ALLOCATION OF INTEREST EXPENSE FOR PASS-THROUGH ENTITY GUIDANCE ISSUED; FIFTEEN-DAY RULE LENGTHENED TO 30 DAYS FOR PRE-1988 TRACING.

Notice 88-20

BACKGROUND

This notice provides temporary guidance with respect to the allocation of interest expense in connection with certain transactions involving partnerships and B corporations ("passthrough entities") and the allocation of interest expense on debt proceeds received in cash or deposited in a commingled account. Section 1.163- 8T of the Income Tax Regulations (T.D. 8145, 52 FR 24,996) provides rules for allocating interest expense for purposes of applying sections 469 and 163(d) and (h). The regulation provides, in general, that debt is allocated by tracing disbursements of the debt proceeds to specific expenditures and that interest expense on such debt is allocated in the same manner as the debt to which such interest expense relates. Section 1.163-8T does not address the treatment of debt allocated to expenditures for interests in passthrough entities and debt of passthrough entities allocated to distributions by such entities.

EFFECTIVE DATES

In the case of allocations of interest expense on debt allocated to expenditures for contributions to or purchases of interests in passthrough entities, owners of such entities may rely on this guidance for taxable years of such owners ending on or before December 31, 1987. In the case of allocations of interest expense on debt allocated to distributions by passthrough entities, taxpayers may rely on this guidance for taxable years of such entities ending on or before December 31, 1987.

The Internal Revenue Service intends to issue regulations concerning the allocation of interest expense in connection with debt-financed contributions, purchases, and distributions. For taxable years ending after December 31, 1987, such regulations may require the allocation of interest expense in connection with such transactions in a manner different from the manner provided in this notice, without regard to when the debt was incurred.

Section 1.163-8T provides certain rules for tracing debt proceeds received in cash or deposited in a commingled account (i.e., an account containing both debt proceeds and unborrowed funds, or the proceeds of two or more debts). This notice modifies those rules with respect to debt proceeds deposited in an account of the taxpayer or received in cash on or before December 31, 1987.

         TREATMENT OF DEBT OF OWNERS OF PASSTHROUGH ENTITIES

Interest expense on debt proceeds allocated under section 1.163- 8T to a contribution to the capital of a passthrough entity may be allocated using any reasonable method. Reasonable methods would ordinarily include allocating the debt among the assets of the entity or tracing the debt proceeds to the expenditures of the entity under the rules of section 1.163-8T as if the contributed debt proceeds were the proceeds of a debt incurred by the entity. For purposes of this notice, a purchase of an interest in a passthrough entity will be treated as a contribution to the capital of the entity to the extent that the entity receives proceeds from the purchase.

TREATMENT OF DEBT OF PASSTHROUGH ENTITIES ALLOCATED TO DISTRIBUTIONS BY SUCH ENTITIES

Debt of passthrough entities and the associated interest expense is generally allocated under the rules of section 1.163-8T. In the case of debt proceeds of passthrough entities used to make distributions to the owners of the entity, the debt proceeds and associated interest expense may, at the option of the entity, be allocated among the expenditures (other than distributions) of the entity during the taxable year, to the extent that debt proceeds have not otherwise been allocated to such expenditures.

If, notwithstanding the optional allocation authorized in the preceding paragraph, debt proceeds of a passthrough entity are allocated to distributions to owners of the entity, each owner's share of the associated interest expense shall be allocated, under the rules of section 1.163-8T, in accordance with the use of the debt proceeds distributed to such owner. To the extent that an owner's share of such interest expense exceeds the passthrough entity's interest expense on debt proceeds distributed to such owner, any reasonable method may be used to allocate the excess interest expense.

Paragraph (d) of section 1.163-8T provides rules governing the treatment of debt repayments. Any repayment of debt of a passthrough entity allocated to distributions and to one or more other expenditures may be treated first as a repayment of the portion of the debt allocated to such distributions.

MODIFICATION OF SINGLE ACCOUNT AND 15-DAY RULES

Paragraph (c)(4)(iii)(B) of section 1.163-8T provides, among other things, that a taxpayer may treat any expenditure made from an account within 15 days after debt proceeds are deposited in such account as made from such proceeds to the extent thereof. Paragraph (c)(5)(i) of section 1.163-8T provides a similar rule with respect to debt proceeds received in cash. Paragraph (n)(2) of section 1.163-8T provides that in the case of expenditures made before August 4, 1987, these rules are applied by substituting 90 days for 15 days.

The Internal Revenue Service intends to issue regulations providing that for debt proceeds deposited in an account on or before December 31, 1987, taxpayers may treat any expenditure made from any account of the taxpayer or from cash within 30 days before or 30 days after (90 days after in the case of expenditures made before August 4, 1987) debt proceeds are deposited in such account or any other account of the taxpayer as made from such proceeds to the extent thereof. Similarly, such regulations will provide that for debt proceeds received in cash on or before December 31, 1987, taxpayers may treat any expenditure made from any account of the taxpayer or from cash within 30 days before or 30 days after (90 days after in the case of expenditures made before August 4, 1987) debt proceeds are received in cash as made from such proceeds to the extent thereof.

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

FOR FURTHER INFORMATION

For further information contact Michael J. Grace of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service, on (202) 566-3288 (not a toll-free call).