of the first pool of assets has been ad-justed to $10,000, so X’s net unrealized built-in gainlimitation is $10,000. X, therefore, has $8,000 net

recognized built-in gain for the taxable year endingon December 31, 2009. X’s net unrealized built-ingain limitation for 2010 is $2,000.

Example 4. Adjustment to net unrealized built-ingain in case of prior gain recognition. (i) X, a cal-endar year C corporation, elects to become an S cor-poration effective January 1, 2005. On that date, X’sassets (the first pool of assets) have a net unrealizedbuilt-in gain of $30,000. Among the assets in the firstpool of assets is all of the outstanding stock of Y, a Ccorporation, with a fair market value of $45,000 andan adjusted basis of $10,000. Y has no current or ac-cumulated earnings and profits. On April 1, 2007, Ydistributes $18,000 to X, $8,000 of which is treatedas gain to X from the sale or exchange of propertyunder section 301(c)(3). That $8,000 is recognizedbuilt-in gain to X under section 1374(d)(3), and re-sults in $8,000 of net recognized built-in gain to Xfor 2007. X’s net unrealized built-in gain limitationfor 2008 is $22,000. On June 1, 2009, Y transfers itsassets to X in a liquidation to which sections 332 and337(a) apply.

(ii) Under paragraph (b) of this section, the netunrealized built in-gain of the first pool of assets isadjusted to account for the elimination of the Y stockin the liquidation. The net unrealized built-in gain ofthat pool of assets, however, can only be adjusted toreflect the amount of built-in gain that was inherent inthe Y stock on January 1, 2005, that has not resultedin recognized built-in gain during the recognition pe-riod. In this case, therefore, the net unrealized built-ingain of the first pool of assets cannot be reduced bymore than $27,000 ($35,000, the amount by whichthe fair market value of the Y stock exceeded its ad-justed basis as of January 1, 2005, minus $8,000, therecognized built-in gain with respect to the stock dur-ing the recognition period). Accordingly, for taxableyears ending after June 1, 2009, the net unrealizedbuilt-in gain of the first pool of assets is $3,000. Thenet unrealized built-in gain limitation for 2009 is $0.

Par. 3. Paragraph (a) of §1.1374–10 isrevised to read as follows:

§1.1374–10 Effective date and additionalrules.

(a) In general. Sections 1.1374–1through 1.1374–9, other than§1.1374–3(b) and (c) Examples 2through 4, apply for taxable years endingon or after December 27, 1994, but onlyin cases where the S corporation’s returnfor the taxable year is filed pursuant to anS election or a section 1374(d)(8) transac-tion occurring on or after December 27,1994. Section 1.1374–3(b) and (c) Exam-ples 2 through 4 apply for taxable yearsbeginning after the date these regulationsare published as final regulations in theFederal Register.

*****

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.

(Filed by the Office of the Federal Register on June 24, 2004,8:45 a.m., and published in the issue of the Federal Registerfor June 25, 2004, 69 F.R. 35544)

Notice of ProposedRulemaking

Stock Held by ForeignInsurance Companies

REG–117307–04

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains aproposed regulation relating to the deter-mination of income of foreign insurancecompanies that is effectively connectedwith the conduct of a trade or businesswithin the United States. The regulationprovides that the exception to the asset-usetest for stock shall not apply in determin-ing whether the income, gain, or loss fromportfolio stock held by foreign insurancecompanies constitutes effectively con-nected income.

DATES: Written or electronic commentsand requests for a public hearing must bereceived by September 23, 2004.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG–117307–04), room5203, Internal Revenue Service, PO Box7604, Ben Franklin Station, Washing-ton, DC 20044. Submissions may behand-delivered Monday through Fridaybetween the hours of 8 a.m. and 4 p.m.to CC:PA:LPD:PR (REG–117307–04),Courier’s Desk, Internal Revenue Service,1111 Constitution Avenue, NW, Washing-ton, DC, or sent electronically, via the IRSInternet site at www.irs.gov/regs or via theFederal eRulemaking Portal at www.regu-lations.gov (IRS and REG–117307–04).

FOR FURTHER INFORMATIONCONTACT: Concerning the regulations,Sheila Ramaswamy, at (202) 622–3870;concerning submissions and delivery ofcomments, Robin Jones, 202–622–7180(not toll-free numbers).

July 12, 2004 39 2004–28 I.R.B.

SUPPLEMENTARY INFORMATION:

Background

In 1992, the Treasury Departmentand the IRS published proposed regula-tions under section 864 providing thatstock is not treated as an asset used in,or held for use in, the conduct of a tradeor business in the United States. Pro-posed §1.864–4(c)(2)(ii)(C). The notice ofproposed rulemaking solicited commentsregarding the appropriate treatment ofincome from portfolio stock investmentsof insurance companies. The TreasuryDepartment and the IRS published finalregulations in 1996 which adopted thegeneral rule in the proposed regulationsthat stock is not treated as an asset usedin, or held for use in, the conduct of a U.S.trade or business. T.D. 8657, 1996–1 C.B.153. The final regulations reserved on thetreatment of stock held by a foreign in-surance company. §1.864–4(c)(2)(iii)(b).This proposed regulation sets forth cir-cumstances in which stock held by a for-eign insurance company is not subject tothe general rule in §1.864–4(c)(2)(iii)(a),which provides that stock is not an assetused in a U.S. trade or business.

Explanation of Provisions

In the case of a foreign corporationengaged in a trade or business within theUnited States during the taxable year, sec-tion 864(c)(2) generally provides rules fordetermining whether certain fixed or deter-minable, annual or periodical income fromsources within the United States or gain orloss from sources within the United Statesfrom sale or exchange of capital assetsis income effectively connected with theconduct of a trade or business in the UnitedStates. Section 864(c)(2). In making thisdetermination, the factors taken into ac-count include whether (a) the income,gain or loss is derived from assets usedin or held for use in the conduct of suchtrade or business (the asset-use test), or(b) the activities of such trade or businesswere a material factor in the realizationof such income, gain or loss. Section864(c)(2). Section 1.864–4(c)(2)(iii)(a)generally provides that stock of a corpora-tion (whether domestic or foreign) is not anasset used in or held for use in the conductof a trade or business in the United Statesexcept as provided in (c)(2)(iii)(b). Sec-

tion 1.864–4(c)(2)(iii)(b) entitled “StockHeld by Foreign Insurance Companies” isreserved.

Insurance companies hold investmentassets, such as stocks and bonds, to fundtheir obligations to policyholders and tomeet their surplus (capital) requirements.Thus, stock held in an investment portfoliomay be an asset held for use in the trade orbusiness of a foreign insurance company.By contrast, stock of a subsidiary generallyis not held for the purpose of meeting aninsurance company’s business needs.

This proposed regulation provides thatthe general rule excluding stock from theasset-use test does not apply to stock heldby a foreign insurance company unlesssuch company owns directly, indirectly, orconstructively 10 percent or more of thevote or value of the company’s stock. The10-percent threshold is intended to distin-guish portfolio stock held to fund poli-cyholder obligations and surplus require-ments from investments in a subsidiary.Comments are requested as to whether this10-percent threshold provides an appropri-ate standard for determining whether stockis a portfolio investment for these pur-poses.

Proposed Effective Date

This regulation is proposed to apply totaxable periods beginning on or after thedate of publication of a Treasury decisionadopting this rule as a final regulation inthe Federal Register.

Special Analyses

It has been determined that this noticeof proposed rulemaking is not a significantregulatory action as defined in ExecutiveOrder 12866. Therefore, a regulatory as-sessment is not required. It has also beendetermined that section 553(b) of the Ad-ministrative Procedure Act (5 U.S.C. chap-ter 5) does not apply to these regulations,and because these regulations do not im-pose a collection of information on smallentities, the provisions of the RegulatoryFlexibility Act (5 U.S.C. chapter 6) do notapply. Pursuant to section 7805(f) of theInternal Revenue Code, this notice of pro-posed rulemaking will be submitted to theChief Counsel for Advocacy of the SmallBusiness Administration for comment onits impact on small business.

Comments and Public Hearing

Before these proposed regulations areadopted as final regulations, considera-tion will be given to any written (a signedoriginal and eight (8) copies) or electroniccomments that are submitted timely tothe IRS. The IRS and Treasury Depart-ment request comments on the clarity ofthe proposed rules and how they can bemade easier to understand. All commentswill be available for public inspection andcopying. A public hearing may be sched-uled if requested in writing by any personthat timely submits written comments. If apublic hearing is scheduled, notice of thedate, time, and place for a public hearingwill be published in the Federal Register.

Drafting Information

The principal author of these proposedregulations is Sheila Ramaswamy, Officeof Associate Chief Counsel (Interna-tional). However, other personnel fromthe IRS and Treasury Department partici-pated in their development.

* * * * *

Proposed Amendment to theRegulations

Accordingly, 26 CFR part 1 is proposedto be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation forpart 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *Par. 2. In §1.864–4, paragraph

(c)(2)(iii)(b) is revised to read as follows:

§1.864–4 U.S. source income effectivelyconnected with U.S. business.

* * * * *(c) * * *(2) * * *(iii) * * *(b) Paragraph (c)(2)(iii) of this section

shall not apply to stock of a corporation(whether domestic or foreign) held by aforeign insurance company unless the for-eign insurance company owns 10 percentor more of the total voting power or valueof all classes of stock of such corpora-tion. For purposes of this section, sec-tion 318(a) shall be applied in determin-

2004–28 I.R.B. 40 July 12, 2004

ing ownership, except that in applying sec-tion 318(a)(2)(C), the phrase “10 percent”is used instead of the phrase “50 percent.”

* * * * *

Mark E. Matthews,Deputy Commissioner forServices and Enforcement.

(Filed by the Office of the Federal Register on June 24, 2004,8:45 a.m., and published in the issue of the Federal Registerfor June 25, 2004, 69 F.R. 35543)

Suspension of Tax-ExemptStatus of an OrganizationIdentified With Terrorism

Announcement 2004–56

I. Purpose

This announcement is a public notice ofthe suspension under section 501(p) of theInternal Revenue Code of the federal taxexemption of a certain organization thathas been designated as supporting or en-gaging in terrorist activity or supportingterrorism. Contributions made to an organ-ization during the period that the organiza-tion’s tax-exempt status is suspended arenot deductible for federal tax purposes.

II. Background

The federal government has designateda number of organizations as supporting orengaging in terrorist activity or supportingterrorism under the Immigration and Na-tionality Act, the International EmergencyEconomic Powers Act, and the United Na-tions Participation Act of 1945. Federallaw prohibits most contributions to orga-nizations that have been so designated.

Section 501(p) of the Code was enactedas part of the Military Family Tax ReliefAct of 2003 (P.L. 108–121), effectiveNovember 11, 2003. Section 501(p)(1)suspends the exemption from tax un-der section 501(a) of any organizationdescribed in section 501(p)(2). An organ-ization is described in section 501(p)(2)if the organization is designated or oth-erwise individually identified (1) undercertain provisions of the Immigration and

Nationality Act as a terrorist organizationor foreign terrorist organization; (2) in orpursuant to an Executive Order which isrelated to terrorism and issued under theauthority of the International EmergencyEconomic Powers Act or section 5 of theUnited Nations Participation Act of 1945for the purpose of imposing on such or-ganization an economic or other sanction;or (3) in or pursuant to an Executive Orderissued under the authority of any federallaw, if the organization is designated orotherwise individually identified in or pur-suant to the Executive Order as supportingor engaging in terrorist activity (as de-fined in the Immigration and NationalityAct) or supporting terrorism (as defined inthe Foreign Relations Authorization Act)and the Executive Order refers to section501(p)(2).

Under section 501(p)(3) of the Code,suspension of an organization’s tax ex-emption begins on the date of the first pub-lication of a designation or identificationwith respect to the organization, as de-scribed above, or the date on which section501(p) was enacted, whichever is later.This suspension continues until all desig-nations and identifications of the organiza-tion are rescinded under the law or Exec-utive Order under which such designationor identification was made.

Under section 501(p)(4) of the Code,no deduction is allowed under any pro-vision of the Internal Revenue Code forany contribution to an organization duringany period in which the organization’stax exemption is suspended under section501(p). Thus, for example, no charitablecontribution deduction is allowed undersection 170 (relating to the income tax),section 545(b)(2) (relating to undistributedpersonal holding company income), sec-tion 556(b)(2) (relating to undistributedforeign personal holding company in-come), section 642(c) (relating to chari-table set asides), section 2055 (relating tothe estate tax), section 2106(a)(2) (relatingto the estate tax for nonresident aliens)and section 2522 (relating to the gift tax)for contributions made to the organizationduring the suspension period.

Prior to the effective date of suspen-sion of exemption under section 501(p),

the organization listed below was desig-nated under Executive Order 13224, en-titled “Blocking Property and ProhibitingTransactions With Persons Who Commit,Threaten To Commit, or Support Terror-ism.” Contributions made to this organi-zation in violation of the Executive Or-der prior to this suspension are not tax de-ductible under the Internal Revenue Code.

III. Notice of Suspension andNondeductibility of Contributions

The organization whose tax exemptionhas been suspended under section 501(p)and the effective date of such suspensionis listed below. Contributions made to thisorganization during the period of suspen-sion are not deductible for federal tax pur-poses.

Rabbi Meir Kahana Memorial FundCedarhurst, New YorkEffective Date: November 11, 2003

IV. Federal Tax Filings

An organization whose exempt statushas been suspended under section 501(p)does not file Form 990 and is required tofile the appropriate Federal income tax re-turns for the taxable periods beginning onthe date of the suspension. The organi-zation must continue to file all other ap-propriate federal tax returns, including em-ployment tax returns, and may also have tofile federal unemployment tax returns.

V. Contact Information

For additional information regardingthe designation or identification of an or-ganization described in section 501(p)(2),contact the Compliance Division at the Of-fice of Foreign Assets Control of the U.S.Treasury Department at 202–622–2490.Additional information is also avail-able for download from the Office’sInternet Home Page at www.treas.gov/offices/eotffc/ofac/index.html

For additional information regardingthe suspension of the federal tax exemp-tion of an organization under section501(p), contact Ward L. Thomas at (202)283–8913 at the Internal Revenue Service.

July 12, 2004 41 2004–28 I.R.B.

Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe the ef-fect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position is be-ing extended to apply to a variation of thefact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds that thesame principle also applies to B, the earlierruling is amplified. (Compare with modi-fied, below).

Clarified is used in those instanceswhere the language in a prior ruling is be-ing made clear because the language hascaused, or may cause, some confusion.It is not used where a position in a priorruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more than re-state the substance and situation of a previ-ously published ruling (or rulings). Thus,the term is used to republish under the1986 Code and regulations the same po-sition published under the 1939 Code andregulations. The term is also used whenit is desired to republish in a single rul-ing a series of situations, names, etc., thatwere previously published over a period oftime in separate rulings. If the new rul-ing does more than restate the substance

of a prior ruling, a combination of termsis used. For example, modified and su-perseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that is selfcontained. In this case, the previously pub-lished ruling is first modified and then, asmodified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further names insubsequent rulings. After the original rul-ing has been supplemented several times, anew ruling may be published that includesthe list in the original ruling and the ad-ditions, and supersedes all prior rulings inthe series.

Suspended is used in rare situationsto show that the previous published rul-ings will not be applied pending somefuture action such as the issuance of newor amended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current useand formerly used will appear in materialpublished in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.E.O.—Executive Order.

ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.

PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D. —Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z —Corporation.

2004–28 I.R.B. i July 12, 2004

Numerical Finding List1

Bulletins 2004–27 through 2004–28

Announcements:

2004-55, 2004-27 I.R.B. 15

2004-56, 2004-28 I.R.B. 41

2004-57, 2004-27 I.R.B. 15

Notices:

2004-41, 2004-28 I.R.B. 31

2004-43, 2004-27 I.R.B. 10

2004-44, 2004-28 I.R.B. 32

2004-45, 2004-28 I.R.B. 33

Proposed Regulations:

REG-131486-03, 2004-28 I.R.B. 36

REG-117307-04, 2004-28 I.R.B. 39

Revenue Procedures:

2004-38, 2004-27 I.R.B. 10

Revenue Rulings:

2004-63, 2004-27 I.R.B. 6

2004-64, 2004-27 I.R.B. 7

2004-65, 2004-27 I.R.B. 1

2004-66, 2004-27 I.R.B. 4

2004-67, 2004-28 I.R.B. 28

Treasury Decisions:

9131, 2004-27 I.R.B. 2

9132, 2004-28 I.R.B. 16

9133, 2004-28 I.R.B. 25

1 A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2004–1 through 2004–26 is in Internal Revenue Bulletin2004–26, dated June 28, 2004.

July 12, 2004 ii 2004–28 I.R.B.

Findings List of Current Actions onPreviously Published Items1

Bulletins 2004–27 through 2004–28

Revenue Procedures:

94-64

Superseded by

Rev. Proc. 2004-38, 2004-27 I.R.B. 10

Revenue Rulings:

81-100

Clarified and modified by

Rev. Rul. 2004-67, 2004-28 I.R.B. 28

1 A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2004–1 through 2004–26 is in Internal Revenue Bulletin 2004–26, dated June 28, 2004.

2004–28 I.R.B. iii July 12, 2004*U.S. Government Printing Office: 2004—304–778/60143