[Federal Register Volume 59, Number 92 (Friday, May 13, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-11493]
[[Page Unknown]]
[Federal Register: May 13, 1994]
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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602
[TD 8537]
RIN 1545-AQ50
Carryover of Passive Activity Losses and Credits and At Risk
Losses to Bankruptcy Estates of Individuals
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the
application of carryover of passive activity losses and credits and at
risk losses to the bankruptcy estates of individuals. The final
regulations affect individual taxpayers who file bankruptcy petitions
under chapter 7 or chapter 11 of title 11 of the United States Code and
have passive activity losses and credits under section 469 or losses
under section 465.
DATES: These regulations are effective May 13, 1994.
These regulations apply to bankruptcy cases commencing on or after
November 9, 1992. In addition, the regulations apply, at the election
of the affected taxpayers, to cases that commenced before, and end on
or after, November 9, 1992.
FOR FURTHER INFORMATION CONTACT: Amy J. Sargent of the Office of
Assistant Chief Counsel (Income Tax & Accounting), Office of Chief
Counsel, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC 20224, or telephone (202) 622-4930 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the requirements of the Paperwork Reduction Act (44
U.S.C. 3504(h)) under control number 1545-1375. The estimated annual
burden per respondent varies from .5 hour to 1.5 hours, depending on
individual circumstances, with an estimated average of 1 hour.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Background
This document contains final Income Tax Regulations (26 CFR part 1)
under section 1398 of the Internal Revenue Code (Code). On November 9,
1992, the IRS published in the Federal Register a notice of proposed
rulemaking designating passive activity losses and credits under
section 469 and unused section 465 losses as attributes that pass from
the debtor to the bankruptcy estate under section 1398(g) of the Code
and that, upon termination of the estate, pass from the bankruptcy
estate to the debtor under section 1398(i). Corrections to the Notice
of Proposed Rulemaking were published in the Federal Register on
December 22, 1992 (57 FR 246). A public hearing was held on January 25,
1993. After consideration of the public comments regarding the proposed
regulations, the final regulations adopt the rules contained in the
proposed regulations without substantive change. A discussion of the
public comments is set forth below.
Public Comments
The comments received by the IRS were generally favorable,
welcoming the designation of attributes under section 1398(g)(8).
Several commentators suggested that the regulations be modified. These
suggestions are discussed below.
I. Expansion of the Proposed Regulations to Include Additional
Attributes
The proposed regulations designate passive activity losses and
credits under section 469 and losses under section 465 as attributes
that pass from the debtor to the estate. Several commentators suggested
that the scope of the proposed regulations be expanded to include
additional attributes of the debtor, either by specifically listing the
additional attributes or by providing that attributes of the debtor
pass to the estate if they are related to property passing to the
estate or are in the nature of a carryforward.
These suggestions were not adopted in the final regulations. The
treatment of other unenumerated attributes under section 1398 (g) and
(i) is more appropriately provided in a separate regulation project.
This would provide taxpayers with an opportunity to comment before
additional attributes of the debtor are designated, by final
regulation, as attributes that pass to the estate.
II. Taxation of Estate's Transfers of an Interest in a Passive Activity
or Former Passive Activity or an Interest in a Section 465 Activity
Before Termination of the Estate
The proposed regulations provide that if, before the termination of
the estate, the estate transfers an interest in a passive activity or
former passive activity to the debtor (other than by sale or exchange),
the transfer is not treated as a disposition for purposes of any
provision of the Code assigning tax consequences to a disposition. By
way of example, the proposed regulations state that such transfers
include transfers from the estate to the debtor of property that is
exempt under section 522 of title 11 of the United States Code and
abandonments of estate property to the debtor under section 554(a) of
such title. The proposed regulations provide similar rules for the
transfer of a section 465 activity.
Several commentators objected on the grounds that these provisions
are outside the scope of the regulatory authority of the IRS under
section 1398(g) and (i). In general, these commentators maintained that
the regulatory authority of the IRS is limited to listing attributes
that pass from the debtor to the estate and that, upon termination of
the estate, pass to the debtor. In addition, one commentator contended
that the provisions relating to pre-termination transfers between the
estate and the debtor constitute an improper attempt to amend by
regulation the express language of section 1398(f)(2). Commentators
also questioned the treatment of abandonments as nontaxable
dispositions, reiterating many of the arguments set forth in In re A.J.
Lane & Co., 133 B.R. 264 (Bankr. D. Mass. 1991), which stated in dicta
that abandonments are taxable dispositions. See also In re Rubin, 154
B.R. 897 (Bankr. D. Md. 1992).
The final regulations retain the rules of the proposed regulations.
Although section 1398 does not provide explicit rules relating to pre-
termination transfers between the estate and the debtor, the Secretary
has authority pursuant to section 7805(a) to issue interpretative
regulations under section 1398. The IRS and the Treasury Department
believe the rules adopted in the final regulations are consistent with
the overall system established by section 1398 and, in the absence of a
contrary statutory provision, are a reasonable exercise of the
Secretary's authority under section 7805(a). Moreover, the rules
adopted in the final regulations are consistent with the only appellate
court case on point, which holds that the transfer (other than by sale
or exchange) of an asset from the estate to the debtor before the
termination of the estate is a nontaxable disposition. See In re Olson,
100 B.R. 458 (Bankr. N.D. Iowa 1989), aff'd, 121 B.R. 346 (N.D. Iowa
1990), aff'd, 930 F.2d 6 (8th Cir. 1991).
III. Debtor's Succession to the Estate's Passive Activity Losses and
Credits and Unused Section 465 Losses Before Termination of the Estate
As a corollary to the treatment of the estate's transfer of an
interest in a passive activity or former passive activity as a
nontaxable disposition, the proposed regulations provide that if,
before the termination of the estate, the estate transfers an interest
in a passive activity or former passive activity to the debtor (other
than by sale or exchange), the debtor succeeds to and takes into
account the allocable portion of the estate's unused passive activity
loss and credit attributable to the activity (determined as of the
first day of the estate's taxable year in which the transfer occurs).
The proposed regulations provide similar rules for section 465 losses.
The objections submitted by one commentator generally parallel the
previously discussed objections to the treatment of the estate's
transfer of an interest in a passive activity or former passive
activity before the termination of the estate as a nontaxable
disposition. The final regulations retain the rules in the proposed
regulations.
IV. Effective Date
The provisions of Secs. 1.1398-1 and 1.1398-2 were proposed to be
effective for bankruptcy cases commencing on or after November 9, 1992.
Several commentators suggested alternative effective dates for the
final regulations. One commentator recommended that a more appropriate
effective date would be the date the regulations become final. Another
commentator contended that, at least in certain situations, the
regulations should be effective for bankruptcy cases commencing prior
to November 9, 1992.
The IRS and the Treasury Department believe that it is not
necessary to delay the effective date because publication of the
proposed regulations, which are being finalized without significant
change, provided adequate notice of the new rules. In addition,
limiting the application of the new rules to cases commenced after
publication of the proposed regulations is clearly within the Treasury
Department's authority to prescribe the extent to which regulations
shall be applied without retroactive effect and conforms to the pattern
of section 1398(g), which applies to cases commencing after March 25,
1981. Accordingly, the final regulations retain the effective date of
the proposed regulations.
V. Joint Election to Have Secs. 1.1398-1 and 1.1398-2 Apply to Cases
Commenced Before November 9, 1992
For cases commenced prior to November 9, 1992, and terminating on
or after that date, the proposed regulations apply only if a joint
election is made by the debtor and the estate. In cases under chapter
7, the election is valid only with the written consent of the
bankruptcy trustee. In cases under chapter 11, the election is valid
only if it is incorporated (a) into a bankruptcy plan that is confirmed
by the bankruptcy court, or (b) into an order of the court.
Additionally, the caption ``ELECTION PURSUANT TO Sec. 1.1398-1 (or
Sec. 1.1398-2)'' must be placed prominently on the first page of each
of the debtor's returns that is affected by the election (other than
returns for taxable years that begin after the termination of the
estate) and on the first page of each of the estate's returns that is
affected by the election.
One commentator recommended eliminating the requirement that the
debtor join in the election. In general, this commentator felt that
this requirement gave the debtor exclusive control over the passive
activity losses and credits and unused section 465 losses to the
detriment of the creditors.
The final regulations retain the requirement that the debtor join
in the election. This requirement permits debtors to rely on the law in
effect at the time they entered into bankruptcy.
One commentator suggested that because the consent of the debtor is
required, the regulations should clarify that the written consent of
the debtor is required in cases under chapter 7, in addition to the
written consent of a bankruptcy trustee. The proposed regulations
require the debtor to show consent by actually making the election. The
debtor's election will be evidenced by the return on which it is made,
and it is not clear what purpose would be served by an additional
paperwork requirement. Accordingly, this suggestion was not adopted.
A commentator requested clarification as to whether the election
could be made on an amended return. In response to this comment, the
regulations clarify that the election can be made on an amended return.
Finally, a commentator requested that the regulations clarify
whether the election is available for estates that are terminated after
November 9, 1992, but before the adoption of final regulations. Because
the regulations are sufficiently clear on this point, this comment was
not adopted.
VI. Other Comments
One commentator requested that the regulations provide guidance on
the determination of basis under section 1398(g)(6), which provides
that, in the case of assets acquired by the estate from the debtor, the
estate succeeds to the debtor's basis, determined as of the first day
of the debtor's taxable year in which the case commenced. The specific
guidance requested concerned the effect on basis of events (such as
depreciation or distributions received by the debtor as the result of
holding an interest in a passthrough entity) that occur after the first
day of the debtor's taxable year in which the case commenced, but prior
to the commencement date. It was also requested that the regulations
provide guidance on the application of the ``varying interest'' rule of
section 706(d)(1) to the estate. This guidance is outside the scope of
these regulations. Accordingly, the final regulations do not provide
guidance on these issues.
Special Analysis
It has been determined that these final regulations are not
significant rules as defined in EO 12866. Therefore, a regulatory
assessment is not required. It has also been determined that section
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the
Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these
regulations. Therefore, a Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f) of the Internal Revenue Code, a
copy of the proposed rules was submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact
on small business.
Drafting Information
The principal author of these regulations is Amy J. Sargent of the
Office of Assistant Chief Counsel (Income Tax and Accounting), IRS.
However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. An undesignated center heading is added immediately
following Sec. 1.1388-1 to read as follows:
``Rules Relating to Individuals' Title 11 Cases''
Par. 3. Sections 1.1398-1 and 1.1398-2 are added to read as
follows:
Sec. 1.1398-1 Treatment of passive activity losses and passive
activity credits in individuals' title 11 cases.
(a) Scope. This section applies to cases under chapter 7 or chapter
11 of title 11 of the United States Code, but only if the debtor is an
individual.
(b) Definitions and rules of general application. For purposes of
this section--
(1) Passive activity and former passive activity have the meanings
given in section 469(c) and (f)(3);
(2) The unused passive activity loss (determined as of the first
day of a taxable year) is the passive activity loss (as defined in
section 469(d)(1)) that is disallowed under section 469 for the
previous taxable year; and
(3) The unused passive activity credit (determined as of the first
day of a taxable year) is the passive activity credit (as defined in
section 469(d)(2)) that is disallowed under section 469 for the
previous taxable year.
(c) Estate succeeds to losses and credits upon commencement of
case. The bankruptcy estate (estate) succeeds to and takes into
account, beginning with its first taxable year, the debtor's unused
passive activity loss and unused passive activity credit (determined as
of the first day of the debtor's taxable year in which the case
commences).
(d) Transfers from estate to debtor--(1) Transfer not treated as
taxable event. If, before the termination of the estate, the estate
transfers an interest in a passive activity or former passive activity
to the debtor (other than by sale or exchange), the transfer is not
treated as a disposition for purposes of any provision of the Internal
Revenue Code assigning tax consequences to a disposition. The transfers
to which this rule applies include transfers from the estate to the
debtor of property that is exempt under section 522 of title 11 of the
United States Code and abandonments of estate property to the debtor
under section 554(a) of such title.
(2) Treatment of passive activity loss and credit. If, before the
termination of the estate, the estate transfers an interest in a
passive activity or former passive activity to the debtor (other than
by sale or exchange)--
(i) The estate must allocate to the transferred interest, in
accordance with Sec. 1.469-1(f)(4), part or all of the estate's unused
passive activity loss and unused passive activity credit (determined as
of the first day of the estate's taxable year in which the transfer
occurs); and
(ii) The debtor succeeds to and takes into account, beginning with
the debtor's taxable year in which the transfer occurs, the unused
passive activity loss and unused passive activity credit (or part
thereof) allocated to the transferred interest.
(e) Debtor succeeds to loss and credit of the estate upon its
termination. Upon termination of the estate, the debtor succeeds to and
takes into account, beginning with the debtor's taxable year in which
the termination occurs, the passive activity loss and passive activity
credit disallowed under section 469 for the estate's last taxable year.
(f) Effective date--(1) Cases commencing on or after November 9,
1992. This section applies to cases commencing on or after November 9,
1992.
(2) Cases commencing before November 9, 1992--(i) Election
required. This section applies to a case commencing before November 9,
1992, and terminating on or after that date if the debtor and the
estate jointly elect its application in the manner prescribed in
paragraph (f)(2)(v) of this section (the election). The caption
``ELECTION PURSUANT TO Sec. 1.1398-1'' must be placed prominently on
the first page of each of the debtor's returns that is affected by the
election (other than returns for taxable years that begin after the
termination of the estate) and on the first page of each of the
estate's returns that is affected by the election. In the case of
returns that are amended under paragraph (f)(2)(iii) of this section,
this requirement is satisfied by placing the caption on the amended
return.
(ii) Scope of election. This election applies to the passive and
former passive activities and unused passive activity losses and
passive activity credits of the taxpayers making the election.
(iii) Amendment of previously filed returns. The debtor and the
estate making the election must amend all returns (except to the extent
they are for a year that is a closed year within the meaning of
paragraph (f)(2)(iv)(D) of this section) they filed before the date of
the election to the extent necessary to provide that no claim of a
deduction or credit is inconsistent with the succession under this
section to unused losses and credits. The Commissioner may revoke or
limit the effect of the election if either the debtor or the estate
fails to satisfy the requirement of this paragraph (f)(2)(iii).
(iv) Rules relating to closed years--(A) Estate succeeds to
debtor's passive activity loss and credit as of the commencement date.
If, by reason of an election under this paragraph (f), this section
applies to a case that was commenced in a closed year, the estate,
nevertheless, succeeds to and takes into account the unused passive
activity loss and unused passive activity credit of the debtor
(determined as of the first day of the debtor's taxable year in which
the case commenced).
(B) No reduction of unused passive activity loss and credit for
passive activity loss and credit not claimed for a closed year. In
determining a taxpayer's carryover of a passive activity loss or credit
to its taxable year following a closed year, a deduction or credit that
the taxpayer failed to claim in the closed year, if attributable to an
unused passive activity loss or credit to which the taxpayer succeeded
under this section, is treated as a deduction or credit that was
disallowed under section 469.
(C) Passive activity loss and credit to which taxpayer succeeds
reflects deductions of prior holder in a closed year. A loss or credit
to which a taxpayer would otherwise succeed under this section is
reduced to the extent the loss or credit was allowed to its prior
holder for a closed year.
(D) Closed year. For purposes of this paragraph (f)(2)(iv), a
taxable year is closed to the extent the assessment of a deficiency or
refund of an overpayment is prevented, on the date of the election and
at all times thereafter, by any law or rule of law.
(v) Manner of making election--(A) Chapter 7 cases. In a case under
chapter 7 of title 11 of the United States Code, the election is made
by obtaining the written consent of the bankruptcy trustee and filing a
copy of the written consent with the returns (or amended returns) of
the debtor and the estate for their first taxable years ending after
November 9, 1992.
(B) Chapter 11 cases. In a case under chapter 11 of title 11 of the
United States Code, the election is made by incorporating the election
into a bankruptcy plan that is confirmed by the bankruptcy court or
into an order of such court and filing the pertinent portion of the
plan or order with the returns (or amended returns) of the debtor and
the estate for their first taxable years ending after November 9, 1992.
(vi) Election is binding and irrevocable. Except as provided in
paragraph (f)(2)(iii) of this section, the election, once made, is
binding on both the debtor and the estate and is irrevocable.
Sec. 1.1398-2 Treatment of section 465 losses in individuals' title 11
cases.
(a) Scope. This section applies to cases under chapter 7 or chapter
11 of title 11 of the United States Code, but only if the debtor is an
individual.
(b) Definition and rules of general application. For purposes of
this section--
(1) Section 465 activity means an activity to which section 465
applies; and
(2) For each section 465 activity, the unused section 465 loss from
the activity (determined as of the first day of a taxable year) is the
loss (as defined in section 465(d)) that is not allowed under section
465(a)(1) for the previous taxable year.
(c) Estate succeeds to losses upon commencement of case. The
bankruptcy estate (the estate) succeeds to and takes into account,
beginning with its first taxable year, the debtor's unused section 465
losses (determined as of the first day of the debtor's taxable year in
which the case commences).
(d) Transfers from estate to debtor--(1) Transfer not treated as
taxable event. If, before the termination of the estate, the estate
transfers an interest in a section 465 activity to the debtor (other
than by sale or exchange), the transfer is not treated as a disposition
for purposes of any provision of the Internal Revenue Code assigning
tax consequences to a disposition. The transfers to which this rule
applies include transfers from the estate to the debtor of property
that is exempt under section 522 of title 11 of the United States Code
and abandonments of estate property to the debtor under section 554(a)
of such title.
(2) Treatment of section 465 losses. If, before the termination of
the estate, the estate transfers an interest in a section 465 activity
to the debtor (other than by sale or exchange) the debtor succeeds to
and takes into account, beginning with the debtor's taxable year in
which the transfer occurs, the transferred interest's share of the
estate's unused section 465 loss from the activity (determined as of
the first day of the estate's taxable year in which the transfer
occurs). For this purpose, the transferred interest's share of such
loss is the amount, if any, by which such loss would be reduced if the
transfer had occurred as of the close of the preceding taxable year of
the estate and been treated as a disposition on which gain or loss is
recognized.
(e) Debtor succeeds to losses of the estate upon its termination.
Upon termination of the estate, the debtor succeeds to and takes into
account, beginning with the debtor's taxable year in which the
termination occurs, the losses not allowed under section 465 for the
estate's last taxable year.
(f) Effective date--(1) Cases commencing on or after November 9,
1992. This section applies to cases commencing on or after November 9,
1992.
(2) Cases commencing before November 9, 1992--(i) Election
required. This section applies to a case commencing before November 9,
1992, and terminating on or after that date if the debtor and the
estate jointly elect its application in the manner prescribed in
paragraph (f)(2)(v) of this section (the election). The caption
``ELECTION PURSUANT TO Sec. 1.1398-2'' must be placed prominently on
the first page of each of the debtor's returns that is affected by the
election (other than returns for taxable years that begin after the
termination of the estate) and on the first page of each of the
estate's returns that is affected by the election. In the case of
returns that are amended under paragraph (f)(2)(iii) of this section,
this requirement is satisfied by placing the caption on the amended
return.
(ii) Scope of election. This election applies to the section 465
activities and unused losses from section 465 activities of the
taxpayers making the election.
(iii) Amendment of previously filed returns. The debtor and the
estate making the election must amend all returns (except to the extent
they are for a year that is a closed year within the meaning of
paragraph (f)(2)(iv)(D) of this section) they filed before the date of
the election to the extent necessary to provide that no claim of a
deduction is inconsistent with the succession under this section to
unused losses from section 465 activities. The Commissioner may revoke
or limit the effect of the election if either the debtor or the estate
fails to satisfy the requirement of this paragraph (f)(2)(iii).
(iv) Rules relating to closed years--(A) Estate succeeds to
debtor's section 465 loss as of the commencement date. If, by reason of
an election under this paragraph (f), this section applies to a case
that was commenced in a closed year, the estate, nevertheless, succeeds
to and takes into account the section 465 losses of the debtor
(determined as of the first day of the debtor's taxable year in which
the case commenced).
(B) No reduction of unused section 465 loss for loss not claimed
for a closed year. In determining a taxpayer's carryover of an unused
section 465 loss to its taxable year following a closed year, a
deduction that the taxpayer failed to claim in the closed year, if
attributable to an unused section 465 loss to which the taxpayer
succeeds under this section, is treated as a deduction that was not
allowed under section 465.
(C) Loss to which taxpayer succeeds reflects deductions of prior
holder in a closed year. A loss to which a taxpayer would otherwise
succeed under this section is reduced to the extent the loss was
allowed to its prior holder for a closed year.
(D) Closed year. For purposes of this paragraph (f)(2)(iv), a
taxable year is closed to the extent the assessment of a deficiency or
refund of an overpayment is prevented, on the date of the election and
at all times thereafter, by any law or rule of law.
(v) Manner of making election--(A) Chapter 7 cases. In a case under
chapter 7 of title 11 of the United States Code, the election is made
by obtaining the written consent of the bankruptcy trustee and filing a
copy of the written consent with the returns (or amended returns) of
the debtor and the estate for their first taxable years ending after
November 9, 1992.
(B) Chapter 11 cases. In a case under chapter 11 of title 11 of the
United States Code, the election is made by incorporating the election
into a bankruptcy plan that is confirmed by the bankruptcy court or
into an order of such court and filing the pertinent portion of the
plan or order with the returns (or amended returns) of the debtor and
the estate for their first taxable years ending after November 9, 1992.
(vi) Election is binding and irrevocable. Except as provided in
paragraph (f)(2)(iii) of this section, the election, once made, is
binding on both the debtor and the estate and is irrevocable.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 4. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 5. In Sec. 602.101(c), entries are added to the table in
numerical order to read as follows:
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
*****
1.1398-1................................................ 1545-1375
1.1398-2................................................ 1545-1375
*****
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: April 6, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-11493 Filed 05-12-94; 8:45 am]
BILLING CODE 4830-01-U